<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 1997
[_] 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.
----------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1951797
- ---------------------------- -------------------
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
1301 Merritt Boulevard, Dundalk, Maryland 21222-2194
- -------------------------------------------- ------------
(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
--------------------------------------
(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, 1997, the registrant had $6,115,150 in
revenues.
As of September 22, 1997, the aggregate market value of voting stock held by
non-affiliates was approximately $7,476,921, computed by reference to the most
recent sales price on September 15, 1997 as 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 22, 1997: 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, 1997. (Parts II and III)
2. Portions of Proxy Statement for registrant's 1997 Annual Meeting of
Stockholders. (Part III)
<PAGE>
PART I
Item 1. Description of Business
- --------------------------------
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 (the "Association"), the
predecessor of The Patapsco Bank (the "Bank"), 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 Stock 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.
The Company has no significant assets other than its investment in the Bank.
The Company is primarily engaged in the business of directing, planning and
coordinating the business activities of the Bank. Accordingly, the information
set forth in this report, including financial statements and related data,
relates primarily to the Bank. In the future, the Company may become an
operating company or acquire or organize other operating subsidiaries, including
other financial institutions. Initially, the Company will not maintain offices
separate from those of the Bank or employ any persons other than its officers
who will not be separately compensated for such service.
The Company's and the Bank's executive offices are located at 1301 Merritt
Boulevard, Dundalk, Maryland 21222-2194, and its main telephone number is (410)
285-1010.
The Patapsco Bank. The Bank is a Maryland commercial bank operating through
a single office located in Dundalk, Maryland and serving eastern Baltimore
County. The Bank was originally chartered by the State of Maryland in 1910 under
the name Patapsco Building and Loan Association. The Bank adopted a federal
charter and received federal insurance of its deposit accounts in 1957, at which
time it adopted the name of Patapsco Federal Savings and Loan Association. The
Association converted to a commercial bank (the "Bank Conversion") on September
30, 1996, at which time it changed its name to The Patapsco Bank.
The principal business of the Bank 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
Bank's market area. The Bank derived 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
were provided principally by operating revenues, deposits and repayments of
outstanding loans and investment securities and mortgage-backed securities.
The Bank's Board of Directors anticipates minimal growth in residential loan
demand within the Bank's market area. In addition, the Board of Directors
believes that as a result of recent consolidations of financial institutions,
the Bank'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 Bank's strategy. Pursuant to this new strategy,
while continuing to pursue its existing business of originating single-family
residential mortgage loans, the Bank 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 Bank began financing home
improvement loans and had $4.6 million of such loans, or 6.9% of total loans
outstanding at June 30, 1997. 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. At June 30, 1997, the Bank had $3.4 million, $2.0 million,
$420,000 and $198,000 in small business loans, construction loans, home equity
loans and other consumer loans, respectively.
2
<PAGE>
Market Area
The Bank's market area for gathering deposits consists of eastern Baltimore
County, Maryland, while the Bank makes loans to customers throughout the
Baltimore Metropolitan area. The economy of the Bank's market area has
historically been based on industries 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 Bank'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.
Lending Activities
General. The Company's gross loan portfolio totaled $66.9 million at June
30, 1997, representing 80.0% of total assets at that date. It is the Company's
policy to concentrate its lending within its market area. At June 30, 1997,
$52.9 million, or 79.1% of the Company's gross loan portfolio, consisted of
residential mortgage loans. Other loans secured by real estate include
construction and commercial real estate loans, which amounted to $4.6 million,
or 6.9% of the Company's gross loan portfolio at June 30, 1997. In addition, the
Company originates consumer and other loans, including home improvement loans
and loans secured by deposits. The Company's commercial loan portfolio, which
consists of small business loans and commercial leases, totaled $3.8 million, or
5.6% of the Company's gross loan portfolio. At June 30, 1997, consumer and other
loans totaled $5.6 million, or 8.4% of the Company's gross loan portfolio.
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 with limited home improvement loan origination in the
Northern Virginia market from established Maryland and Virginia sources.
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 may
travel to meet prospective borrowers and take applications. In all cases, the
Company has final approval of the application.
In recent years, the Company has purchased whole loans and loan
participation interests. During the years ended June 30, 1997 and 1996, the
Company purchased whole loans and loan participation interests totalling $4.5
million and $1.1 million, respectively, from local financial institutions and
local mortgage brokers. In 1996, the Company purchased a $550,000 participant
interest in a commercial construction/permanent loan and a $500,000 participant
interest in a residential construction loan from other local financial
institutions. 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.
Since 1995, the Company generally has sold new originations of 30-year
fixed-rate residential mortgage loans. During the year ended June 30, 1997, no
such loans were originated and sold. During the year ended June 30, 1996, the
Company sold $270,000 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.
3
<PAGE>
During 1997, the Company sold loan participation interests in construction and
commercial real estate loans where the balance of the loan is larger than
desired for retention in the Company's loan portfolio.
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 $207,000, $500,000 and $750,000 may be
approved by the Vice President - Real Estate Landing, the Officers Loan
Committee (consisting of three officers of the Bank) 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, pursuant to the Company's
Appraisal Policy, 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; however, extension fees are usually charged.
The interest rate is guaranteed for the commitment term.
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. It is the
Company's policy that all appraisals be 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 commercial bank to a person outstanding, including commitments,
at one time shall not exceed 15% of the bank's unimpaired capital and surplus.
Under these limits, the Company's loans to one borrower were limited to $1.3
million at June 30, 1997. At that date, the Company had no lending relationships
in excess of the loans-to-one-borrower limit. At June 30, 1997, the Company's
largest lending relationship was a $1.3 million commercial loan secured by
commercial real estate, which includes a 55% guarantee by the United States
Small Business Administration, which was current and performing in accordance
with its terms at June 30, 1997.
4
<PAGE>
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.
Residential Real Estate Lending. The Company historically has been and
continues to be an originator of residential real estate loans in its market
area. Residential real estate loans consist of both single-family and multi-
family residential real estate loans. At June 30, 1997, residential mortgage
loans, excluding home improvement loans, totaled $52.9 million, or 79.1% of the
Company's gross loan portfolio. Of such loans, $5.6 million were secured by
nonowner-occupied investment properties.
The Company originates fixed-rate mortgage loans at competitive interest
rates. At June 30, 1997, $25.7 million, or 48.6% of the Company's residential
real estate loan portfolio was comprised of fixed-rate mortgage loans.
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 0.75%
above the rates charged on comparable loans secured by owner-occupied
properties. As of June 30, 1997, 51.4% of residential real estate 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 in recent years 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 also has been frequently utilized. The interest rates on these
mortgages are adjusted either once a year, every three years or every five 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.
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.
The Company's multi-family residential loan portfolio generally consists
primarily of loans secured by small apartment buildings. Such loans generally
range in size from $100,000 to $500,000. At June 30, 1997, the Company had
$520,000 of multi-family residential real estate loans, which amounted to 0.8%
of the Company's gross loan portfolio at such date. Multi-family 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 real estate lending to borrowers within its
market area or with which it has had prior experience. The Company intends to
expand multi-family residential real estate lending.
5
<PAGE>
Multi-family residential real estate lending entails additional risks as
compared with single-family residential property lending. Multi-family
residential 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.
These risks can be significantly impacted by supply and demand conditions in the
market for 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 multi-family residential real estate loans are
made.
Construction Lending. The Bank also offers residential and commercial
construction loans and land acquisition and development loans. Residential
construction loans are offered to individuals who are having their primary or
secondary residence built as well as to local builders to construct single-
family dwellings. Generally, loans to owner/occupants for the construction of
residential properties are originated in conjunction with the permanent mortgage
on the property. The term of the construction loans is normally from six to
eighteen months and have a variable interest rate which is normally up to 2%
above the prime interest rate. Upon completion of construction, the permanent
loan rate will be set at the interest rate offered by the Bank on that loan
product not sooner than sixty days prior to completion. Interest rates on
residential loans to builders are set at the prime interest rate plus a margin
of 0.5% to 2.0% as may be adjusted from time to time. Interest rates on
commercial construction loans and land acquisition and development loans are
based on the prime rate plus a negotiated margin of between 0.5% and 2.0% and
adjust from time to time, with construction terms generally not exceeding 18
months. Advances are made on a percentage of completed basis. At June 30, 1997,
$2.0 million, or 3.0%, of the Company's gross loan portfolio consisted of
construction loans.
Prior to making a commitment to fund a loan, the Bank requires both an
appraisal of the property by appraisers approved by the Board of Directors and a
study of the feasibility of the proposed project. The Bank also reviews and
inspects each project at the commencement of construction and prior to payment
of draw requests during the term of the construction loan. The Bank generally
charges a construction fee between 1% and 2%.
Construction financing generally is considered to involve a higher degree of
risk of loss than long-term financing on improved, occupied real estate. Risk of
loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. During
the construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction costs proves to be inaccurate and the
borrower is unable to meet the Bank's requirements of putting up additional
funds to cover extra costs or change orders, then the Bank will demand that the
loan be paid off and, if necessary, institute foreclosure proceedings, or
refinance the loan. If the estimate of value proves to be inaccurate, the Bank
may be confronted, at or prior to the maturity of the loan, with collateral
having a value which is insufficient to assure full repayment. The Bank has
sought to minimize this risk by limiting construction lending to qualified
borrowers (i.e., borrowers who satisfy all credit requirements and whose loans
satisfy all other underwriting standards which would apply to the Bank's
permanent mortgage loan financing for the subject property) in the Bank's market
area. On loans to builders, the Bank works only with selected builders with whom
it has experience and carefully monitors the creditworthiness of the builders.
Commercial Real Estate Lending. The Company's commercial real estate loan
portfolio consists of loans to finance the acquisition of small office
buildings, shopping centers and commercial and industrial buildings. Such loans
generally range in size from $100,000 to $900,000. At June 30, 1997, the Company
had $2.6 million of commercial real estate loans, which amounted to 3.9% of the
Company's gross loan portfolio at such date. 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 maturity generally of three to five
years, 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 commercial real estate lending to borrowers within its market
6
<PAGE>
area or with which it has had prior experience. The Company intends to
significantly expand commercial real estate lending.
Commercial real estate lending entails additional risks as compared with
single-family residential property lending. Commercial real estate loans
typically involve larger loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans typically is dependent on the
successful operation of the real estate project, retail establishment or
business. These risks can be significantly impacted by supply and demand
conditions in the market for office, 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 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 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. At June 30, 1997, consumer and
other loans totaled $5.6 million, or 8.4% 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
replacement windows, siding and room additions. The Company's policy is to
originate home improvement loans throughout Maryland, except for the western
portion of the state, and northern Virginia. 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. 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, the majority of
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, 1997,
home improvement loans amounted to $4.6 million, or 6.9% of the Company's gross
loan portfolio, with $1.7 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, 1997, loans on deposit accounts totaled $364,000, or
0.6% of the Company's gross loan portfolio.
Consumer lending affords the Company the opportunity to earn yields higher
than those obtainable with other types of lending. However, consumer loans
entail greater risk than do other 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.
Commercial Lending. The Bank's commercial loans consist of commercial
business loans and commercial leases, which may not be secured by real estate.
For a discussion of the Bank's commercial real estate lending see "--Commercial
Real Estate Lending."
During fiscal 1995, the Company began offering loans to finance the lease of
equipment by small businesses. The Company initiated this program as a result of
its relationship with a Maryland equipment leasing company and such
7
<PAGE>
loans were made with full recourse to the leasing company. However, the Company
currently originates such loans on a nonrecourse basis. In extending a
commercial lease loan, the Company reviews 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 with terms of up to
five years and carry fixed interest rates. At June 30, 1997, commercial lease
loans totaled $388,000, or 0.6% of the Company's gross loan portfolio.
During fiscal 1996 the Company began a commercial lending program. At June
30, 1997 the Company's commercial loans totaled $3.4 million or 5.1% of the
Company's gross loan portfolio. This commercial lending program employs many of
the alternative financing and guarantee programs available through the U.S.
Small Business Administration and other state and local economic development
agencies.
The Bank originates commercial business loans to small and medium sized
businesses in its market area. The Bank's commercial borrowers are generally
small businesses engaged in manufacturing, distribution or retailing, or
professionals in healthcare, accounting and law. Commercial business loans are
generally made to finance the purchase of inventory, new or used commercial
business assets and for short-term working capital. Such loans generally are
secured by equipment and inventory, and, if possible, cross-collateralized by a
real estate lien, although commercial business loans are sometimes granted on an
unsecured basis. Such loans generally are made for terms of seven years or less,
depending on the purpose of the loan and the collateral, with loans to finance
working capital made for one year or less, with interest rates that adjust at
least annually with the prime rate as stated in The Wall Street Journal plus a
-----------------------
margin of up to 4%. Generally, commercial business loans are made in amounts
ranging between $10,000 and $1.3 million.
The Bank underwrites its commercial business loans on the basis of the
borrower's cash flow and ability to service the debt from earnings rather than
on the basis of underlying collateral value, and the Bank seeks to structure
such loans to have more than one source of repayment. The borrower is required
to provide the Bank with sufficient information to allow the Bank to make its
lending determination. In most instances, this information consists of at least
two years of financial statements, a statement of projected cash flows, current
financial information on any guarantor and any additional information on the
collateral. For loans with maturities exceeding one year, the Bank requires that
borrowers and guarantors provide updated financial information at least annually
throughout the term of the loan.
The Bank's commercial business loans may be structured as term loans or as
lines of credit. Commercial business term loans are generally made to finance
the purchase of assets and have maturities of five years or less. Commercial
business lines of credit are typically made for the purpose of providing working
capital and are usually approved with a term of 12 months and are reviewed at
that time to determine if extension is warranted. The Bank also offers both
commercial and standby letters of credit for its commercial borrowers.
