Washington, D.C. 20549

 

FORM 10-Q

 

ý QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2004

 

 

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
EXCHANGE ACT

 

For the transition period from           to           

 

Commission file number     0-23090

 

CARROLLTON BANCORP

(Exact name of registrant as specified in its charter)

 

 

344 NORTH CHARLES STREET, SUITE 300, BALTIMORE, MARYLAND 21201

(Address of principal executive offices)

 

(410) 536-4600

(Issuer’s telephone number)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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 ý  No o

Indicate by check mark whether the registrant is an accelerated filer. Yes o  No ý

 

State the number shares outstanding of each of the issuer’s classes of
common equity, as of the latest practicable date:
2,833,983 common shares outstanding at November 12, 2004

 

 

CARROLLTON BANCORP

CONTENTS

 

PART I - FINANCIAL INFORMATION
	Item 1. Financial Statements:
	Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2004 and 2003 (unaudited)
	Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2004 and 2003 (unaudited)
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003 (unaudited)
	Notes to Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation
	Item 3. Quantitative and Qualitative Disclosures about Market Risk
	Item 4. Controls and Procedures
PART II - OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits

 

2

 

PART I

 

ITEM 1.    FINANCIAL STATEMENTS

 

CARROLLTON BANCORP

CONSOLIDATED BALANCE SHEETS

 

		September 30, 2004			December 31, 2003
		(unaudited)
ASSETS
Cash and due from banks		$	23,452,211		$	19,711,633
Federal funds sold and Federal Home Loan Bank deposit		4,038,285			7,589,293
Cash and cash equivalents		27,490,496			27,300,926
Federal Home Loan Bank stock, at cost		2,250,000			2,250,000
Investment securities:
Available for sale		48,663,744			62,458,957
Held to maturity (fair value of $25,000 in 2004 and 2003)		25,000			25,000
Loans held for sale		8,371,141			2,241,583
Loans, less allowance for loan losses of $3,620,994 in 2004 and $3,648,245 in 2003		207,361,719			195,648,316
Premises and equipment		4,729,204			5,079,551
Accrued interest receivable		1,313,892			1,421,554
Foreclosed real estate		—			100,000
Prepaid income taxes		319,050			33,910
Bank owned life insurance		4,066,139			3,983,317
Other assets		2,023,874			1,866,861
		$	306,614,259		$	302,409,975
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing		$	55,464,868		$	42,484,836
Interest-bearing		159,399,761			164,571,264
Total deposits		214,864,629			207,056,100
Federal funds purchased and securities sold under agreement to repurchase		8,740,604			11,951,594
Notes payable - U.S. Treasury		1,871,271			2,025,339
Advances from the Federal Home Loan Bank		45,000,000			45,000,000
Accrued interest payable		469,562			451,055
Deferred income taxes		250,543			286,475
Other liabilities		1,347,157			1,514,530
		272,543,766			268,285,093
SHAREHOLDERS’ EQUITY
Common stock, par $1.00 per share; authorized 10,000,000 shares; issued and outstanding 2,833,983 in 2004 and 2,828,078 in 2003		2,833,983			2,828,078
Surplus		18,744,154			18,682,387
Retained earnings		10,445,385			10,427,425
Accumulated other comprehensive income		2,046,971			2,186,992
		34,070,493			34,124,882
		$	306,614,259		$	302,409,975

 

See accompanying notes to consolidated financial statements.

 

3

 

