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Table Of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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 March 31, 2016

 

OR

 

[    ]

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

   
  For the transition period from _______________ to _______________

  

Commission File Number: 1-35693

 

HAMILTON BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

MARYLAND

(State or other jurisdiction of incorporation or organization)

46-0543309

(I.R.S. Employer Identification No.)

501 Fairmount Avenue, Suite 200, Towson, Maryland

(Address of principal executive offices)

21286

(Zip Code)

 

(410) 823-4510

(Registrant’s telephone number, including area code)

 

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

 

     Title of each class     

Common Stock, par value $0.01 per share

Name of each exchange on which registered

Nasdaq Capital Market

 

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

  

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

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 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 such shorter period that the registrant was required to submit and post such files). Yes [ X ] No [ ]

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. [ X ]

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

Large accelerated filer [ ]

Accelerated filer [ ]

Non-accelerated filer [ ]

Smaller reporting company [ X ]

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of September 30, 2015 was $47,750,906

 

The number of shares outstanding of the registrant’s common stock as of June 29, 2016 was 3,413,646.

 

DOCUMENTS INCORPORATED BY REFERENCE:

Proxy Statement for the Registrant’s Annual Meeting of Stockholders (Part III)

 

 

INDEX

 

Part I

    Page
Item 1. Business 1
Item 1A. Risk Factors 28
Item 1B. Unresolved Staff Comments 35
Item 2. Properties 36
Item 3. Legal Proceedings 37
Item 4. Mine Safety Disclosures 37
     
Part II
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 37
Item 6.  Selected Financial Data 39
Item 7.  Management’s Discussion and Analysis of Financial Condition And Results of Operations 41
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 69
Item 8. Financial Statements and Supplementary Data 69
Item 9. Changes In and Disagreements With Accountants on Accounting And financial Disclosure 69
Item 9A.  Controls and Procedures 69
Item 9B. Other Information 70
     
Part III
     
Item 10. Directors, Executive Officers and Corporate Governance 71
Item 11. Executive Compensation 71
Item 12. Security Ownership of Certain Beneficial Owners and Management And Related Stockholder Matters 71
Item 13. Certain Relationships and Related Transactions, and Director Independence 72
Item 14. Principal Accounting Fees and Services 72
     
Part IV
     
Item 15. Exhibits and Financial Statement Schedules 73
SIGNATURES 75

 

 

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 ii

Table Of Contents
 

 

This report contains certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts; rather, they are statements based on Hamilton Bancorp, Inc.’s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

 

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could affect actual results include changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the credit quality and composition of the loan and investment portfolios, valuation of assets acquired through foreclosure, deposit flows, competition, demand for loan products and for financial services in Hamilton Bancorp, Inc.’s market area, changes in real estate market values in Hamilton Bancorp, Inc.’s market area, changes in relevant accounting principles and guidelines and the inability of third party service providers to perform as required. For further discussion of factors that may affect the results, see “Item 1A. Risk Factors” in this Annual Report on Form 10-K (“Annual Report”). These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Except as required by law, we disclaim any intention or obligation to update or revise any forward-looking statements after the date of this Annual Report, whether as a result of new information, future events or otherwise.

 

In this Annual Report , the terms “we,” “our,” and “us” refer to Hamilton Bancorp, Inc. and Hamilton Bank, unless the context indicates another meaning. In addition, we sometimes refer to Hamilton Bancorp, Inc. as “Hamilton Bancorp,” and to Hamilton Bank as the “Bank.”

 

PART I

 

Item 1.     BUSINESS

 

General

 

Hamilton Bancorp, Inc. (the “Company”) is a Maryland chartered corporation incorporated on June 7, 2012 to serve as the stock holding company for Hamilton Bank (the “Bank”), a federally chartered savings bank. On October 10, 2012, in accordance with a Plan of Conversion adopted by its Board of Directors and approved by its members, the Bank converted from a mutual savings bank to a stock savings bank and became the wholly owned subsidiary of the Company. In connection with the conversion, the Company sold 3,703,000 shares of common stock at a price of $10.00 per share, through which the Company received net proceeds of approximately $35,580,000. Hamilton Bancorp’s principal business activity is the ownership of the Bank’s capital stock and the management of the offering proceeds it retained in connection with the Bank’s conversion. Hamilton Bancorp does not own or lease any property but instead uses the premises, equipment and other property of the Bank with the payment of appropriate rental fees, as required by applicable law and regulations, under the terms of an expense allocation agreement. In the future, Hamilton Bancorp may acquire or organize other operating subsidiaries.

 

Hamilton Bank is a federally chartered savings bank that has served the banking needs of its customers since 1915. Hamilton Bank is headquartered in Towson, which is located in Baltimore County, Maryland. The Bank conducts business primarily from its seven full-service banking offices located in Baltimore City, Maryland and the Maryland counties of Baltimore, Howard, and Anne Arundel. Our business consists primarily of accepting deposits from the general public and investing those deposits, together with funds generated from operations, in one-to four-family residential mortgage loans (including owner-occupied and investor loans), commercial real estate loans, commercial business loans, home equity loans and lines of credit, construction loans and, to a limited extent, consumer loans (consisting primarily of loans secured by deposits and automobile loans). At March 31, 2016, $102.6 million, or 46.0%, of our gross loan portfolio was comprised of permanent residential mortgage loans.

 

We also invest in securities, which consist primarily of U.S. government agency, municipal and corporate bond obligations, mortgage-backed securities and collateralized mortgage obligations issued or guaranteed by U.S. government-sponsored enterprises, and to a much lesser extent, equity securities of government-sponsored enterprises.

 

 

We offer a variety of deposit accounts, including certificate of deposit accounts, money market accounts, savings accounts, NOW accounts and individual retirement accounts. We historically have not used borrowings to fund our operations. However, in the second half of fiscal 2015, we borrowed from the Federal Home Loan Bank and purchased brokered deposits to meet growing loan demand. We also acquired additional borrowings through a recent acquisition. We are committed to offering alternative banking delivery systems, including ATMs, online banking and remote deposit capture.

 

Recent Acquisitions

 

On September 11, 2015, the Company completed its acquisition of Fairmount Bancorp, Inc. (“Fairmount Bancorp”) through the merger of Fairmount Bancorp, the parent company of Fairmount Bank, with and into the Company pursuant to the Agreement and Plan of Merger dated April 15, 2015. As a result of the acquisition, each shareholder of Fairmount Bancorp received a cash payment equal to thirty dollars ($30.00) for each share of Fairmount Bancorp common stock, or an aggregate of approximately $15.4 million. Immediately after the acquisition of Fairmount Bancorp, Fairmount Bank was merged with and into the Bank, with the Bank the surviving bank.

 

On May 13, 2016, the Company completed its acquisition of Fraternity Community Bancorp, Inc. (“Fraternity Community Bancorp”) through the merger of Fraternity Community Bancorp, the parent company of Fraternity Federal Savings & Loan Association, with and into the Company pursuant to the Agreement and Plan of Merger dated October 12, 2015. As a result of the merger, each shareholder of Fraternity Community Bancorp received a cash payment equal to nineteen dollars and twenty-five cents ($19.25) for each share of Fraternity Community Bancorp common stock, or an aggregate of approximately $25.7 million. Immediately after the acquisition of Fraternity Community Bancorp, Fraternity Federal Savings & Loan Association was merged with and into the Bank, with the Bank the surviving bank.

   

Available Information

 

The Bank’s website address is www.hamilton-bank.com. Information on the Bank’s website should not be considered a part of this Annual Report.

 

Market Area

 

We conduct our operations from our seven full-service banking offices in Maryland. Our primary deposit market includes the areas surrounding our banking offices in Cockeysville, Pasadena, Towson, Rosedale, Ellicott City and two locations in Baltimore City. In May 2015, we closed our stand- alone branch office in the Towson area of Baltimore County and relocated it within our administrative offices, also located in the area of Towson. A branch presence at the administrative office allows the lending area to better service their customers, as well as reduces overhead costs without compromising our customers or our service in this area of Baltimore County.

 

The Bank considers greater Maryland, southern Pennsylvania, Washington D.C., and northern Virginia as its primary lending area for its various consumer, commercial and mortgage lending services. It is the policy of the Bank to focus on lending to customers within its primary lending area, and/or to collateralize secured loans with real property located within the primary lending area. However, we occasionally make loans secured by property located outside of our primary lending market, especially to borrowers with whom we have an existing relationship or who have a significant presence within our primary market. Our primary lending market contains a diverse cross section of employment sectors, with a mix of services, manufacturing, wholesale/retail trade, federal and local government, health care facilities and finance related employment. The city of Baltimore is now considered a major center for both the financial and health service industries.

 

 

Our branch network includes Baltimore City and the Maryland counties of Anne Arundel, Howard, and Baltimore. In recent years Baltimore City and Baltimore County have experienced relatively slow growth, while Anne Arundel County has grown at a faster pace. The stronger population growth experienced in Anne Arundel County has been reflected in higher household income and lower unemployment. Baltimore City, Baltimore County, Howard, and Anne Arundel County reported preliminary unemployment rates of 7.0%, 4.9%, 3.3% and 3.9%, respectively, for December 2015, compared to the statewide and national unemployment rates of 4.7% and 5.1%, respectively.

 

Competition

 

We face significant competition within our market both in making loans and attracting deposits. Our market area has a high concentration of financial institutions including large money center and regional banks, community banks and credit unions. Some of our competitors offer products and services that we currently do not offer, such as trust services and private banking. Our competition for loans and deposits comes principally from commercial banks, savings institutions, internet banks, mortgage banking firms, consumer finance companies, credit unions, and non-bank lenders. We face additional competition for deposits from short-term money market funds, brokerage firms, mutual funds and insurance companies. Our primary focus is to build and develop profitable customer relationships across all lines of business while maintaining our position as a community bank.

