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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (Fee Required)
For the fiscal year ended June 30, 1996
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No Fee Required)
For the transition period from ______________ to _______________
Commission File No. 0-28032
PATAPSCO BANCORP, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 52-1951797
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(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1301 MERRITT BOULEVARD, DUNDALK, MARYLAND 21222-2194
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (410) 285-1010
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)
Check whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 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
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. [X]
For the fiscal year ended June 30, 1996, the registrant had $5.4 million in
revenues.
As of September 23, 1996, the aggregate market value of voting stock held by
non-affiliates was approximately $7,817,940, computed by reference to the most
recent sales price on September 23, 1996 reported on the National Quotation
Bureau Pink Sheets. For purposes of this calculation, it is assumed that
directors, executive officers and beneficial owners of more than 5% of the
registrant's outstanding voting stock are affiliates.
Number of shares of Common Stock outstanding as of September 23, 1996: 362,553.
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part
of the Form 10-KSB into which the document is incorporated:
1. Portions of the registrant's Annual Report to Stockholders for the
Fiscal Year ended June 30, 1996.
(Parts II and III)
2. Portions of Proxy Statement for registrant's 1996 Annual Meeting of
Stockholders. (Part III)
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PART I
Item 1. Description of Business
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General
Patapsco Bancorp, Inc. Patapsco Bancorp, Inc. (the "Company") was
incorporated under the laws of the State of Maryland in November 1995. On April
1, 1996, Patapsco Federal Savings and Loan Association ("Patapsco Federal" or
the "Association") converted from mutual to stock form (the "Stock Conversion")
and reorganized into the holding company form of ownership as a wholly owned
subsidiary of the Company (the "Conversion"). As a result of the Conversion, the
Company issued and sold 362,553 shares of its common stock at a price of $20.00
per share to the Bank's depositors, the Company's employee stock ownership plan
and the public, thereby recognizing net proceeds of $6.7 million. In connection
with the Conversion, the Association adopted a Plan of Conversion which, among
other things, provided that as soon as practicable after the Conversion, the
Association will convert from a federal stock savings and loan association to
Maryland savings and loan association and then immediately thereafter to a
Maryland commercial bank (the "Bank Conversion") to be known as the "The
Patapsco Bank" (the "Bank"). In response to proposed legislation affecting the
amount of the Association's tax bad debt reserve that would have to be
recaptured upon completion of the Bank Conversion, the Board of Directors of the
Company and the Association delayed the Bank Conversion pending the outcome of
the proposed legislation. On August 20, 1996, the President signed tax bad debt
reserve recapture legislation into law. As a result, the Company and the
Association intend to proceed with the Bank Conversion. See "Recent
Developments --Reversal of Tax Bad Debt Recapture."
The Company has no significant assets other than the outstanding capital
stock of the Association, 50% of the net proceeds of the Conversion, after
deducting amounts infused into the Association and used to fund the Employee
Stock Ownership Plan ("ESOP"), and a note receivable from the ESOP. The Company
is primarily engaged in the business of directing, planning and coordinating the
business activities of Patapsco Federal. Accordingly, the information set forth
in this report, including financial statements and related data, relates
primarily to the Association. In the future, the Company may become an operating
company or acquire or organize other operating subsidiaries, including other
financial institutions. Initially, the Company will not maintain offices
separate from those of Patapsco Federal or employ any persons other than its
officers who will not be separately compensated for such service.
The Company's and the Association's executive offices are located at 1301
Merritt Boulevard, Dundalk, Maryland 21222-2194, and its main telephone number
is (410) 285-1010.
Patapsco Federal Savings and Loan Association. The Association is a federal
stock savings and loan association operating through a single office located in
Dundalk, Maryland and serving eastern Baltimore County. The Association was
chartered by the State of Maryland in 1910 under the name Patapsco Building and
Loan Association. The Association adopted a federal charter and received federal
insurance of its deposit accounts in 1957, at which time it adopted its present
name of Patapsco Federal Savings and Loan Association. Upon completion of the
Bank Conversion, the Association will become a Maryland commercial bank and will
change its name to the "The Patapsco Bank."
The principal business of the Association historically has consisted of
attracting deposits from the general public and investing these deposits in
loans secured by first mortgages on one- to four-family ("single-family")
residences in the Association's market area. The Association derives its income
principally from interest earned on loans and, to a lesser extent, interest
earned on mortgage-backed securities and investment securities and noninterest
income. Funds for these activities are provided principally by operating
revenues, deposits and repayments of outstanding loans and investment securities
and mortgage-backed securities.
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Historically, the Association has operated as a traditional savings and
loan association, emphasizing the origination of loans secured by single-family
residences. At June 30, 1996, $47.2 million, or 89.8% of the Association's gross
loan portfolio, consisted of single-family residential mortgage loans in its
market area. However, the Association's Board of Directors anticipates minimal
growth in residential loan demand within the Association's market area. In
addition, the Board of Directors believes that as a result of recent
consolidations of financial institutions, the Association's market area is not
adequately served by the existing financial institutions and there will be
increasing local demand for commercial real estate, commercial business and
consumer loans. As a result, the Board of Directors has refocused the
Association's strategy. Pursuant to this new strategy, while continuing to
pursue its existing business of originating single-family residential mortgage
loans, the Association is seeking to take advantage of the business
opportunities identified by the Board of Directors by gradually expanding into
commercial real estate, commercial business and consumer lending. In furtherance
of this strategy, in June 1995, the Association began offering home improvement
loans and had originated $2.7 million of such loans through June 30, 1996. In
addition, the Board of Directors and management have implemented other new
lending programs such as small business loans, residential and non-residential
construction loans, home equity and other consumer loans.
Recent Developments
Reversal of Tax Bad Debt Recapture. Generally, savings and loan
associations that convert to commercial banks must recapture some or all of
their tax bad debt reserve established for federal income taxation purposes. The
Association incurred a $740,000 expense for recapture of a portion of its tax
bad debt reserve during the year ended June 30, 1995 in connection with the
determination of the Association's Board of Directors to convert the Association
to a Maryland commercial bank. After this determination was made, legislation
was introduced in Congress which provided that savings and loan associations
that convert to commercial banks will not be required to recapture the portion
of tax bad debt reserve accumulated prior to 1988. Following the introduction of
this legislation, the Board of Directors determined to delay consummation of the
Bank Conversion pending the outcome of this legislation. The legislation
ultimately was enacted into law on August 20, 1996. As a result of the enactment
of this legislation, the Association now intends to complete the Bank Conversion
on or about September 30, 1996. Further, the Company intends to reverse
approximately $600,000 of the $740,000 expense previously incurred. The reversal
of the tax bad debt reserve as described above will be reflected as a reduction
of tax expense during the quarter ending September 30, 1996.
Special Assessment. The Bank's savings deposits are insured by the Savings
Association Insurance Fund ("SAIF"), which is administered by the Federal
Deposit Insurance Corporation ("FDIC"). The assessment rate currently ranges
from 0.23% of deposits for well capitalized institutions to 0.31% of deposits
for undercapitalized institutions. The FDIC also administers the Bank Insurance
Fund ("BIF"). On August 8, 1995, the FDIC adopted an amendment to the BIF risk-
based assessment schedule which lowered the deposit insurance assessment rate
for most commercial banks and other depository institutions with deposits
insured by the BIF to a range of from 0.31% of insured deposits for
undercapitalized BIF-insured institutions to 0.04% of deposits for well-
capitalized institutions, which constitute over 90% of BIF-insured institutions.
The FDIC amendment became effective for the quarter ended September 30, 1995,
and the assessment rate for BIF-insured institutions subsequently was lowered to
the statutory minimum of $2,000 per year. The amendment created a substantial
disparity in the deposit insurance premiums paid by BIF and SAIF members and
could place SAIF-insured savings institutions at a significant competitive
disadvantage to BIF-insured institutions.
The Balanced Budget Act of 1995, which was passed by Congress but vetoed by
the President for reasons unrelated to the SAIF recapitalization, provided for a
one-time assessment currently estimated to be up to 0.68% of insured deposits
that would fully capitalize the SAIF. It is unknown whether this legislation
will be enacted or if premiums for either BIF or SAIF members will be adjusted
in the future by the FDIC or by legislative action. If a special assessment as
described above were to be required, it would result in a one-time charge to the
Association of up to $430,000 on a pre-tax basis, assuming the special
assessment is based on deposits held at March 31, 1995. If such a special
assessment were required and the SAIF as a result was fully recapitalized, it
could have the effect
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of reducing the Association's future deposit insurance premiums to the SAIF,
thereby increasing net income in future periods.
Market Area
The Association's market area for gathering deposits consists of eastern
Baltimore County, Maryland, while the Association makes loans to customers
throughout the Baltimore Metropolitan area. The economy of the Association's
market area has historically been based on industry such as steel, shipyards and
automobile assembly. Major employers in the area include Bethlehem Steel and
General Motors. In recent years, the local economy has weakened as a result of
layoffs and plant closings by local employers. The economy in the Association's
market area continues to remain weak and is dependent, to some extent, on a
small number of major industrial employers. Recently, however, a significant
portion of eastern Baltimore County has been designated as an "Enterprise Zone."
As a result, employers relocating to this area are entitled to significant tax
and other economic incentives.
According to data provided by a private marketing firm, the Association
estimates the population of the area within a two-mile radius of the Association
(the "Survey Area") to be approximately 62,300. This compares to a population of
approximately 67,600 in 1980, representing a decrease of 7.8%. During the same
period of time, Baltimore County as a whole had an estimated 5.6% population
increase. The median household income of the Survey Area is approximately
$32,700, as compared to $42,600 for Baltimore County. The Association estimates
that median household income for the Survey Area increased approximately 9%
between 1989 and 1993, compared to an increase of 12% during that period for
Baltimore County. Though the Survey Area is not identical to the Association's
loan and deposit market areas, a substantial percentage of the Association's
loan and deposit customers are residents of or businesses located in the Survey
Area and management believes that the above information is representative of the
Association's loan and deposit markets.
Lending Activities
General. The Company's gross loan portfolio totaled $52.5 million at June
30, 1996, representing 66.6% of total assets at that date. It is the Company's
policy to concentrate its lending within its market area. At June 30, 1996,
$47.2 million, or 89.8% of the Company's gross loan portfolio, consisted of
single-family, residential mortgage loans. Other loans secured by real estate
include multi-family residential and commercial real estate loans, which
amounted to $1.2 million, or 2.3% of the Company's gross loan portfolio at June
30, 1996. In addition, the Company originates consumer and other loans,
including home improvement loans, loans secured by deposits and commercial
leases. At June 30, 1996, consumer and other loans totaled $4.1 million, or 7.9%
of the Company's gross loan portfolio.
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Loan Portfolio Composition. The following table sets forth selected data
relating to the composition of the Company's loan portfolio by type of loan at
the dates indicated. At June 30, 1996, the Company had no concentrations of
loans exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------
1996 1995
---------------- ----------------
Amount % Amount %
------- ------ ------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single-family residential........ $47,165 89.85% $40,668 96.64%
Multi-family residential and
commercial...................... 1,188 2.26 1,059 2.52
Consumer and other loans:
Home improvement................. 2,373 4.52 -- --
Home equity loans................ 39 0.07 -- --
Loans secured by deposits........ 392 0.75 211 0.50
Commercial leases................ 179 0.34 139 0.33
Commercial loans................. 1,020 1.94 -- --
Other............................ 143 0.27 4 0.01
------- ------ ------- -----
52,499 100.00% 42,081 100.00%
====== ======
Less:
Deferred loan origination fees,
net of costs.................... 249 173
Allowance for loan losses........ 219 159
------- -------
Total.......................... $52,031 $41,749
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</TABLE>
Loan Maturities. The following table sets forth certain information at
June 30, 1996 regarding the dollar amount of loans maturing or repricing in
the Company's portfolio. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. Adjustable- and floating-rate loans are included in the period
in which interest rates are next scheduled to adjust rather than the periods
in which they mature, and fixed-rate loans are included in the period in which
the final contractual repayment is due. The table does not include any
estimate of prepayments which significantly shorten the average life of all
mortgage loans and may cause the Company's repayment experience to differ from
that shown below.
<TABLE>
<CAPTION>
Due after
Due during 1 through Due after
the year ending 5 years after 5 years after
June 30, 1997 June 30, 1996 June 30, 1996 Total
--------------- ------------- ------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Single-family residential.. $18,154 $5,827 $23,184 $47,165
Multi-family residential
and commercial............ 551 550 87 1,188
Consumer and other......... 1,410 732 2,004 4,146
------- ------ ------- -------
Total................. $20,115 $7,109 $25,275 $52,499
======= ====== ======= =======
</TABLE>
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The following table sets forth at June 30, 1996 the dollar amount of all
loans due one year or more after June 30, 1996 which have predetermined interest
rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rates Adjustable Rates Total
------------- ---------------- -------
<S> <C> <C> <C>
(In thousands)
Single-family residential.. $23,808 $5,203 $29,011
Multi-family residential
and commercial............ 87 550 637
Consumer and other......... 2,736 -- 2,736
------- ------ -------
Total..................... $26,631 $5,753 $32,384
======= ====== =======
</TABLE>
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less than
their contractual terms because of prepayments. In addition, due-on-sale clauses
on loans generally give the Company the right to declare a loan immediately due
and payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
Originations, Purchases and Sales of Loans. The Company generally has
authority to originate and purchase loans secured by real estate located
throughout the United States. Consistent with its emphasis on being a community-
oriented financial institution, the Company concentrates its lending activities
in its market area.
The Company's loan originations are derived from a number of sources,
including referrals by realtors, depositors and borrowers and advertising, as
well as walk-in customers. The Company's solicitation programs consist of
advertisements in local media, in addition to occasional participation in
various community organizations and events. Real estate loans are originated by
the Company's loan personnel. All of the Company's loan personnel are salaried,
and the Company does not compensate loan personnel on a commission basis for
loans originated. With the exception of applications for home improvement loans,
which loans may be originated on an indirect basis through a limited number of
approved building contractors, loan applications are accepted at the Company's
offices. In addition, the Company has one salaried loan originator who travels
to meet prospective borrowers and take applications. In all cases, the Company
has final approval of the application.
In recent years, the Company generally has not purchased loans. However,
during the year ended June 30, 1996, the Company purchased two whole loans and
three participation interests totalling $477,000 and $149,000, respectively, in
single-family residential mortgage loans from local financial institutions. In
addition, the Company purchased a $550,000 participant interest in a commercial
construction/permanent loan from another local financial institution. In the
future, management intends to consider limited purchases of whole loans or
participation interests in loans secured by single-family, multi-family or
commercial real estate.
In recent years, the Company generally has retained all originated loans in
its portfolio. However, beginning in the first quarter of fiscal 1995, the
Company adopted a policy of selling new originations of 30-year fixed-rate
residential mortgage loans. During the years ended June 30, 1996 and 1995, the
Company sold $270,000 and $289,000, respectively, of such loans. Such loans are
sold in the secondary market to the Federal National Mortgage Association
("FNMA") or to local financial institutions. The Company may retain servicing on
such loans. In the future, the Company may consider selling participation
interests in multi-family residential or commercial real estate loans where the
balance of the loan is larger than desired for retention in the Company's loan
portfolio.
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Loan Underwriting Policies. The Company's lending activities are subject to
the Company's non-discriminatory underwriting standards and to loan origination
procedures prescribed by the Company's Board of Directors and management.
Detailed loan applications are obtained to determine the borrower's ability to
repay, and the more significant items on these applications are verified through
the use of credit reports, financial statements and confirmations. First
mortgage loans in amounts of up to $100,000, $207,000, $500,000 and $750,000 may
be approved by the Mortgage Loan Administrator, the Mortgage Loan Vice
President, the Officers Loan Committee (consisting of three officers of the
Association) and the Directors Loan Committee (consisting of any two non-
employee directors), respectively. Certain officers and committees have been
granted authority by the Board of Directors to approve commercial business loans
in varying amounts depending upon whether the loan is secured or unsecured and,
with respect to secured loans, whether the collateral is liquid or illiquid.
Individual officers and certain committees of the Company have been granted
authority by the Board of Directors to approve consumer loans up to varying
specified dollar amounts, depending upon the type of loan.
Applications for single-family real estate loans are underwritten and
closed in accordance with the standards of Federal Home Loan Mortgage
Corporation ("FHLMC") and FNMA. Generally, upon receipt of a loan application
from a prospective borrower, a credit report and verifications are ordered to
verify specific information relating to the loan applicant's employment, income
and credit standing. If a proposed loan is to be secured by a mortgage on real
estate, an appraisal of the real estate is undertaken by an appraiser approved
by the Company and licensed by the State of Maryland. In the case of single-
family residential mortgage loans, except when the Company becomes aware of a
particular risk of environmental contamination, the Company generally does not
obtain a formal environmental report on the real estate at the time a loan is
made. A formal environmental report may be required in connection with
nonresidential real estate loans.
It is the Company's policy to record a lien on the real estate securing a
loan and to obtain title insurance which insures that the property is free of
prior encumbrances and other possible title defects. Borrowers must also obtain
hazard insurance policies prior to closing and, when the property is in a flood
plain as designated by the Department of Housing and Urban Development, pay
flood insurance policy premiums. Upon receipt of a loan application from a
prospective borrower, a credit report generally is ordered to verify specific
information relating to the loan applicant's employment, income and credit
standing.
With respect to single-family residential mortgage loans, the Company makes
a loan commitment of between 30 and 60 days for each loan approved. If the
borrower desires a longer commitment, the commitment may be extended for good
cause and upon written approval. No fees are charged in connection with the
issuance of a commitment letter. The interest rate is guaranteed until closing.
It is the policy of the Company that appraisals be obtained in connection
with all loans for the purchase of real estate or to refinance real estate loans
where the existing mortgage is held by a party other than the Company. All
appraisals are performed by appraisers approved by the Company's Board of
Directors and licensed by the State of Maryland.
Under applicable law, with certain limited exceptions, loans and extensions
of credit by a savings institution to a person outstanding at one time shall not
exceed 15% of the institution's unimpaired capital and surplus. Loans and
extensions of credit fully secured by readily marketable collateral may comprise
an additional 10% of unimpaired capital and surplus. Applicable law additionally
authorizes savings institutions to make loans to one borrower, for any purpose,
in an amount not to exceed $500,000 or in an amount not to exceed the lesser of
$30,000,000 or 30% of unimpaired capital and surplus to develop residential
housing, provided: (i) the purchase price of each single-family dwelling in the
development does not exceed $500,000; (ii) the savings institution is and
continues to be in compliance with its fully phased-in regulatory capital
requirements; (iii) the loans comply with applicable loan-to-value requirements;
(iv) the aggregate amount of loans made under this authority does not exceed
150% of unimpaired capital and surplus; and (v) the Director of OTS, by order,
permits the savings institution to avail itself of this higher limit. Under
these limits, the Company's loans to one borrower were limited to $1.4 million
at June
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30, 1996. At that date, the Company had no lending relationships in excess of
the loans-to-one-borrower limit. At June 30, 1996, the Company's largest lending
relationship was a $900,000 revolving line of credit secured by commercial real
estate and a personal guarantee which was current and performing in accordance
with its terms at June 30, 1996.
Interest rates charged by the Company on loans are affected principally by
competitive factors, the demand for such loans and the supply of funds available
for lending purposes. These factors are, in turn, affected by general economic
conditions, monetary policies of the federal government, including the Federal
Reserve Board, legislative tax policies and government budgetary matters.
Single-Family Residential Real Estate Lending. The Company historically has
been and continues to be an originator of single-family, residential real estate
loans in its market area. At June 30, 1996, single-family residential mortgage
loans, excluding home improvement loans, totaled $47.2 million, or 89.8% of the
Company's gross loan portfolio. Of such loans, $6.1 million were secured by
nonowner-occupied investment properties.
The Company originates fixed-rate mortgage loans at competitive interest
rates. At June 30, 1996, $23.9 million, or 45.5% of the Company's gross loan
portfolio was comprised of fixed-rate mortgage loans. Single-family mortgage
loans with adjustable rates comprised 44.5% of the Company's gross loan
portfolio at June 30, 1996. Generally, the Company retains fixed-rate mortgages
with maturities of 15 years or less and fixed-rate loans with longer maturities
are typically sold in the secondary market in accordance with the Company's
Asset Liability/Management Policy. It is currently the Company's policy to sell
all 30-year fixed-rate loans it originates.
The Company also offers adjustable-rate residential mortgage loans. Single-
family residential mortgage loans secured by nonowner-occupied properties are
made solely on an adjustable-rate basis and carry interest rates generally 1.5%
above the rates charged on comparable loans secured by owner-occupied
properties. As of June 30, 1996, 49.5% of single-family mortgage loans in the
Company's loan portfolio carried adjustable rates. After the initial term, the
rate adjustments on the Company's adjustable-rate loans are indexed to one of
six recognized indices. The index most frequently used is a rate which adjusts
annually based upon changes in an index based on the weekly average yield on
U.S. Treasury securities adjusted to a constant comparable maturity of one year,
as made available by the Federal Reserve Board, though the National Monthly
Median Cost of Funds Index for OTS-Regulated SAIF-Insured Institutions is also
frequently utilized. The interest rates on these mortgages are adjusted either
once a year or every three years and, in the case of owner-occupied residential
mortgage loans, subject to a maximum adjustment of 2% per adjustment period and
a maximum aggregate adjustment of 6% over the life of the loan. No such limits
apply in the case of nonowner-occupied single-family residential mortgage loans.
The adjustable-rate mortgage loans offered by the Company do not provide for
initial rates of interest below the rates that would prevail when the index used
for repricing is applied.
The retention of adjustable-rate loans in the Company's portfolio helps
reduce the Company's exposure to increases in prevailing market interest rates.
However, there are unquantifiable credit risks resulting from potential
increases in costs to borrowers in the event of upward repricing of adjustable-
rate loans. It is possible that during periods of rising interest rates, the
risk of default on adjustable-rate loans may increase due to increases in
interest costs to borrowers. Further, although adjustable-rate loans allow the
Company to increase the sensitivity of its interest-earning assets to changes in
interest rates, the extent of this interest sensitivity is limited by the
initial fixed-rate period before the first adjustment and the lifetime interest
rate adjustment limitations. Accordingly, there can be no assurance that yields
on the Company's adjustable-rate loans will fully adjust to compensate for
increases in the Company's cost of funds. Finally, adjustable-rate loans
increase the Company's exposure to decreases in prevailing market interest
rates, although decreases in the Company's cost of funds tend to offset this
effect.
Multi-Family Residential and Commercial Real Estate Lending. The Company's
multi-family residential loan portfolio generally consists primarily of loans
secured by small apartment buildings, and the commercial real estate loan
portfolio includes loans to finance the acquisition of small office buildings,
shopping centers and
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commercial and industrial buildings. Such loans generally range in size from
$100,000 to $550,000. At June 30, 1996, the Company had $1.2 million of multi-
family residential and commercial real estate loans, which amounted to 2.3% of
the Company's gross loan portfolio at such date. Multi-family and commercial
real estate loans either are originated on an adjustable-rate basis with terms
of up to 25 years or are amortized over a maximum of 25 years with a three or
five year note maturity, and are underwritten with loan-to-value ratios of up to
80% of the lesser of the appraised value or the purchase price of the property.
Because of the inherently greater risk involved in this type of lending, the
Company generally limits its multi-family and commercial real estate lending to
borrowers within its market area or with which it has had prior experience. The
Company intends to significantly expand multi-family residential and commercial
real estate lending.
Multi-family residential and commercial real estate lending entails
significant additional risks as compared with single-family residential property
lending. Multi-family residential and commercial real estate loans typically
involve larger loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans typically is dependent on the successful
operation of the real estate project, retail establishment or business. These
risks can be significantly impacted by supply and demand conditions in the
market for office, retail and residential space, and, as such, may be subject to
a greater extent to adverse conditions in the economy generally. To minimize
these risks, the Company generally limits itself to its market area or to
borrowers with which it has prior experience or who are otherwise known to the
Company. It has been the Company's policy to obtain annual financial statements
of the business of the borrower or the project for which commercial or multi-
family residential real estate loans are made. In addition, in the case of
commercial mortgage loans made to a partnership or a corporation, the Company
seeks, whenever possible, to obtain personal guarantees and annual financial
statements of the principals of the partnership or corporation.
Consumer and Other Lending. The consumer loans currently in the Company's
loan portfolio consist of home improvement loans, loans secured by savings
deposits and overdraft protection for checking accounts. In addition, the
Company originates small business loans and loans to finance commercial leases.
At June 30, 1996, consumer and other loans totaled $4.1 million, or 7.9% of the
Company's gross loan portfolio.
In July 1995, the Company instituted a home improvement loan program. Such
loans are made to finance a variety of other home improvement projects, such as
swimming pool construction and room additions. The Company's policy is to
originate home improvement loans throughout Maryland, except for the western
portion of the state. While the Company originates some home improvement loans
on a direct basis, most of the home improvement loans in the Company's portfolio
are originated on an indirect basis through the Company's relationships with
selected independent contractors. The Company's underwriting policies apply to
all home improvement loans whether or not directly originated by the Company.
See " -- Loan Underwriting Policies." Home improvement loans generally have
terms ranging from three to 15 years and have fixed interest rates. Home
improvement loans are made on both secured and unsecured bases. However, all
home improvement loans with a principal loan amount over $10,000 or which have a
term longer than 84 months are made on a secured basis with loan-to-value ratios
up to 80% or 90%, depending on the type of project financed. At June 30, 1996,
home improvement loans amounted to $2.4 million, or 4.5% of the Company's gross
loan portfolio, with $1.1 million of such loans being secured by real estate.
The Company makes savings account loans for up to 90% of the depositor's
savings account balance. The interest rates normally range from 2.0% to 2.5%
above the rate paid on a passbook savings account, and the account must be
pledged as collateral to secure the loan. Interest generally is billed on a
monthly basis. At June 30, 1996, loans on deposit accounts totaled $392,000, or
0.8% of the Company's gross loan portfolio.
During fiscal 1995, the Company began offering loans for the lease of
equipment by small businesses. The Company initiated this program as a result of
its relationship with a Maryland equipment leasing company. All such loans
currently are made with full recourse to the leasing company, though the Board
of Directors has authorized the origination of such loans on a nonrecourse
basis. In extending a commercial lease loan, the Company reviews
9
<PAGE>
the borrower's financial statements, credit reports, tax returns and other
documentation. Generally, commercial lease loans are made in amounts ranging
between $3,000 and $35,000. Commercial lease loans have terms of up to five
years and carry fixed interest rates. At June 30, 1996, commercial lease loans
totaled $179,000, or 0.3% of the Company's gross loan portfolio. All commercial
lease loans are made with full recourse to a Baltimore based leasing company.
Consumer lending affords the Company the opportunity to earn yields higher
than those obtainable on single-family residential lending. However, consumer
loans entail greater risk than do residential mortgage loans, particularly in
the case of loans which are unsecured or secured by rapidly depreciable assets.
Repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by events
such as job loss, divorce, illness or personal bankruptcy.
During fiscal 1996 the Company began a commercial lending program. At June
30, 1996 the Company's commercial loans totaled $1.0 million or 1.9% of the
Company's gross loan portfolio. This commercial lending program will employ many
of the alternative financing and guarantee programs available through the U.S.
Small Business Administration and other state and local economic development
agencies.
Loan Fees and Servicing. The Company receives fees in connection with late
payments and for miscellaneous services related to its loans. The Company also
charges fees in connection with loan originations typically from 0 to 3 points
(one point being equal to 1% of the loan amount) on residential mortgage loan
originations. The Company generally does not service loans for others, except
for 30 year fixed-rate residential mortgage loans originated and sold by the
Company with servicing retained, and earns minimal income from this activity. At
June 30, 1996 the Company was servicing loans for others totaling approximately
$409,000.
Nonperforming Loans and Other Problem Assets. It is management's policy to
continually monitor its loan portfolio to anticipate and address potential and
actual delinquencies. When a borrower fails to make a payment on a loan, the
Company takes immediate steps to have the delinquency cured and the loan
restored to current status. Loans which are delinquent 15 days incur a late fee
of 5% of principal and interest due. As a matter of policy, the Company will
contact the borrower after the loan has been delinquent 15 days. If payment is
not promptly received, the borrower is contacted again, and efforts are made to
formulate an affirmative plan to cure the delinquency. Generally, after any loan
is delinquent 90 days or more, formal legal proceedings are commenced to collect
amounts owed.
Loans generally are placed on nonaccrual status if the loan becomes past
due more than 90 days, except in instances where in management's judgment there
is no doubt as to full collectibility of principal and interest. Consumer loans
are generally charged off, or any expected loss is reserved for, after they
become more than 120 days past due. All other loans are charged off when
management concludes that they are uncollectible. See Note 4 of Notes to
Consolidated Financial Statements.
Real estate acquired by the Company as a result of foreclosure is
classified as real estate acquired through foreclosure until such time as it is
sold. When such property is acquired, it is initially recorded at the lower of
cost or estimated fair value and subsequently at the lower of book value or fair
value less estimated costs to sell. Fair value is defined as the amount in cash
or cash-equivalent value of other consideration that a real estate parcel would
yield in a current sale between a willing buyer and a willing seller, as
measured by market transactions. If a market does not exist, fair value of the
item is estimated based on selling prices of similar items in active markets or,
if there are no active markets for similar items, by discounting a forecast of
expected cash flows at a rate commensurate with the risk involved. Fair value is
generally determined through an appraisal at the time of foreclosure. Any
required write-down of the loan to its fair value upon foreclosure is charged
against the allowance for loan losses. See Note 1
10
<PAGE>
of Notes to Consolidated Financial Statements. The Company records a valuation
allowance for estimated selling costs of the property immediately after
foreclosure. Subsequent to foreclosure, real estate acquired through foreclosure
is periodically evaluated by management and an allowance for loss is established
if the estimated fair value of the property, less estimated costs to sell,
declines. Costs relating to holding such real estate are charged against income
in the current period, while costs relating to improving such real estate are
capitalized until a saleable condition is reached.
The following table sets forth information with respect to the Company's
nonperforming assets at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Single-family residential.................... $ 240 $ 122
Multi-family and commercial.................. -- --
Consumer and other............................. -- --
----- -----
Total........................................ $ 240 $ 122
===== =====
Accruing loans which are contractually past due
90 days or more................................ $ -- $ --
----- -----
Total........................................ $ -- $ --
===== =====
Total nonperforming loans.................... $ 240 $ 122
===== =====
Percentage of total loans........................ 0.46% 0.29%
===== =====
Other non-performing assets (2).................. $ 31 $ 50
===== =====
Loans modified in troubled debt restructurings... $ -- $ --
===== =====
</TABLE>
- --------------------
(1) Non-accrual status denotes loans on which, in the opinion of management,
the collection of additional interest is unlikely. Payments received on a
nonaccrual loan are either applied to the outstanding principal balance or
recorded as interest income, depending on management's assessment of the
collectibility of the loan.
(2) Other nonperforming assets represents property acquired by the Company
through foreclosure or repossession or accounted for as a foreclosure in-
substance. This property is carried at the lower of its fair market value
less estimated selling costs or the principal balance of the related loan,
whichever is lower.
During the year ended June 30, 1996, gross interest income of $19,000 would
have been recorded on loans accounted for on a nonaccrual basis if the loans had
been current throughout the respective periods. Interest on such loans included
in income during that period amounted to $8,000.
At June 30, 1996, nonaccrual loans consisted of five mortgage loans secured
by single-family residential real estate properties aggregating $240,000. In
addition, the Company had no loans not classified as non-accrual, 90 days past
due or restructured where known information about possible credit problems of
borrowers caused management to have serious concerns as to the ability of the
borrowers to comply with present loan repayment terms and may result in
disclosure as non-accrual, 90 days past due or restructured.
11
<PAGE>
At June 30, 1996, the Company had $31,000 in real estate owned, which
consisted of one parcel of undeveloped, industrially zoned land located in the
Dundalk area of Baltimore County, Maryland.
