Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------------ ---------------------
Commission File Number 0-25923
EAGLE BANCORP, INC
(Exact name of registrant as specified in its charter)
Maryland 52-2061461
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7815 Woodmont Avenue, Bethesda, Maryland 20814
(Address of principal executive offices) (Zip Code)
(301) 986-1800
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (x) No ( )
--- ---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act Yes (x) No ( )
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
As of April 19, 2004, the registrant had 5,401,767 shares of Common
Stock outstanding.
Item 1 - Financial Statements
EAGLE BANCORP, INC.
Consolidated Balance Sheets
March 31, 2004 and December 31, 2003
(dollars in thousands)
March 31,
2004 December 31,
(unaudited) 2003
----------- ------------
ASSETS
Cash and cash equivalents $ 29,659 $ 25,103
Federal funds sold 17,026 --
Interest bearing deposits with other banks 4,981 4,332
Investment securities available for sale 70,459 82,581
Loans held for sale 4,341 3,649
Loans 330,253 317,533
Less allowance for credit losses (3,750) (3,680)
--------- ---------
Loans, net 326,503 313,853
Premises and equipment, net 4,863 4,259
Deferred income taxes 863 862
Other assets 10,767 8,358
--------- ---------
TOTAL ASSETS $ 469,462 $ 442,997
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing demand $ 93,805 $ 90,468
Interest bearing transaction 57,919 44,093
Savings and money market 117,172 104,429
Time, $100,000 or more 64,946 54,992
Other time 51,798 41,532
--------- ---------
Total deposits 385,640 335,514
Federal funds purchased and securities sold under agreement to repurchase 13,958 38,454
Other short-term borrowings 4,000 4,000
Long-term borrowings 9,551 10,588
Other liabilities 1,657 1,429
--------- ---------
Total liabilities 414,806 389,985
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; shares authorized 20,000,000, shares
Issued and outstanding 5,401,767 (2004) and 5,359,303 (2003) 54 54
Additional paid in capital 46,737 46,406
Retained earnings 7,460 6,281
Accumulated other comprehensive income 405 271
--------- ---------
Total stockholders' equity 54,656 53,012
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 469,462 $ 442,997
========= =========
See notes to consolidated financial statements.
2
EAGLE BANCORP, INC.
Consolidated Statements of Income
For the Three Months Ended March 31, 2004 and 2003
(dollars in thousands, except per share data - unaudited)
Three Months Three Months
Ended Ended
March 31, March 31,
2004 2003
------------ ------------
INTEREST INCOME
Interest and fees on loans $4,787 $3,864
Taxable interest and dividends on investment securities 527 549
Interest on balances with other banks 26 40
Interest on federal funds sold and other cash equivalents 36 13
------ ------
Total interest income 5,376 4,466
INTEREST EXPENSE
Interest on deposits 811 841
Interest on federal funds purchased and securities sold under agreement to repurchase 30 28
Interest on short-term borrowings 27 60
Interest on long-term borrowings 101 146
------ ------
Total interest expense 969 1,075
NET INTEREST INCOME 4,407 3,391
------ ------
PROVISION FOR CREDIT LOSSES 154 224
------ ------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 4,253 3,167
NONINTEREST INCOME
Service charges on deposits 346 272
Gain on sale of loans 172 248
Gain on sale of investment securities 253 192
Other income 311 161
------ ------
Total noninterest income 1,082 873
NONINTEREST EXPENSE
Salaries and employee benefits 1,954 1,346
Premises and equipment expenses 598 423
Advertising 56 62
Outside data processing 142 135
Other expenses 743 499
------ ------
Total noninterest expense 3,493 2,465
------ ------
INCOME BEFORE INCOME TAX EXPENSE 1,842 1,575
------ ------
INCOME TAX EXPENSE 663 592
------ ------
NET INCOME $1,179 $ 983
====== ======
INCOME PER SHARE
Basic $ 0.22 $ 0.34
Diluted $ 0.21 $ 0.32
See notes to consolidated financial statements.
3
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 and 2003
(dollars in thousands-unaudited)
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,179 $ 983
Adjustments to reconcile net income to net cash
Provided (used) by operating activities:
(Decrease) increase in deferred income taxes (1) 106
Provision for credit losses 154 224
Depreciation and amortization 209 145
Gain on sale of loans (172) (248)
Origination of loans held for sale (7,470) (7,646)
Proceeds from sale of loans held for sale 6,950 9,843
Gain on sale of investment securities (253) (192)
Increase in other assets (409) (367)
Increase in other liabilities 206 8
-------- --------
Net cash provided by operating activities 393 2,856
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in interest bearing deposits with other banks (649) 294
Purchases of available for sale investment securities (63,060) (36,141)
Proceeds from maturities of available for sale securities 45,251 31,529
Proceeds from sale of available for sale securities 30,340 8,078
Increase in federal funds sold (17,026) (7,088)
Net increase in loans (12,804) (2,844)
Bank premises and equipment acquired (813) (557)
Increase in BOLI contracts (2,000) (0)
-------- --------
Net cash used by investing activities (20,761) (6,729)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 50,126 475
(Decrease) in federal funds purchased and securities sold
under agreement to repurchase (24,496) (105)
Increase in other short term borrowings -- 2,325
Decrease in long-term borrowings (1,037) (1,000)
Issuance of common stock 331 28
-------- --------
Net cash provided by financing activities 24,924 1,723
-------- --------
NET INCREASE IN CASH 4,556 (2,150)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 25,103 18,569
-------- --------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 29,659 $ 16,419
======== ========
Supplemental cash flow information:
Interest paid $ 916 $ 1,050
Income taxes paid $ 400 $ 127
See notes to consolidated financial statements
4
EAGLE BANCORP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(dollars in thousands - unaudited)
Accumulated
Other
Additional Comprehensive Total
Common Paid in Retained Income Stockholders
Stock Capital Earnings (loss) Equity
-----------------------------------------------------------
Balances at January 1, 2004 $ 54 $46,406 $ 6,281 $ 271 $53,012
-------
Net income 1,179 1,179
Other comprehensive income-
Unrealized gain on investment
securities available for sale 134 134
-------
Total comprehensive income 1,313
Exercise of options for 42,464
shares of common stock 331 331
---------------------------------------------------------
Balances at March 31, 2004 $ 54 $46,737 $ 7,460 $ 405 $54,656
---------------------------------------------------------
Balances at January 1, 2003 $ 29 $16,541 $ 3,066 $ 392 $20,028
-------
Net income 983 983
Other comprehensive income-unrealized
loss on investment securities
available for sale (173) (173)
-------
Total comprehensive income 810
Exercise of options for 2,770 shares
of common stock 28 28
---------------------------------------------------------
Balances at March 31, 2003 $ 29 $16,569 $ 4,049 $ 219 $20,866
=========================================================
See notes to consolidated financial statements.
5
EAGLE BANCORP, INC.
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General - The financial statements of Eagle Bancorp, Inc. (the "Company")
included herein are unaudited; however, they reflect all adjustments
consisting only of normal recurring accruals that, in the opinion of
Management, are necessary to present fairly the results for the periods
presented. The amounts as of December 31, 2003 were derived from audited
financial statements. Certain information and note disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. There have been no significant changes
to the Company's Accounting Policies as disclosed in the 2003 Annual
Report. The Company believes that the disclosures are adequate to make the
information presented not misleading. The results of operations for the
three months ended March 31, 2004 are not necessarily indicative of the
results of operations to be expected for the remainder of the year, or for
any other period.
