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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File No. 0-28032
PATAPSCO BANCORP, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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MARYLAND 52-1951797
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(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1301 MERRITT BOULEVARD, DUNDALK, MARYLAND 21222-2194
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (410) 285-1010
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
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(Title of Class)
Check whether the issuer (1) 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
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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. [ ]
For the fiscal year ended June 30, 1998, the registrant had $7,312, 098 in
revenues.
As of September 18, 1998, the aggregate market value of voting stock held by
non-affiliates was approximately $7,884,232, computed by reference to the most
recent sales price on September 18, 1998 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 18, 1998: 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, 1998. (Parts II and III)
2. Portions of Proxy Statement for registrant's 1998 Annual Meeting of
Stockholders. (Part III)
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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GENERAL
Patapsco Bancorp, Inc. Patapsco Bancorp, Inc. (the "Company") was
incorporated under the laws of the State of Maryland in November 1995. On April
1, 1996, Patapsco Federal Savings and Loan Association (the "Association"), the
predecessor of The Patapsco Bank (the "Bank"), converted from mutual to stock
form and reorganized into the holding company form of ownership as a wholly
owned subsidiary of the Company (the "Stock Conversion"). In 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. Currently, the Company does not maintain offices
separate from those of the Bank or employ any persons other than its officers
who are not separately compensated for such service.
On May 22, 1998, the Company signed a Merger Conversion Agreement with
Belmar Federal Savings and Loan Association ("Belmar"), pursuant to which the
Company intends to acquire Belmar Federal Savings and Loan Association in a
merger conversion transaction. Belmar is a mutual institution with one office,
located in Baltimore, Maryland, and total assets of $18.7 million. As part of
the plan of merger conversion, Belmar will merge into the Bank. In connection
with the merger, the Company intends to grant priority subscription rights in
its common stock to the qualifying members of Belmar at a discount to the market
price. Consummation of the transaction is subject to regulatory approval and
approval of Belmar's members.
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 has not been 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 refocused the Bank's strategy. Pursuant to this 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
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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 $6.7 million
of such loans, or 8.7% of total loans outstanding at June 30, 1998. 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, 1998, the
Bank had $4.1 million, $2.2 million, $1.2 million and $649,000 in small business
loans, construction loans, home equity loans and other consumer loans,
respectively.
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 $76.6 million at
June 30, 1998, representing 82.3% of total assets at that date. It is the
Company's policy to concentrate its lending within its market area. At June 30,
1998, $55.2 million, or 72.1% 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 $7.3 million,
or 9.5% of the Company's gross loan portfolio at June 30, 1998. In addition, the
Company originates consumer and other loans, including home equity loans, home
improvement loans and loans secured by deposits. The Company's commercial loan
portfolio, which consists of small business loans and commercial leases, totaled
$5.1 million, or 6.7% of the Company's gross loan portfolio. At June 30, 1998,
consumer and other loans totaled $9.0 million, or 11.7% 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 home improvement contractors, loan applications are accepted
at the Company's office. 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, 1998 and 1997, the
Company purchased whole loans and loan participation interests totaling $2.5
million and $4.5 million, respectively, from local financial institutions and
local mortgage brokers. 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.
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Loan Underwriting Policies. The Company's lending activities are subject
to the Company's non-discriminatory underwriting standards and to loan
origination procedures prescribed by the Company's Board of Directors and
management. Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. First mortgage loans in amounts of up to $227,150, $350,000 and
$500,000 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, 1998. At that date, the Company had no lending
relationships in excess of the loans-to-one-borrower limit. At June 30, 1998,
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, 1998.
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
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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, 1998, residential mortgage
loans, excluding home improvement loans, and home equity loans totaled $55.2
million, or 72.1% of the Company's gross loan portfolio. Of such loans, $6.3
million were secured by nonowner-occupied investment properties.
The Company originates fixed-rate mortgage loans at competitive interest
rates. At June 30, 1998, $32.6 million, or 59.1% of the Company's residential
real estate loan portfolio was comprised of fixed-rate mortgage loans. With its
15-year fixed-rate loans, borrowers have the option of having the loan payments
calculated on a 30-year amortization schedule. 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
.75% above the rates charged on comparable loans secured by owner-occupied
properties. As of June 30, 1998, 40.9% 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 consists primarily of
loans secured by small apartment buildings. Such loans generally range in size
from $100,000 to $500,000. At June 30, 1998, the Company had $609,000 of multi-
family residential real estate loans, which amounted to .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.
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
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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. Residential construction advances are made on stage of
completion basis. 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
18 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 60 days prior to completion. Interest rates on residential loans to
builders are set at the prime interest rate plus a margin of .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 .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 completion basis. At June 30, 1998, $2.2 million, or 2.9%, 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, 1998, the
Company had $5.1 million of commercial real estate loans, which amounted to 6.7%
of the Company's gross loan portfolio at such date. Commercial real estate
loans 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 area or with which it has had prior experience. The Company intends to
significantly expand commercial real estate lending.
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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, home equity loans, loans secured by
savings deposits and overdraft protection for checking accounts. At June 30,
1998, consumer and other loans totaled $9.0 million, or 11.7% 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, 1998,
home improvement loans amounted to $6.7 million, or 8.7% 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, 1998, loans on deposit accounts totaled $385,000, or
.5% 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 the financing of lease transactions, which may not be secured
by real estate. For a discussion of the Bank's commercial real estate lending
see "--Commercial Real Estate Lending."
The Company offers loans to finance lease transactions, secured by the
lease and the underlying equipment, to small businesses. In extending the
financing in a commercial lease transaction, the Company reviews the borrower's
financial statements, credit reports, tax returns and other documentation.
Generally, commercial lease financing is made in amounts ranging between $3,000
and $120,000 with terms of up to five years and carry fixed interest rates. At
June
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30, 1998, commercial lease finance transaction loans totaled $1.0 million, or
1.3% of the Company's gross loan portfolio.
During fiscal 1996 the Company began a commercial lending program. At
June 30, 1998 the Company's commercial loans totaled $4.1 million, or 5.4% 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 business loans may be
structured as term loans or as lines of credit. 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 or for short-term working capital. Such loans
generally are secured by business assets and, if possible, cross-collateralized
by a real estate lien, although commercial business loans are sometimes granted
on an unsecured basis. Such loans are generally made for terms of seven years
or less, depending on the purpose of the loan and the collateral. Interest
rates on commercial business loans and lines of credit are either fixed for the
term of the loan or adjusted periodically with the prime rate as stated in the
Wall Street Journal plus a negotiated margin. Generally, commercial business
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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.
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 standby letters of
credit for its commercial borrowers. The terms of standby letters of credit
generally do not exceed one year but may contain a renewal option.
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 residential and commercial real estate loans
to other local financial institutions. At June 30, 1998 the Company was
servicing loans for others totaling approximately $2.6 million.
8
<PAGE>
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 between ten and 15 days,
depending on the type of loan, typically incur a late fee of 5% of principal and
interest due. As a matter of policy, the Company will contact the borrower
after the date the late payment is due. 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 Note 1 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,
------------------
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential............................... $ 462 $ 123
Commercial................................ -- --
Construction.............................. -- --
Consumer..................................... -- --
Commercial................................... -- --
----- -----
Total..................................... $ 462 $ 123
===== =====
Accruing loans which are contractually past due
90 days or more............................... $ -- $ --
----- -----
Total..................................... $ -- $ --
===== =====
Total nonperforming loans................. $ 462 $ 123
===== =====
Percentage of total loans........................ .60% .19%
===== =====
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, 1998, gross interest income of $9,900 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 $25,400.
At June 30, 1998, nonaccrual loans consisted of five mortgage loans secured
by single-family residential real estate properties aggregating $462,000. At
that date, 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, 1998, 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
10
<PAGE>
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 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, 1998, the
Company had $1.3 million in classified assets, consisting of $776,000 in assets
classified as special mention, $493,000 in assets classified as substandard,
and no assets classified as doubtful or loss. Special mention assets consisted
of eight single-family residential mortgage loans totaling $704,000 and
15 unsecured home improvement loans with an aggregate unpaid principal balance
of $72,000. The substandard assets consisted of five single-family residential
mortgage loans aggregating $462,000 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),
11
<PAGE>
estimated credit losses over the upcoming 12 months given the facts and
circumstances as of the evaluation date. This amount is considered neither a
"floor" nor a "safe harbor" of the level of allowance for loan losses an
institution should maintain, but examiners will view a shortfall relative to the
amount as an indication that they should review management's policy on
allocating these allowances to determine whether it is reasonable based on all
relevant factors.
The following table sets forth an analysis of the Company's allowance for
loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------
1998 1997
-------- --------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period.......... $ 397 $ 219
Loans charged off:
Residential real estate mortgage..... 5 1
Consumer............................. 87 68
----- -----
Total charge-offs................. 92 69
Recoveries:
Single-family residential mortgage... 4 2
Consumer............................. 5 5
----- -----
Total recoveries.................. 9 7
----- -----
Net loans charged off................... 83 62
Provision for loan losses............... 240 240
----- -----
Balance at end of period................ $ 554 $ 397
===== =====
Ratio of net charge-offs to average
loans outstanding during the period.. .23% .11%
===== =====
</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,
----------------------------------------------------------
1998 1997
---------------------------- ----------------------------
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....................... $ 139 72.06% $ 111 79.09%
Commercial........................ 44 6.66 29 3.90
Construction...................... 28 2.87 20 2.99
Consumer and other................. 138 11.75 89 8.36
Commercial......................... 55 6.66 38 5.66
Unallocated........................ 150 -- 110 --
----- ------ ----- ------
Total allowance for loan losses.. $ 554 100.00% $ 397 100.00%
===== ====== ===== ======
</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
12
<PAGE>
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 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.
Under applicable accounting rules, 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, 1998, the Company's entire portfolio of investment
securities was classified as available for sale and had an aggregate carrying
value of $5.1 million and an unrealized net loss after tax of $1,000. 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.
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 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
13
<PAGE>
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, 1998, the Company had outstanding Federal Home Loan Bank of Atlanta
advances of $10.2 million with an average rate of 6.12%.
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 at
that time. PFSL currently is inactive.
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 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, 1998, the Company had 29 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
14
<PAGE>
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 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.
15
<PAGE>
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.
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, 1998:
Total Capital (to Risk Weighted Assets)... $ 8,947 16.40% $4,365 8.00% $5,457 10.00%
Tier 1 Capital (to Risk Weighted Assets).. 8,393 15.38 2,183 4.00 3,274 6.00
Tier 1 Capital (to Average Assets)........ 8,393 9.20 3,650 4.00 4,563 5.00
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
</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
16
<PAGE>
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 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, 1998, 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
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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, 1998 of $570,000. 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, 1998,
the Bank had $10.2 million in advances outstanding from the FHLB of Atlanta.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts. No reserves are required to be
maintained on the first $4.7 million of transaction accounts, reserves equal to
3% must be maintained on the next $47.8 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, 1998, 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
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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.
Institutions with SAIF-assessable deposits, like the Bank, had 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 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.
Following the special assessment, the regular semi-annual SAIF assessment
rates were lowered to a base assessment rate schedule ranging from 4 to 31 basis
points. 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 .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.
FDIC regulations provide 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
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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. 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 its conversion
in April 1996 from mutual to stock form.
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 Association's conversion to stock form. 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
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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, 1998
was $1.3 million.
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. (S) 1972 on certain tying arrangements and extensions
of credit by correspondent banks. Section 22(g) of the Federal Reserve Act
requires loans to executive officers of depository institutions not be made on
terms more favorable than those afforded to other borrowers, requires approval
by the board of directors of a depository institution for extension of credit to
executive officers of the institution, and
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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 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.
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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.
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 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 that authorizes interstate mergers involving
Maryland banks. The Maryland statute also
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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
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state of the out-of-state bank provides reciprocal interstate branching
authority to Maryland banks. 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.
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, 1998.