 

As of June 30, 2015 (the latest date for which information is available), our market share was 0.33% of total deposits in Baltimore City, making us the 13th largest out of 30 financial institutions in Baltimore City based upon deposit share as of that date. In addition, as of June 30, 2015, our deposit market share was 0.62% and 0.38% of total deposits in Baltimore County and Anne Arundel County, respectively, making us the 20th largest out of 36 financial institutions in Baltimore County and the 21st largest out of 29 financial institutions in Anne Arundel County.

 

Lending Activities 

 

General. Historically, our principal lending activity has been the origination of mortgage loans collateralized by one- to four-family residential real estate located within our primary market area. We have altered that emphasis in recent years to become less reliant upon one- to four-family mortgage lending and to emphasize commercial business and commercial real estate lending. This has allowed the Bank to develop a more diversified loan portfolio, generate loan growth from different resources, and provide our customers with more products and services that fit their needs. In connection with this strategy, we have hired several commercial real estate and commercial business loan officers with strong experience in these lending areas. In addition, back office commercial loan personnel have also been hired to assist with the record keeping, underwriting, and monitoring of our commercial loan portfolio. Our commercial loan underwriting analysis is maintained in-house and allows us to be more efficient in originating loans and enhance the customer experience. We currently sell a majority of our one- to four-family mortgage loans with terms over 10 years into the secondary market. In addition to commercial business loans, commercial real estate loans and residential mortgage loans, we also offer home equity loans and lines of credit, residential and commercial construction loans, and, to a much lesser extent, other consumer loans. A portion of the loans that we portfolio with respect to one- to four-family residential properties are made to investors who reside in our community.    

 

 

Loan Portfolio Composition. Set forth below is selected information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated. Amounts shown do not include loans held for sale equal to $259,000, $581,000, $-0-, $197,000 and $-0- at March 31, 2016, 2015, 2014, 2013 and 2012, respectively.

 

   

At March 31,

 
   

2016

   

2015

   

2014

 
   

Amount

   

Percent

   

Amount

   

Percent

   

Amount

   

Percent

 
   

(Dollars in thousands)

 

Real estate loans:

                                               

Residential mortgage loans:

                                               

One- to four-family residential

  $ 69,300       31.1

%

  $ 49,865       31.1

%

  $ 57,674       39.8

%

One- to four-family investor

    27,860       12.5       12,971       8.1       14,000       9.7  

Construction

    8,527       3.8       6,362       4.0       3,268       2.3  

Commercial real estate

    78,115       35.1       59,273       36.9       41,406       28.6  

Total real estate loans

    183,802       82.5       128,471       80.1       116,348       80.4  

Commercial business loans

    20,395       9.2       18,490       11.5       15,657       10.8  

Consumer:

                                               

Home equity loans and lines of credit

    14,391       6.5       12,261       7.6       11,660       8.0  

Other consumer

    4,179       1.9       1,166       0.8       1,154       0.8  

Total consumer loans

    18,570       8.3       13,427       8.4       12,814       8.8  

Total loans receivable

    222,767       100.0

%

    160,388       100.0

%

    144,819       100.0

%

                                                 

Discount on loans acquired

    (769 )             -               -          

Net deferred loan origination fees and costs

    (139 )             (103 )             (119 )        

Allowance for loan losses

    (1,702 )             (1,690 )             (1,786 )        
                                                 

Total loans receivable, net

  $ 220,157             $ 158,595             $ 142,914          

 

   

At March 31,

 
   

2013

   

2012

 
   

Amount

   

Percent

   

Amount

   

Percent

 
   

(Dollars in thousands)

 

Real estate loans:

                               

Residential mortgage loans:

                               

One- to four-family residential

  $ 63,912       39.6

%

  $ 76,687       44.2

%

One- to four-family investor

    15,826       9.8       17,265       9.9  

Construction

    3,508       2.2       3,865       2.2  

Commercial real estate

    36,239       22.5       31,018       17.9  

Total real estate loans

    119,485       74.1       128,835       74.2  

Commercial business loans

    26,937       16.7       27,158       15.7  

Consumer:

                               

Home equity loans and lines of credit

    13,727       8.5       16,344       9.4  

Other consumer

    1,123       0.7       1,181       0.7  

Total consumer loans

    14,850       9.2       17,525       10.1  

Total loans receivable

    161,272       100.0

%

    173,518       100.0

%

                                 

Discount on loans acquired

    15               38          

Net deferred loan origination fees and costs

    (96 )             (100 )        

Allowance for loan losses

    (2,071 )             (3,552 )        
                                 

Total loans receivable, net

  $ 159,120             $ 169,904          

  

Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at March 31, 2016. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

 

 

   

One- to Four-Family Residential Real Estate

   

One- to Four-Family Investor Real Estate

   

Construction Real Estate

   

Commercial Real Estate

 
   

Amount

   

Weighted Average Rate

   

Amount

   

Weighted Average Rate

   

Amount

   

Weighted Average Rate

   

Amount

   

Weighted Average Rate

 
   

(Dollars in thousands)

 

Due During the Years Ending March 31,

                                                               

2017

  $ 544       5.69

%

  $ 10,010       7.24

%

  $ 6,752       4.25

%

  $ 7,893       4.25

%

2018

    1,432       4.84       1,117       6.58       -       -       3,088       5.67  

2019

    1,136       4.60       3,069       6.11       -       -       6,578       5.40  

2020 to 2021

    3,490       4.39       4,884       5.68       67       3.50       12,549       4.28  

2022 to 2026

    6,166       3.82       6,655       7.30       1,707       4.23       42,756       4.34  

2027 to 2031

    6,111       4.26       1,416       6.11       -       -       3,129       5.24  

2032 and beyond

    50,421       4.52       709       4.95       -       -       2,122       4.21  
                                                                 

Total

  $ 69,300       4.45

%

  $ 27,860       6.71

%

  $ 8,526       4.24

%

  $ 78,115       4.50

%

 

   

Commercial Business

   

Home Equity Loans and Lines of Credit

   

Other Consumer

   

Total

 
   

Amount

   

Weighted Average Rate

   

Amount

   

Weighted Average Rate

   

Amount

   

Weighted Average Rate

   

Amount

   

Weighted Average Rate

 

Due During the Years Ending March 31,

 

(Dollars in thousands)

 

2017

  $ 8,263       3.79

%

  $ 58       1.57

%

  $ 24       2.68

%

  $ 33,544       5.05

%

2018

    115       5.02       80       4.24       120       4.46       5,952       5.58  

2019

    1,471       4.30       85       3.84       255       3.27       12,594       5.32  

2020 to 2021

    6,212       5.16       548       4.71       1,631       3.16       29,381       4.66  

2022 to 2026

    3,850       5.99       2,199       4.39       243       8.65       63,576       4.71  

2027 to 2031

    298       4.75       3,848       4.36       846       9.32       15,648       4.93  

2032 and beyond

    187       6.50       7,573       3.58       1,060       3.31       62,072       4.38  
                                                                 

Total

  $ 20,396       4.71

%

  $ 14,391       3.95

%

  $ 4,179       4.81

%

  $ 222,767       4.74

%

 

 

Fixed and Adjustable-Rate Loan Schedule. The following table sets forth at March 31, 2016, the dollar amount of all fixed-rate and adjustable-rate loans due after March 31, 2017.

 

   

Due after March 31, 2017

 
   

Fixed

   

Adjustable

   

Total

 
   

(In thousands)

 

Real estate loans:

                       

One- to four-family residential

  $ 65,446     $ 3,310     $ 68,756  

One- to four-family investor

    17,816       34       17,850  

Construction

    1,774       -       1,774  

Commercial

    66,011       4,211       70,222  

Commercial business loans

    11,177       956       12,133  

Consumer loans:

                    -  

Home equity loans and lines of credit

    4,857       9,476       14,333  

Other consumer

    4,155       -       4,155  

Total loans

  $ 171,236     $ 17,987     $ 189,223  

 

Residential Mortgage Loans. Hamilton Bank originates mortgage loans secured by owner occupied one- to four-family residential properties. To a lesser extent, we have also acquired, participated and made loans to investors for the purchase of one- to four-family residential properties that are not owner-occupied. As of March 31, 2016, we had a total of $102.4 million of residential mortgage loans secured by one- to four-family properties, of which $74.5 million, or 72.8%, were secured by properties serving as the primary residence of the owner. The remaining $27.9 million, or 27.2%, of such loans were secured by non owner-occupied properties. Almost all of our residential mortgage loans are secured by properties in the Greater Baltimore area.

 

Historically, the terms of our one- to four-family mortgage loans retained in our portfolio ranged from 10 to 30 years. Beginning in 2009, in order to lower our interest rate risk in a rising rate environment, we have sold to the secondary market the majority of our one- to four-family fixed rate loans that have been originated with terms exceeding 10 years. During fiscal 2016 and 2015, we sold $4.4 million, or 68.0%, and $2.4 million, or 55.5%, of one- to four-family mortgage loans that we originated with terms exceeding 10 years, respectively. Our residential mortgage portfolio is almost entirely comprised of fixed-rate loans, with 90.5% of residential mortgage loans due after March 31, 2017 having fixed rates at March 31, 2016. During the year ended March 31, 2016, we originated $137,000 in residential mortgage loans with adjustable-rates.

 

We generally do not make new one- to four-family mortgage loans on owner-occupied properties with loan-to-value ratios exceeding 95% at the time the loan is originated, and all loans with loan-to-value ratios in excess of 80% require private mortgage insurance. Loan to value ratios on refinances may not exceed 80%, and loan-to-value ratios for non-owner occupied properties may not exceed 85%. In addition, borrower debt may generally not exceed 43% of the borrower’s monthly cash flow. With respect to borrower debt on loans secured by non-owner occupied properties, we look to the investor’s aggregate debt and cash flows from all investment properties the investor operates. We require all properties securing residential mortgage loans to be appraised by a board-approved independent appraiser.