2. NATURE OF BUSINESS
The Company, through its bank subsidiary, provides domestic financial
services primarily in Montgomery County, Maryland and Washington, DC. The
primary financial services include real estate, commercial and consumer
lending, as well as traditional demand deposits and savings products.
3. INVESTMENT SECURITIES
Amortized cost and estimated fair value of securities available - for -
sale are summarized as follows: (in thousands)
March 31, 2004
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U. S. Treasury securities $ 11,998 -- -- 11,998
U. S. Government Agency securities 25,534 85 -- 25,619
Mortgage backed securities 24,513 223 (94) 24,642
Federal Reserve Bank and
Federal Home Loan Bank stock 1,634 -- -- 1,634
Other equity investments 6,166 418 (18) 6,566
-------- -------- -------- --------
$ 69,845 $ 726 $ (112) $ 70,459
======== ======== ======== ========
December 31, 2003
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U. S. Treasury securities $ -- $ -- $ -- $ --
U. S. Government Agency securities 25,355 76 (38) 25,373
Mortgage backed securities 51,887 101 (246) 51,842
Federal Reserve Bank and
Federal Home Loan Bank stock 1,670 -- -- 1,670
Other equity investments 3,282 421 (7) 3,696
-------- -------- -------- --------
$ 82,174 $ 698 $ (291) $ 82,581
======== ======== ======== ========
6
Gross unrealized losses and fair value by length of time that the individual
available securities have been in a continuous unrealized position as of March
31, 2004 are as follows:
(in thousands)
Total
Less than More than Unrealized
Fair Value 12 Months 12 Months Losses
-------------------------------------------------------
Mortgage backed securities $ 10,445 $ (94) $ -- $ (94)
Other equity investments 335 (14) (4) (18)
-------- -------- -------- --------
$ 10,780 $ (108) $ (4) $ (112)
======== ======== ======== ========
4. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred-tax assets and liabilities are determined based
on differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities (i.e., temporary differences) and
are measured at the enacted rates that will be in effect when these
differences reverse.
5. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period.
Diluted net income per common share is computed by dividing net income by
the weighted average number of common shares outstanding during the period,
including any potential dilutive common shares outstanding, such as options
and warrants. As of March 31, 2004 there were no shares excluded from the
diluted net income per share computation.
6. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure", but applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting
for its Plan. No compensation expense related to the Plan was recorded
during the three months ended March 31, 2004 and 2003. It the Company had
elected to recognize compensation cost based on fair value at the grant
dates for a wards under the Plan consistent with the method prescribed by
SFAS No. 123, net income and earnings per share would have been changed to
the pro forma amounts as follows for the three months ended March 31.
7
2004 2003
---- ----
Net income, as reported $1,179 $ 983
Less pro forma stock-based compensation
expense determined under the fair value
method, net of related tax effects (39) (6)
------ ------
Pro forma net income $1,140 $ 977
------ ------
Net income per share:
Basic - as reported $ 0.22 $ 0.34
Basic - pro forma $ 0.21 $ 0.34
Diluted - as reported $ 0.21 $ 0.32
Diluted - pro forma $ 0.20 $ 0.31
8
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The following discussion provides information about the results of
operations, and financial condition, liquidity, and capital resources of the
Company and its subsidiary the Bank. This discussion and analysis should be read
in conjunction with the unaudited Consolidated Financial Statements and Notes
thereto, appearing elsewhere in this report.
This report contains forward looking statements within the meaning of
the Securities Exchange Act of 1934, as amended, including statements of goals,
intentions, and expectations as to future trends, plans, events or results of
Company operations and policies and regarding general economic conditions. In
some cases, forward looking statements can be identified by use of such words as
"may", "will", "anticipate", "believes", "expects", "plans", "estimates",
"potential", "continue", "should", and similar words or phases. These statements
are based upon current and anticipated economic conditions, nationally and in
the Company's market, interest rates and interest rate policy, competitive
factors and other conditions which, by their nature, are not susceptible to
accurate forecast, and are subject to significant uncertainty. Because of these
uncertainties and the assumptions on which this discussion and the forward
looking statements are based, actual future operations and results in the future
may differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward looking statements.
GENERAL
Eagle Bancorp, Inc. is a growing, one-bank holding company
headquartered in Bethesda, Maryland. We provide general commercial and consumer
banking services through our wholly owned banking subsidiary EagleBank, a
Maryland chartered bank which is a member of the Federal Reserve System. We were
organized in October 1997 to be the holding company for the Bank. The Bank was
organized as an independent, community oriented, full-service alternative to the
super regional financial institutions, which dominate our primary market area.
The cornerstone of our philosophy is to provide superior, personalized service
to our customers. We focus on relationship banking, providing each customer with
a number of services, becoming familiar with and addressing customer needs in a
proactive, personalized fashion. The Bank has six offices serving the Montgomery
County and two offices in the District of Columbia. On December 15, 2003, the
Bank opened its sixth office in Montgomery County on Rockville Pike. However,
the Bank has announced that it will close one Montgomery County office, the
Sligo Office located at 850 Sligo Avenue, Silver Spring, MD, in June 2004. After
thorough consideration, management and the board of directors decided to close
the office rather than exercise an option to renew option in the lease available
in June. The decision was made because the office had failed to reach initial
growth and profit expectations and an analysis of the office's potential, in its
existing location, did not provide indications that the office would improve its
performance in the foreseeable future. Silver Spring will continue to be served
by the original Silver Spring Office, which is located only a few blocks from
the Sligo Office, and for this reason, the loss of business, in particular
deposits, is expected to be minimal. No employees will be displaced by the
closing but will be absorbed into the positions created by the new branch
offices and other Company vacancies. On April 28, 2004 the Bank opened its
second office in the District of Columbia at 1228 Connecticut Avenue. In
February 2004, the Company executed a lease for a new office to be opened in
2006 in Friendship Heights, Montgomery County, Maryland, on the District of
Columbia line. Lease negotiations are being undertaken for a third District of
Columbia office in the vicinity of 14th and K Sts NW. There is no assurance that
these negotiations will result in the Company acquiring space for a new branch
in this area.
The Company offers full commercial banking services to our business and
professional clients as well as complete consumer banking services to
individuals living and/or working in the service area. We emphasize providing
commercial banking services to sole proprietors, small and medium-sized
businesses, partnerships, corporations, non-profit organizations and
associations, and investors living and working in and near our primary service
area. A full range of retail banking services are offered to accommodate the
individual needs of both corporate customers as well as the community we serve.
These services include the usual deposit functions of commercial banks,
including business and personal checking accounts, "NOW" accounts and savings
accounts, business, construction, and commercial loans, equipment leasing,
residential mortgages and consumer loans and cash management services. We have
developed significant expertise and commitment as an SBA lender, have been
designated a Preferred Lender by the Small Business Administration (SBA), and
are one of the largest SBA lenders, in dollar volume, in the Washington
Metropolitan area.
