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EX-32 - EXHIBIT 32 - BCSB Bancorp Inc.dex32.htm
EX-21 - EXHIBIT 21 - BCSB Bancorp Inc.dex21.htm
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EX-10.17 - EXHIBIT 10.17 - BCSB Bancorp Inc.dex1017.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-K

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended September 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 0-53163

 

 

BCSB BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Maryland   26-1424764

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

4111 E. Joppa Road, Suite 300, Baltimore, Maryland   21236
(Address of principal executive offices)   (Zip Code)

Issuer’s telephone number, including area code: (410) 256-5000

Securities registered pursuant to Section 12(b) of the Act:

 

Common stock, par value $0.01 per share   Nasdaq Global Market
(Title of each class)   (Name each of exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨    Accelerated filer                    ¨
Non-accelerated filer    ¨ (Do not check if a smaller reporting company)    Smaller reporting company  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

The aggregate market value as of March 31, 2010 of voting and nonvoting common equity held by nonaffiliates was approximately $25.6 million. This information is based on the ownership information and closing sale price ($9.50 per share as listed on the Nasdaq Global Market).

Number of shares of Common Stock outstanding as of December 23, 2010: 3,192,119.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

The following lists the documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated:

 

  1. Portions of the registrant’s Annual Report to Stockholders for the Fiscal Year Ended September 30, 2010. (Parts II and IV)

 

  2. Portions of Proxy Statement for the registrant’s 2011 annual meeting of shareholders. (Part III)

 

 

 


INDEX

 

          PAGE  

PART I

     

Item 1.

  

Business

     1   

Item 1A.

  

Risk Factors

     35   

Item 1B.

  

Unresolved Staff Comments

     38   

Item 2.

  

Properties

     39   

Item 3.

  

Legal Proceedings

     39   

Item 4.

  

[Removed and Reserved]

     40   

PART II

     

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     40   

Item 6.

  

Selected Financial Data

     41   

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operation

     43   

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

     55   

Item 8.

  

Financial Statements and Supplementary Data

     55   

Item 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     55   

Item 9A.

  

Controls and Procedures

     55   

Item 9B.

  

Other Information

     57   

PART III

     

Item 10.

  

Directors, Executive Officers and Corporate Governance

     57   

Item 11.

  

Executive Compensation

     57   

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     57   

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

     58   

Item 14.

  

Principal Accounting Fees and Services

     58   

PART IV

     

Item 15.

  

Exhibits and Financial Statement Schedules

     58   

SIGNATURES

  


Forward-Looking Statements

When used in this Annual Report, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company’s market area, competition and information provided by third-party vendors and the matters described herein under “Item 1A. Risk Factors” that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

PART I

 

Item 1. Business

General

BCSB Bancorp, Inc. BCSB Bancorp (“BCSB Bancorp” or the “Company”), a Maryland corporation, is the holding company for Baltimore County Savings Bank, F.S.B. (the “Bank”). The Company’s primary asset is its investment in the Bank. The Company is engaged in the business of directing, planning, and coordinating the business activities of the Bank. Accordingly, the information set forth in this Annual Report on Form 10-K, including financial statements and related data, relates primarily to the Bank. In the future, the Company may become an operating company or acquire or organize other operating subsidiaries, including other financial institutions. Currently, the Company does not maintain offices separate from those of the Bank or employ any persons other than officers of the Bank who are not separately compensated for such service. At September 30, 2010, the Company had total assets of $620.6 million, total deposits of $534.4 million and stockholders’ equity of $61.4 million.

The Company’s and the Bank’s executive offices are located at 4111 E. Joppa Road, Suite 300, Baltimore, Maryland 21236, and its main telephone number is (410) 256-5000.

Baltimore County Savings Bank, F.S.B. The Bank is a community-oriented financial institution dedicated to serving the financial service needs of consumers and businesses within its market area, which consists of the Baltimore Metropolitan Area. The Bank is subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, (“OTS”) its primary federal regulator, and the Federal Deposit Insurance Corporation (“FDIC”), its deposit insurer. The Bank attracts deposits from the general public and invests these funds in loans secured by first mortgages on owner-occupied, single-family residences in its market area and other real estate loans consisting of commercial real estate loans, construction loans and single-family rental property loans. The Bank also originates consumer loans and commercial loans. The Bank derives its income primarily from interest earned on these loans, and to a lesser extent, interest earned on investment securities and mortgage-backed securities. The Bank operates out of its main office in Baltimore County, Maryland and 18 branch offices in Baltimore County, Harford County, Howard County and Baltimore City in Maryland.

Recent Developments

On November 17, 2010 the Bank terminated the definitive Purchase and Assumption Agreement (the “Agreement”) with American Bank (“American”) entered into on January 12, 2010 under which the Bank would have sold four of its branch offices to American. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Terminated Sale of Branches” for more information.

 

1


Available Information

The Company and Bank maintain an Internet website at http://www.baltcosavings.com. The Company makes available its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to such reports filed with the Securities and Exchange Commission (“SEC”) as well as other information related to the Company, free of charge. SEC reports are available on this site as soon as reasonably practicable after electronically filed. The internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

Market Area

The Bank’s market area consists of the Baltimore metropolitan area. At September 30, 2010, management estimates that more than 95% of deposits and lending came from its market area.

The economy of the Bank’s market area is a diverse cross section of employment sectors, with a mix of services, manufacturing, wholesale/retail trade, federal and local government, health care facilities and finance related employment. This partially mitigates the risk associated with a decline in any particular economic sector. The diversification as noted helped to mitigate the impact of the economic recession experienced during fiscal 2009, as Maryland’s seasonable adjusted unemployment rose from 7.2% in September of 2009 to 7.5% by September of 2010, which remained well below the national seasonably adjusted unemployment rate which declined from 9.7% in September of 2009 to 9.6% by September of 2010. (Source: Maryland Department of Labor, Licensing and Regulation) Demographic and economic growth trends, measured by changes in population, number of households, age distribution and median household income, provide key insight into the health of our market area. Baltimore County has the largest population at 801,750, followed by Baltimore City at 644,850, Anne Arundel County at 520,300, Howard County at 281,950 and Harford County at 248,550. (Source: Maryland Department of Planning, 2010 projection) Located adjacent to major transportation corridors and Washington, DC, the Baltimore metropolitan area provides a diversified broad economic base. According to the Baltimore County Department of Economic Development, 84% of Baltimore County’s employees work in the private sector with approximately 7% in manufacturing, 19% in trade, transportation and utilities, 14% in professional business services, 17.0% in education and health services, and 9% in leisure and hospitality. Government provides 15% of Baltimore County’s jobs, with self-employed providing the remaining employment. According to the Maryland Department of Labor Licensing and Regulations, Baltimore County’s total labor force equaled 431,000 and a per capita personal income of $45,400. Select employers include the U.S. Social Security Administration, T. Rowe Price Group, McCormick & Company and Lockheed Martin.

Harford County continues to experience strong economic growth while maintaining a strong government presence. Aberdeen Proving Grounds (“APG”) is a major employer both in the military and civilian capacity. Harford County and the entire Baltimore metropolitan area will benefit from final congressional approval of the Base Realignment or Closure Commission’s (“BRAC”) decision to shift an additional 8,000 U.S. Department of Defense jobs to APG according to the Maryland Department of Planning BRAC report issued in December 2006. The department estimates approximately 14,000 households to be located in Harford and Cecil Counties by 2015.

Based on data provided by the United States Census Bureau from 2000 to 2009, Baltimore City experienced a decline in population at a rate of .26%, annually while Baltimore County’s population increased at a .58% annual rate over the same period. Comparatively, over the same time period, annual population growth rates for Harford County and Howard County equaled 1.4% and 1.7%, respectively.

Lending Activities

General. The Bank’s gross loan portfolio totaled $397.7 million at September 30, 2010, representing 64.1% of total assets at that date. At September 30, 2010, $118.1 million, or 29.7% of the Bank’s gross loan portfolio, consisted of single-family, residential mortgage loans. Other loans secured by real estate include construction loans, single-family rental property and commercial real estate loans, which amounted to $23.8 million, $70.7 million and $136.6 million, respectively, or 6.0%, 17.8% and 34.3%, respectively, of the Bank’s gross loan portfolio at September 30, 2010. The Bank also originates consumer loans, consisting primarily of automobile loans and home equity lines of credit, which totaled $2.5 million and $33.8 million, respectively, or .64% and 8.5% respectively, of the Bank’s gross loan portfolio. Other lending activities include commercial lines of credit, which totaled $8.0 million, or 2.0% of the Bank’s gross loan portfolio.

 

2


Loan Portfolio Composition. The following table sets forth selected data relating to the composition of the Bank’s loan portfolio by type of loan at the dates indicated. At September 30, 2010, the Bank had no concentrations of loans exceeding 10% of gross loans other than as disclosed below.

 

    At September 30,  
    2010     2009     2008     2007     2006  
    Amount     %     Amount     %     Amount     %     Amount     %     Amount     %  
    (Dollars in thousands)  

Real Estate Loans:

                   

Single-family residential (1)

  $ 118,120        29.69   $ 140,991        34.48   $ 165,341        40.47   $ 164,522        38.19   $ 214,724        44.50

Single-family rental property loans

    70,662        17.77        51,698        12.64        41,819        10.24        36,245        8.42        29,131        6.04   

Commercial

    136,573        34.34        136,106        33.29        127,596        31.23        119,598        27.77        110,179        22.83   

Construction (2)

    23,800        5.98        28,869        7.06        24,967        6.11        42,284        9.82        39,021        8.09   

Commercial lines of credit

    7,986        2.01        8,832        2.16        8,328        2.04        12,982        3.01        9,606        2.00   

Commercial leases

    1,225        .31        2,855        .70        4,612        1.13        4,574        1.06        4,749        .98   

Commercial loans secured

    880        .22        296        .07        —          —          —          —          365        .08   

Commercial loans unsecured

    78        .02        322        .08        329        .08        336        .08        409        .08   

Consumer Loans:

                   

Automobile

    2,544        .64        7,322        1.79        15,490        3.79        30,490        7.08        53,530        11.09   

Home equity lines of credit

    33,840        8.51        29,167        7.13        17,914        4.39        16,960        3.94        17,942        3.72   

Other

    2,015        .51        2,443        .60        2,124        .52        2,713        .63        2,849        .59   
                                                                               
    397,723        100.00     408,901        100.00     408,520        100.00     430,704        100.00     482,505        100.00
                                                 

Add:

                   

Purchase accounting premium (net)

    —            62          158          285          451     

Less:

                   

Undisbursed portion of loans in process

    2,042          3,664          4,595          9,846          12,014     

Deferred loan origination fees

    97          234          408          558          355     

Unearned interest

    17          127          534          1,633          4,132     

Allowance for loan losses

    6,634          3,927          2,672          2,650          2,679     
                                                 

Total

  $ 388,933        $ 401,011        $ 400,469        $ 416,302        $ 463,776     
                                                 

 

(1) Includes fixed-rate second mortgage loans and loans available for sale.
(2) Includes acquisition and development loans.

 

3


Loan Maturity Schedules. The following table sets forth certain information at September 30, 2010 regarding the dollar amount of loans maturing in the Bank’s portfolio based on their contractual terms to maturity, including scheduled repayments of principal. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. The table does not include any estimate of prepayments which significantly shorten the average life of mortgage loans and may cause the Bank’s repayment experience to differ from that shown below.

 

     Due in 1 year
or less
     Due 1
through
5 years
     Due after
5 years
     Total  
     (In thousands)  

Real Estate Loans

           

Single-family residential

   $ 4,323       $ 7,205       $ 106,592       $ 118,120   

Single-family rental property

     578         11,216         58,868         70,662   

Commercial

     3,005         26,395         107,173         136,573   

Construction

     13,705         144         9,951         23,800   

Commercial lines of credit

     6,328         —           1,658         7,986   

Commercial leases

     374         784         67         1,225   

Commercial loans secured

     —           698         182         880   

Commercial loans unsecured

     78         —           —           78   

Consumer:

           

Automobile

     611         1,933         —           2,544   

Home equity lines of credit

     —           7         33,833         33,840   

Other

     245         606         1,164         2,015   
                                   

Total

   $ 29,247       $ 48,988       $ 319,488       $ 397,723   
                                   

The following table sets forth at September 30, 2010, the dollar amount of all loans due after one year after September 30, 2010 which have predetermined interest rates and have floating or adjustable interest rates.

 

     Predetermined
Rate
     Floating or
Adjustable
Rates
 
     (In thousands)  

Real Estate loans:

     

Single-family residential

   $ 111,430       $ 2,367   

Single-family rental property

     38,044         32,040   

Commercial

     92,306         41,262   

Construction

     8,761         1,334   

Commercial lines of credit

     —           1,658   

Commercial leases

     851         —     

Commercial loans secured

     880         —     

Commercial loans unsecured

     —           —     

Consumer:

     

Automobiles

     1,933         —     

Home equity lines of credit

     —           33,840   

Other

     1,770         —     
                 

Total

   $ 255,975       $ 112,501   
                 

Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan market rates are substantially lower than rates on existing mortgage loans.

Originations, Purchases and Sales of Loans. The Bank generally has authority to originate and purchase loans secured by real estate located throughout the United States. Consistent with its emphasis on being a community-oriented financial institution, the Bank concentrates its lending activities in its market area.

 

4


The following table sets forth certain information with respect to the Bank’s loan origination, purchase and sale activity for the periods indicated.

 

     Year Ended September 30,  
     2010      2009      2008  
     (In thousands)  

Loans originated:

        

Real Estate Loans:

        

Single-family residential

   $ 7,244       $ 12,112       $ 20,833   

Single-family rental property

     18,773         11,584         10,702   

Commercial

     15,092         26,448         20,354   

Construction

     509         4,314         6,992   

Commercial lines of credit

     4,863         3,459         3,670   

Commercial loans secured

     1,015         264         —     

Commercial leases

     —           200         2,103   

Consumer:

        

Automobile

     309         952         1,673   

Home equity lines of credit

     10,926         19,072         6,396   

Other

     575         1,872         541   
                          

Total loans originated

   $ 59,3066       $ 80,2777       $ 73,2644   
                          

Loans purchased:

        

Real estate loans

   $ —         $ 2,500       $ 2,912   
                          

Total loans purchased

   $ —         $ 2,500       $ 2,912   
                          

Loans sold:

        

Whole loans

   $ 5,720       $ 2,800       $ —     
                          

Participation loans

   $ 86       $ 8,600       $ —     
                          

Total loans sold

   $ 86       $ 11,400       $ —     
                          

The Bank’s loan originations are derived from a number of sources, including business referrals, depositors, borrowers, our website, and advertising, as well as walk-in customers. The Bank’s solicitation programs consist of advertisements in local media, in addition to occasional participation in various community organizations and events. Real estate loans are originated by the Bank’s loan personnel. Automobile loans are originated by the Bank’s loan personnel and loan applications are accepted at the Bank’s offices.

Loan Underwriting Policies. The Bank’s lending activities are subject to the Bank’s written, non-discriminatory underwriting standards and to loan origination procedures prescribed by the Bank’s Board of Directors and its management. Detailed loan applications are obtained to determine the borrower’s ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations. Loans are approved based on a loan approval matrix, which is governed by the type of loan and the loan amount. Levels of approval are the loan officer, officers’ loan committee, which includes the President, Chief Financial Officer, Executive Vice President in charge of lending, Executive Vice President of Operations, the Treasurer, a directors loan committee, and the full Board. Individual officers of the Bank have been granted authority by the Board of Directors to approve loans up to varying specified dollar amounts, depending upon the type of loan. Applications for single-family real estate loans generally are underwritten and closed in accordance with the standards of the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”). Upon receipt of a loan application from a prospective borrower, a credit report and verifications are ordered to verify specific information relating to the loan applicant’s employment, income and credit standing. If a proposed loan is to be secured by a deed of trust or a mortgage on real estate, an appraisal of the real estate is generally undertaken by an appraiser approved by the Bank and licensed by the State of Maryland. In the case of single-family residential mortgage loans, except when the Bank becomes aware of a particular risk of environmental contamination, the Bank generally does not obtain a formal environmental report on the real estate at the time a loan is made. A formal environmental report may be required in connection with a commercial real estate loan.

