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EX-31.1 - EXHIBIT 31.1 - BAY BANCORP, INC.a6097827ex311.txt
EX-32.2 - EXHIBIT 32.2 - BAY BANCORP, INC.a6097827ex322.txt
EX-32.1 - EXHIBIT 32.1 - BAY BANCORP, INC.a6097827ex321.txt
EX-31.2 - EXHIBIT 31.2 - BAY BANCORP, INC.a6097827ex312.txt



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                United States Securities and Exchange Commission
                             Washington, D.C. 20549

                                    FORM 10-Q

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

                For the quarterly period ended September 30, 2009

                           ----------------------------

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

                        For the transition period from  to

                         Commission file number 0-23090

                               CARROLLTON BANCORP
             (Exact name of registrant as specified in its charter)

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

         7151 Columbia Gateway Drive, Suite A, Columbia, Maryland 21046
                    (Address of principal executive offices)
                                 (410) 312-5400
                           (Issuer's telephone number)

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

  Indicate by check mark whether the registrant (1) filed all reports required
  to be filed by Section 13 or 15(d) of the Exchange Act during the preceding
 12 months (or for such shorter period that the registrant was required to file
  such reports), and (2) has been subject to such filing requirements for the
                            past 90 days. Yes |X| No |_|

 Indicate by check mark whether the registrant is a large accelerated filer, an
  accelerated filer, or a non-accelerated filer. See definition of "accelerated
      filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
                                  (Check one).

Large accelerated filer |_|   Accelerated filer |_|   Non-accelerated filer |X|

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|


     State the number shares outstanding of each of the issuer's classes of
               common equity, as of the latest practicable date:
            2,568,588 common shares outstanding at November 5, 2009