Federal regulations require savings institutions to classify their assets
on the basis of quality on a regular basis. An asset meeting one of the
classification definitions set forth below may be classified and still be a
performing loan. An asset is classified as substandard if it is determined to be
inadequately protected by the current retained earnings and paying capacity of
the obligor or of the collateral pledged, if any. An asset is classified as
doubtful if full collection is highly questionable or improbable. An asset is
classified as loss if it is considered uncollectible, even if a partial recovery
could be expected in the future. The regulations also provide for a special
mention designation, described as assets which do not currently expose a savings
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's close
attention. Such assets designated as special mention may include nonperforming
loans consistent with the above definition. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings institution
must either establish a specific allowance for loss in the amount of the portion
of the asset classified loss, or charge off such amount. Federal examiners may
disagree with a savings institution's classifications. If a savings institution
does not agree with an examiner's classification of an asset, it may appeal this
determination to the OTS Regional Director. The Company regularly reviews its
assets to determine whether any assets require classification or re-
classification. At June 30, 1996, the Company had $1,048,000 in classified
assets, consisting of $777,000 in assets classified as special mention, $271,000
in assets classified as substandard, and no assets classified as doubtful or
loss. Special mention assets consisted of nine single-family residential
mortgage loans totalling $772,000 and one unsecured home improvement loan with
an unpaid principal balance of $5,000. The substandard assets consisted of five
single-family residential mortgage loans aggregating $240,000 and $31,000 in
real estate owned.
Allowance for Loan Losses. In originating loans, the Company recognizes
that credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan, general economic conditions and, in the case
of a secured loan, the quality of the security for the loan. It is management's
policy to maintain an adequate allowance for loan losses based on, among other
things, the Company's and the industry's historical loan loss experience,
evaluation of economic conditions, regular reviews of delinquencies and loan
portfolio quality and evolving standards imposed by federal bank examiners. The
Company increases its allowance for loan losses by charging provisions for
possible loan losses against the Company's income.
Management will continue to actively monitor the Company's asset quality
and allowance for loan losses. Management will charge off loans and properties
acquired in settlement of loans against the allowances for losses on such loans
and such properties when appropriate and will provide specific loss allowances
when necessary. Although management believes it uses the best information
available to make determinations with respect to the allowances for losses and
believes such allowances are adequate, future adjustments may be necessary if
economic conditions differ substantially from the economic conditions in the
assumptions used in making the initial determinations.
The Company's methodology for establishing the allowance for loan losses
takes into consideration probable losses that have been identified in connection
with specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of the Company's assets
and evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a quarterly basis based
on an assessment of risk in the Company's assets taking into consideration the
composition and quality of the portfolio, delinquency trends, current charge-off
and loss experience, loan concentrations, the state of the real estate market,
regulatory reviews conducted in the regulatory examination process and economic
conditions generally. Additional provisions for losses on loans are made in
order to bring the allowance to a level deemed adequate. Specific reserves will
be provided for individual assets, or portions of assets, when ultimate
collection is considered improbable by management based on the current payment
status of the assets and the fair value of the
12
<PAGE>
security. At the date of foreclosure or other repossession, the Company would
transfer the property to real estate acquired in settlement of loans initially
at the lower of cost or estimated fair value and subsequently at the lower of
book value or fair value less estimated selling costs. Any portion of the
outstanding loan balance in excess of fair value less estimated selling costs
would be charged off against the allowance for loan losses. If, upon ultimate
disposition of the property, net sales proceeds exceed the net carrying value of
the property, a gain on sale of real estate would be recorded. Management
anticipates that the Company's provisions for loan losses will increase in the
future as it implements the Board of Directors' strategy of continuing existing
lines of business while gradually expanding commercial real estate, commercial
business and consumer lending, which loans generally entail greater risks than
single-family residential mortgage loans.
Banking regulatory agencies, including the OTS, have adopted a policy
statement regarding maintenance of an adequate allowance for loan and lease
losses and an effective loan review system. This policy includes an arithmetic
formula for checking the reasonableness of an institution's allowance for loan
loss estimate compared to the average loss experience of the industry as a
whole. Examiners will review an institution's allowance for loan losses and
compare it against the sum of: (i) 50% of the portfolio that is classified
doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii)
for the portions of the portfolio that have not been classified (including those
loans designated as special mention), estimated credit losses over the upcoming
12 months given the facts and circumstances as of the evaluation date. This
amount is considered neither a "floor" nor a "safe harbor" of the level of
allowance for loan losses an institution should maintain, but examiners will
view a shortfall relative to the amount as an indication that they should review
management's policy on allocating these allowances to determine whether it is
reasonable based on all relevant factors.
The following table sets forth an analysis of the Company's allowance for
loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------
1996 1995
---- ----
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period................. $ 159 $ 156
Loans charged off:
Real estate mortgage:
Single-family residential.................... -- 12
Multi-family and commercial.................. -- --
Consumer and other........................... 8 --
----- -----
Total charge-offs.......................... 8 12
Recoveries..................................... -- --
----- -----
Net loans charged off.......................... 8 12
Provision for loan losses...................... 68 15
----- -----
Balance at end of period....................... $ 219 $ 159
===== =====
Ratio of net charge-offs to average
loans outstanding during the period.......... .02% .03%
===== =====
</TABLE>
13
<PAGE>
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.
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------
1996 1995
--------------------- ----------------------
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Amount Total Loans Amount Total Loans
------ -------------- ------ --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate mortgage:
Single-family residential.......... $163 89.85% $149 96.64%
Multi-family and commercial........ 12 2.26 8 2.52
Consumer and other.................... 44 7.89 2 0.84
---- ------ ---- ------
Total allowance for loan losses.. $219 100.00% $159 100.00%
==== ====== ==== ======
</TABLE>
INVESTMENT ACTIVITIES
General. The Company is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of Atlanta,
certificates of deposit in federally insured institutions, certain bankers'
acceptances and federal funds. It may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest investment
rating categories of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds. Federal
regulations require the Company to maintain an investment in FHLB stock and a
minimum amount of liquid assets which may be invested in cash and specified
securities. From time to time, the OTS adjusts the percentage of liquid
assets which savings banks are required to maintain.
The Company makes investments in order to maintain the levels of liquid
assets required by regulatory authorities and manage cash flow, diversify its
assets, obtain yield and to satisfy certain requirements for favorable tax
treatment. The investment activities of the Company consist primarily of
investments in mortgage-backed securities and other investment securities,
consisting primarily of securities issued or guaranteed by the U.S. government
or agencies thereof. Typical investments include federally sponsored agency
mortgage pass-through and federally sponsored agency and mortgage-related
securities. In addition, until July 1994, the Company maintained an
investment in a mutual fund that purchased adjustable-rate mortgages.
Investment and aggregate investment limitations and credit quality parameters
of each class of investment are prescribed in the Company's investment policy.
The Company performs analyses on mortgage-related securities prior to purchase
and on an ongoing basis to determine the impact on earnings and market value
under various interest rate and prepayment conditions. Under the Company's
current investment policy, securities purchases must be approved by the
Company's Asset/Liability Management Committee. The Company's Asset/Liability
Management Committee has limited authority to sell investment securities and
purchase comparable investment securities with similar characteristics. The
Board of Directors reviews all securities transactions on a monthly basis.
The Company adopted SFAS No. 115 as of July 1, 1994. The effect of
initial adoption of SFAS No. 115 was to decrease Stockholders' Equity as of
July 1, 1994 by approximately $30,800. In December 1995, the Company utilized
a one-time opportunity to change the classification of securities and, as a
result, designated its entire held-to-maturity portfolio with an amortized
cost of $21.3 million and an unrealized net loss of $73,000 as available-for-
sale. Pursuant to SFAS No. 115, investment securities classified as held-to-
maturity are recorded at amortized cost and those classified as available-for-
sale are reported at fair value, with unrealized gains and losses excluded
from earnings and reported as a separate component of stockholders' equity.
At June 30, 1996, the Company's entire portfolio of investment securities was
classified as available for sale and had an aggregate carrying value of $17.2
million and an unrealized net loss after tax of $107,000. As a result,
management of the Company currently does
14
<PAGE>
not anticipate that the presence of unrealized losses in the Company's
portfolio of investment securities and mortgage-backed securities is likely to
have a material adverse effect on the Company's financial condition, results
of operations or liquidity. Securities designated as "held to maturity" are
those assets which the Company has the ability and intent to hold to maturity.
Upon acquisition, securities are classified as to the Company's intent, and a
sale would only be effected due to deteriorating investment quality. The held
to maturity investment portfolio is not used for speculative purposes and is
carried at amortized cost. In the event the Company sells securities from
this portfolio for other than credit quality reasons, all securities within
the investment portfolio with matching characteristics may be reclassified as
assets available-for-sale. Securities designated as "available-for-sale" are
those assets which the Company may not hold to maturity and thus are carried
at market value with unrealized gains or losses, net of tax effect, recognized
in retained earnings.
Mortgage-Backed and Related Securities. Mortgage-backed securities
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators through intermediaries that pool and repackage the
participation interest in the form of securities to investors such as the
Company. Such intermediaries may include quasi-governmental agencies such as
FHLMC, FNMA and Government National Mortgage Association ("GNMA") which
guarantee the payment of principal and interest to investors. Mortgage-backed
securities generally increase the quality of the Company's assets by virtue of
the guarantees that back them, are more liquid than individual mortgage loans
and may be used to collaterize borrowings or other obligations of the Company.
Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have similar maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate mortgage loans. Mortgage-backed securities generally are
referred to as mortgage participation certificates or pass-through
certificates. As a result, the interest rate risk characteristics of the
underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as
prepayment risk, are passed on to the certificate holder. The life of a
mortgage-backed pass-through security is equal to the life of the underlying
mortgages.
The actual maturity of a mortgage-backed security varies, depending on
when the mortgagors prepay or repay the underlying mortgages. Prepayments of
the underlying mortgages may shorten the life of the investment, thereby
adversely affecting its yield to maturity and the related market value of the
mortgage-backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed
securities are amortized or accredited over the estimated term of the
securities using a level yield method. The prepayment assumptions used to
determine the amortization period for premiums and discounts can significantly
affect the yield of the mortgage-backed security, and these assumptions are
reviewed periodically to reflect the actual prepayment. The actual
prepayments of the underlying mortgages depend on many factors, including the
type of mortgage, the coupon rate, the age of the mortgages, the geographical
location of the underlying real estate collateralizing the mortgages and
general levels of market interest rates. The difference between the interest
rates on the underlying mortgages and the prevailing mortgage interest rates
is an important determinant in the rate of prepayments. During periods of
falling mortgage interest rates, prepayments generally increase, and,
conversely, during periods of rising mortgage interest rates, prepayments
generally decrease. If the coupon rate of the underlying mortgage
significantly exceeds the prevailing market interest rates offered for
mortgage loans, refinancing generally increases and accelerates the prepayment
of the underlying mortgages. Prepayment experience is more difficult to
estimate for adjustable-rate mortgage-backed securities.
Mortgage-related securities, which include collateralized mortgage
obligations ("CMOs"), are typically issued by a special purpose entity, which
may be organized in a variety of legal forms, such as a trust, a corporation
or a partnership. The entity aggregates pools of pass-through securities,
which are used to collateralize the mortgage-related securities. Once
combined, the cash flows can be divided into "tranches" or "classes" of
individual securities, thereby creating more predictable average lives for
each security than the underlying pass-through pools.
15
<PAGE>
Accordingly, under this security structure, all principal paydowns from the
various mortgage pools are allocated to a mortgage-related securities' class
or classes structured to have priority until it has been paid off. These
securities generally have fixed interest rates, and, as a result, changes in
interest rates generally would affect the market value and possibly the
prepayment rates of such securities.
Some mortgage-related securities instruments are like traditional debt
instruments due to their stated principal amounts and traditionally defined
interest rate terms. Purchasers of certain other mortgage-related securities
instruments are entitled to the excess, if any, of the issuer's cash flows.
These mortgage-related securities instruments may include instruments
designated as residual interest and are riskier in that they could result in
the loss of a portion of the original investment. Cash flows from residual
interests are very sensitive to prepayments and, thus, contain a high degree
of interest rate risk. The Company does not purchase residual interests in
mortgage-related securities.
The Company's mortgage-backed and related securities portfolio consists
primarily of seasoned fixed-rate and adjustable-rate, mortgage-backed and
related securities. The Company makes such investments in order to manage
cash flow, diversify assets, obtain yield, to satisfy certain requirements for
favorable tax treatment and to satisfy the qualified thrift lender test. See
" -- Depository Institution Regulation -- Qualified Thrift Lender Test."
At June 30, 1996, mortgage-backed securities with a carrying value of
$12.8 million were held as available for sale. At June 30, 1996, the
Company's mortgage-backed securities had a weighted average yield of 6.44%.
At June 30, 1996, the Company had within its mortgage-backed securities
portfolio CMOs with a carrying value of $10.2 million, representing 12.9% of
total assets. The Company's CMOs had a weighted average yield of 6.43% at
June 30, 1996. The Company's investment policy permits investments in
individual issues of CMOs or Real Estate Mortgage Investment Conduits
("REMICs") that are not considered "high risk" securities under OTS policies.
The following table sets forth the carrying value of the Company's
investments at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
----------------------
1996 1995
--------- --------
(Dollars in thousands)
<S> <C> <C>
Securities available for sale:
U.S. government and agency securities.. $ 4,424 $ 2,894
Mortgage-backed securities............. 12,778 3,350
------- -------
Total securities available for sale.. 17,202 6,244
Securities held to maturity:
U.S. government and agency securities.. -- 11,936
Mortgage-backed securities............. -- 12,422
Mutual funds........................... -- --
------- -------
Total securities held to maturity.... -- 24,358
------- -------
Total investment securities....... 17,202 30,602
FHLB stock.............................. 491 491
------- -------
Total investments $17,693 $31,093
======= =======
</TABLE>
16
<PAGE>
The following table sets forth information in the scheduled maturities,
amortized cost, market values and average yields for the Company's investment
portfolio at June 30, 1996.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
----------------- ------------------ ------------------ -------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- ------- --------- ------- --------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
securities................... $ -- --% $2,467 4.53% $ 1,957 7.35% $ -- --%
Mortgage-backed securities..... -- -- -- -- 8,644 6.44 4,134 6.44
------ ------ ------- ------
Total........................ $ -- $2,467 4.53 $10,601 6.61 $4,134 6.44
====== ====== ======= ======
</TABLE>
<TABLE>
<CAPTION>
Total Investment Portfolio
--------------------------------
Carrying Market Average
Value Value Yield
-------- ---------- ---------
<S> <C> <C> <C>
Securities available for sale: $ 4,424 $ 4,424 5.78%
U.S. government and agency
securities................... 12,778 12,778 6.44
Mortgage-backed securities..... ------- -------
Total........................ $17,202 $17,202 6.27
======= =======
</TABLE>
17
<PAGE>
The Company is required to maintain average daily balances of liquid
assets (cash, deposits maintained pursuant to Federal Reserve Board
requirements, time and savings deposits in certain institutions, obligations
of state and political subdivisions thereof, shares in mutual funds with
certain restricted investment policies, highly rated corporate debt, and
mortgage loans and mortgage-backed securities with less than one year to
maturity or subject to repurchase within one year) equal to a monthly average
of not less than a specified percentage (currently 5%) of its net withdrawable
savings deposits plus short-term borrowings. Savings banks are also required
to maintain average daily balances of short-term liquid assets at a specified
percentage (currently 1%) of the total of their net withdrawable savings
accounts and borrowings payable in one year or less. Monetary penalties may
be imposed for failure to meet liquidity requirements. The average liquidity
and short-term liquidity ratios of the Company for the month of June 1996 were
8.5% and 12.6%, respectively.
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
General. Deposits are the primary source of the Company's funds for
lending, investment activities and general operational purposes. In addition
to deposits, the Company derives funds from loan principal and interest
repayments, maturities of investment securities and mortgage-backed securities
and interest payments thereon. Although loan repayments are a relatively
stable source of funds, deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings
may be used on a short-term basis to compensate for reductions in the
availability of funds, or on a longer term basis for general operational
purposes. The Company has access to borrow from the FHLB of Atlanta. Upon
completion of the Bank Conversion, the Bank will still have access to FHLB of
Atlanta advances.
Deposits. The Company attracts deposits principally from within its
market area by offering a variety of deposit instruments, including checking
accounts, Christmas Club accounts, money market accounts, statement and
passbook savings accounts, Individual Retirement Accounts, and certificates of
deposit which range in maturity from seven days to five years. Deposit terms
vary according to the minimum balance required, the length of time the funds
must remain on deposit and the interest rate. Maturities, terms, service fees
and withdrawal penalties for its deposit accounts are established by the
Company on a periodic basis. The Company reviews its deposit mix and pricing
on a weekly basis. In determining the characteristics of its deposit accounts,
the Company considers the rates offered by competing institutions, lending and
liquidity requirements, growth goals and federal regulations. Management
believes it prices its deposits comparably to rates offered by its
competitors. The Company does not accept brokered deposits.
The Company attempts to compete for deposits with other institutions in
its market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Company seeks to
meet customers' needs by providing convenient customer service to the
community, efficient staff and convenient hours of service. Substantially all
of the Company's depositors are Maryland residents. To provide additional
convenience, the Company participates in the MOST Automatic Teller Machine
network at locations throughout the United States, through which customers can
gain access to their accounts at any time. To better serve its customers, the
Company has installed automatic teller machines at its office in Dundalk and
at Dundalk Community College.
18
<PAGE>
The following tables set forth the average balances based on month-end
balances and interest rates for various types of deposits as of the dates
indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------
1996 1995
----------------- -----------------
Average Average Average Average
Balance Rate Balance Rate
------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Passbook, statement savings
and Christmas Club........... $18,693 3.07% $20,352 3.06%
NOW checking.................. 2,781 2.41 2,596 2.37
Money market.................. 4,636 3.52 4,847 3.63
Certificates of deposit....... 37,063 5.52 33,473 4.54
Noninterest-bearing checking.. 1,223 -- 1,034 --
------- -------
Total....................... $64,396 $62,302
======= =======
</TABLE>
The following table indicates the amount of the Company's certificates of
deposit of $100,000 or more by time remaining until maturity as of June 30,
1996. At such date, such deposits represented 1.95% of total deposits and had
a weighted average rate of 5.42%.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- -------------
(In thousands)
<S> <C>
Three months or less........... $ 303
Over three through six months.. 213
Over six through 12 months..... 321
Over 12 months................. 414
------
Total...................................... $1,251
======
</TABLE>
Borrowings. Savings deposits historically have been the primary source
of funds for the Company's lending, investments and general operating
activities. The Company is authorized, however, to use advances from the FHLB
of Atlanta to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB of Atlanta functions as a central reserve
bank providing credit for savings institutions and certain other member
financial institutions. As a member of the FHLB System, the Company is
required to own stock in the FHLB of Atlanta and is authorized to apply for
advances. Advances are pursuant to several different programs, each of which
has its own interest rate and range of maturities. The Company has a Blanket
Agreement for advances with the FHLB under which the Company may borrow up to
25% of assets subject to normal collateral and underwriting requirements.
Advances from the FHLB of Atlanta are secured by the Company's stock in the
FHLB of Atlanta and other eligible assets. During fiscal 1994, 1995 and 1996,
the Company had no borrowings other than FHLB advances. At June 30, 1996, the
Company had no FHLB advances outstanding. The Bank will be a member of the
FHLB system following the Bank Conversion.
19
<PAGE>
The following table sets forth certain information regarding short-term
borrowings by the Company at the dates and for the periods indicated:
<TABLE>
<CAPTION>
At June 30,
----------------------
1996 1995
------ ------
(Dollars in thousands)
<S> <C> <C>
Amounts outstanding at end of period:
FHLB advances.......................... $ -- $5,000
Weighted average rate paid on:
FHLB advances.......................... --% 5.93%
</TABLE>
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------
1996 1995
------ ------
(Dollars in thousands)
<S> <C> <C>
Maximum amount of borrowings outstanding
at any month end:
FHLB advances.......................... $5,000 $7,000
</TABLE>
<TABLE>
<CAPTION>
At June 30,
----------------------
1996 1995
------ ------
(Dollars in thousands)
<S> <C> <C>
Approximate average short-term borrowings
outstanding with respect to:
FHLB advances.......................... $3,282 $5,042
Approximate weighted average rate paid
on: (1)
FHLB advances.......................... 5.68% 5.59%
- --------------------
</TABLE>
(1) Weighted average rate paid is derived from dividing the actual interest
expense by the average daily short-term borrowings outstanding.
SUBSIDIARY ACTIVITIES
As a federally chartered savings and loan association, the Company is
permitted to invest an amount equal to 2% of its assets in subsidiaries, with
an additional investment of 1% of assets where such investment serves
primarily community, inner-city and community development purposes. Under
such limitations, as of June 30, 1996, the Company was authorized to invest up
to approximately $2.3 million in the stock of or loans to subsidiaries,
including the additional 1% investment for community inner-city and community
development purposes. Institutions meeting their applicable minimum
regulatory capital requirements may invest up to 50% of their regulatory
capital in conforming first mortgage loans to subsidiaries in which they own
10% or more of the capital stock.
The Bank has one subsidiary service corporation, PFSL Holding Corp.
("PFSL"), which it formed in November 1995 to hold certain real estate it
acquired in foreclosure.
20
<PAGE>
COMPETITION
The Company faces strong competition both in originating real estate and
consumer loans and in attracting deposits. The Company competes for real
estate and other loans principally on the basis of interest rates, the types
of loans it originates, the deposit products it offers and the quality of
services it provides to borrowers. The Company also competes by offering
products which are tailored to the local community. Its competition in
originating real estate loans comes primarily from other savings institutions,
commercial banks and mortgage bankers. Commercial banks, credit unions and
finance companies provide vigorous competition in consumer lending.
Competition may increase as a result of the continuing reduction of
restrictions on the interstate operations of financial institutions.
Management considers its market area for gathering deposits to be eastern
Baltimore County in Maryland. The Company originates loans throughout the
Baltimore metropolitan area. The Company attracts its deposits through its
office in Dundalk primarily from the local community. Consequently,
competition for deposits is principally from other savings institutions,
commercial banks, credit unions, mutual funds and brokers in the local
community. The Company competes for deposits and loans by offering what it
believes to be a variety of deposit accounts at competitive rates, convenient
business hours, a commitment to outstanding customer service and a well-
trained staff. The Company believes it has developed strong relationships
with local realtors and the community in general.
EMPLOYEES
As of June 30, 1996, the Company had 25 full-time and no part-time
employees, none of whom were represented by a collective bargaining agreement.
Management considers the Company's relationships with its employees to be
good.
DEPOSITORY INSTITUTION REGULATION
General. The Association is a federally chartered stock savings
institution, is a member of the FHLB of Atlanta and its deposits are insured
by the FDIC through the SAIF. As a federal savings institution, the
Association is subject to regulation and supervision by the OTS and the FDIC
and to OTS regulations governing such matters as capital standards, mergers,
establishment of branch offices, subsidiary investments and activities and
general investment authority. The OTS periodically examines the Association
for compliance with various regulatory requirements and for safe and sound
operations. The FDIC also has the authority to conduct special examinations
of the Association because its deposits are insured by the SAIF. The
Association must file reports with the OTS describing its activities and
financial condition and must obtain the approval of the OTS prior to entering
into certain transactions, such as mergers with or acquisitions of other
depository institutions. This regulatory oversight will continue to apply
until consummation of the Bank Conversion.
Upon consummation of the Bank Conversion, the Bank will be a Maryland
commercial bank and its deposit accounts will continue to be insured by the
SAIF. The Bank also will become a member of the Federal Reserve System. The
Bank will be subject to supervision, examination and regulation by the State
of Maryland Commissioner of Financial Regulation ("Commissioner") (rather than
the OTS) and the Federal Reserve Board and to Maryland and federal statutory
and regulatory provisions governing such matters as capital standards, mergers
and establishment of branch offices, and it will remain subject to the FDIC's
authority to conduct special examinations. The Bank will be required to file
reports with the Commissioner and the Federal Reserve Board 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 a federally insured depository institution, the Association is, and
the Bank will be, subject to various regulations promulgated by the Federal
Reserve Board, including Regulation B (Equal Credit Opportunity),
21
<PAGE>
Regulation D (Reserve Requirements), Regulations 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 Association,
and that will be applicable to the Bank, establishes a comprehensive framework
for the operations of the Association, and the Bank and is intended primarily
for the protection of the FDIC and the depositors of the Association and, upon
completion of the Bank Conversion, the Bank. Changes in the regulatory
framework could have a material effect on the Association and the Bank and
their respective operations that in turn, could have a material adverse effect
on the Company.
Capital Requirements. At June 30, 1996, the Association exceeded all
minimum regulatory capital requirements. Under OTS capital standards, savings
associations must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3% of adjusted total assets, and a combination
of core and "supplementary" capital equal to 8% of "risk-weighted" assets. In
addition, the OTS has adopted regulations which impose certain restrictions on
savings associations that have a total risk-based capital ratio that is less
than 8%, a ratio of Tier 1 capital to risk-weighted assets of less than 4% or
a ratio of Tier 1 capital to adjusted total assets of less than 4% (or 3% if
the institution is rated Composite 1 under the OTS examination rating system).
See "-- Prompt Corrective Regulatory Action." The Association is in
compliance with all currently applicable capital requirements. For purposes
of this regulation, Tier 1 capital has the same definition as core capital
which is defined as common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited
exceptions to the deduction of intangible assets are provided for mortgage
servicing rights, purchased credit card relationships and qualifying
supervisory goodwill held by an eligible savings association. Tangible
capital is given the same definition as core capital but does not include an
exception for qualifying supervisory goodwill and is reduced by the amount of
all the savings association's intangible assets with only a limited exception
for mortgage servicing rights and purchased credit card relationships.
Both core and tangible capital are further reduced by an amount equal to
a gradually increasing percentage of the savings association's debt and equity
investments in subsidiaries engaged in activities not permissible for national
banks, other than subsidiaries engaged in activities undertaken as agent for
customers or in mortgage banking activities and subsidiary depository
institutions or holding companies. At June 30, 1996, the Association had no
such investments.
Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles, increased for
certain goodwill amounts and increased by a prorated portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require the
savings association to net its debt and equity investments in such
subsidiaries against capital, as well as a prorated portion of the assets of
other subsidiaries for which netting is not fully required under phase-in
rules. Adjusted total assets are reduced by the amount of assets that have
been deducted from capital, the portion of savings association's investments
in subsidiaries that must be netted against capital under the capital rules
and, for purposes of the core capital requirement, qualifying supervisory
goodwill. At June 30, 1996, the Association's adjusted total assets for
purposes of the core and tangible capital requirements were $76.7 million.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital, provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to
include certain preferred stock issues, nonwithdrawable accounts and pledged
deposits that do not qualify as core capital, certain approved subordinated
debt, certain other capital instruments and a portion of the savings
association's general loan and lease loss allowances.
22
<PAGE>
Total core and supplementary capital are reduced by the amount of capital
instruments held by other depository institutions pursuant to reciprocal
arrangements and by an increasing percentage of the savings association's high
loan-to-value ratio land loans, non-residential construction loans and equity
investments other than those deducted from core and tangible capital. As of
June 30, 1996, the Association had no high ratio land or non-residential
construction loans and no equity investments for which OTS regulations require
a phased deduction from total capital.
The risk-based capital requirement is measured against risk-weighted
assets which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one-to-four family first mortgages not
more than 90 days past due with original loan-to-value ratios under 80%,
multi-family mortgages (maximum 36 dwelling units) with loan-to-value ratios
under 80% and average annual occupancy rates of at least 80%, and certain
qualifying loans for the construction of one- to four-family residences pre-
sold to home purchasers are assigned a risk weight of 50%. Consumer and
residential construction loans are assigned a risk weight of 100%. Mortgage-
backed securities issued, or fully guaranteed as to principal and interest, by
the FNMA or FHLMC are assigned a 20% risk weight. Cash and U.S. Government
securities backed by the full faith and credit of the U.S. Government (such as
mortgage-backed securities issued by GNMA) are given a 0% risk weight.
The table below provides information with respect to the Association's
compliance with its regulatory capital requirements at June 30, 1996.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
-------- ------------
(Dollars in thousands)
<S> <C> <C>
Tangible capital................ $9,607 12.55%
Tangible capital requirement.... 1,150 1.50
------ -----
Excess (deficit).............. $8,457 11.05%
====== =====
Core capital (2)................ $9,607 12.55%
Core capital requirement........ 2,301 3.00
------ -----
Excess (deficit).............. $7,306 9.55%
====== =====
Risk-based capital.............. $9,826 28.67%
Risk-based capital requirement.. 2,742 8.00
------ -----
Excess (deficit).............. $7,084 20.67%
====== =====
- ------------------------
</TABLE>
(1) Based on adjusted total assets for purposes of the tangible capital and
core capital requirements and risk-weighted assets for purpose of the
risk-based capital requirement.
(2) Reflects the capital requirement which the Association must satisfy to
avoid regulatory restrictions that may be imposed pursuant to prompt
corrective action regulations. The core requirement applicable to the
Association may increase if the OTS amends its capital regulations, as it
has proposed, in response to the more stringent leverage ratio adopted by
the Office of the Comptroller of the Currency for national banks.
OTS risk-based capital requirements require savings institutions with
more than a "normal" level of interest rate risk to maintain additional total
capital. A savings institution's interest rate risk will be measured in terms
of the sensitivity of its "net portfolio value" to changes in interest rates.
Net portfolio value is defined, generally, as the present value of expected
cash inflows from existing assets and off-balance sheet contracts less the
present value of expected cash outflows from existing liabilities. A savings
institution will be considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200
basis point increase or decrease in market interest rates (whichever results
in the greater decline) is less than two percent of the current
23
<PAGE>
estimated economic value of its assets. A savings institution with a greater
than normal interest rate risk will be required to deduct from total capital,
for purposes of calculating its risk-based capital requirement, an amount (the
"interest rate risk component") equal to one-half the difference between the
institution's measured interest rate risk and the normal level of interest rate
risk, multiplied by the economic value of its total assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Institutions
with less than $300 million in assets and a risk-based capital ratio above 12%,
like the Association, generally are exempt from filing the interest rate risk
schedule with their Thrift Financial Reports. However, the OTS will require any
exempt institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis and may be subject to
an additional capital requirement based upon its level of interest rate risk as
compared to its peers.
The OTS has proposed an amendment to its capital regulations establishing a
minimum core capital ratio of 3.00% for savings institutions rated composite 1
under the OTS CAMEL examination rating system. For all other savings
associations, the minimum core capital ratio would be from 4.00% to 5.00%. In
determining the amount of additional core capital, the OTS would assess both the
quality of risk management systems and the level of overall risk in each
individual savings institution through the supervisory process on a case-by-case
basis.
In addition to requiring generally applicable capital standards for
savings institutions, the OTS is authorized to establish the minimum level of
capital for a savings institution at such amount or at such ratio of capital-
to-assets as the OTS determines to be necessary or appropriate for such
institution in light of the particular circumstances of the institution. The
OTS may treat the failure of any savings institution to maintain capital at or
above such level as an unsafe or unsound practice and may issue a directive
requiring any savings institution which fails to maintain capital at or above
the minimum level required by the OTS to submit and adhere to a plan for
increasing capital. Such an order may be enforced in the same manner as an
order issued by the FDIC.
Upon consummation of the Bank Conversion, the Bank will be subject to
Federal Reserve Board capital requirements as well as statutory capital
requirements imposed under Maryland law. Federal Reserve Board regulations
establish two capital standards for state-chartered banks that are members of
the Federal Reserve System ("state member banks"): a leverage requirement and a
risk-based capital requirement. In addition, the Federal Reserve may on a case-
by-case basis, establish individual minimum capital requirements for a bank that
vary from the requirements which would otherwise apply under Federal Reserve
Board regulations. A bank that fails to satisfy the capital requirements
established under the Federal Reserve Board's regulations will be subject to
such administrative action or sanctions as the Federal Reserve Board deems
appropriate.