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
was required to change to a reserve method based on actual experience to compute
its bad debt deduction. In addition, the Bank was 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
24
<PAGE>
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 the
Association's Board of Directors to convert the Association to a Maryland
commercial bank. After this determination was made, legislation was introduced
in Congress which provided that savings and loan associations that convert to
commercial banks will not be required to recapture the portion of tax bad debt
reserve accumulated prior to 1988. Following the introduction of this
legislation, the Board of Directors determined to delay consummation of the Bank
Conversion pending the outcome of this legislation. The legislation ultimately
was enacted into law on August 20, 1996. The Association completed the Bank
Conversion on September 30, 1996, and 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 fiscal year ended June 30, 1997.
The Bank's federal income tax returns have been audited through June 30,
1995. The Company's tax returns have never been audited.
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.
ITEM 2. DESCRIPTION OF PROPERTY
- --------------------------------
The following table sets forth the location and certain additional
information regarding the Bank's office at June 30, 1998.
<TABLE>
<CAPTION>
Book Value at
Year Owned or June 30, Approximate
Opened Leased 1998 Square Footage
------ -------- ------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
1301 Merritt Boulevard 1970 Owned $704,000 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, 1998. 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, 1998, 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.
25
<PAGE>
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, 1998 (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 20 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 52 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
--------------------
The information contained in the section captioned "Relationship with
Independent Accountants" on page 11 in the Company's definitive proxy statement
for the Company's 1998 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
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 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.
26
<PAGE>
(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, 1998
and 1997
Consolidated Statements of Income for the Years Ended June 30, 1998
and 1997
Consolidated Statements of Stockholders' Equity for the Years Ended
June 30, 1998 and 1997
Consolidated Statements of Cash Flows for the Years Ended June 30,
1998 and 1997
Notes to Consolidated Financial Statements
(2) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-KSB and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
---- -----------------------------------------------------------
<S> <C> <C>
* 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, 1998.
* 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
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
No. Description
---- -----------------------------------------------------------
<S> <C> <C>
* 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
10.9 The Patapsco Bank Retirement Plan for Non-Employee Directors
13 1998 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23.1 Consent of KPMG Peat Marwick LLP
23.2 Consent of Anderson Associates, LLP
27 Financial Data Schedule
</TABLE>
- ------------------
* Incorporated herein by reference from the Company's Registration Statement
on Form SB-2 (File No. 33-99734).
** Incorporated herein by reference from the Company's Registration Statement
on Form 8-A (File No. 0-28032).
*** 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. During the last quarter of this report, the
-------------------
Registrant filed one Current Report on Form 8-K. In that Current Report on Form
8-K, dated June 18, 1998, the Company reported under Item 5 that it had signed
an agreement to acquire Belmar in a merger conversion transaction.
28
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PATAPSCO BANCORP, INC.
September 25, 1998
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.
<TABLE>
<CAPTION>
<S> <C>
/s/ Joseph J. Bouffard September 25, 1998
- ----------------------------------------------
Joseph J. Bouffard
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Timothy C. King September 25, 1998
- ----------------------------------------------
Timothy C. King
Vice President and Treasurer
(Principal Financial and Accounting Officer)
/s/ S. Robert Kinghorn September 25, 1998
- ----------------------------------------------
S. Robert Kinghorn
Chairman of the Board
/s/ Joseph N. McGowan September 25, 1998
- ----------------------------------------------
Joseph N. McGowan
Vice Chairman of the Board
/s/ Theodore C. Patterson September 25, 1998
- ----------------------------------------------
Theodore C. Patterson
Director and Secretary
/s/ Robert M. Lating September 25, 1998
- ----------------------------------------------
Robert M. Lating
Director
/s/ Douglas H. Ludwig September 25, 1998
- ----------------------------------------------
Douglas H. Ludwig
Director
/s/ Nicole N. Kantorski September 25, 1998
- ----------------------------------------------
Nicole N. Kantorski
Director
/s/ Thomas P. O'Neill September 25, 1998
- ----------------------------------------------
Thomas P. O'Neill
Director
</TABLE>
29
<PAGE>
Exhibit 10.9
THE PATAPSCO BANK
RETIREMENT PLAN FOR NON-EMPLOYEE DIRECTORS
------------------------------------------
The Board of Directors of The Patapsco Bank has adopted this Retirement
Plan for Non-Employee Directors, effective September 28, 1995.
ARTICLE I
Definitions
-----------
The following words and phrases, when used in the Plan with an initial
capital letter, shall have the meanings set forth below unless the context
clearly indicates otherwise.
"Bank" shall mean The Patapsco Bank, its successors, and assigns.
"Beneficiary" shall mean the person or persons whom a Participant may
designate as the beneficiary of the Participant's Benefits under Article III. A
Participant's election of a Beneficiary shall be made on the Election Form,
shall be revocable by the Participant during his or her lifetime, and shall be
effective only upon its delivery to and acceptance by the Board (which
acceptance shall be presumed unless, within ten business days of receiving the
Participant's election, the Board provides the Participant with a written notice
detailing the reasons for its rejection).
"Benefits" shall mean, collectively, the benefits payable under Articles II
and III of the Plan.
"Benefit Percentage" shall be determined based on the number of the
Participant's full years of service on the Board (whether before or after the
Effective Date), and shall be determined according to the following schedule:
Full Years of Service
as a Director Percentage
------------- ----------
Less than 5 0%
5 30%
6 to 14 *%
15 or more 100%
* Each Participant's Benefit Percentage shall increase by 7% for
each full year of service during this period.
"Board" shall mean the Board of Directors of the Bank.
"Change in Control" shall mean any one of the following events: (1) the
acquisition of ownership, holding or power to vote more than 25% of the Bank's
or the Company's voting stock, (2) the acquisition of the ability to control the
election of a majority of the Bank's or the Company's directors, (3) the
acquisition of a controlling influence over the management or policies of the
Bank or the Company by any person or by persons acting as a "group" (within the
meaning of Section 13(d) of the Securities Exchange Act of 1934) (provided that
in the case of (1), (2) and (3) hereof, ownership or control of the Bank by the
Company itself shall not constitute a "Change in Control"), or (4) during any
period of two consecutive years, individuals (the "Continuing Directors") who at
the beginning of such period constitute the Board of Directors of the Company or
the Bank (the "Existing Board") cease for any reason to constitute at least two-
thirds thereof, provided that any individual whose election or nomination for
election as a member of the Existing Board was approved by a vote of at least
two-thirds of the Continuing Directors then in office shall be considered a
Continuing Director. For purposes of this subparagraph only, the term "person"
refers to an individual or a corporation, partnership, trust, Bank, joint
venture, pool, syndicate, sole proprietorship,
<PAGE>
unincorporated organization or any other form of entity not specifically listed
herein. The decision of the Bank's non-employee directors as to whether a Change
in Control has occurred shall be conclusive and binding.
"Company" shall mean Patapsco Bancorp, Inc.
"Director" shall mean a voting member of the Board (and shall not include
honorary directors).
"Effective Date" shall mean September 28, 1995.
"Election Form" shall mean the form attached hereto as Exhibit "A".
"Employee" shall mean any person who is employed by the Bank at some time
after the Effective Date.
"Participant" means an individual who (i) serves on the Board at some time
on or after the Effective Date, and (ii) is not an Employee on the date of being
both nominated and elected (or re-elected) to the Board.
"Plan" shall mean this Patapsco Federal Savings & Loan Bank Retirement Plan
for Non-Employee Directors.
"Trust Agreement" shall mean that agreement entered into pursuant to the
terms hereof between the Bank and the Trustee, and "Trust" means the trust
created thereunder.
"Trustee" shall mean that person(s) or entity appointed by the Board to
hold legal title to the Trust's assets for the purposes set forth herein.
"Vested Percentage" shall be determined based on the number of the
Participant's full years of service on the Board, after the Plan's Effective
-----
Date, and shall be determined according to the following schedule:
Full Years of Service Participant's
After 9/28/95 Vested Percentage
-------------- -----------------
Less than 1 50%
1 75%
2 or more 100%
Notwithstanding the foregoing, a Director's Vested Percentage shall
accelerate to 100% upon either his or her termination of service as a Director
------
at or after his or her attainment of age 72 or his or her death or disability
--
(as determined by the Board).
ARTICLE II
Retirement Benefits
-------------------
In the event that a Participant's service as a Director terminates for any
reason other than his or her death, the Bank shall make a lump sum payment to
the Participant, in an amount equal to the product of the Participant's Vested
Percentage, Benefit Percentage, and $60,000 (as indexed annually beginning with
January 1, 1996 for changes in the cost-of-living as determined by the Board
based on the Consumer Price Index or such other reasonable standard as the Board
shall deem appropriate). Except as provided in Article III, no Benefits shall
be payable hereunder after the death of the Participant.
Each Participant may elect, on an Election Form filed in accordance
herewith, to have the Bank pay Benefits (1) either in a lump sum or in
substantially equal annual installments over a period not exceeding ten years
from their commencement date, and (2) to have distributions commence either in
the calendar year when the Participant terminates
2
<PAGE>
service or in the following year. Until all installment payments are completed
in accordance with the terms of the Plan and a Participant's Election Form, the
undistributed portion of the Participant's account shall be credited at the end
of each fiscal year with a rate of return equal to the Bank's highest annual
rate of interest on certificates of deposit having a term of one year.
In order to be effective with respect to the form or timing of Benefit
distributions, a Participant's Election Form must be submitted either more than
------
one year before termination of the Participant's service with the Bank, or
--
within 30 days from the date the Board adopts this First Amendment to the Plan.
In the absence of a valid election with respect to a Participant's Benefits,
payments shall commence within the 90-day period following termination of the
Participant's service with the Bank, and shall be made in one lump sum payment.
Notwithstanding the foregoing, but only to the extent required under
federal banking law, the amount payable hereunder shall be reduced to the extent
that on the date of a Participant's termination of service as a Director, either
(i) the present value of the Participant's Benefits exceeds the limitations that
are set forth in Regulatory Bulletin 27a of the Office of Thrift Supervision, as
in effect on the Effective Date, or (ii) such reduction is necessary to avoid
subjecting the Bank to liability under Section 280G of the Internal Revenue Code
of 1986, as amended.
ARTICLE III
Death Benefits
--------------
In the event that a Participant dies before collecting the Benefits
provided under Article II, the Bank shall pay to the Participant's Beneficiary,
a lump sum payment having a present value equal to 100% of the amount that the
Participant would have received under Article II if the Participant had both
terminated service as a Director on the date of his or her death, then had a
Vested Percentage equal to 100%, and survived to collect the Benefits payable
under Article II. Such payment of Benefits shall be made no later than the
first day of the second month following the date of the Participant's death. No
Benefits shall be payable hereunder to anyone other than a Beneficiary.
Notwithstanding the foregoing, a Participant may elect on the Election Form to
have, distributions to the Beneficiary occur in accordance with the time and
manner elections made by the Participant on the Election Form (with payments to
be made as though the Participant survived to collect all Benefits).
The Participant shall designate his or her Beneficiary on an Election Form.
This election shall be revocable by the Participant during his or her lifetime,
and shall be effective only upon its delivery to and acceptance by the Board
(which acceptance shall be presumed unless, within ten business days of
receiving the Participant's election, the Board provides the Participant with a
written notice detailing the reasons for its rejection).
ARTICLE IV
Source of Benefits
------------------
Benefits shall constitute an unfunded, unsecured promise by the Bank to
provide such payments in the future, as and to the extent such Benefits become
payable. Benefits shall be paid from the general assets of the Bank, and no
person shall, by virtue of this Plan, have any interest in such assets (other
than as an unsecured creditor of the Bank). For any fiscal year during which a
Trust, as described herein at Article VIII, is maintained, (i) the Trustee shall
inform the Board annually prior to the commencement of each fiscal year as to
the manner in which such trust assets shall be invested, and (ii) the Board
shall, as soon as practicable after the end of each fiscal year of the Bank,
provide the Trustee with a schedule specifying the amounts payable to each
Participant, and the time for making such payments. All expenses incurred in
connection with implementing and maintaining the Trust shall be paid by the
Bank.
3
<PAGE>
ARTICLE V
Assignment
----------
Except as otherwise provided by this Plan, it is agreed that neither the
Participant nor his or her Beneficiary nor any other person or persons shall
have any right to commute, sell, assign, transfer, encumber and pledge or
otherwise convey the right to receive any Benefits hereunder, which Benefits and
the rights thereto are expressly declared to be nontransferable.