It is the Bank’s policy to record a lien on the real estate securing a loan and to obtain title insurance or an attorney’s certification which ensures that the property is free of prior encumbrances and other possible title defects. Borrowers must also obtain hazard insurance policies prior to closing. When the property is in a flood plain as designated by Federal Emergency Management Agency, the Bank requires adequate flood insurance prior to settlement of the loan.

 

5


With respect to single-family residential mortgage loans, the Bank makes a loan commitment of between 30 and 60 days for each loan approved. If the borrower desires a longer commitment, the commitment may be extended for good cause and upon written approval.

The Bank is permitted to lend up to 95% of the lesser of the appraised value or the purchase price of the real property securing a mortgage loan. However, if the amount of a residential loan originated or refinanced exceeds 80% of the appraised value, the Bank’s policy is to obtain private mortgage insurance at the borrower’s expense on the principal amount of the loan. The Bank will make a single-family residential mortgage loan with up to a 95% loan-to-value ratio if the required private mortgage insurance is obtained. The Bank generally limits the loan-to-value ratio on commercial real estate mortgage loans to 80%. The Bank limits the loan-to-value ratio on single-family rental property loans to 75%. Home equity loans are made in amounts which, when added to any senior indebtedness, do not exceed 90% of the value of the property, although the majority of home equity loans have a loan to value ratio of 80% or less.

Under applicable law, with certain limited exceptions, loans and extensions of credit by a savings institution to a person outstanding at one time shall not exceed 15% of the institution’s unimpaired capital and surplus. Loans and extensions of credit fully secured by readily marketable collateral may comprise an additional 10% of unimpaired capital and surplus. Under these limits, the Bank’s loans to one borrower was limited to $10.1 million at September 30, 2010. Applicable law additionally authorizes savings institutions to make loans to one borrower, for any purpose, in an amount not to exceed $500,000 or in an amount not to exceed the lesser of $30.0 million or 30% of unimpaired capital and surplus to develop residential housing, provided: (i) the purchase price of each single-family dwelling in the development does not exceed $500,000; (ii) the savings institution is and continues to be in compliance with its fully phased-in regulatory capital requirements; (iii) the loans comply with applicable loan-to-value requirements; (iv) the aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus; and (v) the Director of the OTS, by order, permits the savings institution to avail itself of this higher limit. At September 30, 2010, the Bank had no lending relationships in excess of the loans-to-one-borrower limit. At September 30, 2010, the Bank’s largest loan customer was a $5.4 million relationship secured by a retail shopping center. At September 30, 2010, this customer’s loans were current and performing in accordance with their terms.

Interest rates charged by the Bank on loans are affected principally by competitive factors, the demand for such loans and the supply of funds available for lending purposes. These factors are, in turn, affected by general economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies and government budgetary matters.

Single-Family Residential Real Estate Lending. The Bank historically has been and continues to be an originator of single-family, residential real estate loans in its market area. At September 30, 2010, single-family, residential mortgage loans, excluding single-family rental property loans and home equity loans, totaled $118.1 million, or 29.7% of the Bank’s gross loan portfolio. The Bank has never participated in the origination of Sub-prime lending and, accordingly, has no direct exposure to this type of lending within its loan portfolio.

The Bank originates fixed-rate mortgage loans at competitive interest rates. At September 30, 2010, the Bank had $115.7 million of fixed-rate single-family mortgage loans, which amounted to 98.0% of the Bank’s single-family mortgage loans. Due to the current economic conditions and the low interest rate environment the Bank has employed a strategy to sell the majority of fixed-rate single-family residential mortgage loans originated into the secondary market.

As of September 30, 2010, $2.4 million, or 2.0% of the Bank’s single-family mortgage loans carried adjustable rates. After the initial term, the rate adjustments on the Bank’s adjustable-rate loans are indexed to a rate which adjusts annually based upon changes in an index based on the weekly average yield on U.S. Treasury securities adjusted to a constant comparable maturity of one year, as made available by the Federal Reserve Board. The interest rates on most of the Bank’s adjustable-rate mortgage loans are adjusted once a year, and the Bank offers loans that have an initial adjustment period of one, three or five years. The maximum adjustment is 2% per adjustment period with a maximum aggregate adjustment of 6% over the life of the loan. The Bank offers adjustable-rate mortgage loans that provide for initial rates of interest below the rates that would prevail when the index used for repricing is applied, i.e., “teaser” rates. All of the Bank’s adjustable-rate loans require that any payment adjustment resulting from a change in the interest rate be sufficient to result in full amortization of the loan by the end of the loan term and, thus, do not permit any of the increased payment to be added to the principal amount of the loan, known as “negative amortization.”

 

6


The retention of adjustable-rate loans in the Bank’s portfolio helps reduce the Bank’s exposure to increases in prevailing market interest rates. However, there are unquantifiable credit risks resulting from potential increases in costs to borrowers in the event of upward repricing of adjustable-rate loans. It is possible that during periods of rising interest rates, the risk of default on adjustable-rate loans may increase due to increases in interest costs to borrowers. Further, although adjustable-rate loans allow the Bank to increase the sensitivity of its interest-earning assets to changes in interest rates, the extent of this interest sensitivity is limited by the initial fixed-rate period before the first adjustment and the lifetime interest rate adjustment limitations. Accordingly, there can be no assurance that yields on the Bank’s adjustable-rate loans will fully adjust to compensate for increases in the Bank’s cost of funds. Finally, adjustable-rate loans increase the Bank’s exposure to decreases in prevailing market interest rates, although decreases in the Bank’s cost of funds tend to offset this effect.

Single-Family Rental Property Loans. The Bank also offers single-family residential mortgage loans secured by properties that are not owner-occupied. As of September 30, 2010, single-family rental property loans totaled $70.7 million, or 17.8%, of the Bank’s gross loan portfolio. Originations of single-family rental property loans were $18.8 million, $11.6 million and $10.7 million for the years ended September 30, 2010, 2009 and 2008, respectively. Single-family residential mortgage loans secured by nonowner-occupied properties are made on a fixed-rate or an adjustable-rate basis and carry interest rates generally from 1.0% to 1.5% above the rates charged on comparable loans secured by owner-occupied properties. The maximum term on such loans is 30 years.

Commercial Real Estate Lending. The Bank’s commercial real estate loan portfolio includes loans to finance the acquisition of office buildings, churches, commercial office condominiums, shopping centers, hospitality, and commercial and industrial buildings. Such loans generally range in size from $100,000 to $6 million, with the largest having an outstanding principal balance of $5.4 million at September 30, 2010. At September 30, 2010, the Bank had $136.6 million of commercial real estate loans, which amounted to 34.3% of the Bank’s gross loan portfolio. Commercial real estate loans are originated on a fixed-rate or adjustable-rate basis with terms of up to 30 years.

Commercial real estate lending entails significant additional risks as compared with single-family residential property lending. Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers. The payment experience on such loans typically is dependent on the successful operation of the real estate project, retail establishment or business. These risks can be significantly impacted by supply and demand conditions in the market for office and retail space and, as such, may be subject to a greater extent to adverse conditions in the economy generally. To minimize these risks, the Bank generally limits itself to its market area or to borrowers with which it has prior experience or who are otherwise known to the Bank. It is the Bank’s policy generally to obtain annual financial statements of the business of the borrower or the project for which commercial real estate loans are made. In addition, in the case of commercial real estate loans made to a legal entity, the Bank seeks, whenever possible, to obtain personal guarantees and annual financial statements of the principals of the legal entity.

Construction Lending. A substantial portion of the Bank’s construction loans are originated for the construction of owner-occupied, single-family dwellings in the Bank’s primary market area. Residential construction loans are offered primarily to individuals building their primary or secondary residence, as well as to selected local developers to build single-family dwellings. Generally, loans to owner/occupants for the construction of owner-occupied, single-family residential properties are originated in connection with the permanent loan on the property and have a construction term of up to 12 months. Such loans are offered on fixed rate terms. Interest rates on residential construction loans made to the owner/occupant have interest rates during the construction period equal to the same rate on the permanent loan selected by the customer. Interest rates on residential construction loans to builders are set at the prime rate plus a margin of between 0% and 1.5%, typically with interest rate floors. Interest rates on commercial construction loans are based on the prime rate plus a negotiated margin of between 0% and 1.5% and adjust monthly, typically with interest rate floors with construction terms generally not exceeding 18 months. Advances are made on a percentage of completion basis. At September 30, 2010, $23.8 million, or 6.0%, of the Bank’s gross loan portfolio consisted of commercial construction loans, acquisition and development loans, and construction loans on single family residences.

Prior to making a commitment to fund a loan, the Bank requires both an appraisal of the property by appraisers approved by the Board of Directors and a study of projected construction costs. The Bank also reviews and inspects each project at the commencement of construction and as needed prior to disbursements during the term of the construction loan.

 

7


Consolidation in the building industry and the increasing presence in the Bank’s market of large builders that are not locally based have limited the Bank’s ability to compete for some loans to builders because the Bank’s loans-to-one-borrower limitation limits its ability to meet the volume requirements of the large builders. The Bank’s construction loans totaled $ 23.8 million, $28.9 million and $25.0 million at September 30, 2010, 2009 and 2008, respectively, and construction loan originations were $509,000, $4.3 million and $7.0 million during the years ended September 30, 2010, 2009 and 2008, respectively.

On occasion, the Bank makes acquisition and development loans to local developers to acquire and develop land for sale to builders who will construct single-family residences. Acquisition and development loans, which are considered by the Bank to be construction loans, are made at a rate that adjusts monthly, based on the prime rate plus a negotiated margin, typically with interest rate floors for terms of up to three years. Interest only is paid during the term of the loan, and the principal balance of the loan is paid down as developed lots are sold to builders. At September 30, 2010 acquisition and development loans totaled $15.6 million or 3.9% of the Bank’s gross loan portfolio. The Bank did not originate any acquisition and development loans during the fiscal year ended September 30, 2010. Generally, in connection with acquisition and development loans, the Bank issues a letter of credit to secure the developer’s obligation to local governments to complete certain work. If the developer fails to complete the required work, the Bank would be required to fund the cost of completing the work up to the amount of the letter of credit. Letters of credit generate fee income for the Bank but create additional risk. At September 30, 2010, the Bank had 12 letters of credit outstanding totaling $853,000.

Construction financing generally is considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate and the borrower is unable to meet the Bank’s requirements of putting up additional funds to cover extra costs or change orders, then the Bank will demand that the loan be paid off and, if necessary, institute foreclosure proceedings, or refinance the loan. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or prior to the maturity of the loan, with collateral having a value which is insufficient to assure full repayment. The Bank has sought to minimize this risk by limiting construction lending to qualified borrowers (i.e., borrowers who satisfy all credit requirements and whose loans satisfy all other underwriting standards which would apply to the Bank’s permanent mortgage loan financing for the subject property) in the Bank’s market area. On loans to builders, the Bank works only with selected builders with whom it has experience and carefully monitors the creditworthiness of the builders.

Commercial Lines of Credit. The Bank provides commercial lines of credit to businesses within the Bank’s market area. These loans are secured by business assets, including real property, equipment, automobiles and consumer leases. Generally, all loans are further personally guaranteed by the owners of the business. The commercial lines have adjustable interest rates tied to the prime rate, typically with interest rate floors and are offered at rates from prime plus 0% to prime plus 3.5%. As of September 30, 2010, the Bank had $8.0 million of such loans, which amounted to 2.0% of the Bank’s gross loan portfolio.

Consumer Lending. The consumer loans currently in the Bank’s loan portfolio consist of automobile loans, home equity lines of credit and loans secured by savings deposits.

Automobile loans totaled $2.5 million, or .64%, of the Bank’s gross loan portfolio at September 30, 2010. Automobile loans are secured by both new and used cars and, depending on the creditworthiness of the borrower, may be made for up to 110% of the “invoice price” or clean “black book” value, whichever is lower, or, with respect to used automobiles, the loan values as published by a wholesale value listing utilized by the automobile industry. Automobile loans are made directly to the borrower-owner. New and used cars are financed for a period generally of up to six years, or less, depending on the age of the car. Collision insurance is required for all automobile loans. The Bank also maintains a blanket collision insurance policy that provides insurance for any borrower who allows their insurance to lapse.

The Bank originates second mortgage loans and home equity lines of credit. As of September 30, 2010, home equity lines of credit totaled $33.8 million, or 8.5% of the Bank’s gross loan portfolio. Second mortgage loans are made at fixed rates and for terms of up to 15 years and totaled $9.2 million, or 2.4%, of the Bank’s gross loans at September 30, 2010.

The Bank’s home equity lines of credit currently have adjustable interest rates tied to the prime rate and can be offered anywhere from as low as the prime rate less 0.25% up to the prime rate plus 1.0%. The interest rate may

 

8


not adjust to a rate higher than 24%. The home equity lines of credit require monthly payments until the loan is paid in full, with a loan term not to exceed 30 years. The minimum monthly payment is the outstanding interest. Home equity lines of credit are secured by subordinate liens against residential real property. The Bank requires that fire and extended coverage casualty insurance (and, if appropriate, flood insurance) be maintained in an amount at least sufficient to cover its loan.

The Bank makes savings account loans for up to 90% of the depositor’s savings account balance. The interest rate is normally 3.0% above the rate paid on the related savings account, and the account must be pledged as collateral to secure the loan. Interest generally is billed on a quarterly basis. At September 30, 2010, savings account loans accounts totaled $369,000, or .09%, of the Bank’s gross loan portfolio.

As part of the Bank’s loan strategy, the Bank has diversified its lending portfolio to afford the Bank the opportunity to earn higher yields and to provide a fuller range of banking services. These products have generally been in the consumer area and include boat loans and loans for the purchase of recreational vehicles. Such loans totaled $1.6 million, or .41% of the Bank’s gross loan portfolio at September 30, 2010.

Consumer lending usually affords the Bank the opportunity to earn yields higher than those obtainable on single-family residential lending. However, consumer loans entail greater risk than residential mortgage loans, particularly in the case of loans which are unsecured or secured by rapidly depreciable assets. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by events such as job loss, divorce, illness or personal bankruptcy.

Loan Fees and Servicing. The Bank receives fees in connection with late payments and for miscellaneous services related to its loans. The Bank also charges fees in connection with loan originations typically from 0 to 1.5 points (one point being equal to 1% of the loan amount) on residential and commercial loan originations. The Bank services certain loans sold to FHLMC and FNMA. The Bank also services participation loans originated and sold by the Bank with servicing retained, and earns minimal income from this activity.

Nonperforming Loans and Other Problem Assets. It is management’s policy to continually monitor its loan portfolio to anticipate and address potential and actual delinquencies. When a borrower fails to make a payment on a loan, the Bank takes immediate steps to have the delinquency cured and the loan restored to current status. Loans which are past due 15 days incur a late fee of 5% of principal and interest due. As a matter of policy, the Bank will send a late notice to the borrower after the loan has been past due 15 days and again after 30 days. If payment is not promptly received, the borrower is contacted again, and efforts are made to formulate an affirmative plan to cure the delinquency. Generally, after any loan is delinquent 90 days or more, formal legal proceedings are commenced to collect amounts owed. In the case of automobile loans, late notices are sent after loans are ten days delinquent, and the collateral is seized after a loan is delinquent 60 days. Repossessed cars subsequently are sold at auction.

Loans generally are placed on nonaccrual status if the loan becomes past due more than 90 days, except in instances where in management’s judgment there is no doubt as to full collectability of principal and interest, or management concludes that payment in full is not likely. Consumer loans are generally charged off, or any expected loss is reserved for, after they become more than 120 days past due. All other loans are charged off, or any expected loss is reserved for when management concludes that they are uncollectible. See Note 3 of Notes to Consolidated Financial Statements.

Real estate acquired by the Bank as a result of foreclosure is classified as real estate acquired through foreclosure until such time as it is sold. When such property is acquired, it is initially recorded at the lower of cost or estimated fair value and subsequently at the lower of book value or fair value less estimated costs to sell. Costs relating to holding such real estate are charged against income in the current period, while costs relating to improving such real estate are capitalized until a saleable condition is reached. Any required write-down of the loan to its fair value less estimated selling costs upon foreclosure is charged against the allowance for loan losses. See Note 3 of Notes to Consolidated Financial Statements.