Commercial letters of credit are written for a maximum term of one year. The
terms of standby letters of credit generally do not exceed one year.
Commercial business loans are often larger and may involve greater risk than
other types of lending. Because payments on such loans are often dependent on
successful operation of the business involved, repayment of such loans may be
subject to a greater extent to adverse conditions in the economy. The Bank seeks
to minimize these risks through its underwriting guidelines, which require that
the loan be supported by adequate cash flow of the borrower, profitability of
the business, collateral and personal guarantees of the individuals in the
business. In addition, the Bank limits this type of lending to its market area
and to borrowers with which it has prior experience or who are otherwise well
known to the Bank.
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 up to 3 points (one
point being equal to 1% of the loan amount) on real estate 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. The Company has
sold participating interests on
8
<PAGE>
residential and commercial real estate loans to other local financial
institutions. At June 30, 1997 the Company was servicing loans for others
totaling approximately $1.5 million.
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 90 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 owned 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 Notes 1 and 4 of Notes to Consolidated Financial
Statements.
9
<PAGE>
The following table sets forth information with respect to the Company's
nonperforming assets at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------------
1997 1996
---------- ---------
(In thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential . . . . . . . . . . . . . $ 123 $ 240
Commercial. . . . . . . . . . . . . . -- --
Construction. . . . . . . . . . . . . -- --
Consumer . . . . . . . . . . . . . . . . -- --
Commercial . . . . . . . . . . . . . . . -- --
---------- ---------
Total . . . . . . . . . . . . . . . . $ 123 $ 240
========== =========
Accruing loans which are contractually past due
90 days or more . . . . . . . . . . . . . $ -- $ --
---------- ---------
Total . . . . . . . . . . . . . . . . $ -- $ --
========== =========
Total nonperforming loans . . . . . . $ 123 $ 240
========== =========
Percentage of total loans. . . . . . . . . . 0.19% 0.46%
========== =========
Other non-performing assets (2). . . . . . . $ 31 $ 31
========== =========
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
collectibility of the loan.
(2) Other nonperforming assets represents property acquired by the Company
through foreclosure or repossession. 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, 1997, gross interest income of $5,500 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 $7,000.
At June 30, 1997, nonaccrual loans consisted of three mortgage loans secured
by single-family residential real estate properties aggregating $123,000. 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.
At June 30, 1997, 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.
Regulations require banks 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 bank to establish general allowances for loan losses. If an
asset or portion thereof is classified loss, a bank must either establish a
specific allowance for loss in the amount of the portion of the asset classified
loss, or charge off
10
<PAGE>
such amount. Examiners may disagree with a bank's classifications. The Company
regularly reviews its assets to determine whether any assets require
classification or re-classification. At June 30, 1997, the Company had $826,000
in classified assets, consisting of $655,000 in assets classified as special
mention, $140,000 in assets classified as substandard, and no assets classified
as doubtful or loss. Special mention assets consisted of six single-family
residential mortgage loans totalling $578,000 and 11 unsecured home improvement
loans with an aggregate unpaid principal balance of $77,000. The substandard
assets consisted of three single-family residential mortgage loans aggregating
$123,000, four home improvement loans totaling $17,000 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 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 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 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
11
<PAGE>
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,
---------------------------
1997 1996
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period . . . . . . . $ 219 $ 159
Loans charged off:
Residential real estate mortgage. . . . . 1 --
Consumer. . . . . . . . . . . . . . . . . 68 8
---------- ----------
Total charge-offs. . . . . . . . . . . 69 8
Recoveries:
Single-family residential mortgage. . . . 2 --
Consumer. . . . . . . . . . . . . . . . . 5 --
---------- ----------
Total recoveries . . . . . . . . . . . 7 --
---------- ----------
Net loans charged off. . . . . . . . . . . . 62 8
Provision for loan losses. . . . . . . . . . 240 68
---------- ----------
Balance at end of period . . . . . . . . . . $ 397 $ 219
========== ==========
Ratio of net charge-offs to average
loans outstanding during the period . . . 0.11% .02%
========== ==========
</TABLE>
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,
--------------------------------------------------------------
1997 1996
----------------------------- -----------------------------
Percent of Loans Percent of Loans
in Each Category in Each Category
Amount to Total Loans Amount to Total Loans
------ ---------------- ------ ----------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate mortgage:
Residential . . . . . . . . . . . . $ 111 79.09% $ 101 90.06%
Commercial. . . . . . . . . . . . . 29 3.90 12 2.05
Construction. . . . . . . . . . . . 20 2.99 -- --
Consumer and other . . . . . . . . . . 89 8.36 24 5.61
Commercial . . . . . . . . . . . . . . 38 5.66 20 2.28
Unallocated. . . . . . . . . . . . . . 110 -- 62 --
------ ------ ------- ------
Total allowance for loan losses . $ 397 100.00% $ 219 100.00%
====== ====== ======= ======
</TABLE>
Investment Activities
General. 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. 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
12
<PAGE>
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 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, 1997, the Company's entire portfolio of investment
securities was classified as available for sale and had an aggregate carrying
value of $9.7 million and an unrealized net loss after tax of $24,000. As a
result, management of the Company currently does 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 Bank ("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
13
<PAGE>
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. 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.
At June 30, 1997, mortgage-backed securities with a carrying value of $7.7
million were held as available for sale. At June 30, 1997, the Company's
mortgage-backed securities had a weighted average yield of 6.36%.
At June 30, 1997, the Company had within its mortgage-backed securities
portfolio CMOs with a carrying value of $5.5 million, representing 6.6% of total
assets. The Company's CMOs had a weighted average yield of 6.20% at June 30,
1997.
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 Bank has access to
borrow from the FHLB of Atlanta.
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
14
<PAGE>
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.
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. At June
30, 1997, the Company had a credit agreement with a commercial bank, due July
15, 1997. The note bears interest at a floating and fluctuating rate equal to
two percent per annum in excess of the daily London Interbank Offered Rate
(7.6875% at June 30, 1997). The note was secured by assets of the Company and
was repaid on July 1, 1997. During 1997, the Company had no borrowings other
than the credit agreement.
15
<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,
------------------------------
1997 1996
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Amounts outstanding at end of period:
FHLB advances. . . . . . . . . . . . . $ -- $ --
Other borrowings . . . . . . . . . . . 2,700 --
Weighted average rate paid on:
FHLB advances. . . . . . . . . . . . . --% --%
Other borrowings . . . . . . . . . . . 7.69% --
<CAPTION>
Year Ended June 30,
------------------------------
1997 1996
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Maximum amount of borrowings outstanding
at any month end:
FHLB advances. . . . . . . . . . . . . $ -- $ 5,000
Other borrowings . . . . . . . . . . . 2,700 --
<CAPTION>
At June 30,
------------------------------
1997 1996
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Approximate average short-term borrowings
outstanding with respect to:
FHLB advances . . . . . . . . . . . . . $ -- $ 3,282
Other borrowings. . . . . . . . . . . . 112 --
Approximate weighted average rate paid on: (1)
FHLB advances . . . . . . . . . . . . . --% 5.68%
Other borrowings. . . . . . . . . . . . 7.91% --
</TABLE>
- ----------
(1) Weighted average rate paid is derived from dividing the actual interest
expense by the average daily short-term borrowings outstanding.
Subsidiary Activities
The Bank has one subsidiary service corporation, PFSL Holding Corp.
("PFSL"), which it formed in November 1995 to hold certain real estate owned.
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 commercial banks, savings institutions and
mortgage bankers. Commercial banks, credit
16
<PAGE>
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 commercial banks, savings institutions,
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, 1997, the Company had 25 full-time and two 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 Bank is a Maryland commercial bank and its deposit accounts are
insured by the SAIF. The Bank also is a member of the Federal Reserve System.
The Bank is subject to supervision, examination and regulation by the State of
Maryland Commissioner of Financial Regulation ("Commissioner") 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 is subject to the FDIC's authority to conduct special
examinations. The Bank is required to file reports with the Commissioner and the
Federal Reserve Board concerning its activities and financial condition and is
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 Bank is subject to
various regulations promulgated by the Federal Reserve Board, including
Regulation B (Equal Credit Opportunity), 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 Bank establishes
a comprehensive framework for the operations of the Bank and is intended
primarily for the protection of the FDIC and the depositors of the Bank. Changes
in the regulatory framework could have a material effect on the Bank and their
respective operations that in turn, could have a material adverse effect on the
Company.
Capital Requirements. The Bank is 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
17
<PAGE>
Federal Reserve Board's leverage requirement, Tier 1 capital consists primarily
of common stockholders' equity, certain perpetual preferred stock (which must be
noncumulative with respect to banks), and minority interests in the equity
accounts of consolidated subsidiaries; less most intangible assets, primarily
goodwill.
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. Tier 2
capital elements include, subject to certain limitations, the allowance for
losses on loans and leases; perpetual preferred stock that does not qualify for
Tier 1 and long-term preferred stock with an original maturity of at least 20
years from issuance; hybrid capital instruments, including perpetual debt and
mandatory convertible securities, and subordinated debt and intermediate-term
preferred stock. Total risk-weighted assets generally are determined under the
Federal Reserve Board's regulations, which establish four risk categories, with
risk weights of 0%, 20%, 50% and 100%. These computations result in the total
risk-weighted assets. Most loans are assigned to the 100% risk category, except
for first mortgage loans fully secured by residential property and, under
certain circumstances, residential construction loans, both of which carry a 50%
rating. Most investment securities are assigned to the 20% category, except for
municipal or state revenue bonds, which have a 50% risk-weight, and direct
obligations of or obligations guaranteed by the United States Treasury or United
States Government agencies, which have a 0% risk-weight. In converting off-
balance sheet items, direct credit substitutes, including general guarantees and
standby letters of credit backing financial obligations, are given a 100%
conversion factor. Transaction-related contingencies such as bid bonds, other
standby letters of credit and undrawn commitments, including commercial credit
lines with an initial maturity of more than one year, have a 50% conversion
factor. Short-term, self-liquidating trade contingencies are converted at 20%,
and short-term commitments have a 0% factor.
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 Bank 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 is 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.
18
<PAGE>
The table below provides information with respect to the Bank's compliance
with its regulatory capital requirements at the dates indicated.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- -------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1997:
Total Capital (to Risk Weighted Assets) . . . . $ 10,910 23.68% $ 3,685 8.00% $ 4,607 10.00%
Tier 1 Capital (to Risk Weighted Assets). . . . 10,513 22.82 1,843 4.00 2,764 6.00
Tier 1 Capital (to Average Assets). . . . . . . 10,513 12.81 3,282 4.00 4,103 5.00
As of June 30, 1996:
Total Capital (to Risk Weighted Assets) . . . . 9,826 28.67 2,742 8.00 3,427 10.00
Tier 1 Capital (to Risk Weighted Assets). . . . 9,607 28.03 1,371 4.00 2,056 6.00
Tier 1 Capital (to Average Assets). . . . . . . 9,607 12.46 3,085 4.00 3,856 5.00
</TABLE>
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.
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
19
<PAGE>
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, 1997, the Bank
was classified as "well capitalized" under Federal Reserve 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 was required to establish safety and soundness
standards for institutions under its authority. The federal banking agencies,
including the Federal Reserve Board, have released Interagency Guidelines
Establishing Standards for Safety and Soundness. 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. In addition, a depository institution
should maintain systems, commensurate with its size and the nature and scope of
its operations, to identify problem assets and prevent deterioration in those
assets as well as to evaluate and monitor earnings and ensure that earnings are
sufficient to maintain adequate capital and reserves. 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 Bank meets substantially all
the standards adopted in the interagency guidelines.
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 Bank 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 Bank was in compliance with this requirement with investment in
FHLB of Atlanta stock at June 30, 1997 of $520,000. 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, 1997,
the Bank had no advances outstanding from the FHLB of Atlanta.
20
<PAGE>
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 $49.3 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, 1997, the Bank met its reserve requirements.
The Bank is a member of the Federal Reserve System and subscribed 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 is subject to the reserve requirements to
which the Bank 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 Bank's savings deposits are insured by the SAIF,
which is administered by the FDIC. The Bank is required to pay assessments,
based on a percentage of its insured deposits, to the FDIC for insurance of its
deposits by the FDIC through the Savings Association Insurance Fund ("SAIF") of
the FDIC. The FDIC is required to set semi-annual assessments for SAIF-insured
institutions at a level necessary to maintain the designated reserve ratio of
the SAIF at 1.25% of estimated insured deposits, or at a higher percentage of
estimated insured deposits that the FDIC determines to be justified for that
year by circumstances indicating a significant risk of substantial future losses
to the SAIF.
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 under 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.
For the past several semi-annual periods, institutions with SAIF-assessable
deposits, like the Bank, have been required to pay higher deposit insurance
premiums than institutions with deposits insured by the BIF. In order to
recapitalize the SAIF and address the premium disparity, the recently-enacted
Deposit Insurance Funds Act of 1996 authorized the FDIC to impose a one-time
special assessment on institutions with SAIF-assessable deposits, based on the
amount determined by the FDIC to be necessary to increase the reserve levels of
the SAIF to the designated reserve ratio of 1.25% of insured deposits.
Institutions were assessed at the rate of 65.7 basis points based on the amount
of their SAIF-assessable deposits as of March 31, 1995. As a result of the
special assessment the Bank incurred a pre-tax expense of $415,000, during the
fiscal year ended June 30, 1997.