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF INCOME

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
		(unaudited)			(unaudited)			(unaudited)			(unaudited)
Interest income:
Loans		$	3,419,364		$	3,261,745		$	9,999,783		$	9,885,590
Investment securities:
Taxable		331,139			482,651			1,099,758			1,780,594
Nontaxable		45,605			54,179			144,271			165,013
Dividends		49,700			9,445			154,912			66,433
Federal funds sold and interest-bearing deposits with other banks		21,298			57,683			69,990			270,218
Total interest income		3,867,106			3,865,703			11,468,714			12,167,848
Interest expense:
Deposits		513,173			653,647			1,493,210			2,944,176
Borrowings		804,161			799,043			2,376,705			2,378,911
Total interest expense		1,317,334			1,452,690			3,869,915			5,323,087
Net interest income		2,549,772			2,413,013			7,598,799			6,844,761
Provision for loan losses		—			—			—			243,000
Net interest income after provision for loan losses		2,549,772			2,413,013			7,598,799			6,601,761
Noninterest income:
Service charges on deposit accounts		245,388			257,174			707,084			768,315
Brokerage commissions		138,852			219,098			490,053			459,970
Other fees and commissions		1,399,085			1,467,816			3,962,038			4,258,921
Mortgage-banking fees and gains		408,427			248,731			1,143,087			447,052
Security gains, net		—			115,781			115,810			462,778
Total noninterest income		2,191,752			2,308,600			6,418,072			6,397,036
Noninterest expenses:
Salaries		1,840,687			1,665,799			5,117,738			4,353,524
Employee benefits		448,430			481,557			1,322,153			1,098,876
Occupancy		407,340			362,149			1,192,079			1,048,822
Furniture and equipment		438,096			449,984			1,319,685			1,373,898
Other operating expenses		1,406,345			1,263,029			3,928,041			3,713,442
Total noninterest expenses		4,540,898			4,222,518			12,879,696			11,588,562
Income before income taxes		200,626			499,095			1,137,175			1,410,235
Income tax provision		51,744			133,742			326,181			430,876
Net income		$	148,882		$	365,353		$	810,994		$	979,359
Net income per common share - basic		$	0.05		$	0.13		$	0.29		$	0.35
Net income per common share - diluted		$	0.05		$	0.13		$	0.28		$	0.34

 

See accompanying notes to consolidated financial statements.

 

4

 

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2004 and 2003 (unaudited)

 

		Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive Income			Comprehensive Income
Balances at December 31, 2002		$	2,821,757		$	18,617,608		$	10,513,874		$	1,737,840
Net income		—			—			979,359			—			$	979,359
Changes in net unrealized gains (losses) on securities available for sale, net of tax		—			—			—			294,627			294,627
Comprehensive income														$	1,273,986
Stock options exercised		5,140			50,762			—			—
Cash dividends, $0.27		—			—			(762,363		)	—
Balances at September 30, 2003		$	2,826,897		$	18,668,370		$	10,730,870		$	2,032,467
Balances at December 31, 2003		$	2,828,078		$	18,682,387		$	10,427,425		$	2,186,992
Net income		—			—			810,994			—			$	810,994
Changes in net unrealized gains (losses) on securities available for sale, net of tax		—			—			—			(140,021		)	(140,021		)
Comprehensive income														$	670,973
Shares acquired and cancelled		(2,100		)	(30,555		)	—			—
Stock options exercised		8,005			92,322			—			—
Cash dividends, $0.28		—			—			(793,034		)	—
Balances at September 30, 2004		$	2,833,983		$	18,744,154		$	10,445,385		$	2,046,971

 

See accompanying notes to consolidated financial statements.

 

5

 

 

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2004 and 2003

 

		Nine Months Ended September 30,
		2004			2003
		(unaudited)			(unaudited)
Cash flows from operating activities:
Net income		$	810,994		$	979,359
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for loan losses		—			243,000
Depreciation and amortization		1,075,205			1,088,506
Deferred income taxes		52,169			—
Amortization of premiums and discounts		186,917			355,192
Gains on disposal of securities		(115,810		)	(462,778		)
Loans held for sale made, net of principal sold		(4,986,471		)	(179,677		)
Mortgage-banking fees and gains		(1,143,087		)	(447,052		)
Gains on sale of premises and equipment		(19,048		)	(33,024		)
(Gains) losses on sale of foreclosed real estate		11,548			(13,846		)
Write-down of foreclosed real estate		25,577			—
(Increase) decrease in:
Accrued interest receivable		107,662			189,061
Prepaid income taxes		(285,140		)	(16,769		)
Other assets		(239,835		)	1,463,123
Increase (decrease) in:
Accrued interest payable		18,507			(66,660		)
Other liabilities		(167,373		)	471,788
Net cash provided by (used in) operating activities		(4,668,185		)	3,570,223
Cash flows from investing activities:
Proceeds from sales of securities available for sale		2,518,491			719,418
Proceeds from maturities of securities available for sale		24,132,903			103,591,894
Proceeds from redemption of Federal Home Loan Bank stock		—			250,000
Purchase of securities available for sale		(13,155,410		)	(92,045,700		)
Purchase of bank owned life insurance		—			(4,000,000		)
Loans made, net of principal collected		(11,797,903		)	(618,745		)
Purchase of loans, net of principal collected		—			5,592,149
Purchase of premises and equipment		(946,165		)	(399,541		)
Proceeds from sale of premises and equipment		240,354			75,000
Proceeds from sale of foreclosed real estate		147,376			235,129
Net cash provided by investing activities		1,139,646			13,399,604
Cash flows from financing activities:
Net decrease in time deposits		(2,813,122		)	(23,922,249		)
Net increase in other deposits		10,621,651			6,184,250
Net decrease in other borrowed funds		(3,365,058		)	(944,598		)
Dividends paid		(793,034		)	(762,363		)
Proceeds from issuance of shares		100,327			55,932
Common stock repurchase and retirement		(32,655		)	—
Net cash provided by (used in) financing activities		3,718,109			(19,389,028		)
Net increase (decrease) in cash and cash equivalents		189,570			(2,419,201		)
Cash and cash equivalents at beginning of period		27,300,926			31,399,756
Cash and cash equivalents at end of period		$	27,490,496		$	28,980,555
Supplemental information:
Interest paid on deposits and borrowings		$	3,851,408		$	5,389,747
Income taxes paid		647,252			664,644
Transfer of loan to foreclosed real estate		84,500			112,327