The following table sets forth information with respect to the Bank’s nonperforming assets at the dates indicated.

 

9


 

     At September 30,  
     2010     2009     2008     2007     2006  
     (Dollars in thousands)  

Loans accounted for on a nonaccrual basis: (1)

          

Real Estate:

          

Single-family residential

   $ 656      $ 1,186      $ 291      $ —        $ 69   

Single-family rental property

     1,664        —          —          —          —     

Commercial

     6,002        6,269        369        2,266        2,381   

Construction

     3,933        —          —          —          —     

Commercial lines of credit

     —          —          —          —          —     

Commercial leases

     240        235        173        —          —     

Commercial loans secured

     267        —          —          —          —     

Consumer

     23        —          2        24        42   
                                        

Total

   $ 12,785      $ 7,690      $ 835      $ 2,290      $ 2,492   

Accruing loans which are contractually past due 90 days or more:

          

Real Estate:

          

Single-family residential

   $ —        $ —        $ —        $ —        $ —     

Single-family rental property

     —          —          —          —          —     

Commercial

     —          —          —          —          —     

Construction

     —          —          —          —          —     

Commercial lines of credit

     —          —          —          —          —     

Commercial loans secured

     —          —          —          —          —     

Consumer

     —          —          —          —          —     
                                        

Total

   $ —        $ —        $ —        $ —        $ —     
                                        

Total nonperforming loans

   $ 12,785      $ 7,690      $ 835      $ 2,290      $ 2,492   
                                        

Percentage of gross loans

     3.21     1.88     0.20     0.53     0.51
                                        

Percentage of total assets

     2.06     1.35     0.14     0.35     0.32
                                        

Other nonperforming assets (2)

   $ —        $ 639      $ 1,244      $ 108      $ 130   
                                        

Loans modified in Troubled Debt Restructuring (3)

   $ 4,007      $ 3,863      $ —        $ —        $ —     
                                        

 

(1) Nonaccrual status denotes loans on which, in the opinion of management, the collection of additional interest is questionable. Also included in this category are $4.0 million in Troubled Debt Restructurings, of which $3.3 million are not delinquent. Reporting guidance requires disclosure of these loans as nonperforming even though they are current in terms of principal and interest payments. Payments received on a nonaccrual loan are either applied to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the collectability of the loan.
(2) Other nonperforming assets include the Bank’s inventory of repossessed cars and other real estate owned.
(3) As described in (1) above, loans modified in a troubled debt restructuring are also included as nonaccrual loans.

During the year ended September 30, 2010, gross interest income of $830,000, would have been recorded on loans accounted for on a nonaccrual basis if the loans had been current throughout the year. Interest on such loans included in income during the year ended September 30, 2010 amounted to $276,000.

At September 30, 2010, the Bank had no loans which were not classified as nonaccrual, 90 days past due or restructured but where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms and may result in disclosure as nonaccrual, 90 days past due or restructured.

At September 30, 2010, nonaccrual loans consisted of commercial loans aggregating $6.0 million, residential loans aggregating $656,000, single family rental loans aggregating $1.7 million, construction loans aggregating $3.9 million, commercial secured loans aggregating $267,000, commercial leases aggregating $240,000 and consumer loans aggregating $23,000.

Real estate acquired through foreclosure is initially recorded at the lower of cost or estimated fair value and subsequently at the lower of book value or fair value less estimated costs to sell. Fair value is defined as the amount in cash or cash-equivalent value of other consideration that a real estate parcel would yield in a current sale between a willing buyer and a willing seller, as measured by market transactions. If a market does not exist, fair value of the item is estimated based on selling prices of similar items in active markets or, if there are no active markets for similar items, by discounting a forecast of expected cash flows at a rate commensurate with the risk involved. Fair value is generally determined through an appraisal at the time of foreclosure. Subsequent to foreclosure, real estate

 

10


acquired through foreclosure is periodically evaluated by management and an allowance for loss is established if the estimated fair value of the property, less estimated costs to sell, declines. At September 30, 2010, the Bank had no real estate owned through foreclosure.

Federal regulations require savings institutions to classify their assets on the basis of quality on a regular basis. An asset meeting one of the classification definitions set forth below may be classified and still be a performing loan. An asset is classified as substandard if it is determined to be inadequately protected by the current paying capacity of the obligor or of the collateral pledged, if any. An asset is classified as doubtful if full collection is highly questionable or improbable. An asset is classified as loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations also provide for a special mention designation, described as assets which do not currently expose a savings institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management’s close attention. Such assets designated as special mention may include nonperforming loans consistent with the above definition. If an asset or portion thereof is classified loss, a savings institution must either establish a specific allowance for loss in the amount of the portion of the asset classified loss, or charge off such amount. Federal examiners may disagree with a savings institution’s classifications. If a savings institution does not agree with an examiner’s classification of an asset, it may appeal this determination to the OTS Regional Director. The Bank regularly reviews its assets to determine whether any assets require classification or re-classification. At September 30, 2010, the Bank had $38.0 million in classified assets consisting of $10.6 million in assets classified as special mention, $24.9 million in assets classified as substandard, $0 in assets classified as doubtful and $2.5 in assets classified as loss. Special mention assets consisted of $823,000 in single-family residential mortgage loans 60 to 89 days delinquent at September 30, 2010, $23,000 in consumer loans 60 to 120 days delinquent and commercial loans of $9.7 million that the Bank is monitoring for management and credit weaknesses at September 30, 2010. Substandard assets consisted of $10.9 million in loans and $14.0 million in private label CMOs.

Allowance for Loan Losses. In originating loans, the Bank recognizes that credit losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. It is management’s policy to maintain an adequate allowance for loan losses based on, among other things, the Bank’s and the industry’s historical loan loss experience, evaluation of economic conditions, regular reviews of delinquencies and loan portfolio quality and evolving standards imposed by federal bank examiners. The Bank increases its allowance for loan losses by charging provisions for loan losses against the Bank’s income. Due to the downturn in the current economic conditions, the Bank increased the allowance for loan losses during the fiscal year ended September 30, 2010 by $3.1 million in provisions for losses on loans. Net loans charged off during the fiscal year ended September 30, 2010 were $393,000.

Management will continue to actively monitor the Bank’s asset quality and allowance for loan losses. Management will charge off loans and properties acquired in settlement of loans against the allowances for losses on such loans and such properties when appropriate and will provide specific loss allowances when necessary. Although management believes it uses the best information available to make determinations with respect to the allowances for losses and believes such allowances are adequate, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used in making the initial determinations.

The Bank’s methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific assets as well as losses that have not been identified but are expected to have occurred. Management conducts regular reviews of the Bank’s assets and evaluates the need to establish allowances on the basis of this review. Allowances are established by management and reviewed by the Board of Directors on a monthly basis based on an assessment of risk in the Bank’s assets taking into consideration the composition and quality of the portfolio, delinquency trends, current charge-off and loss experience, loan concentrations, the state of the real estate market, regulatory reviews conducted in the regulatory examination process and economic conditions generally. Additional provisions for losses on loans are made in order to bring the allowance to a level deemed adequate. Specific reserves will be provided for individual assets, or portions of assets, when ultimate collection is considered improbable by management based on the current payment status of the assets and the fair value of the security. At the date of foreclosure or other repossession, the Bank would transfer the property to real estate acquired in settlement of loans initially at the lower of cost or estimated fair value and subsequently at the lower of book value or fair value less estimated selling costs. Any portion of the outstanding loan balance in excess of fair value less estimated selling costs would be charged off against the allowance for loan losses. If, upon ultimate disposition of the property, net sales proceeds exceed the net carrying value of the property, a gain on sale of real estate would be recorded.

 

11


The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated.

 

     At September 30,  
     2010     2009     2008     2007     2006  
     (Dollars in thousands)  

Balance at the beginning of the period

   $ 3,927      $ 2,672      $ 2,650      $ 2,679      $ 2,746   
                                        

Loans charged-off:

          

Real estate mortgage:

          

Single-family residential

     —          —          —          —          —     

Multi-family residential

     —          —          —          —          —     

Commercial

     235        187        341        —          —     

Commercial leases

     15        27        —          —          —     

Construction

     —          —          —          —          —     

Commercial loans secured

     —          —          —          —          —     

Commercial loans unsecured

     234        —          —          —          —     

Consumer

     75        87        262        364        578   
                                        

Total charge-offs

     559        301        603        364        578   

Recoveries:

          

Real estate mortgage:

          

Single-family residential

     —          —          —          —          —     

Multi-family residential

     —          —          —          —          —     

Commercial

     5        31        —          —          —     

Construction

     —          —          —          —          —     

Commercial loans secured

     —          —          —          —          —     

Consumer

     161        175        265        218        317   
                                        

Total recoveries

     166        206        265        218        317   

Net loans charged-off

     (393     (95     (338     (146     (261

Provision for loan losses

     3,100        1,350        360        117        194   
                                        

Balance at the end of period

   $ 6,634      $ 3,927      $ 2,672      $ 2,650      $ 2,679   
                                        

Ratio of net charge-offs to average loans outstanding during the period

     0.10     0.02     0.08     0.03     0.06
                                        

 

12


The following table allocates the allowance for loan losses by loan category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.

 

     At September 30,  
     2010     2009     2008     2007     2006  
     Amount      Percent
of Loans
in
Category
to Total
Loans
    Amount      Percent
of Loans
in
Category
to Total
Loans
    Amount      Percent
of Loans
in
Category
to Total
Loans
    Amount      Percent
of Loans
in
Category
to Total
Loans
    Amount      Percent
of Loans
in
Category
to Total
Loans
 
     (Dollars in thousands)  

Real estate loans:

                         

Single-family residential

   $ 105         29.69   $ 253         34.48   $ 329         40.47   $ 633         38.19   $ 697         44.50

Single-family rental property

     74         17.77        137         12.64        106         10.24        80         8.42        64         6.04   

Commercial

     5,087         34.34        1,568         33.29        1,292         31.23        976         27.77        591         21.87   

Construction

     906         5.98        980         7.06        360         6.11        127         9.82        94         8.09   

Commercial lines of credit

     13         2.01        88         2.16        75         2.04        39         3.01        42         2.91   

Commercial leases

     209         .31        266         .70        92         1.14        27         1.06        28         .98   

Commercial loans secured

     31         .22        28         .07        —           —          —           —          1         .08   

Commercial loans unsecured

     40         .02        318         .08        330         .08        335         .08        409         .08   

Consumer

     169         9.66        289         9.52        88         8.69        433         11.65        753         15.45   
                                                                                     

Total allowance for loan losses

   $ 6,634         100.00   $ 3,927         100.00   $ 2,672         100.00   $ 2,650         100.00   $ 2,679         100.00
                                                                                     

Investment Activities

General. The Bank is permitted under federal law to make certain investments, including investments in securities issued by various federal agencies and state and municipal governments, deposits at the FHLB of Atlanta, certificates of deposit in federally insured institutions, certain bankers’ acceptances and federal funds. It may also invest, subject to certain limitations, in commercial paper rated in one of the two highest investment rating categories of a nationally recognized credit rating agency, and certain other types of corporate debt securities and mutual funds. Federal regulations require the Bank to maintain an investment in FHLB stock and a minimum amount of liquid assets which may be invested in cash and specified securities. From time to time, the OTS adjusts the percentage of liquid assets which savings banks are required to maintain. See “—Regulation—Depository Institution Regulation—Liquidity Requirements.”

The Bank makes investments in order to maintain the levels of liquid assets required by regulatory authorities and manage cash flow, diversify its assets, obtain yield and to satisfy certain requirements for favorable tax treatment. The investment activities of the Bank consist primarily of investments in mortgage-backed securities and other investment securities, consisting primarily of securities issued or guaranteed by the U.S. government or agencies thereof. Typical investments include federally sponsored agency mortgage pass-through and federally sponsored agency and mortgage-related securities. The Bank performs analyses on mortgage-related securities prior to purchase and on an ongoing basis to determine the impact on earnings and market value under various interest rate and prepayment conditions. Under the Bank’s current investment policy, securities purchases are made by the Bank’s President. The Bank’s President, Chief Financial Officer and Treasurer have authority to sell investment securities subject to the Bank’s designation as available for sale and purchase comparable investment securities with similar characteristics. The Board of Directors oversees securities transactions activity.

Securities designated as “held to maturity” are those assets which the Bank has the ability and intent to hold to maturity. Upon acquisition, securities are classified as to the Bank’s intent. The held to maturity investment portfolio would not be used for speculative purposes and would be carried at amortized cost. In the event the Bank sold securities from this portfolio for other than credit quality reasons, all securities within the investment portfolio with matching characteristics may be reclassified as assets available for sale. Securities designated as “available for sale” are those assets which the Bank may not hold to maturity and thus are carried at market value with unrealized gains or losses, net of tax effect, recognized in retained earnings. At September 30, 2010 the Bank’s securities portfolio consists of available for sale securities only.

Mortgage-Backed and Related Securities. Mortgage-backed securities represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators through intermediaries that pool and repackage the participation interest in the form of securities to investors such as the Bank. Such intermediaries may include quasi-governmental agencies such as

 

13


FHLMC, FNMA and GNMA which guarantee the payment of principal and interest to investors. Mortgage-backed securities generally increase the quality of the Bank’s assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Bank.

Mortgage-related securities typically are issued with stated principal amounts and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have similar maturities. The underlying pool of mortgages can be composed of either fixed-rate or adjustable-rate mortgage loans. Mortgage-backed securities generally are referred to as mortgage participation certificates or pass-through certificates. As a result, the interest rate risk characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder. The life of a mortgage-backed pass-through security is equal to the life of the underlying mortgages.

The actual maturity of a mortgage-backed security varies, depending on when the mortgagors prepay or repay the underlying mortgages. Prepayments of the underlying mortgages may shorten the life of the investment, thereby adversely affecting its yield to maturity and the related market value of the mortgage-backed security. The yield is based upon the interest income and the amortization of the premium or accretion of the discount related to the mortgage-backed security. Premiums and discounts on mortgage-backed securities are amortized or accredited over the estimated term of the securities using a level yield method. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect the actual prepayment. The actual prepayments of the underlying mortgages depend on many factors, including the type of mortgage, the coupon rate, the age of the mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates. The difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates is an important determinant in the rate of prepayments. During periods of falling mortgage interest rates, prepayments generally increase, and, conversely, during periods of rising mortgage interest rates, prepayments generally decrease. If the coupon rate of the underlying mortgage significantly exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages. Prepayment experience is more difficult to estimate for adjustable-rate mortgage-backed securities.

Mortgage-related securities, which include collateralized mortgage obligations (“CMOs”), are typically issued by a special purpose entity, which may be organized in a variety of legal forms, such as a trust, a corporation or a partnership. The entity aggregates pools of pass-through securities, which are used to collateralize the mortgage-related securities. Once combined, the cash flows can be divided into “traunches” or “classes” of individual securities, thereby creating more predictable average lives for each security than the underlying pass-through pools. Accordingly, under this security structure, all principal paydowns from the various mortgage pools are allocated to a mortgage-related securities’ class or classes structured to have priority until it has been paid off. These securities generally have fixed interest rates, and, as a result, changes in interest rates generally would affect the market value and possibly the prepayment rates of such securities.

Some mortgage-related securities instruments are like traditional debt instruments due to their stated principal amounts and traditionally defined interest rate terms. Purchasers of certain other mortgage-related securities instruments are entitled to the excess, if any, of the issuer’s cash flows. These mortgage-related securities instruments may include instruments designated as residual interest and are riskier in that they could result in the loss of a portion of the original investment. Cash flows from residual interests are very sensitive to prepayments and, thus, contain a high degree of interest rate risk. The Bank does not purchase residual interests in mortgage-related securities.

The Bank’s mortgage-backed securities portfolio consists primarily of seasoned fixed-rate and adjustable rate mortgage-backed securities. The Bank makes such investments in order to manage cash flow, diversify assets, obtain yield, to satisfy certain requirements for favorable tax treatment and to satisfy the qualified thrift lender test. See “Regulation – Depository Institution Regulation – Qualified Thrift Lender Test.”

