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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2010
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No.: 0-22961
Annapolis Bancorp, Inc.
(Exact name of registrant as specified in its charter)
| Maryland | 52-1595772 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer I.D. No.) | |
| 1000 Bestgate Road, Suite 400, Annapolis, Maryland | 21401 | |
| (Address of principal executive offices) | (Zip Code) | |
Registrant’s Telephone Number, including area code:
(410) 224-4455
Securities registered pursuant to Section 12(b) of the Exchange Act:
None
Securities registered pursuant to Section 12(g) of the Exchange Act:
| Common Stock $0.01 par value | NASDAQ Capital Market | |
| (Title of class) | (Exchange on which registered) |
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 (§232.405 of this chapter) during the preceding 12 months (or for a 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 (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ¨
Indicate by check mark whether the registrant is a large accelerated filer, 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.
| 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 of the outstanding Common Stock held by nonaffiliates was $7,428,310 as of June 30, 2010 based on a sales price of $4.30 per share of Common Stock.
The number of shares outstanding of the registrant’s Common Stock was 3,943,332 as of March 1, 2011.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010 ARE INCORPORATED BY REFERENCE INTO PART I AND PART II OF THIS FORM 10-K.
PORTIONS OF THE PROXY STATEMENT FOR THE 2011 ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON MAY 19, 2011, ARE INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K.
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PART I
Annapolis Bancorp, Inc. (the “Company”), formerly Annapolis National Bancorp, Inc. and Maryland Publick Banks, Inc., is a bank holding company, incorporated under the laws of Maryland in May 1988 for the purpose of acquiring and holding all of the outstanding stock of BankAnnapolis (the “Bank”). In November 1998 the Company went public and joined the NASDAQ Stock Market using the ticker symbol ANNB. Effective June 1, 2001 the Company changed its name to Annapolis Bancorp, Inc.
The Company and later the Bank were formed by a group of businessmen who at the time the Company was organized were dissatisfied with the banking opportunities available in the Annapolis area. The Bank grew based upon a real desire to serve people and business in the Annapolis region. Throughout the Company’s history the Board of Directors has attempted to and succeeded in hiring talented and competent community bankers to lead the Company and Bank as its Senior Management Team.
BankAnnapolis
The Bank is a federally insured community-oriented bank and one of two independent commercial banks headquartered in Annapolis, Maryland. Effective November 1, 2000 the Bank changed its charter from a national charter to a state charter and joined the State of Maryland and the Federal Reserve banking systems. Also effective November 1, 2000 the Bank changed its name from Annapolis National Bank to BankAnnapolis. The Company (as a bank holding company) and the Bank are subject to governmental supervision, regulation, and control.
The Bank currently operates as a full service commercial bank from its headquarters in Annapolis, its six other branches located in Anne Arundel County, Maryland and one branch located on Kent Island in Queen Anne’s County, Maryland. The Bank has built its reputation on exemplary customer service and outreach to the communities surrounding each of the Bank’s locations. The Bank is committed to offering products and services that focus on relationship banking and provide an alternative to the large multi-regional financial institutions that are so pervasive in the markets the Bank serves.
The Bank also created a Private Business Banking Division to provide local businesses with an unprecedented level of service and attention, as well as easy access to an exclusive set of financial products and services and the professional guidance and support to take advantage of them.
The Bank competes with numerous other financial intermediaries, commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in Anne Arundel County and elsewhere. The Bank continually evaluates new products, and implements such new products as deemed appropriate by management.
The Bank conducts a general commercial and retail banking business in its market area, emphasizing the banking needs of small businesses, professional concerns and individuals. The Bank attracts most of its customer deposits from Anne Arundel County, Maryland, and to a lesser extent, Queen Anne’s County, Maryland. The Bank’s lending operations are centered in Anne Arundel County, but extend throughout Central Maryland.
The Bank’s principal business consists of originating loans and attracting deposits. The Bank originates commercial loans, commercial real estate loans, construction loans, one- to four-family real estate loans, home equity loans and consumer loans. The Bank also invests in U.S. Treasury and U.S. Government agency securities and other securities including mortgage backed securities issued or guaranteed by the federal government.
Bank Services
The Bank’s Anne Arundel County service area is a highly concentrated, highly branched banking market. Competition in Anne Arundel County for loans to small businesses and professionals, the Bank’s target market, is intense and pricing, service and access to decision-makers are important. Deposit competition among institutions in Anne Arundel County also is strong.
The Bank is a full service commercial bank and offers a variety of products and services to both commercial and retail customers. Commercial services offered by the Bank include a variety of lending products including commercial real estate and commercial business loans, cash management services and letters of credit. Commercial business loans are typically made on a secured basis to corporations, partnerships and individual businesses. On the deposit side commercial customers are offered cash management services including account analysis, remote deposit capture, merchant services and a wide array of deposit products. To a lesser extent, the Bank offers consumer loans to its retail customers, including mortgages, home equity loans and lines of credit and new and used car and boat loans. The Bank’s retail banking services also include a variety of deposit products including transaction accounts, a high yielding savings account, money market accounts, certificates of deposit and individual retirement accounts. The Bank also participates in the Certificate of Deposit Account Registry Service® known as CDARS® that allows the Bank to
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offer FDIC insured deposits of $50 million or more to its customers.
Lending Activities
The Bank’s primary business is to make loans. Outstanding loan balances account for 64.8% of total assets at December 31, 2010. The Bank offers a wide selection of consumer loans to individuals primarily through its branch network. The Bank does a majority of its consumer lending on a secured basis with the highest percentage of loans secured by first and second liens on one- to four-family owner occupied residences. The Bank will originate and maintain servicing rights on some loans and sell others into the secondary market. In addition to consumer mortgage loans the Bank offers a variety of home equity products including fixed rate amortizing term loans and revolving lines of credit. The Bank generally requires that the loan to value for such loans be below 80%. The Bank also offers new and used auto loans and to a lesser extent boat loans.
The Bank provides numerous commercial lending products and services to businesses operating in the Bank’s primary market area. These loans consist of lines of credit, which may require an annual repayment, adjustable-rate loans with terms of five to seven years, and fixed-rate loans with terms of up to five years. Such loans are generally secured by receivables, inventories, equipment and other assets of the business. The Bank generally requires personal guarantees on its commercial loans. The Bank also offers unsecured commercial loans to businesses on a selective basis. These types of loans are made to existing customers and are of a short duration, generally one year or less. The Bank also originates commercial loans which are guaranteed by the Small Business Administration. The Bank has been a participant in a variety of SBA loan programs. Refer to pages 19 to 25 for a more detailed discussion on the Bank’s lending activities.
Investment Activities
The Bank’s second largest asset is its investment portfolio, accounting for 22.3% of total assets at December 31, 2010. The investment portfolio generally consists of U.S. Government and Agency notes, and government guaranteed and private label mortgage backed securities. Management invests excess liquidity following specific policies and procedures that limit the Bank’s exposure to any one type of investment. The Bank’s policy generally requires that each new investment be rated “A” or better. All investments are made with the intent to preserve and protect the capital of the Bank.
Investment targets such as total investment securities, the mix of investment products and the average life of the investment are derived from the Bank’s strategic plan and expected liquidity requirements. Strategies to achieve these targets are the responsibility of the Bank’s Asset and Liability Committee. For a further discussion on the Bank’s investment activities refer to pages 18 and 19.
Employees
At December 31, 2010 the Bank employed 91 full-time and 10 part-time individuals. Seven of these individuals are executive officers of the Bank. None of the employees are employees of the Company. The Bank provides both full- and part-time individuals with a comprehensive benefit program that includes health and dental insurance, Bank paid life and short-and long-term disability insurance, access to vision and catastrophic health insurance and a 401(k) plan.
Regulation and Supervision
General
The supervision and regulation of the Company and the Bank by the banking agencies is intended primarily for the protection of depositors, the Deposit Insurance Fund of the FDIC, and the banking system as a whole, and not for the protection of shareholders or creditors. The banking agencies have broad enforcement power over bank holding companies and banks, including the power to impose substantial fines and other penalties for violations of laws and regulations.
The following description summarizes some of the laws to which the Company and the Bank are subject. References in the following description to applicable statutes and regulations are brief summaries of these statutes and regulations, do not purport to be complete, and are qualified in their entirety by reference to such statutes and regulations.
The Company
The Company, by virtue of its control of the Bank, is a registered bank holding company as defined under the Bank Holding Company Act of 1956 (“the Act”). As a bank holding company, the Company is required to file certain reports with, and otherwise comply with the rules and regulations of, the Federal Reserve Board (“FRB”) under the Act.
Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act is intended to effect a fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives regulators new authority to take control of and liquidate financial firms. The Dodd-Frank Act additionally creates a new independent federal regulator to administer federal consumer protection laws. The Dodd-Frank Act is expected to have a significant impact on the Company’s business operations as its provisions take effect.
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The Company may be affected by the following provisions of the Dodd-Frank Act:
| • | Holding Company Capital Requirements – The Dodd-Frank Act requires the Federal Reserve to apply consolidated capital requirements to depository holding companies that are no less stringent than those that apply to depository institutions. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. The Company’s trust preferred securities were issued prior to May 19, 2010 and will not need to be excluded from Tier 1 capital. |
| • | Deposit Insurance – The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits and provided unlimited federal deposit insurance until January 1, 2013, for noninterest-bearing demand transaction accounts at all depository institutions. Amendments to the Federal Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance premium paid to the Deposit Insurance Fund (“DIF”) will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity during the assessment period. Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15 percent to 1.35 percent of the estimated amount total insured deposits and eliminating the requirement that the FDIC pays dividends to depository institutions when the reserve ratio exceeds certain threshold. In December 2010, the FDIC increased the reserve ratio to 2.0 percent. The Dodd-Frank Act also eliminates the federal statutory prohibitions against the payment of interest on business transaction and other accounts. |
| • | Corporate Governance – The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. It will also mandate the enhancement of independence requirements of the compensation committee and adopt incentive based clawback policies for executive officers. The new legislation also authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1 billion, regardless of whether the company is publicly traded or not. The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters. |
| • | Prohibition Against Charter Conversions of Troubled Institutions – Effective one year after enactment, the Dodd-Frank Act prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating hereto. |
| • | Interstate Branching – The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely. The Dodd-Frank Act restricts the preemption of state law by federal law and disallows subsidiaries and affiliates of federally regulated banks from availing themselves of such preemptions. |
| • | Limits on Derivatives – Effective 18 months after enactment, the Dodd-Frank Act prohibits state-chartered banks from engaging in derivatives transactions unless the loans to one borrowers limit of the state in which the bank is chartered takes into considerations credit exposure to derivative transactions. For this purpose, derivative transactions includes any contract, agreement, swap, warrant note or option that is based in whole or in part on the value of, any interest in, or any quantitative measure of occurrence of any event relating to, one or more commodities securities, currencies, interest or other rates indices or other assets. |
| • | Transactions with Affiliates or Insiders – Effective one year from the date of enactment, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution and its affiliates. The Dodd-Frank Act will apply Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The current exemption from Section 23A for transactions with financial subsidiaries will be eliminated. The Dodd-Frank Act will additionally prohibit an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved by the disinterested directors. |
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| • | Debit Card Interchange Fees – Effective July 21, 2011, the Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer. Within nine months of enactment, the Federal Reserve Board is required to establish standards for reasonable and proportional fees which may take into account the costs of preventing fraud. The restrictions on interchange fees, however, do not apply to banks, that, together with their affiliates, have assets of less than $10 billion. |
| • | Consumer Financial Protection Bureau – The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Graham-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with assets in excess of $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. |
| • | Financial Stability Oversight Council – The Dodd-Frank Act creates the Financial Oversight Stability Council that will recommend to the Federal Reserve Board increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity. |
| • | Mortgage Reform – The Dodd-Frank Act provides mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring that the ability to repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions. |
| • | Well Capitalized and Well Managed – The Dodd-Frank Act requires financial holding companies, such as the Company, to be well capitalized and well managed as of July 21, 2011. |
| • | The Electronic Fund Transfer Act – The Dodd-Frank Act amends the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. |
The Bank
The Bank is regulated by the State of Maryland Department of Labor, Licensing and Regulation. The Bank is subject to extensive regulation, examination and supervision by the State of Maryland as its primary regulator, the Federal Reserve Bank of Richmond as its secondary regulator and the FDIC, as the deposit insurer. The Bank must file reports with the Federal Reserve and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of other institutions. The state and the Federal Reserve conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. Many aspects of the Bank’s operations are regulated by federal law including allowable activities, reserves against deposits, branching, mergers and investments. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the State of Maryland, the Federal Reserve, the FDIC or Congress, could have a material adverse impact on the Company or the Bank and their operations.
Insurance of Deposit Accounts. The Bank’s deposit accounts are insured up to applicable limits by the FDIC’s Deposit Insurance Fund (“DIF”) and are subject to deposit insurance assessments to maintain the DIF. Under the Dodd-Frank Act, the maximum deposit insurance amount is permanently increased from $100,000 to $250,000 and unlimited deposit insurance has been extended to non-interest bearing transaction accounts until December 31, 2012.
The Dodd-Frank Act also set a new minimum DIF reserve ratio at 1.35%. The FDIC is required to attain this ratio by September 30, 2020. In addition, the Dodd-Frank Act will have a significant impact on the calculation of deposit insurance premiums going forward. On February 7, 2011 the FDIC Board approved a final rule that changes the assessment base for insurance premiums from domestic deposits to the institution’s average consolidated total assets during the assessment period minus average tangible equity. The rule defines tangible equity as Tier 1 capital. The rule requires banks under $1 billion in assets to report average weekly balances during the calendar quarter unless they elect to report daily averages. The new rate schedule and other revisions
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to the assessment rates will become effective April 1, 2011, to be used to calculate the June 2011 assessments which will be paid in September 2011.
On November 12, 2009, the FDIC adopted a final rule amending the assessment regulations to require insured depository institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009, along with each institution’s risk-based assessment for the third quarter of 2009. On December 30, 2009 the Bank prepaid $2.2 million in FDIC insurance for 2010, 2011 and 2012 estimated assessments. As of December 31, 2010 the Bank had $1.6 million prepaid in FDIC insurance for the 2011 and 2012 estimated assessments.
Emergency Economic Stabilization Act of 2008. On October 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”), which, among other measures, authorized the Secretary of the U. S. Treasury (“Treasury”) to establish the Trouble Asset Relief Program (the “TARP”). Pursuant to TARP, the Treasury has the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. In addition, under TARP, the Treasury created the Capital Purchase Program (the “CPP”), pursuant to which it provides access to capital that will serve as Tier 1 capital to financial institutions through a standardized program to acquire preferred stock (accompanied by warrants) from eligible financial institutions. On January 30, 2009, the Company sold 8,152 shares of the Company’s Fixed Rate Cumulative Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation amount per share equal to $1,000 and a warrant to purchase 299,706 shares of the Company’s common stock, at an exercise price of $4.08 per share, to the Treasury under the CPP for a total purchase price of $8,152,000.
Comprehensive Financial Stability Plan of 2009. On February 10, 2009, the Secretary of the Treasury announced a new comprehensive financial stability plan (the “Financial Stability Plan”), which builds upon existing programs and earmarks the second $350 billion of unused funds originally authorized under the EESA. The major elements of the Financial Stability Plan include: (i) a capital assistance program that will invest in convertible preferred stock of certain qualifying institutions, (ii) a consumer and business lending initiative to fund new consumer loans, small business loans and commercial mortgage asset-backed securities issuances, (iii) a new public-private investment fund that will leverage public and private capital with public financing to purchase $500 billion to $1 trillion of legacy “toxic assets” from financial institutions, (iv) assistance for homeowners to reduce mortgage payments and interest rates and (v) establishment of loan modification guidelines for government and private programs. In addition, all banking institutions with assets over $100 billion will be required to undergo a comprehensive “stress test” to determine if they have sufficient capital to continue lending and to absorb losses that could result from a more severe decline in the economy than projected. Institutions receiving assistance under the Financial Stability Plan going forward will be subject to higher transparency and accountability standards, including restrictions on dividends, acquisitions, executive compensation and additional disclosure requirements.
American Recovery and Reinvestment Act of 2009. On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the “ARRA”), which is intended, among other things, to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting dislocations in the financial markets. ARRA also includes numerous non-economic recovery related items, including a limitation on executive compensation of certain of the most highly-compensated employees and executive officers of financial institutions, such as the Company, that participated in the TARP CPP. Compliance requirements under ARRA for TARP recipients, which will be further described in rules to be adopted by the Securities and Exchange Commission and standards to be established by the Treasury, include restrictions on executive compensation and corporate governance requirements.
The interim final rule (Interim Final Rule) of the Emergency Economic Stabilization Act of 2008 (EESA), as amended by the American Recovery and Reinvestment Act of 2009 (ARRA), provides guidance on the executive compensation and corporate governance provisions of EESA that apply to entities that receive financial assistance under the Troubled Asset Relief Program (TARP). Section 111 of EESA requires entities receiving financial assistance (TARP recipients) from the Department of the Treasury (Treasury) to meet appropriate standards for executive compensation and corporate governance. The requirements generally apply for any period during which any obligation arising from financial assistance under TARP remains outstanding(1).
Annapolis Bancorp, Inc. is a TARP recipient and is therefore subject to the provisions of the Interim Final Rule described above. However, all Executive Compensation Programs are administered through BankAnnapolis, a wholly-owned subsidiary of Annapolis Bancorp, Inc., with the exception of any stock-based awards which are administered through Annapolis Bancorp, Inc.
On June 10, 2009, the U.S. Treasury issued an interim final rule (the “Interim Final Rule”) that provides guidance on the executive compensation and corporate governance provisions of the EESA that apply to TARP recipients.
| • | Limits on compensation that exclude incentives for senior executive officers (SEOs) to take unnecessary and excessive risks that threaten the value of the TARP recipient. |
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| • | A provision for the recovery of any bonus, retention award, or incentive compensation paid to a SEO or the next twenty most highly compensated employees based on materially inaccurate statements of earnings, revenues, gains, or other criteria. |
| • | Prohibition on making any golden parachute payment to a SEO or any of the next five most highly compensated employees. |
| • | Prohibition on the payment or accrual of bonus or retention awards, or incentive compensation to SEOs or certain highly compensated employees, subject to certain exceptions for payments made in the form of restricted stock. |
| • | Prohibition on employee compensation plans that would encourage manipulation of earnings reported by the TARP recipient to enhance an employee’s compensation. |
| • | Establishment of a compensation committee of independent directors to meet semi-annually to review employee compensation plans and the risks posed by these plans to the TARP recipient. |
| • | Adoption of excessive or luxury expenditures policy. |
| • | Disclosure of perquisites offered to SEOs and certain highly compensated employees. |
| • | Disclosure related to compensation consultant engagement. |
| • | Prohibition on tax gross-ups to SEOs and certain highly compensated employees. |
| • | Compliance with federal securities rules and regulations regarding submission of a non-binding resolution on SEO compensation to shareholders. |
| • | The establishment of the Office of the Special Master for TARP Executive Compensation to address the application of these rules to TARP recipients and their employees. |
The Interim Final Rule also establishes compliance reporting and recordkeeping requirements regarding executive compensation and corporate governance standards.
| • | In addition to the standards set forth in the Interim Final Rule certain standards established in prior interim final rules have been determined to not be inconsistent with the most recent rules and thus will continue to be required. The most notable standard from earlier interim final rules is the requirement that any TARP recipient not claim a deduction for compensation during a taxable year in excess of $500,000 for an SEO. |
Regulatory Reform. In June 2009, President Obama’s administration proposed a wide range of regulatory reforms that, if enacted, may have significant effects on the financial services industry in the United States. Significant aspects of the administration’s proposals that may affect the Company included, among other things, proposals: (i) to reassess and increase capital requirements for banks and bank holding companies and examine the types of instruments that qualify as regulatory capital; (ii) to create a federal consumer financial protection agency to be the primary federal consumer protection supervisor with broad examination, supervision and enforcement authority with respect to consumer financial products and services; and (iii) to further limit the ability of banks to engage transactions with affiliates.
The U.S. Congress, state lawmaking bodies and federal and state regulatory agencies continue to consider a number of wide-ranging and comprehensive proposals for altering the structure, regulation and competitive relationships of the nation’s financial institutions, including rules and regulations related to the administration’s proposals. Separate comprehensive financial reform bills intended to address the proposals set forth by the administration were introduced in both houses of Congress in the second half of 2010 and remain under review by both the U.S. House of Representatives and the U.S. Senate. In addition, both the U.S. Treasury Department and the Basel Committee have issued policy statements regarding proposed significant changes to the regulatory capital framework applicable to banking organizations, as discussed above. The Company cannot predict whether or in what form further legislation or regulations may be adopted or the extent to which the Company may be affected thereby.
Forward Looking Statements
This Annual Report on Form 10-K contains statements that constitute forward-looking statements, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1955. These statements appear in a number of places in this Report and include all statements regarding the intent, belief or current expectations of the Company, its directors or its officers with respect to, among other things: (i) the Company’s financing plans; (ii) trends affecting the Company’s financial condition or results of operations; (iii) the Company’s growth strategy; and (iv) the declaration and payment of dividends. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, including but not limited to: changes in interest rates, deposit flows, cost of funds and demand for financial services; general economic conditions; legislative and regulatory changes; changes in tax policies, rates and regulations of federal, state and local tax authorities; and changes in accounting principles, policies and guidelines. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors discussed herein and those factors discussed in the Company’s filings with the Securities and Exchange Commission.
The Company does not intend to update these forward-looking statements, whether written or oral, to reflect change. All forward-looking statements attributable to the Company are expressly qualified by these cautionary statements.
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Not applicable.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
The executive offices of the Company and the Bank are located at 1000 Bestgate Road, Suite 400, Annapolis, Maryland 21401.
The following table sets forth the location of and certain additional information regarding the offices of the Company and the Bank at December 31, 2010:
| Leased/ Owned |
Original Year Leased or Location Acquired |
Year of Lease Expiration |
Net Book Value of Property or Leasehold Improvements at December 31, 2010 ($000) |
|||||||
| Administration (2), (3) |
Owned | 2001 | N/A | $ | 4,434 | |||||
| Bestgate |
Owned | 2001 | N/A | 1,249 | ||||||
| Edgewater |
Land Leased | 1996 | 2016 (1) | 505 | ||||||
| Cape St. Claire |
Leased | 1995 | 2015 (1) | 15 | ||||||
| Kent Island |
Land Leased | 1990 | 2023 (1) | 1,530 | ||||||
| Severna Park |
Leased | 1996 | 2013 (1) | 15 | ||||||
| BayWoods |
Leased | 2003 | 2013 (1) | 5 | ||||||
| Market House (4) |
Leased | 2006 | 2011 (1) | 69 | ||||||
| Annapolis Towne Centre |
Leased | 2008 | 2018 (1) | 318 | ||||||
| (1) | These leases may be extended at the option of the Company for periods ranging from one to twenty years. |
| (2) | The Company owns an undeveloped piece of property in Odenton, Maryland for future branch expansion. |
| (3) | The Company has entered into a long-term lease for a location in Waugh Chapel in Anne Arundel County, Maryland, the property is undeveloped and lease payments have not commenced. |
| (4) | The Company has notified its regulators and customers of its intent to close this branch effective May 27, 2011 and transfer all related deposits to its Bestgate branch. |
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company’s financial condition and results of operations.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Value and Dividend Information
The Company’s common stock is listed on The NASDAQ Capital Market® under the symbol “ANNB.” The Company’s stock began trading on October 1, 1997. At March 1, 2011 the closing price was $4.48 per share.
