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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 September 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 November 4, 2004, the registrant had 5,408,169 shares of Common
Stock outstanding.
Item 1 - Financial Statements
EAGLE BANCORP, INC.
Consolidated Balance Sheets
September 30, 2004 and December 31, 2003
(dollars in thousands)
September 30,
2004 December 31,
ASSETS (unaudited) 2003
----------- -----------
Cash and cash equivalents $ 38,204 $ 25,103
Interest bearing deposits with other banks 9,612 4,332
Investment securities available for sale 77,606 82,581
Loans held for sale 3,138 3,649
Loans 363,824 317,533
Less allowance for credit losses (4,176) (3,680)
--------- ---------
Loans, net 359,648 313,853
Premises and equipment, net 5,425 4,259
Deferred income taxes 936 862
Other assets 13,118 8,358
--------- ---------
TOTAL ASSETS $ 507,687 $ 442,997
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing demand $ 113,730 $ 90,468
Interest bearing transaction 51,602 44,093
Savings and money market 116,529 104,429
Time, $100,000 or more 78,362 54,992
Other time 50,798 41,532
--------- ---------
Total deposits 411,021 335,514
Federal funds purchased and securities sold under agreement to repurchase 27,370 38,454
Other short-term borrowings 3,333 4,000
Long-term borrowings 8,110 10,588
Other liabilities 1,375 1,429
--------- ---------
Total liabilities 451,209 389,985
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; shares authorized 20,000,000, shares
issued and outstanding 5,407,889 (2004) and 5,359,153 (2003) 54 54
Additional paid in capital 46,802 46,406
Retained earnings 9,533 6,281
Accumulated other comprehensive income 89 271
--------- ---------
Total stockholders' equity 56,478 53,012
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 507,687 $ 442,997
========= =========
See notes to consolidated financial statements.
2
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(dollars in thousands, except per share amounts-unaudited)
Nine Months Nine Months Three Months Three Months
Ended Ended Ended Ended
Sept 30, 2004 Sept 30, 2003 Sept 30, 2004 Sept 30, 2003
------------- ------------- ------------- -------------
INTEREST INCOME:
Interest and fees on loans $ 15,157 $ 11,894 $ 5,407 $ 4,111
Taxable interest and dividends on
investment securities 1,639 1,280 584 364
Interest on balances with other banks 98 149 37 54
Interest on federal funds sold /other cash equivalents 241 37 118 12
-------- -------- -------- --------
17,135 13,360 6,146 4,541
-------- -------- -------- --------
INTEREST EXPENSE:
2,689 2,360 973 704
Interest on deposits
Interest on federal funds purchased and securities
sold under agreement to repurchase 61 68 27 10
Interest on short-term borrowings 112 257 27 113
Interest on long-term borrowings 266 363 88 79
-------- -------- -------- --------
Total interest expense 3,128 3,048 1,115 906
-------- -------- -------- --------
NET INTEREST INCOME 14,007 10,312 5,031 3,635
PROVISION FOR CREDIT LOSSES 457 730 227 305
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 13,550 9,582 4,804 3,330
-------- -------- -------- --------
NONINTEREST INCOME:
Service charges on deposit accounts 1,014 892 305 313
Gain (loss) on sale of investment
securities 193 214 (60) --
Gain on sale of loans 561 545 172 199
Other income 836 482 280 175
-------- -------- -------- --------
Total noninterest income 2,604 2,133 697 687
-------- -------- -------- --------
NONINTEREST EXPENSES:
Salaries and employee benefits 6,016 4,202 2,115 1,456
Premises and equipment expenses 1,971 1,498 701 564
Advertising 212 203 53 79
Outside data processing 469 407 183 143
Other expenses 2,418 1,610 910 562
-------- -------- -------- --------
Total noninterest expenses 11,086 7,920 3,962 2,804
-------- -------- -------- --------
NET INCOME BEFORE INCOME TAXES 5,068 3,795 1,539 1,213
INCOME TAXES 1,816 1,395 539 435
-------- -------- -------- --------
NET INCOME $ 3,252 $ 2,400 $ 1,000 $ 778
======== ======== ======== ========
INCOME PER SHARE:
Basic $ 0.60 $ 0.70 $ 0.18 $ 0.17
Diluted $ 0.58 $ 0.65 $ 0.18 $ 0.16
See notes to consolidated financial statements
3
EAGLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 and 2003
(dollars in thousands-unaudited)
Nine Months Ended Nine Months Ended
September 30, 2004 September 30, 2003
------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,252 $ 2,400
Adjustments to reconcile net income to net cash
Provided (used) by operating activities:
