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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-25923
EAGLE BANCORP, INC
(Exact name of registrant as specified in its charter)
Maryland 52-2061461
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7815 Woodmont Avenue, Bethesda, Maryland 20814
(Address of principal executive offices) (Zip Code)
(301) 986-1800
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes ( x ) No (__)
Indicate by check mark whether the registrant is an accelerated filer (
as defined in Rule 12b-2 of the Exchange Act Yes ( ) No ( x )
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
As of August 12, 2004, the registrant had 5,407,173 shares of Common
Stock outstanding.
Item 1 - Financial Statements
EAGLE BANCORP, INC.
Consolidated Balance Sheets
June 30, 2004 and December 31, 2003
(dollars in thousands)
June 30,
2004 December 31,
(unaudited) 2003
----------- ---------
ASSETS
Cash and cash equivalents $ 31,180 $ 25,103
Federal funds sold 23,980 -
Interest bearing deposits with other banks 5,936 4,332
Investment securities available for sale 63,922 82,581
Loans held for sale 3,866 3,649
Loans 349,012 317,533
Less allowance for credit losses (3,957) (3,680)
--------- ---------
Loans, net 345,055 313,853
Premises and equipment, net 5,603 4,259
Deferred income taxes 1,331 862
Other assets 13,154 8,358
--------- ---------
TOTAL ASSETS $ 494,027 $ 442,997
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing demand $ 96,252 $ 90,468
Interest bearing transaction 63,848 44,093
Savings and money market 122,437 104,429
Time, $100,000 or more 67,866 54,992
Other time 52,845 41,532
--------- ---------
Total deposits 403,248 335,514
Federal funds purchased and securities sold under agreement to repurchase 21,906 38,454
Other short-term borrowings 4,000 4,000
Long-term borrowings 8,528 10,588
Other liabilities 1,623 1,429
--------- ---------
Total liabilities 439,305 389,985
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; shares authorized 20,000,000, shares
Issued and outstanding 5,404,257 (2004) and 5,359,303 (2003) 54 54
Additional paid in capital 46,744 46,406
Retained earnings 8,533 6,281
Accumulated other comprehensive (loss) income (609) 271
--------- ---------
Total stockholders' equity 54,722 53,012
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 494,027 $ 442,997
========= =========
See notes to consolidated financial statements.
2
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
SIX AND THREE MONTHS ENDED JUNE 30, 2004 AND 2003
(dollars in thousands, except per share amounts-unaudited)
Six Months Six Months Three Months Three Months
Ended Ended Ended Ended
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
------------- ------------- ------------- -------------
INTEREST INCOME:
Interest and fees on loans $ 9,753 $ 7,783 $ 4,966 $ 3,919
Taxable interest and dividends on
investment securities 1,052 916 587 367
Interest on balances with other banks 61 94 38 54
Interest on federal funds sold /other
cash equivalents 123 26 25 13
------- ------- ------- -------
Total interest income 10,989 8,819 5,616 4,353
------- ------- ------- -------
INTEREST EXPENSE:
Interest on deposits 1,716 1,656 905 815
Interest on federal funds purchased and
securities sold under agreement
to repurchase 34 58 18 30
Interest on short-term borrowings 85 144 28 62
Interest on long-term borrowings 178 284 96 160
------- ------- ------- -------
Total interest expense 2,013 2,142 1,047 1,067
------- ------- ------- -------
NET INTEREST INCOME 8,976 6,677 4,569 3,286
PROVISION FOR CREDIT LOSSES 230 425 76 201
------- ------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 8,746 6,252 4,493 3,085
------- ------- ------- -------
NONINTEREST INCOME:
Service charges on deposit accounts 709 579 363 307
Gain on sale of investment securities 253 214 - 22
Gain on sale of loans 389 346 217 98
Other income 556 307 245 146
------- ------- ------- -------
Total noninterest income 1,907 1,446 825 573
------- ------- ------- -------
NONINTEREST EXPENSES:
Salaries and employee benefits 3,901 2,746 1,947 1,400
Premises and equipment expenses 1,270 934 672 511
Advertising 159 124 103 62
Outside data processing 286 264 144 129
Other expenses 1,508 1,048 765 549
------- ------- ------- -------
Total noninterest expenses 7,124 5,116 3,631 2,651
NET INCOME BEFORE INCOME TAXES 3,529 2,582 1,687 1,007
INCOME TAXES 1,277 960 614 368
------- ------- ------- -------
$ 2,252 $ 1,622 $ 1,073 $ 639
NET INCOME ======= ======= ===== =======
INCOME PER SHARE:
Basic $ 0.42 $ 0.56 $ 0.20 $ 0.22
Diluted $ 0.40 $ 0.52 $ 0.19 $ 0.20
See notes to consolidated financial statements.
3
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 and 2003
(dollars in thousands-unaudited)
Six Months Ended Six Months Ended
June 30, 2004 June 30, 2003
----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,252 $ 1,622
Adjustments to reconcile net income to net cash
Provided (used) by operating activities:
(Decrease) increase in deferred income taxes (1) 125
Provision for credit losses 230 425
Depreciation and amortization 448 317
Gain on sale of loans (389) (346)
Origination of loans held for sale (13,948) (10,415)
Proceeds from sale of loans held for sale 14,120 12,126
Gain on sale of investment securities (253) (214)
Increase in other assets (796) (657)
Increase (decrease) in other liabilities 176 (105)
--------- ---------
Net cash provided by operating activities 1,839 2,878
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in interest bearing deposits with other banks (1,604) (14,636)
Purchases of available for sale investment securities (165,550) (121,313)
Proceeds from maturities of available for sale securities 152,792 93,831
Proceeds from sale of available for sale securities 30,340 14,577
Increase in federal funds sold (23,980) (6,007)
Net increase in loans (31,432) (24,771)
Bank premises and equipment acquired (1,792) (858)
Increase in BOLI contracts (4,000) (0)
--------- ---------
Net cash used by investing activities (45,226) (59,177)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 67,734 30,065
(Decrease) increase in federal funds purchased and
securities sold under agreement to repurchase (16,548) 2,132
Increase in other short term borrowings - 5,340
Decrease in long-term borrowings (2,060) (2,000)
Increase in escrowed subscriptions received - 35,835
Issuance of common stock 338 90
--------- ---------
Net cash provided by financing activities 49,464 71,462
--------- ---------
NET INCREASE IN CASH 6,077 15,163
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 25,103 18,569
--------- ---------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 31,180 $ 33,732
========= =========
Supplemental cash flow information:
Interest paid $ 1,916 $ 2,013
Income taxes paid $ 1,009 $ 1,112
See notes to consolidated financial statements
4
EAGLE BANCORP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(dollars in thousands - unaudited)
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Stockholders
Stock Capital Earnings Income (loss) Equity
----- ------- -------- ------------- ------
Balances at January 1, 2004 $ 54 $ 46,406 $ 6,281 $ 271 $ 53,012
Exercise of options for 44,954 shares of
common stock 338 338
Net income 2,252 2,252
Other comprehensive income:
Unrealized loss on securities available for
Sale (880) (880)
--------
Total other comprehensive income 1,710
-------------------------------------------------------------------
Balances at June 30, 2004 $ 54 $ 46,744 $ 8,533 $ (609) $ 54,722
-------------------------------------------------------------------
Balances at January 1, 2003 $ 29 $ 16,541 $ 3,066 $ 392 $ 20,028
Exercise of options for 9,470 shares of
common stock 90 90
Net income 1,622 1,622
Other comprehensive income:
unrealized loss on investment securities
available for sale (172) (172)
--------
Total comprehensive income 1,540
--------------------------------------------------------------------
Balances at June 30, 2003 $ 29 $ 16,631 $ 4,688 $ 220 $ 21,568
-------------------------------------------------------------------
See notes to consolidated financial statements.