9
In June 2003, the Company formed a second wholly owned subsidiary,
Bethesda Leasing, LLC ("Bethesda Leasing"). Bethesda Leasing was formed for the
purpose of acquiring an impaired loan from the Bank in order to effect more
efficient administration and collection procedures.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and follow general practices within the banking industry.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions, and judgments. Certain policies inherently
have a greater reliance on the use of estimates, assumptions and judgments and
as such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
The allowance for credit losses is an estimate of the losses that may
be sustained in our loan portfolio. The allowance is based on two principles of
accounting: (a) Statement on Financial Accounting Standards ("SFAS") 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued when
it is probable that the Company will not collect all principal and interest
payments according to the contractual terms of the loan. The loss, if any, is
determined by the difference between the loan balance and the value of
collateral, the present value of expected future cash flows, or values
observable in the secondary markets.
Three basic components comprise our allowance for credit losses: a
specific allowance, a formula allowance and a nonspecific allowance. Each
component is determined based on estimates that can and do change when the
actual events occur. The specific allowance is used to individually allocate an
allowance to loans identified as impaired. An impaired loan may show
deficiencies in the borrower's overall financial condition, payment record,
support available from financial guarantors and/or the fair market value of
collateral. When a loan is identified as impaired a specific reserve is
established based on the Company's assessment of the loss that may be associated
with the individual loan. The formula allowance is used to estimate the loss on
internally risk rated loans, exclusive of those identified as impaired. Loans
identified as special mention, substandard, doubtful and loss, as well as
impaired, are segregated from performing loans. Remaining loans are then grouped
by type (commercial, commercial real estate, construction, home equity or
consumer). Each loan type is assigned an allowance factor based on management's
estimate of the risk, complexity and size of individual loans within a
particular category. Classified loans are assigned higher allowance factors than
non-rated loans due to management's concerns regarding collectibility or
management's knowledge of particular elements regarding the borrower. Allowance
factors grow with the worsening of the internal risk rating. The nonspecific
formula is used to estimate the loss of non-classified loans stemming from more
global factors such as delinquencies, loss history, trends in volume and terms
of loans, effects of changes in lending policy, the experience and depth of
management, national and local economic trends, concentrations of credit,
quality of loan review system and the effect of external factors such as
competition and regulatory requirements. The nonspecific allowance captures
losses whose impact on the portfolio have occurred but have yet to be recognized
in either the formula or specific allowance.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses, including
in connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance and
nonspecific allowance components of the allowance. The establishment of
allowance factors is a continuing exercise, based on management's continuing
assessment of the global factors discussed above and their impact on the
portfolio, and allowance factors may change from period to period, resulting in
an increase or decrease in the amount of the provision or allowance, based upon
the same volume and classification of loans. Changes in allowance factors will
10
have a direct impact on the amount of the provision, and a related, after tax
effect on net income. Errors in management's perception and assessment of the
global factors and their impact on the portfolio could result in the allowance
not being adequate to cover losses in the portfolio, and may result in
additional provisions or charge-offs. For additional information regarding the
allowance for credit losses, refer to the discussion under the caption
"Allowance for Credit Losses" below.
RESULTS OF OPERATIONS
The Company reported net income of $1.18 million for the three months
ended March 31, 2004, as compared to net income of $983 thousand for the three
months ended March 31, 2003. Income per basic share was $0.22 for the three
months ended March 31, 2004, as compared to $0.34 for the same period in 2003.
Income per diluted share was $0.21 for the three months ended March 31, 2004, as
compared to $0.32 for the same period in 2003. The Company had a return on
average assets of 1.08% and return on average equity of 8.80% for the first
three months of 2004, as compared to returns on average assets and average
equity of 1.16% and 19.14% respectively for the three months of 2003.
The increase in net income for the three months ended March 31, 2004 as
compared to the same period in 2003 can be attributed to an increase of 30% in
net interest income, reflecting an increase of 30% in average earning assets
while net interest margin remained essentially constant declining, only 2 basis
points. Net interest income increased from $3.4 million to $4.4 million and
average earning assets increased from $315 million to $409 million. Net interest
margin declined from 4.35% for the first quarter of 2003 to 4.33% for the same
period in 2004 as market interest rates fell from the first quarter of 2003
through most of 2003, then stabilized, and longer term interest rates rose
slightly in the first quarter of 2004. The percentage of loans, which generally
have higher yields than securities and other earning assets, increased from 77%
of average earning assets in the three month period of 2003 to 79% of earning
assets in the same period of 2004. Noninterest income increased 24%, to $1.1
million for the first quarter of 2004, from $873 thousand in the same period of
2003.
For the three months ended March 31, 2004, the Company recorded a
provision for credit losses in the amount of $154 thousand. At March 31, 2004,
the allowance for credit losses was $3.78 million, as compared to $3.68 million
at December 31, 2003. The Company had net charge-offs of $84 thousand during the
first three months of 2004 representing 0.10% of average loans on an annualized
basis. This compared to a provision for credit losses of $224 thousand for the
first three months of 2003, and net charge-offs of $129 thousand for the same
period, representing 0.2% of average loans on an annualized basis.
While the results of operations for the first quarter of 2004 compared
to the first quarter of 2003 were up, $1.18 million from $983 thousand, earnings
per share were down $0.22 from $0.34 and return on average equity was down to
8.80% from 19.14%. The reduction in both ratios is directly attributable to the
85% increase in the number of outstanding shares following the completion of the
Company's offering of approximately 2.4 million shares in August 2003. The
additional shares are expected to have an adverse impact on earnings per share
for a number of quarters until the capital can be further leveraged and deployed
in loans and other income producing assets other than low yielding, but highly
liquid short term investment securities. Contributing to the first quarter
results were gains on the sale of securities of $253 thousand, on a pretax
basis, in 2004 compared to $192 thousand in 2003.
The following table sets out the annualized returns on average assets, returns
on average equity and equity to assets (average) for the three months ending
March 31, 2004 and 2003 and the year ending December 31, 2003:
March March December
2004 2003 2003
---- ---- ----
Return on average assets 1.08% 1.16% 0.86%
Return on average equity 8.80% 19.14% 9.45%
Average equity to average assets 12.28% 6.08% 9.05%
11
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income is the difference between interest income on
earning assets and the cost of funds supporting those assets. Earning assets are
composed primarily of loans and investment securities. The cost of funds
represents interest expense on deposits, customer repurchase agreements and
other borrowings. Noninterest bearing deposits and capital are other components
representing funding sources. Changes in the volume and mix of assets and
funding sources, along with the changes in yields earned and rates paid,
determine changes in net interest income. Net interest income for the first
three months of 2004 was $4.4 million compared to $3.4 million for the first
three months of 2003.
The table labeled "Average Balances, Interest Yields and Rates and Net
Interest Margin" presents the average balances and rates of the various
categories of the Company's assets and liabilities. Included in the table is a
measurement of interest rate spread and margin. Interest spread is the
difference between the rate earned on assets less the cost of funds expressed as
a percentage. While spread provides a quick comparison of earnings rates versus
cost of funds, management believes that margin provides a better measurement of
performance. Margin includes the effect of noninterest bearing liabilities in
its calculation and is net interest income expressed as a percentage of total
earning assets. Interest spread decreased in the three months of 2004 from the
first three months of 2003 by 3 basis points, to 3.99% from 4.02%; and margin
decreased 2 basis points, to 4.33% from 4.35%. The decrease in both spread and
margin, from period to period, can be attributed to overall lower market
interest rates and the resulting refinancing, repricing or renegotiation of
existing earning assets and the acquisition of new earning assets at lower
market rates. Management is particularly pleased that the Company was able to
maintain a relatively stable spread and margin following a long period of
interest rate declines. Management was able to maintain stability by reducing
the cost of funds, from 1.72% during the first quarter of 2003 to 1.29% in 2004,
as it faced lower yields on its earning assets, which declined from 5.74% during
the first quarter of 2003 to 5.28% in 2004. At the same time, the mix of earning
assets improved as higher yielding loans from increased from 77% of earning
assets in 2003 to 79% in 2004.