Decrease in deferred income taxes (74) (219)
Provision for credit losses 457 730
Depreciation and amortization 727 504
Gain on sale of loans (561) (545)
Origination of loans held for sale (18,412) (17,644)
Proceeds from sale of loans held for sale 19,484 21,805
Gain on sale of investment securities (193) (214)
Increase in other assets (760) (609)
Decrease (increase) in other liabilities 203 (505)
--------- ---------
Net cash provided by operating activities 4,123 5,703
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in interest bearing deposits with other banks (5,280) 1,758
Purchases of available for sale investment securities (190,580) (156,409)
Proceeds from maturities of available for sale securities 155,720 140,746
Proceeds from sale of available for sale securities 39,667 14,577
Decrease in federal funds sold -- 1,012
Net increase in loans (46,330) (50,400)
Bank premises and equipment acquired (1,893) (1,129)
Increase in BOLI contracts (4,000) (2,000)
--------- ---------
Net cash used by investing activities (52,696) (51,845)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 75,507 34,870
Decrease in federal funds purchased and
securities sold under agreement to repurchase (11,084) (5,045)
Decrease in other short term borrowings (667) (4,600)
Decrease in long-term borrowings (2,478) (2,701)
Issuance of common stock 396 29,887
--------- ---------
Net cash provided by financing activities 61,674 52,411
--------- ---------
NET INCREASE IN CASH 13,101 6,269
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 25,103 18,569
--------- ---------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 38,204 $ 24,838
========= =========
Supplemental cash flow information:
Interest paid $ 2,996 $ 2,958
Income taxes paid $ 1,520 $ 1,372
See notes to consolidated financial statements
4
EAGLE BANCORP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 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
Net income 3,252 3,252
Other comprehensive income:
Unrealized loss on securities available for
sale (net of related tax) (182) (182)
--------
Total other comprehensive income 3,070
---------------------------------------------------------------------------
Exercise of options for 48,866 shares of
common stock 396 396
---------------------------------------------------------------------------
Balances at September 30, 2004 $ 54 $ 46,802 $ 9,533 $ 89 $ 56,478
===========================================================================
Balances at January 1, 2003 $ 29 $ 16,541 $ 3,066 $ 392 $ 20,028
Net income 2,400 2,400
Other comprehensive income:
Unrealized loss on investment securities
available for sale (net of related tax) (414) (414)
--------
Total comprehensive income
1,986
---------------------------------------------------------------------------
Proceeds from sale of 2,448,979
shares of common stock 24 29,744 29,768
Exercise of options for 9,470
shares of common stock 119 119
---------------------------------------------------------------------------
Balances at September 30, 2003 $ 53 $ 46,404 $ 5,466 $ (22) $ 51,901
===========================================================================
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
nine months ended September 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)
September 30, 2004
------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U. S. Government Agency securities $ 46,572 $ 8 $ (103) 46,477
Mortgage backed securities 21,418 84 (131) 21,371
Federal Reserve Bank and
Federal Home Loan Bank stock 1,634 - - 1,634
Other equity investments 7,847 380 (103) 8,124
-------- -------- -------- --------
$ 77,471 $ 472 $ (337) $ 77,606
======== ======== ======== ========
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
======== ======== ======== ========
6
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
September 30, 2004 are as follows:
(in thousands)
Total
Less than More than Unrealized
Fair Value 12 Months 12 Months Losses
--------------------------------------------------------------------------
U. S. Government Agency securities $ 34,480 $ (61) $ (42) $ (103)
Mortgage backed securities 15,830 (31) (100) (131)
Other equity investments 1,049 (98) (5) (103)
-------- -------- -------- --------
Total $ 51,359 $ (190) $ (147) $ (337)
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 September 30, 2004 there were 54,360 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 nine months ended September 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 nine
months ended September 30.