As of March 1, 2011 the Company has outstanding 3,943,332 shares of common stock held by approximately 201 shareholders of record. On January 30, 2009 the Company sold 8,152 shares of Series A Preferred Stock to one shareholder, the Treasury under the Treasury’s TARP CPP. The shares have a liquidation preference of $1,000 per share for an aggregate purchase price of $8.152 million. The Company has also issued a warrant to purchase 299,706 shares of common stock which may be purchased upon exercise of the warrant at a price of $4.08 per share. The warrant is also issued to the Treasury under the CPP. The warrant expires on January 30, 2019. The issuances of the warrant and the Series A Preferred Stock were completed in a private placement to Treasury exempt from the registration requirements of the Securities Act of 1933.
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Under the terms of the CPP the Company will be required to pay a 5% per annum dividend on the Series A Preferred Stock for the five years beginning January 30, 2009 ending February 15, 2014 and a 9% dividend for the period thereafter. The first dividend was paid to the Treasury on May 15, 2009 and with future dividend payments due quarterly thereafter. During 2010 $407,600 in dividends were paid to the Treasury.
The Company paid cash dividends for the first time to its stockholders during 1999 and discontinued the payment of cash dividends in 2002. The Company has no current plans to resume payments of cash dividends on its common stock as Management believes it is in the best interest of the Company to retain capital to support the growth of the Company.
As a condition to the Company’s participation in the CPP, the Company’s ability to declare or pay dividends on its common stock is restricted. Specifically, the Company may not declare dividend payments on its common stock if it is in arrears on the dividends on the Series A Preferred Stock. Until the Series A Preferred Stock issued to the Treasury under the CPP is redeemed or transferred, the Company may not pay a cash dividend without approval from the Treasury.
A summary of the Company’s quarterly stock prices is shown below:
| 2010 | 2009 | |||||||||||||||||||||||
| Stock Price Range | Per
Share Dividend |
Stock Price Range | Per
Share Dividend |
|||||||||||||||||||||
| Quarter |
High | Low | High | Low | ||||||||||||||||||||
| 1st |
$ | 4.18 | $ | 2.02 | $ | 0.0000 | $ | 4.12 | $ | 2.07 | $ | 0.0000 | ||||||||||||
| 2nd |
4.50 | 3.06 | 0.0000 | 5.00 | 2.74 | 0.0000 | ||||||||||||||||||
| 3rd |
4.40 | 3.55 | 0.0000 | 3.50 | 2.30 | 0.0000 | ||||||||||||||||||
| 4th |
4.50 | 3.45 | 0.0000 | 3.10 | 2.85 | 0.0000 | ||||||||||||||||||
The closing price of the Company’s stock at December 31, 2010 was $4.32 per share.
The table setting forth Securities Authorized for Issuance Under Equity Compensation Plans can be found under Item 12 on page 57 of this report.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes the Company’s selected financial information and other financial data. The selected balance sheet and statement of income data are derived from our audited financial statements. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes included elsewhere in this report. Results for past periods are not necessarily indicative of results that may be expected for any future period.
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Selected Consolidated Financial Highlights
Selected Consolidated Financial Data at and for years ended December 31,
| Selected Financial Data |
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
| (Dollars in thousands, except per share data) | ||||||||||||||||||||
| Total assets |
$ | 432,140 | $ | 444,332 | $ | 394,916 | $ | 361,879 | $ | 351,861 | ||||||||||
| Total loans, net |
273,063 | 274,032 | 264,093 | 243,905 | 219,794 | |||||||||||||||
| Total deposits |
340,914 | 350,463 | 300,627 | 291,589 | 274,175 | |||||||||||||||
| Securities sold under agreement to repurchase |
14,558 | 14,642 | 12,639 | 13,337 | 17,734 | |||||||||||||||
| Short-term debt |
— | — | — | 4,170 | — | |||||||||||||||
| Long-term debt |
40,000 | 45,000 | 45,000 | 25,000 | 35,000 | |||||||||||||||
| Stockholders’ equity |
34,774 | 32,632 | 26,814 | 26,852 | 24,121 | |||||||||||||||
| Selected Operating Data |
||||||||||||||||||||
| Interest income |
$ | 19,853 | $ | 21,226 | $ | 21,800 | $ | 22,466 | $ | 19,846 | ||||||||||
| Interest expense |
4,633 | 7,135 | 8,765 | 10,616 | 8,034 | |||||||||||||||
| Net interest income |
15,220 | 14,091 | 13,035 | 11,850 | 11,812 | |||||||||||||||
| Provision for credit losses |
2,148 | 6,540 | 2,375 | 448 | 12 | |||||||||||||||
| Net interest income after provision for credit losses |
13,072 | 7,551 | 10,660 | 11,402 | 11,800 | |||||||||||||||
| Noninterest income |
1,815 | 1,989 | 1,753 | 1,831 | 1,850 | |||||||||||||||
| Noninterest expense |
12,385 | 12,405 | 10,325 | 9,490 | 8,959 | |||||||||||||||
| Income (loss) before income taxes |
2,502 | (2,865 | ) | 2,088 | 3,743 | 4,691 | ||||||||||||||
| Income tax expense (benefit) |
886 | (1,158 | ) | 661 | 1,319 | 1,740 | ||||||||||||||
| Net income (loss) |
$ | 1,616 | ($ | 1,707 | ) | $ | 1,427 | $ | 2,424 | $ | 2,951 | |||||||||
| Preferred stock dividend and discount accretion |
485 | 442 | — | — | — | |||||||||||||||
| Net income (loss) available to common shareholders |
$ | 1,131 | ($ | 2,149 | ) | $ | 1,427 | $ | 2,424 | $ | 2,951 | |||||||||
| Key Financial Ratios and Other Data |
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
| Return on average assets |
||||||||||||||||||||
| Net income (loss) divided by average assets |
0.37 | % | (0.38 | %) | 0.38 | % | 0.69 | % | 0.93 | % | ||||||||||
| Return on average equity |
||||||||||||||||||||
| Net income (loss) divided by average equity |
4.68 | % | (5.24 | %) | 5.41 | % | 9.51 | % | 13.21 | % | ||||||||||
| Equity to asset ratio |
||||||||||||||||||||
| Average equity divided by average assets |
7.93 | % | 7.33 | % | 7.01 | % | 7.28 | % | 6.96 | % | ||||||||||
| Diluted earnings (loss) per common share |
$ | 0.29 | ($ | 0.56 | ) | $ | 0.35 | $ | 0.58 | $ | 0.70 | |||||||||
| Book value per common share |
$ | 6.81 | $ | 6.39 | $ | 6.98 | $ | 6.69 | $ | 5.88 | ||||||||||
| Tangible book value per common share |
$ | 6.81 | $ | 6.39 | $ | 6.98 | $ | 6.69 | $ | 5.88 | ||||||||||
| Number of common shares outstanding |
3,922,006 | 3,867,006 | 3,842,943 | 4,014,928 | 4,101,893 | |||||||||||||||
| Efficiency ratio |
72.70 | % | 77.15 | % | 69.82 | % | 69.37 | % | 65.58 | % | ||||||||||
| Interest rate spread |
3.47 | % | 3.07 | % | 3.28 | % | 3.06 | % | 3.47 | % | ||||||||||
| Net interest margin |
3.66 | % | 3.32 | % | 3.65 | % | 3.59 | % | 3.96 | % | ||||||||||
| Risk based capital ratio – Tier 1 |
12.80 | % | 12.45 | % | 11.37 | % | 12.49 | % | 12.74 | % | ||||||||||
| Risk based capital ratio – Total |
14.06 | % | 13.72 | % | 12.62 | % | 13.39 | % | 13.58 | % | ||||||||||
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following is management’s discussion and analysis of the financial condition and results of operations of Annapolis Bancorp, Inc. on a consolidated basis with its wholly owned subsidiary, BankAnnapolis, for the periods presented, and should be read in conjunction with the consolidated financial statements and the related notes thereto appearing elsewhere in this annual report.
The Company reported net income for 2010 of $1.6 million, an increase of $3.3 million or 194.7% from a net loss of $1.7 million in 2009. Net income available to common shareholders after accruing for preferred stock dividends and discount accretion for 2010 was $1.1 million compared to a net loss of $2.1 million in 2009. The increase in 2010 earnings was primarily due to the lower provision for credit losses ($2.1 million in 2010 compared to $6.5 million in 2009) and higher net interest income primarily due to decreased interest expense. The net income per diluted common share was $0.29 compared to a net loss of $0.56 per diluted common share in 2009.
The primary source of income of the Bank is interest on its loan and investment portfolios, while one of the principal expenses of the Bank is interest on its deposit accounts and borrowings. The difference between interest income on interest earning assets and interest expense on interest bearing liabilities is referred to as net interest income. Net interest income was $15.2 million for 2010, an increase of $1.1 million or 8.0% compared to $14.1 million in 2009. Total assets were $432.1 million as of December 31,
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2010, a $12.2 million or a 2.7% decrease compared to December 31, 2009 total assets of $444.3 million. The Company’s return on average assets was 0.37% and (0.38%) for the years ending December 31, 2010, and 2009, respectively. The Company’s return on average equity was 4.68% and (5.24%) for the years ending December 31, 2010, and 2009, respectively.
At December 31, 2010 the Bank’s gross loan portfolio, including loans held for sale totaled $280.1 million. Of this amount, $51.3 million or 18.3% were commercial loans, $94.9 million or 33.9% were commercial real estate loans, $33.5 million or 12.0% were construction loans, $53.0 million or 18.9% were one- to four-family residential mortgage loans, $36.7 million or 13.1% were home equity loans, and $10.7 million or 3.8% were consumer and other loans.
Application of Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements may reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability must be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are either based on quoted market prices or are provided by other third-party sources, when available.
The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements which can be found on page 34 and continuing to page 36. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses to be the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
The allowance for credit losses represents management’s estimate of probable credit losses inherent in the loan portfolio as of the balance sheet date. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements found on pages 34 and 35 describes the methodology used to determine the allowance for credit losses and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in the Credit Risk Management section of this financial analysis.
Financial Condition as of December 31, 2010 and 2009 and Results of Operations for the Years then Ended
The Company, through its Bank subsidiary, functions as a financial intermediary, and as such its financial condition and results of operations can be examined in terms of developing trends in its sources and uses of funds. These trends are the result of both external environmental factors, such as changing economic conditions, regulatory changes and competition, and also internal environmental factors such as management’s evaluation as to the best use of funds in these changing conditions.
Total assets decreased by $12.2 million or 2.7% during 2010 to $432.1 million from $444.3 million at December 31, 2009 as the Company strategically reduced total assets in response to the continued weak loan demand. Total deposits and securities sold under agreements to repurchase, the Company’s primary sources of funds, decreased $9.6 million or 2.6% to $355.5 million from $365.1 million at December 31, 2009. Time deposits totaled $77.6 million or 22.8% of the Bank’s total deposits at December 31, 2010, compared to $96.9 million or 27.7% in 2009. Savings and money market accounts, the largest portion of the Bank’s total deposits, totaled $184.6 million or 54.1% of the Bank’s total deposits at December 31, 2010, compared to $182.6 million or 52.1% in 2009. NOW accounts totaled $33.2 million or 9.7% and $30.2 million or 8.6% of total deposits at December 31, 2010 and 2009, respectively. Demand, noninterest bearing accounts totaled $45.5 million or 13.4% of total deposits at December 31, 2010 and $40.8 million or 11.7% at December 31, 2009. The increase in NOW and demand deposit accounts is due to higher balances in mortgage title company accounts, a result of increased mortgage lending activity during 2010. Securities sold under agreements to repurchase remained flat at $14.6 million at December 31, 2010 and 2009. During 2010 the Bank repaid $5.0 million in Federal Home Loan Bank convertible advances. Long-term borrowings at December 31, 2010 were $35.0 million
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compared to $40.0 million at December 31, 2009.
On March 26, 2003, Annapolis Bancorp Statutory Trust I (“Statutory Trust I”), a Connecticut business trust formed, funded and wholly owned by the Company, issued $5,000,000 of variable-rate capital securities to institutional investors. The proceeds of the securities were used to provide funding for future growth and to improve the Company’s capital ratios. The current cost of these securities is 3.45%.
The Company’s primary uses of funds are for loans and investments. Loans including loans held for sale and excluding deferred fees/costs and discounts and the allowance for credit losses, decreased by $2.0 million or 0.7% to $280.1 million at December 31, 2010 from $282.1 million a year earlier. Commercial real estate balances increased $12.7 million or 15.5% as $6.0 million in loans were reclassified from the commercial category to the commercial real estate category. In contrast commercial and industrial loans decreased $8.5 million or 14.3%. Construction loans decreased $2.7 million or 7.3% and residential real estate loan balances including loans held for sale increased by $11.8 million or 6.9%. Installment and other consumer loans decreased by $1.8 million or 14.2%.
Operating Results
The following discussion outlines some of the more important factors and trends affecting the earnings of the Company as presented in its consolidated statements of income.
Net Interest Income
Net interest income is the difference between interest income and interest expense and is generally affected by increases or decreases in the amount of outstanding interest earning assets and interest bearing liabilities (volume variance). This volume variance coupled with changes in interest rates on these same assets and liabilities (rate variance) equates to the total change in net interest income in any given period. The table on page 14 sets forth certain information regarding changes in interest income and interest expense attributable to (1) changes in volume (change in volume multiplied by the old rate); (2) changes in rates (change in rate multiplied by the old volume); and (3) changes in rate/volume (change in rate multiplied by change in volume).
Net interest income for the year ended December 31, 2010, was $15.2 million, representing an increase of $1.1 million or 8.0% from net interest income of $14.1 million for the year ended December 31, 2009. The increase in net interest income is due primarily to a decrease in the cost of interest bearing liabilities offset by a decrease in the yield on investment securities and loans. The net interest margin was 3.66% for the year ended December 31, 2010 and 3.32% for the year ended December 31, 2009. The yield on earning assets decreased to 4.77% for the year ended December 31, 2010 compared to 5.00% for the year ended December 31, 2009 while the cost of interest bearing liabilities decreased to 1.30% from 1.93% for the same periods, respectively. Net interest income for 2010 includes $197 thousand of interest collected on a cash basis related to loans on nonaccrual status, compared to $906 thousand of interest collected on nonaccrual loans in 2009.
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Rate/Volume Analysis
| 2010 vs. 2009 | 2009 vs. 2008 | |||||||||||||||||||||||||||||||
| Due to Change in | Due to Change in | |||||||||||||||||||||||||||||||
| Increase or (Decrease) |
Volume | Rate | Rate/ Volume |
Increase or (Decrease) |
Volume | Rate | Rate/ Volume |
|||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||
| Interest income on: |
||||||||||||||||||||||||||||||||
| Loans |
$ | 41 | $ | 175 | ($ | 132 | ) | ($ | 2 | ) | ($ | 1,187 | ) | $ | 1,381 | ($ | 2,377 | ) | ($ | 191 | ) | |||||||||||
| Investment securities |
(1,369 | ) | (301 | ) | (1,134 | ) | 66 | 1,070 | 1,609 | (386 | ) | (153 | ) | |||||||||||||||||||
| Interest bearing deposits in other banks |
(32 | ) | 26 | (40 | ) | (18 | ) | (220 | ) | 128 | (238 | ) | (110 | ) | ||||||||||||||||||
| Federal funds sold and other overnight investments |
(13 | ) | (23 | ) | 17 | (7 | ) | (237 | ) | 225 | (260 | ) | (202 | ) | ||||||||||||||||||
| Total interest income |
(1,373 | ) | (123 | ) | (1,289 | ) | 39 | (574 | ) | 3,343 | (3,261 | ) | (656 | ) | ||||||||||||||||||
| Interest expense on: |
||||||||||||||||||||||||||||||||
| NOW accounts |
(6 | ) | 5 | (10 | ) | (1 | ) | (3 | ) | 2 | (5 | ) | — | |||||||||||||||||||
| Money market accounts |
(141 | ) | (33 | ) | (118 | ) | 10 | (982 | ) | (370 | ) | (833 | ) | 221 | ||||||||||||||||||
| Savings accounts |
(1,097 | ) | (10 | ) | (1,091 | ) | 4 | 594 | 1,816 | (617 | ) | (605 | ) | |||||||||||||||||||
| Certificates of deposit |
(1,128 | ) | (324 | ) | (916 | ) | 112 | (987 | ) | 292 | (1,184 | ) | (95 | ) | ||||||||||||||||||
| Repurchase agreements |
(14 | ) | 13 | (24 | ) | (3 | ) | (136 | ) | (28 | ) | (121 | ) | 13 | ||||||||||||||||||
| Short-term borrowing |
— | — | — | — | — | — | 2 | (2 | ) | |||||||||||||||||||||||
| Long-term borrowing |
(89 | ) | (122 | ) | 37 | (4 | ) | 12 | 15 | (3 | ) | — | ||||||||||||||||||||
| Junior subordinated debt |
(27 | ) | — | (27 | ) | — | (128 | ) | — | (128 | ) | — | ||||||||||||||||||||
| Total interest expense |
(2,502 | ) | (471 | ) | (2,149 | ) | 118 | (1,630 | ) | 1,727 | (2,889 | ) | (468 | ) | ||||||||||||||||||
| Net interest income |
$ | 1,129 | $ | 348 | $ | 860 | ($ | 79 | ) | $ | 1,056 | $ | 1,616 | ($ | 372 | ) | ($ | 188 | ) | |||||||||||||
Interest Income
The Company’s interest income decreased $1.4 million or 6.5% to $19.8 million for the year ended December 31, 2010 from $21.2 million for the year ended December 31, 2009. The decrease in interest income can be attributed to a decrease in the yield on earning assets offset by a slight increase in average loan balances. Average loans increased $3.0 million or 1.1%, while the loan yield decreased to 5.78% for the year ended December 31, 2010 from 5.83% for the year ended December 31, 2009. Contributing to the decrease in interest income is a decrease in the yield on the securities portfolio dropping to 3.56% from 4.57%. Average federal funds sold balances decreased $5.3 million or 26.1% and interest bearing balances with banks remained flat. Yields on federal funds sold and interest bearing balances with banks decreased to 0.22% and 0.18% for the year ended December 31, 2010 from 0.23% and 0.35% for the year ended December 31, 2009, respectively.
Interest Expense
The Company’s interest expense decreased $2.5 million or 35.1% to $4.6 million for 2010, compared to $7.1 million for 2009. The decrease in interest expense for the year ended December 31, 2010 can be attributed primarily to lower interest rates on all of the Bank’s deposit accounts, repurchase agreement accounts and the junior subordinated debentures.
Provision for Credit Losses
The Company recorded a provision for credit losses of $2.1 million for the year ended December 31, 2010 compared to $6.5 million for the year ended December 31, 2009, a decrease of $4.4 million or 67.2%. The decrease in provision was primarily the result of a decrease in nonperforming assets offset by the impact of net charge-offs on the historical loss factor of the methodology used to calculate the allowance for credit losses.
Nonperforming assets at year end decreased to $10.1 million for the year ended December 31, 2010 from $19.3 million for the year ended December 31, 2009. Nonperforming assets included $1.6 million of foreclosed real estate at December 31, 2010 and $145 thousand of repossessed assets. Nonperforming assets of $19.3 million at December 31, 2009 included $2.4 million of foreclosed real estate and $122 thousand of repossessed assets.
Net charge-offs totaled $3.2 million for the year ended December 31, 2010 compared to net charge-offs of $2.7 million for the same period in 2009. The charge-offs for both 2010 and 2009 were concentrated in the land acquisition and development portfolio and in the commercial and consumer and installment portfolios. See the discussion under the heading “Provision for Credit Losses and Credit Risk Management” on pages 22 through 24 for greater analysis regarding the Allowance for Credit Losses and related provision.
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Noninterest Income
The Company’s primary sources of noninterest income are fees charged on deposit products, fees generated by the Bank’s VISA check card program, fees recognized on the sale of residential mortgage loans or residential mortgage loans originated by a broker. In 2009 noninterest income also included rental income from leasing space at the Bank’s headquarters building. No rental income was collected on the headquarters building in 2010 compared to $171 thousand collected for the year ended December 31, 2009 as the leased space in the Bank’s headquarters was vacated in December 2009. Noninterest income decreased $174 thousand for the year ended December 31, 2010 to $1.8 million compared to $2.0 million for the year ended December 31, 2009, a decrease of 8.7%. Included in noninterest income for the year ended December 31, 2010 were gains on the sale of loans in the secondary market of $159 thousand compared to $135 thousand for the year ended December 31, 2009. For the year ended December 31, 2010 the Bank recorded net losses on the sale of other assets primarily real estate owned and repossessed assets of $50 thousand compared to gains of $56 thousand in 2009 on similar assets. The Bank also recorded a loss of $55 thousand on the sale of securities available for sale during 2010 with no losses recorded in 2009. Fees charged on deposit products decreased $14 thousand or 1.2%, while other mortgage banking fees totaled $74 thousand for the year ended December 31, 2010, a decrease of $24 thousand or 24.5% from fees of $98 thousand for the year ended December 31, 2009.
Noninterest Expense
Noninterest expense decreased $20 thousand or 0.2% remaining at $12.4 million for the year ended December 31, 2010, compared to $12.4 million for the year ended December 31, 2009. Personnel costs increased $244 thousand while marketing expense increased $101 thousand for the year ended December 31, 2010. These increases were offset by a decrease in legal expenses of $175 thousand due to lower collection costs and FDIC expense. FDIC expense decreased $340 thousand for the year ended December 31, 2010 compared to the year ended December 31, 2009 due to lower deposit levels in 2010 and due to 2009 including a special assessment of $212 thousand recognized in the second quarter of 2009.
Personnel expense increased $244 thousand or 3.7% to $6.8 million from $6.6 million, with $103 thousand due to staff additions for business development purposes, merit increases and $135 thousand related to increased benefit costs.
Occupancy and equipment expense increased $78 thousand or 5.1% primarily due to repairs and equipment maintenance costs and increased depreciation costs. Repairs and equipment maintenance increased $60 thousand for the year ended December 31, 2010 due to costs associated with adding an image document storage system and to building maintenance at the headquarters building and branches. Depreciation and amortization expense increased $20 thousand due to renovations completed in several of the Bank’s branches.
