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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-18279
TRI-COUNTY FINANCIAL CORPORATION
--------------------------------
(Exact name of registrant as specified in its charter)
MARYLAND 52-1652138
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 LEONARDTOWN ROAD, WALDORF, MARYLAND 20601
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 645-5601
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or 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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Based on the average of the high bid and low asked prices reported on the OTC
Bulletin Board ($28.875 per share), the aggregate market value of voting stock
held by non-affiliates of the registrant was $18.2 million as of March 15, 2002.
For purposes of this calculation only, the shares held by directors and
executive officers of the registrant and by any stockholder beneficially owning
more than 5% of the registrant's outstanding common stock are deemed to be
shares held by affiliates.
Number of shares of Common Stock outstanding as of March 15, 2002: 765,580
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Proxy Statement for 2002 Annual Meeting of Stockholders. (Part
III)
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PART I
ITEM 1. BUSINESS
-----------------
Tri-County Financial Corporation (the "Company") is a bank holding company
organized in 1989 under the laws of the State of Maryland. It presently owns all
the outstanding shares of capital stock of the Community Bank of Tri-County (the
"Bank"), a Maryland-chartered commercial bank. The Bank was originally organized
in 1950 as Tri-County Building and Loan Association of Waldorf, a mutual savings
and loan association, and in 1986 converted to a federal stock savings bank and
adopted the name Tri-County Federal Savings Bank. The Bank converted to a
Maryland-chartered commercial bank and adopted its current corporate title in
1997. The Company engages in no significant activity other than holding the
stock of the Bank and operating the business of the Bank. Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to the Bank and its subsidiaries.
The Bank serves the southern Maryland counties of Charles, Calvert and St.
Mary's through its main office and eight branches located in Waldorf, Bryans
Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, and California, Maryland.
During 2001, the Bank closed a micro-branch and opened an additional
full-service branch. The Bank also operates fourteen Automated Teller Machines
("ATMs") including six stand-alone locations in the Tri-County area. The Bank is
engaged in the commercial and retail banking business as authorized by the
banking statutes of the State of Maryland and applicable Federal regulations,
including the acceptance of demand and time deposits, and the origination of
loans to individuals, associations, partnerships and corporations. The Bank's
real estate financing consists of residential first and second mortgage loans,
home equity lines of credit and commercial mortgage loans. Commercial lending
consists of both secured and unsecured loans. The Bank is a member of the
Federal Reserve and Federal Home Loan Bank ("FHLB") Systems and its deposits are
insured up to applicable limits by Savings Association Insurance Fund ("SAIF")
of the Federal Deposit Insurance Corporation ("FDIC").
The Company's executive offices are located at 3035 Leonardtown Road, Waldorf,
Maryland. Its telephone number is (301) 645-5601. The Bank also maintains a
website at www.communitybktricounty.com.
MARKET AREA
The Bank considers its principal lending and deposit market area to consist of
the Southern Maryland counties of Charles, Calvert and St. Mary's. These
counties have experienced significant population growth during the past decade
due to their proximity to the rapidly growing Washington, D.C. and Baltimore
metropolitan areas. Southern Maryland is generally considered to have more
affordable housing than many other Washington and Baltimore area suburbs. In
addition, the area has experienced rapid growth in businesses and federal
facilities located in the area. Major federal facilities include the Patuxent
Naval Air Station in St. Mary's county. The Patuxent Naval Air Station has
undergone significant expansion in the last several years and is projected to
continue to expand for several more years.
LENDING ACTIVITIES
GENERAL. The Bank offers a wide variety of consumer and commercial loans. The
Bank's lending activities include residential and commercial real estate loans,
construction loans, land acquisition and development loans, equipment financing,
and commercial and consumer demand and installment loans. Most of the Bank's
customers are residents of, or businesses located in the southern Maryland area.
The Bank's primary market for commercial loans consists of small and medium
sized businesses located in southern Maryland. The Bank believes that this
market is responsive to the Bank's ability to provide personal service and
flexibility. The Bank attracts customers for its consumer lending products based
upon its ability to offer service, flexibility, and competitive pricing, as well
as by leveraging other banking relationships such as soliciting deposit
customers for loans.
The Bank's previous savings and loan charter restricted its ability to hold
certain loan types in its portfolio. As a result, prior to its conversion to a
state chartered commercial bank, the Bank's loan portfolio was primarily made up
2
of residential mortgage loans. Since conversion, the Bank has moved to diversify
its lending by adding a larger portion of commercial real estate, commercial,
and consumer loans to its portfolio. Management believes that this
diversification of the loan portfolio will increase the Bank's overall long-term
financial performance. Management recognizes that these new loan types may
increase the Bank's risk of losses due to loan default.
RESIDENTIAL FIRST MORTGAGE LOANS. Prior to its conversion to a commercial bank
on March 29, 1997, residential first mortgages made up the majority of the
Bank's loan portfolio. Since that date, residential first mortgage loans have
represented a progressively smaller portion of the Bank's loan portfolio. Since
December 31, 1997, residential first mortgage loans have decreased in dollar
amount to $61.4 million from $61.6 million, while falling as a percentage of the
loan portfolio to 31.8% from 49.6%.
Residential first mortgage loans made by the Bank are generally long-term loans,
amortized on a monthly basis, with principal and interest due each month. The
initial contractual loan payment period for residential loans typically ranges
from 10 to 30 years. The Bank's experience indicates that real estate loans
remain outstanding for significantly shorter periods than their contractual
terms. Borrowers may refinance or prepay loans at their option, without penalty.
The Bank originates both fixed- and adjustable-rate residential first mortgages.
The Bank emphasizes the origination of adjustable-rate mortgages for its
portfolio. The Bank offers mortgages which are adjustable on a one, three, and
five-year basis generally with limitations on upward adjustments of two
percentage points per year and six percentage points over the life of the loan.
The Bank markets adjustable-rate loans with rate adjustments based upon a United
States Treasury bill index. As of December 31, 2001, the Bank had $28.9 million
in loans using a U.S. Treasury bill index. In the past, the Bank also offered
adjustable-rate mortgage loans based upon other indices including various cost
of funds indices. These adjustable rate loans totaled $162 thousand as of
December 31, 2001. The Bank also offers long-term, fixed-rate loans. Fixed-rate
loans may be packaged and sold in the secondary market, primarily to the Federal
Home Loan Mortgage Corporation ("FHLMC"), private mortgage correspondents, the
Federal National Mortgage Association ("FNMA") and the Mortgage Partnership
Finance program of the FHLB of Atlanta, or are exchanged for FHLMC participation
certificates or FNMA mortgage-backed securities. Depending on market conditions
the Bank may elect to retain the right to service the loans sold for a payment
based upon a percentage, (generally 0.25% of the outstanding loan balance).
These servicing rights may be sold to other qualified servicers. As of December
31, 2001, the Bank serviced $68.3 million in residential mortgage loans for
various organizations.
The retention of adjustable-rate mortgage loans in the Bank's loan portfolio
helps reduce the negative effects of increases in interest rates on the Bank's
net interest income. Under certain conditions, however, the annual and lifetime
limitations on interest rate adjustments may limit the increases in interest
rates on these loans. There are also unquantifiable credit risks resulting from
potential increased costs to the borrower as a result of repricing of
adjustable-rate mortgage loans. It is foreseeable that during periods of rising
interest rates, the risk of default on adjustable-rate mortgage loans may
increase due to the upward adjustment of interest cost to the borrower. In
addition, depending on market conditions, the initial interest rate on
adjustable-rate loans is generally lower than that on a fixed-rate loan of
similar credit quality and size.
The Bank makes loans up to 95% of appraised value or sales price of the
property, whichever is less, to qualified owner-occupants upon the security of
single-family homes. Non-owner occupied one- to four-family loans and loans
secured by other than residential real estate are generally permitted to a
maximum 70% loan-to-value of the appraised value depending on the overall
strength of the application. The Bank currently requires that substantially all
residential loans with loan-to-value ratios in excess of 80% carry private
mortgage insurance to lower the Bank's exposure to approximately 80% of the
value of the property.
All improved real estate which serves as security for a loan made by the Bank
must be insured, in the amount and by such companies as may be approved by the
Bank, against fire, vandalism, malicious mischief and other hazards. Such
insurance must be maintained through the entire term of the loan and in an
amount not less than that amount necessary to pay the Bank's indebtedness in
full.
3
COMMERCIAL REAL ESTATE AND OTHER NON-RESIDENTIAL REAL ESTATE LOANS. The Bank has
increased its emphasis on loans for the permanent financing of commercial and
other improved real estate projects, including, to a limited extent, office
buildings, as well as churches and other special purpose projects. As a result,
commercial real estate loans increased $23.4 million or 55.4% during 2001. The
primary security on a commercial real estate loan is the real property and the
leases which produce income for the real property. Commercial real estate loans
amounted to approximately $65.6 million or 33.9% of the Bank's loan portfolio at
December 31, 2001. The Bank generally limits its exposure to a single borrower
to 15% of the Bank's capital and frequently participates with other lenders on
larger projects. Loans secured by commercial real estate are generally limited
to 80% of appraised value and have an initial contractual loan payment period
ranging from three to 20 years. Virtually all of the Bank's commercial real
estate loans, as well as its construction loans discussed below, are secured by
real estate located in the Bank's primary market area.
Loans secured by commercial real estate are larger and involve greater risks
than one- to four-family residential mortgage loans. Because payments on loans
secured by such properties are often dependent on the successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Bank restricts its commercial real estate lending primarily to
owner-occupied buildings which will, to some extent, be occupied by the borrower
as opposed to speculative rental projects. As a result of the greater emphasis
that the Bank places on commercial real estate loans under its business plan as
a commercial bank, the Bank is increasingly exposed to the risks posed by this
type of lending.
CONSTRUCTION AND LAND DEVELOPMENT LOANS. The Bank offers construction loans to
individuals and building contractors primarily for the construction of one- to
four-family dwellings. Loans to individuals primarily consist
construction/permanent loans which have fixed rates, payable monthly for the
construction period and are followed by a 30-year, fixed- or adjustable-rate
permanent loan. The construction/permanent loans provide for disbursement of
loan funds based on draw requests submitted by the builder during construction
and site inspections by independent inspectors. The Bank will also make a
construction loan if the borrower has a commitment from another lender for a
permanent loan at the completion of the construction. These loans typically have
terms of six months. The application process includes the same items which are
required for other mortgage loans and also requires the borrower to submit to
the Bank accurate plans, specifications, and costs of the property to be
constructed. These items are used as a basis to determine the appraised value of
the subject property.
The Bank also provides construction and land development loans to home building
and real estate development companies. Generally, these loans are secured by the
real estate under construction as well as by guarantees of the principals
involved. Draws are made upon satisfactory completion of pre-defined stages of
construction or development. The Bank will lend up to 80% of the appraised
value.
The Bank also offers builders lines of credit, which are revolving notes
generally secured by real property. Outstanding builders lines of credit
amounted to approximately $7.8 million at December 31, 2001. The Bank offers a
builder's master note program in which the builder receives a revolving line of
credit at a market rate and the Bank obtains security in the form of a first
lien on home sites under construction.
In addition, the Bank offers loans for the purpose of acquisition and
development of land, as well as loans on undeveloped, subdivided lots for home
building by individuals. Land acquisition and development loans, included in
construction loans discussed above, totaled $3.6 million at December 31, 2001.
Bank policy provides that zoning and permits must be in place prior to making
development loans.
The Bank's ability to originate all types of construction and development loans
is heavily dependent on the continued demand for single family housing
construction in the Bank's market areas. In the event the demand for new houses
in the Bank's market areas were to decline, the Bank may be forced to shift a
portion of its lending emphasis. There can be no assurance of the Bank's ability
to continue growth and profitability in its construction lending activities in
the event of such a decline.
Construction and land development loans are inherently riskier than providing
financing on owner occupied real estate. The Bank's risk of loss is dependent on
the accuracy of the initial estimate of the market value of the
4
completed project as well as the accuracy of the cost estimates made to complete
the project. As these projects may take an extended period of time to complete,
market, economic, and regulatory conditions may change during the construction
or development period.
HOME EQUITY AND SECOND MORTGAGE LOANS. The Bank has maintained a growing level
of home equity and second mortgage loans in recent years. Home equity loans,
which totaled $13.1 million at December 31, 2001, are generally made in the form
of lines of credit with minimum amounts of $5,000, have terms of up to 20 years,
variable rates priced at prime or some margin above prime and require an 80% or
90% loan-to-value ratio (including any prior liens), depending on the specific
loan program. Second mortgage loans which totaled $5.5 million at December 31,
2001 are fixed-rate loans which have original terms between 5 and 15 years.
Loan-to-value ratios of up to 80% or 90% are allowed depending on the specific
loan program.
These products represent a higher risk of default than residential first
mortgages as in the event of foreclosure, the first mortgage would need to be
paid off prior to collection of the second. The Bank believes that its policies
and procedures are sufficient to mitigate the additional risk.
CONSUMER AND COMMERCIAL LOANS. The Bank has developed a number of programs to
serve the needs of its customers with primary emphasis upon direct loans secured
by automobiles, boats, recreational vehicles and trucks and heavy equipment. The
Bank also makes home improvement loans and offers both secured and unsecured
lines of credit.
The Bank also offers a variety of commercial loan services including term loans,
lines of credit and equipment financing. The Bank's commercial loans are
primarily underwritten on the basis of the borrower's ability to service the
debt from income. Such loans are generally made for terms of five years or less
at interest rates which adjust periodically.
The higher interest rates and shorter loan terms available on commercial and
consumer lending make these products attractive to the Bank. In particular, the
consumer and commercial loan portfolio will increase its yield as interest rates
increase. Consumer and commercial business loans, however, entail greater risk
than residential mortgage loans, particularly in the case of consumer loans
which are unsecured or secured by rapidly depreciable assets such as
automobiles. In such cases, any repossessed collateral may not provide an
adequate source of repayment of the outstanding loan balance as a result of the
greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower. In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the
application of various Federal and state laws including Federal and state
bankruptcy and insolvency laws, may limit the amount which can be recovered on
such loans. Such loans may also give rise to claims and defenses by a consumer
loan borrower against an assignee such as the Bank, and a borrower may be able
to assert against such assignee claims and defenses which it has against the
seller of the underlying collateral.
5
LOAN PORTFOLIO ANALYSIS. Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan on the dates indicated.
AT DECEMBER 31,
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2001 2000 1999
----------------- --------------- -----------------
AMOUNT % AMOUNT % AMOUNT %
------ ----- ------ ----- ------ -----
(DOLLARS IN THOUSANDS)
Real Estate Loans --
Residential first mortgage ............. $ 61,430 31.26% $67,975 38.89% $ 66,263 44.42%
Commercial ............................. 65,617 33.39 42,226 24.16 29,947 20.08
Construction and land development (1)... 18,136 9.23 17,301 9.90 17,142 11.49
Home equity and second mortgage ........ 18,580 9.46 18,637 10.66 16,691 11.19
Commercial loans.......................... 18,539 9.44 15,047 8.61 10,025 6.72
Consumer loans............................ 14,187 7.22 13,610 7.79 9,102 6.10
--------- ----- --------- ----- --------- -----
Total loans...................... 196,489 100.00% 174,796 100.00% 149,171 100.00%
====== ====== ======
Less: Deferred loan fees.............. 757 776 808
Loan loss reserve............ 2,282 1,930 1,653
--------- --------- ---------
Loans receivable, net............. $ 193,450 $172,090 $ 146,710
========= ======== =========
AT DECEMBER 31,
-----------------------------------------
1998 1997
------------------ -----------------
AMOUNT % AMOUNT %
------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Real Estate Loans --
Residential first mortgage ............. $ 64,243 47.55% $ 61,630 49.61%
Commercial ............................. 19,733 14.60 19,201 15.46
Construction and land development (1)... 20,776 15.38 14,707 11.84
Home equity and second mortgage ........ 16,314 12.07 17,428 14.03
Commercial loans.......................... 6,161 4.56 4,852 3.91
Consumer loans............................ 7,889 5.84 6,420 5.17
-------- ----- -------- -----
Total loans...................... 135,117 100.00% 124,238 100.00%
====== ======
Less: Deferred loan fees.............. 930 1,060
Loan loss reserve............ 1,540 1,310
-------- --------
Loans receivable, net............. $132,646 $121,867
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----------
(1) Presented net of loans in process.
6
LOAN ORIGINATIONS, PURCHASES AND SALES. The Bank solicits loan applications
through its branch network, direct solicitation of customers, referrals from
customers, and marketing by commercial and residential mortgage loan officers.
Loans are processed and approved according to guidelines deemed appropriate for
each product type. Loan requirements such as income verification, collateral
appraisal, credit reports, etc. vary by loan type. Loan processing functions are
generally centralized except for small consumer loans. Loan approval authority
is established by Board policy and delegated as deemed necessary and
appropriate. Loan approval authorities vary by individual with the President
having approval authority up to $750,000, Senior Vice Presidents up to $400,000,
and Business Development officers up to $150,000. Authorities may be combined up
to $1,000,000. For residential mortgage loans, the residential loan underwriter
may approve loans up to the conforming loan limit of $255,000. Selected branch
personnel may approve secured loans up to $75,000, and unsecured loans up to
$50,000. A loan committee consisting of the President and two members of the
Board, ratify all real estate mortgages and approve all loans in excess of
$1,000,000. Depending on the loan and collateral type, conditions for protecting
the Bank's collateral are specified in the loan documents. Typically these
conditions might include requirements to maintain hazard and title insurance,
pay property taxes, and other conditions.
Depending on market conditions, mortgage loans may be originated primarily with
the intent to sell to third parties such as FNMA or FHLMC. During the year 2001,
the Bank sold $11.4 million of mortgage loans which were originated during the
year generating $187 thousand in income. In order to comply with internal and
regulatory limits on loans to one borrower, the Bank routinely sells portions of
commercial and commercial real estate loans to other lenders. The Bank also
routinely buys portions of loans, whole loans, or participation certificates
from other lenders. The Bank only purchases loans or portions of loans after
reviewing loan documents, underwriting support, and other procedures as
necessary. Purchased loans are subject to the same regulatory and internal
policy requirements as other loans in the Bank's portfolio.
LOANS TO ONE BORROWER. Under Maryland law, the maximum amount which the Bank is
permitted to lend to any one borrower and their related interests may generally
not exceed 10% of the Bank's unimpaired capital and surplus which is defined to
include the Bank's capital, surplus, retained earnings and 50% of its reserve
for possible loan losses. Under this authority, the Bank would have been
permitted to lend up to $2.6 million to any one borrower at December 31, 2001.