ARTICLE VI
No Retention of Services
------------------------
The Benefits payable under this Plan shall be independent of, and in
addition to, any other compensation payable by the Bank to a Participant,
whether in the form of fees, bonus, retirement income under employee benefit
plans sponsored or maintained by the Bank or otherwise. This Plan shall not be
deemed to constitute a contract of employment between the Bank and any
Participant.
ARTICLE VII
Rights of Directors;
-------------------
Termination or Suspension under Federal Law
-------------------------------------------
The rights of the Directors under this Plan and of their Beneficiaries (if
any) shall be solely those of unsecured creditors of the Bank. In the event
that the Bank shall establish an irrevocable Trust, such assets of the Bank may
be held by the Trust, subject to claims by general creditors of the Bank by
appropriate judicial action as provided by such Trust.
If the Participant is removed and/or permanently prohibited from
participating in the conduct of the Bank's affairs by an order issued under
Sections 8(e)(4) or 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12
U.S.C. 1818(e)(4) or (g)(1)), all obligations of the Bank under this Plan shall
terminate, as of the effective date of the order, but vested rights of the
parties shall not be affected.
If the Bank is in default (as defined in Section 3(x)(1) of FDIA), all
obligations under this Plan shall terminate as of the date of default; however,
this Paragraph shall not affect the vested rights of the parties.
All obligations under this Plan shall terminate, except to the extent that
continuation of this Plan is necessary for the continued operation of the Bank:
(i) by the Director of the Office of Thrift Supervision ("Director of OTS"), or
his or her designee, at the time that the Federal Deposit Insurance Corporation
("FDIC") or the Resolution Trust Corporation enters into an agreement to provide
assistance to or on behalf of the Bank under the authority contained in Section
13(c) of FDIA; or (ii) by the Director of the OTS, or his or her designee, at
the time that the Director of the OTS, or his or her designee approves a
supervisory merger to resolve problems related to operation of the Bank or when
the Bank is determined by the Director of the OTS to be in an unsafe or unsound
condition. Such action shall not affect any vested rights of the parties.
If a notice served under Section 8(e)(3) or (g)(1) of the FDIA (12 U.S.C.
1818(e)(3) or (g)(1)) suspends and/or temporarily prohibits the Participant from
participating in the conduct of the Bank's affairs, the Bank's obligations under
this Plan shall be suspended as of the date of such service, unless stayed by
appropriate proceedings. If the charges in the notice are dismissed, the Bank
may in its discretion (i) pay the Participant all or part of the compensation
withheld while its contract obligations were suspended, and (ii) reinstate (in
whole or in part) any of its obligations which were suspended.
4
<PAGE>
ARTICLE VIII
Change in Control
-----------------
The provisions of this Article shall supersede any provisions of this Plan
to the contrary. In the event of a Change in Control while a Participant is
serving on the Board, the Participant's Vested Percentage shall become 100%, and
the Bank shall establish an irrevocable Trust and make a lump sum contribution
to the Trust in an amount that is projected to be sufficient to pay each
Participant the benefits to which he or she is entitled pursuant to the Plan as
of the date of the Change in Control.
ARTICLE IX
Reorganization
--------------
The Bank agrees that it will not merge or consolidate with any other
corporation or organization, or permit its business activities to be taken over
by any other organization, unless and until the succeeding or continuing
corporation or other organization shall expressly assume the rights and
obligations of the Bank herein set forth. The Bank further agrees that it will
not cease its business activities or terminate its existence, other than as
heretofore set forth in this paragraph, without having made adequate provision
for the fulfillment of its obligation hereunder.
ARTICLE X
Amendment and Termination
-------------------------
The Board may amend or terminate the Plan at any time, provided that no
such amendment or termination shall, without the written consent of an affected
Participant, alter or impair any rights of the Participant under the Plan.
Unless terminated earlier in accordance with this Article X, this Plan shall
remain in effect during the term of service of the Participants and until all
Benefits payable hereunder have been made.
ARTICLE XI
State Law
---------
This Plan shall be construed and governed in all respects under and by the
laws of the State of Maryland. If any provision of this Plan shall be held by a
court of competent jurisdiction to be invalid or unenforceable, the remaining
provisions hereof shall continue to be fully effective.
ARTICLE XII
Headings; Gender
----------------
Headings and subheadings in this Plan are inserted for convenience and
reference only and constitute no part of this Plan. This Plan shall be
construed, where required, so that the masculine gender includes the feminine.
ARTICLE XIII
Interpretation of the Plan
--------------------------
The Board shall have sole and absolute discretion to administer, construe,
and interpret the Plan, and the decisions of the Board shall be conclusive and
binding on all affected parties (unless such decisions are arbitrary and
capricious).
ARTICLE XIV
Legal Fees
----------
In the event any dispute shall arise between a Director and the Bank as to
the terms or interpretation of this Plan, whether instituted by formal legal
proceedings or otherwise, including any action taken by a Director to enforce
5
<PAGE>
the terms of this Plan or in defending against any action taken by the Bank, the
Bank shall reimburse the Director for all costs and expenses, including
reasonable attorneys' fees, arising from such dispute, proceedings or actions;
provided that the Director shall return such amounts to the Bank if he fails to
obtain a final judgment by a court of competent jurisdiction or obtain a
settlement of such dispute, proceedings, or actions substantially in his or her
favor. Such reimbursements to a Director shall be paid within 10 days of the
Director furnishing to the Bank written evidence, which may be in the form,
among other things, of a canceled check or receipt, of any costs or expenses
incurred by the Director. Any such request for reimbursement by a Director
shall be made no more frequently than at 30 day intervals.
6
<PAGE>
EXHIBIT 13
PATAPSCO BANCORP, INC.
[LOGO]
1998 ANNUAL REPORT
<PAGE>
PATAPSCO BANCORP, INC.
- --------------------------------------------------------------------------------
Patapsco Bancorp, Inc. (the "Company") is the holding company for The
Patapsco Bank (the "Bank"). 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 405 holders of
record of 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,
as well as the dividends paid during such quarters.
<TABLE>
<CAPTION>
High Low Dividends Per Share
------- ------ --------------------
<S> <C> <C> <C>
Fiscal 1998:
First Quarter $ 30.00 $26.00 $ --
Second Quarter 32.00 27.00 .10
Third Quarter 32.063 30.00 .10
Fourth Quarter 33.50 32.00 .10
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 12.50 (1)
------------
</TABLE>
(1) Dividend was tax-free return of capital distribution, reducing
each stockholder's basis in the common stock by the dividends
received.
The stated high and low closing sale prices reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not represent actual
transactions.
TABLE OF CONTENTS
- ----------------------------------------------------------------------
<TABLE>
<CAPTION>
<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................................. 21
Corporate Information............................. Inside Back Cover
</TABLE>
(i)
<PAGE>
Dear Stockholder:
The directors, officers and staff of Patapsco Bancorp, Inc. and The
Patapsco Bank proudly present you with our third Annual Report.
You will recall that we ended fiscal year 1997 by paying a $12.50 per share
tax free return of capital distribution. We began fiscal year 1998 by declaring
our first regular dividend, which was followed by three additional quarterly
dividends of $.10 per share. In September, 1998, the Company's Board of
Directors declared a $.12 per share dividend payable to stockholders in October,
1998.
The payment of dividends is reflective of the continued improving
performance of our Company. As shown in this report, during the year we
continued to grow our assets; to diversify our loan portfolio; to build our loan
loss reserves; and to control our expenses.
Most significantly, this year our core earnings increased by 43% to
$678,000 or $2.05 per share and $1.95 per share on a fully diluted basis. This
growth is the result of our continuing transition to commercial banking. During
the year we divested ourselves from the remaining $7.7 million investment in low
yielding mortgage backed securities. Our loan portfolio increased $9.6 million,
despite record loan payoffs caused by low interest rates. Since our deposits
remained level, much of our asset growth was funded with loans from the Federal
Home Loan Bank. These borrowings were used for loan growth and a leveraged
transaction which was used to improve our earnings.
Since we have become a stock company we have emphasized improving the
Company's return on equity. During fiscal 1998 this ratio increased 105% to
7.88%. In addition, return on assets increased to .76%, an increase of 29%.
These ratios are numerical measures of the progress we have made. To truly
measure our improvement one must look back beyond one year. Less than three
years ago we were a mutual thrift with very poor earnings. Today, we have grown
the organization by 20%. We have focused on earnings growth commensurate with
safety and soundness considerations. We have changed the organization and put
the concept of maximization of shareholders wealth in the forefront. Our success
is reflected in our stock price. Our most recent trade was at $28.875. Despite a
recent price decline due to stock market turmoil, our stock has done extremely
well.
<PAGE>
However in today's competitive banking environment we cannot rest on past
accomplishments. A significant example involves our recent agreement to acquire
Belmar Federal Savings and Loan Association. Belmar, a mutual institution with
one office and eight employees, has approximately $18.7 million in assets and is
located in the Overlea section of Baltimore, an area with similar demographics
to the communities we currently serve. It will double our branch offices and
bring our varied product offerings to Belmar's customers. We believe this
transaction is a perfect fit with our long term strategy of controlled growth.
We also expect it to yield improved financial results, particularly in the next
few years, as we realize the many efficiencies of our combined organizations.
In fiscal 1999, we will continue to expand the array of services we offer
to compete in a highly competitive environment. Specifically, we must expand our
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 our strategy of achieving a steady growth
rate which can be sustained over time consistent with prudent safe and sound
practices.
The new year also will present other challenges. The Year 2000 is on the
immediate horizon with data processing implications for financial institutions.
At Patapsco we are preparing for this event. We have successfully completed two
examinations by federal regulators and we fully expect to be able to conduct
business as usual in the Year 2000, as well as for many years thereafter. On
other fronts, proposed legislation at the national level creates uncertainty for
financial institutions while the banking business 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.
In summary, it has been a very good year and we look forward to the coming
year with enthusiasm. We want to acknowledge the many contributions made by
Joseph N. McGowan and Robert M. Lating who both retire as voting directors this
fall. Fortunately, both will continue to serve as honorary directors, providing
the Board with the benefit of their experience and counsel. We also take this
opportunity on behalf of the directors, officers and staff of Patapsco Bancorp,
Inc. and The Patapsco Bank to express our collective appreciation to our
stockholders and customers for their confidence and support during the year. We
look forward to a successful new year.
/s/ S. Robert Kinghorn /s/ Joseph J. Bouffard
S. Robert Kinghorn Joseph J. Bouffard
Chairman of the Board President and Chief Executive Officer
3
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
- --------------------------------------------------------------------------------
SELECTED CONSOLIDATED FINANCIAL CONDITION DATA
<TABLE>
<CAPTION>
At June 30,
------------------
1998 1997
------- ---------
(In thousands)
<S> <C> <C>
Total assets................................. $92,371 $83,650
Loans receivable, net........................ 75,871 66,236
Cash, federal funds sold and other interest
bearing deposits.......................... 8,538 5,113
Investment securities........................ 5,119 1,989
Mortgage-backed securities................... -- 7,678
Deposits..................................... 70,327 70,152
Borrowings................................... 10,200 2,700
Stockholders' equity......................... 9,123 8,334
</TABLE>
- -------------------------------------------------------------------------------
SELECTED CONSOLIDATED INCOME DATA
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------
1998 1997
------ --------
(In thousands)
<S> <C> <C>
Interest income..................................... $7,038 $ 5,897
Interest expense.................................... 3,444 2,706
------ --------
Net interest income before provision
for loan losses.................................. 3,594 3,191
Provision for loan losses........................... 240 240
------ --------
Net interest income after provision
for loan losses.................................. 3,354 2,951
Noninterest income.................................. 274 219
Noninterest expenses:
Compensation and employee benefits............... 1,597 1,467
Insurance........................................ 72 515 (1)
Professional fees................................ 134 148
Equipment expenses............................... 117 116
Net occupancy costs.............................. 90 81
Advertising...................................... 53 44
Data processing.................................. 114 96
Other............................................ 372 346
------ --------
Total noninterest expenses.................... 2,549 2,813
Income before provision (benefit) for income taxes.. 1,079 357
Income tax provision (benefit)...................... 401 (463)(2)
------ --------
Net income.......................................... $ 678 $ 820
====== ========
</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.