7
Nine Months Three Months
Ended September 30, Ended September 30,
---------------------------- ---------------------------
2004 2003 2004 2003
------------- -------------- ------------- -------------
Net income, as reported $ 3,252 $ 2,400 $ 1,000 $ 778
Less pro forma stock-based compensation expense
determined under the fair value method, net of
related tax effects (724) (173) (6) -
------------- -------------- ------------- -------------
Pro forma net income $ 2,528 $ 2,227 $ 994 $ 778
============= ============== ============= =============
Net income per share:
Basic - as reported $ 0.60 $ 0.70 $ 0.18 $ 0.17
Basic - pro forma $ 0.52 $ 0.65 $ 0.18 $ 0.17
Diluted - as reported $ 0.47 $ 0.65 $ 0.18 $ 0.16
Diluted - pro forma $ 0.44 $ 0.61 $ 0.18 $ 0.16
8
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The following discussion provides information about the results of
operations, and financial condition, liquidity, and capital resources of the
Company and its subsidiary, the Bank. This discussion and analysis should be
read in conjunction with the unaudited Consolidated Financial Statements and
Notes thereto, appearing elsewhere in this report.
This report contains forward looking statements within the meaning of
the Securities Exchange Act of 1934, as amended, including statements of goals,
intentions, and expectations as to future trends, plans, events or results of
Company operations and policies and regarding general economic conditions. In
some cases, forward looking statements can be identified by use of such words as
"may", "will", "anticipate", "believes", "expects", "plans", "estimates",
"potential", "continue", "should", and similar words or phases. These statements
are based upon current and anticipated economic conditions, nationally and in
the Company's market, interest rates and interest rate policy, competitive
factors and other conditions which, by their nature, are not susceptible to
accurate forecast, and are subject to significant uncertainty. Because of these
uncertainties and the assumptions on which this discussion and the forward
looking statements are based, actual future operations and results in the future
may differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward looking statements.
GENERAL
Eagle Bancorp, Inc. is a growing, one-bank holding company
headquartered in Bethesda, Maryland. We provide general commercial and consumer
banking services through our wholly owned banking subsidiary EagleBank, a
Maryland chartered bank which is a member of the Federal Reserve System. We were
organized in October 1997 to be the holding company for the Bank. The Bank was
organized as an independent, community oriented, full-service alternative to the
super regional financial institutions, which dominate our primary market area.
The cornerstone of our philosophy is to provide superior, personalized service
to our customers. We focus on relationship banking, providing each customer with
a number of services, becoming familiar with and addressing customer needs in a
proactive, personalized fashion. The Bank currently has five offices serving
Montgomery County and two offices in the District of Columbia. 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 the first
quarter of 2005.
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.
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.
9
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.
RESULTS OF OPERATIONS
The Company reported net income of $3.3 million for the nine months and
$1.0 million for the three months ended September 30, 2004, as compared to net
income of $2.4 million for the nine months and $ 778 thousand for the three
months ended September 30, 2003. Income per basic share was $0.60 for the nine
months and $0.18 for the three months ended September 30, 2004, as compared to
$0.70 and $0.17 for the same periods in 2003. Income per diluted share was $0.58
for the nine months and $0.18 for the three months ended September 30, 2004, as
compared to $0.65 and $0.16 for the same periods in 2003. The Company had a
return on average assets of 0.9% and return on average equity of 7.9% for the
first nine months of 2004, as compared to returns on average assets and average
equity of 0.9% and 11.5%, respectively, for the same nine months of 2003.
10
The increase in net income for the nine months ended September 30, 2004
as compared to the same period in 2003, can be attributed to an increase of
35.8% in net interest income, resulting from an increase of 29.7% in average
earning assets and an increase in the net interest margin of 18 basis points.
Net interest income increased from $10.3 million to $14.0 million and average
earning assets increased from $337 million to $438 million. Net interest margin
increased from 4.09% for the first nine months of 2003 to 4.27% for the same
period in 2004 as market interest rates began to rise after falling through most
of 2003. On June 30, 2004, the Federal Reserve Bank announced its first increase
in the federal funds target rate in over two years. That 25 basis point increase
was followed by 25 basis point increases in August and September. The impact of
these increases has contributed to the improvement in the Company's margin.