By interpretive ruling of the Commissioner of Financial Regulation, Maryland
banks have the option of lending up to the amount that would be permissible for
a national bank which is generally 15% of unimpaired capital and surplus
(defined to include a bank's total capital for regulatory capital purposes plus
any loan loss allowances not included in regulatory capital). Under this
formula, the Bank would have been permitted to lend up to $4.2 million to any
one borrower at December 31, 2001. At December 31, 2001, the largest amount
outstanding to any one borrower and their related interests was $3.6 million.
LOAN COMMITMENTS. The Bank does not normally negotiate standby commitments for
the construction and purchase of real estate. Conventional loan commitments are
granted for a one-month period. The total amount of the Bank's outstanding
commitments to originate loans at December 31, 2001, was approximately $1.9
million, excluding undisbursed portions of loans in process. It has been the
Bank's experience that few commitments expire unfunded.
7
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain information
at December 31, 2001 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less.
DUE AFTER 1 DUE MORE
DUE WITHIN THROUGH 5 THAN 5
1 YEAR AFTER YEARS FROM YEARS FROM
DECEMBER DECEMBER DECEMBER
31, 2001 31, 2001 31, 2001 TOTAL
---------- ---------- ---------- -----
(IN THOUSANDS)
Real estate loans --
Residential first mortgages...... $ 6,632 $ 21,989 $ 32,809 $ 61,430
Commercial ...................... 7,746 20,833 37,038 65,617
Construction..................... 13,200 2,043 2,893 18,136
Home equity and second
mortgage....................... 13,127 3,488 1,965 18,580
Commercial loans.................... 18,539 18,539
Consumer loans...................... 4,358 9,767 62 14,188
--------- ---------- ---------- ----------
$ 63,602 $ 58,120 $ 74,767 $ 196,490
========== ========== ========== ==========
The next table sets forth the dollar amount of all loans due after one year from
December 31, 2001 which have predetermined interest rates and have floating or
adjustable interest rates.
FLOATING OR
FIXED RATES ADJUSTABLE RATES TOTAL
----------- ---------------- ----------
(IN THOUSANDS)
Real estate loans --
Residential first mortgage... $ 25,360 $ 29,438 $ 54,798
Commercial................... 2,878 54,993 57,871
Construction................. 1,305 3,631 4,936
Home equity and second
mortgage................... 5,453 -- 5,453
Consumer........................ 9,829 -- 9,829
----------- ----------- ----------
$ 44,825 $ 88,062 $ 132,887
=========== =========== ==========
DELINQUENCIES. The Bank's collection procedures provide that when a loan is 15
days delinquent, the borrower is contacted by mail and payment is requested. If
the delinquency continues, subsequent efforts will be made to contact the
delinquent borrower and obtain payment. If these efforts prove unsuccessful, the
Bank will pursue appropriate legal action including repossession of the
collateral and other actions as deemed necessary. In certain instances, the Bank
will attempt to modify the loan or grant a limited moratorium on loan payments
to enable the borrower to reorganize his financial affairs.
NON-PERFORMING ASSETS AND ASSET CLASSIFICATION. Loans are reviewed on a regular
basis and are placed on a non-accrual status when, in the opinion of management,
the collection of additional interest is doubtful. Residential mortgage loans
are placed on non-accrual status when either principal or interest is 90 days or
more past due unless they are adequately secured and there is reasonable
assurance of full collection of principal and interest. Consumer loans generally
are charged off when the loan becomes over 120 days delinquent. Commercial
business and real estate loans are placed on non-accrual status when the loan is
90 days or more past due or when the loan's condition puts the timely repayment
of principal and interest in doubt. Interest accrued and unpaid at the time a
loan is placed
8
on non-accrual status is charged against interest income. Subsequent payments
are either applied to the outstanding principal balance or recorded as interest
income, depending on the assessment of the ultimate collectibility of the loan.
Real estate acquired by the Bank as a result of foreclosure or by deed in lieu
of foreclosure is classified as foreclosed real estate until such time as it is
sold. When such property is acquired, it is recorded at its fair market value.
Subsequent to foreclosure, the property is carried at the lower of cost or fair
value less selling costs. Additional write-downs as well as carrying expenses of
the foreclosed properties are charged to expenses in the current period. The
Bank had foreclosed real estate with a fair market value of approximately $1.8
million at December 31, 2001.
During 2001, due to changes in local zoning ordinances severely restraining
building permits, one borrower could not meet the financial obligations of his
$1.2 million loan. The Bank negotiated with this borrower and agreed to accept a
deed in lieu of foreclosure on July 12, 2001 in order to complete development of
the land. The property was transferred to a wholly owned subsidiary of the Bank
on this date. As of December 31, 2001, this asset is classified as foreclosed
real estate. Management has reviewed the value of the property received and
related costs, approximately $1.3 million, and has concluded that no write down
of the property value is required. The value of the property will be reviewed
periodically, and any necessary reduction in the carrying value of the property
will be reflected in the results of operations. Management intends to
aggressively pursue its rights with regard to this asset including possible
legal action.
9
The following table sets forth information with respect to the Bank's
non-performing loans for the periods indicated. During the periods shown, the
Bank had no impaired loans within the meaning of Statement of Financial
Accounting Standards No. 114 and 118.
AT DECEMBER 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
----- ------ ----- ---- -----
(DOLLARS IN THOUSANDS)
Restructured loans.................... $ -- $ -- $ -- $ -- $ --
---------- ---------- ---------- --------- -----------
Accruing loans which are contractually
past due 90 days or more:
Real estate:
Residential first mortgage....... $ -- $ -- $ -- $ -- $ --
Commercial........................ -- -- -- -- --
Construction and land development. -- -- -- -- --
Home equity and second
mortgage........................ 25 102 171 196 165
Commercial ......................... -- -- -- -- --
Consumer............................ -- -- -- -- --
---------- ---------- ---------- --------- -----------
Total............................. 25 102 171 196 165
---------- ---------- ---------- --------- -----------
Loans accounted for on a nonaccrual
basis:
Real estate:
Residential first mortgage........ $ 134 $ -- $ 20 $ 126 $ 34
Commercial........................ -- -- -- -- --
Construction and land development. -- -- -- -- --
Home equity and second
mortgage........................ -- -- -- -- --
Commercial ......................... -- -- -- 85 30
Consumer............................ 70 7 198 58 95
---------- ---------- ---------- --------- -----------
Total............................. 204 7 218 269 159
---------- ---------- ---------- --------- -----------
Total non-performing loans............ $ 229 $ 109 $ 389 $ 465 $ 324
========== ========== ========== ========= ===========
Non-performing loans to total
loans............................. 0.07% 0.06% 0.26% 0.34% 0.26%
========== =========== ========== ========= ===========
Allowance for loan losses
to non-performing loans........... 996.07% 1,770.55% 424.94% 331.18% 404.32%
========== =========== ========== ========= ===========
During the year ended December 31, 2001, gross interest income of $10 thousand
would have been recorded on loans accounted for on a non-accrual basis if the
loans had been current throughout the period. During the year 2001, the Company
recognized $0 in interest on these loans.
At December 31, 2001, there were no loans outstanding not reflected in the above
table as to which known information about possible credit problems of borrowers
caused management to have serious doubts as to the ability of such borrowers to
comply with present loan repayment terms.
10
The following table sets forth an analysis of activity in the Bank's allowance
for possible loan losses for the periods indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
Balance at Beginning of Period........ $ 1,930 $ 1,653 $ 1,540 $ 1,310 $ 1,120
---------- ---------- ---------- --------- -----------
Charge-Offs:
Real estate loans --
Residential first mortgages........ -- 56 -- -- 11
Commercial .......................... -- 33 102 -- 21
Consumer............................. 39 6 32 10 18
---------- ---------- ---------- --------- -----------
Total Charge-Offs..................... 39 95 134 10 50
---------- ---------- ---------- --------- -----------
Recoveries:
Real estate loans --
Residential first mortgages........ -- -- -- -- --
Commercial........................... -- -- -- -- --
Consumer............................. 31 12 7 -- --
---------- ---------- ---------- --------- -----------
Total Recoveries...................... 31 12 7 -- --
---------- ---------- ---------- --------- -----------
Net Charge-Offs....................... 8 83 127 10 50
Provision for Possible Loan Losses.... 360 360 240 240 240
---------- ---------- ---------- --------- -----------
Balance at End of Period.............. $ 2,282 $ 1,930 $ 1,653 $ 1,540 $ 1,310
========== ========== ========== ========= ===========
Ratio of Net Charge-Offs to Average
Loans Outstanding During
the Period.......................... 0.01% 0.05% 0.09% 0.01% 0.04%
========== ========== ========== ========= ==========
11
The following table allocates the allowance for loan losses by loan category at
the dates indicated. The allocation of the allowance to each category is not
necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.
AT DECEMBER 31,
-------------------------------------------------------------------------------
2001 2000 1999
-------------------------- ----------------------- --------------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ------------- ------ ------------- ------ -------------
(DOLLARS IN THOUSANDS)
Real estate loans --
Residential first mortgage............. $ 160 31.3% $ 192 38.9% $ 632 44.4%
Commercial............................. 923 33.4 645 24.1 399 20.1
Construction and land development...... 355 9.2 285 9.9 164 11.5
Home equity and second mortgage........ 373 9.5 394 10.7 159 11.2
Commercial................................ 186 9.4 138 8.6 178 6.7
Consumer.................................. 285 7.2 276 7.8 121 6.1
--------- ---- --------- ------ --------- ------
Total allowance for loan losses... $ 2,282 100.0% $ 1,930 100.0% $ 1,653 100.0%
========= ===== ========= ===== ========= =====
AT DECEMBER 31,
----------------------------------------------------
1998 1997
-------------------------- ------------------------
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ------------- ------ -------------
(DOLLARS IN THOUSANDS)
Real estate loans --
Residential first mortgage............. $ 652 47.6% $ 579 49.6%
Commercial............................. 281 14.6 255 15.5
Construction and land development...... 211 15.4 138 11.8
Home equity and second mortgage........ 166 12.1 164 14.0
Commercial................................ 117 4.5 87 3.9
Consumer.................................. 113 5.8 87 5.2
--------- ----- --------- ------
Total allowance for loan losses... $ 1,540 100.0% $ 1,310 100.0%
========= ===== ========= =====
The Bank closely monitors the loan payment activity of all its loans. A loan
loss provision is provided by a regular accrual. The Bank periodically reviews
the adequacy of the allowance for loan losses based on an analysis of the loan
portfolio, the Bank's historical loss experience, economic conditions in the
Bank's market area, and a review of selected individual loans. Loan losses are
charged off against the allowance when the uncollectibility is confirmed.
Subsequent recoveries, if any, are credited to the allowance. The Bank believes
it has established its existing allowance for loan losses in accordance with
generally accepted accounting principles and is in compliance with appropriate
regulatory guidelines. However, the establishment of the level of the allowance
for loan losses is highly subjective and dependent on incomplete information as
to the ultimate disposition of loans. Accordingly, there can be no assurance
that actual losses may vary from the amounts estimated or that the Bank's
regulators will not request the Bank to significantly increase or decrease its
allowance for loan losses, thereby affecting the Bank's financial condition and
earnings.
12
INVESTMENT ACTIVITIES
The Bank maintains a portfolio of investment securities to provide liquidity as
well as a source of earnings. The Bank's investment securities portfolio
consists primarily of mortgage-backed and other securities issued by U.S.
Government-sponsored enterprises ("GSEs") including FHLMC, FNMA, SLMA and the
FHLB System. The Bank also has smaller holdings of privately issued
mortgage-backed securities, U.S. Treasury obligations, and other equity and debt
securities. As a member of the Federal Reserve and FHLB Systems, the Bank is
also required to invest in the stock of the Federal Reserve Bank of Richmond and
FHLB of Atlanta, respectively.
The following table sets forth the carrying value of the Company's investment
securities portfolio and FHLB of Atlanta and Federal Reserve Bank stock at the
dates indicated. At December 31, 2001, their market value was $47 million.
AT DECEMBER 31,
-------------------------------------------------
2001 2000 1999
---- ----- -----
(IN THOUSANDS)
Asset-backed securities:
FHLMC and FNMA.................................... $ 26,084 $ 30,577 $ 29,501
Other............................................. 8,993 16,855 17,964
--------- --------- ---------
Total asset-backed securities.................. 35,077 47,432 47,465
FHLMC, FNMA, SLMA and FHLB notes..................... -- 7,912 7,619
FHLMC and FNMA stock................................. 727 764 751
Money market funds................................... 5,868 753 820
Treasury bills....................................... 300 200 198
Other investments.................................... 1,989 1,514 1,749
--------- --------- ---------
Total investment securities.................... 43,961 58,575 58,602
FHLB and Federal Reserve Bank stock......... 3,036 3,036 2,288
--------- --------- ---------
Total investment securities and FHLB and
Federal Reserve Bank stock................... $ 46,997 $ 61,611 $ 60,890
========= ========= =========
The maturities and weighted average yields for investment securities available
for sale and held to maturity at December 31, 2001 are shown below.
AFTER ONE AFTER FIVE
ONE YEAR OR LESS THROUGH FIVE YEARS THROUGH TEN YEARS AFTER TEN YEARS
-------------------- ------------------- -------------------- --------------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- ------- -------- ------- -------- ------- -------- --------
(DOLLARS IN THOUSANDS)
Investment securities available
for sale:
Corporate equity securities... $ 727 3.76% $ -- --% $ -- --% $ -- --%
Asset-backed securities....... 8,068 5.55 14,606 6.09 12,108 4.95 295 7.99
Money market funds............ 5,868 1.70 -- -- -- -- -- --
----- -------- ------- ------
Total investment securities
available for sale....... $ 14,663 3.92 % $14,606 6.09% $12,108 4.95% $ 295 7.99%
======== ==== ======= ==== ======= ==== ====== ====
Investment securities held-to-
maturity:
Treasury bills............. $ 300 5.30% $ -- --% $ -- --% $ -- --%
Other investments.......... 978 6.18 1,011 5.90 -- -- -- --
-------- ------- ------- ------
Total investment securities
held-to-maturity......... $ 1,278 5.97 $ 1,011 5.90% $ -- --% $ -- --%
======== ==== ======= ==== ======= ==== ====== ====
13
The Bank's investment policy provides that securities that will be held for
indefinite periods of time, including securities that will be used as part of
the Bank's asset/liability management strategy and that may be sold in response
to changes in interest rates, prepayments and similar factors, are classified as
available for sale and accounted for at the fair value. Management's intent is
to hold securities reported at amortized cost to maturity.
Certain of the Company's securities are issued by private issuers (defined as an
issuer which is not a government or a government sponsored entity). Although the
Company generally limits its exposure to private issuers to total investments
from any one issuer to less than 10% of equity, in certain cases the Company has
made higher investments. These investments are classified as available for sale,
and carrying value therefore equals market value. Details of such investments at
December 31, 2001 follow:
ESTIMATED FAIR
ISSUER MOODY'S RATING MARKET VALUE
------ -------------- --------------
(IN THOUSANDS)
GE Capital Mortgage Services.............. AAA $ 4,571
For further information regarding the Company's investment securities, see Note
2 of Notes to Consolidated Financial Statements.
DEPOSITS AND OTHER SOURCES OF FUNDS
GENERAL. The funds needed by the Bank to make loans are primarily generated by
deposit accounts solicited from the communities surrounding its main office and
seven branches in the southern Maryland area. Consolidated total deposits were
$183,116,534 as of December 31, 2001. The Bank uses borrowings from the FHLB of
Atlanta and other sources to supplement funding from deposits.
DEPOSITS. The Bank's deposit products include regular savings accounts
(statements), money market deposit accounts, demand deposit accounts,
interest-bearing demand deposit accounts, IRA and SEP accounts, Christmas club
accounts and certificates of deposit. Variations in service charges, terms and
interest rates are used to target specific markets. Ancillary products and
services for deposit customers include safe deposit boxes, money orders and
travelers checks, night depositories, automated clearinghouse transactions, wire
transfers, ATMs, and telephone banking. The Bank is a member of JEANIE, Cirrus
and Honor ATM networks. The Bank has occasionally used deposit brokers to obtain
funds. At year end, no brokered deposits were held.
The following table sets forth for the periods indicated the average balances
outstanding and average interest rates for each major category of deposits.
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2001 2000 1999
-------------------- -------------------- ----------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
------- ------- ------- ------- ------- --------
(DOLLARS IN THOUSANDS)
Savings.......................... $ 19,723 2.01% $ 20,051 2.37% $ 23,774 2.32%
Interest-bearing demand and money
market accounts............... 72,052 2.35 59,720 3.58 46,663 2.82
Certificates of deposit.......... 70,453 5.45 69,592 5.32 75,093 4.87
------------ ----------- ------------
Total interest-bearing
deposits................... 162,228 3.65 149,363 4.23 145,530 3.80
Noninterest-bearing demand
deposits...................... 13,872 10,691 9,169
------------ ----------- ------------
Total average deposits...... $ 176,100 3.37 $ 160,324 3.94 $ 154,699 3.57
============ =========== ============
14
The following table indicates the amount of the Bank's certificates of deposit
and other time deposits of more than $100,000 by time remaining until maturity
as of December 31, 2001.
CERTIFICATES
MATURITY PERIOD OF DEPOSIT
--------------- --------------
(IN THOUSANDS)
Three months or less.................................... $ 7,496
Three through six months................................ 2,202
Six through twelve months............................... 2,615
Over twelve months...................................... 4,705
----------
Total............................................ $ 17,018
==========
BORROWINGS. Deposits are the primary source of funds for the Bank's lending and
investment activities and for its general business purposes. The Bank uses
advances from the FHLB of Atlanta to supplement its supply of lendable funds and
to meet deposit withdrawal requirements. Advances from the FHLB are secured by
the Bank's stock in the FHLB, a portion of the Bank's residential mortgage loans
and its eligible investments. Generally the Bank's ability to borrow from the
FHLB of Atlanta is limited by its available collateral and also by an overall
limitation of 35% of assets. Other short-term debt consists of notes payable to
the U.S. Treasury on Treasury, Tax and Loan accounts. Long-term borrowings
consist of adjustable-rate advances with rates based upon LIBOR, fixed-rate
advances, and convertible advances. Information about borrowings for the years
indicated (which consisted almost entirely of FHLB advances) is as follows:
AT OR FOR THE
YEAR ENDED DECEMBER 31,
------------------------------------------------
2001 2000 1999
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Long-term amounts outstanding at end of period............... $ 48,650 $ 41,400 $ 31,400
Weighted average rate on outstanding long-term............... 5.41% 5.91% 5.54%
Short-term borrowings outstanding at end of period........... $ 1,813 $ 13,551 $ 13,398
Weighted average rate on outstanding short-term.............. 1.83% 6.35% 5.55%
Maximum outstanding short-term debt at any month end......... $ 15,725 $ 35,100 $ 16,500
Average outstanding short-term debt ......................... $ 6,213 $ 25,810 $ 9,129
Approximate weighted average rate paid on short-term
debt (1)................................................... 5.75% 6.62% 5.39%
__________
(1) Based on month-end balances.