The leverage ratio adopted by the Federal Reserve Board requires a minimum
ratio of "Tier 1 capital" to adjusted total assets of 3% for banks rated
composite 1 under the CAMEL rating system for banks. Banks not rated composite 1
under the CAMEL rating system for banks are required to maintain a minimum ratio
of Tier 1 capital to adjusted total assets of 4% to 5%, depending upon the level
and nature of risks of their operations. For purposes of the Federal Reserve
Board's leverage requirement, Tier 1 capital generally consists of the same
components as core capital under the OTS's capital regulations, except that no
intangibles except certain mortgage servicing rights and purchased credit card
relationships may be included in capital.
The risk-based capital requirements established by the Federal Reserve
Board's regulations require state member banks to maintain "total capital" equal
to at least 8% of total risk-weighted assets. For purposes of the risk-based
capital requirement, "total capital" means Tier 1 capital (as described above)
plus "Tier 2 capital" (as described below), provided that the amount of Tier 2
capital may not exceed the amount of Tier 1 capital, less certain assets. The
components of Tier 2 capital under the Federal Reserve Board's regulations
generally correspond to the components of supplementary capital under OTS
regulations. Total risk-weighted assets generally are determined
24
<PAGE>
under the Federal Reserve Board's regulations in the same manner as under the
OTS's regulations, except that the Federal Reserve Board regulations establish
only four risk categories, with risk weights of 0%, 20%, 50% and 100%.
The Federal Reserve Board has proposed to revise its risk-based capital
requirements to ensure that such requirements provide for explicit consideration
of interest rate risk. Under the proposed rule, a state member bank's interest
rate risk exposure would be quantified using either the measurement system set
forth in the proposal or the bank's internal model for measuring such exposure,
if such model is determined to be adequate by the bank's examiner. If the dollar
amount of a bank's interest rate risk exposure, as measured under either
measurement system, exceeds 1% of the bank's total assets, the bank would be
required under the proposed rule to hold additional capital equal to the dollar
amount of the excess. Management of the Association has not determined what
effect, if any, the Federal Reserve Board's proposed interest rate risk
component would have on the Bank's capital if adopted as proposed.
In addition, the Bank will be subject to the statutory capital requirements
imposed by the State of Maryland. Under Maryland statutory law, if the surplus
of a Maryland commercial bank at any time is less than 100% of its capital
stock, then, until the surplus is 100% of the capital stock, the commercial
bank: (i) must transfer to its surplus annually at least 10% of its net
earnings; and (ii) may not declare or pay any cash dividends that exceed 90% of
its net earnings. In addition, the Bank will be subject to Federal Reserve Board
capital requirements. Federal Reserve Board regulations establish two capital
standards for national banks: a leverage requirement and a risk-based capital
requirement.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A "significantly
undercapitalized" institution, as well as any undercapitalized institution that
did not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution could also
be required to divest the institution or the institution could be required to
divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total assets
falls below a "critical capital level," the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
25
<PAGE>
Federal banking regulators have adopted regulations implementing the prompt
corrective action provisions of FDICIA. Under these regulations, the federal
banking regulators will generally measure a depository institution's capital
adequacy on the basis of the institution's total risk-based capital ratio (the
ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital
ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio
(the ratio of its core capital to adjusted total assets). Under the regulations,
an institution that is not subject to an order or written directive by its
primary federal regulator to meet or maintain a specific capital level will be
deemed "well capitalized" if it also has: (i) a total risk-based capital ratio
of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater;
and (iii) a leverage ratio of 5.0% or greater. An "adequately capitalized"
depository institution is an institution that does not meet the definition of
well capitalized and has: (i) a total risk-based capital ratio of 8.0% or
greater; (ii) a Tier 1 risk-based capital ratio of 4.0% or greater; and (iii) a
leverage ratio of 4.0% or greater (or 3.0% or greater if the depository
institution has a composite 1 CAMEL rating). An "undercapitalized institution"
is a depository institution that has (i) a total risk-based capital ratio less
than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii)
a leverage ratio of less than 4.0% (or less than 3.0% if the institution has a
composite 1 CAMEL rating). A "significantly undercapitalized" institution is
defined as a depository institution that has: (i) a total risk-based capital
ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than
3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically
undercapitalized" institution is defined as a depository institution that has a
ratio of "tangible equity" to total assets of less than 2.0%. Tangible equity is
defined as core capital plus cumulative perpetual preferred stock (and related
surplus) less all intangibles other than qualifying supervisory goodwill and
certain mortgage servicing rights. The appropriate federal banking agency may
reclassify a well capitalized depository institution as adequately capitalized
and may require an adequately capitalized or undercapitalized institution to
comply with the supervisory actions applicable to institutions in the next lower
capital category (but may not reclassify a significantly undercapitalized
institution as critically under-capitalized) if it determines, after notice and
an opportunity for a hearing, that the institution is in an unsafe or unsound
condition or that the institution has received and not corrected a less-than-
satisfactory rating for any CAMEL rating category. At June 30, 1996, the
Association was classified as "well capitalized" under OTS regulations, and
management of the Association believes that the Bank will, immediately after the
Conversion, also be classified as "well-capitalized" under Federal Reserve Board
regulations.
Safety and Soundness Guidelines. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal banking agency is required to establish safety and soundness
standards for institutions under its authority. On July 10, 1995, the federal
banking agencies, including the OTS and the Federal Reserve Board, released
Interagency Guidelines Establishing Standards for Safety and Soundness and
published a final rule establishing deadlines for submission and review of
safety and soundness compliance plans. The final rule and the guidelines went
into effect on August 9, 1995. The guidelines require depository institutions to
maintain internal controls and information systems and internal audit systems
that are appropriate for the size, nature and scope of the institution's
business. The guidelines also establish certain basic standards for loan
documentation, credit underwriting, interest rate risk exposure, and asset
growth. The guidelines further provide that depository institutions should
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and should
take into account factors such as comparable compensation practices at
comparable institutions. If the appropriate federal banking agency determines
that a depository institution is not in compliance with the safety and soundness
guidelines, it may require the institution to submit an acceptable plan to
achieve compliance with the guidelines. A depository institution must submit an
acceptable compliance plan to its primary federal regulator within 30 days of
receipt of a request for such a plan. Failure to submit or implement a
compliance plan may subject the institution to regulatory sanctions. Management
believes that the Association meets substantially all the standards adopted in
the interagency guidelines.
Additionally under FDICIA, as amended by the CDRI Act, the federal banking
agencies are required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
federal banking agencies, including the OTS and the Federal Reserve Board,
issued proposed guidelines relating to asset quality and earnings. Under the
proposed guidelines, an FDIC insured depository institution should maintain
systems, commensurate with its size and the nature and scope of its operations,
to identify problem assets
26
<PAGE>
and prevent deterioration in those assets as well as to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves. Management believes that the asset quality and earnings standards,
in the form proposed by the banking agencies, would not have a material effect
on the operations of the Association or the Bank.
Federal Home Loan Bank System. The FHLB System consists of 12 district
FHLBs subject to supervision and regulation by the Federal Housing Finance Board
("FHFB"). The FHLBs provide a central credit facility primarily for member
institutions. As a member of the FHLB of Atlanta, the Association is required to
acquire and hold shares of capital stock in the FHLB of Atlanta in an amount at
least equal to 1% of the aggregate unpaid principal of its home mortgage loans,
home purchase contracts, and similar obligations at the beginning of each year,
or 1/20 of its advances (borrowings) from the FHLB of Atlanta, whichever is
greater. The Association was in compliance with this requirement with investment
in FHLB of Atlanta stock at June 30, 1996 of $491,000. The FHLB of Atlanta
serves as a reserve or central bank for its member institutions within its
assigned district. It is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB System. It offers advances to members in
accordance with policies and procedures established by the FHFB and the Board of
Directors of the FHLB of Atlanta. Long-term advances may only be made for the
purpose of providing funds for residential housing finance. At June 30, 1996,
the Association had no advances outstanding from the FHLB of Atlanta. Upon
completion of the Bank Conversion, the Bank will continue to be a member of the
FHLB of Atlanta.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts. No reserves are required to be
maintained on the first $4.3 million of transaction accounts, reserves equal to
3% must be maintained on the next $52.0 million of transaction accounts, and a
reserve of 10% must be maintained against all remaining transaction accounts.
These reserve requirements are subject to adjustment by the Federal Reserve
Board. Because required reserves must be maintained in the form of vault cash or
in a noninterest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's interest-
earning assets. At June 30, 1996, the Association met its reserve requirements.
Upon completion of the Bank Conversion, the Bank will become a member of
the Federal Reserve System and will subscribe for stock in the Federal Reserve
Bank of Richmond in an amount equal to 6% of the Bank's paid-up capital and
surplus. The Bank will continue to be subject to the reserve requirements to
which the Association is presently subject under Federal Reserve Board
regulations.
The monetary policies and regulations of the Federal Reserve Board have a
significant effect on the operating results of commercial banks. The Federal
Reserve Board's policies affect the levels of bank loans, investments and
deposits through its open market operation in United States government
securities, its regulation of the interest rate on borrowings of member banks
from Federal Reserve Banks and its imposition of non-earning reserve
requirements on all depository institutions, such as the Bank, that maintain
transaction accounts or non-personal time deposits.
Deposit Insurance. The Association's savings deposits are insured by the
SAIF, which is administered by the FDIC. The assessment rate currently ranges
from 0.23% of deposits for well capitalized institutions to 0.31% of deposits
for undercapitalized institutions. The FDIC also administers the BIF, which has
the same designated reserve ratio as the SAIF. The deposit insurance assessment
rate for most commercial banks and other depository institutions with deposits
insured by the BIF ranges from .27% of insured deposits for undercapitalized
BIF-insured institutions to a statutory minimum of $2,000 annually for well-
capitalized institutions, which constitute over 90% of the BIF-insured
institutions. The existing substantial disparity in the deposit insurance
premiums paid by BIF and SAIF members places SAIF-insured savings institutions,
such as the Association, at a significant competitive disadvantage to BIF-
insured institutions. See "Recent Developments -- Special Assessment."
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Under the FDIC's risk-based deposit insurance assessment system, 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 seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
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. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
Although the Bank, as a Maryland commercial bank, would qualify for
insurance of deposits by the BIF of the FDIC, the Bank will be prohibited under
current federal law from converting from SAIF to BIF insurance. Accordingly,
following the Bank Conversion, the Bank will remain a member of the SAIF, which
will insure the deposits of the Bank to a maximum of $100,000 for each insured
member. Because the Bank will continue to be a SAIF member, its deposit
insurance assessments will be determined on the same basis as the deposit
insurance assessments paid by the Association. Under federal statute, the
prohibition on conversion from SAIF to BIF insurance will continue until such
time as the SAIF's ratio of reserves to insured deposits (the "reserve ratio")
equals 1.25%. Based on projections published by the FDIC, the SAIF reserve ratio
is not expected to reach 1.25% for a number of years.
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, would not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than mortgage servicing rights and qualifying supervisory goodwill
eligible for inclusion in core capital under OTS regulations and minus
identified losses and investments in certain securities subsidiaries. Insured
depository institutions with Tier 1 capital equal to or greater than 2% of total
assets may also be deemed to be operating in an unsafe or unsound condition
notwithstanding such capital level. The regulation further provides that in
considering applications that must be submitted to it by savings associations,
the FDIC will take into account whether the savings association is meeting with
the Tier 1 capital requirement for state non-member banks of 4% of total assets
for all but the most highly rated state non-member banks.
Liquidity Requirements. The Association is required under OTS regulations
to maintain average daily balances of liquid assets (cash, deposits maintained
pursuant to Federal Reserve Board reserve requirements, time and savings
deposits in certain institutions, obligations of the United States and states
and political subdivisions thereof, shares in mutual funds with certain
restricted investment policies, highly rated corporate debt, and mortgage loans
and mortgage-related securities with less than one year to maturity or subject
to pre-arranged sale within one year) equal to the monthly average of not less
than a specified percentage (currently 5%) of its net withdrawable savings
deposits plus short-term borrowings. The Association is also required to
maintain average daily balances of short-term liquid assets at a specified
percentage (currently 1%) of the total of their net withdrawable savings
accounts and borrowings payable in one year or less. Monetary penalties may be
imposed for failure to meet liquidity requirements. The average daily and short-
term liquidity ratios of the Association for the month of June 1996 were
approximately 8.5% and 12.6%, respectively.
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Upon consummation of the Bank Conversion, the Bank will be subject to the
reserve requirements imposed by the State of Maryland. A Maryland commercial
bank is required to have at all times a reserve equal to at least 15% of its
demand deposits. The board of directors of a Maryland commercial bank must by
resolution direct the commercial bank to maintain this reserve ratio in: (i)
cash on hand; (ii) demand deposits in a bank of good standing in any state; or
(iii) as to 5% of its demand deposits, on approval of the Commissioner, (a)
registered or coupon bonds, or (b) general obligations guaranteed by the
United States government, an agency of the United States government, the State
of Maryland, or any political subdivision. Additionally, A Maryland
commercial bank must have at all times a reserve equal to at least 3% of all
time deposits. Time deposit reserves must be kept in: (i) cash on hand; (ii)
deposits in a bank of good standing in any state; or (iii) direct obligations
of the United States government or of the State of Maryland. Under the
Maryland statute, "demand deposits" are defined as deposits payable within 30
days and "time deposits" are defined to be deposits that are payable after 30
days, including a savings account or certificate of deposit that requires at
least a 30-day notice before payment. Assuming completion of the Bank
Conversion, the Bank would (as of June 30, 1996) be in compliance with
Maryland's reserve requirements.
Qualified Thrift Lender Test. A savings institution that does not meet
the Qualified Thrift Lender ("QTL") test must either convert to a bank charter
or comply with the following restrictions on its operations: (i) the
institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for
a national bank; (ii) the branching powers of the institution shall be
restricted to those of a national bank; (iii) the institution shall not be
eligible to obtain any advances from its FHLB; and (iv) payment of dividends
by the institution shall be subject to the rules regarding payment of
dividends by a national bank. Upon the expiration of three years from the
date the institution ceases to be a QTL, it must cease any activity and not
retain any investment not permissible for a national bank and immediately
repay any outstanding FHLB advances (subject to safety and soundness
considerations).
To meet the QTL test, an institution's "Qualified Thrift Investments"
must total at least 65% of "portfolio assets." Under OTS regulations,
portfolio assets are defined as total assets less intangibles, property used
by a savings institution in its business and liquidity investments in an
amount not exceeding 20% of assets. Qualified Thrift Investments consist of
(i) loans, equity positions or securities related to domestic, residential
real estate or manufactured housing and (ii) 50% of the dollar amount of
residential mortgage loans subject to sale under certain conditions. In
addition, subject to a 20% of portfolio assets limit, savings institutions are
able to treat as Qualified Thrift Investments 200% of their investments in
loans to finance "starter homes" and loans for construction, development or
improvement of housing and community service facilities or for financing small
businesses in "credit-needy" areas.
In addition, a savings institution must maintain its status as a QTL on
a monthly basis in nine out of every 12 months. A savings institution that
fails to maintain Qualified Thrift Lender status will be permitted to
requalify once, and if it fails the QTL test a second time, it will become
immediately subject to all penalties as if all time limits on such penalties
had expired. Failure to qualify as a QTL results in a number of sanctions,
including the imposition of certain operating restrictions imposed on national
banks and a restriction on obtaining additional advances from the Federal Home
Loan Bank System. Upon failure to qualify as a QTL for two years, a savings
association must convert to a commercial bank. At June 30, 1996, the
Association qualified as a QTL. The QTL test, and the penalties for failing
to maintain QTL status, will not be applicable following the Bank Conversion.
Dividend Restrictions. Under OTS regulations, the Association may not
pay dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Association at the time of the
Stock Conversion. See Note 10 of Notes to Consolidated Financial Statements
contained in the Company's Annual Report to Stockholders attached hereto as
Exhibit 13. In addition, savings institution subsidiaries of savings and loan
holding companies are required to give the OTS 30 days prior notice of any
proposed declaration of dividends to the holding company.
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OTS regulations impose additional limitations on the payment of dividends
and other capital distributions (including stock repurchases and cash mergers)
by the Association. Under these regulations, a savings institution that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS
regulation) that is equal to or greater than the amount of its fully phased-in
capital requirements (a "Tier 1 Association") is generally permitted, without
OTS approval after notice, to make capital distributions during a calendar
year in the amount equal to the greater of: (i) 75% of its net income for the
previous four quarters; or (ii) up to 100% of its net income to date during
the calendar year plus an amount that would reduce by one-half the amount by
which its capital-to-assets ratio exceeded regulatory requirements at the
beginning of the calendar year. A savings institution with total capital in
excess of current minimum capital ratio requirements, but not in excess of its
fully phased-in requirements (a "Tier 2 Association") is permitted, after
notice, to make capital distributions without OTS approval of up to 75% of its
net income for the previous four quarters, less dividends already paid for
such period. A savings institution that fails to meet current minimum capital
requirements (a "Tier 3 Association") is prohibited from making any capital
distributions without the prior approval of the OTS. A Tier 1 Association
that has been notified by the OTS that its is in need of more than normal
supervision will be treated as either a Tier 2 or Tier 3 Association. The
Association is a Tier 1 Association. The Association is also prohibited from
making any capital distributions if after making the distribution, the
Association would have: (i) a total risk-based capital ratio of less than
8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. See "-- Prompt Corrective Regulatory
Action."
Following the Bank Conversion, the Bank's ability to pay dividends will
not be subject to the limitations in the OTS regulations but will instead be
governed by the Maryland General Corporation Law, Maryland law relating to
financial institutions, and the regulations of the Federal Reserve Board.
Under the Maryland General Corporation Law, dividends may not be paid if,
after giving effect to the dividend: (i) the corporation would not be able to
pay the indebtedness of the corporation as the indebtedness becomes due in the
normal course of business; or (ii) the corporation's total assets would be
less than the sum of the corporation's total liabilities plus, unless the
charter permits otherwise, the amount needed, if the corporation were to be
dissolved at the time of distribution, to satisfy the preferential rights upon
dissolution of stockholders whose preferential rights are superior to those
receiving the dividend. Under Maryland law relating to financial
institutions, if the surplus of a commercial bank at any time is less than
100% of its capital stock, then, until the surplus is 100% of the capital
stock, the commercial bank: (i) must transfer to its surplus annually at least
10% of its net earnings; and (ii) may not declare or pay any cash dividends
that exceed 90% of its net earnings.
The Bank's payment of dividends will also be subject to the Federal
Reserve Board's Regulation H, which limits the dividends payable by a state
member bank to the net profits of the Bank then on hand, less the Bank's
losses and bad debts. Additionally, the Federal Reserve Board has the
authority to prohibit the payment of dividends by a Maryland commercial bank
when it determines such payment to be an unsafe and unsound banking practice.
Finally, the Bank, like the Association, would not be able to pay dividends on
its capital stock if its capital would thereby reduced below the remaining
balance of the liquidation account established in connection with the Stock
Conversion.
Uniform Lending Standards. Under OTS and Federal Reserve Board
regulations, savings banks and state member banks must adopt and maintain
written policies that establish appropriate limits and standards for
extensions of credit that are secured by liens or interests in real estate or
are made for the purpose of financing permanent improvements to real estate.
These policies must establish loan portfolio diversification standards,
prudent underwriting standards, including loan-to-value limits, that are clear
and measurable, loan administration procedures and documentation, approval and
reporting requirements. The real estate lending policies of savings
associations and state member banks must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") that have been adopted by the federal banking agencies.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured
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by raw land, the supervisory loan-to-value limit is 65% of the value of the
collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multifamily or other nonresidential property, the supervisory limit is 80%;
(iv) for loans for the construction of one-to-four family properties, the
supervisory limit is 85%; and (v) for loans secured by other improved property
(e.g., farmland, completed commercial property and other income-producing
property including non-owner-occupied, one-to-four family property), the limit
is 85%. Although no supervisory loan-to-value limit has been established for
owner-occupied, one-to-four family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate
credit enhancement in the form of either mortgage insurance or readily
marketable collateral.
The Interagency Guidelines state that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of
the supervisory loan-to-value limits, based on the support provided by other
credit factors. The aggregate amount of loans in excess of the supervisory
loan-to-value limits, however, should not exceed 100% of total capital and the
total of such loans secured by commercial, agricultural, multifamily and other
non-one-to-four family residential properties should not exceed 30% of total
capital. The supervisory loan-to-value limits do not apply to certain
categories of loans including loans insured or guaranteed by the U.S.
government and its agencies or by financially capable state, local or
municipal governments or agencies, loans backed by the full faith and credit
of a state government, loans that are to be sold promptly after origination
without recourse to a financially responsible party, loans that are renewed,
refinanced or restructured without the advancement of new funds, loans that
are renewed, refinanced or restructured in connection with a workout, loans to
facilitate sales of real estate acquired by the institution in the ordinary
course of collecting a debt previously contracted and loans where the real
estate is not the primary collateral.
Management will periodically evaluate its lending policies to assure
conformity to the Interagency Guidelines and does not anticipate that the
Interagency Guidelines will have a material effect on its lending activities.
Limits on Loans to One Borrower. Savings institutions generally are
subject to the lending limits applicable to national banks. With certain
limited exceptions, the maximum amount that a savings institution may lend to
any borrower (including certain related entities of the borrower) at one time
may not exceed 15% of the unimpaired capital and surplus of the institution,
plus an additional 10% of unimpaired capital and surplus for loans fully
secured by readily marketable collateral. Savings institutions are
additionally authorized to make loans to one borrower, for any purpose, in an
amount not to exceed $500,000 or, by order of the Director of OTS, in an
amount not to exceed the lesser of $30,000,000 or 30% of unimpaired capital
and surplus to develop residential housing, provided: (i) the purchase price
of each single-family dwelling in the development does not exceed $500,000;
(ii) the savings institution is and continues to be in compliance with its
fully phased-in capital requirements; (iii) the loans comply with applicable
loan-to-value requirements, and; (iv) the aggregate amount of loans made under
this authority does not exceed 150% of unimpaired capital and surplus. The
lending limits generally do not apply to purchase money mortgage notes taken
from the purchaser of real property acquired by the institution in
satisfaction of debts previously contracted if no new funds are advanced to
the borrower and the institution is not placed in a more detrimental position
as a result of the sale. Certain types of loans are excepted from the lending
limits, including loans secured by savings deposits. At June 30, 1996, the
maximum amount that the Association could have loaned to any one borrower
without prior OTS approval was $1.4 million. At such date, the largest
aggregate amount of loans that the Association had outstanding to any one
borrower was $900,000.
Following the Bank Conversion, the Bank will be subject to Maryland
statutory law with respect to limits on loans to one borrower. Generally,
under Maryland law, the maximum amount that a commercial bank may loan to one
borrower at one time may not exceed: (i) 10% of the unimpaired capital and
surplus of the commercial bank; or (ii) 30% of the unimpaired capital and
surplus of the commercial bank if the excess over 10% is approved by a two-
thirds vote of the board of directors and is secured by currency or
obligations of the United States or obligations of the State of Maryland or
any political subdivision. Assuming completion of the Bank Conversion, the
Bank's
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lending limit to one borrower (as of June 30, 1996) without a vote of the
Bank's board of directors would be $950,000, and such limit would be $2.8
million if the loan was approved by a two-third vote of the board of directors
and was properly secured.
Transactions with Related Parties. Transactions between a savings
institution or a state member bank and any affiliate are governed by Sections
23A and 23B of the Federal Reserve Act. An affiliate of a savings institution
or state member bank is any company or entity which controls, is controlled by
or is under common control with the savings institution or state member bank.
In a holding company context, the parent holding company of a savings
institution or state member bank (such as the Company) and any companies which
are controlled by such parent holding company are affiliates of the savings
institution or state member bank. Generally, Sections 23A and 23B (i) limit
the extent to which an institution or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such
capital stock and surplus and (ii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the institution 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. In addition to the
restrictions imposed by Sections 23A and 23B, no savings institution or state
member bank may (i) loan or otherwise extend credit to an affiliate, except
for any affiliate which engages only in activities which are permissible for
bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for
affiliates which are subsidiaries of the savings institution or state member
bank.
Savings institutions and state member banks also are subject to the
restrictions contained in Section 22(h) of the Federal Reserve Act and the
Federal Reserve's Regulation O thereunder on loans to executive officers,
directors and principal stockholders. Under Section 22(h), loans to a
director, executive officer and to a greater than 10% stockholder of a savings
institution or state member bank and certain affiliated interests of such
persons, may not exceed, together with all other outstanding loans to such
person and affiliated interests, the institution's loans-to-one-borrower limit
(generally equal to 15% of the institution's unimpaired capital and surplus)
and all loans to such persons may not exceed the institution's unimpaired
capital and unimpaired surplus. Section 22(h) also prohibits loans, above
amounts prescribed by the appropriate federal banking agency, to directors,
executive officers and greater than 10% stockholders of a savings institution,
and their respective affiliates, unless such loan is approved in advance by a
majority of the board of directors of the institution with any "interested"
director not participating in the voting. Regulation O prescribes the loan
amount (which includes all other outstanding loans to such person) as to which
such prior board of director approval is required as being the greater of
$25,000 or 5% of capital and surplus (up to $500,000). Further, Section 22(h)
requires that loans to directors, executive officers and principal
stockholders be made on terms substantially the same as offered in comparable
transactions to other persons. Section 22(h) also generally prohibits a
depository institution from paying the overdrafts of any of its executive
officers or directors.
Savings institutions and state member banks also are subject to the
requirements and restrictions of Section 22(g) of the Federal Reserve Act on
loans to executive officers and the restrictions of 12 U.S.C. (S) 1972 on
certain tying arrangements and extensions of credit by correspondent banks.
Section 22(g) of the Federal Reserve Act requires loans to executive officers
of depository institutions not be made on terms more favorable than those
afforded to other borrowers, requires approval by the board of directors of a
depository institution for extension of credit to executive officers of the
institution, and imposes reporting requirements for and additional
restrictions on the type, amount and terms of credits to such officers.
Section 1972 (i) 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 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
exceptions, and (ii) prohibits extensions of credit to executive officers,
directors, and greater than 10% stockholders of a depository institution by
any other institution which has a correspondent banking relationship with the
institution, unless such extension of
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credit is on substantially the same terms as those prevailing at the time for
comparable transactions with other persons and does not involve more than the
normal risk of repayment or present other unfavorable features.
Additionally, Maryland statutory law imposes restrictions on certain
transactions with affiliates of Maryland commercial banks. Generally, under
Maryland law, a director, officer or employee of a commercial bank may not
borrow, directly or indirectly, any money from the bank, unless the loan has
been approved by a resolution adopted at and recorded in the minutes of the
board of directors of the bank, or the executive committee of the bank, if
that committee is authorized to make loans. If such a loan is approved by the
executive committee, the loan approval must be reported to the board of
directors at its next meeting. Certain commercial loans made to directors of
a bank and certain consumer loans made to non-officer employees of the bank
are exempt from the statute's coverage.
REGULATION OF THE COMPANY PRIOR TO THE BANK CONVERSION
General. The Company is a savings and loan holding company as defined by
the Home Owners' Loan Act and will remain such until consummation of the Bank
Conversion. As a savings and loan holding company, the Company is subject to
OTS regulation, examination, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, the Association is subject
to certain restrictions in its dealings with the Company and affiliates
thereof. The Company also is required to file certain reports with, and
otherwise comply with the rules and regulations of, the Securities and
Exchange Commission ("SEC") under the federal securities laws.
Activities Restrictions. The Board of Directors of the Company will
continue to operate the Company as a unitary savings and loan holding company
until consummation of the Bank Conversion. There are generally no
restrictions on the activities of a unitary savings and loan holding company.
However, if the Director of the OTS determines that there is reasonable cause
to believe that the continuation by a savings and loan holding company of an
activity constitutes a serious risk to the financial safety, soundness or
stability of its subsidiary savings institution, the Director of the OTS may
impose such restrictions as deemed necessary to address such risk including
limiting: (i) payment of dividends by the savings institution; (ii)
transactions between the savings institution and its affiliates; and (iii) any
activities of the savings institution that might create a serious risk that
the liabilities of the holding company and its affiliates may be imposed on
the savings institution. Notwithstanding the above rules as to permissible
business activities of unitary savings and loan holding companies, if the
savings institution subsidiary of such a holding company fails to meet the QTL
test, then such unitary holding company shall also presently become subject to
the activities restrictions applicable to multiple holding companies and,
unless the savings institution requalifies as a QTL within one year
thereafter, register as, and become subject to, the restrictions applicable to
a bank holding company. See " -- Depository Institution Regulation --
Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Association,
the Company would thereupon become a multiple savings and loan holding
company. Except where such acquisition is pursuant to the authority to
approve emergency thrift acquisitions and where each subsidiary savings
institution meets the QTL test, the activities of the Company and any of its
subsidiaries (other than the Association or other subsidiary savings
institutions) would thereafter be subject to further restrictions. Among
other things, no multiple savings and loan holding company or subsidiary
thereof which is not a savings institution shall commence or continue for a
limited period of time after becoming a multiple savings and loan holding
company or subsidiary thereof, any business activity, upon prior notice to,
and no objection by, the OTS, other than: (i) furnishing or performing
management services for a subsidiary savings institution; (ii) conducting an
insurance agency or escrow business; (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution; (iv)
holding or managing properties used or occupied by a subsidiary savings
institution; (v) acting as trustee under deeds of trust; (vi) those activities
authorized by regulation as of March 5, 1987 to be engaged in by multiple
holding companies; or (vii) unless the Director of the OTS by regulation
prohibits or limits such activities for savings and loan holding companies,
those activities authorized by the Federal Reserve Board as permissible for
bank holding companies. Those activities described in (vii) above must also
be approved by the Director of the OTS prior to being engaged in by a multiple
holding company.
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Restrictions on Acquisitions. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the Director of OTS, (i)
control of any other savings institution or savings and loan holding company
or substantially all the assets thereof or (ii) more than 5% of the voting
shares of a savings institution or holding company thereof which is not a
subsidiary. Under certain circumstances, a registered savings and loan
holding company is permitted to acquire, with the approval of the Director of
the OTS, up to 15% of the voting shares of an under-capitalized savings
institution pursuant to a "qualified stock issuance" without that savings
institution being deemed controlled by the holding company. In order for the
shares acquired to constitute a "qualified stock issuance," the shares must
consist of previously unissued stock or treasury shares, the shares must be
acquired for cash, the savings and loan holding company's other subsidiaries
must have tangible capital of at least 6-1/2% of total assets, there must not
be more than one common director or officer between the savings and loan
holding company and the issuing savings institution, and transactions between
the savings institution and the savings and loan holding company and any of
its affiliates must conform to Sections 23A and 23B of the Federal Reserve
Act. Except with the prior approval of the Director of the OTS, no director
or officer of a savings and loan holding company or person owning or
controlling by proxy or otherwise more than 25% of such company's stock, may
also acquire control of any savings institution, other than a subsidiary
savings institution, or of any other savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls
savings institutions in more than one state if: (i) the multiple savings and
loan holding company involved controls a savings institution which operated a
home or branch office in the state of the institution to be acquired as of
March 5, 1987; (ii) the acquiror is authorized to acquire control of the
savings institution pursuant to the emergency acquisition provisions of the
Federal Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
REGULATION OF THE COMPANY FOLLOWING THE BANK CONVERSION
General. Upon consummation of the Bank Conversion, the Company, as the
sole shareholder of the Bank, will become a bank holding company and will
register as such with the Federal Reserve Board. Bank holding companies are
subject to comprehensive regulation by the Federal Reserve Board under the
Bank Holding Company Act of 1956, as amended (the "BHCA"), and the regulations
of the Federal Reserve Board. As a bank holding company, the Company will be
required to file with the Federal Reserve Board annual reports and such
additional information as the Federal Reserve Board may require, and will be
subject to regular examinations by the Federal Reserve Board. The Federal
Reserve Board 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 Federal Reserve Board
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.