While short term rates on earning assets have risen, the cost of short term
core, NOW and MMA accounts, deposits have not increased by comparable basis
points. The percentage of loans, which generally have higher yields than
securities and other earning assets, increased from 76% of average earning
assets in the nine month period of 2003 to 78% of earning assets in the same
period of 2004. Noninterest income increased 22%, to $2.6 million for the first
nine months of 2004, from $2.1 million in the same period of 2003. The net
income for the three months ended September 30, 2004, represents an increase of
28% from the same period in 2003, $1 million as compared to $778 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 nine months ended September 30, 2004, the Company recorded a
provision for credit losses in the amount of $457 thousand compared to $730
thousand for the first nine months of 2003. The provision for the third quarter
of 2004 was $227 thousand compared to $305 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 September 30, 2004, the
allowance for credit losses was $4.2 million, as compared to $3.7 million at
December 31, 2003. The Company had net recoveries of $39 thousand during the
first nine months of 2004. This compared to net charge-offs of $259 thousand for
the first nine months of 2003.
While the results of operations for the first nine months and third
quarter of 2004 compared to the first nine months and to the third quarter of
2003 were up, $3.3 million from $2.4 million, for the nine month periods and $1
million from $778 thousand for the quarterly periods, earnings per share were
down, $0.60 from $0.70 for the nine month period but up for the quarter from
$0.17 in 2003 to $0.18 in the third quarter of 2004. The increase in earnings
per share in the third quarter can be attributed to the commonality of share
basis for the computation. In August 2003, the Company closed its stock offering
and included an additional 2.4 million shares in its earnings per share
computation giving the effect of a reduced earnings per share. For the nine
month period return on average equity was down to 7.9% for 2004 from 11.5% for
2003. The reduction in this ratio is directly attributable to the increase in
equity of approximately $30 million resulting from the stock offering closed in
August 2003.
The following table sets out the annualized returns on average assets, returns
on average equity and equity to assets (average) for the nine months ended
September 30, 2004 and 2003 and the year ended December 31, 2003:
September September December
2003 2003 2004
---- ---- ----
Return on average assets 0.92% 0.88% 0.86%
Return on average equity 7.91% 11.50% 9.45%
Average equity to average assets 11.68% 7.66% 9.05%
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 nine
months of 2004 was $14.0 million compared to $10.3 million for the first nine
months of 2003 and for the third quarter of 2004 was $5.0 compared to $3.6
million for the third quarter of 2003.
11
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 nine months of 2004 from the
first nine months of 2003 by 20 basis points, to 3.92% from 3.72%; and margin
increased 18 basis points, to 4.27% from 4.09%. The increases by the Federal
Reserve in the federal funds target rate, beginning June 30 and continuing in
August and September, aggregated 75 basis points and contributed to and is
expected to continue to contribute to 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 1.58% during
the first nine months of 2003 to 1.31% for the same period in 2004, as it faced
lower yields on its earning assets, which declined from 5.29% during the first
nine months of 2003 to 5.23% in 2004. At the same time, the mix of earning
assets improved as higher yielding loans increased from 76% of earning assets in
2003 to 78% in 2004.
The declines in the yields on earning assets from the first nine months
of 2003 to the first nine 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 61 basis points from the first nine
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 2.35% during the first nine 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 September 30, 2004, the Bank had $9.6 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 recent increases in the federal
funds target rate are 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, 28 basis points from
September 2003 to September 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 to rise. 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 nine months of 2003 to the first nine months of 2004 was 27 basis
points which compares to a reduction of 6 basis points in the yield on earning
assets over the same period.