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CARROLLTON BANCORP CONTENTS PART I - FINANCIAL INFORMATION PAGE ------------------------------ ---- Item 1. Financial Statements: Consolidated Balance Sheets as of September 30, 2009 (unaudited) and December 31, 2008 3 Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2009 and 2008 (unaudited) 4 Consolidated Statements of Shareholders' Equity for the Nine Months Ended September 30, 2009 and 2008 (unaudited) 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008 (unaudited) 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation 17 Item 3. Quantitative and Qualitative Disclosures about Market Risk 28 Item 4. Controls and Procedures 28 PART II - OTHER INFORMATION 28 Item 1. Legal Proceedings 28 Item 2. Changes in Securities and Use of Proceeds 28 Item 3. Defaults Upon Senior Securities 28 Item 4. Submission of Matters to a Vote of Security Holders 28 Item 5. Other Information 28 Item 6. Exhibits 29 2
PART I ITEM 1. FINANCIAL STATEMENTS CARROLLTON BANCORP CONSOLIDATED BALANCE SHEETS September 30, December 31, 2009 2008 -------------- -------------- (unaudited) ASSETS Cash and due from banks $ 5,672,097 $ 6,110,122 Federal funds sold and other interest bearing deposits 14,100,460 4,052,166 Federal Home Loan Bank stock, at cost 3,876,100 3,575,700 Investment securities: Available for sale 56,289,143 56,393,865 Held to maturity (fair value of $9,121,182 and $11,601,875) 8,947,332 10,374,288 Loans held for sale 31,173,671 21,701,287 Loans, less allowance for loan losses of $4,636,063 in 2009 and $3,682,756 in 2008 288,324,192 280,513,415 Premises and equipment 7,325,676 7,012,193 Accrued interest receivable 1,648,707 1,797,241 Bank owned life insurance 4,721,692 4,593,182 Deferred income taxes 3,103,388 3,416,895 Other real estate owned 2,223,427 1,736,018 Other assets 2,724,588 2,904,812 -------------- -------------- $ 430,130,473 $ 404,181,184 ============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Noninterest-bearing $ 48,625,677 $ 45,324,537 Interest-bearing 291,039,613 247,028,739 -------------- -------------- Total deposits 339,665,290 292,353,276 Federal funds purchased and securities sold under agreement to repurchase 6,458,017 14,210,755 Advances from the Federal Home Loan Bank 43,460,000 65,230,000 Accrued interest payable 308,128 288,410 Accrued pension plan 1,968,896 1,968,896 Other liabilities 1,850,885 2,739,154 -------------- -------------- 393,711,216 376,790,491 -------------- -------------- SHAREHOLDERS' EQUITY Preferred stock, par value $1.00 per share (liquidation preference of $1,000 per share) authorized 9,201 shares; issued and outstanding 9,201 in 2009 and 0 in 2008 (discount of $358,250 in 2009 and 0 in 2008) 8,821,751 -- Common stock, par $1.00 per share; authorized 10,000,000 shares; issued and outstanding 2,568,588 in 2009 and 2,564,988 in 2008 2,568,588 2,564,988 Additional paid-in capital 15,684,029 15,255,971 Retained earnings 12,546,139 13,252,272 Accumulated other comprehensive income (3,201,250) (3,682,538) -------------- -------------- 36,419,257 27,390,693 -------------- -------------- $ 430,130,473 $ 404,181,184 ============== ============== See accompanying notes to consolidated financial statements. 3
CARROLLTON BANCORP CONSOLIDATED STATEMENTS OF INCOME Three Months Ended Nine Months Ended September 30, September 30, --------------------------- ---------------------------- 2009 2008 2009 2008 ------------- ------------ ------------- ------------- (unaudited) (unaudited) (unaudited) (unaudited) Interest income: Loans $ 4,620,824 $ 4,673,173 $ 13,804,256 $ 13,959,111 Investment securities: Taxable 593,183 868,309 2,081,832 2,293,207 Nontaxable 118,277 85,145 342,884 261,101 Dividends 1,872 48,709 23,392 149,623 Federal funds sold and interest-bearing deposits with other banks 3,927 9,385 6,259 55,867 ------------- ------------ ------------- ------------- Total interest income 5,338,083 5,684,721 16,258,623 16,718,909 ------------- ------------ ------------- ------------- Interest expense: Deposits 1,773,522 1,550,240 5,138,474 4,898,945 Borrowings 345,118 617,437 1,076,144 1,355,921 ------------- ------------ ------------- ------------- Total interest expense 2,118,640 2,167,677 6,214,618 6,254,866 ------------- ------------ ------------- ------------- Net interest income 3,219,443 3,517,044 10,044,005 10,464,043 Provision for loan losses 1,600,000 799,000 2,336,000 997,000 ------------- ------------ ------------- ------------- Net interest income after provision for loan losses 1,619,443 2,718,044 7,708,005 9,467,043 ------------- ------------ ------------- ------------- Noninterest income: Electronic Banking 496,369 450,560 1,404,630 1,380,388 Mortgage-banking fees and gains 1,049,299 652,099 3,180,426 1,933,762 Service charges on deposit accounts 182,378 215,645 547,266 627,136 Brokerage commissions 140,827 176,694 387,899 569,213 Other fees and commissions 101,737 146,054 313,425 355,779 Security gains (losses), net (243,927) 1,051 (234,840) 81,715 ------------- ------------ ------------- ------------- Total noninterest income 1,726,683 1,642,103 5,598,806 4,947,993 ------------- ------------ ------------- ------------- Noninterest expenses: Salaries 1,916,411 1,772,170 5,559,040 5,173,710 Employee benefits 374,492 415,779 1,283,582 1,369,384 Occupancy 590,384 596,717 1,770,935 1,768,821 Furniture and equipment 152,795 162,416 444,888 469,853 Professional services 187,552 201,503 587,467 647,740 Lease buyout - branch (108,153) -- (108,153) 368,000 Other operating expenses 1,300,894 1,216,390 3,901,901 3,148,341 ------------- ------------ ------------- ------------- Total noninterest expenses 4,414,375 4,364,975 13,439,660 12,945,849 ------------- ------------ ------------- ------------- Income (loss) before income taxes (1,068,249) (4,828) (132,849) 1,469,187 Income tax provision (benefit) (474,736) (55,557) (223,809) 362,591 ------------- ------------ ------------- ------------- Net income (loss) (593,513) 50,729 90,960 1,106,596 Preferred stock dividends and discounts accretion 138,039 -- 345,099 -- Net income (loss) available to common shareholders $ (731,552) $ 50,729 $ (254,139) $ 1,106,596 ============= ============ ============= ============= Basis net income (loss) per common share $ (0.28) $ 0.02 $ (0.10) $ 0.42 ============= ============ ============= ============= Diluted net income (loss) per common share $ (0.28) $ 0.02 $ (0.10) $ 0.42 ============= ============ ============= ============= See accompanying notes to consolidated financial statements. 4
CARROLLTON BANCORP CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Nine Months Ended September 30, 2009 and 2008 (unaudited) Accumulated Additional Other Preferred Common Paid-In Retained Comprehensive Comprehensive Stock Stock Capital Earnings Income Income ------------ ------------ ------------- ------------- ------------- ------------- Balances at December 31, 2007 $ -- $ 2,834,975 $ 18,781,651 $ 13,654,180 $ 660,495 Net income -- -- -- 1,106,596 -- $ 1,106,596 Changes in net unrealized gains (losses) on securities available for sale, net of tax -- -- -- -- (1,625,399) (1,625,399) Cash flow hedging derivative -- -- -- -- 124,351 124,351 ------------- Comprehensive loss $ (394,452) ============= Shares acquired and canceled -- (276,137) (3,607,733) -- -- Stock options exercised including tax benefit of $32,663 -- 2,550 27,939 -- -- Issuance of stock under 2007 Equity Plan -- 3,600 46,800 -- -- Stock based compensation -- -- 5,486 -- -- Cash dividends, $0.24 per share -- -- -- (940,962) -- ------------ ------------ ------------- ------------- ------------- Balances at September 30, 2008 $ -- $ 2,564,988 $ 15,254,143 $ 13,819,814 $ (840,553) ============ ============ ============= ============= ============= Balances at December 31, 2008 $ -- $ 2,564,988 $ 15,255,971 $ 13,252,272 $ (3,682,538) Net income -- -- -- 90,960 -- $ 90,960 Changes in net unrealized gains (losses) on securities available for sale, net of tax -- -- -- -- 625,647 625,647 Cash flow hedging derivatives -- -- -- -- (144,359) (144,359) ------------- Comprehensive income -- -- -- -- $ 572,248 ============= Issuance of U.S. Treasury preferred stock 8,770,572 -- 409,428 -- -- Accretion of discount associated with U.S. Treasury preferred stock 51,179 -- -- (51,179) -- Issuance of stock under 2007 Equity Plan -- 3,600 17,037 -- -- Stock based compensation -- -- 1,593 -- -- Preferred stock cash dividend $25.28 per share -- -- -- (232,581) -- Cash dividends, $0.20 per share -- -- -- (513,333) -- ------------ ------------ ------------- ------------- ------------- Balances at September 30, 2009 $ 8,821,751 $ 2,568,588 $ 15,684,029 $ 12,546,139 $ (3,201,250) ============ ============ ============= ============= ============= See accompanying notes to consolidated financial statements. 5
CARROLLTON BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months Ended September 30, 2009 and 2008 Nine Months Ended September 30, ------------------------------- 2009 2008 -------------- --------------- (unaudited) (unaudited) Cash flows from operating activities: Net income $ 90,960 $ 1,106,596 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for loan losses 2,336,000 997,000 Depreciation and amortization 631,065 646,119 Deferred income taxes (benefits) (238,394) 224,777 Amortization of premiums and discounts (101,041) (60,562) Gains on disposal of securities (9,087) (81,715) Write down of securities 243,927 -- (Gains) loss on sale of Other Real Estate Owned 105,971 (18,981) Loans held for sale made, net of principal sold (9,472,384) (11,684,214) Write down of foreclosed real estate -- 201,000 Loss on disposal of premises and equipment 1,390 -- Stock-based compensation expense 1,593 5,486 Issuance of stock under 2007 Equity Plan 20,637 50,400 (Increase) decrease in: Accrued interest receivable 148,534 (89,144) Prepaid income taxes (119,421) (357,410) Cash surrender value for bank owned life insurance (128,510) (117,831) Other assets 164,865 (250,096) Increase (decrease) in: Accrued interest payable 19,718 161,450 Deferred loan origination fees (98,290) (55,907) Other liabilities (888,269) 620,372 -------------- --------------- Net cash used in provided by operating activities (7,290,736) (8,702,660) Cash flows from investing activities: Proceeds from sales, maturities, calls and principal payments of securities available for sale 7,207,096 495,514 Proceeds of maturities, calls and principal payments of securities held to maturity 1,198,166 5,966,928 Purchase of Federal Home Loan Bank stock (300,400) (2,990,600) Purchase of securities available for sale (5,974,194) (32,511,446) Loans made, net of principal collected (11,413,444) (21,283,831) Purchase of premises and equipment (811,159) (477,121) Proceeds from sale of foreclosed real estate 771,578 -- Proceeds from sale of premises and equipment -- 15,081 -------------- --------------- Net cash used in investing activities (9,322,357) (48,832,752) -------------- --------------- Cash flows from financing activities: Net increase in time deposits 44,365,386 10,347,121 Net increase (decrease) in other deposits 2,946,628 (18,155,793) (Payments) advances of Federal Home Loan Bank Advances (21,770,000) 66,400,000 Net decrease in other borrowed funds (7,752,738) (2,422,495) Stock options exercised -- 28,607 Common stock repurchases and retirement -- (3,883,870) Net proceeds of issuance of preferred stock and warrant 9,180,000 -- Income tax benefit from exercise of stock options -- 1,883 Dividends paid (745,914) (940,962) -------------- --------------- Net cash provided by financing activities 26,223,362 51,377,491 -------------- --------------- Net increase (decrease) in cash and cash equivalents 9,610,269 (6,160,921) Cash and cash equivalents at beginning of period 10,162,288 16,926,981 -------------- --------------- Cash and cash equivalents at end of period $ 19,772,557 $ 10,766,060 ============== =============== Supplemental information: Interest paid on deposits and borrowings $ 6,194,900 $ 6,093,416 ============== =============== Income taxes (refund) paid $ (203,388) $ 20,001 ============== =============== Non cash activity Real estate acquired in settlement of loans $ 1,364,958 $ 1,432,343 ============== =============== See accompanying notes to consolidated financial statements. 