United States Securities and Exchange Commission

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 March 31, 2005

 

 

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)

 

MARYLAND		52-1660951
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

 

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: 2,850,298 common shares outstanding at May 4, 2005

 

 

PART I

 

ITEM 1.    FINANCIAL STATEMENTS

 

CARROLLTON BANCORP

CONSOLIDATED BALANCE SHEETS

 

		March 31, 2005			December 31, 2004
		(unaudited)
ASSETS
Cash and due from banks		$	23,512,683		$	19,341,463
Federal funds sold and Federal Home Loan Bank deposit		20,480,349			14,851,081
Cash and cash equivalents		43,993,032			34,192,544
Federal Home Loan Bank stock, at cost		2,656,600			2,622,900
Investment securities available for sale		38,306,907			42,488,492
Loans held for sale		10,726,442			10,219,729
Loans, less allowance for loan losses of $3,508,440 in 2005 and $3,485,076 in 2004		227,316,939			216,241,218
Premises and equipment		5,658,630			5,416,934
Accrued interest receivable		1,327,484			1,295,719
Prepaid income taxes		180,249			194,611
Bank owned life insurance		4,000,000			4,052,648
Other assets		1,907,060			2,398,337
		$	336,073,343		$	319,123,132
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing		$	58,555,978		$	53,739,771
Interest-bearing		185,502,840			172,106,374
Total deposits		244,058,818			225,846,145
Federal funds purchased and securities sold under agreement to repurchase		9,046,871			10,183,951
Notes payable - U.S. Treasury		1,958,750			1,984,714
Advances from the Federal Home Loan Bank		45,000,000			45,000,000
Accrued interest payable		505,396			493,179
Deferred income taxes		260,654			200,762
Other liabilities		930,990			1,199,101
		301,761,479			284,907,852
SHAREHOLDERS’ EQUITY
Common stock, par $1.00 per share; authorized 10,000,000 shares; issued and outstanding 2,849,773 in 2005 and 2,834,823 in 2004		2,849,773			2,834,823
Surplus		18,937,033			18,774,448
Retained earnings		10,368,469			10,239,356
Accumulated other comprehensive income		2,156,589			2,366,653
		34,311,864			34,215,280
		$	336,073,343		$	319,123,132

 

See accompanying notes to consolidated financial statements.

 

2

 

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF INCOME

 

		Three Months Ended March 31,
		2005			2004
		(unaudited)			(unaudited)
Interest income:
Loans, including fees		$	3,867,805		$	3,253,680
Investment securities:
Taxable		241,158			406,455
Nontaxable		42,461			50,176
Dividends		64,959			51,075
Federal funds sold and interest-bearing deposits with other banks		58,646			28,754
Total interest income		4,275,029			3,790,140
Interest expense:
Deposits		745,783			492,779
Borrowings		809,485			784,021
Total interest expense		1,555,268			1,276,800
Net interest income		2,719,761			2,513,340
Provision for loan losses		—			—
Net interest income after provision for loan losses		2,719,761			2,513,340
Noninterest income:
Service charges on deposit accounts		239,677			234,839
Brokerage commissions		162,233			184,486
Other fees and commissions		1,756,229			1,300,709
Security gains, net		73,087			115,810
Gain on sale of loans held for sale		97,363			234,670
Total noninterest income		2,328,589			2,070,514
Noninterest expenses:
Salaries		1,771,031			1,617,658
Employee benefits		387,263			422,376
Occupancy		463,718			410,634
Furniture and equipment		279,834			451,221
Other operating expenses		1,465,397			1,269,803
Total noninterest expenses		4,367,243			4,171,692
Income before income taxes		681,107			412,162
Income tax provision		268,511			105,190
Net income		$	412,596		$	306,972
Net income per common share - basic		$	0.15		$	0.11
Net income per common share - diluted		$	0.14		$	0.11

 

See accompanying notes to consolidated financial statements.