 

Loans secured by non-owner occupied properties typically have 5 to 10 year terms and amortize over a 25 to 30 year period. Because of the increased risk associated with non-owner occupied properties, interest rates on such loans are higher than owner-occupied properties, and averaged 6.7% during the year ended March 31, 2016. We have generally only originated loans secured by non-owner occupied properties to investors that reside in our market area.

 

In an effort to provide financing for first-time home buyers, we offer 30-year fixed-rate one- to four-family mortgage loans with loan-to-value ratios up to 95%, which cannot be readily sold to the secondary market and are held in portfolio. In fiscal 2016 and 2015, we did not originate any such loans which we did not sell.

 

 

We also make “jumbo loans” (loans above $417,000, the current maximum conforming loan amount as established by the Federal Housing Finance Agency) that we typically sell into the secondary market. Jumbo loans that we originate and sell, typically have 30 year terms and maximum loan-to-value ratios of 80%. At March 31, 2016, our largest outstanding jumbo residential mortgage loan was for $1.6 million, with a book balance of $1.4 million. This loan is performing in accordance with its original terms.

 

Beginning in 2009, applications for loans that we intend to sell are processed through Mortgage Department Services, LLC (“MDS”), a company in which we have a minority interest.  Prior to delivering applications to MDS, we review each application to ensure that the loan meets MDS’ standards for sale to the secondary market.   See “—Loan Originations, Participations, Purchases and Sales.” We receive an origination fee for each loan processed and sold to the secondary market through MDS. All such loans are sold with servicing released and in most cases, with recourse that we provide due to (i) delinquency within the first 90 days of sale or (ii) breaches of customary representations and warranties to the buyers.

 

All residential mortgage loans that we originate include “due-on-sale” clauses, which give us the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. All borrowers are required to obtain title insurance for the benefit of Hamilton Bank. We also require homeowner’s insurance and fire and casualty insurance and, where circumstances warrant, flood insurance on properties securing real estate loans.

 

Commercial Real Estate Loans. We originate commercial real estate loans in the Greater Baltimore area that are secured by properties used for business purposes such as small office buildings or retail facilities. We have increased our origination of commercial real estate loans over the last several years, and intend to continue to grow this portion of our loan portfolio in the future. At March 31, 2016, commercial real estate loans amounted to 35.0% of total loans or $78.1 million, including $2.9 million acquired in the Fairmount acquisition, compared to approximately $36.2 million, or 22.5% of total loans, at March 31, 2013.

 

Our commercial real estate loans are underwritten based on our loan underwriting polices. Our policies provide that such loans may be made in amounts of up to 85% of the appraised value of the property, provided that the property is more than 50% owner-occupied, or 75% of the appraised value of the property if it is not owner-occupied. Our commercial real estate loans typically have terms of 5 to 10 years and amortize for a period of up to 25 years. In the past year we have originated an increased amount of commercial real estate loans with terms of 7 to 10 years based upon the strength of the property cash flow and loan to value ratio. Interest rates may be fixed or adjustable. If adjustable, then they are generally based on the Prime rate of interest or LIBOR.

 

The regulatory loan-to-one borrower limit is 15% of a bank’s unimpaired capital plus unimpaired surplus. As a result of the additional capital received in the stock offering, Hamilton Bank’s loans-to-one borrower limit is approximately $6.9 million. We have adopted an internal limit equal to 75% of the Bank’s loan-to-one borrower limit. We generally target commercial real estate loans with balances of $250,000 to $4.0 million. At March 31, 2016, our commercial real estate loans had an average balance of $1.0 million. At that same date, our largest commercial real estate relationship included one loan totaling $5.0 million. This loan is secured by a shopping center, and was performing in accordance with their original terms at March 31, 2016.

 

Commercial real estate lending involves additional risks compared to one- to four-family residential lending because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, and/or the collateral value of the commercial real estate securing the loan. Repayment of such loans may be subject, to a greater extent than residential loans, to adverse conditions in the real estate market or the economy. Also, commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. Commercial real estate loans generally have a higher rate of interest and shorter term than residential mortgage loans because of increased risks associated with commercial real estate lending. We seek to minimize these risks through our underwriting standards. We have experienced a decrease over the past several years in delinquencies and non-performing loans in our commercial real estate loan portfolio. See “Risk Factors—Our entry into commercial real estate and commercial business lending may result in higher losses on our loans.”

 

 

Commercial Business Loans. We originate commercial business loans and lines of credit secured by non-real estate business assets. These loans are generally originated to small and middle market businesses in our primary market area. Our commercial business loans are generally used for working capital purposes or for acquiring equipment, inventory or furniture, and are primarily secured by business assets other than real estate, such as business equipment, inventory and accounts receivable. We have increased our origination of commercial business loans over the last few years and intend to continue to grow this portfolio at a moderate pace. At March 31, 2016, commercial business loans and lines of credit outstanding totaled $20.4 million, including $2.6 million acquired in the Fairmount Bancorp acquisition, which amounted to 9.1% of total loans, compared to approximately $18.5 million, or 11.5% of total loans, at March 31, 2015. At March 31, 2016, we also had $9.8 million of unfunded commitments on such loans.

 

Our commercial business loans have terms up to 5 years at both fixed and adjustable rates of interest, although, adjustable rates of interest are preferred and obtained when possible. Our commercial business loans are underwritten based on our commercial business loan underwriting policies. We typically avoid making commercial business loans to purchase highly specialized, custom made equipment which may be difficult to dispose of in the event of default. When making commercial business loans, we consider the financial statements, lending history and debt service capabilities of the borrower (generally requiring a minimum debt service coverage ratio of 1.20:1.00), the projected cash flows of the business, and the value of the collateral, if any. The majority all commercial business loans are guaranteed by the principals of the borrower.

 

Hamilton Bank is also qualified to make Small Business Administration (“SBA”) loans. The SBA program is an economic development program which finances the expansion of small businesses. Under the SBA program, we originate and fund loans under the SBA 7(a) Loan Program which qualify for guarantees up to 85% for loans less than or equal to $150,000 and 75% for loans greater than $150,000. We also originate loans under the SBA’s CDC/504 Loan Program in which we generally provide 50% of the financing, taking a first lien on the real property as collateral. We do not treat the SBA guarantee as a substitute for a borrower meeting our credit standards, and, except for minimum capital levels or maximum loan terms, the borrower must meet our other credit standards as applicable to loans outside the SBA process. During fiscal 2016 and 2015, we did not originate any loans under the SBA 7(a) Loan Program, compared to $75,000 and $1.1 million of such loans originated in fiscal 2014 and 2013, respectively.

 

We focus on the origination of commercial business loans in amounts between $250,000 and $4.0 million. At March 31, 2016, our commercial business loans had an average outstanding balance of $245,000. At that same date, our largest commercial business loan was a commercial line of credit with a commitment balance of $3.9 million, of which $1.7 million was advanced. The loan is secured by the business assets of the company and is performing in accordance with its original terms at March 31, 2016.

 

Commercial business loans generally have a greater credit risk than one- to four-family residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. We seek to minimize these risks through our underwriting standards. See “Risk Factors - Our entry into commercial real estate and commercial business lending may result in higher losses on our loans.”

 

 

Home Equity Loans and Lines of Credit. In addition to traditional one- to four-family residential mortgage loans, we offer home equity loans and lines of credit that are secured by the borrower’s primary or secondary residence. At March 31, 2016, we had $14.4 million, or 6.5% of our total loan portfolio in home equity loans and lines of credit. At that date we also had $16.0 million of undisbursed funds related to home equity lines of credit.

 

Home equity loans and lines of credit are generally underwritten using the same criteria that we use to underwrite one- to four-family residential mortgage loans. Home equity loans and lines of credit may be underwritten with a loan-to-value ratio of up to 80% when combined with the principal balance of the existing first mortgage loan. Our home equity loans are primarily originated with fixed rates of interest with terms of up to 20 years. Our home equity lines of credit are originated with adjustable-rates based on the prime rate of interest minus an applicable margin and require interest paid monthly. Home equity loans and lines of credit are available in amounts of between $10,000 and $1.0 million.

 

Home equity loans and lines of credit secured by second mortgages have greater risk than one- to four-family residential mortgage loans secured by first mortgages. We face the risk that the collateral will be insufficient to compensate us for loan losses and costs of foreclosure. When customers default on their loans, we attempt to foreclose on the property and resell the property as soon as possible to minimize foreclosure and carrying costs. However, the value of the collateral may not be sufficient to compensate us for the amount of the unpaid loan and we may be unsuccessful in recovering the remaining balance from those customers. Particularly with respect to our home equity loans and lines of credit, decreases in real estate values could adversely affect the value of property securing the loan.

 

Construction Loans. We originate construction loans for both commercial and residential real estate. Construction loans we originate generally provide for the payment of interest only during the construction phase. At the end of the construction phase, the loan converts to a permanent mortgage loan at the same or a different rate of interest. The construction period on the residential homes is typically nine to twelve months, at which time Hamilton Bank is repaid through permanent financing by a third party with servicing released.

 

Before making a commitment to fund a construction loan, Hamilton Bank requires detailed cost estimates to complete the project and an appraisal of the property by an independent licensed appraiser. Hamilton Bank also reviews and inspects each property before disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection based on the percentage of completion method. Construction loans for one- to four-family residential real estate may be underwritten with a loan-to-value ratio of up to 80% or 95% with private mortgage insurance. Commercial construction loans generally may not exceed a loan-to-value ratio of 75% to 80%.

 

Construction lending generally involves a greater degree of risk than other one- to four-family mortgage lending. The repayment of the construction loan is, to a great degree, dependent upon the successful and timely completion of construction. Various potential factors including construction delays or the financial viability of the builder may further impair the borrower’s ability to repay the loan.

 

At March 31, 2016, total construction loans represented $8.5 million, or 3.8%, of Hamilton Bank’s total loans, of which $5.3 million consisted of residential construction loans and $3.2 million were commercial construction. At March 31, 2016, the commitment to fund or advance funds on total construction loans equaled $9.5 million. At March 31, 2016, our largest construction loan was a residential construction loan with a contractual principal balance of $1.3 million and a recorded investment balance of $848,000. The loan is secured by the residential property being constructed and is performing in accordance with its original terms at March 31, 2016.