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Information as of and for the three and nine months ended September 30, 2009 and 2008 is unaudited) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying consolidated financial statements prepared for Carrollton Bancorp ("the Company") have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a full presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto, included in the Company's 2008 Annual Report on Form 10-K filed with the Security and Exchange Commission (SEC). The consolidated financial statements include the accounts of the Company's subsidiary, Carrollton Bank, Carrollton Bank's wholly-owned subsidiaries, Carrollton Mortgage Services, Inc. ("CMSI"), Carrollton Financial Services, Inc. ("CFS"), Mulberry Street, LLC ("MSLLC"), and Carrollton Bank's 96.4% owned subsidiary, Carrollton Community Development Corporation ("CCDC") (collectively, the "Bank"). All significant intercompany balances and transactions have been eliminated. The consolidated financial statements as of September 30, 2009 and for the three and nine months ended September 30, 2009 are unaudited but include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of financial position and results of operations for those periods. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that will be achieved for the entire year. Accounting Standards Codification. The Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) became effective on July 1, 2009. At that date, the ASC became FASB's officially recognized source of authoritative U.S. generally accepted accounting principles (GAAP) applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. Derivative Instruments and Hedging Activities The Company accounts for derivative instruments and hedging activities utilizing accounting guidance established for Accounting for Derivative Instruments and Hedging Activities, as amended. The Company recognizes all derivatives as either assets or liabilities on the balance sheet and measures those instruments at fair value using Level 2 inputs as defined in Note 7. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in "Other Comprehensive Income," net of deferred taxes. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item. Management periodically reviews contracts from various functional areas of the Company to identify potential derivatives embedded within selected contracts. Management has identified potential embedded derivatives in certain loan commitments for residential mortgages where the Company has intent to sell to an outside investor. Due to the short-term nature of these loan commitments and the minimal historical dollar amount of commitments outstanding, the corresponding impact on the Company's financial condition and results of operation has not been material. The Company entered into an interest rate Floor transaction on December 14, 2005. The Floor has a notional amount of $10.0 million with a minimum interest rate of 7.00% based on U.S. prime rate and was initiated to hedge exposure to the variability in the future cash flows derived from adjustable rate home equity loans in a declining interest rate environment. The Floor has a term of five years. This interest rate Floor is designated a cash flow hedge, as it is designed to reduce variation in overall changes in cash flow below the above designated strike level associated with the first Prime based interest payments received each period on its then existing loans. The interest rate of these loans will change whenever the repricing index changes, plus or minus a credit spread (based on each loan's underlying credit characteristics), until the maturity of the interest rate Floor. Should the Prime rate index fall below the strike level of the Floor prior to maturity, the Floor's counterparty will pay the Bank the difference between the strike rate and the rate index multiplied by the notional value of the Floor multiplied by the number of days in the period divided by 360 days. The estimated fair value of the Floor at September 30, 2009 was $353,000 and is recorded in "Other Assets" and changes in the fair value are recorded as "Other Comprehensive Income," a component of shareholders' equity. The bank counterparty to the interest rate floor exposes the Company to credit-related losses in the event of its non-performance. The Company monitors ratings, and potential downgrades of the counterparty on at least a quarterly basis. 7
NOTE 2 - NET INCOME PER SHARE The calculation of net income per common share is as follows: Three Months Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------- 2009 2008 2009 2008 ------------ ------------ ------------ ------------ Basic: Net income (loss) $ (593,513) $ 50,729 $ 90,960 $ 1,106,596 Net income (loss) available to common shareholders (731,552) 50,729 (254,139) 1,106,596 Average common shares outstanding 2,568,588 2,567,284 2,566,847 2,639,061 Basic net income (loss) per common share $ (0.28) $ 0.02 $ (0.10) $ 0.42 ============ ============ ============ ============ Diluted: Net income (loss) $ (593,513) $ 50,729 $ 90,960 $ 1,106,596 Net income (loss) available to common shareholders (731,552) 50,729 (254,139) 1,106,596 Average common shares outstanding 2,568,588 2,567,284 2,566,847 2,639,061 Stock option adjustment -- -- -- -- ------------ ------------ ------------ ------------ Average common shares outstanding - diluted 2,568,588 2,567,284 2,566,847 2,639,061 Diluted net income (loss) per common share $ (0.28) $ 0.02 $ (0.10) $ 0.42 ============ ============ ============ ============ 8
NOTE 3 - INVESTMENT SECURITIES Investment securities are summarized as follows: Amortized Unrealized Unrealized Fair cost gains losses value ------------------------------------------------------------------------------------------- September 30, 2009 Available for sale U.S. government agency $ 18,281,050 $ 255,184 $ 12,558 $ 18,523,676 Mortgage-backed securities 21,558,560 1,228,299 266,608 22,520,251 State and municipal 8,812,836 230,755 -- 9,043,590 Corporate bonds 9,703,401 -- 5,077,287 4,626,114 ------------- ------------ ------------ ------------- 58,355,847 1,714,238 5,356,453 54,713,631 Equity securities 1,604,048 250,715 279,250 1,575,512 ------------- ------------ ------------ ------------- $ 59,959,895 $ 1,964,953 $ 5,635,703 $ 56,289,143 ============= ============ ============ ============= Held to maturity U.S. government agency $ -- $ -- $ -- $ -- Mortgage-backed securities 4,782,874 241,933 -- 5,024,807 State and municipal 3,912,889 131,014 -- 4,043,903 Corporate bonds 251,569 -- 199,097 52,472 ------------- ------------ ------------ ------------- $ 8,947,332 $ 372,947 $ 199,097 $ 9,121,182 ============= ============ ============ ============= Amortized Unrealized Unrealized Fair cost gains losses value ------------------------------------------------------------------------------------------- December 31, 2008 Available for sale U.S. government agency $ 18,103,498 $ 230,681 $ -- $ 18,334,178 Mortgage-backed securities 24,688,564 859,292 578,010 24,969,846 State and municipal 7,033,219 20,282 162,788 6,890,713 Corporate bonds 9,664,031 -- 5,530,389 4,133,642 ------------- ------------ ------------ ------------- 59,489,312 1,110,255 6,271,187 54,328,379 Equity securities 1,608,495 539,982 82,991 2,065,486 ------------- ------------ ------------ ------------- $ 61,097,807 $ 1,650,237 $ 6,354,178 $ 56,393,865 ============= ============ ============ ============= Held to maturity U.S. government agency $ -- $ -- $ -- $ -- Mortgage-backed securities 5,966,091 144,174 1,714 6,108,552 State and municipal 3,912,836 -- 20,277 3,892,560 Corporate bonds 495,361 -- 364,616 130,745 ------------- ------------ ------------ ------------- $ 10,374,288 $ 144,174 $ 386,607 $ 10,131,857 ============= ============ ============ ============= As of September 30, 2009, securities with unrealized losses segregated by length of impairment were as follows: Less than 12 months 12 months or longer Total Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ---------------------------------------------------------------------------------------------------- U. S. government agency $ 4,970,300 $ (12,558) $ -- $ -- $ 4,970,300 $ (12,558) Mortgage-backed securities -- -- 3,029,805 (266,608) 3,029,805 (266,608) Corporate bonds -- -- 4,678,585 (5,276,385) 4,678,585 (5,276,385) Equity securities 989,706 (257,819) 33,124 (21,431) 1,022,830 (279,250) ------------ ----------- ------------ ------------- ------------- ------------- $ 5,960,006 $ (270,377) $ 7,741,514 $ (5,564,424) $ 13,701,520 $ (5,834,801) ============ =========== ============ ============= ============= ============= 9
NOTE 3 - INVESTMENT SECURITIES (CONTINUED) Contractual maturities of debt securities at September 30, 2009 are shown below. Actual maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Available for sale Held to maturity Amortized Fair Amortized Fair Maturing Cost Value Cost Value -------------------------------------------------------------------------------- Within one year $ -- $ -- $ -- $ -- Over one to five years 3,710,389 3,686,365 -- -- Over five to ten years 7,333,907 7,522,526 3,912,889 4,043,903 Over ten years 25,752,990 20,984,489 251,569 52,472 Mortgage-backed securities 21,558,560 22,520,251 4,782,874 5,024,807 ------------- ------------- ------------ ------------ $ 58,355,846 $ 54,713,631 $ 8,947,332 $ 9,121,182 ============= ============= ============ ============ Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time, the Company will receive full value for the securities. Furthermore, as of September 30, 2009, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. The unrealized losses, except for the trust preferred securities described below, are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of September 30, 2009, management believes the impairments detailed in the table above except for the trust preferred securities described below are temporary and no impairment loss has been realized in the Company's consolidated income statement. At September 30, 2009 and December 31, 2008, the Company owned five collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies ("TRUP CDOs"). The market for these securities at September 30, 2009 and December 31, 2008 was not active and markets for similar securities were also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which TRUP CDOs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as no new TRUP CDOs have been issued since 2007. There are currently very few market participants who are willing or able to transact for these securities. The market values for these securities (and any securities other than those issued or guaranteed by the U.S. Treasury) are very depressed relative to historical levels. Thus, in today's market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general versus being an indicator of credit problems with a particular issuer. Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined: o The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at September 30, 2009 and December 31, 2008; o An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates; and o Our TRUP CDOs will be classified within Level 3 of the fair value hierarchy because we determined that significant adjustments are required to determine fair value at the measurement date. 10