5
EAGLE BANCORP, INC.
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General - The financial statements of Eagle Bancorp, Inc. (the "Company")
included herein are unaudited; however, they reflect all adjustments
consisting only of normal recurring accruals that, in the opinion of
Management, are necessary to present fairly the results for the periods
presented. The amounts as of December 31, 2003 were derived from audited
financial statements. Certain information and note disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. There have been no significant changes
to the Company's Accounting Policies as disclosed in the 2003 Annual
Report. The Company believes that the disclosures are adequate to make the
information presented not misleading. The results of operations for the six
months ended June 30, 2004 are not necessarily indicative of the results of
operations to be expected for the remainder of the year, or for any other
period.
2. NATURE OF BUSINESS
The Company, through its bank subsidiary, provides domestic financial
services primarily in Montgomery County, Maryland and Washington, DC. The
primary financial services include real estate, commercial and consumer
lending, as well as traditional demand deposits and savings products.
3. INVESTMENT SECURITIES
Amortized cost and estimated fair value of securities available - for -
sale are summarized as follows: (in thousands)
June 30, 2004
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
U. S. Government Agency securities $ 33,627 $ - $ (469) $ 33,158
Mortgage backed securities 22,669 - (556) 22,113
Federal Reserve Bank and
Federal Home Loan Bank stock 1,634 - - 1,634
Other equity investments 6,915 284 (182) 7,017
-------- -------- -------- --------
$ 64,845 $ 284 $ (1,207) $ 63,922
======== ======== ======== ========
December 31, 2003
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
U. S. Government Agency securities $ 25,355 $ 76 $ (38) $ 25,373
Mortgage backed securities 51,887 101 (246) 51,842
Federal Reserve Bank and Federal Home
Loan Bank stock 1,670 - - 1,670
Other equity investments 3,282 421 (7) 3,696
-------- -------- -------- --------
$ 82,174 $ 698 $ (291) $ 82,581
======== ======== ======== ========
Gross unrealized losses and fair value by length of time that the individual
available securities have been in a continuous unrealized loss position as of
June 30, 2004 are as follows:
6
(in thousands)
Total
Less than More than Unrealized
Fair Value 12 Months 12 Months Losses
----------- --------- --------- ----------
U. S. Government Agency securities $ 33,627 $ (469) $ - $ (469)
Mortgage backed securities 22,669 (556) - (556)
Other equity investments 3,415 (177) (5) (182)
$ 59,711 $ (1,202) $ (5) $ (1,207)
4. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred-tax assets and liabilities are determined based
on differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities (i.e., temporary differences) and
are measured at the enacted rates that will be in effect when these
differences reverse.
5. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period.
Diluted net income per common share is computed by dividing net income by
the weighted average number of common shares outstanding during the period,
including any potential dilutive common shares outstanding, such as options
and warrants. As of June 30, 2004 there were 54,810 shares excluded from
the diluted net income per share computation because their inclusion would
be anti-dilutive
6. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure", but applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting
for its Plan. No compensation expense related to the Plan was recorded
during the three and six months ended June 30, 2004 and 2003. If the
Company had elected to recognize compensation cost based on fair value at
the grant dates for awards under the Plan consistent with the method
prescribed by SFAS No. 123, net income and earnings per share would have
been changed to the pro forma amounts as follows for the three and six
months ended June 30.
Six Months Three Months
Ended June 30, Ended June 30,
--------------------------------------------------------
2004 2003 2004 2003
--------------------------------------------------------
Net income, as reported $ 2,252 $ 1,622 $ 1,073 $ 639
Less pro forma stock-based compensation expense
determined under the fair value method, net of
related tax effects (718) (173) - (167)
------------- -------------- ------------- -------------
Pro forma net income $ 1,543 $ 1,449 $ 1,073 $ 472
============= ============== ============= =============
Net income per share:
Basic - as reported $ 0.42 $ 0.56 $ 0.20 $ 0.22
Basic - pro forma $ 0.29 $ 0.50 $ 0.20 $ 0.16
Diluted - as reported $ 0.40 $ 0.52 $ 0.19 $ 0.20
Diluted - pro forma $ 0.28 $ 0.46 $ 0.19 $ 0.15
7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The following discussion provides information about the results of
operations, and financial condition, liquidity, and capital resources of the
Company and its subsidiary the Bank. This discussion and analysis should be read
in conjunction with the unaudited Consolidated Financial Statements and Notes
thereto, appearing elsewhere in this report.
This report contains forward looking statements within the meaning of
the Securities Exchange Act of 1934, as amended, including statements of goals,
intentions, and expectations as to future trends, plans, events or results of
Company operations and policies and regarding general economic conditions. In
some cases, forward looking statements can be identified by use of such words as
"may", "will", "anticipate", "believes", "expects", "plans", "estimates",
"potential", "continue", "should", and similar words or phases. These statements
are based upon current and anticipated economic conditions, nationally and in
the Company's market, interest rates and interest rate policy, competitive
factors and other conditions which, by their nature, are not susceptible to
accurate forecast, and are subject to significant uncertainty. Because of these
uncertainties and the assumptions on which this discussion and the forward
looking statements are based, actual future operations and results in the future
may differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward looking statements.
GENERAL
Eagle Bancorp, Inc. is a growing, one-bank holding company
headquartered in Bethesda, Maryland. We provide general commercial and consumer
banking services through our wholly owned banking subsidiary EagleBank, a
Maryland chartered bank which is a member of the Federal Reserve System. We were
organized in October 1997 to be the holding company for the Bank. The Bank was
organized as an independent, community oriented, full-service alternative to the
super regional financial institutions, which dominate our primary market area.
The cornerstone of our philosophy is to provide superior, personalized service
to our customers. We focus on relationship banking, providing each customer with
a number of services, becoming familiar with and addressing customer needs in a
proactive, personalized fashion. The Bank has five offices serving Montgomery
County and two offices in the District of Columbia. The Bank had six Montgomery
County offices, however, the Sligo Office located at 850 Sligo Avenue, Silver
Spring, MD, was closed June 11, 2004. After thorough consideration, management
and the board of directors decided to close the office rather than exercise an
option to renew option in the lease available in June. The decision was made
because the office had failed to reach initial growth and profit expectations
and an analysis of the office's potential, in its existing location, did not
provide indications that the office would improve its performance in the
foreseeable future. Silver Spring will continue to be served by the original
Silver Spring Office, which is located only a few blocks from the Sligo Office,
and for this reason, the loss of business, in particular deposits, is expected
to be minimal. No employees were displaced by the closing but were absorbed into
positions created by a new District of Columbia branch office and other Company
vacancies. On April 28, 2004 the Bank opened its second office in the District
of Columbia at 1228 Connecticut Avenue. In February 2004, the Company executed a
lease for a new office to be opened in 2006 in Friendship Heights, Montgomery
County, Maryland, on the District of Columbia line. Most recently the Company
executed a lease for a third District of Columbia office to be located at 1425 K
Street NW, Washington, D. C. This office will become the District of Columbia
regional office and is expected to open in December 2004.
The Company offers full commercial banking services to our business and
professional clients as well as complete consumer banking services to
individuals living and/or working in the service area. We emphasize providing
commercial banking services to sole proprietors, small and medium-sized
businesses, partnerships, corporations, non-profit organizations and
associations, and investors living and working in and near our primary service
area. A full range of retail banking services are offered to accommodate the
individual needs of both corporate customers as well as the community we serve.
These services include the usual deposit functions of commercial banks,
including business and personal checking accounts, "NOW" accounts and savings
accounts, business, construction, and commercial loans, equipment leasing,
residential mortgages and consumer loans and cash management services. We have
developed significant expertise and commitment as an SBA lender, have been
designated a Preferred Lender by the Small Business Administration (SBA), and
are one of the largest SBA lenders, in dollar volume, in the Washington
Metropolitan area.