 

3

 

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Three Months Ended March 31, 2005 and 2004 (unaudited)

 

		Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive Income			Comprehensive Income
Balances at December 31, 2003		$	2,828,078		$	18,682,387		$	10,427,425		$	2,186,992
Net income		—			—			306,972			—			$	306,972
Changes in net unrealized gains (losses) on securities available for sale, net of tax		—			—			—			(102,645		)	(102,645		)
Comprehensive income														$	204,327
Cash dividends, $0.09		—			—			(254,529		)	—
Balances at March 31, 2004		$	2,828,078		$	18,682,387		$	10,479,868		$	2,084,347
Balances at December 31, 2004		$	2,834,823		$	18,774,448		$	10,239,356		$	2,366,653
Net income		—			—			412,596			—			$	412,596
Changes in net unrealized gains (losses) on securities available for sale, net of tax		—			—			—			(210,064		)	(210,064		)
Comprehensive income														$	202,532
Stock options exercised		14,950			162,585			—			—
Cash dividends, $0.10		—			—			(283,483		)	—
Balances at March 31, 2005		$	2,849,773		$	18,937,033		$	10,368,469		$	2,156,589

 

See accompanying notes to consolidated financial statements.

 

4

 

CARROLLTON BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2005 and 2004

 

		Three Months Ended March 31,
		2005			2004
		(unaudited)			(unaudited)
Cash flows from operating activities:
Net income		$	412,596		$	306,972
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		188,567			318,990
Deferred income taxes		192,063			(12,415		)
Amortization of premiums and discounts		59,663			75,037
Gains on disposal of securities		(73,087		)	(115,810		)
Loans held for sale made, net of principal sold		(409,351		)	(7,754,224		)
Gain on sale of loans held for sale		(97,363		)	(234,670		)
(Gains) losses on sale and write-down of premises and equipment		(4,000		)	18,762
Write-down of foreclosed real estate		—			8,077
(Increase) decrease in:
Accrued interest receivable		(31,765		)	12,096
Prepaid income taxes		14,362			(12,983		)
Other assets		543,925			30,758
Increase (decrease) in:
Accrued interest payable		12,217			447
Other liabilities		(268,112		)	(356,959		)
Net cash provided by (used in) operating activities		539,715			(7,715,922		)
Cash flows from investing activities:
Proceeds from sales of securities available for sale		1,372,537			2,518,491
Proceeds from maturities of securities available for sale		2,511,031			15,871,124
Purchase of Federal Home Loan Bank stock		(33,700		)	—
Purchase of securities available for sale		—			(13,155,410		)
Loans made, net of principal collected		(11,075,721		)	5,414,972
Purchase of premises and equipment		(457,056		)	(327,573		)
Proceeds from sale of premises and equipment		—			76,859
Net cash provided by (used in) investing activities		(7,682,909		)	10,398,463
Cash flows from financing activities:
Net increase (decrease) in time deposits		7,952,950			(2,295,988		)
Net increase in other deposits		10,259,723			7,112,633
Net increase (decrease) in other borrowed funds		(1,163,044		)	(2,988,323		)
Dividends paid		(283,483		)	(254,529		)
Proceeds from issuance of shares		177,535			—
Net cash provided by financing activities		16,943,682			1,573,793
Net increase in cash and cash equivalents		9,800,488			4,256,334
Cash and cash equivalents at beginning of period		34,192,544			27,300,926
Cash and cash equivalents at end of period		$	43,993,032		$	31,557,260
Supplemental information:
Interest paid on deposits and borrowings		$	1,543,051		$	1,276,353
Income taxes paid		194,257			130,588
Transfer of loan to foreclosed real estate		—			84,500

 

See accompanying notes to consolidated financial statements.

 

5

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of and for the three months ended March 31, 2005 and 2004 is unaudited)

 

NOTE 1 - BASIS OF PRESENTATION

 

The accompanying consolidated financial statements prepared for Carrollton Bancorp (the “Company”) have been prepared in accordance with the instructions for Form 10-Q 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 2004 Annual Report on Form 10-K Filed with the Securities and Exchange Commission on March 18, 2005.

 

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 March 31, 2005 and for the three months ended March 31, 2005 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 months ended March 31, 2005 are not necessarily indicative of the results that will be achieved for the entire year.

 

Certain amounts for 2004 have been reclassified to conform to the 2005 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 March 31,
		2005			2004
Basic:
Net income		$	412,596		$	306,972
Average common shares outstanding		2,840,682			2,828,078
Basic net income per common share		$	0.15		$	0.11
Diluted:
Net income		$	412,596		$	306,972
Average common shares outstanding		2,840,682			2,828,078
Stock option adjustment		10,476			39,834
Average common shares outstanding - diluted		2,851,158			2,867,912
Diluted net income per common share		$	0.14		$	0.11

 

6

 

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.