NOTE 3 - INVESTMENT SECURITIES (CONTINUED) The following table (Dollars in Thousands) lists the class, credit rating, deferrals and defaults of the five trust preferred securities (PreTSL): Moody Deferrals Defaults Credit ------------------- ------------------- PreTSL Class Rating Amount Percent Amount Percent --------- ---------- ---------- ---------- -------- -------- --------- XIV Mezzanine Ca $ 18,000 1.9% $ 0 0% XVIII C Ca 124,000 17.5 10,000 1.5 XIX B B3 43,000 5.9 60,000 8.2 XIX C Ca 43,000 5.9 60,000 8.2 XXII B-1 B3 206,500 14.2 111,000 7.6 XXIV C-1 Caa3 203,300 18.5 96,000 8.7 Based on qualitative considerations such as a down grade in credit rating or further defaults of underlying issuers during the quarter, and an analysis of expected cash flows, we determined that one TRUP CDO included in corporate bonds was other-than-temporarily impaired (OTTI) and wrote our investment in this TRUP CDO down $247,000 to its present value of expected cash flows through earnings at September 30, 2009 to properly reflect credit losses associated with this TRUP CDO. The remaining fair value of the security was approximately $252,000 at September 30, 2009. The issuers in these securities are primarily banks, but some of the pools do include a limited number of insurance companies. The Company uses the OTTI evaluation model prepared by an independent third party to compare the present value of expected cash flows to the previous estimate to ensure there are no adverse changes in cash flows during the quarter. The OTTI model considers the structure and term of the TRUP CDO and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. Cash flows are projected using a forward rate LIBOR curve, as these TRUP CDOs are variable rate instruments. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the model include expected future default rates and prepayments. NOTE 4 - STOCK BASED COMPENSATION At the Company's annual shareholders meeting on May 15, 2007, the 2007 Equity Plan was approved. Under this plan, 500,000 shares of the Common Stock of the Company were reserved for issuance. Also, in accordance with the 2007 Equity Plan, 300 shares of unrestricted Company Stock are issued to each non-employee director in May of each year. One director received cash in lieu of stock due to restrictions by his/her employer on receiving stock of a company. Also, in accordance with the 2007 Equity Plan, 300 shares were awarded to each new director as of the effective date of their acceptance onto the board. No new grants will be made under the 1998 Long Term Incentive Plan. However, incentive stock options issued under this plan will remain outstanding until exercised or until the tenth anniversary of the grant date of such options. Stock option expense recognized was $1,593 during the first nine months of 2009 compared to $5,486 during the first nine months of 2008. As of September 30, 2009, there was $531 of unrecognized stock option expense related to nonvested stock options, which will be recognized over the remaining vesting period. Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the vesting period of the award (3 years). NOTE 5 - COMMITMENTS AND CONTINGENT LIABILITIES The Company enters into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit and letters of credit. The Company applies the same credit policies to these off-balance sheet arrangements as it does for on-balance-sheet instruments. Additionally, the Company enters into commitments to originate residential mortgage loans to be sold in the secondary market, where the interest rate is determined prior to funding the loan. The commitments on mortgage loans to be sold are considered to be derivatives. The intent is that the borrower has assumed the interest rate risk on the loan. As a result, the Company is not exposed to losses due to interest rate changes. As of September 30, 2009, the difference between the market value and the carrying amount of these commitments is immaterial and therefore, no gain or loss has been recognized in the financial statements. 11
NOTE 5 - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) Outstanding loan commitments, unused lines of credit, and letters of credit were as follows: September 30, December 31, September 30, 2009 2008 2008 ------------- ------------- ------------- Loan commitments $ 29,606,000 $ 31,395,000 $ 32,278,000 Unused lines of credit 76,042,000 79,654,000 80,128,000 Letters of credit 3,006,000 2,604,000 2,708,000 NOTE 6 - TARP CAPITAL PURCHASE PROGRAM On February 13, 2009, as part of the TARP Capital Purchase Program, the Company entered into a Letter Agreement, and the related Securities Purchase Agreement - Standard Terms (collectively, the "Purchase Agreement"), with the United States Department of the Treasury ("Treasury"), pursuant to which the Company issued (i) 9,201 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation preference $1,000 per share ("Series A Preferred Stock"), and (ii) a warrant to purchase 205,379 shares of the Company's common stock, par value $1.00 per share at $6.72 per share at any time on or before February 13, 2019. Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the warrant. The Series A Preferred Stock and the warrant were issued in a transaction exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company raised $9,201,000 through the sale of the Series A Preferred Stock which will qualify as Tier 1 capital. With the full amount of the Treasury's investment, on a pro-forma basis, at December 31, 2008, the Company's Tier I capital ratio would increase to approximately 12.78% and total risk-based capital ratio would increase to approximately 13.84%. The Series A Preferred Stock will pay cumulative dividends at a rate of 5% per annum until February 15, 2014. Beginning February 16, 2014, the dividend rate will increase to 9% per annum. Dividends are payable quarterly. On May 15, 2009 and August 15, 2009, the Company paid dividends totaling $232,581. The recently enacted American Recovery and Reinvestment Act of 2009 permits the Company to redeem the Series A preferred stock without regard to the limitations in the Articles Supplementary to the Company's Articles of Incorporation. The Company may, at its option, with prior regulatory approval, redeem shares of Series A Preferred Stock, in whole or in part, at any time and from time to time, for cash at a per share amount equal to the sum of the liquidation preference per share plus any accrued and unpaid dividends to but excluding the redemption date. The Purchase Agreement also subjects the Company to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (the "EESA"). As a condition to the closing of the transaction, Robert A. Altieri, James M. Uveges, Gary M. Jewell, William D. Sherman, and Lola B. Stokes (the Company's Senior Executive Officers, as defined in the Purchase Agreement) each: (i) voluntarily waived any claim against the Treasury or the Company for any changes to such Senior Executive Officer's compensation or benefits that are required to comply with the regulation issued by the Treasury under the TARP Capital Purchase Program as published in the Federal Register on October 20, 2008 and acknowledging that the regulation may require modification of the compensation, bonus, incentive and other benefit plans, arrangements and policies and agreements (including so-called "golden parachute" agreements) as they relate to the period the Treasury holds any equity or debt securities of the Company acquired through the TARP Capital Purchase Program; and (ii) entered into an amendment to Messer's Altieri, Uveges, Jewell and Mrs. Stokes employment agreements that provide that any severance payments made to such officers have been reduced, as necessary, so as to comply with the requirements of the TARP Capital Purchase Program. The Treasury's current consent shall be required for any increase in the common dividends per share until February 13, 2012 unless prior to such date, the Series A preferred stock is redeemed in whole or the Treasury has transferred all of the Series A Preferred Stock to third parties. NOTE 7 - FAIR VALUE The fair value of an asset or liability is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows: 12
NOTE 7 - FAIR VALUE (CONTINUED) Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability. The Company uses the following methods and significant assumptions to estimate fair value for financial assets and financial liabilities: Securities available for sale: The fair value of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities. Equity securities are reported at fair value using Level 1 inputs. Derivatives: Derivatives are reported at fair value utilizing Level 2 inputs. The Company obtains dealer quotations to value its interest rate floor. For purposes of potential valuation adjustments to its derivative position, the Company evaluates the credit risk of its counterparty. Accordingly, the Company has considered factors such as the likelihood of default by the counterparty and the remaining contractual life, among other things, in determining if any fair value adjustment related to credit risk is required. Loans held for sale: The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted pricing exists, the fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan. Impaired loans and other real estate owned: Nonrecurring fair value adjustments to loans and other real estate owned ("OREO") reflect full or partial write-downs that are based on the loans or OREO's observable market price or current appraised value of the collateral in accordance with "Accounting by Creditors for Impairment of a Loan". Since the market for impaired loans and OREO is not active, loans or OREO subjected to nonrecurring fair value adjustments based on the current appraised value of the collateral may be classified as Level 2 or Level 3 depending on the type of asset and the inputs to the valuation. When appraisals are used to determine impairment and these appraisals are based on a market approach incorporating a dollar-per-square-foot multiple, the related loans or OREO are classified as Level 2. If the appraisals require significant adjustments to market-based valuation inputs or apply an income approach based on unobservable cash flows to measure fair value, the related loans or OREO subjected to nonrecurring fair value adjustments are typically classified as Level 3 due to the fact that Level 3 inputs are significant to the fair value measurement. The following table represents the Company's financial assets measured at fair value on a recurring basis as of September 30, 2009: Carrying Value at September 30, 2009: Total (Level 1) (Level 2) (Level 3) ------------- ------------ ------------- ------------ Available for sale securities $ 56,289,143 $ 1,575,512 $ 51,843,798 $ 2,869,833 Derivative asset 388,598 -- 388,598 -- During the first nine months of 2009, the Company recognized $247,000 of other-than-temporary impairment charges related to a debt security issued by financial institutions. Certain other assets are measured at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets due to impairment. For assets measured at fair value on a nonrecurring basis during the first nine months of 2009 that were still held in the balance sheet at period end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets at period end. 13
NOTE 7 - FAIR VALUE (CONTINUED) Total (Level 1) (Level 2) (Level 3) ------------- ------------ ------------- ------------ Loans held for sale $ 31,173,671 $ -- $ 31,173,671 $ -- Impaired loans 4,468,403 -- 4,468,403 -- Other real estate owned (OREO) 2,223,427 -- 2,223,427 -- During the first nine months of 2009, the Company recognized losses related to certain assets that are measured at fair value on a nonrecurring basis (i.e. loans and loans held for sale). Approximately $998,000 of losses related to loans were recognized as chargeoffs for loan losses. There was a $29,000 write down of OREO properties and $77,000 of net losses on sales of OREO properties. During the first nine months of 2009, there were no losses related to loans held for sale accounted for at the lower of cost or fair value. The following table represents the Company's fair value hierarchy for its financial assets measured at fair value on a recurring basis as of December 31, 2008: Carrying Value at December 31, 2008: Total (Level 1) (Level 2) (Level 3) ------------- ------------ ------------- ------------ Available for sale securities $ 56,393,865 $ 2,065,486 $ 50,194,737 $ 4,133,642 Derivative asset 649,792 -- 649,792 -- Certain other assets are measured at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets due to impairment. For assets measured at fair value on a nonrecurring basis during 2008 that were still held in the balance sheet at year end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets at year end. Carrying Value at December 31, 2008: Total (Level 1) (Level 2) (Level 3) ------------- ------------ ------------- ------------ Loans held for sale $ 21,701,287 $ -- $ 21,701,287 $ -- Impaired loans 1,553,548 -- 1,553,548 -- Other real estate owned 1,736,018 -- 1,736,018 -- The following table reconciles the beginning and ending balances of available for sale securities measured at fair value on a recurring basis using significant unobservable (Level 3) inputs during the nine months ended September 30, 2009: Balance, beginning of period $ 4,133,642 Transfers into Level 3 -- Unrealized gains 492,472 ------------ Balance, end of period $ 4,626,114 ============ NOTE 8 - INTEREST RATE FLOOR DERIVATIVE The fair value of the derivative instrument, which is included in other assets in the unaudited condensed consolidated balance sheet as of September 30, 2009, was approximately $389,000. The net change in this financial statement line item is included in the accompanying consolidated statement of cash flows. The effect of the derivative instrument designated as a cash flow hedge on the Company's unaudited condensed consolidated statement of income for the nine months ended September 30, 2009, was approximately $281,000. 14