For more information regarding the Bank's borrowings, see Note 7 of Notes to
Consolidated Financial Statements.
SUBSIDIARY ACTIVITIES
Under the Maryland Financial Institutions Code, commercial banks may invest in
service corporations and in other subsidiaries that offer the public a
financial, fiduciary or insurance service. In 1985, the Bank formed Tri-County
Federal Finance One as a finance subsidiary for the purpose of issuing a $6.5
million collateralized mortgage obligation. In June 1999, the obligation was
satisfied, allowing the return of the participation certificates serving as
collateral to the Bank and closing the subsidiary. In April 1997, the Bank
formed a wholly owned subsidiary, Community Mortgage Corporation of Tri-County,
to offer mortgage banking, brokerage, and other services to the public. This
corporation was inactive until 2001. At that time, the Bank transferred a
property which was acquired by deed in lieu of foreclosure to this subsidiary in
order to complete development of this parcel. In August 1999, the Bank formed a
wholly owned subsidiary, Tri-County Investment Corporation to hold and manage a
portion of the Bank's investment portfolio in the State of Delaware.
15
COMPETITION
The Bank faces strong competition in the attraction of deposits and in the
origination of loans. Its most direct competition for deposits and loans comes
from other banks, savings and loan associations, and federal and state credit
unions located in its primary market area. There are currently 15 FDIC-insured
depository institutions operating in the Tri-County area including subsidiaries
of several regional and super-regional bank holding companies. According to
statistics compiled by the FDIC, the Bank was ranked sixth in deposit market
share in the Tri-County area as of June 30, 2001, the latest date for which such
data is available. The Bank faces additional significant competition for
investors' funds from mutual funds, brokerage firms, and other financial
institutions.
The Bank competes for loans by providing competitive rates, flexibility of
terms, and service. It competes for deposits by offering depositors a wide
variety of account types, convenient office locations, and competitive rates.
Other services offered include tax-deferred retirement programs, brokerage
services, safe deposit boxes, and miscellaneous services. The Bank has used
direct mail, billboard and newspaper advertising to increase its market share of
deposits, loans and other services in its market area. It provides ongoing
training for its staff in an attempt to ensure high quality service.
SUPERVISION AND REGULATION
REGULATION OF THE BANK
GENERAL. The Bank is a Maryland commercial bank and its deposit accounts are
insured by the SAIF. The Bank is a member of the Federal Reserve and FHLB
Systems. The Bank is subject to supervision, examination and regulation by
Commissioner of Financial Regulation of the State of Maryland (the
"Commissioner") and the Board of Governors of the Federal Reserve System (the
"FRB") and to Maryland and federal statutory and regulatory provisions governing
such matters as capital standards, mergers and establishment of branch offices.
The Bank is required to file reports with the Commissioner and the FRB
concerning its activities and financial condition and will be required to obtain
regulatory approvals prior to entering into certain transactions, including
mergers with, or acquisitions of, other depository institutions.
As an institution with federally insured deposits, the Bank is subject to
various regulations promulgated by the FRB, including Regulation B (Equal Credit
Opportunity), Regulation D (Reserve Requirements), Regulation E (Electronic Fund
Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds and Collection of Checks) and Regulation DD (Truth in Savings).
The system of regulation and supervision applicable to the Bank establishes a
comprehensive framework for the operations of the Bank and is intended primarily
for the protection of the FDIC and the depositors of the Bank. Changes in the
regulatory framework could have a material effect on the Bank and its respective
operations that in turn, could have a material effect on the Company.
CAPITAL ADEQUACY. The FRB has established guidelines with respect to the
maintenance of appropriate levels of capital by bank holding companies and state
member banks, respectively. The regulations impose two sets of capital adequacy
requirements: minimum leverage rules, which require bank holding companies and
member banks to maintain a specified minimum ratio of capital to total assets,
and risk-based capital rules, which require the maintenance of specified minimum
ratios of capital to "risk-weighted" assets.
The regulations of the FRB require bank holding companies and state member
banks, respectively, to maintain a minimum leverage ratio of "Tier 1 capital"
(as defined in the risk-based capital guidelines discussed in the following
paragraphs) to total assets of 3.0%. Although setting a minimum 3.0% leverage
ratio, the capital regulations state that only the strongest bank holding
companies and banks, with composite examination ratings of 1 under the rating
system used by the federal bank regulators, would be permitted to operate at or
near such minimum level of capital. All other bank holding companies and banks
are expected to maintain a leverage ratio of at least 1% to 2% above the minimum
ratio, depending on the assessment of an individual organization's capital
adequacy by its primary
16
regulator. Any bank or bank holding company experiencing or anticipating
significant growth would be expected to maintain capital well above the minimum
levels. In addition, the FRB has indicated that whenever appropriate, and in
particular when a bank holding company is undertaking expansion, seeking to
engage in new activities or otherwise facing unusual or abnormal risks, it will
consider, on a case-by-case basis, the level of an organization's ratio of
tangible Tier 1 capital (after deducting all intangibles) to total assets in
making an overall assessment of capital.
The risk-based capital rules of the FRB require bank holding companies and state
member banks, respectively, to maintain minimum regulatory capital levels based
upon a weighting of their assets and off-balance sheet obligations according to
risk. Risk-based capital is composed of two elements: Tier 1 capital and Tier 2
capital. Tier 1 capital consists primarily of common stockholders' equity,
certain perpetual preferred stock (which must be noncumulative in the case of
banks), and minority interests in the equity accounts of consolidated
subsidiaries; less all intangible assets, except for certain servicing assets,
purchased credit card relationships, deferred tax assets and credit enhancing
interest-only strips. Tier 2 capital elements include, subject to certain
limitations, the allowance for losses on loans and leases; perpetual preferred
stock that does not qualify as Tier 1 capital and long-term preferred stock with
an original maturity of at least 20 years from issuance; hybrid capital
instruments, including perpetual debt and mandatory convertible securities; and
subordinated debt and intermediate-term preferred stock.
The risk-based capital regulations assign balance sheet assets and credit
equivalent amounts of off-balance sheet obligations to one of four broad risk
categories based principally on the degree of credit risk associated with the
obligor. The assets and off-balance sheet items in the four risk categories are
weighted at 0%, 20%, 50% and 100%. These computations result in the total
risk-weighted assets. The risk-based capital regulations require all banks and
bank holding companies to maintain a minimum ratio of total capital (Tier 1
capital plus Tier 2 capital) to total risk-weighted assets of 8%, with at least
4% as Tier 1 capital. For the purpose of calculating these ratios: (i) Tier 2
capital is limited to no more than 100% of Tier 1 capital; and (ii) the
aggregate amount of certain types of Tier 2 capital is limited. In addition, the
risk-based capital regulations limit the allowance for loan losses includable as
capital to 1.25% of total risk-weighted assets.
FRB regulations and guidelines additionally specify that state member banks with
significant exposure to declines in the economic value of their capital due to
changes in interest rates may be required to maintain higher risk-based capital
ratios. The federal banking agencies, including the FRB, have proposed a system
for measuring and assessing the exposure of a bank's net economic value to
changes in interest rates. The federal banking agencies, including the FRB, have
stated their intention to propose a rule establishing an explicit capital charge
for interest rate risk based upon the level of a bank's measured interest rate
risk exposure after more experience has been gained with the proposed
measurement process. FRB regulations do not specifically take into account
interest rate risk in measuring the capital adequacy of bank holding companies.
The FRB has issued regulations which classify state member banks by capital
levels and which authorize the FRB to take various prompt corrective actions to
resolve the problems of any bank that fails to satisfy the capital standards.
Under such regulations, a well-capitalized bank is one that is not subject to
any regulatory order or directive to meet any specific capital level and that
has or exceeds the following capital levels: a total risk-based capital ratio of
10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. An
adequately capitalized bank is one that does not qualify as well-capitalized but
meets or exceeds the following capital requirements: a total risk-based capital
ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of
either (i) 4% or (ii) 3% if the bank has the highest composite examination
rating. A bank not meeting these criteria is treated as undercapitalized,
significantly undercapitalized, or critically undercapitalized depending on the
extent to which the bank's capital levels are below these standards. A state
member bank that falls within any of the three undercapitalized categories
established by the prompt corrective action regulation will be subject to severe
regulatory sanctions. As of December 31, 2001, the Bank was well capitalized as
defined by the FRB's regulations.
BRANCHING. Maryland law provides that, with the approval of the Commissioner,
Maryland banks may establish branches within the State of Maryland without
geographic restriction and may establish branches in other states by any means
permitted by the laws of such state or by federal law. The Riegle-Neal Act
authorizes the FRB to approve interstate branching de novo by state banks, only
in states which specifically allow for such branching. The
17
Riegle-Neal Act also required the appropriate federal banking agencies to
prescribe regulations which prohibit any out-of-state bank from using the
interstate branching authority primarily for the purpose of deposit production.
These regulations include guidelines to ensure that interstate branches operated
by an out-of-state bank in a host state are reasonably helping to meet the
credit needs of the communities which they serve.
DIVIDEND LIMITATIONS. Pursuant to the Maryland Financial Institutions Code,
Maryland banks may only pay dividends from undivided profits or, with the prior
approval of the Commissioner, their surplus in excess of 100% of required
capital stock. The Maryland Financial Institutions Code further restricts the
payment of dividends by prohibiting a Maryland bank from declaring a dividend on
its shares of common stock until its surplus fund equals the amount of required
capital stock or, if the surplus fund does not equal the amount of capital
stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
DEPOSIT INSURANCE. The Bank is required to pay semi-annual assessments based on
a percentage of its insured deposits to the FDIC for insurance of its deposits
by the Savings Association Insurance Fund ("SAIF"). Under the Federal Deposit
Insurance Act, the FDIC is required to set semi-annual assessments for
SAIF-insured institutions to maintain the designated reserve ratio of the SAIF
at 1.25% of estimated insured deposits or at a higher percentage of estimated
insured deposits that the FDIC determines to be justified for that year by
circumstances raising a significant risk of substantial future losses to the
SAIF. In the event that the SAIF should fail to meet its statutory reserve
ratio, the FDIC would be required to set semi-annual assessment rates for SAIF
members that are sufficient to increase the reserve ratio to 1.25% within one
year or in accordance with such other schedule that the FDIC adopts by
regulation to restore the reserve ratio in not more than 15 years.
Under the risk-based deposit insurance assessment system adopted by the FDIC,
the assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution by the FDIC, which is
determined by the institution's capital level and supervisory evaluations. Based
on the data reported to regulators for the date closest to the last day of the
fourth month preceding the semi-annual assessment period, institutions are
assigned to one of three capital groups -- "well capitalized, adequately
capitalized or undercapitalized." Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund. Under the current assessment
schedule, well-capitalized banks with the best supervisory ratings are not
required to pay any premium for deposit insurance. All SAIF-insured banks,
however, are required to pay assessments to the FDIC to help fund interest
payments on certain bonds issued by the Financing Corporation, an agency
established by the federal government to finance takeovers of insolvent thrifts.
TRANSACTIONS WITH AFFILIATES. A state member bank or its subsidiaries may not
engage in "covered transactions" with any one affiliate in an amount greater
than 10% of such bank's capital stock and surplus, and for all such transactions
with all affiliates a state non-member bank is limited to an amount equal to 20%
of capital stock and surplus. All such transactions must also be on terms
substantially the same, or at least as favorable, to the bank or subsidiary as
those provided to a non-affiliate. The term "covered transaction" includes the
making of loans, purchase of assets, issuance of a guarantee and similar other
types of transactions. An affiliate of a state non-member bank is any company or
entity which controls or is under common control with the state non-member bank
and, for purposes of the aggregate limit on transactions with affiliates, any
subsidiary that would be deemed a financial subsidiary of a national bank. In a
holding company context, the parent holding company of a state non-member bank
(such as the Company) and any companies which are controlled by such parent
holding company are affiliates of the state non-member bank. The BHCA further
prohibits a depository institution from extending credit to or offering any
other services, or fixing or varying the consideration for such extension of
credit or service, on the
18
condition that the customer obtain some additional service from the institution
or certain of its affiliates or not obtain services of a competitor of the
institution, subject to certain limited exceptions.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS. Loans to
directors, executive officers and principal stockholders of a state non-member
bank must be made on substantially the same terms as those prevailing for
comparable transactions with persons who are not executive officers, directors,
principal stockholders or employees of the Bank unless the loan is made pursuant
to a compensation or benefit plan that is widely available to employees and does
not favor insiders. Loans to any executive officer, director and principal
stockholder together with all other outstanding loans to such person and
affiliated interests generally may not exceed 15% of the bank's unimpaired
capital and surplus and all loans to such persons may not exceed the
institution's unimpaired capital and unimpaired surplus. Loans to directors,
executive officers and principal stockholders, and their respective affiliates,
in excess of the greater of $25,000 or 5% of capital and surplus (up to
$500,000) must be approved in advance by a majority of the board of directors of
the bank with any "interested" director not participating in the voting. State
member banks are prohibited from paying the overdrafts of any of their executive
officers or directors unless payment is made pursuant to a written,
pre-authorized interest-bearing extension of credit plan that specifies a method
of repayment or transfer of funds from another account at the bank. In addition,
loans to executive officers may not be made on terms more favorable than those
afforded other borrowers and are restricted as to type, amount and terms of
credit.
REGULATION OF THE COMPANY
GENERAL. The Company, as the sole shareholder of the Bank, is a bank holding
company and registered as such with the FRB. Bank holding companies are subject
to comprehensive regulation by the FRB under the Bank Holding Company Act of
1956, as amended (the "BHCA"), and the regulations of the FRB. As a bank holding
company, the Company is required to file with the FRB annual reports and such
additional information as the FRB may require, and is subject to regular
examinations by the FRB. The FRB also has extensive enforcement authority over
bank holding companies, including, among other things, the ability to assess
civil money penalties, to issue cease and desist or removal orders and to
require that a holding company divest subsidiaries (including its bank
subsidiaries). In general, enforcement actions may be initiated for violations
of law and regulations and unsafe or unsound practices.
Under the BHCA, a bank holding company must obtain FRB approval before: (i)
acquiring, directly or indirectly, ownership or control of any voting shares of
another bank or bank holding company if, after such acquisition, it would own or
control more than 5% of such shares (unless it already owns or controls the
majority of such shares); (ii) acquiring all or substantially all of the assets
of another bank or bank holding company; or (iii) merging or consolidating with
another bank holding company.
Effective September 29, 1995, the Riegle-Neal Interstate Banking and Branching
Efficiency of 1994 (the "Riegle-Neal Act") authorized the FRB to approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the assets
of, a bank located in a state other than such holding company's home state,
without regard to whether the transaction is prohibited by the laws of any
state. The FRB may not approve the acquisition of a bank that has not been in
existence for the minimum time period (not exceeding five years) specified by
the statutory law of the host state. The Riegle-Neal Act also prohibits the FRB
from approving such an application if the applicant (and its depository
institution affiliates) controls or would control more than 10% of the insured
deposits in the United States or 30% or more of the deposits in the target
bank's home state or in any state in which the target bank maintains a branch.
The Riegle-Neal Act does not affect the authority of states to limit the
percentage of total insured deposits in the state which may be held or
controlled by a bank or bank holding company to the extent such limitation does
not discriminate against out-of-state banks or bank holding companies.
Individual states may also waive the 30% state-wide concentration limit
contained in the Riegle-Neal Act. Under Maryland law, a bank holding company is
prohibited from acquiring control of any bank if the bank holding company would
control more than 30% of the total deposits of all depository institutions in
the State of Maryland unless waived by the Commissioner of Financial Regulation.
19
Additionally, the federal banking agencies are authorized to approve interstate
merger transactions without regard to whether such transaction is prohibited by
the law of any state, unless the home state of one of the banks opted out of the
Riegle-Neal Act by adopting a law after the date of enactment of the Riegle-Neal
Act and prior to June 1, 1997 which applies equally to all out-of-state banks
and expressly prohibits merger transactions involving out-of-state banks. The
State of Maryland did not pass such a law during this period. Interstate
acquisitions of branches will be permitted only if the law of the state in which
the branch is located permits such acquisitions. Interstate mergers and branch
acquisitions will also be subject to the nationwide and statewide insured
deposit concentration amounts described above.
The BHCA also prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any company which is not a bank or bank holding company, or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by FRB regulation or order, have been identified as
activities closely related to the business of banking or managing or controlling
banks. The list of activities permitted by the FRB includes, among other things,
operating a savings institution, mortgage company, finance company, credit card
company or factoring company; performing certain data processing operations;
providing certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit-related insurance; leasing property
on a full-payout, non-operating basis; selling money orders, travelers' checks
and United States Savings Bonds; real estate and personal property appraising;
providing tax planning and preparation services; and, subject to certain
limitations, providing securities brokerage services for customers.
Effective with the enactment of the Gramm-Leach-Bliley Act (the "G-L-B Act") on
November 12, 1999, bank holding companies whose financial institution
subsidiaries are well capitalized and well managed and have satisfactory
Community Reinvestment Act records can elect to become "financial holding
companies" which will be permitted to engage in a broader range of financial
activities than are currently permitted to bank holding companies. Financial
holding companies are authorized to engage in, directly or indirectly, financial
activities. A financial activity is an activity that is: (i) financial in
nature; (ii) incidental to an activity that is financial in nature; or (iii)
complementary to a financial activity and that does not pose a safety and
soundness risk. The G-L-B Act includes a list of activities that are deemed to
be financial in nature. Other activities also may be decided by the Federal
Reserve Board to be financial in nature or incidental thereto if they meet
specified criteria. A financial holding company that intends to engage in a new
activity to acquire a company to engage in such an activity is required to give
prior notice to the FRB. If the activity is not either specified in the G-L-B
Act as being a financial activity or one that the FRB has determined by rule or
regulation to be financial in nature, the prior approval of the FRB is required.
The Maryland Financial Institutions Code prohibits a bank holding company from
acquiring more than 5% of any class of voting stock of a bank or bank holding
company without the approval of the Commissioner of Financial Regulation except
as otherwise expressly permitted by federal law or in certain other limited
situations. The Maryland Financial Institutions Code additionally prohibits any
person from acquiring voting stock in a bank or bank holding company without 60
days' prior notice to the Commissioner if such acquisition will give the person
control of 25% or more of the voting stock of the bank or bank holding company
or will affect the power to direct or to cause the direction of the policy or
management of the bank or bank holding company. Any doubt whether the stock
acquisition will affect the power to direct or cause the direction of policy or
management shall be resolved in favor of reporting to the Commissioner. The
Commissioner may deny approval of the acquisition if the Commissioner determines
it to be anti-competitive or to threaten the safety or soundness of a banking
institution. Voting stock acquired in violation of this statute may not be voted
for five years.