 

Additionally, the Company enters into commitments to originate residential mortgage loans to be sold in the secondary market, where the interest rate is determined prior to funding the loan. The commitments on mortgage loans to be sold are considered to be derivatives. The intent is that the borrower has assumed the interest rate risk on the loan. As a result, the Company is not exposed to losses due to interest rate changes. As of March 31, 2005, the market value of these commitments is immaterial and therefore, no gain or loss has been recognized in the financial statements.

 

Outstanding loan commitments, unused lines of credit, and letters of credit were as follows:

 

 

NOTE 4 - RETIREMENT PLANS

 

The Company has a defined benefit pension plan covering substantially all of its 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.  During 2004, the Company froze the Plan.

 

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 net periodic benefit cost for the Plan for the three months ended March 31 is as follows:

 

 

7

 

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.   In conjunction with the curtailment of the pension plan, the Company expanded the thrift plan to make it a Safe Harbor Plan.  Once an employee has been at the Company for one year, the Company then contributes 3% of the employee’s salary quarterly to the Plan for the employee’s benefit.

 

NOTE 5 - RECENT ACCOUNTING PRONOUNCEMENTS

 

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 provision 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. 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.

 

FASB Statement No. 123, Accounting for Stock-Based Compensation (Revised 2004) Share Based Payment, establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The Statement eliminates the alternative to use the Accounting Principles Board Opinion 25’s intrinsic value method of accounting that was provided in Statement 123 as originally issued. Under Opinion 25, issuing stock options to employees generally result in recognition of no compensation costs. This Statement requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. In addition, this Statement amends FASB Statement No. 95, Statement of Cash Flows to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. This Statement is effective as of the first interim period beginning after December 15, 2005.

 

AICPA Statement of Position No. 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.

 

Also during 2004, APB Opinion No. 29, Accounting for Nonmonetary Transactions, was amended to eliminate the exception for nonmonetary exchanges of similar productive assets and replace it with a general exception for exchanges of nonmonetary assets that do not have commercial substance.

 

Management does not expect these statements to have any material effect on the Company’s financial position or results of operation, during 2005. FASB Statement No. 123 will have an effect on the quarter ending March 31, 2006.

 

8

 

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

 

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, formed on April 10, 1900, 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.

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Statements that include the use of terminology such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “estimates” and similar expressions also identify forward-looking statements. The forward-looking statements are based on the Company’s current intent, belief and expectations. Forward-looking statements in this Quarterly Report on Form 10-Q include, but are not limited to statements of the Company’s plans, strategies, objectives, intentions, including, among other statements, statements involving the Company’s projected loan and deposit growth, loan collateral values, collectability of loans, anticipated changes in noninterest income, payroll and branching expenses, branch, office and product expansion of the Company and its subsidiary, and liquidity and capital levels.

 

These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Actual results may differ materially from these forward-looking statements because of interest rate fluctuations, a deterioration of economic conditions in the Baltimore-Washington metropolitan area, a downturn in the real estate market, losses from impaired loans, an increase in nonperforming assets, potential exposure to environmental laws, changes in federal and state bank laws and regulations, the highly competitive nature of the banking industry, a loss of key personnel, changes in accounting standards and other risks described in the Company’s filings with the Securities and Exchange Commission. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today’s date. The Company undertakes no obligation to update or revise the information contained in this Annual Report whether as a result of new information, future events or circumstances or otherwise. Past results of operations may not be indicative of future results. Readers should carefully review the risk factors described in other documents the Company files time to time with the Securities and Exchange Commission.

 

BUSINESS AND OVERVIEW

 

The Company is a bank holding company headquartered in Baltimore, Maryland with one wholly-owned subsidiary, Carrollton Bank. The Bank has three subsidiaries, CMSI, and CFS, which are wholly owned, and CCDC, which is 96.4% owned.

 

The Bank is engaged in general commercial and retail banking business with eleven branch locations. CMSI is in the business of originating residential mortgage loans and has four branch locations. CFS provides brokerage services to customers and CCDC promotes, develops and improves the housing and economic conditions of people in Maryland.

 

The Bank also operates a network of ATMs in Maryland, Virginia, and West Virginia and sponsors national retailers who accept ATM cards for purchases in various electronic networks.