NOTE 9 - NEW AUTHORITATIVE ACCOUNTING GUIDANCE As discussed in Note 1 - Summary of Significant Accounting Policies, on July 1, 2009, the Accounting Standards Codification became FASB's officially recognized source of authoritative U.S. generally accepted accounting principles applicable to all public and non-public non-governmental entities, superseding existing FASB, AICPA, EITF and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the away companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. "Investments - Debt and Equity Securities." New authoritative accounting guidance under "Investments - Debt and Equity Securities," (i) changes existing guidance for determining whether an impairment is other than temporary to debt securities and (ii) replaces the existing requirement that the entity's management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. The Corporation adopted the provisions of the new authoritative accounting guidance during the first quarter of 2009. Adoption of the new guidance did not significantly impact the Company's financial statements. "Compensation - Retirement Benefits." New authoritative accounting guidance under "Compensation - Retirement Benefits," provides guidance related to an employer's disclosures about plan assets of defined benefit pension or other post-retirement benefit plans. Under this guidance, disclosures should provide users of financial statements with an understanding of how investment allocation decisions are made, the factors that are pertinent to an understanding of investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. The disclosures required will be included in the Company's financial statements beginning with the financial statements for the year-ended December 31, 2009. "Business Combinations." On January 1, 2009, new authoritative accounting guidance, "Business Combinations," became applicable to the Company's accounting for business combinations closing on or after January 1, 2009. This applies to all transactions and other events in which one entity obtains control over one or more other businesses. It requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under previous accounting guidance whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. This guidance requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under prior accounting guidance. Assets acquired and liabilities assumed in a business combination that arise from contingencies are to be recognized at fair value if fair value can be reasonably estimated. If fair value of such an asset or liability cannot be reasonably estimated, the asset or liability would generally be recognized in accordance with ASC Topic, "Contingencies." Under ASC Topic, "Business Combinations", the requirements of ASC Topic, "Exit or Disposal Cost Obligations," would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimable recognition criteria of ASC Topic, "Contingencies." "Consolidation." New authoritative accounting guidance under ASC Topic, "Consolidation," amended prior guidance to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Under this ASC Topic, a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, this guidance requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. The new authoritative accounting guidance under ASC Topic, "Consolidation", became effective for the Company on January 1, 2009 and did not have a significant impact on the Company's financial statements. 15
NOTE 9 - NEW AUTHORITATIVE ACCOUNTING GUIDANCE (CONTINUED) "Derivatives and Hedging." New authoritative accounting guidance under ASC Topic, "Derivatives and Hedging," amends prior guidance to amend and expand the disclosure requirements for derivatives and hedging activities to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under this guidance, and (iii) how derivative instruments and related hedged items affect an entity's financial position, results of operations and cash flows. To meet those objectives, the new authoritative accounting guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. The new authoritative accounting guidance under this ASC Topic became effective for the Company on January 1, 2009 and the required disclosures are reported in Note 8-Interest Rate Floor Derivative. "Fair Value Measurements and Disclosures." New authoritative accounting guidance under ASC Topic,"Fair Value Measurements and Disclosures," affirms that the objective of fair value when the market for an asset is not active, is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. This guidance requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. The new accounting guidance amended prior guidance to expand certain disclosure requirements. The Company adopted the new authoritative accounting guidance under this ASC Topic during the first quarter of 2009. Adoption of the new guidance did not significantly impact the Company's financial statements. Further new authoritative accounting guidance (Accounting Standards Update No. 2009-5) under Fair Value Measurements and Disclosures provides guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (i) the quoted price of the identical liability when traded as an asset, (ii) quoted prices for similar liabilities or similar liabilities when traded as assets, or (iii) another valuation technique that is consistent with the existing principles of Fair Value Measurements and Disclosures, such as an income approach or market approach. The new authoritative accounting guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The forgoing new authoritative accounting guidance under Fair Value Measurements and Disclosures will be effective for the Company's financial statements beginning October 1, 2009 and is not expected to have a significant impact on the Company's financial statements. "Financial Instruments." New authoritative accounting guidance under ASC Topic, "Financial Instruments," requires an entity to provide disclosures about the fair value of financial instruments in interim financial information and amends prior guidance to require those disclosures in summarized financial information at interim reporting periods. The new interim disclosures required under this ASC Topic are included in Note 7 - Fair Value. "Subsequent Events." New authoritative accounting guidance under "Subsequent Events," establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. This guidance defines (i) the period after the balance sheet date during which a reporting entity's management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date. This new authoritative accounting guidance became effective for the Company's financial statements for periods ending after June 15, 2009 and did not have a significant impact on the Company's financial statements. 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION THE COMPANY Carrollton Bancorp was formed on January 11, 1990 and is a Maryland chartered bank holding company. The Company holds all of the outstanding shares of common stock of Carrollton Bank. The Bank, formed on April 10, 1900, is a commercial bank that provides a full range of financial services to individuals, businesses and organizations through its branch and loan origination offices and its automated teller machines. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation. The Bank considers its core market area to be the Baltimore Metropolitan Area. FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements within the meaning of Section 27 A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements included or incorporated by reference in this Quarterly Report on form 10-Q, other than statements that are purely historical, are forward-looking statements. Statements that include the use of terminology such as "anticipates," "expects," "intends," "plans," "believes," "estimates," and similar expressions also identify forward-looking statements. The forward-looking statements are based on the Company's current intent, belief, and expectations. Forward-looking statements in this Quarterly Report on Form 10-Q include, but are not limited to, statements of the Company's plans, strategies, objectives, intentions, including, among other statements, statements involving the Company's projected loan and deposit growth, collateral values, collectibility of loans, anticipated changes in noninterest income, payroll and branching expenses, branch office and product expansion of the Company and its subsidiary, and liquidity and capital levels. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Actual results may differ materially from these forward-looking statements because of interest rate fluctuations, a deterioration of economic conditions in the Baltimore-Washington Metropolitan area, a downturn in the real estate market, losses from impaired loans, an increase in nonperforming assets, potential exposure to environmental laws, changes in federal and state bank laws and regulations, the highly competitive nature of the banking industry, a loss of key personnel, changes in accounting standards and other risks described in the Company's filings with the Securities and Exchange Commission. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today's date. The Company undertakes no obligation to update or revise the information contained in this report whether as a result of new information, future events or circumstances, or otherwise. Past results of operations may not be indicative of future results. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission. BUSINESS AND OVERVIEW The Company is a bank holding company headquartered in Columbia, Maryland with one wholly-owned subsidiary, Carrollton Bank. The Bank has four subsidiaries, CMSI, CFS, and MSLLC which are wholly owned, and CCDC, which is 96.4% owned. The Bank is engaged in general commercial and retail banking business with ten branch locations. CMSI is in the business of originating residential mortgage loans to be sold and has three branch locations. CFS provides brokerage services to customers, MSLLC is used to dispose of other real estate owned, and CCDC promotes, develops, and improves the housing and economic conditions of people in Maryland. Net income decreased 92% or $1 million for the nine months ended September 30, 2009 compared to the same period in 2008. The decrease was due primarily to the $1.3 million increase in provision for loan losses, the $494,000 increase in noninterest expense, the $420,000 decrease in net interest income partially offset by the $651,000 increase in noninterest income and the $586,000 decrease in income tax expenses. The net interest margin decreased to 3.45% for the nine months ended September 30, 2009 from 4.07% in the comparable period in 2008. The Company declared a dividend of $0.04 per share to shareholders for the fourth quarter of 2009 and paid a dividend of $0.08 per share during the first and second quarters and $0.04 in the third quarter of 2009. 17
