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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] Annual report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the fiscal year ended December 31, 2004
[ ] Transition report under 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 Identification Number)
incorporation or organization)
7815 Woodmont Avenue, Bethesda, Maryland 20814
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including area code: (301) 986-1800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock $.01
par value
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 if disclosure of delinquent filers in pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether this registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [X] No [ ]
The aggregate market value of the outstanding Common Stock held by nonaffiliates
as of June 30, 2004 was approximately $85.6 million.
As of March 9, 2005, the number of outstanding shares of the Common Stock, $.01
par value, of Eagle Bancorp, Inc. was 7,060,784.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's definitive Proxy Statement for the
Annual Meeting of Shareholders, to be held on
May 17th, 2005 are incorporated by reference in part III hereof.
FORM 10-K CROSS REFERENCE OF MATERIAL INCORPORATED BY REFERENCE
The following shows the location in this Annual Report on Form 10-K or the
Company's Proxy Statement for the Annual Meeting of Stockholders to be held on
May 17, 2005, of the information required to be disclosed by the United States
Securities and Exchange Commission Form 10-K. References to pages only are to
pages in this report.
PART I ITEM 1. BUSINESS. See "Business" at Pages 46 through 55.
ITEM 2. PROPERTIES. See "Properties" at Page 55.
ITEM 3. LEGAL PROCEEDINGS. From time to time the Company is a
participant in various legal proceedings incidental to its
business. In the opinion of management, the liabilities (if
any) resulting from such legal proceeding will not have a
material effect on the financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No
matter was submitted to a vote of the security holders of
the Company during the fourth quarter of 2004.
PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS. See "Market for Common Stock and Dividends" at Page
22.
ITEM 6. SELECTED FINANCIAL DATA. See "Six Year Summary of Financial
Information" at Page 3.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation" at
Pages 4 through 22.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
See "Interest Rate Risk Management - Asset/Liability
Management and Quantitative and Qualitative Disclosure About
Market Risk" at Page 19.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See
Consolidated Financial Statements and Notes thereto at Pages
24 through 45.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE. None.
ITEM 9A. CONTROLS AND PROCEDURES. See "Controls and Procedures" at
Page 55 and "Management Report on Internal Control Over
Financial Reporting" at page 56.
ITEM 9B. OTHER INFORMATION. None.
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The
information required by this Item is incorporated by
reference to, the material appearing under the captions
"Election of Directors"; "Executive Officers who are Not
Directors"; and "Compliance with Section 16(a) of the
Securities Exchange Act of 1934" in the Proxy Statement. The
Company has adopted a code of ethics that applies to its
Chief Executive Officer and Chief Financial Officer. A copy
of the code of ethics will be provided to any person,
without charge, upon written request directed to Thomas D.
Murphy, EVP and COO, Eagle Bancorp, Inc., 7815 Woodmont
Avenue, Bethesda, Maryland 20814.
ITEM 11. EXECUTIVE COMPENSATION. The information required by this
Item is incorporated by reference to the material appearing
under the captions "Election of Directors - Director's
Compensation"; "- Executive Compensation" and "- Report of
the Compensation Committee" and "Stock Performance
Comparison" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS. See "Securities
Authorized for Issuance Under Equity Compensation Plans at
page 23. The other information required by this Item is
incorporated by reference to the material appearing under
the captions "Voting Securities and Principal Shareholders".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The
information required by this Item is incorporated by
reference to, the material appearing under the caption
"Election of Directors - Certain Relationships and Related
Transactions" in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. The information
required by this Item is incorporated by reference to the
material appearing under the caption "Independent Registered
Public Accounting Firm - Fees Paid to Independent Accounting
Firm" in the Proxy Statement.
PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. See "Exhibits
and Financial Statements" at Page 58.
2
SIX YEAR SUMMARY OF SELECTED FINANCIAL DATA
The following table shows selected historical financial data for the Company.
You should read it together with the Company's audited consolidated financial
statements appearing elsewhere in this report.
Year Ended December 31, 5 Year
--------------------------------------------------------------------------- Compound
(dollars in thousand except per 2004 2003 2002 2001 2000 1999 Growth Rate
share) ------------ ------------ ----------- ------------- ----------- ----------- ------------
SELECTED BALANCES- PERIOD END
Total assets $553,453 $442,997 $347,829 $236,833 $164,082 $113,218 37%
Total stockholders' equity 58,534 53,012 20,028 17,132 15,522 13,675 34%
Total loans (net) 411,269 313,853 234,094 180,145 116,576 63,276 45%
Total deposits 462,287 335,514 278,434 195,688 135,857 90,991 38%
RESULTS OF OPERATIONS
Interest income $24,195 $18,404 $16,661 $14,121 $10,501 $5,170 36%
Interest expense 4,328 3,953 5,170 5,998 4,549 2,022 16%
Net interest income 19,867 14,451 11,491 8,123 5,952 3,148 45%
Provision for credit losses 675 1,175 843 979 581 424 10%
Net interest income after
provision for credit losses 19,192 13,275 10,648 7,144 5,371 2,724 48%
Noninterest income 3,753 2,850 2,107 1,324 351 211 79%
Noninterest expense 14,952 11,007 8,530 6,445 4,664 3,786 32%
Income (loss) before taxes (1) 7,993 5,118 4,225 2,023 1,058 (851) 66%
Income tax expense 2,906 1,903 1,558 269 - -
Net income or loss (1) $5,087 $3,215 $2,667 $1,754 $1,058 $(851) 48%
PER SHARE DATA (2)
Net income (loss), basic (1) $0.72 $0.63 $0.71 $0.47 $0.28 $(0.22) 27%
Net income (loss), diluted (1) 0.69 0.59 0.66 0.45 0.28 (0.22) 26%
Book value 8.29 7.61 5.32 4.55 4.14 3.65 18%
FINANCIAL RATIOS
Return on average assets 1.04% 0.86% 0.91% 0.88% 0.78% (1.07)%
Return on average equity 9.16% 9.45% 14.51% 10.56% 7.41% (5.91)%
Average equity to average assets 11.38% 9.05% 6.28% 8.36% 10.40% 18.22%
Net interest margin 4.35% 4.14% 4.16% 4.31% 4.62% 4.29%
Efficiency ratio (3) 63.30% 63.62% 62.73% 68.22% 74.00% 112.71%
(1) Compounded growth rate computed on a four year basis due to negative values
in year 1.
(2) Adjusted for all years presented giving retroactive effect to the 1.3 to one
stock split in the form of a 30% stock dividend paid on February 28, 2005,
and in the form of a 40% stock dividend paid on June 15, 2001 and a five for
four stock split in the form of a 25% stock dividend paid on March 31, 2000.
(3) Computed by dividing noninterest expense by the sum of net interest income
and noninterest income.
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion provides information about the results of
operations, financial condition, liquidity, and capital resources of Eagle
Bancorp, Inc. (the "Company") and its subsidiaries, EagleBank (the "Bank") and
Bethesda Leasing, LLC ("Bethesda Leasing"). This discussion and analysis should
be read in conjunction with the audited 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 phrases. 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 three offices in the District of Columbia. In May 2004, the Bank
opened a branch in the Dupont Circle area of the District of Columbia. In
January 2005, the Bank opened a branch in McPherson Square area of 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.
The Company offers full commercial banking services to our business and
professional clients as well as complete consumer banking services to
individuals living 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.
To afford greater service to commercial customers, the Bank has formed
a title company, Eagle Land Title Company, LLC, which is a wholly owned
subsidiary of the Bank.
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 must 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.
4
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 of Financial Accounting Standards ("SFAS") No. 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 an allowance to take into
consideration external, environmental factors. 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 which
have been classified. Classified loans 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 has been
classified as substandard or doubtful a specific reserve is established based on
the Company's assessment of the impairment that may be associated with the
individual loan. Specific allowances constituted 5.45% of the total allowance at
December 31, 2004. The formula allowance is used to estimate the loss on
internally risk rated loans, exclusive of those classified loans with a specific
allowance. All loans are grouped by type (commercial, commercial real estate,
construction, home equity or consumer). Each loan type is assigned an allowance
and risk classification 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 formula allowance comprised 65.18% of
the total allowance at December 31, 2004. The allowance associated with external
or environmental factors is used to estimate the potential 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
environmental allowance captures potential risk losses whose impact on the
portfolio have occurred but have yet to be recognized in either the formula or
specific allowance. This component comprised 29.37% of the total allowance at
December 31, 2004.
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 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 Notes 1 and 4 to the Consolidated Financial
Statements and the discussion under the caption "Allowance for Credit Losses"
below.
5
RESULTS OF OPERATIONS
The Company reported net income of $5.09 million for the year ended
December 31, 2004, as compared to income of $3.22 million for the year ended
December 31, 2003 and income of $2.67 million for the year ended December 31,
2002. Income per basic share was $0.72 for the year ended December 31, 2004, as
compared to $0.63 for 2003 and $0.71 for 2002. Income per diluted share was
$0.69 for 2004, $0.59 for 2003 and $0.66 for 2002. The Company had a return on
average assets of 1.04% and return on average equity of 9.16% in 2004, as
compared to returns on average assets and average equity of 0.86% and 9.45%,
respectively in 2003 and 0.91% and 14.51% in 2002. The Company recorded an
income tax expense of $2.90 million for 2004, compared to $1.90 million for 2003
and $1.56 million for 2002, the first full year for which it recognized tax
expense.
During 2004, the Company recorded a provision for credit losses in the
amount of $675 thousand. At December 31, 2004, the allowance for credit losses
was $4.24 million, compared to $3.68 million at December 31, 2003. The Company
had net charge-offs of $115 thousand in 2004 or 0.03% of average loans.
For the quarter ending December 31, 2004 the Company had net income of
$1.8 million, $0.26 per basic share and $0.25 per diluted share. This compared
to net income of $815 thousand, $0.12 per basic and $0.12 per diluted share for
the fourth quarter of 2003.
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 in 2004 was $19.87
million compared to $14.45 million in 2003 and $11.49 million in 2002.
The table labeled "Average Balances, Interest Yields and Rates and Net
Interest Margin" shows 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.
The net interest spread increased in 2004 from 2003 by 22 basis points to 3.99%
from 3.77%; and margin increased 21 basis points, to 4.35% from 4.14%. The
increase in margin is attributable to an increase in the yield on earning assets
of 4 basis points, from 5.27% for 2003 to 5.31% in 2004, and a decrease in the
cost of interest bearing liabilities of 18 basis points from 1.50% to 1.32%,
during the same period.
The yield on earning assets increased from 5.27% for the year ended
December 31, 2003 to 5.31% for the year ended December 31, 2004, and the rates
paid on interest bearing liabilities decreased from 1.50% for the year ended
December 31, 2003 to 1.32% for the year ended December 31, 2004. The average
yield on loans fell 8 basis points from 2003 to 2004, following a decline of 71
basis points from 2002 to 2003. These declines reflect the impact of the
significant rate reductions effected by the Federal Reserve in 2001 and
continued into 2002 and 2003 with the last rate reduction occurring in June
2003. The Federal Reserve began a measured increase in rates by 25 basis points
in June 2004. The increases in rates continued over the balance of 2004 ending
with a cumulative increase of 125 basis points. On a comparative basis, the
increases in loan rates over the last six months of 2004 did not fully offset
the low interest levels prevalent in the first six months. Current levels of
interest yields on Bank loans exceed those of 2003 and the higher yields are
expected to offset projected pressures on the margin from increased cost of
funds. The yield in the investment portfolio increased by 48 basis points from
2003 to 2004 as the Company maintained a portfolio of short term fixed rate
securities, mortgage backed securities ("MBS") and equity securities,
principally REITs, which provided higher yields than the short term debt
securities and MBS. The average federal funds rate, reflecting the increase in
short term market rates, increased 65 basis points from 1.15% for 2003 to 1.80%
for the year 2004.
6
On the liability side, management had aggressively reduced rates on
deposit accounts throughout the period of declining interest rates and into the
first six months of 2004. The reduction in the rate on total interest bearing
liabilities from 2003 to 2004 was 18 basis points. Management notes that
competitive pressures are increasing to raise interest rates on interest bearing
liabilities and does not expect to maintain the exceptionally low level of its
cost of funds.
The Company is well positioned to benefit from further increases in
interest rates as is reflected in the "shock" analysis included later in this
presentation. However, as yields on earning assets are expected to increase, so
does the cost of funds. During the period of increasing short term market rates,
beginning in June, competition has maintained the rates paid on core interest
bearing liabilities. There are indications that, with strong loan demand
throughout the market area, there will be greater upward pressure on the
Company's cost of funds throughout 2005.
7
AVERAGE BALANCES, INTEREST YIELDS AND RATES AND NET INTEREST MARGIN
Year Ended December 31,
---------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------ ---------------------------- -------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
(dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------- --------- --------- ---------- -------- -------- ---------- ---------- ---------
ASSETS:
Interest earning assets:
Interest bearing deposits with
other banks $ 6,432 $ 152 2.36% $ 7,843 $ 180 2.29% $ 2,868 $ 77 2.67%
Loans (1) 353,537 21,393 6.05 266,811 16,354 6.13 210,303 14,379 6.84
Investment securities 70,720 2,195 3.10 69,086 1,807 2.62 57,983 2,124 3.68
Federal funds sold and cash
equivalents 25,290 455 1.80 5,417 62 1.15 5,166 81 1.56
-------- ------- -------- ------ -------- -------
Total interest earning assets 455,979 24,195 5.31 349,157 18,403 5.27 276,320 16,661 6.03
-------- ------- -------- ------ -------- -------
Total noninterest earning assets 35,810 29,687 19,057
Less: allowance for credit losses (3,936) (3,042) (2,456)
-------- -------- --------
Total noninterest earning assets 31,874 26,645 16,601
-------- -------- --------
TOTAL ASSETS $487,853 $375,802 $292,921
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
NOW accounts $ 50,599 $ 72 0.14% $ 38,820 $ 79 0.20% $ 30,886 $ 96 0.31%
Savings and money market accounts 121,477 1,185 0.98 100,226 1,161 1.16 81,509 1,598 1.96
Certificates of deposit $100,000
or more 71,360 1,408 1.97 46,381 953 2.05 41,683 1,337 3.21
Other time deposits 51,504 1,090 2.12 35,407 906 2.56 36,902 1,301 3.70
-------- ------- -------- ------ -------- -------
Total interest bearing 294,940 3,755 1.27 220,834 3,099 1.40 190,980 4,332 2.27
deposits
Federal funds purchased and
securities sold under
agreement to repurchase 20,258 105 0.52 22,146 108 0.49 19,535 230 1.18
Short term borrowings 5,271 171 3.24 7,979 266 3.33 4,670 177 3.79
Long term borrowings 7,210 297 4.12 12,489 480 3.84 11,159 431 3.86
-------- ------- -------- ------ -------- -------
Total interest bearing
liabilities 327,679 4,328 1.32 263,448 3,953 1.50 226,344 5,170 2.28
-------- ------- -------- ------ -------- -------
Noninterest bearing liabilities:
Noninterest bearing demand
deposits 102,848 72,119 46,930
Other liabilities 1,819 6,207 1,266
-------- -------- --------
Total noninterest bearing 104,667 78,326 48,196
liabilities
Stockholders' equity 55,507 34,028 18,381
-------- -------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $487,853 $375,802 $292,921
======== ======== ========
Net interest income $19,867 $14,450 $11,491
======= ======= =======
Net interest spread 3.99% 3.77% 3.75%
Net interest margin 4.35% 4.14% 4.16%
- ------------------
(1) Loans placed on nonaccrual status are included in average balances. Net loan
fees and late charges in interest income on loans totaled $595 thousand, $181
thousand and $(19) thousand for 2004, 2003 and 2002, respectively.
8
The rate/volume table shows the composition of the change in net
interest income for the periods indicated, as allocated between the change in
net interest income due to changes in the volume of average earning assets and
interest bearing liabilities, and the changes in net interest income due to
changes in interest rates. As the table shows, the increase in net interest
income in 2004 as compared to 2003 is primarily due to the growth in the volume
of earning assets as it was in the period 2002 to 2003.
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
2004 compared with 2003 2003 compared with 2002
------------------------------------ ------------------------------------
Total Total
Due to Increase Due to Increase
(dollars in thousands) Volume Due to Rate (Decrease) Volume Due to Rate (Decrease)
--------- ------------ ------------- ---------- ----------- -------------
INTEREST EARNED ON:
Loans $5,317 $(278) $5,039 $3,463 $(1,487) $1,976
Investment securities 43 345 388 290 (607) (317)
Interest bearing bank deposits (32) 4 (28) 115 (12) 103
Federal funds sold and other
cash equivalents 369 24 393 3 (22) (19)
------ ---- ------ ------ ------- ------
Total interest income 5,697 95 5,792 3,871 (2,128) 1,743
------ ---- ------ ------ ------- ------
INTEREST PAID ON:
NOW accounts 23 (30) (7) 16 (33) (17)
Savings and MMA accounts 246 (222) 24 217 (654) (437)
Certificates of deposit 934 (295) 639 72 (851) (779)
Customer repurchase
agreements and federal
funds purchased (16) - (16) 4 (143) (139)
Other borrowings (230) (35) (265) 216 (61) 155
------ ---- ------ ------ ------- ------
Total interest expense 957 (582) 375 525 (1,742) (1,217)
------ ---- ------ ------ ------- ------
NET INTEREST INCOME $4,740 $677 $5,417 $3,346 $ (386) $2,960
====== ==== ====== ====== ======= ======
NONINTEREST INCOME
The 31.3% increase in noninterest income from $2.85 million in 2003 to
$3.75 million in 2004, is attributed primarily to increased gains on sales of
assets and other loan related noninterest income. Service charge income was
essentially flat for 2004, when compared to 2003, increasing only $40 thousand,
to $1.26 million. While in 2002 and 2003 there was reasonable growth in service
charge income because of declining interest rates, service charge income
increases slowed in 2004 because of rising interest rates. Many accounts which
pay service charges are charged on the basis of activity and the computed charge
is offset by an earnings credit based on market interest rates. As short term
interest rates began to rise in June 2004, customers began to receive a greater
credit to offset these activity fees leading to reduced service charges paid by
those customers. A significant contributor to noninterest income is the income
from the sale of assets. 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.