 

See accompanying notes to consolidated financial statements.

 

6

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of and for the three and nine months ended September 30, 2004 and 2003 is unaudited)

 

NOTE 1 - BASIS OF PRESENTATION

 

The accompanying consolidated financial statements prepared for the Company have been prepared in accordance with the instructions for Form 10-Q/A and, therefore, do not include all information and notes necessary for a full presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America.  The consolidated financial statements should be read in conjunction with the audited financial statements included in the Company’s 2003 Annual Report on Form 10-K.

 

The consolidated financial statements include the accounts of the Company’s subsidiary, Carrollton Bank, Carrollton Bank’s wholly-owned subsidiaries, Carrollton Mortgage Services, Inc. (“CMSI”) and Carrollton Financial Services, Inc. (“CFS”), and Carrollton Bank’s 96.4% owned subsidiary, Carrollton Community Development Corporation (“CCDC”) (collectively, the “Bank”).  All significant intercompany balances and transactions have been eliminated.

 

The consolidated financial statements as of September 30, 2004 and for the three and nine months ended September 30, 2004 are unaudited but include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of financial position and results of operations for those periods.  The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that will be achieved for the entire year.

 

Certain amounts for 2003 have been reclassified to conform to the 2004 presentation.

 

NOTE 2 - NET INCOME PER SHARE

 

The calculation of net income per common share as restated giving retroactive effect to any stock dividends and splits is as follows:

 

		Three Months Ended September 30,							Nine Months Ended September 30,
		2004				2003			2004			2003
Basic:
Net income		$	148,882			$	365,353		$	810,994		$	979,359
Average common shares outstanding		2,834,036				2,826,762			2,831,076			2,824,219
Basic net income per common share		$		0.05		$	0.13		$	0.29		$	0.35
Diluted:
Net income		$	148,882			$	365,353		$	810,994		$	979,359
Average common shares outstanding		2,834,036				2,826,762			2,831,076			2,824,219
Stock option adjustment		23,773				57,365			29,370			23,898
Average common shares outstanding - diluted		2,857,809				2,884,127			2,860,446			2,848,117
Diluted net income per common share		$	0.05			$	0.13		$	0.28		$	0.34

 

7

 

NOTE 3 - COMMITMENTS AND CONTINGENT LIABILITIES

 

The Company enters into off-balance sheet arrangements in the normal course of business.  These arrangements consist primarily of commitments to extend credit, lines of credit and letters of credit. The Company applies the same credit policies to these off-balance sheet arrangements as it does for on-balance-sheet instruments.  Outstanding loan commitments, unused lines of credit, and letters of credit were as follows:

 

		September 30, 2004
Loan commitments		$	54,037,406
Unused lines of credit		$	90,207,224
Letters of credit		$	3,037,429

 

NOTE 4 - RETIREMENT PLANS

 

The Company has a defined benefit pension plan covering substantially all of the employees. Benefits are based on years of service and the employee’s highest average rate of earnings for the three consecutive years during the last five full years before retirement. The Company’s funding policy is to contribute annually the amount recommended by the Plan’s independent actuarial consultants. Assets of the plan are held in a trust fund managed by an insurance company.