4
<PAGE>
KEY OPERATING RATIOS
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
---------------
1998 1997
---- ----
<S> <C> <C> <C>
PERFORMANCE RATIOS:
Return on average assets (net income divided by
average total assets.................................. 0.76% 1.03% (1)
Return on average stockholders' equity (net income
divided by average stockholders' equity).............. 7.88 6.62 (1)
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost)........................... 3.54 3.30
Net interest margin (net interest income
divided by average interest-earning assets)........... 4.10 4.08
Ratio of average interest-earning assets to
average interest-bearing liabilities.................. 114.12 122.78
Ratio of noninterest expense to average total assets... 2.85 3.52 (2)
ASSET QUALITY RATIOS:
Nonperforming assets to total assets at
end of period......................................... 0.53 0.18
Nonperforming (nonaccrual) loans to loans
receivable, net at end of period...................... 0.61 0.19
Allowance for loan losses to total loans
at end of period...................................... 0.72 0.59
Allowance for loan losses to nonperforming
loans at end of period................................ 119.81 322.77
Net charge-offs to average loans outstanding........... 0.11 0.11
CAPITAL RATIOS:
Stockholders' equity to total assets at end of period.. 9.88 9.96
Average stockholders' equity to average assets......... 9.62 15.51
</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%.
5
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
GENERAL
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.
PENDING ACQUISITION
On May 22, 1998, the Company signed a Merger Conversion Agreement with
Belmar Federal Savings and Loan Association ("Belmar"), pursuant to which the
Company intends to acquire Belmar Federal Savings and Loan Association in a
merger conversion transaction. Belmar is a mutual institution with one office,
located in Baltimore, Maryland, and total assets of $18.7 million. As part of
the plan of acquisition, Belmar will merge into the Bank. In connection with
the merger, the Company intends to grant priority subscription rights in its
common stock to the qualifying members of Belmar at a discount to the market
price. Consummation of the transaction is subject to regulatory approval and
approval of Belmar's members.
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.
6
<PAGE>
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.
POSSIBLE YEAR 2000 COMPUTER PROGRAM PROBLEMS
A great deal of information has been disseminated about the global computer
crash that may occur in the year 2000. Many computer programs that can only
distinguish the final two digits of the year entered (a common programming
practice in earlier years) are expected to read entries for the year 2000 as the
year 1900 and compute payment, interest or delinquency based on the wrong date
or are expected to be unable to compute payment, interest or delinquency. Rapid
and accurate data processing is essential to the operations of the Company.
Data processing is also essential to most other financial institutions and many
other companies.
All of the material data processing of the Company that could be affected
by this problem is provided by a third party bureau. Management closely
monitors the progress of the service bureau in resolving this potential problem
and reports the status of the service bureau's progress to the Company's Audit
Committee on a quarterly basis. This service bureau has advised the Company
that it expects to resolve this potential problem before the year 2000 by
completing all implementation and testing procedures by December 31, 1998.
However, if the service bureau is unable to resolve this potential problem in
time, the Company would seek to retain a replacement service bureau and would
likely experience significant data processing delays, mistakes or failures.
These delays, mistakes or failures could have a significant adverse impact on
the financial condition and results of operation of the Company.
7
<PAGE>
AVERAGE BALANCE, INTEREST AND AVERAGE YIELDS AND RATES
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods and at the date indicated. Such yields and costs are derived by
dividing income or expense by the average daily balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from daily balances.
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,
--------------------------------------------------------------------
1998 1997
-------------------------------------- ---------------------------
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)...................................... $73,476 $6,153 8.37% $58,473 $4,721 8.07%
Investment securities..................................... 5,911 412 6.97 2,988 191 6.40
Mortgage-backed securities................................ 1,881 103 5.48 8,629 534 6.18
Short-term investments and other interest-earning assets.. 6,435 370 5.75 8,068 451 5.59
------- ------ ------- ------
Total interest-earning assets............................ 87,703 7,038 8.02 78,158 5,897 7.55
------ ------
Non-interest-earning assets................................ 1,666 1,757
------- -------
Total assets............................................. $89,369 $79,915
======= =======
Interest-bearing liabilities:
Deposits (2).............................................. $66,952 2,840 4.24 $63,545 2,697 4.25
Borrowings................................................ 9,902 604 6.10 112 9 7.91
------- ------ ------- ------
Total interest-bearing liabilities....................... 76,854 3,444 4.48 63,657 2,706 4.25
------ ------ ------
Non-interest-bearing liabilities........................... 3,914 3,866
------- -------
Total liabilities........................................ 80,768 67,523
Retained earnings.......................................... 8,601 12,392
------- -------
Total liabilities and retained earnings.................. $89,369 $79,915
======= =======
Net interest income........................................ $3,594 $3,191
====== ======
Interest rate spread....................................... 3.54% 3.30%
====== ======
Net yield on interest-earning assets....................... 4.10% 4.08%
====== ======
Ratio of average interest-earning assets to average
interest-bearing liabilities.............................. 114.12% 122.78%
====== ======
</TABLE>
- -------------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing escrow accounts.
8
<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,
--------------------------------
1998 vs. 1997
--------------------------------
Increase (Decrease) Due to
--------------------------------
Rate/
Volume Rate Volume Total
------- ----- ------- -------
(In thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable........................ $1,211 $175 $ 45 $1,431
Investment securities................... 187 17 17 221
Mortgage-backed securities.............. (417) (60) 47 (430)
Short-term investments and other
interest-earning assets............... (91) 13 (3) (81)
------ ---- ----- ------
Total interest-earning assets....... 890 145 106 1,141
------ ---- ----- ------
Interest expense:
Deposits (1)............................ 149 (6) (1) 142
Borrowings.............................. 774 (2) (177) 595
------ ---- ----- ------
Total interest-bearing liabilities.. 923 (8) (178) 737
------ ---- ----- ------
Change in net interest income.............. $ (33) $153 $ 284 $ 404
====== ==== ===== ======
</TABLE>
- -------------------------
(1) Includes interest-bearing escrow accounts.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1998 AND 1997
General. Total assets increased by $8.8 million, or 10.5%, to $92.4
million at June 30, 1998 from $83.6 million at June 30, 1997. The increase was
primarily due to increases of $9.6 million, $3.1 million and $3.4 million in
loans receivable, investment securities and cash and cash equivalents,
respectively, partially offset by a decrease of $7.7 million in mortgage-backed
securities.
Loans Receivable. Net loans receivable increased by $9.6 million, or
11.5%, to $75.9 million at June 30, 1998 from $66.2 million at June 30, 1997.
The increase is directly attributable to the Company's increased loan demand for
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 mutual savings and loan association to a
stock savings bank and later to a 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 $2.3 million, $2.4 million and $200,000,
respectively, and the Company's consumer and commercial loan portfolios
increased by $3.4 million and $1.3 million during the year ended June 30, 1998,
respectively.
9
<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, 1998, the Company had no concentrations of loans exceeding 10% of gross
loans other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------
1998 1997
---------------- -----------------
Amount % Amount %
------- ------- ------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential...................... $55,212 72.08% $52,907 79.09%
Commercial....................... 5,106 6.67 2,612 3.90
Construction (1)................. 2,204 2.88 2,002 2.99
Consumer loans:
Home improvement................. 6,726 8.78 4,605 6.88
Home equity loans................ 1,227 1.60 420 0.63
Loans secured by deposits........ 385 0.50 364 0.55
Other consumer loans............. 649 0.85 198 0.30
Commercial loans:
Commercial loans................. 4,091 5.34 3,400 5.08
Commercial leases................ 997 1.30 388 0.58
------- ------ ------- ------
76,597 100.00% 66,896 100.00%
====== ======
Less:
Deferred loan origination fees,
net of costs................... 172 263
Allowance for loan losses........ 554 397
------- -------
Total......................... $75,871 $66,236
======= =======
</TABLE>
- -------------------------
(1) Less loans in process.
The following table sets forth certain information at June 30, 1998
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, 1999 June 30, 1998 June 30, 1998 Total
--------------- ------------- ------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential...... $15,821 $ 7,790 $31,601 $55,212
Commercial....... 2,896 1,210 1,000 5,106
Construction..... 2,204 -- -- 2,204
Consumer loans...... 1,645 2,696 4,646 8,987
Commercial loans.... 3,305 1,299 484 5,088
------- ------- ------- -------
Total.......... $25,871 $12,995 $37,731 $76,597
======= ======= ======= =======
</TABLE>
10
<PAGE>
The following table sets forth at June 30, 1998 the dollar amount of all
loans which may reprice or are due one year or more after June 30, 1998 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...... $32,140 $7,251 $39,391
Commercial....... 1,533 677 2,210
Consumer............ 7,342 -- 7,342
Commercial.......... 1,262 521 1,783
------- ------ -------
Total............ $42,277 $8,449 $50,726
======= ====== =======
</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 and Mortgage-Backed Securities. Investment
securities increased by $3.1 million, or 155.5%, to $5.1 million at June 30,
1998 from $2.0 million at June 30, 1997, and mortgage-backed securities
decreased by $7.7 million, or 100%, to $0 at June 30, 1998 from $7.7 million at
June 30, 1997. During the year ended June 30, 1998, the Company purchased a
$5.0 million investment security match funded with the proceeds from a $5.0
million FHLB advance. During the year ended June 30, 1998, the Company sold
$5.1 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, 1998 and 1997.
The following table sets forth the carrying value of the Company's
investments at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
----------------
1998 1997
------- ------
(Dollars in thousands)
<S> <C> <C>
Securities available for sale, at fair value:
U.S. government and agency securities........ $5,014 $ 1,989
Equity securities............................ 105 --
Mortgage-backed securities................... -- 7,678
------ -------
Total securities available for sale........ 5,119 9,667
------ -------
Investments required by law, at cost:
FHLB of Atlanta stock......................... 570 520
FRB of Richmond stock......................... 106 102
------ -------
Total investments required by law, at cost.. 676 622
------ -------
Total investments........................... $5,795 $10,289
====== =======
</TABLE>
11
<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, 1998.
<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................... $ -- --% $ -- --% $ 5,014 6.29%
-------- ------- -------- ------- ---------
Total....................... $ -- $ -- $ 5,014
======== ======== =========
<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................... $ -- --% $5,014 $5,014 6.29%
-------- ------- ------
Total....................... $ -- $5,014 $5,014
======== ======= ======
</TABLE>
12
<PAGE>
Deposits. Deposits increased by $175,000, or .2%, to $70.3 million at June
30, 1998 from $70.2 million at June 30, 1997. Interest-bearing deposits
increased by $1.5 million and noninterest-bearing deposits decreased by $1.3
million during fiscal 1998.
The following tables set forth the average balances based on daily balances
and interest rates for various types of deposits as of the dates indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------
1998 1997
----------------- ---------------------
Average Average Average Average
Balance Rate Balance Rate
------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Passbook, statement savings
and Christmas Club........... $20,061 2.88% $19,253 (1) 2.97%
NOW checking.................. 3,398 1.82 2,699 2.02
Money market.................. 4,696 3.25 4,893 3.25
Certificates of deposit....... 38,797 5.28 36,700 5.24
Noninterest-bearing checking.. 2,351 -- 2,017 --
------- -------
Total....................... $69,303 $65,562
======= =======
</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,
1998. At such date, such deposits represented 3.70% of total deposits and had a
weighted average rate of 5.54%.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- -----------
(In thousands)
<S> <C>
Three months or less........... $ 824
Over three through six months.. 224
Over six through 12 months..... 707
Over 12 months................. 846
------
Total....................... $2,601
======
</TABLE>
Borrowings. The Company's borrowings increased by $7.5 million to $10.2
million at June 30, 1998 from $2.7 million at June 30, 1997. During the year
ended June 30, 1998, the Company borrowed $10.2 million from the FHLB to fund
loan originations and the purchase of a $5.0 investment security. In July 1997,
the Company repaid a short-term borrowing with another financial institution in
connection with the Company's return of capital distribution in fiscal 1997.