In June 2003, the Company formed a second wholly owned subsidiary,
Bethesda Leasing, LLC ("Bethesda Leasing"). Bethesda Leasing was formed for the
purpose of acquiring an impaired loan from the Bank in order to effect more
efficient administration and collection procedures.
8
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and follow general practices within the banking industry.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions, and judgments. Certain policies inherently
have a greater reliance on the use of estimates, assumptions and judgments and
as such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
The allowance for credit losses is an estimate of the losses that may
be sustained in our loan portfolio. The allowance is based on two principles of
accounting: (a) Statement on Financial Accounting Standards ("SFAS") 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued when
it is probable that the Company will not collect all principal and interest
payments according to the contractual terms of the loan. The loss, if any, is
determined by the difference between the loan balance and the value of
collateral, the present value of expected future cash flows, or values
observable in the secondary markets.
Three basic components comprise our allowance for credit losses: a
specific allowance, a formula allowance and a nonspecific allowance. Each
component is determined based on estimates that can and do change when the
actual events occur. The specific allowance is used to individually allocate an
allowance to loans identified as impaired. An impaired loan may show
deficiencies in the borrower's overall financial condition, payment record,
support available from financial guarantors and/or the fair market value of
collateral. When a loan is identified as impaired a specific reserve is
established based on the Company's assessment of the loss that may be associated
with the individual loan. The formula allowance is used to estimate the loss on
internally risk rated loans, exclusive of those identified as impaired. Loans
identified as special mention, substandard, doubtful and loss, as well as
impaired, are segregated from performing loans. Remaining loans are then grouped
by type (commercial, commercial real estate, construction, home equity or
consumer). Each loan type is assigned an allowance factor based on management's
estimate of the risk, complexity and size of individual loans within a
particular category. Classified loans are assigned higher allowance factors than
non-rated loans due to management's concerns regarding collectibility or
management's knowledge of particular elements regarding the borrower. Allowance
factors grow with the worsening of the internal risk rating. The nonspecific
formula is used to estimate the loss of non-classified loans stemming from more
global factors such as delinquencies, loss history, trends in volume and terms
of loans, effects of changes in lending policy, the experience and depth of
management, national and local economic trends, concentrations of credit,
quality of loan review system and the effect of external factors such as
competition and regulatory requirements. The nonspecific allowance captures
losses whose impact on the portfolio have occurred but have yet to be recognized
in either the formula or specific allowance.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses, including
in connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance and
nonspecific allowance components of the allowance. The establishment of
allowance factors is a continuing exercise, based on management's continuing
assessment of the global factors discussed above and their impact on the
portfolio, and allowance factors may change from period to period, resulting in
an increase or decrease in the amount of the provision or allowance, based upon
the same volume and classification of loans. Changes in allowance factors will
have a direct impact on the amount of the provision, and a related, after tax
effect on net income. Errors in management's perception and assessment of the
global factors and their impact on the portfolio could result in the allowance
not being adequate to cover losses in the portfolio, and may result in
additional provisions or charge-offs. For additional information regarding the
allowance for credit losses, refer to the discussion under the caption
"Allowance for Credit Losses" below.
9
RESULTS OF OPERATIONS
The Company reported net income of $2.3 million for the six months and
$1.1 million for the three months ended June 30, 2004, as compared to net income
of $1.6 million for the six months and $639 thousand for the three months ended
June 30, 2003. Income per basic share was $0.42 for the six months and $0.20 for
the three months ended June 30, 2004, as compared to $0.56 and $0.22 for the
same periods in 2003. Income per diluted share was $0.40 for the six months and
$0.19 for the three months ended June 30, 2004, as compared to $0.52 for the six
months and $0.20 for the same periods in 2003. The Company had a return on
average assets of 0.99% and return on average equity of 8.30% for the first six
months of 2004, as compared to returns on average assets and average equity of
0.93% and 15.52% respectively for the same six months of 2003.
The increase in net income for the six months ended June 30, 2004 as
compared to the same period in 2003, can be attributed to an increase of 34% in
net interest income, reflected in an increase of 31% in average earning assets
and an increase in the net interest margin of 6 basis points. Net interest
income increased from $6.7 million to $9.0 million and average earning assets
increased from $323 million to $424 million. Net interest margin increased from
4.17% for the first six months of 2003 to 4.23% for the same period in 2004 as
market interest rates fell from the first quarter of 2003 through most of 2003,
then stabilized, and longer term interest rates rose slightly in the first six
months of 2004. The percentage of loans, which generally have higher yields than
securities and other earning assets, increased from 77% of average earning
assets in the six month period of 2003 to 78% of earning assets in the same
period of 2004. Noninterest income increased 32%, to $1.9 million for the first
six months of 2004, from $1.4 million in the same period of 2003. The net income
for the three months ended June 30, 2004, represents an increase of 69% for the
same period in 2003, $1.1 million as compared to $639 thousand. The combination
of an increase in net interest income, a lower provision for credit losses, and
an increase in noninterest income resulted in the significant improvement in
reported income.
For the six months ended June 30, 2004, the Company recorded a
provision for credit losses in the amount of $230 thousand compared to $425
thousand for the first six months of 2003. The provision for the second quarter
of 2004 was $76 thousand compared to $201 thousand for the same quarter in 2003.
As discussed in the section on Allowance for Credit losses, the Company had
significant recoveries on previously charged off loans and the Company's loss
experience continued to be very favorable allowing for an adjustment in factors
influencing the level of the allowance. At June 30, 2004, the allowance for
credit losses was $4.0 million, as compared to $3.7 million at December 31,
2003. The Company had net recoveries of $47 thousand during the first six months
of 2004. This compared to net charge-offs of $239 thousand for the first six
months of 2003, representing 0.10% of average loans on an annualized basis.
While the results of operations for the first six months and second
quarter of 2004 compared to the first six months and to the second quarter of
2003 were up, $2.3 million from $1.1 million, for the six month periods and $1.6
million and $639 thousand for the quarterly periods, earnings per share were
down, $0.42 from $0.56 and $0.20 from $0.22 respectively, and return on average
equity was down to 8.30% from 15.52%. The reduction in both ratios is directly
attributable to the 85% increase in the number of outstanding shares following
the completion of the Company's offering of approximately 2.4 million shares in
August 2003, netting the Company approximately $30 million in new capital. The
additional shares are expected to have an adverse impact on earnings per share
for a number of quarters until the capital can be further leveraged and deployed
in loans and other income producing assets other than low yielding, but highly
liquid short term investment securities.
The following table sets out the annualized returns on average assets, returns
on average equity and equity to assets (average) for the three months ending
June 30, 2004 and 2003 and the year ending December 31, 2003:
June June December
2004 2003 2003
---- ---- ----
Return on average assets 0.99% 0.93% 0.86%
Return on average equity 8.30% 15.52% 9.45%
Average equity to average assets 11.89% 6.02% 9.05%
10
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income is the difference between interest income on
earning assets and the cost of funds supporting those assets. Earning assets are
composed primarily of loans and investment securities. The cost of funds
represents interest expense on deposits, customer repurchase agreements and
other borrowings. Noninterest bearing deposits and capital are other components
representing funding sources. Changes in the volume and mix of assets and
funding sources, along with the changes in yields earned and rates paid,
determine changes in net interest income. Net interest income for the first six
months of 2004 was $9.0 million compared to $6.7 million for the first six
months of 2003 and for the second quarter of 2004 was $4.6 compared to $3.3
million for the second quarter of 2003.