 

The Plan’s investment strategy is predicated on its investment objectives and the risk and return expectations of asset classes appropriate for the Plan. Investment objectives have been established by considering the Plan’s liquidity needs and time horizon and the fiduciary standards under ERISA. The asset allocation strategy is developed to meet the Plan’s long term needs in a manner designed to control volatility and to reflect the Company’s risk tolerance.

 

In determining the long-term rate of return on pension plan assets assumption, the target asset allocation is first reviewed. An expected long-term rate of return is assumed for each asset class, and an underlying inflation rate assumption is also made. The effects of asset diversification and periodic fund rebalancing are also considered.  The Company estimates it will contribute approximately $400,000 to the Plan for 2004.

 

The net periodic benefit cost for the Plan for the nine months ended September 30 is as follows:

 

		2004				2003
Service cost		$		396,306		$	326,241
Interest cost		409,283				408,300
Expected return on plan assets		(434,022			)	(403,723			)
Net amortization and deferral		79,142				124,845
Net periodic benefit cost		$	450,709			$		455,663

 

The Company has a contributory thrift plan qualifying under Section 401(k) of the Internal Revenue Code.  Employees with one year of service are eligible for participation in the plan.

 

NOTE 5 - NEW ACCOUNTING PRONOUNCEMENTS

 

FASB Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, amends Statement 133 by (1) clarifying under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifying when a derivative contains a financing component, (3) amending the definition of an underlying, (4) amending certain other existing pronouncements.

 

8

 

This Statement is effective for contracts entered into or modified after June 30, 2003 with certain exceptions.

 

FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify certain financial instruments as a liability (or an asset in some circumstances).  This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.

 

FASB Statement No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits – an amendment of FASB Statements No. 87, 88, and 106, was revised in 2003 requiring additional disclosures, including information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and components of net periodic benefit cost recognized during interim periods.  This Statement is effective for financial statements with fiscal years ending after December 15, 2003, with interim-period disclosures required by this Statement effective for interim periods beginning after December 15, 2003.  Certain disclosure provisions of the Statement are effective for fiscal years ending after June 15, 2004.

 

FASB Interpretation No. 46, Consolidation of Variable Interest Entities, An Interpretation of ARB No. 51, requires consolidation of variable interest entities by the primary beneficiary.  This interpretation is effective for the first interim period or fiscal year beginning after June 15, 2003, for variable interest entities created before February 1, 2003.  For entities created after January 31, 2003, the effective date was immediate.

 

AICPA Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, prohibits the “carrying over” of valuation allowances in loans and securities acquired in a transfer.  At transfer, the assets are to be recorded at the total cash flows expected to be collected.  The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004.

 

On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, Application of Accounting Principles to Loan Commitments, to inform registrants of the Staff’s view that the fair value of the recorded loan commitments should not consider the expected future cash flows related to the associated servicing of the future loan.  The provisions of the Bulletin must be applied to loan commitments accounted for as derivatives for reporting periods beginning after March 31, 2004.

 

In March 2004, the Emerging Issues Task Force reached a consensus on Issue 03-1, Meaning of Other Than Temporary Impairment.  The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under Statement of Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities and cost method investments.  The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows:  Step 1:  Determine whether the investment is impaired.  An investment is impaired if its fair value is less than its cost.  Step 2:  Evaluate whether the impairment is other-than-temporary.  Step 3:  If the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value.  The three-step model used to determine other-than-temporary impairments shall be applied prospectively to all current and future investments in interim or annual reporting periods beginning after June 15, 2004.

 

Management does not expect these statements to have any material effect on the Company’s financial position or results of operation.

 

9

 

ITEM 2.                        MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

FORWARD-LOOKING STATEMENTS

 

In addition to historical information, this quarterly report contains forward-looking statements, which are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.  Important factors that might cause such a difference include, but are not limited to, those discussed in this section.  Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof.  The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof.

 

THE COMPANY

 

Carrollton Bancorp was formed on January 11, 1990 and is a Maryland chartered bank holding company.  The Company holds all of the outstanding shares of common stock of Carrollton Bank.  The Bank is a commercial bank that provides a full range of financial services to individuals, businesses and organizations through its branch and loan origination offices and its Automated Teller Machines.  Deposits in the Bank are insured by the Federal Deposit Insurance Corporation.  The Bank considers its core market area to be the Baltimore Metropolitan Area.