The declines in both the yields on earning assets and interest bearing
liabilities from the first three months of 2003 to the first three months of
2004 reflect the impact of the significant rate reductions effected by the
Federal Reserve in 2001 and continued into 2002 with the last rate reduction
occurring in June 2003. The investment portfolio yield declined by 32 basis
points from the first quarter of 2003 to the same period in 2004 as the Bank
maintained a portfolio of short term fixed rate securities and pass through
mortgage backed securities. The Bank is pleased at the small decline in yield
given the general interest rate climate and the effect on yield that mortgage
refinancing activities had on the investment portfolio. The yield on mortgage
backed securities declined as mortgage refinancing accelerated, resulting in
earlier repayment of mortgage backed securities, and reinvestment of the
proceeds at lower current market rates. In order to keep the investment
portfolio short for liquidity with expectations that rates would start to move
upward the Bank invested in interest bearing deposits with other banks, in
amounts which made them eligible for FDIC insurance to obtain better short term
yields. These CDs yielded 2.56% during the first quarter, a relatively
attractive rate given their short term nature and low risk, as compared to the
rates offered on federal funds and U. S. Treasury bills. At March 31, 2004, the
Bank had $4.9 million of such deposits.
The decline in the yield on the loan portfolio, while 55 basis points,
was less than might be expected in the general interest rate environment of 2003
leading into the first quarter of 2004. Approximately 33% of the Bank's loan
portfolio consists of loans which reprice in periods of three to five years and
8% reprice beyond five years. This repricing frequency minimizes the effects of
rate reductions in repricable loans thereby slowing the decline in the overall
yield of the portfolio. Over time, of course, market pressures and loan
repayments and maturities will force the portfolio yield down even when there
may be no further market rate reductions. In a rising rate environment, this
repricing frequency may delay the Bank's ability to increase the yield on these
loans. However, management is comfortable with 59% of the loan portfolio
repricing within one year and expects to increase profitability in a rising
interest rate environment. Interest rate shock results are included under the
section Asset/Liability Management.
On the liability side, management aggressively reduced rates on deposit
accounts. The reduction in the rate on total interest bearing liabilities from
the first three months of 2003 to the first three months of 2004 was 43 basis
points which compares to a reduction of 46 basis points in the yield on earning
assets over the same period.
12
It is anticipated that any further reductions in interest rates may
have a significant adverse effect on earnings as rates paid on interest bearing
liabilities, which are as low as 0.10% on NOW accounts, cannot continue to
decline at the same rate as yields on loans and investments.
AVERAGE BALANCES, INTEREST YIELDS, AND RATES, AND NET INTEREST MARGIN
THREE MONTHS ENDED MARCH 31,
2004 2003
------------------------------------ ------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
ASSETS:
Interest earnings assets:
Interest bearing deposits with other banks $ 4,163 $ 26 2.56% $ 6,101 $ 40 2.67%
Loans 324,942 4,787 5.93% 241,805 3,864 6.48%
Investment securities 65,869 527 3.20% 62,395 549 3.52%
Federal funds sold and cash equivalents 14,094 36 1.03% 4,542 13 1.17%
--------- --------- --------- ---------
Total interest earning assets 409,068 5,376 5.28% 314,843 4,466 5.74%
Total noninterest earning assets 33,330 25,732
Less: allowance for credit losses 3,764 2,852
--------- ---------
Total nonearning assets 29,566 22,880
--------- ---------
TOTAL ASSETS $ 438,634 $ 337,723
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest bearing liabilities:
NOW accounts $ 45,263 14 0.13% $ 36,018 24 0.27%
Savings and money market accounts 111,523 261 0.94% 95,334 308 1.31%
Certificates of deposit 109,774 537 1.97% 78,231 509 2.63%
Customer repurchase agreements 21,263 30 0.56% 20,577 28 0.55%
Short-term borrowing 4,000 27 2.79% 6,513 60 3.77%
Long-term borrowing 10,170 101 4.00% 16,922 146 3.49%
--------- --------- --------- ---------
Total interest bearing liabilities 301,993 969 1.29% 253,595 1,075 1.72%
--------- --------- --------- ---------
Noninterest bearing liabilities:
Noninterest bearing deposits 81,438 62,083
Other liabilities 1,326 1,503
--------- ---------
Total noninterest bearing liabilities 82,764 63,586
Stockholders' equity 53,877 20,542
--------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 438,634 $ 337,723
========= =========
Net interest income $ 4,407 $ 3,391
========= =========
Net interest spread 3.99% 4.02%
Net interest margin 4.33% 4.35%
13
ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses represents the expense recognized to
fund the allowance for credit losses. The amount of the allowance for credit
losses is based on many factors which reflect management's assessment of the
risk in the loan portfolio. Those factors include economic conditions and
trends, the value and adequacy of collateral, volume and mix of the portfolio,
performance of the portfolio, and internal loan processes of the Company and
Bank.
Management has developed a comprehensive review process to monitor the
adequacy of the allowance for credit losses. The review process and guidelines
were developed utilizing guidance from federal banking regulatory agencies. The
results of this review process, in combination with conclusions of the Bank's
outside loan review consultant, support management's view as to the adequacy of
the allowance as of the balance sheet date. During the first three months of
2004, a provision for credit losses was made in the amount of $154 thousand
before net charge-offs of $84 thousand. Please refer to the discussion under the
caption, "Critical Accounting Policies" for an overview of the underlying
methodology management employs on a quarterly basis to maintain the allowance.
At March 31, 2004, the Company had five loans classified as nonaccrual
in the amount of $561 thousand which it considered impaired under Statement of
Financial Accounting Standards ("SFAS No. 114"). As part of its comprehensive
loan review process, the Bank's Board of Director's Loan Committee and/or Board
of Directors Credit Review Committee carefully evaluates loans over thirty days
past due. The Committee(s) makes a thorough assessment of the conditions and
circumstances surrounding each past due loan. The Bank's loan policy requires
that loans be placed on nonaccrual if they are ninety days past due, unless they
are well secured and in the process of collection.
The provision for credit losses of $154 thousand in the first three
months of 2004 compared to a provision for credit losses of $224 thousand in the
first three months of 2003. The higher level of the provision in 2003 is
primarily attributable to a specific reserve set aside for a problem credit in
2003 which was not required when compared to 2004.
As the portfolio and allowance review process matures, there will be
changes to different elements of the allowance and this may have an effect on
the overall level of the allowance maintained. To date the Bank has enjoyed a
very high quality portfolio with minimal net charge offs and very low
delinquency. The maintenance of a high quality portfolio will continue to be
management's prime objective as it relates to the lending process and to the
allowance for credit losses.