The FDIC has proposed a rule that would lower the regular semi-annual SAIF
assessment rates by establishing a base assessment rate schedule ranging from 4
to 31 basis points effective October 1, 1996. The rule widens the range between
the lowest and highest assessment rates among healthy and troubled institutions
with the intent of creating an
21
<PAGE>
incentive for institutions to control risk-taking behavior. The rule also
prevents the FDIC from collecting more funds than needed to maintain the SAIF's
capitalization at 1.25% of insured deposits. Until December 31, 1999, however,
SAIF-insured institutions will be required to pay assessments to the FDIC at the
rate of 6.44 basis points to help fund interest payments on certain bonds issued
by the Financing Corporation ("FICO"), an agency of the federal government
established to finance takeovers of insolvent thrifts. During this period, BIF
members will be assessed for these obligations at the rate of 1.3 basis points.
After December 31, 1999, both BIF and SAIF members will be assessed at the same
rate for FICO payments.
SAIF members are generally prohibited from converting to BIF, also
administered by the FDIC, or merging with or transferring assets to a BIF member
before the date on which the SAIF first meets or exceeds the designated reserve
ratio of 1.25% of insured deposits. However, the FDIC may approve such a
transaction in the case of a SAIF member in default or if the transaction
involves an insubstantial portion of the deposits of each participant. In
addition, mergers, transfers of assets and assumptions of liabilities may be
approved by the appropriate bank regulator so long as deposit insurance premiums
continue to be paid to the SAIF for deposits attributable to the SAIF members,
plus an adjustment for the annual rate of growth of deposits in the surviving
bank without regard to subsequent acquisitions. Each depository institution
participating in a SAIF-to-BIF conversion transaction is required to pay an exit
fee to SAIF equal to 0.90% of the deposits transferred and an entrance fee to
BIF based on the current reserve ratio of the BIF. A savings institution is not
prohibited from adopting a commercial bank or savings bank charter if the
resulting bank remains a SAIF member.
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 Banks, the FDIC
will take into account whether the savings Bank 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.
Dividend Restrictions. The Bank's ability to pay dividends is 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 is also subject to the Federal Reserve
Board's Regulation H, which provides that a state member bank may not pay a
dividend if the total of all dividends declared by the bank in any calendar year
exceeds the total of its net profits for the year combined with its retained net
profits for the preceding two calendar years, less any required transfers to
surplus or to a fund for the retirement of preferred stock, unless the bank has
received the prior approval of the Federal Reserve Board. In June 1997, the Bank
paid a dividend of $4,531,913 which exceeded the limitation for dividends that
the Bank may declare in a calendar year and for which Federal Reserve Board
approval
22
<PAGE>
was obtained. Therefore, the Bank will need the approval of the Federal Reserve
Board in order to declare any further dividends for the calendar year.
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 is not
able to pay dividends on its capital stock if its capital would thereby be
reduced below the remaining balance of the liquidation account established in
connection with the Stock Conversion.
In addition, the Bank 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 the Notes to
Consolidated Financial Statements contained in the Company's Annual Report to
Stockholders attached hereto as Exhibit 13.
Uniform Lending Standards. Under Federal Reserve Board regulations, 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 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 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. The Bank has chosen to be subject to
federal law with respect to limits on loans to one borrower. Generally, under
federal law, the maximum amount that a commercial bank may loan to one borrower
at one time may not exceed 15% of the unimpaired capital and surplus of the
commercial bank. The Bank's lending limit to one borrower (as of June 30, 1997)
is $1.3 million.
23
<PAGE>
Transactions with Related Parties. Transactions between a state member bank
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a state member bank is any company or entity which
controls, is controlled by or is under common control with the state member
bank. In a holding company context, the parent holding company of a state member
bank and any companies which are controlled by such parent holding company are
affiliates of the 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 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 state member
bank.
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 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 state member bank, 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.
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. (section) 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 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 non-employee
directors of
24
<PAGE>
a bank and certain consumer loans made to non-officer and non-director employees
of the bank are exempt from the statute's coverage.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank
holding company and is registered 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 is required to file with the Federal Reserve Board annual reports and
such additional information as the Federal Reserve Board may require, and is
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 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.
Acquisitions of Bank Holding Companies and Banks. Under the BHCA, any
company must obtain approval of the Federal Reserve Board prior to acquiring
control of the Company or the Bank. For purposes of the BHCA, "control" is
defined as ownership of more than 25% of any class of voting securities of the
Company or the Bank, the ability to control the election of a majority of the
directors, or the exercise of a controlling influence over management or
policies of the Company or the Bank.
Under the Holding Company Act, a bank holding company must obtain the prior
approval of the Federal Reserve Board before (i) acquiring direct or indirect
ownership or control of any voting shares of any bank or bank holding company
if, after such acquisition, the bank holding company would directly or
indirectly own or control more than 5% of such shares; (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or (3)
merging or consolidating with another bank holding company. Satisfactory
financial condition, particularly with regard to capital adequacy, and
satisfactory Community Reinvestment Act ratings generally are prerequisites to
obtaining federal regulatory approval to make acquisitions.
The Change in Bank Control Act and the related regulations of the Federal
Reserve Board require any person or persons acting in concert (except for
companies required to make application under the BHCA), to file a written notice
with the Federal Reserve Board before such person or persons may acquire control
of the Company or the Bank. The Change in Bank Control Act defines "control" as
the power, directly or indirectly, to vote 25% or more of any voting securities
or to direct the management or policies of a bank holding company or an insured
bank.
25
<PAGE>
Under Maryland 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 five 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.
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 permits 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 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 net worth. 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.
26
<PAGE>
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 are less than $150
million, the Federal Reserve Board's holding company capital requirements do 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.
Taxation
The Company and the Bank, together with the Bank's subsidiary, to date have
not filed a consolidated federal income tax return. The Company has had no
material tax liability through June 30, 1997.
The Federal tax bad debt reserve method available to thrift institutions was
repealed in 1996 for tax years beginning after 1995. As a result, the Bank must
change to a reserve method based on actual experience to compute its bad debt
deduction. In addition, the Bank is required to recapture into income the
portion of its bad debt reserve that exceeds its base year reserves of
approximately $200,000.
The recapture amount resulting from the change in a thrift's method of
accounting for its bad debt reserves generally will be taken into taxable income
ratably (on a straight-line basis) over a six-year period. If the Bank meets a
"residential loan requirement" for a tax year beginning in 1996 or 1997, the
recapture of the reserves will be suspended for such tax year. Thus, recapture
can potentially be deferred for up to two years. The residential loan
requirement is met if the principal amount of housing loans made by the Bank
during the year at issue (1996 and 1997) is at least as much as the average of
the principal amount of loans made during the six most recent tax years prior to
1996. Refinancings and home equity loans are excluded.
Earnings appropriated to the Bank's bad debt reserve and claimed as a tax
deduction are not available for the payment of cash dividends or for
distribution to stockholders (including distributions made on dissolution or
liquidation), unless the Bank includes the amount in taxable income, along with
the amount deemed necessary to pay the resulting federal income tax.
Reversal of Tax Bad Debt Recapture. Generally, prior to the enactment of the
recent legislation, savings and loan associations that converted to commercial
banks were required to recapture some or all of their tax bad debt reserve
established for federal income taxation purposes. The Bank 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 its predecessor's
(Patapsco Federal Savings and Loan Association (the "Association")) 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. The Association completed the Bank Conversion on September 30, 1996.
Further, the Company reversed approximately $600,000 of the $740,000 expense
previously incurred. The reversal of the tax bad debt reserve as described above
was reflected as a reduction of tax expense during the quarter ending September
30, 1996.
The Bank'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, except that U.S. Government interest is not fully taxable.
For additional information regarding taxation, see Note 8 of Notes to
Consolidated Financial Statements.
27
<PAGE>
Item 2. Description of Property
- --------------------------------
The following table sets forth the location and certain additional
information regarding the Bank's office at June 30, 1997.
<TABLE>
<CAPTION>
Book Value at
Year Owned or June 30, Approximate
Opened Leased 1997 Square Footage
------ -------- -------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Main Office:
1301 Merritt Boulevard 1970 Owned $736 9,600
Dundalk, Maryland 21222-2194
</TABLE>
The book value of the Bank's investment in premises and equipment totaled
$1.1 million at June 30, 1997. See Note 5 of Notes to Consolidated Financial
Statements.
Item 3. Legal Proceedings.
- -------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At June 30, 1997, there were no legal proceedings to
which the Company or the Bank 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 Bank. There are no pending regulatory proceedings to which the
Company, the Bank 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, 1997 (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 19 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 21 through 50 in the Annual Report, which are listed under Item 13
herein, are incorporated herein by reference.
Item 8. Changes in and Disagreements With Accountants on Accounting and
- -----------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
28
<PAGE>
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 1997 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
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.
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, 1997
and 1996
Consolidated Statements of Income for the Years Ended June 30, 1997
and 1996
Consolidated Statements of Stockholders' Equity for the Years Ended
June 30, 1997 and 1996
Consolidated Statements of Cash Flows for the Years Ended June 30, 1997
and 1996
Notes to Consolidated Financial Statements
29
<PAGE>
(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.
No. Description
* 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, 1997.
* 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 1997 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule
- ----------------
* 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).
*** Incorporated herein by reference from the Company's Annual Report on Form
10-KSB for the year ended June 30, 1996 (File No. 0-28032)
(b) Reports on Form 8-K. On May 30, 1997, the Registrant filed a Current
-------------------
Report on Form 8-K announcing that it had approved a special cash distribution
of $12.50 per share.
30
<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 26, 1997
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 26, 1997
- -------------------------------------
Joseph J. Bouffard
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Timothy C. King September 26, 1997
- -------------------------------------
Timothy C. King
Controller and Treasurer
(Principal Financial and Accounting Officer)
/s/ S. Robert Kinghorn September 26, 1997
- -------------------------------------
S. Robert Kinghorn
Chairman of the Board
/s/ Joseph N. McGowan September 26, 1997
- -------------------------------------
Joseph N. McGowan
Vice Chairman of the Board
/s/ Theodore C. Patterson September 26, 1997
- -------------------------------------
Theodore C. Patterson
Director and Secretary
/s/ Robert M. Lating September 26, 1997
- -------------------------------------
Robert M. Lating
Director
/s/ Douglas H. Ludwig September 26, 1997
- -------------------------------------
Douglas H. Ludwig
Director
/s/ Nicole N. Kantorski September 26, 1997
- -------------------------------------
Nicole N. Kantorski
Director
/s/ Thomas P. O'Neill September 26, 1997
- -------------------------------------
Thomas P. O'Neill
Director
<PAGE>
PATAPSCO BANCORP, INC.
[LOGO]
1997 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 ("Stock
Conversion"). The Association completed the Stock Conversion in April 1996 and
subsequently converted to a commercial bank on September 30, 1996, at which time
it changed its name to The Patapsco Bank (the "Bank"). The Company has no
significant assets other than its investment in the Bank. The Company's
principal business is overseeing the business of the Bank and investing the
retained net Conversion proceeds.
The Bank is a Maryland commercial bank operating through a single office
located in Dundalk, Maryland and serving eastern Baltimore County. The principal
business of the Bank consists of attracting deposits from the general public and
investing these deposits in loans secured by residential and commercial real
estate, construction loans, commercial business loans and consumer loans. The
Bank 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.
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. On June 27, 1997, the Company paid a special cash
dividend of $12.50 per share, which was treated as a tax-free return of capital
distribution, reducing each stockholders' basis in the common stock by the
dividends received. No regular 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>
High Low
---- ---
<S> <C> <C>
Fiscal 1997:
First Quarter $ 26.375 $ 24.50
Second Quarter 29.375 26.00
Third Quarter 32.00 29.00
Fourth Quarter 42.00 27.50
Fiscal 1996:
Fourth Quarter $ 25.75 $ 22.00
</TABLE>
The stated prices reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not represent actual transactions.
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................................................................................19
Corporate Information............................................................................................51
</TABLE>
(i)
<PAGE>
[LETTERHEAD]
Dear Shareholder:
The directors, officers and staff of Patapsco Bancorp, Inc. and The
Patapsco Bank proudly present our second Annual Report to our shareholders. This
report reflects a year of firsts in the history of your Company. This was our
first full year as a public company and our first year as a commercial bank. It
was the first year our assets exceeded $80 million, our loans exceeded $60
million and our deposits reached $70 million.
Most significantly, this was the first year our earnings exceeded $820,000,
which was the best in our 87 year history. A significant portion of this
improvement resulted from pretax core earnings increasing by approximately
$900,000 as well as certain legislative acts at the national level. The
elimination of the bad debt recapture provisions for converting thrifts and the
resolution of the FDIC insurance disparity had a positive net effect on our
bottom line of $345,000. Without the impact of this legislation our earnings
would have been $475,000, which is a substantial improvement over prior years.
The national legislation allowed us in September 1996 to complete our
planned conversion to a commercial bank. In reality, we did little more than
change our name to The Patapsco Bank since we had already begun our commercial
bank transition. We had completed our stock conversion and started the
reallocation of our assets. Our new, but experienced, commercial bank management
team had begun originating new types of loans.
During the year ended June 30, 1997, we originated our first Small Business
Administration guaranteed loan and our first commercial construction loan. We
increased our loan portfolio by $14.2 million with approximately 400 new loans.
We also increased the overall yield on our average assets by 46 basis points to
7.55% and this, along with a reduced cost of deposits, allowed us to increase
our spread between average interest-earning assets and average interest-bearing
liabilities to 3.30% in fiscal 1997 from 2.54% in fiscal 1996. This resulted in
net interest income increasing by approximately $700,000. NOW interest income
also increased by approximately $200,000. These achievements are strong
indicators that we are moving in the right direction.