 

Other Consumer Loans. We make loans secured by deposit accounts up to 90% of the amount of the depositor’s deposit account balance. On a more limited basis, we also originate automobile loans to our customers. Other consumer loans totaled $4.2 million, or 1.9% of our total loan portfolio, at March 31, 2016.

 

 

Loan Originations, Participations, Purchases and Sales. Most of our loan originations are generated by our loan personnel operating at our corporate headquarters and banking office locations. All loans we originate are underwritten pursuant to our policies and procedures. While we originate both fixed-rate and adjustable-rate loans, our ability to generate each type of loan depends upon relative borrower demand and the pricing levels as set in the local marketplace by competing banks, thrifts, credit unions, and mortgage banking companies. Our volume of real estate loan originations is influenced significantly by market interest rates, and, accordingly, the volume of our real estate loan originations can vary from period to period.

 

Consistent with our interest rate risk strategy, in the low interest rate environment that has existed in recent years, we have sold on a servicing-released basis the majority of our one- to four-family residential mortgage loans with maturities over 10 years that we have originated. All loan applications that we have the intention of selling are processed through MDS. We have outsourced the loan processing and loan underwriting for one- to four-family residential mortgage loans to MDS as a cost savings measure. We pay a flat fee to MDS for each loan settled and we receive a fee per loan in return for delivery of the loan to the secondary market. All loans sold through MDS are sold with servicing released and in most cases, with recourse that we provide due to (i) delinquency within the first 90 days of sale or (ii) breaches of customary representations and warranties to the buyers.

 

From time to time, we have purchased loan participations in commercial loans in which we are not the lead lender that are secured by real estate or other assets within the state of Maryland. With regard to all loan participations, we follow our customary loan underwriting and approval policies, and although we may be only approving and servicing a portion of the loan, we underwrite the loan request as if we had originated the loan to ensure cash flow and collateral are sufficient. At March 31, 2016, our loan participations totaled $17.8 million, or 8.0% of our total loan portfolio, the majority of which were in our primary market area. Of these $17.8 million in participations, $636,000 were on nonaccrual at March 31, 2016, a decrease of $864,000 from March 31, 2015. We do not specifically look to loan participations as a means to increase loan volume, however, we do look at opportunities for participations, if presented, on a case by case basis.  

 

In September 2015, in connection with the acquisition of Fairmount Bank, we acquired approximately $54.0 million in outstanding loans. As of March 31, 2016, the outstanding balance of those acquired from Fairmount Bank totaled $49.2 million, or 22.2% of gross loans, of which $1.2 million are on non-accrual. The remaining loans are performing as agreed under their current terms at March 31, 2016. In May 2016 we also acquired $108.3 million in loans associated with the acquisition of Fraternity Community Bancorp. The loans acquired through our acquisition of Fraternity Community Bancorp are not included in the tabular and other loan information provided in the Form 10-K as the acquisition was completed after March 31, 2016.

 

 

The following table shows our loan origination, repayment and sale activities for the fiscal years indicated.

  

   

Year Ended March 31,

 
   

2016

   

2015

 
   

(In thousands)

 
                 

Total loans at beginning of year

  $ 160,388     $ 144,819  

Loans originated:

               

Real estate loans:

               

Residential mortgage loans:

               

One- to four-family residential

    6,114       4,938  

One- to four-family investor

    -       -  

Construction

    10,017       9,519  

Commercial real estate

    21,959       22,816  

Total real estate loans

    38,090       37,273  
                 

Commercial business loans

    7,607       14,378  

Consumer:

               

Home equity loans and lines of credit

    3,447       3,899  

Other consumer

    34       117  

Total consumer loans

    3,481       4,016  
                 

Total loans originated

    49,178       55,667  
                 

Automobile loan pool purchased

    2,971       -  

Fairmount Bank loans acquired

    54,029       -  
                 

Deduct:

               

Principal repayments

    32,381       27,960  

Loans sold in the secondary market

    4,395       2,436  

Transferred to foreclosed real estate

    -       12  

Unused lines of credit

    7,023       9,690  
                 

Net loan activity

    62,379       15,569  
                 

Total loans at end of year

  $ 222,767     $ 160,388  

 

Loan Approval Procedures and Authority. Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures developed by management and approved by our board of directors. The loan approval process is intended to assess the borrower’s ability to repay the loan and the value of the collateral that will secure the loan. To assess the borrower’s ability to repay, our policies provide for the review of the borrower’s employment and credit history and information on the historical and projected income and expenses of the borrower. We will also evaluate a guarantor when a guarantee is provided as part of the loan. We have outsourced most of the processing and underwriting of our one-to four-family residential loan applications to a third party who provides Hamilton Bank with a report on each loan application. Our processors then review that report for any exceptions.

 

Hamilton Bank’s policies and loan approval limits are established by our board of directors. Designated Bank officers and loan committee are assigned levels of loan authority. Having loan authority gives the individuals or committee the ability to authorize the extension of credit. Every extension of credit requires two signatures, one of which must have sufficient authority given the risk rating and aggregate exposure. The second approver cannot be an individual assigned less loan authority than the sponsor of the loan. Loan authority is recommended by the Chief Credit Officer and approved by the Loan Committee of the Board of Directors. All loan authorities are reviewed and confirmed annually by the Loan Committee. The Chief Credit Officer, and or the President may recommend interim changes to establish loan limits or assign loan authority for new officers. These interim changes shall be presented to the Loan Committee for approval at its next regularly scheduled meeting. The Chief Credit Officer and/or the President also have the authority to reduce or remove loan authority. Such changes in lending authority are to be reported to Loan Committee after the fact.

 

 

Securities Activities

 

General. Our investment policy is developed by management and approved by the board of directors. The objectives of the policy are to: (i) ensure adequate liquidity for loan demand and deposit fluctuations, and to allow us to alter our liquidity position to meet both day-to-day and long-term changes in assets and liabilities; (ii) manage interest rate risk in accordance with our interest rate risk policy; (iii) provide collateral for pledging requirements; (iv) maximize return on our investments; and (v) maintain a balance of high quality diversified investments to minimize risk.

 

Our Investment Committee, consisting of our President and Chief Executive Officer, our Chief Financial Officer, and Controller is responsible for implementing our investment policy, including approval of investment strategies and monitoring investment performance. The President and Chief Financial Officer are authorized to execute purchases or sales of securities. The board of directors regularly reviews our investment strategies and the market value of our investment portfolio.

 

We account for investment and mortgage-backed securities in accordance with Accounting Standards Codification Topic 320, “Investments – Debt and Equity Securities.” Accounting Standards Codification 320 requires that investments be categorized as held-to maturity, trading, or available for sale. Our securities are generally categorized as available-for-sale based on our need to meet daily liquidity needs and to take advantage of profits that may occur from time to time. At March 31, 2016, all of our securities were classified as available for sale.

 

Federally chartered savings institutions have authority to invest in various types of assets, including government-sponsored enterprise obligations, securities of various federal agencies, residential mortgage-backed securities, certain certificates of deposit of insured financial institutions, overnight and short-term loans to other banks, corporate debt instruments, debt instruments of municipalities and Fannie Mae and Freddie Mac equity securities. At March 31, 2016, our investment portfolio consisted almost entirely of securities and mortgage-backed securities issued by U.S. Government agencies, municipalities or U.S. Government-sponsored enterprises.At that same date we also held $2.0 million of corporate bonds, which equaled approximately 2.9% of our total investment securities based upon the fair value of such securities. The principal and interest on our mortgage-backed securities are guaranteed by the issuing entity.

   

At March 31, 2016, we owned just over $1.0 million in Federal Home Loan Bank of Atlanta stock. As a member of Federal Home Loan Bank of Atlanta, we are required to purchase stock in the Federal Home Loan Bank of Atlanta. At March 31, 2016, we had no investments in a single company or entity (other than an agency of the U.S. Government, a municipality or a U.S. Government-sponsored enterprise) that had an aggregate book value in excess of 10% of our equity.

 

 

Over the last several years, our investment balances have decreased due to either calls or maturing bonds, normal principal pay downs on our mortgage backed securities, or the sale of certain securities. The proceeds from these transactions have been used to fund loan activity and acquisitions, and to a lesser extent reinvested.

 

 

Amortized Cost and Estimated Fair Value of Securities. The following table sets forth certain information regarding the amortized cost and estimated fair values of our securities as of the dates indicated.

 

   

At March 31,

 
   

2016

   

2015

   

2014

 
   

Amortized Cost

   

Fair Value

   

Amortized Cost

   

Fair Value

   

Amortized Cost

   

Fair Value

 
   

(In thousands)

 

Mortgage-backed securities:

                                               

Fannie Mae

  $ 27,774     $ 27,712     $ 44,083     $ 43,831     $ 47,189     $ 46,356  

Ginnie Mae

    5,988       6,006       2,415       2,456       4,753       4,802  

Freddie Mac

    20,178       20,222       25,281       25,070       26,426       25,617  

Total mortgage-backed securities

    53,940       53,940       71,779       71,357       78,368       76,775  

U.S. Government agencies

    10,519       10,533       17,509       17,312       24,539       23,413  

Municipal bonds

    4,061       4,112       2,149       2,317       3,242       3,338  

Corporate bonds

    2,000       1,899       2,000       1,953       -       -  

Freddie Mac stock

    -       -       -       -       7       27  
                                                 

Total

  $ 70,520     $ 70,484     $ 93,437     $ 92,939     $ 106,156     $ 103,553  

 

Portfolio Maturities and Yields. The composition and maturities of the debt investment securities portfolio at March 31, 2016 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur.