12
AVERAGE BALANCES, INTEREST YIELDS, AND RATES, AND NET INTEREST MARGIN
NINE MONTHS ENDED SEPTEMBER 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 $ 5,571 $ 98 2.35% $ 8,898 $ 149 2.24%
Loans 341,559 15,160 5.93% 256,012 11,893 6.21%
Investment securities 70,011 1,636 3.12% 67,941 1,280 2.51%
Federal funds sold and cash equivalents 20,510 241 1.57% 4,472 37 1.10%
------- ------ ------- ------
Total interest earning assets 437,651 17,135 5.23% 337,323 13,359 5.29%
Total noninterest earning assets 35,587 28,657
Less: allowance for credit losses 3,881 2,933
-------- --------
Total nonearning assets 31,706 25,724
-------- --------
TOTAL ASSETS $469,357 $363,047
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest bearing liabilities:
NOW accounts $ 49,512 50 0.13% $ 37,994 64 0.23%
Savings and money market accounts 118,293 854 0.96% 99,063 916 1.24%
Certificates of deposit 118,665 1,785 2.01% 77,392 1,380 2.38%
Customer repurchase agreements 16,647 61 0.49% 20,646 68 0.49%
Short-term borrowing 6,248 112 2.39% 7,476 177 3.17%
Long-term borrowing 9,128 266 3.89% 16,007 442 3.69%
------- ------ ------- ------
Total interest bearing liabilities 318,493 3,128 1.31% 258,578 3,047 1.58%
------- ------ ------- ------
Noninterest bearing liabilities:
Noninterest bearing deposits 94,396 68,779
Other liabilities 1,642 1,325
Escrowed subscriptions received - 6,539
-------- -------
Total noninterest bearing liabilities 96,038 76,643
Stockholders' equity 54,826 27,826
-------- -------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $469,357 $363,047
======== ========
Net interest income $ 14,007 $ 10,312
======== ========
Net interest spread 3.92% 3.72%
Net interest margin 4.27% 4.09%
13
ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses represents the expense recognized to
fund the allowance for credit losses. The amount of the allowance for credit
losses is based on many factors which reflect management's assessment of the
risk in the loan portfolio. Those factors include economic conditions and
trends, the value and adequacy of collateral, volume and mix of the portfolio,
performance of the portfolio, and internal loan processes of the Company and
Bank.
Management has developed a comprehensive review process to monitor the
adequacy of the allowance for credit losses. The review process and guidelines
were developed utilizing guidance from federal banking regulatory agencies. The
results of this review process, in combination with conclusions of the Bank's
outside loan review consultant, support management's view as to the adequacy of
the allowance as of the balance sheet date. During the first nine months of
2004, a provision for credit losses was made in the amount of $457 thousand
after considering the impact of $39 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 September 30, 2004, the Company had three loans classified as
nonaccrual in the amount of $2.6 million (includes one loan which has a US
Government SBA guarantee of $150 thousand) which are 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 $457 thousand in the first nine
months of 2004 compared to a provision for credit losses of $730 thousand in the
first nine 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.
14
The following table sets forth activity in the allowance for credit
losses for the periods indicated.
Nine Months Ended Year Ended
(dollars in thousands) September 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 (95) (318) (319) (192) -
Real estate - commercial - - - - -
Construction - - - - -
Home equity - - - - -
Other consumer (18) (8) (14) (40) (23)
----------- --------- -------- --------- ---------
Total (113) (326) (333) (232) (23)
----------- --------- -------- --------- ---------
Recoveries:
Commercial 152 64 68 26 -
Real estate - commercial - - - - -
Construction - - - - -
Home equity - - - - -
Other consumer - 3 4 18 13
----------- --------- -------- --------- ---------
Total 152 67 72 44 13
----------- --------- -------- --------- ---------
Net recoveries (charge-offs) 39 (259) (261) (188) (10)
----------- --------- -------- --------- ---------
Additions charged to operations 457 730 1,175 843 979
----------- --------- -------- --------- ---------
Balance at end of period $ 4,l76 $ 3,237 $ 3,680 $ 2,766 $ 2,111
=========== ========= ======== ========= =========
Annualized ratio of net
charge-offs during the during the
period to average loans
outstanding during the period N/A 0.13% 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 September 30, As of December 31,
---------------------------- -----------------------------
2004 2003
---------------------------- -----------------------------
Amount Percent (1) Amount Percent (1)
------------- -------------- ------------- ---------------
Commercial $ 2,486 23.6% $ 1,689 29.3%
Real estate 550 47.0 888 47.3
Construction 969 16.8 613 11.2
Home equity 108 11.8 171 10.7
Other consumer 63 0.8 72 1.5
Unallocated - - 247 -
------------- -------------- ------------- ---------------
Total allowance for credit losses $ 4,176 100% $ 3,680 100%
============= ============== ============= ===============
(1) Represents the percent of loans in category to gross loans
15
NON-PERFORMING ASSETS
The Company's non-performing assets, which are comprised of loans
delinquent 90 days or more, non-accrual loans, and other real estate owned,
totaled $2.6 million at September 30, 2004 compared to $476 thousand at
September 30, 2003 and $654 thousand at December 31, 2003. The percentage of
non-performing assets to total assets was 0.51% at September 30, 2004, compared
to 0.12% at September 30, 2003 and 0.15% at December 31, 2003.