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,
-------------------------
1998 1997
-------- --------
(Dollars in thousands)
<S> <C> <C>
Amounts outstanding at end of period:
FHLB advances............................... $ 10,200 $ --
Other borrowings............................ -- 2,700
Weighted average rate paid on:
FHLB advances............................... 6.12% --%
Other borrowings............................ --% 7.69%
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------
1998 1997
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Maximum amount of borrowings outstanding
at any month end:
FHLB advances............................... $10,200 $ --
Other borrowings............................ -- 2,700
<CAPTION>
Year Ended June 30,
----------------------------
1998 1997
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Approximate average short-term borrowings
outstanding with respect to:
FHLB advances................................ $ 9,902 $ --
Other borrowings............................. -- 112
Approximate weighted average rate paid on: (1)
FHLB advances................................ 6.10% --%
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.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1998 AND 1997
General. The Company had net income of $678,000 for the year ended
June 30, 1998 as compared to net income of $820,000 for the year ended June 30,
1997. The $142,000 decrease 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 after adjustment
for the two items described above was due to increases of $404,000 and $54,000
in net interest income and noninterest income, respectively, offset in part by a
$130,000 increase in compensation and employee benefits.
Net Interest Income. The Company's net interest income increased by
$404,000, or 12.6%, to $3.6 million at June 30, 1998 from $3.2 million at
June 30, 1997.
The increase in the Company's net interest income is directly attributable
to the Company's loan growth. The Company has implemented 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
products generally earn higher yields than conventional single-family
residential mortgage loans. To fund these new loan products, the Company has
divested 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 Federal Home Loan Bank of Atlanta borrowings to fund
loans.
The Company's interest rate spread increased to 3.54% in 1998 from 3.30% in
1997. The increase in the interest rate spread was primarily the result of an
increase in the average yield on interest-earning assets to 8.02% during fiscal
1998 from 7.55% in fiscal 1997. The increase in the interest rate spread was
offset slightly due to an increase in the average rate paid on interest-bearing
liabilities to 4.48% during fiscal 1998 from 4.25% in fiscal 1997. The
14
<PAGE>
Company's net yield on average interest-earning assets increased to 4.10% during
fiscal 1998 from 4.08% in fiscal 1997 The average balance of interest-earning
assets increased by $9.5 million to $87.7 million during fiscal 1998 from $78.2
million in fiscal 1997. The average balance of interest-bearing liabilities
increased by $13.2 million to $76.9 million during fiscal 1998 from $63.7
million in fiscal 1997.
Interest Income. The Company's total interest income increased by $1.1
million, or 18.6%, to $7.0 million for the year ended June 30, 1998 as compared
to $5.9 million for the year ended June 30, 1997. The increase was due
primarily to an increase in the average balance of interest-earning assets of
$9.5 million to $87.7 million during fiscal 1998 from $78.2 million in fiscal
1997, as well as to an increase in the average yield on average interest-earning
assets to 8.02% during fiscal 1998 from 7.55% in fiscal 1997.
Interest income on loans increased $1.5 million, or 31.9% to $6.2 million
during fiscal 1998 as compared to $4.7 million in fiscal 1997. The increase was
attributable primarily to the increase of $15.0 million in the average balance
of loans receivable to $76.5 million during fiscal 1998 from $58.5 million in
fiscal 1997, as well as to an increase in the average yield to 8.37% during 1998
from 8.07% in fiscal 1997.
Interest income on investment securities increased by $221,000, or 115.7%,
to $412,000 during fiscal 1998 as compared to $191,000 in fiscal 1997. The
increase was primarily due to an increase in the average balance of $2.9 million
to $5.9 million during fiscal 1998 from $3.0 million in fiscal 1997. The effect
on interest income from the increase in the average balance of investment
securities was also attributable to an increase in the average yield to 6.97%
during fiscal 1998 from 6.40% in fiscal 1997.
Interest income on mortgage-backed securities decreased by $430,000, or
80.5%, to $104,000 during fiscal 1998 as compared to $534,000 in fiscal 1997.
The decrease was the result of a $6.7 million decrease in the average balance of
mortgage-backed securities to $1.9 million during fiscal 1998 from $8.6 million
in fiscal 1997 and the decrease of the average yield on mortgage-backed
securities to 5.48% during fiscal 1998 from 6.18% in fiscal 1997.
Interest income on short-term investments and other interest-earning assets
decreased by $81,000 to $370,000 during fiscal 1998 as compared to $451,000 in
fiscal 1997. The decrease was primarily due to a decrease of $1.7 million in
the average balance partially offset by an increase in the average yield to
5.75% during fiscal 1998 from 5.59% in fiscal 1997.
Interest Expense. The Company's interest expense increased by $700,000, or
25.9%, to $3.4 million during fiscal 1998 as compared to $2.7 million in fiscal
1997. The increase was primarily attributable to the increase of $13.2 million
in the average balance of interest-bearing liabilities to $76.9 million during
fiscal 1998 from $63.7 million in fiscal 1997 and the increase in the average
rate to 4.48% during fiscal 1998 from 4.25% in fiscal 1997.
Interest expense on deposits increased by $141,000, or 5.2% to $2.8 million
during fiscal 1998 as compared to $2.7 million in fiscal 1997. The increase was
primarily attributable to an increase in the average balance to $67.0 million
during fiscal 1998 from $63.5 million in fiscal 1997. The average yield on
deposits decreased to 4.24% in fiscal 1998 from 4.25% in fiscal 1997.
Interest expense on borrowings increased by $595,000 to $604,000 during
fiscal 1998 as compared to $9,000 in fiscal 1997. In fiscal 1997, the Company
relied on the proceeds from the stock conversion and the growth of its deposits
to fund loan growth. However, during fiscal 1998 the Company borrowed a total
of $10.2 million from the Federal Home Loan Bank of Atlanta to fund loan growth.
In addition, 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
15
<PAGE>
based upon its analysis of the loan portfolio. The Company provided $240,000 to
its allowance for loan losses during both years ended June 30, 1998 and 1997.
The provision for loan losses was partially based on the Company's 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 0.72% at June 30, 1998 from 0.59% at June 30, 1997. The
Company's allowance for loan losses as a percentage of nonperforming loans was
119.8% at June 30, 1998 as compared to 322.8% at June 30, 1997.
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 $54,000
to $274,000 during fiscal 1998, as compared to $220,000 in fiscal 1997. The
increase was due to an increase of $48,000 in fees and service charges during
fiscal 1998 as compared to fiscal 1997. The increases in fees and service
charges are primarily attributable to higher volumes in fee-related commercial
demand deposit transactions and automated teller machine transactions.
Noninterest Expenses. The Company's total noninterest expenses decreased
by $263,000, or 9.3%, to $2.5 million during fiscal 1998, as compared to $2.8
million in fiscal 1997. The decrease included a $415,000 one-time savings
deposit premium expense to recapitalize the FDIC's SAIF during fiscal 1997. 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 11.1%
during fiscal 1997. The Company experienced an increase of $130,000 in
compensation and other benefits during fiscal 1998 as compared to fiscal 1997
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 $25,000 as a result of the new
lower SAIF assessment.
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 $137,000 for 1997 as compared to
$401,000 in fiscal 1998. 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, 1998.
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
16
<PAGE>
but increase during periods of falling interest rates. The Company's policy has
been to mitigate the interest rate risk inherent in the 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, carried at fair value,
totaling $5.1 million as of June 30, 1998. The Company is holding these
investment securities as available for sale because it may sell these 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. The Company has 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, 1998.
[CONFIRM.] At June 30, 1998, the Company held approximately $33.5 million in
loans with adjustable interest rates, which represented approximately 43.7% 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.
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, 1998, the Company had a positive one-year
interest rate sensitivity gap of 9.04%. Generally, for institutions with a
positive gap, net interest income would be expected to be positively affected by
rising interest rates and adversely affected by falling interest rates.
17
<PAGE>
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1998 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....................... $10,433 $16,289 $21,002 $ 8,588 $ 3,674 $ 332 $60,318
Construction loans...................... 2,204 -- -- -- -- -- 2,204
Consumer loans.......................... 2,211 1,648 4,252 815 61 -- 8,987
Commercial loans........................ 3,177 127 1,300 484 -- -- 5,088
Investment securities................... -- 4,381 633 -- -- -- 5,014
Federal funds sold, other interest-
earning assets and investments
required by law........................ 7,562 5 1 -- -- 676 8,244
------- ------- ------- ------- ------- ------- -------
Total................................. 25,587 22,450 27,188 9,887 3,735 1,008 89,855
------- ------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits (1)............................ 16,804 21,087 20,871 5,541 3,187 664 68,154
Borrowings.............................. 800 1,000 8,400 -- -- -- 10,200
------- ------- ------- ------- ------- ------- -------
Total.................................. 17,604 22,087 29,271 5,541 3,187 664 78,354
------- ------- ------- ------- ------- ------- -------
Interest sensitivity gap................. $ 7,983 $ 363 $(2,083) $ 4,346 $ 548 $ 344 $11,501
======= ======= ======= ======= ======= ======= =======
Cumulative interest sensitivity gap...... $ 7,983 $ 8,346 $ 6,263 $10,609 $11,157 $11,501
======= ======= ======= ======= ======= =======
Ratio of cumulative gap to total assets.. 8.64% 9.04% 6.78% 11.49% 12.08% 12.45%
======= ======= ======= ======= ======= =======
</TABLE>
- -------------------------
(1) Includes $417,000 of interest-bearing escrows.
18
<PAGE>
The preceding table was prepared utilizing certain assumptions as of
June 30, 1998 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 26.8% for lagging index adjustable-rate
loans and 18.0% 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 7.0% 8.9%
7.01 to 8.0 11.8
8.01 to 9.0 14.8
9.01 to 10.0 20.4
10.01 or greater 28.7
</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.
19
<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, 1998, the Company's cash on hand, interest-bearing deposits and
Federal funds sold totaled $8.5 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 $1.7 million,
$981,000 and $1.2 million, respectively. Certificates of deposit which are
scheduled to mature in less than one year at June 30, 1998 totaled $29.2
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, 1998, the Bank exceeded all regulatory minimum capital
requirements. The table below presents certain information relating to the
Bank's regulatory compliance at June 30, 1998.
<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>
Total Capital (to Risk Weighted Assets)... $8,947 16.40% $4,365 8.00% $5,457 10.00%
Tier 1 Capital (to Risk Weighted Assets).. 8,393 15.38 2,183 4.00 3,274 6.00
Tier 1 Capital (to Average Assets)........ 8,393 9.20 3,650 4.00 4,563 5.00
</TABLE>
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.
20
<PAGE>
IMPACT OF NEW ACCOUNTING STANDARDS
Reporting Comprehensive Income. In June 1997, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 130, which requires that comprehensive income - made up of all
revenues, expenses, gains and losses - be reported and displayed in an entity's
financial statements with the same prominence as its other financial statements.
Currently, the only item that would be presented as a component of the Company's
comprehensive income which is not also a component of its net income is the
change during the year in unrealized gain or loss on available for sale
securities. The Statement, which is effective for years beginning after
December 15, 1997, will not affect the Company's financial position or its
results of operations.
Disclosures About Segments of an Enterprise and Related Income. In June
1997, the FASB issued SFAS No. 131, which establishes standards for the way
public companies report information about operating segments in the annual and
interim financial statements. This Statement is effective for fiscal years
beginning after December 15, 1997. Management believes the adoption of this
Statement will not have a material effect on the financial statements of the
Company.
Employers' Disclosures About Pensions and Other Postretirement Benefits.
In February 1998, the FASB issued SFAS No. 132, which standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable. The Statement, which is effective for fiscal years
beginning after December 15, 1997, will not affect the Company's financial
position or its results of operations.
Accounting for Derivative Instruments and Hedging Activities. In June
1998, the FASB issued SFAS No.133, which standardizes the accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts, by requiring that an entity recognize these items as assets or
liabilities in the statement of financial position and measure them at fair
value. This Statement generally provides for matching the timing of gain or
loss recognition on the hedging instrument which the recognition of the changes
in the fair value of the hedged asset or liability that are attributable to the
hedged risk or the earnings effect of the hedged forecasted transaction. The
Statement, which is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999, will not affect the Company's financial position
or its results of operations.