 

9

 

Additionally, the Company enters into commitments to originate residential mortgage loans to be sold

 

Net income increased 34.41% for the three months ended March 31, 2005 compared to the same period in 2004, and core earnings (earnings before the effect of investment security transactions-a non-GAAP financial measure) increased 55.89% for the same period. The Company is asset sensitive and as a result, in the increasing interest rate environment of 2005, net interest income increased 8.21% for the first quarter of 2005 compared to the first quarter of 2004. The Company recognized gains on sales of securities during the first quarter of 2005 of $73,000 and increases in other fees and commissions in the same period by over 35.02%.

 

The Company opened its newest retail branch in Bel Air, Maryland in January of 2005.  As of March 31, 2005, that branch has attracted $1.4 million in deposits.

 

Based upon current earnings and encouraging prospects for future earnings, the Company paid dividends of $.10 per share to shareholders during the first quarter of 2005.

 

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.

 

Another critical accounting policy is related to securities. Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Management reviews criteria such as the magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

 

FINANCIAL CONDITION

 

Summary

 

Total assets increased $17.0 million to $336.1 million at March 31, 2005 compared to $319.1 million at the end of 2004. Loans increased by $11.1 million or 5.12% to $227.3 million during the period as a result of commercial loan demand.  Total interest-earning assets increased $13.1 million during the period to $299.5 million and were 89.1% of total assets at March 31, 2005.

 

10

 

Investment Securities

 

The investment portfolio consists entirely of securities available for sale. Securities available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors.

 

The investment portfolio consists primarily of U. S. Government agency securities, mortgage-backed securities, corporate bonds, state and municipal obligations, and equity securities. The income from state and municipal obligations is exempt from federal income tax. Certain agency securities are exempt from state income taxes. The Company uses its investment portfolio as a source of both liquidity and earnings.

 

Investment securities decreased $4.2 million to $38.3 million at March 31, 2005 from $42.5 million at December 31, 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 to $ 10.7 million at March 31, 2005 from $10.2 million at December 31, 2004 due to increased origination activity during the first three months of 2005. Loans held for sale are carried at the lower of cost or the committed sale price, determined on an individual basis.

 

Loans

 

Loans increased $11.1 million or 5.12% to $227.3 million at March 31, 2005 from $216.2 million at December 31, 2004. The increase was due to growth in commercial real estate and small business lending.

 

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 March 31, 2005 totaled $448,000.  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 effective interest rates for loans that are not collateral dependent.

 

11

 

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

 

		March 31, 2005			December 31, 2004			March 31, 2004
Nonaccrual loans		$	290,269		$	615,394		$	762,492
Restructured loans		447,602			455,864			661,974
Foreclosed real estate		—			—			176,423
Total nonperforming assets		$	737,871		$	1,071,258		$	1,600,889
Accruing loans past-due 90 days or more		$	1,845,719		$	1,567,919		$	1,334,501

 

Allowance for Loan Losses

 

An allowance for loan losses is maintained to absorb losses in the existing loan portfolio. The allowance is a function of specific loan allowances, general loan allowances based on historical loan loss experience and current trends, and allowances based on general economic conditions that affect the collectibility of the loan portfolio. These can include, but are not limited to exposure to an industry experiencing problems, changes in the nature or volume of the portfolio and delinquency and nonaccrual trends. The portfolio review and calculation of the allowance is performed by management on a continuing basis.

 

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.

 

During the quarter ended March 31, 2005 and the year ended December 31, 2004, the unallocated portion of the allowance for loan losses has fluctuated with the specific and general allowances so that the total allowance for loan losses would be at a level that management believes is the best estimate of probable future loan losses at the balance sheet date. The specific allowance may fluctuate from period to period if the balance of what management considers problem loans changes. The general allowance will fluctuate with changes in the mix of the Company’s loan portfolio, economic conditions, or specific industry conditions. The requirements of the Company’s federal regulators are a consideration in determining the required total allowance.

 

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 $3.5 million at March 31, 2005, which was 1.52% of loans

 

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compared to $3.5 million at December 31, 2004, which was 1.59% of loans.  During the first three months of 2005, the Company experienced net recoveries of $23,000.  The ratio of net loan losses to average loans outstanding decreased to zero for the three months ended March 31, 2005 from 0.08% for the year ended December 31, 2004. The ratio of nonperforming assets as a percent of period-end loans and foreclosed real estate decreased to 1.12% as of March 31, 2005 compared to 1.20% at December 31, 2004.