Non-performing loans constituted all of the non-performing assets at
September 30, 2004, September 30, 2003 and December 31, 2003. Non-performing
loans at September 30, 2004 consist of $2.5 million loans on nonaccrual and one
impaired loan in the amount of $109 thousand compared to one loan over ninety
days delinquent of $210 thousand and one impaired loan of $266 thousand at
September 30, 2003. The increase in nonperforming loans is primarily the result
of one nonaccrual loan in the amount of $2.2 million. The Company believes that
this loan is well secured, by real estate collateral, and that it will be
resolved without loss to the Company in the fourth quarter of 2004.
The Company had no other real estate owned at either September 30, 2004
or 2003.
The following table shows the amounts of non-performing assets at the
dates indicated.
September 30, December 31,
------------------------ -------------
(dollars in thousands) 2004 2003 2003
---------- ---------- -------------
Nonaccrual Loans
Commercial $ 380 $ 486 $ 554
Consumer - - 100
Real estate 2,200 - -
Accrual loans-past due 90 days
Commercial - - -
Consumer - - -
Real estate - - -
Restructured loans - - -
Real estate owned
---------- ---------- -------------
Total non-performing assets $ 2,580 $ 486 $ 654
========== ========== =============
At September 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 nine months ended
September 30, 2004 noninterest income was $2.6 million, which included $193
thousand in net gains on the sale of investment securities. This compared to
$2.1 million of noninterest income for the nine months ended September 30, 2003,
which included $214 thousand in net gains on the sale of investment securities.
For the quarter ending September 30, 2004, the Company had $697 thousand in
noninterest income compared to $687 thousand for the same period in 2003. During
the third quarter of 2004 the Company sold securities recognizing a loss of $60
thousand compared to no gain or loss in the third quarter of 2003. 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 $346
thousand for the nine months ended September 30, 2004 compared to $316 thousand
for the nine months ended September 30, 2003. For the comparative third quarters
ending September 30, the income from the sale of the insured portion of SBA
loans was $105 thousand in 2004 and $153 thousand 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 $215 thousand in the
nine months of 2004 compared to $229 thousand in the same period 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.
16
Other items in noninterest income increased 36% from $1.4 million for the nine
months ended September 30, 2003 to $1.9 million for the nine months ended
September 30, 2004. This category includes deposit account service charges and
noninterest income fees such as documentation preparation and prepayment
penalties. Income for the nine months ended September 30, 2004 was $1.0 million
from deposit account services charges, $109 thousand from SBA loan service fees
and $280 thousand from BOLI, versus $892 thousand from deposit account service
charges, $59 thousand from SBA service fees and $180 thousand from BOLI for the
nine months ended September 30, 2003.
To increase noninterest income the Company is planning on establishing, as a
subsidiary of the Bank, a title company service which can be offered to its many
commercial borrowers. This venture is expected to begin operations in the first
quarter of 2005.