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 Federal Reserve Board 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
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<PAGE>
Federal Reserve Board 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. The Company has no present plans to engage in any of these
activities.
Under Maryland statutory law, acquisitions of 25% or more of the voting
stock of a commercial bank or a bank holding company and other acquisitions of
voting stock of such entities which affect the power to direct or to cause the
direction of the management or policy of a commercial bank or a bank holding
company must be approved in advance by the Commissioner. Any person proposing
to make such an acquisition must file an application with the Commissioner at
least 60 days before the acquisition becomes effective. The Commissioner may
deny approval of any such acquisition if the Commissioner determines that the
acquisition is anticompetitive or threatens the safety or soundness of a
banking institution. Any voting stock acquired without the approval required
under the statute may not be voted for a period of 5 years. This restriction
is not applicable to certain acquisitions by bank holding companies of the
stock of Maryland banks or Maryland bank holding companies which are governed
by Maryland's holding company statute.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and
its Application in Maryland. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Act") was enacted to ease restrictions on
interstate banking. Effective September 29, 1995, the Act allows the Federal
Reserve Board 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 Federal Reserve Board 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 Act also prohibits the Federal Reserve Board from
approving 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 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 Act.
Pursuant to the Act, the Federal Reserve Board may approve an application
of an adequately capitalized and adequately managed non-Maryland bank holding
company to acquire control of, or acquire all or substantially all of the
assets of, a Maryland bank, as long as certain requirements of the Act are
met.
Additionally, the Act authorizes the federal banking agencies, effective
June 1, 1997, 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 opts out of the Act by adopting a law after the
date of enactment of the Act and prior to June 1, 1997 that applies equally to
all out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. The State of Maryland has enacted legislation, effective
September 29, 1995, that authorizes interstate mergers involving Maryland
banks. The Maryland statute also authorizes out-of-state banks to establish
branch offices in Maryland by means of merger, branch acquisition or de novo
branching, provided that the home state of the out-of-state bank provides
reciprocal interstate branching authority to Maryland banks. Effective June
1, 1997, the Maryland statute will permit an out-of-state bank to branch into
Maryland without regard to the laws of such bank's home state.
Dividends. The Federal Reserve Board has issued a policy statement on
the payment of cash dividends by bank holding companies, which expresses the
Federal Reserve Board's view that a bank holding company should
35
<PAGE>
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 Federal Reserve Board 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 Federal Reserve Board pursuant to
FDICIA, the Federal Reserve Board may prohibit a bank holding company from
paying any dividends if the holding company's bank subsidiary is classified as
"undercapitalized". See "Depository Institution Regulation -- Prompt
Corrective Regulatory Action."
Bank holding companies are required to give the Federal Reserve Board
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 Federal Reserve Board 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, Federal
Reserve Board order, or any condition imposed by, or written agreement with,
the Federal Reserve Board.
Capital Requirements. The Federal Reserve Board 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. Since the Company's consolidated assets will be less than
$150 million, the Federal Reserve Board's holding company capital requirements
would not apply to the Company. However, assuming the application of such
requirements to the Company, the Company's levels of consolidated regulatory
capital would exceed the Federal Reserve Board's minimum requirements, as
follows:
<TABLE>
<CAPTION>
Amount Percent
---------- -----------
(Dollars in thousands)
<S> <C> <C>
Tier 1 capital.......................... $9,607 12.55%
Minimum Tier 1 (leverage) requirement... 3,067 4.00
------ -----
Excess............................... $6,540 8.55%
====== =====
Risk-based capital...................... $9,826 28.67%
Minimum risk-based capital requirement.. 2,742 8.00
------ -----
Excess............................... $7,084 20.67%
====== =====
</TABLE>
TAXATION
The Company and the Association, together with the Association's
subsidiary, will not file a consolidated federal income tax return.
Consolidated returns would have the effect of deferring gain or loss on
intercompany transactions and allowing companies included within the
consolidated return to offset income against losses under certain
circumstances.
FEDERAL INCOME TAXATION. Savings institutions such as the Association
are subject to the provisions of the Internal Revenue Code of 1986, as amended
(the "Internal Revenue Code") in the same general manner as other
corporations. However, institutions such as the Association which meet
certain definitional tests and other conditions prescribed by the Internal
Revenue Code may benefit from certain favorable provisions regarding their
deductions from taxable income for annual additions to their bad debt reserve.
For purposes of the bad debt reserve deduction, loans are separated into
"qualifying real property loans," which generally are loans secured by
interests in certain real property, and "nonqualifying loans", which are all
other loans. The bad debt reserve deduction with respect to
36
<PAGE>
nonqualifying loans must be based on actual loss experience. The amount of
the bad debt reserve deduction with respect to qualifying real property loans
may be based upon actual loss experience (the "experience method") or a
percentage of taxable income determined without regard to such deduction (the
"percentage of taxable income method"). Under the experience method, the bad
debt deduction for an addition to the reserve for qualifying real property
loans is an amount determined under a formula based generally on the bad debts
actually sustained by a savings institution over a period of years. Under the
percentage of taxable income method, the bad debt reserve deduction for
qualifying real property loans is computed as 8% of a savings institution's
taxable income, with certain adjustments. The Association generally has
elected to use the method which has resulted in the greatest deductions for
federal income tax purposes in any given year.
Recapture of the Bad Debt Reserve -- In general. To the extent (i) a
savings institution's reserve for losses on qualifying real property loans
under the percentage of income method exceeds the amount that would have been
allowed under the experience method and (ii) a savings institution makes
distributions to stockholders (including distributions in redemption,
dissolution or liquidation) that are considered to result in withdrawals from
that excess bad debt reserve, then the amounts considered withdrawn will be
included in the savings institution's taxable income. The amount that would
be deemed withdrawn from such reserves upon such distribution and which would
be subject to taxation at the savings institution level at the normal
corporate tax rate would be an amount that, when reduced by taxes on such
amount, would equal the amount actually distributed. Dividends paid out of a
savings institution's current or accumulated earnings and profits as
calculated for federal income tax purposes, however, will not be considered to
result in withdrawals from its bad debt reserves to the extent of such
earnings and profits. Dividends in excess of a savings institution's current
and accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation of a savings institution will
be considered to come from its bad debt reserve.
Reversal of Tax Bad Debt Recapture. Generally, savings and loan
associations that convert to commercial banks must recapture some or all of
their tax bad debt reserve established for federal income taxation purposes.
The Association incurred a $740,000 expense for recapture of a portion of its
tax bad debt reserve during the year ended June 30, 1995 in connection with
the determination of the Association's Board of Directors to convert the
Association to a Maryland commercial bank. After this determination was made,
legislation was introduced in Congress which provided that savings and loan
associations that convert to commercial banks will not be required to
recapture the portion of tax bad debt reserve accumulated prior to 1988.
Following the introduction of this legislation, the Board of Directors
determined to delay consummation of the Bank Conversion pending the outcome of
this legislation. The legislation ultimately was enacted into law on August
20, 1996. As a result of the enactment of this legislation, the Association
now intends to complete the Bank Conversion on or about September 30, 1996.
Further, the Company intends to reverse approximately $600,000 of the $740,000
expense previously incurred. The reversal of the tax bad debt reserve as
described above will be reflected as a reduction of tax expense during the
quarter ending September 30, 1996.
The Association's federal income tax returns have been audited through
June 30, 1995.
STATE INCOME TAXATION. The State of Maryland imposes an income tax of
approximately 7% on income measured substantially the same as federally
taxable income. In addition, Maryland imposes a franchise tax, at a rate of
0.013% of the total withdrawal value of the deposits that a savings and loan
association holds in Maryland at December 31 each year.
For additional information regarding taxation, see Note 8 of Notes to
Consolidated Financial Statements.
37
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
The following table sets forth the location and certain additional
information regarding the Association's office at June 30, 1996.
<TABLE>
<CAPTION>
Book Value at
Year Owned or June 30, Approximate
Opened Leased 1996 Square Footage
------ -------- -------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
MAIN OFFICE:
1301 Merritt Boulevard 1970 Owned $695 9,600
Dundalk, Maryland 21222-2194
</TABLE>
The book value of the Association's investment in premises and equipment
totaled $1.0 million at June 30, 1996. See Note 5 of Notes to Consolidated
Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Association is a party to various legal
proceedings incident to its business. At June 30, 1996, there were no legal
proceedings to which the Company or the Association was a party, or to which
any of their property was subject, which were expected by management to result
in a material loss to the Company or the Association. There are no pending
regulatory proceedings to which the Company, the Association or its subsidiary
is a party or to which any of their properties is subject which are currently
expected to result in a material loss.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information contained under the sections captioned "Market
Information" in the Company's Annual Report to Stockholders for the Fiscal
Year Ended June 30, 1996 (the "Annual Report") filed as Exhibit 13 hereto is
incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" on
pages 5 through 15 in the Annual Report is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements, Independent Auditors' Report and Selected Financial Data contained
on pages 16 through 49 in the Annual Report, which are listed under Item 13
herein, are incorporated herein by reference.
38
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
For information concerning the Board of Directors and executive officers
of the Company, the information contained under the section captioned
"Proposal I -- Election of Directors" in the Company's definitive proxy
statement for the Company's 1996 Annual Meeting of Stockholders (the "Proxy
Statement") is incorporated herein by reference.
Based solely on a review of beneficial ownership reports filed of Forms
3, 4 and 5, there were no delinquent filers of such reports for the fiscal
year ended June 30, 1996.
ITEM 10. EXECUTIVE COMPENSATION
The information contained under the sections captioned "Proposal I --
Election of Directors -- Executive Compensation" " -- Director Compensation,"
" -- Employment Agreements" in the Proxy Statement is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and Principal
Holders thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the sections captioned "Security Ownership of
Management" in 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 12. 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 -- Transactions
with Management" in the Proxy Statement.
39
<PAGE>
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K.
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(1) Financial Statements. The following consolidated financial
statements are incorporated by reference from Item 7 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Statement of Financial Condition as of June 30, 1996
and 1995
Consolidated Statements of Operations for the Years Ended June 30,
1996 and 1995
Consolidated Statements of Stockholders' Equity for the Years Ended
June 30, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended June 30,
1996 and 1995
Notes to Consolidated Financial Statements
(2) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-KSB and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
--- -----------
<C> <S>
* 3.1 Articles of Incorporation of Patapsco Bancorp, Inc.
* 3.2 Bylaws of Patapsco Bancorp, Inc.
** 4 Form of Common Stock Certificate of Patapsco Bancorp, Inc.
10.1 Patapsco Bancorp, Inc. 1996 Stock Option and Incentive Plan
10.2 Patapsco Bancorp, Inc. Management Recognition Plan
* 10.3(a) Employment Agreement between Patapsco Federal Savings and
Loan Association and Joseph J. Bouffard
* 10.3(b) Employment Agreement between Patapsco Bancorp, Inc. and
Joseph J. Bouffard
* 10.4(a) Severance Agreements between Patapsco Federal Savings and
Loan Association and Debra Brockschmidt, Timothy King, John McClean
and Joseph Sallese
* 10.4(b) Severance Agreements between Patapsco Bancorp, Inc. and
Debra Brockschmidt, Timothy King, John McClean and Joseph Sallese
for the year ended June 30, 1996.
* 10.5 Patapsco Federal Savings and Loan Association Retirement Plan
for Non-Employee Directors
* 10.6 Patapsco Federal Savings and Loan Association Incentive
Compensation Plan
* 10.7 Deferred Compensation Agreements between Patapsco Federal
Savings and Loan Association and each of Directors McGowan and
Patterson
* 10.8(a) Severance Agreement between Patapsco Federal Savings and
Loan Association and Frank J. Duchacek
* 10.8(b) Severance Agreement between Patapsco Bancorp, Inc. and
Frank J. Duchacek
13 1996 Annual Report to Stockholders
21 Subsidiary of the Registrant
27 Financial Data Schedule
</TABLE>
- ------------------
* Incorporated herein by reference from the Company's Registration Statement
on Form SB-2 (File No. 33-99734).
** Incorporated herein by reference from the Company's Registration Statement
on Form 8-A (File No. 0-28032).
(b) REPORTS ON FORM 8-K. During the quarter ended June 30, 1996,
the Registrant did not file any Current Reports on Form 8-K.
40
<PAGE>
SIGNATURES
In accordance with 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.
PATAPSCO BANCORP, INC.
September 25, 1996
By: /s/ Joseph J. Bouffard
-------------------------------------
Joseph J. Bouffard
President and Chief Executive Officer
In accordance with 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.
/s/ Joseph J. Bouffard September 25, 1996
- --------------------------------------------
Joseph J. Bouffard
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Timothy C. King September 25, 1996
- --------------------------------------------
Timothy C. King
Controller and Treasurer
(Principal Financial and Accounting Officer)
/s/ Joseph N. McGowan September 25, 1996
- --------------------------------------------
Joseph N. McGowan
Chairman of the Board
/s/ S. Robert Kinghorn September 25, 1996
- --------------------------------------------
S. Robert Kinghorn
Vice Chairman of the Board
/s/ Theodore C. Patterson September 25, 1996
- --------------------------------------------
Theodore C. Patterson
Secretary
/s/ Robert M. Lating September 25, 1996
- --------------------------------------------
Robert M. Lating
Director
/s/ Douglas H. Ludwig September 25, 1996
- --------------------------------------------
Douglas H. Ludwig
Director
/s/ Nicole N. Kantorski September 25, 1996
- --------------------------------------------
Nicole N. Kantorski
Director
/s/ Thomas P. O'Neill September 25, 1996
- --------------------------------------------
Thomas P. O'Neill
Director
<PAGE>
Exhibit 10.1
PATAPSCO BANCORP, INC.
1996 STOCK OPTION AND INCENTIVE PLAN
1. PURPOSE OF THE PLAN.
The purpose of this Patapsco Bancorp, Inc. 1996 Stock Option and Incentive
Plan (the "Plan") is to advance the interests of the Company through providing
select key Employees and Directors of the Association, the Company, and their
Affiliates with the opportunity to acquire Shares. By encouraging such stock
ownership, the Company seeks to attract, retain and motivate the best available
personnel for positions of substantial responsibility and to provide additional
incentive to Directors and key Employees of the Company or any Affiliate to
promote the success of the business.
2. DEFINITIONS.
As used herein, the following definitions shall apply.
(a) "Affiliate" shall mean any "parent corporation" or "subsidiary
corporation" of the Company, as such terms are defined in Section 424(e) and
(f), respectively, of the Code.
(b) "Agreement" shall mean a written agreement entered into in accordance
with Paragraph 5(c).
(c) "Association" shall mean Patapsco Federal Savings & Loan Association.
(d) "Awards" shall mean, collectively, Options and SARs, unless the context
clearly indicates a different meaning.
(e) "Board" shall mean the Board of Directors of the Company.
(f) "Code" shall mean the Internal Revenue Code of 1986, as amended.
(g) "Committee" shall mean the Stock Option Committee appointed by the
Board in accordance with Paragraph 5(a) hereof.
(h) "Common Stock" shall mean the common stock, par value $.01 per share,
of the Company.
(i) "Company" shall mean Patapsco Bancorp, Inc.
(j) "Continuous Service" shall mean the absence of any interruption or
termination of service as an Employee, Director, or honorary Director of the
Company or an Affiliate. Continuous Service shall not be considered interrupted
in the case of sick leave, military leave or any other leave of absence approved
by the Company, in the case of transfers between payroll locations of the
Company or between the Company, an Affiliate or a successor, or in the case of a
Director's performance of services in an emeritus, advisory, or honorary
capacity.
(k) "Director" shall mean any member of the Board, and any member of the
board of directors of any Affiliate that the Board has by resolution designated
as being eligible for participation in this Plan.
1
<PAGE>
(l) "Disability" shall mean a physical or mental condition, which in the
sole and absolute discretion of the Committee, is reasonably expected to be of
indefinite duration and to substantially prevent a Participant from fulfilling
his or her duties or responsibilities to the Company or an Affiliate.
(m) "Effective Date" shall mean the date specified in Paragraph 14 hereof.
(n) "Employee" shall mean any person employed by the Company, the
Association, or an Affiliate.
(o) "Exercise Price" shall mean the price per Optioned Share at which an
Option or SAR may be exercised.
(p) "ISO" means an option to purchase Common Stock which meets the
requirements set forth in the Plan, and which is intended to be and is
identified as an "incentive stock option" within the meaning of Section 422 of
the Code.
(q) "Market Value" shall mean the fair market value of the Common Stock, as
determined under Paragraph 7(b) hereof.
(r) "Non-employee Director" shall mean any member of the Board who, at the
time discretion under the Plan is exercised, is a "Non-employee Director" within
the meaning of Rule 16b-3.
(s) "Non-ISO" means an option to purchase Common Stock which meets the
requirements set forth in the Plan but which is not intended to be and is not
identified as an ISO.
(t) "Option" means an ISO and/or a Non-ISO.
(u) "Optioned Shares" shall mean Shares subject to an Option granted
pursuant to this Plan.
(v) "Participant" shall mean any person who receives an Award pursuant to
the Plan.
(w) "Plan" shall mean this Patapsco Bancorp, Inc. 1996 Stock Option and
Incentive Plan.
(x) "Rule 16b-3" shall mean Rule 16b-3 of the General Rules and Regulations
under the Securities Exchange Act of 1934, as amended.
(y) "Share" shall mean one share of Common Stock.
(z) "SAR" (or "Stock Appreciation Right") means a right to receive the
appreciation in value, or a portion of the appreciation in value, of a specified
number of shares of Common Stock.
3. TERM OF THE PLAN AND AWARDS.
(a) Term of the Plan. The Plan shall continue in effect for a term of ten
years from the Effective Date, unless sooner terminated pursuant to Paragraph 16
hereof. No Award shall be granted under the Plan after ten years from the
Effective Date.
(b) Term of Awards. The term of each Award granted under the Plan shall be
established by the Committee, but shall not exceed 10 years; provided, however,
that in the case of an Employee who owns Shares representing more than 10% of
the outstanding Common Stock at the time an ISO is granted, the term of such ISO
shall not exceed five years.
2
<PAGE>
4. SHARES SUBJECT TO THE PLAN.
(a) General Rule. Except as otherwise required by the provisions of
Paragraph 11 hereof, the aggregate number of Shares deliverable pursuant to
Awards shall not exceed 36,255 shares, which equals ten percent (10%) of the
Shares issued by the Company in connection with the Association's conversion
from mutual to stock form ("Conversion"). Such Shares may be (i) authorized but
unissued Shares, (ii) Shares held in treasury, or (iii) Shares held in a grantor
trust. If any Awards should expire, become unexercisable, or be forfeited for
any reason without having been exercised, the Optioned Shares shall, unless the
Plan shall have been terminated, be available for the grant of additional Awards
under the Plan.
(b) Special Rule for SARs. The number of Shares with respect to which an
SAR is granted, but not the number of Shares which the Company delivers or could
deliver to an Employee or individual upon exercise of an SAR, shall be charged
against the aggregate number of Shares remaining available under the Plan;
provided, however, that in the case of an SAR granted in conjunction with an
Option, under circumstances in which the exercise of the SAR results in
termination of the Option and vice versa, only the number of Shares subject to
the Option shall be charged against the aggregate number of Shares remaining
available under the Plan. The Shares involved in an Option as to which option
rights have terminated by reason of the exercise of a related SAR, as provided
in Paragraph 10 hereof, shall not be available for the grant of further Options
under the Plan.
5. ADMINISTRATION OF THE PLAN.
(a) Composition of the Committee. The Plan shall be administered by the
Committee, which shall consist of not less than two (2) members of the Board who
are Non-employee Directors. Members of the Committee shall serve at the
pleasure of the Board. In the absence at any time of a duly appointed
Committee, the Plan shall be administered by those members of the Board who are
Disinterested Persons.
(b) Powers of the Committee. Except as limited by the express provisions
of the Plan or by resolutions adopted by the Board, the Committee shall have
sole and complete authority and discretion (i) to select Participants and grant
Awards, (ii) to determine the form and content of Awards to be issued in the
form of Agreements under the Plan, (iii) to interpret the Plan, (iv) to
prescribe, amend and rescind rules and regulations relating to the Plan, and (v)
to make other determinations necessary or advisable for the administration of
the Plan. The Committee shall have and may exercise such other power and
authority as may be delegated to it by the Board from time to time. A majority
of the entire Committee shall constitute a quorum and the action of a majority
of the members present at any meeting at which a quorum is present, or acts
approved in writing by a majority of the Committee without a meeting, shall be
deemed the action of the Committee.
(c) Agreement. Each Award shall be evidenced by a written agreement
containing such provisions as may be approved by the Committee. Each such
Agreement shall constitute a binding contract between the Company and the
Participant, and every Participant, upon acceptance of such Agreement, shall be
bound by the terms and restrictions of the Plan and of such Agreement. The
terms of each such Agreement shall be in accordance with the Plan, but each
Agreement may include such additional provisions and restrictions determined by
the Committee, in its discretion, provided that such additional provisions and
restrictions are not inconsistent with the terms of the Plan. In particular,
the Committee shall set forth in each Agreement (i) the Exercise Price of an
Option or SAR, (ii) the number of Shares subject to, and the expiration date of,
the Award, (iii) the manner, time and rate (cumulative or otherwise) of exercise
or vesting of such Award, and (iv) the restrictions, if any, to be placed upon
such Award, or upon Shares which may be issued upon exercise of such Award.
The Chairman of the Committee and such other Directors and officers as
shall be designated by the Committee are hereby authorized to execute Agreements
on behalf of the Company and to cause them to be delivered to the recipients of
Awards.
3
<PAGE>
(d) Effect of the Committee's Decisions. All decisions, determinations
and interpretations of the Committee shall be final and conclusive on all
persons affected thereby.
(e) Indemnification. In addition to such other rights of indemnification
as they may have, the members of the Committee shall be indemnified by the
Company in connection with any claim, action, suit or proceeding relating to any
action taken or failure to act under or in connection with the Plan or any
Award, granted hereunder to the full extent provided for under the Company's
governing instruments with respect to the indemnification of Directors.
6. GRANT OF OPTIONS.
(a) General Rule. Only Employees shall be eligible to receive Awards. In
selecting those Employees to whom Awards will be granted and the number of
shares covered by such Awards, the Committee shall consider the position, duties
and responsibilities of the eligible Employees, the value of their services to
the Company and its Affiliates, and any other factors the Committee may deem
relevant. Notwithstanding the foregoing, the Committee shall automatically make
the Awards specified in Sections 6(b) and 9 hereof, and no Employee shall
receive Options to purchase more than 25% of the Shares reserved under Paragraph
4(a), and no Non-employee Director shall receive Options to purchase more than
5% of the Shares reserved under Paragraph 4(a), with all Non-employee Directors
as a group receiving Options on the Effective Date to purchase no more than 30%
of the Shares reserved under Paragraph 4(a).
(b) Automatic Grants to Employees. On the Effective Date, each of the
following Employees shall receive an Option (in the form of an ISO, to the
extent permissible under the Code) to purchase the number of Shares listed
below, at an Exercise Price per Share equal to the Market Value of a Share on
the Effective Date; provided that such grant shall not be made to an Employee
whose Continuous Service terminates on or before the Effective Date:
<TABLE>
<CAPTION>
Percentage of Shares
Participant Reserved under Paragraph 4(a)
----------- -----------------------------
<S> <C>
Joseph Bouffard 18.6%
Timothy King 9.3%
Debra Brockschmidt 9.3%
Jack McClean 9.3%
Joe Sallese 9.3%
</TABLE>
With respect to each of the above-named Participants, the Option granted to
the Participant hereunder (i) shall vest in accordance with the general rule set
forth in Paragraph 8(a) of the Plan, (ii) shall have a term of ten years from
the Effective Date, and (iii) shall be subject to the general rule set forth in
Paragraph 8(c) with respect to the effect of a Participant's termination of
Continuous Service on the Participant's right to exercise his Options.
(c) Special Rules for ISOs. The aggregate Market Value, as of the date the
Option is granted, of the Shares with respect to which ISOs are exercisable for
the first time by an Employee during any calendar year (under all incentive
stock option plans, as defined in Section 422 of the Code, of the Company or any
present or future Affiliate of the Company) shall not exceed $100,000.
Notwithstanding the foregoing, the Committee may grant Options in excess of the
foregoing limitations, in which case such Options granted in excess of such
limitation shall be Options which are Non-ISOs.
7. EXERCISE PRICE FOR OPTIONS.
(a) Limits on Committee Discretion. The Exercise Price as to any
particular Option shall not be less than 100% of the Market Value of the
Optioned Shares on the date of grant. In the case of an Employee who owns
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<PAGE>
Shares representing more than 10% of the Company's outstanding Shares of Common
Stock at the time an ISO is granted, the Exercise Price shall not be less than
110% of the Market Value of the Optioned Shares at the time the ISO is granted.
(b) Standards for Determining Exercise Price. If the Common Stock is
listed on a national securities exchange (including the NASDAQ National Market
System) on the date in question, then the Market Value per Share shall be the
average of the highest and lowest selling price on such exchange on such date,
or if there were no sales on such date, then the Exercise Price shall be the
mean between the bid and asked price on such date. If the Common Stock is
traded otherwise than on a national securities exchange on the date in question,
then the Market Value per Share shall be the mean between the bid and asked
price on such date, or, if there is no bid and asked price on such date, then on
the next prior business day on which there was a bid and asked price. If no
such bid and asked price is available, then the Market Value per Share shall be
its fair market value as determined by the Committee, in its sole and absolute
discretion.
8. EXERCISE OF OPTIONS.
(a) Generally. Each Option shall become exercisable with respect to
twenty percent (20%) of the Optioned Shares upon the Participant's completion of
each of five Years of Service, provided that an Option shall become fully (100%)
exercisable immediately upon termination of the Participant's Continuous Service
due to the Participant's Disability or death. An Option may not be exercised
for a fractional Share.
(b) Procedure for Exercise. A Participant may exercise Options, subject
to provisions relative to its termination and limitations on its exercise, only
by (1) written notice of intent to exercise the Option with respect to a
specified number of Shares, and (2) payment to the Company (contemporaneously
with delivery of such notice) in cash, in Common Stock, or a combination of cash
and Common Stock, of the amount of the Exercise Price for the number of Shares
with respect to which the Option is then being exercised. Each such notice (and
payment where required) shall be delivered, or mailed by prepaid registered or
certified mail, addressed to the Treasurer of the Company at the Company's
executive offices. Common Stock utilized in full or partial payment of the
Exercise Price for Options shall be valued at its Market Value at the date of
exercise, and may consist of Shares subject to the Option being exercised. Upon
a Participant's exercise of an Option, the Company shall pay the Participant a
cash amount equal to any dividends declared on the underlying Shares between the
date of grant and the date of exercise of the Option.
(c) Period of Exercisability. Except to the extent otherwise provided in
the terms of an Agreement, an Option may be exercised by a Participant only
while he is an Employee and has maintained Continuous Service from the date of
the grant of the Option, or within three months after termination of such
Continuous Service (but not later than the date on which the Option would
otherwise expire), except if the Employee's Continuous Service terminates by
reason of --
(1) "Just Cause" which for purposes hereof shall have the meaning set
forth in any unexpired employment or severance agreement between the
Participant and the Association and/or the Company (and, in the absence of
any such agreement, shall mean termination because of the Employee's
personal dishonesty, incompetence, willful misconduct, breach of fiduciary
duty involving personal profit, intentional failure to perform stated
duties, willful violation of any law, rule or regulation (other than
traffic violations or similar offenses) or final cease-and-desist order),
then the Participant's rights to exercise such Option shall expire on the
date of such termination;
(2) death, then to the extent that the Participant would have been
entitled to exercise the Option immediately prior to his death, such Option
of the deceased Participant may be exercised within two years from the date
of his death (but not later than the date on which the Option would
otherwise expire) by the
5
<PAGE>
personal representatives of his estate or person or persons to whom his
rights under such Option shall have passed by will or by laws of descent
and distribution;
(3) Disability, then to the extent that the Participant would have
been entitled to exercise the Option immediately prior to his or her
Disability, such Option may be exercised within one year from the date of
termination of employment due to Disability, but not later than the date on
which the Option would otherwise expire.
(d) Effect of the Committee's Decisions. The Committee's determination
whether a Participant's Continuous Service has ceased, and the effective date
thereof, shall be final and conclusive on all persons affected thereby.
9. GRANTS OF OPTIONS TO NON-EMPLOYEE DIRECTORS
(a) Automatic Grants. Notwithstanding any other provisions of this Plan,
honorary Director Frank Carey and each Director who is not an Employee but is a
Director on the Effective Date shall receive, on said date, Non-ISOs to purchase
the number of Shares listed below. Such Non-ISOs shall have an Exercise Price
per Share equal to the Market Value of a Share on the date of grant.
<TABLE>
<CAPTION>
Number
Participant of Shares
----------- ---------
<S> <C>
Joseph N. McGowan, Chairman of the Board 1,345
S. Robert Kinghorn, Vice Chairman of the Board 1,813
Theodore C. Patterson, Secretary 1,770
Nicole N. Kantorski 1,302
Robert M. Lating 1,685
Douglas H. Ludwig 1,557
Thomas P. O'Neill 1,404
Frank W. Carey, Honary Director --
</TABLE>
Each Director who joins the Board after the Effective Date and who is not then
an Employee shall receive, on the date of joining the Board, Non-ISOs to
purchase 1% of the Shares reserved under Paragraph 4(a) of the Plan, at an
Exercise Price per Share equal to its Market Value on the date of grant.
(b) Terms of Exercise. Options received under the provisions of this
Paragraph will become exercisable in accordance with the general rule set forth
in Paragraph 8(a) hereof, and may be exercised from time to time by (a) written
notice of intent to exercise the Option with respect to all or a specified
number of the Optioned Shares, and (b) payment to the Company (contemporaneously
with the delivery of such notice), in cash, in Common Stock, or a combination of
cash and Common Stock, of the amount of the Exercise Price for the number of the
Optioned Shares with respect to which the Option is then being exercised. Each
such notice and payment shall be delivered, or mailed by prepaid registered or
certified mail, addressed to the Treasurer of the Company at the Company's
executive offices. Upon a Director's exercise of an Option, the Company shall
pay the Participant a cash amount equal to any dividends declared on the
underlying Shares between the date of grant and the date of exercise of the
Option. A Director who exercises Options pursuant to this Paragraph may satisfy
all applicable federal, state and local income and employment tax withholding
obligations, in whole or in part, by irrevocably electing to have the Company
withhold shares of Common Stock, or to deliver to the Company shares of Common
Stock that he already owns, having a value equal to the amount required to be
withheld; provided that to the extent not inconsistent herewith, such election
otherwise complies with those requirements of Paragraphs 8 and 20 hereof.
Options granted under this Paragraph shall have a term of ten years;
provided that Options granted under this Paragraph shall (i) become exercisable
in accordance with paragraph 8(a) of the Plan, and (ii) expire one year
6
<PAGE>
after the date on which a Director terminates Continuous Service as a voting
member on the Board, or five years after the date on which a Director retires at
or after age 72, but in no event later than the date on which such Options would
otherwise expire. In the event of such Director's death during the term of his
directorship, Options granted under this Paragraph shall become immediately
exercisable, and may be exercised within two years from the date of his death by
the personal representatives of his estate or person or persons to whom his
rights under such Option shall have passed by will or by laws of descent and
distribution, but in no event later than the date on which such Options would
otherwise expire. In the event of such Director's Disability during his or her
directorship, the Director's Option shall become immediately exercisable, and
such Option may be exercised within one year of the termination of directorship
due to Disability, but not later than the date that the Option would otherwise
expire. Unless otherwise inapplicable or inconsistent with the provisions of
this Paragraph, the Options to be granted to Directors hereunder shall be
subject to all other provisions of this Plan.
(c) Effect of the Committee's Decisions. The Committee's determination
whether a Participant's Continuous Service has ceased, and the effective date
thereof, shall be final and conclusive on all persons affected thereby.