 

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

 

		Three months Ended March 31,
		2005				2004
Allowance for loan losses - beginning of period		$	3,485,076			$	3,648,245
Provision for loan losses		—				—
Charge-offs		—				(27,835		)
Recoveries		23,364				31,260
Allowance for loan losses - end of period		$		3,508,440		$	3,651,670

 

Funding Sources

 

Deposits

 

Total deposits increased by $18.3 million to $244.1 million as of March 31, 2005 from $225.8 million as of December 31, 2004. Increases in deposits were realized in both interest-bearing and noninterest-bearing accounts. The Company intentionally attracted new noninterest-bearing accounts during the first three months of 2005.

 

The Company began offering CDARS deposits to its customers during 2004. This program allows for customers that wish to invest more than the amounts that would normally be covered by FDIC insurance with the Bank. The program is a nationwide one that allows participating banks to “swap” customer deposits so that no customer has greater than the insurable maximum in one bank, but the customer only deals with his/her own bank. As of March 31, 2005, the Bank had approximately $17.7 million in CDARS deposits.

 

Borrowings

 

Advances from the Federal Home Loan Bank (FHLB) remain at $45.0 million, subject to the first call at the option of the FHLB of $40.0 million in 2005. Total borrowings decreased to $56.0 million at March 31, 2005 compared to $57.2 million at the end of 2004. The Company does not anticipate that the $40.0 million advance will be called in 2005, since the rate on the advance is higher than current market rates.

 

Capital Resources

 

Bank holding companies and banks are required by the Federal Reserve and FDIC to maintain minimum levels of Tier 1 (or Core) and Tier 2 capital measured as a percentage of assets on a risk-weighted basis. Capital is primarily represented by shareholders’ equity, adjusted for the allowance for loan losses and certain issues of preferred stock, convertible securities, and subordinated debt, depending on the capital level being measured. Assets and certain off-balance sheet transactions are assigned to one of five different risk-weighting factors for purposes of determining the risk-adjusted asset base. The minimum levels of Tier 1 and Tier 2 capital to risk-adjusted assets are 4% and 8%, respectively, under the regulations.

 

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In addition, the Federal Reserve and the FDIC require that bank holding companies and banks maintain a minimum level of Tier 1 (or Core) capital to average total assets excluding intangibles for the current quarter. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered adequately capitalized is 4%, but could be required to be maintained at a higher level based on the regulator’s assessment of an institution’s risk profile. The Company’s subsidiary bank also exceeded the FDIC required minimum capital levels at those dates by a substantial margin. Based on the levels of capital, the Company and the Bank are well capitalized.

 

The following table summarizes the Company’s capital ratios:

 

		March 31, 2005		December 31, 2004		Minimum Regulatory Requirements
Risk-based capital ratios:
Tier 1 capital		11.36	%	11.52	%	4.00	%
Total capital		12.61		12.74		8.00
Tier 1 leverage ratio		9.30		9.41		4.00

 

Total shareholders’ equity increased 0.3% to $34.3 million at March 31, 2005.  Earnings of the Company of $413,000 for the three months ended March 31, 2005 were offset by dividends of $283,000 and a decrease in capital of $210,000 from unrealized losses on securities available for sale.

 

RESULTS OF OPERATIONS

 

Summary

 

Carrollton Bancorp reported net income for the first three months of 2005 of $413,000, or $0.15 per share. For the same period of 2004, net income amounted to $307,000, or $0.11 per share.  Core earnings (earnings before the effect of investment security transactions, a non-GAAP financial measure) for the three months ended March 31, 2005 were $368,000, a 55.9% increase over 2004 core earnings of $236,000.

 

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 months ended March 31, 2005 was 0.51%, compared to 0.41% for the corresponding period in 2004.  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 months ended March 31, 2005 was 4.81%, compared to 3.57% for the corresponding period in 2004.

 

Interest and fee income on loans increased 18.9% as a result of loan growth, with total interest income increasing 12.8%. Net interest income increased 8.2% due to the experienced loan growth. Noninterest income, excluding gains/losses on security sales, increased 15.4% and noninterest expenses increased 4.7% compared to the first three months of 2004.

 

Net Interest Income

 

Net interest income, the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities, is the most significant component of the Company’s earnings. Net interest income is a function of several factors, including changes in the volume and mix of interest-earning assets and funding sources, and market interest rates. While management policies influence these factors,

 

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external forces, including customer needs and demands, competition, the economic policies of the federal government and the monetary policies of the Federal Reserve Board, are also important.