NONINTEREST EXPENSE
Noninterest expense was $11.0 million for the nine months ended September 30,
2004 compared to $7.9 million for the nine months ended September 30, 2003. This
represented a period to period increase of 39%. The increase for the quarter
ending September 30 of each year was 41%, increasing from $2.8 million to $4
million. Increases in noninterest expense primarily relate to increases in
salaries and employee benefits which increased 43% from the first nine months of
2003 to the first nine months of 2004, from $4.2 million to $6 million. Salaries
and benefits increased 45% in the third quarter of 2004 from the third quarter
of 2003 to $2.1 million from $1.5 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 33% in premises
and equipment for the nine months ended September 30, 2004 compared to the nine
months ended September 30, 2003, from $1.5 million to $2 million, and 24% for
the third quarter from $564 thousand to $701 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 50% from $1.6 million to $2.4 million for the
nine months ending September 30, 2004 compared to the nine months ended
September 30, 2003 and 62%, from $562 thousand for the third quarter of 2003 to
$910 thousand for the third quarter of 2004, 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 September 30, 2004, assets were $507.6 million and deposits were $411.0
million. Assets grew by $64.7 million from December 31, 2003, and deposits grew
by approximately $75.5 million.
Loans
Total loans, excluding loans held for sale, increased approximately $46.3
million from December 31, 2003 to September 30, 2004, from $317.5 million to
$363.8 million.
17
Loans, net of amortized deferred fees and costs, at September 30, 2004,
September 30, 2003 and December 31, 2003 are summarized by type as follows:
September 30, Percent September 30, Percent September 30, Percent
2004 of Total 2003 of Total 2003 of Total
------------- ------- ------------- ------- ------------- -------
Commercial $ 85,685 23.6% $ 70,087 26.8% $ 93,112 29.3%
Real estate 171,110 47.0% 130,583 50.0% 149,783 47.3%
Construction 61,054 16.8% 24,111 9.2% 35,644 11.2%
Home equity 42,961 11.8% 31,908 12.2% 34,092 10.7%
Other consumer 3,014 0.8% 4,703 1.8% 4,902 1.5%
---------- ---- ---------- ---- ---------- ----
Total loans 363,824 100% 261,392 100% 317,533 100%
==== ==== ====
Less: allowance for credit losses (4,176) (2,952) (3,680)
---------- ---------- ----------
Loans, net $ 359,648 $ 257,440 $ 313,853
========== ========== ==========
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 nine months ending September 30, 2004 from December 31, 2003, deposits
grew $75.5 million, from $335.5 million to $411.0 million.
Approximately 31% 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 September 30, 2004 the Bank
held $28.9 million of these deposits at an average rate of 2.30% as compared to
$28.8 million of these deposits, at an average rate of 3.43% at September 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 customers to
manage all their CDs through one relationship. Under this program, the Bank
receives a comparable volume of deposits from other participating institutions
thereby gaining the full advantage of its customers' deposits while providing a
service which allows all of the customers' deposits to be insured.
18
At September 30, 2004, the Company had approximately $113.7 million in
noninterest bearing demand deposits, representing 27.6% of total deposits. This
compared to $90.5 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 $20..2 million at September 30, 2004 compared to $17.0
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.
At September 30, 2004, the Company had no outstanding balance under its line of
credit provided by a correspondent bank. The Bank had $11.3 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. At September 30, 2004, the Bank also had federal funds purchased of
$7.0 million. This borrowing was paid in full the first week of October. Through
another subsidiary of the Company, Bethesda Leasing LLC, there were outstanding
long term borrowings of $110 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 $110 thousand loan to its subsidiary
Bethesda Leasing. The Bank can purchase up to $17.0 million in federal funds on
an unsecured basis and enter into reverse repurchase agreements up to $10.0
million. At September 30, 2004, the Bank was also eligible to take FHLB advances
of up to $82 million, of which it had advances outstanding of $11.3 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.
19
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 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 September 30, 2004, under the Bank's liquidity formula, it had $106 million
of liquidity representing 22% 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.
One of the tools used by the Company to manage its interest rate risks is a
static GAP analysis presented below. The Company also uses an earnings
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 near historic lows, 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
September 30, 2004, earning assets and interest bearing liabilities and the
change in net interest income resulting from the simulated immediate increase
and decrease in interest of 100 and 200 basis points. Also shown is the change
in the Market Value Portfolio Equity resulting from the simulation. The model as
presented is projected for one year.
Percentage change in
Change in interest Percentage change in net Percentage change Market Value of
rates (basis points) interest income in net income Portfolio Equity
-------------------- ------------------------ -------------------- ---------------------
+200 + 15.4% + 39.0% + 17.2%
+100 + 7.9% + 19.9% + 9.2%
0 - - -
-100 - 10.3% - 25.9% - 11.6%
-200 - 24.8% - 62.7% - 25.2%
20
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.