This past year was also significant in terms of improving shareholder
value. We began the year with our stock trading at $25.25 per share. On June 12,
1997, we announced a special $12.50 per share return of capital distribution
which was tax free to our shareholders. We are very much aware that we must
manage our capital to the benefit of our owners and this action represented a
step in the direction of improving the Company's return on equity. Even after
this substantial payout our stock was trading at $27.50 as our fiscal year ended
and the Company retained sufficient capital to grow and remain competitive. The
Company continues to recognize the desirability of providing
<PAGE>
current income for our shareholders through the payment of regular dividends as
well as achieving steady and continuous growth in per share value.
We still have longer-term goals to accomplish. We must continue to focus on
products and services which will allow us to compete in the highly competitive
banking environment. Specifically, we must expand our new ventures into small
business loans, commercial real estate loans, construction and consumer loans
while we continue to build on the strengths of our residential mortgage
business. We must attract more commercial deposit accounts and continue to build
our loan loss reserves as our portfolio continues to grow and change. In short,
we must continue to implement our strategy to achieve a rate of growth which can
be sustained over time consistent with safe and sound practices.
Your Company will need to grow while continuing to reallocate its assets.
We will focus more attention on the liability side of the balance sheet. We need
to attract new deposits and we will need to supplement deposit growth with
borrowings. We will continue to focus on improving return on equity.
The new year also will present other challenges. The banking landscape
continues to change as big banks continue to merger in an attempt to increase
market share. Proposed legislation at the national level creates uncertainty for
financial institutions. The economic environment continues to remain extremely
competitive for deposit dollars and quality loans. Nevertheless, your Company
intends to continue in its quest to become a leading independent provider of
financial services throughout the Baltimore area by delivering exceptional
service to an expanding customer base in our tradition of integrity,
personalized style and community orientation.
Last but not least, the directors, officers and staff of Patapsco Bancorp,
Inc. and The Patapsco Bank thank all of our shareholders and customers for their
confidence and support during the year. We look forward to a successful new
year.
S. Robert Kinghorn
Chairman of the Board
Joseph J. Bouffard
President and
Chief Executive Officer
2
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
- --------------------------------------------------------------------------------
Selected Consolidated Financial Condition Data
<TABLE>
<CAPTION>
At June 30,
----------------------------
1997 1996
---- ----
(In thousands)
<S> <C> <C>
Total assets................................. $ 83,650 $ 78,850
Loans receivable, net........................ 66,236 52,031
Cash, federal funds sold and other interest
bearing deposits.......................... 5,113 7,424
Investment securities........................ 1,989 4,424
Mortgage-backed securities................... 7,678 12,778
Deposits..................................... 70,152 64,157
Borrowings................................... 2,700 --
Stockholders' equity......................... 8,334 12,301
</TABLE>
- --------------------------------------------------------------------------------
Selected Consolidated Income Data
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------
1997 1996
---- ----
(In thousands)
<S> <C> <C>
Interest income.............................. $ 5,897 $ 5,332
Interest expense............................. 2,706 3,038
--------- ---------
Net interest income before provision
for loan losses........................... 3,191 2,294
Provision for loan losses.................... 240 68
--------- ---------
Net interest income after provision
for loan losses........................... 2,951 2,226
Noninterest income........................... 219 30
Noninterest expenses:
Compensation and employee benefits........ 1,467 1,178
Insurance................................. 515 (1) 193
Professional fees......................... 148 129
Equipment expenses........................ 116 114
Net occupancy costs....................... 81 79
Advertising............................... 44 38
Data processing........................... 96 92
Other..................................... 346 265
--------- ---------
Total noninterest expenses............. 2,813 2,088
Income before provision (benefit) for
income taxes.............................. 357 168
Income tax provision (benefit)............... (463) (2) 67
--------- ---------
Net income................................... $ 820 $ 101
========= =========
</TABLE>
(1) Includes $415,000 of expense resulting from a one-time assessment to
capitalize the Savings Association Insurance Fund ("SAIF").
(2) Includes $600,000 reduction of tax expense related to the partial reversal
of the $740,000 tax bad debt reserve which was recorded in fiscal 1995 as a
result of the anticipated bank conversion.
3
<PAGE>
Key Operating Ratios:
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
-----------------------
1997 1996
---- ----
<S> <C> <C>
Performance Ratios:
Return on average assets (net income divided by
average total assets....................................... 1.03% (1) 0.13%
Return on average stockholders' equity (net income
divided by average stockholders' equity)................... 6.62 (1) 1.35
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost)................................ 3.30 2.54
Net interest margin (net interest income
divided by average interest-earning assets)................ 4.08 3.05
Ratio of average interest-earning assets to
average interest-bearing liabilities....................... 122.78 112.63
Ratio of noninterest expense to average total assets.......... 3.52 (2) 2.71
Asset Quality Ratios:
Nonperforming assets to total assets at
end of period.............................................. 0.18 0.35
Nonperforming (nonaccrual) loans to loans receivable,
net at end of period....................................... 0.19 0.46
Allowance for loan losses to total loans
at end of period........................................... 0.59 0.42
Allowance for loan losses to nonperforming
loans at end of period..................................... 322.77 91.25
Provision for loan losses to loans receivable,
net at end of period....................................... 0.36 0.13
Net charge-offs to average loans outstanding.................. 0.11 0.02
Capital Ratios:
Stockholders' equity to total assets at end of period......... 9.96 15.95
Average stockholders' equity to average assets................ 15.51 9.71
</TABLE>
- ------------
(1) Return on average assets and return on average equity ratios include
$415,000 of expense resulting from a one-time assessment to capitalize
SAIF and a $600,000 reduction of tax expense related to the partial
reversal of the $740,000 tax bad debt reserve which was recorded in
fiscal 1995 as a result of the anticipated bank conversion. If those
transactions had not occurred, a current return on average assets and
return of average equity would have been 0.59% and 3.84%, respectively.
(2) Noninterest expense includes a $415,000 one-time expense as described
in Note (1) above. Excluding the one-time expense, noninterest expense
as a percentage of average total assets would have been 3.00%.
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 Stock
Conversion. The Stock Conversion and the acquisition of the Association by the
Company were consummated on April 1, 1996. The Association converted to a
Maryland commercial bank on September 30, 1996, at which time it changed its
name to The Patapsco Bank. All references to the Company prior to September 30,
1996, except where otherwise indicated, are to the Association.
The Company's results of operations 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.
Forward-Looking Statements
When used in this Annual Report, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in the Company's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Company's market area, and competition that could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected. The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made. The
Company wishes to advise readers that the factors listed above could affect the
Company's financial performance and could cause the Company's actual results for
future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements.
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
5
<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 exceed interest-bearing liabilities, any positive interest rate spread
will generate net interest income.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------------------------------
1997 1996
------------------------------- ---------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------- -------- ------- ------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1)...................................... $ 58,473 $ 4,721 8.07% $ 45,548 $ 3,514 7.72%
Investment securities..................................... 2,988 191 6.40 10,642 612 5.75
Mortgage-backed securities................................ 8,629 534 6.18 15,559 1,003 6.44
Short-term investments and other interest-earning assets.. 8,068 451 5.59 3,432 203 5.91
---------- -------- ------ --------- ------- ------
Total interest-earning assets.......................... 78,158 5,897 7.55 75,181 5,332 7.09
-------- -------
Non-interest-earning assets.................................. 1,757 1,933
---------- ---------
Total assets........................................... $ 79,915 $ 77,114
========== =========
Interest-bearing liabilities:
Deposits (2).............................................. $ 63,545 2,697 4.25 $ 63,469 2,851 4.49
Borrowings................................................ 112 9 7.91 3,282 187 5.68
---------- -------- ------ --------- ------- ------
Total interest-bearing liabilities..................... 63,657 2,706 4.25 66,751 3,038 4.55
-------- ------ ------- ------
Non-interest-bearing liabilities............................. 3,866 2,873
---------- ---------
Total liabilities...................................... 67,523 69,624
Retained earnings............................................ 12,392 7,490
---------- ---------
Total liabilities and retained earnings................ $ 79,915 $ 77,114
========== =========
Net interest income.......................................... $ 3,191 $ 2,294
======== =======
Interest rate spread......................................... 3.30% 2.54%
====== ======
Net yield on interest-earning assets......................... 4.08% 3.05%
====== ======
Ratio of average interest-earning assets to average
interest-bearing liabilities.............................. 122.78% 112.63%
====== ======
</TABLE>
- ------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing escrow accounts.
6
<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,
-------------------------------------------------
1997 vs. 1996
-------------------------------------------------
Increase (Decrease) Due to
-------------------------------------------------
Rate/
Volume Rate Volume Total
------ ---- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable................................. $ 1,002 $ 160 $ 45 $ 1,207
Investment securities............................ (440) 69 (50) (421)
Mortgage-backed securities....................... (447) (40) 18 (469)
Short-term investments and other
interest-earning assets........................ 274 (11) (15) 248
------- ------- -------- -------
Total interest-earning assets................ 389 178 (2) 565
------- ------- -------- -------
Interest expense:
Deposits (1)..................................... 4 (157) (1) (154)
Borrowings....................................... (180) 73 (71) (178)
------- ------- -------- -------
Total interest-bearing liabilities........... (176) (84) (72) (332)
------- ------- -------- -------
Change in net interest income....................... $ 565 $ 262 $ 70 $ 897
======= ======= ======== =======
</TABLE>
- -----------
(1) Includes interest-bearing escrow accounts.
Comparison of Financial Condition at June 30, 1997 and 1996
Total assets increased by $4.8 million, or by 6.1%, to $83.6 million at
June 30, 1997 from $78.8 million at June 30, 1996. The increase was primarily
due to a $14.2 million increase in loans receivable partially offset by
decreases of $5.1 million, $2.4 million and $2.3 million in mortgage-backed
securities, investment securities and cash and cash equivalents.
Net loans receivable increased by $14.2 million, or by 27.3%, to $66.2
million at June 30, 1997 from $52.0 million at June 30, 1996. The increase is
directly attributable to the Company's increased loan demand in residential,
commercial and construction real estate lending, as well as increases in
consumer and commercial lending. Since the recent conversions of the Company's
primary subsidiary from a mutually owned savings and loan association to a
publicly owned commercial bank, the Company has diversified its lending into
segments of the market more closely identified with commercial banks. As a
result, the Company's residential, commercial and construction real estate loan
portfolios increased by $5.6 million, $1.5 million and $2.0 million,
respectively, and the Company's consumer and commercial loan portfolios each
increased by $2.6 million during the year ended June 30, 1997.
7
<PAGE>
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,
1997, the Company had no concentrations of loans exceeding 10% of gross loans
other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------------
1997 1996
--------------------- ----------------------
Amount % Amount %
------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential............................................ $ 52,907 79.09% $ 47,279 90.06%
Commercial............................................. 2,612 3.90 1,074 2.05
Construction (1)....................................... 2,002 2.99 -- --
Consumer loans:
Home improvement....................................... 4,605 6.88 2,373 4.52
Home equity loans...................................... 420 0.63 39 0.07
Loans secured by deposits.............................. 364 0.55 392 0.75
Other consumer loans................................... 198 0.30 143 0.27
Commercial loans:
Commercial loans....................................... 3,400 5.08 1,020 1.94
Commercial leases...................................... 388 0.58 179 0.34
---------- ------ --------- ------
66,896 100.00% 52,499 100.00%
====== ======
Less:
Deferred loan origination fees,
net of costs......................................... $ 263 249
Allowance for loan losses.............................. 397 219
---------- ---------
Total............................................... $ 66,236 $ 52,031
========== =========
</TABLE>
- ------------
(1) Less loans in process.
The following table sets forth certain information at June 30, 1997
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-rate 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, 1998 June 30, 1997 June 30, 1997 Total
-------------- ------------- ------------- --------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential.................... $ 17,936 $ 9,557 $ 25,414 $ 52,907
Commercial..................... 1,350 1,177 85 2,612
Construction................... 2,002 -- -- 2,002
Consumer loans.................... 756 1,474 3,357 5,587
Commercial loans.................. 2,562 843 383 3,788
----------- ---------- ---------- ----------
Total........................ $ 24,606 $ 13,051 $ 29,239 $ 66,896
=========== ========== ========== ==========
</TABLE>
8
<PAGE>
The following table sets forth at June 30, 1997 the dollar amount of all
loans which may reprice or are due one year or more after June 30, 1997 which
have predetermined interest rates and have floating or adjustable interest
rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rates Adjustable Rates Total
------------- ---------------- ---------
(In thousands)
<S> <C> <C> <C>
Real estate loans:
Residential.................... $ 25,565 $ 9,406 $ 34,971
Commercial..................... 265 997 1,262
Consumer.......................... 4,831 -- 4,831
Commercial........................ 1,226 -- 1,226
-------- --------- ---------
Total.......................... $ 31,887 $ 10,403 $ 42,290
======== ========= =========
</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.
Investment securities decreased by $2.4 million, or by 55.0%, to $2.0
million at June 30, 1997 from $4.4 million at June 30, 1996, and mortgage-backed
securities decreased by $5.1 million, or by 40.0%, to $7.7 million at June 30,
1997 from $12.8 million at June 30, 1996. During the year ended June 30, 1997,
the Company sold $4.3 million of mortgage-backed securities classified as
available for sale. The proceeds from the sale of mortgage-backed securities,
along with cash obtained through maturing investment securities and
mortgage-backed securities were used to fund higher yielding loans. The
following table summarizes the Company's investment securities and
mortgage-backed securities portfolios as of June 30, 1997 and 1996.