 

   

At March 31, 2016

 
   

One Year or Less

   

More Than One Year Through Five Years

   

More Than Five Years Through Ten Years

   

More Than Ten Years

   

Total Securities

 
   

Amortized Cost

   

Weighted Average Yield

   

Amortized Cost

   

Weighted Average Yield

   

Amortized Cost

   

Weighted Average Yield

   

Amortized Cost

   

Weighted Average Yield

   

Amortized Cost

   

Estimated Fair Value

   

Weighted Average Yield

 
   

(Dollars in thousands)

 

Mortgage-backed securities:

                                                                                       

Fannie Mae

  $ -       0.00 %   $ 327       3.54 %   $ 5,561       2.29 %   $ 21,886       2.19 %   $ 27,774     $ 27,712       2.22 %

Ginnie Mae

    -       -       6       2.76       68       4.24       5,914       2.71       5,988       6,006       2.73  

Freddie Mac

    2       6.00       6       5.41       1,890       2.26       18,280       2.34       20,178       20,222       2.33  

Total mortgage-backed securities

    2       6.00       339       3.56       7,519       2.30       46,080       2.32       53,940       53,940       2.32  

U.S. Government agencies

    251       1.25       3,268       1.36       7,000       2.22       -       -       10,519       10,533       1.90  

Municipal bonds

    480       0.92       -       -       830       2.82       2,751       4.15       4,061       4,112       3.50  

Corporate bonds

    -       -       -       -       2,000       3.00       -       -       2,000       1,899       3.00  
                                                                                         

Total

  $ 733       1.05 %   $ 3,607       1.57 %   $ 17,349       2.37 %   $ 48,831       2.42 %   $ 70,520     $ 70,484       2.34 %

 

 

Sources of Funds

 

General. Deposits, scheduled amortization and prepayments of loan principal, maturities and calls of securities and funds provided by operations are our primary sources of funds for use in lending, investing and for other general purposes. We historically have not used Federal Home Loan Bank of Atlanta (FHLB) advances to fund our operations. In the second half of fiscal 2015, we borrowed $6.0 million from the FHLB and recently acquired $10.5 million of FHLB advances in the acquisition of Fairmount Bancorp. As of March 31, 2016, we have $14.5 million in advances outstanding from the FHLB.

 

Deposits. We offer deposit products having a range of interest rates and terms. We currently offer statement savings accounts, NOW accounts, noninterest-bearing demand accounts, health savings accounts (HSA), money market accounts and certificates of deposit. We also offer the Certificate of Deposit Account Registry Service (CDARS) program to our customers. Our strategic plan includes a greater emphasis on developing commercial business activities, both deposit and lending customer relationships.

 

Deposit flows are significantly influenced by general and local economic conditions, changes in prevailing interest rates, internal pricing decisions and competition. Our deposits are primarily obtained from areas surrounding our branch offices. In order to attract and retain deposits we rely on paying competitive interest rates and providing quality service.

 

Based on experience, we believe that our deposits are relatively stable. However, the ability to attract and maintain deposits and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. At March 31, 2016, $195.0 million, or 62.2% of our total deposit accounts were certificates of deposit, of which $106.0 million had maturities of one year or less.

 

 

The following tables set forth the distribution of our average deposit accounts, by account type, for the years indicated. Our focus has been on growing our lower costing core deposits (considered all deposits other certificates of deposit) and relying less on originating certificates of deposit.

  

   

For the Years Ended March 31,

 
   

2016

   

2015

   

2014

 
   

Average Balance

   

Percent

   

Weighted Average Rate

   

Average Balance

   

Percent

   

Weighted Average Rate

   

Average Balance

   

Percent

   

Weighted Average Rate

 
   

(Dollars in thousands)

 

Deposit type:

                                                                       

Certificates of deposit

  $ 172,064       65.0

%

    0.96

%

  $ 160,764       69.3

%

    1.00

%

  $ 179,191       72.3

%

    1.04

%

Money market

    35,124       13.3       0.17       29,168       12.6       0.12       28,761       11.6       0.12  

Statement savings

    25,843       9.8       0.10       15,343       6.6       0.05       15,394       6.2       0.05  

Noninterest bearing demand

    19,282       7.3       -       16,765       7.2       -       14,869       6.0       -  

NOW accounts

    12,447       4.7       0.03       9,967       4.3       0.03       9,558       3.9       0.05  
                                                                         

Total deposits

  $ 264,760       100.0

%

    0.66

%

  $ 232,007       100.0

%

    0.71

%

  $ 247,773       100.0

%

    0.77

%

 

The following table sets forth certificates of deposit classified by interest rate as of the dates indicated.

 

   

At March 31,

 
   

2016

   

2015

   

2014

 
   

(In thousands)

 

Interest Rate:

                       

Less than 2.00%

  $ 181,572     $ 134,569     $ 148,282  

2.00% to 2.99%

    13,459       15,127       21,522  

3.00% to 3.99%

    -       -       270  

4.00% to 4.99%

    -       -       17  

5.00% and above

    -       -       -  
                         

Total

  $ 195,031     $ 149,696     $ 170,091  

 

 

Maturities of Certificates of Deposit Accounts. The following table sets forth the amount and maturities of certificates of deposit accounts at the dates indicated.

 

   

At March 31, 2016

 
   

Period to Maturity

 
   

Less Than or Equal to One Year

   

More Than One to Two Years

   

More Than Two to Three Years

   

More Than Three Years

   

Total

   

Percent of Total

 
   

(Dollars in thousands)

 

Interest Rate Range:

                                               

Less than 2.00%

  $ 96,646     $ 46,831     $ 18,401     $ 19,694     $ 181,572       93.1

%

2.00% to 2.99%

    8,994       250       1,960       2,255       13,459       6.9  

3.00% to 3.99%

    -       -       -       -       -       -  

4.00% to 4.99%

    -       -       -       -       -       -  

5.00% to 5.99%

    -       -       -       -       -       -  
                                                 

Total

  $ 105,640     $ 47,081     $ 20,361     $ 21,949     $ 195,031       100.0

%

 

As of March 31, 2016, the aggregate amount of outstanding certificates of deposit at Hamilton Bank in amounts greater than or equal to $100,000 was approximately $84.8 million. The following table presents the maturity of these certificates of deposit at such date.

 

Period to Maturity

 

At March 31, 2016

 
   

(In thousands)

 
         

Three months or less

  $ 10,695  

Over three through six months

    5,836  

Over six months through one year

    28,852  

Over one year to three years

    27,676  

Over three years

    11,779  
         

Total

  $ 84,838  

  

Borrowed Funds. As a member of the FHLB, Hamilton Bank is eligible to obtain advances upon the security of the Federal Home Loan Bank common stock owned and certain loan products, provided certain standards related to credit-worthiness have been met. Federal Home Loan Bank advances are available pursuant to several credit programs, each of which has its own interest rate and range of maturities. At March 31, 2016, based on available collateral, we had the ability to borrow approximately $58.0 million from the Federal Home Loan Bank of Atlanta. We historically have not used Federal Home Loan Bank of Atlanta (FHLB) advances to fund our operations. In the second half of fiscal 2015, we borrowed $6.0 million from the FHLB and recently acquired $10.5 million of FHLB advances in the acquisition of Fairmount Bancorp. As of March 31, 2016, we have $14.5 million in advances outstanding from the FHLB as presented in the table below.

 

 

   

March 31, 2016

   

March 31, 2015

 
   

Amount

   

Rate

   

Maturity Date

   

Amount

   

Rate

   

Maturity Date

 

FHLB advance

    2,000,000       0.43 %   6/3/2016     $ 2,000,000       0.21 %   6/3/2015  

FHLB advance

    2,000,000       0.60 %  

9/6/2016

      2,000,000       0.28 %  

9/3/2015

 

FHLB advance *

    1,500,000       0.75 %  

3/31/2017

      2,000,000       0.43 %  

3/3/2016

 

FHLB advance *

    1,000,000       4.24 %  

7/31/2017

      -                  

FHLB advance *

    1,000,000       4.01 %  

8/21/2017

      -                  

FHLB advance *

    1,000,000       0.91 %  

8/31/2017

      -                  

FHLB advance *

    1,500,000       3.23 %  

11/24/2017

      -                  

FHLB advance *

    1,500,000       3.40 %  

11/27/2017

                         

FHLB advance *

    1,000,000       2.60 %  

7/2/2018

      -                  

FHLB advance *

    1,000,000       3.05 %  

7/3/2018

      -                  

FHLB advance *

    1,000,000       2.60 %  

10/2/2018

      -                  
      14,500,000                       6,000,000                  

Premium on borrowings assumed

    347,192                       -                  

Total borrowings

  $ 14,847,192                     $ 6,000,000                  

 

* Advances assumed in the Fairmount Bancorp acquisition

 

Hamilton Bank may also borrow up to $5.0 million from a correspondent bank under a secured federal funds line of credit, and $1.0 million under an unsecured line of credit. We would be required to pledge investment securities to draw upon the secured line of credit. During fiscal 2016, there was nothing drawn upon either line of credit.

 

Employees

 

As of March 31, 2016, we had 61 full-time equivalent employees. Our employees are not represented by any collective bargaining group. Management believes that we have a good working relationship with our employees.

 

Subsidiary Activities

 

Hamilton Bancorp has one direct subsidiary, Hamilton Bank. At March 31, 2016, Hamilton Bank has one wholly owned subsidiary, 3110 FC, LLC, a Maryland limited liability company that was formed to hold other real estate owned acquired through foreclosure or deed-in-lieu of foreclosure. On May 13, 2016, in connection with the acquisition of Fraternity Community Bancorp, the Bank acquired four additional subsidiaries: 4819 Palmer Avenue LLC, a limited liability company organized under the laws of the State of Maryland ("4819 Palmer"); 764 Washington Boulevard LLC, a limited liability company organized under the laws of the State of Maryland ("764 WB LLC"); 764 Washington Boulevard II LLC, a limited liability company organized under the laws of the State of Maryland ("764 WB LLC II"); and Fraternity Insurance Agency, Inc., an inactive corporation organized under the laws of the State of Maryland. 4819 Palmer, 764 WB LLC and 764 WB LLC II were each formed by Fraternity Federal Savings & Loan Association to hold other real estate owned.