10. SARS (STOCK APPRECIATION RIGHTS)
(a) Granting of SARs. In its sole discretion, the Committee may from time
to time grant SARs to Employees either in conjunction with, or independently of,
any Options granted under the Plan. An SAR granted in conjunction with an Option
may be an alternative right wherein the exercise of the Option terminates the
SAR to the extent of the number of shares purchased upon exercise of the Option
and, correspondingly, the exercise of the SAR terminates the Option to the
extent of the number of Shares with respect to which the SAR is exercised.
Alternatively, an SAR granted in conjunction with an Option may be an additional
right wherein both the SAR and the Option may be exercised. An SAR may not be
granted in conjunction with an ISO under circumstances in which the exercise of
the SAR affects the right to exercise the ISO or vice versa, unless the SAR, by
its terms, meets all of the following requirements:
(1) The SAR will expire no later than the ISO;
(2) The SAR may be for no more than the difference between the Exercise
Price of the ISO and the Market Value of the Shares subject to the ISO at
the time the SAR is exercised;
(3) The SAR is transferable only when the ISO is transferable, and under
the same conditions;
(4) The SAR may be exercised only when the ISO may be exercised; and
(5) The SAR may be exercised only when the Market Value of the Shares
subject to the ISO exceeds the Exercise Price of the ISO.
(b) Exercise Price. The Exercise Price as to any particular SAR shall not
be less than the Market Value of the Optioned Shares on the date of grant.
(c) Timing of Exercise. Any election by a Participant to exercise SARs
shall be made during the period beginning on the 3rd business day following the
release for publication of quarterly or annual financial information and ending
on the 12th business day following such date. This condition shall be deemed to
be satisfied when the specified financial data is first made publicly available.
In no event, however, may an SAR be exercised within the six-month period
following the date of its grant.
The provisions of Paragraph 8(c) regarding the period of exercisability of
Options are incorporated by reference herein, and shall determine the period of
exercisability of SARs.
7
<PAGE>
(d) Exercise of SARs. An SAR granted hereunder shall be exercisable at
such times and under such conditions as shall be permissible under the terms of
the Plan and of the Agreement granted to a Participant, provided that an SAR may
not be exercised for a fractional Share. Upon exercise of an SAR, the
Participant shall be entitled to receive, without payment to the Company except
for applicable withholding taxes, an amount equal to the excess of (or, in the
discretion of the Committee if provided in the Agreement, a portion of) the
excess of the then aggregate Market Value of the number of Optioned Shares with
respect to which the Participant exercises the SAR, over the aggregate Exercise
Price of such number of Optioned Shares. This amount shall be payable by the
Company, in the discretion of the Committee, in cash or in Shares valued at the
then Market Value thereof, or any combination thereof.
(e) Procedure for Exercising SARs. To the extent not inconsistent
herewith, the provisions of Paragraph 8(b) as to the procedure for exercising
Options are incorporated by reference, and shall determine the procedure for
exercising SARs.
11. EFFECT OF CHANGES IN COMMON STOCK SUBJECT TO THE PLAN.
(a) Recapitalizations; Stock Splits, Etc. The number and kind of shares
reserved for issuance under the Plan, and the number and kind of shares subject
to outstanding Awards, and the Exercise Price thereof, shall be proportionately
adjusted for any increase, decrease, change or exchange of Shares for a
different number or kind of shares or other securities of the Company which
results from a merger, consolidation, recapitalization, reorganization,
reclassification, stock dividend, split-up, combination of shares, or similar
event in which the number or kind of shares is changed without the receipt or
payment of consideration by the Company.
(b) Transactions in which the Company is Not the Surviving Entity. In the
event of (i) the liquidation or dissolution of the Company, (ii) a merger or
consolidation in which the Company is not the surviving entity, or (iii) the
sale or disposition of all or substantially all of the Company's assets (any of
the foregoing to be referred to herein as a "Transaction"), all outstanding
Awards, together with the Exercise Prices thereof, shall be equitably adjusted
for any change or exchange of Shares for a different number or kind of shares or
other securities which results from the Transaction.
(c) Special Rule for ISOs. Any adjustment made pursuant to subparagraphs
(a) or (b)(1) hereof shall be made in such a manner as not to constitute a
modification, within the meaning of Section 424(h) of the Code, of outstanding
ISOs.
(d) Conditions and Restrictions on New, Additional, or Different Shares or
Securities. If, by reason of any adjustment made pursuant to this Paragraph, a
Participant becomes entitled to new, additional, or different shares of stock or
securities, such new, additional, or different shares of stock or securities
shall thereupon be subject to all of the conditions and restrictions which were
applicable to the Shares pursuant to the Award before the adjustment was made.
(e) Other Issuances. Except as expressly provided in this Paragraph, the
issuance by the Company or an Affiliate of shares of stock of any class, or of
securities convertible into Shares or stock of another class, for cash or
property or for labor or services either upon direct sale or upon the exercise
of rights or warrants to subscribe therefor, shall not affect, and no adjustment
shall be made with respect to, the number, class, or Exercise Price of Shares
then subject to Awards or reserved for issuance under the Plan.
12. NON-TRANSFERABILITY OF AWARDS.
Awards may not be sold, pledged, assigned, hypothecated, transferred or
disposed of in any manner other than by will or by the laws of descent and
distribution. Notwithstanding the foregoing, or any other provision of this
Plan, an Optionee who holds Options that are not Incentive Stock Options within
the meaning of Section 422 of the Code may transfer such Options to his or her
spouse, lineal ascendants, lineal descendants, or to a duly
8
<PAGE>
established trust for the benefit of one or more of these individuals. Options
so transferred may thereafter be transferred only to the Optionee who originally
received the grant or to an individual or trust to whom the Optionee could have
initially transferred the Option pursuant to this Paragraph. Options which are
transferred pursuant to this Paragraph shall be exercisable by the transferee
according to the same terms and conditions as applied to the Optionee.
13. TIME OF GRANTING AWARDS.
The date of grant of an Award shall, for all purposes, be the later of the
date on which the Committee makes the determination of granting such Award, and
the Effective Date. Notice of the determination shall be given to each
Participant to whom an Award is so granted within a reasonable time after the
date of such grant.
14. EFFECTIVE DATE.
The Plan shall become effective immediately upon its approval by a
favorable vote of stockholders owning at least a majority of the total votes
eligible to be cast at a duly called meeting of the Company's stockholders held
in accordance with applicable laws, provided that the Plan shall not be
submitted for such approval within the six-month period after the Association
completes its Conversion and provided further that the Plan's effectiveness
shall be contingent on its approval by the Office of Thrift Supervision ("OTS").
No Awards may be made prior to approval of the Plan by the stockholders of the
Company, and any Awards made before the Plan receives OTS approval shall be
subject thereto.
15. MODIFICATION OF AWARDS.
At any time, and from time to time, the Board may authorize the Committee
to direct execution of an instrument providing for the modification of any
outstanding Award, provided no such modification shall confer on the holder of
said Award any right or benefit which could not be conferred on him by the grant
of a new Award at such time, or impair the Award without the consent of the
holder of the Award.
16. AMENDMENT AND TERMINATION OF THE PLAN.
The Board may from time to time amend the terms of the Plan and, with
respect to any Shares at the time not subject to Awards, suspend or terminate
the Plan; provided that the provisions of Paragraph 9 may not be amended more
than once every six months (other than to comport with changes in the Code, the
Employee Retirement Income Security Act of 1974, as amended, or the rules
thereunder).
No amendment, suspension or termination of the Plan shall, without the
consent of any affected holders of an Award, alter or impair any rights or
obligations under any Award theretofore granted.
17. CONDITIONS UPON ISSUANCE OF SHARES.
(a) Compliance with Securities Laws. Shares of Common Stock shall not be
issued with respect to any Award unless the issuance and delivery of such Shares
shall comply with all relevant provisions of law, including, without limitation,
the Securities Act of 1933, as amended, the rules and regulations promulgated
thereunder, any applicable state securities law, and the requirements of any
stock exchange upon which the Shares may then be listed.
(b) Special Circumstances. The inability of the Company to obtain
approval from any regulatory body or authority deemed by the Company's counsel
to be necessary to the lawful issuance and sale of any Shares hereunder shall
relieve the Company of any liability in respect of the non-issuance or sale of
such Shares. As a condition to the exercise of an Option or SAR, the Company may
require the person exercising the Option or SAR
9
<PAGE>
to make such representations and warranties as may be necessary to assure the
availability of an exemption from the registration requirements of federal or
state securities law.
(c) Committee Discretion. The Committee shall have the discretionary
authority to impose in Agreements such restrictions on Shares as it may deem
appropriate or desirable, including but not limited to the authority to impose a
right of first refusal or to establish repurchase rights or both of these
restrictions.
18. RESERVATION OF SHARES.
The Company, during the term of the Plan, will reserve and keep available a
number of Shares sufficient to satisfy the requirements of the Plan.
19. WITHHOLDING TAX.
The Company's obligation to deliver Shares upon exercise of Options and/or
SARs shall be subject to the Participant's satisfaction of all applicable
federal, state and local income and employment tax withholding obligations.
20. NO EMPLOYMENT OR OTHER RIGHTS.
In no event shall an Employee's or Director's eligibility to participate or
participation in the Plan create or be deemed to create any legal or equitable
right of the Employee, Director, or any other party to continue service with the
Company, the Association, or any Affiliate of such corporations. Except to the
extent provided in Paragraphs 6(b) and 9(a), no Employee or Director shall have
a right to be granted an Award or, having received an Award, the right to again
be granted an Award. However, an Employee or Director who has been granted an
Award may, if otherwise eligible, be granted an additional Award or Awards.
21. GOVERNING LAW.
The Plan shall be governed by and construed in accordance with the laws of
the State of Maryland, except to the extent that federal law shall be deemed to
apply.
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Exhibit 10.2
PATAPSCO BANCORP, INC.
MANAGEMENT RECOGNITION PLAN
ARTICLE I
ESTABLISHMENT OF THE PLAN
1.01 The Company hereby establishes this Plan upon the terms and
conditions hereinafter stated.
1.02 Through acceptance of their appointment to the Committee, each member
of the Committee hereby accepts his or her appointment hereunder upon the terms
and conditions hereinafter stated.
ARTICLE II
PURPOSE OF THE PLAN
2.01 The purpose of the Plan is to reward and retain personnel of
experience and ability in key positions of responsibility by providing Employees
and Directors of the Company, the Association, and their Affiliates with a
proprietary interest in the Company, and as compensation for their past
contributions to the Association, and as an incentive to make such contributions
in the future.
ARTICLE III
DEFINITIONS
The following words and phrases when used in this Plan with an initial
capital letter, shall have the meanings set forth below unless the context
clearly indicates otherwise. Wherever appropriate, the masculine pronoun shall
include the feminine pronoun and the singular shall include the plural.
3.01 "Affiliate" shall mean any "parent corporation" or "subsidiary
corporation" of the Company, as such terms are defined in Section 424(e) and
(f), respectively, of the Internal Revenue Code of 1986, as amended.
3.02 "Association" means Patapsco Federal Savings and Loan Association.
3.03 "Beneficiary" means the person or persons designated by a Participant
to receive any benefits payable under the Plan in the event of such
Participant's death. Such person or persons shall be designated in writing on
forms provided for this purpose by the Committee and may be changed from time to
time by similar written notice to the Committee. In the absence of a written
designation, the Beneficiary shall be the Participant's surviving spouse, if any
or if none, his estate.
3.04 "Board" means the Board of Directors of the Company or, prior to the
Company's formation on November 9, 1995, Board of Directors of the Association.
3.05 "Committee" means the Management Recognition Plan Committee appointed
by the Board pursuant to Article IV hereof.
3.06 "Common Stock" means shares of the common stock, par value $.01 per
share, of the Company.
3.07 "Company" means Patapsco Bancorp, Inc.
3.08 "Continuous Service" shall mean the absence of any interruption or
termination of service as an Employee, Director, or honorary Director of the
Company or an Affiliate. Continuous Service shall not be
1
<PAGE>
considered interrupted in the case of sick leave, military leave or any other
leave of absence approved by the Company in the case of transfers between
payroll locations of the Company or between the Company, an Affiliate or a
successor, or in the case of a Director's performance of services in an
emeritus, advisory, or honorary capacity.
3.09 "Date of Conversion" means the date of the conversion of the
Association from mutual to stock form.
3.10 "Director" means a member of the Board.
3.11 "Disability" shall mean a physical or mental condition, which in the
sole and absolute discretion of the Committee, is reasonably expected to be of
indefinite duration and to substantially prevent a Participant from fulfilling
his or her duties or responsibilities to the Company or an Affiliate.
3.12 "Non-employee Director" means any member of the Board who, at the
time discretion under the Plan is exercised, is a "Non-employee Director" within
the meaning of Rule 16b-3 of the General Rules and Regulations under the
Securities Exchange Act of 1934, as amended.
3.13 "Effective Date" means the date on which the Plan first becomes
effective, as determined under Section 8.07 hereof.
3.14 "Employee" means any person who is employed by the Company or an
Affiliate.
3.15 "Participant" means an Employee, Director, or honorary Director who
holds a Plan Share Award.
3.16 "Plan" means this Patapsco Bancorp, Inc. Management Recognition
Plan.
3.17 "Plan Shares" means shares of Common Stock held in the Trust which
are awarded or issuable to a Participant pursuant to the Plan.
3.18 "Plan Share Award" means a right granted under this Plan to receive
Plan Shares.
3.19 "Plan Share Reserve" means the shares of Common Stock held by the
Trustee pursuant to Sections 5.02 and 5.03.
3.20 "Trust Agreement" means that agreement entered into pursuant to the
terms hereof between the Company and the Trustee, and "Trust" means the trust
created thereunder.
3.21 "Trustee" means that person(s) or entity appointed by the Board
pursuant to the Trust Agreement to hold legal title to the Plan assets for the
purposes set forth herein.
ARTICLE IV
ADMINISTRATION OF THE PLAN
4.01 ROLE AND POWERS OF THE COMMITTEE. The Plan shall be administered
and interpreted by the Committee, which shall consist of not less than two Non-
employee members of the Board who are Non-employee Directors. In the absence at
any time of a duly appointed Committee, the Plan shall be administered by those
members of the Board who are Disinterested Persons, and by the Board if there
are less than two Non-employee Directors.
The Committee shall have all of the powers allocated to it in this and
other Sections of the Plan. Except as limited by the express provisions of the
Plan or by resolutions adopted by the Board, the Committee shall have sole and
complete authority and discretion (i) to make Plan Share Awards to such
Employees as the Committee may
2
<PAGE>
select, (ii) to determine the form and content of Plan Share Awards to be issued
under the Plan, (iii) to interpret the Plan, (iv) to prescribe, amend and
rescind rules and regulations relating to the Plan, and (v) to make other
determinations necessary or advisable for the administration of the Plan. The
Committee shall have and may exercise such other power and authority as may be
delegated to it by the Board from time to time. Subject to Section 4.02, the
interpretation and construction by the Committee of any provisions of the Plan
or of any Plan Share Award granted hereunder shall be final and binding. The
Committee shall act by vote or written consent of a majority of its members, and
shall report its actions and decisions with respect to the Plan to the Board at
appropriate times, but in no event less than one time per calendar year. The
Committee may recommend to the Board one or more persons or entity to act as
Trustee(s) in accordance with the provisions of this Plan and the Trust.
4.02 ROLE OF THE BOARD. The members of the Committee shall be appointed
or approved by, and will serve at the pleasure of, the Board. The Board may in
its discretion from time to time remove members from, or add members to, the
Committee. The Board shall have all of the powers allocated to it in this and
other Sections of the Plan, may take any action under or with respect to the
Plan which the Committee is authorized to take, and may reverse or override any
action taken or decision made by the Committee under or with respect to the
Plan, provided, however, that the Board may not revoke any Plan Share Award
already made or impair a participant's vested rights under a Plan Share Award.
Members of the Board who are eligible for or who have been granted Plan Share
Awards (other than pursuant to Section 6.04) may not vote on any matters
affecting the administration of the Plan or the grant of Plan Shares or Plan
Share Awards (although such members may be counted in determining the existence
of a quorum at any meeting of the Board during which actions with regard thereto
are taken). Further, with respect to all actions taken by the Board in regard
to the Plan, such action shall be taken by a majority of the Board where such a
majority of the directors acting in the matter are Non-employee Directors.
4.03 LIMITATION ON LIABILITY. No member of the Board or the Committee or
the Trustee(s) shall be liable for any determination made in good faith with
respect to the Plan or any Plan Shares or Plan Share Awards granted under it.
If a member of the Board or the Committee or any Trustee is a party or is
threatened to be made a party to any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or investigative, by
reason of anything done or not done by him in such capacity under or with
respect to the Plan, the Company shall indemnify such member against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by him or her in connection with such action,
suit or proceeding if he or she acted in good faith and in a manner he or she
reasonably believed to be in the best interests of the Company and its
Affiliates and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful.
ARTICLE V
CONTRIBUTIONS; PLAN SHARE RESERVE
5.01 AMOUNT AND TIMING OF CONTRIBUTIONS. The Board shall determine the
amounts (or the method of computing the amounts) to be contributed by the
Company to the Trust. Such amounts shall be paid to the Trustee at the time of
contribution. No contributions to the Trust by Employees shall be permitted.
5.02 INVESTMENT OF TRUST ASSETS. The Trustee shall invest Trust assets
only in accordance with the Trust Agreement; provided that the Trust shall not
purchase more than four percent (4%) of the number of shares of Common Stock
issued on the Date of Conversion. Such shares may either be authorized but
unissued shares or shares held in treasury.
5.03 EFFECT OF ALLOCATIONS, RETURNS AND FORFEITURES UPON PLAN SHARE
RESERVES. Upon the allocation of Plan Share Awards under Section 6.02, the Plan
Share Reserve shall be reduced by the number of Shares subject to the Awards so
allocated. Any Shares subject or attributable to an Award which may not be
earned because of a forfeiture by the Participant pursuant to Section 7.01 shall
be added to the Plan Share Reserve.
3
<PAGE>
ARTICLE VI
ELIGIBILITY; ALLOCATIONS
6.01 ELIGIBILITY. Only Employees shall be eligible to receive Plan Share
Awards. In selecting those Employees to whom Plan Share Awards will be granted
and the number of shares covered by such Awards, the Committee shall consider
the position, duties and responsibilities of the eligible Employees, the value
of their services to the Company and its Affiliates, and any other factors the
Committee may deem relevant. Notwithstanding the foregoing, (i) the Committee
shall automatically make the Plan Share Awards specified in Sections 6.04 and
6.05 hereof; and (ii) no Employee shall receive Plan Share Awards relating to
more than 25% of the Plan Shares reserved under Section 5.02, and no Non-
employee Director shall receive Plan Share Awards relating to more than 5% of
the Plan Shares reserved under Section 5.02, with all Non-employee Directors as
a group receiving Plan Share Awards relating to no more than 30% of the Plan
Shares reserved under Section 5.02.
6.02 ALLOCATIONS. The Committee will determine which Employees will be
granted discretionary Plan Share Awards, and the number of Shares covered by
each Plan Share Award, provided that in no event shall any Awards be made which
will violate the governing instruments of the Association or its Affiliates or
any applicable federal or state law or regulation. In the event Plan Shares are
forfeited for any reason or additional shares of Common Stock are purchased by
the Trustee, the Committee may, from time to time, determine which of the
Employees referenced in Section 6.01 above will be granted additional Plan Share
Awards to be awarded from the forfeited or acquired Plan Shares.
6.03 FORM OF ALLOCATION. As promptly as practicable after a determination
is made pursuant to Section 6.02 that a Plan Share Award is to be made, the
Committee shall notify the Participant in writing of the grant of the Award, the
number of Plan Shares covered by the Award, and the terms upon which the Plan
Shares subject to the Award may be earned. The date on which the Committee so
notifies the Participant shall be considered the date of grant of the Plan Share
Awards. The Committee shall maintain records as to all grants of Plan Share
Awards under the Plan.
6.04 AUTOMATIC GRANTS TO NON-EMPLOYEE DIRECTORS. Notwithstanding any
other provisions of this Plan, each Director who is a Non-employee Director on
September 30, 1995 and who has not terminated Continuous Service before the
Effective Date shall receive, on the Effective Date, a Plan Share Award for a
number of shares equal to 4.5% of the number of Plan Shares which the Trust is
authorized to purchase pursuant to Section 5.02 of the Plan. Honorary Director
Frank Carey shall receive, on the Effective Date, two percent (2%) of the Plan
Shares authorized for purchase under the Plan.
Each Non-employee Director who joins the Board after September 30, 1995
shall receive, on the later of the Effective Date and the date of becoming a
Director, a Plan Share Award of one percent (1%) of the number of Plan Shares
which the Trust is authorized to purchase pursuant to Section 5.02 of the Plan
(or such lesser number as are available hereunder for Plan Share Awards). Plan
Share Awards received under the provisions of this Section shall become vested
and nonforfeitable according to the general rules set forth in subsections (a)
and (b) of Section 7.01, and the Committee shall have no discretion to alter or
accelerate said vesting requirements. Unless otherwise inapplicable or
inconsistent with the provisions of this Section, the Plan Share Awards to be
granted hereunder shall be subject to all other provisions of this Plan.
6.05 AUTOMATIC GRANTS TO EMPLOYEES. On the Effective Date, each of the
following individuals shall receive a Plan Share Award as to the number of Plan
Shares listed below, provided that such award shall not be made to an individual
who is not an Employee on the Effective Date:
4
<PAGE>
<TABLE>
<CAPTION>
Percentage of Plan Shares Authorized
Employee for Purchase under Plan (S)5.02
-------- ------------------------------------
<S> <C>
Joseph Bouffard 21.50%
Debra Brockschmidt 16.25%
Timothy King 10.75%
Jack McClean 10.75%
Joe Sallese 10.75%
</TABLE>
Plan Share Awards received under the provisions of this Section shall
become vested and nonforfeitable according to the general rules set forth in
subsections (a) and (b) of Section 7.01, and the Committee shall have no
discretion to alter said vesting requirements. Unless otherwise inapplicable or
inconsistent with the provisions of this Section, the Plan Share Awards to be
granted hereunder shall be subject to all other provisions of this Plan.
6.06 ALLOCATIONS NOT REQUIRED. Notwithstanding anything to the contrary
in Sections 6.01 and 6.02, but subject to Sections 6.04 and 6.05, no Employee or
Director shall have any right or entitlement to receive a Plan Share Award
hereunder, such Awards being at the total discretion of the Committee, nor shall
any Employees or Directors as a group have such a right. The Committee may,
with the approval of the Board (or, if so directed by the Board) return all
Common Stock in the Plan Share Reserve to the Company at any time, and cease
issuing Plan Share Awards.
ARTICLE VII
EARNINGS AND DISTRIBUTION OF PLAN SHARES; VOTING RIGHTS
7.01 EARNING PLAN SHARES; FORFEITURES.
(a) GENERAL RULES. Twenty percent (20%) of the Plan Shares subject to a
Plan Share Award shall be earned and become non-forfeitable by a Participant
upon his or her completion of each of five Years of Service. For purposes of
this paragraph, with respect to each Plan Share Award, "Year of Service" means a
full twelve-month period, measured from the date of a Plan Share Award and each
annual anniversary of that date, throughout which the Participant's Continuous
Service has not terminated for any reason.
(b) EXCEPTION FOR TERMINATIONS DUE TO DEATH OR DISABILITY.
Notwithstanding the general rule contained in Section 7.01(a) above, all Plan
Shares subject to a Plan Share Award held by a Participant whose service with
the Company or an Affiliate terminates due to the Participant's death or
Disability, shall be deemed earned as of the Participant's last day of service
with the Company or an Affiliate and shall be distributed as soon as practicable
thereafter.
7.02 ACCRUAL OF DIVIDENDS. Whenever Plan Shares are paid to a Participant
or Beneficiary under Section 7.03, such Participant or Beneficiary shall also be
entitled to receive, with respect to each Plan Share paid an amount equal to any
cash dividends and a number of shares of Common Stock equal to any stock
dividends, declared and paid with respect to a share of Common Stock between the
date the relevant Plan Share Award was initially granted to such Participant and
the date the Plan Shares are being distributed. There shall also be distributed
an appropriate amount of net earnings, if any, of the Trust with respect to any
cash dividends so paid out.
7.03 DISTRIBUTION OF PLAN SHARES.
(a) TIMING OF DISTRIBUTIONS: GENERAL RULE. Except as provided in
Subsections (c) and (d) below, the Trustee shall distribute Plan Shares and
accumulated cash from dividends and interest to the Participant or his
Beneficiary, as the case may be, as soon as practicable after they have been
earned. No fractional shares shall be distributed.
5
<PAGE>
(b) FORM OF DISTRIBUTION. The Trustee shall distribute all Plan Shares,
together with any shares representing stock dividends, in the form of Common
Stock. One share of Common Stock shall be given for each Plan Share earned.
Payments representing cash dividends (and earnings thereon) shall be made in
cash.
(c) WITHHOLDING. The Trustee shall withhold from any cash payment made
under this Plan sufficient amounts to cover any applicable withholding and
employment taxes, and if the amount of such cash payment is not sufficient, (i)
the Trustee shall require the Participant or Beneficiary to pay to the Trustee
the amount required to be withheld as a condition of delivering the Plan Shares,
and (ii) the Participant or Beneficiary shall be entitled to have the Company
withhold shares subject to the Plan Share Award in order to satisfy such
obligations. The Trustee shall pay over to the Company or Affiliate which
employs or employed such Participant any such amount withheld from or paid by
the Participant or Beneficiary.
(d) TIMING: EXCEPTION FOR 10% SHAREHOLDERS. Notwithstanding Subsections
(a) and (b) above, no Plan Shares may be distributed prior to the date which is
five (5) years from the Date of Conversion to the extent the Participant or
Beneficiary, as the case may be, would after receipt of such Shares own in
excess of ten percent (10%) of the issued and outstanding shares of Common Stock
unless such action is approved in advance by a majority vote of disinterested
directors of the Board. To the extent this limitation would delay the date on
which a Participant receives Plan Shares, the Participant may elect to receive
from the Trust, in lieu of such Plan Shares, the cash equivalent thereof. Any
Plan Shares remaining undistributed solely by reason of the operation of this
Subsection (d) shall be distributed to the Participant or his Beneficiary on the
date which is five years from the Date of Conversion.
(e) REGULATORY EXCEPTIONS. No Plan Shares shall be distributed unless and
until all of the requirements of all applicable law and regulation shall have
been fully complied with, including the receipt of approval of the Plan by the
stockholders of the Company by such vote, if any, as may be required by
applicable law and regulations.
7.04 VOTING OF PLAN SHARES. All shares of Common Stock held by the Trust
(whether or not subject to a Plan Share Award) shall be voted by the Trustee in
the same proportion as the trustee of the Company's Employee Stock Ownership
Plan votes Common Stock held in the trust associated therewith, and in the
absence of any such voting, shall be voted in the manner directed by the Board.
ARTICLE VIII
MISCELLANEOUS
8.01 ADJUSTMENTS FOR CAPITAL CHANGES.
(a) RECAPITALIZATIONS; STOCK SPLITS, ETC. The number and kind of shares
which may be purchased under the Plan, and the number and kind of shares subject
to outstanding Plan Share Awards, shall be proportionately adjusted for any
increase, decrease, change or exchange of shares of Common Stock for a different
number or kind of shares or other securities of the Company which results from a
merger, consolidation, recapitalization, reorganization, reclassification, stock
dividend, split-up, combination of shares, or similar event in which the number
or kind of shares is changed without the receipt or payment of consideration by
the Company.
(b) TRANSACTIONS IN WHICH THE COMPANY IS NOT THE SURVIVING ENTITY. In the
event of (i) the liquidation or dissolution of the Company, (ii) a merger or
consolidation in which the Company is not the surviving entity, or (iii) the
sale or disposition of all or substantially all of the Company's assets (any of
the foregoing to be referred to herein as a "Transaction"), all outstanding Plan
Share Awards shall be adjusted for any change or exchange of shares of Common
Stock for a different number or kind of shares or other securities which results
from the Transaction.
(c) CONDITIONS AND RESTRICTIONS ON NEW, ADDITIONAL, OR DIFFERENT SHARES OR
SECURITIES. If, by reason of any adjustment made pursuant to this Section, a
Participant becomes entitled to new, additional, or
6
<PAGE>
different shares of stock or securities, such new, additional, or different
shares of stock or securities shall thereupon be subject to all of the
conditions and restrictions which were applicable to the shares pursuant to the
Plan Share Award before the adjustment was made. In addition, the Committee
shall have the discretionary authority to impose on the Shares subject to Plan
Share Awards such restrictions as the Committee may deem appropriate or
desirable, including but not limited to a right of first refusal, or repurchase
option, or both of these restrictions.
(d) OTHER ISSUANCES. Except as expressly provided in this Section, the
issuance by the Company or an Affiliate of shares of stock of any class, or of
securities convertible into shares of Common Stock or stock of another class,
for cash or property or for labor or services either upon direct sale or upon
the exercise of rights or warrants to subscribe therefor, shall not affect, and
no adjustment shall be made with respect to, the number or class of shares of
Common Stock then subject to Plan Share Awards or reserved for issuance under
the Plan.
8.02 AMENDMENT AND TERMINATION OF PLAN. The Board may, by resolution, at
any time amend or terminate the Plan; provided that no amendment or termination
of the Plan shall, without the written consent of a Participant, impair any
rights or obligations under a Plan Share Award theretofore granted to the
Participant. The power to amend or terminate the Plan in accordance with this
Section 8.02 shall include the power to direct the Trustee to return to the
Company all or any part of the assets of the Trust, including shares of Common
Stock held in the Plan Share Reserve. However, the termination of the Trust
shall not affect a Participant's right to earn Plan Share Awards and to receive
a distribution of Common Stock relating thereto, including earnings thereon, in
accordance with the terms of this Plan and the grant by the Committee or the
Board.
8.03 NONTRANSFERABILITY. Plan Share Awards may not be sold, pledged,
assigned, hypothecated, transferred or disposed of in any manner other than by
will or by the laws of descent and distribution. Notwithstanding the foregoing,
or any other provision of this Plan, a Participant who holds Plan Share Awards
may transfer such Plan Share Awards to his or her spouse, lineal ascendants,
lineal descendants, or to a duly established trust for the benefit of one or
more of these individuals. Plan Share Awards so transferred may thereafter be
transferred only to the Participant who originally received the grant or to an
individual or trust to whom the Participant could have initially transferred the
Plan Share Awards pursuant to this Paragraph. Plan Share Awards which are
transferred pursuant to this Paragraph shall be exercisable by the transferee
according to the same terms and conditions as applied to the Participant.
8.04 NO EMPLOYMENT OR OTHER RIGHTS. Neither the Plan nor any grant of a
Plan Share Award or Plan Shares hereunder nor any action taken by the Trustee,
the Committee or the Board in connection with the Plan shall create any right,
either express or implied, on the part of any Employee or Director to continue
in the service of the Company, the Association, or an Affiliate thereof.
8.05 VOTING AND DIVIDEND RIGHTS. No Participant shall have any voting or
dividend rights or other rights of a stockholder in respect of any Plan Shares
covered by a Plan Share Award, except as expressly provided in Section 7.03
above, prior to the time said Plan Shares are actually distributed to him.
8.06 GOVERNING LAW. The Plan and Trust shall be governed and construed
under the laws of the State of Maryland to the extent not preempted by Federal
law.
8.07 EFFECTIVE DATE. The Plan shall become effective immediately upon its
approval by a favorable vote of stockholders of the Company who own at least a
majority of the total votes eligible to be cast at a duly called meeting of the
Company's stockholders held in accordance with applicable laws, provided that
the Plan shall not be submitted for such approval within the six-month period
after the Date of Conversion. In no event shall Plan Share Awards be made prior
to the Effective Date.