The following table sets forth the carrying value of the Company's
investments at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
----------------------
1997 1996
-------- --------
(Dollars in thousands)
<S> <C> <C>
Securities available for sale, at fair value:
U.S. government and agency securities................... $ 1,989 $ 4,424
Mortgage-backed securities.............................. 7,678 12,778
-------- --------
Total securities available for sale................... 9,667 17,202
-------- --------
Investments required by law, at cost:
FHLB of Atlanta stock.................................... 520 491
FRB of Richmond stock.................................... 102 --
-------- --------
Total investments required by law, at cost............. 622 491
-------- --------
Total investments...................................... $ 10,289 $ 17,693
======== ========
</TABLE>
9
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Company's investment portfolio at June
30, 1997.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years
--------------------- --------------------- ---------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
--------- ------- --------- --------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
securities................... $ -- -- % $ -- -- % $ 1,989 7.35%
Mortgage-backed securities..... -- -- 3,369 6.46 2,962 6.17
------ -------- -------
Total...................... $ -- $ 3,369 $ 4,951
====== ======== =======
<CAPTION>
More than Ten Years Total Investment Portfolio
--------------------- ----------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
--------- --------- --------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
securities................... $ -- -- % $ 1,989 $ 1,989 7.35%
Mortgage-backed securities..... 1,347 6.61 7,678 7,678 6.36
------- -------- --------
Total...................... $ 1,347 $ 9,667 $ 9,667
======= ======== ========
</TABLE>
10
<PAGE>
Deposits increased by $6.0 million, or by 9.3%, to $70.2 million at
June 30, 1997 from $64.2 million at June 30, 1996. The increase in deposits was
primarily due to increases in non-interest bearing commercial demand accounts
and certificates of deposits. The following table summarizes deposits as of June
30, 1997 and 1996.
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,
------------------------------------------------------------
1997 1996
------------------------- -------------------------
Average Average Average Average
Balance Rate Balance Rate
------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Passbook, statement savings
and Christmas Club................. $ 19,253 (1) 2.97% $ 18,989 (1) 3.07%
NOW checking.......................... 2,699 2.02 2,781 2.41
Money market.......................... 4,893 3.25 4,636 3.52
Certificates of deposit............... 36,700 5.24 37,063 5.52
Noninterest-bearing checking 2,017 -- 1,223 --
-------- --------
Total............................ $ 65,562 $ 64,692
======== ========
</TABLE>
- ----------
(1) Includes interest-bearing escrow accounts.
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,
1997. At such date, such deposits represented 3.4% of total deposits and had a
weighted average rate of 5.11%.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- -----------
(In thousands)
<S> <C>
Three months or less....................... $ 1,161
Over three through six months.............. 684
Over six through 12 months................. 410
Over 12 months............................. 112
-------
Total.................................. $ 2,367
=======
</TABLE>
Comparison of Operating Results for the Years Ended June 30, 1997 and 1996
The Company had net income of $820,000 for the year ended June 30, 1997 as
compared to net income of $101,000 for the year ended June 30, 1996. The
$719,000 increase in net income was significantly influenced by two events
during September, 1996. First, the Company recognized $255,000 of expense after
tax resulting from the one-time assessment to recapitalize the Federal Deposit
Insurance Corporation's Savings Associations Insurance Fund. Secondly, as a
result of legislation enacted in August, 1996 the Company was able to reverse
$600,000 of tax expense upon its subsidiary's conversion to a state chartered
commercial bank. Excluding those two items, the Company would have earned
$475,000 during fiscal 1997. The increase in net income was also impacted by
increases of $897,000 and $190,000 in net interest income and noninterest
income, respectively, slightly offset by increases in noninterest expenses and
provision for losses on loans.
Net Interest Income. The Company's net interest income increased $897,000,
or by 39.1%, to $3.2 million at June 30, 1997 from $2.3 million at June 30,
1996.
The increase in the Company's net interest income is directly attributable
to the Company's loan growth. During fiscal 1996, the Company began to implement
a strategy to improve the interest rate spread by expanding its lending products
to include commercial real estate, construction, consumer and commercial
business loans. These loan
11
<PAGE>
products generally earn higher yields than conventional single-family
residential mortgage loans. To fund these new loan products, the Company began
to divest itself of lower yielding investment securities and mortgage-backed
securities either by normal principal amortization or through the sale of
securities. In addition to the reallocation of its assets, the Company has
utilized the proceeds from its stock conversion and deposit growth to fund
loans.
The Company's interest rate spread increased to 3.30% in 1997 from 2.54% in
1996. The increase in the interest rate spread was primarily the result of an
increase in the average yield on interest-earning assets to 7.55% during fiscal
1997 from 7.09% in fiscal 1996. The increase in the interest rate spread was
also due to a decrease in the average rate paid on interest-bearing liabilities
to 4.25% during fiscal 1997 from 4.55% in fiscal 1996. The Company's net yield
on average interest-earning assets increased to 4.08% during fiscal 1997 from
3.05% in fiscal 1996 primarily due to the increase in the interest rate spread
and the increase in the ratio of average interest-earning assets to average
interest-bearing liabilities to 122.78% during fiscal 1997 from 112.63% in
fiscal 1996. The average balance of interest-earning assets increased by $3.0
million to $78.2 million during fiscal 1997 from $75.2 in fiscal 1996. The
average balance of interest-bearing liabilities decreased by $3.1 million to
$63.7 million during fiscal 1997 from $66.8 million in fiscal 1996. The Company
completed its stock conversion in the fourth quarter of fiscal of fiscal 1996
and as a result, the average balance sheet does not reflect the full impact from
the use of the proceeds in fiscal 1996.
Interest Income. The Company's total interest income increased by $565,000,
or by 10.6%, to $5.9 million for the year ended June 30, 1997 as compared to
$5.3 million for the year ended June 30, 1996. The increase was due to an
increase in the average balance of interest-earning assets of $3.0 million to
$78.1 million during fiscal 1997 from $75.2 million in fiscal 1996 and an
increase in the average yield on average interest-earning assets to 7.55 %
during fiscal 1997 from 7.09% in fiscal 1996.
Interest income on loans increased $1.2 million, or by 34.3% to $4.7
million during 1997 as compared to $3.5 million in fiscal 1996. The increase was
attributable to the increase of $12.9 million in the average balance of loans
receivable to $58.5 million during fiscal 1997 from $45.6 million in fiscal 1996
and the increase in the average yield to 8.07% during 1997 from 7.72% in fiscal
1996.
Interest income on investment securities decreased by $421,000, or by
68.8%, to $191,000 during fiscal 1997 as compared to $612,000 in fiscal 1996.
The decrease was primarily due to a decrease in the average balance of $7.6
million to $3.0 million during fiscal 1997 from $10.6 million in fiscal 1996.
The effect on interest income from the decline in the average balance of
investment securities was slightly offset by an increase in the average yield to
6.40% during fiscal 1997 from 5.75% in fiscal 1996.
Interest income on mortgage-backed securities decreased by $468,000, or by
46.8%, to $534,000 during fiscal 1997 as compared to $1,002,000 in fiscal 1996.
The decrease was the result of a $7.0 decrease in the average balance of
mortgage-backed securities to $8.6 million during fiscal 1997 from $15.6 million
in fiscal 1996 and the decrease of the average yield on mortgage-backed
securities to 6.18% during fiscal 1997 from 6.44% in fiscal 1996.
Interest income on short-term investments and other interest-earning assets
increased by $248,000 to $451,000 during fiscal 1997 as compared to $203,000 in
fiscal 1996. The increase was primarily due to an increase of $4.6 million in
the average balance resulting from the proceeds from the Company's stock
conversion. The average yield declined to 5.59% during fiscal 1997 from 5.91% in
fiscal 1996. The increase in the average balances was partially due to the
Company's stock conversion during the fourth quarter of fiscal 1996.
Interest Expense. The Company's interest expense decreased by $332,000, or
by 10.9%, to $2.7 million during fiscal 1997 as compared to $3.0 million in
fiscal 1996. The decrease was primarily attributable to the decrease of $3.1
million in the average balance of interest-bearing liabilities to $63.7 million
during fiscal 1997 from $66.8 million in fiscal 1996 and the decrease in the
average rate to 4.25% during fiscal 1997 from 4.55% in fiscal 1996.
Interest expense on deposits decreased by $154,000, or by 5.4% to $2.7
million during fiscal 1997 as compared to $2.9 million in fiscal 1996. The
decrease was primarily attributable to decrease in the average rate paid on
deposits
12
<PAGE>
to 4.25% during fiscal 1997 from 4.49% in fiscal 1996. The average
balance of deposits remained virtually unchanged at $63.5 million during fiscal
years 1997 and 1996.
Interest expense on borrowings decreased by $177,000 to $9,000 during
fiscal 1997 as compared to $186,000 in fiscal 1996. During fiscal 1996, the
Company repaid all of its borrowings with the Federal Home Loan Bank of Atlanta.
In fiscal 1997, the Company relied on the proceeds from the stock conversion and
the growth of its deposit to fund loan growth. However, during June, 1997, the
Company borrowed $2.7 million in connection with the payment of the $4.5 million
return of capital distribution.
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
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 $240,000 during the year ended June 30, 1997, as compared to
$68,000 for the year ended June 30, 1996. The increased provision for loan
losses was due to the Company's higher levels of commercial real estate,
construction, consumer and commercial loan lending, 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 to 0.59% at
June 30, 1997 from 0.42% at June 30, 1996. The Company's allowance for loan
losses as a percentage of nonperforming loans was 322.8% at June 30, 1997 as
compared to 91.3% at June 30, 1996.
Noninterest Income. The Company's noninterest income consists of loan
fees and service charges and net gains and losses on sales of investment
securities, mortgage-backed securities and loans. Noninterest income increased
by $190,000 to $220,000 during fiscal 1997, as compared to $30,000 in fiscal
1996. The increase was due to an increase of $95,000 in fees and service charges
during fiscal 1997 as compared to fiscal 1996 and a $99,000 loss resulting
primarily from the sale of investment securities in fiscal 1996. The increases
in fees and service charges are primarily attributable to higher volumes in
commercial demand deposits and automated teller machine transactions.
Noninterest Expenses. The Company's total noninterest expenses increased by
$725,000, or by 34.7%, to $2.8 million during fiscal 1997, as compared to $2.1
million in fiscal 1996. The increase included a $415,000 one-time savings
deposit premium expense to recapitalize the FDIC's SAIF. The Bank's FDIC
insurance assessment rate was reduced following payment of the special
assessment. Excluding the one-time savings deposit premium expense, the
Company's total noninterest expense would have increased by $310,000, or by
11.1%. The Company experienced an increase of $288,000 in compensation and other
benefits during fiscal 1997 as compared to fiscal 1996 primarily the result of
normal salary increases and additional expenses relating to the Company
stock-based benefit plans and the incentive compensation plan. The Company's
regular SAIF premiums decreased by $92,000 as a result of the new lower SAIF
assessment. Professional fees increased by $19,000 to $148,000 during fiscal
1997 from $129,000 in fiscal 1996 due to fees associated with the bank
conversion and the return of capital distribution. Other noninterest expenses
increased by $81,000 to $346,000 during fiscal 1997 as compared to $265,000 in
fiscal 1996, as a result of increases in transfer agent costs, expense related
to the return of capital distribution and additional stationery and printing
expenses relating to the bank conversion.
Provision for Income Taxes. The Bank incurred a $740,000 expense for the
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 would 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, and the Association completed the Bank
Conversion on September 30, 1996. As a result, the Company reversed $600,000 of
the $740,000 expense previously incurred, which was reflected as a reduction of
tax expense during fiscal 1997. Excluding the one-time reversal, the Company's
provision for tax would have been approximately
13
<PAGE>
$137,000 for 1997 as compared to $67,000 in fiscal 1996. See Note 8 of Notes to
Financial Statements. The Company and the Bank have not entered into an
agreement to file a consolidated federal income tax return as of June 30, 1997.
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 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, the
Company has available for sale investment securities and mortgage-backed
securities, carried at fair value, totaling $9,667,897 million as of June 30,
1997. The Company is holding these investment securities 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 of 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, 1997. At June 30, 1997, the
Company held approximately $32.8 million in loans with adjustable interest
rates, which represented approximately 49.0% 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, which
provides higher rates of interest on its longer term certificates.
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.
14
<PAGE>
Interest Rate Sensitivity Analysis
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific period if it
will mature or reprice within that period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities, and is considered negative when the amount
of interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets. At June 30, 1997, the Company had a negative one-year interest
rate sensitivity gap of 0.10%. Generally, for institutions with a negative gap,
net interest income would be expected to be positively affected by falling
interest rates and adversely affected by rising interest rates. Generally,
during a period of rising interest rates, a negative gap would be expected to
adversely affect net interest income while a positive gap would be expected to
result in an increase in net interest income, while conversely during a period
of falling interest rates, a negative gap would be expected to result in an
increase in net interest income and a positive gap would be expected to
adversely affect net interest income.
15
<PAGE>
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1997 which are expected to
mature or reprice in each of the time periods shown.