 

CRITICAL ACCOUNTING POLICIES

 

The Company’s financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain.  When applying accounting policies in areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets.  One of the most critical accounting policies applied is related to the valuation of the loan portfolio.

 

A variety of estimates impact the carrying value of the loan portfolio including the calculation of the allowance for loan losses, valuation of underlying collateral and the timing of loan charge-offs.

 

The allowance for loan losses is one of the most difficult and subjective judgments.  The allowance is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payments on loans.  Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio.  Current trends in delinquencies and charge-offs, the views of Bank regulators, changes in the size and composition of the loan portfolio and peer comparisons are also factors.  The analysis also requires consideration of the economic climate and direction and change in the interest rate environment, which may impact a borrower’s ability to pay, legislation impacting the banking industry and economic conditions specific to the Bank’s service areas.  Because the calculation of the allowance for loan losses relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates.

 

FINANCIAL CONDITION

 

Changes in Financial Condition

 

Summary

 

Total assets increased $4.2 million to $306.6 million at September 30, 2004 compared to $302.4 million at the end of 2003. Gross loans increased by $11.7 million or 5.9% to $211.0 million during the period.

 

10

 

Investment Securities

 

Investment securities decreased $13.8 million from $62.5 million at December 31, 2003 to $48.7 million at September 30, 2004. The Company continues to restructure its investment portfolio to reduce further potential for interest rate risk, while improving liquidity.

 

Loans Held for Sale

 

Loans held for sale increased $6.1 million from December 31, 2003 to September 30, 2004 due to increased origination activity during the first nine months of 2004. Loans held for sale are carried at the lower of cost or the committed sale price, determined on an individual basis.

 

Loans

 

Total gross loans increased $11.7 million or 5.9% to $211.0 million at September 30, 2004 from $199.3 million at December 31, 2003. The increase was due to growth in commercial real estate and small business lending.

 

The following table provides information concerning non-performing assets and past due loans:

 

		September 30, 2004				December 31, 2003				September 30, 2003
Nonaccrual loans		$		624,627		$		712,116		$	771,573
Restructured loans		463,873				661,974				661,974
Foreclosed real estate		—				100,000				109,442
Total nonperforming assets		$		1,088,500		$	1,474,090			$	1,542,989
Accruing loans past-due 90 days or more		$	1,901,646			$		1,036,018		$		3,292,177

 

Loans are placed on nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of all interest and/or principal is in doubt.  Management may grant a waiver from nonaccrual status for a 90-day past-due loan that is both well secured and in the process of collection.  A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current.

 

A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans at September 30, 2004 totaled $463,873.  Impaired loans are measured based on the fair value of the collateral for collateral dependent loans and at the present value of expected future cash flows using the loans’ effective interest rates for loans that are not collateral dependent.

 

Allowance for Loan Losses

 

The Company provides for loan losses through the establishment of an allowance for loan losses (the allowance”) by provisions charged against earnings.  The allowance is maintained at a level which represents management’s best estimate of known and inherent losses in the existing portfolio.  The allowance consists of specific allowances for individual loans, a general allowance based on historical loan loss experience and

 

11

 

current trends, and an unallocated allowance based on general economic conditions that affect the collectibility of the loan portfolio.

 

The specific allowance is based on regular analysis of the loan portfolio and is determined by analysis of collateral value, cash flow and guarantor capacity, as applicable.

 

The general allowance is calculated using internal loan grading results and appropriate allowance factors on approximately ten classes of loans.  This process is reviewed on a regular basis.  The allowance factors may be revised whenever necessary to address current credit quality trends or risks associated with particular loan types.  Historic trend analysis is utilized to obtain the factors to be applied.

 

Allocation of a portion of the allowance does not preclude its availability to absorb losses in other categories.  An unallocated reserve is maintained to recognize the imprecision in estimating and measuring loss when evaluating the allowance for individual loans or pools of loans.

 

Management believes that it has adequately assessed the risk of loss in the loan portfolios based on a subjective evaluation and has provided an allowance which is appropriate based on that assessment.  Because the allowance is an estimate based on current conditions, any change in the economic conditions of the Company’s market area or change within a borrower’s business could result in a revised evaluation, which could alter the Company’s earnings.