 

 

 

REGULATION AND SUPERVISION

 

General

 

As a federal savings bank, Hamilton Bank is subject to examination and regulation by the Office of the Comptroller of the Currency (the “OCC”), and is also subject to examination by the Federal Deposit Insurance Corporation (the “FDIC’). The federal system of regulation and supervision establishes a comprehensive framework of activities in which Hamilton Bank may engage and is intended primarily for the protection of depositors and the FDIC’s Deposit Insurance Fund, and not for the protection of stockholders. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to matters such as their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Hamilton Bank is also regulated to a lesser extent by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), which governs the reserves to be maintained against deposits and other matters. Hamilton Bank must comply with the consumer protection regulations issued by the Consumer Financial Protections Bureau. Hamilton Bank also is a member of and owns stock in the Federal Home Loan Bank of Atlanta, which is one of the twelve regional banks in the Federal Home Loan Bank System. The OCC examines Hamilton Bank and prepares reports for the consideration of its board of directors on any operating deficiencies. Hamilton Bank’s relationship with its depositors and borrowers is also regulated to a great extent by federal law and, to a much lesser extent, state law, especially in matters concerning the ownership of deposit accounts, the form and content of Hamilton Bank’s loan documents and certain consumer protection matters.

 

As a savings and loan holding company, Hamilton Bancorp is subject to examination and supervision by, and is required to file certain reports with, the Federal Reserve Board. Hamilton Bancorp is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.

 

Set forth below are certain material regulatory requirements that are applicable to Hamilton Bank and Hamilton Bancorp. This description of statutes and regulations is not intended to be a complete description of such statutes and regulations and their effects on Hamilton Bank and Hamilton Bancorp. Any change in these laws or regulations, whether by Congress or the applicable regulatory agencies, could have a material adverse impact on Hamilton Bancorp, Hamilton Bank and their operations.

 

Federal Banking Regulation

 

Business Activities. A federal savings bank derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and applicable federal regulations. Under these laws and regulations, Hamilton Bank may invest in mortgage loans secured by residential and nonresidential real estate, commercial business loans and consumer loans, certain types of debt securities and certain other assets, subject to applicable limits. The Dodd-Frank Act authorized, for the first time, the payment of interest on commercial checking accounts. Hamilton Bank may also establish subsidiaries that may engage in certain activities not otherwise permissible for Hamilton Bank, including real estate investment and securities and insurance brokerage.

 

Capital Requirements. Federal regulations require FDIC-insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8%, and a 4% Tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act.

 

 

For purposes of the regulatory capital requirements, common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale-securities). Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.

 

In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one to four- family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.

 

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted asset above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019.

 

In assessing an institution’s capital adequacy, the OCC takes into consideration, not only these numeric factors, but qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions if deemed necessary.

 

At March 31, 2016, Hamilton Bank’s capital exceeded all applicable regulatory requirements.

 

Loans to One Borrower. Generally, a federal savings bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of March 31, 2016, Hamilton Bank was in compliance with the loans-to-one-borrower limitations.

 

Qualified Thrift Lender Test. As a federal savings bank, Hamilton Bank must satisfy the qualified thrift lender, or “QTL,” test. Under the QTL test, Hamilton Bank must either (i) maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine months of the most recent 12 months or (ii) qualify as a “domestic building and loan association” as defined in the Internal Revenue Code. “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings institution’s business. A federal savings bank that fails the QTL test must operate under specified restrictions specified in the Home Owners’ Loan Act. The Dodd-Frank Act made noncompliance with the QTL Test subject to enforcement action for a violation of law. At March 31, 2016, Hamilton Bank held 80.04% of its “portfolio assets” in “qualified thrift investments,” and satisfied the QTL Test.

 

 

Capital Distributions. Federal regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the capital account. A federal savings bank must file an application with the OCC for approval of a capital distribution if:

 

 

the total capital distributions for the applicable calendar year exceed the sum of the savings bank’s net income for that year to date plus the savings bank’s retained net income for the preceding two years;

 

 

the savings bank would not be at least adequately capitalized following the distribution;

 

 

the distribution would violate any applicable statute, regulation, agreement or regulatory condition; or

 

 

the savings bank is not eligible for expedited treatment of its filings.

 

Even if an application is not otherwise required, every savings bank that is a subsidiary of a savings and loan holding company, such as Hamilton Bank, must still file a notice with the Federal Reserve Board at least 30 days before the board of directors declares a dividend or approves a capital distribution.

 

A notice or application related to a capital distribution may be disapproved if:

 

 

the federal savings bank would be undercapitalized following the distribution;

 

 

the proposed capital distribution raises safety and soundness concerns; or

 

 

the capital distribution would violate a prohibition contained in any statute, regulation, agreement.

 

In addition, the Federal Deposit Insurance Act provides that an insured depository institution may not make any capital distribution if, after making such distribution, the institution would fail to satisfy any applicable regulatory capital requirement. A federal savings bank also may not make a capital distribution that would reduce its regulatory capital below the amount required for the liquidation account established in connection with its conversion to stock form. In addition, Hamilton Bank’s ability to pay dividends will now be limited if Hamilton Bank does not have the capital conservation buffer required by the new capital rules, which may limit the ability of Hamilton Bancorp to pay dividends to its stockholders. See — “Capital Requirements.”

 

Community Reinvestment Act and Fair Lending Laws. All federal savings banks have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a federal savings bank, the OCC is required to assess the federal savings bank’s record of compliance with the Community Reinvestment Act. A savings bank’s failure to comply with the provisions to the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branch mergers, or in restrictions on its activities. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the OCC, as well as other federal regulatory agencies and the Department of Justice. Hamilton Bank received a “satisfactory” Community Reinvestment Act rating in its last federal examination in 2015.

 

Transactions with Related Parties. A federal savings bank’s authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and federal regulation. An affiliate is generally a company that controls, or is under common control with an insured depository institution, such as Hamilton Bank. Hamilton Bancorp is an affiliate of Hamilton Bank because of its control of Hamilton Bank. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative limits and collateral requirements. In addition, federal regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve the purchase of low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates. Federal regulations require savings banks to maintain detailed records of all transactions with affiliates.

 

 

Hamilton Bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions generally require that extensions of credit to insiders:

 

 

be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and

 

 

not to exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Hamilton Bank’s capital.

 

In addition, extensions of credit in excess of certain limits must be approved by Hamilton Bank’s loan committee or board of directors. Extensions of credit to executive officers are subject to additional limits based on the type of extension involved.

 

Enforcement. The OCC has primary enforcement responsibility over federal savings banks and has the authority to bring enforcement action against all “institution-affiliated parties,” including officers, directors and employees, as well as stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action by the OCC may range from the issuance of a capital directive or cease and desist order, to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to terminate deposit insurance or to recommend to the OCC that enforcement action be taken with respect to a particular savings bank. If action is not taken by the OCC, the FDIC has authority to take action under specified circumstances.

 

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest-rate risk exposure, asset growth, compensation and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.

 

Federal law requires that federal bank regulators take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements. For this purpose, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The applicable OCC regulations were amended to incorporate the previously mentioned increased regulatory capital standards that were effective January 1, 2015. Under the amended regulations, an institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0% or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0% or a common equity Tier 1 ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.

 

 

Generally a receiver or conservator must be appointed for an institution that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the OCC within 45 days of the date a federal savings bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company for the institution required to submit a capital restoration plan must guarantee the lesser of an amount equal to 5% of the institution’s assets at the time it was notified or deemed to be undercapitalized by the OCC, or the amount necessary to restore the institution to adequately capitalized status. This guarantee remains in place until the OCC notifies the savings institution that it has maintained adequately capitalized status for each of four consecutive calendar quarters, and the OCC has the authority to require payment and collect payment under the guarantee. Various restrictions, such as on capital distributions and growth, also apply to “undercapitalized” institutions. The OCC may also take any one of a number of discretionary supervisory actions against undercapitalized institutions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

 

As of March 31, 2016, Hamilton Bank was classified as a “well capitalized” institution.

 

Insurance of Deposit Accounts. The Deposit Insurance Fund of the FDIC insures deposits at FDIC-insured financial institutions such as Hamilton Bank. Deposit accounts in Hamilton Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The FDIC charges insured depository institutions premiums to maintain the Deposit Insurance Fund.

 

Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. Rates are based on each institution’s risk category and certain specified risk adjustments. Stronger institutions pay lower rates while riskier institutions pay higher rates.

 

The FDIC issued a final rule that redefined the assessment base used for calculating deposit insurance assessments effective April 1, 2011. Under the rule, assessments are based on an institution’s average consolidated total assets minus average tangible equity instead of total deposits. The final rule revised the assessment rate schedule to establish assessments ranging from 2.5 to 45 basis points.

 

In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended March 31, 2016, the annualized FICO assessment was equal to 0.58 of a basis point of total assets less tangible capital.

 

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

 

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

 

 

Prohibitions Against Tying Arrangements. Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.

 

Federal Home Loan Bank System. Hamilton Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the Federal Home Loan Bank of Atlanta, Hamilton Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank. As of March 31, 2016, Hamilton Bank was in compliance with this requirement.

 

Federal Reserve System

 

Federal Reserve Board regulations require savings banks to maintain noninterest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At March 31, 2016, Hamilton Bank was in compliance with these reserve requirements.

 

Other Regulations

 

Interest and other charges collected or contracted for by Hamilton Bank are subject to state usury laws and federal laws concerning interest rates. Hamilton Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:

 

 

Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; including the Loan Estimate and Closing Disclosure required for residential mortgage loans;

 

 

Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;

 

 

Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

 

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

 

Fair and Accurate Credit Transaction Act, formerly known as the Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;

 

 

fair lending laws;

 

 

Unfair or Deceptive Acts or Practices laws and regulations;

 

 

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

 

Truth in Savings Act; and

 

 

Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

 

In addition, the Consumer Financial Protection Bureau issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and mortgage loan servicing and originator compensation standards. Hamilton Bank is evaluating recent regulations and proposals, and devotes significant compliance, legal and operational resources to compliance with consumer protection regulations and standards.