The Company also originates residential construction and permanent loans on a
pre-sold basis, servicing released. Income from these sources increased from
$671 thousand in 2003 to $952 thousand in 2004. Both of these programs were
enhanced, through the increase of staff, during 2004 and plans are to continue
the emphasis on these programs in 2005. The continued success of the mortgage
program, and to a lesser degree the SBA program, will be influenced by the level
of interest rates. As rates rise mortgage activity generally decreases.
Other noninterest income increased 67.2 % in 2004 from $652 thousand
for the year ended December 31, 2003 to $1.09 million for the same period in
2004. This category includes noninterest income fees such as documentation
preparation and prepayment penalties which increased 77.3% from $313 thousand in
2003 to $555 thousand in 2004. In addition, income for the year ended December
31, 2004 was $153 thousand from SBA servicing fees and $385 thousand from Bank
Owned Life Insurance ("BOLI"), versus $89 thousand from SBA servicing fees and
$250 thousand from BOLI for the year ended December 31, 2003. SBA loan servicing
income is expected to increase as the number of loans originated and serviced by
the Bank increases. Income from BOLI is expected to increase as interest rates
increase; however, there is no assurance that the BOLI contract issuer(s) will
increase the interest on contracts as interest rates rise. The Bank purchased $4
million in new BOLI contracts in 2004, increasing its holdings from $6 million
to $10 million, and may elect to purchase additional contracts in the future.
9
NONINTEREST EXPENSE
Noninterest expenses were $14.95 million in 2004, a 35.9% increase over
the $11.00 million noninterest expense in 2003, which was a 29.0% increase over
noninterest expense of $8.53 million in 2002. The increases in noninterest
expense are consistent with the overall growth in assets of 24.9% from December
31, 2003 to December 31, 2004, and management's internal expectations.
The most significant noninterest expense item is salaries and employee
benefits, which were $8.20 million for the year ended December 31, 2004, an
increase of 40.3% over the $5.85 million for the year ended December 31, 2003,
which reflected a 31.3% increase over the $4.45 million for 2002. In 2004, the
additional salary and benefit costs reflected additional staffing in the loan
area, particularly in the SBA and residential mortgage lending groups, and
operations area, required to keep pace with the growth of the Bank, and a full
year of salary expense for the Rockville Pike office and eight months of
salaries at the Dupont Circle office. In addition to increases attributable to
new functions and offices, the market for employees is very strong and
competitive and has forced salary and benefit packages to higher levels for new
and existing personnel.
The increase in premises and equipment expenses of 25.8% from 2003 to
2004, from $2.11 million to $2.66 million can be attributed to a full year of
expenses for the Rockville Pike office, the Dupont Circle office and a new
operations center, additional equipment and software and maintenance expenses
for loan and deposit operations departments.
Other expenses increased 34.2% from the year ended December 31, 2003 to
the year ended December 31, 2004, including a 17.5% increase in outside data
processing expense. Other expenses increased 40.5% from $2.25 million in 2003 to
$3.16 million in 2004 and increased 28.9% from $1.75 million in 2002 to $2.25
million in 2003. In 2005, the Company expects to experience slower growth in
other expenses as fidelity and directors and officers insurance premiums have
been stabilized for one and one-half years and as management implements new
expense control procedures. 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 affect on the results of operations of the Company.
INCOME TAX
The Company had income tax expense of $2.90 million in 2004 compared to
$1.90 million in 2003, resulting in an effective tax rate of 36.4% and 37.2%
respectively.
FINANCIAL CONDITION
The Company ended the year with total assets of $553.45 million, an
increase of 24.9% from assets of $443.00 million at December 31, 2003. At
December 31, 2004 total deposits were $462.29 million as compared to $335.51
million at December 31, 2003, an increase of 38%. Loans were at $415.51 million
at December 31, 2004 as compared to $317.53 million at December 31, 2003, an
increase of 30.9%. Other liabilities consisting of customer repurchase
agreements, Federal Home Loan Bank ("FHLB") borrowings, a leveraged repurchase
agreement program and an advance to Bethesda Leasing by a correspondent bank and
guaranteed by the Company, decreased 42.8% from $53.04 million at December 31,
2003 to $30.32 million at December 31, 2004. The principal reduction resulted
from a leveraged transaction of $19 million entered into by the Company in late
2003 and paid off in January 2004. Net loans increased 31.0% from $313.85
million at December 31, 2003 to $ 411.27 million at December 31, 2004. Other
earning assets (investment securities, federal funds sold and other cash
equivalents, interest bearing deposits and loans held for sale) increased $373
thousand or 0.40%.
10
INVESTMENT SECURITIES AND OTHER EARNING ASSETS
The Company's investment securities portfolio is comprised primarily of
U.S. Treasury and Agency securities with maturities not exceeding seven years,
except mortgage pass-through securities which have average expected lives of
less than six years but contractual maturities of up to thirty years. Federal
funds sold also represent a significant earning asset and are sold, on an
unsecured basis, only to highly rated banks, in limited amounts both in the
aggregate and to any one bank.
The investment portfolio declined $18.48 million from $82.58 million at
December 31, 2003 to $64.10 million at December 31, 2004. The decline in the
investment portfolio provided the liquidity necessary to fund the strong loan
growth in 2004. The tables below and Note 3 to the Consolidated Financial
Statements provide additional information regarding the Company's investment
securities.
The Company classifies all investment securities as available for sale
("AFS"). This method of accounting requires that investment securities be
reported at their fair value and the difference between the fair value and
amortized cost (the purchase price adjusted by any accretion or amortization) be
reported in the equity section as accumulated other comprehensive income, net of
deferred taxes. At December 31, 2004, the Company had a net unrealized gain in
AFS securities of $148 thousand as compared to a net unrealized gain in AFS
securities of $407 thousand at December 31, 2003. The accumulated comprehensive
income component of these unrealized gains was $98 thousand and $271 thousand,
respectively.
In 2003, the Bank began using excess liquidity to invest in
certificates of deposit of other banks, which generally offer more favorable
rates than traditional short term investment securities. These deposits are in
insured institutions, and are generally in amounts of $100 thousand or less. At
December 31, 2004 and 2003 the Bank had $9.59 million and $4.33 million,
respectively, of this type of investment.
The following table provides information regarding the composition of
the Company's investment securities portfolio at the dates indicated. Amounts
are reported at estimated fair value.
December 31,
-----------------------------------------------------------------------
2004 2003 2002
---------------------- ---------------------- -----------------------
Percent Percent Percent
(dollars in thousands) Balance of Total Balance of Total Balance of Total
----------- ---------- --------- ----------- ----------- ----------
U.S. Treasury - - - - $ 5,504 7.8%
U.S. Government agency obligations $34,184 53.4% $25,373 30.7% 20,114 28.6
Mortgage backed securities 23,066 35.9 51,842 62.8 43,268 61.0
Federal Reserve and Federal Home
Loan Bank Stock 1,956 3.1 1,670 2.0 1,564 2.3
Other equity investments 4,892 7.6 3,696 4.5 225 0.3
------- ---- ------- ---- ------ ----
Total $64,098 100% $82,581 100% $70,675 100%
======= === ======= === ======= ===
The following table provides information, on an amortized cost basis,
regarding the contractual maturity and weighted average yield of the investment
portfolio at December 31, 2004. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
11
After One Year After Five Years
One Year or Less Through Five Years Through Ten Years After Ten Years Total
------------------- ------------------- -------------------- ------------------ -------------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
(dollars in thousands) Value Yield Value Yield Value Yield Value Yield Value Yield
--------- --------- -------- ---------- -------- --------- -------- -------- -------- ---------
U.S. Government Agency
obligations $5,995 2.18% $28,483 2.91% - 0.00% - 0.00% $34,478 2.75%
Mortgage backed securities - 0.00 - 0.00 $15,137 3.58 $ 8,040 4.29% 23,177 3.83
Federal Reserve and
Federal Home Loan
Bank Stock - 0.00 - 0.00 - 0.00 1,956 4.09 1,956 4.09
Other Equity Investments - 0.00 - 0.00 - 0.00 4,339 2.75 4,339 2.75
------ ---- ------- ---- ------- ---- ------- ---- ------- ----
Total $5,995 2.18% $28,483 2.91% $15,137 3.58% $14,335 3.76% $63,950 3.17%
====== ==== ======= ==== ======= ==== ======= ==== ======= ====
At December 31, 2004, there were no issuers, other than the U.S.
Government and its agencies, whose securities owned by the Company had a book or
fair value exceeding ten percent of the Company's stockholders' equity.
LOAN PORTFOLIO
In its lending activities, the Bank seeks to develop sound credits with
customers who will grow with the Bank. There has been an effort to aggressively
build the loan portfolio and earnings, while maintaining the highest asset
quality. Loan growth over the past three years was strong, with loans
outstanding reaching $415.51 million at December 31, 2004 from $317.53 million
at December 31, 2003, an increase of $97.98 million or 30.9% after increasing
34.1% from $236.86 million at December 31, 2002.
During 2001, the Bank became active in the origination and selling of
both residential mortgage loans and the insured portion of SBA loans. In 2004,
in addition to the loans the Bank held for its portfolio, it originated
approximately $29.59 million in residential mortgage and SBA loans which were
sold. The Bank sells residential mortgages, servicing released, but retains
servicing on the sold SBA loans. As of December 31, 2004, the Bank serviced
$16.44 million in loans which are not reflected on the balance sheet. At
December 31, 2004, there were $ 2.21 million of loans held for sale and at
December 31, 2003 there were $3.65 million of such loans.
The Bank is primarily business oriented in its development focus. This
is demonstrated by the 84.7% of the loan portfolio which is in commercial, real
estate and construction loans as compared to 15.3% in home equity and other
consumer loans.
The following table shows the composition of the loan portfolio by type
of loan at the dates indicated.
December 31,
-------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ----------------- ------------------ ------------------ -------------------
(dollars in thousands) Percent Percent Percent Percent Percent
Balance of Total Balance of Total Balance of Total Balance of Total Balance of Total
----------------- ----------------- ------------------ ------------------ -------------------
Commercial $101,911 24.5% $ 93,112 29.3% $ 64,869 27.5% $ 49,432 27.1% $ 37,123 31.5%
Real Estate-commercial 189,708 45.7 142,819 45.1 111,262 46.9 86,553 47.5 58,214 49.4
Real Estate-residential 11,717 2.8 6,964 2.2 3,699 1.6 - - - -
Construction 60,258 14.5 35,644 11.2 23,180 9.8 15,512 8.5 9,952 8.4
Home equity 49,632 11.9 34,092 10.7 30,631 12.9 26,656 14.6 9,129 7.8
Other consumer 2,283 0.6 4,902 1.5 3,219 1.3 4,103 2.3 3,300 2.9
----------------- ----------------- ------------------ ------------------ -------------------
Total loans 415,509 100% 317,533 100% 236,860 100% 182,246 100% 117,718 100%
Less: allowance for
credit losses 4,240 3,680 2,766 2,111 1,142
-------- -------- --------- --------- --------
Loans, net $411,269 $313,853 $234,094 $ 180,145 $116,576
======== ======== ========= ========= =========
12
LOAN MATURITY
The following table sets forth the term to contractual maturity of the
loan portfolio as of December 31, 2004;
Due In
-----------------------------------------------------------------------
(dollars in thousands) One Year One to Over Five to Over Ten
Total or Less Five Years Ten Years Years
------------- ----------- ------------ ----------- -----------
Commercial $101,911 $35,002 $ 37,850 $ 18,248 $10,811
Real estate-commercial 189,708 16,216 61,442 95,204 16,846
Real estate-residential 11,717 7,192 2,650 53 1,822
Construction 60,258 33,922 17,565 5,789 2,982
Home equity 49,632 2,417 1,397 733 45,085
Other consumer 2,283 208 1,342 10 723
-------- ------- -------- -------- -------
Total loans $415,509 $94,957 $122,246 $120,037 $78,269
======== ======= ======== ======== =======
Loans with:
Predetermined fixed interest
rate $ 85,586 $ 6,228 $ 50,294 $ 16,518 $12,546
Floating interest rate 329,923 88,729 71,952 103,519 65,723
-------- ------- -------- -------- -------
Total loans $415,509 $94,957 $122,246 $120,037 $78,269
======== ======= ======== ======== =======
Loans which have adjustable rates and fixed rate loans are all shown in
the period of contractual maturity. Demand loans, having no contractual maturity
and overdrafts are reported as due in one year of less.
As noted above, the majority of the loan portfolio consists of
commercial, construction and commercial real estate loans, primarily made in the
Washington, D.C. metropolitan area and secured by real estate or other
collateral in that market. At December 31, 2004, approximately 84.7% of the loan
portfolio was comprised of such loans. Although these loans are made to a
diversified pool of unrelated borrowers across numerous businesses, adverse
developments in the metropolitan Washington D.C. real estate market or economy
could have an adverse impact on this portfolio of loans and the Company's income
and financial position. At December 31, 2004, the Company had no other
concentrations of loans in any one industry exceeding 10% of its total loan
portfolio. An industry for this purpose is defined as a group of counterparties
that are engaged in similar activities and have similar economic characteristics
that would cause their ability to meet contractual obligations to be similarly
affected by changes in economic or other conditions.
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 2004, a provision for credit
losses was made in the amount of $675 thousand before net charge-offs of $115
thousand. A full discussion of the accounting for allowance for credit losses is
contained in Note 1 to the Consolidated Financial Statements; activity in the
allowance for credit losses is contained in Note 4 to the Consolidated Financial
Statements. 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 December 31, 2004, the Company had $156 thousand of loans classified
as nonaccrual, of which $43 thousand was guaranteed by the SBA. There were no
loans past due over ninety days and still accruing interest at December 31,
2004. Please refer to Note 1 of the notes to the Consolidated Financial
Statements under the caption "Loans" for a discussion of the Company's policy
regarding impairment of loans.
13
The provision for credit losses was $675 thousand in 2004 compared to a
provision for credit losses of $1.18 million in 2003. The lower provision for
2004, during which loans grew over 30%, maintains the allowance at a level
management believes to be adequate, and is supported by the very thorough review
and monitoring process applied by the Company and reviewed by an independent
outside consultant. Of the many factors considered in determining the
appropriate maintenance level of the allowance are the Company's loss
experience, quality of performing loans as reflected in delinquency experience
and the amount of impaired loans. As reported for the third quarter of 2004, the
Company had one loan in excess of $2 million which was impaired. This loan was
paid in full during the fourth quarter with the collection of all principal,
interest and expenses associated with the credit. The payoff of this loan
resulted in releasing approximately $400 thousand of the allowance which had
been specifically allocated for this loan. The related portion of the reserve
and the exceptionally low ratios of net loan charge-offs for 2004 and the year
end ratio of impaired loans to total loans, 0.03% and 0.04%, respectively,
reduced the need for a higher provision. Supporting the overall level of the
allowance at $4.2 million, in addition to the mentioned factors, were other
environmental factors applied in the analysis process. These included, but were
not limited to, peer group experience, the local and national economy, and
concentration of loans held by the Company.
As the portfolio and allowance review process evolves, 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.
Management, aware of the strong loan growth experienced by the Company
and the problems which could develop in an unmonitored environment, is intent on
maintaining a strong credit review system and risk rating process. The Company
established a Credit Department in January 2003 to provide independent analysis
of credit requests and manage classified credits. The Credit Department has over
time developed and implemented additional analytical procedures for evaluating
credit requests, further refining the Bank's risk rating system, and monitoring
portfolio quality. The entire loan portfolio analysis process is an ongoing and
evolving practice directed at maintaining a portfolio of quality credits and
quickly identifying any weaknesses before they become irremediable.
The following table sets forth activity in the allowance for credit
losses for the periods indicated.
(dollars in thousands) Year Ended December 31,
--------------------------------------------------------------
2004 2003 2002 2001 2000
----------- --------- -------- --------- ---------
Balance at beginning of year $3,680 $2,766 $2,111 $1,142 $579
Charge-offs:
Commercial (257) (319) (192) - -
Other consumer (35) (14) (40) (23) (18)
------ ------ ------ ------ ----
Total (292) (333) (232) (23) (18)
------ ------ ------ ------ ----
Recoveries:
Commercial 175 68 26 - -
Other consumer 2 4 18 13 -
------ ------ ------ ------ ----
Total 177 72 44 13 -
------ ------ ------ ------ ----
Net charge-offs (115) (261) (188) (10) (18)
------ ------ ------ ------ ----
Additions charged to operations 675 1,175 843 979 581
------ ------ ------ ------ ----
Balance at end of period $4,240 $3,680 $2,766 $2,111 $1,142
====== ====== ====== ====== ======
Ratio of net charge-offs during
the period to average loans
outstanding during the period 0.03% 0.10% 0.09% 0.01% 0.02%
------ ------ ------ ------ ----
14
The following table shows the allocation of the allowance by loan
category and the percent of loans each category bears to total loans. 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) Year Ended December 31,
----------------------------------------------------------------------------------
2004 2003 2002
----------------------- ---------------------- -----------------------
Amount Percent (1) Amount Percent (1) Amount Percent (1)
-------- ----------- ------- ----------- -------- -----------
Commercial $1,963 24.5% $1,689 29.3% $1,134 27.5%
Real estate-commercial 1,426 45.7 850 45.1 835 46.9
Real estate - residential 105 2.8 38 2.2 27 1.6
Construction 431 14.5 613 11.2 231 9.8
Home equity 223 11.9 171 10.7 253 12.9
Other consumer 58 0.6 72 1.5 83 1.3
Unallocated 34 - 247 - 203 -
------ ---- ------ ---- ------ ----
Total allowance for credit
losses $4,240 100% $3,680 100% $2,766 100%
====== ==== ====== ==== ====== ====
(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 and nonaccrual loans, totaled $156 thousand at
December 31, 2004 compared to $654 thousand at December 31, 2003. The percentage
of non-performing assets to total assets was 0.03% at December 31, 2004 compared
to 0.15% at December 31, 2003.
Non-accrual loans constituted all of the non-performing assets at
December 31, 2004 and December 31, 2003, $156 thousand at December 31, 2004 as
compared to $654 thousand at December 31, 2003.
The Company had no other real estate owned at either December 31, 2004
or 2003.
The following table shows the amounts of non-performing assets at the
dates indicated.