14
The following table sets forth activity in the allowance for credit
losses for the periods indicated.
-------------------------------------------------------------------
Three Months Ended Year Ended
-------------------------------------------------------------------
March 31, December 31,
(dollars in thousands) -------------------------------------------------------------------
2004 2003 2003 2002 2001
------- ------- ------- ------- -------
Balance at beginning of year $ 3,680 $ 2,766 $ 2,766 $ 2,111 $ 1,142
Charge-offs: -- -- -- -- --
Commercial (66) (148) (319) (192) --
Real estate - commercial -- -- -- -- --
Construction -- -- -- -- --
Home equity -- -- -- -- --
Other consumer (18) -- (14) (40) (23)
------- ------- ------- ------- -------
Total (84) (148) (333) (232) (23)
------- ------- ------- ------- -------
Recoveries:
Commercial -- 19 68 26 --
Real estate - commercial -- -- -- -- --
Construction -- -- -- -- --
Home equity -- -- -- -- --
Other consumer -- -- 4 18 13
------- ------- ------- ------- -------
Total -- 19 72 44 13
------- ------- ------- ------- -------
Net charge-offs (84) (129) (261) (188) (10)
------- ------- ------- ------- -------
Additions charged to operations 154 224 1,175 843 979
------- ------- ------- ------- -------
Balance at end of period $ 3,750 $ 2,861 $ 3,680 $ 2,766 $ 2,111
======= ======= ======= ======= =======
Annualized ratio of net
charge-offs during the during
the period to average loans
outstanding during the period 0.10% 0.20% 0.10% 0.09% 0.01%
------- ------- ------- ------- -------
The following table reflects the allocation of the allowance for credit
losses at the dates indicated. The allocation of the allowance to each category
is not necessarily indicative of future losses or charge-offs and does not
restrict the use of the allowance to absorb losses in any category.
(dollars in thousands) As of March 31, As of December 31,
-------------------- --------------------
2004 2003
-------------------- --------------------
Amount Percent (1) Amount Percent (1)
------- ----------- ------ -----------
Commercial $2,358 26.5% $1,689 29.3%
Real estate - commercial 568 49.1 888 47.3
Construction 457 12.4 613 11.2
Home equity 90 10.9 171 10.7
Other consumer 82 1.1 72 1.5
Unallocated 195 -- 247 --
------ ---- ------ ----
Total allowance for credit losses $3,750 100% $3,680 100%
====== ==== ====== ====
(1) Represents the percent of loans in category to gross loans
15
NON-PERFORMING ASSETS
The Company's non-performing assets, which are comprised of loans
delinquent 90 days or more, non-accrual loans, and other real estate owned,
totaled $561 thousand at March 31, 2004 compared to $759 thousand at March 31,
2003 and $654 thousand at December 31, 2003. The percentage of non-performing
assets to total assets was 0.17% at March 31, 2004, compared to 0.20% at March
31, 2003 and 0.20% at December 31, 2003.
Non-performing loans constituted all of the non-performing assets at
March 31, 2004, March 31, 2003 and December 31, 2003. Non-performing loans at
March 31, 2004 consist of five loans on nonaccrual of $561 thousand compared to
one nonaccrual loan in the amount of $149 thousand and one impaired loan in the
amount of $610 thousand at March 31, 2003.
The Company had no other real estate owned at either March 31, 2004 or
2003.
The following table shows the amounts of non-performing assets at the
dates indicated.
March 31, December 31,
---------------- ------------
(dollars in thousands) 2004 2003 2003
---- ---- ----
Nonaccrual Loans
Commercial $470 $149 $554
Consumer 91 -- 100
Real estate -- -- --
Accrual loans-past due 90 days
Commercial -- 610 --
Consumer -- -- --
Real estate -- -- --
Restructured loans -- -- --
Real estate owned
---- ---- ----
Total non-performing assets $561 $759 $654
==== ==== ====
At March 31, 2004, there were no performing loans considered potential problem
loans, defined as loans which are not included in the past due, nonaccrual or
restructured categories, but for which known information about possible credit
problems causes management to be uncertain as to the ability of the borrowers to
comply with the present loan repayment terms.
NONINTEREST INCOME
Noninterest income primarily represents deposit account service charges and
fees, gains on the sale of loans, other noninterest loan fees, income from bank
owned life insurance ("BOLI") and other service fees. For the three months ended
March 31, 2004 noninterest income was $1.08 million which included $253 thousand
in gains on the sale of investment securities. This compared to $873 thousand of
noninterest income for the three months ended March 31, 2003 which included $192
thousand in gains on the sale of investment securities. The Company is an active
originator of SBA loans and its current practice is to sell the insured portion
of those loans at a premium. Income from this source was $97 thousand for the
three months ended March 31, 2004 compared to $153 thousand for the three months
ended March 31, 2003. The decreased March 31, 2003 to March 31, 2004 can be
attributed to a slow down in SBA loan originations due to a reduction in the
maximum loan eligible for an SBA guarantee. The Company believes that SBA
activity will pick up with an improving economy and increased commercial loan
activity. The Company also originates residential permanent mortgage loans on a
pre-sold basis, servicing released. Sales of these mortgage loans yielded gains
of $75 thousand in 2004 compared to $95 thousand in 2003. The decrease in the
premiums realized on the sale of mortgage loans can be directly attributed to
the rise in mortgage loan interest rates in the first quarter of 2004. The slow
down in this area could continue as mortgage rates rise.
Other items in noninterest income increased 52% from $433 thousand for the three
months ended March 31, 2003 to $657 thousand for the three months ended March
31, 2004. This category includes deposit account service charges
16
and noninterest income fees such as documentation preparation and prepayment
penalties. Income for the three months ended March 31, 2004 was $346 thousand
from deposit account services charges, $32 thousand from SBA loan service fees
and $83 thousand from BOLI, versus $272 thousand from deposit account service
charges, $19 thousand from SBA service fees and $55 thousand from BOLI for the
three months ended March 31, 2003.
NONINTEREST EXPENSE
Noninterest expense was $3.5 million for the three months ended March 31, 2004
compared to $2.5 million for the three months ended March 31, 2003. This
represented a period to period increase of 42%. Increases in noninterest expense
primarily relate to increases in the expense category salaries and employee
benefits which increased 45% from the first three months of 2003 to the first
three months of 2004, from $1.3 million to $1.9 million. During the first
quarter of 2004, to accommodate the growth in assets, customer accounts and
offices experienced by the Bank in 2003 and to accommodate the growth
anticipated in 2004, a number of additions to staff were made in the lending and
operations (customer service) areas. Management felt that these additions and
the associated expenses were necessary to assure a continued growth pattern and
quality of service which characterized the Company since its inception. The
increase of 41% in premises and equipment for the three months, from $423
thousand to $598 thousand can be attributed to the expenses for the Bank's
Rockville Pike Office, new deposit and loan operations offices in Silver Spring
acquired to house an expanded support staff.
Other expenses which increased 49% from $499 thousand to $743 thousand for the
three months ending March 31, 2004 compared to the three months ended March 31,
2003, represent a number of expense categories ranging from business
development, office supplies to charitable contributions. Management monitors
these expenses closely and believes that the increase in them is consistent with
the needs of an aggressively growing Company. In future periods, noninterest
expenses to which the Company has not been subject to date, such as deposit
insurance premiums which may be required as a result of declines in the reserve
ratios of the deposit insurance funds, may have an adverse effect on the results
of operations of the Company.