The table labeled "Average Balances, Interest Yields and Rates and Net
Interest Margin" presents the average balances and rates of the various
categories of the Company's assets and liabilities. Included in the table is a
measurement of interest rate spread and margin. Interest spread is the
difference between the rate earned on assets less the cost of funds expressed as
a percentage. While spread provides a quick comparison of earnings rates versus
cost of funds, management believes that margin provides a better measurement of
performance. Margin includes the effect of noninterest bearing liabilities in
its calculation and is net interest income expressed as a percentage of total
earning assets. Interest spread increased in the six months of 2004 from the
first six months of 2003 by 14 basis points, to 3.92% from 3.78%; and margin
increased 6 basis points, to 4.23% from 4.17%. The stabilizing of rates with
some upward movement over the six months of 2004 is also a contributing factor
to the improved spread and margin. Management is particularly pleased that the
Company was able to maintain a relatively stable spread and margin following a
long period of interest rate declines. Management was able to maintain stability
by reducing the cost of funds, from 1.68% during the first six months of 2003 to
1.29% for the same period in 2004, as it faced lower yields on its earning
assets, which declined from 5.46% during the first six months of 2003 to 5.21%
in 2004. At the same time, the mix of earning assets improved as higher yielding
loans increased from 77% of earning assets in 2003 to 78% in 2004.
The declines in the yields on earning assets from the first six months
of 2003 to the first six months of 2004 reflect the impact of the significant
rate reductions effected by the Federal Reserve from 2001 through 2003 on loans,
which comprise the vast majority of earning assets. After a long decline, the
investment portfolio yield increased by 10 basis points from the first six
months of 2003 to the same period in 2004. The slowdown in mortgage refinancing
caused by slightly higher rates helped improve the Bank's investment portfolio
yield as premium amortizations on mortgage backed securities slowed. In order to
keep the investment portfolio short for liquidity with expectations that rates
would start to move upward, the Bank invested in interest bearing deposits with
other banks, in amounts which made them eligible for FDIC insurance to obtain
better short term yields. These CDs yielded 2.44% during the first six months of
2004, a relatively attractive rate given their short term nature and low risk,
as compared to the rates offered on federal funds and U. S. Treasury bills. At
June 30, 2004, the Bank had $5.9 million of such deposits. The decline in yields
on interest bearing liabilities is also reflective of the series of rate cuts by
the Federal Reserve. The increase, by the Federal Reserve Bank on June 30, 2004,
in the federal funds target rate is expected to have a positive impact on
Company earnings. Management feels that the Company's earning assets are of a
short enough duration to take full advantage of further increases in rates by
the Federal Reserve System and other market forces, while increases in rates on
deposits are expected to lag increases on earning assets.. See the section
addressing GAP and Asset/Liability Management.
The decline in the yield on the loan portfolio, 44 basis points from
June 2003 to June 2004, was less than might be expected in the general interest
rate environment of 2003 leading into the 2004. Approximately 59% of the Bank's
loan portfolio consists of loans which reprice in periods of one to twelve
months, 11% in one to three years, 25% in three to five years and 5% reprice
beyond five years. Management feels that this repricing frequency positions the
Bank to improve its interest margin in the coming months, if interest rates
continue the rise started on June 30. Interest rate shock results are included
under the section Asset/Liability Management.
On the liability side, management aggressively reduced rates on deposit
accounts. The reduction in the rate on total interest bearing liabilities from
the first six months of 2003 to the first six months of 2004 was 39 basis points
which compares to a reduction of 25 basis points in the yield on earning assets
over the same period.
11
AVERAGE BALANCES, INTEREST YIELDS, AND RATES, AND NET INTEREST MARGIN
SIX MONTHS ENDED JUNE 30,
2004 2003
-------------------------------- ---------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
ASSETS:
Interest earnings assets:
Interest bearing deposits with
other banks $ 5,033 $ 61 2.44% $ 8,647 $ 94 2.20%
Loans 332,108 9,753 5.90% 247,527 7,783 6.34%
Investment securities 69,190 1,052 3.05% 62,078 916 2.95%
Federal funds sold and cash
equivalents 17,928 123 1.38% 4,704 26 1.14%
-------- ------- -------- -----
Total interest earning assets 424,259 10,989 5.21% 322,956 8,819 5.46%
Total noninterest earning assets 36,028 27,012
Less: allowance for credit losses 3,792 2,881
-------- --------
Total non earning assets 32,236 24,131
-------- --------
TOTAL ASSETS $456,495 $347,087
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest bearing liabilities:
NOW accounts $ 49,853 32 0.13% $ 36,355 49 0.27%
Savings and money market accounts 116,425 552 0.95% 93,308 652 1.34%
Certificates of deposit 114,321 1,132 1.99% 76,792 955 2.51%
Customer repurchase agreements 15,224 34 0.45% 20,921 58 0.56%
Short-term borrowing 7,384 85 2.40% 8,060 144 3.60%
Long-term borrowing 9,648 173 3.64% 16,436 284 3.48%
-------- ------- -------- -----
Total interest bearing liabilities 312,855 2,013 1.29% 256,872 2,142 1.68%
-------- ------- -------- -----
Noninterest bearing liabilities:
Noninterest bearing deposits 87,772 64,222
Other liabilities 1,571 1,489
Escrowed subscriptions received - 3,604
-------- --------
Total noninterest bearing 89,343 69,315
liabilities
Stockholders' equity 54,297 20,900
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $456,495 $347,087
======== ========
Net interest income $ 8,976 $ 6,677
======= ========
Net interest spread 3.92% 3.78%
Net interest margin 4.23% 4.17%
12
ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses represents the expense recognized to
fund the allowance for credit losses. The amount of the allowance for credit
losses is based on many factors which reflect management's assessment of the
risk in the loan portfolio. Those factors include economic conditions and
trends, the value and adequacy of collateral, volume and mix of the portfolio,
performance of the portfolio, and internal loan processes of the Company and
Bank.
Management has developed a comprehensive review process to monitor the
adequacy of the allowance for credit losses. The review process and guidelines
were developed utilizing guidance from federal banking regulatory agencies. The
results of this review process, in combination with conclusions of the Bank's
outside loan review consultant, support management's view as to the adequacy of
the allowance as of the balance sheet date. During the first six months of 2004,
a provision for credit losses was made in the amount of $230 thousand after
considering the impact of $47 thousand in net recoveries during the period.
Please refer to the discussion under the caption, "Critical Accounting Policies"
for an overview of the underlying methodology management employs on a quarterly
basis to maintain the allowance.
At June 30, 2004, the Company had three loans classified as nonaccrual
in the amount of $253 thousand (this is net of a $211 thousand US Government
guaranteed portion of one loan) which is considered impaired under Statement of
Financial Accounting Standards ("SFAS No. 114"). As part of its comprehensive
loan review process, the Bank's Board of Director's Loan Committee and/or Board
of Directors Credit Review Committee carefully evaluates loans over thirty days
past due. The Committee(s) makes a thorough assessment of the conditions and
circumstances surrounding each past due loan. The Bank's loan policy requires
that loans be placed on nonaccrual if they are ninety days past due, unless they
are well secured and in the process of collection.
The provision for credit losses of $230 thousand in the first six
months of 2004 compared to a provision for credit losses of $425 thousand in the
first six months of 2003. The higher level of the provision in 2003 is primarily
attributable to a specific reserve set aside for a problem credit in 2003 which
was not required when compared to 2004 and to two significant recoveries on
previously charged-off loans. See the following table which reflects the
comparative charge-off and recovery information.
As the portfolio and allowance review process matures, there will be
changes to different elements of the allowance and this may have an effect on
the overall level of the allowance maintained. To date the Bank has enjoyed a
very high quality portfolio with minimal net charge offs and very low
delinquency. The maintenance of a high quality portfolio will continue to be
management's prime objective as it relates to the lending process and to the
allowance for credit losses.
13
The following table sets forth activity in the allowance for credit
losses for the periods indicated.