 

Net interest income for the Company on a tax equivalent basis (a non-GAAP measure) increased from $2.6 million for the first three months of 2004 to $2.8 million for the first three months of 2005.  The net yield on average earning assets increased from 3.82% for the first three months of 2004 to 3.86% for the first three months of 2005. The increase in the net yield came principally from loan growth.

 

Interest income on loans on a tax equivalent basis (a non-GAAP measure) increased 0.4% during the first three months of 2005 due to the growth in the loan portfolio.  The yield on loans decreased to 6.51% during the first three months of 2005 from 6.56% during the first three months of 2004.  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 on a tax equivalent basis was $443,000 for the first three months of 2005, compared to $592,000 for the first three months of 2004, representing a 25.2% decrease.  The portfolio on average decreased 15.2% and the overall yield on investments decreased from 3.60% for the first three months of 2004 to 3.35% for the first three months of 2005.

 

Interest expense increased $278,000 to $1.6 million for the first three months of 2005 from $1.3 million for the first three months of 2004.  The increase in interest expense was due to increased deposit levels, primarily in higher costing deposits.  The cost of interest bearing deposits increased to 1.71% for the first three months of 2005 compared to 1.22% for the first three months of 2004. Average interest-bearing deposits increased 7.8% to $174.2 million for the quarter ended March 31, 2005 from $161.7 million for the quarter ended March 31, 2004.

 

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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.

 

		Three Months Ended March 31, 2005
		Average balance			Interest			Yield
ASSETS
Interest-earning assets:
Federal funds sold and Federal Home Loan Bank deposit		$	9,362,884		$	58,646		2.51	%
Federal Home Loan Bank stock		2,624,023			24,253			3.70
Investment securities available for sale (a)		36,088,287			360,322			3.99
Loans, net of unearned income: (a)
Demand and time		60,214,209			982,351			6.53
Residential mortgage (b)		73,742,499			1,056,769			5.73
Commercial mortgage and construction		98,195,592			1,717,142			6.99
Installment		2,194,694			48,325			8.81
Lease financing		3,368,980			66,412			7.89
Total loans		237,715,974			3,870,999			6.51
Total interest-earning assets		285,791,168			4,314,220			6.04
Noninterest-earning assets:
Cash and due from banks		22,681,085
Premises and equipment		5,540,661
Other assets		7,035,065
Allowance for loan losses		(3,493,064		)
Unrealized gains on available for sale securities		3,722,978
Total assets		$	321,277,893
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and NOW		$	70,066,578		45,167			0.26	%
Money market		33,234,752			159,915			1.92
Other time		70,931,505			540,701			3.05
Borrowings		54,905,970			809,485			5.90
		229,138,805			1,555,268			2.71
Noninterest-bearing liabilities:
Noninterest-bearing deposits		56,298,937
Other liabilities		1,554,422
Shareholders’ equity		34,285,729
Total liabilities and shareholders’ equity		$	321,277,893
Net interest income					$	2,758,952
Net interest spread								3.33	%
Net interest margin								3.86	%

 

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

(b) Includes loans held for sale

 

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		Three Months Ended March 31, 2004
		Average balance			Interest			Yield
ASSETS
Interest-earning assets:
Federal funds sold and Federal Home Loan Bank deposit		$	13,223,173		$	35,711		1.08	%
Federal Home Loan Bank stock		2,250,000			19,580			3.48
Investment securities held to maturity and investment securities available for sale (a)		54,867,922			536,220			3.91
Loans, net of unearned income: (a)
Demand and time		48,361,534			596,375			4.93
Residential mortgage (b)		62,505,455			1,047,503			6.70
Commercial mortgage and construction		81,360,701			1,474,049			7.25
Installment		2,352,778			53,914			9.17
Lease financing		4,174,777			85,714			8.21
Total loans		198,755,245			3,257,555			6.56
Total interest-earning assets		269,096,340			3,849,066			5.72
Noninterest-earning assets:
Cash and due from banks		20,969,610
Premises and equipment		5,069,202
Other assets		7,266,691
Allowance for loan losses		(3,643,776		)
Unrealized gains on available for sale securities		3,367,488
Total assets		$	302,125,555
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and NOW		$	71,481,658		44,641			0.25	%
Money market		29,834,093			55,271			0.74
Other time		60,372,294			392,867			2.60
Borrowings		56,337,746			784,021			5.57
		218,025,791			1,276,800			2.34
Noninterest-bearing liabilities:
Noninterest-bearing deposits		47,839,592
Other liabilities		1,844,007
Shareholders’ equity		34,416,165
Total liabilities and shareholders’ equity		$	302,125,555
Net interest income					$	2,572,266
Net interest spread								3.38	%
Net interest margin								3.82	%