At September 30, 2010, there were no mortgage-backed securities classified as held to maturity. Securities are designated into one of the three categories at the time of purchase. Debt securities that the Bank has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Debt and equity securities are classified as trading securities if bought and held principally for the purpose of selling them in the near term. Trading securities are reported at the estimated fair value, with unrealized gains and losses included in earnings. Debt securities not classified as held to maturity and debt and equity securities not classified as trading securities are considered available for sale and are reported at estimated fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity, net of tax effects, in accumulated other comprehensive income.

 

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At September 30, 2010, mortgage-backed securities including CMOs with an amortized cost of $66.7 million were classified as available for sale and had a weighted average yield of 4.57%. At September 30, 2010, the Bank’s mortgage-backed securities portfolio had gross unrealized gains and losses of approximately $2.0 million and $2.8 million, respectively. The gross unrealized losses primarily related to $16.9 million in CMO obligations, represented by three individual securities. In September 2010, the Company sold a CMO for which $600,000 in cumulative credit related OTTI charges have been previously recognized as a change in non-interest income. The sale resulted in a realized loss of approximately $924,000. This loss was effectively offset by gains on sales of other securities within the portfolio. The Bank does not presently intend to sell the remaining CMOs and it is not expected that the Bank will be required to sell these securities prior to maturity or recovery.

During the year ended September 30, 2010, we determined that, based on our most recent estimate of cash flows, other-than-temporary-impairment (“OTTI”) had occurred with respect to two of our mortgage-backed securities that resulted in a pre-tax charge to earnings of $200,000. These securities were rated “AAA” by Standard & Poors at origination. One of the two securities was sold in September 2010, as described in the preceeding paragraph. The remaining security had an original principle balance of $10.0 million and had a current principal balance of $6.7 million at September 30, 2010. This security had an estimated fair value of $5.3 million at September 30, 2010.

In April 2009, the FASB issued guidance on “Other Than Temporary Impairment.” and “Fair Value Measurements.” FASB has issued this guidance to address concerns regarding (1) determining whether a market is not active and a transaction is not orderly, (2) recognition and presentation of other-than-temporary impairments and (3) interim disclosures of fair values of financial instruments. This was effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted this guidance effective for the period ending June 30, 2009. As a result of the adoption of this guidance, impairment recognition for the Company’s investment and mortgage-backed securities are now segmented into credit and non-credit related components. Any fair value adjustment due to identified credit-related components will be recorded as an adjustment to current period earnings, while noncredit-related fair value adjustments will be recorded through other comprehensive income. Under the revised guidance, the amount of other-than-temporary impairment that is recognized through earnings is determined by comparing the present value of the expected cash flows to the amortized cost of the security. The discount rate used to determine the credit loss is the expected book yield on the security.

 

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The following table sets forth the carrying value of the Bank’s investments at the dates indicated.

 

     At September 30,  
     2010      2009      2008  
     (In thousands)  

Securities available for sale:

        

U.S. government and agency securities

   $ 17,013       $ —         $ 994   

Corporate Bonds

     1,377         —           —     

Mortgage-backed securities

     51,644         74,707         68,789   

Private label collateralized mortgage obligations

     14,331         15,771         21,167   
                          

Total available for sale

   $ 84,365       $ 90,478       $ 90,950   
                          

Securities held to maturity:

        

U.S. government and agency securities

   $ —         $ —         $ —     

Mortgage-backed securities

     —           —           —     

Collateralized mortgage obligations

     —           —           —     
                          

Total held to maturity

   $ —         $ —         $ —     

Total

   $ 84,365       $ 90,478       $ 90,950   
                          

 

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The following table sets forth information in the scheduled maturities, amortized cost, market value and average yields for the Bank’s investment portfolio at September 30, 2010.

 

    One Year or Less     One to Five Years     Five to Ten Years     More than Ten
Years
    Total Investment Portfolio  
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Average
Yield
    Amortized
Cost
    Market
Value
    Average
Yield
 
    (Dollars in thousands)  

Securities available for sale:

                     

U.S. Agency notes

  $ —          $ 15,006        $ 2,000        $             $ 17,006      $ 17,013     

Corporate Bonds

    —            —            1,380              1,380        1,377     

Mortgage-backed securities

    17          21          1,279          48,391          49,708        51,644     

Private label collateralized mortgage obligations

    —            —            —            17,039          17,039        14,331     
                                                         

Total available for sale

  $ 17        5.76   $ 15,027        .82   $ 4,659        3.18   $ 65,430        4.28   $ 85,133      $ 84,365        3.61
                                                         

 

17


Deposit Activity and Other Sources of Funds

General. Deposits are the primary source of the Bank’s funds for lending, investment activities and general operational purposes. In addition to deposits, the Bank derives funds from loan principal and interest payments, maturities of investment securities and mortgage-backed securities and interest payments thereon. Although loan repayments are a relatively stable source of funds, deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds, or on a longer term basis for general operational purposes. The Bank has access to borrow from the FHLB of Atlanta, the Federal Reserve Bank and correspondent banks.

Deposits. The Bank attracts deposits principally from within its market area by offering a variety of deposit instruments, including checking accounts, money market accounts, statement and passbook savings accounts, Individual Retirement Accounts, and certificates of deposit which range in maturity from seven days to five years. Deposit terms vary according to the minimum balance required, the length of time the funds must remain on deposit and the interest rate. Maturities, terms, service fees and withdrawal penalties for its deposit accounts are established by the Bank on a periodic basis. The Bank reviews its deposit mix and pricing on a weekly basis. In determining the characteristics of its deposit accounts, the Bank considers the rates offered by competing institutions, lending and liquidity requirements, growth goals and federal regulations. Management believes it prices its deposits comparably to rates offered by its competitors.

The Bank attempts to compete for deposits with other institutions in its market area by offering competitively priced deposit instruments that are tailored to the needs of its customers. Additionally, the Bank seeks to meet customers’ needs by providing convenient customer service to the community, efficient staff and convenient hours of service. Substantially all of the Bank’s depositors are Maryland residents. To provide additional convenience, the Bank participates in several networks at locations throughout the Mid-Atlantic and the South and MoneyPass, a surcharge free Automated Teller Machine network at locations throughout the United States, through which customers can gain access to their accounts at any time. The Bank currently has ATM machines in all of its eighteen offices.

 

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Savings deposits in the Bank at September 30, 2010 were represented by the various types of savings programs described below.

 

Interest*
Rate

  

Minimum Term

  

Category

   Minimum
Amount
     Balances
(in thousands)
     Percentage
of Total
Savings
 
      Demand deposits:         
0.40%    None   

NOW and Super NOW accounts

   $ 250       $ 86,351         16.16
0.26    None   

Money Market

     250         68,431         12.81   
                          
      Total demand deposits         154,782         28.97   
      Passbook savings deposits:         
0.35    None   

Regular Passbook

     250         67,690         12.67   
0.30    None   

Money market passbook

     250         14,245         2.66   
                          
      Total passbook savings deposits       $ 81,935         15.33
                          
      Certificates of Deposit         
0.18    3 months or less    Fixed-term, fixed rate    $ 500       $ 1,850         .35
0.64    6 months    Fixed-term, fixed rate      500         23,455         4.39   
1.07    12 months    Fixed-term, fixed rate      500         18,180         3.40   
1.71    18 months    Fixed-term, fixed rate      500         43,722         8.18   
1.99    24 months    Fixed-term, fixed rate      500         15,745         2.95   
4.58    30 months    Fixed-term, fixed rate      500         7,285         1.36   
4.53    36 months    Fixed-term, fixed rate      500         32,950         6.17   
3.05    48 months    Fixed-term, fixed rate      500         36,501         6.83   
4.13    60 months    Fixed-term, fixed rate      500         23,776         4.45   
3.05    $100,000 and over    Fixed-term, fixed rate      N/A         94,093         17.60   
                          
     

Total Certificates of deposit

        297,557         55.68   
     

Accrued interest payable

        92         .02   
                          
     

Total deposits

      $ 534,366         100.00
                          

 

* Represents weighted average interest rate

 

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The following table sets forth the change in dollar amount of deposits in the various types of accounts offered by the Bank between the dates indicated.

 

     Balance at
September 30,
2010
     % of
Deposits
    Increase
(Decrease)
    Balance at
September 30,
2009
     % of
Deposits
    Increase
(Decrease)
    Balance at
September 30,
2008
     % of
Deposits
 
     (Dollars in thousands)  

NOW

   $ 86,351         16.16   $ 26,474      $ 59,877         12.27   $ 4,150      $ 55,727         11.50

Money market deposit

     68,431         12.80        11,715        56,716         11.62        23,867        32,849         6.78   

Passbook & statement savings deposits

     81,935         15.34        2,343        79,592         16.31        2,808        76,784         15.84   

Certificate of deposit

     203,464         38.08        (2,703     206,167         42.25        (22,023     228,190         47.07   

Certificate of deposit $100,000 and over

     94,093         17.60        8,507        85,586         17.54        (5,614     91,200         18.81   

Accrued interests payable

     92         .02        41        51         .01        10        41         —     
                                                                   

Total

   $ 534,366         100.00   $ 46,377      $  487,989         100.00   $ 3,198      $ 484,791         100.00
                                                                   

 

20


The following tables set forth the average balances and average interest rates based on month-end balances for various types of deposits as of the dates indicated.

 

     Year Ended September 30,  
     2010     2009     2008  
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 
     (Dollars in thousands)  

NOW

   $ 52,532         1.09   $ 36,375         0.46   $ 34,396         0.31

Money market deposits

     59,757         1.22        34,663         1.76        28,311         1.56   

Passbook savings deposits

     82,122         .34        77,990         0.49        80,270         0.73   

Noninterest-bearing demand deposits

     27,461         —          27,203         —          29,171         —     

Certificates of deposit

     294,857         2.58        316,599         3.56        353,937         4.38   
                                 

Total

   $ 516,729         1.78   $ 492,830         2.52   $ 526,085         3.23
                                 

The following table sets forth the time deposits in the Bank classified by rates at the dates indicated.

 

     At September 30,  
     2010      2009      2008  
     (Dollars in thousands)  

0.20 – 2.00%

   $ 116,797       $ 73,395       $ 5,340   

2.01 – 4.00

     141,005         143,864         154,312   

4.01 – 5.60

     39,755         74,494         159,738   
                          

Total

   $ 297,557       $ 291,753       $ 319,390   
                          

The following table sets forth the amount and maturities of time deposits at September 30, 2010.

 

Rate

   Less Than
One Year
     1 – 2 Years      2 – 3 Years      After 3 Years      Total  

0.20 - 2.00%

   $ 107,261       $ 6,115       $ 417       $ 3,004       $ 116,797   

2.01 - 4.00

     30,330         16,270         33,846         60,559         141,005   

4.01 - 5.60

     18,597         14,716         4,357         2,085         39,755   
                                            

Total

   $ 156,182       $ 37,107       $ 38,620       $ 65,648       $ 297,557   
                                            

 

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The following table indicates the amount of the Bank’s certificates of deposit of $100,000 or more by time remaining until maturity as of September 30, 2010. At such date, such deposits represented 31.6% of total deposits and had a weighted average rate of 2.59%.

 

Maturity Period

   Certificates of
Deposit
 
     (In thousands)  

Three months or less

   $ 20,634   

Over three through six months

     18,182   

Over six through 12 months

     3,813   

Over 12 months

     51,464   
        

Total

   $ 94,093   
        

The following table sets forth the savings activities of the Bank for the periods indicated.

 

     At September 30,  
     2010     2009     2008  
     (In thousands)  

Deposits

   $ 1,147,503      $ 1,052,956      $ 1,098,328   

Withdrawals

     (1,110,299     (1,062,196     (1,188,974
                        

Net increase (decrease) before interest credit

     37,204        (9,240     (90,646

Interest credited

     9,173        12,438        16,980   
                        

Net increase (decrease) in savings deposits

   $ 46,377      $ 3,198      $ (73,666
                        

In the unlikely event the Bank is liquidated, depositors will be entitled to full payment of their deposit accounts prior to any payment being made to the sole stockholder of the Bank.

Borrowings. Savings deposits historically have been the primary source of funds for the Bank’s lending, investments and general operating activities. The Bank is authorized, however, to use advances from the FHLB of Atlanta to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Atlanta functions as a central reserve bank providing credit for savings institutions and certain other member financial institutions. As a member of the FHLB System, the Bank is required to own stock in the FHLB of Atlanta and is authorized to apply for advances. Advances are pursuant to several different programs, each of which has its own interest rate and range of maturities. The Bank has a Blanket Agreement for advances with the FHLB under which the Bank may borrow up to 75% of assets subject to normal collateral and underwriting requirements. Advances from the FHLB of Atlanta are secured by the Bank’s stock in the FHLB of Atlanta and other eligible assets. At September 30, 2010, the Bank had no outstanding FHLB advances. The Bank also has the ability to borrow from the Federal Reserve’s discount window with pledged securities and from an established line of credit with its correspondent bank.

 

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The following table sets forth certain information regarding our short-term borrowings at the end of and during the periods indicated:

 

     At or For the Year Ended
September 30,
 
     2010     2009     2008  

Outstanding advances from FHLB

   $ —        $ —        $ 10,000   

Weighted-average rate paid on advances from FHLB

     —          —          4.44

Maximum outstanding advances from FHLB at any month end

   $ —        $ 10,000      $ 20,000   

Weighted-average rate paid on advances from FHLB (1)

     —       4.44     4.181

Average advances from FHLB outstanding

   $     —        $ 6,302      $ 16,312   

 

(1) The weighted-average rate paid is based on the weighted-average balances determined on a daily basis.

On June 27, 2002, the Company established a Delaware business trust subsidiary (the “Business Trust”), which issued and sold to private investors 12,500 securities with a liquidation amount of $1,000 per security, for a total of $12.5 million of preferred securities. The Company funded the Business Trust with $387,000 in exchange for 100% of the Business Trust’s common securities. The Business Trust used the proceeds from these transactions to purchase $12,887,000 of floating rate junior subordinated debentures from the Company. The Company makes periodic interest payments on the debentures to the Business Trust, and the Business Trust in turn makes interest payments on the trust preferred securities to the private investors.

The trust preferred securities issued by the Business Trust and the junior subordinated debentures held by the Business Trust are due June 30, 2032. The rate is 3.65% per annum over the three-month LIBOR rate and resets quarterly. The rate at September 30, 2010 was 4.18%. The junior subordinated debentures are the sole assets of the Business Trust. The subordinated debt securities, unsecured, rank junior and are subordinate in right of payment of all senior debt of the Company, and the Company has guaranteed repayment on the trust preferred securities issued by the Business Trust. The Company used the proceeds from these transactions to increase the capital of the Bank. The $12.5 million proceeds from the subordinated debt securities are includable as part of Tier 1 regulatory capital for the Bank.

Payments to be made by the Business Trust on the trust preferred securities are dependent on payments that the Company has undertaken to make, particularly the payment to be made by the Company on the debentures. Distributions on the trust preferred securities are payable quarterly at a rate of 3.65% per annum over the three-month LIBOR rate. The distributions are funded by interest payments received on the debentures and are subject to deferral for up to five years under certain conditions. Distributions are included in interest expense. The Company may redeem the debentures, in whole or in part, or under certain conditions in whole but not in part, at any time at par plus any accrued unpaid interest. The Company used a portion of the net proceeds that it retained from its 2008 stock offering to redeem $6.0 million of the $12.5 million in outstanding trust preferred securities.

On September 29, 2003, the Company established a second Delaware statutory trust subsidiary (the “Statutory Trust”), which issued and sold to private investors 10,000 securities with a liquidation amount of $1,000 per security, for a total of $10.0 million of preferred securities. The Company funded the Statutory Trust with $310,000 in exchange for 100% of the Statutory Trust’s common securities. The Statutory Trust used the proceeds from these transactions to purchase $10,310,000 of floating rate junior subordinated debentures from the Company. The Company makes periodic interest payments on the debentures to the Statutory Trust, and the Statutory Trust in turn makes interest payments on the trust preferred securities to the private investors.