8.08 TERM OF PLAN. This Plan shall remain in effect until the earlier of
(i) termination by the Board, or (ii) the distribution of all assets of the
Trust. Termination of the Plan shall not affect any Plan Share Awards
7
<PAGE>
previously granted, and such Awards shall remain valid and in effect until they
have been earned and paid, or by their terms expire or are forfeited.
8.09 TAX STATUS OF TRUST. It is intended that (i) the Trust associated
with the Plan be treated as a grantor trust of the Company under the provisions
of Section 671 et seq. of the Code, as the same may be amended from time to
time, and (ii) that in accordance with Revenue Procedure 92-65 (as the same may
be amended from time to time), Participants have the status of general unsecured
creditors of the Company, the Plan constitutes a mere unfunded promise to make
benefit payments in the future, the Plan is unfunded for tax purposes and for
purposes of Title I of the Employee Retirement Income Security Act of 1974, as
amended, and the Trust has been and will continue to be maintained in conformity
with Revenue Procedure 92-64 (as the same may be amended from time to time).
8
<PAGE>
PATAPSCO BANCORP, INC.
[LOGO]
1996 ANNUAL REPORT
<PAGE>
PATAPSCO BANCORP, INC.
================================================================================
Patapsco Bancorp, Inc. (the "Company") was incorporated under the laws of
the State of Maryland in November 1995 at the direction of the Board of
Directors of Patapsco Federal Savings and Loan Association (the "Association")
for the purpose of serving as a savings institution holding company of the
Association upon the acquisition of all of the capital stock issued by the
Association in the Association's conversion from mutual to stock form
("Conversion"). The Company has no significant assets other than the
outstanding capital stock of the Association, a note receivable from the
Company's Employee Stock Ownership Plan ("ESOP") and $2.3 million of cash and
investment securities. The Company's principal business is overseeing the
business of the Association and investing the portion of the retained net
Conversion proceeds.
The Association is a federal savings and loan association operating through
a single office located in Dundalk, Maryland and serving Baltimore County. The
principal business of the Association historically has consisted of attracting
deposits from the general public and investing these deposits in loans secured
by first mortgages on one- to four-family residences in the Association's market
area. The Association derives its income principally from interest earned on
loans and, to a lesser extent, interest earned on mortgage-backed securities and
investment securities and noninterest income. Funds for these activities are
provided principally by operating revenues, deposits and repayments of
outstanding loans and investment securities and mortgage-backed securities. At
the time of the Conversion, the Company and the Association submitted
applications to the Maryland Banking Commissioner and the Board of Governors of
the Federal Reserve System for the Association to convert to a Maryland
commercial bank and for the Company to become a bank holding company. These
applications were approved. However, the Company and the Association have
determined to delay consummation of the Association's conversion to a Maryland
commercial bank pending the outcome of legislation relating to the tax bad debt
reserve recapture for savings institutions converting to commercial banks. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Potential Impact on Future Results of Operations of Pending
Legislation."
MARKET INFORMATION
================================================================================
The Company's common stock began trading under the symbol "PATD" on the
National Quotation Bureau "Pink Sheets" on April 2, 1996. There are currently
362,553 shares of the common stock outstanding and approximately 441 holders of
record of the common stock. No dividends have been paid on the common stock.
Following are the high and low closing sale prices, by fiscal quarter, as
reported on the Pink Sheets during the periods indicated.
<TABLE>
<CAPTION>
Fiscal 1996
----------------------
High Low
---- ---
<S> <C> <C>
Fourth quarter................. $25.75 $22.00
</TABLE>
TABLE OF CONTENTS
================================================================================
<TABLE>
<S> <C>
Patapsco Bancorp, Inc. ..................................................... (i)
Market Information ......................................................... (i)
Letter to Stockholders...................................................... 1
Selected Consolidated Financial and Other Data.............................. 3
Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................ 5
Consolidated Financial Statements........................................... 16
Corporate Information........................................ Inside Back Cover
</TABLE>
(i)
<PAGE>
[LETTERHEAD]
Dear Stockholder:
The directors, officers and staff of Patapsco Bancorp, Inc. and Patapsco
Federal Savings and Loan Association proudly present our first Annual Report to
our shareholders. This report reflects an extraordinary year in the history of
Patapsco Federal Savings and Loan Association. Not only did we successfully
complete our transition from a mutual savings and loan association to a public
company, but we also obtained the necessary approval to convert to a commercial
bank. We expect to complete the charter conversion to a commercial bank in the
very near future.
In anticipation of our new charter, we have begun doing business in new and
exciting ways. While residential mortgage lending was our primary source of
loan business, and will continue to be a major product line for us, the
Association has entered into the consumer, commercial and construction lending
markets. Experienced loan officers have been retained to originate these
products in a manner that maximizes asset quality. We have also begun to
restructure our balance sheet by paying off our borrowings, moving out of low
yielding securities, and investing in the aforementioned higher yielding loans.
While we are beginning to see results from these changes, much remains to
be accomplished. We recognize the need to improve our earnings. Further, given
the amount of additional capital raised in the conversion, we must begin to
improve our return on equity. We realize that we now serve a new constituency,
our stockholders. We intend to serve our stockholders in the same excellent
manner in which we have served our depositors and our community. Be assured
that Patapsco is aware of its mandate to enhance shareholder value while
maintaining a high level of customer satisfaction and operating in a safe and
sound manner.
On a very personal note, we wish to thank Mr. Joseph N. McGowan for the
outstanding job he has done as the Chairman of Patapsco Bancorp, Inc. and
Patapsco Federal Savings and Loan Association. Mr. McGowan has capably led the
Company for many years and presided over our conversion to a stock company.
Although Mr. McGowan is proceeding with his plan to step down as Chairman, he
will remain on the Board of Directors and several committees, so his invaluable
counsel will not be lost.
<PAGE>
We also want to congratulate Mr. S. Robert Kinghorn who the Board
anticipates electing as Chairman immediately after our October 10, 1996 Annual
Meeting. Mr. Kinghorn also has many years experience with Patapsco, most
recently as Vice Chairman, and the Company will not miss a beat as he assumes
his responsibilities.
Last but not least, the directors, officers and staff of Patapsco Bancorp,
Inc. and Patapsco Federal Savings and Loan Association thank all of our
stockholders and customers for their confidence and support in our new
organization. We also look forward to a successful new year.
Sincerely,
/s/ Joseph J. Bouffard
Joseph J. Bouffard
President
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
================================================================================
Selected Consolidated Financial Condition Data
<TABLE>
<CAPTION>
At June 30,
----------------
1996 1995
------- -------
(In thousands)
<S> <C> <C>
Total assets.................................................. $78,850 $77,144
Loans receivable, net......................................... 52,031 41,749
Cash and short-term unsecured loans to commercial banks....... 7,424 2,482
Investment securities......................................... 4,424 14,830
Mortgage-backed securities.................................... 12,778 15,772
Savings deposits.............................................. 64,157 63,930
FHLB advances................................................. -- 5,000
Stockholders' equity.......................................... 12,301 6,040
</TABLE>
- --------------------------------------------------------------------------------
Selected Consolidated Operations Data
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------
1996 1995
--------- ---------
(In thousands)
<S> <C> <C>
Interest income........................................... $5,332 $5,054
Interest expense........................................... 3,038 2,662
------ ------
Net interest income before provision for loan losses....... 2,294 2,392
Provision for loan losses.................................. 68 15
------ ------
Net interest income after provision for loan losses........ 2,226 2,377
Noninterest income......................................... 30 88
Noninterest expenses....................................... 2,088 1,980
------ ------
Income before provision for income taxes................... 168 485
Income taxes (1)........................................... 67 948
------ ------
Net income (loss).......................................... $ 101 $ (463)
====== ======
</TABLE>
- --------------------
(1) For the year ended June 30, 1995, income taxes included $740,000 of
expense related to the recapture of the tax bad debt reserve as a result of
the anticipated conversion of the Association to a Maryland commercial
bank. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations --Comparison of Operating Results for the Years Ended
June 30, 1996 and 1995."
3
<PAGE>
<TABLE>
<CAPTION>
Key Operating Ratios:
At or for the
Year Ended June 30,
----------------------
1996 1995
-------- --------
<S> <C> <C>
Performance Ratios:
Return on average assets (net income divided by
average total assets (1).............................. 0.13% (0.62)%
Return on average stockholders' equity (net income
divided by average stockholders' equity) (1).......... 1.35 (7.16)
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost)........................... 2.54 2.86
Net interest margin (net interest income
divided by average interest-earning assets)........... 3.05 3.25
Ratio of average interest-earning assets to
average interest-bearing liabilities.................. 112.63 110.76
Ratio of noninterest expense to average total assets... 2.71 2.64
Asset Quality Ratios:
Nonperforming assets to total assets at
end of period......................................... 0.35 0.22
Nonperforming loans to loans receivable,
net at end of period (2).............................. 0.46 0.29
Allowance for loan losses to total loans
at end of period...................................... 0.42 0.38
Allowance for loan losses to nonperforming
loans at end of period................................ 91.25 130.33
Provision for loan losses to loans receivable,
net at end of period.................................. 0.13 0.03
Net charge-offs to average loans outstanding........... 0.02 0.03
Capital Ratios:
Stockholders' equity to total assets at end of period.. 15.95 7.83
Average stockholders' equity to average assets......... 9.71 8.63
</TABLE>
<TABLE>
<CAPTION>
At June 30,
--------------------
1996 1995
-------- --------
<S> <C> <C>
Number of:
Real estate loans outstanding.......................... 751 713
Savings accounts....................................... 8,567 8,157
Offices open........................................... 1 1
</TABLE>
- --------------------
(1) The ratios for 1995 are based on net income including $740,000 of expense
related to the recapture of the tax bad debt reserve. If the $740,000 of
expense related to the recapture of tax bad debt reserve were excluded from
net income, return on average assets and return on average retained
earnings would have been 0.37% and 4.24%, respectively.
(2) Nonperforming loans consist of nonaccrual loans.
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
================================================================================
General
Patapsco Bancorp, Inc. (the "Company") was formed in November 1995 by the
Association to become the holding company of the Association following the
Conversion. The Conversion and the acquisition of the Association by Patapsco
Bancorp, Inc. were consummated on April 1, 1996. All references to the Company
prior to April 1, 1996, except where otherwise indicated, are to the
Association.
The Company's results of operation depend primarily on its level of net
interest income, which is the difference between interest earned on interest-
earning assets, consisting primarily of loans, investment securities, mortgage-
backed securities and other investments, and the interest paid on interest-
bearing liabilities, consisting primarily of deposits. The difference between
yields earned on interest-earning assets and rates paid on interest-bearing
liabilities ("net interest rate spread") and the ratio of interest-earning
assets to interest-bearing liabilities significantly impact net interest income.
The Company's net interest rate spread is affected by regulatory, economic and
competitive factors that influence interest rates, loan and deposit flows. The
Company, like other financial institutions, is subject to interest rate risk to
the degree that its interest-earning assets mature or reprice at different
times, or on a different basis, than its interest-bearing liabilities. To a
lesser extent, the Company's results of operations are also affected by the
amount of its noninterest income, including loan fees and service charges, and
levels of noninterest expense, which consists principally of compensation and
employee benefits, insurance premiums, professional fees, equipment expense,
occupancy, costs, advertising, data processing and other operating expenses.
The Company's operating results are significantly affected by general
economic and competitive conditions, in particular, changes in market interest
rates, government policies and actions taken by regulatory authorities. Lending
activities are influenced by the demand for and supply of housing, competition
among lenders, the level of interest rates and the availability of funds.
Deposit flows and costs of funds are influenced by prevailing market rates of
interest, primarily on competing investments, account maturities and the level
of personal income and savings in the Company's market area.
Potential Impact on Future Results of Operations of Pending Legislation
Reversal of Tax Bad Debt Recapture. Generally, savings and loan
associations that convert to commercial banks must recapture some or all of
their tax bad debt reserve established for federal income taxation purposes.
The Association incurred a $740,000 expense for recapture of a portion of its
tax bad debt reserve during the year ended June 30, 1995 in connection with the
determination of the Association's Board of Directors to convert the Association
to a Maryland commercial bank (the "Bank Conversion"). After this determination
was made, legislation was introduced in Congress which provided that savings and
loan associations that convert to commercial banks will not be required to
recapture the portion of tax bad debt reserve accumulated prior to 1988.
Following the introduction of this legislation, the Board of Directors
determined to delay consummation of the Bank Conversion pending the outcome of
this legislation. The legislation ultimately was enacted into law on August 20,
1996. As a result of the enactment of this legislation, the Association now
intends to complete the Bank Conversion as expeditiously as possible. Further,
the Company intends to reverse approximately $600,000 of the $740,000 expense
previously incurred. The reversal of the tax bad debt reserve as described
above will be reflected as a reduction of tax expense during the quarter ending
September 30, 1996.
Special Assessment. The Bank's savings deposits are insured by the Savings
Association Insurance Fund ("SAIF"), which is administered by the Federal
Deposit Insurance Corporation ("FDIC"). The assessment rate currently ranges
from 0.23% of deposits for well capitalized institutions to 0.31% of deposits
for undercapitalized
5
<PAGE>
institutions. The FDIC also administers the Bank Insurance Fund ("BIF"). On
August 8, 1995, the FDIC adopted an amendment to the BIF risk-based assessment
schedule which lowered the deposit insurance assessment rate for most commercial
banks and other depository institutions with deposits insured by the BIF to a
range of from 0.31% of insured deposits for undercapitalized BIF-insured
institutions to 0.04% of deposits for well-capitalized institutions, which
constitute over 90% of BIF-insured institutions. The FDIC amendment became
effective for the quarter ended September 30, 1995, and the assessment rate for
BIF-insured institutions subsequently was lowered to the statutory minimum of
$2,000 per year. The amendment created a substantial disparity in the deposit
insurance premiums paid by BIF and SAIF members and could place SAIF-insured
savings institutions at a significant competitive disadvantage to BIF-insured
institutions.
The Balanced Budget Act of 1995, which was passed by Congress but vetoed by
the President for reasons unrelated to the SAIF recapitalization, provided for a
one-time assessment currently estimated to be 0.85% of insured deposits that
would fully capitalize the SAIF. It is unknown whether this legislation will be
enacted or if premiums for either BIF or SAIF members will be adjusted in the
future by the FDIC or by legislative action. If a special assessment as
described above were to be required, it would result in a one-time charge to the
Association of up to $537,000 on a pre-tax basis, assuming the special
assessment is based on deposits held at March 31, 1995. If such a special
assessment were required and the SAIF as a result was fully recapitalized, it
could have the effect of reducing the Association's future deposit insurance
premiums to the SAIF, thereby increasing net income in future periods.
Asset/Liability Management
Net interest income, the primary component of the Company's net income, is
derived from the difference or "spread" between the yield on interest-earning
assets and the cost of interest-bearing liabilities. The Company has sought to
reduce its exposure to changes in interest rates by matching more closely the
effective maturities or repricing characteristics of its interest-earning assets
and interest-bearing liabilities. The matching of the Company's assets and
liabilities may be analyzed by examining the extent to which its assets and
liabilities are interest rate sensitive and by monitoring the expected effects
of interest rate changes on the Company's net interest income.
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Company's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the Company's net interest income would tend to increase during
periods of rising interest rates but decrease during periods of falling interest
rates. If the Company's assets mature or reprice more slowly or to a lesser
extent than its liabilities, the Company's net portfolio value and net interest
income would tend to decrease during periods of rising interest rates but
increase during periods of falling interest rates. The Company's policy has
been to mitigate the interest rate risk inherent in the historical savings
institution business of originating long-term loans funded by short-term
deposits by pursuing certain strategies designed to decrease the vulnerability
of its earnings to material and prolonged changes in interest rates.
The Company has established an Asset/Liability Management Committee which
currently is comprised of three non-employee directors, the President, an
honorary director and the Controller. This Committee meets on a monthly basis
and reviews the maturities of the Company's assets and liabilities and
establishes policies and strategies designed to regulate the Company's flow of
funds and to coordinate the sources, uses and pricing of such funds. The first
priority in structuring and pricing the Company's assets and liabilities is to
maintain an acceptable interest rate spread while reducing the net effects of
changes in interest rates.
Management's principal strategy in managing the Company's interest rate
risk has been to maintain short-and intermediate-term assets in portfolio,
including locally originated adjustable-rate mortgage loans. In addition, in
managing its portfolio of investment securities and mortgage-backed securities,
the Company in recent periods has purchased short-term or adjustable-rate
investment securities to reduce the Company's exposure to increases in interest
rates. In addition, the Company has available for sale investment securities
and mortgage-backed securities, carried at fair value, totaling $17.2 million as
of June 30, 1996. The Company is holding these investment securities
6
<PAGE>
and mortgage-backed securities as available for sale because it may sell these
investment securities and mortgage-backed securities prior to maturity should it
need to do so for liquidity or asset and liability management purposes.
Management also has shortened the average repricing period of its assets by
emphasizing the origination of 5, 7, 10 and 15 year fixed-rate or adjustable-
rate residential mortgage loans, all of which are retained by the Company for
its portfolio. Beginning in the first quarter of fiscal 1995, the Company
adopted a policy selling newly originated fixed-rate residential mortgage loans
with original maturities of 30 years in the secondary market. There were no
loans held for sale at June 30, 1996. At June 30, 1996, the Company held
approximately $24.5 million in loans with adjustable interest rates, which
represented approximately 46.6% of the Company's gross loan portfolio.
In addition to shortening the average repricing period of its assets, the
Company has sought to lengthen the average maturity of its liabilities by
adopting a tiered pricing program for its certificates of deposit, which
provides higher rates of interest on its longer term certificates in order to
encourage depositors to invest in certificates with longer maturities.
The Company's Board of Directors is responsible for reviewing the Company's
asset and liability management policies. The Asset/Liability Management
Committee reports to the Board monthly on interest rate risk and trends, as well
as liquidity and capital ratios and requirements. The Company's management is
responsible for administering the policies of the Board of Directors with
respect to the Company's asset and liability goals and strategies.
Net Portfolio Value
Management also measures the Company's interest rate risk by computing
estimated changes in the net portfolio value ("NPV") of its cash flows from
assets, liabilities and off-balance sheet items in the event of a range of
assumed changes in market interest rates. These computations estimate the effect
on the Company's NPV of sudden and sustained 1% to 4% increases and decreases in
market interest rates. The following table presents the Company's projected
change in NPV for the various interest rate shock levels at March 31, 1996.
<TABLE>
<CAPTION>
NPV as % of
Portfolio Value
Net Portfolio Value of Assets
------------------------------- ------------------
Basis
Change NPV Point
in Rates Amount $ Change % Change Ratio Changes
-------- ------ -------- -------- ----- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
+400 bp $ 6,319 -2,694 -30% 8.01% -288 bp
+300 bp 7,152 -1,861 -21 8.94 -195 bp
+200 bp 7,910 -1,104 -12 9.76 -113 bp
+100 bp 8,541 -473 -5 10.42 -47 bp
-- 9,014 10.89
-100 bp 9,285 271 +3 11.14 +25 bp
-200 bp 9,422 408 +5 11.24 +34 bp
-300 bp 9,525 511 +6 11.29 +40 bp
-400 bp 9,812 798 +9 11.54 +65 bp
</TABLE>
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit run-offs, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the Company may undertake in response to changes in interest rates.
7
<PAGE>
Average Balance, Interest and Average Yields and Rates
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods and at the date indicated. Such yields and costs are derived by
dividing income or expense by the average monthly balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from month-end balances. Management does not believe that the use of
month-end balances instead of daily balances has caused any material difference
in the information presented.
The table also presents information for the periods indicated with respect
to the difference between the average yield earned on interest-earning assets
and average rate paid on interest-bearing liabilities, or "interest rate
spread," which savings institutions have traditionally used as an indicator of
profitability. Another indicator of an institution's net interest income is its
"net yield on interest-earning assets," which is its net interest income divided
by the average balance of interest-earning assets. Net interest income is
affected by the interest rate spread and by the relative amounts of interest-
earning assets and interest-bearing liabilities. When interest-earning assets
approximate or exceed interest-bearing liabilities, any positive interest rate
spread will generate net interest income.
8
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------------------
1996 1995
--------------------------- ---------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------- -------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)...................................... $45,548 $3,514 7.72% $40,241 $3,067 7.62%
Investment securities..................................... 10,642 612 5.75 13,290 718 5.40
Mortgage-backed securities................................ 15,559 1,003 6.44 16,748 1,092 6.52
Trading account investments............................... -- -- -- 74 3 4.05
Short-term investments and other interest-earning assets.. 3,432 203 5.91 3,234 174 5.38
------- ------ ------- ------
Total interest-earning assets............................ 75,181 5,332 7.09 73,587 5,054 6.87
Non-interest-earning assets................................ 1,933 -- 1,366 --
------- ------ ------- ------
Total assets............................................. $77,114 5,332 $74,953 5,054
======= =======
Interest-bearing liabilities:
Savings deposits (2)...................................... $63,469 2,851 4.49 $61,395 $2,380 3.88
Borrowings................................................ 3,282 187 5.68 5,042 282 5.59
------- ------ ------- ------
Total interest-bearing liabilities....................... 66,751 3,038 4.55 66,437 2,662 4.01
------ ---- ------ ------
Non-interest-bearing liabilities........................... 2,873 2,046
------- -------
Total liabilities........................................ 69,624 68,483
Retained earnings.......................................... 7,490 6,470
------- -------
Total liabilities and retained earnings.................. $77,114 $74,953
======= =======
Net interest income........................................ $2,294 $2,392
====== ======
Interest rate spread....................................... 2.54% 2.86%
==== ======
Net yield on interest-earning assets....................... 3.05% 3.25%
==== ======
Ratio of average interest-earning assets to average
interest-bearing liabilities.............................. 112.63% 110.76%
====== ======
</TABLE>
- --------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing escrow accounts.
9
<PAGE>
Rate/Volume Analysis
The following table sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by prior year's rate); (ii) changes in rate
(changes in rate multiplied by prior year's volume); and (iii) changes in
rate/volume (changes in rate multiplied by changes in volume).
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------
1996 vs. 1995
--------------------------------
Increase (Decrease) Due to
--------------------------------
Rate/
Volume Rate Volume Total
------- ------ ------- ------
(In thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable........................ $ 402 $ 40 $ 5 $ 447
Investment securities................... (142) 46 (10) (106)
Mortgage-backed securities.............. (77) (13) 1 (89)
Trading account investments............. (3) (3) 3 (3)
Short-term investments and other
interest-earning assets............... 10 17 2 29
----- ----- ----- -----
Total interest-earning assets....... 190 87 1 278
----- ----- ----- -----
Interest expense:
Savings deposits (1).................... 81 377 13 471
Borrowings.............................. (98) 5 (2) (95)
----- ----- ----- -----
Total interest-bearing liabilities.. (17) 382 11 376
----- ----- ----- -----
Change in net interest income.............. $ 207 $(295) $ (10) $ (98)
===== ===== ===== =====
</TABLE>
- --------------------
(1) Includes interest-bearing escrow accounts.
Comparison of Financial Condition at June 30, 1996 and 1995
Total assets increased by $1.8 million, or 2.2%, to $78.9 million at June
30, 1996 from $77.1 million at June 30, 1995. The increase was primarily due to
a $10.3 million increase in loans receivable and a $4.9 million increase in cash
and cash equivalents, which were partially offset by decreases of $10.4 million
and $3.0 million in investment securities and mortgage-backed securities,
respectively.
Net loans receivable increased by $10.3 million, or 24.6%, to $52.0 million
at June 30, 1996 from $41.7 million at June 30, 1995. The increase is directly
attributable to the Company's increased loan demand in real estate lending, as
well as increases in consumer and commercial lending. The Company's real
estate, consumer and commercial loan portfolios increased by $6.4 million, $2.7
million and $1.1 million, respectively, during the year ended June 30, 1996.
Investment securities decreased by $10.4 million, or 70.2%, to $4.4 million
at June 30, 1996 from $14.8 million at June 30, 1995, and mortgage-backed
securities decreased by $3.0 million, or 19.0%, to $12.8 million at June 30,
1996 from $15.8 million at June 30, 1995. During fiscal year 1996, the Company
sold certain securities to improve its net interest rate spread and generate
liquidity to fund loan demand. During the year ended June 30, 1996, the Company
sold $3.0 million of investment securities classified as available for sale
yielding 4.6% and reinvested the proceeds into mortgage-backed securities
yielding 6.5%. Also during the year, the Company sold $2.6
10
<PAGE>
million of mortgage-backed securities to fund higher yielding loans. The
Company incurred net losses of $71,000 and $26,000 in connection with the sale
of investment securities and mortgage-backed securities, respectively. The
Company utilized the cash obtained through maturing investment securities and
repayment of mortgage-backed securities to fund loan originations and repay $5.0
million of high cost Federal Home Loan Bank of Atlanta ("FHLB") advances.
Cash and cash equivalents, consisting of cash on hand, interest-bearing
deposits and short-term unsecured loans to commercial banks, increased by $4.9
million, or 199.1%, to $7.4 million at June 30, 1996 from $2.5 million at June
30, 1995. The increase was primarily due to the $6.2 million in net proceeds
from the Conversion, after deducting the cost of funding the Company's Employee
Stock Ownership Plan ("ESOP"), and $2.5 million in cash provided by the
repayments and sales of loans, investment securities and mortgage-backed
securities, net of loan originations and purchases of mortgage-backed
securities. Those increases were partially offset by the repayment of $5.0
million of FHLB advances.
Deposits increased by $227,000 or 0.4%, to $64.2 million at June 30, 1996
from $63.9 million at June 30, 1995. Included in the increase is a reduction of
$1.9 million of savings deposits, which were withdrawn by depositors for the
purchase of common stock of the Company in the Conversion.
Total stockholders' equity increased by $6.3 million, or 103.7%, to $12.3
million at June 30, 1996 from $6.0 million at June 30, 1995. The increase in
stockholders' equity was primarily attributable to net proceeds obtained in the
Conversion of $6.7 million and net earnings of $101,000 for the fiscal year
partially offset by an increase of $76,000 in the unrealized net losses on
available for sale portfolios net of taxes at June 30, 1996.
Comparison of Operating Results for the Years Ended June 30, 1996 and 1995
The Company had net income of $101,000 for the year ended June 30, 1996, as
compared to a net loss of $463,000 for the year ended June 30, 1995. The fiscal
1995 net loss was attributable to an additional tax expense of $740,000 for the
recapture of the Association's tax bad debt reserve. If the Association had not
had this tax bad debt recapture, the Company would have had net income of
$277,000 for the year ended June 30, 1995. The reduction in net income during
the year ended June 30, 1995 also reflected an increase of $434,000, or 28.1%,
in total noninterest expense.
Net Interest Income. The Company's net interest income decreased by
$98,000, or 4.1%, to $2.3 million for the year ended June 30, 1996 from $2.4
million for the year ended June 30, 1995. The decrease in net increase income
is primarily the result of a $376,000 or 14.1%, increase in total interest
expense offset in part by an increase in total interest income of $278,000, or
5.5%, in fiscal 1996 as compared to fiscal 1995. The Company's net interest
spread decreased to 2.54% for fiscal 1996 from 2.86% for fiscal 1995. The
decrease in the net interest spread was primarily the result of an increase in
the average rate paid on average interest-bearing liabilities to 4.55% during
fiscal 1996 from 4.01% during fiscal 1995. The balance of average interest-
bearing liabilities increased by $314,000, or 0.5%, to $66.7 million for fiscal
1996 from $66.4 million for fiscal 1995. The average yield on average interest-
earning assets increased to 7.09% for the year ended June 30, 1996 from 6.87%
for the year ended June 30, 1995. The average balance of interest earning
assets increased by $1.6 million, or 2.2%, to $75.2 million for fiscal 1996 from
$73.6 million for fiscal 1995. The Company completed its Conversion in the
fourth quarter of fiscal 1996 and as a result, the average balance sheet did not
reflect the full impact from the use of the proceeds.
During fiscal 1996, the Company began to implement a strategy to improve
the net interest spread by expanding its lending products to include
construction, consumer and commercial business loans. These loan products
generally earn higher yields than conventional single-family residential
mortgage loans.
Interest Income. The Company's total interest income increased by
$278,000, or 5.5%, to $5.3 million for the year ended June 30, 1996 compared to
$5.1 million for the year ended June 30, 1995. The increase was primarily due
to an increase in the balance of average interest-earning assets of $1.6
million, or 2.2%, to $75.2
11
<PAGE>
million for fiscal 1996 from $73.6 million for fiscal 1995 and an increase in
the yield on average interest-earning assets to 7.09% for the year ended June
30, 1996 from 6.87% for the year ended June 30, 1995. The Company's deployment
of the proceeds from the Conversion helped boost the ratio of average interest-
earning assets to average interest-bearing liabilities to 112.63% for fiscal
1996 from 110.76% for fiscal 1995.
Interest income on loans increased by $447,000, or 14.6%, to $3.5 million
during the year ended June 30, 1996 compared to $3.1 million for the year ended
June 30, 1995. The increase in interest on loans is the result of a $5.3
million increase in average loans receivable to $45.5 million for the year ended
June 30, 1996 from $40.2 million for the year ended June 30, 1995.
Interest income on investment securities decreased by $106,000, or 14.7%,
to $612,000 for the year ended June 30, 1996 from $718,000 for the year ended
June 30, 1995. The decrease was primarily the result of a $2.6 million, or
19.9%, decrease in the average balance to $10.6 million for the year ended June
30, 1995 from $13.3 million for the year ended June 30, 1995. The effect from
the decline in the average balance was partially offset by an increase in the
average yield to 5.75% for the year ended June 30, 1996 from 5.40% for the year
ended June 30, 1995. During fiscal 1996, the Company sold $3.0 million of
investment securities yielding 4.6% and purchased mortgage-backed securities
yielding 6.5%. The Company incurred a loss of $71,000 on the sale.
Interest income on mortgage-backed securities decreased by $89,000, or
8.2%, to $1.0 million for the year ended June 30, 1996 compared to $1.1 million
for the year ended June 30, 1995. The decrease is primarily the result of a
decrease in the average balance of mortgage-backed securities of $1.2 million,
or 7.1%, to $15.6 million for the year ended June 30, 1996 from $16.7 million
for the year ended June 30, 1995 offset in part by a decrease in the average
yield to 6.44% for the year ended June 30, 1996 from 6.52% for the year ended
June 30, 1995.
Interest income on short-term investments and other interest-earning assets
increased by $29,000, or 16.7%, to $203,000 for the year ended June 30, 1996
from $174,000 for the year ended June 30, 1995. Short-term investments and
other interest-earning assets consist of overnight Federal funds sold, interest-
earning FHLB deposits and FHLB stock. The increase was the result of a slight
increase in the average yields and average balances. The level of these
balances is a function of liquidity management.
Interest Expense. The Company's interest expense increased by $376,000, or
14.1%, to $3.0 million for the year ended June 30, 1996 from $2.7 million for
the year ended June 30, 1995. The increase was primarily attributable to an
increase in the average rate paid on average interest-bearing liabilities to
4.55% for the year ended June 30, 1996 from 4.01% for the year ended June 30,
1995, as well as to an increase in the average balance of interest-bearing
liabilities of $314,000, or 0.5%, to $66.8 million for the year ended June 30,
1996 from $66.4 million for the year ended June 30, 1995.
Interest expense on deposits increased by $471,000, or 19.8%, to $2.9
million for the year ended June 30, 1996 from $2.4 million for the year ended
June 30, 1995. The increase in interest expense on deposits is primarily the
result of an increase in the average rate of 4.49% for the year ended June 30,
1996 from 3.88% for the year ended June 30, 1995. The increase in the average
rate is the direct result of certificates of deposit which repriced to an
average rate of 5.52% for fiscal 1996 from an average rate of 4.54% for fiscal
1995. The average balance of interest-bearing deposits increased by $2.1
million, or 3.4%, to $63.5 million for the year ended June 30, 1996 from $61.4
million for the year ended June 30, 1995.