21
<PAGE>
[Letterhead of Anderson Associates, LLP Appears Here]
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 as of June 30, 1998, and the related
consolidated statements of income, stockholders' equity and cash flows for the
year ended June 30, 1998. These consolidated financial statements are the
responsibility of Patapsco Bancorp, Inc.'s management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit. The consolidated statement of financial condition of Patapsco Bancorp,
Inc. and Subsidiary as of June 30, 1997 and the related statements of income,
stockholders' equity and cash flows for the year ended June 30, 1997 were
audited by other auditors whose report, dated August 1, 1997, expressed on those
statements an unqualified opinion.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated 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 audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Patapsco Bancorp, Inc. and Subsidiary at June 30, 1998, and the consolidated
results of their operations and their cash flows for the year ended June 30,
1998, in conformity with generally accepted accounting principles.
/s/ Anderson Associates LLP
August 7, 1998
22
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
June 30, 1998 and 1997
<TABLE>
<CAPTION>
===========================================================================================================
1998 1997
- -----------------------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C>
Cash:
On hand and due from banks $ 970,218 161,895
Interest bearing deposits 419,583 3,698
Federal funds sold 7,148,619 4,947,594
Investment securities at fair value (note 2) 5,118,910 1,989,380
Mortgage-backed securities at fair value (note 3) - 7,678,517
Loans receivable, net (note 4) 75,870,779 66,236,126
Investment required by law, at cost (note 9) 675,650 622,050
Property and equipment, net (note 5) 1,095,621 1,117,454
Deferred taxes (note 8) 336,000 236,000
Accrued interest, prepaid expenses and other assets 735,576 656,822
- -----------------------------------------------------------------------------------------------------------
$92,370,956 83,649,536
===========================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Interest bearing deposits $67,736,810 66,214,826
Non-interest bearing deposits 2,590,571 3,937,467
Borrowings (note 7) 10,200,000 2,700,000
Accrued expenses and other liabilities 2,378,936 2,239,240
Income taxes payable 341,799 224,000
- -----------------------------------------------------------------------------------------------------------
Total liabilities 83,248,116 75,315,533
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 2,330,681 2,249,725
Contra equity - Employee Stock Option Plan (ESOP) (396,341) (464,064)
Contra equity - Management Recognition Plan (MRP) (339,225) (423,724)
Retained earnings, substantially restricted 7,525,501 6,992,716
Unrealized net holding losses on available-for-sale
portfolios, net of taxes (1,402) (24,276)
- -----------------------------------------------------------------------------------------------------------
9,122,840 8,334,003
Commitments (notes 4, 10 and 11)
- -----------------------------------------------------------------------------------------------------------
$92,370,956 83,649,536
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
Years Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
==========================================================================================================
1998 1997
- ----------------------------------------------------------------------------------------------------------
Interest income:
<S> <C> <C>
Loans receivable $6,152,735 4,721,514
Mortgage-backed securities 103,517 533,537
Investment securities 411,551 191,228
Federal funds sold and other investments 370,327 450,964
- ----------------------------------------------------------------------------------------------------------
Total interest income 7,038,130 5,897,243
- ----------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 2,839,476 2,697,609
Borrowings 604,162 8,898
- ----------------------------------------------------------------------------------------------------------
Total interest expense 3,443,638 2,706,507
- ----------------------------------------------------------------------------------------------------------
Net interest income 3,594,492 3,190,736
Provision for losses on loans (note 4) 240,000 240,000
- ----------------------------------------------------------------------------------------------------------
Net interest income after provision for losses on loans 3,354,492 2,950,736
- ----------------------------------------------------------------------------------------------------------
Noninterest income:
Fees and service charges 251,791 203,952
Net gain on sales of securities 5,015 1,844
Other 17,162 13,915
- ----------------------------------------------------------------------------------------------------------
Total noninterest income 273,968 219,711
- ----------------------------------------------------------------------------------------------------------
Noninterest expenses:
Compensation and employee benefits 1,597,100 1,467,143
Insurance 72,488 515,260
Professional fees 133,956 147,757
Equipment expenses 117,417 115,573
Net occupancy costs 89,890 81,403
Advertising 52,550 44,371
Data processing 113,801 96,012
Other 372,451 345,617
- ----------------------------------------------------------------------------------------------------------
Total noninterest expenses 2,549,653 2,813,136
- ----------------------------------------------------------------------------------------------------------
Income before income taxes 1,078,807 357,311
Income tax provision (benefit) (note 8) 401,000 (463,000)
- ----------------------------------------------------------------------------------------------------------
Net income $ 677,807 820,311
- ----------------------------------------------------------------------------------------------------------
Net income per share of common stock (note 1):
Basic $2.05 2.44
Diluted 1.95 2.42
==========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
Years Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Unrealized
net holding
losses on
Additional Contra- Contra- available- Total
Common paid-in equity equity Retained for-sale stockholders'
stock capital ESOP MRP earnings portfolios equity
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1996 $3,626 6,754,240 (522,072) - 6,172,405 (107,056) 12,301,143
Purchase of 14,502 shares of common stock for
Management Recognition Plan (MRP) Trust - - - (423,724) - (423,724)
Compensation under stock-based benefit plans - 27,398 58,008 - - - 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) - - - (4,531,913)
Net income - - - - 820,311 - 820,311
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 3,626 2,249,725 (464,064) (423,724) 6,992,716 (24,276) 8,334,003
Cash dividends declared ($0.40 per share) - - - - (145,022) - (145,022)
Compensation under stock-based benefit plans - 80,956 67,723 84,499 - - 233,178
Adjustment to unrealized net holding losses on
available-for-sale portfolios, net (note 1) - - - - - 22,874 22,874
Net income - - - - 677,807 - 677,807
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 $3,626 2,330,681 (396,341) (339,225) 7,525,501 (1,402) 9,122,840
===================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
============================================================================================================
1998 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 677,807 820,311
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 118,169 122,497
Provision for losses on loans 240,000 240,000
Non-cash compensation under stock-based benefit 233,178 85,406
plans
Amortization of premiums and discounts, net 6,362 18,098
Deferred loan origination fees, net of costs 148,969 14,685
Gain on sales of investment securities and
mortgage-backed securities (5,015) (1,844)
Increase in income taxes payable 117,799 149,000
Change in deferred taxes (114,000) (886,000)
Increase in accrued interest on investments,
prepaid expenses and other assets (79,173) (55,704)
Increase in accrued expenses and other
liabilities 103,463 519,325
- ------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,447,559 1,025,774
- ------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of investment security available-for-sale (5,028,125) -
Purchase of equity securities (106,485) -
Maturities of investment securities available-for-sale 2,000,000 2,500,000
Principal repayments on mortgage-backed securities
available-for-sale 2,651,087 817,440
Sales of mortgage-backed securities available-for-sale 5,068,433 4,335,784
Loan principal disbursements, net of repayments (7,542,267) (9,870,978)
Purchase of loans (2,481,355) (4,516,255)
Purchase of stock in Federal Home Loan Bank of Atlanta (49,300) (30,000)
Purchase of stock in Federal Reserve Bank of Richmond (4,300) (101,550)
Purchases of property and equipment (96,336) (211,261)
- ------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (5,588,648) (7,076,820)
- ------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
See accompanying notes to consolidated financial statements.
26
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows, Continued
Years ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
===========================================================================================================
1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from financing activities:
Net increase in deposits $ 175,088 5,995,405
(Decrease) increase in note payable (2,700,000) 2,700,000
Return of capital distribution - (4,531,913)
Purchase of common stock for stock-based benefit plans - (423,724)
Advances from Federal Home Loan Bank of Atlanta 10,200,000 -
Dividends paid (108,766) -
- -----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 7,566,322 3,739,768
- -----------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 3,425,233 (2,311,278)
Cash and cash equivalents at beginning of year 5,113,187 7,424,465
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 8,538,420 5,113,187
===========================================================================================================
Supplemental information:
Interest paid on savings deposits and borrowed funds $ 3,457,723 2,705,637
Income taxes paid 395,000 199,000
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
------------------------------------------------------------------------
(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 (the Bank). The primary business of the Bank is to attract deposits
from individual and corporate customers and to originate residential and
commercial mortgage loans, commercial loans and consumer loans. The Bank is
subject to competition from other financial and mortgage institutions in
attracting and retaining deposits and in making loans. The Bank 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, the Bank. 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 the Bank's allowance for
loan losses. Such agencies may require the Bank 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
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(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.
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.
(Continued)
29
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(1) CONTINUED
LOAN FEES
Loan origination fees are deferred and amortized to income over the
contractual lives of the related loans using the interest method. Certain
incremental direct loan origination costs are deferred and recognized over
the contractual lives of the related loans using the interest method as a
reduction of the loan yield. Deferred fees and costs are combined where
applicable and the net amount is amortized.
PROVISION FOR LOSSES ON LOANS
Provisions for losses on loans receivable are charged to income, based on
management's judgment with respect to the risks inherent in the portfolio.
Such judgment considers a number of factors including historical loss
experience, the present and prospective financial condition of borrowers, the
estimated value of underlying collateral, geographic concentrations, current
and prospective economic conditions, delinquency experience and status of non
performing 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 non-accrual 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"), the Bank 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 the Bank 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 the Bank expects
to collect all amounts due, including past-due interest. The Bank 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.
(Continued)
30
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(1) CONTINUED
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 non accrual status since loans are placed in non
accrual 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.
The Bank recognized 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 carry forwards) 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.
(Continued)
31
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(1) CONTINUED
NET INCOME PER SHARE OF COMMON STOCK
As required, the Company adopted Statement of Financial Accounting Standards
No. 128 during the year ended June 30, 1998. This Statement requires dual
presentation of basic and diluted earnings per share ("EPS") with a
reconciliation of the numerator and denominator of the EPS computations.
Basic per share amounts are based on the weighted average shares of common
stock outstanding. Diluted earnings per share assume the conversion, exercise
or issuance of all potential common stock instruments such as options,
warrants and convertible securities, unless the effect is to reduce a loss or
increase earnings per share. No adjustments were made to net income
(numerator) for all periods presented. Accordingly, this presentation has
been adopted for all periods presented. The basic and diluted weighted
average shares outstanding are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
-------------------------------------------------------------------
JUNE 30, 1998 JUNE 30, 1997
BASIC DILUTED BASIC DILUTED
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $677,807 $677,807 $820,311 $820,311
Weighted average shares outstanding 331,125 331,125 336,449 336,449
Diluted securities:
Options - 16,155 - 2,283
MRP shares - 432 - 113
----------------------------------------------------------------------------------------------------------
Adjusted weighted average shares 331,125 347,712 336,449 338,845
----------------------------------------------------------------------------------------------------------
Per share amount $2.05 $1.95 $2.44 $2.42
==========================================================================================================
</TABLE>
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.
(Continued)
32
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(2) INVESTMENT SECURITIES
Investment securities, classified as available-for-sale, are summarized as
follows as of June 30:
<TABLE>
<CAPTION>
1998
----------------------------------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Equity securities $ 106,487 - $1,642 $ 104,845 $ 104,845
U.S. Government and Agency
obligations due 5 through 10 years 5,014,704 - 639 5,014,065 5,014,065
--------------------------------------------------------------------------------------------------------------------
$5,121,191 - 2,281 $5,118,910 $5,118,910
====================================================================================================================
<CAPTION>
1997
----------------------------------------------------------------------------
<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>
Accrued interest receivable at June 30, 1998 and 1997 was $2,908 and $1,611,
respectively.
There were no sales of investment securities in 1998 and 1997.
(3) MORTGAGE-BACKED SECURITIES
Mortgage-backed securities, classified as available-for-sale, are summarized
as follows as of June 30, 1997:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------
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
============================================================================================================
</TABLE>
Accrued interest receivable at June 30, 1997 was $41,110.
In 1998, the Company sold mortgage-backed securities classified available-
for-sale with an amortized cost of $5,063,417 and realized a net gain of
$5,015. 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.