FINANCIAL CONDITION
As of March 31, 2004, assets were $469 million and deposits were $386 million.
Assets grew by $26 million from December 31, 2003, and deposits grew by
approximately $50 million.
Loans
Total loans, excluding loans held for sale, increased approximately $12 million
from December 31, 2003 to March 31, 2004, from $318 million to $330 million.
Loans, net of amortized deferred fees and costs, at March 31, 2004, March 31,
2003 and December 31, 2003 are summarized by type as follows:
March 31, Percent of March 31, Percent of December 31, Percent of
2004 Total 2003 Total 2003 Total
--------- ---------- --------- ---------- ------------ ----------
Commercial $ 87,471 26.5% $ 64,254 26.8% $ 93,112 29.3%
Real estate - commercial 162,188 49.1% 118,239 49.4% 149,783 47.3%
Construction 40,842 12.4% 23,268 9.7% 35,644 11.2%
Home equity 36,140 10.9% 30,531 12.7% 34,092 10.7%
Other consumer 3,612 1.1% 3,259 1.4% 4,902 1.5%
--------- ---- --------- ---- --------- ----
Total loans 330,253 100% 239,551 100% 317,533 100%
Less: allowance for credit losses (3,750) (2,861) (3,680)
--------- --------- ---------
Loans, net $ 326,503 $ 236,690 $ 313,853
========= ========= =========
17
Deposits And Other Borrowings
The principal sources of funds for the Bank are core deposits, consisting of
demand deposits, NOW accounts, money market accounts, savings accounts and
relationship certificates of deposits, from the local market areas surrounding
the Bank's offices. The Bank's deposit base includes transaction accounts, time
and savings accounts and accounts which customers use for cash management and
which provide the Bank with a source of fee income and cross-marketing
opportunities as well as a low-cost source of funds. Time and savings accounts,
including money market deposit accounts, also provide a relatively stable and
low-cost source of funding.
For the three months ending March 31, 2004 from December 31, 2003, deposits grew
$50 million, from $336 million to $386 million.
Approximately 30% of the Bank's deposits are made up of certificates of
deposits, which are generally the most expensive form of deposit because of
their fixed rate and term. Certificates of deposit in denominations of $100
thousand or more can be more volatile and more expensive than certificates of
less than $100 thousand. However, because the Bank focuses on relationship
banking and does not accept brokered certificates, its historical experience has
been that large certificates of deposit have not been more volatile or
significantly more expensive than smaller denomination certificates. It has been
the practice of the Bank to pay posted rates on its certificates of deposit
whether under or over $100 thousand. The Bank has paid negotiated rates for
deposits in excess of $500 thousand but the rates paid have rarely been more
than 25 to 50 basis points higher than posted rates and deposits also have been
negotiated at below market rates. In late 2000, to fund strong loan demand, the
Bank began accepting certificates of deposits, generally in denominations of
less than $100 thousand on a non brokered basis, from bank and credit union
subscribers to a wholesale deposit rate line. The Bank has found rates on these
deposits to be generally competitive with rates in our market given the speed
and minimal noninterest cost at which deposits can be acquired, although it is
possible for rates to significantly exceed local market rates it has not been
the experience of the Bank. At March 31, 2004 the Bank held $32.6 million of
these deposits at an average rate of 2.57% as compared to $12.1 million of these
deposits, at an average rate of 4.08% at March 31, 2003. With the strong core
deposit growth experienced by the Bank in 2002, these deposits were allowed to
mature without renewal or replacement. However, during the first quarter of 2004
management felt that there was an opportunity to acquire longer maturities of
these deposits at attractive interest rates and again began accepting these
deposits with maturities greater than one year. During the first quarter of
2004, the Company introduced a new certificate of deposit program CDARS, which
will provides its customers with access to greater FDIC insurance coverage.
Using CDARS the Bank can distribute customer funds among other FDIC-insured
banks and thrifts, allowing customer to manage all their CDs through one
relationship.
At March 31, 2004, the Company had approximately $94 million in noninterest
bearing demand deposits, representing 24% of total deposits. This compared to
$90 million of these deposits at December 31, 2003. These are primarily business
checking accounts on which the payment of interest is prohibited by regulations
of the Federal Reserve. Proposed legislation has been introduced in each of the
last several sessions of Congress which would permit banks to pay interest on
checking and demand deposit accounts established by businesses. If legislation
effectively permitting the payment of interest on business demand deposits is
enacted, of which there can be no assurance, it is likely that we may be
required to pay interest on some portion of our noninterest bearing deposits in
order to compete with other banks. Payment of interest on these deposits could
have a significant negative impact on our net income, net interest income,
interest margin, return on assets and equity, and indices of financial
performance.
As an enhancement to the basic noninterest bearing demand deposit account, the
Company offers a sweep account, or "customer repurchase agreement", allowing
qualifying businesses to earn interest on short term excess funds which are not
suited for either a CD investment or a money market account. The balances in
these accounts were $14 million at March 31, 2004 compared to $17 million at
December 31, 2003. Customer repurchase agreements are not deposits and are not
FDIC insured but are secured by US Treasury and/or US government agency
securities. These accounts are particularly suitable to businesses with
significant change in the levels of cash flow over a very short time frame often
measured in days. Attorney and title company escrow accounts are an example of
accounts which can benefit from this product, as are customers who may require
collateral for deposits in excess of $100 thousand but do not qualify for other
pledging arrangements. This program requires the Company to maintain a
18
sufficient investment securities level to accommodate the fluctuations in
balances which may occur in these accounts.
At March 31, 2004, the Company had no outstanding balance under its line of
credit provided by a correspondent bank. The Bank had $13.3 million of FHLB
short and long-term borrowings, as compared to $14.3 million at December 31,
2003. These advances are secured 50% by US government agency securities and 50%
by a blanket lien on qualifying loans in the Bank's commercial mortgage loan
portfolio. Through another subsidiary of the Company, Bethesda Leasing LLC,
there were outstanding long term borrowings of $218 thousand. This loan was
obtained to fund the purchase of an impaired loan from the Bank.
LIQUIDITY MANAGEMENT
Liquidity is the measure of the Bank's ability to meet the demands required for
the funding of loans and to meet depositor requirements for use of their funds.
The Bank's sources of liquidity consist of cash balances, due from banks, loan
repayments, federal funds sold and short term investments. These sources of
liquidity are supplemented by the ability of the Company and Bank to borrow
funds. The Company maintains a $10 million line of credit with a correspondent
bank, against which it has guaranteed a $218 thousand loan to its subsidiary
Bethesda Leasing. The Bank can purchase up to $12 million in federal funds on an
unsecured basis and enter into reverse repurchase agreements up to $10 million.
At March 31, 2004, the Bank was also eligible to take FHLB advances of up to $82
million, of which it had advances outstanding of $13.3 million.
The loss of deposits, through disintermediation, is one of the greater risks to
liquidity. Disintermediation occurs most commonly when rates rise and depositors
withdraw deposits seeking higher rates than the Bank may offer. The Bank was
founded under a philosophy of relationship banking and, therefore, believes that
it has less of an exposure to disintermediation and resultant liquidity concerns
than do banks which build an asset base on non-core deposits and other
borrowings. The history of the Bank includes a period of rising interest rates
and significant competition for deposit dollars. During that period the Bank
grew its core business without sacrificing its interest margin in higher deposit
rates for non-core deposits. There is, however, a risk that some deposits would
be lost if rates were to spike up and the Bank elected not to meet the market.