 

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

(b) Includes loans held for sale

 

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Provision for Loan Losses

 

On a monthly basis, management of the Company reviews all loan portfolios to determine trends and monitor asset quality. For consumer loan portfolios, this review generally consists of reviewing delinquency levels on an aggregate basis with timely follow-up on accounts that become delinquent. In commercial loan portfolios, delinquency information is monitored and periodic reviews of business and property leasing operations are performed on an individual basis to determine potential collection and repayment problems.

 

The Company did not provide for any loan losses in the first quarter of 2005 or 2004.  Nonaccrual, restructured, and delinquent loans over 90 days to total loans remained stable at 1.12% and 1.51% at March 31, 2005 and March 31, 2004, respectively.

 

Noninterest Income

 

Noninterest income was $2.3 million for the three months ended March 31, 2005, an increase of $258,000 or 12.5%, compared to the corresponding period in 2004.  The Company experienced lower brokerage commissions and mortgage-banking revenue in 2005 compared to 2004.

 

The Company offers a variety of financial planning and investment options to customers, through its subsidiary, CFS, and recognizes commission income as these services are provided.  Brokerage commission decreased $22,000, or 12.1%, during the three months ended March 31, 2005, compared to the same period in 2004.  Management believes that brokerage commissions are a good source of noninterest income for the Company and intends to continue focusing on increasing this source of income.

 

Other fees and commissions increased by $456,000 to $1,756,000 for the three months ended March 31, 2005, compared to $1,301,000 for the same period in 2004. The increase is attributed to increases in fee income from electronic banking and mortgage banking revenues. Electronic banking fee income increased by $93,000 for the first quarter of 2005 compared to the first quarter of 2004.  Electronic banking income is comprised of three sources: national point of sale, (“POS”) sponsorships, ATM fees and check card card fees. The Company maintains ATMs in Wal-Mart stores in Maryland, Virginia and West Virginia, as well as at its branches. The fees from these ATMs represent approximately 46% of total electronic banking revenue. The Company sponsors merchants who accept ATM cards for purchases within various networks (i.e. STAR, PULSE, NYCE). This national POS sponsorship income represents approximately 45% of total electronic banking revenue. Fees from check cards comprise the remaining 9% of electronic banking revenue.

 

Mortgage-banking revenue increased by $376,000 to $487,000 in 2005 from $102,000 in 2004.  During 2004, the Company opened three mortgage-banking “net branches.” The employees of these net branches earn as salaries all revenues earned on the sale of mortgage loans less operating expenses. In addition, each net branch pays management fees to CMSI for use of its processing and underwriting staff. The net branch expenses are included in the Company’s income statement, as they are divisions of CMSI, but the net effect of the operations of the net branches on the Company’s net income is limited to the management fees paid to CMSI. The inclusion of the expenses in the financial statements has the effect of showing significant expenses related to mortgage-banking and increases the Company’s efficiency ratio.

 

The Company realized gains on the sales of securities of $73,000 for the three months ended March 31, 2005, compared to $116,000 for the same period in 2004.  These security gains were taken to reposition the Company’s securities portfolio for funding loans as well as because of interest rate considerations. The gain in 2005 was recongized upon the sale of FHLMC preferred stock that was written down, due to other then temporary impairment, in 2004.

 

Noninterest Expense

 

Noninterest expense increased $196,000 or 4.68% for the three months ended March 31, 2005,

 

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compared to the same period in 2004.

 

Salaries, the largest component of noninterest expense, grew by $153,000, or 9.48%.  Full time equivalent staff increased from 146 positions at March 31, 2004 to 167 positions at March 31, 2005.  Additional staff was added in conjunction with the re-activation of CMSI and the Bank’s newest branch, which opened in January of 2005.

 

Employee benefits decreased by $35,000 due to the freezing of the Company’s deferred benefit pension plan at the end of 2004.

 

Occupancy expenses were $464,000 for the three months ended March 31, 2005, compared to $411,000 for the same period in 2004, which represented an increase of $53,000 or 12.89%.  This increase was primarily due to additional occupancy expenses associated with CMSI and with the new branch.