The trust preferred securities and junior subordinated debentures are due October 7, 2033. The rate is 3.00% per annum over the three-month LIBOR rate and resets quarterly. The rate at September 30, 2010 was 3.53%. The junior subordinated debentures are the sole assets of the Statutory Trust. The subordinated debt securities, unsecured, rank junior and are subordinate in right of payment of all senior debt of the Company, and the

 

23


Company has guaranteed repayment on the trust preferred securities issued by the Statutory Trust. The Company used the proceeds from these transactions to increase the capital of the Bank. The $10.3 million proceeds from the subordinated debt securities are includable as part of Tier 1 regulatory capital for the Bank.

During the fiscal year ended September 30, 2010, the Company had a total annual interest expense of $620,482 related to all of its trust preferred securities. Payments to be made by the Statutory Trust on the trust preferred securities are dependent on payments that the Company has undertaken to make, particularly the payment to be made by the Company on the debentures. Distributions on the trust preferred securities are payable quarterly at a rate of 3.00% per annum over the three-month LIBOR rate. The distributions are funded by interest payments received on the debentures and are subject to deferral for up to five years under certain conditions. Distributions are included in interest expense. The Company may redeem the debentures, in whole or in part, or under certain conditions in whole but not in part, at any time at par plus any accrued unpaid interest.

Troubled Asset Relief Program Capital Purchase Program. On December 23, 2008, the Company sold $10.8 million in Series A preferred stock (the “Series A Preferred Stock”) to the U.S. Department of Treasury (“U.S. Treasury”) as a participant in the federal government’s Troubled Asset Relief Program (“TARP”) Capital Purchase Program. The TARP Capital Purchase Program is a voluntary program for healthy U.S. financial institutions designed to encourage these institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the weakened U.S. economy. Participation in this program provided an additional source of funds during the fiscal year ended September 30, 2009.

Subsidiary Activities

As a federally chartered savings bank, the Bank is permitted to invest an amount equal to 2% of its assets in subsidiaries, with an additional investment of 1% of assets where such investment serves primarily community, inner-city and community development purposes. Under such limitations, as of September 30, 2010, the Bank was authorized to invest up to approximately $18.6 million in the stock of or loans to subsidiaries, including the additional 1% investment for community inner-city and community development purposes. Institutions meeting their applicable minimum regulatory capital requirements may invest up to 50% of their regulatory capital in conforming first mortgage loans to subsidiaries in which they own 10% or more of the capital stock.

The Bank has two subsidiary service corporations, Ebenezer Road, Inc. (“Ebenezer Road”) which is a Maryland licensed insurance company that trades under the trade name BCSB Insurance Services. The company offers life and annuity insurance products through the Bank’s licensed branch platform sales representatives as part of an overall non-deposit investment and insurance program. The second subsidiary is (“Lyons Properties”), LLC which may be utilized for holding foreclosed properties in the future. Fees from activities of subsidiaries were immaterial during the year ended September 30, 2010.

Competition

The Bank faces strong competition both in originating real estate and consumer loans and in attracting deposits. It competes for real estate and other loans principally on the basis of interest rates, the types of loans it originates, the deposit products it offers and the quality of service it provides to borrowers. The Bank also competes by offering products which are tailored to the local community. The Bank’s competition in originating real estate loans comes primarily from other savings institutions, commercial banks and mortgage bankers. Commercial banks, credit unions and finance companies provide vigorous competition in consumer lending. Competition may increase as a result of the continuing reduction of restrictions on the interstate operations of financial institutions.

The Bank attracts deposits through its offices from the local community. Consequently, competition for deposits is principally from other savings institutions, commercial banks, credit unions and brokers in the local community. The Bank competes for deposits and loans by offering what it believes to be a variety of deposit accounts at competitive rates, convenient business hours, a commitment to outstanding customer service and a well-trained staff. Management believes that the Bank has developed relationships with local realtors and the community in general.

 

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As of June 30, 2010, the most recent date for which data is available from the Federal Deposit Insurance Corporation, we held approximately 0.94% of all deposits in the Baltimore metropolitan area, which ranked us 15 out of 79 financial institutions in the Baltimore metropolitan area. In Baltimore County and Harford County we held 2.80% and 2.94%, respectively, of deposits held by all banks and savings institutions. The Baltimore metropolitan area has a high concentration of financial institutions and financial service providers, many of which are branches of large money center, super-regional and regional banks that have greater resources than the Bank’s and may offer products or services that the Bank does not provide.

Employees

As of September 30, 2010, the Company had 139 full-time and 33 part-time employees, none of whom were represented by a collective bargaining agreement. Management considers the Bank’s relationships with its employees to be good.

Depository Institution Regulation

General. The Bank is a federally chartered savings institution, a member of the FHLB of Atlanta and its deposits are insured by the FDIC through the Deposit Insurance Fund. As a federal savings institution, the Bank is subject to regulation and supervision by the Office of Thrift Supervision (“OTS”) and the FDIC and to OTS regulations governing such matters as capital standards, mergers, establishment of branch offices, subsidiary investments and activities and general investment authority. The OTS periodically examines the Bank for compliance with various regulatory requirements and for safe and sound operations. The FDIC also has the authority to conduct special examinations of the Bank because its deposits are insured by the Deposit Insurance Fund. The Bank must file reports with the OTS describing its activities and financial condition and must obtain the approval of the OTS prior to entering into certain transactions, such as mergers with or acquisitions of other depository institutions.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), signed by the President on July 21, 2010, provides for the regulation and supervision of federal savings institutions like the Bank to be transferred from the OTS to the Office of the Comptroller of the Currency, the agency that regulates national banks. The Office of the Comptroller of the Currency will assume primary responsibility for examining the Bank and implementing and enforcing many of the laws and regulations applicable to federal savings institutions as the OTS will be eliminated. The transfer will occur over a transition period of up to one year from July 21, 2010 enactment of the Dodd-Frank Act, subject to a possible six month extension. At the same time, the responsibility for supervising and regulating savings and loan holding companies will be transferred to the Federal Reserve Board. The Dodd-Frank Act also provides for the creation of a new agency, the Consumer Financial Protection Bureau, as an independent bureau of the Federal Reserve Board, to take over the implementation of federal consumer financial protection and fair lending laws from the depository institution regulators. However, institutions of $10 billion or fewer in assets will continue to be examined for compliance with such laws and regulations by, and subject to the enforcement authority of, the prudential regulator rather than the Consumer Financial Protection Bureau.

The Dodd-Frank Act authorizes depository institutions to pay interest on business demand deposits effective July 31, 2011. Depending upon competitive responses, that change could have an adverse impact on the Bank’s interest exposure.

Certain of the laws and regulations governing the Bank and Company are described below. However, the description does not purport to be a complete discussion of the legal and regulatory requirements to which the Bank and Company are subject and is qualified in its entirety by reference to the actual laws and regulations.

Regulatory Capital Requirements. Under the OTS’s regulatory capital requirements, savings associations must maintain “tangible” capital equal to 1.5% of adjusted total assets, “core” capital equal to at least 4.0% (or 3.0%, if the institution is rated composite 1 CAMELS under the OTS examination rating system) of adjusted total assets and “total” capital (a combination of “core” and “supplementary” capital) equal to at least 8.0% of risk-weighted assets. In addition, the OTS has adopted regulations which impose certain restrictions on savings associations that have a total risk-based capital ratio that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less than 4.0% (or 3.0%, if the institution is rated composite 1 CAMELS under the OTS examination rating system). For purposes of these regulations, Tier 1 capital has the same definitions as core capital. See “–Prompt Corrective Regulatory Action.”

 

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Core capital is defined as common stockholders’ equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits. Core capital is generally reduced by the amount of the savings institution’s intangible assets. Limited exceptions to the deduction of intangible assets are provided for certain mortgage servicing rights and credit card relationships and qualifying supervisory goodwill. Tangible capital is given the same definition as core capital but does not include an exception for qualifying supervisory goodwill and is reduced by the amount of all the savings association’s intangible assets with only a limited exception for purchased mortgage servicing rights. Both core and tangible capital are further reduced by an amount equal to a savings institution’s debt and equity investments in subsidiaries engaged in activities not permissible to national banks (other than subsidiaries engaged in activities undertaken as agent for customers or in mortgage banking activities and subsidiary depository institutions or their holding companies). Investments in and extensions of credit to such subsidiaries are required to be fully netted against tangible and core capital. At September 30, 2010, the Bank had no such investments.

Adjusted total assets are a savings association’s total assets as determined under generally accepted accounting principles increased by certain goodwill amounts and by a prorated portion of the assets of unconsolidated includable subsidiaries in which the savings association holds a minority interest. Adjusted total assets are reduced by the amount of assets that have been deducted from capital, the portion of savings association’s investments in unconsolidated includable subsidiaries, and, for purpose of the core capital requirement, qualifying supervisory goodwill. At September 30, 2010, the Bank’s adjusted total assets for the purposes of the core and tangible capital requirements were approximately $616.9 million.

In determining compliance with the risk-based capital requirement, a savings association is allowed to include both core capital and supplementary capital in its total capital provided the amount of supplementary capital included does not exceed the savings association’s core capital. Supplementary capital is defined to include certain preferred stock issues, certain approved subordinated debt, certain other capital instruments, a portion of the savings association’s allowances for loan and lease losses and up to 45% of unrealized net gains on equity securities. Total core and supplementary capital are reduced by the amount of capital instruments held by other depository institutions pursuant to reciprocal arrangements and equity investments other than those deducted from core and tangible capital. As of September 30, 2010, the Bank had no investments for which OTS regulations require a deduction from total capital.

The risk-based capital requirement is measured against risk-weighted assets which equal the sum of each asset and the credit-equivalent amount of each off-balance sheet item after being multiplied by an assigned risk weight. Under the OTS risk-weighting system, one-to-four family first mortgages not more than 90 days past due with loan-to-value ratios under 80% and average annual occupancy rates of at least 80% and certain qualifying loans for the construction of one-to-four family residences pre-sold to home purchasers are assigned a risk weight of 50%. Consumer and residential construction loans are assigned a risk weight of 100%. Mortgage-backed securities issued, or fully guaranteed as to principal and interest by the FNMA or FHLMC are assigned a 20% risk weight. Cash and U.S. Government securities backed by the full faith and credit of the U.S. Government (such as mortgage-backed securities issued by GNMA) are given a 0% risk weight.

For information with respect to the Bank’s compliance with its regulatory capital requirements at September 30, 2010 see Note 14 of Notes to Consolidated Financial Statements.

The risk-based capital requirements of the OTS also require that savings institutions with more than a “normal” level of interest rate risk to maintain additional total capital. A savings institution’s interest rate risk is measured in terms of the sensitivity of its “net portfolio value” to changes in interest rates. The interest rate risk rule did not have a material effect on the Bank’s risk-based capital at September 30, 2010.

In addition to requiring generally applicable capital standards for savings institutions, the OTS is authorized to establish the minimum level of capital for a savings institution at such amount or at such ratio of capital-to-assets as the OTS determines to be necessary or appropriate for such institution in light of the particular circumstances of

 

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the institution. Such circumstances would include a high degree of exposure to interest rate risk, concentration of credit risk and certain risks arising from non-traditional activity. The OTS may treat the failure of any savings institution to maintain capital at or above such level as an unsafe or unsound practice and may issue a directive requiring any savings institution which fails to maintain capital at or above the minimum level required by the OTS to submit and adhere to a plan for increasing capital.

Qualified Thrift Lender Test. A savings institution that does not meet the Qualified Thrift Lender (“QTL”) test must either convert to a bank charter or comply with the following restrictions on its operations: (i) the institution may not engage in any new activity or make any new investment, directly or indirectly, unless such activity or investment is permissible for both a national bank and a savings institution; (ii) the branching powers of the institution shall be restricted to those of a national bank and (iii) payment of dividends by the institution shall generally be subject to the rules regarding payment of dividends by a national bank. In addition, any company that controls a savings institution that fails to qualify as a QTL will be required to register as, and to be deemed, a bank holding company subject to all of the provisions of the Bank Holding Company Act of 1956 (the “BHCA”) and other statutes applicable to bank holding companies. Upon the expiration of three years from the date the institution ceases to be a QTL, it must cease any activity nor retain any investment not permissible for a national bank. The Dodd-Frank Act also makes noncompliance with the QTL test subject to agency enforcement action for a violation of law.

To meet the QTL test, an institution must either qualify as a “domestic building and loan association” under the Internal Revenue Code or its “Qualified Thrift Investments” must total at least 65% of “portfolio assets.” Under OTS regulations, portfolio assets are defined as total assets less intangibles, property used by a savings institution in its business and liquidity investments in an amount not exceeding 20% of assets. Qualified Thrift Investments consist of (i) loans, equity positions or securities related to domestic, residential real estate or manufactured housing, (ii) 50% of the dollar amount of residential mortgage loans subject to sale under certain conditions, (iii) education loans, small business loans and credit card loans, and (iv) stock in an FHLB. In addition, subject to a 20% of portfolio assets limit, savings institutions are able to treat as Qualified Thrift Investments consumer loans, 200% of their investments in loans to finance “starter homes” and loans for construction, development or improvement of housing and community service facilities or for financing small businesses in “credit-needy” areas. In order to maintain QTL status, the savings institution must maintain a weekly average percentage of Qualified Thrift Investments to portfolio assets equal to 65% on a monthly average basis in nine out of 12 months.

At September 30, 2010, the percentage of the Bank’s portfolio assets invested in Qualified Thrift Investments was in excess of the percentage required to qualify the Bank under the QTL test.

Dividend Limitations. Under the OTS prompt corrective action regulations, the Bank would be prohibited from making any capital distributions if, after making the distribution, it would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a Tier 1 leverage ratio of less than 4.0%. See “—Prompt Corrective Regulatory Action.” Under OTS regulations, the Bank is not permitted to pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of the Bank at the time of its conversion to stock form.

Savings institutions must submit notice to the OTS prior to making a capital distribution if (a) they would not be well-capitalized after the distribution, (b) the distribution would result in the retirement of any of the institution’s common or preferred stock or debt counted as its regulatory capital, or (c) the institution is a subsidiary of a holding company. A savings institution must make application to the OTS to pay a capital distribution if (w) the institution would not be adequately capitalized following the distribution, (x) the institution’s total distributions for the calendar year exceeds the institution’s net income for the calendar year to date plus its net income (less distributions) for the preceding two years, the savings association is not eligible for “expedited treatment” under OTS regulations (generally, examination and Community Reinvestment Act ratings in one of the two top categories), or (y) the distribution would otherwise violate applicable law or regulation or an agreement with or condition imposed by the OTS.

 

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In addition to the foregoing, earnings of the Bank appropriated to bad debt reserves and deducted for federal income tax purposes are not available for payment of cash dividends or other distributions to the Company without payment of taxes at the then current tax rate by the Bank on the amount of earnings removed from the reserves for such distributions. See “Taxation.” The Company intends to make full use of this favorable tax treatment afforded to the Bank and the Company and does not contemplate use of any earnings of the Bank in a manner which would limit either institution’s bad debt deduction or create federal tax liabilities.

Insurance of Deposit Accounts. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned, and certain potential adjustments established by FDIC regulations. Assessment rates currently range from seven to 77.5 basis points of assessable deposits. The Federal Deposit Insurance may adjust the scale uniformly from one quarter to the next, except that no adjustment can deviate more than three basis points from the base scale without notice and comment. The Dodd-Frank Act requires the FDIC to revise its procedures to base its assessments upon total assets less tangible equity instead of deposits. The FDIC recently issued a proposed rule that if finalized, could implement that change beginning the second quarter of 2011. No institution may pay a dividend if in default of the federal deposit insurance assessment.

The FDIC imposed on all insured institutions a special emergency assessment of five basis points of total assets minus Tier 1 capital (as of June 30, 2009), capped at ten basis points of an institution’s deposit assessment base, in order to cover losses to the Deposit Insurance Fund. That special assessment was collected on September 30, 2009. The FDIC provided for similar assessments during the final two quarters of 2009, if deemed necessary. However, in lieu of further special assessments, the FDIC required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012. The estimated assessments, which include an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 30, 2009. As of December 31, 2009, and each quarter thereafter, a charge to earnings will be recorded for each regular assessment with an offsetting credit to the prepaid asset.

Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000. That limit was made permanent by the Dodd-Frank Act. In addition, the FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010, and certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the FDIC through June 30, 2012, or in some cases, December 31, 2012. The Bank opted to participate in the unlimited noninterest- bearing transaction account coverage and the Bank and the Company opted to participate in the unsecured debt guarantee program. The Dodd-Frank Act extended the unlimited coverage for certain noninterest-bearing transaction accounts until December 31, 2012.

In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. That payment is established quarterly and during the four quarters ended September 30, 2010 averaged 1.04 basis points of assessable deposits.

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC and the FDIC has recently exercised that discretion by establishing a long range fund ratio of 2%.

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or regulatory condition imposed in writing. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

 

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Federal Home Loan Bank System. The Bank is a member of the FHLB System, which consists of 12 district Federal Home Loan Banks subject to supervision and regulation by the Federal Housing Finance Board (“FHFB”). The Federal Home Loan Banks provide a central credit facility primarily for member institutions. As a member of the FHLB of Atlanta, the Bank is required to acquire and hold shares of capital stock in the FHLB of Atlanta. The Bank was in compliance with this requirement with investment in FHLB of Atlanta stock at September 30, 2010 of $1.4 million. Due to recent economic conditions, dividend payments by the Federal Home Loan Bank of Atlanta were curtailed beginning in 2009. At September 30, 2010, the Bank had no advances outstanding from the FHLB of Atlanta.

Federal Reserve System. Pursuant to regulations of the Federal Reserve Board, all FDIC-insured depository institutions must maintain average daily reserves equal to 3% on aggregate transaction accounts up to and including $55.2 million, plus 10% on the remainder. The first $10.7 million of transaction accounts are exempt. These percentages are subject to adjustment by the Federal Reserve Board. The amounts are adjusted annually. Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets. As of September 30, 2010, the Bank met its reserve requirements.

Prompt Corrective Regulatory Action. Under FDICIA, the federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements, including a leverage limit, a risk-based capital requirement, and any other measure deemed appropriate by the federal banking regulators for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees if the institution would thereafter fail to satisfy the minimum levels for any of its capital requirements. An institution that fails to meet the minimum level for any relevant capital measure (an “undercapitalized institution”) may be: (i) subject to increased monitoring by the appropriate federal banking regulator; (ii) required to submit an acceptable capital restoration plan within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of businesses. The capital restoration plan must include a guarantee by the institution’s holding company that the institution will comply with the plan until it has been adequately capitalized on average for four consecutive quarters, under which the holding company would be liable up to the lesser of 5% of the institution’s total assets or the amount necessary to bring the institution into capital compliance as of the date it failed to comply with its capital restoration plan. A “significantly undercapitalized” institution, as well as any undercapitalized institution that does not submit an acceptable capital restoration plan, may be subject to regulatory demands for recapitalization, broader application of restrictions on transactions with affiliates, limitations on interest rates paid on deposits, asset growth and other activities, possible replacement of directors and officers, and restrictions on capital distributions by any bank holding company controlling the institution. Any company controlling the institution may also be required to divest the institution or the institution could be required to divest subsidiaries. The senior executive officers of a significantly undercapitalized institution may not receive bonuses or increases in compensation without prior approval and the institution is prohibited from making payments of principal or interest on its subordinated debt. In their discretion, the federal banking regulators may also impose the foregoing sanctions on an undercapitalized institution if the regulators determine that such actions are necessary to carry out the purposes of the prompt corrective provisions. If an institution’s ratio of tangible capital to total assets falls below the “critical capital level” established by the appropriate federal banking regulator, the institution will be subject to conservatorship or receivership within specified time periods.

Under the implementing regulations, the federal banking regulators, including the OTS, generally measure an institution’s capital adequacy on the basis of its total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio of its core capital to adjusted total assets). The following table shows the capital ratios required for the various prompt corrective action categories. The OTS may reclassify a well capitalized savings institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with the supervisory actions applicable to institutions in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically undercapitalized) if the OTS determines, after notice and an

 

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opportunity for a hearing, that the savings institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any CAMELS rating category.

 

    

Well Capitalized

   Adequately Capitalized    Undercapitalized    Significantly
Undercapitalized

Total risk-based capital ratio

   10.0% or more    8.0% or more    Less than 8.0%    Less than 6.0%

Tier I risk-based capital ratio

   6.0% or more    4.0% or more    Less than 4.0%    Less than 3.0%

Leverage ratio

   5.0% or more    4.0% or more*    Less than 4.0%*    Less than 3.0%

 

* 3.0% if institution has composite 1 CAMELS rating.

A “critically undercapitalized” savings institution is defined as an institution that has a ratio of “tangible equity” to total assets of less than 2.0%. Tangible equity is defined as core capital plus cumulative perpetual preferred stock (and related surplus) less all intangibles other than qualifying supervisory goodwill and certain purchased mortgage servicing rights.

Safety and Soundness Standards. Interagency Guidelines Establishing Standards for Safety and Soundness require savings institutions to maintain internal controls and information systems and internal audit systems that are appropriate for the size, nature and scope of the institution’s business. The guidelines also establish certain basic standards for loan documentation, credit underwriting, interest rate risk exposure, and asset quality and growth. The guidelines further provide that savings institutions should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss, and should take into account factors such as comparable compensation practices at comparable institutions. If the OTS determines that a savings institution is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines. A savings institution must submit an acceptable compliance plan to the OTS within 30 days of receipt of a request for such a plan. Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions. Under the guidelines, a savings institution should maintain systems, commensurate with its size and the nature and scope of its operations, to identify problem assets and prevent deterioration in those assets as well as to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves. Management believes that these regulatory standards do not materially affect the Bank’s operations.

Lending Limits. Savings institutions generally are subject to the lending limits applicable to national banks. With certain limited exceptions, the amount that a savings institution or a national bank may lend to any borrower outstanding at one time may not exceed 15% of the unimpaired capital and surplus of the institution. Loans and extensions of credit fully secured by readily marketable collateral may comprise an additional 10% of unimpaired capital and surplus. Savings institutions are additionally authorized to make loans to one borrower, for any purpose: (i) in an amount not to exceed $500,000, or (ii) by order of the Director of OTS, in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop residential housing, provided: (a) the savings institution is and continues to be in compliance with its regulatory capital requirements; (b) the loans comply with applicable loan-to-value requirements; and (c) the aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus.

At September 30, 2010, the Bank’s general lending limit was $10.1 million.

Uniform Lending Standards. Under OTS regulations, savings institutions must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards, including loan-to-value limits, that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements.

 

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The real estate lending policies must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the “Interagency Guidelines”) that have been adopted by the federal bank regulators.

Management believes that the Bank’s current lending policies conform to the Interagency Guidelines.

Transactions with Related Parties. Generally, transactions between a savings bank or its subsidiaries and its affiliates (i.e., companies that control the Bank or are under common control of the Bank) must be on terms as favorable to the Bank as transactions with nonaffiliates. In addition, certain of these transactions are restricted to a percentage of the Bank’s capital and are subject to specified collateral requirements. Affiliates of the Bank include the Company, BCSB Bankcorp Capital Trust I, BCSB Bankcorp Capital Trust II and any company which is under common control with the Bank.

The Bank’s authority to extend credit to executive officers, directors, trustees and 10% stockholders, as well as entities under such persons control is currently governed by Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated by the Federal Reserve Board. Among other things, these regulations generally require such loans to be made on terms substantially similar to those offered to unaffiliated individuals, place limits on the amount of loans the Bank may make to such persons based, in part, on the Bank’s capital position, and require certain board of directors’ approval procedures to be followed.

Enforcement. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors in institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OTS that enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. The Office of the Comptroller of the Currency will assume the enforcement authority of the OTS as part of the Dodd-Frank Act regulatory restructuring.

Assessments. Federal savings banks are required to pay assessments to the OTS to fund its operations. The general assessments, paid on a semi-annual basis, are based upon the savings institution’s total assets, including consolidated subsidiaries, as reported in the institution’s latest quarterly thrift financial report, the institution’s financial condition and the complexity of its asset portfolio. The Office of the Comptroller of the Currency also funds its operations through assessments on regulated institutions.

Holding Company Regulation

The Company is a non-diversified unitary savings and loan holding company within the meaning of federal law. Under prior law, a unitary savings and loan holding company, such as the Company, was not generally restricted as to the types of business activities in which it may engage, provided that the Bank continued to be a qualified thrift lender. The Gramm-Leach-Bliley Act of 1999 provided that no company may acquire control of a savings institution after May 4, 1999 unless the company engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, so long as the holding company’s savings institution subsidiary continues to comply with the qualified thrift lender test. The Company believes it qualifies for the grandfather exception. Upon any non-supervisory acquisition by the Company of another savings institution that meets the qualified thrift lender test and is deemed to be a savings institution by the OTS, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the OTS, and certain activities

 

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authorized by OTS regulation. However, the OTS has issued an interpretation concluding that multiple savings and loan holding companies may also engage in activities permitted for financial holding companies.

As part of the Dodd-Frank Act regulatory restructuring, the OTS’s authority over savings and loan holding companies will be transferred to the Federal Reserve Board, which is the agency that regulates and supervises bank holding companies.

A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company, without prior written approval of the OTS and from acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS considers the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive effects.

The OTS may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies. Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions. That requires holding companies to provide capital and other support to their subsidiary institutions in times of financial distress.

The Bank must notify the OTS 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.

Acquisition of Control. Under the Federal Change in Control Act, a notice must be submitted to the OTS if any person (including a company or savings association), or group acting in concert, seeks to acquire “control” of a savings and loan holding company or savings association. A change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the Company’s outstanding voting stock, unless the OTS has found that the acquisition will not result in a change of control of BCSB Bancorp. Under the Change in Control Act, the OTS generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company.

Regulatory Restructuring Legislation. On July 21, 2010, President Obama signed the Dodd-Frank Act, which is legislation that restructures the regulation of depository institutions. In addition to eliminating the Office of Thrift Supervision and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, requires changes in the way that institutions are assessed for deposit insurance, mandates the imposition of consolidated capital requirements on savings and loan holding companies, requires that originators of securitized loans retain a percentage of the risk for the transferred loans, requires the Federal Reserve Board to regulate pricing of debit card interchange fees, reduces the federal preemption afforded to federal savings associations and contains a number of reforms related to mortgage origination. Many of the provisions of the Dodd-Frank Act require the

 

32


issuance of regulations before their impact on operations can be assessed by management. However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in an increased regulatory burden and higher compliance, operating, and possibly, interest expense costs for the Company and the Bank.

Taxation

General. The Company and the Bank, together with the Bank’s subsidiaries, file a consolidated federal income tax return based on a fiscal year ending September 30. Consolidated returns have the effect of deferring gain or loss on intercompany transactions and allowing companies included within the consolidated return to offset income against losses under certain circumstances.

Federal Income Taxation. Thrift institutions are subject to the provisions of the Internal Revenue Code of 1986, as amended (the “Code”) in the same general manner as other corporations. However, institutions such as the Bank which met certain definitional tests and other conditions prescribed by the Code benefited from certain favorable provisions regarding their deductions from taxable income for annual additions to their bad debt reserve. For purposes of the bad debt reserve deduction, loans were separated into “qualifying real property loans,” which generally are loans secured by interests in certain real property, and nonqualifying loans, which are all other loans. The bad debt reserve deduction with respect to nonqualifying loans was based on actual loss experience, however, the amount of the bad debt reserve deduction with respect to qualifying real property loans could be based upon actual loss experience (the “experience method”) or a percentage of taxable income determined without regard to such deduction (the “percentage of taxable income method”).

Earnings appropriated to an institution’s bad debt reserve and claimed as a tax deduction were not available for the payment of cash dividends or for distribution to stockholders (including distributions made on dissolution or liquidation), unless such amount was included in taxable income, along with the amount deemed necessary to pay the resulting federal income tax.

Beginning with the first taxable year beginning after December 31, 1995, savings institutions, such as the Bank, are treated the same as commercial banks. Associations with $500 million or more in assets will only be able to take a tax deduction when a loan is actually charged off. Associations with less than $500 million in assets will still be permitted to make deductible bad debt additions to reserves, but only using the experience method.

The Bank’s tax returns were last audited for the year ended September 30, 1994.

Under provisions of the Revenue Reconciliation Act of 1993 (“RRA”), enacted on August 10, 1993, the maximum federal corporate income tax rate was increased from 34% to 35% for taxable income over $10.0 million, with a 3% surtax imposed on taxable income over $15.0 million. Also under provisions of RRA, a separate depreciation calculation requirement has been eliminated in the determination of adjusted current earnings for purposes of determining alternative minimum taxable income, rules relating to payment of estimated corporate income taxes were revised, and certain acquired intangible assets such as goodwill and customer-based intangibles were allowed a 15-year amortization period. Beginning with tax years ending on or after January 1, 1993, RRA also provides that securities dealers must use mark-to-market accounting and generally reflect changes in value during the year or upon sale as taxable gains or losses. The IRS has indicated that financial institutions which originate and sell loans will be subject to the rule.

State Income Taxation. The state of Maryland imposes an income tax of approximately 8.25% on income measured substantially the same as federally taxable income. The state of Maryland currently assesses a personal property tax for December 2000 and forward.

For additional information regarding taxation, see Note 16 of Notes to Financial Statements.

 

33


Executive Officers

Below is information regarding the executive officers of the Company who are not also directors of the Company. Executive officers are elected annually by the Board of Directors and serve at the Board’s discretion. Unless otherwise stated, each executive officer has held his or her position for at least five years. The ages presented are as of September 30, 2010.

 

Name

    

Position with BCSB Bancorp and/or Baltimore County Savings Bank

Anthony R. Cole

     Executive Vice President and Chief Financial Officer of BCSB Bancorp and Baltimore County Savings Bank

Daniel R. Wernecke

     Executive Vice President and Chief Lending Officer of Baltimore County Savings Bank

David M. Meadows

     Executive Vice President, General Counsel and Secretary of BCSB Bancorp and Baltimore County Savings Bank

Bonnie M. Klein

     Senior Vice President, Treasurer and Controller of BCSB Bancorp and Baltimore County Savings Bank

Anthony R. Cole joined BCSB Bancorp and Baltimore County Savings Bank as Executive Vice President and Chief Financial Officer effective September 4, 2007. Previously, Mr. Cole served as Senior Vice President and Chief Financial Officer of Bay Net A Community Bank in Bel Air, Maryland from January 2000 through March 2007. Age 49.

Daniel R. Wernecke was named Executive Vice President and Chief Lending Officer of Baltimore County Savings Bank effective November 21, 2007. Prior to being named Executive Vice President and Chief Lending Officer, he served as Senior Vice President of Baltimore County Savings Bank in charge of lending operations. Mr. Wernecke joined Baltimore County Savings Bank in 2002. Age 54.

David M. Meadows was named Vice President, General Counsel and Secretary of BCSB Bancorp and Baltimore County Savings Bank effective January 4, 1999 and Executive Vice President of BCSB Bancorp and Baltimore County Savings Bank effective November 27, 2006. He served as President and Chief Executive Officer of BCSB Bancorp and Baltimore County Savings Bank on an interim basis from July 24, 2006 through November 26, 2006. Previously, he was a Partner in the law firm of Moore, Carney, Ryan and Lattanzi, L.L.C. Age 54.

Bonnie M. Klein joined Baltimore County Savings Bank in 1975 and has served in various capacities of increasing responsibility since then. She was named Vice President and Treasurer of BCSB Bancorp and Baltimore County Savings Bank effective January 4, 1999 and Senior Vice President of BCSB Bancorp and Baltimore County Savings Bank effective January 1, 2005. She is a Certified Public Accountant. Age 55.

 

34


 

Item 1A. Risk Factors

The Bank’s increased emphasis on commercial real estate and commercial lending may expose it to increased lending risks.

In recent years, the Bank has significantly increased its emphasis on commercial real estate lending. Commercial real estate loans increased from $75.0 million, or 15.5% of its total loans, at September 30, 2005 to $136.6 million, or 34.3% of its total loans, at September 30, 2010. Moreover, as part of the Bank’s strategy to increase earnings, it will seek to continue to increase commercial real estate lending, as well as commercial lending, and intends to add commercial lending personnel to assist in these efforts. These types of loans generally expose a lender to greater risk of non-payment and loss than single-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to single-family residential mortgage loans. Commercial business loans expose the Bank to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time. In addition, since such loans generally entail greater risk than single-family residential mortgage loans, the Bank may need to increase its allowance for loan losses in the future to account for the possible increase in credit losses associated with the growth of such loans. Also, many of the Bank’s commercial and construction borrowers have more than one loan outstanding with the Bank. Consequently, an adverse development with respect to one loan or one credit relationship can expose the Bank to a significantly greater risk of loss compared to an adverse development with respect to a single-family residential mortgage loan.