(dollars in thousands) Year End December 31,
---------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
Nonaccrual Loans
Commercial $156 $554 $147 - -
Consumer - 100 - - -
Accrual loans-past due 90 days
Commercial - - 818 $19 $15
---------- ---------- ---------- ---------- ----------
Total non-performing
assets $156 $654 $965 $19 $15
========== ========== ========== ========== ==========
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 certificates of deposits, primarily 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 year ended December 31, 2004, deposits grew $126.78 million,
from $335.51 million to $462.29 million or 37.8%
15
Approximately 32.2% 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 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 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 have been negotiated at below market rates. During periods of
strong loan demand, the Bank, may from time to time, accept 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 these deposits can be acquired, although it is possible for rates
to significantly exceed local retail market rates. At December 31, 2004 the Bank
held $24.9 million of these deposits at an average rate of 2.70% as compared to
$27.0 million of these deposits, at an average rate of 2.88% at December 31,
2003. During the second quarter of 2004 management felt that there was an
opportunity to acquire longer maturities of these deposits at an attractive
interest rate and again began accepting these deposits with maturities greater
than one year. At December 31, 2004 the average life of these deposits was 10.1
months, while at December 31, 2003 the average life was 17.4 months.
At December 31, 2004, the Company had $130.31 million in noninterest
bearing demand deposits, representing a 44.0% increase from $90.47 million in
noninterest bearing 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. For additional information relating to the composition of the
Bank's deposit base, see average balance tables above and Note 6 to the
Consolidated Financial Statements.
As an enhancement to the basic noninterest bearing deposit account, the
Company offers a sweep account, referred to as a "customer repurchase
agreement", allowing qualifying businesses to earn interest on short term excess
funds which are not suited for either a certificate of deposit investment or a
money market account. The balances in these accounts were $23.9 million at
December 31, 2004, a 49.4% increase from December 31, 2003 balance of $16.09
million. The level of balances in this category of liabilities at December 31,
2003 was attributable to a slowdown in real estate related activity, from which
a significant portion of these funds are derived. The December 31, 2004 level of
balances is more characteristic of the balances generally maintained in the
repurchase product. 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 peaks and valleys 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 December 31, 2004, the Bank also had $6.33 million of FHLB
borrowings. This short-term liability is the residual balance of long-term
borrowings incurred prior to 2004, which come due in 2005. During 2004, in order
to better manage its asset/liability structure, the Company reduced its level of
long-term borrowings, through a voluntary prepayment of $4 million of long-term
FHLB borrowings, in excess of mandatory principal reductions. For additional
information regarding other borrowings, see Note 7 to the Consolidated Financial
Statements.
16
The following table provides information regarding the Bank's deposit
composition at the dates indicated and shows the average rate paid on the
interest bearing deposits in December of each year.
(dollars in thousands) December 31,
------------------------------------------------------------------------------
2004 2003 2002
---------------------- ---------------------- ---------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
---------------------- ---------------------- ---------------------
Noninterest bearing demand $130,309 $ 90,468 - $46,930 -
Interest bearing transaction accounts 57,063 0.17% 44,093 0.14% 39,968 0.30%
Savings and money market accounts 126,299 0.99 104,492 0.94 92,324 1.40
Time, $100,000 or more 99,882 2.05 54,992 1.74 46,989 2.67
Other time 48,734 2.17 41,532 2.25 34,721 3.04
-------- -------- --------
Total $462,287 $335,514 $278,434
======== ======== ========
The following table indicates the time remaining until maturity for the
Bank's certificates of deposit of $100,000 or more as of December 31, 2004.
Due in:
3 months or less $15,754
Over 3 through 6 months 14,715
Over 6 through 12 months 60,915
Over 12 months 8,498
-------
Total $99,882
=======
The following table provides information regarding the Company's
short-term borrowings for the periods indicated. See Note 7 to the Consolidated
Financial Statements for additional information regarding the Company's
borrowings.
(dollars in thousands)
Maximum
Amount
Federal funds purchased and Outstanding Ending
securities sold under agreement at Any Average Average Ending Average
to repurchase Month End Balance Rate Balance Rate
- --------------------------------- ------------- ----------- --------- ---------- ---------
Year Ended December 31,
2004 $34,727 $20,258 0.52% $23,983 0.50%
2003 38,454 22,146 0.49 38,454 0.78
2002 26,560 19,535 1.18 25,054 0.50
Other short-term borrowings
Year Ended December 31,
2004 $11,000 $ 5,721 3.24% $ 6,333 3.73%
2003 13,570 7,979 3.33 4,000 2.79
2002 8,600 4,670 3.81 8,600 4.00
CONTRACTUAL OBLIGATIONS
The Company has various financial obligations, including contractual
obligations and commitments that may require future cash payments.
The following table presents, as of December 31, 2004, significant
fixed and determinable contractual obligations to third parties by payment date.
17
Within One One to Three to Over Five
(dollars in thousands) Year Three Years Five Years Years Total
------------ ---------- ------------ ----------- ----------
Deposits without a stated
maturity (1) $313,691 - - - $313,691
Time deposits (1) 128,504 $19,556 $ 835 - 148,895
Short term borrowings 30,316 - - - 30,316
Operating lease obligations 1,377 2,948 2,474 $2,873 9,672
-------- ------- ------ ------ --------
Total $473,888 $22,504 $3,309 $2,873 $502,574
======== ======= ====== ====== ========
(1) Includes accrued interest payable through December 31, 2004.
OFF BALANCE SHEET ARRANGEMENTS
The Company is party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit and standby
letters of credit. They involve, to varying degrees, elements of credit risk in
excess of the amount recognized in the balance sheets. The contract or notional
amounts of those instruments reflect the extent of involvement the Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments. A summary
of the Company's commitments is as follows:
(dollars in thousands) December 31,
-------------------------------
2004 2003
------------- --------------
Loan commitments $ 57,617 $58,433
Unused lines of credit 105,590 95,535
Letters of credit 3,370 2,660
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation of the party. Collateral held varies, but may
include certificates of deposit, accounts receivable, inventory, property and
equipment, residential real estate and income producing commercial properties.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The majority of the guarantees are short term, and the remaining
guarantees of $915 thousand expire in decreasing amounts through 2008. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
as specified above and is required in instances which the Company deems
necessary. At December 31, 2004, approximately 99% percent of the dollar amount
of standby letters of credit was collateralized.
With the exception of these off-balance sheet arrangements, the Company
has no off-balance sheet arrangements that have or are reasonably likely to have
a current or future effect on the Company's financial condition, changes in
financial condition, revenues or expenses, results of operations, capital
expenditures or capital resources, that is material to investors.
18
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 no borrowings or guarantees at December
31, 2004. The Bank can purchase up to $24 million in federal funds on an
unsecured basis and enter into reverse repurchase agreements up to $10 million.
At December 31, 2004, there were no federal funds purchased and no reverse
repurchase agreements. At December 31, 2004, the Bank was also eligible to make
FHLB advances of up to $110 million, of which it had advances outstanding of
$6.3 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 interest rates were to increase and the Bank
elected not to meet the market rates being offered by competitors. 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 less than 25% of total deposits, an amount which it believes
it could replace with alternative liquidity sources, although there can be no
assurance of this.
The mature earning pattern of the Bank is also a liquidity management
resource for the Bank. The earnings of the Bank are now at a level that allows
the Bank to pay higher rates to retain deposits over a short period, while it
adjusts it 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 year end 2004, under the Bank's liquidity formula, it had $74
million of liquidity representing 13.4% of total Bank assets.
INTEREST RATE RISK MANAGEMENT
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. As interest rates continue to rise, the Company expects that it will
seek to keep asset maturities and repricing periods short until rates appear to
be nearing their top 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.
19
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 still near 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 December 31, 2004, earning assets and interest bearing liabilities and the
change in net interest income resulting from the simulated immediate increase
and decrease in interest of 100 and 200 basis points. Also shown is the change
in the Market Value Portfolio Equity resulting from the simulation. The model as
presented is projected for one year.
Percentage change in
Change in interest Percentage change in net Percentage change in Market Value of
rates (basis points) interest income net income Portfolio Equity
-------------------- ------------------------ -------------------- ---------------------
+200 +15.7% +36.5% +16.8%
+100 + 8.0% +18.7% + 8.6%
0 - - -
-100 -10.6% -24.8% -10.9%
-200 -24.8% -57.7% -24.1%
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 interest
rate environment, there can be no assurance as to actual results.
20
GAP, a measure of the difference in volume between the repricing
characteristics of 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 December 31, 2004, the Bank has a positive GAP of 38.40% out to three months
and 8.02% out to twelve months.
If interest rates were to decline, the Bank's interest income and
margin may be adversely affected. Because of the positive GAP measure in the 0 -
3 month period, a decline in the prime lending rate will reduce income on
repriceable assets within thirty to sixty days, while the repricing of
liabilities will occur in later time periods. This will cause a short term
decline in net interest income and net income in a static environment.
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 ALCO Committee and management believes that current strategies are
appropriate to current economic and interest rate trends. The GAP position is
carefully monitored and will be adjusted as conditions change.
GAP ANALYSIS
(dollars in thousands)
0-3 4 - 12 13 - 36 37 - 60 Over 60
Repriceable in: Months Months Months Months Months Total
------------- ------------ ------------ ------------ ------------ -----------
ASSETS:
Investment securities $ 5,939 $ 10,589 $26,786 $ 10,962 $ 9,822 $ 64,098
Interest bearing deposits in
other banks 7,909 1,685 - - - 9,594
Loans held for sale 2,208 - - - - 2,208
Loans 238,844 10,153 44,385 90,197 31,930 415,509
Federal funds sold and cash
equivalents 33,995 - - - - 33,995
-------- --------- ------- -------- -------- --------
Total repriceable assets $288,895 $ 22,427 $71,171 $101,159 $ 41,752 $525,404
======== ========= ======= ======== ======== ========
LIABILITIES:
NOW accounts - $ 28,532 $ 5,706 $ 22,825 $ - $ 57,063
Savings and Money Market accounts $ 49,281 40,057 24,641 12,320 - 126,299
Certificates of deposit 29,679 98,546 19,556 835 - 148,616
Federal funds sold and securities
sold under agreements to
repurchase 7,195 9,585 2,398 4,805 - 23,983
Other borrowing-short and long
term 1,000 5,333 - - - 6,333
-------- --------- ------- -------- -------- --------
Total repriceable liabilities $ 87,155 $ 182,053 $52,301 $ 40,785 $ - $362,294
======== ========= ======= ======== ======== ========
GAP $201,740 $(159,626) $18,870 $ 60,374 $ 41,752
Cumulative GAP 201,740 42,114 60,984 121,358 163,110
Interval gap/earnings assets 38.40% (30.38%) 3.59% 11.49% 7.95%
Cumulative gap/earning assets 38.40% 8.02% 11.61% 23.10% 31.04%
Although, NOW and money market 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.
21
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. The Company's
capital ratios were all in excess of guidelines established by the Federal
Reserve and the Bank's capital ratios were in excess of those required to be
classified as a "well capitalized" institution under the prompt corrective
action rule of the Federal Deposit Insurance Act. At December 31, 2004, the
Company's and Bank's capital ratios are presented in Note 14 to the Consolidated
Financial Statements.
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 the sale of additional
shares of common stock for gross proceeds of approximately $30 million.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto have been
prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollars without considering the
changes in the relative purchasing power of money over time due to inflation.
The impact of inflation is reflected in the increased cost of operations. Unlike
most industrial companies, nearly all of our assets and liabilities are monetary
in nature. As a result, interest rates have a greater impact on our performance
than do the effects of general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the price of
goods or services.
NEW ACCOUNTING STANDARDS
Refer to Note 1 of the Notes to Consolidated Financial Statements for
statements on New Accounting Standards.
MARKET FOR COMMON STOCK AND DIVIDENDS
Market for Common Stock. The Company's Common Stock is listed for
trading on the Nasdaq Small Cap Market under the symbol "EGBN". To date, trading
in the common stock has been relatively light. No assurance can be given that an
active trading market will develop in the foreseeable future or can be
maintained. The following table sets forth the high and low bid prices for the
Common Stock during each calendar quarter during the last three fiscal years, as
adjusted for the 1.3 for 1 stock split in the form of a 30% stock dividend paid
on February 28, 2005. These quotations reflect interdealer prices, without
retail markup, markdown or commission, and may not represent actual
transactions. As of March 9, 2005, there were 7,060,784 shares of Common Stock
outstanding, held by approximately 1,950 total beneficial shareholders,
including approximately 900 shareholders of record.
2004 2003 2002
------------------------ -------------------------- ------------------------
Quarter High Bid Low Bid High Bid Low Bid High Bid Low Bid
---------- ---------- ----------- ---------- ---------- ----------
First $15.38 $13.23 $11.77 $10.32 $12.31 $ 8.19
Second $15.33 $12.88 $13.08 $11.06 $12.12 $11.19
Third $15.38 $13.86 $11.98 $ 9.51 $11.19 $ 8.65
Fourth $16.36 $13.62 $13.62 $11.69 $10.51 $ 8.97
Dividends. Through December 31, 2004, the Company had not paid any cash
dividends. In March 2000, the Company effected a five for four stock split in
the form of a 25% stock dividend. In June 2001 the Company effected a seven for
five stock split in the form of a 40% stock dividend and in February 2005 the
Company effected a 1.3 for 1 stock split in the form of a 30% stock dividend.
22
In January 2005, the Company declared its first cash dividend of seven
cents per share payable March 31, 2005 to shareholders of record March 1, 2005.
The continued payment of cash dividends by the Company will depend largely upon
the ability of the Bank, its sole operating business, to declare and pay
dividends to the Company. Future dividends will depend primarily upon the Bank's
earnings, financial condition, and need for funds, as well as governmental
policies and regulations applicable to the Company and the Bank.
Regulations of the Federal Reserve Board and Maryland law place limits
on the amount of dividends the Bank may pay to the Company without prior
approval. Prior regulatory approval is required to pay dividends which exceed
the Bank's net profits for the current year plus its retained net profits for
the preceding two calendar years, less required transfers to surplus. State and
federal bank regulatory agencies also have authority to prohibit a bank from
paying dividends if such payment is deemed to be an unsafe or unsound practice,
and the Federal Reserve Board has the same authority over bank holding
companies.
The Federal Reserve Board has established guidelines with respect to
the maintenance of appropriate levels of capital by registered bank holding
companies. Compliance with such standards, as presently in effect, or as they
may be amended from time to time, could possibly limit the amount of dividends
that the Company may pay in the future. In 1985, the Federal Reserve Board
issued a policy statement on the payment of cash dividends by bank holding
companies. In the statement, the Federal Reserve Board expressed its view that a
holding company experiencing earnings weaknesses should not pay cash dividends
exceeding its net income, or which could only be funded in ways that weaken the
holding company's financial health, such as by borrowing. As a depository
institution, the deposits of which are insured by the FDIC, the Bank may not pay
dividends or distribute any of its capital assets while it remains in default on
any assessment due the FDIC. The Bank currently is not in default under any of
its obligations to the FDIC.
Issuer Repurchase of Common Stock. No shares of the Company's Common
Stock were repurchased by or on behalf of the Company during the fourth quarter
of 2004.
Securities Authorized for Issuance Under Equity Compensation Plans. The
following table sets forth information regarding outstanding options and other
rights to purchase common stock granted under the Company's compensation plans
as of December 31, 2004. All information has been adjusted to reflect the 1.3
for 1 stock split in the form of a 30% stock dividend paid on February 28, 2005.
Equity Compensation Plan Information
Number of securities remaining
Number of securities to be Weighted average available for future issuance
issued upon exercise of exercise price of under equity compensation plans
outstanding options, outstanding options, (excluding securities reflected
Plan category warrants and rights warrants and rights in column (a)
- ------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders (1) 689,935 $7.63 535,071
Equity compensation plans not
approved by security holders -0- -0- -0-
--------------------------------------------------------------------------------------
Total 689,935 $7.63 535,071
(1) Consists of the Company's 1998 Stock Option Plan and 2004 Employee Stock
Purchase Plan. For additional information, see Note 11 to the Consolidated
Financial Statements for the year ended December 31, 2004. Does not reflect
grants subsequent to December 31, 2004. Certain employment agreements not
approved by stockholders require the grant of options under plans approved
by stockholders.
Internet Access To Company Documents. The Company provides access to
its SEC filings through the Bank's web site at www.eaglebankmd.com by linking to
the SEC's web site. After accessing the web site, the filings are available upon
selecting "investor relations SEC filings." Reports available include the annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and all amendments to those reports as soon as reasonably practicable after
the reports are electronically filed or furnished to the SEC.
23
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and
Stockholders of Eagle Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Eagle Bancorp,
Inc. (the "Company") as of December 31, 2004 and 2003, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Eagle Bancorp Inc.
as of December 31, 2004 and 2003, and the results of its operations and cash
flows for each of the three years in the period ended December 31, 2004, in
conformity with accounting principles generally accepted in the United States of
America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, based on the
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated February 21, 2005 expressed an unqualified opinion on management's
assessment of, and the effective operation of, internal control over financial
reporting.
/s/ Stegman & Company
Stegman & Company
Baltimore, Maryland
February 21, 2005
24
EAGLE BANCORP, INC.
Consolidated Balance Sheets
December 31, 2004 and 2003
(dollars in thousands)
ASSETS 2004 2003
---------------- ---------------
Cash and cash equivalents $ 31,100 $ 25,103
Interest bearing deposits with other banks 9,594 4,332
Federal funds sold 15,035 -
Investment securities available for sale 64,098 82,581
Loans held for sale 2,208 3,649
Loans 415,509 317,533
Less allowance for credit losses (4,240) (3,680)
-------- --------
Loans, net 411,269 313,853
Premises and equipment, net 5,726 4,259
Deferred income taxes 1,102 862
Other assets 13,321 8,358
-------- --------
TOTAL ASSETS $553,453 $442,997
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing demand $130,309 $ 90,468
Interest bearing transaction 57,063 44,093
Savings and money market 126,299 104,429
Time, $100,000 or more 99,882 54,992
Other time 48,734 41,532
-------- --------
Total deposits 462,287 335,514
Federal funds purchased and securities sold under agreement to
repurchase 23,983 38,454
Other short-term borrowings 6,333 4,000
Long-term borrowings - 10,588
Other liabilities 2,316 1,429
-------- --------
Total liabilities 494,919 389,985
-------- --------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; shares authorized 20,000,000, shares
issued and outstanding: 5,421,730 (2004) and 5,359,303 (2003) 54 54
Additional paid in capital 47,014 46,406
Retained earnings 11,368 6,281
Accumulated other comprehensive income 98 271
-------- --------
Total stockholders' equity 58,534 53,012
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $553,453 $442,997
======== ========
See notes to consolidated financial statements.