Provision for Income Taxes
The Company and the Bank file consolidated federal income tax returns and separate Maryland income tax returns. The Company recognized tax expense of $886 thousand for the year ended December 31, 2010 compared to a tax benefit of $1.2 million year ended December 31, 2009, for an effective tax rate of 35.4% in 2010 and (40.4%) in 2009.
Consolidated Average Balances, Yields and Rates
The following table presents a condensed average balance sheet as well as income/expense and yields/costs of funds thereon for the years ended December 31, 2010 and 2009. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities for the periods shown. Average balances are derived from average daily balances. The yields and costs include loan fees that are considered adjustments to yields. Net interest spread, the difference between the average rate on interest bearing assets and the average rate on interest bearing liabilities, increased to 3.47% for the year ended December 31, 2010 from 3.07% at December 31, 2009.
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| Years Ended | ||||||||||||||||||||||||
| December 31, 2010 | December 31, 2009 | |||||||||||||||||||||||
| Average Balance |
Interest (1) |
Yield/ Rate |
Average Balance |
Interest (1) |
Yield/ Rate |
|||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||
| Assets |
||||||||||||||||||||||||
| Interest Earning Assets |
||||||||||||||||||||||||
| Federal funds sold and other overnight investments |
$ | 14,868 | $ | 32 | 0.22 | % | $ | 20,126 | $ | 46 | 0.23 | % | ||||||||||||
| Interest bearing balances in other banks |
18,106 | 32 | 0.18 | % | 18,161 | 63 | 0.35 | % | ||||||||||||||||
| Investment securities (2) |
105,989 | 3,776 | 3.56 | % | 112,554 | 5,145 | 4.57 | % | ||||||||||||||||
| Loans |
276,984 | 16,013 | 5.78 | % | 273,990 | 15,972 | 5.83 | % | ||||||||||||||||
| Total interest earning assets |
415,947 | 19,853 | 4.77 | % | 424,831 | 21,226 | 5.00 | % | ||||||||||||||||
| Noninterest Earning Assets |
||||||||||||||||||||||||
| Cash and due from banks |
4,044 | 7,018 | ||||||||||||||||||||||
| Other assets |
15,487 | 12,565 | ||||||||||||||||||||||
| Total Assets |
$ | 435,478 | $ | 444,414 | ||||||||||||||||||||
| Liabilities and Stockholders’ Equity |
||||||||||||||||||||||||
| Interest Bearing Deposits |
||||||||||||||||||||||||
| NOW accounts |
$ | 30,003 | $ | 45 | 0.15 | % | $ | 27,211 | $ | 51 | 0.19 | % | ||||||||||||
| Money market accounts |
42,191 | 272 | 0.64 | % | 45,866 | 413 | 0.90 | % | ||||||||||||||||
| Savings accounts |
140,580 | 1,348 | 0.96 | % | 140,874 | 2,445 | 1.74 | % | ||||||||||||||||
| Certificates of deposit |
85,190 | 1,533 | 1.80 | % | 96,987 | 2,661 | 2.74 | % | ||||||||||||||||
| Repurchase agreements |
16,516 | 107 | 0.65 | % | 14,912 | 121 | 0.81 | % | ||||||||||||||||
| Long-term borrowings |
36,065 | 1,151 | 3.15 | % | 40,000 | 1,240 | 3.06 | % | ||||||||||||||||
| Junior subordinated debt |
5,000 | 177 | 3.49 | % | 5,000 | 204 | 4.02 | % | ||||||||||||||||
| Total interest bearing liabilities |
355,545 | 4,633 | 1.30 | % | 370,850 | 7,135 | 1.93 | % | ||||||||||||||||
| Noninterest Bearing Liabilities |
||||||||||||||||||||||||
| Demand deposit accounts |
43,273 | 39,239 | ||||||||||||||||||||||
| Other liabilities |
2,113 | 1,729 | ||||||||||||||||||||||
| Stockholders’ Equity |
34,547 | 32,596 | ||||||||||||||||||||||
| Total Liabilities and Stockholders’ Equity |
$ | 435,478 | $ | 444,414 | ||||||||||||||||||||
| Interest rate spread |
3.47 | % | 3.07 | % | ||||||||||||||||||||
| Ratio of interest earning assets to interest bearing liabilities |
116.99 | % | 114.56 | % | ||||||||||||||||||||
| Net interest income and net interest margin |
$ | 15,220 | 3.66 | % | $ | 14,091 | 3.32 | % | ||||||||||||||||
| (1) | No tax-equivalent adjustments are made, as the effect would not be material. |
| (2) | Includes Federal Reserve and Federal Home Loan Bank stock. |
Risk Management
The Board of Directors is the foundation for effective corporate governance and risk management. The Board demands accountability of management, keeps stockholders’ and other constituencies’ interests in focus, advocates the upholding of the Company’s code of ethics, and fosters a strong internal control environment. Through its Audit Committee, the Board actively reviews critical risk positions, including market, credit, liquidity, and operational risk. The Company’s goal in managing risk is to reduce earnings volatility, control exposure to unnecessary risk, and ensure appropriate returns for risk assumed. Senior management manages risk at the business line level, supplemented with corporate-level oversight through the Asset Liability Committee, internal audit and quality control functions.
Liquidity Risk Management and Capital Resources
The objective of liquidity management is to ensure that the cash flow requirements of depositors and borrowers, as well as the operating cash needs of the Company are met, taking into account all on- and off-balance sheet funding demands. Liquidity management also includes ensuring that cash flow needs are met at a reasonable cost. Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or the Company may become unduly reliant on alternative funding sources. The Company maintains a liquidity risk management policy to address and manage this risk. The policy identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements which comply with regulatory guidance. The policy is updated at a minimum on a yearly basis. The liquidity position is continually monitored and reported monthly to the Board of Directors.
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Deposits, commercial reverse repurchase agreements, and lines of credit are the primary sources of the Bank’s funds for lending and investing activities. As of December 31, 2010 the Company’s deposit and repurchase agreement balances decreased $9.6 million or 2.6% over December 31, 2009 balances. At December 31, 2010 the Company also had available both secured and unsecured lines of credit with the Federal Home Loan Bank and correspondent banks totaling $14.2 million. Secondary sources of funds are derived from loan repayments and investment maturities. Loan repayments and investment maturities can be considered a relatively stable funding source, while deposit activity is greatly influenced by interest rates, general market conditions and competition.
The Bank offers a variety of retail deposit account products to both consumer and commercial deposit customers. The Bank’s deposit accounts consist of savings, NOW accounts, checking accounts, money market accounts and certificate of deposit accounts. The Bank also offers individual retirement accounts. Time deposits comprised 22.8% of the deposit portfolio at December 31, 2010. Core deposits, considered to be noninterest bearing and interest bearing demand deposit accounts, savings deposits and money market accounts, accounted for 77.2% of the deposit portfolio at December 31, 2010. This represents a 4.9% increase in the percentage of core deposits to total deposits. Core deposits accounted for 72.4% of the deposit portfolio at December 31, 2009.
The Bank intends to continue to emphasize retail deposit accounts as its primary source of liquidity. Deposit products are promoted in periodic newspaper advertisements, along with notices provided in customer account statements. The Bank’s market strategy is based on its reputation as a community bank providing quality products and personal customer service.
The Bank pays interest rates on interest bearing deposit products competitive with rates offered by other financial institutions in its market area, and in certain deposit categories may lead the market. Interest rates on deposits are reviewed by management which considers a number of factors including: (1) the Bank’s internal cost of funds; (2) rates offered by competing financial institutions; (3) investing and lending opportunities; and (4) the Bank’s liquidity position.
Jumbo certificates of deposit are accounts of $100,000 or more. These accounts totaled $46.8 million at December 31, 2010 and consisted principally of time certificates of deposit. The following table sets forth the amount and maturity of jumbo certificates of deposit at December 31, 2010:
| Three Months or Less |
Greater than Three Months to Six Months |
Greater than Six Months to One Year |
Greater than One Year |
Total | ||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||
| $ | 11,468 | $ | 9,936 | $ | 10,500 | $ | 14,928 | $ | 46,832 | |||||||||
Securities sold under agreements to repurchase represent transactions with customers for correspondent or commercial account cash management services. These are overnight borrowing arrangements with interest rates discounted from the federal funds sold rate. Securities underlying the repurchase agreements are maintained in the Company’s control. For the years ended December 31, 2010 and 2009, the average cost of these borrowings was 0.65% and 0.81%, respectively.
The Bank maintains a secured borrowing line with the Federal Home Loan Bank (FHLB) with the potential to draw up to $108.0 million, and may borrow up to $14.2 million under secured and unsecured lines established with correspondent commercial banks. In addition, the Bank has the ability to borrow directly from the Federal Reserve Bank discount window. At December 31, 2010, the Bank had advances outstanding of $35.0 million under the Federal Home Loan Bank’s convertible advance program and had no borrowings outstanding under its secured and unsecured lines of credit.
Potential adverse impacts on liquidity can occur as a result of changes in the estimated cash flows from investment, loan, and deposit portfolios. The Bank manages this inherent risk by maintaining a portfolio of available for sale investments and through secondary sources of liquidity including FHLB advances and reverse repurchase agreements. In addition, the Bank has the ability to increase its liquidity by raising interest rates on deposit accounts, selling loans in the secondary market or curtailing the volume of loan originations.
The Bank maintains the majority of the assets held for liquidity purposes in overnight federal funds and short-term interest bearing balances with banks.
Interest Rate Risk Sensitivity
Interest rate sensitivity is an important factor in the management of the composition and maturity configurations of the Company’s interest earning assets and funding sources. Additionally, the Bank’s profitability is dependent to a large extent upon
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its net interest income, which is the difference between its interest income on interest bearing assets, such as loans and investments, and its interest expense on its funding sources, such as deposits and borrowings. Accordingly, the Bank’s results of operations and financial condition are largely dependent on movements in market interest rates and its ability to manage its assets in response to such movements.
The Bank attempts to manage fluctuations in interest rates by matching the maturities of its interest earning assets and interest bearing liabilities. The Bank’s current strategy to manage its sensitivity to interest rate fluctuations is to emphasize adjustable rate loans and short and intermediate-term fixed rate loans. To reduce the negative impact of engaging in excessive fixed rate lending in a volatile rate environment, the Bank uses a third party for settlement long-term fixed rate loans and sells the majority of those loans in the secondary market.
The following table summarizes the anticipated maturities or repricing of the Company’s interest earning assets and interest bearing liabilities as of December 31, 2010, and the Company’s interest sensitivity gap (i.e., interest earning assets less interest bearing liabilities). A positive gap for any time period indicates that more interest earning assets will mature or reprice during that period than interest bearing liabilities. The Company’s goal is to maintain a cumulative gap position for the period of one year or less of plus or minus fifteen percent in order to mitigate the impact of changes in interest rates on liquidity, interest margins and operating results. The actual results show the Bank to be negatively gapped cumulatively in the three to twelve month category.
The analysis presented below represents a modified gap position for interest sensitive assets and liabilities at December 31, 2010.
Interest Sensitivity Gap Analysis
December 31, 2010
| Within Three Months |
After Three but within Twelve Months |
After One but within Five Years |
After Five Years |
Total | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
| Assets |
||||||||||||||||||||
| Federal funds sold and other overnight investments |
$ | 11,984 | $ | — | $ | — | $ | — | $ | 11,984 | ||||||||||
| Interest bearing balances with banks |
16,678 | — | 178 | — | 16,856 | |||||||||||||||
| Investment securities (1) |
14,921 | 26,236 | 10,256 | 44,264 | 95,677 | |||||||||||||||
| Loans (2) (3) |
75,255 | 36,684 | 102,163 | 58,023 | 272,125 | |||||||||||||||
| $ | 118,838 | $ | 62,920 | $ | 112,597 | $ | 102,287 | $ | 396,642 | |||||||||||
| Liabilities |
||||||||||||||||||||
| Interest bearing liabilities |
||||||||||||||||||||
| NOW accounts (5) |
$ | 6,644 | $ | 3,322 | $ | 23,254 | $ | — | $ | 33,220 | ||||||||||
| Money market accounts (5) |
28,820 | 1,828 | 11,285 | — | 41,933 | |||||||||||||||
| Savings accounts (5) |
68,747 | 14,263 | 59,617 | — | 142,627 | |||||||||||||||
| Certificates of deposit (4) |
17,380 | 34,636 | 25,604 | — | 77,620 | |||||||||||||||
| Commercial repurchase agreements |
14,558 | — | — | — | 14,558 | |||||||||||||||
| Long-term borrowings |
15,000 | — | 20,000 | — | 35,000 | |||||||||||||||
| Junior subordinated debt |
5,000 | — | — | — | 5,000 | |||||||||||||||
| $ | 156,149 | $ | 54,049 | $ | 139,760 | $ | — | $ | 349,958 | |||||||||||
| Interest sensitivity gap |
($ | 37,311 | ) | $ | 8,871 | ($ | 27,163 | ) | $ | 102,287 | $ | 46,684 | ||||||||
| Cumulative interest sensitivity gap |
($ | 37,311 | ) | ($ | 28,440 | ) | ($ | 55,603 | ) | $ | 46,684 | |||||||||
| Cumulative interest sensitivity gap as a percentage of total interest-earning assets |
(9.41 | %) | (7.17 | %) | (14.02 | %) | 11.77 | % | ||||||||||||
| (1) | Net of Federal Reserve Bank, Federal Home Loan Bank stock and other equity investments, debt securities by call date. |
| (2) | Loans scheduled by contractual maturities. |
| (3) | Net of non-accrual loans of $7.8 million and deferred costs of $162 thousand. |
| (4) | Certificates of deposits scheduled by contractual maturities. |
| (5) | NOW, savings and money market accounts are presented using decay rates and historical repricing patterns. |
Investment Portfolio
At December 31, 2010, the Bank’s investment portfolio, which totaled $99.3 million, consisted primarily of U.S. Government Agency securities and mortgage-backed securities. Additionally, the Company owns $748,750 in stock of the Federal Reserve Bank of Richmond, $2,285,900 in stock of the Federal Home Loan Bank of Atlanta (FHLB) and a $618 thousand investment in a community development activity qualified mutual fund.
Investment decisions are made within policy guidelines established by the Board of Directors. It is the Bank’s policy to invest in non-speculative debt instruments, particularly debt instruments that are guaranteed by the U.S. Government or an agency thereof, to maintain a diversified investment portfolio which complements the overall asset/liability and liquidity objectives of the Bank, while limiting the related credit risk to an acceptable level. To meet the credit risk objectives, non-government debt instruments
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must have a rating of “B” or better to be held in the portfolio. The Bank’s investment policy designates the investment portfolio to be classified as “available-for-sale,” unless otherwise designated. At December 31, 2010, 100% of the investment portfolio was classified available-for-sale. The composition of securities at December 31 for each of the past five fiscal years was:
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
| Available for Sale |
||||||||||||||||||||
| U.S. Agency |
$ | 53,761 | $ | 54,788 | $ | 47,297 | $ | 55,496 | $ | 51,127 | ||||||||||
| State and Municipal |
1,089 | 1,089 | 834 | 868 | 1,029 | |||||||||||||||
| Mortgage-backed |
40,828 | 61,415 | 32,035 | 24,181 | 24,526 | |||||||||||||||
| Equity Securities |
617 | 591 | 564 | 541 | 511 | |||||||||||||||
| Total Securities |
$ | 96,295 | $ | 117,883 | $ | 80,730 | $ | 81,086 | $ | 77,193 | ||||||||||
The following table presents maturities and weighted average yields for investments in available-for-sale securities.
December 31, 2010
| Years to Maturity | ||||||||||||||||||||||||
| Within One Year | Within One Year to Five Years | Within Five to Ten Years | ||||||||||||||||||||||
| Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||
| Available for Sale |
||||||||||||||||||||||||
| U.S. Agency |
$ | 7,014 | 0.75 | % | $ | 13,861 | 1.91 | % | $ | 21,088 | 2.81 | % | ||||||||||||
| State and Municipal |
— | 0.00 | % | 392 | 4.35 | % | 697 | 3.90 | % | |||||||||||||||
| Mortgage-backed |
— | 0.00 | % | — | 0.00 | % | 2,815 | 4.66 | % | |||||||||||||||
| Total Debt Securities |
$ | 7,014 | 0.75 | % | $ | 14,253 | 1.98 | % | $ | 24,600 | 3.04 | % | ||||||||||||
| Greater than Ten Years | ||||||||||||||||||||||||
| Amount | Yield | Total | ||||||||||||||||||||||
| Available for Sale |
||||||||||||||||||||||||
| U.S. Agency |
$ | 11,798 | 4.17 | % | $ | 53,761 | ||||||||||||||||||
| State and Municipal |
— | 0.00 | % | 1,089 | ||||||||||||||||||||
| Mortgage-backed |
38,013 | 4.62 | % | 40,828 | ||||||||||||||||||||
| Total Debt Securities |
$ | 49,811 | 4.51 | % | $ | 95,678 | ||||||||||||||||||
Actual maturities of these securities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.
Lending Activities
The types of loans that the Bank may originate are subject to federal laws and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors.
These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the federal government, including the Federal Reserve Board, and legislative tax policies.
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Analysis of Loans
The following table presents the composition of the loan portfolio over the previous five years:
As of December 31,
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||||||||||||||||||||||
| Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||
| Commercial loans |
$ | 51,359 | 18.3 | % | $ | 59,900 | 21.2 | % | $ | 53,366 | 19.9 | % | $ | 46,007 | 18.7 | % | $ | 40,545 | 18.3 | % | ||||||||||||||||||||
| Real estate loans |
||||||||||||||||||||||||||||||||||||||||
| Commercial |
94,864 | 33.9 | % | 82,168 | 29.2 | % | 78,215 | 29.1 | % | 71,537 | 29.0 | % | 60,995 | 27.5 | % | |||||||||||||||||||||||||
| Construction |
33,534 | 12.0 | % | 36,185 | 12.8 | % | 28,381 | 10.6 | % | 24,563 | 10.0 | % | 23,304 | 10.5 | % | |||||||||||||||||||||||||
| One to four-family (1) |
52,960 | 18.9 | % | 57,098 | 20.2 | % | 66,964 | 24.9 | % | 64,796 | 26.3 | % | 57,251 | 25.8 | % | |||||||||||||||||||||||||
| Home equity |
36,697 | 13.1 | % | 34,262 | 12.2 | % | 27,072 | 10.1 | % | 21,376 | 8.7 | % | 22,567 | 10.2 | % | |||||||||||||||||||||||||
| Consumer loans |
10,664 | 3.8 | % | 12,479 | 4.4 | % | 14,422 | 5.4 | % | 18,070 | 7.3 | % | 17,063 | 7.7 | % | |||||||||||||||||||||||||
| Total loans |
280,078 | 100.0 | % | 282,092 | 100.0 | % | 268,420 | 100.0 | % | 246,349 | 100.0 | % | 221,725 | 100.0 | % | |||||||||||||||||||||||||
| Less: |
||||||||||||||||||||||||||||||||||||||||
| (Unearned income), deferred costs |
(162 | ) | (134 | ) | (204 | ) | (161 | ) | 45 | |||||||||||||||||||||||||||||||
| Allowance for credit losses |
(6,853 | ) | (7,926 | ) | (4,123 | ) | (2,283 | ) | (1,976 | ) | ||||||||||||||||||||||||||||||
| Net loans receivable |
$ | 273,063 | $ | 274,032 | $ | 264,093 | $ | 243,905 | $ | 219,794 | ||||||||||||||||||||||||||||||
| (1) | Includes loans held for sale. |
The Bank’s loan portfolio consists of commercial, commercial real estate, residential construction, one- to four-family residential mortgage, home equity and consumer loans. At December 31, 2010 the Bank’s loan portfolio totaled $280.1million. All of the loans in the Bank’s portfolio are either adjustable-rate with terms to maturity of 30 days to 30 years or short- to intermediate-term fixed-rate loans.
The following table presents the maturity distribution of the loan portfolio:
As of December 31, 2010
| Due in One Year or Less |
Due after One Year but before Five Years |
Due after Five Years |
Nonaccrual Loans |
90 Days Past Due |
Total | |||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||
| Commercial loans |
$ | 26,452 | $ | 15,818 | $ | 6,982 | $ | 2,107 | $ | — | $ | 51,359 | ||||||||||||
| Real estate loans |
||||||||||||||||||||||||
| Commercial |
22,185 | 51,534 | 19,517 | 1,030 | 598 | 94,864 | ||||||||||||||||||
| Construction |
25,930 | 6,199 | — | 1,405 | — | 33,534 | ||||||||||||||||||
| One to four-family (1) |
15,348 | 22,287 | 13,230 | 2,095 | — | 52,960 | ||||||||||||||||||
| Home equity loans |
20,452 | 1,605 | 14,116 | 524 | — | 36,697 | ||||||||||||||||||
| Consumer loans |
1,136 | 4,904 | 3,994 | 630 | — | 10,664 | ||||||||||||||||||
| Total loans |
$ | 111,503 | $ | 102,347 | $ | 57,839 | $ | 7,791 | $ | 598 | $ | 280,078 | ||||||||||||
| Due After One Year (2) | ||||||||||||||||||||||||
| Fixed Rate |
Variable Rate |
Total | ||||||||||||||||||||||
| Commercial loans |
$ | 18,350 | $ | 4,450 | $ | 22,800 | ||||||||||||||||||
| Real estate loans |
||||||||||||||||||||||||
| Commercial |
30,115 | 40,936 | 71,051 | |||||||||||||||||||||
| Construction |
6,199 | — | 6,199 | |||||||||||||||||||||
| One to four-family (1) |
18,838 | 16,679 | 35,517 | |||||||||||||||||||||
| Home equity loans |
15,721 | — | 15,721 | |||||||||||||||||||||
| Consumer loans |
3,290 | 5,608 | 8,898 | |||||||||||||||||||||
| Total loans |
$ | 92,513 | $ | 67,673 | $ | 160,186 | ||||||||||||||||||
| (1) | Includes loans held for sale. |
| (2) | Excludes nonaccruals loans and 90 days past due loans. |
Commercial Lending. The Bank offers commercial business loans to businesses operating in the Bank’s primary market area.
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These loans consist of lines of credit, which may require an annual repayment, adjustable-rate loans with terms of five to seven years, and fixed-rate loans with terms of up to five years. Such loans are generally secured by receivables, inventories, equipment and other assets of the business. The Bank generally requires personal guarantees on its commercial loans. The Bank also offers unsecured commercial loans to businesses on a selective basis. These types of loans are made to existing customers and are of a short duration, generally one year or less. The Bank also originates commercial loans which are guaranteed by the Small Business Administration. The Bank has been a participant in a variety of SBA loan programs.