(Continued)
33
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(4) LOANS RECEIVABLE
Loans receivable and accrued interest receivable thereon are summarized as
follows as of June 30:
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------------------------------------------------------------
Real estate secured by first mortgage:
<S> <C> <C>
Residential $55,212,243 $52,906,474
Commercial 5,106,188 2,611,818
Construction, net of loans in process 2,203,407 2,001,892
-------------------------------------------------------------------------------------------------
62,521,838 57,520,184
Home improvement loans 6,726,365 4,604,954
Commercial loans 4,091,340 3,399,694
Home equity loans 1,227,088 420,392
Commercial leases 996,468 388,618
Loans secured by deposits 384,975 364,334
Consumer loans 649,011 198,285
-------------------------------------------------------------------------------------------------
76,597,085 66,896,461
Less:
Deferred loan origination fees, net of costs 172,793 263,323
Allowance for loan losses 553,513 397,012
-------------------------------------------------------------------------------------------------
Loans receivable, net $75,870,779 66,236,126
=================================================================================================
</TABLE>
Accrued interest receivable on loans was $419,310 and $363,448 at June 30,
1998 and 1997, respectively.
A substantial portion 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)
34
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(4) CONTINUED
Impairment of loans having recorded investments of $194,000 at June 30, 1998
has been recognized in conformity with SFAS No. 114. The average recorded
investment in impaired loans during 1998 was $190,154. The total allowance
for loan losses related to these loans was $38,900. The amount of interest
that would have been recorded on impaired loans at June 30, 1998 had the
loans performed in accordance with their terms was approximately $16,000. The
actual interest income recorded on these loans was $12,000. No loans were
impaired as defined during 1997.
Nonaccrual loans amounted to approximately $268,000 and $123,000 at June 30,
1998 and 1997, respectively. The amount of interest income that would have
been recorded on loans in nonaccrual status at June 30, 1998 and 1997 had
such loans performed in accordance with their terms, was approximately $6,300
and $5,500, respectively. The actual interest income recorded on these loans
during 1998 and 1997 was approximately $13,400 and $7,000, respectively.
The Company, through its normal asset review process, classifies certain
loans which management believes involve a degree of risk warranting
additional attention. These classifications are special mention, substandard,
doubtful and loss. At June 30, 1998, loans classified special mention and
substandard totaled approximately $776,400 and $462,000, respectively. No
loans were classified doubtful or loss at June 30, 1998.
The activity in the allowance for loan losses is summarized as follows for
the years ended June 30:
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $397,012 $219,001
Provision for losses on loans 240,000 240,000
Charge-offs, net of recoveries (83,499) (61,989)
- ------------------------------------------------------------------------------------------------------
Balance at end of year $553,513 $397,012
======================================================================================================
</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, 1998 and
1997 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)
35
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(4) CONTINUED
Outstanding commitments to extend credit, which generally expire within
60 days, are as follows at June 30, 1998:
<TABLE>
<CAPTION>
FIXED RATE FLOATING RATE
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Residential mortgage loans $1,573,450 $147,750
Commercial business and lease loans - 25,000
Undisbursed lines of credit 91,681 889,065
=======================================================================================================
</TABLE>
As of June 30, 1998 and 1997, the Bank was servicing loans for the benefit of
others, approximately $2,570,632 and $1,470,000, respectively.
(5) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows at June 30:
<TABLE>
<CAPTION>
ESTIMATED
1998 1997 USEFUL LIVES
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Land $ 92,684 $ 92,684 -
Building and improvements 982,653 981,015 40 years
Furniture, fixtures and equipment 1,141,957 1,047,272 5 - 10 years
- ------------------------------------------------------------------------------- -------------------
Total, at cost 2,217,294 2,120,971
Less accumulated depreciation 1,121,673 1,003,517
- -------------------------------------------------------------------------------
Property and equipment, net $1,095,621 $1,117,454
===============================================================================
</TABLE>
The Company has no obligations under long-term operating leases.
(Continued)
36
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(6) DEPOSITS
The aggregate amount of short-term jumbo certificates, each with a minimum
denomination of $100,000, was approximately $2,601,000 and $2,367,000 in 1998
and 1997, respectively.
At June 30, 1998, the scheduled maturities of certificates are as follows:
<TABLE>
<S> <C>
Under 12 months $27,623,773
12 months to 24 months 8,855,402
24 months to 36 months 1,364,077
36 months to 48 months 917,993
48 months to 60 months 50,078
- -------------------------------------------------------------------------------------------------------
$38,811,323
=======================================================================================================
</TABLE>
(7) BORROWINGS
At June 30, 1998 and 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.
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, 1998, the scheduled maturities of borrowings are as follows:
<TABLE>
<CAPTION>
Weighted
Balance Average Rate
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Under 12 months $ 1,800,000 5.99%
12 months to 24 months - -
24 months to 36 months 400,000 6.15
36 months to 48 months 1,000,000 6.55
48 months to 60 months 7,000,000 6.02
- -------------------------------------------------------------------------------------------------------
$10,200,000 6.12%
=======================================================================================================
</TABLE>
(Continued)
37
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(8) INCOME TAXES
The provision (benefit) for income taxes is composed of the following for the
years ended June 30:
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------------------------------------------------------
Current:
<S> <C> <C>
Federal $442,000 $347,000
State 73,000 76,000
- ---------------------------------------------------------------------------------------------------------
$515,000 $ 423,000
- ---------------------------------------------------------------------------------------------------------
Deferred:
Federal (93,000) (726,000)
State (21,000) (160,000)
- ---------------------------------------------------------------------------------------------------------
(114,000) (886,000)
- ---------------------------------------------------------------------------------------------------------
$401,000 $(463,000)
=========================================================================================================
</TABLE>
The net deferred tax asset (liability) consists of the following at June 30:
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Total deferred tax liabilities $(177,000) $(191,000)
Total deferred tax assets 513,000 427,000
- ---------------------------------------------------------------------------------------------------------
$ 336,000 $ 236,000
=========================================================================================================
</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>
1998 1997
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Tax bad debt reserves $ (52,000) $(65,000)
Allowance for losses on loans 214,000 153,000
Federal Home Loan Bank stock dividends (101,000) (71,000)
Unrealized holding losses 1,000 15,000
Accumulated depreciation (25,000) (25,000)
Deferred compensation 253,000 206,000
Deferred loan fees 37,000 37,000
Other, net 9,000 (14,000)
- ---------------------------------------------------------------------------------------------------------
$ 336,000 $236,000
=========================================================================================================
</TABLE>
(Continued)
38
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(8) CONTINUED
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>
1998 1997
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
Tax at statutory rate $367,000 $ 121,000
State income taxes, net of Federal income tax benefit 34,000 (55,000)
Reinstatements of Federal bad debt deductions - (548,000)
Other - 19,000
- --------------------------------------------------------------------------------------------------------
Income tax provision (benefit) $401,000 $(463,000)
========================================================================================================
</TABLE>
The Company has qualified under provisions of the Federal Internal Revenue Code
which permit it to deduct from taxable income a provision for bad debts based on
actual bad debt experience. Therefore, the provision for bad debts deducted
from taxable income for Federal income tax purposes was based on the experience
method.
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) insures deposits of account
holders up to $100,000. The Bank pays an annual premium to provide for this
insurance. The Bank 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 to the Bank, whichever is greater. Purchases and sales of stock are
made directly with the Bank at par value.
(Continued)
39
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(9) CONTINUED
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
$4.7 million of transaction accounts, reserves equal to 3% must be maintained
on the next $47.8 million of transaction accounts, and a reserve of 10% plus
$1,434,000 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, 1998, the Bank met its reserve
requirements.
The Bank 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 the Bank's financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank 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,
1998, that the Bank meets all capital adequacy requirements to which it is
subject.
As of June 30, 1998, the most recent notification from banking regulators
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as adequately capitalized the
Bank 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)
40
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(9) CONTINUED
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> <C> <C> <C> <C> <C>
As of June 30, 1998:
Total Capital (to Risk
Weighted Assets) $ 8,947 16.40% $4,365 8.00% $5,457 10.00%
Tier I Capital (to Risk
Weighted Assets) 8,393 15.38% 2,183 4.00% 3,274 6.00%
Tier I Capital (to Average
Assets) 8,393 9.20% 3,650 4.00% 4,563 5.00%
As of June 30, 1997:
Total Capital (to Risk
Weighted Assets) 10,910 23.68% 3,685 8.00% 4,607 10.00%
Tier I Capital (to Risk
Weighted Assets) 10,513 22.82% 1,843 4.00% 2,764 6.00%
Tier I Capital (to Average
Assets) $10,513 12.81% $3,282 4.00% $4,103 5.00%
==============================================================================================================
</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 the Bank'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 the Bank 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 the Bank in exchange for
all of its outstanding common stock.
(Continued)
41
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(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 the Bank 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 the Bank,
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 the
Bank, 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
The Bank 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 the Bank's conversion to a capital stock form
of organization. The ESOP purchased an additional 12,861 shares with cash it
received as a result of the return of capital distribution paid by the
Company in June 1997. 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 the Bank to the ESOP
and earnings thereon.
All employees of the Bank who attain the age of 21 and complete six months of
service with the Bank will be eligible to participate in the ESOP.
Participants will become 100% vested in their accounts after three years of
service with the Bank or, if earlier, upon death, disability or attainments
of normal retirement age. Participants receive credit for service with the
Bank prior to the establishment of the ESOP.
(Continued)
42
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
- --------------------------------------------------------------------------------
(11) CONTINUED
The Bank 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, the Bank 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, 1998 and 1997 compensation expense recognized related to the ESOP
and the Bank's contribution to the ESOP was $148,679 and $85,405,
respectively.
The ESOP shares were as follows as of June 30:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------------------------------------------------------------
<S> <C> <C>
Shares released and allocated 13,098 5,800
Unearned shares 28,767 23,204
41,865 29,004
========================================================================================================
Fair value of unearned shares $960,099 $638,110
========================================================================================================
</TABLE>
DIRECTORS RETIREMENT PLAN
Effective September 28, 1995, the Bank 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, 1998 and 1997 was $44,446 and
$75,659, respectively.
STOCK OPTIONS
The Company's 1996 Stock Option 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 shares and fair
value have been adjusted to 43,093 shares at $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. If a participant in the
Plan terminates employment for reasons other than death, disability,
retirement at age 65 or change in control, he or she forfeits all rights to
unvested shares.
(Continued)
43
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(11) CONTINUED
The following table summarizes the status of and changes in the Company's
stock option plan during the past two years, as retroactively adjusted for
the Company's return of capital.
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE OPTIONS EXERCISE
OPTIONS PRICE EXERCISABLE PRICE
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at end of 1996 - - - -
Granted 43,093 $18.91 - -
Exercised -
-----------------------------------------------------------------------------------------------------
Outstanding at end of 1997 43,093 - - -
Granted - - - -
Exercised -
-----------------------------------------------------------------------------------------------------
Outstanding at end of 1998 43,093 $18.91 6,895 $18.91
=====================================================================================================
</TABLE>
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 would have been decreased to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997
---------------------------------------------------------------------------------------------------
Net income:
<S> <C>
As reported 820,311
Pro forma 774,311
Basic earnings per share:
As reported 2.44
Pro forma 2.30
===================================================================================================
</TABLE>
The fair value of option grant was calculated using the Black-Scholes option-
pricing model with the following assumptions as of June 30:
<TABLE>
<CAPTION>
1997
---------------------------------------------------------------------------------------------------
<S> <C>
Risk-free rate 6.00%
Expected volatility 30.00%
Expected lives 9.25 years
====================================================================================================
</TABLE>
(Continued)
44
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(11) CONTINUED
STOCK AWARD PLAN
During the year ended June 30, 1998, the Company approved a Stock Award Plan
to one of its officers. The Plan provides for 1,247 shares to be vested at
25% per year beginning in October, 1998. The fair value of the shares was
$39,904 at date of grant.
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. On October 11,
1997, 2,892 shares vested and were distributed to participants. On May 4,
1998, the MRP purchased 1,084 shares with cash received from the return of
capital distribution paid by the Company in June 1997. At June 30, 1998 the
MRP had 12,694 shares. 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, disability,
change in control or retirement he or she forfeits all rights to unvested
shares. For the years ended June 30, 1998 and 1997, compensation expense
related to the MRP was $129,924 and $145,136, respectively.
401(K) RETIREMENT SAVINGS PLAN
The Company has a 401(k) Retirement Savings Plan. Employees may contribute a
percentage of their salary up to a maximum of 15%. The Company is obligated
to contribute 50% of the employee's contribution, not to exceed 6% of the
employee's annual salary. All employees who have completed one month of
service with the Company and are 21 years old are eligible to participate.