 

The allowance for loan losses was $3.6 million at September 30, 2004, which was 1.72% of loans compared to $3.6 million at December 31, 2003, which was 1.83% of loans .  During the first three months of 2004, the Company experienced recoveries of $14,000 to bring total net charge-offs for the first nine months of 2004 to $27,000.  The ratio of net loan losses to average loans outstanding decreased to 0.01% for the nine months ended September 30, 2004 from 0.09% for the year ended December 31, 2003. The ratio of nonperforming assets as a percent of period-end loans and foreclosed real estate decreased to 0.52% as of September 30, 2004 compared to 0.74% at December 31, 2003.

 

The following table shows the activity in the allowance for loan losses:

 

		Nine months Ended September 30,
		2004				2003
Allowance for loan losses - beginning of period		$	3,648,245			$	3,578,762
Provision for loan losses		—				243,000
Charge-offs		(123,726			)	(180,103		)
Recoveries		96,475				31,330
Allowance for loan losses - end of period		$		3,620,994		$	3,672,989

 

Funding Sources

 

Total deposits increased by $7.8 million to $214.9 million as of September 30, 2004 from $207.1 million as of December 31, 2003. Interest-bearing accounts decreased by $5.2 million while noninterest-bearing accounts increased by $13.0 million.  The Company intentionally attracted new noninterest-bearing accounts during the first nine months of 2004.

 

Advances from the Federal Home Loan Bank remain at $45.0 million, subject to the first call of $40.0

 

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million in 2005. Total borrowings decreased to $55.6 million at September 30, 2004 compared to $59.0 million at the end of 2003.

 

LIQUIDITY

 

Liquidity describes the ability of the Company to meet financial obligations, including lending commitments and contingencies, that arise during the normal course of business.  Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the customers of the Company, as well as to meet current and planned expenditures.

 

The Company’s liquidity is derived primarily from its deposit base and equity capital.  Additionally, liquidity is provided through the Company’s portfolios of cash and interest-bearing deposits in other banks, federal funds sold, loans held for sale, investment securities due within one year, and securities available for sale.  Such assets totaled $84.5 million or 27.6% of total assets at September 30, 2004.

 

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled $144.2 million at September 30, 2004.  Of this total, management places a high probability of required funding within one year on approximately $33.6 million. The amount remaining is unused home equity lines and other consumer lines on which management places a low probability of funding.

 

The Company also has established lines of credit totaling $76 million with the Federal Home Loan Bank of Atlanta (the “FHLB”) as an additional source of liquidity.  At September 30, 2004, the Company had $45.0 million outstanding with the FHLB and had sufficient collateral necessary to borrow the full amount available under the lines of credit.  Additionally, the Company has available unsecured federal funds lines of credit of $9 million with other institutions.  There was no balance outstanding under these lines at September 30, 2004.  The lines bear interest at the current federal funds rate of the correspondent bank.

 

CAPITAL RESOURCES

 

Total shareholders’ equity remained relatively stable at $34.1 million at September 30, 2004.  Earnings of the Company of $0.8 million for the nine months ended September 30, 2004 were offset by dividends of $0.8 million and a decrease in capital of $0.1 million from unrealized losses on securities available for sale.

 

The following table summarizes the Company’s capital ratios:

 

		September 30, 2004		December 31, 2003		Minimum Regulatory Requirements
Risk-based capital ratios:
Tier 1 capital		12.96	%	13.75	%	4.00	%
Total capital		14.75		15.51		8.00
Tier 1 leverage ratio		10.20		10.35		4.00

 

Market Risk and Interest Rate Sensitivity

 

The Company’s interest rate risk represents the level of exposure it has to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates.  The Asset/Liability Management Committee of the Board of Directors (the “ALCO”)

 

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oversees the Company’s management of interest rate risk.  The objective of the management of interest rate risk is to optimize net interest income during periods of volatile as well as stable interest rates while maintaining a balance between the maturity and repricing characteristics of assets and liabilities that is consistent with the Company’s liquidity, asset and earnings growth, and capital adequacy goals.