Commercial Real Estate Lending. The Bank originates adjustable-rate commercial real estate loans that are generally secured by properties used for business purposes such as small office buildings and retail facilities located in the Bank’s primary market area. The Bank’s underwriting procedures provide that commercial real estate loans may generally be made in amounts up to 80-85% of the lower of the appraised value or sales price of the property, subject to the Bank’s current loans-to-one-borrower limit, which at December 31, 2010, was $6.4 million. These loans may be made with terms up to 30 years if owner occupied and are generally offered at interest rates which adjust annually or annually after an initial three-, five- or seven-year period in accordance with the prime rate, or the 3 and 5 year U.S. Constant Maturity Indices as reported in the Wall Street Journal. In reaching a decision whether to make a commercial real estate loan, the Bank considers the value of the real estate to be financed and the credit strength of the borrower and/or the lessee of the real estate project. The Bank has generally required that properties securing commercial real estate loans have debt service coverage ratios of at least 1.2:1.
Loans secured by commercial real estate properties generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards, which require such loans to be qualified on the basis of the property’s value, debt service coverage ratio, and, under certain circumstances, additional collateral. The Bank generally requires personal guarantees on its commercial real estate loans.
Construction Lending. The Bank originates construction loans on both one- to four-family residences and on commercial real estate properties. The Bank originates two types of residential construction loans, consumer and builder. The Bank originates consumer construction loans to build a primary residence, a secondary residence, or an investment or rental property. The Bank will originate builder construction loans to companies engaged in the business of constructing homes for resale. These loans may be for homes currently under contract for sale, model homes from which other homes will be marketed within a subdivision or, on a very limited basis, homes built for speculative purposes to be marketed for sale during construction. The Bank offers permanent end-financing to the Bank’s construction loan customers generally on a 3/1 or 5/1 ARM basis.
The Bank originates land acquisition and development loans with the source of repayment being either the sale of finished lots or the sale of homes to be constructed on the finished lots. The Bank will originate land acquisition, development, and construction loans on a revolving line of credit basis for subdivisions whereby the borrower may draw upon such line of credit as lots are sold for the purpose of improving additional lots. Construction loans are generally offered with terms up to twelve months for consumer and builder loans, and up to twenty-four months for land development loans.
Construction loans are generally made in amounts up to 80% of the appraised market value of the security property. During construction, loan proceeds are disbursed in draws as construction progresses based upon inspections of work in place by independent construction inspectors.
At December 31, 2010, the Bank had construction loans, including land acquisition and development loans, totaling $33.5 million, or 12.0% of the Bank’s total loan portfolio, of which $2.3 million consisted of one- to four-family residential construction loans, $7.8 million consisted of commercial real estate construction loans and $23.4 million consisted of land acquisition and development loans. Construction loans are generally considered to involve a higher degree of credit risk than long-term financing of improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security property’s value upon completion of construction as compared to the estimated costs of construction, including interest. Also, the Bank assumes certain risks associated with the borrowers’ ability to complete construction in a timely and workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is not performed timely or accurately, the Bank may be faced with a project which, when completed, has a value that is insufficient to assure full repayment.
One- to Four-Family Residential Mortgage Lending. The Bank currently offers both fixed-rate and adjustable-rate mortgage loans, first and second mortgage loans secured by one- to four-family residences and lot loans for one- to four-family residences located throughout the Baltimore-Washington Metropolitan area. It is currently the general policy of the Bank to originate for sale in the secondary market one- to four-family fixed-rate residential mortgage loans which conform, except as to size, to the underwriting standards of Fannie Mae and Freddie Mac, and to originate for investment adjustable rate one- to four-family residential mortgage loans. The Bank generally does not retain the servicing rights of loans it sells and sells such loans without recourse, with the exception of recourse in the event of breaches in any representations or warranties made by the Bank. The
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Bank recognizes, at the end of the recourse period, the cash gain or loss on the sale of the loans based on the difference between the net cash proceeds received and the carrying value of the loans sold. One- to four-family loans currently held for sale totaled $1.4 million at December 31, 2010. One- to four-family mortgage loan originations are generally obtained from the Bank’s loan representatives and their contacts in the local real estate industry, direct contacts made by the Bank’s and the Company’s directors, existing or past customers, and members of the local communities.
At December 31, 2010, one- to four-family residential mortgage loans totaled $53.0 million, or 18.9% of total loans. Of the one-to four-family mortgage loans outstanding at that date, $27.1 million were fixed-rate loans with terms of up to fifteen years with a balloon payment at the end of the term, and $25.9 million were adjustable-rate loans with terms of up to 30 years and interest rates which adjust annually from the outset of the loan or which adjust annually after a 3 or 5 year initial period in which the loan has a fixed rate. The interest rates for the majority of the Bank’s adjustable-rate mortgage loans are indexed to the one-year Treasury Constant Maturity Index. Interest rate increases on such loans are limited to a 2% annual adjustment cap with a maximum adjustment of 6% over the life of the loan.
The origination of adjustable-rate residential mortgage loans, as opposed to fixed-rate residential mortgage loans, helps to reduce the Bank’s exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default.
Periodic and lifetime caps on interest rate increases help to reduce the risks associated with the Bank’s adjustable-rate loans, but also limit the interest rate sensitivity of its adjustable-rate mortgage loans.
The Bank currently originates one- to four-family residential mortgage loans in amounts typically up to 80% (or higher with private mortgage insurance) of the lower of the appraised value or the selling price of the property securing the loan. Mortgage loans originated by the Bank generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Bank’s consent. Due-on-sale clauses are an important means of adjusting the yields on the Bank’s fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses.
Home Equity Lending. As of December 31, 2010, home equity loans totaled $36.7 million, or 13.1% of the Bank’s total loan portfolio. Fixed-rate, fixed-term home equity loans and adjustable rate home equity lines of credit are generally offered in amounts up to 80% of the market value of the security property. Home equity lines of credit are offered with terms up to twenty years. Of the $36.7 million in home equity loans, $15.7 million are fixed rate with terms up to 10 years. The remaining $21.0 million of the Bank’s home equity loans are adjustable rate and reprice with changes in the Wall Street Journal prime rate.
Consumer Lending. The Bank’s portfolio of consumer loans primarily consists of adjustable rate, personal lines of credit and generally fixed rate installment loans secured by new or used automobiles, new or used boats, and loans secured by deposit accounts. At December 31, 2010, consumer loans totaled $10.7 million or 3.8% of total loans outstanding. Consumer loans are generally originated in the Bank’s primary market area.
Provision for Credit Losses and Credit Risk Management
Originating loans involves a degree of risk that credit losses will occur in varying amounts according to, among other factors, the type of loans being made, the credit-worthiness of the borrowers over the term of the loans, the quality of the collateral for the loan, if any, as well as general economic conditions.
The Bank’s allowance for credit losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for credit losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. The Bank estimates an acceptable allowance for credit loss with the objective of quantifying portfolio risk into a dollar figure of inherent losses, thereby translating the subjective risk value into an objective number. Emphasis is placed on independent external loan reviews and regular internal reviews. The determination of the allowance for loan losses is based on a combination of the higher of the Bank’s historical loss experience or the peer group average historical loss experience and ten (10) qualitative factors for specific categories and types of loans. The combination of the loss experience factor and the total qualitative factors (“Total ALLL Factor”) is expressed as a percentage of the portfolio for specific categories and types of loans to create the inherent loss index for each loan portfolio. Individual loans deemed impaired are separated from the respective loan portfolios and a specific reserve allocation is assigned based upon Bank management’s best estimate as to the loss exposure for each loan. Each Total ALLL Factor is assigned a percentage weight and that total weight is applied to each loan category. The Total ALLL Factor is different for each loan type and for each risk assessment category within each loan type.
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| • | The Bank’s historical loss experience is calculated by aggregating the actual loan losses by category for the previous eight quarters and converting that total into a percentage for each loan category. |
| • | Peer Group average loss experience is calculated by averaging the industry loss experience by loan category over the last eight rolling quarters. |
| • | Qualitative factors include: levels and trends in delinquencies and non-accruals; trends in volumes and terms of loans; effects of any changes in lending policies; the experience, ability and depth of management; national and local economic trends and conditions; concentrations of credit; quality of the bank’s loan review system; and, external factors, such as competition, legal and regulatory requirements. |
The total allowance for credit losses requires these changes as the percentage weight assigned to each Total ALLL Factor is increased or decreased due to its particular circumstance, as the various types and categories of loans change as a percentage of total loans and as the aggregate of specific allowances is adjusted due to an increase or decrease in impaired loans.
Management believes this approach effectively measures the risk associated with any particular loan or group of loans. The Bank’s Board of Directors engages an independent loan review consultant to evaluate the adequacy of the Bank’s allowance for credit losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to make additional provisions for estimated credit losses based upon judgments different from those of management. The Bank recorded a total provision for credit losses of $2.1 million for the year ended December 31, 2010 and $6.5 million in 2009. The decrease in provision was primarily the result of a decrease in nonperforming assets offset by the impact of net charge-offs on the historical loss factor of the methodology used to calculate the allowance for credit losses. The aggregate provision was based upon the results of quarterly evaluations using a combination of factors including the level of nonperforming loans, the Bank’s growth in total gross loans and the Bank’s net credit loss experience. Total gross loans decreased by $2.0 million for the year ended December 31, 2010. The Bank recorded charge-offs of $3.3 million on loans deemed uncollectible and recovered $84 thousand on previously charged-off loans. As of December 31, 2010, the Bank’s allowance for credit losses was $6.9 million or 2.45% of total loans and 81.7% of nonperforming loans as compared to $7.9 million, or 2.81% of total loans and 47.2% of nonperforming loans as of December 31, 2009. The Bank had total nonperforming loans of $8.4 million at December 31, 2010 and $16.8 million at December 31, 2009, and nonperforming loans to total assets of 1.94% and 3.78% at December 31, 2010 and December 31, 2009, respectively.
The Bank places loans on a nonaccrual status after 90 days of not having received contractual principal or interest payments unless the loan is well secured and in the process of collection. In addition the Bank maintains a watch list of loans on a monthly basis that warrant more than the normal level of management supervision. At December 31, 2010 the Bank had approximately $33.3 million in watch list loans compared to $20.5 million at December 31, 2009.
At December 31, 2010 $7.8 million in loans were classified as nonaccrual compared to $16.8 at December 31, 2009. Approximately 27.1% of the year-end nonaccrual total consisted of commercial loans with approximately 18.0% of the total acquisition and development loans. Commercial mortgages accounted for approximately 13.2% of the total while one- to four-family loans totaled 26.9%, home equity 6.7% and consumer and installment loans 8.1%.
The Bank continues to monitor and modify its allowance for credit losses as conditions dictate. While management believes that, based on information currently available, the Bank’s allowance for credit losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Bank’s level of allowance for credit losses will be sufficient to cover future loan losses incurred by the Bank or that future adjustments to the allowance for credit losses will not be necessary if economic and other conditions differ substantially from economic and other conditions at the time management determined the current level of the allowance for credit losses. Management may in the future increase the level of the allowance as its loan portfolio increases or as circumstances dictate.
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The following table presents the allocation of the allowance for credit losses, reflecting use of the methodology presented above, along with the percentage of total loans in each category.
At December 31,
| 2010 | 2009 | |||||||||||||||
| Amount | Loan Mix | Amount | Loan Mix | |||||||||||||
| (Dollars in thousands) | ||||||||||||||||
| Amount applicable to: |
||||||||||||||||
| Commercial |
$ | 1,868 | 18.3 | % | $ | 2,923 | 21.2 | % | ||||||||
| Real estate |
||||||||||||||||
| Commercial |
1,374 | 33.9 | % | 1,336 | 29.2 | % | ||||||||||
| One to four-family |
1,257 | 32.0 | % | 901 | 32.4 | % | ||||||||||
| Construction |
1,831 | 12.0 | % | 2,319 | 12.8 | % | ||||||||||
| Consumer |
523 | 3.8 | % | 447 | 4.4 | % | ||||||||||
| Total allowance |
$ | 6,853 | 100.0 | % | $ | 7,926 | 100.0 | % | ||||||||
Analysis of Credit Risk
Activity in the allowance for credit losses for the two years ended December 31 is shown below:
| 2010 | 2009 | |||||||
| Total loans outstanding - at December 31 (1) |
$ | 279,916 | $ | 281,958 | ||||
| Average loans outstanding for the year |
276,984 | 273,990 | ||||||
| Allowance for credit losses at beginning of period |
$ | 7,926 | $ | 4,123 | ||||
| Provision charged to expense |
2,148 | 6,540 | ||||||
| Chargeoffs: |
||||||||
| Commercial loans |
1,169 | 519 | ||||||
| Real estate loans |
1,610 | 1,572 | ||||||
| Consumer and other loans |
526 | 758 | ||||||
| Total |
3,305 | 2,849 | ||||||
| Recoveries: |
||||||||
| Commercial loans |
43 | 95 | ||||||
| Real estate loans |
6 | — | ||||||
| Consumer and other loans |
35 | 17 | ||||||
| Total |
84 | 112 | ||||||
| Net charge-offs |
3,221 | 2,737 | ||||||
| Allowance for credit losses at end of year |
$ | 6,853 | $ | 7,926 | ||||
| Allowance for credit losses as a percent of total loans |
2.45 | % | 2.81 | % | ||||
| Net charge-offs as a percent of average loans |
1.16 | % | 1.00 | % | ||||
| (1) | Net of deferred fees and costs. |
Nonperforming Loans and Other Delinquent Assets
Management performs reviews of all delinquent loans. Management will generally classify loans as nonaccrual when collection of full principal and interest under the original terms of the loan is not expected or payment of principal or interest has become 90 days past due. Classifying a loan as non-accrual results in the Company no longer accruing interest on such loan and reversing any interest previously accrued but not collected. A nonaccrual loan may be restored to accrual status when delinquent principal and interest payments are brought current and future monthly principal and interest payments are expected to be collected. The Company will recognize interest on nonaccrual loans only when received. As of December 31, 2010 and 2009, the Company had $7.8 and $16.8 million of nonaccrual loans, respectively. (See the previous discussion under the heading “Provision for Credit Losses and Credit Risk Management” for additional comments regarding nonaccrual loan activity.)
Property acquired by the Company as a result of foreclosure on a mortgage loan will be classified as “real estate owned.” Personal property acquired through repossession will be classified as “repossessed assets.” Property acquired will be recorded at the lower of the unpaid principal balance or fair value at the date of acquisition and subsequently carried at the lower of cost or net realizable value. Any required write-down of the loan to its net realizable value will be charged against the allowance for credit losses. As of December 31, 2010 the Company held $1.6 million in real estate owned as a result of foreclosure. The Company held $2.4 million in real estate owned at December 31, 2009. Property held as the result of repossession totaled $145 thousand at December 31, 2010 and $122 thousand at December 31, 2009.
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The following table shows the amounts of nonperforming assets at December 31 for the past five years.
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
| Nonaccrual loans: |
||||||||||||||||||||
| Commercial |
$ | 2,107 | $ | 6,718 | $ | 292 | $ | 116 | $ | 332 | ||||||||||
| Real estate |
5,054 | 9,532 | 3,397 | 532 | 332 | |||||||||||||||
| Consumer |
630 | 517 | 604 | 139 | 190 | |||||||||||||||
| Accrual loans - past due 90 days |
||||||||||||||||||||
| Commercial |
— | 33 | — | — | 129 | |||||||||||||||
| Real estate |
598 | — | 2,005 | 172 | 34 | |||||||||||||||
| Consumer |
— | — | — | — | — | |||||||||||||||
| Restructured loans |
— | — | — | — | — | |||||||||||||||
| Total nonperforming loans |
8,389 | 16,800 | 6,298 | 959 | 1,017 | |||||||||||||||
| Real estate owned |
1,608 | 2,398 | — | — | 60 | |||||||||||||||
| Repossessed assets |
145 | 122 | 182 | 137 | — | |||||||||||||||
| Total nonperforming assets |
$ | 10,142 | $ | 19,320 | $ | 6,480 | $ | 1,096 | $ | 1,077 | ||||||||||
| Allowance for credit losses to total nonperforming loans |
81.69 | % | 47.18 | % | 65.47 | % | 238.06 | % | 194.30 | % | ||||||||||
| Ratio of nonperforming loans to total loans |
3.00 | % | 5.96 | % | 2.35 | % | 0.39 | % | 0.46 | % | ||||||||||
| Ratio of nonperforming assets to total assets |
2.35 | % | 4.35 | % | 1.64 | % | 0.30 | % | 0.31 | % | ||||||||||
Contractual Obligations
The Bank has various financial obligations, including contractual obligations and commitments that may require future cash payments.
The following table presents, as of December 31, 2010, significant fixed and determinable contractual obligations to third parties by payment date.
| Payments due by Period | Total | Less than one year |
One to three years |
Three to five years |
More than five years |
|||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
| Deposits with a stated maturity |
$ | 77,620 | $ | 52,016 | $ | 21,038 | $ | 4,566 | $ | — | ||||||||||
| Long-term borrowings |
35,000 | — | — | 5,000 | 30,000 | |||||||||||||||
| Junior subordinated debentures |
5,000 | — | — | — | 5,000 | |||||||||||||||
| Operating lease obligations |
11,160 | 447 | 1,505 | 1,375 | 7,833 | |||||||||||||||
| Data processing contracts |
332 | 284 | 48 | — | — | |||||||||||||||
| $ | 129,112 | $ | 52,747 | $ | 22,591 | $ | 10,941 | $ | 42,833 | |||||||||||
Off-Balance Sheet Arrangements
As of December 31, 2010, the Company had a wholly-owned statutory trust formed for the purpose of issuing junior subordinated debentures in the form of trust preferred securities. The statutory trust has not been consolidated with the holding company.
The Company does have significant commitments to fund loans in the ordinary course of business. Such commitments and resulting off-balance sheet risk is discussed further in Note 6 to the consolidated financial statements.
With the exception of these off-balance sheet arrangements, the Company has no-off balance sheet arrangements that have or are reasonably likely to have a material current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, capital expenditures or capital resources.
Capital Management
Total stockholders’ equity was $34.8 million at December 31, 2010, representing an increase of $2.1 million or 6.6% from December 31, 2009. The growth of stockholders’ equity during 2010 as compared to the same period in 2009 was attributable to income of $1.6 million and improvement in the market value of securities of $790 thousand.
On January 30, 2009, the Company sold 8,152 shares of the Company’s Fixed Rate Cumulative Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, and a warrant to purchase 299,706 shares of the Company’s common stock, at an exercise price of $4.08 per share, to the Treasury under the CPP for a total purchase price of $8,152,000.
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Offsetting the increase in stockholder’s equity attributable to net income and the increase in accumulated other comprehensive income were $407 thousand in preferred stock dividends. Stock based compensation, stock purchases through the Company’s Employee Stock Purchase Plan and the exercise of options added $143 thousand to the stockholder’s equity for the period ended December 31, 2010.
Regulatory Capital Requirements
The Federal Reserve’s capital regulations require state member banks to meet two minimum capital standards: a 4% Tier 1 capital to total adjusted average assets ratio (the “leverage” ratio), and an 8% risk-based capital ratio. Tier 1 capital is defined as common stockholders’ equity (including retained earnings), certain non-cumulative perpetual preferred stock and related paid in capital, and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships.
The risk-based capital standard requires the maintenance of Tier 1 and Total capital (which is defined as Tier 1 capital plus Tier 2 capital) to risk-weighted assets of at least 4% and 8%, respectively. A well-capitalized institution has Tier 1 and Total capital to risk-weighted assets of at least 6% and 10%, respectively and a leverage ratio of at least 5%. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, as assigned by the Federal Reserve capital regulations based on the risks the agency believes are inherent in the type of asset. The regulators have recently added a market risk adjustment to cover a bank’s trading account, and foreign exchange and commodity positions. The components of Tier 1 capital are equivalent to those discussed above. Tier 2 capital may include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt, intermediate preferred stock, and the allowance for credit losses limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of Tier 2 capital included as part of total capital cannot exceed 100% of Tier 1 capital.
Trust preferred securities are considered regulatory capital for purposes of determining the Company’s Tier 1 capital ratios.
At December 31, 2010, the Company’s Tier 1 and Total Risk-based capital ratios were 12.8% and 14.1%, respectively. At December 31, 2010, the Bank’s Tier 1 and Total Risk-based capital ratios were 12.8% and 14.1%, respectively. The Bank was considered well-capitalized for regulatory purposes as of December 31, 2010. Designation as a well-capitalized institution under these regulations is not a recommendation or endorsement of the Company or the Bank by federal bank regulators.
See Note 19 of the Consolidated Financial Statements for more information on the Bank’s risk-based capital ratios.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Nearly all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods or services.
| ITEM 7A. | QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK |
Not applicable
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements are filed with this report:
Report of Independent Registered Public Accounting Firm
Management’s Report on Internal Control over Financial Reporting
Consolidated Balance Sheets — December 31, 2010 and 2009
Consolidated Statements of Income (Loss) — For the years ended December 31, 2010 and 2009
Consolidated Statements of Changes in Stockholders’ Equity — For the years ended December 31, 2010 and 2009
Consolidated Statements of Cash Flows — For the years ended December 31, 2010 and 2009
Notes to Consolidated Financial Statements
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management’s Report
The Management of Annapolis Bancorp, Inc. (the “Company”) is responsible for the preparation, integrity and fair presentation of the consolidated financial statements included in this Annual Report on Form 10-K. These financial statements are in conformity with accounting principles generally accepted in the United States of America and, therefore, include amounts based on informed judgments and estimates. We also accept responsibility for the preparation of other financial information that is included in this document.
Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on this assessment management believes that the Company maintained effective internal control over financial reporting as of December 31, 2010.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
| /s/ Richard M. Lerner |
| Richard M. Lerner |
| Chairman and Chief Executive Officer |
| /s/ Edward J. Schneider |
| Edward J. Schneider |
| Principal Financial and Accounting Officer |
March 25, 2011
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ANNAPOLIS BANCORP, INC.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Annapolis Bancorp, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Annapolis Bancorp, Inc. and subsidiaries (the “Company”) as of December 31, 2010 and 2009 and the related consolidated statements of income (loss), changes in stockholders’ equity and comprehensive income (loss), and cash flows for each of the two years in the period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of their internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Annapolis Bancorp, Inc. and subsidiaries as of December 31, 2010 and 2009 and the results of their operations and their cash flows for each of the years in the two year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
| /s/ Stegman & Company |
| Baltimore, Maryland |
| March 25, 2011 |
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ANNAPOLIS BANCORP, INC.