----------------------------------------------------------------
Six Months Ended Year Ended
----------------------------------------------------------------
(dollars in thousands) June 30, December 31,
----------------------------------------------------------------
2004 2003 2003 2002 2001
---------- --------- -------- --------- ---------
Balance at beginning of year $ 3,680 $ 2,766 $ 2,766 $ 2,111 $ 1,142
Charge-offs: - - - - -
Commercial (81) (290) (319) (192) -
Real estate - commercial - - - - -
Construction - - - - -
Home equity - - - - -
Other consumer (18) (8) (14) (40) (23)
------- ------- ------- ------- -------
Total (99) (298) (333) (232) (23)
------- ------- ------- ------- -------
Recoveries:
Commercial 146 58 68 26 -
Real estate - commercial - - - - -
Construction - - - - -
Home equity - - - - -
Other consumer - 1 4 18 13
------- ------- ------- ------- -------
Total 146 59 72 44 13
------- ------- ------- ------- -------
Net recoveries (charge-offs) 47 (239) (261) (188) (10)
------- ------- ------- ------- -------
Additions charged to operations 230 425 1,175 843 979
------- ------- ------- ------- -------
Balance at end of period $ 3,957 $ 2,952 $ 3,680 $ 2,766 $ 2,111
======= ======= ======= ======= =======
Annualized ratio of net
charge-offs during the
period to average loans
outstanding during the period N/A 0.02% 0.10% 0.09% 0.01%
------- ------- ------- ------- -------
The following table reflects the allocation of the allowance for credit
losses at the dates indicated. The allocation of the allowance to each category
is not necessarily indicative of future losses or charge-offs and does not
restrict the use of the allowance to absorb losses in any category.
(dollars in thousands) As of June 30, As of December 31,
-------------------------------------------------------------
2004 2003
-------------------------- ---------------------------
Amount Percent (1) Amount Percent (1)
--------- ----------- ----------- --------------
Commercial $2,469 24.1% $1,689 29.3%
Real estate - commercial 565 49.9 888 47.3
Construction 712 14.1 613 11.2
Home equity 96 10.9 171 10.7
Other consumer 63 1.0 72 1.5
Unallocated 52 - 247 -
------ ----- ------ -----
Total allowance for credit losses $3,957 100% $3,680 100%
====== ===== ====== =====
(1) Represents the percent of loans in category to gross loans
NON-PERFORMING ASSETS
The Company's non-performing assets, which are comprised of loans
delinquent 90 days or more, non-accrual loans, and other real estate owned,
totaled $464 thousand at June 30, 2004 compared to $486 thousand at June 30,
2003 and $654 thousand at December 31, 2003. The percentage of non-performing
assets to total assets was 0.09% at June 30, 2004, compared to 0.11% at June 30,
2003 and 0.15% at December 31, 2003.
14
Non-performing loans constituted all of the non-performing assets at
June 30, 2004, June 30, 2003 and December 31, 2003. Non-performing loans at June
30, 2004 consist of three loans on nonaccrual of $326 thousand and one impaired
loan in the amount of $138 thousand compared to one nonaccrual loan in the
amount of $123 thousand and one impaired loan in the amount of $363 thousand at
June 30, 2003.
The Company had no other real estate owned at either June 30, 2004 or
2003.
The following table shows the amounts of non-performing assets at the
dates indicated.
June 30, December 31,
------------------------ -------------
(dollars in thousands) 2004 2003 2003
---------- ---------- -------------
Nonaccrual Loans
Commercial $ 399 $ 486 $ 554
Consumer 65 - 100
Real estate - - -
Accrual loans-past due 90 days
Commercial - - -
Consumer - - -
Real estate - - -
Restructured loans - - -
Real estate owned
-------- --------- ------------
Total non-performing
assets $ 464 $ 486 $ 654
======== ========= ============
At June 30, 2004, there were no performing loans considered potential problem
loans, defined as loans which are not included in the past due, nonaccrual or
restructured categories, but for which known information about possible credit
problems causes management to be uncertain as to the ability of the borrowers to
comply with the present loan repayment terms.
NONINTEREST INCOME
Noninterest income primarily represents deposit account service charges and
fees, gains on the sale of loans, other noninterest loan fees, income from bank
owned life insurance ("BOLI") and other service fees. For the six months ended
June 30, 2004 noninterest income was $1.9 million which included $253 thousand
in gains on the sale of investment securities. This compared to $1.4 million of
noninterest income for the six months ended June 30, 2003 which included $214
thousand in gains on the sale of investment securities. For the quarter ending
June 30, 2004, the Company had $825 thousand in noninterest income compared to
$573 thousand for the same period in 2003. Gains on sales of loans was a
significant contributing factor to the improvement in noninterest income. The
Company is an active originator of SBA loans and its current practice is to sell
the insured portion of those loans at a premium. Income from this source was
$241 thousand for the six months ended June 30, 2004 compared to $153 thousand
for the six months ended June 30, 2003. For the comparative second quarters
ending June 30, the income from the sale of the insured portion of SBA loans was
$144 in 2004 and $0 in 2003. The Company also originates residential permanent
mortgage loans on a pre-sold basis, servicing released. Sales of these mortgage
loans yielded gains of $148 thousand in 2004 compared to $193 thousand in 2003.
The decrease in the premiums realized on the sale of mortgage loans can be
directly attributed to the rise in mortgage loan interest rates in the first
quarter of 2004. The slow down in this area could continue as mortgage rates
rise.
Other items in noninterest income increased 43% from $886 thousand for the six
months ended June 30, 2003 to $1.3 million for the six months ended June 30,
2004. This category includes deposit account service charges and noninterest
income fees such as documentation preparation and prepayment penalties. Income
for the six months ended June 30, 2004 was $709 thousand from deposit account
services charges, $65 thousand from SBA loan service fees and $123 thousand from
BOLI, versus $363 thousand from deposit account service charges, $37 thousand
from SBA service fees and $116 thousand from BOLI for the six month ended June
30, 2003.
15
NONINTEREST EXPENSE
Noninterest expense was $7.1 million for the six months ended June 30, 2004
compared to $5.1 million for the six months ended June 30, 2003. This
represented a period to period increase of 39%. The increase for the quarter
ending June 30 of each year was 37%, increasing from $2.7 million to $3.6
million. Increases in noninterest expense primarily relate to increases in
salaries and employee benefits which increased 42% from the first six months of
2003 to the first six months of 2004, from $2.7 million to $3.9 million.
Salaries and benefits increased 39% in the second quarter of 2004 from the
second quarter of 2003 to $1.9 million from $1.4 million. During the first
quarter of 2004, to accommodate the growth in assets, customer accounts and
offices experienced by the Bank in 2003 and to accommodate the growth
anticipated in 2004, a number of additions to staff were made in the lending and
operations (customer service) areas. Management felt that these additions and
the associated expenses were necessary to assure a continued growth pattern and
quality of service which characterized the Company since its inception. The
increase of 36% in premises and equipment for the six months ended June 30, 2004
compared to the six months ended June 30, 2003, from $934 thousand to $1.3
million, and 32% for the second quarter from $511 thousand to $672 thousand, can
be attributed to the expenses for the Bank's Rockville Pike Office, new deposit
and loan operations offices in Silver Spring acquired to house an expanded
support staff and the Bank's new office at 1228 Connecticut Avenue in
Washington, DC.
Other expenses, which increased 44% from $1.0 million to $1.5 million for the
six months ending June 30, 2004 compared to the six months ended June 30, 2003
and 39%, $549 thousand to $765 thousand for the second quarter of each period,
represent a number of expense categories ranging from business development and
office supplies to charitable contributions. Management monitors these expenses
closely and believes that the increase in them is consistent with the needs of
an aggressively growing Company. In future periods, noninterest expenses to
which the Company has not been subject to date, such as deposit insurance
premiums which may be required as a result of declines in the reserve ratios of
the deposit insurance funds, may have an adverse effect on the results of
operations of the Company.