<TABLE>
<CAPTION>
Three Over Three Over One Over Five Over Ten Over
Months Months Through Through Through Through Twenty
or Less One Year Five Years Ten Years Twenty Years Years Total
------- -------- ---------- --------- ------------ ------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Real estate loans and mortgage-
backed securities................ $ 8,329 $ 17,972 $ 22,855 $ 10,839 $ 4,506 $ 699 $ 65,200
Consumer loans....................... 1,130 1,025 2,766 604 62 -- 5,587
Commercial loans..................... 2,515 47 843 368 -- 15 3,788
Investment securities................ 1,989 -- -- -- -- -- 1,989
Federal funds sold, other interest-
earning assets and investments
required by law.................. 4,951 -- -- -- -- 622 5,573
--------- -------- --------- -------- -------- -------- --------
Total........................... 18,914 19,044 26,464 11,811 4,568 1,336 82,137
--------- -------- --------- -------- -------- -------- --------
Interest-bearing liabilities:
Deposits (1)......................... 14,742 20,599 22,093 5,316 3,057 636 66,443
Borrowings........................... 2,700 -- -- -- -- -- 2,700
--------- -------- --------- -------- -------- -------- --------
Total............................ 17,442 20,599 22,093 5,316 3,057 636 69,143
--------- -------- --------- -------- -------- -------- --------
Interest sensitivity gap................ $ 1,472 $ (1,555) $ 4,371 $ 6,495 $ 1,511 $ 700 $ 12,994
========= ======== ========= ======== ======== ======== ========
Cumulative interest sensitivity gap..... $ 1,472 $ (83) $ 4,288 $ 10,783 $ 12,294 $ 12,994
========= ======== ========= ======== ======== ========
Ratio of cumulative gap to total assets. 1.76% (0.10)% 5.13% 12.89% 14.70% 15.53%
========= ======== ========= ======== ======== ========
</TABLE>
- --------------
(1) Includes $228,000 of interest-bearing escrows.
16
<PAGE>
The preceding table was prepared utilizing certain assumptions as of June
30, 1997 regarding prepayment and decay rates provided by the FHLB of Atlanta.
While management believes that these assumptions are reasonable, the actual
interest rate sensitivity of the Company's assets and liabilities could vary
significantly from the information set forth in the table due to market and
other factors. The following assumptions were used: (i) adjustable-rate first
mortgage loans on single-family residences and mortgage-backed and related
securities will prepay at the rate of 18.0% for lagging index adjustable-rate
loans and 18.4% for current index adjustable-rate loans per year; (ii) first
mortgage loans on multi-family and commercial properties will not prepay; (iii)
consumer and commercial business loans will prepay at an annual rate of 18.0%
and (iv) fixed-rate mortgage loans on single-family residential properties will
prepay annually as follows:
<TABLE>
<CAPTION>
Coupon Rate Annual Prepayment Rate
<S> <C>
Up to 8.0% 8.0%
8.01 to 9.0 10.4
9.01 to 10.0 12.8
10.01 to 11.0 16.9
11.01 or greater 24.6
</TABLE>
The table further assumes the following annual decay rates or withdrawal
factors for deposit accounts other than certificates of deposit:
<TABLE>
<CAPTION>
Through 2 through After
1 Year 3 Years 3 Years
-------- --------- --------
<S> <C> <C> <C>
NOW............................... 37% 32% 17%
Money market...................... 79 31 31
Passbook and statement............ 17 17 16
</TABLE>
The interest rate-sensitivity of the Company's assets and liabilities
illustrated in the table above could vary substantially if different assumptions
were used or actual experience differs from the assumptions used. If passbook
and NOW accounts were assumed to mature in one year or less, the Company's
one-year negative gap would have increased.
Certain shortcomings are inherent in the method of analysis presented in
the above table. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types of assets and liabilities may lag behind
changes in market interest rates. Certain assets, such as adjustable-rate
mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the table. The ability of many
borrowers to service their adjustable-rate debt may decrease in the event of an
interest rate increase.
17
<PAGE>
Liquidity and Capital Resources
An important component of the Company's asset/liability structure is the
level of liquidity available to meet the needs of customers and creditors.
Patapsco's Asset/Liability Management Committee has established general
guidelines for the maintenance of prudent levels of liquidity. The Committee
continually monitors the amount and source of available liquidity, the time to
acquire it and its cost. 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. 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 Federal funds sold, 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, 1997, the Company's cash on hand, interest-bearing deposits and
Federal funds sold totaled $5.1 million.
The Company anticipates that it will have sufficient funds available to
meet its current loan origination, unused lines-of-credit and undisbursed
construction loans-in-process commitments of approximately $1.1 million,
$600,000 and $1.6 million, respectively. Certificates of deposit which are
scheduled to mature in less than one year at March 31, 1997 totaled $27.0
million. Historically, a high percentage of maturing deposits have remained with
the Company.
The Company's primary sources of funds are deposits, borrowings 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 predictable sources of
funds, deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions, competition and other factors.
At June 30, 1997, the Bank exceeded all regulatory minimum capital
requirements. The table below presents certain information relating to the
Bank's regulatory compliance at June 30, 1997.
The Bank'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>
As of June 30, 1997:
Total Capital (to Risk
Weighted Assets).................. $ 10,910 23.68% $3,685 8.00% $ 4,607 10.00%
Tier 1 Capital (to Risk
Weighted Assets).................. 10,513 22.82 1,843 4.00 2,764 6.00
Tier 1 Capital (to Average
Assets)........................... 10,513 12.81 3,282 4.00 4,103 5.00
As of June 30, 1996:
Total Capital (to Risk
Weighted Assets)................... 9,826 28.67 2,742 8.00 3,427 10.00
Tier 1 Capital (to Risk
Weighted Assets)................... 9,607 28.03 1,371 4.00 2,056 6.00
Tier 1 Capital (to Average Assets) 9,607 12.46 3,085 4.00 3,856 5.00
</TABLE>
18
<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
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. In December 1996, SFAS No. 127 was issued which deferred the
effectiveness date of certain provisions of SFAS No. 125 related to repurchase
agreements, securities lending and similar transactions until January 1, 1998.
In December 1996, SFAS No. 127 was issued which deferred the effective date of
certain provisions of SFAS No. 125 related to repurchase agreements, securities
lending and similar transactions until January 1, 1998. The Company adopted the
effective provisions of SFAS No. 125 on January 1, 1997, and the adoption did
not have a material effect on the Company's reported financial condition or
results of operations.
Earnings per Share. In February 1997, the FASB issued SFAS No. 128,
"Earnings per Share," which is effective for the financial statements issued for
periods ending after December 15, 1997. SFAS No. 128 establishes standards for
computing and presenting earnings per share ("EPS") and replaces the
presentation of primary EPS with a presentation of basic EPS. It requires dual
presentation of basic and diluted EPS on the face of the consolidated statement
of income and the reconciliation of the numerator and denominator of the basic
EPS computation to the numerator and denominator of the diluted EPS computation.
Earlier application is not permitted but disclosure of pro forma EPS amounts
computed using the standards established by SFAS No. 128 is permitted in the
notes to financial statements for periods ending prior to the effective date.
Management believes the adoption of the provisions of this statement will not
have a significant effect on the Company's EPS.
Reporting Comprehensive Income. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income" (SFAS No. 130). SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. It does not, however,
specify when to recognize or how to measure items that make up comprehensive
income. SFAS No. 130 is effective for both interim and annual periods beginning
after December 15, 1997. Earlier application is permitted. Comparative financial
statements provided for earlier periods are required to be reclassified to
reflect the provisions of this statement. Management has not determined when it
will adopt the provisions of SFAS No. 130 but believes that it will not have a
material effect on the financial condition or results of operations of the
Company.
Disclosures about Segments of an Enterprise and Related Information. In
June 1997, the FASB also issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131). SFAS No. 131 establishes
standards for the way public business enterprises are to report information
about operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial reports issued to shareholders. SFAS No. 131 is effective for
financial statements for periods beginning after December 15, 1997. Earlier
application is encouraged. Management has not determined when it will adopt the
provisions of SFAS No. 131 but believes that it will not have a material effect
on the financial condition or results of operations of the Company.
19
<PAGE>
[Patapsco Bancorp, Inc. Logo]
20
<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, 1997 and
1996, and the related consolidated statements of income, 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, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
-------------------------
KPMG Peat Marwick LLP
Baltimore, Maryland
August 1, 1997
21
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
June 30, 1997 and 1996
<TABLE>
<CAPTION>
===================================================================================================================
1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash:
On hand and due from banks $ 161,895 400,286
Interest bearing deposits 3,698 229,290
Federal funds sold 4,947,594 6,794,889
Investment securities at fair value (note 2) 1,989,380 4,423,767
Mortgage-backed securities at fair value (note 3) 7,678,517 12,777,828
Loans receivable, net (note 4) 66,236,126 52,031,297
Investment required by law, at cost (note 9) 622,050 490,500
Property and equipment, net (note 5) 1,117,454 1,028,690
Deferred taxes (note 8) 236,000 -
Accrued interest, prepaid expenses and other assets 656,822 673,399
- -------------------------------------------------------------------------------------------------------------------
$83,649,536 78,849,946
===================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Interest bearing deposits $66,214,826 62,739,519
Non-interest bearing deposits 3,937,467 1,417,369
Borrowings (note 7) 2,700,000 -
Accrued expenses and other liabilities 2,239,240 1,719,915
Income taxes payable 224,000 75,000
Deferred taxes (note 8) - 597,000
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 75,315,533 66,548,803
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 3,626
Additional paid-in capital 2,249,725 6,754,240
Contra equity - Employee Stock Option Plan (ESOP) (464,064) (522,072)
Contra equity - Management Recognition Plan (MRP) (423,724) -
Retained earnings, substantially restricted 6,922,716 6,172,405
Unrealized net holding losses on available-for-sale portfolios,
net of taxes (24,276) (107,056)
- -------------------------------------------------------------------------------------------------------------------
8,334,003 12,301,143
Commitments (notes 4, 10 and 11)
- -------------------------------------------------------------------------------------------------------------------
$83,649,536 $78,849,946
===================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
Years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
===============================================================================================
1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Loans receivable $ 4,721,514 3,514,298
Mortgage-backed securities 533,537 1,002,469
Investment securities 191,228 612,390
Federal funds sold and other investments 450,964 202,821
- -----------------------------------------------------------------------------------------------
Total interest income 5,897,243 5,331,978
- -----------------------------------------------------------------------------------------------
Interest expense:
Deposits 2,697,609 2,851,327
Borrowings 8,898 186,495
- -----------------------------------------------------------------------------------------------
Total interest expense 2,706,507 3,037,822
- -----------------------------------------------------------------------------------------------
Net interest income 3,190,736 2,294,156
Provision for losses on loans (note 4) 240,000 68,000
- -----------------------------------------------------------------------------------------------
Net interest income after provision for losses on loans 2,950,736 2,226,156
- -----------------------------------------------------------------------------------------------
Noninterest income:
Fees and service charges 203,952 108,997
Net gain (loss) on sales of securities 1,844 (99,446)
Other 13,915 20,153
- -----------------------------------------------------------------------------------------------
Total noninterest income 219,711 29,704
- -----------------------------------------------------------------------------------------------
Noninterest expenses:
Compensation and employee benefits 1,467,143 1,178,829
Insurance 515,260 192,654
Professional fees 147,757 128,725
Equipment expenses 115,573 113,697
Net occupancy costs 81,403 79,377
Advertising 44,371 38,090
Data processing 96,012 91,861
Other 345,617 264,543
- -----------------------------------------------------------------------------------------------
Total noninterest expenses 2,813,136 2,087,776
- -----------------------------------------------------------------------------------------------
Income before income taxes 357,311 168,084
Income tax provision (benefit) (note 8) (463,000) 67,000
- -----------------------------------------------------------------------------------------------
Net income $ 820,311 101,084
===============================================================================================
</TABLE>
(Continued)
23
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income, Continued
Years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
===============================================================================================
1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Net income per share of common stock (note 1):
Primary $ 2.44 -
From date of conversion - 0.26
Proforma - 0.74
===============================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
Years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
==================================================================================================================================
Common Additional Contra-equity Contra-equity
stock paid-in capital ESOP MRP
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at June 30, 1995 $ - - - -
Proceeds from stock offering, net of conversion costs 3,626 6,742,184 - -
Borrowings for Employee Stock Ownership Plan (ESOP) - - (580,080) -
Compensation under stock-based benefit plans - 12,056 58,008 -
Adjustment to unrealized net holding losses on available-for-sale
portfolios, net (note 1) - - - -
Net income - - - -
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996 3,626 6,754,240 (522,072) -
Purchase of 14,502 shares of common stock for Management Recognition
Plan (MRP) Trust - - - (423,724)
Compensation under stock-based benefit plans - 27,398 58,008 -
Adjustment to unrealized net holding losses on available-for-sale
portfolios, net (note 1) - - - -
Return of capital distribution ($12.50 per share) (note 10) (4,531,913) - -
Net income - - - -
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 $ 3,626 2,249,725 (464,064) (423,724)
==================================================================================================================================
<CAPTION>
=======================================================================================================================
Unrealized net
holding losses on Total
Retained available-for-sale stockholders'
earnings portfolios equity
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at June 30, 1995 6,071,321 (31,233) 6,040,088
Proceeds from stock offering, net of conversion costs - - 6,745,810
Borrowings for Employee Stock Ownership Plan (ESOP) - - (580,080)
Compensation under stock-based benefit plans - - 70,064
Adjustment to unrealized net holding losses on available-for-sale
portfolios, net (note 1) - (75,823) (75,823)
Net income 101,084 - 101,084
- -----------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996 6,172,405 (107,056) 12,301,143
Purchase of 14,502 shares of common stock for Management Recognition
Plan (MRP) Trust - - (423,724)
Compensation under stock-based benefit plans - - 85,406
Adjustment to unrealized net holding losses on available-for-sale
portfolios, net (note 1) - 82,780 82,780
Return of capital distribution ($12.50 per share) (note 10) - - (4,531,913)
Net income 820,311 - 820,311
- -----------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 6,992,716 (24,276) 8,334,003
=======================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
===============================================================================================
1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 820,311 101,084
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 122,497 109,664
Provision for losses on loans 240,000 68,000
Non-cash compensation under stock-based
benefit plans 85,406 70,064
Amortization of premiums and discounts, net 18,098 (48,782)
Deferred loan origination fees, net of costs 14,685 95,465
(Gain) loss on sales of investment securities and
mortgage-backed securities (1,844) 97,102
Loss on sales of loans - 2,344
Proceeds from sale of mortgage loans originated
for sale - 270,500
Increase in income taxes payable 149,000 75,000
Change in deferred taxes (886,000) (102,000)
Decrease in taxes recoverable - 41,000
Increase in accrued interest on investments, prepaid
expenses and other assets (55,704) (15,466)
Increase in accrued expenses and other liabilities 519,325 292,889
- -----------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,025,774 1,056,864
- -----------------------------------------------------------------------------------------------
Cash flows from investing activities:
Loan principal disbursements, net of repayments (9,870,978) (9,578,882)
Purchases of loans (4,516,255) (1,120,086)
Proceeds from sales and operations of real estate acquired
through foreclosure - 18,919
Purchases of property and equipment (211,261) (35,664)
Purchase of stock in Federal Home Loan Bank of Atlanta (30,000) -
Purchase of stock in Federal Reserve Bank of Richmond (101,550) -
Principal repayments on:
Mortgage-backed securities available-for-sale 817,440 2,001,361
Mortgage-backed securities held-to-maturity - 1,268,790
Maturities of:
Investment securities available-for-sale 2,500,000 5,500,000
Investment securities held-to-maturity - 2,000,000
Sales of:
Mortgage-backed securities available-for-sale 4,335,784 2,620,522
Investment securities available-for-sale - 2,857,317
</TABLE>
(Continued)
26
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows, Continued
Years ended June 30, 1997 and 1996
<TABLE>
<CAPTION>
===============================================================================================
1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from investing activities, continued:
Purchases of:
Mortgage-backed securities available-for-sale $ - (3,039,875)
- -----------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (7,076,820) 2,492,402
- -----------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposits 5,995,405 227,315
Increase in note payable 2,700,000 -
Return of capital distribution (4,531,913) -
Purchase of common stock for stock-based benefit plans (423,724) -
Decrease in advances from Federal Home Loan Bank of Atlanta - (5,000,000)
Proceeds from stock offering - 6,165,730
- -----------------------------------------------------------------------------------------------
Net cash provided by financing activities 3,739,768 1,393,045
- -----------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (2,311,278) 4,942,311
Cash and cash equivalents at beginning of year 7,424,465 2,482,154
- -----------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 5,113,187 7,424,465
===============================================================================================
Supplemental information:
Interest paid on savings deposits and borrowed funds $ 2,705,637 3,036,930
Income taxes paid 199,000 53,000
===============================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1997 and 1996
- --------------------------------------------------------------------------------
(1) Basis of Presentation and Summary of Significant Accounting Policies
Description of Business
Patapsco Bancorp, Inc. (the Company) is the holding company of The
Patapsco Bank (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)
28
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) Continued
Investment and Mortgage-Backed Securities
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.