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 September 30, 2004, the Bank had a positive GAP
of 28% out to three months and a cumulative positive GAP of 5% out to twelve
months, as opposed to a three month positive gap of 11% and a cumulative twelve
month negative gap of (10%) at December 31, 2003.
If interest rates continue to rise at a measured pace, 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 position is carefully monitored and is adjusted as conditions
change. The following GAP table is presented on the basis of the Bank only.
21
GAP ANALYSIS
September 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 $ 1,050 $ 20,522 $ 30,107 $ 9,996 $ 7,805 $ 69,480
Interest bearing deposits in other banks -- 9,540 -- -- -- 9,540
Loans 205,006 14,232 39,623 84,529 22,304 365,694
Federal funds sold and cash equivalents 11,049 -- -- -- -- 11,049
--------- --------- --------- --------- --------- ---------
Total repriceable assets $ 217,105 $ 44,294 $ 69,730 $ 94,525 $ 30,109 $ 455,763
========= ========= ========= ========= ========= =========
LIABILITIES:
NOW accounts $ -- $ 25,801 $ 5,160 $ 20,641 $ -- $ 51,602
Savings and Money Market accounts 45,420 37,045 22,710 11,354 -- 116,529
Certificates of deposit 31,987 75,323 21,091 759 -- 129,160
Customer repurchase agreements and
Federal funds purchased 13,111 8,148 2,037 4,074 -- 27,370
Other borrowing-short and long term 1,000 2,333 8,000 -- -- 11,333
--------- --------- --------- --------- --------- ---------
Total repriceable liabilities $ 91,518 $ 148,650 $ 58,998 $ 36,828 $ -- $ 335,994
========= ========= ========= ========= ========= =========
GAP $ 125,587 $(104,356) $ 10,732 $ 57,697 $ 30,109 $ 119,769
Cumulative GAP 125,587 21,231 31,963 89,660 119,769
Interval gap/earnings assets 27.56% (22.90)% 2.36% 12.66% 6.61%
Cumulative gap/earning assets 27.56% 4.66 % 7.02% 19.68% 26.29%
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.
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 September 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.
22
CAPITAL
The actual capital amounts and ratios for the Company and Bank as of September
30, 2004 and 2003 are presented in the table below:
To Be Well
For Capital Capitalized Under
Company Bank Adequacy Prompt Corrective
Actual Actual Purposes Action Provisions**
In thousands Amount Ratio Amount Ratio Ratio Ratio
------ ----- ------ ----- ----- -----
As of September 30, 2004
Total capital (to risk-weighted Assets) $60,565 14.5% $43,431 10.7% 8.0% 10.0%
Tier 1 capital (to risk-weighted assets) $56,389 13.5% 39,300 9.7% 4.0% 6.0%
Tier 1 capital (to average Assets) $56,389 12.0% 39,300 8.4% 3.0% 5.0%
As of September 30, 2003
Total capital (to risk-weighted assets) $55,137 17.1% $33,662 11.9% 8.0% 10.0%
Tier 1 capital (to risk
weighted assets) $51,900 16.1% 30,436 10.0% 4.0% 6.0%
Tier 1 capital (to average assets) $51,900 14.3% 30,436 8.3% 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 September
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".
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 September 30, 2004 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
23
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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Sales of Unregistered Securities. None
(b) Use of Proceeds. Not Applicable.
(c) Issuer Purchases of Securities. None
ITEM 3 DEFAULTS UPON SENIOR SECURITIES None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None
ITEM 5. OTHER INFORMATION None.
(a) Required 8-K Disclosures. None
(b) Changes in Procedures for Director Nominations, by Security Holders. None
ITEM 6. EXHIBITS
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)
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EAGLE BANCORP, INC.
Date: November 8, 2004 By: /s/ Ronald D. Paul
---------------------------------------
Ronald D. Paul, President and CEO
Date: November 8, 2004 By: /s/ Wilmer L. Tinley
-----------------------------------------------
Wilmer L. Tinley, Senior Vice President and CFO
25