FINANCIAL CONDITION
As of June 30, 2004, assets were $494 million and deposits were $403 million.
Assets grew by $51 million from December 31, 2003, and deposits grew by
approximately $67 million.
Loans
Total loans, excluding loans held for sale, increased approximately $31 million
from December 31, 2003 to June 30, 2004, from $318 million to $349 million.
Loans, net of amortized deferred fees and costs, at June 30, 2004, June 30, 2003
and December 31, 2003 are summarized by type as follows:
June 30, Percent June 30, Percent December 31, Percent
2004 of Total 2003 of Total 2003 of Total
---------- -------- --------- ------- ------------ --------
Commercial $ 84,248 24.1% $ 70,087 26.8% $ 93,112 29.3%
Real estate - commercial 173,938 49.9% 130,583 50.0% 149,783 47.3%
Construction 49,319 14.1% 24,111 9.2% 35,644 11.2%
Home equity 38,113 10.9% 31,908 12.2% 34,092 10.7%
Other consumer 3,397 1.0% 4,703 1.8% 4,902 1.5%
--------- ---- --------- ---- ---------- ----
Total loans 349,012 100% 261,392 100% 317,533 100%
Less: allowance for credit
losses (3,957) (2,952) (3,680)
--------- --------- ----------
Loans, net $ 345,055 $ 257,440 $ 313,853
========= ========= ==========
16
Deposits And Other Borrowings
The principal sources of funds for the Bank are core deposits, consisting of
demand deposits, NOW accounts, money market accounts, savings accounts and
relationship certificates of deposits, from the local market areas surrounding
the Bank's offices. The Bank's deposit base includes transaction accounts, time
and savings accounts and accounts which customers use for cash management and
which provide the Bank with a source of fee income and cross-marketing
opportunities as well as a low-cost source of funds. Time and savings accounts,
including money market deposit accounts, also provide a relatively stable and
low-cost source of funding.
For the six months ending June 30, 2004 from December 31, 2003, deposits grew
$67 million, from $336 million to $403 million.
Approximately 30% of the Bank's deposits are made up of certificates of
deposits, which are generally the most expensive form of deposit because of
their fixed rate and term. Certificates of deposit in denominations of $100
thousand or more can be more volatile and more expensive than certificates of
less than $100 thousand. However, because the Bank focuses on relationship
banking and does not accept brokered certificates, its historical experience has
been that large certificates of deposit have not been more volatile or
significantly more expensive than smaller denomination certificates. It has been
the practice of the Bank to pay posted rates on its certificates of deposit
whether under or over $100 thousand. The Bank has paid negotiated rates for
deposits in excess of $500 thousand but the rates paid have rarely been more
than 25 to 50 basis points higher than posted rates and deposits also have been
negotiated at below market rates. From time to time, when appropriate in order
to fund strong loan demand, the Bank accepts certificates of deposits, generally
in denominations of less than $100 thousand on a non brokered basis, from bank
and credit union subscribers to a wholesale deposit rate line. The Bank has
found rates on these deposits to be generally competitive with rates in our
market given the speed and minimal noninterest cost at which deposits can be
acquired. Although it is possible for rates to significantly exceed local market
rates it has not been the experience of the Bank. At June 30, 2004 the Bank held
$33 million of these deposits at an average rate of 2.51% as compared to $5.2
million of these deposits, at an average rate of 4.00% at June 30, 2003. During
the first quarter of 2004 management felt that there was an opportunity to
acquire longer maturities of these deposits at attractive interest rates and
again began accepting these deposits with maturities greater than one year.
Also, during the first quarter of 2004, the Company introduced a new certificate
of deposit program CDARS, which will provides its customers with access to
greater FDIC insurance coverage. Using CDARS the Bank can distribute customer
funds among other FDIC-insured banks and thrifts, allowing customer to manage
all their CDs through one relationship.
At June 30, 2004, the Company had approximately $96 million in noninterest
bearing demand deposits, representing 24% of total deposits. This compared to
$90 million of these deposits at December 31, 2003. These are primarily business
checking accounts on which the payment of interest is prohibited by regulations
of the Federal Reserve. Proposed legislation has been introduced in each of the
last several sessions of Congress which would permit banks to pay interest on
checking and demand deposit accounts established by businesses. If legislation
effectively permitting the payment of interest on business demand deposits is
enacted, of which there can be no assurance, it is likely that we may be
required to pay interest on some portion of our noninterest bearing deposits in
order to compete with other banks. Payment of interest on these deposits could
have a significant negative impact on our net income, net interest income,
interest margin, return on assets and equity, and indices of financial
performance.
As an enhancement to the basic noninterest bearing demand deposit account, the
Company offers a sweep account, or "customer repurchase agreement", allowing
qualifying businesses to earn interest on short term excess funds which are not
suited for either a CD investment or a money market account. The balances in
these accounts were $22 million at June 30, 2004 compared to $17 million at
December 31, 2003. Customer repurchase agreements are not deposits and are not
FDIC insured but are secured by US Treasury and/or US government agency
securities. These accounts are particularly suitable to businesses with
significant change in the levels of cash flow over a very short time frame often
measured in days. Attorney and title company escrow accounts are an example of
accounts which can benefit from this product, as are customers who may require
collateral for deposits in excess of $100 thousand but do not qualify for other
pledging arrangements. This program requires the Company to maintain a
sufficient investment securities level to accommodate the fluctuations in
balances which may occur in these accounts.
17
At June 30, 2004, the Company had no outstanding balance under its line of
credit provided by a correspondent bank. The Bank had $12.3 million of FHLB
short and long-term borrowings, as compared to $14.3 million at December 31,
2003. These advances are secured 50% by US government agency securities and 50%
by a blanket lien on qualifying loans in the Bank's commercial mortgage loan
portfolio. Through another subsidiary of the Company, Bethesda Leasing LLC,
there were outstanding long term borrowings of $195 thousand. This loan was
obtained to fund the purchase of an impaired loan from the Bank.
LIQUIDITY MANAGEMENT
Liquidity is the measure of the Bank's ability to meet the demands required for
the funding of loans and to meet depositor requirements for use of their funds.
The Bank's sources of liquidity consist of cash balances, due from banks, loan
repayments, federal funds sold and short term investments. These sources of
liquidity are supplemented by the ability of the Company and Bank to borrow
funds. The Company maintains a $10 million line of credit with a correspondent
bank, against which it has guaranteed a $195 thousand loan to its subsidiary
Bethesda Leasing. The Bank can purchase up to $17 million in federal funds on an
unsecured basis and enter into reverse repurchase agreements up to $10 million.
At June 30, 2004, the Bank was also eligible to take FHLB advances of up to $82
million, of which it had advances outstanding of $12.3 million.
The loss of deposits, through disintermediation, is one of the greater risks to
liquidity. Disintermediation occurs most commonly when rates rise and depositors
withdraw deposits seeking higher rates than the Bank may offer. The Bank was
founded under a philosophy of relationship banking and, therefore, believes that
it has less of an exposure to disintermediation and resultant liquidity concerns
than do banks which build an asset base on non-core deposits and other
borrowings. The history of the Bank includes a period of rising interest rates
and significant competition for deposit dollars. During that period the Bank
grew its core business without sacrificing its interest margin in higher deposit
rates for non-core deposits. There is, however, a risk that some deposits would
be lost if rates were to spike up and the Bank elected not to meet the market.
Under those conditions the Bank believes that it is well positioned to use other
liability management instruments such as FHLB borrowing, reverse repurchase
agreements and Bank lines to offset a decline in deposits in the short run. Over
the long term an adjustment in assets and change in business emphasis could
compensate for a loss of deposits. Under these circumstances, further asset
growth could be limited as the Bank utilizes its liquidity sources to replace,
rather than supplement, core deposits.