25
EAGLE BANCORP, INC.
Consolidated Statements of Income
Years Ended December 31, 2004, 2003 and 2002
(dollars in thousands, except per share data)
INTEREST INCOME 2004 2003 2002
------------- -------------- --------------
Interest and fees on loans $21,393 $16,354 $14,379
Taxable interest and dividends on investment
securities 2,195 1,807 2,124
Interest on balances with other banks 152 180 77
Interest on federal funds sold and other cash
equivalents 455 62 81
------- ------- -------
Total interest income 24,195 18,403 16,661
------- ------- -------
INTEREST EXPENSE
Interest on deposits 3,755 3,099 4,332
Interest on federal funds purchased and
securities sold under agreement to
repurchase 105 108 230
Interest on other short-term borrowings 171 266 177
Interest on long-term borrowings 297 480 431
------- ------- -------
Total interest expense 4,328 3,953 5,170
------- ------- -------
NET INTEREST INCOME 19,867 14,450 11,491
PROVISION FOR CREDIT LOSSES 675 1,175 843
------- ------- -------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT
LOSSES 19,192 13,275 10,648
------- ------- -------
NONINTEREST INCOME
Service charges on deposits 1,255 1,216 1,038
Gain on sale of loans 952 671 438
Gain on sale of investment securities 453 311 337
Other income 1,093 652 294
------- ------- -------
Total noninterest income 3,753 2,850 2,107
------- ------- -------
NONINTEREST EXPENSE
Salaries and employee benefits 8,204 5,847 4,452
Premises and equipment expenses 2,655 2,111 1,648
Advertising 280 244 197
Outside data processing 652 555 488
Other expenses 3,161 2,250 1,745
------- ------- -------
Total noninterest expense 14,952 11,007 8,530
------- ------- -------
INCOME BEFORE INCOME TAX EXPENSE 7,993 5,118 4,225
------- ------- -------
INCOME TAX EXPENSE 2,906 1,903 1,558
------- ------- -------
NET INCOME $ 5,087 $ 3,215 $ 2,667
======= ======= =======
INCOME PER SHARE
Basic $ 0.72 $ 0.63 $ 0.71
Diluted $ 0.69 $ 0.59 $ 0.66
See notes to consolidated financial statements.
26
EAGLE BANCORP, INC.
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 2004, 2003 and 2002
(dollars in thousands)
Accumulated
Additional Other Total
Common Paid In Retained Comprehensive Stockholders'
Stock Capital Earnings Income (Loss) Equity
------------- -------------- -------------- -------------- --------------
Balance, January 1, 2002 $29 $16,515 $ 399 $189 $17,132
Exercise of options for 2,580 shares of common
stock 26 26
Net income 2,667 2,667
Other comprehensive income:
Unrealized gain on securities available
for sale 203 203
-------
Total other comprehensive income 2,896
--- ------- ------- ---- -------
Balance, December 31, 2002 29 16,541 3,066 392 20,028
Exercise of options for 12,620 shares of
common stock 123 123
Issuance of 2,448,979 shares of common stock 25 29,742 29,767
Net income 3,215 3,215
Other comprehensive income:
Unrealized loss on securities available
for sale (121) (121)
-------
Total other comprehensive income 3,094
--- ------- ------- ---- -------
Balance December 31, 2003 54 46,406 6,281 271 53,012
Exercise of options for 62,427 shares of
common stock 510 510
Tax benefit for non-qualified stock options
exercised 98 98
Net income 5,087 5,087
Other comprehensive income:
Unrealized loss on securities available
for sale (173) (173)
-------
Total other comprehensive income 4,914
-------
--- ------- ------- ---- -------
Balance, December 31, 2004 $54 $47,014 $11,368 $ 98 $58,534
=== ======= ======= ==== =======
See notes to consolidated financial statements.
27
EAGLE BANCORP, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 2004, 2003 and 2002
(dollars in thousands)
2004 2003 2002
-------------- -------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,087 $ 3,215 $ 2,667
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses 675 1,175 843
Increase in deferred income taxes (151) (319) (178)
Depreciation and amortization 984 714 557
Gains on sale of loans (952) (671) (438)
Origination of loans held for sale (29,592) (24,726) (19,110)
Proceeds from sale of loans held for sale 31,985 27,294 19,675
Gains on sale of investment securities (453) (311) (337)
Increase in other assets (913) (708) (380)
Increase (decrease) in other liabilities 932 (126) 494
-------- -------- --------
Net cash provided by operating activities 7,602 5,537 3,793
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in interest bearing deposits with other
banks (5,262) 1,787 (5,958)
Purchases of available for sale investment securities (204,254) (443,296) (385,210)
Proceeds from maturities of available for sale securities 166,962 382,186 333,993
Proceeds from sale of available for sale securities 55,969 49,328 20,626
Increase in federal funds sold (15,035) - -
Net increase in loans (98,091) (80,673) (54,792)
Bank premises and equipment acquired (2,451) (1,372) (986)
Purchase of bank owned life insurance (4,000) (2,000) (4,000)
-------- -------- --------
Net cash used in investing activities (106,162) (94,040) (96,327)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 126,773 57,080 82,746
(Decrease) increase in federal funds purchased and securities
sold under agreement to repurchase (14,471) 13,400 11,602
Increase (decrease) in other short-term borrowings (4,000) (8,600) 4,600
(Decrease) increase in long-term borrowings (4,255) 255 8,658
Issuance of common stock 510 29,890 26
-------- -------- --------
Net cash provided by financing activities 104,557 92,025 107,632
-------- -------- --------
NET INCREASE IN CASH 5,997 3,522 15,098
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 25,103 21,581 6,483
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 31,100 $ 25,103 $ 21,581
======== ======== ========
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid $ 3,818 $ 4,024 $ 5,092
Income taxes paid $ 2,462 $ 1,887 $ 1,840
NON-CASH FINANCING ACTIVITIES
Reclassification of borrowings from
long-term to short-term $ 6,333 $ 4,000 $ 4,000
See notes to consolidated financial statements.
28
EAGLE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31,
2004, 2003 AND 2002:
1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Eagle Bancorp,
Inc. (the "Company") and its subsidiaries, EagleBank (the "Bank") and Bethesda
Leasing, LLC ("Bethesda Leasing") with all significant intercompany transactions
eliminated. The investment in subsidiaries is recorded on the Company's books
(Parent Only) on the basis of its equity in the net assets of the subsidiary.
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices in the banking industry. Certain reclassifications have been made to
amounts previously reported to conform to the classification made in 2004. The
following is a summary of the more significant accounting policies.
NATURE OF OPERATIONS
The Company, through its bank subsidiary, provides domestic financial services
primarily in Montgomery County, Maryland and Washington, D.C. The primary
financial services include real estate, commercial and consumer lending, as well
as traditional demand deposits and savings products.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Actual results could differ from those estimates.
CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, and liquid investments with an original maturity of three months
of less.
LOANS HELD FOR SALE
The Company engages in sales of residential mortgage loans and the guaranteed
portion of Small Business Administration ("SBA") loans originated by the Bank.
Loans held for sale are carried at the lower of aggregate cost or fair value.
Fair value is derived from secondary market quotations for similar instruments.
Gains and losses on sales of these loans are recorded as a component of
noninterest income in the Consolidated Statements of Income.
The Company's current practice is to sell residential mortgage loans on a
servicing released basis, and, therefore, it has no intangible asset recorded
for the value of such servicing as of December 31, 2004.
INVESTMENT SECURITIES
Marketable equity securities and debt securities not classified as held to
maturity or trading are classified as available for sale. Securities
available-for-sale are acquired as part of the Company's asset/liability
management strategy and may be sold in response to changes in interest rates,
loan demand, changes in prepayment risk and other factors. Securities
available-for-sale are carried at fair value, with unrealized gains or losses
based on the difference between amortized cost and fair value reported as
accumulated other comprehensive income, a separate component of stockholders'
equity, net of deferred tax. Realized gains and losses, using the specific
identification method, are included as a separate component of noninterest
income. Related interest and dividends are included in interest income. Declines
in the fair value of individual available-for-sale securities below their cost
that are other than temporary result in write-downs of the individual securities
to their fair value. Factors affecting the determination of whether an
other-than-temporary impairment has occurred include a downgrading of the
security by a rating agency, a significant deterioration in the financial
condition of the issuer, or that management would not have the intent and
ability to hold a security for a period of time sufficient to allow for any
anticipated recovery in fair value.
29
LOANS
Loans are stated at the principal amount outstanding, net of unamortized
origination costs and fees. Interest income on loans is accrued at the
contractual rate on the principal amount outstanding. It is the Company's policy
to discontinue the accrual of interest when circumstances indicate that
collection is doubtful. Fees charged and costs capitalized for originating loans
are amortized on the straight line method over the term of the loan.
Management considers loans impaired when, based on current information, it is
probable that the Company will not collect all principal and interest payments
according to contractual terms. Loans are tested for impairment once principal
or interest payments become ninety days or more past due and they are placed on
nonaccrual. Management also considers the financial condition of the borrower,
cash flows of the loan and the value of the related collateral. Impaired loans
do not include large groups of smaller balance homogeneous loans such as
residential real estate and consumer installment loans which are evaluated
collectively for impairment. Loans specifically reviewed for impairment are not
considered impaired during periods of "minimal delay" in payment (ninety days or
less) provided eventual collection of all amounts due is expected. The
impairment of a loan is measured based on the present value of expected future
cash flows discounted at the loan's effective interest rate, or the fair value
of the collateral if repayment is expected to be provided by the collateral.
Generally, the Company's impairment on such loans is measured by reference to
the fair value of the collateral. Interest income on impaired loans is
recognized on the cash basis.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses represents an amount which, in management's
judgment, is adequate to absorb probable losses on existing loans and other
extensions of credit that may become uncollectible. The adequacy of the
allowance for credit losses is determined through careful and continuous review
and evaluation of the loan portfolio and involves the balancing of a number of
factors to establish a prudent level. Among the factors considered are lending
risks associated with growth and entry into new markets, loss allocations for
specific nonperforming credits, the level of the allowance to nonperforming
loans, historical loss experience, economic conditions, portfolio trends and
credit concentrations, changes in the size and character of the loan portfolio,
and management's judgment with respect to current and expected economic
conditions and their impact on the existing loan portfolio. Allowances for
impaired loans are generally determined based on collateral values. Loans deemed
uncollectible are charged against, while recoveries are credited to, the
allowance. Management adjusts the level of the allowance through the provision
for credit losses, which is recorded as a current period operating expense. The
allowance for credit losses may consist of an allocated component and an
unallocated component.
The components of the allowance for credit losses represent an estimation done
pursuant to either Statement of Financial Accounting Standards ("SFAS") No. 5,
"Accounting for Contingencies," or SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan." Specific allowances are established in cases where
management has identified significant conditions or circumstances related to a
credit that management believes indicate the probability that a loss may be
incurred in an amount different from the amount determined by application of the
formula allowance. For other problem graded credits, allowances are established
according to the application of credit risk factors. These factors are set by
management to reflect its assessment of the relative level of risk inherent in
each grade. The nonspecific allowance is based upon management's evaluation of
various conditions that are not directly measured in the determination of the
formula and specific allowances. Such conditions include general economic and
business conditions affecting key lending areas, credit quality trends
(including trends in delinquencies and nonperforming loans expected to result
from existing conditions), loan volumes and concentrations, specific industry
conditions within portfolio categories, recent loss experience in particular
loan categories, duration of the current business cycle, bank regulatory
examination results, findings of outside review consultants, and management's
judgment with respect to various other conditions including credit
administration and management and the quality of risk identification systems.
Executive management reviews these conditions quarterly.
Management believes that the allowance for credit losses is adequate; however,
determination of the allowance is inherently subjective and requires significant
estimates. While management uses available information to recognize losses on
loans, future additions to the allowance may be necessary based on changes in
economic conditions. Evaluation of the potential effects of these factors on
estimated losses involves a high degree of uncertainty, including the strength
and timing of economic cycles and concerns over the effects of a prolonged
economic downturn in the current cycle. In addition, various regulatory
agencies, as an integral part of their examination process, and independent
consultants engaged by the Bank periodically review the Bank's loan portfolio
and allowance for credit losses. Such review may result in recognition of
additions to the allowance based on their judgments of information available to
them at the time of their examination.
30
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization computed using the straight-line method. Premises and equipment are
depreciated over the useful lives of the assets, which generally range from
three to ten years for furniture, fixtures and equipment, three to five years
for computer software and hardware, and ten to forty years for buildings and
building improvements. Leasehold improvements are amortized over the terms of
the respective leases or the estimated useful lives of the improvements,
whichever is shorter. The costs of major renewals and betterments are
capitalized, while the costs of ordinary maintenance and repairs are expensed as
incurred.
RATE LOCK COMMITMENTS
The Company enters into commitments to originate residential mortgage loans
whereby the interest rate on the loan is determined prior to funding (i.e. rate
lock commitments). Such rate lock commitments on mortgage loans to be sold in
the secondary market are considered to be derivatives. The period of time
between issuance of a loan commitment and closing and sale of the loan generally
ranges from 15 to 60 days. The Company protects itself from changes in interest
rates through the use of best efforts forward delivery commitments, whereby the
Company commits to sell a loan at the time the borrower commits to an interest
rate with the intent that the buyer has assumed interest rate risk on the loan.
As a result, the Company is not exposed to losses nor will it realize gains
related to its rate lock commitments due to changes in interest rates.
The market values of rate lock commitments and best efforts contracts are not
readily ascertainable with precision because rate lock commitments and best
efforts contracts are not actively traded. Because of the high correlation
between rate lock commitments and best efforts contracts, no gain or loss occurs
on the rate lock commitments.
ADVERTISING
Advertising costs are generally expensed as incurred.
INCOME TAXES
The Company uses the liability method of 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 are
settled.
TRANSFER OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales, when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtain the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income available
to common stockholders by the weighted average number of common shares
outstanding during the year. Diluted net income per common share is computed by
dividing net income available to common stockholders by the weighted average
number of common shares outstanding during the year including any potential
dilutive effects of common stock equivalents, such as options and warrants. Net
income per common share has been adjusted to retroactively reflect all stock
dividends and splits.
31
STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" and SFAS 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 years ended December 31, 2004. 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 years ended December 31.
2004 2003 2002
---------------- ----------------- ----------------
Net income, as reported $5,087 $3,215 $2,667
Less pro forma stock-based compensation
expense determined under the fair
value method, net of related tax
effects (867) (224) (125)
---------------- ----------------- ----------------
Pro forma net income $4,220 $2,991 $2,542
================ ================= ================
Net income per share:
Basic - as reported $ 0.72 $ 0.63 $ 0.71
Basic - pro forma $ 0.60 $ 0.58 $ 0.68
Diluted - as reported $ 0.69 $ 0.59 $ 0.66
Diluted - pro forma $ 0.57 $ 0.55 $ 0.63
The pro forma amounts are not representative of the effects on reported net
income for future years.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (AICPA) issued Statement of Position
No. 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities Acquired
in a Transfer." SOP 03-3 addresses accounting for differences between the
contractual cash flows of certain loans and debt securities and the cash flow
differences are attributable, at least in part, to credit quality. As such, SOP
03-3 applies to loans and debt securities acquired individually, in pools or as
part of a business combination and does not apply to originated loans. The
application of SOP 03-3 limits the interest income, including accretion of
purchase price discounts that may be recognized for certain loans and debt
securities. Additionally, SOP 03-3 does not allow the excess of contractual cash
flows over cash flows expected to be collected to be recognized as an adjustment
of yield, loss accrual or valuation allowance, such as the allowance for
possible loan losses. SOP 03-3 requires that increases in expected cash flows
subsequent to the initial investment be recognized prospectively through
adjustment of the yield on the loan or debt security over its remaining life.
Decreases in expected cash flows should be recognized as impairment. In the case
of loans acquired in a business combination where the loans show signs of credit
deterioration, SOP 03-3 represents a significant change from current purchase
accounting practice whereby the acquiree's allowance for loan losses is
typically added to the acquirer's allowance for loan losses. Loans carried at
fair value, mortgage loans held for sale, and loans to borrowers in good
standing under revolving credit agreements are excluded from the scope of SOP
03-3. SOP 03-3 is effective for loans and debt securities acquired by the
Company beginning January 1, 2005. Management does not expect the adoption of
this new standard to have a material impact on the Company's financial
statements.
In March 2004, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 105, "Application of Accounting Principles to Loan
Commitments." SAB 105 summarizes the views of the staff of the SEC regarding the
application of generally accepted accounting principles to loan commitments
accounted for as derivative instruments. SAB 105 provides that the fair value of
recorded loan commitments that are accounted for as derivatives under SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities," should not
incorporate the expected future cash flows related to the associated servicing
of the future loan. In this SAB, the SEC determined that an interest rate lock
should generally be valued at zero at inception. In addition, SAB 105 requires
registrants to disclosed their accounting policy for loan commitments. The
provisions of SAB 105 must be applied to loan commitments accounted for as
derivatives that are entered into after March 31, 2004. The adoption of this
accounting standard did not have a material impact on the Company's financial
statements.
32
In March 2004, the Financial Accounting Standards Board (FASB) Emerging Issues
Task Force (EITF) released Issue 03-01, "Meaning of Other Than Temporary
Impairment," which addressed other-than-temporary impairment for certain debt
and equity investments. EITF 03-1 provides guidance for determining when an
investment is considered impaired, whether impairment is other-than-temporary,
and measurement of an impairment loss. An investment is considered impaired if
the fair value of the investment is less than its cost. Generally, an impairment
is considered other-than-temporary unless: (i) the investor has the ability and
intent to hold an investment for a reasonable period of time sufficient for an
anticipated recovery of fair value up to (or beyond) the cost of the investment;
and (ii) evidence indicating that the cost of the investment is recoverable
within a reasonable period of time outweighs evidence to the contrary. If
impairment is determined to be other-than-temporary, then an impairment loss
should be recognized equal to the difference between the investment's cost and
its fair value. Certain disclosure requirements of EITF 03-1 were adopted in
2003 and the Company began presenting the new disclosure requirements in its
consolidated financial statements for the year ended December 31, 2003. The
recognition and measurement requirements of Issue 03-01, and other disclosure
requirements not already implemented, were effective for periods beginning after
June 15, 2004. In September 2004, the FASB staff issued FASB Staff Position
(FSP) EITF 03-1-1, which delayed the effective date for certain measurement and
recognition guidance contained in Issue 03-1. The FSP requires the application
of pre-existing other-than-temporary guidance during the period of delay until a
final consensus is reached. Management does not anticipate the issuance of the
final consensus will have a material impact on Company's financial condition,
results of operations or liquidity.