 

Due to changes in interest rates, the level of income for a financial institution can be affected by the repricing characteristics of its assets and liabilities. At September 30, 2004, the Company is in an asset sensitive position.  Management continuously takes steps to reduce higher costing fixed rate funding instruments, while increasing assets that are more fluid in their repricing.  An asset sensitive position, theoretically, is favorable in a rising rate environment since more assets than liabilities will reprice in a given time frame as interest rates rise. Management works to maintain a consistent spread between yields on assets and costs of deposits and borrowings, regardless of the direction of interest rates.

 

RESULTS OF OPERATIONS

 

Summary

 

Carrollton Bancorp reported net income for the three and nine month periods ended September 30, 2004 of $149,000, or $0.05 per share and $811,000, or $0.29 per share, respectively.  For the same periods of 2003, net income amounted to $365,000, or $0.13 per share and $979,000, or $0.35 per share, respectively. Return on average assets and return on average equity are key measures of a bank’s performance.

 

Return on average assets, the product of net income divided by total average assets, measures how effectively the Company utilizes its assets to produce income.  The Company’s return on average assets for the three and nine months ended September 30, 2004 was 0.26% and 0.36%, respectively, compared to 0.45% and 0.41%, respectively, for the corresponding period in 2003. Return on average equity, the product of net income divided by average equity, measures how effectively the company invests its capital to produce income.  Return on average equity for the three and nine months ended September 30, 2004 was 2.31% and 3.16%, respectively, compared to 4.28% and 3.83%, respectively, for the corresponding period in 2003.

 

Interest and fee income on loans increased 4.8% and 1.2% for the three and nine months ending September 30, 2004, respectively, as a result of loan growth, with total interest income decreasing 5.7% for the nine month period and remaining relatively stable for the three month period. Net interest income increased 5.7% and 11.0% for the three and nine months ended September 30, 2004, respectively, due to the experienced loan growth and to decreased costs of deposits.  Noninterest income, excluding gains/losses on security sales, remained relatively stable for the three months ended September 30, 2004 compared to the same period in 2003 and increased 6.2% for the nine month period ended September 30, 2004. Noninterest expenses increased 7.5% and 11.1% for the three and nine months ended September 30, 2004, respectively, compared to the three and nine months ended September 30, 2003.

 

Net Interest Income

 

Net interest income for the Company for the three and nine months ended September 30, 2004 was $2.5 million and $7.6 million, respectively, compared to $2.4 million and $6.8 million, respectively, for the same periods in 2003, representing a 5.7% and 11.0% increase, respectively. The net yield on average earning assets increased from 3.36% to 4.39% and from 3.21% to 3.82% for the three and nine months ended September 30, 2004, respectively. The increase in the net yield came principally from the decline in the cost of deposits, primarily caused by the repricing of a substantial amount of certificates of deposit in the second half of 2003 as well as from loan growth.

 

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Interest income on loans increased 4.8% and 1.2%, respectively, for the three and nine months ended September 30, 2004 due to the growth in the loan portfolio.  The yield on loans increased to 6.44% for the nine months ended September 30, 2004 as compared to 6.65% for the same period in 2003. The Company continues to emphasize commercial real estate and small business loan production and a systematic program to restructure the balance sheet to reduce interest rate risk.

 

Interest income from investment securities and overnight investments was $.5 million and $1.5 million for the three and nine months ended September 30, 2004, respectively, compared to $0.6 million and $2.3 million for the six and nine months ended September 30, 2003, respectively, representing a 25.9% and 35.6% decrease, respectively.  The portfolio on average decreased 55.8% for the three month period and 32.3% for the nine month period and the overall yield on investments increased from 2.74% for the three month period ended September 30, 2003 to 4.57% for the same period in 2004 and decreased from 3.51% for the first nine months of 2003 to 3.38% for the first nine months of 2004.

 

Interest expense decreased $0.1 million to $1.3 million for the three months ended September 30, 2004 compared to the same period in 2003 and $1.5 million to $3.9 million for the first nine months of 2004 from $5.3 million for the first nine months of 2003.  The decrease in interest expense was due to decreased levels of higher costing deposits.  During the third quarter of 2003, a significant amount of 36 month certificates of deposit repriced, which contributed to the decline in the cost of deposits. The cost of interest-bearing deposits increased to 1.68% for the three months ended September 30, 2004 compared to 1.39% for the same period of 2003 and decreased to 1.24% for the nine months ended September 30, 2004 compared to 2.12% for the same period in 2003.  During the third quarter of 2004, the Company raised its deposit rates slightly to attract new deposit accounts.  Interest-bearing deposits declined on average 13.3% to $160.1 million at September 30, 2004 from $184.7 million since September 30, 2003, with $23.4 million of the decline being from certificates of deposit.  The decline in interest-bearing deposits for the three month period ended September 30, 2004 was 34.8%.