Certificates of deposit acquired through the subscription service may be more
sensitive to rate changes and pose a greater risk of disintermediation than
deposits acquired in the local community. The Bank has limited the amount of
such deposits to 25% of total assets, an amount which it believes it could
replace with alternative liquidity sources, although there can be no assurance
of this.
The mature earning pattern of the Bank is also a liquidity management resource.
The earnings of the Bank are now at a level that allows the it to pay higher
rates to retain deposits over a short period, while it adjusts its asset base
repricing to offset a higher cost of funds. The cost of retaining business in
the short run and the associated reduction in earnings can be preferable to
reducing deposit and asset levels and restricting growth.
At June 30, 2004, under the Bank's liquidity formula, it had $114 million of
liquidity representing 23% of total Bank assets.
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK
A fundamental risk in banking, outside of credit risk, is exposure to market
risk, or interest rate risk, since a bank's net income is largely dependent on
net interest income. The Bank's Asset Liability Committee (ALCO) of the Board of
Directors formulates and monitors the management of interest rate risk within
policies established by it and the Board of Directors. In its consideration of
establishing guidelines for levels and/or limits on market risk, the ALCO
committee considers the impact on earnings and capital, the level and direction
of interest rates, liquidity, local economic conditions, outside threats and
other factors. Banking is generally a business of attempting to match asset and
liability components to produce a spread sufficient to provide net income to the
bank at nominal rate risk. The Company, through ALCO, continually monitors the
interest rate environment in which it operates and adjusts rates and maturities
of its assets and liabilities to meet the market conditions. In the current low
interest rate environment, the Company is keeping its assets either variably
priced or with short term maturities or short average lives. At the same time it
strives to attract longer term liabilities to lock in the lower cost of funds.
In the current market, due to competitive factors and customer preferences, the
effort to attract longer term fixed priced liabilities has not been as
successful as the Company's best case asset liability mix would prefer. When
interest rates begin to rise, the Company expects that it will seek to keep
asset maturities and repricing periods short until rates appear to be nearing
their peak and then extend maturities to extend the benefit of higher rates.
There can be no assurance that the Company will be able to successfully carry
out this intention, as a result of competitive pressures, customer preferences
and the inability to perfectly forecast future interest rates.
18
One of the tools used by the Company to manage its interest rate risk is a
static GAP analysis presented below. The Company also uses an earning simulation
model on a quarterly basis to closely monitor interest sensitivity and to expose
its balance sheet and income statement to different scenarios. The model is
based on current Company data and adjusted by assumptions as to growth patterns,
noninterest income and noninterest expense and interest rate sensitivity, based
on historical data, for both assets and liabilities. The model is then subjected
to a "shock test" assuming a sudden interest rate increase of 200 basis points
or a decrease of 200 basis points, but not below zero. The results are measured
by the effect on net income. The Company, in its latest model, shows a positive
effect on income when interest rates immediately rise 200 basis points because
of the short maturities of assets and a negative impact if rates were to decline
further. With rates already at historic lows, a further reduction would reduce
income on earning assets which could not be offset by a corresponding reduction
in the cost of funds.
The following table reflects the result of a "shock test" simulation on the
March 31, 2004 (the most recent simulation available as of the date of filing of
this report) earning assets and interest bearing liabilities and the change in
net interest income resulting from the simulated immediate increase and decrease
in interest of 100 and 200 basis points. Also shown is the change in the Market
Value Portfolio Equity resulting from the simulation. The model as presented is
projected for one year. The Company does not expect a material variance in
results based on the June 30, 2004 analysis.
Change in interest Percentage change Percentage change
rates (basis in net interest Percentage change in Market Value of
points) income in net income Portfolio Equity
-------------------- --------------------- -------------------- ---------------------
+200 + 16.4% + 40.4% + 19.1%
+100 + 8.6% + 21.1% + 10.3%
0 - - -
-100 - 11.8% - 29.2% - 13.6%
-200 - 26.4% - 65.0% - 26.1%
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or repricing periods, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate mortgage loans,
have features that restrict changes in interest rates on a short-term basis and
over the life of the loan. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels could deviate significantly from those
assumed in calculating the tables. Finally, the ability of many borrowers to
service their debt may decrease in the event of a significant interest rate
increase.
GAP
Banks and other financial institutions are dependent upon net interest income,
the difference between interest earned on interest earning assets and interest
paid on interest bearing liabilities. In falling interest rate environments, net
interest income is maximized with longer term, higher yielding assets being
funded by lower yielding short-term funds; however, when interest rates trend
upward this asset/liability structure can result in a significant adverse impact
on net interest income. The current interest rate environment is signaling
steady to possibly higher rates. Management has for a number of months shortened
maturities in the Bank's investment portfolio and where possible also has
shortened repricing opportunities for new loan requests. While management
believes that this will help minimize interest rate risk in a rising rate
environment, there can be no assurance as to actual results.
19
GAP, a measure of the difference in volume between interest earning assets and
interest bearing liabilities, is a means of monitoring the sensitivity of a
financial institution to changes in interest rates. The chart below provides an
indicator of the rate sensitivity of the Company. A negative GAP indicates the
degree to which the volume of repriceable liabilities exceeds repriceable assets
in particular time periods. At June 30, 2004, the Bank had a positive GAP of 34%
out to three months and a cumulative positive GAP of 4% out to twelve months, as
opposed to a three month positive gap of 11.02% and a cumulative twelve month
negative gap of (10.06%) at December 31, 2003.
If interest rates are to rise, as forecasters are predicting, the Bank's
interest income and margin are expected to rise because of the favorable GAP
position. Because competitive market behavior does not necessarily track the
trend of interest rates but at times moves ahead of financial market influences,
the rise in the cost of liabilities may be greater than anticipated by the GAP
model. If this were to occur, the benefits of a rising interest rate environment
would not be as significant as management is expecting. Management has carefully
considered its strategy to maximize interest income by reviewing interest rate
levels, economic indicators and call features of some of its assets. These
factors have been thoroughly discussed with the Board of Directors Asset
Liability Committee and management believes that current strategies are
appropriate to current economic and interest rate trends. The negative GAP is
carefully monitored and will be adjusted as conditions change. The following GAP
table is presented on the basis of the Bank only.
GAP ANALYSIS
June 30, 2004
(dollars in thousands)
0-3 4-12 13-36 37-60 Over 60
Repriceable in: Months Months Months Months Months Total
----------------------------------------------------------------------------
ASSETS:
Investment securities $ 5,917 $ 3,101 $ 26,492 $ 15,865 $ 9,549 $ 60,924
Interest bearing deposits
in other banks 2,279 3,178 396 - - 5,936
Loans 196,790 13,146 38,333 86,259 17,055 351,583
Federal funds sold 23,980 - - - - 23,980
----------------------------------------------------------------------------
Total repriceable assets 228,966 19,425 65,221 102,124 26,604 442,340
============================================================================
LIABILITIES:
NOW accounts - 31,924 6,385 25,539 - 63,848
Savings and Money Market accounts 47,924 38,570 23,962 11,981 - 122,437
Certificates of deposit 22,068 72,435 25,343 865 - 120,711
Customer repurchase agreements and
Federal funds purchased 6,572 8,765 2,191 4,378 - 21,906
Other borrowing-short and long term 1,000 3,000 8,333 - - 12,333
----------------------------------------------------------------------------
Total repriceable liabilities 77,564 154,694 66,214 42,763 - 341,235
============================================================================
GAP $ 151,402 $(135,269) $ (993) $ 59,361 $ 26,604 $ 101,105
Cumulative GAP 151,402 16,133 15,140 74,501 101,105
Interval gap/earnings assets 34.23% (30.58)% (0.22)% 13.42% 10.40%
Cumulative gap/earning assets 34.23% 3.65% 3.43% 16.85% 23.22%
Although, NOW and MMA accounts are subject to immediate repricing, the Bank's
GAP model has incorporated a repricing schedule to account for the historical
lag in effecting rate changes and the amount of those rate changes relative to
the amount of rate change in assets.