Under those conditions the Bank believes that it is well positioned to use other
liability management instruments such as FHLB borrowing, reverse repurchase
agreements and Bank lines to offset a decline in deposits in the short run. Over
the long term an adjustment in assets and change in business emphasis could
compensate for a loss of deposits. Under these circumstances, further asset
growth could be limited as the Bank utilizes its liquidity sources to replace,
rather than supplement, core deposits.
Certificates of deposit acquired through the subscription service may be more
sensitive to rate changes and pose a greater risk of disintermediation than
deposits acquired in the local community. The Bank has limited the amount of
such deposits to 25% of total assets, an amount which it believes it could
replace with alternative liquidity sources, although there can be no assurance
of this.
The mature earning pattern of the Bank is also a liquidity management resource
for the Bank. The earnings of the Bank are now at a level that allows the Bank
to pay higher rates to retain deposits over a short period, while it adjusts its
asset base repricing to offset a higher cost of funds. The cost of retaining
business in the short run and the associated reduction in earnings can be
preferable to reducing deposit and asset levels and restricting growth.
At March 31, 2004, under the Bank's liquidity formula, it had $123 million of
liquidity representing 27.3% of total Bank assets.
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK
A fundamental risk in banking, outside of credit risk, is exposure to market
risk, or interest rate risk, since a bank's net income is largely dependent on
net interest income. The Bank's Asset Liability Committee (ALCO) of the Board of
Directors formulates and monitors the management of interest rate risk within
policies established by it and the Board of Directors. In its consideration of
establishing guidelines for levels and/or limits on market risk, the ALCO
committee considers the impact on earnings and capital, the level and direction
of interest rates, liquidity, local economic conditions, outside threats and
other factors. Banking is generally a business of attempting to match asset and
liability components to produce a spread sufficient to provide net income to the
bank at nominal rate risk. The
19
Company, through ALCO, continually monitors the interest rate environment in
which it operates and adjusts rates and maturities of its assets and liabilities
to meet the market conditions. In the current low interest rate environment, the
Company is keeping its assets either variably priced or with short term
maturities or short average lives. At the same time it strives to attract longer
term liabilities to lock in the lower cost of funds. In the current market, due
to competitive factors and customer preferences, the effort to attract longer
term fixed priced liabilities has not been as successful as the Company's best
case asset liability mix would prefer. When interest rates begin to rise, the
Company expects that it will seek to keep asset maturities and repricing periods
short until rates appear to be nearing their peak and then extend maturities to
extend the benefit of higher rates. There can be no assurance that the Company
will be able to successfully carry out this intention, as a result of
competitive pressures, customer preferences and the inability to perfectly
forecast future interest rates.
One of the tools used by the Company to manage its interest rate risk is a
static GAP analysis presented below. The Company also uses an earning simulation
model on a quarterly basis to closely monitor interest sensitivity and to expose
its balance sheet and income statement to different scenarios. The model is
based on current Company data and adjusted by assumptions as to growth patterns,
noninterest income and noninterest expense and interest rate sensitivity, based
on historical data, for both assets and liabilities. The model is then subjected
to a "shock test" assuming a sudden interest rate increase of 200 basis points
or a decrease of 200 basis points, but not below zero. The results are measured
by the effect on net income. The Company, in its latest model, shows a positive
effect on income when interest rates immediately rise 200 basis points because
of the short maturities of assets and a negative impact if rates were to decline
further. With rates already at historic lows, a further reduction would reduce
income on earning assets which could not be offset by a corresponding reduction
in the cost of funds.
The following table reflects the result of a "shock test" simulation on the
March 31, 2004, earning assets and interest bearing liabilities and the change
in net interest income resulting from the simulated immediate increase and
decrease in interest of 100 and 200 basis points. Also shown is the change in
the Market Value Portfolio Equity resulting from the simulation. The model as
presented is projected for one year.
Percentage change
Change in interest Percentage change in net Percentage change in in Market Value of
rates (basis points) interest income net income Portfolio Equity
- -------------------- ------------------------ -------------------- ------------------
+200 +16.4% +40.4% +19.1%
+100 +8.6% +21.1% +10.3%
0 -- -- --
-100 -11.8% -29.2% -13.6%
-200 -26.4% -65.0% -26.1%
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or repricing periods, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate mortgage loans,
have features that restrict changes in interest rates on a short-term basis and
over the life of the loan. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels could deviate significantly from those
assumed in calculating the tables. Finally, the ability of many borrowers to
service their debt may decrease in the event of a significant interest rate
increase.
GAP
Banks and other financial institutions are dependent upon net interest income,
the difference between interest earned on interest earning assets and interest
paid on interest bearing liabilities. In falling interest rate environments, net
interest income is maximized with longer term, higher yielding assets being
funded by lower yielding short-term funds; however, when interest rates trend
upward this asset/liability structure can result in a significant adverse impact
on net interest income. The current interest rate environment is signaling
steady to possibly higher rates. Management has for a number of months shortened
maturities in the Bank's investment portfolio and where possible also has
shorten repricing opportunities for new loan requests. While management believes
that this will help minimize interest rate risk in a rising rate environment,
there can be no assurance as to actual results.
20
GAP, a measure of the difference in volume between interest earning assets and
interest bearing liabilities, is a means of monitoring the sensitivity of a
financial institution to changes in interest rates. The chart below provides an
indicator of the rate sensitivity of the Company. A negative GAP indicates the
degree to which the volume of repriceable liabilities exceeds repriceable assets
in particular time periods. At March 31, 2004, the Bank had a positive GAP of
35.4% out to three months and a cumulative positive GAP of 4.5% out to twelve
months, as opposed to a three month positive gap of 11.02% and a cumulative
twelve month negative gap of (10.06%) at December 31, 2003.
If interest rates were to continue to decline, the Bank's interest income and
margin may be adversely effected. Because of the positive GAP measure in the 0 -
3 month period, continued decline in the prime lending rate will reduce income
on repriceable assets within thirty to ninety days, while the repricing of
liabilities may occur over future time periods and there may not be an ability
to reduce the cost of interest bearing liabilities to fully offset the reduction
in short term interest rates. This will result in a decline in net interest
income and net income. Management has carefully considered its strategy to
maximize interest income by reviewing interest rate levels, economic indicators
and call features of some of its assets. These factors have been thoroughly
discussed with the Board of Directors Asset Liability Committee and management
believes that current strategies are appropriate to current economic and
interest rate trends. The negative GAP is carefully monitored and will be
adjusted as conditions change. The following GAP table is presented on the basis
of the Bank only as inclusion of escrowed subscription assets and noninterest
bearing escrowed subscription liabilities would create a distorted
representation of the operating GAP.