In December 2004, the FASB published Statement of Financial Accounting Standards
No. 123 (revised 2004), "Share-Based Payment" (SFAS 123R). This statement
establishes standards for the accounting for transactions in which an entity (i)
exchanges its equity instruments for goods or services, or (ii) incurs
liabilities in exchange for goods or services that are based on the fair value
of the entity's equity instruments or that may be settled by the issuance of the
equity instruments. SFAS 123R eliminates the ability to account for stock-based
compensation using APB 25 and requires that such transactions be recognized as a
compensation cost in the income statement based on their fair values on the date
of the grant. SFAS 123R is effective for the Company on July 1, 2005. The
Company will transition to fair value based accounting for stock-based
compensation using a modified version of prospective application ("modified
prospective application"). Under modified prospective application, as it is
applicable to the Company, SFAS 123R applies to new awards and to awards
modified, repurchased, or cancelled after July 1, 2005. Additionally,
compensation cost for the portion of awards for which the requisite service has
not been rendered (generally referring to non-vested awards) that are
outstanding as of July 1, 2005 must be recognized as he remaining requisite
service is rendered during the period of and/or the periods after the adoption
of SFAS 123R. SFAS 123R permits entities to use any option pricing model that
meets the fair value objective of the Statement. The impact of this Statement on
the Company in periods subsequent to June 30, 2005 will depend on a number of
factors, such as the Company's compensation practices, new awards, modifications
and cancellations of existing awards, and the application of alternative option
pricing models.
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29,
Accounting for Nonmonetary Transactions." This statement amends the principle
that exchanges of nonmonetary assets should be measured based on the fair value
of the assets exchanged and more broadly provides for exceptions regarding
exchanges of nonmonetary assets that do not have commercial substance. This
Statement is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this standard is not
expected to have a material impact on financial condition, results of
operations, or liquidity.
2 CASH AND DUE FROM BANKS
Regulation D of the Federal Reserve Act requires that banks maintain reserve
balances with the Federal Reserve Bank based principally on the type and
amount of their deposits. During 2004, the Bank maintained balances at the
Federal Reserve (in addition to vault cash) to meet the reserve requirements
as well as balances to partially compensate for services. Additionally, the
Bank maintained balances with the Federal Home Loan Bank and four domestic
correspondents as compensation for services they provided to the Bank.
33
3 INVESTMENTS AVAILABLE FOR SALE
The amortized cost and estimated fair values of investments available for sale
at December 31, 2004 and 2003 are as follows:
Gross Gross
(dollars in thousands) Amortized Unrealized Unrealized Estimated
2004 Cost Gains Losses Fair Value
---- -------------- -------------- -------------- --------------
U. S. Government agency securities $34,478 $ - $ (294) $34,184
Mortgage backed securities 23,177 77 (188) 23,066
Federal Reserve and Federal Home Loan Bank
stock 1,956 - - 1,956
Other equity investments 4,339 555 (2) 4,892
------- ------ ------- -------
$63,950 $ 632 $ (484) $64,098
======= ====== ======= =======
Gross Gross
Amortized Unrealized Unrealized Estimated
2003 Cost Gains Losses Fair Value
---- -------------- -------------- -------------- --------------
U. S. Government agency securities $25,335 $ 76 $ (38) $25,373
Mortgage backed securities 51,887 201 (246) 51,842
Federal Reserve 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 for sale securities have been in a continuous
unrealized loss position as of December 31, 2004 are as follows:
(dollars in thousands) Total
Less than More than Unrealized
Available for sale: Fair Value 12 Months 12 Months Losses
------------------- -------------- -------------- ----------- -----------
U. S. Government agency securities $34,478 $ (221) $ (73) $(294)
Mortgage backed securities 17,879 (21) (167) (188)
Federal Reserve and Federal Home Loan Bank
stock - - - -
Other equity investments 86 - (2) (2)
------- ------ ----- -----
$52,443 $ (242) $(242) $(484)
======= ====== ===== =====
The available for sale investment portfolio has a fair value of approximately
$64.1 million of which approximately $52.4 million of the securities have some
unrealized losses as compared to amortized cost. Of these securities, $34.5
million, or 65.74%, are U.S. agency bonds and $17.9 million, or 34.09% are
mortgage backed securities. All of the bonds are rated AAA. The securities
representing the unrealized losses in the available for sale portfolio all have
modest duration risk (2.89 years), low credit risk, and minimal loss
(approximately 0.92%) when compared to book value. The unrealized losses that
exist are the result of market changes in interest rates since the original
purchase. These factors coupled with the fact that the Company has both the
intent and ability to hold these investments for a period of time sufficient to
allow for any anticipated recovery in fair value substantiates that the
unrealized losses in the available for sale portfolio are temporary. In addition
to bonds and mortgage backed securities, the Company, at December 31, 2004, held
$6.85 million in equity securities, $4.89 million which were marketable stocks
and mutual funds and $1.97 million which were investments in Federal Reserve
Bank ("FRB") and Federal Home Loan Bank ("FHLB") stocks which are not
marketable.
The amortized cost and estimated fair values of investments available for sale
at December 31, 2004 and 2003 by contractual maturity are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
34
2004 2003
--------------------------------- --------------------------------
(dollars in thousands) Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
----------------- --------------- ---------------- ---------------
Amounts maturing:
One year or less $ 5,995 $ 5,964 $ 6,648 $ 6,648
After one year through five years 28,483 28,220 15,687 15,725
After five years through ten years - - 3,000 3,000
Mortgage backed securities 23,177 23,066 51,887 51,842
FRB, FHLB and other equity
securities 6,295 6,848 4,952 5,366
------- ------- ------- -------
$63,950 $64,098 $82,174 $82,581
======= ======= ======= =======
Realized gains on sales of investment securities were $577 thousand and
realized losses on sales of investment securities were $124 thousand in 2004,
the realized gains on sales of investment securities were $334 thousand and
realized losses on sales of investment securities were $23 thousand in 2003
and the realized gains on sales of investment securities were $343 thousand
and realized losses on sales of investment securities were $6 thousand in
2002. Proceeds from sales of securities in 2004 were $56.0 million, in 2003
were $49.3 million and in 2002 were $20.6 million.
At December 31, 2004, $28.2 million fair value of securities were pledged as
collateral for certain government deposits, FHLB advances and securities sold
under agreement to repurchase. The outstanding balance of no single issuer,
except for U.S. Government and U.S. Government agency securities, exceeded ten
percent of stockholders' equity at December 31, 2004 or 2003.
4 LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Bank makes loans to customers primarily in Montgomery County, Maryland and
surrounding communities. A substantial portion of the Bank's loan portfolio
consists of loans to businesses secured by real estate and other business
assets.
Loans, net of unamortized net deferred fees, at December 31, 2004 and 2003 are
summarized by type as follows:
(dollars in thousands)
2004 2003
------------------ -------------------
Commercial $101,911 $ 93,112
Real estate - commercial 189,708 142,819
Real estate - residential 11,717 6,964
Construction 60,258 35,644
Home equity 49,632 34,092
Other consumer 2,283 4,902
-------- --------
Total loans 415,509 317,553
Less: allowance for credit losses (4,240) (3,680)
-------- --------
Loans, net $411,269 $313,853
======== ========
As of December 31, 2004 and 2003, the Bank serviced $16.44 million and $11.43
million, respectively, of SBA loans for others which are not reflected on the
balance sheet.
Activity in the allowance for credit losses for the years ended December 31,
2004, 2003 and 2002 is shown below:
35
(dollars in thousands) 2004 2003 2002
------------------ ------------------ -----------------
Balance at beginning of year $3,680 $2,766 $2,111
Provision for credit losses 675 1,175 843
Loan charge-offs (292) (333) (232)
Loan recoveries 177 72 44
------ ------ ------
Balance at end of year $4,240 $3,680 $2,766
====== ====== ======
Information regarding impaired loans at December 31, 2004 and 2003 is as
follows:
(dollars in thousands) 2004 2003
----------------- ----------------
Impaired loans with a valuation allowance $ 58 $ 434
Impaired loans without a valuation allowance 98 220
------ ------
Total impaired loans $ 156 $ 654
====== ======
Allowance for credit losses related to impaired loans $ 31 $82
Allowance for credit losses related to other than
impaired loans 4,209 3,598
------ ------
Total allowance for credit losses $4,240 $3,680
====== ======
Average impaired loans for the year $ 879 $ 594
Interest income on impaired loans recognized on a cash
basis $ - $ -
5 PREMISES AND EQUIPMENT
Premises and equipment include the following at December 31:
(dollars in thousands)
2004 2003
----------------- ----------------
Leasehold improvements $3,680 $2,370
Furniture and equipment 5,268 4,218
Less accumulated depreciation and amortization (3,222) (2,329)
------ ------
Total premises and equipment, net $5,726 $4,259
====== ======
The Company occupies banking and office space in ten locations under
noncancellable lease arrangements accounted for as operating leases. The
initial lease periods range from 5 to 10 years and provide for one or more
5-year renewal options. The leases provide for percentage annual rent
escalations and require that the lessee pay certain operating expenses
applicable to the leased space. Rent expense applicable to operating leases
amounted to $1,198 thousand in 2004, $838 thousand in 2003, and $769
thousand in 2002. At December 31, 2004, future minimum lease payments under
noncancellable operating leases having an initial term in excess of one
year are as follows:
(dollars in thousands)
Years ending December 31:
2005 $1,377
2006 1,450
2007 1,498
2008 1,315
2009 1,159
Thereafter 2,873
------
Total minimum lease payments $9,672
======
In February 2004, the Company entered into an operating lease with the
intention of opening an additional branch location. The lease, which is
expected to commence in 2006, is for a term of ten years and calls for
initial monthly rental payments of approximately $19 thousand, which are
not included in the above schedule.
36
6 DEPOSITS
The remaining maturity of certificates of deposit of $100,000 or more at
December 31, 2004 and 2003 are as follows:
(dollars in thousands) 2004 2003
---------------- ----------------
Three months or less $15,754 $10,783
More than three months through six months 14,715 12,808
More than six months through twelve months 60,915 18,920
Over twelve months 8,498 12,481
------- -------
Total $99,882 $54,992
======= =======
Interest expense on deposits for the three years ended December 31, 2004,
2003 and 2002 is as follows:
2004 2003 2002
----------- ---------- ---------
Interest bearing transaction $ 72 $ 79 $ 95
Savings and money market 1,185 1,161 1,599
Time, $100,000 or more 1,408 953 1,337
Other time 1,090 906 1,301
------ ------ ------
Total $3,755 $3,099 $4,332
====== ====== ======
7 BORROWINGS
Information relating to short and long-term borrowings is as follows for the
years ended December 31:
2004 2003
--------------------------- ---------------------------
Amount Rate Amount Rate
------------- ------------- ------------- -------------
Short-term
At Year-End
Federal funds purchased and securities sold under
agreement to repurchase $23,983 0.50% $38,454 0.78%
Federal Home Loan Bank - current portion 6,333 3.73% 4,000 2.79%
------- -------
Total $26,316 $42,454
------- -------
Average for the Year:
Federal funds purchased and securities sold under
agreement to repurchase $20,258 0.52% $22,146 0.49%
Federal Home Loan Bank - current portion 5,271 3.24% 4,000 2.79%
Bank line of credit - - 3,979 3.89%
Maximum Month-end Balance:
Federal funds purchased and securities sold under
agreement to repurchase 34,727 0.44% 38,454 0.69%
Federal Home Loan Bank - current portion 11,000 3.87% 4,000 2.79%
Line of credit - - 9,570 4.00%
------- -------
Long-term Borrowing
Correspondent bank term loan at prime minus 0.25% due
2006 - - 255 3.75%
Federal Home Loan Bank 4.28% Advance due 2005 - - 8,000 4.28%
Federal Home Loan Bank 2.79% principal reducing credit
due 2005 - - 2,333 2.79%
------- -------
Total long-term borrowing - $10,588
======= =======
The Company offers its business customers a repurchase agreement sweep account
in which it sells to the customer U. S. Government and U. S. Government agency
securities segregated in its investment portfolio for this purpose. By
entering into the agreement the customer agrees to have the Bank repurchase
the designated securities on the business day following the initial
transaction in consideration of the payment of interest at the rate prevailing
on the day of the transaction.
37
The Bank has commitments from correspondent banks under which it can purchase
up to $24 million in federal funds and $10 million in reverse repurchase
agreements on a short-term basis. The Bank also can draw Federal Home Loan
Bank advances up to $110 million against which it had $6.3 million outstanding
at December 31, 2004. The Company has a line of credit approved for $10
million secured by stock in the Bank against which it had no borrowings
outstanding as of December 31, 2004 and 2003.
8 INCOME TAXES
Federal and state income tax expense consists of the following for the periods
ended December 31:
(dollars in thousands) 2004 2003 2002
------------------ ------------------- ------------------
Current federal income tax $ 2,569 $ 1,297 $ 1,434
Current state income tax 488 287 318
------- ------- -------
Total current 3,057 1,584 1,752
Deferred federal income tax expense (benefit) (123) (260) (159)
Deferred state income tax expense (benefit) (28) (59) (35)
------- ------- -------
Total deferred (151) (319) (194)
------- ------- -------
Total income tax expense $ 2,906 $ 1,903 $ 1,558
======= ======= =======
The following table is a summary of the tax effect of temporary differences that
give rise to significant portions of deferred tax assets for the periods ended
December 31:
(dollars in thousands) 2004 2003
------------------ -------------------
Deferred tax assets:
Allowance for credit losses $ 1,273 $ 1,065
Deferred loan fees and costs 255 137
------- -------
Total deferred tax assets 1,528 1,202
------- -------
Deferred tax liabilities:
Unrealized gain on securities available for sale (50) (139)
Premises and equipment (376) (201)
------- -------
Total deferred tax liabilities (426) (340)
------- -------
Net deferred income tax account $ 1,102 $ 862
======= =======
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate for the years ended December 31 follows:
2004 2003 2002
------------------ ------------------- ------------------
Statutory federal income tax rate 34.00% 34.00% 34.00%
State income taxes, net of federal income tax benefit 3.83 4.70 3.80
Non-taxable income (1.79) (1.70) (0.70)
Other 0.26 0.20 (0.20)
----- ----- -----
Effective tax rates 37.20% 36.30% 36.90%
===== ===== =====
9 INCOME PER COMMON SHARE
In the following table, basic earnings per share is derived by dividing net
income available to common stockholders by the weighted-average number of
common shares outstanding during the year. The diluted earnings per share is
calculated by dividing net income available to common stockholders by the
weighted-average number of shares outstanding, adjusted for the dilutive
effect of outstanding stock options.
The calculation of net income per common share for the years ended December 31
was as follows:
38
(dollars and shares in thousands,
except per share data) 2004 2003 2002
------------------ ------------------ -------------------
Basic:
Net income allocable to common stockholders $5,087 $3,215 $2,667
------ ------ ------
Average common shares outstanding 7,025 5,112 3,764
------ ------ ------
Basic net income per share $ 0.72 $ 0.63 $0.71
------ ------ ------
Diluted:
Net income allocable to common stockholders $5,087 $3,215 $2,667
------ ------ ------
Average common shares outstanding 7,025 5,112 3,764
Adjustment for stock options 336 304 274
------ ------ ------
Average common shares outstanding-diluted 7,361 5,416 4,038
------ ------ ------
Diluted net income per share $ 0.69 $ 0.59 $ 0.66
------ ------ ------
As of December 31, 2004, there were -0- shares, as of December 31, 2003,
there were 1,075 shares, and as of December 31, 2002 there were 1,150 shares,
excluded from the diluted net income per share computation because the option
price exceeded the market price and therefore, their effect would be
anti-dilutive.
10 RELATED PARTY TRANSACTIONS
Certain directors and executive officers have had loan transactions with the
Company. Such loans were made in the ordinary course of business on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with outsiders. The
following table summarizes changes in amounts of loans outstanding, both
direct and indirect, to those persons during 2004 and 2003.
(dollars in thousands) 2004 2003
------------------- ------------------
Balance at January 1 $ 3,891 $ 2,956
Additions 1,840 1,347
Repayments (1,612) (412)
------- -------
Balance at December 31 $ 4,119 $ 3,891
======= =======
11 STOCK OPTION PLAN
The Company maintains the 1998 Stock Option Plan (the "1998 Plan"). The 1998
Plan provides for the periodic granting of incentive and nonqualifying
options to selected key employees and members of the Board. Options for not
more than 1,142,732, as adjusted for the 1.3 for 1 split paid in February
2005, shares of common stock may be granted under the Plan and the term of
such options shall not exceed ten years.
The Company also maintains the 2004 Employee Stock Purchase Plan (the
"ESPP"). Under the ESPP, a total of 195,000 shares of common stock, as
adjusted for the 1.3 for 1 stock split in February 2005, were reserved for
issuance to eligible employees at a price equal to at least 85% of the fair
market value of the shares of common stock on the date of grant. Grants each
year expire no later than the last business day of January in the calendar
year following the year in which the grant is made.
Following is a summary of changes in shares under option for the years
indicated:
39
(in thousands of shares) Year Ended December 31,
2004 2003 2002
------------------------ ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
------------ ----------- ------------ ------------ ----------- ------------
Outstanding at beginning of year 632 $ 6.14 569 $ 5.29 549 $5.17
Granted 142 13.88 83 12.09 26 8.42
Exercised (81) (6.30) (15) (7.52) (4) (7.75)
Cancelled (3) (14.73) (5) (4.39) (2) (7.88)
--- ----- -----
Outstanding at end of year 690 $ 7.63 632 $ 6.14 569 $5.39
=== ===== =====
Weighted average fair value of
options granted during the year $ 8.85 $4.76 $4.76
------ ----- -----
Weighted average remaining contract
life 5.8 years
-----------
Weighted Average
Remaining Contract Life Weighted Average
Range of Exercise Price Number (in years) Exercise Price
-------------------------------------- ----------------- -------------------------- ------------------
$ 4.26-$4.67 380,553 4.4 $4.40
$7.73-$9.66 98,030 6.8 7.97
$10.12-$12.12 65,388 5.0 11.15
$13.42-$15.78 145,964 9.0 14.24
-------
689,935 $7.63
======= =====
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions used
for grants during the years ended December 31, 2004, 2003 and 2002.