Consolidated Balance Sheets ($000)
| December 31, | 2010 | 2009 | ||||||
| Assets |
||||||||
| Cash and due from banks |
$ | 7,854 | $ | 5,936 | ||||
| Interest bearing balances with banks |
16,856 | 10,138 | ||||||
| Federal funds sold and other overnight investments |
11,984 | 8,690 | ||||||
| Investment securities available for sale |
96,295 | 117,883 | ||||||
| Federal Reserve Bank and Federal Home Loan Bank stock |
3,035 | 3,260 | ||||||
| Loans held for sale |
1,379 | 3,296 | ||||||
| Loans, less allowance for credit losses of $6,853 and $7,926 |
271,684 | 270,736 | ||||||
| Premises and equipment, net |
8,787 | 9,274 | ||||||
| Accrued interest receivable |
1,567 | 1,934 | ||||||
| Deferred income taxes |
2,929 | 3,902 | ||||||
| Investment in bank owned life insurance |
5,442 | 4,226 | ||||||
| Real estate owned |
1,608 | 2,398 | ||||||
| Other assets |
2,720 | 2,659 | ||||||
| Total assets |
$ | 432,140 | $ | 444,332 | ||||
| Liabilities and Stockholders’ Equity |
||||||||
| Deposits |
||||||||
| Noninterest bearing |
$ | 45,514 | $ | 40,834 | ||||
| Interest bearing |
295,400 | 309,629 | ||||||
| Securities sold under agreements to repurchase |
14,558 | 14,642 | ||||||
| Long-term borrowings |
35,000 | 40,000 | ||||||
| Guaranteed preferred beneficial interests in junior subordinated debentures |
5,000 | 5,000 | ||||||
| Accrued interest payable and other liabilities |
1,894 | 1,595 | ||||||
| Total liabilities |
397,366 | 411,700 | ||||||
| Stockholders’ Equity |
||||||||
| Preferred stock, par value $0.01 per share; authorized 5,000,000 shares; Series A, $1,000 per share liquidation preference, shares issued and outstanding 8,152 shares at December 31, 2010 and 2009, net of discount of $89 and $167, respectively |
8,063 | 7,985 | ||||||
| Common stock, par value $0.01 per share; authorized 10,000,000 shares; issued and outstanding 3,922,006 shares in 2010 and 3,867,006 shares in 2009 |
39 | 39 | ||||||
| Warrants |
234 | 234 | ||||||
| Paid in capital |
11,643 | 11,500 | ||||||
| Retained earnings |
14,499 | 13,368 | ||||||
| Accumulated other comprehensive income (loss) |
296 | (494 | ) | |||||
| Total stockholders’ equity |
34,774 | 32,632 | ||||||
| Total liabilities and stockholders’ equity |
$ | 432,140 | $ | 444,332 | ||||
The accompanying notes are an integral part of these financial statements.
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ANNAPOLIS BANCORP, INC.
Consolidated Statements of Income (Loss) ($000 except per share data)
| Years Ended December 31, | 2010 | 2009 | ||||||
| Interest and Dividend Income |
||||||||
| Loans, including fees |
$ | 16,013 | $ | 15,972 | ||||
| Interest bearing deposits with banks |
32 | 63 | ||||||
| Federal funds sold and other overnight investments |
32 | 46 | ||||||
| Mortgage-backed securities |
1,875 | 2,462 | ||||||
| U.S. Treasury securities and obligations of other U.S. Government agencies |
1,783 | 2,573 | ||||||
| State and municipal securities |
44 | 42 | ||||||
| Equity securities |
74 | 68 | ||||||
| Total interest income |
19,853 | 21,226 | ||||||
| Interest Expense |
||||||||
| Certificates of deposit, $100,000 or more |
675 | 1,099 | ||||||
| Other deposits |
2,523 | 4,471 | ||||||
| Securities sold under agreements to repurchase |
107 | 121 | ||||||
| Interest on long-term borrowings |
1,328 | 1,444 | ||||||
| Total interest expense |
4,633 | 7,135 | ||||||
| Net interest income |
15,220 | 14,091 | ||||||
| Provision for credit losses |
2,148 | 6,540 | ||||||
| Net interest income after provision for credit losses |
13,072 | 7,551 | ||||||
| Noninterest Income |
||||||||
| Service charges and fees on deposits |
1,193 | 1,207 | ||||||
| Mortgage banking fees |
74 | 98 | ||||||
| Rental income |
— | 171 | ||||||
| Other income |
494 | 322 | ||||||
| Net gain on sale of loans |
159 | 135 | ||||||
| Net loss on sale of securities, available for sale |
(55 | ) | — | |||||
| Net (loss) gain on sale of real estate owned and other assets |
(50 | ) | 56 | |||||
| Total noninterest income |
1,815 | 1,989 | ||||||
| Noninterest Expense |
||||||||
| Personnel |
6,801 | 6,557 | ||||||
| Occupancy and equipment |
1,603 | 1,525 | ||||||
| Data processing |
836 | 845 | ||||||
| Marketing and advertising |
352 | 251 | ||||||
| Legal and professional fees |
554 | 729 | ||||||
| FDIC insurance |
562 | 902 | ||||||
| Other operating expenses |
1,677 | 1,596 | ||||||
| Total noninterest expense |
12,385 | 12,405 | ||||||
| Income (Loss) Before Income Taxes |
2,502 | (2,865 | ) | |||||
| Income Tax Expense (Benefit) |
886 | (1,158 | ) | |||||
| Net Income (Loss) |
1,616 | (1,707 | ) | |||||
| Preferred Stock Dividend and Discount Accretion |
485 | 442 | ||||||
| Net Income (Loss) Available to Common Shareholders |
$ | 1,131 | ($ | 2,149 | ) | |||
| Basic earnings (loss) per common share |
$ | 0.29 | ($ | 0.56 | ) | |||
| Average common shares outstanding before the effect of grants, options and warrants |
3,909,688 | 3,857,957 | ||||||
| Diluted earnings (loss) per common share |
$ | 0.29 | ($ | 0.56 | ) | |||
| Average common shares outstanding with the effect of grants, options and warrants |
3,946,656 | 3,857,957 | ||||||
The accompanying notes are an integral part of these financial statements.
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ANNAPOLIS BANCORP, INC.
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss) ($000)
For the years ended December 31, 2010 and 2009
| Preferred Stock |
Common Stock |
Warrants | Paid in Capital |
Retained Earnings |
Accumulated Other Comprehensive Income (Loss) |
Total Stockholders’ Equity |
Comprehensive Income (Loss) |
|||||||||||||||||||||||||
| BALANCE JANUARY 1, 2009 |
$ | — | $ | 38 | $ | — | $ | 11,299 | $ | 15,517 | $ | (40 | ) | $ | 26,814 | |||||||||||||||||
| Net loss |
— | — | — | — | (1,707 | ) | — | (1,707 | ) | ($ | 1,707 | ) | ||||||||||||||||||||
| Issuance of Series A, preferred stock |
7,918 | — | — | — | — | — | 7,918 | |||||||||||||||||||||||||
| Issuance of warrants to Purchase common stock |
— | — | 234 | — | — | — | 234 | |||||||||||||||||||||||||
| Preferred stock dividends declared and discount accretion |
67 | — | — | — | (442 | ) | — | (375 | ) | |||||||||||||||||||||||
| Stock-based compensation |
— | — | — | 112 | — | — | 112 | |||||||||||||||||||||||||
| Issuance of restricted stock |
— | — | — | 57 | — | — | 57 | |||||||||||||||||||||||||
| Stock options exercised |
— | — | — | 20 | — | — | 20 | |||||||||||||||||||||||||
| Employee stock purchase plan |
— | 1 | — | 12 | — | — | 13 | |||||||||||||||||||||||||
| Unrealized loss on investment securities available for sale, net of income tax benefit of $296 |
— | — | — | — | — | (454 | ) | (454 | ) | (454 | ) | |||||||||||||||||||||
| BALANCE DECEMBER 31, 2009 |
7,985 | 39 | 234 | 11,500 | 13,368 | (494 | ) | 32,632 | (2,161 | ) | ||||||||||||||||||||||
| Net income |
— | — | — | — | 1,616 | — | 1,616 | 1,616 | ||||||||||||||||||||||||
| Preferred stock dividends declared and discount accretion |
78 | — | — | — | (485 | ) | — | (407 | ) | |||||||||||||||||||||||
| Stock-based compensation |
— | — | — | 30 | — | — | 3-0 | |||||||||||||||||||||||||
| Issuance of restricted stock |
— | — | — | 60 | — | — | 60 | |||||||||||||||||||||||||
| Stock options exercised |
— | — | — | 43 | — | — | 43 | |||||||||||||||||||||||||
| Employee stock purchase plan |
— | — | — | 10 | — | — | 10 | |||||||||||||||||||||||||
| Reclassification adjustment for Securities losses, net of taxes of $20 included in net income |
35 | 35 | 35 | |||||||||||||||||||||||||||||
| Unrealized gain on investment securities available for sale, net of income taxes of $495 |
— | — | — | — | — | 755 | 755 | 755 | ||||||||||||||||||||||||
| BALANCE DECEMBER 31, 2010 |
$ | 8,063 | $ | 39 | $ | 234 | $ | 11,643 | $ | 14,499 | $ | 296 | $ | 34,774 | $ | 2,406 | ||||||||||||||||
The accompanying notes are an integral part of these financial statements.
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ANNAPOLIS BANCORP, INC.
Consolidated Statements of Cash Flows ($000)
| Years Ended December 31, | 2010 | 2009 | ||||||
| Cash Flows from Operating Activities |
||||||||
| Net income (loss) |
$ | 1,616 | ($ | 1,707 | ) | |||
| Adjustments to reconcile net income to net cash from operating activities: |
||||||||
| Depreciation and amortization |
619 | 600 | ||||||
| Provision for credit losses |
2,148 | 6,540 | ||||||
| Origination of loans held for sale |
(22,549 | ) | (28,960 | ) | ||||
| Proceeds from sale of loans held for sale |
24,625 | 26,143 | ||||||
| Stock-based compensation |
90 | 169 | ||||||
| Deferred income taxes |
458 | (1,859 | ) | |||||
| Earnings on life insurance policies |
(216 | ) | (141 | ) | ||||
| Amortization of premiums and accretion of discounts, net |
408 | 313 | ||||||
| Loss on sale of securities, available for sale |
55 | — | ||||||
| Loss (gain) on sale of real estate owned and other assets, net |
50 | (56 | ) | |||||
| Gain on sale of loans held for sale |
(159 | ) | (135 | ) | ||||
| (Increase) decrease in: |
||||||||
| Accrued interest receivable |
367 | (166 | ) | |||||
| Prepaids and other assets |
(10 | ) | (1,948 | ) | ||||
| (Decrease) increase in |
||||||||
| Accrued interest payable |
(24 | ) | (76 | ) | ||||
| Accrued income taxes, net of taxes refundable |
(47 | ) | 114 | |||||
| Deferred loan origination fees |
(28 | ) | (70 | ) | ||||
| Other liabilities |
370 | 378 | ||||||
| Net cash provided by (used in) operations |
7,773 | (811 | ) | |||||
| Cash Flows from Investing Activities |
||||||||
| Proceeds from sales and maturities of securities available for sale |
63,310 | 43,913 | ||||||
| Purchase of securities available for sale |
(40,655 | ) | (82,434 | ) | ||||
| Contract to purchase available for sale securities |
— | (8,709 | ) | |||||
| Purchase of life insurance policy |
(1,000 | ) | — | |||||
| Net decrease (increase) in federal funds sold |
(3,294 | ) | 15,078 | |||||
| Net (increase) decrease in interest bearing certificates of deposit |
(6,718 | ) | (9,138 | ) | ||||
| Net increase in loans receivable |
(4,174 | ) | (16,213 | ) | ||||
| Proceeds from sale of repossessed assets |
181 | 474 | ||||||
| Proceeds from sale of REO |
1,642 | — | ||||||
| Purchases of premises and equipment, net |
(160 | ) | (221 | ) | ||||
| Net cash provided by (used in) investing activities |
9,132 | (57,300 | ) | |||||
| Cash Flows from Financing Activities |
||||||||
| Net increase (decrease) in: |
||||||||
| Time deposits |
(19,271 | ) | 4,402 | |||||
| Other deposits |
9,722 | 45,434 | ||||||
| Securities sold under agreements to repurchase |
(84 | ) | 2,003 | |||||
| Repayment of long-term borrowings |
(5,000 | ) | — | |||||
| Issuance of preferred stock and warrants |
— | 8,152 | ||||||
| Proceeds from stock options exercised |
43 | 20 | ||||||
| Proceeds from issuance of common stock |
10 | 13 | ||||||
| Payment of preferred stock dividend |
(407 | ) | (323 | ) | ||||
| Net cash (used in) provided by financing activities |
(14,987 | ) | 59,701 | |||||
| Net increase in cash and cash equivalents |
1,918 | 1,590 | ||||||
| Cash and cash equivalents at beginning of year |
5,936 | 4,346 | ||||||
| Cash and cash equivalents at end of year |
$ | 7,854 | $ | 5,936 | ||||
| Supplemental Cash Flow Information |
||||||||
| Interest paid, including interest credited to accounts |
$ | 5,068 | $ | 7,482 | ||||
| Income taxes paid |
1,082 | 857 | ||||||
| Non-cash investing activities |
||||||||
| Transfers from loans to other assets and real estate owned |
$ | 1,106 | $ | 3,111 | ||||
The accompanying notes are an integral part of these financial statements.
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ANNAPOLIS BANCORP, INC.
Notes to Consolidated Financial Statements ($000 except share data)
For the years ended December 31, 2010 and 2009
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies in the consolidated financial statements conform with accounting principles generally accepted in the United States of America and to general practices within the banking industry. Management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions may affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Certain reclassifications have been made to the 2009 consolidated financial statements to conform with the 2010 presentation.
Business
Annapolis Bancorp, Inc. (the “Company”) was incorporated on May 26, 1988, under the laws of the State of Maryland to serve as a bank holding company. The Company (as a bank holding company) and BankAnnapolis (the “Bank”) are subject to governmental supervision, regulation, and control.
The principal business of the Bank is to make loans and other investments and to accept savings, and time and demand deposits. The Bank’s primary market area is in Anne Arundel County, Maryland, although the Bank’s business development efforts generate business outside of the area. The Bank offers a broad range of banking products, including a full line of business and personal savings and checking accounts, money market demand accounts, certificates of deposit and other banking services.
The Bank funds a variety of loan types including commercial and residential real estate loans, commercial term loans and lines of credit, consumer loans, and letters of credit. The Bank’s customers are primarily individuals and small businesses.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, BankAnnapolis and Annapolis Bancorp Statutory Trust I. All significant intercompany balances and transactions have been eliminated in consolidation. The financial statements of Annapolis Bancorp, Inc. (Parent only) include its investment in the Bank under the equity method of accounting.
Cash Equivalents
For purposes of reporting cash flows, cash and demand balances due from banks are considered “cash equivalents” for financial reporting purposes.
Investment Securities
As securities are purchased, management determines if the securities should be classified as held to maturity or available for sale. Securities which management has the intent and ability to hold to maturity are recorded at amortized cost. Securities which may be sold before maturity are classified as available for sale and carried at fair value with unrealized gains and losses included in accumulated other comprehensive income, a separate component of stockholders’ equity, on an after-tax basis. Investments in Federal Home Loan Bank and Federal Reserve stock are excluded from securities classified as available for sale and are carried at cost.
Declines in the fair value of individual available for sale or held to maturity securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether an other-than-temporary impairment has occurred include a downgrading of the security by the rating agency or a significant deterioration in the financial condition of the issuer.
Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) the structure of the security.
An impairment loss is recognized in earnings only when (1) the Bank intends to sell the debt security; (2) it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis or (3) the Bank does not expect to recover the entire amortized cost basis of the security. In situations where the Bank intends to sell or when it is more likely than not that the Bank will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in stockholders’ equity as a component of other comprehensive income, net of deferred taxes.
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Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets. Useful lives range from three to 10 years for furniture, fixtures, and equipment; three to five years for software, hardware, and data handling equipment; and 10 to 40 years for buildings and building improvements. Land improvements are amortized over a period of 15 years; and leasehold improvements are amortized over the term of the respective lease plus the first optional renewal period, if applicable. Maintenance and repairs are charged to expense as incurred, while improvements which extend the useful life are capitalized and depreciated over the estimated remaining life of the asset.
Loans Held for Sale
Beginning in 2008 the Company engaged in the sale of residential mortgage loans. Loans held for sale are carried at the lower of aggregate cost or fair market value. Fair market value is determined by secondary market quotations for similar instruments. Gains and losses on the sale of these instruments are recognized after the loans sold are no longer subject to recourse from the purchasers, which is generally 90 days, and are shown as a component of noninterest income in the Consolidated Statement of Income.
The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing as of December 31, 2010. The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 60 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.
The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.
Loans
Loans are stated at their principal balance outstanding, plus deferred origination costs, less unearned discounts, deferred origination fees, and the allowance for credit losses.
Interest on loans is credited to income based on the principal amounts outstanding. Origination fees and costs are amortized to income over the contractual life of the related loans as an adjustment of yield. Discounts on the purchase of mortgage loans are amortized to income over the contractual lives of the loans.
Accrual of interest on a loan is discontinued when the loan is delinquent more than ninety days unless the collateral securing the loan is sufficient to liquidate the loan. Management considers all loans where the accrual of interest has been discontinued to be impaired.
Loans are considered impaired when, based on current information, it is probable that the Bank will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal and interest payments are past due and they are placed on non-accrual. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance homogeneous credits such as residential real estate and consumer installment loans, which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (usually ninety days or less) provided eventual collection of all amounts due is expected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Bank may measure impairment based on a loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. The Bank recognizes interest income on impaired loans on a cash basis if the borrower demonstrates the ability to meet the contractual obligation and collateral is sufficient. If there is doubt regarding the borrower’s ability to make payments or the collateral is not sufficient, payments received are accounted for as a reduction in principal. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Credit Losses
The allowance for credit losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans, actual loss experience, current economic events in specific industries and geographic areas including unemployment levels and other pertinent factors including regulatory guidance and general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Credit losses are charged off against the
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allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.
The components of the allowance for credit losses represent an estimation done pursuant to FASB guidance in Accounting Standards Codification (“ASC”) Topic 310 “Receivables,” and ASC Topic 450 “Contingencies.” The specific component of the allowance for credit losses reflects expected losses resulting from analysis developed through credit allocations for individual loans and historical loss experience for each loan category The determination of the allowance for credit losses is based on a combination of the higher of the Bank’s historical loss experience or the peer group average historical loss experience plus ten (10) qualitative factors for specific categories and types of loans. The combination of the loss experience factor and the total qualitative factor (“Total ALLL Factor”) is expressed as a percentage of the portfolio for specific categories and types of loans to create the inherent loss index for each loan portfolio. Individual loans deemed impaired are separated from the respective loan portfolios and a specific reserve allocation is assigned based upon Bank Management’s best estimate as to the loss exposure for each loan. Each Total ALLL Factor is assigned a percentage weight and that total weight is applied to each loan category. The Total ALLL Factor is different for each loan type and for each risk assessment category within each loan type.
Qualitative factors include: levels and trends in delinquencies and non-accruals; trends in volumes and terms of loans; effects of any changes in lending policies; the experience, ability and depth of management; national and local economic trends and conditions; concentrations of credit; quality of the bank’s loan review system; and, external factors, such as competition, legal and regulatory requirements.
Real Estate Owned
Real estate acquired in satisfaction of a debt is carried at the lower of cost or net realizable value. At the time of foreclosure, the excess if any, of the loan over the net realizable value of the assets received is charged to the allowance for credit losses. Costs incurred in maintaining foreclosed real estate and subsequent write-downs to reflect declines in the fair value of the properties after acquisition are included in noninterest expense.
Advertising Costs
Advertising costs are generally expensed when incurred.
Income Taxes
The Company and its subsidiaries file a consolidated federal income tax return. The provision for income taxes is based upon income in the financial statements adjusted for permanent differences, rather than amounts reported on the Company’s income tax return. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities (excluding components of other comprehensive income).
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. 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 as income or expense in the period that includes the enactment date.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, presuming that a tax examination will occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized on examination. For tax positions not meeting the “more likely than not” test, no benefit is recorded. The Company recognizes interest accrued and penalties related to unrecognized tax benefits in other expense. Management considers the likelihood of changes by taxing authorities in its filed income tax returns and recognizes a liability for or discloses potential changes that management believes are more likely than not to occur upon examination by tax authorities. Management has not identified any uncertain tax positions in filed income tax returns that require recognition or disclosure in the accompanying financial statements. The Company’s income tax returns for the past three years are subject to examination by tax authorities, and may change upon examination.
Earnings per Share
Basic earnings per common share is determined by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per common share is calculated by including the average dilutive common stock equivalents outstanding during the period.
Dilutive common equivalent shares consist of stock warrants, options and restricted stock grants, calculated using the treasury stock method.
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Stock-Based Compensation
The fair value of stock-based awards is determined on the date of grant, and is recognized as compensation expense over the service period of the awards.
New Accounting Pronouncements
All pending but not yet effective Accounting Standards Updates (“ASU”) were evaluated and only those listed below could have a material impact on the Company’s financial condition or results of operation.
In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures About Fair Value Measurement,” which provided guidance on disclosure requirements about transfers into and out of Levels 1, 2, and 3, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of the valuation technique (e.g., market approach, income approach, or cost approach) and inputs used to measure fair value was required for recurring, nonrecurring, and Level 2 and 3 fair value measurements. The guidance is effective for the Company’s interim and annual reporting periods beginning after December 15, 2009 except for gross basis presentation for Level 3 reconciliation, which is effective for interim and annual periods beginning after December 15, 2010. The disclosure requirements for interim and annual periods beginning after December 15, 2009 have been adopted for the interim period beginning March 31, 2010 and did not have a material impact on our financial condition or results of operations.
In the second quarter 2010, additional guidance was issued under the Disclosures about Credit Quality of Financing Receivables and the Allowance for Loan Losses. This standard requires additional disclosures related to the Allowance for Loan Losses with the objective of providing financial statement users with greater transparency about an entity’s loan loss reserves and overall credit quality. Additional disclosures include showing on a disaggregated basis the aging of receivables, credit quality indicators and troubled debt restructuring with its effect on the Allowance for Loan Losses. The provisions of this standard are effective for interim annual periods ending on or after December 15, 2010. The adoption of this standard did have a material impact on our financial condition or results of operations but did increase the amount of disclosures in the notes to the financial statements.
2. CASH AND DUE FROM BANKS
Banks are required to carry cash reserves of specified percentages of deposit balances. The Bank’s normal balances of cash on hand and on deposit with other banks are sufficient to satisfy these reserve requirements.
The Bank normally maintains balances with other banks that exceed the federally insured limit. The average balance maintained in excess of the limit, including federal funds sold to the same bank, was approximately $8.2 million. At December 31, 2010 the Bank had invested $2.2 million in the Certificate of Deposit Account Registry Service® known as CDARS®.