CRITICAL ACCOUNTING POLICIES The Company's financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets. One of the most critical accounting policies applied is related to the valuation of the loan portfolio. A variety of estimates impact the carrying value of the loan portfolio including the calculation of the allowance for loan losses, valuation of underlying collateral and the timing of loan charge-offs. The allowance for loan losses is one of the most difficult and subjective judgments. The allowance is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payments on loans. Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio. Current trends in delinquencies and charge-offs, the views of Bank regulators, changes in the size and composition of the loan portfolio and peer comparisons are also factors. The analysis also requires consideration of the economic climate and direction and change in the interest rate environment, which may impact a borrower's ability to pay, legislation impacting the banking industry and economic conditions specific to the Bank's service areas. Because the calculation of the allowance for loan losses relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates. Another critical accounting policy is related to securities. Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term "other than temporary" is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of an investment. Management reviews other criteria such as magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized. FINANCIAL CONDITION Summary Total assets increased $26.0 million to $430.1 million at September 30, 2009 compared to $404.2 million at the end of 2008. The increase was due primarily to the $9.5 million increase in loans held for sale due to the high demand for refinancing existing residential loans because of the low interest rates. Loans increased by $7.8 million or 2.8% to $288.3 million during the period. Total average interest-earning assets increased $36.5 million during the period to $397.8 million and were 96.3% of total average assets at September 30, 2009. Total deposits increased by $47.3 million or 16.2% to $339.7 million as of September 30, 2009 from $292.4 million as of December 31, 2008. Certificate of deposit accounts increased $44.4 million while non-interest bearing checking and money market accounts increased $3.3 million and $3.2 million respectively. These increases were partially offset by a $3.8 million decrease in interest bearing checking. Stockholders' equity increased 33.0% or $9.0 million to $36.4 million at September 30, 2009. The increase was due primarily to the $9.2 million raised by participation in the U.S. Treasury's Capital Purchase Program through the sale of Series A Preferred Stock, net income of $91,000, all of which was partially offset by Preferred Stock dividends paid of $233,000, Common Stock dividends paid of $513,000 and a decrease in accumulated other comprehensive loss of $481,000. The decrease in accumulated other comprehensive loss was due to the increase in the fair market value of the available for sale securities partially offset by the decrease in the fair market value of the effective cash flow hedge. 18
Investment Securities The investment portfolio consists primarily of securities available for sale. Securities available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors. Investment securities held to maturity are recorded at amortized cost. The investment portfolio consists primarily of U.S. Government agency securities, mortgage-backed securities, corporate bonds, state and municipal obligations, and equity securities. The income from state and municipal obligations is exempt from federal income tax. Certain agency securities are exempt from state income taxes. The Company uses its investment portfolio as a source of both liquidity and earnings. Investment securities decreased $1.6 million to $65.2 million at September 30, 2009 from $66.8 million at December 31, 2008. The Company continues to restructure its investment portfolio to manage interest rate risk. Loans Held for Sale Loans held for sale increased $9.5 million from December 31, 2008 to September 30, 2009 due to the increase in origination activity from the decline in interest rates during the first nine months of 2009. Loans held for sale are carried at the lower of cost or the committed sale price, determined on an individual loan basis. Loans Gross loans increased by $8.8 million to $293.0 million at September 30, 2009 from $284.2 million at December 31, 2008. The increase was due to originations exceeding payoffs and was partially reduced by the reclassification of $1.4 million of loans to other real estate owned property. Loans are placed on nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of all interest and/or principal is in doubt. Management may grant a waiver from nonaccrual status for a 90-day past-due loan that is both well secured and in the process of collection. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current. A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the fair value of the collateral for collateral dependent loans and at the present value of expected future cash flows using the loans' effective interest rates for loans that are not collateral dependent. At September 30, 2009, the Company had nineteen impaired loans totaling approximately $5.8 million, all of which have been classified as nonaccrual. The valuation allowance for impaired loans was $1.3 million as of September 30, 2009. 19
The following table provides information concerning non-performing assets and past due loans: September 30, December 31, September 30, 2009 2008 2008 ------------- ------------- ------------- Nonaccrual loans $ 7,918,015 $ 5,027,767 $ 9,619,194 Restructured loans 4,691,136 771,216 773,109 Foreclosed real estate 2,223,427 1,736,018 1,432,343 ------------- ------------- ------------- Total nonperforming assets $ 14,832,578 $ 7,535,001 $ 11,824,646 ------------- ------------- ------------- Accruing loans past-due 90 days or more $ -- $ 2,216,728 $ 244,913 ============= ============= ============= Allowance for Loan Losses The allowance for loan losses represents management's best estimate of probable losses in the existing loan portfolio. The Company believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term and is established through a provision for loan losses. The Company's allowance for loan loss methodology is based on historical loan loss experience by major category of loans and internal risk grade, specific homogenous risk pools and specific loss allocations, with adjustments for existing economic conditions. The provision for possible loan losses reflects loan quality trends, including the levels and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans, and net charge-offs or recoveries, among other factors. The provision for loan losses is determined by management as the amount needed to replenish the allowance for loan losses, after net charge-offs have been deducted, to a level considered adequate to absorb inherent losses in the loan portfolio, in accordance with accounting principles generally accepted in the United States of America. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases in the allowance will not be necessary if loan quality deteriorates. The allowance for loan losses was $4.6 million at September 30, 2009, which was 1.58% of loans compared to $3.2 million at December 31, 2008, which was 1.12% of loans. During the first nine months of 2009, the Company experienced net charge-offs of $880,000. The ratio of net loan losses to average loans outstanding decreased to 0.31% for the nine months ended September 30, 2009 from 0.82% for the year ended December 31, 2008. The ratio of nonperforming assets, including accruing loans past-due 90 days or more, as a percent of period-end loans and foreclosed real estate increased to 5.02% as of September 30, 2009 compared to 3.42% at December 31, 2008. The following table shows the activity in the allowance for loan losses: Nine months Ended Year Ended September 30, December 31, 2009 2008 2008 ------------ ------------ ------------- Allowance for loan losses - beginning of period $ 3,179,741 $ 3,270,425 $ 3,270,425 Provision for loan losses 2,336,000 997,000 2,096,000 Charge-offs (987,527) (656,802) (2,268,477) Recoveries 107,849 72,133 81,793 ------------ ------------ ------------- Allowance for loan losses - end of period $ 4,636,063 $ 3,682,756 $ 3,179,741 ------------ ------------ ------------- Funding Sources Deposits Total deposits increased by $47.3 million or 16.2% to $339.7 million as of September 30, 2009 from $292.4 million as of December 31, 2008. Certificate of deposit accounts increased $44.4 million while non-interest bearing checking and money market accounts increased $3.3 million and $3.2 million, respectively. These increases were partially offset by a $3.8 million decrease in interest bearing checking. Borrowings Advances from the Federal Home Loan Bank (FHLB) decreased $21.8 million to $43.5 million at September 30, 2009. The increase in deposits was used to pay down the advances. Total borrowings decreased $29.5 million to $49.9 million at September 30, 2009, compared to $79.4 million at the end of 2008. 20
CAPITAL RESOURCES Bank holding companies and banks are required by the Federal Reserve and FDIC to maintain levels of Tier 1 (or Core) and Tier 2 capital measured as a percentage of assets on a risk-weighted basis. Capital is primarily represented by shareholders' equity, adjusted for the allowance for loan losses and certain issues of preferred stock, convertible securities, and subordinated debt, depending on the capital level being measured. Assets and certain off-balance sheet transactions are assigned to one of five different risk-weighting factors for purposes of determining the risk-adjusted asset base. The minimum levels of Tier 1 and Tier 2 capital to risk-adjusted assets are 4% and 8%, respectively, under the regulations. In addition, the Federal Reserve and the FDIC require that bank holding companies and banks maintain a minimum level of Tier 1 (or Core) capital to average total assets excluding intangibles for the current quarter. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered adequately capitalized is 4%, but could be required to be maintained at a higher level based on the regulator's assessment of an institution's risk profile. The Company's subsidiary bank also exceeded the FDIC required minimum capital levels at those dates by a substantial margin. As of September 30, 2009 and December 31, 2008, the Company is considered well capitalized. Management knows of no conditions or events that would change this classification. The following table summarizes the Company's capital ratios: Minimum September 30, December 31, Regulatory To Be 2009 2008 Requirements Well Capitalized ------------- ------------ ------------ ---------------- Risk-based capital ratios: Tier 1 capital 10.27% 9.84% 4.00% 6.00% Total capital 11.47 10.91 8.00 10.00 Tier 1 leverage ratio 9.55 8.17 4.00 5.00 Total shareholders' equity increased 33.0% or $9.0 million to $36.4 million at September 30, 2009. The increase was due primarily to the $9.2 million raised by participation in the U. S. Treasury's Capital Purchase Program through the sale of Series A Preferred Stock, net income of $91,000, all of which was partially offset by Preferred Stock dividends paid of $233,000 and Common Stock dividends paid of $513,000 and a decrease in accumulated other comprehensive loss of $481,000. The decrease in accumulated other comprehensive loss was due to the increase in the fair market value of the available for sale securities partially offset by the decrease in the fair market value of the effective cash flow hedge. RESULTS OF OPERATIONS Summary Carrollton Bancorp reported net income for the first nine months of 2009 of $91,000 compared to $1.1 million for the comparable period in 2008. Net loss attributable to common shareholders for the nine months ended September 30, 2009 was $254,000 ($0.10 loss per diluted shares) compared to net income available to common shareholder of $1.1 million ($0.42 income per diluted share) for the prior year period. The Company's provision for loan losses increased $1.3 million to $2.3 million for the nine months ended September 30, 2009. The Company's earning performance in the first nine months of 2008 was impacted by the $368,000 pretax charge to close the Wilkens drive-thru effective April 30, 2008, partially offset by the $80,000 gain related to the Visa, Inc. initial public offering that occurred in March 2008. The net interest margin decreased to 3.45% for the nine months ended September 30, 2009 from 4.07% in the comparable period in 2008. Return on average assets and return on average equity are key measures of a Company's performance. Return on average assets, the product of net income divided by total average assets, measures how effectively the Company utilizes its assets to produce income. The Company's return on average assets for the nine months ended September 30, 2009 was 0.04%, compared to 0.40% for the corresponding period in 2008. Return on average equity, the product of net income divided by average equity, measures how effectively the Company invests its capital to produce income. Return on average equity for the nine months ended September 30, 2009 was 0.52%, compared to 4.51% for the corresponding period in 2008. Interest and fee income on loans decreased 1.1% or $155,000 as a result of the yield on loans declining 90 basis points to 5.87% while average loans increased $38.9 million to $314.4 million. Total interest decreased 2.8 % or $460,000. Net interest income decreased 4.0% or $420,000 due to the compression of the Company's net interest margin to 3.45% for the nine months ended September 30, 2009 from 4.07% in the comparable period in 2008. Non-interest income was $5.6 million compared to $4.9 million for the same period in 2008, an increase of $651,000 or 13.2%. This increase was due to the $1.2 million increase in mortgage banking fees and gains and was partially offset by the $80,000 decrease in service charges, $181,000 decrease in brokerage commissions, and the $317,000 decrease in gains on securities sales due to the $247,000 other-than-temporary impairment charges related to the debt securities issued by financial institutions compared to the one time $80,000 gain related to the Visa, Inc. initial public offering that occurred in March 2008. Non-interest expenses were $13.4 million for the first nine months of 2009 compared to $12.9 million for the same period in 2008, an increase of $494,000 or 3.8%. Salaries increased $385,000 due to increased commissions paid primarily to the loan originators in the mortgage subsidiary. Because of the lower interest rates, loan originations due to refinancing of residential loans increased significantly in 2009 compared to the same period in 2008. Other operating expenses increased $754,000 due to the $544,000 increase in the FDIC insurance premiums for the FDIC special assessment, average deposits increasing $35.6 million and the one time assessment credit fully utilized as of December 31, 2008. Also, other real estate owned expenses increased $308,000 and various loan expenses, i.e. appraisals, credit reports, and fees related to collection of loans increased $152,000. These increases were partially offset by the $86,000 decrease in employee benefits, primarily medical benefits and the $60,000 decrease in professional fees due to reimbursement of legal fees from the insurance company related to a specific claim. In 2009, there was a recovery of $108,000 of the charges recorded in 2008 for closing the Wilkens drive-thru due to negotiating a lease buy out from the landlord. 21