2004 2003 2002
----------------- --------------- ----------------
Dividend yield 0.00% 0.00% 0.00%
Expected volatility 35.85% 21.88% 20.00%
Risk free interest 4.23% 4.23% 5.04%
Expected lives (in years) 10 10 10
12 EMPLOYEE BENEFIT PLANS
The Company has a 401(k) Plan covering all employees who have reached the age
of 21 and have completed at least one month of service as defined by the
Plan. The Company made contributions to the Plan based on a matching formula
of approximately $133 thousand, $98 thousand, and $87 thousand in 2004, 2003
and 2002, respectively. These amounts are included in salaries and employee
benefits in the accompanying Consolidated Statements of Income.
13 COMMITMENTS AND CONTINGENCIES
Various commitments to extend credit are made in the normal course of banking
business. Letters of credit are also issued for the benefit of customers.
These commitments are subject to loan underwriting standards and geographic
boundaries consistent with the Company's loans outstanding.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements.
40
Loan commitments outstanding and lines and letters of credit at December 31,
2004 and 2003 are as follows:
(dollars in thousands) 2004 2003
------------------- ------------------
Loan commitments $ 57,617 $58,433
Unused lines of credit 105,590 95,535
Letters of credit 3,370 2,660
Because most of the Company's business activity is with customers located in
the Washington, DC, metropolitan area, a geographic concentration of credit
risk exists within the loan portfolio, and, as such, its performance will be
influenced by the economy of the region.
At December 31, 2004, the Company also had commitments to vendors for
leasehold improvement and equipment acquisitions associated with the Bank's
new McPherson office. The remaining amount of these commitments at December
31, 2004 was $50 thousand.
In the normal course of business, the Company may become involved in
litigation arising from banking, financial, and other activities. At December
31, 2004, the Company was not involved in any litigation.
14 REGULATORY MATTERS
The Company and Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and Bank must meet specific capital guidelines that involve
quantitative measures of assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank and Company to maintain amounts and ratios (set forth in the
table below) of total Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined). Management believes, as of December 31, 2004 and
2003, that the Company and Bank met all capital adequacy requirements to
which they are subject.
The actual capital amounts and ratios for the Company and Bank as of December
31, 2004 and 2003 are presented in the table below:
To Be Well
Capitalized
Under Prompt
(dollars in thousands) Company Bank For Capital Corrective
------------------------ ---------------------- Adequacy Action
Actual Actual Purposes Provisions*
As of December 31, 2004 Amount Ratio Amount Ratio Ratio Ratio
----------- ------------ ----------- ---------- -------------- ------------------
Total capital (to risk weighted
assets) 62,774 13.45% $48,588 10.69% 8.0% 10.0%
Tier 1 capital (to risk weighted
assets) 58,436 12.52% 44,364 9.76% 4.0% 6.0%
Tier 1 capital (to average
assets) 58,436 11.98% 44,364 8.45% 3.0% 5.0%
As of December 31, 2003
Total capital (to risk weighted
assets) 56,422 16.4% 37,872 11.3% 8.0% 10.0%
Tier 1 capital (to risk weighted
assets) 52,742 15.3% 34,206 10.2% 4.0% 6.0%
Tier 1 capital (to average
assets) 52,742 14.0% 34,206 9.5% 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
extensions of credit and transfers of assets between the Bank and the
Company. At December 31, 2004, the Bank was limited from paying dividends to
its parent company by the positive amount of retained earnings it held and
the requirement to meet certain capital ratios. In 2002, the Bank paid
dividends of $200 thousand to the Company. The Bank did not pay any dividends
in 2004 or 2003.
41
15 FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires the disclosure of estimated fair values for financial instruments.
Quoted market prices, if available, are utilized as an estimate of the fair
value of financial instruments. Because no quoted market prices exist for a
portion of the Company's financial instruments, the fair value of such
instruments has been derived based on management's assumptions with respect
to future economic conditions, the amount and timing of future cash flows and
estimated discount rates. Different assumptions could significantly affect
these estimates. Accordingly, the net realizable value could be materially
different from the estimates presented below. In addition, the estimates are
only indicative of individual financial Instruments' values and should not be
considered an indication of the fair value of the Company taken as a whole.
Cash and federal funds sold: For cash and due from banks, and federal funds
sold the carrying amount approximates fair value.
Interest bearing deposits with banks: Values are estimated by discounting the
future cash flows using the current rates at which similar deposits would be
earning.
Investment securities: For these instruments, fair values are based on
published market or dealer quotes.
Loans held for sale: Values are at the carrying value since such loans are
short term and are carried on a pre-sold basis.
Loans net of unearned interest: For variable rate loans that reprice on a
scheduled basis, fair values are based on carrying values. The fair value of
the remaining loans are estimated by discounting the future cash flows using
the current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining term.
Noninterest bearing deposits: The fair value of these deposits is the amount
payable on demand at the reporting date.
Interest bearing deposits: The fair value of interest bearing transaction,
savings, and money market deposits with no defined maturity is the amount
payable on demand at the reporting date. The fair value of certificates of
deposit is estimated by discounting the future cash flows using the current
rates at which similar deposits would be accepted.
Customer repurchase agreements and other borrowings: The carrying amount for
variable rate borrowings approximate the fair values at the reporting date.
The fair value of Federal Home Loan Bank advances is estimated by computing
the discounted value of contractual cash flows payable at current interest
rates for obligations with similar remaining terms.
Off-balance sheet items: Management has reviewed the unfunded portion of
commitments to extend credit, as well as standby and other letters of credit,
and has determined that the fair value of such instruments is not material.
The estimated fair values of the Company's financial instruments at December
31, 2004 and 2003 are as follows:
2004 2003
-------------------------------------- -----------------------------------
(dollars in thousands) Carrying Value Fair Value Carrying Value Fair Value
------------------- ------------------ ----------------- -----------------
ASSETS:
Cash and cash equivalents $ 31,100 $31,100 $25,103 $25,103
Interest bearing deposits with other
banks 9,594 9,594 4,332 4,332
Federal funds sold 15,035 15,035 - -
Investment securities 63,950 64,098 82,581 82,581
Loans held for sale 2,208 2,208 3,649 3,649
Loans, net 411,269 411,307 313,853 317,039
LIABILITIES:
Noninterest bearing deposits 130,309 130,309 90,468 90,468
Interest bearing deposits 331,978 331,387 245,046 245,174
Borrowings 30,316 30,354 53,042 53,511
42
16 QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table reports the unaudited results of operations for each
quarter during 2004, 2003 and 2002:
(dollars in thousands except per share data) 2004
-----------------------------------------------------------------
Fourth Quarter Third Quarter Second Quarter First Quarter
---------------- --------------- --------------- ----------------
Total interest income $7,057 $6,146 $5,616 $5,376
Total interest expense 1,197 1,115 1,047 969
Net interest income 5,860 5,031 4,569 4,407
Provision for credit losses 218 227 76 154
Net interest income after provision for
credit losses 5,642 4,804 4,493 4,253
Noninterest income 1,149 697 825 1,082
Noninterest expense 3,866 3,962 3,631 3,493
Net income before income tax expenses 2,925 1,539 1,687 1,842
Income tax expense 1,090 539 614 663
------ ------ ------ ------
Net income $1,835 $1,000 $1,073 $1,179
====== ====== ====== ======
Income per share
Basic $0.26 $ 0.14 $ 0.15 $ 0.17
Diluted 0.25 0.14 0.15 0.16
2003
-----------------------------------------------------------------
Fourth Quarter Third Quarter Second Quarter First Quarter
---------------- --------------- --------------- ----------------
Total interest income $5,044 $4,541 $4,353 $4,466
Total interest expense 905 906 1,067 1,075
Net interest income 4,139 3,635 3,286 3,391
Provision for credit losses 445 305 201 224
Net interest income after provision for
credit losses 3,694 3,330 3,085 3,167
Noninterest income 803 687 573 873
Noninterest expense 3,174 2,804 2,651 2,465
Net income before income tax expenses 1,323 1,213 1,007 1,575
Income tax expense 508 435 368 592
------ ------ ------ ------
Net income $ 815 $ 778 $ 639 $ 983
====== ====== ====== ======
Income per share
Basic $ 0.12 $ 0.11 $ 0.17 $ 0.26
Diluted 0.12 0.10 0.15 0.25
43
2002
-----------------------------------------------------------------
Fourth Quarter Third Quarter Second Quarter First Quarter
---------------- --------------- --------------- ----------------
Total interest income $4,537 $4,405 $4,030 $3,689
Total interest expense 1,294 1,362 1,258 1,256
Net interest income 3,243 3,043 2,772 2,433
Provision for credit losses 168 182 213 280
Net interest income after provision for
credit losses 3,075 2,861 2,559 2,153
Noninterest income 744 689 428 299
Noninterest expense 2,363 2,177 2,150 1,893
Net income before income tax expenses 1,456 1,373 837 559
Income tax expense 534 525 309 190
------ ------ ------ ------
Net income $ 922 $ 848 $ 528 $ 369
====== ====== ====== ======
Income per share
Basic $ 0.25 $ 0.22 $ 0.14 $ 0.10
Diluted 0.23 0.21 0.13 0.09
Note: Earnings per share are calculated on a quarterly basis and may not be
additive to the year-to-date amount. Income per share has been adjusted for a
1.3 to 1 stock split in the form of a 30% stock dividend paid in February
2005.
17 PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Eagle Bancorp, Inc. (Parent Company only)
is as follows:
CONDENSED BALANCE SHEETS
December 31, 2004 and 2003
(dollars in thousands)
ASSETS: 2004 2003
------------------- -------------------
Cash $ 28 $ 46
Cash equivalents 6,843 1,525
Investment securities available for sale 4,891 30,402
Investment in subsidiary 44,190 34,238
Loans 2,743 1,150
Less: allowance for credit losses (14) (14)
-------- --------
2,729 1,146
Other assets 33 168
-------- --------
TOTAL ASSETS $ 58,714 $ 67,525
======== ========
LIABILITIES:
Accounts payable $ 5 $ 13
Short-term borrowings - 14,363
Other liabilities 175 137
-------- --------
Total liabilities 180 14,513
-------- --------
STOCKHOLDERS' EQUITY:
Common stock 54 54
Additional paid in capital 47,014 46,406
Retained earnings 11,368 6,281
Accumulated other comprehensive income 98 271
-------- --------
Total stockholders' equity 58,534 53,012
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 58,714 $ 67,525
======== ========
44
CONDENSED STATEMENTS OF INCOME
For the Years Ended December 31, 2004, 2003, and 2002
(dollars in thousands)
2004 2003 2002
---------------- ---------------- -----------------
INCOME
EagleBank dividends - - $200
Other interest and dividends $669 $384 41
Gain on sale of investment securities 421 - -
---------------- ---------------- -----------------
Total income 1,090 384 241
---------------- ---------------- -----------------
EXPENSES:
Salaries and employee benefits 39 39 39
Interest expense 13 180 126
Legal and professional 62 39 58
Directors' fees 35 18 14
Other 167 183 134
---------------- ---------------- -----------------
Total expenses 316 459 371
Provision for Credit Losses - 14 -
---------------- ---------------- -----------------
INCOME (LOSS) BEFORE INCOME TAX (EXPENSE) BENEFIT AND EQUITY
IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 774 (89) (130)
INCOME TAX (EXPENSE) BENEFIT (263) 30 112
---------------- ---------------- -----------------
INCOME (LOSS) BEFORE EQUITY IN UNDISTRIBUTED INCOME OF
SUBSIDIARIES 511 (59) (18)
EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 4,576 3,274 2,685
---------------- ---------------- -----------------
NET INCOME $5,087 $3,215 $2,667
================ ================ =================
CONDENSED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004, 2003 and 2002
(dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES: 2004 2003 2002
---------------- ---------------- -----------------
NET INCOME $5,087 $3,215 $2,667
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH (USED) PROVIDED BY OPERATING ACTIVITIES:
Provision for credit losses - 14 -
Gain on sale of investment securities (421) - -
Equity in undistributed income loss of subsidiary (4,576) (3,274) (2,685)
Decrease (increase) in other assets 135 (135) 37
(Decrease) increase in other liabilities (522) 15 (7)
---------------- ---------------- -----------------
Net cash (used in) provided by operating activities (297) (165) 12
---------------- ---------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) in loans (1,583) (1,150) -
Purchase of available for sale investment securities (43,632) (229,374) -
Proceeds from maturity and sales of available for sale
investment securities 70,347 199,580 769
Investment in subsidiary (net) (5,682) (7,020) (3,700)
---------------- ---------------- -----------------
Net cash provided by (used in) investing activities 19,450 (37,964) (2,931)
---------------- ---------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 510 29,890 26
(Repayment of) proceeds from short-term borrowings (14,363) 9,763 2,925
---------------- ---------------- -----------------
Net cash (used in) provided by financing activities (13,853) 39,653 2,951
---------------- ---------------- -----------------
NET INCREASE IN CASH 5,300 1,524 32
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,571 47 15
---------------- ---------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $6,871 $1,571 $47
================ ================ =================
45
BUSINESS
Eagle Bancorp, Inc. (the "Company") was incorporated under the laws of
the State of Maryland on October 28, 1997, to serve as the bank holding company
for a newly formed Maryland chartered commercial bank. The Company was formed by
a group of local businessmen and professionals with significant prior experience
in community banking in the Company's market area, together with an experienced
community bank senior management team. EagleBank, a Maryland chartered
commercial bank which is a member of the Federal Reserve System, the Company's
principal operating subsidiary, was chartered as a bank and commenced banking
operations on July 20, 1998. The Bank operates from five Montgomery County
offices located in Gaithersburg, Rockville, Bethesda and Silver Spring, Maryland
and three locations in the District of Columbia, at 20th and K Streets, NW,
south of Dupont Circle and near McPherson Square. 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.
The Bank operates as a community bank alternative to the superregional
financial institutions which dominate its primary market area. The cornerstone
of the Bank's philosophy is to provide superior, personalized service to its
customers. The Bank focuses on relationship banking, providing each customer
with a number of services, familiarizing itself with, and addressing itself to,
customer needs in a proactive, personalized fashion.
Description of Services. The Bank offers full commercial banking
services to its business and professional clients as well as complete consumer
banking services to individuals living and/or working in the service area. The
Bank emphasizes providing commercial banking services to sole proprietorships,
small and medium-sized businesses, partnerships, corporations, non-profit
organizations and associations, and investors living and working in and near the
Bank's 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 the Bank serves.
The Bank has developed a loan portfolio consisting primarily of
business loans with variable rates and/or short maturities where the cash flow
of the borrower is the principal source of debt service with a secondary
emphasis on collateral. Real estate loans are made generally for commercial
purposes and are structured using fixed rates which adjust in three to five
years, with maturities of five to ten years. Consumer loans are made on the
traditional installment basis for a variety of purposes. The Bank has developed
significant expertise and commitment as an SBA lender and is one of the largest
SBA lenders, in dollar volume, in the Washington metropolitan area.
All new business customers are screened to determine, in advance, their
credit qualifications and history. This practice permits the Bank to respond
quickly to credit requests as they arise.
In general, the Bank offers the following credit services:
1) Commercial loans for business purposes including working
capital, equipment purchases, real estate, lines of credit,
and government contract financing. Asset based lending and
accounts receivable financing are available on a selective
basis.
2) Real estate loans, including construction loan financing, for
business and investment purposes.
3) Lease financing for business equipment.
4) Traditional general purpose consumer installment loans
including automobile and personal loans. In addition, the Bank
offers personal lines of credit.
5) Credit card services are offered through an outside vendor.
The direct lending activities in which the Bank engages each carries
the risk that the borrowers will be unable to perform on their obligations. As
such, interest rate policies of the Federal Reserve Board and general economic
conditions, nationally and in the Bank's primary market area have a significant
impact on the Bank's and the Company's results of operations. To the extent that
economic conditions deteriorate, business and individual borrowers may be less
able to meet their obligations to the Bank in full, in a timely manner,
resulting in decreased earnings or losses to the Bank. To the extent the Bank
makes fixed rate loans, general increases in interest rates will tend to reduce
the Bank's spread as the interest rates the Bank must pay for deposits increase
while interest income is flat. Economic conditions and interest rates may also
adversely affect the value of property pledged as security for loans.
46
The Bank constantly strives to mitigate risks in the event of
unforeseen threats to the loan portfolio as a result of economic downturn or
other negative influences. Our plans for mitigating inherent risks in managing
loan assets include; carefully enforcing loan policies and procedures,
evaluating each borrower's business plan during the underwriting process,
identifying and monitoring primary and alternative sources for repayment, and
obtaining collateral to minimize losses in the event of liquidation. Specific
loan reserves will be used to increase overall reserves based upon increased
credit and/or collateral risks on an individual loan bases. A risk rating system
is used to proactively determine loss exposure and provide a measuring system
for setting general and specific reserves allocations.
The Bank attempts to further mitigate commercial term loan losses by
using loan guarantee programs offered by the SBA. The Bank has been approved for
the SBA's preferred lender program (PLP). SBA loans made using PLP by the Bank
are not subject to SBA preapproval. However, the Bank is very selective of these
types of loans because of the greater responsibility of acting as agents for the
SBA.
The composition of the Bank's loan portfolio is heavily commercial real
estate, both owner occupied and investment real estate. At December 31, 2004,
commercial real estate secured loans represented 45.7% of the loan portfolio.
These loans are carefully underwritten to mitigate lending risks typical of this
type of loan such as drops in real estate values, changes in cash flow and
general economic conditions. The Bank requires a loan to value of 80% and cash
flow debt service of 1.2x to 1.0. In making commercial mortgage loans, the Bank
generally requires that interest rates adjust not less frequently than five
years and generally seeks more frequent adjustments. To date, the Bank's
experience with this type of credit has been excellent and it has experienced no
commercial mortgage loan losses.
The Bank is also an active general commercial loan lender providing
loans for a large variety of typical commercial loan purposes, including
equipment and account receivable financing. This category represents
approximately 24.5% of the loan portfolio and is generally characterized by
variably priced loans tied to an index such as prime or U. S. Treasury borrowing
rates. Subject to limitations in a particular loan agreement, interest rates on
variable rate loans change at the same time and at the some rate as the
designated index changes. As do all loans in the portfolio, commercial loans
must meet high underwriting standards with proper collateral, which may include
real estate, and cash flow needed to service the debt. Personal guarantees of
promoters and/or principals are generally required, although, may be limited. A
growing segment of the commercial loan portfolio is SBA loans.