3. INVESTMENT SECURITIES
Investment securities are summarized as follows:
| Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Estimated Fair Value |
|||||||||||||
| December 31, 2010 |
||||||||||||||||
| Available for sale |
||||||||||||||||
| U.S. Government agency |
$ | 54,062 | $ | 209 | $ | 510 | $ | 53,761 | ||||||||
| State and Municipal |
1,079 | 10 | — | 1,089 | ||||||||||||
| Residential mortgage-backed securities |
40,067 | 873 | 112 | 40,828 | ||||||||||||
| Other equity securities |
599 | 18 | — | 617 | ||||||||||||
| $ | 95,807 | $ | 1,110 | $ | 622 | $ | 96,295 | |||||||||
| December 31, 2009 |
||||||||||||||||
| Available for sale |
||||||||||||||||
| U.S. Government agency |
$ | 55,558 | $ | 137 | $ | 907 | $ | 54,788 | ||||||||
| State and Municipal |
1,080 | 10 | 1 | 1,089 | ||||||||||||
| Residential mortgage-backed securities |
61,482 | 615 | 682 | 61,415 | ||||||||||||
| Other equity securities |
578 | 13 | — | 591 | ||||||||||||
| $ | 118,698 | $ | 775 | $ | 1,590 | $ | 117,883 | |||||||||
Proceeds from the sale of securities totaled $13.8 million in 2010 with no proceeds received in 2009. Gains of $70 thousand and losses of $125 thousand were recognized on the sale of securities in 2010 while no securities were sold in 2009. Gains and losses are determined using the specific identification method.
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Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position at December 31, 2010 and 2009 are as follows:
| Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
| Estimated Fair Value |
Unrealized Losses |
Estimated Fair Value |
Unrealized Losses |
Estimated Fair Value |
Unrealized Losses |
|||||||||||||||||||
| December 31, 2010 |
||||||||||||||||||||||||
| (dollars in thousands) |
||||||||||||||||||||||||
| U. S. Government Agency |
$ | 24,934 | $ | 500 | $ | 897 | $ | 10 | $ | 25,831 | $ | 510 | ||||||||||||
| State and Municipal |
— | — | — | — | — | — | ||||||||||||||||||
| Residential mortgage-backed securities |
3,118 | 10 | 2,401 | 102 | 5,519 | 112 | ||||||||||||||||||
| $ | 28,052 | $ | 510 | $ | 3,298 | $ | 112 | $ | 31,350 | $ | 622 | |||||||||||||
| December 31, 2009 |
||||||||||||||||||||||||
| (dollars in thousands) |
||||||||||||||||||||||||
| U. S. Government Agency |
$ | 37,413 | $ | 796 | $ | 2,238 | $ | 111 | $ | 39,651 | $ | 907 | ||||||||||||
| State and Municipal |
213 | 1 | — | — | 213 | 1 | ||||||||||||||||||
| Residential mortgage-backed securities |
22,975 | 315 | 4,262 | 367 | 27,237 | 682 | ||||||||||||||||||
| $ | 60,601 | $ | 1,112 | $ | 6,500 | $ | 478 | $ | 67,101 | $ | 1,590 | |||||||||||||
The available-for-sale investment portfolio has a fair value of approximately $96.3 million at December 31, 2010 and $117.9 million at December 31, 2009. As of December 31, 2010, $53.8 million of the investment security portfolio were U.S. Government Agency securities, $1.1 million were state and municipal securities, $40.8 million were mortgage-backed securities and $617 thousand were equity securities. Of the $40.8 million in mortgage-backed securities, $37.7 million were government agency issue while $3.1 million were private issue. As of December 31, 2009, $54.8 million were U.S. Government Agency securities, $1.1 million were state and municipal securities, $61.4 million were mortgage-backed securities and $591 thousand were equity securities. Of the $61.4 million in mortgage-backed securities at December 31, 2009, $56.8 million were government agency issue while $4.6 million were private issue. At December 31, 2010 $29.6 million or 30.7% showed an unrealized loss from the purchase price while $67.1 million or 56.9% showed an unrealized loss from the purchase price at December 31, 2009. As of December 31, 2010 $25.8 million or 87.4% of these securities were government agency bonds and $3.7 million or 12.6% were mortgage-backed securities. As of December 31, 2009 $39.7 million or 59.1% of these securities were government agency bonds, $213 thousand or 0.3% were state and municipal bonds and $27.2 million or 40.6% were mortgage-backed securities. As of December 31, 2010 and 2009 $2.4 million and $4.6 million, respectively of the mortgaged-back securities showing unrealized losses were private issue. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2010. The unrealized losses shown in the table above are the result of market changes in interest rates since the original purchase. The Company has used a variety of tools to analyze the contents of its security portfolio and at this time does not believe that the unrealized losses in the portfolio shown in the table above are other than temporary. At December 31, 2010 mortgaged-backed securities with a fair market value of $2.4 million carried bond ratings below investment grade. These securities were evaluated by an independent third-party consulting firm and were deemed by management not to be other-than-temporarily impaired at December 31, 2010. The valuation uses an expected cash flow model that includes assumptions related to prepayment rates, default trends, and loss severity. At December 31, 2010, both securities were current on both principal and interest payments.
The amortized cost and estimated fair -value of securities by contractual maturities at December 31, 2010 are shown below. Actual maturities of these securities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.
| Available for Sale | ||||||||
| Amortized Cost |
Estimated Fair Value |
|||||||
| December 31, 2010 |
||||||||
| Due within one year |
$ | 7,009 | $ | 7,014 | ||||
| Due after one through five years |
14,293 | 14,253 | ||||||
| Due after five years |
73,906 | 74,410 | ||||||
| Equity securities |
599 | 618 | ||||||
| $ | 95,807 | $ | 96,295 | |||||
At December 31, 2010 and 2009 investments available for sale with a carrying value of $25.4 million and $24.6 million, respectively, were pledged as collateral for certain government deposits and for other purposes as required by law.
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5. LOANS, ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY
The Bank’s loan portfolio consists of commercial, commercial real estate, residential construction, one- to four-family residential mortgage, home equity and consumer loans. The portfolio balances as of December 31, 2010 and 2009 are as follows:
| 2010 | 2009 | |||||||
| Commercial |
$ | 51,359 | $ | 59,900 | ||||
| Real estate |
||||||||
| Commercial |
94,864 | 82,168 | ||||||
| Construction |
33,534 | 36,185 | ||||||
| One to four-family |
51,581 | 53,802 | ||||||
| Home equity |
36,697 | 34,262 | ||||||
| Consumer |
10,664 | 12,479 | ||||||
| 278,699 | 278,796 | |||||||
| Deferred loan fees, net |
(162 | ) | (134 | ) | ||||
| Allowance for credit losses |
(6,853 | ) | (7,926 | ) | ||||
| (7,015 | ) | (8,060 | ) | |||||
| Loans, net |
$ | 271,684 | $ | 270,736 | ||||
The maturity and rate repricing distribution of the loan portfolio is as follows:
| Repricing or maturing within one year |
$ | 117,574 | $ | 113,360 | ||||
| Maturing over one to five years |
102,755 | 113,675 | ||||||
| Maturing over five years |
58,370 | 51,761 | ||||||
| $ | 278,699 | $ | 278,796 | |||||
The Company’s goal is to mitigate risks inherent in the loan portfolio. Commercial loans and loans secured by real estate make up the majority of the loan portfolio, accounting for 96% of the portfolio as of December 31, 2010 and 2009. To mitigate risk, commercial loans are generally secured by receivables, inventories, equipment and other assets of the business. Personal guarantees of the borrowers are generally required.
Loans secured by commercial real estate properties generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards, which require such loans to be qualified on the basis of the property’s value, debt service coverage ratio, and, under certain circumstances, additional collateral. The Bank generally also requires personal guarantees on its commercial real estate loans.
Construction loans are generally considered to involve a higher degree of credit risk than long-term financing of improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security property’s value upon completion of construction as compared to the estimated costs of construction, including interest. Also, the Bank assumes certain risks associated with the borrowers’ ability to complete construction in a timely and workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is not performed timely or accurately, the Bank may be faced with a project which, when completed, has a value that is insufficient to assure full repayment.
The Bank currently originates one- to four-family residential mortgage loans in amounts typically up to 80% (or higher with private mortgage insurance) of the lower of the appraised value or the selling price of the property securing the loan. The origination of adjustable-rate residential mortgage loans, as opposed to fixed-rate residential mortgage loans, helps to reduce the Bank’s exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Periodic and lifetime caps on interest rate increases help to reduce the risks associated with the Bank’s adjustable-rate loans, but also limit the interest rate sensitivity of its adjustable-rate mortgage loans.
Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.
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The following table shows the allowance for credit losses and recorded investment in loans receivable for the years ended December 31, 2010 and 2009:
Allowance for Credit Losses and Recorded Investment in Loans Receivable
for the Year Ended December 31, 2010
| (Dollars in thousands) | Commercial | Commercial Real Estate |
Residential | Consumer | Unallocated | Total | ||||||||||||||||||
| 2009 |
||||||||||||||||||||||||
| Allowance for credit losses: |
||||||||||||||||||||||||
| Beginning balance, December 31, 2008 |
$ | 1,211 | $ | 1,780 | $ | 236 | $ | 896 | $ | — | $ | 4,123 | ||||||||||||
| Charge-offs |
519 | 890 | 682 | 758 | — | 2,849 | ||||||||||||||||||
| Recoveries |
95 | — | — | 17 | — | 112 | ||||||||||||||||||
| Provision |
2,136 | 2,765 | 1,347 | 292 | — | 6,540 | ||||||||||||||||||
| Ending balance, December 31, 2009 |
$ | 2,923 | $ | 3,655 | $ | 901 | $ | 447 | $ | — | $ | 7,926 | ||||||||||||
| 2010 |
||||||||||||||||||||||||
| Beginning balance, December 31, 2009 |
$ | 2,923 | $ | 3,655 | $ | 901 | $ | 447 | $ | — | $ | 7,926 | ||||||||||||
| Charge-offs |
1,170 | 1,388 | 221 | 526 | — | 3,305 | ||||||||||||||||||
| Recoveries |
43 | — | 6 | 35 | — | 84 | ||||||||||||||||||
| Provision |
72 | 938 | 571 | 567 | — | 2,148 | ||||||||||||||||||
| Ending balance, December 31, 2010 |
$ | 1,868 | $ | 3,205 | $ | 1,257 | $ | 523 | $ | — | $ | 6,853 | ||||||||||||
| Period ending amount allocated to: Individually evaluated for impairment |
$ | 545 | $ | 351 | $ | 416 | $ | 150 | $ | — | $ | 1,462 | ||||||||||||
| Period ending amount allocated to: Collectively evaluated for impairment |
$ | 1,323 | $ | 2,854 | $ | 841 | $ | 373 | $ | — | $ | 5,391 | ||||||||||||
| Period ending amount: Loans acquired with deteriorating credit quality |
$ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
| Loans individually evaluated for impairment |
$ | 2,107 | $ | 3,033 | $ | 2,619 | $ | 630 | $ | — | $ | 8,389 | ||||||||||||
| Loans collectively evaluated for impairment |
$ | 49,252 | $ | 123,036 | $ | 87,988 | $ | 10,034 | $ | — | $ | 270,310 | ||||||||||||
Nonaccrual loans totaled approximately $7.8 million and $16.8 million at December 31, 2010 and 2009, respectively. As of December 31, 2010 and 2009, $1.5 million and $3.0 million, respectively, of loan loss allowances were allocated to all loans classified as impaired.
Credit Risk Monitoring
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management assigns a Risk Assessment Rating (‘Risk Rating”) to extensions of credit based upon the degree of risk, the likelihood of repayment and the effect on the Bank’s safety and soundness. The Risk Rating, applied consistently, enables lending personnel and bank management to monitor the loan portfolio. The Risk Rating is an integral part of the bank’s loan loss provision formulation process and, properly maintained, the Risk Rating assessment can provide an early warning signal of deterioration in a credit.
The Company uses a risk rating matrix to assign a risk grade to each loan. The Risk Ratings are divided into five general categories:
1. Risk Ratings 1 – 7 are assigned to “Pass” credits.
2. Risk Rating 7 is assigned to “Watch” credits.
3. Risk Rating 8 is assigned to “Criticized” credits.
4. Risk Ratings 9 and 10 are assigned to “Classified” credits.
5. Risk Rating 11 is assigned to “Loss” credits.
A general description of the characteristics of the risk ratings are described below:
| • | Risk ratings 1, 2 and 3 – these ratings have the highest degree of probability of repayment. Borrowers in these categories are established entities, well-positioned within their industry with a proven track record of solid financial performance. These ratings are usually reserved for the strongest customers of the Bank who have strong capital, stable earnings and alternative sources of financing. |
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| • | Risk ratings 4 and 5 – these ratings have a below and average degree of risk. The customers have generally strong to adequate net worth, stable earnings trends and strong to moderate liquidity. |
| • | Risk rating 6 – this category represents an above average degree of risk as to repayment with minimal loss potential. Borrowers in this category generally exhibit adequate operating trends, satisfactory balance sheet trends, moderate leverage and adequate liquidity; however, there is minimal excess operating cushion. |
| • | Risk rating 7 – this rating includes loans on management’s “Watch” list. Borrowers in this category generally exhibit characteristics of an acceptable/adequate credit, but may be experiencing income volatility, negative operating trends, and a more highly leveraged balance sheet. |
| • | Risk rating 8 – this rating is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This rating generally includes loans to borrowers with currently protected, but potentially weak assets that deserve management’s close attention. |
| • | Risk rating 9 – this rating is for loans considered “Substandard” in accordance with regulatory guidelines. This rating represents assets inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness, or weaknesses, that jeopardize liquidation of the debt and are characterized by the distinct possibility that the bank will sustain some loss if deficiencies are not corrected. |
| • | Risk rating 10 – this rating is for loans considered “Doubtful” in accordance with regulatory guidelines. Borrowers in this category have all the weaknesses inherent in a “Substandard” credit with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly improbable. |
| • | Risk rating 11 – this rating is for loans considered “Loss” in accordance with regulatory guidelines. This category represents loans that are considered uncollectible and of such little value that their continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but simply it is neither practical nor desirable to defer writing off all or some portion of the credit, even though partial recovery may be effected in the future. |
The following table presents credit quality indicators:
Credit Quality Indicators
as of December 31, 2010
(Dollars in thousands)
| Commercial Real Estate | ||||||||||||||||
| Commercial | Construction | Other | ||||||||||||||
| 2010 | 2010 | 2010 | ||||||||||||||
| Risk Rating: |
||||||||||||||||
| Other Assets Especially Mentioned |
$ | 7,358 | $ | 1,671 | $ | 8,938 | ||||||||||
| Substandard |
2,048 | 7,010 | 2,438 | |||||||||||||
| Doubtful |
600 | — | — | |||||||||||||
| Loss |
— | — | — | |||||||||||||
| $ | 10,006 | $ | 8,681 | $ | 11,376 | |||||||||||
| Residential | Consumer | |||||||||||||||
| Prime | Subprime | Installment | Other | |||||||||||||
| 2010 | 2010 | 2010 | 2010 | |||||||||||||
| Risk Rating: |
||||||||||||||||
| Other Assets Especially Mentioned |
$ | 1,517 | $ | — | $ | 123 | $ | — | ||||||||
| Substandard |
3,868 | — | 575 | — | ||||||||||||
| Doubtful |
— | — | — | — | ||||||||||||
| Loss |
— | — | — | — | ||||||||||||
| $ | 5,385 | $ | — | $ | 698 | $ | — | |||||||||
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The following table presents an age analysis of past due loans receivable:
Age Analysis of Past Due Loans Receivable
As of December 31, 2010
| (Dollars in thousands) | 30-59 Days Past Due |
59-89 Days Past Due |
Greater than 90 Days |
Total Past Due |
Current | Total Loans |
Recorded Investment 90 Days and Accruing |
|||||||||||||||||||||
| Commercial |
$ | 191 | $ | 691 | $ | 2,079 | $ | 2,961 | $ | 48,398 | $ | 51,359 | $ | — | ||||||||||||||
| Commercial Real Estate |
||||||||||||||||||||||||||||
| Construction |
3,515 | — | 1,585 | 5,100 | 28,434 | 33,534 | 180 | |||||||||||||||||||||
| Other |
488 | 239 | 1,449 | 2,176 | 92,688 | 94,864 | 419 | |||||||||||||||||||||
| Residential |
||||||||||||||||||||||||||||
| Prime |
1,669 | 596 | 1,795 | 4,060 | 84,218 | 88,278 | — | |||||||||||||||||||||
| Subprime |
— | — | — | — | — | — | — | |||||||||||||||||||||
| Consumer |
189 | 108 | 187 | 484 | 10,180 | 10,664 | — | |||||||||||||||||||||
| $ | 6,052 | $ | 1,634 | $ | 7,095 | $ | 14,781 | $ | 263,918 | $ | 278,699 | $ | 599 | |||||||||||||||
Loans are considered impaired when, based on current information, it is probable that the Bank will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal and interest payments are past due and they are placed on non-accrual. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance homogeneous credits such as residential real estate and consumer installment loans, which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (usually ninety days or less) provided eventual collection of all amounts due is expected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Bank may measure impairment based on a loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. Interest payments on impaired loans are typically applied to principal unless collectability is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged-off when deemed uncollectible.
The following table presents a summary of impaired loans for the year ended December 31, 2010:
Impaired Loans
for the Year Ended December 31, 2010
| (Dollars in thousands) | Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Average Recorded Investment |
Interest Income Recognized |
|||||||||||||||
| With no related allowance recorded |
||||||||||||||||||||
| Commercial |
$ | 1,009 | $ | 1,009 | $ | — | $ | 539 | $ | 43 | ||||||||||
| Commercial real estate |
1,628 | 1,628 | — | 1,940 | — | |||||||||||||||
| Residential real estate |
1,478 | 1,478 | — | 1,060 | 73 | |||||||||||||||
| Consumer |
181 | 181 | — | 439 | 14 | |||||||||||||||
| 4,296 | 4,296 | — | 3,978 | $ | 130 | |||||||||||||||
| With an allowance recorded |
||||||||||||||||||||
| Commercial |
$ | 1,098 | $ | 1,098 | $ | 545 | $ | 2,293 | $ | 3 | ||||||||||
| Commercial real estate |
1,405 | 1,405 | 351 | 3,371 | 24 | |||||||||||||||
| Residential real estate |
1,341 | 1,341 | 416 | 1,347 | 21 | |||||||||||||||
| Consumer |
249 | 249 | 150 | 241 | 19 | |||||||||||||||
| 4,093 | 4,093 | 1,462 | 7,252 | 67 | ||||||||||||||||
| Total |
||||||||||||||||||||
| Commercial |
$ | 2,107 | $ | 2,107 | $ | 545 | $ | 2,832 | $ | 46 | ||||||||||
| Commercial real estate |
3,033 | 3,033 | 351 | 5,311 | 24 | |||||||||||||||
| Residential real estate |
2,819 | 2,819 | 416 | 2,407 | 94 | |||||||||||||||
| Consumer |
430 | 430 | 150 | 680 | 33 | |||||||||||||||
| $ | 8,389 | $ | 8,389 | $ | 1,462 | $ | 11,230 | $ | 197 | |||||||||||
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Interest income that would have been recorded under the original terms of nonaccrual loans and the interest actually recognized for the years ended December 31, 2009 is summarized below:
| 2009 | ||||
| Interest income that would have been recognized |
$ | 1,638 | ||
| Interest income recognized |
906 | |||
| Interest income not recognized |
$ | 732 | ||
The balance of nonaccrual and impaired loans as of December 31, 2009 is as follows:
Loans on Nonaccrual Status
as of December 31, 2009
| (Dollars in thousands) | 2009 | |||
| Commercial loans |
$ | 6,718 | ||
| Real estate loans |
||||
| Commercial |
2,353 | |||
| Construction |
4,876 | |||
| One to four-family (1) |
1,768 | |||
| Home equity loans |
482 | |||
| Consumer loans |
570 | |||
| $ | 16,767 | |||
| Loan 90 days or more past due |
33 | |||
| Total impaired loans |
$ | 16,800 | ||
| Average impaired loans |
$ | 13,589 | ||
| Related allowance for credit losses |
$ | 3,526 | ||
The Bank lends to customers located primarily in Anne Arundel County and surrounding areas of central Maryland. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.
Loans that were 90 days or more past due, including nonaccrual loans were $8.0 million at December 31, 2010 and $6.6 million at December 31, 2009.
Certain officers and directors (and directors’ companies which have a 10% or more beneficial ownership) have loans with the Bank. Such loans were made in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties and are being repaid as agreed.
A summary of the activity of these loans follows:
| 2010 | 2009 | |||||||
| Beginning balance |
$ | 10,785 | $ | 7,848 | ||||
| Advances |
1,123 | 3,786 | ||||||
| Repayments |
(1,741 | ) | (956 | ) | ||||
| Change in officers and directors, net |
112 | 107 | ||||||
| Ending balance |
$ | 10,279 | $ | 10,785 | ||||
6. CREDIT COMMITMENTS
Loan commitments outstanding, unused lines of credit and letters of credit are as follows:
| Dollars in thousands | 2010 | 2009 | ||||||
| Loan commitments and lines of credit |
||||||||
| Construction |
$ | 1,601 | $ | 524 | ||||
| Other |
63,623 | 50,685 | ||||||
| $ | 65,224 | $ | 51,209 | |||||
| Letter of credit |
||||||||
| Deposit secured |
$ | 941 | $ | 418 | ||||
| Other |
1,236 | 1,174 | ||||||
| $ | 2,177 | $ | 1,592 | |||||
Loan commitments including lines of credit are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have variable interest rates, fixed expiration dates, and may require
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payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Loan commitments and lines and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss the Company will incur by the funding of these commitments.
7. INVESTMENT IN BANK OWNED LIFE INSURANCE
In 2002, the Bank purchased single premium policies of Bank Owned Life Insurance (BOLI) amounting to $3,110,000. During 2010 an additional single premium policy in the amount of $1.0 million was purchased. The increase in cash surrender value is recorded as other noninterest income. The Bank recorded $216 thousand in BOLI income for 2010 and $141 thousand in 2009.
8. PREMISES AND EQUIPMENT
A summary of premises and equipment and the related depreciation is as follows:
| 2010 | 2009 | |||||||
| Land, land improvements and building |
$ | 6,118 | $ | 6,088 | ||||
| Leasehold improvements |
3,246 | 3,245 | ||||||
| Furniture, fixtures, and equipment |
3,080 | 3,002 | ||||||
| Construction in progress |
798 | 820 | ||||||
| 13,242 | 13,155 | |||||||
| Accumulated depreciation |
4,455 | 3,881 | ||||||
| Net premises and equipment |
$ | 8,787 | $ | 9,274 | ||||
Depreciation and amortization expense was $619 thousand for 2010 and $600 thousand for 2009. No interest was capitalized for the years ended December 31, 2010 and 2009.
9. LEASE COMMITMENTS
Lease obligations will require minimum rent payments as follows:
| Period |
Minimum Rentals $(000) |
|||
| 2011 |
$ | 447 | ||
| 2012 |
767 | |||
| 2013 |
738 | |||
| 2014 |
698 | |||
| 2015 |
677 | |||
| Remaining years |
7,794 | |||
| $ | 11,121 | |||
The leases generally provide for payment of property taxes, insurance, and maintenance costs by the Company. The total rental expense for all real property leases was $356 thousand and $354 thousand for 2010 and 2009, respectively.