 

Furniture and equipment expenses decreased by $ 171,000 or 37.98% for the three months ended March 31, 2005 compared to the same period in 2004. A significant portion of the Company’s ATM network was fully depreciated by September 30, 2004, which signficantly reduced depreciation expense.

 

Other operating expenses increased $196,000 or 15.40% for the three months ended March 31, 2005. This increase was primarily due to an increase in advertising expense and in operating expenses incurred in the operations of CMSI and the new branch.

 

Income Taxes

 

For the three month period ended March 31, 2005, the Company’s effective tax rate was 39.42%, compared to 25.5% for the same period in 2004. During the quarter ended March 31, 2005 the Company redeemed its BOLI policies and converted to a new policy. The income tax provision for the quarter ended March 31, 2005 includes an accrual for the liability asscociated with the redemption.

 

LIQUIDITY AND CAPITAL EXPENDITURES

 

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, and securities available for sale.  Such assets totaled $93.0 or 27.68% of total assets at March 31, 2005.

 

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled $236.8 million at March 31, 2005.  Of this total, management places a high probability of required funding within one year on approximately $132.5 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 $84 million with the Federal Home Loan Bank of Atlanta (the “FHLB”) as an additional source of liquidity.  At March 31, 2005, 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

 

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$5 million and secured federal funds lines of credit of $10 million with other institutions.  There was no balance outstanding under these lines at March 31, 2005.  The lines bear interest at the current federal funds rate of the correspondent bank.

 

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”) 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 March 31, 2005, 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.

 

INFLATION

 

Inflation may be expected to have an impact on the Company’s operating costs and thus on net income. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect the Company’s results of operations unless the fees charged by the Company could be increased correspondingly. However, the Company believes that the impact of inflation was not material for for the first three months of 2005 or 2004.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

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. In addition, the Company has certain operating lease obligations.

 

Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

 

The Company’s exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. The Company is not aware of any accounting loss it would incur by funding its commitments.

 

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

For information regarding the market risk of the Company’s financial instruments, see “Market Risk and Interest Rate Sensitivity” in Management’s Discussion and Analysis of Financial Condition and Results of

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Operations.

 

ITEM 4.    CONTROLS AND PROCEDURES

 

The Company maintains disclosure controls and procedures (as those terms are defined in Exchange Act Rules 240-13-a-14(c) and 15d-14(c)) that are designed to provide material information about the Company to the chief executive officer, the chief financial officer, and others within the Company so that information may be recorded, processed, summarized, and reported as required under the Securities Exchange Act of 1934. The chief executive officer and the chief financial officer have each reviewed and evaluated the effectiveness of the Company’s internal controls and procedures as of a date within 90 days of the filing of this three month report and have each concluded that such disclosure controls and procedures are effective.

 

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect such controls subsequent to the date of the evaluations by the chief executive officer and the chief financial officer.  Neither the chief executive officer nor the chief financial officer is aware of any significant deficiencies or material weaknesses in the Company’s internal controls, so no corrective actions have been taken with respect to such internal controls.

 

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PART II    OTHER INFORMATION

 

ITEM 1.    LEGAL PROCEEDINGS

 

The Company is involved in various legal actions arising from normal business activities.  In management’s opinion, the outcome of these matters, individually or in the aggregate, will not have a material adverse impact on the results of operation or financial position of the Company.

 

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

The Company held its Annual Meeting of Shareholders on April 19, 2005.  At that meeting, directors were elected and the appointment of independent auditors was ratified.

 

ITEM 5.    OTHER INFORMATION

 

On April 14, 2005, the Board of Directors of the Company declared a $0.10 per share cash dividend to common shareholders of record on May 12, 2005, payable June 1, 2005.

 

ITEM 6.  EXHIBITS

 

(a)  Exhibits

 

(31.1)		Rule 13a-14(a) Certification by the Principal Executive Officer
(31.2)		Rule 13a-14(a) Certification by the Principal Financial Officer
(32.1)		Certification by the Principal Executive Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002
(32.2)		Certification by the Principal Financial Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002

 

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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.

 

				CARROLLTON BANCORP
				PRINCIPAL EXECUTIVE OFFICER:
Date	May 12, 2005			/s/ Robert A. Altieri
				Robert A. Altieri
				President and Chief Executive Officer
				PRINCIPAL FINANCIAL OFFICER:
Date	May 12, 2005			/s/ Barbara M. Broczkowski
				Barbara M. Broczkowski
				Senior Vice President and Chief Financial Officer

 

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