Changes in interest rates could reduce the Bank’s net interest income and earnings.

The Bank’s net interest income is the interest it earns on loans and investments less the interest it pays on its deposits and borrowings. The net interest margin is the difference between the yield the Bank earns on its assets and the interest rate it pays for deposits and its other sources of funding. Changes in interest rates – up or down – could adversely affect the Bank’s net interest margin and, as a result, its net interest income. Although the yield the Bank earns on its assets and its funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing the Bank’s net interest margin to expand or contract. Liabilities tend to be shorter in duration than the Bank’s assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, the Bank’s funding costs may rise faster than the yield it earns on its assets, causing the Bank’s net interest margin to contract until the yield catches up. Changes in the slope of the “yield curve” – or the spread between short-term and long-term interest rates – could also reduce net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because the Bank’s liabilities tend to be shorter in duration than its assets, when the yield curve flattens or even inverts, the Bank could experience pressure on its net interest margin as its cost of funds increases relative to the yield that can be earned on its assets.

A further downturn in the local economy or a further decline in real estate values could hurt our profits.

Much of the Bank’s loans are in Baltimore, Harford and Howard Counties and Baltimore City in Maryland. As a result, a downturn in the local economy, and, particularly, a downturn in real estate values, could cause significant increases in nonperforming loans, which would adversely affect profits. Additionally, a decrease in asset quality could require additions to the Bank’s allowance for loan losses through increased provisions for loan losses, which would negatively affect profits. A decline in real estate values could also cause some of the Bank’s mortgage loans to become inadequately collateralized, which would expose it to a greater risk of loss.

If we conclude that the decline in value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings.

We review our investment securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the decline is other-than-temporary. If we

 

35


conclude that the decline is other-than-temporary, we are required to write down the value of that security through a charge to earnings. As of September 30, 2010, our mortgage-backed securities portfolio included 78 securities with a book value of $66.7 million and an estimated fair value of $66.0 million. Changes in the expected cash flows of these securities and/or prolonged price declines may result in our concluding in future periods that the impairment of these securities is other than temporary, which would require a charge to earnings to write down theses securities to their fair value. During the fiscal year ended September 30, 2010, we wrote down these securities for an other-than-temporary impairment of $200,000. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity.

Increased and/or special FDIC assessments will hurt our earnings.

The recent economic downturn has caused a high level of bank failures, which has dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions. Our special assessment, which was reflected in earnings for the quarter ended June 30, 2009, was $270,000. In lieu of imposing an additional special assessment, the FDIC required all institutions to prepay their assessments for all of 2010, 2011 and 2012, which for us totaled $2.8 million. Additional increases in the base assessment rate or additional special assessments would negatively impact our earnings.

Our allowance for loan losses may be inadequate, which could hurt our earnings.

When borrowers default and do not repay the loans that we make to them, we may lose money. The allowance for loan losses is the amount estimated by management as necessary to cover probable losses in the loan portfolio at the statement of financial condition date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. If our estimates and judgments regarding such matters prove to be incorrect, our allowance for loan losses might not be sufficient, and additional loan loss provisions might need to be made. Depending on the amount of such loan loss provisions, the adverse impact on our earnings could be material.

In addition, bank regulators may require us to make a provision for loan losses or otherwise recognize further loan charge-offs following their periodic review of our loan portfolio, our underwriting procedures, and our loan loss allowance. Any increase in our allowance for loan losses or loan charge-offs as required by such regulatory authorities could have a material adverse effect on our financial condition and results of operations. Please see “Critical Accounting Policies and Estimates” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a discussion of the procedures we follow in establishing our loan loss allowance.

Strong competition within Baltimore County Savings Bank’s market area could adversely affect profits and slow growth.

The Bank faces intense competition both in making loans and attracting deposits. This competition has made it more difficult for the Bank to make new loans and at times has forced us to offer higher deposit rates. Price competition for loans and deposits might result in the Bank earning less on loans and paying more on deposits, which would reduce net interest income. Some of the institutions with which it competes have substantially greater resources and lending limits than the Bank has and may offer services that the Bank does not provide. The Bank expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. The Bank’s profitability depends upon its continued ability to compete successfully in its market area.

 

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The Bank and Company operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.

Both the Bank and the Company are subject to extensive regulation, supervision and examination by the Office of Thrift Supervision, their primary federal regulator, and by the Federal Deposit Insurance Corporation, as insurer of the Bank’s deposits. Such regulation and supervision govern the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than holders of the Company’s common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on operations, the classification of our assets and determination of the level of allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on operations.

Proposed regulatory reform may have a material impact on the value of our stock.

On July 21, 2010, the President signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act restructures the regulation of depository institutions. Under the Dodd-Frank Act, the Office of Thrift Supervision will be transferred to the Office of the Comptroller of the Currency, which regulates national banks. Savings and loan holding companies will be regulated by the Federal Reserve Board. The Dodd-Frank Act contains various provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. Also included is the creation of a new federal agency to administer consumer and fair lending laws, a function that is now performed by the depository institution regulators. The federal preemption of state laws currently accorded federally chartered depository institutions will be reduced as well. The Dodd-Frank Act also will impose consolidated capital requirements on savings and loan holding companies effective in five years, which will limit our ability to borrow at the holding company and invest the proceeds from such borrowings as capital in Baltimore County Savings Bank that could be leveraged to support additional growth. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased compliance costs resulting from possible future consumer and fair lending regulations.

The market price of our common stock may be materially adversely affected by market volatility.

Many publicly traded financial services companies have recently experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance or prospects of such companies. We may experience market fluctuations that are not directly related to our operating performance, but are influenced by the market’s perception of the state of the financial services industry in general and, in particular, the market’s assessment of general credit quality conditions, including default and foreclosure rates in the industry.

The limitations on executive compensation imposed through our participation in the TARP Capital Purchase Program may restrict our ability to attract, retain and motivate key employees, which could adversely affect our operations.

As part of our participation in the TARP Capital Purchase Program, we agreed to be bound by certain executive compensation restrictions, including limitations on severance payments and the clawback of any bonus and incentive compensation that were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria. Subsequent to the issuance of the preferred stock, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted, which provides more stringent limitations on severance pay and the payment of bonuses. To the extent that any of these compensation restrictions do not permit us to provide a comprehensive compensation package to our key employees that is competitive in our market area, we have difficulty in attracting, retaining and motivating our key employees, which could have an adverse effect on our results of operations.

 

37


Future dividend payments and common stock repurchases are restricted by the terms of the U.S. Treasury’s equity investment in us.

Under the terms of the TARP Capital Purchase Program, until the earlier of the third anniversary of the date of issuance of the Company’s Series A Cumulative Perpetual Preferred Stock and the date on which the Series A Cumulative Perpetual Preferred Stock has been redeemed in whole or the U.S. Treasury has transferred all of the Series A Cumulative Perpetual Preferred Stock to third parties, we are prohibited from increasing dividends on our common stock above $0.125 per share and from making certain repurchases of equity securities, including our common stock, without the consent of the U.S. Treasury. Furthermore, as long as the Series A Cumulative Perpetual Preferred Stock is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.

The terms governing the issuance of the preferred stock to the U.S. Treasury may be changed, the effect of which may have an adverse effect on our operations.

The terms of the Securities Purchase Agreement in which we entered into with U.S. Treasury pursuant to the TARP Capital Purchase Program provides that the U.S. Treasury may unilaterally amend any provision of the Purchase Agreement to the extent required to comply with any changes in applicable federal law that may occur in the future. We have no assurances that changes in the terms of the transaction will not occur in the future. Such changes may place restrictions on our business or results of operation, which may adversely affect the market price of our common stock.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

38


 

Item 2. Properties

The following table sets forth the location and certain additional information regarding the Bank’s offices at September 30, 2010.

 

     Year
Opened
     Owned
    or Leased    
    Expiration Date (If
Leased) (1)
     Net Book
Value at
September 30,
2010
     Approximate
Square
Footage
     Deposits at
September 30,
2010
 
                                       (Deposits in
Thousands)
 

Main Office:

                

Perry Hall

     1955         Leased(2)        November 2018       $ 112,964         8,000       $ 115,285   

Branch Offices:

                

Bel Air

     1975         Leased        May 2013         —           1,200         40,320   

Dundalk (3)

     1976         Leased        June 2011         —           1,700         41,083   

Timonium

     1978         Leased        July 2013         —           2,500         58,429   

Catonsville

     2003         Leased        November 2011         —           3,550         48,376   

Abingdon

     1999         Leased(2)        October 2018         365,896         1,800         13,501   

Forest Hill

     1999         Leased(2)        July 2019         313,164         1,800         20,972   

Essex

     1999         Leased        November 2012         —           3,200         16,215   

Hickory

     2000         Leased(2)        January 2020         364,339         1,800         12,864   

White Marsh

     2000         Leased(2)        January 2015         454,082         1,800         28,910   

Carney

     2001         Leased        February 2016         —           2,100         20,951   

Lutherville

     2002         Owned           556,816         7,440         27,122   

Golden Ring

     2002         Leased        May 2011         —           1,200         23,154   

Hamilton

     2002         Owned           139,923         1,500         8,645   

Ellicott City

     2002         Leased        August 2020         —           2,300         25,207   

Honeygo

     2005         Leased(2)        December 2025         631,911         1,800         10,838   

Sparks

     2005         Leased(2)        December 2025         593,700         1,800         14,503   

Owings Mills

     2005         Leased(2)        September 2026         724,937         1,800         7,991   

Administrative Offices:

                

4111 E. Joppa Road

     1994         Owned           991,125         18,000      

 

(1) All leases have at least one five-year option, except for Catonsville, Dundalk, Ellicott City and Timonium locations.
(2) Building is owned, but the land is leased.
(3) The Bank also is leasing a kiosk and drive-in ATM facility at this location. The Kiosk lease expires in August of 2011.

The net book value of the Bank’s investment in premises and equipment totaled $7.8 million at September 30, 2010. See Note 5 of Notes to Consolidated Financial Statements.

 

Item 3. Legal Proceedings

On August 6, 2008 the Bank along with two other banks that were victims of the check kitting scheme were sued by another creditor of the failed check casher, Global Express Money Orders, Inc., in the Circuit Court for Baltimore City, Maryland (Case No. 24 C 08-004896). On April 3, 2010, a Notice of Dismissal was filed by the Plaintiff dismissing the action with prejudice resolving the matter.

On November 2, 2010, the Bank was sued in the United States District Court for the District of Maryland in the matter of Vicki Piontek v. Baltimore County Saving Bank, F.S.B. (Civil Action No. 10-cv-3101). The Plaintiff’s Complaint alleges violations of the Electronic Funds Transfer Act concerning notice requirements to be displayed

 

39


upon one of the Bank’s ATM machines and seeks certification of the action as a class action. The Bank has answered the Complaint, denied any such violations and demanded that the Complaint be dismissed with prejudice and that it be awarded the costs of suit, and reasonable attorneys fees and intends to vigorously defend the matter.

 

Item 4. Removed and Reserved

Not applicable.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock trades under the symbol “BCSB” on the Nasdaq Global Market. At December 23, 2010 there were 3,192,119 shares of the common stock outstanding and approximately 1900 holders of record of the common stock. Following are the high and low bid prices, by fiscal quarter, as reported on the Nasdaq Global Market during the periods indicated, as well as dividends declared on the common stock during each quarter.

 

Fiscal 2010

   High      Low      Dividends
Per Share
 

First Quarter

   $ 9.90       $ 8.05       $ —     

Second Quarter

     9.97         8.29         —     

Third Quarter

     10.50         9.44         —     

Fourth Quarter

     10.25         9.50         —     

 

Fiscal 2009

   High      Low      Dividends
Per Share
 

First Quarter

   $ 10.38       $ 7.75       $ —     

Second Quarter

     9.46         6.59         —     

Third Quarter

     8.75         7.78         —     

Fourth Quarter

     10.45         7.95         —     

The stated high and low bid prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.

The Company did not repurchase any of its common stock during the fiscal year ended September 30, 2010.

Dividends payments by the Company depend primarily on dividends received by the Company from the Bank. However, payment of cash dividends on capital stock by a savings institution is limited by OTS regulations. The Bank may not make a distribution that would constitute a return of capital during the three-year term of the business plan submitted in connection with its reorganization. No insured depository institution may make a capital distribution if, after making the distribution, the institution would be undercapitalized. See Note 14 to the Notes to the Consolidated Financial Statements for information regarding the dividend restrictions applicable to the Company and the Bank.

 

40


 

Item 6. Selected Financial Data

Selected Consolidated Financial Condition Data

 

     At September 30,  
     2010      2009      2008      2007      2006  
     (In thousands)  

Total assets

   $ 620,555       $ 569,438       $ 567,082       $ 642,381       $ 785,857   

Loans receivable, net

     388,933         401,011         400,469         416,302         463,776   

Investment securities:

              

Available for sale

     18,390         —           994         3,970         143,068   

Held to maturity

     —           —           —           —           4,496   

Mortgage-backed securities:

              

Available for sale

     65,975         90,478         89,956         104,999         86,801   

Held to maturity

     —           —           —           —           28,675   

FHLB stock

     1,378         1,485         1,559         2,270         6,972   

Deposits

     534,366         487,989         484,791         558,457         604,845   

FHLB advances

     —           —           10,000         20,000         118,473   

Junior Subordinated Debentures

     17,011         17,011         17,011         23,197         23,197   

Stockholders’ equity

     61,390         59,133         49,755         34,592         33,421   

Selected Consolidated Operations Data

 

     For the Years Ended September 30,  
     2010     2009     2008      2007     2006  
     (In thousands)  

Interest income

   $ 28,862      $ 29,939      $ 34,137       $ 39,112      $ 39,995   

Interest expense

     9,794        13,614        19,329         25,517        25,776   
                                         

Net interest income

     19,068        16,325        14,808         13,595        14,219   

Provision for loan losses

     3,100        1,350        360         117        194   
                                         

Net interest income after provision for loan losses

     15,968        14,975        14,448         13,478        14,025   

Other income (loss)

     2,406        1,875        2,047         (5,335     1,501   

Noninterest expenses

     16,682        18,794        15,266         12,809        26,968   
                                         

Income (loss) before income taxes

     1,692        (1,944     1,229         (4,666     (11,442

Income tax provision (benefit)

     485        11        335         (1,745     (4,049
                                         

Net income (loss)

   $ 1,207      $ (1,955   $ 894       $ (2,921   $ (7,393

Preferred stock dividends and discount accretion

     (625     (477     —           —          —     
                                         

Net income (loss) available to common shareholders

   $ 582      $ (2,432   $ 894       $ (2,921   $ (7,393
                                         

Net income (loss) per share of common stock:

           

Basic

   $ 0.20      $ (0.84   $ 0.30       $ (0.95   $ (2.39
                                         

Diluted

   $ 0.19      $ (0.84   $ 0.30       $ (0.95   $ (2.39
                                         

Cash dividend declared per share

   $ —        $ —        $ —         $ —        $ 0.95   
                                         

All per share amounts have been adjusted to reflect the stock offering and conversion which occurred on April 10, 2008.

 

41


Key Operating Ratios:

 

     At or for the Year Ended September 30,  
     2010     2009     2008     2007     2006  

Performance Ratios:

          

Return on average assets (net income (loss) divided by average total assets)

     0.20     (0.34 )%      0.15     (0.41 )%      (0.92 )% 

Return on average equity (net income (loss) divided by average equity)

     1.99        (3.36     (2.08     (8.57     (19.86

Interest rate spread (combined weighted average interest rate earned less combined weighted average interest rate cost)

     3.30        2.97        2.60        2.04        1.96   

Net interest margin (net interest income divided by average interest-earning assets).