DIVIDENDS. The FRB has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the FRB's view that a bank
holding company should pay cash dividends only to the extent that the company's
net income for the past year is sufficient to cover both the cash dividends and
a rate of earning retention that is consistent with the company's capital needs,
asset quality and overall financial condition. The FRB also indicated that it
would be inappropriate for a company experiencing serious financial problems to
borrow funds to pay dividends. Furthermore, under the prompt corrective action
regulations adopted by the FRB pursuant to
20
FDICIA, the FRB may prohibit a bank holding company from paying any dividends if
the holding company's bank subsidiary is classified as "undercapitalized".
Bank holding companies are required to give the FRB prior written notice of any
purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the their consolidated retained earnings. The
FRB may disapprove such a purchase or redemption if it determines that the
proposal would constitute an unsafe or unsound practice or would violate any
law, regulation, FRB order, or any condition imposed by, or written agreement
with, the FRB.
CAPITAL REQUIREMENTS. The FRB has established capital requirements, similar to
the capital requirements for state member banks described above, for bank
holding companies with consolidated assets of $150 million or more. As of
December 31, 2001, the Company's levels of consolidated regulatory capital
exceeded the FRB's minimum requirements.
PERSONNEL
As of December 31, 2001, the Bank had 84 full-time employees and 14 part-time
employees. The employees are not represented by a collective bargaining
agreement. The Bank believes its employee relations are good.
ITEM 2. PROPERTIES
The following table sets forth the location of the Bank's offices, as well as
certain additional information relating to these offices as of December 31,
2001.
YEAR
FACILITY LEASED APPROXIMATE
OFFICE COMMENCED OR SQUARE
LOCATION OPERATION OWNED FOOTAGE
-------- --------- ------- ------------
MAIN OFFICE
3035 Leonardtown Road 1974 Owned 16,500
Waldorf, Maryland
BRANCH OFFICES
22730 Three Notch Rd. 1992 Owned 2,500
California, Maryland
25395 Point Lookout Rd. 1961 Owned 2,500
Leonardtown, Maryland
101 Drury Drive 2001 Owned 2,645
La Plata, Maryland
10321 Southern Md. Blvd. 1991 Leased 1,400
Dunkirk, Maryland
8010 Matthews Road 1996 Owned 2,500
Bryans Road, Maryland
20 St. Patrick's Drive (1) 1998 Leased (Land) 2,840
Waldorf, Maryland Owned (Building)
21
YEAR
FACILITY LEASED APPROXIMATE
OFFICE COMMENCED OR SQUARE
LOCATION OPERATION OWNED FOOTAGE
-------- --------- -------- ------------
10195 Berry Road 1999 Leased 600
Waldorf, Maryland
30165 Three Notch Road (2) 2001 Leased (Land) N/A
Charlotte Hall, Maryland
----------------
(1) The Bank purchased the location in 1998. The building is owned by the Bank
with the land on a lease basis.
(2) The Bank has leased the land on a long term basis and is operating out of a
temporary facility while the permanent building is constructed.
Construction is expected to be completed in the second quarter of 2002.
ITEM 3. LEGAL PROCEEDINGS
--------------------------
Neither the Company, the Bank, nor any subsidiary is engaged in any legal
proceedings of a material nature at the present time. From time to time the Bank
is a party to legal proceedings in the ordinary course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2001.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
--------------------------------------------------------------------------------
MARKET INFORMATION. Beginning in the first quarter of 2002, bid and asked quotes
and last sale information became available for the Company's common stock on the
OTC Bulletin Board under the symbol "TCFC." During fiscal years 2001 and 2000,
there was no established trading market for the Common Stock and bid and asked
quotes were not regularly available. The Company has maintained a list of
persons who have expressed an interest in buying or selling the Common Stock and
has made this information available to persons seeking to sell or buy shares, as
the case may be, and believes that most trading activity in the Common Stock
resulted from these referrals. During 2001, a total of 28,698 shares traded,
with a high price of $32.00 and a low price of $25.00. The weighted average
price was $27.27. The Company expects to continue maintaining a list of
potential buyers and sellers.
HOLDERS. The number of stockholders at December 31, 2001 was 547 and the total
outstanding shares were 756,805.
DIVIDENDS. The Company has paid annual cash dividends since 1994. During fiscal
year 2001 and 2000, the Company paid cash dividends of $0.40 and $0.30,
respectively. On January 22, 2002, the Board of Directors declared a $0.50 per
share cash dividend to be distributed on April 8, 2002 to holders of record as
of March 25, 2002.
The Company's ability to pay dividends is governed by the policies and
regulations of the FRB which prohibit the payment of dividends under certain
circumstances involving the bank holding company's financial condition and
capital adequacy. The Company's ability to pay dividends is also dependent on
the receipt of dividends from the Bank.
22
Federal regulations impose certain limitations on the payment of dividends and
other capital distributions by the Bank. The Bank's ability to pay dividends is
governed by the Maryland Financial Institutions Code and the regulations of the
FRB. Under the Maryland Financial Institution Code, a Maryland bank (1) may only
pay dividends from undivided profits or, with prior regulatory approval, its
surplus in excess of 100% of required capital stock and (2) may not declare
dividends on its common stock until its surplus funds equals the amount of
required capital stock or, if the surplus fund does not equal the amount of
capital stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
EQUITY COMPENSATION PLANS. The Company has adopted a variety of compensation
plans pursuant to which equity may be awarded to participants including the
Company's 1995 Stock Option and Incentive Plan and the 1995 Stock Option Plan
for Non-Employee Directors. The Bank's Executive Incentive Compensation Plan
provides for grants of options under the 1995 Stock Option and Incentive Plan if
certain performance criteria are met.
The following table sets forth certain information with respect to the Company's
Equity Compensation Plans.
NUMBER OF SECURITIES REMAINING
AVAILABLE FOR FUTURE ISSUANCE
NUMBER OF SECURITIES TO BE ISSUED WEIGHTED-AVERAGE EXERCISE UNDER EQUITY COMPENSATION
UPON EXERCISE OF OUTSTANDING PRICE OF OUTSTANDING PLANS (EXCLUDING SECURITIES
PLAN CATEGORY OPTIONS, WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
------------- ---------------------------- ---------------------------- ------------------------
Equity compensation plans
approved by security holders 79,469 $18.08 58,839
Equity compensation plans not
approved by security holders (1) 20,210 $22.60 6,642
Total (2)
----------
(1) Consists of the 1995 Stock Option Plan for Non-Employee Directors which
provides grants of non-incentive options to directors who are not employees
of the Company or its subsidiaries. Options are granted under the plan at
an exercise price equal to their fair market value at the date of grant and
have a term of ten years. Options are generally exercisable while an
optionee serves as a director or within one year thereafter.
(2) The 1995 Stock Option and Incentive Plan and 1995 Stock Option Plan for
Non-Employee Directors each provide for a proportionate adjustment to the
number of shares reserved thereunder in the event of a stock split, stock
dividend reclassification, recapitalization or similar event.
23
ITEM 6. SELECTED FINANCIAL DATA
--------------------------------
The following table presents consolidated selected financial data for the
Company and its subsidiaries for each of the periods indicated. Dividends and
earnings per share have been adjusted to give retroactive effect to stock splits
and stock dividends accounted for as stock splits.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
OPERATIONS DATA:
Net Interest Income......................... $ 9,757 $ 8,862 $ 8,412 $ 8,125 $ 7,616
Provision for Loan Losses................... 360 360 240 240 240
Noninterest Income.......................... 1,402 1,373 1,271 1,421 931
Noninterest Expense......................... 6,995 6,332 6,276 5,467 4,877
Net Income.................................. 2,486 2,336 2,153 2,382 2,057
SHARE DATA:
Basic Net Income Per Common Share........... $ 3.24 $ 2.98 $ 2.75 $ 3.00 $ 2.53
Diluted Net Income Per Common Share......... 3.11 2.85 2.59 2.79 2.37
Cash Dividends Paid Per Common Share...... 0.40 0.30 0.20 0.125 0.10
Weighted Average Common
Shares Outstanding:
Basic............................... 766,927 784,605 782,950 793,458 811,694
Diluted............................. 798,787 821,139 832,283 853,145 867,503
FINANCIAL CONDITION DATA:
Total Assets................................ $ 261,957 $ 248,339 $ 222,897 $ 206,863 $ 191,188
Loans Receivable, Net....................... 193,450 172,090 146,710 132,646 121,867
Total Deposits.............................. 183,117 167,806 155,742 151,815 142,276
Long and Short Term Debt.................... 50,463 54,951 44,798 33,434 29,202
Total Stockholders' Equity.................. 25,586 23,430 21,115 20,975 19,086
PERFORMANCE RATIOS:
Return on Average Assets.................... 0.97% 1.00% 1.00% 1.20% 1.13%
Return on Average Equity.................... 10.09 10.65 10.23 11.87 11.53
Net Interest Margin......................... 4.02 3.98 4.11 4.21 4.21
Efficiency Ratio............................ 62.68 61.86 64.81 57.27 57.07
Dividend Payout Ratio....................... 12.44 10.13 7.29 4.10 3.62
CAPITAL RATIOS:
Average Equity to Average
Assets.................................... 9.64% 9.37% 9.79% 10.10% 9.79%
Leverage Ratio.............................. 9.64 9.61 9.86 10.28 9.68
Total Risk-Based Capital Ratio.............. 14.08 13.53 17.23 18.27 17.38
ASSET QUALITY RATIOS:
Allowance for Loan Losses to
Total Loans............................... 1.16% 1.10% 1.11% 1.14% 1.05%
Nonperforming Loans to Total Loans.......... 0.12 0.06 0.26 0.34 0.26
Allowance for Loan Losses to
Nonperforming Loans....................... 996.07 1770.55 424.94 331.18 404.32
Net Charge-offs to Average Loans............ 0.01 0.05 0.09 0.01 0.04
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------
OVERVIEW
Since its conversion to a commercial bank charter in 1997, the Bank has sought
to increase total assets as well as the percentage of assets represented by
certain targeted loan types. The Bank feels that its ability to offer fast,
flexible and local decision-making in the commercial, commercial real estate,
and consumer loan areas will continue to attract significant new loans and spur
asset growth. Since December 31, 1997, total loan assets have increased by $71
million or 58.7%, with increases concentrated in commercial real estate,
commercial, and consumer lending. The Bank's local focus and targeted marketing
is also directed towards increasing its balances of consumer and business
deposit accounts such as interest-bearing and noninterest bearing checking
accounts, money market accounts, and other transaction-oriented accounts. The
Bank believes that increases in these account types will lessen the Bank's
dependence on time deposits such as certificates of deposit to fund loan growth.
For the year 2001, the Company earned $2.5 million, an increase of $149
thousand, or 6.4%, over 2000. Earnings were positively affected by the Bank's
continued success in building its loan portfolio while controlling its
non-performing loans. The significantly lower interest rate environment
positively affected the Bank's ability to earn noninterest income in certain
areas. Noninterest expense increased by 10.5% primarily in increased expenses
for marketing, occupancy, and other expenses.
FORWARD-LOOKING STATEMENTS
When used in this discussion and elsewhere in this Annual Report on Form 10-K,
the words or phrases "will likely result," "are expected to," "will continue,"
"is anticipated," "estimate," "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Company cautions readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors, including regional
and national economic conditions, unfavorable judicial decisions, substantial
changes in levels of market interest rates, credit and other risks of lending
and investment activities and competitive and regulatory factors could affect
the Company's financial performance and could cause the Company's actual results
for future periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001, 2000
AND 1999
GENERAL. For the year ended December 31, 2001, the Company reported consolidated
net income of $2,485,535 ($3.24 basic and $3.11 fully diluted earnings per
share) compared to consolidated net income of $2,336,196 ($2.98 basic and $2.85
fully diluted earnings per share) for the year ended December 31, 2000, and
consolidated net income of $2,153,490 ($2.75 basic and $2.59 fully diluted
earnings per share) for the year ended December 31, 1999. The increase in net
income for 2001 compared to 2000 was attributable to several factors including
growth in net interest income and improved noninterest income. These positive
developments were partially offset by increases in noninterest expenses and
income tax expenses. For the year ended December 31, 2001, net interest income
was $9,756,865 compared to $8,862,072 for the year ended December 31, 2000, an
increase of $894,793 or 10.1%. The Company also increased total noninterest
income to $1,401,520 in 2001 from $1,372,928 in 2000, an increase of $28,532 or
2.1%. Noninterest expenses increased to $6,994,500 for the year ended December
31, 2001, compared to $6,331,864 an increase of $662,636 or 10.5%. Income before
income taxes increased to $3,803,885 for the year ended December 31, 2001,
compared to $3,543,196 for the year ended December 31, 2000, an increase of
$260,689 or 7.4%. Income tax expense for 2001 increased to $1,318,350 from
$1,207,000 for the year ended December 31, 2000.
25
For the year ended December 31, 2000, net interest income was $8,862,072
compared to $8,412,151 for the year ended December 31, 1999, an increase of
$449,921 or 5.4%. This increase was partially offset by an increase in the
provision for loan losses to $360,000 for the year ended December 31, 2000
compared to $240,000 for 1999, an increase of $120,000 or 50%. The Company also
increased total noninterest income to $1,372,928 in 2000 from $1,271,464 in
1999, an increase of $101,524 or 8.0%. Noninterest expenses increased to
$6,331,864 for the year ended December 31, 2000, compared to $6,276,125 an
increase of $55,739 or 0.9%. Income before income taxes increased to $3,543,196
for the year ended December 31, 2000, compared to $3,167,490 for the year ended
December 31, 1999, an increase of $375,706 or 11.9%.
NET INTEREST INCOME. The primary component of the Company's net income is its
net interest income which is the difference between income earned on assets and
interest paid on the deposits and borrowings used to fund them. Net interest
income is determined by the spread between the yields earned on the Company's
interest-earning assets and the rates paid on interest-bearing liabilities as
well as the relative amounts of such assets and liabilities. Net interest
income, divided by average interest-earning assets, represents the Company's net
interest margin.
Consolidated net interest income for the year ended December 31, 2001 was
$9,756,865 compared to $8,862,072 for the year ended December 31, 2000 and
$8,412,151 for the year ended December 31, 1999. The $894,793 increase in the
most recent year was due to an increase of $225,114 in interest income combined
with a decrease of $669,679 in interest expense for the same period. For the
year ended December 31, 2000 compared to the prior year, interest income
increased by $2,436.232 partially offset by an increase in expense of
$1,986,311. Changes in the components of net interest income due to changes in
average balances of assets and liabilities compared to changes in net interest
income caused by changes in interest rates are presented in the rate volume
analysis below.
During 2001, the Company's interest rate spread increased slightly because; the
Bank was able to decrease the amount and relative share of its assets devoted to
investments and move these assets into higher yielding loans. The Bank was also
able to continue its shift from lower yielding loan types to higher yielding
loans types. The Bank was able to cut costs on borrowing and deposit costs
commensurate with decreases in loan rates, and the Bank was able to increase the
share of its funding provided by deposits as opposed to borrowings.
The following table presents information on the average balances of the
Company's interest-earning assets and interest-bearing liabilities and interest
earned or paid thereon for the past three fiscal years. Average balances are
computed on the basis of month-end balances.
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
2001 2000 1999
------------------------------ ------------------------- ----------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------- ------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loan portfolio (1)............. $184,370 $15,223 8.26% $159,989 $13,950 8.72% $138,140 $ 11,563 8.37%
Cash and investment securities. 58,276 3,291 5.65 62,673 4,340 6.92 66,379 4,290 6.46
-------- ------- -------- ------- -------- --------
Total interest-earning
assets.................... 242,646 18,514 7.63 222,662 18,290 8.21 204,519 15,853 7.75
-------- ------- ----- -------- ------- ------ -------- -------- -----
Interest-bearing liabilities:
Savings deposits and escrow.... $175,919 $ 5,935 3.37% $160,324 $ 6,315 3.94% $154,699 $ 5,529 3.59%
FHLB advances and other
borrowings................... 52,387 2,822 5.39 49,664 3,113 6.26 35,859 1,912 5.33
------- ------- -------- ------- -------- --------
Total interest-bearing
liabilities............... $228,306 8,757 3.84 $209,988 9,428 4.49 $190,558 7,441 3.92
======== ------- ----- ======== ------- ======== -------- -----
Net interest income.............. $ 9,757 $ 8,862 $ 8,412
======= ======= ========
Interest rate spread............. 3.79% 3.72% 3.83%
===== ===== =====
Net yield on interest-earning
assets......................... 4.02% 3.98% 4.11%
===== ===== =====
Ratio of average interest-
earning assets to average
interest-bearing liabilities... 106.3% 106.0% 107.3%
===== ===== =====
----------
(1) Average balance includes non-accrual loans.
26
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (1) changes in volume (changes in volume
multiplied by old rate); and (2) changes in rate (changes in rate multiplied by
old volume). Changes in rate-volume (changes in rate multiplied by the change in
volume) have been allocated to changes due to volume.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2001 VS. 2000 2000 VS. 1999
-------------------------- ----------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
-------------------------- ----------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -------
(IN THOUSANDS)
Interest income:
Loan portfolio........................... $ 2,126 $ (853) $ 1,273 $ 1,905 $ 482 $ 2,387
Interest-earning cash and
investment portfolio................... (304) (744) (1,048) (257) 306 49
-------- -------- -------- -------- ------- --------
Total interest-earning assets............... $ 1,822 $(1,597) $ 225 $ 1,648 $ 788 $ 2,436
======= ======= ======= ======= ======= ========
Interest expense:
Savings deposits and escrow.............. $ 614 $ (993) $ (379) $ 222 $ 564 $ 786
FHLB advances and other
borrowings............................. 170 (460) (290) 864 336 1,200
------- -------- -------- ------- ------- --------
Total interest-bearing liabilities.......... $ 784 $(1,453) $ (669) $ 1,086 $ 900 $ 1,986
======= ======== ======== ======= ======= ========
PROVISION FOR LOAN LOSSES. Provision for loan losses for the year ended December
31, 2001 was $360,000 compared to $360,000 and $240,000 for December 31, 2000
and 1999. The higher provision for loan losses in 2001 and 2000 is reflective of
the increases in the size of the Bank's loan portfolio as well as increased
emphasis on certain loan types which have inherently higher credit risks than
residential first mortgage lending. At December 31, 2001 the allowance for loan
loss equaled 996% of non-accrual and past due loans compared to 1,771% and 425%
at December 31, 2000 and 1999, respectively. During the year ended December 31,
2001, the Company recorded net charge-offs of $8 thousand (0.004% of average
loans) compared to $83 thousand (0.05% of average loans) and $127 thousand
(0.09% of average loans) in net charge-offs during the years ended December 31,
2000 and 1999.