 

The operations of Hamilton Bank also are subject to the:

 

 

Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

 

Electronic Funds Transfer Act and Regulation E promulgated there under, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 

 

Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;

 

 

The USA PATRIOT Act, which requires savings banks to, among other things, establish broadened anti-money laundering compliance programs, and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and

 

 

The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.

 

Holding Company Regulation

 

General. Hamilton Bancorp is a savings and loan holding company within the meaning of Home Owners’ Loan Act. As such, Hamilton Bancorp is registered with the Federal Reserve Board and is subject to regulations, examinations, supervision and reporting requirements applicable to savings and loan holding companies. In addition, the Federal Reserve Board has enforcement authority over Hamilton Bancorp and any future non-savings institution subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.

 

Permissible Activities. Under present law, the business activities of Hamilton Bancorp are generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, provided certain conditions are met, including electing such status or, in the absence of such an election, for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to regulatory approval, and certain additional activities authorized by federal regulations. As of March 31, 2016, Hamilton Bancorp, Inc. has not elected financial holding company status.

 

 

Federal law prohibits a savings and loan holding company, including Hamilton Bancorp, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior regulatory approval. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a non-subsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.

 

The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:

 

 

the approval of interstate supervisory acquisitions by savings and loan holding companies; and

 

 

the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition.

 

The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

 

Capital. Savings and loan holding companies have not historically been subjected to consolidated regulatory capital requirements. The Dodd-Frank Act required the FRB to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to their subsidiary depository institutions. The previously discussed final rule regarding regulatory capital requirements implemented these Dodd-Frank Act requirements. As is the case with institutions themselves, the capital conservation buffer is being phased in between 2016 and 2019. However, legislation was enacted in December 2014 which required the FRB to amend its “Small Bank Holding Company” exemption from consolidated holding company capital requirements to (i) extend its applicability to savings and loan holding companies and (ii) raise the threshold for the exemption from $500 million to $1 billion in consolidated assets. Regulations doing so were effective May 15, 2015. Consequently, both bank and savings and loan holding companies with under $1 billion in consolidated assets are exempt from the consolidated regulatory capital requirements unless the FRB determines otherwise on a case by case basis.

 

Source of Strength. The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies. The Federal Reserve Board has issued regulations requiring that all savings and loan holding companies serve as a source of managerial and financial strength to their subsidiary savings and loan associations by providing capital, liquidity and other support in times of financial stress.

 

Dividends. The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies and savings and loan holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate or earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a savings and loan holding company to pay dividends may be restricted if a subsidiary savings and loan association becomes undercapitalized. The policy statement also states that a savings and loan holding company should inform the Federal Reserve Board supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the savings and loan holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect the ability of Hamilton Bancorp to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.

 

 

Acquisition. Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the company’s outstanding voting stock, unless the Federal Reserve Board has found that the acquisition will not result in control of the company. A change in control definitively occurs upon the acquisition of 25% or more of the company’s outstanding voting stock. Under the Change in Bank Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.

 

Federal Securities Laws

 

Hamilton Bancorp’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. Hamilton Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.

 

The registration under the Securities Act of 1933 of shares of common stock issued in the stock offering does not cover the resale of those shares. Shares of common stock purchased by persons who are not our affiliates may be resold without registration. Shares purchased by our affiliates are subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If we meet the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of ours that complies with the other conditions of Rule 144, including those that require the affiliate’s sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of 1% of our outstanding shares, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, we may permit affiliates to have their shares registered for sale under the Securities Act of 1933.

 

Emerging Growth Company Status

 

The JOBS Act which was enacted in April 2012 has made numerous changes to the federal securities laws to facilitate access to capital markets. Under the JOBS Act, a company with total annual gross revenues of less than $1.0 billion during its most recently completed fiscal year qualifies as an “emerging growth company.” Hamilton Bancorp qualifies as an emerging growth company under the JOBS Act.

 

An “emerging growth company” may choose not to hold stockholder votes to approve annual executive compensation (more frequently referred to as “say-on-pay” votes) or executive compensation payable in connection with a merger (more frequently referred to as “say-on-golden parachute” votes). An emerging growth company also is not subject to the requirement that its auditors attest to the effectiveness of the company’s internal control over financial reporting, and can provide scaled disclosure regarding executive compensation; however, Hamilton Bancorp will also not be subject to the auditor attestation requirement or additional executive compensation disclosure so long as it remains a “smaller reporting company” under Securities and Exchange Commission regulations (generally less than $75 million of voting and non-voting equity held by non-affiliates). Finally, an emerging growth company may elect to comply with new or amended accounting pronouncements in the same manner as a private company, but must make such election when the company is first required to file a registration statement. Such an election is irrevocable during the period a company is an emerging growth company. Hamilton Bancorp has elected to comply with new or amended accounting pronouncements in the same manner as a private company.

 

A company loses emerging growth company status on the earlier of: (i) the last day of the fiscal year of the company during which it had total annual gross revenues of $1.0 billion or more; (ii) the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of common equity securities of the company pursuant to an effective registration statement under the Securities Act of 1933; (iii) the date on which such company has, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; or (iv) the date on which such company is deemed to be a “large accelerated filer” under Securities and Exchange Commission regulations (generally, at least $700 million of voting and non-voting equity held by non-affiliates).

 

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, our Chief Executive Officer and Chief Financial Officer are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: (i) they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; (ii) they have made certain disclosures to our auditors and the audit committee of the board of directors about our internal control over financial reporting; and (iii) they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.

 

 

ITEM 1A.     RISK FACTORS

 

Our recent emphasis on commercial real estate and commercial business loans has increased our credit risk.

 

Beginning in 2009, we changed our business strategy to become less reliant upon one- to four-family lending and emphasize commercial business and commercial real estate lending. To support this strategy, we have hired additional commercial real estate and commercial loan officers with commercial lending experience, as well as enhanced our back office monitoring and loan administration with additional personnel. We are now performing the underwriting analysis of such loans in-house versus contracting with an outside third party in past years. We have also purchased whole commercial business and commercial real estate loans from other institutions and participated in commercial business and commercial real estate loans originated by other institutions in the past. Although we do not actively seek to participate in or purchase such loans from other financial institutions, we evaluate opportunities on a case by case basis if they present themselves.

 

We have increased our origination of commercial real estate loans and commercial business loans during the last five years, and we intend to continue to grow our portfolio of commercial real estate loans, as well as increase our portfolio of commercial business loans, in the near term, subject to market conditions. At March 31, 2016, commercial real estate loans totaled $78.1 million, or 35.1% of total loans, compared to $21.0 million, or 11.7% of total loans, at March 31, 2011. At March 31, 2016, commercial business loans and lines of credit outstanding totaled $20.4 million, or 9.2% of total loans, compared to $19.4 million, or 10.8% of total loans, at March 31, 2011. We have increased our origination of commercial business loans over the last few years to replace the commercial business loans we have charged-off due to poor asset quality or lost to other financial institutions based upon market terms. We expect additional growth in our commercial business lending portfolio as we continue to originate more of such loans and retain them.

 

Commercial real estate and commercial business loans generally have more risk than the one- to four-family residential real estate loans that we originate. Because the repayment of commercial real estate and commercial business loans depends on the successful management and operation of the borrower’s properties or businesses, repayment of such loans can be affected by adverse conditions in the local real estate market or economy. Commercial real estate and commercial business loans may also involve relatively large loan balances to individual borrowers or groups of related borrowers. In addition, a downturn in the real estate market or the local economy could adversely affect the value of properties securing the loan or the revenues from the borrower’s business, thereby increasing the risk of nonperforming loans. See — “Our entry into commercial real estate and commercial business lending may result in higher losses on our loans,” below.

 

Our entry into commercial real estate and commercial business lending may result in higher losses on our loans.

 

Beginning in 2011, the level of our delinquent and non-performing commercial and commercial real estate (including commercial construction) loans began to increase, particularly in our portfolio of loan participations and purchased loans. During fiscal 2012, nonperforming loans increased $5.8 million, or 354%, to $7.4 million at March 31, 2012. Of the $7.4 million in nonperforming loans, $6.3 million were related to commercial real estate and commercial business loans. As a result of this large increase, we experienced charge-offs of $3.2 million and $2.3 million in fiscal 2013 and 2014, respectively. Commercial real estate and commercial business loans accounted for over 90% of the charge-offs in both those fiscal years. Through workout and charge-offs, as well as a thorough review of the commercial loan portfolio, we were able to reduce our nonperforming commercial loans from $6.3 million at March 31, 2012 to $2.8 million at March 31, 2016. Commercial real estate loans comprised $2.7 million of the $5.1 million in nonperforming loans at March 31, 2016, while commercial business loans accounted for $122,000 of that total. The $2.7 million in nonperforming commercial real estate loans consisted of two loans to the same borrower.

 

 

Given our recent emphasis on commercial business and commercial real estate lending, and that our portfolio of commercial business loans and commercial real estate loans is not seasoned, we have a limited loss history with which to measure the level of risk in our commercial real estate and commercial business loan portfolios. In addition, with our in-house underwriting function for commercial business and commercial real estate loans being relatively new, we have a limited history on which to assess the effectiveness of our commercial business and commercial real estate loan underwriting processes and personnel. Delinquencies and loan losses related to our commercial real estate loans and commercial business loans could increase more than we have provided for in our allowance for loan losses as we continue to emphasize this type of lending activity. See – “Our recent emphasis on commercial real estate and commercial business loans has increased our credit risk,” above.

 

A portion of our one- to four-family residential mortgage loans is comprised of non-owner occupied (investor) properties, which increases the credit risk on this portion of our loan portfolio.