Net Interest Income Net interest income, the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities, is the most significant component of the Company's earnings. Net interest income is a function of several factors, including changes in the volume and mix of interest-earning assets and funding sources, and market interest rates. While management policies influence these factors, external forces, including customer needs and demands, competition, the economic policies of the federal government and the monetary policies of the Federal Reserve Board, are also important. Net interest income for the Company on a tax equivalent basis (a non-GAAP measure) decreased from $10.7 million for the first nine months of 2008 to $10.3 million for the first nine months of 2009. This decrease in net interest income was due primarily to the decrease in the net interest margin from 4.07% for the first nine months of 2008 to 3.45% for the first nine months of 2009. The decrease in net interest income from the decrease in the net interest margin was partially offset by the $48.8 million increase in average interest-earning assets. Interest income on loans on a tax equivalent basis (a non-GAAP measure) decreased 1.1% during the first nine months of 2009. The yield on loans decreased to 5.87% during the first nine months of 2009 from 6.77% during the first nine months of 2008. The Company continues to emphasize commercial real estate and small business loan production. Interest income from investment securities and overnight investments on a tax equivalent basis (a non-GAAP measure) was $2.7 million for the first nine months of 2009, compared to $3.0 million for the first nine months of 2008, representing a 10.1% decrease. The investment portfolio on average increased 5.9% or $4.0 million, while the overall yield on investments decreased from 5.53% for the first nine months of 2008 to 4.96% for the first nine months of 2009. The yield on Federal Funds Sold and other interest bearing deposits decreased to 0.10% for the first nine months of 2009 compared to 2.71% for the same period in 2008. The Federal Reserve has set the Federal Funds rate between 0% and 25 basis points. Interest expense was substantially the same at $6.2 million for the first nine months of 2009 and 2008. The cost of interest-bearing liabilities decreased to 2.54% for the first nine months of 2009 compared to 2.91% for the first nine months of 2008. The decrease was due to lower interest rates set by the Federal Open Market Committee (FOMC). The decrease in the yield of interest-bearing liabilities was offset by the $41.0 million or 14.3% increase in average interest-bearing liabilities to $327.8 million as of September 30, 2009 from $286.7 million as of September 30, 2008. 22
The following tables, for the periods indicated, set forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities. Nine Months Ended September 30, 2009 ---------------------------------------- Average balance Interest Yield --------------- ------------- --------- ASSETS Interest-earning assets: Federal funds sold and other interest bearing deposits $ 7,998,947 $ 6,293 0.10% Federal Home Loan Bank stock 3,752,599 (1,171) (0.04) Investment securities (a) 71,617,713 2,657,366 4.96 Loans, net of unearned income: (a) Demand and time 64,733,391 2,347,272 4.85 Residential mortgage (b) 114,518,262 4,817,559 5.61 Commercial mortgage and construction 133,990,039 6,578,823 6.57 Installment 1,162,873 59,749 6.87 Lease financing 8,121 1,122 18.42 --------------- ------------- Total loans 314,412,686 13,804,525 5.87 --------------- ------------- Total interest-earning assets 397,781,945 16,467,013 5.54 Noninterest-earning assets: Cash and due from banks 2,777,052 Premises and equipment 7,300,849 Other assets 14,075,309 Allowance for loan losses (3,320,232) Unrealized gains on available for sale securities (5,644,787) --------------- Total assets $ 412,970,136 =============== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Savings and NOW $ 51,387,721 88,188 0.23% Money market 44,367,682 524,889 1.58 Other time 168,295,104 4,518,695 3.59 Borrowings 63,721,488 1,082,846 2.27 --------------- ------------- Total interest bearing liabilities 327,771,995 6,214,618 2.54 ------------- Noninterest-bearing liabilities: Noninterest-bearing deposits 46,712,733 Other liabilities 3,799,534 Shareholders' equity 34,685,874 --------------- Total liabilities and shareholders' equity $ 412,970,136 =============== Net interest income $ 10,252,395 ============= Net interest margin 3.45% ========= _____________________________________ (a) Interest on investments and loans is presented on a fully taxable equivalent basis, using regular income tax rates, (a non-GAAP financial measure). (b) Includes loans held for sale 23
Nine Months Ended September 30, 2008 ---------------------------------------- Average balance Interest Yield --------------- ------------- --------- ASSETS Interest-earning assets: Federal funds sold and other interest bearing deposits $ 3,069,186 $ 62,239 2.71% Federal Home Loan Bank stock 2,748,144 98,783 4.80 Investment securities held to maturity and investment securities available for sale (a) 67,663,238 2,799,224 5.53 Loans, net of unearned income: (a) Demand and time 67,625,475 3,121,716 6.17 Residential mortgage (b) 87,938,146 4,340,002 6.59 Commercial mortgage and construction 118,564,401 6,422,483 7.24 Installment 1,228,334 68,584 7.46 Lease financing 173,442 5,602 4.31 --------------- ------------- Total loans 275,529,798 13,958,387 6.77 --------------- ------------- Total interest-earning assets 349,010,366 16,918,633 6.48 Noninterest-earning assets: Cash and due from banks 7,969,518 Premises and equipment 7,272,809 Other assets 10,007,991 Allowance for loan losses (3,064,450) Unrealized losses on available for sale securities (475,941) --------------- Total assets $ 370,720,293 =============== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Savings and NOW $ 53,194,763 93,469 0.24% Money market 48,259,465 822,284 2.28 Other time 124,000,456 3,973,557 4.28 Borrowings 61,293,372 1,365,556 2.98 --------------- ------------- 286,748,056 6,254,866 2.91 ------------- Noninterest-bearing liabilities: Noninterest-bearing deposits 49,674,341 Other liabilities 1,559,868 Shareholders' equity 32,738,028 --------------- Total liabilities and shareholders' equity $ 370,720,293 =============== Net interest income $ 10,663,767 ============= Net interest margin 4.07% ========= _____________________________________ (a) Interest on investments and loans is presented on a fully taxable equivalent basis, using regular income tax rates, (a non-GAAP financial measure). (b) Includes loans held for sale 24
Provision for Loan Losses The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management's best estimate, is necessary to absorb probable losses within the existing loan portfolio. The Company recorded a provision for loan losses of $2.3 million in the first nine months of 2009 compared to $1.0 million in the first nine months of 2008. Nonaccrual, restructured, foreclosed real estate, and delinquent loans over 90 days to total loans and OREO increased to 5.02% at September 30, 2009 compared to 4.28% at September 30, 2008 and increased from 3.42% at December 31, 2008. See the section captioned "Allowance for Loan Losses" elsewhere in this discussion for further analysis of the provision for loan losses. Noninterest Income For the first nine months of 2009, non-interest income was $5.6 million compared to $4.9 million for the same period in 2008, an increase of $651,000 or 13%. This increase was due to the $1.2 million increase in mortgage banking fees and gains and the $24,000 increase in Electronic Banking. These increases were partially offset by the $80,000 decrease in service charges, the $181,000 decrease in brokerage commissions and the $317,000 decrease in gains on securities sales due to the $247,000 other-than-temporary impairment charges related to the debt securities issued by financial institutions compared to the one time $80,000 gain related to the Visa, Inc. initial public offering that occurred in March 2008. The Company offers a variety of financial planning and investment options to customers, through its subsidiary, CFS, and recognizes commission income as these services are provided. Brokerage commission decreased $181,000, or 31.9%, during the nine months ended September 30, 2009, compared to the same period in 2008. Electronic banking fee income increased by $24,000 for the nine months ended September 30, 2009 compared to the corresponding period in 2008. Electronic banking income is comprised of three sources: national point of sale, ("POS") sponsorships, ATM fees and check card fees. The Company sponsors merchants who accept ATM cards for purchases within various networks (i.e. STAR, PULSE, NYCE). This national POS sponsorship income represents approximately 85% of total electronic banking revenue. Fees from ATMs represent approximately 4% of total electronic banking revenue. Fees from check cards and other service charges represent approximately 11% of electronic banking revenue. Mortgage-banking revenue increased by $1.3 million to $3.2 million in 2009 from $1.9 million in 2008. Because of the low interest rates, loan originations due to refinancing of residential loans increased significantly in 2009, compared to the same period in 2008. During 2004, the Company opened a mortgage subsidiary, CMSI. Our mortgage-banking business is structured to provide a source of fee income largely from the process of originating residential mortgage loans for sale on the secondary market, as well as the origination of loans to be held in our loan portfolio. Mortgage-banking products include Federal Housing Administration ("FHA") and the federal Veterans Administration ("VA") loans, conventional and nonconforming first and second mortgages, and construction and permanent financing. The Company incurred losses on securities sales of $235,000 for the nine months ended September 30, 2009, compared to gains of $81,000 on the sales of equity securities for the same period in 2008. The $317,000 decrease in gains on security sales was due to the $247,000 other-than-temporary impairment charge related to the debt securities issued by financial institutions compared to the $80,000 gain related to the Visa, Inc. initial public offering that occurred in March 2008. Noninterest Expense Non-interest expenses were $13.4 million for the first nine months of 2009 compared to $12.9 million for the same period in 2008, an increase of $494,000 or 3.8%. Salaries increased $385,000 due to increased commissions paid primarily to the loan originators in the mortgage subsidiary. Because of the low interest rates, loan originations due to refinancing of residential loans increased significantly in 2009, compared to the same period in 2008. Other operating expenses increased $754,000 due to the $544,000 increase in the FDIC insurance premiums for the FDIC special assessment, average deposits increasing $35.6 million and the one time assessment credit fully utilized as of December 31, 2008. Also, other real estate owned expenses increased $308,000 and various loan expenses, i.e. appraisals, credit reports, and fees related to collection of loans increased $152,000. These increases were partially offset by the $86,000 decrease in employee benefits, primarily medical benefits and the $60,000 decrease in professional fees due to reimbursement of legal fees from the insurance company related to a specific claim. In 2009, there was a recovery of $108,000 of the charges recorded in 2008 for closing the Wilkens drive-thru due to negotiating a lease buy out from the landlord. 25