NONINTEREST INCOME. Noninterest income increased to $1,401,520 for the year
ended December 31, 2001 compared to $1,372,988, for the prior year, an increase
of 2.1%. Noninterest income for the year ended December 31, 2000 represented an
increase of 8.0% from the December 31, 1999 total of $1,271,464. Changes in
noninterest income over the past three years have been the result of wide
fluctuations in certain noninterest income categories, (gain on sale of loans,
gain on sale of investments, loan fees) and an increase in service charges from
1999 to 2000. Gain on sale of investments increased to $184,704 in 2000 from a
loss of $605 in 1999. In 2001, the Company had no investment sales or income
from sales. Gain on sale of loans held for sale has been highly variable
reflecting the overall interest rate environment. As rates decrease, the Bank's
volume of mortgage lending which is fixed rate increases, which in turn provides
a higher volume of loan sales and gains. Mortgage interest rates moved higher in
2000 from 1999 levels which caused a decreased gain on sales of mortgage loans
to $85,716 in 2000, down from $238,215 in 1999. In 2001, interest rates
decreased from 2000 levels and income from gain on sale of mortgage loans
increased to $187,304. In percentage terms gain on sale of loans held for sale
fell 64% from 1999 to 2000 and increased by 119% from 2000 to 2001. Loan
appraisal, credit and miscellaneous charges followed a similar pattern, these
charges decreased from $182,494 in 1999 to $76,326 in 2000, a decrease of 58.2%.
From 2000 to 2001, these charges increased to $226,641 an increase of 196.9%.
Service charges and fees are primarily generated by the Bank's ability to
attract and retain transaction-based deposit accounts. Service charges and fees
declined slightly to $953,496 for the year ended December 31, 2001 as compared
to $996,884 and $811,991 in the two prior years. The decrease for the year ended
December 31, 2001 from the prior year was $43,388, or 4.4% while the increase
for the year ended December 31, 1999 from the prior year was $184,893, or 22.8%.
The Company hopes to increase its service charge and fee revenues in the future
by increasing the level of transaction-based accounts. Finally, other
27
noninterest income declined slightly from 1999 to 2000 and increased from 2000
to 2001. For the year ended December 31, 2001, other noninterest income was
$34,079, an increase from the prior year total of $29,358.
NONINTEREST EXPENSES. Noninterest expenses for the year ended December 31, 2001
totaled $6,994,500, an increase of $662,636 or 10.5% from the prior year. Salary
and employee benefits increased by 4.9% to $3,821,330 for the year ended
December 31, 2001 compared to $3,643,865 for the prior year. The small increase
reflects a stabilization in the size of the Company's workforce, an effort by
management to control certain discretionary employee costs such as the cost of
the Company's Employee Stock Ownership Plan ("ESOP") program and other measures.
Occupancy expense increased to $689,575 compared to $615,809 and $540,667 in the
two prior years. This increase was due to certain needed repairs and maintenance
at several of the Company's locations as well as the opening of the Charlotte
Hall branch. ATM and deposit expenses decreased to $254,176 for the year 2001
from $340,534 and $287,178 for the prior two years. Data processing expense
increased to $291,399 from the prior year total of $255,792, an increase of
13.9%. As discussed previously, the Bank intends to convert its core processing
system in 2002 from its current provider. The Bank anticipates that this
conversion will increase certain related costs including data processing and
other costs above 2001 levels. The decrease in ATM and deposit expenses is
reflective of certain operating changes made to decrease costs. The increase in
data processing expense is reflective of the Company's additional transaction
based deposit accounts and an increase in overall deposit volume. Advertising
decreased from 2000 levels to $301,975 for the year ended December 31, 2001
compared to $246,619 and $280,044 in the two prior years. The Company
anticipates that noninterest expense will increase during 2002 due to the
opening of a new branch in the fourth quarter of 2001.
INCOME TAX EXPENSE. During the year ended December 31, 2001, the Company
recorded income tax expense of $1,318,350 compared to expenses of $1,207,000 and
$1,014,000 in the two prior years. The Company's effective tax rates for the
years ended December 31, 2001, 2000, and 1999 were 34.7%, 34.1% and 32.0%,
respectively. The increase in the tax rate during 2001 was primarily
attributable to an increase in the state income tax burden. In 2000 and 1999,
taxes were substantially reduced because income earned on investment securities
held by the Bank's passive investment corporation subsidiary, Tri-County
Investment Corporation ("TCIC"), was not subject to state income tax. In the
current year, reductions in the assets invested in TCIC as well as the interest
rate earned on these investments have reduced the amount of income sheltered
from state income tax, increasing the effective tax rate.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2001 AND 2000
The Company's total assets increased $13,617,834, or 5.5%, to $261,957,290 as of
December 31, 2001 from $248,339,456 at December 31, 2000. The increase in assets
was primarily due to an increase in the loan portfolio which grew to
$193,450,011 at December 31, 2001 from $172,090,088 at December 31, 2000. The
increase in the loan portfolio were concentrated in the loan types targeted by
management in its long-term business plan to increase the financial performance
of the Company. The Company experienced its greatest loan growth in the
commercial mortgage loan portfolio which grew $23,390,780 or 55.4% during 2001
to $65,616,917. Commercial mortgages constituted 33.4% of total loans at
December 31, 2001. The Company also registered strong growth in its commercial
loan portfolios which grew 23%. Although residential first mortgage lending
continues to be a major portion of the Company's loan portfolio, it has declined
as a percentage of the loan portfolio from 38.9% at December 31, 2000 to 31.3%
at December 31, 2001, while decreasing in dollar terms for the same period to
$61,429,647 from $67,975,177 at December 31, 2000.
Investments and interest-bearing deposits totaled $54,676,804 at December 31,
2001 compared to $67,586,227 for December 31, 2000. The decrease of $12,909,423,
or 19.1%, is the result of principal paydowns on the portfolio, which increased
over the prior year due to the lower interest rate environment. The principal
paydowns were partially offset by increased market values of securities and
earnings on the portfolio. Management expects that the investment portfolio will
continue to be a smaller portion of the Bank's asset composition as the Company
will use principal paydowns and calls to increase the size of its loan
portfolio.
Premises and equipment increased $937,417 primarily due to upgrades of computer
equipment and offices, the opening of an additional branch, and the relocation
of one branch from leased premises to a Bank-owned facility. Other assets
increased $863 thousand primarily due to an increase in certain prepaid tax
accounts. Foreclosed real
28
estate increased primarily as the result of the single large development loan
discussed previously being acquired by deed in lieu of foreclosure.
Deposits increased to $183,116,534 at December 31, 2001 compared to $167,805,999
for the prior year. The total increase of 9.1% was concentrated in certain
transaction-based account types. Noninterest-bearing demand deposits increased
to $17,738,065 at December 31, 2001 from the prior year's total of $12,537,649,
an increase of $5,200,416, or 41.5%. Interest-bearing demand deposits increased
to $20,842,088 at year end compared with $20,551,420, an increase of $290,668,
or 1.4%. Money market deposits increased to $53,807,885 at December 31, 2001
from $44,965,316 at December 31, 2000 for the prior year end, an increase of
$8,842,569, or 19.7%. Savings deposits increased by $1,815,057 or 9.8% to
$20,367,634 from $18,552,577. These increases in deposit balances were offset by
declines in certificates of deposit to $70,360,762 from $71,199,037 a decrease
of $838,275, or 1.2%.
The Company used the increases in deposits coupled with shifting assets from the
investment portfolio to fund growth in the loan portfolio. The Company also
decreased overall borrowings and shifted most short term borrowings into longer
term debt to attempt to lock in lower interest rates during 2001. Short term
borrowings declined to $1,813,317 from $13,550,903, a decline of $11,737,586 or
86.6%. Long-term debt increased to $48,650,000 from $41,400,000, a decline of
$7,250,000 or 17.5%.
The Company experienced a $2,156,636, or 9.2%, increase in stockholders' equity
for the year ended December 31, 2001. The increase in stockholders' equity was
attributable to the retention of earnings from the period less cash dividends
combined with comprehensive income of $670,442, option exercises and smaller
amounts of ESOP activity. These increases in equity were partially offset by
repurchases of common stock totaling $673,920.
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Company's net income, arises
from the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities and the relative amounts of such assets and
liabilities. The Company manages its assets and liabilities by coordinating the
levels of and gap between interest-rate sensitive assets and liabilities to
control changes in net interest income and in the economic value of its equity
despite changes in market interest rates.
Among other tools used to monitor interest rate risk is a "gap" report which
measures the dollar difference between the amount of interest-earning assets and
interest-bearing liabilities subject to repricing within a given time period.
Generally, during a period of rising interest rates, a negative gap position
would adversely affect net interest income, while a positive gap would result in
an increase in net interest income, while, conversely, during a period of
falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
The following sets forth the Bank's interest rate sensitivity at December 31,
2001:
29
OVER 1
OVER 3 TO THROUGH 5 OVER 5
0-3 MONTHS 12 MONTHS YEARS YEARS
---------- --------- ----- -----
(AMOUNTS IN THOUSANDS)
Assets:
Cash and due from banks................... $ 693 $ -- $ -- $ --
Interest-bearing deposits................. 7,678 -- -- --
Securities................................ 8,137 7,804 15,617 12,405
Loans held for sale....................... 2,354 -- -- --
Loans..................................... 43,715 19,887 58,120 74,767
----------- ----------- ---------- -----------
Total Assets.............................. $ 62,577 $ 27,691 $ 73,737 $ 87,172
=========== =========== ========== ===========
Liabilities:
Noninterest bearing deposits.............. $ 17,738 $ -- $ -- $ --
Interest-bearing demand deposits.......... 20,842 -- -- --
Money Market Deposits..................... 53,808 -- -- --
Savings................................... 20,368 -- -- --
Certificates of Deposit................... 18,573 24,285 27,503 --
Short-term debt........................... 1,813 -- -- --
Long-term debt............................ -- 6,400 17,250 25,000
----------- ----------- ---------- -----------
Total Liabilities......................... $ 133,142 $ 30,685 $ 44,753 $ 25,000
=========== =========== ========== ===========
Gap....................................... $ (70,565) $ (2,993) $ 28,984 $ 62,172
Cumulative Gap............................ $ (70,565) $ (73,558) $ (44,574) $ 17,598
Cumulative Gap as % of total assets....... (26.94)% (28.08)% (17.02)% 6.72%
The foregoing analysis assumes that the Bank's assets and liabilities move with
rates at their earliest repricing opportunities based on final maturity.
Mortgage-backed securities are assumed to mature during the period in which they
are estimated to prepay and it is assumed that loans and other securities are
not called prior to maturity. Certificates of deposit and IRA accounts are
presumed to reprice at maturity. NOW and savings accounts are assumed to reprice
within three months although it is the Company's experience that such accounts
may be less sensitive to changes in market rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank and does not
currently have any material funding commitments. The Company's principal sources
of liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of dividends.
The Bank's principal sources of funds for investments and operations are net
income, deposits from its primary market area, principal and interest payments
on loans, interest received on investment securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered the primary source of funds supporting the Bank's lending and
investment activities. The Bank also uses borrowings from the FHLB of Atlanta to
supplement deposits. The amount of FHLB advances available to the Bank is
limited to the lower of 35% of Bank assets or the amount supportable by eligible
collateral including FHLB stock, current residential first mortgage loans, and
certain securities.
The Bank's most liquid assets are cash, cash equivalents, and interest-bearing
deposits which are comprised of cash on hand, amounts due from financial
institutions, and interest-bearing deposits. The levels of such assets are
30
dependent on the Bank's operating financing and investment activities at any
given time. The variations in levels of cash and cash equivalents are influenced
by deposit flows and anticipated future deposit flows.
Cash, cash equivalents, and interest-bearing deposits as of December 31, 2001,
totaled $8,371,597, an increase of $1,750,466 (26.44%) from the December 31,
2000 total of $6,621,131. This increase was primarily in interest-bearing
deposits at other financial institutions which totaled $7,678,158 at December
31, 2001 compared to $5,975,314 at the end of 2000. Cash on hand increased to
$693,439 from $645,817 at December 31, 2000.
The Company's principal sources of cash flows are its financing activities
including deposits and borrowings and issuances of shares on the exercise of
stock options or allocations of shares to participant accounts in the ESOP.
During the year 2001, financing activities provided $9.8 million in cash
compared to $21.6 million during 2000 and $14.6 million during 1999. The
decrease in cash flows from financing activities during the most recent period
was principally due to a decrease in long and short-term borrowing activities.
During 2001, net activity in short -term borrowing was a decline of $11.7
million as compared to an increase of $152 thousand in 2000. Net activity in
long term borrowings, proceeds from borrowings minus principal payments provided
a net of $7.3 million in 2001 compared to $10 million in 2000. These declines in
cash flow from borrowing activities was partially offset by an increase in
deposit funding growth. In the year ended 2000, net deposit growth was $12.0
million, while in 2001 net deposit growth was $15.3 million. The Company also
receives cash from its operating activities which provided $5.0 million in cash
during 2001, compared to cash flows of $4.1 million and $4.4 million during 2000
and 1999, respectively. The increase in operating cash flows during 2001 was
primarily due to higher sales of loans originated for resale.
The Company's principal use of cash has been in investing activities including
its investments in loans for portfolio, investment securities and other assets.
During the year ended December 31, 2001, the Company used a total of $14.8
million in its investing activities compared to $28.5 million in 2000 and $16.5
million in 1999. The principal reason for the decline in cash used in investing
activities was an increase in the excess of the proceeds of sales, redemptions,
and principal reductions of investments over new purchases.
Federal banking regulations require the Company and the Bank to maintain
specified levels of capital. At December 31, 2001 the Company was in compliance
with these requirements with a leverage ratio of 9.8%, a Tier 1 risk-based
capital ratio of 12.8% and total risk-based capital ratio of 14.1%. At December
31, 2001, the Bank met the criteria for designation as a well-capitalized
depository institution under FRB regulations.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in the relative purchasing
power of money over time due to inflation. Unlike most industrial companies,
nearly all of the Company's assets and liabilities are monetary in mature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the prices of goods and
services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------
Not applicable since the registrant is a small business issuer.
31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
----------------------------------------------------
The Company's financial statements and supplementary data appear in this Annual
Report beginning on the page immediately following Item 14 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
--------------------------------------------------------------------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------
The information contained under the section captioned "Proposal I -- Election of
Directors" in the Company's definitive proxy statement for the Company's 2002
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.
The executive officers of the Company are as follows:
MICHAEL L. MIDDLETON (54 years old) is President and Chief Executive Officer of
the Company and the Bank. He joined the Bank in 1973 and served in various
management positions until 1979 when he became president of the Bank. Mr.
Middleton is a Certified Public Accountant and holds a Masters of Business
Administration. As President and Chief Executive Officer of the Bank, Mr.
Middleton is responsible for the overall operation of the Bank pursuant to the
policies and procedures established by the Board of Directors. Since December
1995, Mr. Middleton has served on the Board of Directors of the Federal Home
Loan Bank of Atlanta and also serves as its Board Representative to the Council
of Federal Home Loan Banks.
C. MARIE BROWN (59 years old) has been employed with the Bank for over 27 years
and has served as Chief Operating Officer since 1999. Prior to her appointment
as Chief Operating Officer, Ms. Brown served as Senior Vice President of the
Bank. She is a supporter of the Handicapped and Retarded Citizens of Charles
County, of Zonta and serves on various administrative committees of the
Hughesville Baptist Church and the board of the Charles County Chapter of the
American Red Cross.
H. BEAMAN SMITH (56 years old) was the Treasurer of the Company in 1998 and
became Secretary-Treasurer in January 1999 and has been the president of
Accoware, a computer software company, since 1989. Prior to that time, Mr. Smith
was a majority owner of the Smith's Family Honey Company in Bryans Road,
Maryland. Mr. Smith is a Vice President of Fry Plumbing Company of Washington,
D.C., a Trustee of the Ferguson Foundation, a member of the Bryans Road Sports
Council and the Treasurer of the Mayaone Association.
GREGORY C. COCKERHAM (47 years old) joined the Bank in November 1988 and has
served as Senior Vice President of Lending since 1996. Prior to his appointment
as Senior Vice President, Mr. Cockerham served as Vice President of the Bank.
Mr. Cockerham has been in banking for 22 years. He is a Paul Harris Fellow with
the Rotary Club of Charles County and serves on various civic boards in the
County.
WILLIAM J. PASENELLI (43 years old) joined the Bank as Chief Financial Officer
in April 2000. Prior to joining the Bank, Mr. Pasenelli had been Chief Financial
Officer of Acacia Federal Savings Bank, Annandale, Virginia, with which he had
been employed since 1987. Mr. Pasenelli is a member of the American Institute of
Certified Public Accountants, the DC Institute of Certified Public Accountants,
and other civic groups.
32
ITEM 11. EXECUTIVE COMPENSATION
--------------------------------
The information contained under the section captioned "Proposal I -- Election of
Directors -- Executive Compensation" in the Proxy Statement is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------
(a) SECURITY OWNERSHIP OF CERTAIN OWNERS
The information required by this item is incorporated herein by reference to the
sections captioned "Proposal I -- Election of Directors" and "Voting Securities
and Principal Holders Thereof" of the Proxy Statement.
(b) SECURITY OWNERSHIP OF MANAGEMENT
Information required by this item is incorporated herein by reference to the
section captioned "Proposal I -- Election of Directors" of the Proxy Statement.
(c) CHANGES IN CONTROL
Management of the Company knows of no arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a subsequent
date result in a change in control of the registrant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------
The information required by this item is incorporated herein by reference to the
section captioned "Proposal I -- Election of Directors" and "Transactions with
the Company and the Bank" of the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
--------------------------------------------------------------------------
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following is a list of the consolidated
financial statements which are being filed as part of this Annual Report on Form
10-K.
Page
----
Independent Auditors' Report F-1
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-2
Consolidated Statements of Income for the Years Ended
December 31, 2001, 2000 and 1999 F-3
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Cash Flows for the Years
Ended December 31, 2001, 2000 and 1999 F-5
Notes to Consolidated Financial Statements F-7
(2) Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
33
(3) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.