Interest expense on FHLB advances decreased by $95,000, or 33.9%, to
$187,000 for the year ended June 30, 1996 from $282,000 for the year ended June
30, 1995. The decrease was the direct result of the Company repaying all $5.0
million of FHLB advances during fiscal 1996. The Company used proceeds from
maturing investments and the Conversion to repay the advances.
Provision for Loan Losses. Provisions for loan losses are charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate by management to provide for probable loan losses, based on prior loss
12
<PAGE>
experience, volume and type of lending conducted by the Company, industry
standards and past due loans in the Company's loan portfolio. The Company's
management periodically monitors and adjusts its allowance for loan losses based
upon its analysis of the loan portfolio. The Company increased its provision
for loan losses to $68,000 for the year ended June 30, 1996, as compared to
$15,000 for the year ended June 30, 1995. The increased provision for loan
losses for the year ended June 30, 1996 was due to the Company's higher levels
of consumer and commercial loans, which generally entail a greater risk than
single-family residential loans. The Company has increased its allowance for
loan losses as a percentage of total loans outstanding, net of unearned
origination fees to 0.42% at June 30, 1996 from 0.38% at June 30, 1995.
Noninterest Income. The Company's noninterest income consists of loan fees
and service charges, gain and losses on sale of investment securities, mortgage-
backed securities, trading accounts and loans. Noninterest income decreased by
$58,000, or 66.3%, to $30,000 for the year ended June 30, 1996 from $88,000 for
the year ended June 30, 1995. The decrease in noninterest income was primarily
due to the loss of $97,000 incurred on the sale of $3.0 million and $2.6 million
of investment securities and mortgage-backed securities, respectively, in fiscal
1996 as described above. The Company's net loss on the sale of assets during
fiscal 1995 was $19,000. The losses incurred during fiscal 1996 were partially
offset by an increase of $19,000, or 20.9%, in other fees and service charges
primarily related to checking accounts and automated teller machine fees.
Noninterest Expenses. Total noninterest expenses increased by $108,000, or
5.5%, to $2.1 million for the year ended June 30, 1996 from $2.0 million for the
year ended June 30, 1995. The increase in noninterest expenses was primarily
attributable to increases in compensation and employee benefits, partially
offset by decreases in professional fees and other noninterest expenses.
Compensation and employee benefits increased by $239,000, or 25.4%, to $1.2
million during fiscal 1996 from $940,000 during fiscal 1995, which was largely
due to a $131,000 expense related to a directors' retirement plan, adopted in
the first quarter of fiscal 1996, $70,000 associated with the ESOP and normal
salary increases associated with the hiring of additional lending personnel.
Professional fees decreased by $100,000, or 43.7%, to $129,000 during fiscal
1996 from $228,000 during fiscal 1995, primarily due to legal fees incurred
during fiscal 1995 as a result of certain severance arrangements with former
employees. Other noninterest expenses decreased by $46,000, or 14.7%, to
$264,000 in fiscal 1996 from $310,000 in fiscal 1995, which was largely
attributable to decreases in the Company's expenses relating to bank service
charges, seminar and meeting expenses, stationery and printing costs and real
estate owned expenses.
Provision for Income Taxes. The provision for income tax expense was
$67,000 and $948,000 for the years ended June 30, 1996 and 1995, respectively.
The income tax expense for the year ended June 30, 1995 included a $740,000
charge relating to the recapture of bad debt deductions. See Note 8 of Notes to
Financial Statements. The Company and the Association have not entered into an
agreement to file a consolidated federal income tax return.
Liquidity and Capital Resources
The Company is required to maintain levels of liquid assets as defined by
OTS regulations. This requirement, which may be changed at the direction of the
OTS depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required minimum ratio is
currently 5.0%. The Company's average daily liquidity ratio for the month of
June 1996 was approximately 12.6%, which exceeds required levels for such
period. Management of the Company seeks to maintain a relatively high level of
liquidity in order to retain flexibility in terms of investment opportunities
and deposit pricing and to meet its asset and liability management objectives.
Because liquid assets generally provide lower rates of return, the Company's
relatively high liquidity will, to a certain extent, result in lower rates of
return on assets.
The Company's most liquid assets are cash on hand, interest-bearing
deposits and unsecured loans to commercial banks, which are short-term, highly
liquid investments with original maturities of less than three months that are
readily convertible to known amounts of cash. The levels of these assets are
dependent on the Company's operating, financing and investing activities during
any given period. At June 30, 1996, cash and interest-bearing deposits and
short-term unsecured loans to commercial banks, totaled $7.4 million.
13
<PAGE>
The Company anticipates that it will have sufficient funds available to
meet its current loan commitments of $1.3 million. Certificates of deposit
which are scheduled to mature in less than one year at June 30, 1996 totaled
$25.6 million. Historically, a high percentage of maturing deposits have
remained with the Company.
The Company's primary sources of funds are deposits and proceeds from
maturing investment securities and mortgage-backed securities and principal and
interest payments on loans. While maturities and scheduled amortization of
mortgage-backed securities and loans are a predictable source of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest rates,
economic conditions, competition and other factors.
In past years, the primary investing activities of the Company were the
origination of residential first mortgage loans and the purchase of investment
securities and mortgage-backed securities. During the years ended June 30, 1996
and 1995, the Company originated $15.7 million and $8.3 million of loans and
purchased $1.1 million and $0 of loans, respectively. During the years ended
June 30, 1996 and 1995, the Company purchased investment securities of $0 and
$5.8 million, respectively, and purchased mortgage-backed securities of $2.9
million and $2.5 million, respectively.
The primary financing activities of the Company are the attraction of
savings deposits and obtaining FHLB advances. At June 30, 1996 and 1995, the
Company had FHLB advances of $0 and $5.0 million, respectively. The Company has
other sources of liquidity if there is a need for funds. As stated earlier, the
Company has a portfolio of investment securities and mortgage-backed securities
with an aggregate market value of $17.2 million classified as available for sale
as of June 30, 1996. During the years June 30, 1996 and 1995, the Company sold
investment securities of $3.0 million and $2.0 million, respectively, and sold
mortgage-backed securities of $2.6 million and $1.9 million, respectively.
As discussed earlier, the Company completed the Conversion during the
fourth quarter of fiscal 1996, which generated $7.3 million of gross proceeds.
After adjusting for the non-leveraged loan to the ESOP, which purchased
$580,000, or 8.0% of the outstanding shares, and the expenses related to the
Conversion of $505,000, the net proceeds from the Conversion were approximately
$6.2 million. The net cash provided to the Company from the Conversion was $4.3
million after adjusting for $1.9 million of savings deposits which were used to
purchase stock.
At June 30, 1996, the Association exceeded all regulatory minimum capital
requirements. The table below presents certain information relating to the
Association's regulatory compliance at June 30, 1996.
<TABLE>
<CAPTION>
Percent of
Amount Assets (1)
------ ----------
(Dollars in thousands)
<S> <C> <C>
Tangible capital....................................... $9,607 12.55%
Tangible capital requirement........................... 1,150 1.50
------ -----
Excess.............................................. $8,457 11.05%
====== =====
Core capital........................................... $9,607 12.55%
Core capital requirement............................... 2,301 3.00
------ -----
Excess.............................................. $7,306 9.55%
====== =====
Total capital.......................................... $9,826 28.67%
Risk-based capital requirement......................... 2,742 8.00
------ -----
Excess.............................................. $7,084 20.67%
====== =====
</TABLE>
- --------------------
(1) Based on adjusted total assets for purposes of the tangible capital and
core capital requirements and risk-weighted assets for purpose of the risk-
based capital requirement.
14
<PAGE>
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 change in the relative
purchasing power of money over time and due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations.
Unlike most industrial companies, nearly all the assets and liabilities of the
Company are monetary in nature. 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 price of goods and services.
Impact of New Accounting Standards
Impairment of Long-Lived Assets. In March 1995, the FASB issued Statement
of Financial Accounting Standards ("SFAS") No. 121 "Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of." The
statement is effective for years beginning after December 15, 1995 and requires,
among other things, recognition of impairment of long-lived assets, if any,
based upon the difference between the undiscounted expected future cash flows
and the carrying value. Further, the statement requires that long-lived assets
to be disposed of be reported at the lower of carrying amount or fair value less
costs to sell. The Company adopted the provisions of SFAS No. 121 on July 1,
1996 and management does not believe the adoption of this statement will have a
material effect on the Association's financial position or results of
operations.
Accounting for Stock-Based Compensation. In November 1995, the FASB issued
SFAS No. 123 "Accounting for Awards of Stock-Based Compensation to Employees"
("SFAS No. 123"). SFAS No. 123 is effective for years beginning after December
15, 1995. Earlier application is permitted. The Statement defines a fair value
based method of accounting for an employee stock option or similar equity
instrument and encourages all entities to adopt that method of accounting for an
employee stock option or similar equity instrument and encourages all entities
to adopt that method of accounting for all of their employee stock compensation
plans. However, it also allows an entity to continue to measure compensation
cost for those plans using the intrinsic value based method of accounting
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees"
("Opinion 25"). Under the fair value based method, compensation cost is
measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. Under the
intrinsic value based method, compensation cost is the excess, if any, of the
quoted market price of the stock at the grant date or other measurement date
over the amount an employee must pay to acquire the stock. Most fixed stock
option plans -- the most common type of stock compensation plan -- have no
intrinsic value at grant date, and under Opinion 25 no compensation cost is
recognized for them. Compensation cost is recognized for other types of stock
based compensation plans under Opinion 25, including plans with variable,
usually performance-based, features. This Statement requires that an employer's
financial statements include certain disclosures about stock-based employee
compensation arrangements regardless of the method used to account for them.
The Company intends to continue using the intrinsic value method and will
provide the pro forma disclosures about its stock-based employee compensation
plans in its 1997 financial statements, as required by SFAS No. 123.
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. In June 1996 the FASB issued Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" ("SFAS No. 125"). SFAS No. 125 is effective
for transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996 and is to be applied
prospectively. This Statement will require, among other things, the Company to
record at fair value, assets and liabilities resulting from a transfer of
financial assets. The Company plans to adopt the provisions of SFAS No. 125 on
January 1, 1996. Management does not believe the adoption of this statement
will have a material effect on the Company's financial position or results of
operations.
15
<PAGE>
Independent Auditors' Report
The Board of Directors
Patapsco Bancorp, Inc.
Dundalk, Maryland:
We have audited the accompanying consolidated statements of financial condition
of Patapsco Bancorp, Inc. and subsidiary (the Company) as of June 30, 1996 and
1995, and the related consolidated statements of operations, stockholders'
equity and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 financial position of Patapsco Bancorp,
Inc. and subsidiary as of June 30, 1996 and 1995, and the results of their
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ KMPG Peat Marwick LLP
July 31, 1996,
except as to the last paragraph of Note 8,
which is as of August 20, 1996
16
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
June 30, 1996 and 1995
<TABLE>
<CAPTION>
====================================================================================================================================
1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash:
On hand and due from banks $ 400,286 1,097,268
Interest bearing deposits 229,290 832,414
Federal funds sold 6,794,889 552,472
Investments securities, fair value of $4,423,767 in 1996
and $14,624,399 in 1995 (note 2) 4,423,767 14,829,984
Mortgage-backed securities, fair value of $12,777,828 in 1996
and $15,676,469 in 1995 (note 3) 12,777,828 15,771,861
Loans receivable, net (note 4) 52,031,297 41,748,646
Investment in Federal Home Loan Bank stock, at cost (notes 7 and 9) 490,500 490,500
Ground rents owned, at cost 41,200 41,200
Real estate acquired through foreclosure, net 31,081 50,000
Property and equipment, net (note 5) 1,028,690 1,102,690
Income taxes recoverable (note 8) - 41,000
Accrued interest, prepaid expenses and other assets 601,118 585,652
- ------------------------------------------------------------------------------------------------------------------------------------
$ 78,849,946 77,143,687
====================================================================================================================================
Liabilities and Stockholders' Equity
Liabilities:
Savings deposits (note 6) $ 64,156,888 63,929,573
Advances from the Federal Home Loan Bank of Atlanta (note 7) - 5,000,000
Advance payments by borrowers for taxes, insurance and ground rents 1,189,735 1,089,652
Accrued expenses and other liabilities 530,180 337,374
Income taxes payable (note 8) 75,000 -
Deferred income taxes (note 8) 597,000 747,000
- ------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 66,548,803 71,103,599
Stockholders' equity (notes 9, 10, and 11):
Common stock $0.01 par value; authorized 4,000,000 shares; issued and
outstanding 362,553 shares 3,626 -
Additional paid-in capital 6,754,240 -
Contra equity - ESOP (522,072) -
Retained earnings, substantially restricted 6,172,405 6,071,321
Unrealized net holding losses on available-for-sale portfolios,
net of taxes (107,056) (31,233)
- ------------------------------------------------------------------------------------------------------------------------------------
12,301,143 6,040,088
Commitments (notes 4, 11 and 12)
- ------------------------------------------------------------------------------------------------------------------------------------
$ 78,849,946 77,143,687
====================================================================================================================================
</TABLE>
See accompaning notes to consolidated financial statements.
17
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Operations
Years ended June 30, 1996 and 1995
<TABLE>
<CAPTION>
=================================================================================================
1996 1995
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Loans receivable $ 3,514,298 3,066,432
Mortgage-backed securities 1,002,469 1,091,920
Investment securities 612,390 717,609
Trading account investments -- 3,463
Federal funds sold 167,187 139,167
Dividends of Federal Home Loan Bank stock 35,634 34,989
- -------------------------------------------------------------------------------------------------
Total interest income 5,331,978 5,053,580
- -------------------------------------------------------------------------------------------------
Interest expense:
Savings deposits (note 6) 2,851,327 2,379,917
Advances from Federal Home Loan Bank of Atlanta 186,495 282,145
- -------------------------------------------------------------------------------------------------
Total interest expense 3,037,822 2,662,062
- -------------------------------------------------------------------------------------------------
Net interest income 2,294,156 2,391,518
Provision for losses on loans (note 4) 68,000 15,000
- -------------------------------------------------------------------------------------------------
Net interest income after provision for losses on loans 2,226,156 2,376,518
- -------------------------------------------------------------------------------------------------
Noninterest income:
Fees and service charges 108,997 90,157
Net loss on sales of securities and loans (99,446) (19,271)
Other 20,153 17,160
- -------------------------------------------------------------------------------------------------
Total noninterest income 29,704 88,046
- -------------------------------------------------------------------------------------------------
Noninterest expenses:
Compensation and employee benefits 1,178,829 939,861
Insurance 192,654 194,820
Professional fees 128,725 228,422
Equipment expenses 113,697 109,888
Net occupancy costs 79,377 74,763
Advertising 38,090 43,614
Data processing 91,861 78,356
Other 264,543 310,004
- -------------------------------------------------------------------------------------------------
Total noninterest expenses 2,087,776 1,979,728
- -------------------------------------------------------------------------------------------------
Income before provision for income taxes 168,084 484,836
Provision for income taxes (including $740,000
recapture of bad debt deductions in 1995)(note 8) 67,000 948,000
- -------------------------------------------------------------------------------------------------
Net income (loss) $ 101,084 (463,164)
=================================================================================================
</TABLE>
(Continue)
18
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Operations, Continued
Years ended June 30, 1996 and 1995
<TABLE>
<CAPTION>
================================================================================
1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Net income per share of common stock (note 1):
From date of conversion 0.26 N/A
Proforma 0.74 N/A
================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
Years ended June 30, 1996 and 1995
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Unrealized net
holding losses on Total
Common Additional Contra-equity Retained available-for-sale stockholders'
stock paid-in capital ESOP earnings portfolios equity
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1994 $ -- -- -- 6,534,485 -- 6,534,485
Adjustment to unrealized net
holding loss on available-
for-sale portfolios, net
(note 1) -- -- -- -- (31,233) (31,233)
Net loss--1995 -- -- -- (463,164) -- (463,164)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1995 -- -- -- 6,071,321 (31,233) 6,040,088
Proceeds from stock offering,
net of conversion costs 3,626 6,742,184 -- -- -- 6,745,810
Borrowings for Employee Stock
Ownership Plan (ESOP) -- -- (580,080) -- -- (580,080)
Compensation under stock-based
benefit plans -- 12,056 58,008 -- -- 70,064
Adjustment to unrealized net
holding losses on available-
for-sale portfolios, net
(note 1) -- -- -- -- (75,823) (75,823)
Net income--1996 -- -- -- 101,084 -- 101,084
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996 $ 3,626 6,754,240 (522,072) 6,172,405 (107,056) 12,301,143
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
20
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended June 30, 1996 and 1995
<TABLE>
<CAPTION>
===========================================================================================================
1996 1995
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 101,084 (463,164)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 109,664 100,760
Provision for losses on loans 68,000 15,000
Non-cash compensation under stock-based
benefit plans 70,064 --
Amortization of premiums and discounts, net (69,814) (54,797)
Deferred loan origination fees, net of costs 95,465 83,291
Loss on sales of investment securities and
mortgage-backed securities 97,102 16,455
Loss on sales of loans 2,344 4,248
Gain on sales of real estate -- (10,680)
Sales of trading account investments -- 1,401,877
Loans originated for sale, net (272,794) (297,676)
Proceeds from sale of mortgage loans originated
for sale 270,250 293,428
Increase (decrease) in deferred income taxes (150,000) 658,000
Decrease (increase) in taxes recoverable 41,000 (25,000)
Decrease (increase) in accrued interest on
investments, prepaid expenses and other assets (15,466) 20,359
Decrease in accrued expenses and other liabilities 192,806 69,921
- -----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 539,705 1,812,022
- -----------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Loan principal disbursements, net of repayments (9,740,148) (4,631,268)
Purchase of loans (1,120,086) --
Proceeds from sales and operations of real estate acquired
through foreclosure 18,919 67,523
Purchases of property and equipment (35,664) (191,070)
Disposals of property and equipment -- 500
Principal repayments on:
Mortgage-backed securities available-for-sale 2,001,361 457,731
Mortgage-backed securities held-to-maturity 1,268,790 1,396,716
Maturity of:
Investment securities available-for-sale 5,500,000 --
Investment securities held-to-maturity 2,000,000 --
Sale of:
Mortgage-backed securities available-for-sale 2,620,522 1,850,668
Investment securities available-for-sale 2,857,317 2,000,313
</TABLE>
21
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows, Continued
Years ended June 30, 1996 and 1995
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from investing activities, continued:
Purchase of:
Mortgage-backed securities available-for-sale $ (2,895,020) (2,457,511)
Investment securities available-for-sale - (1,858,171)
Investment securities held-to-maturity - (3,986,000)
Investment securities - -
- --------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities 2,475,991 (7,347,569)
- --------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in savings deposits 227,315 1,771,000
Increase (decrease) in advance payments by borrowers
for taxes, insurance and ground rents 100,083 (33,119)
Increase (decrease) in advances from Federal Home
Loan Bank of Atlanta (5,000,000) 2,500,000
Proceeds from stock offering 6,165,730 -
- --------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 1,493,128 4,237,881
- --------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 4,942,311 (1,300,666)
Cash and cash equivalents at beginning of year 2,482,154 3,782,820
- --------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 7,424,465 2,482,154
- --------------------------------------------------------------------------------------------
Supplemental information:
Interest paid on savings deposits and borrowed funds $ 3,036,930 2,639,456
Income taxes paid 53,000 315,000
- --------------------------------------------------------------------------------------------
Non-cash transactions:
Transfers of balances from loans to real estate owned, net $ - 55,000
- --------------------------------------------------------------------------------------------
Increase in unrealized holding losses on securities
available for sale, net of income tax effect $ 75,823 31,233
- --------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1996 and 1995
================================================================================
(1) Basis of Presentation and Summary of Significant Accounting Policies
Description of Business
Patapsco Bancorp, Inc. (the Company) is the holding company of Patapsco
Federal Savings and Loan Association (Patapsco). The primary business of
Patapsco is to attract deposits from individual and corporate customers
and to originate residential and commercial mortgage loans, commercial
loans and consumer loans. Patapsco is subject to competition from other
financial and mortgage institutions in attracting and retaining deposits
and in making loans. Patapsco is subject to the regulations of certain
agencies of the federal government and undergoes periodic examination by
those agencies.
Basis of Presentation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, Patapsco. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the date of the statements of
financial condition and income and expenses for the periods then ended.
Actual results could differ significantly 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.
In connection with this determination, management obtains independent
appraisals for significant properties and prepares fair value analyses
as appropriate.
Management believes that the allowance for loan losses is adequate.
While management uses and considers available information in making the
required estimates, additional provisions for possible losses may be
necessary based on changes in economic conditions, particularly in
Baltimore and the State of Maryland. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review Patapsco's allowance for loan losses. Such agencies may require
Patapsco to recognize additions to the allowance based on their
judgments about information available to them at the time of their
examination.
Cash and Cash Equivalents
Cash equivalents include short-term investments which consists of
Federal funds sold. Cash equivalents and other liquidity and short-term
investments are carried at cost, which approximates market value.
(Continued)
23
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
Investment and Mortgage-Backed Securities
As of July 1, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt
and Equity Securities, (SFAS No. 115), which addresses the accounting
and reporting for certain investments in debt and equity securities. The
effect of initial adoption of SFAS No. 115 was to decrease retained
earnings as of July 1, 1994 by approximately $30,800.
SFAS No. 115 requires classification of investments into three
categories. Debt securities that the Company has the positive intent and
ability to hold to maturity are classified as held-to-maturity and
recorded at amortized cost. Debt and equity securities not classified as
held-to-maturity and equity securities with readily determinable fair
values are classified as trading securities if bought and held
principally for the purpose of selling them in the near term. Trading
securities are reported at fair value, with unrealized gains and losses
included in earnings. Investments not classified as held-to-maturity or
trading are considered available-for-sale and are reported at fair
value, with unrealized holding gains and losses excluded from earnings
and reported as a separate component of stockholders' equity, net of tax
effects.
If a decline in value of an individual security classified as held-to-
maturity or available-for-sale is judged to be other than temporary, the
cost basis of that security is reduced to its fair value and the amount
of the write-down is included in earnings. Fair value is determined
based on bid prices published in financial newspapers or bid quotations
received from securities dealers. For purposes of computing realized
gains or losses on the sales of investments, cost is determined using
the specific identification method. Premiums and discounts on investment
and mortgage-backed securities are amortized over the term of the
security using methods that approximate the interest method.
In November 1995, the Financial Accounting Standards Board announced its
intention to allow a one-time change in the classification of
securities, providing such change was effected by December 31, 1995.
Management utilized this opportunity and on December 15, 1995 designated
its held-to-maturity investment and mortgage-backed securities, with an
amortized cost of $21,299,156 and an unrealized net loss of $73,099, as
available-for-sale.
(Continued)
24
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation
computed by use of straight-line and accelerated methods over the
estimated useful lives of the related assets. Additions and betterments
are capitalized and costs of repairs and maintenance are expensed when
incurred. The related costs and accumulated depreciation are eliminated
from the accounts when an asset is sold or retired and the resultant
gain or loss is credited or charged to income.
Loan Fees
Loan origination fees are deferred and amortized to income over the
contractual lives of the related loans using the interest method.
Certain incremental direct loan origination costs are deferred and
recognized over the contractual lives of the related loans using the
interest method as a reduction of the loan yield. Deferred fees and
costs are combined where applicable and the net amount is amortized.
Provision for Losses on Loans
Provisions for losses on loans receivable are charged to income, based
on management's judgment with respect to the risks inherent in the
portfolio. Such judgment considers a number of factors including
historical loss experience, the present and prospective financial
condition of borrowers, the estimated value of underlying collateral,
geographic concentrations, current and prospective economic conditions,
delinquency experience and status of nonperforming assets. Additionally,
accrual of interest on potential problem loans is excluded from income
when, in the opinion of management, the full collection of principal or
interest is in doubt, or payment of principal or interest has become 90
days past due, unless the obligation is well secured and in the process
of collection. Interest collected on nonaccrual loans is generally
recorded in income in the period received.
In May 1993 the Financial Accounting Standards Board (FASB) issued SFAS
No. 114 Accounting by Creditors for Impairment of a Loan (SFAS No. 114),
which was effective for fiscal years beginning after December 15, 1994.
The Statement addresses the accounting by creditors for impairment of
certain loans. It is generally applicable for all loans except large
groups of smaller balance homogenous loans that are collectively
evaluated for impairment including residential mortgage loans and
consumer installment loans.
(Continued)
25
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
SFAS No. 114 requires that impaired loans be measured based on the
present value of expected future cash flows discounted at the loan's
effective interest rate, or at the loan's observable market price or the
fair value of the collateral if the loan is collateral dependent. A loan
is considered impaired when, based on current information and events, it
is probable that a creditor will be unable to collect all amounts due
according to the contractual terms of the loan agreements.
In October 1994, the FASB issued SFAS No. 118, which was effective
concurrent with the effective date of SFAS No. 114. This Statement amends
SFAS No. 114 to allow a creditor to use existing methods for recognizing
interest income on impaired loans. Also, this statement requires the
disclosure about the recorded investment in certain impaired loans and
how the creditor recognizes interest income related to those impaired
loans.
The Company adopted the provisions of SFAS Nos. 114 and 118 as of July 1,
1994 and the adoption of SFAS Nos. 114 and 118 did not have a significant
effect on the financial statements.
Real Estate Acquired Through Foreclosure
Real estate acquired through foreclosure is initially recorded at the
lower of cost or estimated fair value and subsequently at the lower of
book value or fair value less estimated costs to sell. Costs relating to
holding such real estate are charged against income in the current
period, while costs relating to improving such real estate are
capitalized until a salable condition is reached.
Sales of Mortgage Loans
Loans originated for sale are carried at the lower of aggregate cost or
market value. Market value is determined based on outstanding investor
commitments or, in the absence of such commitments, based on current
investor yield requirements. Gains and losses on loan sales are
determined using the specific identification method.
Income Taxes
Deferred income taxes are recognized, with certain exceptions, for
temporary differences between the financial reporting basis and income
tax basis of assets and liabilities based on enacted tax rates expected
to be in effect when such amounts are realized or settled. Deferred tax
assets (including tax loss carryforwards) are recognized only to the
extent that it is more likely than not that such amounts will be realized
based on consideration of available evidence, including tax planning
strategies and other factors.
(Continued)
26
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(1) Continued
The effects of changes in tax laws or rates on deferred tax assets and
liabilities are recognized in the period that includes the enactment
date.
Net Income per Share of Common Stock
Net income per share for 1996 has been computed based on 333,549 weighted
average shares of common stock outstanding.
Net income per share for the portion of the year ended June 30, 1996 the
Company was a stock corporation, April 1, 1996 through June 30, 1996, is
computed using net income for such period. Pro forma net income per share
for the year ended June 30, 1996 utilized net income for the portion of
the year the Company was a stock corporation and assumed net proceeds of
the sale of common stock in the conversion were received and invested
beginning for the period July 1, 1995 to March 31, 1996 at a net
effective yield of 3.45% (approximate yield on the one-year Treasury bill
at June 30, 1995, net of tax).
Reclassifications
Certain amounts for 1995 have been reclassified to conform to the
presentation for 1996.
(Continued)
27
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(2) Investment Securities
Investment securities are summarized as follows as of June 30:
<TABLE>
<CAPTION>
1996
-------------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Available-for-sale
U.S. Government and
Agency obligations
due:
1 through 5 years $ 2,500,000 -- 32,800 2,467,200 2,467,200
5 through 10 years 1,987,067 -- 30,500 1,956,567 1,956,567
- ------------------------------------------------------------------------------------------------------------
$ 4,487,067 -- 63,300 4,423,767 4,423,767
============================================================================================================
<CAPTION>
1995
-------------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Available-for-sale
U.S. Government and
Agency obligations
due:
Within 1 year $ 1,930,261 2,609 -- 1,932,870 1,932,870
1 through 5 years 1,000,000 -- 38,578 961,422 961,422
- ------------------------------------------------------------------------------------------------------------
2,930,261 2,609 38,578 2,894,292 2,894,292
Held-to-maturity
U.S. Government and
Agency obligations
due:
Within 1 year 2,497,632 4,880 -- 2,502,512 2,497,632
1 through 5 years 7,452,060 -- 219,832 7,232,228 7,452,060
After 10 years 1,986,000 9,367 -- 1,995,367 1,986,000
- ------------------------------------------------------------------------------------------------------------
11,935,692 14,247 219,832 11,730,107 11,935,692
- ------------------------------------------------------------------------------------------------------------
$ 14,865,953 16,856 258,410 14,624,399 14,829,984
============================================================================================================
</TABLE>
Accrued interest receivable on available-for-sale investment securities at June
30, 1996 was $32,126. Accrued interest receivable on available-for-sale and
held-to-maturity investment securities at June 30, 1995 was $21,407 and $80,567,
respectively.
28
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(2) Continued
In 1996, the Company sold investment securities classified available-for-
sale with an amortized cost of $2,928,753 and realized a net loss of
$71,436.
In 1995, the Company sold investment securities classified available-for-
sale with an amortized cost of $2,000,000 and realized a gain of $313.
Also, the Company liquidated a trading account comprised of an investment
in Asset Management Fund for Financial Institutions, Inc. realizing a
gain of $1,432.
There were no sales of investment securities in 1994.
(3) Mortgage-Backed Securities
Mortgage-backed securities and accrued interest thereon are summarized as
follows as of June 30:
<TABLE>
<CAPTION>
1996
-----------------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Available-for-sale
Federal National Mortgage
Association (FNMA) $ 1,767,779 -- 29,564 1,738,215 1,738,215
Federal Home Loan
Mortgage Corporation
(FHLMC) 855,044 -- 25,068 829,976 829,976
FNMA Collateralized
Mortgage Obligations 6,597,595 8,177 59,902 6,545,870 6,545,870
FHLMC Collateralized
Mortgage Obligations 3,668,525 7,975 12,733 3,663,767 3,663,767
----------------------------------------------------------------------------------------------------------
$ 12,888,943 16,152 127,267 12,777,828 12,777,828
==========================================================================================================
</TABLE>
(Continued)
29
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(3) Continued
<TABLE>
<CAPTION>
1995
-----------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Available-for-sale
Government National
Mortgage Association $ 1,261,155 113 14,829 1,246,439 1,246,439
FNMA 2,103,159 18,743 18,944 2,102,958 2,102,958
- ------------------------------------------------------------------------------------------------------------------
3,364,314 18,856 33,773 3,349,397 3,349,397
Held-to-maturity
FNMA Collateralized
Mortgage Obligations 8,207,262 12,886 93,592 8,126,556 8,207,262
FHLMC Collateralized
Mortgage Obligations 4,215,202 14,424 29,110 4,200,516 4,215,202
- ------------------------------------------------------------------------------------------------------------------
12,422,464 27,310 122,702 12,327,072 12,422,464
- ------------------------------------------------------------------------------------------------------------------
$ 15,786,778 46,166 156,475 15,676,469 15,771,861
==================================================================================================================
</TABLE>
Accrued interest receivable on available-for-sale mortgage-backed securities at
June 30, 1996 was $75,530. Accrued interest receivable on available-for-sale and
held-to-maturity mortgage-backed securities at June 30, 1995 was $11,339 and
$68,827.
In 1996, the Company sold mortgage-backed securities classified
available-for-sale with an amortized cost of $2,646,188 and realized a net
loss of $25,666.
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(3) Continued
In 1995, the Company sold mortgage-backed securities classified available-
for-sale with an amortized cost of $1,865,315 and realized a net loss of
$16,768.
Contractual maturities of mortgage-backed securities as of June 30 are as
follows:
<TABLE>
<CAPTION>
1996 1995
----------------------- ----------------------
Amortized Fair Amortized Fair
cost value cost value
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale
Due after five through ten years $ 8,670,917 8,644,226 -- --
Due after ten years 4,218,026 4,133,602 3,364,314 3,349,397
----------------------------------------------------------------------------------------
12,888,943 12,777,828 3,364,314 3,349,397
Held-to-maturity
Due after five through ten years -- -- 8,242,752 8,195,410
Due after ten years -- -- 4,179,712 4,131,662
----------------------------------------------------------------------------------------
-- -- 12,422,464 12,327,072
----------------------------------------------------------------------------------------
$ 12,888,943 12,777,828 15,786,778 15,676,469
========================================================================================
</TABLE>
Contractual maturities do not consider anticipated prepayments of
mortgage-backed securities.