In making SBA loans, the Company assumes the risk of nonpayment on the
uninsured portion of the credit, which comprises 20-25% of the aggregate loan
amount. The Company generally sells the insured portion of the loan, generating
noninterest income from the gains on sale, and servicing income from continuing
to service the loans. SBA loans are subject to the same high underwriting
standards, including cash flow analyses and collateral requirements, as loans
which are not guaranteed. Recent issues related to the funding of the Small
Business Administration, and the Section 7A lending program in particular, have
resulted in periodic reductions in the maximum size of loans which may receive
SBA guarantees. While the Company believes that the current issues will not have
a long term effect on the availability of the program, there can be no assurance
that the Company will be able to continue to originate SBA loans, be able to
continue to increase the volume of SBA loans, or to maintain or increase the
level of noninterest income relating to SBA loans.
The balance, or approximately 29.8%, of the loan portfolio is made up
of residential mortgage loans, home equity loans and other consumer loans and
construction loans. These loans, while making up a smaller portion of the loan
portfolio, demand the same emphasis on underwriting and credit decision
processes as the other types of loans advanced by the Bank.
The Bank at December 31, 2004, had a legal lending limit of $7.3
million and had customers who had been approved for aggregate loans of this
amount. Because of the legal lending limitation, the Bank has regularly
participated out portions of credits to other area banks, an accepted practice
in the industry. The Bank has also participated loans to the Company. These have
generally been in nominal amounts and for relatively short terms, either until
the Bank could accommodate the participation under its legal limit or the loan
could be participated to another lender. The ability of the Company to assist
the Bank with these credits has expanded the flexibility and service the Bank
can offer its customers. From time to time the Company may make loans for its
portfolio. Such loans, which may be made to accommodate borrowers at the Bank
level, and may have higher risk characteristics than loans made by the Bank,
such as lower priority security interests. The Company will generally make such
loans only to borrowers in industries where the Company's directors or lending
officers have significant expertise, such as real estate development lending.
The Company seeks interest rates and compensation commensurate with the risks
involved in the particular loan.
47
The Bank originates residential mortgage loans, on a pre-sold basis,
for sale to secondary market purchasers, on a servicing released basis. This
produces benefits primarily in the form of gains on the sale of the loans at a
premium. Activity in the residential mortgage loan market is highly sensitive to
changes in interest rates. The loans are sold on a limited recourse basis. Most
contracts with investors contain recourse periods that may vary from 90 days up
to one year. In general, the Company may be required to repurchase a previously
sold mortgage loan or indemnify the investor if there is major non-compliance
with defined loan origination or documentation standards, including fraud,
negligence or material misstatement in the loan documents. Repurchase may also
be required if necessary governmental loan guarantees are canceled or never
issued, or if an investor is forced to buy back a loan after it has been re-sold
as part of a loan pool. In addition, the Company may have an obligation to
repurchase a loan if the mortgagor has defaulted early in the loan term. The
potential default period is approximately twelve months after sale of the loan
to the investor. Mortgages subject to recourse are collateralized by
single-family residential properties, have loan-to-value ratios of 80% or less,
or have private mortgage insurance.
Deposit services include business and personal checking accounts, NOW
accounts, and a tiered savings/money market account basing the payment of
interest on balances on deposit. Certificates of deposits are offered using a
tiered rate structure and various maturities. The acceptance of brokered
deposits is not a part of the current strategy. A complete IRA program is
available. In cooperation with Goldman Sachs Asset Management, the bank has
introduced Eagle Asset Management Account, a sophisticated cash management
checking account that works like an investment account.
Other services for business accounts include cash management services
such as PC banking, sweep accounts, lock box, and account reconciliation, credit
card depository, title insurance, safety deposit boxes and Automated Clearing
House origination. After hours depositories and ATM service are also available.
Investment Portfolio Management, The ALCO Committee of the Bank, which
consists of directors and two senior officers, operates within investment and
funds management policies established by it and approved by the Board of
Directors. The Committee is the prime steering force setting parameters for
management while providing flexibility to meet changing circumstances between
its monthly meetings. Management, on a daily basis, administers the investment
portfolio and other non-lending, earning assets and prepares reports and
recommendations for the Committee. A typical Committee meeting includes
discussion of current economic conditions, interest rate expectations, report
reviews and consideration of recommendations for modification in strategies and
specific investment issues.
The investment policy limits the Bank to investments of the highest
quality, U.S. Treasury securities, U.S. Government agency securities and high
grade municipal securities. High risk investments, derivatives and non
traditional investments are prohibited. Investment maturities are limited to
seven years, except as specifically approved by ALCO, and mortgage backed pass
through securities with average lives of generally seven years or less. The
funds management policy establishes limits on overnight funds purchases and
sales, percentage of holdings of various securities, investments in bank
deposits and other asset and liability instruments.
During 2004, the Committee expanded eligible investments to include
bank certificates of deposits of $100 thousand or less, except CDs issued by
significant regional banks which can be purchased in amounts up to $500
thousand. The addition of this investment vehicle provided additional yield and
flexibility to the portfolio.
During the past two years, the investment strategy has been to stay
short expecting that interest rates would rise and to improve yields by using
mortgage backed pass through securities of short, generally fifteen year final
maturities, or shorter, where repricing opportunities are provided by monthly
cash flow.
As rates rise the Company will invest with the rise in rates improving
income opportunities from maturities and cash flow of the portfolio. When the
expectation is for rates to peak, following the next increase in rates, the
Committee will explore the advisability of extending maturities to accumulate a
volume of higher earning investments.
48
Source of Business. Management believes that the market segments which
the Bank targets, small to medium sized businesses and the consumer base of the
Bank's market area, demand the convenience and personal service that a smaller,
independent financial institution such as the Bank can offer. It is these themes
of convenience and personal service that form the basis for the Bank's business
development strategies. The Bank provides services from its strategically
located main office in Bethesda, Maryland, and branches in Gaithersburg,
Rockville and Silver Spring. The Bank opened a branch in NW, Washington, DC in
2001, opened second branch in May 2004 and a third branch in January 2005, A
sixth Montgomery County, Maryland branch in Friendship Heights, on the Maryland
/DC border, is expected to open in 2006. There can be no assurance that the Bank
will establish any additional branches or that they will be profitable.
The Bank has capitalized upon the extensive business and personal
contacts and relationships of its Directors and Executive Officers to establish
the Bank's initial customer base. To introduce new customers to the Bank,
reliance is placed on aggressive officer-originated calling programs and
director, customer and shareholder referrals.
The risk of nonpayment (or deferred payment) of loans is inherent in
commercial banking. The Bank's marketing focus on small to medium-sized
businesses may result in the assumption by the Bank of certain lending risks
that are different from those attendant to loans to larger companies. Management
of the Bank carefully evaluates all loan applications and attempts to minimize
its credit risk exposure by use of thorough loan application, approval and
monitoring procedures; however, there can be no assurance that such procedures
can significantly reduce such lending risks.
In addition to holding all of the capital stock of the Bank, the
Company holds investments in securities and loan participation purchased from
the Bank or other financial institutions.
EMPLOYEES
At February 28, 2005 the Bank employed 124 persons on a full time
basis, six of which are executive officers of the Bank. Except for the President
of the Company, the Company (as distinguished from the Bank) does not have any
employees or officers who are not employees or officers of the Bank. None of the
Bank's employees are represented by any collective bargaining group, and the
Bank believes that its employee relations are good. The Bank provides a benefit
program which includes health and dental insurance, a 401k plan, life and long
term disability insurance for substantially all full time employees, and an
incentive stock option plan for key employees of the Company and Bank.
MARKET AREA AND COMPETITION
Location and Market Area. The Bank's main office and the headquarters
of the Company and the Bank is located at 7815 Woodmont Avenue, Bethesda,
Maryland 20814. The Bank has four additional Maryland offices, located at 110
North Washington Street, Rockville, 8677 Georgia Avenue, Silver Spring, 11921
Rockville Pike, Rockville, and 9600 Blackwood Road, Gaithersburg. There are
three offices in Washington D.C., located at 20th and K Streets, NW, 1228
Connecticut Ave., NW and 1425 K Street, NW.
The primary service areas of the Bank are Montgomery County, Maryland,
and Washington D.C., with a secondary market area of, Prince George's County in
Maryland, and Arlington and Fairfax Counties in Virginia. The Washington, D.C.
area attracts a substantial federal workforce as well as supporting a variety of
support industries such as attorneys, lobbyists, government contractors, real
estate developers and investors, non-profit organizations, tourism and
consultants.
Montgomery County, with a total population of about 942,000, represents
the second largest suburban employment center in the Washington, D.C. area, with
approximately 494,815 jobs in 2003, and an unemployment rate of 2.5%. While
government employment provides a significant number of jobs, approximately 82%
of the jobs in the county involve private employers. In 2002, there were 96,000
private sector professional and business service jobs in Montgomery County.
Almost half of the county's employment is located in the Bethesda, Rockville,
North Bethesda area in which the Bank has three branch locations. Much of the
job growth and development is located in that area and in the nearby I-270
technology corridor.
49
Montgomery County is home to nineteen major federal and private sector
research and development and regulatory agencies, including the National
Institute of Standards and Technology, the National Institutes of Health,
National Oceanic and Atmospheric Administration, Naval Research and Development
Center, Naval Surface Warfare Center, Nuclear Regulatory Commission and the Food
and Drug Administration.
Household income for Montgomery County in 2000 was established at
$125,090 compared to a national average for similar counties of $67,090. Per
capita income of $46,450 similarly exceeded the national average of $22,851.
Competition. Deregulation of financial institutions and holding company
acquisitions of banks across state lines has resulted in widespread, fundamental
changes in the financial services industry. This transformation, although
occurring nationwide, is particularly intense in the greater Washington, D.C.
metropolitan area because of the changes in the area's economic base in recent
years and changing state laws authorizing interstate mergers and acquisitions of
banks, and the interstate establishment or acquisition of branches.
In Montgomery County, Maryland, competition is exceptionally keen from
large banking institutions headquartered outside of Maryland. In addition, the
Bank competes with other community banks, savings and loan associations, credit
unions, mortgage companies, finance companies and others providing financial
services. Among the advantages that many of these institutions have over the
Bank are their abilities to finance extensive advertising campaigns, maintain
extensive branch networks and technology investments, and to directly offer
certain services, such as international banking and trust services, which are
not offered directly by the Bank. Further, the greater capitalization of the
larger institutions allows for substantially higher lending limits than the
Bank. Certain of these competitors have other advantages, such as tax exemption
in the case of credit unions, and lesser regulation in the case of mortgage
companies and finance companies.
REGULATION
The following summaries of statutes and regulations affecting bank
holding companies do not purport to be complete discussions of all aspects of
such statutes and regulations and are qualified in their entirety by reference
to the full text thereof.
The Company. The Company is a bank holding company registered under the
Bank Holding Company Act of 1956, as amended, (the "Act") and is subject to
supervision by the Federal Reserve Board. As a bank holding company, the Company
is required to file with the Federal Reserve Board an annual report and such
other additional information as the Federal Reserve Board may require pursuant
to the Act. The Federal Reserve Board may also make examinations of the Company
and each of its subsidiaries.
The Act requires approval of the Federal Reserve Board for, among other
things, the acquisition by a proposed bank holding company of control of more
than five percent (5%) of the voting shares, or substantially all the assets, of
any bank or the merger or consolidation by a bank holding company with another
bank holding company. The Act also generally permits the acquisition by a bank
holding company of control or substantially all the assets of any bank located
in a state other than the home state of the bank holding company, except where
the bank has not been in existence for the minimum period of time required by
state law, but if the bank is at least 5 years old, the Federal Reserve Board
may approve the acquisition.
With certain limited exceptions, a bank holding company is prohibited
from acquiring control of any voting shares of any company which is not a bank
or bank holding company and from engaging directly or indirectly in any activity
other than banking or managing or controlling banks or furnishing services to or
performing service for its authorized subsidiaries. A bank holding company may,
however, engage in or acquire an interest in, a company that engages in
activities which the Federal Reserve Board has determined by order or regulation
to be so closely related to banking or managing or controlling banks as to be
properly incident thereto. In making such a determination, the Federal Reserve
Board is required to consider whether the performance of such activities can
reasonably be expected to produce benefits to the public, such as convenience,
increased competition or gains in efficiency, which outweigh possible adverse
effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. The Federal
Reserve Board is also empowered to differentiate between activities commenced de
novo and activities commenced by the acquisition, in whole or in part, of a
going concern. Some of the activities that the Federal Reserve Board has
determined by regulation to be closely related to banking include making or
servicing loans, performing certain data processing services, acting as a
fiduciary or investment or financial advisor, and making investments in
corporations or projects designed primarily to promote community welfare.
50
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit to
the bank holding company or any of its subsidiaries, or investments in the stock
or other securities thereof, and on the taking of such stock or securities as
collateral for loans to any borrower. Further, a holding company and any
subsidiary bank are prohibited from engaging in certain tie-in arrangements in
connection with the extension of credit. A subsidiary bank may not extend
credit, lease or sell property, or furnish any services, or fix or vary the
consideration for any of the foregoing on the condition that: (i) the customer
obtain or provide some additional credit, property or services from or to such
bank other than a loan, discount, deposit or trust service; (ii) the customer
obtain or provide some additional credit, property or service from or to the
Company or any other subsidiary of the Company; or (iii) the customer not obtain
some other credit, property or service from competitors, except for reasonable
requirements to assure the soundness of credit extended.
Effective on March 11, 2000, the Gramm Leach-Bliley Act of 1999 (the
"GLB Act") allows a bank holding company or other company to certify status as a
financial holding company, which allows such company to engage in activities
that are financial in nature, that are incidental to such activities, or are
complementary to such activities. The GLB Act enumerates certain activities that
are deemed financial in nature, such as underwriting insurance or acting as an
insurance principal, agent or broker, underwriting, dealing in or making markets
in securities, and engaging in merchant banking under certain restrictions. It
also authorizes the Federal Reserve Board to determine by regulation what other
activities are financial in nature, or incidental or complementary thereto. The
GLB Act allows a wider array of companies to own banks, which could result in
companies with resources substantially in excess of the Company's entering into
competition with the Company and the Bank.
The Bank. The Bank, as a Maryland chartered commercial bank which is a
member of the Federal Reserve System (a "state member bank") and whose accounts
will be insured by the Bank Insurance Fund of the Federal Deposit Insurance
Corporation (the "FDIC") up to the maximum legal limits of the FDIC, is subject
to regulation, supervision and regular examination by the Maryland Department of
Financial Institutions and the Federal Reserve Board. The regulations of these
various agencies govern most aspects of the Bank's business, including required
reserves against deposits, loans, investments, mergers and acquisitions,
borrowing, dividends and location and number of branch offices.
The laws and regulations governing the Bank generally have been
promulgated to protect depositors and the deposit insurance funds, and not for
the purpose of protecting stockholders.
Competition among commercial banks, savings and loan associations, and
credit unions has increased following enactment of legislation which greatly
expanded the ability of banks and bank holding companies to engage in interstate
banking or acquisition activities. As a result of federal and state legislation,
banks in the Washington D.C./Maryland/Virginia area can, subject to limited
restrictions, acquire or merge with a bank in another of the jurisdictions, and
can branch de novo in any of the jurisdictions. Additionally, legislation has
been proposed which may result in non-banking companies being authorized to own
banks, which could result in companies with resources substantially in excess of
the Company's entering into competition with the Company and the Bank.
Banking is a business which depends on interest rate differentials. In
general, the differences between the interest paid by a bank on its deposits and
its other borrowings and the interest received by a bank on loans extended to
its customers and securities held in its investment portfolio constitute the
major portion of the bank's earnings. Thus, the earnings and growth of the Bank
will be subject to the influence of economic conditions generally, both domestic
and foreign, and also to the monetary and fiscal policies of the United States
and its agencies, particularly the Federal Reserve Board, which regulates the
supply of money through various means including open market dealings in United
States government securities. The nature and timing of changes in such policies
and their impact on the Bank cannot be predicted.
51
Branching and Interstate Banking. The federal banking agencies are
authorized to approve interstate bank merger transactions without regard to
whether such transaction is prohibited by the law of any state, unless the home
state of one of the banks has opted out of the interstate bank merger provisions
of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Riegle-Neal Act") by adopting a law after the date of enactment of the
Riegle-Neal Act and prior to June 1, 1997 which applies equally to all
out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. Interstate acquisitions of branches are permitted only if
the law of the state in which the branch is located permits such acquisitions.
Such interstate bank mergers and branch acquisitions are also subject to the
nationwide and statewide insured deposit concentration limitations described in
the Riegle-Neal Act.
The Riegle-Neal Act authorizes the federal banking agencies to approve
interstate branching de novo by national and state banks in states which
specifically allow for such branching. The District of Columbia, Maryland and
Virginia have all enacted laws which permit interstate acquisitions of banks and
bank branches and permit out-of-state banks to establish de novo branches.
The GLB Act made substantial changes in the historic restrictions on
non-bank activities of bank holding companies, and allows affiliations between
types of companies that were previously prohibited. The GLB Act also allows
banks to engage in a wider array of non banking activities through "financial
subsidiaries."
USA Patriot Act. Under the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act,
commonly referred to as the "USA Patriot Act" or the "Patriot Act", financial
institutions are subject to prohibitions against specified financial
transactions and account relationships, as well as enhanced due diligence
standards intended to detect, and prevent, the use of the United States
financial system for money laundering and terrorist financing activities. The
Patriot Act requires financial institutions, including banks, to establish
anti-money laundering programs, including employee training and independent
audit requirements, meet minimum standards specified by the act, follow minimum
standards for customer identification and maintenance of customer identification
records, and regularly compare customer lists against lists of suspected
terrorists, terrorist organizations and money launderers. The costs or other
effects of the compliance burdens imposed by the Patriot Act or future
anti-terrorist, homeland security or anti-money laundering legislation or
regulation cannot be predicted with certainty.
Capital Adequacy Guidelines. The Federal Reserve Board and the FDIC have
adopted risk based capital adequacy guidelines pursuant to which they assess the
adequacy of capital in examining and supervising banks and bank holding
companies and in analyzing bank regulatory applications. Risk-based capital
requirements determine the adequacy of capital based on the risk inherent in
various classes of assets and off-balance sheet items.