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.
(Continued)
29
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) Continued
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 accordance with the provisions of Statement of Financial Accounting
Standards No. 114, Accounting for Creditors for Impairment of a Loan,
as amended by Statement 118, Accounting by Creditors for Impairment of
a Loan - Income Recognition and Disclosures (collectively referred to
as "Statement 114"), Patapsco determines and recognizes impairment of
certain loans. A loan is determined to be impaired when, based on
current information and events, it is probable that Patapsco will be
unable to collect all amounts due according to the contractual terms of
the loan agreement. A loan is not considered impaired during a period
of delay in payment if Patapsco expects to collect all amounts due,
including past-due interest. Patapsco generally considers a period of
delay in payment to include delinquency up to and including 90 days.
Statement 114 requires that impaired loans be measured at the present
value of its 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.
Statement 114 is generally applicable for all loans except large groups
or smaller-balance homogeneous loans that are evaluated collectively
for impairment, including residential first and second mortgage loans
and consumer installment loans. Impaired loans are therefore generally
comprised of commercial mortgage, real estate development, and certain
restructured residential loans. In addition, impaired loans are
generally loans which management has placed in nonaccrual status since
loans are placed in nonaccrual status on the earlier of the date that
management determines that the collection of principal and/or interest
is in doubt or the date that principal or interest is 90 days or more
past-due.
(Continued)
30
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) Continued
Patapsco recognizes interest income for impaired loans consistent with
its method for non-accrual loans. Specifically, interest payments
received are recognized as interest income or, if the ultimate
collectibility of principal is in doubt, are applied to principal.
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.
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 1997 and 1996 has been computed based on the
weighted average shares of common stock equivalents outstanding,
336,449 and 333,549, respectively.
(Continued)
31
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(1) Continued
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).
Stock-Based Compensation
In October 1995, the FASB issued Statement of Financial Standards No.
123 (Statement 123), Accounting for Stock-Based Compensation. Statement
123, which is effective for fiscal years beginning after December 15,
1995, establishes financial accounting and reporting standards for
stock-based employee compensation plans and for transactions in which
an entity issues its equity instruments to acquire goods and services
from nonemployees. Statement 123 allows companies to account for
stock-based compensation either under the new provisions of SFAS 123 or
under the provisions of Accounting Principles Board Opinion No. 25 (APB
25), Accounting for Stock Issued to Employees, but requires pro forma
disclosure in the footnotes to the financial statements as if the
measurement provisions of Statement 123 had been adopted. The Company
has continued to account for its stock-based compensation in accordance
with APB 25. Information required by Statement 123 regarding the
Company's stock-based compensation plans is provided in note 11.
Reclassification
Certain amounts from 1996 have been reclassified to conform to the
presentation in 1997.
(2) Investment Securities
Investment securities, classified as available-for-sale, are summarized
as follows as of June 30:
<TABLE>
<CAPTION>
1997
---------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Government
and Agency
obligations
due 5 through
10 years $ 1,988,310 1,070 - 1,989,380 1,989,380
-----------------------------------------------------------------------
</TABLE>
(Continued)
32
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(2) Continued
<TABLE>
<CAPTION>
1996
-----------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
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
====================================================================================================
</TABLE>
Accrued interest receivable at June 30, 1997 and 1996 was $1,611 and
$32,126, respectively.
There were no sales of investment securities in 1997. 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.
(3) Mortgage-Backed Securities
Mortgage-backed securities, classified as available-for-sale, are
summarized as follows as of June 30:
<TABLE>
<CAPTION>
1997
---------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Federal National Mortgage
Association (FNMA) $ 1,482,295 6,549 4,949 1,483,895 1,483,895
Federal Home Loan
Mortgage Corporation
(FHLMC) 747,221 - 8,520 738,701 738,701
FNMA Collateralized
Mortgage Obligations 5,489,622 - 33,701 5,455,921 5,455,921
--------------------------------------------------------------------------------------------------
$ 7,719,138 6,549 47,170 7,678,517 7,678,517
===================================================================================================
(Continued)
</TABLE>
33
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(3) Continued
<TABLE>
<CAPTION>
1996
--------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
cost gains losses value value
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FNMA $ 1,767,779 -- 29,564 1,738,215 1,738,215
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>
Accrued interest receivable at June 30, 1997 and 1996 was $41,110 and
$75,530, respectively.
In 1997, the Company sold mortgage-backed securities classified available-
for-sale with an amortized cost of $4,333,940 and realized a net gain of
$1,844. 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.
Contractual maturities of mortgage-backed securities as of June 30 are
as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------- --------------------------
Amortized Fair Amortized Fair
cost value cost value
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due one through five years $ 3,370,321 3,369,288 -- --
Due after five through ten years 2,988,890 2,962,771 8,670,917 8,644,226
Due after ten years 1,359,927 1,346,458 4,218,026 4,133,602
--------------------------------------------------------------------------------------------------
$ 7,719,138 7,678,517 12,888,943 12,777,828
==================================================================================================
</TABLE>
Contractual maturities do not consider anticipated prepayments of
mortgage-backed securities.
(Continued)
34
<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>
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Real estate secured by first mortgage:
Residential $ 52,906,474 47,278,681
Commercial 2,611,818 1,074,454
Construction, net of loans in process 2,001,892 -
- ------------------------------------------------------------------------------------------------
57,520,184 48,353,135
Home improvement loans 4,604,954 2,372,648
Commercial loans 3,399,694 1,020,000
Home equity loans 420,392 39,340
Commercial leases 388,618 179,386
Loans secured 364,334 391,428
Consumer loans 198,285 142,999
- ------------------------------------------------------------------------------------------------
66,896,461 52,498,936
Less:
Deferred loan origination fees, net of costs 263,323 248,638
Allowance for loan losses 397,012 219,001
- ------------------------------------------------------------------------------------------------
Loans receivable, net $ 66,236,126 52,031,297
================================================================================================
</TABLE>
Accrued interest receivable on loans was $363,448 and $306,883 at June
30, 1997 and 1996, 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. On first mortgage loans, the
Company does not lend more than 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.
(Continued)
35
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(4) Continued
Nonaccrual loans amounted to approximately $123,000 and $240,000 at
June 30, 1997 and 1996, respectively. The amount of interest income
that would have been recorded on loans in nonaccrual status at June 30,
1997 and 1996 had such loans performed in accordance with their terms,
was approximately $5,500 and $19,000, respectively. The actual interest
income recorded on these loans during 1997 and 1996 was approximately
$7,000 and $8,000, respectively. No loans were impaired, as defined,
during 1997 and 1996.
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, 1997, loans
classified special mention and substandard totaled approximately
$655,000 and $140,000, respectively. No loans were classified doubtful
or loss at June 30, 1997.
The activity in the allowance for loan losses is summarized as follows
for the years ended June 30:
<TABLE>
<CAPTION>
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 219,001 158,768
Provision for losses on loans 240,000 68,000
Charge-offs, net of recoveries (61,989) (7,767)
- --------------------------------------------------------------------------------
Balance at end of year $ 397,012 219,001
================================================================================
</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)
36
<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, 1997:
<TABLE>
<CAPTION>
Floating
Fixed rate rate
---------------------------------------------------------------------------
<S> <C> <C>
Residential mortgage loans $ 298,125 626,550
Commercial business and lease loans 140,875 45,000
Undisbursed lines of credit 87,077 502,808
===========================================================================
</TABLE>
As of June 30, 1997 and 1996, Patapsco was servicing loans for the
benefit of others approximately $1,470,000 and $409,000, respectively.
(5) Property and Equipment
Property and equipment are summarized as follows at June 30:
<TABLE>
<CAPTION>
Estimated
1997 1996 useful lives
----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Land $ 92,684 92,684 --
Building and improvements 981,015 908,528 40 years
Furniture, fixtures and equipment 1,047,272 908,498 5-10 years
---------------------------------------------------------------------------- ============
Total, at cost 2,120,971 1,909,710
Less accumulated depreciation 1,003,517 881,020
----------------------------------------------------------------------------
Property and equipment, net $ 1,117,454 1,028,690
============================================================================
</TABLE>
The Company has no obligations under long-term operating leases.
(Continued)
37
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(6) Deposits
The aggregate amount of short-term jumbo certificates, each with a
minimum denomination of $100,000, was approximately $2,367,000 and
$1,251,000 in 1997 and 1996, respectively.
At June 30, 1997, the scheduled maturities of certificates are as
follows:
<TABLE>
<S> <C>
Under 12 months $ 25,568,008
12 months to 24 months 6,800,016
24 months to 36 months 4,274,149
36 months to 48 months 653,235
48 months to 60 months 955,786
-----------------------------------------------------------------
$ 38,251,194
=================================================================
</TABLE>
(7) Borrowings
At June 30, 1997, the Company had a credit agreement with a commercial
bank, due July 15, 1997. The note bears interest at the LIBOR rate plus
2% (7.6875% at June 30, 1997). The note was secured by assets of the
Company and was repaid in July 1997.
At June 30, 1997 the Company had an agreement under a blanket floating
lien with the Federal Home Loan Bank of Atlanta providing the Company a
line of credit of $20 million. There were no advances outstanding
during 1997.
(8) Income Taxes
The provision (benefit) for income taxes is composed of the following
for the years ended June 30:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------------
<S> <C> <C>
Current:
Federal $ 347,000 221,000
State 76,000 44,000
-------------------------------------------------------------------------------
423,000 265,000
-------------------------------------------------------------------------------
Deferred:
Federal (726,000) (160,000)
State (160,000) (38,000)
-------------------------------------------------------------------------------
(886,000) (198,000)
-------------------------------------------------------------------------------
$ (463,000) 67,000
===============================================================================
</TABLE>
(Continued)
38
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(8) Continued
The net deferred tax asset (liability) consists of the following at
June 30:
<TABLE>
<CAPTION>
1997 1996
----------------------------------------------------------------------
<S> <C> <C>
Total deferred tax liabilities $ (191,000) (934,000)
Total deferred tax assets 427,000 337,000
----------------------------------------------------------------------
$ 236,000 (597,000)
======================================================================
</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>
1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Tax bad debt reserves $ (65,000) (758,000)
Allowance for losses on loans 153,000 85,000
Federal Home Loan Bank stock dividends (71,000) (71,000)
Unrealized holding losses 15,000 68,000
Accumulated depreciation (25,000) (69,000)
Deferred compensation 206,000 133,000
Deferred loan fees 37,000 37,000
Assets and liabilities recognized on the accrual basis
for financial statement purposes and on the cash basis
for tax purposes - (36,000)
Other, net (14,000) 14,000
- ---------------------------------------------------------------------------------------
$ 236,000 (597,000)
=======================================================================================
</TABLE>
A reconciliation of the income tax provision (benefit) 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>
1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
Tax at statutory rate $ 121,000 59,000
State income taxes, net of Federal income tax benefit (55,000) 4,000
Reinstatements of Federal bad debt deductions (548,000) -
Other 19,000 4,000
- -------------------------------------------------------------------------------------
Income tax provision (benefit) $ (463,000) 67,000
=====================================================================================
(Continued)
</TABLE>
39
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(8) Continued
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 experience method in 1997 and the
percentage method in 1996.