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10. DEPOSITS
Major classifications of deposits are as follows:
| 2010 | 2009 | |||||||
| Demand, noninterest bearing |
$ | 45,514 | $ | 40,834 | ||||
| NOW accounts |
33,220 | 30,152 | ||||||
| Savings and Money Market accounts |
184,560 | 182,586 | ||||||
| Time deposits, $100,000 and over |
46,832 | 55,643 | ||||||
| Other time |
30,788 | 41,248 | ||||||
| $ | 340,914 | $ | 350,463 | |||||
Time deposits mature as follows:
| 2010 | 2009 | |||||||
| Repricing or maturing within one year |
$ | 52,016 | $ | 79,392 | ||||
| Maturing over one to three years |
21,038 | 14,291 | ||||||
| Maturing over three to five years |
4,566 | 3,208 | ||||||
| $ | 77,620 | $ | 96,891 | |||||
At December 31, 2010 and 2009 there were no time deposits with maturities in excess of five years.
11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are securities sold to the Bank’s customers, at the customer’s request, under a continuing “roll-over” contract that matures in one business day. The underlying securities sold are U.S. Treasury notes or Federal agencies that are segregated in the Bank’s correspondent safekeeping account from the Bank’s other investment securities.
The following table presents certain information for repurchase agreements:
| 2010 | 2009 | |||||||
| Balance outstanding, at year end |
$ | 14,558 | $ | 14,642 | ||||
| Average balance during the year |
20,060 | 14,912 | ||||||
| Average interest rate during the year |
0.65 | % | 0.81 | % | ||||
| Maximum month-end balance |
$ | 22,792 | $ | 19,342 | ||||
12. BORROWINGS
The Company had other long-term borrowings at December 31, 2010 and 2009 as follows:
| 2010 | 2009 | |||||||
| FHLB 2.85% Advance due March 2014 |
$ | 5,000 | $ | 5,000 | ||||
| FHLB 3.04% Advance due November 2017, Callable February 2011 |
5,000 | 5,000 | ||||||
| FHLB 3.19% Advance due December 2017, Callable March 2011 |
5,000 | 5,000 | ||||||
| FHLB 3.42% Advance due December 2017, Callable March 2011 |
5,000 | 5,000 | ||||||
| FHLB 3.50% Advance due January 2018, Callable January 2012 |
5,000 | 5,000 | ||||||
| FHLB 3.11% Advance due January 2018, Callable January 2013 |
10,000 | 10,000 | ||||||
| FHLB 2.23% Advance due March 2018, Called March 2010 |
— | 5,000 | ||||||
| Total |
$ | 35,000 | $ | 40,000 | ||||
Interest on these instruments is paid quarterly. FHLB advances are fully collateralized by pledges of loans. The Company has pledged under a blanket lien all qualifying residential and commercial mortgage loans under the borrowing agreement with the FHLB.
The Company had no short-term borrowings at December 31, 2010 and 2009.
13. GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES
On March 26, 2003, Annapolis Bancorp Statutory Trust I (“Statutory Trust I”), a Connecticut business trust formed, funded and wholly owned by the Company, issued $5,000,000 of variable-rate capital securities to institutional investors in a private pooled transaction. The variable rate on these securities adjusts quarterly based on the 90-day LIBOR rate plus 3.15%. The current rate is 3.45%. The proceeds were up-streamed to the Company as junior subordinated debt under the same terms and conditions. The Company then down-streamed $4,875,000 to the Bank in the form of additional capital. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Statutory Trust I’s obligations with respect
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to the capital securities. These capital securities currently qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” The sole asset of the Statutory Trust I is $5,155,000 of junior subordinated debentures issued by the Company. These junior subordinated debentures carry a variable interest rate of 3.15% over the 90 day LIBOR, payable semiannually, with a non-call provision over the first five year period. Both the capital securities of Statutory Trust I and the junior subordinated debentures are scheduled to mature on March 26, 2033, unless called by the Company. Interest expense on the trust preferred securities for the years ended December 31, 2010 and 2009 totaled $177 thousand and $204 thousand, respectively.
14. PROFIT SHARING AND OTHER EMPLOYEE BENEFIT PLANS
The Company has a profit sharing plan, qualifying under Section 401(k) of the Internal Revenue Code, for those employees who meet the eligibility requirements set forth in the plan. The plan does not require the Company to match the participants' contributions. The Company’s contributions to the plan were $144 thousand in 2010 and $132 thousand in 2009.
The Company has entered into individual Supplemental Executive Retirement Agreements (SERAs) with certain of its executives. The SERAs are designed to provide certain post-retirement benefits to enable a targeted level of covered retirement income to be met and to provide certain death benefits. The Company is accruing the present value of these benefits over the remaining number of years to the executives’ retirement dates. Benefit accruals included in noninterest expense for 2010 and 2009 were $274 thousand, $258 thousand, respectively.
In 2007 the Company created an Employee Stock Purchase Plan (“ESPP”) whereby under the terms of the ESPP an employee may purchase Annapolis Bancorp, Inc. common stock at a 5% discount of the market price at the end of a purchase period. During 2010 employees purchased 2,719 shares of common stock under the ESPP and in 2009 employees purchased 4,136 shares of common stock under the ESPP.
15. STOCK-BASED COMPENSATION
In April 1997, the Company adopted a stock option plan, authorizing the issuance of 177,777 shares of common stock, intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code. The plan provided for granting options to purchase shares of common stock to the officers and other key employees of the Company and the Bank. Options granted under this plan have ten-year expiration dates with vesting periods from immediate to five years. After April 2000 no additional options could be granted under this plan.
In April 2000, a new incentive stock option plan was approved by the shareholders at the annual meeting. Under this plan, the Company’s compensation committee has discretionary authority to grant stock options, restricted stock awards, and deferred share awards to employees and directors, including members of the committee. Under this plan, up to 355,554 shares of Company stock, as adjusted for the August 24, 2001 and December 3, 2006 four-for-three stock splits in the form of stock dividends, may be awarded under the direction of the committee. The plan provides for the awards to vest over a five-year period of time. Options have a ten-year expiration period. After April 2006 no additional options could be granted under this plan.
In May 2006, a new Company stock incentive plan was approved by shareholders at the annual meeting. Under the plan, up to 200,000 shares of the Company’s common stock may be awarded under the direction of the Company’s Compensation Committee. The Compensation Committee may in its discretion grant the following types of awards: options, share appreciation rights, restricted shares, deferred shares and performance awards. During 2010 33,384 restricted shares were granted under the terms of the plan.
The Company recognized $143 thousand in stock-based compensation expense for the year ended December 31, 2010 and $169 thousand in 2009. Stock-based compensation expense recognized in the consolidated statement of income for the years ended December 31, 2010 and 2009 reflects estimated forfeitures.
There were no options granted during 2010 and 2009.
Net cash proceeds from the exercise of stock options were approximately $43,000 and $20,000 for the years ending December 31, 2010 and 2009, respectively.
Stock option activity for the years ended December 31, 2010 and 2009 is as follows:
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| 2010 | 2009 | |||||||||||||||
| Number of Shares |
Weighted
Average Exercise Price |
Number of Shares |
Weighted
Average Exercise Price |
|||||||||||||
| Options Outstanding |
||||||||||||||||
| Outstanding, beginning of year |
183,819 | $ | 5.05 | 216,261 | $ | 4.87 | ||||||||||
| Granted |
— | — | — | — | ||||||||||||
| Exercised |
(17,776 | ) | 2.42 | (7,777 | ) | 2.64 | ||||||||||
| Forfeited |
(6,221 | ) | 7.24 | (11,332 | ) | 6.08 | ||||||||||
| Expired |
(35,552 | ) | 2.42 | (13,333 | ) | 2.69 | ||||||||||
| Outstanding, end of year |
124,270 | $ | 6.06 | 183,819 | $ | 5.05 | ||||||||||
| Vested |
121,378 | $ | 6.00 | 170,626 | $ | 4.74 | ||||||||||
| Nonvested |
2,892 | 8.77 | 13,193 | 9.06 | ||||||||||||
| Outstanding, end of year |
124,270 | $ | 6.06 | 183,819 | $ | 5.05 | ||||||||||
| Weighted average remaining contractual term in years |
2.8 | 2.8 | ||||||||||||||
| Total intrinsic value of options vested, end of year |
$ | 41,000 | $ | 49,000 | ||||||||||||
The remaining options expire as follows:
| Expiration Date |
Weighted Average Exercise Price |
Options Vested |
Nonvested | |||||||||
| 2011 |
2.72 | 31,968 | — | |||||||||
| 2012 |
4.14 | 33,333 | — | |||||||||
| 2014 |
7.68 | 7,463 | — | |||||||||
| 2015 |
9.24 | 41,256 | — | |||||||||
| 2016 |
8.77 | 4,832 | 1,208 | |||||||||
| 2017 |
8.77 | 2,526 | 1,684 | |||||||||
| 121,378 | 2,892 | |||||||||||
A summary of the status of the Company’s restricted share awards follows:
| 2010 | 2009 | |||||||||||||||
| Number of Shares |
Weighted Average Exercise Price |
Number of Shares |
Weighted Average Exercise Price |
|||||||||||||
| Restricted Shares |
||||||||||||||||
| Outstanding, beginning of year |
98,005 | $ | 3.69 | 18,150 | $ | 8.44 | ||||||||||
| Granted |
33,384 | 3.90 | 92,005 | 3.02 | ||||||||||||
| Vested |
(34,505 | ) | 2.70 | (12,150 | ) | 5.72 | ||||||||||
| Forfeited |
(28,500 | ) | 5.96 | — | — | |||||||||||
| Outstanding, end of year |
68,384 | $ | 3.66 | 98,005 | $ | 3.69 | ||||||||||
The aggregate intrinsic value in the table above represents the total pre-tax value (that is, the difference between the closing stock price on the last trading day in the year and the exercise price for those options in the money multiplied by the number of shares) that would have been received by the option holders had all options holders exercised their options on the last trading day of the year. This amount changes based on the fair market value of the Company’s stock. Total intrinsic value of options vested at the end of the year is approximately $41 thousand and $49 thousand for years ended December 31, 2010 and 2009, respectively.
As of December 31, 2010, $7 thousand of total unrecognized compensation costs related to unvested options is expected to be recognized over a weighted average period of 0.67 years, while $214 thousand of total unrecognized compensation costs related to restricted share units is expected to be recognized over a weighted average period of 2.84 years.
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16. LINES OF CREDIT
The Bank is a member of the Federal Home Loan Bank system and has the potential to borrow up to an additional $73.0 million. If funded, this line is secured by one- to four-family residential and commercial mortgage loans held in the Bank’s portfolio. In addition, the Bank has available secured and unsecured lines of credit of $14.2 million at December 31, 2010.
17. PREFERRED STOCK
The Company is authorized to issue up to 5,000,000 shares of preferred stock with a par value of $.01 per share. On January 30, 2010 the Company completed a transaction to participate in the Government sponsored Troubled Asset Relief Program which resulted in the Treasury purchasing 8,152 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) at a value of $8.2 million. The Series A Preferred Stock qualifies as Tier 1 Capital. The Series A Preferred Stock pays a dividend of 5% per annum; payable quarterly for five years then pays a dividend of 9% per annum thereafter. Dividends declared for the years ended December 31, 2010 and 2009 were $407 thousand and $375 thousand, respectively.
18. INCOME TAXES
The components of income tax expense (benefit) are as follows:
| 2010 | 2009 | |||||||
| Current |
||||||||
| Federal |
$ | 360 | $ | 554 | ||||
| State |
68 | 147 | ||||||
| 428 | 701 | |||||||
| Deferred |
458 | (1,859 | ) | |||||
| $ | 886 | ($ | 1,158 | ) | ||||
The components of the deferred tax expense (benefit) are as follows:
| 2010 | 2009 | |||||||
| Provision for credit losses |
$ | 789 | ($ | 1,500 | ) | |||
| Deferred compensation |
(135 | ) | (158 | ) | ||||
| Depreciation expense |
(77 | ) | (66 | ) | ||||
| Deferred loan fees |
(3 | ) | 19 | |||||
| Nonaccrual interest |
(76 | ) | (184 | ) | ||||
| Sale of loans |
(31 | ) | (4 | ) | ||||
| Other |
(9 | ) | 34 | |||||
| Deferred tax benefit |
$ | 458 | ($ | 1,859 | ) | |||
The components of the net deferred tax assets are as follows:
| 2010 | 2009 | |||||||
| Deferred tax assets |
||||||||
| Allowance for credit losses |
$ | 2,233 | $ | 3,022 | ||||
| Deferred compensation |
509 | 374 | ||||||
| Deferred Loan Fees |
64 | 61 | ||||||
| Unrealized loss on securities available for sale |
— | 322 | ||||||
| Nonaccrual interest |
365 | 289 | ||||||
| Other |
45 | 3 | ||||||
| Total deferred tax assets |
3,216 | 4,071 | ||||||
| Deferred tax liabilities |
||||||||
| Depreciation |
94 | 169 | ||||||
| Unrealized gain on securities available for sale |
193 | — | ||||||
| Total deferred tax liabilities |
287 | 169 | ||||||
| Net deferred tax asset |
$ | 2,929 | $ | 3,902 | ||||
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The differences between federal income taxes at statutory rates and the amount reported by the Company follow:
| 2010 | 2009 | |||||||||||||||
| Amount | % | Amount | % | |||||||||||||
| Income (loss) before income taxes |
$ | 2,502 | ($ | 2,865 | ) | |||||||||||
| Taxes computed at the federal income tax rate |
$ | 851 | 34.0 | % | ($ | 974 | ) | (34.0 | %) | |||||||
| Increases (decreases) resulting from |
||||||||||||||||
| State income taxes, net of federal benefit |
136 | 5.5 | % | (197 | ) | (6.8 | %) | |||||||||
| Nondeductible expenses |
4 | 0.1 | % | 61 | 2.1 | % | ||||||||||
| Nontaxable income |
(105 | ) | (4.2 | %) | (48 | ) | (1.7 | %) | ||||||||
| Income tax (benefit) expense |
$ | 886 | 35.4 | % | ($ | 1,158 | ) | (40.4 | %) | |||||||
19. CAPITAL STANDARDS
The Federal Reserve Board and the Federal Deposit Insurance Corporation have adopted risk-based capital standards for banking organizations. These standards require ratios of capital to assets for minimum capital adequacy and to be classified as well capitalized under prompt corrective action provisions. The capital ratios and minimum capital requirements of the Company and the Bank as of December 31, 2010 and 2009 are as follows:
| Actual Amount |
Ratio | Minimum Capital Adequacy Amount |
Ratio | To be Well Capitalized Amount |
Ratio | |||||||||||||||||||
| December 31, 2010 |
||||||||||||||||||||||||
| Total capital (to risk-weighted assets) |
||||||||||||||||||||||||
| Company |
$ | 43,370 | 14.1 | % | $ | 24,668 | 8.0 | % | ||||||||||||||||
| Bank |
$ | 43,110 | 14.0 | % | $ | 24,664 | 8.0 | % | $ | 30,830 | 10.0 | % | ||||||||||||
| Tier 1 capital (to risk-weighted assets) |
||||||||||||||||||||||||
| Company |
$ | 39,478 | 12.8 | % | $ | 12,334 | 4.0 | % | ||||||||||||||||
| Bank |
$ | 39,218 | 12.7 | % | $ | 12,332 | 4.0 | % | $ | 18,498 | 6.0 | % | ||||||||||||
| Tier 1 capital (to average assets) |
||||||||||||||||||||||||
| Company |
$ | 39,478 | 9.1 | % | $ | 17,402 | 4.0 | % | ||||||||||||||||
| Bank |
$ | 39,218 | 9.0 | % | $ | 17,399 | 4.0 | % | $ | 21,749 | 5.0 | % | ||||||||||||
| December 31, 2009 |
||||||||||||||||||||||||
| Total capital (to risk-weighted assets) |
||||||||||||||||||||||||
| Company |
$ | 42,004 | 13.7 | % | $ | 24,490 | 8.0 | % | ||||||||||||||||
| Bank |
$ | 42,003 | 13.7 | % | $ | 24,488 | 8.0 | % | $ | 30,610 | 10.0 | % | ||||||||||||
| Tier 1 capital (to risk-weighted assets) |
||||||||||||||||||||||||
| Company |
$ | 38,126 | 12.5 | % | $ | 12,245 | 4.0 | % | ||||||||||||||||
| Bank |
$ | 38,126 | 12.5 | % | $ | 12,244 | 4.0 | % | $ | 18,368 | 6.0 | % | ||||||||||||
| Tier 1 capital (to average assets) |
||||||||||||||||||||||||
| Company |
$ | 38,126 | 8.6 | % | $ | 17,750 | 4.0 | % | ||||||||||||||||
| Bank |
$ | 38,126 | 8.6 | % | $ | 17,750 | 4.0 | % | $ | 22,188 | 5.0 | % | ||||||||||||
Tier 1 capital consists of capital stock, paid in capital, and retained earnings. Total capital includes a limited amount of the allowance for credit losses. In calculating risk-weighted assets, specified risk percentages are applied to each category of asset and off-balance sheet items.
Failure to meet the capital requirements could affect the Bank’s ability to pay dividends and accept deposits and may significantly affect the operations of the Bank.
The Series A Preferred Stock issued under the TARP transaction that closed on January 30, 2010 qualify as tier one capital.
20. FAIR VALUE MEASUREMENTS
Effective January 1, 2010, the Company adopted FASB’s guidance on “Fair Value Measurements,” which provides a framework for measuring and disclosing fair value under GAAP. The guidance requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or a nonrecurring basis (for example, impaired loans).
The guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
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The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value all other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
The guidance establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:
Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.
Level 2 inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the assets credit rating, prepayment assumptions and other factors such as credit loss assumptions
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Investment Securities Available for Sale. Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, market spreads, cash flows, the U. S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include securities below investment grade and asset-backed securities in illiquid markets.
Impaired Loans. The Company does not report loans at fair value on a recurring basis, however from time to time, a loan is considered impaired and an allowance for credit loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment under the guidance of “Accounting by Creditors for Impairment of a Loan.” The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2010, substantially all of the totally impaired loans were evaluated based upon the fair value of the collateral. In accordance with the guidance, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.
The following table’s present information about the Company’s assets measured at fair value on a recurring basis as of December 31, 2010, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.
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| (in thousands) | Fair Value Measurements at December 31, 2010 Using |
|||||||||||||||||||||||
| Description |
Fair Value December 31, 2010 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Trading Gains and (Losses) |
Total Changes in Fair Values Included in Period Earnings |
||||||||||||||||||
| Investment Securities Available for Sale – Debt Securities |
||||||||||||||||||||||||
| Issued by the U.S. Treasury and Government agencies |
$ | 53,761 | $ | — | $ | 53,761 | $ | — | $ | — | $ | — | ||||||||||||
| Issued by State and municipal |
1,089 | — | 1,089 | — | — | — | ||||||||||||||||||
| Mortgage-backed securities issued by Government agencies |
37,737 | — | 37,737 | — | — | — | ||||||||||||||||||
| Other debt securities |
3,091 | — | 690 | 2,401 | — | — | ||||||||||||||||||
| Total Debt Securities |
95,678 | — | 93,277 | 2,401 | — | — | ||||||||||||||||||
| Investment Securities Available for Sale – Equity Securities |
||||||||||||||||||||||||
| Mutual funds |
617 | — | 617 | — | — | — | ||||||||||||||||||
| Total Equity Securities |
617 | — | 617 | — | — | |||||||||||||||||||
| Total Assets Measured at Fair Value on a Recurring Basis |
$ | 96,295 | $ | — | $ | 93,894 | $ | 2,401 | $ | — | $ | — | ||||||||||||
| Fair Value Measurements Using Significant Unobservable Inputs (Level 3) – Roll Forward at December 31, 2010 |
||||
| Investment Securities Available for Sale – Debt Securities |
||||
| Beginning Balance |
$ | — | ||
| Transfers in to Level 3 |
2,401 | |||
| Transfers out of Level 3 |
— | |||
| Ending Balance |
$ | 2,401 | ||
Level 3 securities include two private-label residential one to-four family mortgage backed securities. These 2005 senior tranches in a securitization trust were rated “Aa1 and Aaa” by Moody’s when purchased in 2005 and are currently rated “B3“. In 2010, these securities were transferred from a Level 2 classification to a Level 3 classification in recognition of the rating downgrade and continued market illiquidity for privately-issued securities. It is the Company’s policy to recognize transfers at the end of the reporting period. The Company engages the service of independent third party valuation professionals to estimate the fair value of these securities. The valuation is meant to be “Level Three” pursuant to FASB ASC Topic 820 – Fair Value Measurements and Disclosures. The valuation uses an expected cash flow model that includes assumptions related to prepayment rates, default trends, and loss severity. At December 31, 2010, both securities were current on both principal and interest payments, had a fixed weighted average coupon of 5.50% and weighted average remaining life of less than two years.