GAP ANALYSIS
March 31, 2004
(dollars in thousands)
0-3 4-12 13-36 37-60 Over 60
Repriceable in: Months Months Months Months Months Total
----------------------------------------------------------------------------
ASSETS:
Investment securities $ 14,899 $ 2,700 $ 13,409 $ 16,112 $ 13,477 $ 60,597
Interest bearing deposits in other banks 99 4,167 494 -- -- 4,760
Loans 176,807 18,200 39,792 68,684 29,767 333,250
Federal funds sold 17,026 -- -- -- -- 17,026
----------------------------------------------------------------------------
Total repriceable assets 208,831 25,067 53,695 84,796 43,244 415,633
============================================================================
LIABILITIES:
NOW accounts -- 28,961 5,793 23,165 -- 57,919
Savings and Money Market accounts 45,906 36,834 22,953 11,479 -- 117,172
Certificates of deposit 10,662 78,895 25,826 1,361 -- 116,744
Customer repurchase agreements and
Federal funds purchased 4,187 5,584 1,395 2,791 -- 13,957
Other borrowing-short and long term 1,000 3,000 9,333 -- -- 13,333
----------------------------------------------------------------------------
Total repriceable liabilities 61,755 153,274 65,300 38,796 -- 319,125
============================================================================
GAP $ 147,076 $(128,207) $ (11,605) $ 46,000 $ 43,244 $ 96,508
Cumulative GAP 147,076 18,869 7,264 53,264 96,508
Interval gap/earnings assets 35.39% (30.85)% (2.79)% 11.07% 10.40%
Cumulative gap/earning assets 35.39% 4.54% 1.75% 12.82% 23.22%
Although, NOW and MMA accounts are subject to immediate repricing, the Bank's
GAP model has incorporated a repricing schedule to account for the historical
lag in effecting rate changes and the amount of those rate changes relative to
the amount of rate change in assets.
CAPITAL RESOURCES AND ADEQUACY
The assessment of capital adequacy depends on a number of factors such as asset
quality, liquidity, earnings performance, changing competitive conditions and
economic forces, and the overall level of growth. The adequacy of the Company's
current and future capital needs is monitored by management on an ongoing basis.
Management
21
seeks to maintain a capital structure that will assure an adequate level of
capital to support anticipated asset growth and to absorb potential losses.
The capital position of the Company's wholly-owned subsidiary, the Bank,
continues to meet regulatory requirements. The primary indicators relied on by
bank regulators in measuring the capital position are the Tier 1 risk-based
capital, total risk-based capital, and leverage ratios. Tier 1 capital consists
of common and qualifying preferred stockholders' equity less goodwill. Total
risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and
a portion of the allowance for credit losses. Risk-based capital ratios are
calculated with reference to risk-weighted assets. The leverage ratio compares
Tier1 capital to total average assets. At March 31, 2003, the Company's and
Bank's capital ratios were in excess of the mandated minimum requirements.
The ability of the Company to continue to grow is dependent on its earnings and
the ability to obtain additional funds for contribution to the Bank's capital,
through additional borrowing, the sale of additional common stock, the sale of
preferred stock, or through the issuance of additional qualifying equity
equivalents, such as subordinated debt or trust preferred securities. On August
1, 2003 the Company completed its offering with the sale of 2,448,979 shares of
common stock for gross proceeds of approximately $30 million.
CAPITAL
- -------
The actual capital amounts and ratios for the Company and Bank as of March 31,
2004 and 2003 are presented in the table below:
To Be Well
For Capital Capitalized Under
Company Bank Adequacy Prompt Corrective
In thousands Actual Actual Purposes Action Provisions**
Amount Ratio Amount Ratio Ratio Ratio
------- ----- ------ ----- ----- -----
As of March 31, 2004
Total capital (to risk-weighted
assets) $58,431 16.4% $39,003 10.9% 8.0% 10.0%
Tier 1 capital (to risk-weighted
assets) $54,656 15.3% 35,243 9.9% 4.0% 6.0%
Tier 1 capital (to average
Assets) $54,656 14.0% 35,243 8.5% 3.0% 5.0%
As of March 31, 2003
Total capital (to risk-weighted
assets) $23,727 9.2% $27,793 10.9% 8.0% 10.0%
Tier 1 capital (to risk
weighted assets) $20,866 8.1% 24,953 9.8% 4.0% 6.0%
Tier 1 capital (to average
assets) $20,866 6.2% 24,953 7.4% 3.0% 5.0%
** Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Bank, as well as restricting extension
of credit and transfers of assets between the Bank and the Company. At March 31,
2004, the Bank could pay dividends to the parent to the extent of its earnings
and so long as it maintained required capital ratios.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to Item 2 of this report, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", under the caption
"Asset/Liability Management and Quantitative and Qualitative Disclosure About
Market Risk".
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, evaluated as of the last day of the period covered by this report the
effectiveness of the operation of the Company's disclosure controls and
procedures, as defined in Rule 13a-14 under the Securities and Exchange Act of
1934. Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
adequate. There were no changes in the Company's internal control over financial
reporting (as defined in Rule 13a-15 under the Securities Act of 1934) during
the quarter ended March 31, 2004 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
From time to time the Company may become involved in legal proceedings.
At the present time there are no proceedings which the Company believes will
have an adverse impact on the financial condition or earnings of the Company.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
(a) Modification of Rights of Registered Securities. None
(b) Issuance or Modification of Other Securities Affecting Rights of
Registered Securities. None
(c) Sales of Unregistered Securities. None
(d) Use of Proceeds. Not Applicable.
(e) Issuer Purchases of Securities. None
ITEM 3 DEFAULTS UPON SENIOR SECURITIES None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None
ITEM 5. OTHER INFORMATION None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Description of Exhibit
- ----------- ----------------------
3(a) Certificate of Incorporation of the Company, as amended (1)
3(b) Bylaws of the Company (2)
10.1 1998 Stock Option Plan (3)
10.2 Employment Agreement between Michael Flynn and the Company (4)
10.3 Employment Agreement between Thomas D. Murphy and the Bank (4)
10.4 Employment Agreement between Ronald D. Paul and the Company (4)
10.5 Director Fee Agreement between Leonard L. Abel and the Company (4)
10.6 Employment Agreement between Susan G. Riel and the Bank (4)
10.7 Employment Agreement between Martha F. Tonat and the Bank (4)
10.8 Employment Agreement between Wilmer L. Tinley and the Bank (4)
23
11 Statement Regarding Computation of Per Share Income
21 Subsidiaries of the Registrant
31.1 Certification of Ronald D. Paul
31.2 Certification of Wilmer L. Tinley
32.1 Certification of Ronald D. Paul
32.2 Certification of Wilmer L. Tinley
- -----------------
(1) Incorporated by reference to the exhibit of the same number to the
Company's Quarterly Report on Form 10-QSB for the period ended September
30, 2002.
(2) Incorporated by reference to Exhibit 3(b) to the Company's Registration
Statement on Form SB-2, dated December 12, 1997.
(3) Incorporated by reference to Exhibit 10.1 to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1998.
(4) Incorporated by reference to exhibits of the same number to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003.
(b) Reports on Form 8-K
On January 16, 2004, the Company filed a Current Report on Form 8-K,
under Items 7, 9 and 12 thereof, reporting earnings for the year ended December
31, 2003.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EAGLE BANCORP, INC.
Date: May 13, 2004 By: /s/ Ronald D. Paul
-----------------------------------------------
Ronald D. Paul, President and CEO
Date: May 13, 2004 By: /s/ Wilmer L. Tinley
-----------------------------------------------
Wilmer L. Tinley, Senior Vice President and CFO
25