Income Taxes For the nine month period ended September 30, 2009, the Company recorded a tax benefit of $224,000 compared to a tax expense of $363,000 (effective tax rate was 24.7%) for the same period in 2008. The effective tax rate may fluctuate from year to year due to changes in the mix of tax-exempt loans and investments. Results of Operations - Third Quarter 2009 and 2008 Net loss for the third quarter of 2009 was $594,000 compared to net income of $51,000 for the third quarter of 2008, a $644,000 decrease. Net loss attributable to common shareholders for the third quarter of 2009 was $732,000 ($0.28 loss per diluted share) compared to net income available to common shareholders of $51,000 ($0.02 per diluted share) for the third quarter of 2008. The Company recorded a provision for loan losses of $1.6 million in the third quarter of 2009 compared to $799,000 in the same period of 2008. The allowance for loan losses represented 1.58% of outstanding loans as of September 30, 2009 compared to 1.31% at September 31, 2008. Non-performing assets totaled $14.8 million at September 30, 2009 compared to $9.8 million at December 31, 2008 and $12.1 million at September 30, 2008. For the quarter ended September 30, 2009, net interest income declined 8.5% or $298,000 to $3.2 million. The $298,000 decrease in net interest income was due to the 60 basis point decrease in the Company's net interest margin to 3.25% for the quarter ended September 30, 2009 from 3.85% in the comparable quarter in 2008. This decrease was partially offset by the $33.3 million increase in average interest-earning assets. Non-interest income continues to be a large contributor to the Company's profitability. The majority of the Company's non- interest income is derived from three sources: the Bank's Electronic Banking Division, Carrollton Mortgage Services, Inc. and Carrollton Financial Services, Inc. Non-interest income was $1.7 million for the three months ended September 30, 2009, an increase of 5.2% or $85,000, compared to the corresponding period in 2008. This increase was due to the $397,000 increase in mortgage banking fees and gains and the $46,000 increase in Electronic Banking. These increases were partially offset by the $33,000 decrease in service charges, the $36,000 decrease in brokerage commissions and the $245,000 security losses due primarily to the other-than-temporary impairment charges related to debt securities issued by financial institutions. Non-interest expenses were substantially the same at $4.4 million for the quarters ended September 30, 2009 and 2008. Salaries increased $144,000 due to increased commissions paid primarily to the loan originators in the mortgage subsidiary. Because of the lower interest rates, loan originations due to refinancing of residential loans increased significantly in 2009 compared to the same period in 2008. Other operating expenses increased $85,000 due to the $137,000 increase in the FDIC insurance premiums from the effect of the $61.8 million increase in deposits and the one time assessment credit fully utilized as of December 31, 2008. Also, credit expenses relating to OREO increased $95,000 and various loan expenses, such as appraisals, credit reports, and fees related to collection of loans increased $91,000. These increases were partially offset by the $41,000 decrease in employee benefits, primarily medical expenses, and a $14,000 decrease in professional fees due primarily to a reimbursement of legal fees from the insurance company related to a specific claim. The Corporate Headquarter and the Operations Center were relocated to Columbia, Maryland in March 2009 and various costs decreased in the quarter ended September 30, 2009. In 2009, there was a recovery of $108,000 of the charges recorded in 2008 for closing the Wilkens drive-thru due to negotiating a lease buy out from the landlord. 26
LIQUIDITY AND CAPITAL EXPENDITURES Liquidity Liquidity describes the ability of the Company to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the customers of the Company, as well as to meet current and planned expenditures. The Company's liquidity is derived primarily from its deposit base and equity capital. Additionally, liquidity is provided through the Company's portfolios of cash and interest-bearing deposits in other banks, federal funds sold, loans held for sale, and securities available for sale. Such assets totaled $107.2 million or 25% of total assets at September 30, 2009. The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled $106 million at September 30, 2009. Of this total, management places a high probability of required funding within one year of approximately $54.0 million. The amount remaining is unused home equity lines and other consumer lines on which management places a low probability of funding. The Company also has external sources of funds through the FRB and FHLB, which can be drawn upon when required. There is a line of credit totaling approximately $82 million with the FHLB based on qualifying loans pledged as collateral. In addition, the Company can pledge securities at the FRB and FHLB and borrow approximately 97% of the fair market value of the securities. The Company had $29.5 million of securities pledged at the FHLB under which the Company's subsidiary, Carrollton Bank, could have borrowed approximately $28.6 million. Also, Carrollton Bank has $7.9 million of securities pledged at FRB under which it could have borrowed approximately $7.7 million. Outstanding borrowings at the FHLB were $43.5 million at September 30, 2009. Additionally, the Company has an unsecured federal funds line of credit of $5.0 million and a $10.0 secured federal funds line of credit with other institutions. The secured federal funds line of credit with another institution would require Carrollton Bank to transfer securities pledged at the FHLB or FRB to this institution before Carrollton Bank could borrow against this line. There was no balance outstanding under these lines at September 30, 2009. These lines bear interest at the current federal funds rate of the correspondent bank. MARKET RISK AND INTEREST RATE SENSITIVITY The Company's interest rate risk represents the level of exposure it has to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates. The Asset/Liability Management Committee of the Board of Directors (the "ALCO") oversees the Company's management of interest rate risk. The objective of the management of interest rate risk is to optimize net interest income during periods of volatile as well as stable interest rates while maintaining a balance between the maturity and repricing characteristics of assets and liabilities that is consistent with the Company's liquidity, asset and earnings growth, and capital adequacy goals. Due to changes in interest rates, the level of income for a financial institution can be affected by the repricing characteristics of its assets and liabilities. At September 30, 2009, the Company is in an asset sensitive position. Management continuously takes steps to reduce higher costing fixed rate funding instruments, while increasing assets that are more fluid in their repricing. An asset sensitive position, theoretically, is favorable in a rising rate environment since more assets than liabilities will reprice in a given time frame as interest rates rise. Management works to maintain a consistent spread between yields on assets and costs of deposits and borrowings, regardless of the direction of interest rates. INFLATION Inflation may be expected to have an impact on the Company's operating costs and thus on net income. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect the Company's results of operations unless the fees charged by the Company could be increased correspondingly. However, the Company believes that the impact of inflation was not material for the first nine months of 2009 or 2008. OFF-BALANCE SHEET ARRANGEMENTS The Company enters into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, and letters of credit. In addition, the Company has certain operating lease obligations. 27
Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. The Company's exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. The Company is not aware of any accounting loss it would incur by funding its commitments. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For information regarding the market risk of the Company's financial instruments, see "Market Risk and Interest Rate Sensitivity" in Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures (as those terms are defined in Exchange Act Rules 240-13-a-14(c) and 15d-14(c)) that are designed to provide material information about the Company to the chief executive officer, the chief financial officer, and others within the Company so that information may be recorded, processed, summarized, and reported as required under the Securities Exchange Act of 1934. The chief executive officer and the chief financial officer have each reviewed and evaluated the effectiveness of the Company's internal controls and procedures as of a date within 90 days of the filing of this nine month report and have each concluded that such disclosure controls and procedures are effective. There have been no changes that have materially affected or are reasonably likely to materially affect the Company's internal controls (as defined in Rule 13a-15 under the Securities Act of 1934) or in other factors that could materially affect such controls subsequent to the date of the evaluations by the chief executive officer and the chief financial officer. Neither the chief executive officer nor the chief financial officer is aware of any significant deficiencies or material weaknesses in the Company's internal controls. PART II ITEM 1. LEGAL PROCEEDINGS The Company is involved in various legal actions arising from normal business activities. In management's opinion, the outcome of these matters, individually or in the aggregate, will not have a material adverse impact on the results of operation or financial position of the Company. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION On October 22, 2009, the Board of Directors of the Company declared a $0.04 per share cash dividend to common shareholders of record on November 13, 2009, payable December 1, 2009. 28
ITEM 6. EXHIBITS (a) Exhibits (31.1) Rule 13a-14(a) Certification by the Principal Executive Officer (31.2) Rule 13a-14(a) Certification by the Principal Financial Officer (32.1) Certification by the Principal Executive Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (32.2) Certification by the Principal Financial Officer of the periodic financial reports, required by Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K On October 21, 2009 the Company reported the departure of James M. Uveges, Senior Vice President/Chief Financial Officer effective October 16, 2009. Francis X. Ryan, CPA and a member of the Board of Directors, will be the interim Chief Financial Officer until a replacement is found. On November 3, 2009, the Company announced a third quarter net loss and a $0.04 quarterly dividend. 29
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CARROLLTON BANCORP PRINCIPAL EXECUTIVE OFFICER: Date November 12, 2009 /s/ Robert A. Altieri ----------------- ------------------------------------- Robert A. Altieri President and Chief Executive Officer PRINCIPAL FINANCIAL OFFICER: Date November 12, 2009 /s/ Francis X. Ryan ----------------- ------------------------------------- Francis X. Ryan Chief Financial Officer 3