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Table of Contents
| (in thousands) | Fair Value Measurements at December 31, 2009 Using |
|||||||||||||||||||||||
| Description |
Fair Value December 31, 2009 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level3) |
Trading Gains and (Losses) |
Total Changes in Fair Values Included in Period Earnings |
||||||||||||||||||
| Investment Securities Available for Sale – Debt Securities |
||||||||||||||||||||||||
| Issued by the U.S. Treasury and Government agencies |
$ | 54,788 | $ | — | $ | 54,788 | $ | — | $ | — | $ | — | ||||||||||||
| Issued by State and municipal |
1,089 | — | 1,089 | — | — | — | ||||||||||||||||||
| Mortgage-backed securities issued by Government agencies |
56,377 | — | 56,377 | — | — | — | ||||||||||||||||||
| Other debt securities |
5,038 | — | 5,038 | — | — | — | ||||||||||||||||||
| Total Debt Securities |
117,292 | — | 117,292 | — | — | — | ||||||||||||||||||
| Investment Securities Available for Sale – Equity Securities |
||||||||||||||||||||||||
| Mutual funds |
591 | — | 591 | — | — | — | ||||||||||||||||||
| Total Equity Securities |
591 | — | 591 | — | — | |||||||||||||||||||
| Total Assets Measured at Fair Value on a Recurring Basis |
$ | 117,883 | $ | — | $ | 117,883 | $ | — | $ | — | $ | — | ||||||||||||
The Company may be required from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The Company has not elected the fair value option for any financial assets or liabilities at December 31, 2010. Assets measured at fair value on a nonrecurring basis are included in the table below.
| (in thousands) | Fair Value Measurements at December 31, 2010 Using |
|||||||||||||||||||||||
| Description |
Fair Value December 31, 2010 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level3) |
Trading Gains and (Losses) |
Total Changes in Fair Values Included in Period Earnings |
||||||||||||||||||
| Impaired loans |
||||||||||||||||||||||||
| Commercial |
$ | 1,562 | $ | — | $ | 1,562 | $ | — | $ | — | $ | — | ||||||||||||
| Commercial real estate |
1,449 | — | 1,449 | — | — | — | ||||||||||||||||||
| Residential real estate |
2,402 | — | 2,402 | — | — | — | ||||||||||||||||||
| Construction |
1,234 | — | 1,234 | — | — | — | ||||||||||||||||||
| Consumer |
280 | — | 280 | — | — | — | ||||||||||||||||||
| Total impaired loans |
6,927 | — | 6,927 | — | — | — | ||||||||||||||||||
| Real estate owned |
1,608 | — | 1,608 | — | — | — | ||||||||||||||||||
| Other assets (repossessed assets) |
145 | — | 145 | — | — | — | ||||||||||||||||||
| Total Assets Measured at Fair Value on a Non Recurring Basis |
$ | 8,680 | $ | — | $ | 8,680 | $ | — | $ | — | $ | — | ||||||||||||
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| (in thousands) | Fair Value Measurements at December 31, 2009 Using |
|||||||||||||||||||||||
| Description |
Fair Value December 31, 2009 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level3) |
Trading Gains and (Losses) |
Total Changes in Fair Values Included in Period Earnings |
||||||||||||||||||
| Impaired loans |
||||||||||||||||||||||||
| Commercial |
$ | 5,020 | $ | — | $ | 5,020 | $ | — | $ | — | $ | — | ||||||||||||
| Commercial real estate |
2,217 | — | 2,217 | — | — | — | ||||||||||||||||||
| Residential real estate |
1,454 | — | 1,454 | — | — | — | ||||||||||||||||||
| Construction |
4,644 | — | 4,644 | — | — | — | ||||||||||||||||||
| Consumer |
448 | — | 448 | — | — | — | ||||||||||||||||||
| Total impaired loans |
13,783 | — | 13,783 | — | — | — | ||||||||||||||||||
| Real estate owned |
2,398 | — | 2,398 | — | — | — | ||||||||||||||||||
| Other assets (repossessed assets) |
122 | — | 122 | — | — | — | ||||||||||||||||||
| Total Assets Measured at Fair Value on a Non Recurring Basis |
$ | 16,303 | $ | — | $ | 16,303 | $ | — | $ | — | $ | — | ||||||||||||
21. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Bank’s financial instruments are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.
| 2010 | 2009 | |||||||||||||||
| December 31, | Carrying Amount |
Estimated Fair Value |
Carrying Amount |
Estimated Fair Value |
||||||||||||
| Financial assets |
||||||||||||||||
| Cash and due from banks |
$ | 7,854 | $ | 7,854 | $ | 5,936 | $ | 5,936 | ||||||||
| Interest bearing balances with banks |
16,856 | 16,856 | 10,138 | 10,138 | ||||||||||||
| Federal funds sold and other overnight investments |
11,984 | 11,984 | 8,690 | 8,690 | ||||||||||||
| Investment securities available for sale |
96,295 | 96,295 | 117,883 | 117,883 | ||||||||||||
| Federal Reserve and Federal Home Loan Stock |
3,035 | 3,035 | 3,260 | 3,260 | ||||||||||||
| Loans and loans held for sale, net |
273,063 | 273,454 | 274,032 | 274,056 | ||||||||||||
| Accrued interest receivable |
1,567 | 1,567 | 1,934 | 1,934 | ||||||||||||
| Bank owned life insurance |
5,442 | 5,442 | 4,226 | 4,226 | ||||||||||||
| Real estate owned |
1,608 | 1,608 | 2,398 | 2,398 | ||||||||||||
| Financial liabilities |
||||||||||||||||
| Noninterest-bearing deposits |
$ | 45,514 | $ | 45,514 | $ | 40,834 | $ | 40,834 | ||||||||
| Interest-bearing deposits |
295,400 | 299,239 | 309,629 | 315,343 | ||||||||||||
| Securities sold under agreements to repurchase |
14,558 | 14,558 | 14,642 | 14,642 | ||||||||||||
| Long-term borrowings |
35,000 | 32,483 | 40,000 | 38,308 | ||||||||||||
| Junior subordinated debt |
5,000 | 5,000 | 5,000 | 5,000 | ||||||||||||
| Accrued interest payable |
187 | 187 | 211 | 211 | ||||||||||||
The carrying amount for cash and due from banks, federal funds sold and interest bearing balances due from banks approximates fair value.
The fair values of U.S. Treasury and Government agency securities and mortgage backed securities are determined using market quotations where available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.
The fair value of fixed-rate loans is estimated to be the present value of scheduled payments discounted using interest rates currently in effect. The fair value of variable-rate loans, including loans with a demand feature, is estimated to equal the carrying amount. The valuation of loans is adjusted for possible credit losses. The carrying value of loans held for sale approximates fair market value since such loans are typically committed to be sold at a profit.
The fair value of bank owned life insurance is assumed to be the cash surrender value.
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The fair value of interest-bearing checking, savings, and money market deposit accounts is equal to the carrying amount. The fair value of fixed-maturity time deposits is estimated based on interest rates currently offered for deposits of similar remaining maturities.
The carrying amount for customer repurchase agreements and variable rate borrowings approximate the fair values at the reporting date.
The fair value of fixed rate Federal Home Loan Bank advances is estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The fair value of variable rate Federal Home Loan Bank advances is estimated to be carrying value since these liabilities are based on a spread to a current pricing index.
The carrying amount of junior subordinated debentures approximate the fair values at the reporting date.
22. EARNINGS PER SHARE
A summary of shares outstanding for basic and fully diluted earnings per share is as follows:
| In thousands(000) | 2010 | 2009 | ||||||
| Weighted average shares outstanding, basic |
3,910 | 3,858 | ||||||
| Common stock equivalents |
37 | — | ||||||
| Average common shares and equivalents, fully diluted |
3,947 | 3,858 | ||||||
| Options and warrants outstanding excluded from above as they were antidilutive at December 31, |
455 | 474 | ||||||
23. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED
| December 31, | September 30, | June 30, | March 31, | |||||||||||||
| 2010 |
||||||||||||||||
| Interest income |
$ | 4,817 | $ | 4,771 | $ | 4,917 | $ | 5,349 | ||||||||
| Interest expense |
1,000 | 1,093 | 1,211 | 1,330 | ||||||||||||
| Net interest income |
3,817 | 3,678 | 3,706 | 4,019 | ||||||||||||
| Provision for credit losses |
927 | 622 | 363 | 236 | ||||||||||||
| Net income |
262 | 299 | 438 | 617 | ||||||||||||
| Net income available to common shareholders |
141 | 176 | 318 | 497 | ||||||||||||
| Comprehensive income |
(508 | ) | 434 | 1,091 | 1,389 | |||||||||||
| Earnings per common share - basic |
0.04 | 0.04 | 0.08 | 0.13 | ||||||||||||
| Earnings per share common - diluted |
0.04 | 0.04 | 0.08 | 0.13 | ||||||||||||
| 2009 |
||||||||||||||||
| Interest income |
$ | 5,492 | $ | 5,404 | $ | 5,343 | $ | 4,986 | ||||||||
| Interest expense |
1,513 | 1,605 | 1,956 | 2,061 | ||||||||||||
| Net interest income |
3,979 | 3,799 | 3,387 | 2,925 | ||||||||||||
| Provision for credit losses |
427 | 1,102 | 3,803 | 1,208 | ||||||||||||
| Net income (loss) |
381 | 223 | (1,861 | ) | (450 | ) | ||||||||||
| Net income (loss) available to common shareholders |
261 | 103 | (1,981 | ) | (532 | ) | ||||||||||
| Comprehensive income (loss) |
21 | 1,479 | (3,088 | ) | (573 | ) | ||||||||||
| Earnings (loss) per common share - basic |
0.07 | 0.03 | (0.51 | ) | (0.14 | ) | ||||||||||
| Earnings (loss) per share common - diluted |
0.07 | 0.03 | (0.51 | ) | (0.14 | ) | ||||||||||
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24. PARENT COMPANY FINANCIAL INFORMATION
The balance sheet and statements of income and cash flows for ANNAPOLIS BANCORP, INC. (Parent Company only) follow:
Balance Sheets
| December 31, | 2010 | 2009 | ||||||
| Assets |
||||||||
| Cash and due from banks |
$ | 272 | $ | 193 | ||||
| Due from subsidiaries |
— | — | ||||||
| Investment in subsidiaries |
39,669 | 37,646 | ||||||
| Deferred income taxes and other assets |
49 | 29 | ||||||
| Total assets |
$ | 39,990 | $ | 37,868 | ||||
| Liabilities and Stockholders’ Equity |
||||||||
| Junior subordinated debt |
$ | 5,155 | $ | 5,155 | ||||
| Due to subsidiaries |
1 | 20 | ||||||
| Accrued dividends |
52 | 52 | ||||||
| Other liabilities |
8 | 9 | ||||||
| Stockholders’ Equity |
||||||||
| Preferred stock |
8,063 | 7,985 | ||||||
| Common stock |
39 | 39 | ||||||
| Warrants |
234 | 234 | ||||||
| Paid in capital |
11,643 | 11,500 | ||||||
| Retained earnings |
14,499 | 13,368 | ||||||
| Accumulated other comprehensive income (loss) |
296 | (494 | ) | |||||
| Total liabilities and stockholders’ equity |
$ | 39,990 | $ | 37,868 | ||||
Statement of Income
| Years Ended December 31, | 2010 | 2009 | ||||||
| Interest income |
$ | — | $ | — | ||||
| Interest expense |
177 | 204 | ||||||
| Net interest income |
(177 | ) | (204 | ) | ||||
| Equity in undistributed income (loss) of subsidiaries |
1,233 | (1,979 | ) | |||||
| Dividends from subsidiary |
588 | 636 | ||||||
| Total income (loss) |
1,644 | (1,547 | ) | |||||
| Noninterest expense |
||||||||
| Compensation |
30 | 112 | ||||||
| Legal |
50 | 93 | ||||||
| Shareholder communications |
82 | 85 | ||||||
| Total expense |
162 | 290 | ||||||
| Income (loss) before income tax benefit |
1,482 | (1,837 | ) | |||||
| Income tax benefit |
(134 | ) | (130 | ) | ||||
| Net income (loss) |
$ | 1,616 | ($ | 1,707 | ) | |||
| Preferred Stock Dividend and Discount Accretion |
(485 | ) | (442 | ) | ||||
| Net Income (Loss) Available to Common Shareholders |
$ | 1,131 | ($ | 2,149 | ) | |||
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Statements of Cash Flows
| Years Ended December 31, | 2010 | 2009 | ||||||
| Cash flows from operating activities |
||||||||
| Net income (loss) |
$ | 1,616 | ($ | 1,707 | ) | |||
| Due from subsidiaries |
(20 | ) | 26 | |||||
| Tax benefit (provided) received |
(14 | ) | 3 | |||||
| Stock-based compensation |
90 | 169 | ||||||
| Downstream of cash to subsidiary |
— | (8,152 | ) | |||||
| Undistributed net (income) loss of subsidiary |
(1,821 | ) | 1,343 | |||||
| Net (decrease) increase in other assets and liabilities |
(6 | ) | (2 | ) | ||||
| Net cash used in operations |
(155 | ) | (8,320 | ) | ||||
| Cash flows from financing activities |
||||||||
| Dividends received from Bank |
588 | 636 | ||||||
| Issuance of preferred stock and warrants |
— | 8,152 | ||||||
| Payment of dividends on preferred stock |
(407 | ) | (323 | ) | ||||
| Proceeds from stock options exercised and |
||||||||
| Employee Stock Purchase Plan |
53 | 32 | ||||||
| Net cash provided by financing activities |
234 | 8,497 | ||||||
| Net increase in cash |
79 | 177 | ||||||
| Cash and equivalents at beginning of year |
193 | 16 | ||||||
| Cash and equivalents at end of year |
$ | 272 | $ | 193 | ||||
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T). CONTROLS AND PROCEDURES
Disclosure Controls
As of the end of the period covered by this Annual Report on Form 10-K, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d – 15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Internal Control over Financial Reporting
Management’s report on the Company’s internal control over financial reporting is included in Item 8 under the heading Management’s Report on Internal Control Over Financial Reporting and is incorporated herein by reference.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15 or Rule 15d-15 under the Exchange Act) during the quarter ended December 31, 2010, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information relating to directors, officers, promoters and control persons and regarding compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 19, 2011 at pages 4 through 7 which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company’s fiscal year (“Proxy Statement”).
Code of Ethics
On June 20, 2003, the Company’s Board of Directors adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. On February 18, 2011 the Company’s Board of Directors reaffirmed the code of ethics. The Code of Ethics for the Principal Executive Officer and the Senior Financial Officer has been posted on the Company’s internet website at www.bankannapolis.com.
Audit Committee
The information relating to the Company’s Audit Committee is incorporated herein by reference to the Company’s Proxy Statement at page 7.
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ITEM 11. EXECUTIVE COMPENSATION
The information relating to director and executive compensation is incorporated herein by reference to the Company’s Proxy Statement at pages 11 through 15.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
On May 17, 2007 shareholders approved a new Employee Stock Purchase Plan. Under the plan, which was effective July 1, 2007, eligible employees are able to purchase shares of the Company’s common stock through payroll deductions. Shares have a price equal to 95% of the fair market value on the purchase date (and could be as low as 85% per Code Section 423 rules). During 2010, 2,719 shares of common stock were purchased through the Employee Stock Purchase Plan.
The Company currently has three stock incentive plans. In April 1997, the Company’s 1997 Employee Incentive Stock Option Plan was approved by shareholders at the annual meeting. Under the 1997 plan, up to 177,777 shares of the Company’s common stock could be awarded under the direction of the Company’s Compensation Committee. Incentive stock options vest over a five year period. No additional awards may be made from this plan. During April 2000, the Company’s 2000 stock incentive plan was approved by shareholders at the annual meeting. Under the plan, up to 355,554 shares of the Company’s common stock could be awarded under the direction of the Company’s Compensation Committee. Incentive stock options and grants vest over a five-year period. No additional awards may be made from this plan. In May 2006, a new Company stock incentive plan was approved by shareholders at the annual meeting. Under the plan, up to 200,000 shares of the Company’s common stock may be awarded under the direction of the Company’s Compensation Committee. The Compensation Committee may in its discretion grant the following types of awards: options, share appreciation rights, restricted shares, deferred shares and performance awards. During 2010, 33,384 restricted shares of common stock with vesting on various dates beginning on January 28, 2011 and continuing through September 27, 2015 were granted under the terms of the 2006 Plan. During 2010, 17,776 options granted in prior years were exercised, 6,221 were forfeited and 35,552 options to purchase common stock expired. Also during 2010 34,505 restricted shares vested and were issued and 28,500 shares were forfeited. At December 31, 2010, the Company had a total of 124,270 options granted and outstanding and 68,384 restricted shares granted and outstanding. See Note 15 to the Consolidated Financial Statements for more information on the Company’s stock option plans.
A table of the Equity Compensation Plan Information is shown below:
| Plan Category |
Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) |
Weighted average exercise price of outstanding options, warrants and rights (b) |
Number of securities
remaining available for future issuance under equity compensation plans excluding securities reflected in column (a) (c) |
|||||||||
| Equity compensation plans approved by security holders |
192,654 | $ | 5.21 | 168,596 | ||||||||
| Equity compensation plans not approved by security holders |
— | — | — | |||||||||
| Total |
192,654 | $ | 5.21 | 168,596 | ||||||||
In addition to the securities listed above as part of the TARP CPP, the Company sold a warrant to purchase 299,706 shares of common stock at a price of $4.08 per share to the Treasury on January 30, 2009.
The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Company’s Proxy Statement at pages 2 though 4.
The Equity Compensation Plan Information appears in the Company’s Proxy Statement on pages 14 through 15 and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information relating to certain relationships and related transactions is incorporated herein by reference to the Company’s Proxy Statement on pages 15 through 16.
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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit and Non-Audit Fees
The following table presents fees for professional audit services rendered by Stegman & Company for the audit of Annapolis Bancorp’s annual consolidated financial statements for the years ended December 31, 2010 and December 31, 2009 and fees billed for other services rendered by Stegman & Company during those periods.
| Year ended December 31, | ||||||||
| 2010 | 2009 | |||||||
| Audit fees (1) |
$ | 68,719 | $ | 72,793 | ||||
| Audit related fees (2) |
7,000 | 6,500 | ||||||
| Tax fees (3) |
5,750 | 5,750 | ||||||
| All other fees |
— | — | ||||||
| Total fees |
$ | 81,469 | $ | 85,043 | ||||
| (1) | Audit Fees consist of fees billed for professional services rendered for the audit of the Company’s consolidated annual financial statements and review procedures in accordance with SAS 100 of Form 10-Q for the quarters ended March 31, 2010 and 2009, June 30, 2010 and 2009 and September 2010 and 2009 respectively, and services that are normally provided by Stegman & Company in connection with statutory and regulatory filings or engagements. |
| (2) | Audit Related Fees consist of fees billed for professional services rendered for the audit of the Company’s Employee Stock Purchase Plan for the years ended December 31, 2009 and 2008. |
| (3) | Tax Fees consist of fees billed for professional services rendered for federal and state tax return assistance and compliance, tax advice and tax planning and property and other tax return assistance. |
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
| (a) | The following documents are filed as a part of this report: |
| 1. | Consolidated Financial Statements of Annapolis Bancorp, Inc. have been included in Item 8. |
| 2. | All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto. |
| (b) | Exhibits |
The following exhibits are filed as part of this report.
| 3.1 |
Articles of Incorporation of Annapolis Bancorp, Inc.* | |
| 3.2 |
Amended and Restated Bylaws of Annapolis Bancorp, Inc.** | |
| 3.3 |
Articles of Incorporation of BankAnnapolis*** | |
| 3.4 |
Bylaws of BankAnnapolis*** | |
| 4.0 |
Stock Certificate of Annapolis National Bancorp, Inc.* | |
| 4.1 |
Form of Stock Certificate for the Fixed Rate Cumulative Preferred Stock, Series A. ******* | |
| 4.2 |
Warrant To Purchase 299,706 Shares of Common Stock Of Annapolis Bancorp, Inc. ******* | |
| 10.1 |
Annapolis National Bancorp, Inc. Employee Stock Option Plan*+ | |
| 10.2 |
Annapolis National Bancorp, Inc. 2000 Employee Stock Option Plan**** | |
| 10.3 |
Annapolis Bancorp, Inc. 2007 Stock Incentive Plan***** | |
| 10.4 |
Form of Stock Option Award Agreement***** | |
| 10.5 |
Form of Restricted Share Award Agreement***** | |
| 10.6 |
Form of Deferral Election Agreement for Deferred Share Units***** | |
| 10.7 |
Annapolis Bancorp, Inc. 2007 Employee Stock Purchase Plan ****** | |
| 10.8 |
Securities Purchase Agreement by and between the United States Department of the Treasury and Annapolis Bancorp, Inc. dated January 30, 2009******* | |
| 14.0 |
Code of Ethics++ | |
| 23.0 |
Consent of Independent Registered Public Accounting Firm (filed herewith) | |
| 31.1 |
Certification Pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith) | |
| 31.2 |
Certification Pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith) | |
| 32.1 |
Certification Pursuant to 18 U.S.C. Section 1350 | |
| 32.2 |
Certification Pursuant to 18 U.S.C. Section 1350 | |
| 99.1 |
Certification Pursuant to 31 C. F. R. 30.15 | |
| 99.2 |
Certification Pursuant to 31 C. F. R. 30.15 | |
| + |
Management contract or compensatory plan or arrangement. | |
| ++ |
Incorporated herein by reference to the Annual Report on Form 10-KSB for fiscal year ended December 31, 2003, filed with the Securities and Exchange Commission on March 25, 2005. | |
| * |
Incorporated herein by reference to the Company’s Registration Statement on Form SB-2, as amended, Commission File Number 333-29841, filed with the Securities and Exchange Commission on June 23, 1997. | |
| ** |
Incorporated herein by reference to the Company’s Report on Form 8-K, filed with the Securities and Exchange Commission on October 23, 2008. | |
| *** |
Incorporated herein by reference to the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2000, filed with the Securities and Exchange Commission on March 28, 2001. | |
| **** |
Incorporated herein by reference to the Company’s Definitive Proxy Statement for the 2000 annual meeting, filed with the Securities and Exchange Commission on April 5, 2000. | |
| ***** |
Incorporated herein by reference to the Company’s Registration Statement on Form S-8, Commission File Number 333-136382, filed with the Securities and Exchange Commission on August 8, 2007. | |
| ****** |
Incorporated herein by reference to the Company’s Definitive Proxy Statement for the 2007 annual meeting, filed with the Securities and Exchange Commission on April 13, 2007. | |
| ******* |
Incorporated herein by reference to the Company’s Report on Form 8-K, filed with the Securities and Exchange Commission on February 2, 2009. | |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
| ANNAPOLIS BANCORP, INC. | ||
| By: | /s/ Richard M. Lerner | |
| Richard M. Lerner | ||
| Chairman and CEO | ||
| Date: | March 25, 2011 | |
| By: | /s/ Edward J. Schneider | |
| Edward J. Schneider | ||
| Chief Financial Officer | ||
| Date: | March 25, 2011 | |
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons in the capacities and on the dates stated.
| NAME |
Title |
Date | ||
| /s/ Richard M. Lerner |
Chairman, Chief Executive Officer and | March 25, 2011 | ||
| Richard M. Lerner | Director (principal executive officer) | |||
| /s/ Edward J. Schneider |
Treasurer and Chief Financial Officer | March 25, 2011 | ||
| Edward J. Schneider | (principal accounting and financial officer) | |||
| /s/ Joseph G. Baldwin |
Director | March 25, 2011 | ||
| Joseph G. Baldwin | ||||
| /s/ Walter L. Bennett, IV |
Director | March 25, 2011 | ||
| Walter L. Bennett, IV | ||||
| /s/ Clyde E. Culp, III |
Director | March 25, 2011 | ||
| Clyde E. Culp, III | ||||
| /s/ Kendel S. Ehrlich |
Director | March 25, 2011 | ||
| Kendel S. Ehrlich | ||||
| /s/ F. Carter Heim |
Director | March 25, 2011 | ||
| F. Carter Heim | ||||
| /s/ Richard E. Hug |
Director | March 25, 2011 | ||
| Richard E. Hug | ||||
| /s/ Stanley J. Klos, Jr. |
Director | March 25, 2011 | ||
| Stanley J. Klos, Jr. | ||||
| /s/ Lawrence E. Lerner |
Director | March 25, 2011 | ||
| Lawrence E. Lerner | ||||
| /s/ Lawrence W. Schwartz |
Director | March 25, 2011 | ||
| Lawrence W. Schwartz | ||||
| /s/ Ermis Sfakiyanudis |
Director | March 25, 2011 | ||
| Ermis Sfakiyanudis | ||||
| /s/ Clifford T. Solomon |
Director | March 25, 2011 | ||
| Clifford T. Solomon | ||||
60