 

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The following tables, for the periods indicated, set forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities.

 

		Nine Months Ended September 30, 2004
		Average balance			Interest			Yield
ASSETS
Interest-earning assets:
Federal funds sold and Federal Home Loan Bank deposit		$	8,713,151		$	69,990		1.07	%
Federal Home Loan Bank stock		2,250,000			58,991			3.50
Investment securities held to maturity and investment securities available for sale (a)		52,236,239			1,471,037			3.75
Loans, net of unearned income: (a)
Demand and time		49,030,339			1,961,224			5.33
Residential mortgage (b)		67,076,128			3,107,114			6.18
Commercial mortgage and construction		84,568,847			4,536,555			7.15
Installment		2,404,648			159,444			8.84
Lease financing		4,104,979			245,950			7.99
Total loans		207,184,941			10,010,287			6.44
Total interest-earning assets		270,384,331			11,610,305			5.73
Noninterest-earning assets:
Cash and due from banks		21,017,147
Premises and equipment		4,980,431
Other assets		8,004,357
Allowance for loan losses		(3,635,964		)
Unrealized gains on available for sale securities		3,112,738
Total assets		$	303,863,040
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and NOW		$	71,708,948		135,021			0.25	%
Money market		29,043,418			198,539			0.91
Other time		59,341,844			1,159,650			2.61
Borrowings		56,574,754			2,376,705			5.60
		216,668,964			3,869,915			2.38
Noninterest-bearing liabilities:
Noninterest-bearing deposits		50,269,795
Other liabilities		2,730,426
Shareholders’ equity		34,193,855
Total liabilities and shareholders’ equity		$	303,863,040
Net interest income					$	7,740,390
Net interest spread								3.35	%
Net interest margin								3.82	%

 

(a) Interest on investments and loans is presented on a fully taxable equivalent basis, using regular income tax rates.

(b) Includes loans held for sale

 

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		Nine Months Ended September 30, 2003
		Average balance			Interest			Yield
ASSETS
Interest-earning assets:
Federal funds sold and Federal Home Loan Bank deposit		$	20,919,114		$	172,633		1.10	%
Federal Home Loan Bank stock		2,386,414			70,226			3.92
Investment securities held to maturity and investment securities available for sale (a)		70,049,532			2,215,773			4.22
Loans, net of unearned income: (a)
Demand and time		38,301,618			1,787,967			6.22
Residential mortgage (b)		69,962,564			3,382,263			6.45
Commercial mortgage and construction		83,158,351			4,244,900			6.81
Installment		2,745,267			210,743			10.24
Lease financing		4,182,139			272,016			8.67
Total loans		198,349,939			9,897,889			6.65
Total interest-earning assets		291,704,999			12,356,521			5.65
Noninterest-earning assets:
Cash and due from banks		19,165,238
Premises and equipment		5,248,877
Other assets		6,094,794
Allowance for loan losses		(3,689,853		)
Unrealized gains on available for sale securities		3,244,116
Total assets		$	321,768,171
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and NOW		$	73,566,536		185,704			0.34	%
Money market		28,395,822			209,351			0.98
Other time		82,781,003			2,549,121			4.11
Borrowings		58,888,232			2,378,911			5.39
		243,631,593			5,323,087			2.91
Noninterest-bearing liabilities:
Noninterest-bearing deposits		41,920,436
Other liabilities		2,086,547
Shareholders’ equity		34,129,595
Total liabilities and shareholders’ equity		$	321,768,171
Net interest income					$	7,033,434
Net interest spread								2.74	%
Net interest margin								3.21	%

 

(a) Interest on investments and loans is presented on a fully taxable equivalent basis, using regular income tax rates.

(b) Includes loans held for sale

 

Provision for Loan Losses

 

The provision for loan losses for the three and nine months ended September 30, 2004 was $0 and $0, respectively,

 

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