(Continued)
31
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(4) Loans Receivable
Loans receivable and accrued interest receivable thereon are summarized
as follows as of June 30:
<TABLE>
<CAPTION>
1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Loans secured by first mortgages on real estate:
Residential $ 47,278,681 40,889,930
Commercial 1,074,454 836,820
- ------------------------------------------------------------------------------------------------------------------------------------
48,353,135 41,726,750
Commercial leases 179,386 139,156
Commercial loans 1,020,000 -
Home improvement loans 2,372,648 -
Home equity loans 39,340 -
Loans secured by savings deposits 391,428 210,473
Line of credit loans 142,999 4,200
- ------------------------------------------------------------------------------------------------------------------------------------
52,498,936 42,080,579
Less:
Allowance for loan losses 219,001 158,768
Deferred loan origination fees, net of costs 248,638 173,165
- ------------------------------------------------------------------------------------------------------------------------------------
Loans receivable, net $ 52,031,297 41,748,646
====================================================================================================================================
</TABLE>
Accrued interest receivable on loans was $306,883 and $217,262 at June
30, 1996 and 1995, respectively.
Substantially all of the Company's loans receivable are mortgage loans
secured by residential real estate properties. Loans are extended only
after evaluation by management of customers' creditworthiness and other
relevant factors on a case-by-case basis. The Company does not lend more
that 95% of the appraised value of an owner occupied residential
property and in instances where the Company lends more than 80% of the
appraised value, private mortgage insurance is required. For investor
loans on residential property (not owner occupied) the Company does not
lend more than 70% of the appraised value.
The Company's residential lending operations are focused in the State of
Maryland, primarily the Baltimore Metropolitan area. While residential
lending is generally considered to involve less risk than other forms of
lending, payment experience on these loans is dependent to some extent
on economic and market conditions in the Company's primary lending area.
32
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(4) Continued
Nonaccrual loans amounted to approximately $240,000 and $122,000 at June
30, 1996 and 1995, respectively. The amount of interest income that would
have been recorded on loans in nonaccrual status at June 30, 1996 and
1995 had such loans performed in accordance with their terms, was
approximately $19,000 and $12,000, respectively. The actual interest
income recorded on these loans during 1996 and 1995 was approximately
$8,000 and $8,000, respectively.
The Company, through its normal asset review process, classifies certain
loans which management believes involve a degree of risk warranting
additional attention. These classifications are special mention,
substandard, doubtful and loss. At June 30, 1996, loans classified
special mention and substandard totaled approximately $777,000 and
$240,000, respectively. No loans were classified doubtful or loss at
June 30, 1996.
The activity in the allowance for loan losses is summarized as follows
for the years ended June 30:
<TABLE>
<CAPTION>
1996 1995
------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 158,768 156,444
Provision for losses on loans 68,000 15,000
Charge-offs, net of recoveries (7,767) (12,676)
------------------------------------------------------------------------
Balance at end of year $ 219,001 158,768
------------------------------------------------------------------------
</TABLE>
Commitments to extend credit are agreements to lend to customers,
provided that terms and conditions of the commitment are met. Commitments
are generally funded from loan principal repayments, excess liquidity and
savings deposits. Since certain of the commitments may expire without
being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Substantially all of the Company's outstanding commitments at June 30,
1996 are for loans which would be secured by real estate with appraised
values in excess of the commitment amounts. The Company's exposure to
credit loss under these contracts in the event of non-performance by the
other parties, assuming that the collateral proves to be of no value, is
represented by the commitment amounts.
(Continued)
33
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(4) Continued
Outstanding commitments to extend credit, which generally expire within
60 days, are as follows at June 30, 1996:
<TABLE>
<CAPTION>
Floating
Fixed rate rate
-------------------------------------------------------------------------
<S> <C> <C>
Residential mortgage loans $ 105,200 187,300
Commercial mortgage loans -- 110,000
Commercial business loans 235,000 300,000
Undisbursed lines of credit 221,231
=========================================================================
</TABLE>
As of June 30, 1996 and 1995, Patapsco was servicing loans for the
benefit of others approximately $409,000 and $141,000, respectively.
(5) Property and Equipment
Property and equipment are summarized as follows at June 30:
<TABLE>
<CAPTION>
Estimated
1996 1995 useful lives
----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Land $ 92,684 92,684 --
Building and improvements 908,528 882,308 40 years
Furniture, fixtures and equipment 908,498 899,054 5 - 10 years
----------------------------------------------------------------------------- ===============
Total, at cost 1,909,710 1,874,046
Less accumulated depreciation $ 881,020 771,356
-----------------------------------------------------------------------------
Property and equipment, net $ 1,028,690 1,102,690
=============================================================================
</TABLE>
The Company has no obligations under long-term operating leases.
34
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(6) Savings Deposits
Savings deposits are summarized as follows at June 30:
<TABLE>
<CAPTION>
Weighted
average rate 1996 1995
Type of ---------------------- ----------------------- ----------------------
account 1996 1995 Amount % Amount %
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Certificates 5.50% 5.42% $ 36,329,647 56.6% 36,117,154 56.6%
-----------------------------------------------------------------------------------------------
Non-Certificate:
Passbook 3.00% 3.00% 17,268,380 26.9% 18,093,672 28.3%
Statement
savings accounts 3.20% 3.50% 1,631,704 2.6% 1,335,598 2.1%
Christmas Club 3.00% 3.00% 112,599 0.2% 108,311 0.2%
NOW 2.00% 2.25% 2,565,200 4.0% 2,544,199 4.0%
Noninterest-bearing
NOW -- -- 777,539 1.2% 465,180 0.7%
Commercial
demand accounts -- -- 639,830 1.0% 776,213 1.2%
Money Market 3.30% 3.80% 4,831,989 7.5% 4,489,246 7.0%
-----------------------------------------------------------------------------------------------
27,827,241 43.4% 27,812,419 43.5%
-----------------------------------------------------------------------------------------------
$ 64,156,888 100.0% 63,929,573 100.0%
===============================================================================================
Certificate accounts maturing:
Under 12 months $ 25,567,419 70.4% 27,675,411 76.6%
12 months to 24 months 6,003,049 16.5% 4,461,916 12.4%
24 months to 36 months 615,221 1.7% 654,545 1.8%
36 months to 48 months 3,493,844 9.6% 53,696 0.1%
48 months to 60 months 650,114 1.8% 3,271,586 9.1%
-----------------------------------------------------------------------------------------------
$ 36,329,647 100.0% 36,117,154 100.0%
===============================================================================================
</TABLE>
The aggregate amount of certificates with a minimum balance of $100,000 was
approximately $1,251,000 and $1,230,000 at June 30, 1996 and 1995,
respectively.
(Continued)
35
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(6) Continued
Interest expense on savings deposits consists of the following for the
years ended June 30:
<TABLE>
<CAPTION>
1996 1995
------------------------------------------------------------------------
<S> <C> <C>
Certificates $ 2,047,123 1,520,162
Passbook, Statement Savings, and
Christmas Club 573,959 622,459
NOW 66,997 61,389
Money Market 163,248 175,907
------------------------------------------------------------------------
$ 2,851,327 2,379,917
========================================================================
</TABLE>
(7) Advances from the Federal Home Loan Bank of Atlanta
Advances from the Federal Home Loan Bank of Atlanta are summarized as
follows at June 30, 1995:
<TABLE>
<S> <C> <C>
Due February 2, 1996, bears interest at 5.11% $ 1,500,000
Due February 24, 1996, bears interest at 4.73% 1,000,000
Due April 5, 1996, bears interest at 6.92% 2,500,000
------------------------------------------------------------------------
$ 5,000,000
========================================================================
</TABLE>
Advances from the Federal Home Loan Bank of Atlanta were repaid during
the year ended June 30, 1996.
(Continued)
36
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(8) Income Taxes
The provision for income taxes is composed of the following for the years
ended June 30:
<TABLE>
<CAPTION>
1996 1995
--------------------------------------------------------------------------------
<S> <C> <C>
Current:
Federal $ 221,000 239,000
State 44,000 51,000
--------------------------------------------------------------------------------
265,000 290,000
--------------------------------------------------------------------------------
Deferred
Federal (160,000) 539,000
State (38,000) 119,000
--------------------------------------------------------------------------------
(198,000) 658,000
--------------------------------------------------------------------------------
$ 67,000 948,000
================================================================================
</TABLE>
The net deferred tax liability consists of the following at June 30:
<TABLE>
<CAPTION>
1996 1995
--------------------------------------------------------------------------------
<S> <C> <C>
Total deferred tax liabilities $(934,000) (951,000)
Total deferred tax assets 337,000 204,000
--------------------------------------------------------------------------------
$(597,000) (747,000)
================================================================================
</TABLE>
The tax effects of temporary differences between the financial reporting
and income tax basis of assets and liabilities relate to the following at
June 30:
<TABLE>
<CAPTION>
1996 1995
--------------------------------------------------------------------------------
<S> <C> <C>
Tax bad debt reserves $(758,000) (763,000)
Assets and liabilities recognized on the
accrual basis for financial statement
purposes and on the cash basis for
tax purposes (36,000) (72,000)
Allowance for losses on loans 85,000 61,000
Federal Home Loan Bank stock dividends (71,000) (71,000)
Unrealized holding losses 68,000 20,000
Accumulated depreciation (69,000) (59,000)
Deferred compensation 133,000 73,000
Deferred loan fees 37,000 35,000
Other, net 14,000 29,000
--------------------------------------------------------------------------------
$(597,000) (747,000)
================================================================================
</TABLE>
(Continued)
37
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(8) Continued
A reconciliation of the provision for income taxes and the amount
computed by multiplying income before income taxes by the statutory
Federal income tax rate of 34% is as follows for the years ended June 30:
<TABLE>
<CAPTION>
1996 1995
--------------------------------------------------------------------------------------
<S> <C> <C>
Tax at statutory rate $ 59,000 170,000
State income taxes, net of Federal income tax benefit 4,000 111,000
Federal recapture of bad debt deductions -- 655,000
Other 4,000 12,000
--------------------------------------------------------------------------------------
Provision for income taxes $ 67,000 948,000
======================================================================================
Effective tax rate 38.7% 42.9%
======================================================================================
</TABLE>
The Company has qualified under provisions of the Federal Internal
Revenue Code which permit it to deduct from taxable income a provision
for bad debts based on either actual bad debt experience or a percentage
of taxable income before such deduction. The deduction percentage,
subject to certain minimum tax provisions and other limitations, is 8%.
The provision for bad debts deducted from taxable income for Federal
income tax purposes was based on the percentage method in 1996 and 1995.
The Company's Federal income tax returns have been audited through
June 30, 1995.
In 1995, the Company recorded a $740,000 charge in connection with the
decision to convert the Association to a commercial bank. Legislation
enacted by Congress and signed by the President on August 20, 1996 will
allow for recovery of a portion of this charge. This recovery is expected
to approximate $600,000 and will be recorded in the quarter ended
September 30, 1996.
(Continued)
38
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(9) Regulatory Matters
The Federal Deposit Insurance Corporation, through the Savings
Association Insurance Fund, insures deposits of accountholders up to
$100,000. Patapsco pays an annual premium to provide for this insurance.
Patapsco is also a member of the Federal Home Loan Bank System and is
required to maintain an investment in the stock of the Federal Home Loan
Bank of Atlanta equal to at least 1% of the unpaid principal balances of
its residential mortgage loans, .3% of its total assets or 5% of its
outstanding advances from Patapsco, whichever is greater. Purchases and
sales of stock are made directly with Patapsco at par value.
Patapsco is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on Patapsco's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, Patapsco must meet specific capital guidelines that
involve quantitative measures of Patapsco's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. Patapsco'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 Patapsco to maintain minimum amounts and ratios (as
defined in the regulations and as set forth in the table below, as
defined) of total and Tier I capital (as defined) to risk-weighted assets
(as defined), and of Tier I capital to average assets (as defined).
Management believes, as of June 30, 1996, that Patapsco meets all capital
adequacy requirements to which it is subject.
As of March 31, 1996, the most recent notification from the Officer of
Thrift Supervision categorized Patapsco as adequately capitalized under
the regulatory framework for prompt corrective action. To be categorized
as adequately capitalized Patapsco must maintain minimum total risk-
based, Tier I risk-based, and Tier I leverage ratios as set forth in
table. There are no conditions or events since that notification that
management believes have changed the institution's category.
(Continued)
39
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(9) Continued
Patapsco's actual capital amounts and ratios are also presented in the
table (in thousands).
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------------- --------------------------- ----------------------------
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1996:
Tangible capital (a) $ 9,607 12.60% 1,150 1.50% $ 3,833 greater than 5%
Core capital (b) 9,607 12.60% 2,301 3.00% 2,056 greater than 6%
Risk-based capital (b) 9,826 28.70% 2,742 8.00% 3,427 greater than 10%
As of June 30, 1995:
Tangible capital (a) 6,071 7.90% 1,157 1.50% 3,858 greater than 5%
Core capital (b) 6,071 7.90% 2,315 3.00% 1,971 greater than 6%
Risk-based capital (b) 6,230 19.00% 2,628 8.00% 3,286 greater than 10%
===============================================================================================================================
</TABLE>
(a) Percentage of Capital to Average Assets
(b) Percentage of Capital to Average Assets for Actual and Capital Adequacy
Purposes and Percentage of Capital to Risk Weighed Assets to be Well
Capitalized Under Prompt Corrective Action Provisions.
(c) Percentage of Capital to Risk Weighted Assets
(10) Stockholders' Equity and Related Matters
On September 14, 1995, the Board of Directors approved a plan of
reorganization from a mutual savings association to a capital stock savings
bank and the concurrent formation of a holding company. The conversion was
accomplished through amendment of Patapsco's charter and the sale of the
Company's common stock in an amount equal to the consolidated pro forma
market value of the Company and Patapsco after giving effect to the
conversion. A subscription offering of the shares of common stock was
offered initially to employee benefit plans of the Company, depositors,
borrowers, directors, officers and employees of the Company and to certain
other eligible subscribers. In
40
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(10) Continued
connection with the Conversion, the Company publicly issued 362,553 shares
of its common stock, par value $.01 per share (the "Common Stock"), for
gross proceeds of $7,251,060 and net proceeds of $6,745,810, of which
$3,372,905 was contributed to Patapsco in exchange for all of its
outstanding common stock.
Federal regulations require that, upon conversion from mutual to stock form
of ownership, a "liquidation account" be established by restricting a
portion of net worth for the benefit of eligible savings account holders
who maintain their savings accounts with Patapsco after conversion. In the
event of complete liquidation (and only in such event), each savings
account holder who continues to maintain his savings account shall be
entitled to receive a distribution from the liquidation account after
payment to all creditors, but before any liquidation distribution with
respect to capital stock. This account will be proportionately reduced for
any subsequent reduction in the eligible holders' savings accounts. At
conversion the liquidation account totaled approximately $6,088,000.
OTS regulations impose limitations on all capital distributions by savings
institutions. Capital distributions include cash dividends, payments to
repurchase or otherwise acquire the savings institution's capital stock,
payments to shareholders of another institution in a cash-out merger, and
other distributions charged against capital. The rule establishes three
tiers of institutions. An institution that exceeds all fully phased-in
capital requirements before and after a proposed capital distribution (Tier
1 Institution) may, after prior notice but without the approval of the OTS,
make capital distributions during a calendar year up to 100% of its net
income to date during the calendar year plus the amount that would reduce
by one-half its "surplus capital ratio" (the excess capital over its fully
phased-in capital requirements) at the beginning of the calendar year; or
75% of its net income over the most recent four-quarter period. Any
additional capital distributions would require prior regulatory approval.
An institution that meets its regulatory capital requirement, but not its
fully phased-in capital requirement before or after its capital
distribution (Tier 2 Institution) may, after prior notice but without the
approval of the OTS, make capital distributions of: up to 75% of its net
income over the most recent four quarter period if it satisfies the risk-
based capital requirement that would be applicable to it on January 1,
1993, computed based on its current portfolio; up to 50% of its net income
over the most recent four quarter period if it satisfies the risk based
capital standard that was applicable to it on January 1, 1991, computed
based on its current portfolio; and up to 25% of its net income over the
most recent four quarter period if it satisfies its current risk based
capital requirement. In computing the institution's permissible percentage
of capital distributions, previous distributions made during the prior four
quarter period must be included.
41
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(10) Continued
An institution that does not meet its current regulatory capital
requirement before or after payment of a proposed capital distribution
(Tier 3 Institution) may not make any capital distributions without the
prior approval of the OTS.
In addition, the OTS would prohibit a proposed capital distribution by any
institution which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice. In addition, FDICIA provides that, as a general rule, a financial
institution may not make a capital distribution if it would be
undercapitalized after making the capital distribution. Also, an
institution meeting the Tier 1 capital criteria which has been notified
that it needs more than normal supervision will be treated as a Tier 2 or
Tier 3 Institution unless the OTS deems otherwise.
In addition to the foregoing, certain bad debt reserves deducted from
income for federal income tax purposes and included in retained income of
Patapsco, are not available for the payment of cash dividends or other
distributions to stockholders without payment of taxes at the then-current
tax rate by Patapsco, on the amount removed from the reserves for such
distributions.
(11) Benefit Plans
Employee Stock Ownership Plan
Patapsco has established an Employee Stock Ownership Plan (ESOP) for its
employees. On April 1, 1996 the ESOP acquired 29,004 shares of the
Company's common stock in connection with Patapsco's conversion to a
capital stock form of organization. The ESOP holds the common stock in a
trust for allocation among participating employees. in trust or allocated
to the participants' accounts, and an annual contribution from Patapsco to
the ESOP and earnings thereon.
All employees of Patapsco who attain the age of 21 and complete six months
of service with Patapsco will be eligible to participate in the ESOP.
Participants will become 100% vested in their accounts after three years of
service with Patapsco or, if earlier, upon death, disability or attainment
of normal retirement age. Participants receive credit for service with
Patapsco prior to the establishment of the ESOP.
42
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(11) Continued
Patapsco recognizes the cost of the ESOP in accordance with AICPA Statement
of Position 93-6 Employers' Accounting for Employee Stock Ownership Plans.
As shares are released from collateral, Patapsco reports compensation
expense equal to the current market price of the shares and the shares
become outstanding for earnings-per-share computations. Dividends on
allocated shares are recorded as a reduction of retained earnings;
dividends on unallocated shares are recorded as a reduction of debt. For
the year ended June 30, 1996 compensation expense recognized related to the
ESOP and Patapsco's contribution to the ESOP was $70,064.
The ESOP shares as of June 30, 1996 were as follows:
<TABLE>
<S> <C>
Allocated shares $ --
Shares released for allocation 2,900
Unearned shares 26,104
---------------------------------------------------------------------------
29,004
---------------------------------------------------------------------------
Fair value of unearned shares at June 30, 1996 $ 659,126
===========================================================================
</TABLE>
Directors Retirement Plan
Effective September 28, 1995, Patapsco adopted a deferred compensation plan
covering all non-employee directors. The plan provides benefits based upon
certain vesting requirements. During the year ended June 30, 1996,
approximately $131,257 was recognized as compensation expense in connection
with the Plan.
(12) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments (SFAS 107) requires the Company to disclose
estimated fair values for certain on- and off-balance sheet financial
instruments. Fair value estimates, methods, and assumptions are set forth
below for the Company's financial instruments as of June 30, 1996.
43
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(12) Continued
The carrying value and estimated fair value of financial instruments is
summarized as follows:
<TABLE>
<CAPTION>
Carrying Fair
Amount Value
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Cash and interest-bearing deposits $ 629,576 630,000
Federal funds sold 6,794,889 6,794,000
Investment securities 4,423,767 4,424,000
Mortgage-backed securities 12,777,828 12,778,000
Loans receivable 52,031,297 52,047,000
Liabilities:
Savings accounts 64,156,888 64,457,000
Advance payments by borrowers for taxes, insurance and ground rents 1,189,735 1,190,000
Off balance sheet instruments:
Commitments to extend credit -- --
=========================================================================================================================
</TABLE>
Cash on Hand and in Banks
The carrying amount for cash on hand and in banks approximates fair value
due to the short maturity of these instruments.
Short-Term Investments
The carrying amount for short-term investments which consists of Federal
funds sold, approximates fair value due to the overnight maturity of these
instruments.
Investment Securities and Mortgage-Backed Securities
The fair value of investment securities and mortgage-backed securities is
based on bid prices received from an external pricing service or bid
quotations received from securities dealers.
Loans
Loans were segmented into portfolios with similar financial
characteristics. Loans were also segmented by type such as residential,
multifamily and nonresidential, construction and land, second mortgage
loans, commercial, and consumer. Each loan category was further segmented
by fixed and adjustable rate interest terms and performing and
nonperforming categories.
44
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(12) Continued
The fair value of residential loans was calculated by discounting
anticipated cash flows based on weighted-average contractual maturity,
weighted-average coupon, prepayment assumptions and discount rate.
Prepayment speed estimates were derived from published historical
prepayment experience in the mortgage pass-through market and recent
issuance activity in the primary and secondary mortgage markets. The
discount rate for residential loans was calculated by adding to the
Treasury yield for the corresponding weighted average maturity associated
with each prepayment assumption a market spread as observed for mortgage-
backed securities with similar characteristics. The fair values of
multifamily and nonresidential loans were calculated by discounting the
contractual cash flows at Patapsco's current nonresidential loan
origination rate. Construction, land and commercial loans, loans secured by
savings accounts and mortgage lines of credit were determined to be at fair
value due to their adjustable rate nature. The fair value of second
mortgage loans was calculated by discounting scheduled cash flows through
the estimated maturity using estimated market discount rates that reflected
the credit and interest rate risk inherent in the portfolio. The fair value
of consumer loans was calculated by discounting the contractual cash flows
at the Company's current consumer loan origination rate.
The fair value for nonperforming loans was determined by reducing the
carrying value of nonperforming loans by the Company's historical loss
percentage for each specific loan category.
The carrying amounts and fair values of loans receivable consisted of the
following at June 30, 1996 were:
<TABLE>
<CAPTION>
Carrying Fair
Amount Value
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Loans secured by first mortgages on real estate $ 48,353,135 47,638,000
Consumer and other loans 4,145,801 4,409,000
Unamoritized premiums, discount and fees, net (248,638) --
-------------------------------------------------------------------------------------------------------------------------
52,250,298 52,047,000
-------------------------------------------------------------------------------------------------------------------------
Allowance for losses 219,001
-------------------------------------------------------------------------------------------------------------------------
Total loans $ 52,031,297 52,047,000
=========================================================================================================================
</TABLE>
Accrued Interest Receivable
The carrying amount of accrued interest receivable approximates its fair
value.
45
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(12) Continued
Savings Accounts
Under SFAS 107, the fair value of deposits with no stated maturity, such as
noninterest bearing deposits, interest bearing NOW accounts, money market
and statement savings accounts, is equal to the carrying amounts. The fair
value of certificates of deposit was based on the discounted value of
contractual cash flows. The discount rate for certificates of deposit was
estimated using the rate currently offered for deposits of similar
remaining maturities.
The carrying value and estimated fair value of savings accounts at June 30,
1996 were:
<TABLE>
<CAPTION>
Carrying Fair
Amount Value
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Certificates of deposit and Christmas Club $ 36,329,647 36,630,000
Deposit accounts with no stated maturity 27,827,241 27,827,000
-------------------------------------------------------------------------------------------------------------------------
Total savings accounts $ 64,156,888 64,457,000
=========================================================================================================================
</TABLE>
Borrowed Funds
Securities sold under agreements to repurchase are considered to be at fair
value.
Accrued Interest Payable
The carrying amount of accrued interest payable approximates its fair
value.
Advance Payments by Borrowers for Taxes, Insurance and Ground Rents
The carrying amount of advance payments by borrowers for taxes, insurance
and ground rents approximates its fair value.
Off-Balance Sheet Financial Instruments
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business, including mortgage loan commitments and
undisbursed lines of credit on commercial business loans. These instruments
involve, to various degrees, elements of credit and interest rate risk in
excess of the amount recognized in the consolidated statements of financial
condition.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument is represented by the contract
amount of the financial instrument.
46
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(12) Continued
The company uses the same credit policies in making commitments for off-
balance-sheet financial instruments as it does for on-balance-sheet
financial instruments. The fair values of such commitments are immaterial.
The disclosure of fair value amounts does not include the fair values of
any intangibles, including core deposit intangibles. Core deposit
intangibles represent the value attributable to total deposits based on an
expected duration of customer relationships.
Limitations
Fair value estimates are made at a specific point in time, based on
relevant market information and information about financial instruments.
These estimates do not reflect any premium or discount that could result
from offering for sale at one time the Company's entire holdings of a
particular financial instrument. Because no market exists for a significant
portion of the Company's financial instruments, fair value estimates are
based on judgments regarding future expected loss experience, current
economic conditions, risk characteristics of various financial instruments
and other factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot be
determined with precision. Changes in assumptions could significantly
affect estimates.
47
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(13) Condensed Financial Information (Parent Company Only)
Summarized financial information for the Company are as follows as of and
for the year ended June 30, 1996:
<TABLE>
<S> <C>
Statement of Financial Condition
Cash $ 8,196
Federal funds sold 2,299,859
Equity in net assets of the bank 9,499,999
Note receivable--bank 522,072
Other assets 26,993
---------------------------------------------------------------------------
$ 12,357,119
===========================================================================
Accrued expenses and other liabilities $ 55,976
---------------------------------------------------------------------------
55,976
Stockholders' equity 12,301,143
---------------------------------------------------------------------------
$ 12,357,119
===========================================================================
Statement of Income
Income:
Loans receivable $ 11,931
Federal funds sold 1,621
---------------------------------------------------------------------------
Income before equity in net income of subsidiary
and income taxes 13,552
Equity in net income of subsidiary 92,766
---------------------------------------------------------------------------
Income before income taxes 106,318
Income taxes 5,234
---------------------------------------------------------------------------
Net income $ 101,084
===========================================================================
</TABLE>
(Continued)
48
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
================================================================================
(13) Continued
<TABLE>
<CAPTION>
STATEMENT OF CASH FLOWS
<S> <C>
Operating activities:
Net income $ 101,084
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in net income of subsidiary (92,766)
Other, net 28,983
----------------------------------------------------------------------------------------
Net cash provided by operating activities 37,301
----------------------------------------------------------------------------------------
Investing activities:
Purchase of stock of subsidiary (3,372,904)
Loan to fund ESOP (580,080)
Loan repayment 58,008
----------------------------------------------------------------------------------------
Net cash used in investing activities (3,894,976)
----------------------------------------------------------------------------------------
Financing activities:
Net proceeds of stock conversion 6,165,730
----------------------------------------------------------------------------------------
Net cash provided by financing activities 6,165,730
----------------------------------------------------------------------------------------
Increase in cash and equivalents 2,308,055
Cash and equivalents, beginning of year -
----------------------------------------------------------------------------------------
Cash and equilavents, end of year $ 2,308,055
----------------------------------------------------------------------------------------
</TABLE>
================================================================================
49
<PAGE>
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C> <C>
Joseph N. McGowan Joseph J. Bouffard Douglas H. Ludwig
Chairman of the Board President and Chief Executive Officer of Retired Principal of the Baltimore
Director, Training Division, the Company and the Bank County Public School System
Baltimore County Police Department
Nicole N. Kantorski Dr. Theodore C. Patterson
S. Robert Kinghorn Budget Director for Baltimore County Physician
Vice Chairman of the Board Police Department Secretary of the Company
Retired Controller of Bethlehem Steel
Corporation, Sparrows Point Plant Robert M. Lating Honorary Director:
President and Manager of Model Realty; Frank W. Carey
Thomas P. O'Neill Partner in C&L Associates Retired AT&T Executive
Partner in Wolpoff & Company, LLP
</TABLE>
<TABLE>
<CAPTION>
EXECUTIVE OFFICERS
<S> <C> <C>
Joseph J. Bouffard Debra L. Brockschmidt Frank J. Duchacek, Jr.
President and Chief Executive Officer Vice President - Operations; Vice President - Commercial Lending
Assistant Secretary
Timothy C. King John W. McClean Joseph R. Sallese
Controller and Treasurer Vice President - Real Estate Lending Vice President - Consumer Lending
</TABLE>
OFFICE LOCATION
1301 Merritt Boulevard
Dundalk, Maryland 21222-2194
<TABLE>
<CAPTION>
CORPORATE INFORMATION
<S> <C> <C>
Independent Certified Accountants Special Counsel Annual Report on Form 10-KSB
KPMG Peat Marwick LLP Housley Kantarian & Bronstein, P.C.
111 South Calvert Street 1220 19th Street, N.W., Suite 700 A copy of the Company's Annual
Baltimore, Maryland 21202 Washington, D.C. 20036 Report on Form 10-KSB for the
fiscal year ended June 30, 1996 as
General Counsel Annual Meeting filed with the Securities and
Nolan Plumhoff & Williams The 1996 Annual Meeting of Stockholders Exchange Commission, will be
Suite 700, Court Towers will be held on October 10, 1996 at 10:00 furnished without charge to
210 W. Pennsylvania Avenue a.m. at 1301 Merritt Boulevard, Dundalk, stockholders as of the record date
Towson, MD 21204 Maryland 21222-2194 for the 1996 Annual Meeting upon
written request to Corporate
Transfer Agent and Registrar Secretary, Patapsco Bancorp, Inc.,
Registrar and Transfer Co. 1301 Merritt Boulevard, Dundalk,
10 Commerce Drive Maryland 21222-2194
Cranford, New Jersey 07016-3572
1 (800) 368-5948
</TABLE>
50
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
<TABLE>
<CAPTION>
State or Other
Jurisdiction of Percentage
Parent Incorporation Ownership
- ------ ------------- ---------
<S> <C> <C>
Patapsco Bancorp, Inc. Maryland --
Subsidiary (1)
- ----------
Patapsco Federal Savings and Loan Association United States 100%
Subsidiaries of Patapsco Federal Savings and Loan Association (1)
- -------------------------------------------------------------
PFSL Holding Corp. Maryland 100%
</TABLE>
- --------------------
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the Annual Report to
Stockholders attached hereto as Exhibit 13.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PATAPSCO
BANCORP, INC. AND SUBSIDIARY AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-01-1995
<PERIOD-END> JUN-30-1996
<CASH> 400,286
<INT-BEARING-DEPOSITS> 229,290
<FED-FUNDS-SOLD> 6,794,889
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 17,201,595
<INVESTMENTS-CARRYING> 17,201,595
<INVESTMENTS-MARKET> 17,201,595
<LOANS> 52,031,297
<ALLOWANCE> 219,001
<TOTAL-ASSETS> 78,849,946
<DEPOSITS> 64,156,888
<SHORT-TERM> 0
<LIABILITIES-OTHER> 2,391,915
<LONG-TERM> 0
0
0
<COMMON> 3,626
<OTHER-SE> 12,297,517
<TOTAL-LIABILITIES-AND-EQUITY> 78,849,946
<INTEREST-LOAN> 3,514,298
<INTEREST-INVEST> 1,817,680
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 5,331,978
<INTEREST-DEPOSIT> 2,851,327
<INTEREST-EXPENSE> 3,037,822
<INTEREST-INCOME-NET> 2,294,156
<LOAN-LOSSES> 68,000
<SECURITIES-GAINS> (99,446)
<EXPENSE-OTHER> 2,087,776
<INCOME-PRETAX> 168,084
<INCOME-PRE-EXTRAORDINARY> 168,084
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 101,084
<EPS-PRIMARY> 0.26
<EPS-DILUTED> 0.26
<YIELD-ACTUAL> 7.09
<LOANS-NON> 240,000
<LOANS-PAST> 240,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 158,768
<CHARGE-OFFS> 7,767
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 219,001
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