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
allowed for recovery of a portion of this charge and in 1997 the Company
recorded the recovery totaling $600,000.
(9) Regulatory Matters
The Federal Deposit Insurance Corporation (FDIC), 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.
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 $49.3 million of transaction accounts,
and a reserve of 10% must be maintained against all remaining
transaction accounts. These reserve requirements are subject to
adjustments 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, 1997, the Bank met its reserve requirements.
(Continued)
40
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(9) Continued
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 June 30, 1997, the most recent notification from banking
regulators categorized Patapsco as well 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)
41
<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, 1997:
Total Capital (to Risk
Weighted Assets) $ 10,910 23.68% $ 3,685 8.00% $ 4,607 10.0%
Tier 1 Capital (to Risk
Weighted Assets) 10,513 22.82% 1,843 4.00% 2,764 6.0%
Tier 1 Capital (to Average
Assets) 10,513 12.81% 3,282 4.00% 4,103 5.0%
As of June 30, 1996:
Total Capital (to Risk
Weighted Assets) 9,826 28.67% 2,742 8.00% 3,427 10.0%
Tier 1 Capital (to Risk
Weighted Assets) 9,607 28.03% 1,371 4.00% 2,056 6.0%
Tier 1 Capital (to Average
Assets 9,607 12.46% 3,085 4.00% 3,856 5.0%
==========================================================================================================
</TABLE>
(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 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.
(Continued)
42
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(10) Continued
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.
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.
During fiscal 1997, the Company declared a special distribution of
$12.50 per common share from funds retained by the Company in the
conversion and was deemed by management to constitute a return of
capital. Accordingly, the Company charged the return of capital
distribution to additional paid-in-capital. Management has obtained a
Private Letter Ruling from the Internal Revenue Service which states
that the Company's dividend payments in excess of accumulated earnings
and profits are considered a tax-free return of capital for federal
income tax purposes. As a result, management believes the entire
distribution constitutes a tax-free return of capital.
(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.
(Continued)
43
<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 years ended June 30, 1997 and 1996
compensation expense recognized related to the ESOP and Patapsco's
contribution to the ESOP was $85,405 and $70,046, respectively.
The ESOP shares were as follows as of June 30:
<TABLE>
<CAPTION>
1997 1996
- ----------------------------------------------------------------------------
<S> <C> <C>
Shares released and allocated 5,800 2,900
Unearned shares 23,204 26,104
- ----------------------------------------------------------------------------
29,004 29,004
============================================================================
Fair value of unearned shares $ 638,110 659,126
============================================================================
</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. Compensation expense
recognized in connection with the Plan during the year ended June 30,
1997 and 1996 was $75,659 and $131,257, respectively.
Stock Options
The Company's 1996 Stock Options and Incentive Plan (Plan) was approved
by the stockholders at the 1996 annual meeting. The Plan provides for
the granting of options to acquire common stock to directors and key
employees. Option prices are equal or greater than the estimated fair
market value of the common stock at the date of the grant. In October
1996 the Company granted options to purchase 34,474 shares at $27.50
per share. Such fair value has been adjusted to $18.91 per share for
the effect of the return of capital distribution paid by the Company in
June 1997. The Plan provides for one-fifth of the options granted to be
exercisable on each of the first five anniversaries of the date of
grant.
The weighted average remaining life of options outstanding at June 30,
1997 was 9.25 years.
(Continued)
44
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(11) Continued
The Company applies the intrinsic value method in accounting for its
stock options and, accordingly, no compensation cost has been
recognized for its options in the financial statements. Had the Company
determined compensation cost based on the fair value at the grant date
for its stock options under Statement No. 123, the Company's net income
for 1997 would have been decreased to the pro forma amounts indicated
below:
Net loss:
As reported $ 820,311
Pro forma 774,311
Primary loss per share:
As reported 2.44
Pro forma 2.30
================================================================================
The weighted average fair values of options granted during 1997 were
$27.50 on the dates of grant. The fair value of option grant was
calculated using the Black-Scholes option-pricing model with the
following assumptions: risk-free interest rate of 6%; expected
volatility of 30%; and expected lives of 9.25 years.
Management Recognition Plan
Effective October 11, 1996, the Company established a Management
Recognition Plan (MRP) to retain personnel of experience and ability in
key positions of responsibility. Members of the Board of Directors and
certain executive officers were awarded a total of 14,502 shares of
stock which are held in a separate trust that manages the MRP. The
Company funded the MRP in 1997 by purchasing 14,502 shares of common
stock in the open market. Shares awarded to participants in the MRP
vest at a rate of 20% per year on each anniversary of the effective
date of the MRP. If a participant terminates employment for reasons
other than death or disability, he or she forfeits all rights to
unvested shares. For the years ended June 30, 1997, compensation
expense related to the MRP was $145,136.
(Continued)
45
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(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, 1997 and 1996.
The carrying value and estimated fair value of financial instruments is
summarized as follows at June 30:
<TABLE>
<CAPTION>
1997 1996
--------------------------- ---------------------------
Carrying Fair Carrying Fair
value value value value
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and interest-bearing
deposits $ 165,593 164,000 629,576 630,000
Federal funds sold 4,947,594 4,948,000 6,794,889 6,794,000
Investment securities 1,989,380 1,989,000 4,423,767 4,424,000
Mortgage-backed securities 7,678,517 7,679,000 12,777,828 12,778,000
Loans receivable, net 66,236,126 65,294,000 52,031,297 52,047,000
Liabilities:
Deposits 70,152,293 70,495,000 64,156,888 64,457,000
Advance payments by
borrowers for taxes,
insurance and ground rents 1,323,193 1,323,000 1,189,735 1,190,000
Borrowings 2,700,000 2,700,000 - -
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.
(Continued)
46
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(12) Continued
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.
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.
(Continued)
47
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(12) Continued
Accrued Interest Receivable
The carrying amount of accrued interest receivable approximates its
fair value.
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.
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.
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.
(Continued)
48
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(12) Continued
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.
(13) Condensed Financial Information (Parent Company Only)
Summarized financial information for the Company are as follows as of
and for the years ended June 30:
<TABLE>
<CAPTION>
Statements of Financial Condition 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Cash $ 80,659 8,196
Federal funds sold - 2,299,859
Equity in net assets of the bank 10,497,661 9,499,999
Note receivable - bank 464,064 522,072
Other assets 8,400 26,993
- -------------------------------------------------------------------------------
$ 11,050,784 12,357,119
===============================================================================
Accrued expenses and other liabilities $ 16,781 55,976
Note payable 2,700,000 -
Stockholders' equity 8,334,003 12,301,143
- -------------------------------------------------------------------------------
$ 11,050,784 12,357,119
===============================================================================
</TABLE>
The note payable was repaid in July 1997.
(Continued)
49
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
(13) Continued
<TABLE>
<CAPTION>
Statements of Income 1997 1996
-------------------------------------------------------------------------------------------
<S> <C> <C>
Income:
Loans receivable $ 43,071 11,931
Federal funds sold 6,701 1,621
Expenses (64,694) --
-------------------------------------------------------------------------------------------
Net income (loss) before equity in net income of
subsidiary and income taxes (14,922) 13,552
Equity in net income of subsidiary 829,477 92,766
-------------------------------------------------------------------------------------------
Income before income tax provision (benefit) 814,555 106,318
Income tax provision (benefit) (5,756) 5,234
-------------------------------------------------------------------------------------------
Net income $ 820,311 101,084
===========================================================================================
<CAPTION>
Statements of Cash Flows 1997 1996
-------------------------------------------------------------------------------------------
<S> <C> <C>
Operating activities:
Net income $ 820,311 101,084
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in net income of subsidiary (829,477) (92,766)
Other, net (20,601) 28,983
-------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (29,767) 37,301
-------------------------------------------------------------------------------------------
Investing activities:
Purchase of stock of subsidiary -- (3,372,904)
Loan to fund ESOP -- (580,080)
Loan repayment 58,008 58,008
-------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 58,008 (3,894,976)
-------------------------------------------------------------------------------------------
Financing activities:
Increase in note payable 2,700,000 --
Purchase of common stock for stock-based
benefits plan (423,724) --
Return of capital distribution (4,531,913) --
Net proceeds of stock conversion -- 6,165,730
-------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (2,255,637) 6,165,730
-------------------------------------------------------------------------------------------
Increase (decrease) in cash and equivalents (2,227,396) 2,308,055
Cash and equivalents, beginning of year 2,308,055 --
-------------------------------------------------------------------------------------------
Cash and equivalents, end of year $ 80,659 2,308,055
===========================================================================================
</TABLE>
- --------------------------------------------------------------------------------
50
<PAGE>
BOARD OF DIRECTORS
S. Robert Kinghorn
Chairman of the Board
Retired Controller of Bethlehem Steel Corporation, Sparrows Point Plant
Joseph N. McGowan
Vice Chairman of the Board
Director, Training Division, Baltimore County
Police Department
Thomas P. O'Neill
Managing Partner of Wolpoff & Company, LLP
Joseph J. Bouffard
President and Chief Executive Officer of the Company and the Bank
Nicole N. Kantorski
Budget Director for Baltimore County Police Department
Robert M. Lating
President and Manager of Model Realty; Partner in C&L Associates
Douglas H. Ludwig
Retired Principal of the Baltimore County Public School System
Dr. Theodore C. Patterson
Retired Physician
Secretary of the Company
EXECUTIVE OFFICERS
Joseph J. Bouffard
President and Chief Executive Officer
Timothy C. King
Vice President, Controller and Treasurer
Debra L. Brockschmidt
Vice President - Operations; Assistant Secretary
John W. McClean
Vice President - Real Estate Lending
Frank J. Duchacek, Jr.
Vice President - Commercial Lending
Joseph R. Sallese
Vice President - Consumer Lending
OFFICE LOCATION
1301 Merritt Boulevard
Dundalk, Maryland 21222-2194
Website: \www.patapscobank.com
Telephone: (410) 285-1010
CORPORATE INFORMATION
Independent Certified Accountants
KPMG Peat Marwick LLP
111 South Calvert Street
Baltimore, Maryland 21202
General Counsel
Nolan Plumhoff & Williams
Suite 700, Nottingham Centre
502 Washington Avenue
Towson, MD 21204-4528
Transfer Agent and Registrar
Registrar and Transfer Co.
10 Commerce Drive
Cranford, New Jersey 07016-3572
1 (800) 368-5948
Special Counsel
Housley Kantarian & Bronstein, P.C.
1220 19th Street, N.W., Suite 700
Washington, D.C. 20036
Annual Meeting
The 1997 Annual Meeting of Stockholders
will be held on October 23, 1997 at 10:00 a.m. at 1301 Merritt Boulevard,
Dundalk, Maryland 21222-2194
Annual Report on Form 10-KSB
A copy of the Company's Annual Report on Form 10-KSB for the fiscal year ended
June 30, 1997 as filed with the Securities and Exchange Commission, will be
furnished without charge to stockholders as of the record date for the 1997
Annual Meeting upon written request to: Corporate Secretary, Patapsco Bancorp,
Inc., 1301 Merritt Boulevard, Dundalk, Maryland 21222-2194
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
<TABLE>
<CAPTION>
State or Other
Jurisdiction of Percentage
Incorporation Ownership
------------- ---------
<S> <C> <C>
Parent
- ------
Patapsco Bancorp, Inc. Maryland --
Subsidiary (1)
- ----------
The Patapsco Bank Maryland 100%
Subsidiaries of The Patapsco Bank (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.
<PAGE>
Exhibit 23
[LETTERHEAD OF KPMG PEAT MARWICK LLP]
INDEPENDENT ACCOUNTANTS' CONSENT
The Board of Directors
Patapsco Bancorp, Inc.:
We consent to incorporation by reference in the registration statement (No.
333-13975) on Form S-8 of Patapsco Bancorp, Inc. of our report dated August 1,
1997, relating to the consolidated statements of financial condition of Patapsco
Bancorp, Inc. and subsidiary as of June 30, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the years ended, which report appears in the June 30, 1997 Annual Report on
Form 10-KSB of Patapsco Bancorp, Inc.
/s/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
Baltimore, Maryland
September 25, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> JUN-30-1997
<CASH> 161,895
<INT-BEARING-DEPOSITS> 3,698
<FED-FUNDS-SOLD> 4,947,594
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 9,667,897
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 66,236,126
<ALLOWANCE> 397,012
<TOTAL-ASSETS> 83,649,536
<DEPOSITS> 70,152,293
<SHORT-TERM> 2,700,000
<LIABILITIES-OTHER> 2,463,240
<LONG-TERM> 0
0
0
<COMMON> 2,253,351
<OTHER-SE> 6,080,652
<TOTAL-LIABILITIES-AND-EQUITY> 83,649,536
<INTEREST-LOAN> 4,721,514
<INTEREST-INVEST> 1,175,729
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 5,897,243
<INTEREST-DEPOSIT> 2,697,609
<INTEREST-EXPENSE> 8,898
<INTEREST-INCOME-NET> 3,190,736
<LOAN-LOSSES> 240,000
<SECURITIES-GAINS> 1,844
<EXPENSE-OTHER> 2,813,136
<INCOME-PRETAX> 357,311
<INCOME-PRE-EXTRAORDINARY> 357,311
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 357,311
<EPS-PRIMARY> 2.44
<EPS-DILUTED> 2.44
<YIELD-ACTUAL> 4.08
<LOANS-NON> 123,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 219,001
<CHARGE-OFFS> 68,837
<RECOVERIES> 6,848
<ALLOWANCE-CLOSE> 397,012
<ALLOWANCE-DOMESTIC> 287,012
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 110,000
</TABLE>