 

A portion of our loan portfolio is comprised of loans secured by non-owner occupied one- to four-family properties, which we refer to as "investor loans". At March 31, 2016, $27.9 million of our one- to four-family residential mortgage loans in our portfolio, or 12.5% of total loans, were comprised of investor loans. We acquired approximately $17.1 million of investor loans in connection with our acquisition of Fairmount Bancorp, Inc. in September 2015. There is a greater credit risk inherent in non-owner occupied properties, than in owner-occupied since the repayment of these loans may depend, in part, on the successful management of the property and/or the borrower’s ability to lease the unit or units of the property. A downturn in the real estate market or the local economy could adversely affect the value of properties securing these loans or the revenues derived from these properties, which could affect the borrower’s ability to repay the loan.

 

In addition, we have limited experience with the performance of the investor loans acquired in connection with the acquisition of Fairmount Bancorp, Inc. See — “We have limited experience with the performance of loans acquired in our recent acquisitions of Fairmount Bancorp, Inc. and Fraternity Community Bancorp, Inc. Certain of our estimates related to accounting for acquired loans may differ from actual results" below regarding risks associated with our recent acquisition of these and other loans.


We have limited experience with the performance of loans acquired in our recent acquisitions of Fairmount Bancorp, Inc. and Fraternity Community Bancorp, Inc. Certain of our estimates related to accounting for acquired loans may differ from actual results.

 

It is difficult to assess the future performance of loans recently added to our portfolio as part of our acquisitions of Fairmount Bancorp, Inc. and Fraternity Community Bancorp, Inc. because our relatively limited experience with such loans does not provide us with a significant history from which to judge future collectability. These loans may experience higher delinquency or charge-off levels than our historical loan portfolio experience, which could adversely affect our future performance.     

 

In addition, under generally accepted principles for business combinations, there is no loan loss allowance initially recorded for acquired loans, which are recorded at net fair value on the acquisition date. This net fair value generally includes embedded loss estimates for acquired loans with deteriorated credit quality. These estimates are based on projections of expected cash flows for these problem loans, which in many cases rely on estimates deriving from the liquidation of collateral.

 

 

If the estimates we have made regarding the performance of loans we have acquired are inadequate, the fair value estimates may exceed the actual collectability of the balances, and this may result in the related loans being considered by us as impaired, which would result in a reduction in interest income. The tangible book value we record is based in part on these estimates, and if fair value estimates differ from actual collectability, then subsequent earnings may also differ from original estimates. Measures of tangible book value and earnings impact of business combinations are frequently used in evaluating the merits and value of business combinations. Numerous assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.

 

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.

 

We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover probable incurred losses in our loan portfolio, resulting in additions to our allowance for loan losses. Additions to the allowance for loan losses are established through the provision for losses on loans which is charged against income.

 

The unseasoned nature of much of our commercial real estate loans and commercial business loans increases the risk that our allowance may be insufficient to absorb losses without significant additional provisions. See — “Our recent emphasis on commercial real estate and commercial business loans has increased our credit risk,” and — “Our entry into commercial real estate and commercial business lending may result in higher losses on our loans,” above. At March 31, 2016, our allowance for loan losses was $1.7 million, or 33.7% of non-performing loans.

 

In addition, if the loans we have acquired in our recent acquisitions of Fairmount Bancorp, Inc. and Fraternity Community Bancorp, Inc. do not perform as we have estimated, our allowance for loan losses may not be adequate. See — “We have limited experience with the performance of loans acquired in our recent acquisitions of Fairmount Bancorp, Inc. and Fraternity Community Bancorp, Inc. Certain of our estimates related to accounting for acquired loans may differ from actual results," above.

 

Material additions to our allowance could materially decrease our net income. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities might have a material adverse effect on our financial condition and results of operations.

 

The Financial Accounting Standards Board has adopted a new accounting standard that will become effective for us on January 1, 2021. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which would likely require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses.

 

 

Our recent acquisitions of Fairmount Bancorp, Inc. and Fraternity Community Bancorp, Inc. involve integrations and other risks.

 

Acquisitions involve a number of risks and challenges including: our ability to integrate the branches and operations we acquire, and the associated internal controls and regulatory functions, into our current operations; our ability to limit the outflow of deposits held by our new customers in the acquired branches and to successfully retain and manage the loans we acquire; our ability to attract new deposits and to generate new interest-earning assets in geographic areas we have not previously served. Additionally, no assurance can be given that the operation of acquired branches would not adversely affect our existing profitability; that we would be able to achieve results in the future similar to those achieved by our existing banking business; that we would be able to compete effectively in the market areas served by acquired branches; or that we would be able to manage any growth resulting from the transaction effectively. We face the additional risk that the anticipated benefits of the acquisition may not be realized fully or at all, or within the time period expected. Finally, acquisitions typically involve the payment of a premium over book and trading values and therefore, may result in dilution of our book and tangible book value per share.

 

Historically low interest rates and/or changes in interest rates may adversely affect our net interest income and profitability.

 

While it has been the policy of the Federal Reserve Board to maintain interest rates at historically low levels over the past several years through its targeted federal funds rate and the purchase of mortgage-backed securities, the Federal Reserve Board raised the federal funds rate by a quarter point on December 17, 2015. As a general matter, our net interest income has been adversely impacted by the low rate environment that has existed over the past several years, however, at this point it is uncertain what impact the December rate increase might have on our net interest income (the difference between interest income we earn on our assets and the interest expense we pay on our liabilities). It is also uncertain when the Federal Reserve Board might raise or lower the federal funds rate in the future. If interest rates rise it may negatively impact the housing markets and the U.S. economic recovery. If rates remain low it could create deflationary pressures, which while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance.

 

Our profitability depends substantially on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities. Increases in interest rates may decrease loan demand (which would also decrease our ability to generate noninterest income through the sale of loans into the secondary market and related fees for continuing to service those sold loans, particularly SBA loans sold) and make it more difficult for borrowers to repay adjustable-rate loans. In addition, as market interest rates rise, we will have competitive pressures to increase the rates we pay on deposits. Because interest rates we pay on our deposits would be expected to increase more quickly than the increase in the yields we earn on our interest-earning assets, our net interest income would be adversely affected.

 

We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the interest rates on existing loans and securities.

 

We could potentially recognize goodwill impairment charges.

 

As of March 31, 2016, we had $6.8 million of goodwill related to acquisitions. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of Hamilton Bank be compared to the carrying amount of the Bank’s net assets, including goodwill. If the fair value of the Bank is less than book value, an expense may be required to write-down the related goodwill to the proper carrying value. We test for impairment of goodwill during February of each year. As a result of impairment testing performed during February 2016, no impairment charge was recorded. However, future declines in our banking franchise value could result in goodwill impairment expense that is material to our earnings.

 

 

Strong competition within our market areas may limit our growth and profitability.

 

Competition in the banking and financial services industry within our market area is intense. In our market area we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater resources and lending limits than we have and offer certain services that we do not or cannot provide. Our profitability depends upon our continued ability to successfully compete in our market area. The greater resources and broader range of deposit and loan products offered by our competition may limit our ability to increase our interest-earning assets and profitability. We expect competition to remain intense in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Competition for deposits and the origination of loans could limit our ability to successfully implement our business plan, and could adversely affect our results of operations in the future.

 

Competition in the banking and financial services industry is coming not only from local markets but from technology oriented financial services (“FinTech) companies, which are subject to limited regulation. They offer user friendly front-end, quick turnaround times for loans and other benefits. While Hamilton is evaluating FinTech companies with the possibility of developing relationships for efficiency in processing and/or as a source of loans and other business, we cannot limit the possibility that our customers or future prospects will work directly with a FinTech company instead. This could impact our growth and profitability going forward.

 

A worsening of economic conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.

 

Our markets have been adversely impacted by the severe national economic recession of 2008 and 2009. Recovery by many businesses has been impaired by lower consumer spending. If the Federal Reserve Board increases the federal funds rate, higher interest rates would likely result, which may reduce our loan originations, and housing markets and U.S. economic activity would be negatively affected.

 

Unlike larger financial institutions that are more geographically diversified, our profitability depends on the general economic conditions in the Baltimore, Maryland metropolitan area. Local economic conditions have a significant impact on our commercial real estate and construction and consumer loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. Almost all of our loans are to borrowers located in the greater Baltimore, Maryland metropolitan area or secured by collateral located in the greater Baltimore, Maryland metropolitan area.

 

A further deterioration in economic conditions or a prolonged delay in economic recovery in the market areas we serve, in particular the greater Baltimore, Maryland metropolitan area, could result in the following consequences, any of which could have a material adverse effect on our business, financial condition, liquidity and results of operations:

 

 

demand for our products and services may decline;

 

 

loan delinquencies, problem assets and foreclosures may increase;

 

 

collateral for loans, especially real estate, may decline further in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans;

 

 

the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us ; and

 

 

The amount of our low-cost or non-interest bearing deposits may decrease.

 

Moreover, a significant decline in general economic condition could further impact these local economic conditions and could further negatively affect the financial results of our banking operations.

 

 

We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.

 

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

 

Income from secondary mortgage market operations is volatile, and we may incur losses or charges with respect to our secondary mortgage market operations which would negatively affect our earnings.

 

We generally sell in the secondary market all residential mortgage loans that we originate with terms over 10 years on a servicing released basis, earning noninterest income in the form of gains on sale. When interest rates rise, the demand for mortgage loans tends to fall and may reduce the number of loans available for sale. In addition to interest rate levels, weak or deteriorating economic conditions also tend to reduce loan demand. We do sell loans in the secondary market with recourse based upon delinquency or breach of customary representations and warranties we provide to the buyers. If we breach those representations and warranties, the buyers can require us to repurchase the loans and we may incur a loss on the repurchase. Since 2009, we have outsourced the loan processing and underwriting functions with respect to loans that we intend to sell in the secondary market to a third-party company. While we review each application to ensure compliance with secondary market standards, there may be some additional risk in outsourcing these functions to a third party rather than utilizing our own employees. If our relationship with this third-party loa