The Company's contribution to this plan was $23,500 for the year ended June
30, 1998.
(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 the Company's financial instruments as of June 30, 1998 and 1997.
(Continued)
45
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(12) CONTINUED
The carrying value and estimated fair value of financial instruments is
summarized as follows at June 30:
<TABLE>
<CAPTION>
1998 1997
------------------------------ ------------------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and interest-bearing deposits $ 1,389,801 $ 1,390,000 $ 165,593 $ 164,000
Federal funds sold 7,148,619 7,149,000 4,947,594 4,948,000
Investment securities 5,118,910 5,119,000 1,989,380 1,989,000
Mortgage-backed securities - - 7,678,517 7,679,000
Loans receivable, net 75,870,779 74,363,000 66,236,126 65,294,000
Liabilities:
Deposits 70,327,381 70,459,000 70,152,293 70,495,000
Advance payments by borrowers for
taxes, insurance and ground rents 1,403,884 1,404,000 1,323,193 1,323,000
Borrowings 10,200,000 10,200,000 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.
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.
(Continued)
46
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(12) CONTINUED
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 the Bank'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.
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.
(Continued)
47
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(12) CONTINUED
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.
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.
(Continued)
48
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(12) CONTINUED
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 1998 1997
--------------------------------------------------------------------------
<S> <C> <C>
Cash $ 258,484 $ 80,659
Investment securities 92,810 -
Equity in net assets of the bank 8,392,960 10,497,661
Note receivable - bank 396,341 464,064
Other assets 12,000 8,400
--------------------------------------------------------------------------
$ 9,152,595 $11,050,784
==========================================================================
Accrued expenses and other liabilities $ 29,755 16,781
Note payable - 2,700,000
Stockholders' equity 9,122,840 8,334,003
--------------------------------------------------------------------------
$ 9,152,595 $11,050,784
==========================================================================
</TABLE>
The note payable was repaid in July 1997.
(Continued)
49
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(13) CONTINUED
<TABLE>
<CAPTION>
STATEMENTS OF INCOME 1998 1997
-----------------------------------------------------------------------------------------------------
<S> <C> <C>
Income:
Loans receivable $ 39,445 $ 43,071
Cash deposits 123 6,701
Expenses - (64,694)
-----------------------------------------------------------------------------------------------------
Net income (loss) before equity in net income
of subsidiary and income taxes 39,568 (14,922)
Net income of subsidiary 638,239 829,477
-----------------------------------------------------------------------------------------------------
Income before income tax provision 677,807 814,555
Income tax benefit - (5,756)
-----------------------------------------------------------------------------------------------------
Net income $ 677,807 $ 820,311
=====================================================================================================
<CAPTION>
STATEMENTS OF CASH FLOWS 1998 1997
-----------------------------------------------------------------------------------------------------
<S> <C> <C>
Operating activities:
Net income $ 677,807 $ 820,311
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in net income of subsidiary 2,361,761 (829,477)
Other, net (26,247) (20,601)
-----------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 3,013,321 (29,767)
-----------------------------------------------------------------------------------------------------
Investing activities:
Purchase of equity security (94,453) -
Loan repayment 67,723 58,008
-----------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (26,730) 58,008
-----------------------------------------------------------------------------------------------------
Financing activities:
(Decrease) increase in note payable (2,700,000) 2,700,000
Cash dividend paid (108,766) -
Purchase of common stock for stock-based benefits plan - (423,724)
Return of capital distribution - (4,531,913)
-----------------------------------------------------------------------------------------------------
Net cash used in financing activities (2,808,766) (2,255,637)
-----------------------------------------------------------------------------------------------------
Increase (decrease) in cash and equivalents 177,825 (2,227,396)
Cash and equivalents, beginning of year 80,659 2,308,055
-----------------------------------------------------------------------------------------------------
Cash and equivalents, end of year $ 258,484 $ 80,659
=====================================================================================================
</TABLE>
(Continued)
50
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(14) PENDING ACQUISITION
On May 22, 1998, the Company signed a Merger Conversion Agreement with Belmar
Federal Savings and Loan Association ("Belmar"), pursuant to which the
Company intends to acquire Belmar Federal Savings and Loan Association in a
merger conversion transaction. Belmar is a mutual institution with one
office, located in Baltimore, Maryland, and total assets of $18.7 million. As
part of the plan of acquisition, Belmar will merge into the Bank. In
connection with the merger, the Company intends to grant priority
subscription rights in its common stock to the qualifying members of Belmar
at a discount to the market price. Consummation of the transaction is subject
to regulatory approval and approval of Belmar's members.
(15) ACCOUNTING PRONOUNCEMENTS WITH FUTURE EFFECTIVE DATES
SFAS No. 130, "Reporting Comprehensive Income" was issued in June 1997. This
Statement requires that comprehensive income - made up of all revenues,
expenses, gains and losses - be reported and displayed in an entity's
financial statements with the same prominence as its other financial
statements. Currently, the only item that would be presented as a component
of the Company's comprehensive income which is not also a component of its
net income is the change during the year in unrealized gain or loss on
available for sale securities. The Statement, which is effective for years
beginning after December 15, 1997, will not affect the Company's financial
position or its results of operations.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" was also issued in June 1997. This Statement requires that
public business enterprises report financial and descriptive information
about their reportable operating segments. Reportable operating segments are
defined as components of an enterprise about which separate financial
information is available and is evaluated regularly by the chief operating
decision maker as a basis for allocating resources and assessing performance.
It also requires those enterprises to report information about countries in
which they do business and about major customers. The Statement, which is
effective for financial statements for periods beginning after December 15,
1997, will not affect the Company's financial position or its results of
operations.
SFAS No. 132, "Employers' Disclosures About Pensions and Other Postretirement
Benefits" was issued in February 1998. This Statement standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable. The Statement, which is effective for fiscal years
beginning after December 15, 1997, will not affect the Company's financial
position or its results of operations.
(Continued)
51
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 1998 and 1997
-----------------------------------------------------------------------------
(15) CONTINUED
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
was issued in June, 1998. This Statement standardizes the accounting for
derivative instruments including certain derivative instruments embedded in
other contracts, by requiring that an entity recognize these items as assets
or liabilities in the statement of financial position and measure them at
fair value. This Statement generally provides for matching the timing of gain
or loss recognition on the hedging instrument with the recognition of the
changes in the fair value of the hedged asset or liability that are
attributable to the hedged risk or the earnings effect of the hedged
forecasted transaction. The Statement, which is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999, will not affect
the Company's financial position or its results of operations.
52
<PAGE>
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C> <C>
S. ROBERT KINGHORN JOSEPH J. BOUFFARD DOUGLAS H. LUDWIG
Chairman of the Board President and Chief Executive Officer of Retired Principal of the Baltimore
Retired Controller of Bethlehem Steel the Company and the Bank County Public School System
Corporation, Sparrows Point Plant
NICOLE N. KANTORSKI DR. THEODORE C. PATTERSON
JOSEPH N. MCGOWAN Budget Director for Baltimore County Retired Physician
Vice Chairman of the Board Police Department Secretary of the Company
Director, Training Division,
Baltimore County Police Department ROBERT M. LATING
President and Manager of Model Realty;
THOMAS P. O'NEILL Partner in C&L Associates
Managing Partner of Wolpoff &
Company, LLP
<CAPTION>
EXECUTIVE OFFICERS
<S> <C> <C>
JOSEPH J. BOUFFARD DEBRA L. BROCKSCHMIDT FRANK J. DUCHACEK, JR.
President and Chief Executive Officer Vice President - Operations; Vice President - Commercial Lending
Assistant Secretary
TIMOTHY C. KING JOHN W. MCCLEAN JOSEPH R. SALLESE
Vice President, Controller Vice President - Real Estate Lending Vice President - Consumer Lending
and Treasurer
<CAPTION>
OFFICE LOCATION
1301 Merritt Boulevard
Dundalk, Maryland 21222-2194
Website: http:\\www.patapscobank.com
Telephone: (410) 285-1010
CORPORATE INFORMATION
<S> <C> <C>
INDEPENDENT CERTIFIED ACCOUNTANTS SPECIAL COUNSEL ANNUAL REPORT ON FORM 10-KSB
Anderson Associates, LLP Housley Kantarian & Bronstein, P.C.
7621 Fitch Lane 1220 19th Street, N.W., Suite 700 A COPY OF THE COMPANY'S ANNUAL
Baltimore, Maryland 21236 Washington, D.C. 20036 REPORT ON FORM 10-KSB FOR THE
FISCAL YEAR ENDED JUNE 30, 1998 AS
GENERAL COUNSEL ANNUAL MEETING FILED WITH THE SECURITIES AND
NOLAN PLUMHOFF & WILLIAMS The 1998 Annual Meeting of Stockholders EXCHANGE COMMISSION, WILL BE
Suite 700, Nottingham Centre will be held on October 22, 1998 at 10:00 FURNISHED WITHOUT CHARGE TO
502 Washington Avenue a.m. in Room 800A in the Business and STOCKHOLDERS AS OF THE RECORD DATE
Towson, MD 21204-4528 Industry Building on the Dundalk FOR THE 1998 ANNUAL MEETING UPON
Community College Campus, 7200 Sollors WRITTEN REQUEST TO: CORPORATE
TRANSFER AGENT AND REGISTRAR Point Road, Dundalk, Maryland 21222. SECRETARY, PATAPSCO BANCORP, INC.,
Registrar and Transfer Co. 1301 MERRITT BOULEVARD, DUNDALK,
10 Commerce Drive MARYLAND 21222-21942
Cranford, New Jersey 07016-3572
1 (800) 368-5948
</TABLE>
<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 23.1
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 the related
consolidated statements of income, stockholders' equity, and cash flows for the
year then ended, which report appears in the June 30, 1998 Annual Report on
Form 10-KSB of Patapsco Bancorp, Inc.
/s/ KPMG PEAT MARWICK LLP
Baltimore, Maryland
September 25, 1998
<PAGE>
Exhibit 23.2
[LETTERHEAD OF ANDERSON ASSOCIATES, LLP APPEARS HERE]
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 7, 1998,
relating to the consolidated statements of financial condition of Patapsco
Bancorp, Inc. and Subsidiary as of June 30, 1998, and the related consolidated
statements of income, stockholders' equity and cash flows for the year then
ended, which report appears in the June 30, 1998 Annual Report of Form 10-KSB of
Patapsco Bancorp, Inc.
/s/ Anderson Associates LLP
Anderson Associates, LLP
Baltimore, Maryland
September 25, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 970,218
<INT-BEARING-DEPOSITS> 419,583
<FED-FUNDS-SOLD> 7,148,619
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 5,118,910
<INVESTMENTS-CARRYING> 5,118,910
<INVESTMENTS-MARKET> 0
<LOANS> 75,870,779
<ALLOWANCE> 553,513
<TOTAL-ASSETS> 92,370,956
<DEPOSITS> 70,327,381
<SHORT-TERM> 800,000
<LIABILITIES-OTHER> 2,720,735
<LONG-TERM> 9,400,000
0
0
<COMMON> 2,334,307
<OTHER-SE> 9,122,840
<TOTAL-LIABILITIES-AND-EQUITY> 92,370,956
<INTEREST-LOAN> 6,152,735
<INTEREST-INVEST> 885,395
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 7,038,130
<INTEREST-DEPOSIT> 2,839,476
<INTEREST-EXPENSE> 3,443,638
<INTEREST-INCOME-NET> 3,354,492
<LOAN-LOSSES> 240,000
<SECURITIES-GAINS> 5,015
<EXPENSE-OTHER> 2,549,907
<INCOME-PRETAX> 1,078,553
<INCOME-PRE-EXTRAORDINARY> 1,078,553
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 677,807
<EPS-PRIMARY> 2.05
<EPS-DILUTED> 1.95
<YIELD-ACTUAL> 8.02
<LOANS-NON> 462,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 776,400
<ALLOWANCE-OPEN> 397,012
<CHARGE-OFFS> 91,936
<RECOVERIES> 8,437
<ALLOWANCE-CLOSE> 553,513
<ALLOWANCE-DOMESTIC> 403,513
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 150,000
</TABLE>