CAPITAL RESOURCES AND ADEQUACY
The assessment of capital adequacy depends on a number of factors such as asset
quality, liquidity, earnings performance, changing competitive conditions and
economic forces, and the overall level of growth. The adequacy of the Company's
current and future capital needs is monitored by management on an ongoing basis.
Management seeks to maintain a capital structure that will assure an adequate
level of capital to support anticipated asset growth and to absorb potential
losses.
20
The capital position of the Company's wholly-owned subsidiary, the Bank,
continues to meet regulatory requirements. The primary indicators relied on by
bank regulators in measuring the capital position are the Tier 1 risk-based
capital, total risk-based capital, and leverage ratios. Tier 1 capital consists
of common and qualifying preferred stockholders' equity less goodwill. Total
risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and
a portion of the allowance for credit losses. Risk-based capital ratios are
calculated with reference to risk-weighted assets. The leverage ratio compares
Tier1 capital to total average assets. At June 30, 2004, the Company's and
Bank's capital ratios were in excess of the mandated minimum requirements.
The ability of the Company to continue to grow is dependent on its earnings and
the ability to obtain additional funds for contribution to the Bank's capital,
through additional borrowing, the sale of additional common stock, the sale of
preferred stock, or through the issuance of additional qualifying equity
equivalents, such as subordinated debt or trust preferred securities. On August
1, 2003 the Company completed its offering with the sale of 2,448,979 shares of
common stock for gross proceeds of approximately $30 million.
CAPITAL
The actual capital amounts and ratios for the Company and Bank as of June 30,
2004 and 2003 are presented in the table below:
To Be Well
For Capital Capitalized Under
In thousands Company Bank Adequacy Prompt Corrective
Actual Actual Purposes Action Provisions**
As of June 30, 2004 Amount Ratio Amount Ratio Ratio Ratio
------ ----- ------ ----- ----- -------------------
Total capital (to risk-weighted assets) $59,288 16.2% $42,236 11.0% 8.0% 10.0%
Tier 1 capital (to risk-weighted assets) $55,331 15.1% 38,293 10.0% 4.0% 6.0%
Tier 1 capital (to average Assets) $55,331 12.1% 38,293 9.0% 3.0% 5.0%
As of June 30, 2003
Total capital (to risk-weighted assets) $23,727 9.2% $27,793 10.9% 8.0% 10.0%
Tier 1 capital (to risk weighted assets) $20,866 8.1% 24,953 9.8% 4.0% 6.0%
Tier 1 capital ( to average assets) $20,866 6.2% 24,953 7.4% 3.0% 5.0%
** Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Bank, as well as restricting extension
of credit and transfers of assets between the Bank and the Company. At June 30,
2004, the Bank could pay dividends to the parent to the extent of its earnings
so long as it maintained required capital ratios.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to Item 2 of this report, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", under the caption
"Asset/Liability Management and Quantitative and Qualitative Disclosure About
Market Risk".
21
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, evaluated as of the last day of the period covered by this report the
effectiveness of the operation of the Company's disclosure controls and
procedures, as defined in Rule 13a-14 under the Securities and Exchange Act of
1934. Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
adequate. There were no changes in the Company's internal control over financial
reporting (as defined in Rule 13a-15 under the Securities Act of 1934) during
the quarter ended June 30, 2004 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
From time to time the Company may become involved in legal proceedings.
At the present time there are no proceedings which the Company believes will
have an adverse impact on the financial condition or earnings of the Company.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
(a) Modification of Rights of Registered Securities. None
(b) Issuance or Modification of Other Securities Affecting Rights of
Registered Securities. None
(c) Sales of Unregistered Securities. None
(d) Use of Proceeds. Not Applicable.
(e) Issuer Purchases of Securities. None
ITEM 3 DEFAULTS UPON SENIOR SECURITIES None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 17, 2004, the annual meeting of shareholders of the Company was held for
the purpose of (1) electing seven (7) directors to serve until the next annual
meeting and until their successors are duly elected and qualified; (2) to vote
on an amendment to the Company's 1998 Stock Option Plan which increases the
number of shares available for issuance under the plan by 300,000; and (3) to
vote on the adoption of the Company's Employee Stock Purchase Plan.
The name of each director elected at the meeting, and the votes cast for such
persons, who constitute the entire Board of Directors in office following the
meeting, are set forth below.
Name For Against/Withheld Abstentions
- ---------------------------- --------- ---------------- -----------
Leonard L. Abel 4,168,271 103,490 -
Leslie M. Alperstein, Ph.D. 4,239,705 32,056 -
Dudley C. Dworken 4,240,705 31,056 -
Michael T. Flynn 4,141,291 130,470 -
Eugene F. Ford, Sr. 4,240,085 31,676 -
Philip N. Margolius 4,240,305 31,456 -
Ronald D. Paul 4,168,891 102,870 -
22
The vote on the amendment to the Company's 1998 Stock Option Plan was as
follows:
For Against/Withheld Abstentions
- -------------------- ---------------------- -----------------
2,758,948 1,421,242 91,571
The vote on the adoption of the Company's Employee Stock Purchase Plan was as
follows:
For Against/Withheld Abstentions
- -------------------- ---------------------- -----------------
2,903,722 1,311,633 56,406
ITEM 5. OTHER INFORMATION None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Description of Exhibit
3(a) Certificate of Incorporation of the Company, as amended (1)
3(b) Bylaws of the Company (2)
10.1 1998 Stock Option Plan (3)
10.2 Employment Agreement between Michael Flynn and the Company (4)
10.3 Employment Agreement between Thomas D. Murphy and the Bank (4)
10.4 Employment Agreement between Ronald D. Paul and the Company (4)
10.5 Director Fee Agreement between Leonard L. Abel and the Company (4)
10.6 Employment Agreement between Susan G. Riel and the Bank (4)
10.7 Employment Agreement between Martha F. Tonat and the Bank (4)
10.8 Employment Agreement between Wilmer L. Tinley and the Bank (4)
10.9 Employee Stock Purchase Plan (5)
11 Statement Regarding Computation of Per Share Income
21 Subsidiaries of the Registrant
31.1 Rule 13a-14(a) Certification of Ronald D. Paul
31.2 Rule 13a-14(a) Certification of Wilmer L. Tinley
31.3 Rule 13a-14(a) Certification of Michael T. Flynn
32.1 Section 1350 Certification of Ronald D. Paul
32.2 Section 1350 Certification of Wilmer L. Tinley
32.3 Section 1350 Certification of Michael T. Flynn
- -----------------------------
(1) Incorporated by reference to the exhibit of the same number to the
Company's Quarterly Report on Form 10-QSB for the period ended
September 30, 2002.
(2) Incorporated by reference to Exhibit 3(b) to the Company's Registration
Statement on Form SB-2, dated December 12, 1997.
(3) Incorporated by reference to Exhibit 10.1 to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1998.
(4) Incorporated by reference to exhibits of the same number to the
Company's Annual Report on Form 10-K for the year ended December 31, 2003.
(5) Incorporated by reference to Exhibit 4 to the Company's Registration
Statement on Form S-8 (No. 333-116352)
(b) Reports on Form 8-K
On April 16, 2004, the Company filed a Current Report on Form 8-K,
reporting earnings for the quarter ended March 31, 2004.
On May 4, 2004 the Company filed a Current Report on Form 8-K,
providing expanded earnings information for the quarter ended March 31, 2004.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EAGLE BANCORP, INC.
Date: August 11, 2004 By: /s/ Ronal D. Paul
----------------------------------
Ronald D. Paul, President and CEO
Date: August 11, 2004 By: /s/ Wilmer L. Tinley
----------------------------------
Wilmer L. Tinley,
Senior Vice President and CFO
24