3.1 Articles of Incorporation of Tri-County Financial
Corporation*
3.2 Bylaws of Tri-County Financial Corporation
10.1 + Tri-County Financial Corporation 1995 Stock Option and
Incentive Plan, as amended **
10.2 + Tri-County Financial Corporation 1995 Stock Option Plan
for Non-Employee Directors, as amended ***
10.3 + Employment Agreements with Michael L. Middleton, as
amended, C. Marie Brown, as amended, and Gregory C.
Cockerham ****
10.4 + Guaranty Agreements with Michael L. Middleton, C.
Marie Brown and Gregory C. Cockerham **
10.5 + Executive Incentive Compensation Plan **
10.6 + Employment Agreement with William J. Pasenelli **
10.7 + Retirement Plan for Directors **
10.8 + Split Dollar Agreements with Michael L. Middleton and
C. Marie Brown **
10.9 + Guaranty Agreement with William J. Pasenelli
10.10+ Split Dollar Agreement with William J. Pasenelli
21 Subsidiaries of the Registrant
23 Consent of Stegman & Company
_____________
+ Management contract or compensatory plan required to be filed as an
exhibit pursuant to Item 14(c).
* Incorporated by reference to the Registrant's Registration Statement
on Form S-4 (No. 33-31287).
** Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 2000.
*** Incorporated by reference to the Registrant's Registration Statement
on Form S-8 (File No. 333-70800).
**** Incorporated by reference to Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998
(b) REPORTS ON FORM 8-K. No reports on Form 8-K have been filed during the
-------------------
last quarter of the fiscal year covered by this report.
(c) EXHIBITS. The exhibits required by Item 601 of Regulation S-K are
--------
either filed as part of this Annual Report on Form 10-K or
incorporated by reference herein.
(d) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. There
---------------------------------------------------------------
are no other financial statements and financial statement schedules
which were excluded from the Annual Report pursuant to Rule
14a-3(b)(1) which are required to be included herein.
34
[LETTERHEAD OF STEGMAN & COMPANY]
Stockholders and Board of Directors
Tri-County Financial Corporation
We have audited the accompanying consolidated balance sheets of Tri-County
Financial Corporation as of December 31, 2001 and 2000, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Tri-County Financial Corporation as of December 31, 2001 and 2000, and the
results of its operations and cash flows for each of the three years in the
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Stegman & Company
Baltimore, Maryland
March 6, 2002
F-1
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
ASSETS
2001 2000
------ ------
Cash and due from banks $ 693,439 $ 645,817
Interest-bearing deposits with banks 7,678,158 5,975,314
Investment securities available for sale - at fair value 41,673,742 56,860,996
Investment securities held to maturity - at amortized cost 2,289,354 1,714,367
Stock in Federal Home Loan Bank and Federal Reserve Bank -
at cost 3,035,550 3,035,550
Loans held for sale 2,354,315 355,000
Loans receivable - net of allowance for loan losses
of $2,281,581 and $1,929,531, respectively 193,450,011 172,090,088
Premises and equipment, net 5,432,848 4,495,431
Foreclosed real estate 1,800,569 176,626
Accrued interest receivable 1,049,401 1,353,658
Other assets 2,499,903 1,636,609
------------- -------------
TOTAL ASSETS $ 261,957,290 $ 248,339,456
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 17,738,165 $ 12,537,649
Interest-bearing deposits 165,378,369 155,268,350
------------- -------------
Total deposits 183,116,534 167,805,999
Short-term borrowings 1,813,317 13,550,903
Long-term debt 48,650,000 41,400,000
Accrued expenses and other liabilities 2,790,981 2,152,732
------------- -------------
Total liabilities 236,370,832 224,909,634
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 756,805 and 777,680 shares, respectively 7,568 7,777
Surplus 7,545,590 7,500,865
Retained earnings 17,678,367 16,175,708
Accumulated other comprehensive income 555,513 (114,929)
Unearned ESOP shares (200,580) (139,599)
------------- -------------
Total stockholders' equity 25,586,458 23,429,822
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 261,957,290 $ 248,339,456
============= =============
See notes to consolidated financial statements
F-2
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2001 2000 1999
---- ---- ----
INTEREST INCOME:
Interest and fees on loans $15,223,463 $13,950,200 $11,562,846
Taxable interest and dividends on investment securites 3,215,164 4,237,326 4,197,132
Interest on bank deposits 76,049 102,036 93,352
----------- ----------- -----------
Total interest income 18,514,676 18,289,562 15,853,330
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 5,935,478 6,314,871 5,528,672
Interest on short term borrowings 259,558 1,418,146 1,410,863
Interest on long term debt 2,562,775 1,694,473 501,644
----------- ----------- -----------
Total interest expenses 8,757,811 9,427,490 7,441,179
----------- ----------- -----------
NET INTEREST INCOME 9,756,865 8,862,072 8,412,151
PROVISION FOR LOAN LOSSES 360,000 360,000 240,000
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,396,865 8,502,072 8,172,151
----------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 226,641 76,326 182,494
Net gain on sale of loans held for sale 187,304 85,716 238,215
Net gain (loss) on sales of investment securities - 184,704 (605)
Service charges 953,496 996,884 811,991
Other 34,079 29,358 39,369
----------- ----------- -----------
Total noninterest income 1,401,520 1,372,988 1,271,464
----------- ----------- -----------
NONINTEREST EXPENSE:
Salary and employee benefits 3,821,330 3,643,865 3,600,119
Occupancy expense 689,575 615,809 540,667
ATM and deposit expenses 254,176 340,532 287,178
Advertising 301,975 246,619 280,044
Data processing expense 291,399 255,792 215,227
Depreciation of furniture, fixtures, and equipment 263,535 241,714 231,240
Other expenses 1,372,510 987,533 1,121,650
----------- ----------- -----------
Total noninterest expenses 6,994,500 6,331,864 6,276,125
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,803,885 3,543,196 3,167,490
Income tax expense 1,318,350 1,207,000 1,014,000
----------- ----------- -----------
NET INCOME $ 2,485,535 $ 2,336,196 $ 2,153,490
=========== =========== ===========
INCOME PER COMMON SHARE
Basic $3.24 $2.98 $2.75
Diluted 3.11 2.85 2.59
See notes to consolidated financial statements
F-3
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
Accumu-
lated
Other
Compre-
hensive Unearned
Common Paid-in Retained Income ESOP
Stock Capital Earnings (Loss) Shares Total
----- ------- -------- -------- --------- -----
BALANCES, JANUARY 1, 1999 $ 7,893 $7,309,901 $13,215,770 $ 648,614 $(206,883) $20,975,295
Comprehensive income:
Net Income - - 2,153,490 - - 2,153,490
Unrealized gains on investment
securities net of tax of $770,187 (1,367,112) (1,367,112)
-----------
Total comprehensive income 786,378
Cash dividend $0.20 per share - - (157,034) - - (157,034)
Excess of fair market value over cost
of leveraged ESOP shares released - 11,401 - - - 11,401
Exercise of stock options 222 125,938 - - - 126,160
Repurchase of common stock (248) - (656,902) - - (657,150)
Net change in unearned ESOP shares 15 - - - 30,318 30,333
------- ---------- ----------- ---------- --------- -----------
BALANCES, DECEMBER 31, 1999 $ 7,882 $7,447,240 $14,555,324 $ (718,498) $(176,565) $21,115,383
Comprehensive income:
Net Income - - 2,336,196 - - 2,336,196
Unrealized gains on investment
securities net of tax of $310,083 - - - 603,569 - 603,569
-----------
Total comprehensive income 2,939,765
Cash dividend $0.30 per share - - (236,595) - - (236,595)
Excess of fair market value over cost
of leveraged ESOP shares released - 12,964 - - - 12,964
Exercise of stock options 50 40,661 - - - 40,711
Repurchase of common stock (173) - (479,217) - - (479,390)
Net change in unearned ESOP shares 18 - - - 36,966 36,984
------- ---------- ----------- ---------- --------- -----------
BALANCES, DECEMBER 31, 2000 $ 7,777 $7,500,865 $16,175,708 $ (114,929) $(139,599) $23,429,822
Comprehensive income:
Net Income - - 2,485,535 - - 2,485,535
Unrealized gains on investment
securities net of tax of $343,599 - - - 670,442 - 670,442
-----------
Total comprehensive income 3,155,977
Cash dividend $0.40 per share - - (309,204) - - (309,204)
Excess of fair market value over cost
of leveraged ESOP shares released - 12,964 - - - 12,964
Exercise of stock options 56 31,761 - - - 31,817
Repurchase of common stock (248) - (673,672) (673,920)
Net change in unearned ESOP shares (17) - - - (60,981) (60,998)
------- ---------- ----------- ---------- --------- -----------
BALANCES, DECEMBER 31, 2001 $ 7,568 $7,545,590 $17,678,368 $ 555,513 $(200,580) $25,586,458
======= ========== =========== ========== ========= ===========
F-4
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECMBER 31, 2001, 2000, AND 1999
2001 2000 1999
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,485,535 $ 2,336,196 $ 2,153,490
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 360,000 360,000 240,000
Depreciation and amortization 396,400 348,110 336,383
Net amortization of premium/discount on
mortgage backed securities and investments 66,146 (86,909) (236,443)
Deferred income tax benefit (205,000) (118,000) (68,000)
Decrease (increase) in accrued interest receivable 304,257 (207,138) 183,585
Decrease in deferred loan fees (18,131) (31,732) (122,180)
Increase in accrued expenses and other liabilities 638,249 911,013 690,273
Decrease (increase) in other assets (1,006,157) 323,234 (276,747)
Loss (gain) on disposal of premises and equipment (8,386) - 3,256
(Gain) loss on sale of investment securities - (184,704) 605
Origination of loans held for sale (9,752,097) (1,966,774) (9,268,298)
Proceeds from sale of loans held for sale 11,938,716 2,470,589 11,000,111
Gain on sales of loans held for sale (187,304) (85,716) (238,215)
----------- ---------- -----------
Net cash provided by operating activities 5,012,228 4,068,169 4,397,820
----------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase (decrease) in interest-bearing deposits with banks (1,702,844) (2,912,035) 1,089,537
Purchase of investment securities available for sale (29,410,447) (18,235,337) (74,254,708)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 45,549,859 19,212,629 71,673,801
Purchase of investment securities held to maturity (1,345,703) (893,649) (1,697,520)
Proceeds from maturities or principal payments
of investment securities held to maturity 770,717 1,128,333 1,890,569
Net purchase of FHLB and Federal Reserve stock - (747,850) (282,350)
Loans originated or acquired (96,149,353) (70,415,720) (62,475,059)
Principal collected on loans 70,448,931 44,707,731 48,239,092
Purchase of premises and equipment (1,334,396) (327,155) (551,968)
Proceeds from disposal of premises and equipment 8,963 - 12,150
Acquisition of foreclosed real estate (1,623,943) - (122,910)
----------- ---------- -----------
Net cash used in investing activities (14,788,216) (28,483,053) (16,479,366)
----------- ---------- -----------
F-5
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECMBER 31, 2001, 2000, AND 1999
2001 2000 1999
---- ---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 15,310,535 $ 12,064,199 $ 3,926,436
Net (decrease) increase in short-term borrowings (11,737,586) 152,525 (3,539,504)
Dividends paid (309,204) (236,595) (157,034)
Exercise of stock options 31,817 40,711 126,160
Net change in unearned ESOP shares (48,033) 49,948 41,734
Repurchase of common stock (673,920) (479,391) (657,150)
Proceeds from long-term borrowings 12,250,000 30,000,000 35,000,000
Payments of long-term borrowings (5,000,000) (20,000,000) (20,096,450)
------------ ------------ ------------
Net cash provided by financing activities 9,823,609 21,591,397 14,644,192
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 47,622 (2,823,487) 2,562,646
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 645,817 3,469,304 906,658
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 693,439 $ 645,817 $ 3,469,304
============ ============ ============
Supplementary cash flow information:
Cash paid during the year for:
Interest $ 9,015,483 $ 8,737,746 $ 7,368,462
Income taxes 1,431,000 925,000 1,288,882
Noncash transfer from loans to foreclosed real estate 1,276,070 - 53,716
See notes to consolidated financial statements.
F-6
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
---------------------------------------
The consolidated financial statements include the accounts of
Tri-County Financial Corporation and its wholly owned subsidiary, Community Bank
of Tri-County (the "Bank") and the Bank's wholly owned subsidiaries, Tri-County
Investment Corporation and Community Mortgage Corporation of Tri-County
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation. The accounting and reporting
policies of the Company conform with accounting principles generally accepted in
the United States of America and to general practices within the banking
industry. Certain reclassifications have been made to amounts previously
reported to conform with classifications made in 2001.
Use of Estimates
----------------
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, and the valuation of foreclosed
real estate and deferred tax assets.
Nature of Operations
--------------------
The Company, through its bank subsidiary, conducts full service
commercial banking operations throughout the Southern Maryland area. Its primary
financial deposit products are savings, transaction, and term certificate
accounts. Its primary lending products are mortgage loans on residential,
construction and commercial real estate and various types of consumer and
commercial lending.
Significant Group Concentrations of Credit
------------------------------------------
Most of the Company's activities take place in the Southern
Maryland area comprising St. Mary's, Charles, and Calvert counties. Note 2
discusses the types of securities the Company invests in. Note 3 discusses the
type of lending that the Company engages in. The Company does not have any
significant concentration to any one customer or industry.
F-7
Cash and Cash Equivalents
-------------------------
For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid debt instruments with original maturities
when purchased of three months or less to be cash equivalents. These instruments
are presented as cash and due from banks.
Investment Securities
---------------------
Investment securities that are held principally for resale in the
near term are classified as trading assets and are recorded at fair value with
changes in fair value recorded in earnings. The Company had no trading assets
during the periods presented. Debt securities that management has the positive
intent and ability to hold to maturity are classified as "held- to-maturity" and
recorded at amortized cost. Securities not classified as held to maturity or
trading, including equity securities with readily determinable fair values are
classified as "available-for-sale" and recorded at fair value, with unrealized
gains and losses excluded from earnings and reported net of deferred taxes in
other comprehensive income, a separate component of stockholders' equity.
Purchase premiums and discounts are recognized in interest income
using the interest method over the terms of the securities. Declines in the fair
value of held-to-maturity and available-for-sale securities below their cost
that are deemed to be other than temporary are reflected in earnings as realized
losses. Gains and losses on the sales of securities are recorded on the trade
date and are determined using the specific identification method.
The Company invests in Federal Home Loan Bank and Federal Reserve
Bank stock which are considered restricted as to marketability.
Loans Held for Sale
-------------------
Loans originated and intended for sale in the secondary market
are carried at the lower of cost or estimated fair value, in the aggregate. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income.
Loans Receivable
----------------
The Company grants mortgage, commercial, and consumer loans to
customers. A substantial portion of the loan portfolio is represented by loans
throughout Southern Maryland. The ability of the Company's debtors to honor
their contracts is dependent upon the real estate and general economic
conditions in this area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff generally are reported at their
outstanding unpaid principal balances adjusted for charge-offs, the allowance
for loan losses, and any deferred fees or costs on originated loans. Interest
income is accrued on the unpaid principal balance. Loan origination fees, net of
certain direct origination costs, are deferred and recognized as an adjustment
of the related loan yield using the interest method.
F-8
The accrual of interest on mortgage and commercial loans is
discontinued at the time the loan is 90 days delinquent unless the credit is
well secured and in the process of collection. Consumer loans are charged-off no
later than 120 days past due. In all cases, loans are placed on nonaccrual or
charged-off at an earlier date if collection of principal or interest is
considered doubtful.
All interest accrued but not collected from loans that are placed
on nonaccrual or charged-off is reversed against interest income. The interest
on these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when all
principal and interest amounts contractually due are brought current and future
payments are reasonably assured.
Allowance for Loan Losses
-------------------------
The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan losses charged to
earnings. Loan losses are charged against the allowance when management believes
that the uncollectibility of a loan balance is confirmed. Subsequent recoveries,
if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the collectibility
of the loans in light of historical experience, the nature and volume of the
loan portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.
The allowance for loan loss consists of an allocated component
and an unallocated component. The components of allowance for loan losses
represent an estimation done pursuant to either SFAS No. 5 "Accounting for
Contingencies", or SFAS No. 114 "Accounting by Creditors for Impairment of a
Loan". The allocated component of the allowance for loan losses reflects
expected losses resulting from analysis developed through specific credit
allocations for individual loans and historical loss experience for each loan
category. The specific credit allocations are based on a regular analysis of all
loans over a fixed-dollar amount where the internal credit rating is at or below
a predetermined classification. The historical loan loss element is determined
statistically using a loss migration analysis that examines loss experience and
the related internal gradings of loans charged-off. The loss migration analysis
is performed quarterly and loss factors are updated regularly based on actual
experience. The allocated component of the allowance for loan losses also
includes management's determination of the amounts necessary for concentrations
and changes in portfolio mix and volume.
The unallocated portion of the allowance is determined based on
management's assessment of general economic conditions, as well as specific
economic factors in the individual markets in which the Company operates. This
determination inherently involves a higher risk of uncertainty and considers
current risk factors that may not have yet manifested themselves in the
Company's historical loss factors used to determine the allocated component of
the allowance and it recognizes knowledge of the portfolio may be incomplete.
F-9
A loan is considered impaired when, based on current information
and events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls are
reviewed on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower's prior payment record, and the
amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial and construction
loans by either the present value of expected future cash flows discounted at
the loan's effective interest rate, the loan's observable market price, or the
fair value of the collateral if the loan is collateral dependent. Large groups
of smaller homogeneous loans are collectively evaluated for impairment.
Accordingly, the Company does not separately identify individual consumer and
residential loans for impairment disclosures.
Mortgage Servicing Assets
-------------------------
Mortgage servicing assets are recognized as separate assets when
rights are acquired through purchase or through sale of mortgages or mortgage
servicing rights. Capitalized servicing rights are reported in other assets and
are amortized into noninterest income in proportion to, and over the period of,
the estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost. Impairment is determined by stratifying
rights by predominant characteristics, when available, such as interest rates
and terms. Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market based assumptions. Impairment is recognized through a valuation allowance
for an individual stratum, to the extent that fair value is less than the
capitalized amount for the stratum.
Premises and Equipment
----------------------
Land is carried at cost. Premises and equipment are carried at
cost, less accumulated depreciation computed by the straight-line method over
the estimated useful lives of the assets which are as follows:
Buildings and improvements 15 - 50 years
Furniture and equipment 3 - 15 years
Automobiles 5 years
Foreclosed Real Estate
----------------------
Assets acquired through, or in lieu of, loan foreclosure are held
for sale and are initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, valuations are
periodically performed by management and the assets are carried at the lower of
carrying amount or fair value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in noninterest
expense.