State member banks are expected to meet a minimum ratio of total
qualifying capital (the sum of core capital (Tier 1) and supplementary capital
(Tier 2)) to risk weighted assets of 8%. At least half of this amount (4%)
should be in the form of core capital.
Tier 1 Capital generally consists of the sum of common stockholders'
equity and perpetual preferred stock (subject in the case of the latter to
limitations on the kind and amount of such stock which may be included as Tier 1
Capital), less goodwill, without adjustment for changes in the market value of
securities classified as "available for sale" in accordance with FAS 115. Tier 2
Capital consists of the following: hybrid capital instruments; perpetual
preferred stock which is not otherwise eligible to be included as Tier 1
Capital; term subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan losses. Assets are adjusted
under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no risk-based
capital) for assets such as cash, to 100% for the bulk of assets which are
typically held by a bank holding company, including certain multi-family
residential and commercial real estate loans, commercial business loans and
consumer loans. Residential first mortgage loans on one to four family
residential real estate and certain seasoned multi-family residential real
estate loans, which are not 90 days or more past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
52
In addition to the risk-based capital requirements, the Federal Reserve
Board has established a minimum 3.0% Leverage Capital Ratio (Tier 1 Capital to
total adjusted assets) requirement for the most highly-rated banks, with an
additional cushion of at least 100 to 200 basis points for all other banks,
which effectively increases the minimum Leverage Capital Ratio for such other
banks to 4.0% - 5.0% or more. The highest-rated banks are those that are not
anticipating or experiencing significant growth and have well diversified risk,
including no undue interest rate risk exposure, excellent asset quality, high
liquidity, good earnings and, in general, those which are considered a strong
banking organization. A bank having less than the minimum Leverage Capital Ratio
requirement shall, within 60 days of the date as of which it fails to comply
with such requirement, submit a reasonable plan describing the means and timing
by which the bank shall achieve its minimum Leverage Capital Ratio requirement.
A bank which fails to file such plan is deemed to be operating in an unsafe and
unsound manner, and could subject the bank to a cease-and-desist order. Any
insured depository institution with a Leverage Capital Ratio that is less than
2.0% is deemed to be operating in an unsafe or unsound condition pursuant to
Section 8(a) of the Federal Deposit Insurance Act (the "FDIA") and is subject to
potential termination of deposit insurance. However, such an institution will
not be subject to an enforcement proceeding solely on account of its capital
ratios, if it has entered into and is in compliance with a written agreement to
increase its Leverage Capital Ratio and to take such other action as may be
necessary for the institution to be operated in a safe and sound manner. The
capital regulations also provide, among other things, for the issuance of a
capital directive, which is a final order issued to a bank that fails to
maintain minimum capital or to restore its capital to the minimum capital
requirement within a specified time period. Such directive is enforceable in the
same manner as a final cease-and-desist order.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal
banking agency is required to implement a system of prompt corrective action for
institutions which it regulates. The federal banking agencies have promulgated
substantially similar regulations to implement the system of prompt corrective
action established by Section 38 of the FDIA. Under the regulations, a bank
shall be deemed to be: (i) "well capitalized" if it has a Total Risk Based
Capital Ratio of 10.0% or more, a Tier 1 Risk Based Capital Ratio of 6.0% or
more, a Leverage Capital Ratio of 5.0% or more and is not subject to any written
capital order or directive; (ii) "adequately capitalized" if it has a Total Risk
Based Capital Ratio of 8.0% or more, a Tier 1 Risk Based Capital Ratio of 4.0%
or more and a Tier 1 Leverage Capital Ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized;" (iii)
"undercapitalized" if it has a Total Risk Based Capital Ratio that is less than
8.0%, a Tier 1 Risk based Capital Ratio that is less than 4.0% or a Leverage
Capital Ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a Total Risk Based Capital Ratio that
is less than 6.0%, a Tier 1 Risk Based Capital Ratio that is less than 3.0% or a
Leverage Capital Ratio that is less than 3.0%; and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%.
An institution generally must file a written capital restoration plan
which meets specified requirements with an appropriate federal banking agency
within 45 days of the date the institution receives notice or is deemed to have
notice that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. A federal banking agency must provide the institution with
written notice of approval or disapproval within 60 days after receiving a
capital restoration plan, subject to extensions by the applicable agency.
An institution which is required to submit a capital restoration plan
must concurrently submit a performance guaranty by each company that controls
the institution. Such guaranty shall be limited to the lesser of (i) an amount
equal to 5.0% of the institution's total assets at the time the institution was
notified or deemed to have notice that it was undercapitalized or (ii) the
amount necessary at such time to restore the relevant capital measures of the
institution to the levels required for the institution to be classified as
adequately capitalized. Such a guaranty shall expire after the federal banking
agency notifies the institution that it has remained adequately capitalized for
each of four consecutive calendar quarters. An institution which fails to submit
a written capital restoration plan within the requisite period, including any
required performance guaranty, or fails in any material respect to implement a
capital restoration plan, shall be subject to the restrictions in Section 38 of
the FDIA which are applicable to significantly undercapitalized institutions.
A "critically undercapitalized institution" is to be placed in
conservatorship or receivership within 90 days unless the FDIC formally
determines that forbearance from such action would better protect the deposit
insurance fund. Unless the FDIC or other appropriate federal banking regulatory
agency makes specific further findings and certifies that the institution is
viable and is not expected to fail, an institution that remains critically
undercapitalized on average during the fourth calendar quarter after the date it
becomes critically undercapitalized must be placed in receivership. The general
rule is that the FDIC will be appointed as receiver within 90 days after a bank
becomes critically undercapitalized unless extremely good cause is shown and an
extension is agreed to by the federal regulators. In general, good cause is
defined as capital which has been raised and is imminently available for
infusion into the Bank except for certain technical requirements which may delay
the infusion for a period of time beyond the 90 day time period.
53
Immediately upon becoming undercapitalized, an institution shall become
subject to the provisions of Section 38 of the FDIA, which (i) restrict payment
of capital distributions and management fees; (ii) require that the appropriate
federal banking agency monitor the condition of the institution and its efforts
to restore its capital; (iii) require submission of a capital restoration plan;
(iv) restrict the growth of the institution's assets; and (v) require prior
approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any number of discretionary
supervisory actions if the agency determines that any of these actions is
necessary to resolve the problems of the institution at the least possible
long-term cost to the deposit insurance fund, subject in certain cases to
specified procedures. These discretionary supervisory actions include: requiring
the institution to raise additional capital; restricting transactions with
affiliates; requiring divestiture of the institution or the sale of the
institution to a willing purchaser; and any other supervisory action that the
agency deems appropriate. These and additional mandatory and permissive
supervisory actions may be taken with respect to significantly undercapitalized
and critically undercapitalized institutions.
Additionally, under Section 11(c)(5) of the FDIA, a conservator or
receiver may be appointed for an institution where: (i) an institution's
obligations exceed its assets; (ii) there is substantial dissipation of the
institution's assets or earnings as a result of any violation of law or any
unsafe or unsound practice; (iii) the institution is in an unsafe or unsound
condition; (iv) there is a willful violation of a cease-and-desist order; (v)
the institution is unable to pay its obligations in the ordinary course of
business; (vi) losses or threatened losses deplete all or substantially all of
an institution's capital, and there is no reasonable prospect of becoming
"adequately capitalized" without assistance; (vii) there is any violation of law
or unsafe or unsound practice or condition that is likely to cause insolvency or
substantial dissipation of assets or earnings, weaken the institution's
condition, or otherwise seriously prejudice the interests of depositors or the
insurance fund; (viii) an institution ceases to be insured; (ix) the institution
is undercapitalized and has no reasonable prospect that it will become
adequately capitalized, fails to become adequately capitalized when required to
do so, or fails to submit or materially implement a capital restoration plan; or
(x) the institution is critically undercapitalized or otherwise has
substantially insufficient capital.
Regulatory Enforcement Authority. Federal banking law grants
substantial enforcement powers to federal banking regulators. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties. In general, these enforcement actions may be initiated for violations
of laws and regulations and unsafe or unsound practices. Other actions or
inactions may provide the basis for enforcement action, including misleading or
untimely reports filed with regulatory authorities.
Deposit Insurance Premiums. The FDIA establishes a risk based deposit
insurance assessment system. Under applicable regulations, deposit premium
assessments are determined based upon a matrix formed utilizing capital
categories - well capitalized, adequately capitalized and undercapitalized -
defined in the same manner as those categories are defined for purposes of
Section 38 of the FDIA. Each of these groups is then divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with rates ranging from 0.04% of insured deposits for well
capitalized institutions having the lowest level of supervisory concern, to
0.31% of insured deposits for undercapitalized institutions having the highest
level of supervisory concern. In general, while the Bank Insurance Fund of the
FDIC ("BIF") maintains a reserve ratio of 1.25% or greater, no deposit insurance
premiums are required. When the BIF reserve ratio falls below that level, all
insured banks would be required to pay premiums. The payment of deposit
insurance premiums will have an adverse effect on earnings.
54
PROPERTIES
The main branch and the executive offices for the Bank and the Company
are located at 7815 Woodmont Avenue, Bethesda, Maryland, in a 12,000 square
foot, two story masonry structure (plus basement), with parking. The Company
leases the building under a ten-year lease which commenced in April 1998; at an
initial annual rent $142,500, subject to annual increase based on the CPI, not
to exceed 4% per year. The Company has two five-year renewal options, and an
option to purchase the building at a price to be negotiated. The Silver Spring
branch of the Bank is located at 8677 Georgia Avenue, Silver Spring, Maryland
and consists of 2,794 square feet. The property is occupied under a five year
lease, commenced April 1998, at an initial annual rent of $55,878, subject to
annual increase based on the CPI, plus additional rent relating to common area
fees and taxes. The Company has one five year renewal option. The Rockville
branch is located at 110 North Washington Street, Rockville, Maryland, and
consists of 2,000 square feet. The property is occupied under a five year lease
commenced April 1998, at an initial annual rent of $35,000, subject to annual
increase based upon the CPI, with a minimum 3% annual increase, plus additional
rent relating to common area fees and taxes. The Company has one five-year
renewal option. The K Street branch of the Bank is located at 2001 K Street NW,
Washington, DC and consists of 4,154 square feet. The property is occupied under
a ten year lease, commenced February 2001, at an initial annual rent of
$186,930, with a 3% annual increase, plus additional rent relating to common
area fees and taxes. The Company has two five-year renewal options. The Shady
Grove/Gaithersburg branch is located at 9600 Blackwood Road, Rockville,
Maryland, and consists of 2,326 square feet. The property is occupied under a
ten year lease, commenced February 2002, at an initial annual rent of $70,361,
with 3% annual increases, plus additional rent relating to common area fees and
taxes. The Company has one five-year renewal option. The Rockville Pike branch
is located at 11921 Rockville Pike, Rockville, Maryland and consists of 2,183
square feet. The property is occupied under a 5 year lease, commenced December
2003, at an initial annual rent of $64,399, with a 3% annual increase. The
Company has one five-year renewal option. The Dupont Circle branch is located at
1228 Connecticut Avenue, N.W., Washington, DC 20036 and consists of 1,738 square
feet. The property is occupied under a 10 year lease, commenced in April 2004,
at an initial annual rent of $81,686, with a 3% annual increase. The McPherson
Square branch is located at 1425 K Street, N.W., Washington, DC 20036 and
consists of 5,199 square feet. The property is occupied under a 10 year lease,
commenced in July 2004, at an initial annual rent of $144,067 with a 5% annual
increase.
In January 2002, the Company occupied a facility in Bethesda,
consisting of 2,698 square feet, under a 10 year lease, with one five year
renewal option, at an initial base rent of $67,450 per year with a 3% annual
increase, plus additional rent relating to common area fees and taxes. In June
2004, the Company occupied an additional facility in Bethesda, consisting of
2,820 square feet under a 10 year lease, with one five-year renewal option, at
an initial base rent of $59,784 per year, with a 3% annual increase.
In April 2004, the Company occupied a new operations center at 11961
Tech Road, Silver Spring, Maryland, consisting of 9,172 square feet. The
property is occupied under a 7 year lease, at an initial annual rent of $99,789,
with a 3% annual increase. The Company has two five-year renewal options.
In February 2004, the Company entered into a lease for a facility at 11
Wisconsin Circle, Chevy Chase, Maryland, with the intention of opening an
additional branch location in 2006. The facility consists of 4,276 square feet
and will be occupied under a 10 year lease, at an initial annual rent of
$239,884, with a 3% annual increase. The Company has two five-year renewal
options.
CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Chief Executive Officer and Chief Financial Officer,
evaluated, as of the last day of he period covered by this report, the
effectiveness of the design and operation of the Company's disclosure controls
and procedures, as defined in Rule 13a-15(e) under the Securities 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 December 31, 2004 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
55
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Eagle Bancorp, Inc. (the "Company") is responsible
for the preparation, integrity and fair presentation of the financial statements
included in this Annual Report. The financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America and reflect management's judgments and estimates concerning the effects
of events and transactions that are accounted for or disclosed.
Management is also responsible for establishing and maintaining
effective internal control over financial reporting. The Company's internal
control over financial reporting includes those policies and procedures that
pertain to the Company's ability to record, process, summarize and report
reliable financial data. The internal control system contains monitoring
mechanisms, and appropriate actions taken to correct identified deficiencies.
Management believes that internal controls over financial reporting, which are
subject to scrutiny by management and the Company's internal auditors, support
the integrity and reliability of the financial statements. Management recognizes
that there are inherent limitations in the effectiveness of any internal control
system, including the possibility of human error and the circumvention or
overriding of internal controls. Accordingly, even effective internal control
over financial reporting can provide only reasonable assurance with respect to
financial statement preparation. In addition, because of changes in conditions
and circumstances, the effectiveness of internal control over financial
reporting may vary over time. The Audit Committee of the Board of Directors (the
"Committee"), is comprised entirely of outside directors who are independent of
management. The Committee is responsible for the appointment and compensation of
the independent auditors and makes decisions regarding the appointment or
removal of members of the internal audit function. The Committee meets
periodically with management, the independent auditors, and the internal
auditors to ensure that they are carrying out their responsibilities. The
Committee is also responsible for performing an oversight role by reviewing and
monitoring the financial, accounting, and auditing procedures of the Company in
addition to reviewing the Company's financial reports. The independent auditors
and the internal auditors have full and unlimited access to the Audit Committee,
with or without the presence of management, to discuss the adequacy of internal
control over financial reporting, and any other matters which they believe
should be brought to the attention of the Audit Committee.
Management assessed the Company's system of internal control over
financial reporting as of December 31, 2004. This assessment was conducted based
on the Committee of Sponsoring Organizations ("COSO") of the Treadway Commission
"Internal Control - Integrated Framework." Based on this assessment, management
believes that the Company maintained effective internal control over financial
reporting as of December 31, 2004. Management's assessment concluded that there
were no material weaknesses within the Company's internal control structure.
The 2004 financial statements have been audited by the independent
registered public accounting firm of Stegman & Company ("Stegman"). Personnel
from Stegman were given unrestricted access to all financial records and related
data, including minutes of all meetings of the Board of Directors and committees
thereof. Management believes that all representations made to the independent
auditors were valid and appropriate. The resulting report from Stegman
accompanies the financial statements. Stegman has also issued an attestation
report on management's assessment of the effectiveness of internal control over
financial reporting. That report has also been made a part of this Annual
Report.
/s/ Ronald D. Paul /s/ Michael T. Flynn /s/ Wilmer Tinley
President and Chief Executive Executive Vice President of the Senior Vice President and Chief
Officer of the Company Company and President of Financial Officer of the Company
EagleBank
56
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
of Eagle Bancorp, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Eagle
Bancorp, Inc. (the "Company") maintained effective internal control over
financial reporting as of December 31, 2004, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Eagle Bancorp, Inc.
maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our
opinion, Eagle Bancorp, Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2004, based in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets as of December 31, 2004, and 2003 and the related consolidated statements
of income, changes in stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 2004 of Eagle Bancorp, Inc. and our
report dated February 21, 2005 expressed an unqualified opinion on those
consolidated financial statements.
/s/ Stegman & Company
Baltimore, Maryland
February 21, 2005
57
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following financial statements are included in this report
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2004 and 2003
Consolidated Statements of Income for the years ended December
31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2004, 2003 and 2002
Notes to the Consolidated Financial Statements
All financial statement schedules have been omitted as the required information
is either inapplicable or included in the consolidated financial statements or
related notes.
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 Employment Agreement between James H. Langmead and the Bank,
filed herewith
10.10 Employee Stock Purchase Plan (5)
11 Statement Regarding Computation of Per Share Income
Please refer to Note 9 to the consolidated financial statements for the
year ended December 31, 2004.
21 Subsidiaries of the Registrant
23 Consent of Stegman & Company
31.1 Certification of Ronald D. Paul
31.2 Certification of Wilmer L. Tinley
31.3 Certification of Michael T. Flynn
32.1 Certification of Ronald D. Paul
32.2 Certification of Wilmer L. Tinley
32.3 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, 2004.
(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 exhibit of the same number to the
Company's Annual Report on Form 10-K for
the year ended December 31, 2004.
(5) Incorporated by reference to Exhibit 4 the Company's Registration
Statement on Form S-8 (No. 333-116352).
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
March 9, 2005 By: /s/ Ronald D. Paul
----------------------------------------
Ronald D. Paul, President and CEO
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NAME POSITION DATE
/s/ Leonard L. Abel Chairman of the Board of Directors March 9, 2005
- ------------------------------------
Leonard L. Abel
/s/ Leslie M. Alperstein Director March 9, 2005
- ------------------------------------
Leslie M. Alperstein
/s/ Dudley C. Dworken Director March 9, 2005
- ------------------------------------
Dudley C. Dworken
/s/ Michael T. Flynn Executive Vice President and Director March 9, 2005
- ------------------------------------ of the Company, President of the Bank
Michael T. Flynn
/s/ Eugene F. Ford, Sr. Director March 9, 2005
- ------------------------------------
Eugene F. Ford, Sr.
/s/ Philip N. Margolius Director March 9, 2005
- ------------------------------------
Philip N. Margolius
/s/ Ronald D. Paul President and Director March 9, 2005
- ------------------------------------ Principal Executive Officer
Ronald D. Paul
/s/ Wilmer L. Tinley Executive Vice President of the Bank, March 9, 2005
- ------------------------------------ and Senior Vice President and
Wilmer L. Tinley Chief Financial Officer of the Company
Principal Financial and Accounting Officer
59