     3.39        3.05        2.61        2.04        1.89   

Ratio of average interest-earning assets to average interest-bearing liabilities

     105.14        103.32        100.35        99.83        98.30   

Ratio of noninterest expense to average total assets

     2.77        3.24        2.50        1.80        3.35   

Efficiency ratio

     77.68        103.27        90.56        155.07        173.69   

Dividend payout ratio (dividend declared per share divided by net income per share)

     n/a        n/a        n/a        n/a        n/a   

Asset Quality Ratios:

          

Nonperforming assets to total assets at end of period

     2.06        1.46        0.37        0.37        0.32   

Nonperforming loans to gross loans at end of period

     3.21        1.88        0.21        0.53        0.51   

Allowance for loan losses to gross loans at end of period

     1.67        0.96        0.65        0.62        0.56   

Allowance for loan losses to nonperforming loans at end of period

     51.89        51.06        320.00        115.72        109.30   

Provision for loan losses to gross loans

     0.78        0.33        0.08        0.03        0.04   

Net charge-offs to average loans outstanding

     0.10        0.02        0.08        (0.03     (0.06

Capital Ratios:

          

Equity to total assets at end of period

     9.89        10.38        8.77        5.38        4.25   

Average equity to average assets

     10.04        10.02        7.05        4.80        4.63   

 

n/a = not applicable.

 

42


 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The Company is a Maryland corporation which was organized to be the stock holding company for the Bank in connection with our second-step conversion and reorganization completed on April 10, 2008, discussed further below. The Bank operates as a federally chartered stock savings association. The Bank’s deposit accounts are insured up to a maximum of $250,000 by the FDIC. The Bank’s noninterest-earning demand deposit accounts have unlimited FDIC insurance.

BCSB Bankcorp, Inc., a federal corporation, was the former mid-tier stock holding company for the Bank. BCSB Bankcorp was organized in conjunction with the Bank’s reorganization from the mutual savings association to the mutual holding company structure in 1998. Baltimore County Savings Bank, M.H.C., a federal mutual holding company, was the mutual holding company parent of BCSB Bankcorp, Inc. and originally owned 63.3% of BCSB Bankcorp, Inc.’s outstanding stock. As a result of treasury stock purchases, this stake increased to approximately 64.5% of BCSB Bankcorp’s outstanding stock at the time of the second-step conversion. On April 10, 2008, a second-step conversion was completed after which Baltimore County Savings Bank, M.H.C. and BCSB Bankcorp, Inc. ceased to exist. A newly organized Maryland corporation BCSB Bancorp, Inc., became the holding company for the Bank. The second-step conversion was accounted for as a change in corporate form with no resulting change in the historical basis of the former BCSB Bankcorp, Inc.’s assets, liabilities and equity. A total of 1,976,538 new shares of the Company were sold at $10.00 per share in the subscription, community and syndicated community offerings through which the Company received proceeds of approximately $17.1 million, net of offering costs of approximately $2.6 million. The Company contributed $8.5 million or approximately 50% of the net proceeds to the Bank in the form of a capital contribution. The Company loaned $1.2 million to the Bank’s Employee Stock Ownership Plan (the “ESOP”) and the ESOP used those funds to acquire 122,197 shares of the Company’s common stock at $10 per share. As part of the conversion, outstanding public shares of BCSB Bankcorp, Inc. were exchanged for 0.5264 shares of the new holding company of the Bank. No fractional shares were issued. Instead, cash was paid to shareholders at $10.00 per share for any fractional shares that would otherwise be issued. The exchange resulted in an additional 1,144,407 outstanding shares of the Company for a total of 3,120,945 outstanding shares as of the closing of the second-step conversion on April 10, 2008. Information herein for dates and periods prior to April 10, 2008 reflect such information for BCSB Bankcorp, Inc.

The Company’s net income is dependent primarily on its net interest income, which is the difference between interest income earned on its interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (“interest rate spread”); and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Company’s interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. To a lesser extent, the Company’s net income also is affected by the level of other income, which primarily consists of fees and charges, and levels of noninterest expenses such as salaries and related expenses.

The operations of the Company are significantly affected by prevailing economic conditions, competition and the monetary, fiscal and regulatory policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities and the levels of personal income and savings in the Company’s market area.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of the Company’s financial condition is based on the consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, including those related to the allowance for loan losses.

 

43


Management believes the allowance for loan losses is a critical accounting policy that requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on management’s evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. Management believes the allowance for loan losses is a significant estimated loss and therefore regularly evaluates it for adequacy by taking into consideration factors such as prior loan loss experience, the character and size of the loan portfolio, business and economic conditions and management’s estimation of losses. The use of different estimates or assumptions could produce different provisions for loan losses. Refer to the discussion of “Allowance for Loan Losses” in Note 1 to the Consolidated Financial Statements for a detailed description of management’s estimation process and methodology related to the allowance for loan losses.

Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. The term “other-than-temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Under the revised guidance, for recognition and presentation of other-than-temporary impairments the amount of other-than-temporary impairment that is recognized through earnings for debt securities is determined by comparing the present value of the expected cash flows to the amortized cost of the security. The discount rate used to determine the credit loss is the expected book yield on the security.

The Company accounts for income taxes under the asset/liability method. Deferred tax assets are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period indicated by the enactment date. A valuation allowance is established for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond the Company’s control. It is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred tax assets could change in the near term.

The Company accounts for goodwill and other intangible assets under the Financial Accounting Standard Board’s (“FASB”) guidance regarding goodwill and other intangible assets. This guidance prescribes a two-phase process for impairment testing of goodwill. The first phase screens for impairment; while the second phase, if necessary, measures the impairment. We consider the Company to be a single reporting unit. Accordingly, all of the goodwill is associated with the entire Company. The Company performs the required impairment analysis of goodwill annually or on an interim basis if circumstances dictate. Any reduction of the enterprise fair value below the recorded amount of equity could require us to write down the value of goodwill or purchased intangibles and record an expense for an impairment loss. During fiscal 2009, we determined that based on valuations of our Company, the entire $2.3 million of goodwill recorded in conjunction with a 2002 acquisition was completely impaired. The Company has no goodwill remaining at September 30, 2010.

Terminated Agreement for the Sale of Branches

American Bank and Baltimore County Savings Bank have mutually agreed to terminate the agreement entered into on January 12, 2010. Baltimore County Savings Bank entered into a Purchase and Assumption Agreement (the “Agreement”) with American Bank (“American”) under which the Bank would sell four branch offices, located at 6335 Baltimore National Pike, Catonsville, Maryland, 9416 Baltimore National Pike, Ellicott City, Maryland, 4228 Harford Road, Baltimore, Maryland, and 9231 Lakeside Boulevard, Owings Mills, Maryland (collectively, the “Branches”), to American. The agreement was terminated on November 17, 2010.

Troubled Asset Relief Program Capital Purchase Program

On December 23, 2008, the Company sold $10.8 million in preferred shares to the U.S. Department of Treasury as a participant in the federal government’s Troubled Asset Relief Program (“TARP”) Capital Purchase

 

44


Program. The TARP Capital Purchase Program is a voluntary program for healthy U.S. financial institutions designed to encourage these institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the weakened U.S. economy. In connection with the investment, the Company entered into a Letter Agreement and related Securities Purchase Agreement with the U.S. Treasury pursuant to which the Company issued (1) 10,800 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation preference $1,000 per share (the “Series A Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 183,465 shares of the Company’s common stock for an aggregate purchase price of $10.8 million in cash. The warrant term is 10 years and it is immediately exercisable, in whole or in part, at an exercise price of $8.83 per share. The Company and the Bank met all regulatory requirements to be considered well-capitalized under the federal prompt corrective action regulations as of September 30, 2010. For more information on the Series A Preferred Stock and Warrant issued to the U.S. Treasury in connection with the TARP Capital. See Note 15 of Notes to Consolidated Financial Statements.

Asset/Liability Management

The Company strives to achieve consistent net interest income and reduce its exposure to adverse changes in interest rates by attempting to match the terms to re-pricing of its interest-sensitive assets and liabilities. Factors beyond the Bank’s control, such as market interest rates and competition, may also have an impact on the Bank’s interest income and interest expense.

In the absence of any other factors, the overall yield or return associated with the Bank’s earning assets generally will increase from existing levels when interest rates rise over an extended period of time, and conversely interest income will decrease when interest rates decrease. In general, interest expense will increase when interest rates rise over an extended period of time, and conversely interest expense will decrease when interest rates decrease. By managing the increases and decreases in its interest income and interest expense which are brought about by changes in market interest rates, the Bank can significantly influence its net interest income.

The senior officers of the Bank meet on a regular basis to monitor the Bank’s interest rate risk position and to set prices on loans and deposits to manage interest rate risk within the parameters set by the Board of Directors. The President of the Bank reports to the Board of Directors on a regular basis on interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Board of Directors reviews the maturities of the Bank’s assets and liabilities and establishes policies and strategies designed to regulate the Bank’s flow of funds and to coordinate the sources, uses and pricing of such funds. The first priority in structuring and pricing the Bank’s assets and liabilities is to maintain an acceptable interest rate spread while reducing the net effects of changes in interest rates. The Bank’s management is responsible for administering the policies and determinations of the Board of Directors with respect to the Bank’s asset and liability goals and strategies.

 

45


Market Risk

Management measures the Bank’s interest rate risk by computing estimated changes in the net portfolio value (“NPV”) of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. NPV represents the market value of portfolio equity and is the difference between incoming and outgoing discounted cash flows from assets and liabilities, with adjustments made for off-balance sheet items. These computations estimate the effect on the Bank’s NPV of sudden and sustained increases and decreases in market interest rates. The Bank’s Board of Directors has adopted an interest rate risk policy which establishes maximum decreases in the Bank’s estimated NPV in the event of increases or decreases in market interest rates. The following table presents the Bank’s projected change in NPV for the various rate shock levels at September 30, 2010. All changes meet the Bank’s policy requirements.

 

     Net Portfolio Value     NPV as % of Portfolio Value of Assets  

Change in Rates

   $ Amount      $ Change (1)     % Change (2)     NPV Ratio (3)     Change (4)  
     (Dollars in Thousands)                    

+300 bp

   $ 76,546       $ (13,840     (15 )%      12.26     -159bp   

+200 bp

     82,136         (8,250     (9     12.95        -90bp   

+100 bp

     86,936         (3,450     (4     13.50        -35bp   

  +50 bp

     88,818         (1,568     (2     13.70        -15bp   

      0 bp

     90,386             13.85     

   -50 bp

     91,885         1,499        2        13.99        14bp   

 -100 bp

     93,319         2,933        3        14.14        29bp   

 

  (1) Represents the excess (deficiency) of the estimated NPV assuming the indicated change in interest rates minus the estimated NPV assuming no change in interest rates.
  (2) Calculated as the amount of change in the estimated NPV divided by the estimated NPV assuming no change in interest rates.
  (3) Calculated as the estimated NPV divided by average total assets.
  (4) Calculated as the excess (deficiency) of the NPV ratio assuming the indicated change in interest rates over the estimated NPV ratio assuming no change in interest rates.

 

  *** Risk Measures: 200 bp rate shock***

 

     At September 30,  
     2010     2009  

Pre-Stock NPV Ratio: NPV as % of Portfolio Value of Assets

     13.85     14.08

Exposure Measure: Post Shock NPV Ratio

     12.95        13.26   

Sensitivity Measure: Change in NPV Ratio

     90bp        82bp   

The above table indicates that at September 30, 2010, in the event of sudden and sustained increases in prevailing market interest rates, the Bank’s NPV would be expected to decrease, and that in the event of a sudden and sustained decrease in prevailing market interest rates, the Bank’s NPV would be expected to increase. The Bank’s Board of Directors reviews the Bank’s NPV position quarterly, and, if estimated changes in NPV are not within the targets established by the Board, the Board may direct management to adjust its asset and liability mix to bring interest rate risk within Board approved targets. At September 30, 2010, the Bank’s estimated changes in NPV were within the targets established by the Board of Directors. NPV is calculated by the Office of Thrift Supervision by using information provided by the Bank. The calculation is based on the net present value of discounted cash flows utilizing market prepayment assumptions.

Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Bank may undertake in response to changes in interest rates.

Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. Actual values may differ from those projections set forth in the table, should market conditions vary from assumptions used

 

46


in the preparation of the table. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In addition, the proportion of adjustable-rate loans in the Bank’s portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinance activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the tables. Finally, the ability of many borrowers to repay their adjustable-rate debt may decrease in the event of an interest rate increase.

 

47


Average Balance, Interest and Average Yields and Rates

The following table sets forth certain information relating to the Company’s average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yield and cost are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the years ended September 30, 2010, September 30, 2009 and September 30, 2008. Total average assets are computed using month-end balances. No tax-equivalent adjustments have been made as the Company did not invest in any tax exempt assets during the periods presented. The table also presents information for the periods indicated with respect to the differences between the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities, or “interest rate spread,” which banks have traditionally used as an indicator of profitability. Another indicator of net interest income is “net interest margin,” which is its net interest income divided by the average balance of interest-earning assets.

 

    Year Ended September 30,  
    2010     2009     2008  
    Average
Balance
    Interest     Average
Yield/Cost
    Average
Balance
    Interest     Average
Yield/Cost
    Average
Balance
    Interest     Average
Yield/Cost
 
    (Dollars in thousands)  

Interest-earning assets:

                 

Loans receivable (1)

  $ 399,771      $ 24,363        6.09   $ 397,984      $ 24,565        6.17   $ 410,484      $ 26,646        6.49

Mortgage-backed
securities

    83,288        4,264        5.12        92,157        5,148        5.59        99,603        5,506        5.53   

Investment securities and FHLB stock

    2,102        33        1.62        2,052        37        1.80        3,887        218        5.61   

Other interest-earning assets

    77,480        202        .26        43,076        189        .44        53,670        1,767        3.29   
                                                     

Total interest earning assets

    562,641        28,862        5.13        535,269        29,939        5.59        567,644        34,137        6.01   

Bank-owned life insurance

    15,280            14,658            14,045       

Noninterest-earning assets

    24,675            30,568            28,028       
                                   

Total assets

  $ 602,596          $ 580,495          $ 609,717       
                                   

Interest-bearing liabilities:

                 

Deposits

  $ 516,729      $ 9,173        1.78   $ 492,830      $ 12,438        2.52   $ 526,085      $ 16,980        3.23

FHLB advances short-term

    —          —          —          6,319        284        4.49        10,000        481        4.81   

FHLB advances long-term

    —          —          —          —          —          —          6,346        287        4.52   

Junior subordinated debentures

    17,011        621        3.64        17,011        892        5.24        21,634        1,581        7.31   

Other liabilities

    1,385        —          —          1,918        —          —          1,613        —          —     
                                                     

Total interest-bearing liabilities

    535,125        9,794        1.83        518,078        13,614        2.63        565,678        19,329        3.41   
                                               

Noninterest-bearing liabilities

    6,950            4,273            1,021       
                                   

Total liabilities

    542,075            522,351            566,699       

Stockholders’ equity

    60,521            58,144            43,018       
                                   

Total liabilities and stockholders’ equity

  $ 602,596          $ 580,495          $ 609,717       
                                   

Net interest income

    $ 19,068          $ 16,325          $ 14,808     
                                   

Interest rate spread

        3.30         2.96         2.60
                                   

Net interest margin (2)

        3.39         3.05         2.61
                                   

Ratio of average interest-earning assets to average interest-bearing liabilities

        105.14         103.32          100.35 
                                   

 

(1) Includes nonaccrual loans.
(2) Represents net interest income divided by the average balance of interest-earning assets.

 

48


Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume multiplied by old rate); (ii) changes in rates (change in rate multiplied by old volume); and (iii) changes in rate/volume (changes in rate multiplied by the changes in volume).

 

     Year Ended September 30,  
     2010 v. 2009     2009 v. 2008  
     Increase (Decrease)
Due to
 
     Volume     Rate     Rate/
Volume
    Total     Volume     Rate     Rate/
Volume
    Total  
     (In thousands)  

Interest income:

                

Loans receivable

   $ 110      $ (311   $ (1   $ (202   $ (825   $ (1,296   $ 40      $ (2,081

Mortgage-backed securities

     (496     (430     42        (884     (414     60        (4