F-10
Income Taxes
------------
The Company files a consolidated federal income tax return with
its subsidiaries. Deferred tax assets and liabilities are determined using the
liability (or balance sheet) method. Under this method, the net deferred tax
asset or liability is determined based on the tax effects of the temporary
differences between the book and tax bases of the various balance sheet assets
and liabilities and gives current recognition to changes in tax rates and laws.
Earnings Per Share
------------------
Basic earnings per common share represents income available to
common stockholders divided by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflects additional
common shares that would have been outstanding if potential dilutive common
shares had been issued, as well as any adjustment to income that would result
from the assumed issuance. Potential common shares that may be issued by the
Company relate solely to outstanding stock options, and are determined using the
treasury stock method.
Stock-Based Compensation
------------------------
Stock based compensation is recognized using the intrinsic value
method. For disclosure purposes, pro forma net income and earnings per share
effects are provided as if the fair value method had been applied.
New Accounting Standards
------------------------
In July 2001, the Securities and Exchange Commission (the "SEC")
issued Staff Accounting Bulletin ("SAB") No. 102, Selected Loan Loss Allowance
Methodology and Documentation Issues. SAB 102 summarizes certain SEC views on
the development, documentation, and application of a systematic methodology as
required by Financial Reporting Release No. 28 for determining allowances for
loan and lease losses in accordance with accounting principles generally
accepted in the United States. In particular, the guidance focuses on the
documentation the staff normally would expect registrants to prepare and
maintain in support of their allowances for loan losses.
SAB 102 provides parallel guidance to the federal banking
agencies guidance issued through the Federal Financial Institutions Examination
Council as interagency guidance, "Policy Statement on Allowance for Loan and
Lease Losses Methodologies and Documentation for Banks and Savings
Institutions". The adoption of SAB 102 had no affect on the financial position
or results of operations of the Company.
In July 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all purchase method
business combinations completed after June 30, 2001. SFAS 141 also specifies
criteria that intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill. SFAS
142 requires that goodwill and intangible assets with indefinite useful lives no
F-11
longer be amortized, but instead be tested for impairment at least annually in
accordance with the provisions of Statement 142. Statement 142 also requires
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values and
reviewed for impairment in accordance with SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The
provisions of SFAS Nos. 141 and 142 are effective for years beginning after July
1, 2001 and January 1, 2002, respectively. The adoption of SFAS No. 141 and 142
did not affect the financial position or results of operations of the Company.
In August 2001, the Financial Accounting Standards Board issued
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
which supersedes both SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets to be Disposed Of and the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions (Opinion 30), for the disposal of a segment of
a business (as previously defined in that Opinion). SFAS No. 144 retains the
fundamental provisions in SFAS No. 121 for recognizing and measuring impairment
losses in long-lived assets held for use and long-lived assets to be disposed of
by sale, while also resolving significant implementation issues associated with
SFAS No. 121. The provisions of SFAS No. 144 are effective for years beginning
after December 15, 2001. The adoption of SFAS No. 144 is not expected to affect
the financial position or results of operations of the Company.
F-12
2. INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities with
gross unrealized losses and gains are:
December 31, 2001
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Values
---- ----- ------ ------
Securities available for sale
Mutual Funds $ 5,868,115 $ - $ - $ 5,868,115
Government Sposored Enterprises (GSE's) - - - -
Asset-backed securities issued by:
GSE's 25,603,305 564,133 82,494 26,084,944
Other 8,846,200 147,777 516 8,993,461
----------- --------- -------- -----------
Total debt securities available for sale 40,317,620 711,910 83,010 40,946,520
Corporate equity securities 509,010 218,212 - 727,222
----------- --------- -------- -----------
Total securities available for sale $40,826,630 $ 930,122 $ 83,010 $41,673,742
=========== ========= ======== ===========
Securities held-to-maturity
U.S. government obligations $ 300,000 $ - $ 500 $ 299,500
Other investments 1,989,354 - - 1,989,354
----------- --------- -------- -----------
Total securities held-to-maturity $ 2,289,354 $ - $ 500 $ 2,288,854
=========== ========= ======== ===========
December 31, 2000
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Values
---- ----- ------ ------
Securities available for sale
Mutual Funds $ 753,116 $ - $ - $ 753,116
Government Sposored Enterprises (GSE's) 8,000,000 - 88,397 7,911,603
Asset-backed securities issued by:
GSE's 30,894,088 139,721 456,854 30,576,955
Other 16,890,571 32,527 68,100 16,854,998
----------- --------- -------- -----------
Total debt securities available for sale 56,537,775 172,248 613,351 56,096,672
Corporate equity securities 509,010 255,314 - 764,324
----------- --------- -------- -----------
Total securities available for sale $57,046,785 $ 427,562 $ 613,351 $56,860,996
=========== ========= ======== ===========
Securities held-to-maturity
U.S. government obligations $ 200,000 $ - $ - $ 200,000
Other investments 1,514,367 - - 1,514,367
----------- --------- -------- -----------
Total securities held-to-maturity $ 1,714,367 $ - $ - $ 1,714,367
=========== ========= ======== ===========
At December 31, 2001 and 2000, U.S. Government obligations with a
carrying value of $300,000 and $200,000, respectively, were pledged to secure
public unit deposits and for other purposes required or permitted by law. In
addition, at December 31, 2001 and 2000, certain other securities with a
carrying value of $3,413,300 and $4,644,600 were pledged to secure certain
deposits. At December 31, 2001, securities with a carrying value of $34,738,000
were pledged as collateral for advances from the Federal Home Loan Bank of
Atlanta.
F-13
The scheduled maturities of securities at December 31, 2001 are
as follows:
Available for Sale Held to Maturity
------------------------------ ---------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ------------ ----------- ----------
Within one year $ 5,868,115 $ 5,868,115 $ 1,277,724 $ 1,277,224
Over one year through five years - - 1,011,630 1,011,630
Over five years through ten years - - - -
----------- ----------- ----------- -----------
5,868,115 5,868,115 2,289,354 2,288,854
Mortgage-backed securities 34,449,505 35,078,405 - -
----------- ----------- ----------- -----------
$40,317,620 $40,946,520 $ 2,289,354 $ 2,288,854
=========== =========== =========== ===========
Proceeds from the sales of investment securities available for
sale during 2001, 2000, and 1999 were $0, $186,900, and $200,000, respectively.
Gross gains in the years ending December 31, 2001, 2000, and 1999 were $0,
$184,704, and $0, respectively. Gross losses for the years ending December 31,
2001, 2000, and 1999 were $-0-, $0, and $605, respectively.
Asset-backed securities are comprised of mortgage-backed
securities as well as mortgage derivative securities such as collateralized
mortgage obligations and real estate mortgage investment conduits. In certain
cases, the Bank will purchase securities of a single private issuer, defined as
an issuer which is not a government or government sponsored entity, in total
amounts in excess of 10% of stockholders' equity. The Bank only does so when
satisfied that such concentrations pose no threat to the Bank's safety or
soundness. The following summarizes securities positions and the quality of
private issuers where those positions were in excess of 10% of stockholders'
equity as of December 31, 2001 and 2000:
2001 2000
----------------------- ---------------------
Carrying Moody's Carrying Moody's
Value Rating Value Rating
------------ --------- -------- ---------
Country Wide Home Loans $ 2,043,415 AAA $3,874,885 AAA
GE Capital Mortgage Services 4,570,638 AAA 5,733,391 AAA
----------- ----------
$ 6,614,053 $9,608,276
=========== ==========
F-14
3. LOANS RECEIVABLE
Loans receivable at December 31, 2001 and 2000 consist of the
following:
2001 2000
---- ----
Commercial real estate $ 65,616,917 $ 42,226,137
Residential real estate 61,429,647 67,975,177
Residential construction 18,136,008 17,301,263
Second mortgage loans 18,580,099 18,637,062
Lines of credit - commercial 18,539,209 15,046,074
Consumer loans 14,187,608 13,609,934
------------ ------------
196,489,488 174,795,647
------------ ------------
Less:
Deferred loan fees 757,896 776,028
Allowance for loan losses 2,281,581 1,929,531
------------ ------------
3,039,477 2,705,559
------------ ------------
$193,450,011 $172,090,088
============ ============
The following table sets forth the activity in the allowance for
loan losses:
2001 2000 1999
---- ---- ----
Balance January 1, $1,929,531 $1,653,290 $1,540,551
Add:
Provision charged to operations 360,000 360,000 240,000
Recoveries 31,417 12,034 6,790
Less:
Charge-offs 39,367 95,793 134,051
---------- ---------- ----------
Balance, December 31 $2,281,581 $1,929,531 $1,653,290
========== ========== ==========
No loans included within the scope of SFAS No. 114 were
identified as being impaired at December 31, 2001 or 2000 and for the years then
ended.
Loans on which the recognition of interest has been discontinued,
which were not included within the scope of SFAS No. 114, amounted to
approximately $280,000, $7,000, and $218,000 at
F-15
December 31, 2001, 2000, and 1999, respectively. If interest income had been
recognized on nonaccrual loans at their stated rates during 2001, 2000, and
1999, interest income would have been increased by approximately $10,480, $913,
and $27,000, respectively. No income was recognized for these loans in 2001,
2000 and 1999.
Included in loans receivable at December 31, 2001 and 2000, is
$1,223,840 and $536,005 due from officers and directors of the Bank. Activity in
loans outstanding to officers and directors is summarized as follows:
2001 2000
---- ----
Balance, beginning of year $ 536,005 $1,379,274
Changes due to retirement or addition of directors net - (916,170)
New loans made during year 1,150,460 131,636
Repayments made during year (462,625) (58,735)
----------- ----------
Balance, end of year $ 1,223,840 $ 536,005
=========== ==========
4. LOAN SERVICING
Loans serviced for others and not reflected in the balance sheets
are $68,287,344 and $64,754,825 at December 31, 2001 and 2000, respectively.
Servicing loans for others generally consists of collecting mortgage payments,
maintaining escrow accounts, disbursing payments to investors and foreclosure
processing. Loan servicing income is recorded on the accrual basis and includes
servicing fees from investors and certain charges collected from borrowers, such
as late payment fees. Mortgage servicing rights capitalized during 2001, 2000,
and 1999 totaled $182,119, $45,365, and $142,201, respectively.
Amortization of mortgage servicing rights totaled $144,000,
$144,000, and $103,097, respectively. Net servicing rights assets totaled
$525,075, $486,956, and $585,591 at December 31, 2001, 2000, and 1999,
respectively.
F-16
5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 2001 and 2000
is as follows:
2001 2000
---- ----
Land $1,731,941 $ 1,533,412
Building and improvements 3,642,101 3,011,967
Furniture and equipment 2,824,015 2,318,860
Automobiles 103,144 103,144
---------- -----------
Total cost 8,301,201 6,967,383
Less accumulated depreciation 2,868,353 2,471,952
---------- -----------
Premises and equipment, net $5,432,848 $ 4,495,431
========== ===========
Certain bank facilities are leased under various operating
leases. Rent expense was $242,387, $168,921, and $175,949 in 2001, 2000 and
1999, respectively. Future minimum rental commitments under noncancellable
operating leases are as follows:
2002 $218,902
2003 196,853
2004 196,404
2005 195,955
2006 195,506
Thereafter 507,000
--------
Total $1,510,620
==========
6. DEPOSITS
Deposits outstanding at December 31 consist of:
2001 2000
---- ----
Noninterest-bearing demand $ 17,738,165 $ 12,537,649
Interest-bearing:
Demand 20,842,088 20,551,420
Money market deposits 53,807,885 44,965,316
Savings 20,367,634 18,552,577
Certificates of deposit 70,360,762 71,199,037
------------ ------------
Total interest-bearing 165,378,369 155,268,350
------------ ------------
Total deposits $183,116,534 $167,805,999
============ ============
The aggregate amount of time deposits in denominations of
$100,000 or more at December 31, 2001 and 2000 were $17,018,000 and $14,857,000,
respectively.
F-17
At December 31, 2001, the scheduled maturities of time deposits
are as follows:
2002 $42,857,583
2003 16,056,571
2004 7,259,541
2005 1,827,744
2006 2,359,323
-----------
$70,360,762
===========
7. LONG-TERM DEBT AND OTHER BORROWINGS
The Bank's long-term debt consists of advances from the Federal
Home Loan Bank of Atlanta. The Bank classifies debt based upon original
maturity, and does not reclassify debt to short term status during its life.
These include fixed rate, adjustable rate, and convertible advances. The Bank's
fixed rate, non-convertible, long-term debt of $8,250,000 at December 31, 2001
matures through 2006. The interest rates on fixed rate, non-convertible,
long-term debt ranged from 1.125% to 5.43% at December 31, 2001 and 6.25% at
December 31, 2000. At December 31, 2001 and 2000, the weighted average interest
rates on fixed rate, non-convertible, long-term debt were 5.14% and 6.25%,
respectively.
The Bank's fixed rate, convertible, long-term debt of $35,000,000
at December 31, 2000 matures through 2011. This debt is callable by the issuer,
after an initial period ranging from six months to five years. These advances
become callable on dates ranging from 2002 to 2005. Depending on the specific
instrument, the instrument is callable either continuously after the initial
period (Bermuda option) or only at the date ending the initial period
(European). At December 31, 2001 and 2000 the interest rates on this debt ranged
from 4.62% to 6.25% and 4.67% to 6.25%, respectively. At December 31, 2001 and
2000 the weighted average interest rates on fixed rate, convertible, long-term
debt were 5.42% and 5.63%, respectively.
The Bank's adjustable rate, long-term debt at December 31, 2000
matures in 2002. This debt adjusts quarterly based upon a margin over the three
month London Interbank Offer Rate ("LIBOR"). Margins range from 29 to 31 basis
points. The debt has minimum interest rates ranging from 5.31% to 5.79%. The
debt has maximum rates ranging from 7.50% to 7.81%. At December 31, 2001 and
2000, the interest rates on adjustable rate, long-term debt ranged from 5.31% to
5.79% and 6.94% to 6.96%, respectively. At December 31, 2001 and 2000, the
weighted average rate on adjustable rate, long-term debt was 5.69% and 6.94%,
respectively.
F-18
The contractual maturities of long-term debt are as follows:
December 31,
2001 2000
-------------------------------------------------------------- ------------
Fixed Adjustable Fixed Rate
Rate Rate Covertible Total Total
---- ---------- ----------- ----- -----
Due in 2002 $ 1,000,000 $ 6,400,000 $ - $ 7,400,000 $ 11,400,000
Due in 2003 88,000 10,000,000 10,088,000
Due in 2004 88,000 88,000 5,000,000
Due in 2005 74,000 74,000 10,000,000
Due in 2006 7,000,000 7,000,000
Thereafter - - 25,000,000 25,000,000 15,000,000
----------- ----------- ------------ ------------ ------------
$ 8,250,000 $ 6,400,000 $ 35,000,000 $ 49,650,000 $ 41,400,000
=========== =========== ============ ============ ============
The Bank also has daily advances outstanding which are classified
as short-term debt. These advances are repayable at the Bank's option at any
time and reprice daily. These advances totaled $1,000,000 and $12,975,000 at
December 31, 2001 and 2000, respectively. Average rates at December 31, 2001 and
2000 on this short-term debt were 1.83% and 6.35%, respectively.
Under the terms of an Agreement for Advances and Security
Agreement with Blanket Floating Lien (the "Agreement"), the Company maintains
eligible collateral consisting of 1 - 4 unit residential first mortgage loans,
discounted at 75% of the unpaid principal balance, equal to 100% at December 31,
2000, of its total outstanding long and short term Federal Home Loan Bank
advances. This amount was $65,169,000 at December 31, 2000. At December 31,
2000, the Bank also pledged its Federal Home Loan Bank stock of $2,961,300 and
has securities with a carrying value of $50,646,000 eligible as collateral for
these advances.
During 2001, the Bank entered into an addendum to the Agreement
that expanded the types of eligible collateral under the Agreement to include
certain commercial real estate loans. These loans are subject to eligibility
rules, and collateral values are discounted at 50% of the unpaid loan principal
balance. In addition, only 50% of total collateral for Federal Home Loan Bank
advances may consist of commercial real estate loans. At December 31, 2001, the
Bank had eligible collateral in its commercial real estate and residential
portfolios to borrow up to approximately $78,000,000 from the Federal Home Loan
Bank. In addition the Bank has pledged its Federal Home Loan Bank stock of
$2,961,300 and securities with a carrying value of $34,738,000 as additional
collateral for its advances.
Other short-term debt consists of notes payable to the U.S.
Treasury, which are Federal treasury tax and loan deposits accepted by the Bank
and remitted on demand to the Federal Reserve Bank. At December 31, 2001 and
2000, such borrowings were $813,317 and $575,903, respectively. The Bank pays
interest on these balances at a slight discount to the federal funds rate. The
notes are secured by investment securities with an amortized cost of
approximately $786,700 and $912,535 at December 31, 2001 and 2000, respectively.
F-19
8. INCOME TAXES
Income tax was as follows:
2001 2000 1999
---- ---- ----
Current
Federal $1,409,350 $ 1,307,000 $ 973,000
State 114,000 18,000 109,000
---------- ----------- ----------
1,523,350 1,325,000 1,082,000
---------- ----------- ----------
Deferred
Federal (168,000) (97,000) (56,000)
State (37,000) (21,000) (12,000)
---------- ----------- ----------
(205,000) (118,000) (68,000)
---------- ----------- ----------
Total Income Tax Expense $1,318,350 $ 1,207,000 $1,014,000
========== =========== ==========
Total income tax expense differed from the amounts computed by
applying the federal income tax rate of 34% to income before income taxes as a
result of the following:
2001 2000 1999
---------------------- ----------------------- -----------------------
Percent of Percent of Percent of
Pre Tax Pre Tax Pre Tax
Amount Income Amount Income Amount Income
---------------------- ----------------------- -----------------------
Expected income tax expense at
federal tax rate $1,293,321 34.0% $1,205,000 34.0% $1,077,000 34.0%
State taxes net of federal benefit 77,000 2.0% - 0.0% 62,000 1.9%
Nondeductible expenses 5,233 0.1% 14,000 0.4% 14,000 0.4%
Deduction for stock options exercised - 0.0% - 0.0% (90,000) -2.9%
Other (57,204) -1.4% (12,000) -0.3% (49,000) -1.4%
---------- ---- ---------- ---- ---------- ----
$1,318,350 34.7% $1,207,000 34.1% $1,014,000 32.0%
========== ==== ========== ==== ========== ====
F-20
The net deferred tax assets in the accompanying balance sheets
include the following components:
2001 2000
---- ----
Deferred tax assets:
Deferred fees $ 44,566 $ 48,073
Allowance for loan losses 768,525 577,486
Deferred compensation 102,568 83,510
Unrealized loss on investment
securities available for sale - 52,000
-------- --------
915,659 761,069
-------- --------
Deferred tax liabilities:
FHLB stock dividends 153,866 152,896
Depreciation 98,328 97,708
Unrealized gain on investment
securities available for sale 291,599 -
-------- --------
543,793 250,604
-------- --------
$371,866 $510,465
======== ========
Retained earnings at December 31, 2001, include approximately
$1.2 million of bad debt deductions allowed for federal income tax purposes (the
"base year tax reserve") for which no deferred income tax has been recognized.
If, in the future, this portion of retained earnings is used for any purpose
other than to absorb bad debt losses, it would create income for tax purposes
only and income taxes would be imposed at the then prevailing rates. The
unrecorded income tax liability on the above amount was approximately $458,000
at December 31, 2001.
Prior to January 1, 1996, the Bank computed its tax bad debt
deduction based upon the percentage of taxable income method as defined by the
Internal Revenue Code. The bad debt deduction allowable under this method
equaled 8% of taxable income determined without regard to the bad debt deduction
and with certain adjustments. The tax bad debt deduction differed from the bad
debt expense used for financial accounting purposes.
In August 1996, the Small Business Job Protection Act (the "Act")
repealed the percentage of taxable income method of accounting for bad debts
effective for years beginning after December 31, 1995. The Act required the Bank
to change its method of computing reserves for bad debts to the experience
method. This method is available to banks with assets less than $500 million and
allows the Bank to maintain a tax reserve for bad debts and to take bad debt
deductions for reasonable additions to the reserve. As a result of this change,
the Bank has to recapture into income a portion of its existing tax bad debt
reserve. This recapture occurs ratably over a six-taxable year period, beginning
with the 1998 tax year. For financial reporting purposes, this recapture does
not result in additional tax expense as the Bank adequately provided deferred
taxes in prior years. Furthermore, this change does not require the Bank to
recapture its base year tax reserve.
F-21
9. COMMITMENTS AND CONTINGENCIES
The Bank is party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
borrowers. These financial instruments are commitments to extend credit. These
instruments may, but do not necessarily, involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the
balance sheets. The Bank's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument is represented by
the contractual amount of those instruments. The Bank uses the same credit
policies in making commitments as it does for on-balance-sheet loans receivable.
As of December 31, 2001 and 2000, in addition to the undisbursed
portion of loans receivable of approximately $6,031,000 and $5,032,000,
respectively, the Bank had outstanding loan commitments approximating $1,926,500
and $995,000, respectively.
Standby letters of credit written are conditional commitments
issued by the Bank to guarantee the performance of a customer to a third party.
These guarantees are issued primarily to support construction borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank holds cash or a secured interest in real estate as collateral to
support those commitments for which collateral is deemed necessary. Standby
letters of credit outstanding amounted to $5,698,000 and $6,256,000 at December
31, 2001 and 2000, respectively. In addition to the commitments noted above,
customers had approximately $10,123,000 and $9,891,000 available under lines of
credit at December 31, 2001 and 2002, respectively.
10. STOCK OPTION AND INCENTIVE PLAN
The Company has a stock option and incentive plan to attract and
retain personnel and provide incentive to employees to promote the success of
the business. At December 31, 2001, 61,081 shares of stock have been authorized
and are available for grants of options under this plan. The exercise price for
options granted is set at the discretion of the Board, but is not less than the
market value of the shares as of the date of grant. An option's maximum term is
ten years and the options generally vest immediately upon issuance.
The Company applies APB Opinion 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation cost has been
recognized. Had compensation cost for the Company's stock option plan been
determined based upon fair values at the grant dates for awards under the plan
consistent with the method prescribed by SFAS No. 123, the Company's net income
and earnings per share would have been adjusted to the pro forma amounts
indicated below:
2001 2000 1999
---- ---- ----
Net Income As reported $ 2,485,535 $ 2,336,119 $ 2,153,490
Pro forma 2,259,284 2,270,079 1,990,645
Basic Earnings Per Share As reported 3.24 2.98 2.75
Pro forma 2.95 2.89 2.54
Diluted Earnings Per Share As reported 3.11 2.85 2.59
Pro forma 2.83 2.76 2.39
F-22
For the purpose of computing the pro forma amounts indicated
above, the fair value of each option on the date of grant is estimated using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for the grants:
2001 2000 1999
---- ---- ----
Dividend Yield 1.30% 0.75% 0.75%
Expected volatility 15.00% 15.00% 15.00%
Risk - free interest rate 4.91% 5.85% 5.72%
Expected lives (in years) 10 10 10
Weighted average fair value $11.06 $12.28 $11.51
The following tables summarize activity in the plan:
2001 2000 1999
------------------- ----------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Outstanding at beginning of year 91,036 $16.89 91,184 $12.61 101,818 $12.61
Granted 20,448 26.57 9,179 26.66 14,143 25.24
Exercised (7,105) 10.28 (7,790) 14.61 (24,369) 7.61
Forfeitures (4,700) 24.41 (1,537) 25.25 (408) 26.60
------ ------ -------
Outstanding at end of year 99,679 $18.99 91,036 $16.89 91,184 $15.85
====== ====== ====== ====== ======= ======
Options Outstanding Options Exercisable
------------------------------------- -------------------------------------
Weighted Weighted
Number Remaining Number Average
Outstanding Contractual Exercisable Exercise
12/31/01 Life 12/31/01 Price
------------ --------------- ------------- --------------
43,174 4 years 43,174 $10.28
775 6 years 775 21.51
21,628 7 years 21,628 24.31
8,051 8 years 8,051 26.60
9,029 9 years 9,029 26.70
17,022 10 years 17,022 26.55
11. EMPLOYEE BENEFIT PLANS
The Bank has an Employee Stock Ownership Plan (ESOP) which covers
substantially all of the Bank's employees. The ESOP acquires stock of the Bank's
parent corporation, Tri-County Financial Corporation. The Company accounts for
its ESOP in accordance with AICPA Statement of Position 93-6. Accordingly,
unencumbered shares held by the ESOP are treated as outstanding in
F-23
computing earnings per share. Shares issued to the ESOP but pledged as
collateral for loans obtained to provide funds to acquire the shares are not
treated as outstanding in computing earnings per share. Dividends on ESOP shares
are recorded as a reduction of retained earnings. The ESOP may acquire in the
open market up to 195,700 shares. At December 31, 2001, the Plan owns 53,731
shares.
The Company also has a 401(k) plan. The Bank matches a portion of
the employee contributions. This ratio is determined annually by the Board of
Directors. Currently one-half of an employee's first 6% deferral is matched. All
employees who have completed one year of service and have reached the age of 21
are covered under this defined contribution plan. Contributions are determined
at the discretion of management and the Board of Directors. For the years ended
December 31, 2001, 2000, and 1999, the Company charged $93,000, $90,000, and
$342,000, against earnings to fund the Plans.
12. DIVIDENDS
On January 22, 2002, the Board of Directors declared a $.50 per
share cash dividend to be paid on April 8, 2002 to holders of record as of March
25, 2002. On January 31, 2001, the Board of Directors declared a $.40 per share
cash dividend which was distributed on April 9, 2001 to holders of record as of
March 26, 2001. On February 3, 2000, the Board of Directors declared a $.30 per
share cash dividend which was distributed April 14, 2000 to holders of record as
of March 14, 2000.
13. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory
capital requirements administered by the federal and state banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory and
possible additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's and the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
(set forth in the table below) of tangible and core capital (as defined in the
regulations) to total adjusted assets (as defined), and of risk-based capital
(as defined) to risk-weighted assets (as defined). Management believes, as of
December 31, 2001, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 2001, the most recent notification from the
Federal Reserve categorized the Bank as well-capitalized under the regulatory
framework for prompt corrective action. To be categorized as well-capitalized,
the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1
leverage ratios as set forth in the table. There are no conditions or events
since that notification that management believes have changed the Company's or
the Bank's category.
F-24
The Company's and the Bank's actual capital amounts and ratios
for 2001 and 2000 are presented in the tables below: (dollar amounts in
thousands)
To be Considered
Well Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
---------------------- ------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
--------- ------- ------- ------ -------- --------
At December 31, 2001:
Total capital (to risk-
weighted assets):
The Company $27,314 14.08% $15,511 8.0%
The Bank 25,799 13.26% 15,570 8.0% $19,462 10.0%
Tier 1 capital (to risk-
weighted assets):
The Company 24,841 12.81% 7,756 4.0%
The Bank 23,517 12.08% 7,785 4.0% 11,677 6.0%
Tier 1 capital (to
average assets):
The Company 24,841 9.64% 10,311 4.0%
The Bank 23,517 9.46% 9,944 4.0% 12,430 5.0%
At December 31, 2000:
Total capital (to risk-
weighted assets):
The Company 25,475 13.53% $15,069 8.0%
The Bank 25,227 13.40% 15,069 8.0% 18,837 10.0%
Tier 1 capital (to risk-
weighted assets):
The Company 23,545 12.50% 7,535 4.0%
The Bank 23,182 12.31% 7,535 4.0% 11,302 6.0%
Tier 1 capital (to
average assets):
The Company 23,545 9.61% 9,803 4.0%
The Bank 23,182 9.46% 9,803 4.0% 12,254 5.0%
F-25
14. EARNINGS PER SHARE
The calculations of basic and diluted earnings per share are as
follows:
2001 2000 1999
---------- ---------- ----------
Basic earnings per share
Net income $2,485,535 $2,336,196 $2,153,490
Average common shares outstanding 766,927 784,605 782,950
Net income per common share - basic $ 3.24 $ 2.98 $ 2.75
Diluted earnings per share
Net income $2,485,535 $2,336,196 $2,153,490
Average common shares outstanding 766,927 784,605 782,950
Stock option adjustment 31,860 36,534 49,333
Average common shares outstanding - diluted 798,787 821,139 832,283
Net income per common share - diluted $ 3.11 $ 2.85 $ 2.59
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is necessarily required to
interpret market data to develop the estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts. Therefore, any aggregate unrealized gains or
losses should not be interpreted as a forecast of future earnings or cash flows.
Furthermore, the fair values disclosed should not be interpreted as the
aggregate current value of the Company.
December 31, 2001 December 31, 2000
------------------------- ---------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ --------- -------- ----------
Assets:
Cash and cash equivalents $ 693,439 $ 693,439 $ 645,817 $ 645,817
Interest bearing deposits with banks 7,678,158 7,678,158 5,975,314 5,975,314
Investment securities and stock in FHLB
and FRB 46,998,646 46,998,146 61,610,913 61,610,913
Loans receivable, net 193,450,011 199,325,377 174,795,647 175,551,335
Loans held for sale 2,354,315 2,354,315 355,000 355,000
Liabilities:
Savings, NOW, and money market accounts 112,755,772 112,755,862 96,251,723 96,251,723
Time certificates 70,360,762 71,827,020 71,199,037 71,209,125
Long-term debt and other borrowed funds 50,463,317 52,340,500 54,950,903 55,187,033
F-26
At December 31, 2001 and 2000, the Company had outstanding loan
commitments and standby letters of credit of $7.6 million and $7.3 million,
respectively. Based on the short-term lives of these instruments, the Company
does not believe that the fair value of these instruments differs significantly
from their carrying values.
Valuation Methodology
---------------------
Cash and Cash Equivalents - For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value.
Investment Securities - Fair values are based on quoted market
prices or dealer quotes. If a quoted market price is not available, fair value
is estimated using quoted market prices for similar securities.
Mortgage-Backed Securities - Fair values are based on quoted
market prices or dealer quotes. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.
Loans Receivable and Loans Held for Sale - For conforming
residential first-mortgage loans, the market price for loans with similar
coupons and maturities was used. For nonconforming loans with maturities similar
to conforming loans, the coupon was adjusted for credit risk. Loans which did
not have quoted market prices were priced using the discounted cash flow method.
The discount rate used was the rate currently offered on similar products. Loans
priced using the discounted cash flow method included residential construction
loans, commercial real estate loans, and consumer loans. The estimated fair
value of loans held for sale is based on the terms of the related sale
commitments.
Deposits - The fair value of checking accounts, saving accounts,
and money market accounts was the amount payable on demand at the reporting
date.
Time Certificates - The fair value was determined using the
discounted cash flow method. The discount rate was equal to the rate currently
offered on similar products.
Long-Term Debt and Other Borrowed Funds - These were valued using
the discounted cash flow method. The discount rate was equal to the rate
currently offered on similar borrowings.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2001 and 2000. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amount presented herein.
F-27
16. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Financial information pertaining only to Tri-County Financial
Corporation is as follows:
Balance Sheets:
ASSETS
2001 2000
---- ----
Cash - noninterest-bearing $ 25,000 $ 204,937
Cash - interest-bearing 925,521 280,000
Other assets 691,208 79,645
Investment securities available for sale 111,582 34,679
Investment in wholly owned subsidiary 24,073,273 23,067,087
----------- -----------
TOTAL ASSETS $25,826,584 $23,666,348
=========== ===========
Current liabilities $ 240,126 $ 236,526
Stockholders' equity
Common stock 7,568 7,777
Surplus 7,545,590 7,500,865
Retained earnings 17,678,367 16,175,708
Unearned ESOP shares (200,580) (139,599)
Accumulated other comprehensive income 555,513 (114,929)
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $25,826,584 $23,666,348
=========== ===========
Condensed Statements of Income:
Year Ended December 31,
------------------------------------
2001 2000 1999
---- ---- ----
Dividends from subsidiary $2,250,000 $ 500,000 $1,000,000
Interest income 26,929 27,510 42,675
Loss on sale of investment securities - - (605)
Miscellaneous expenses (167,787) (90,391) (97,844)
---------- ---------- ----------
Income before income taxes and equity in 2,109,142 437,119 944,226
undistributed net income of subsidiary
Federal and state income tax benefit 40,650 - 21,000
Equity in undistributed net income of subsidiary 335,743 1,899,077 1,188,264
---------- ---------- ----------
NET INCOME $2,485,535 $2,336,196 $2,153,490
========== ========== ==========
F-28
Condensed Statements Cash Flows:
2001 2000 1999
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,485,535 $ 2,336,196 $ 2,153,490
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of subsidiary (335,743) (1,899,077) (1,188,264)
Loss on sale of investment securities - - 605
Increase in current assets (611,564) (39,398) (28,513)
Increase in current liabilities 3,600 - 186,893
----------- ----------- -----------
Net cash provided by operating activities 1,541,828 397,721 1,124,211
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing deposits (645,521) 439,068 (677,177)
Purchase of investment securities available for sale (76,903) (6,677) (3,637)
Maturity or redemption of investment securities
available for sale - - 200,000
----------- ----------- -----------
Net cash provided (used) by investing activities (722,424) (432,391) (480,814)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (309,204) (236,595) (157,034)
Exercise of stock options 31,817 53,676 126,160
Net change in ESOP loan (48,034) 36,984 41,734
Redemption of common stock (673,920) (479,391) (657,150)
----------- ----------- -----------
Net cash used in financing activities (999,341) (625,326) (646,290)
----------- ----------- -----------
INCREASE (DECREASE) IN CASH (179,937) 204,786 (2,893)
CASH AT BEGINNING OF YEAR 204,937 151 3,044
----------- ----------- -----------
CASH AT END OF YEAR $ 25,000 $ 204,937 $ 151
=========== =========== ===========
F-29
17. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
A summary of selected consolidated quarterly financial data for
the two years ended December 31, 2001 is reported as follows:
2001
---------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest and dividend income $ 4,326,809 $ 4,630,360 $ 4,649,286 $ 4,908,221
Interest expenses 1,821,087 2,132,804 2,316,701 2,487,219
----------- ----------- ----------- -----------
Net interest income 2,505,722 2,497,556 2,332,585 2,421,002
Provision for loan loss 90,000 90,000 90,000 90,000
----------- ----------- ----------- -----------
Net interest income after provision
for loan loss 2,415,722 2,407,556 2,242,585 2,331,002
Noninterest income 355,728 344,406 353,858 347,528
Noninterest expense 1,840,743 1,862,904 1,609,104 1,681,749
Income before income taxes 930,707 889,058 987,339 996,781
Provision for income taxes 312,650 322,000 335,700 348,000
Net Income 618,057 567,058 651,639 648,781
Earnings per common share:
Basic $ 0.83 $ 0.74 $ 0.84 $ 0.83
=========== =========== =========== ===========
Diluted $ 0.79 $ 0.71 $ 0.81 $ 0.80
=========== =========== =========== ===========
2000
---------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest and dividend income $ 4,829,400 $ 4,637,439 $ 4,487,475 $ 4,335,248
Interest expenses 2,619,502 2,470,503 2,289,364 2,048,121
----------- ----------- ----------- -----------
Net interest income 2,209,898 2,166,936 2,198,111 2,287,127
Provision for loan loss 90,000 90,000 90,000 90,000
----------- ----------- ----------- -----------
Net interest income after provision
for loan loss 2,119,898 2,076,936 2,108,111 2,197,127
Noninterest income 470,936 300,658 309,275 292,119
Noninterest expense 1,580,431 1,553,978 1,631,991 1,565,464
Income before income taxes 1,010,403 823,616 785,395 923,782
Provision for income taxes 352,000 279,000 276,000 300,000
Net Income 658,403 544,616 509,395 623,782
Earnings per common share:
Basic $ 0.85 $ 0.69 $ 0.65 $ 0.79
=========== =========== =========== ===========
Diluted $ 0.82 $ 0.66 $ 0.62 $ 0.75
=========== =========== =========== ===========
F-30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TRI-COUNTY FINANCIAL CORPORATION
Date: March 27, 2002 By:/s/ Michael L. Middleton
----------------------------------------
Michael L. Middleton
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ Michael L. Middleton By:/s/ William J. Pasenelli
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Michael L. Middleton William J. Pasenelli
(Director, President and Chief (Chief Financial and Accounting
Executive Officer) Officer)
Date: March 27, 2002 Date: March 27, 2002
By: /s/ C. Marie Brown By:/s/ Herbert N. Redmond, Jr.
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C. Marie Brown Herbert N. Redmond, Jr.
(Director and Chief Operating Officer) (Director)
Date: March 27, 2002 Date: March 27, 2002
By: /s/ H. Beaman Smith By:/s/ W. Edelin Gough, Jr.
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H. Beaman Smith W. Edelen Gough, Jr.
(Director and Secretary/Treasurer) (Director)
Date: March 27, 2002 Date: March 27, 2002
By: /s/ Louis P. Jenkins, Jr. By:/s/ Catherine A. Askey
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Louis P. Jenkins, Jr. Catherine A. Askey
(Director) (Director)
Date: March 27, 2002 Date: March 27, 2002