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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 1999
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.
(Exact name of registrant as specified in its charter)
Maryland 52-1951797
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(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
1301 Merritt Boulevard, Dundalk, Maryland 21222-2194
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 285-1010
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
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(Title of Class)
Check whether the 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
---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
For the fiscal year ended June 30, 1999, the registrant had $7,485,829 in
revenues.
As of September 16, 1999, the aggregate market value of voting stock held by
non-affiliates was approximately $6,981,211, computed by reference to the most
recent sales price on September 16, 1999 as reported on the OTC Bulletin Boards.
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 16, 1999: 340,201.
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, 1999. (Parts II and III)
2. Portions of Proxy Statement for registrant's 1999 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.
The Company's and the Bank's executive offices are located at 1301 Merritt
Boulevard, Dundalk, Maryland 21222-2194, and their 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 was the investment of
deposits from the general public 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 believe the Bank's market area has not been
adequately served by the existing financial institutions and there is strong
local demand for commercial real estate, commercial business, equipment leases
and consumer loans. As a result, the Board of Directors refocused the Bank's
strategy to pursue its existing business of originating single-family
residential mortgage loans, and expanding into commercial real estate,
commercial business, consumer lending, construction loans and small equipment
leases. In furtherance of this strategy, in June 1995, the Bank began financing
home improvement loans and had $8.8 million of such loans, or 11.2% of total
loans outstanding at June 30, 1999. 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, commercial real
estate loans, home equity and other consumer loans and equipment leases. At
June 30, 1999, the Bank had $6.8 million, $2.4 million, $7.9 million, $2.7
million and $1.5 million in small business loans, construction loans, commercial
real estate loans, home equity and other consumer loans, and equipment leases,
respectively.
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Market Area
The Bank's market area for gathering deposits consists of eastern Baltimore
County, Maryland, while the Bank makes loans to customers in much of the Mid-
Atlantic area with strong emphasis on 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 stabilized from the layoffs and plant closings by local employers in
previous years. The economy in the Bank's market area continues to be
dependent, to some extent, on a small number of major industrial employers.
Recently, 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.
Proposed Legislative and Regulatory Changes
Legislation has been reintroduced in the U.S. Congress which calls for the
modernization of the banking system and which would significantly affect the
operations and regulatory structure of the financial services industry,
including savings institutions like the Bank. At this time, management does not
know what form the final legislation might take, or if enacted into law, how the
legislation would affect the Company's and Bank's business and operations and
competitive environment. For additional information on the provisions of this
legislation, see "Regulation of the Bank -- Proposed Legislative and Regulatory
Changes."
Lending Activities
General. The Company's gross loan portfolio totaled $78.5 million at June
30, 1999, representing 82.4% of total assets at that date. It is the Company's
policy to concentrate its lending within its market area. At June 30, 1999,
$48.5 million, or 61.9% 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 $10.2 million,
or 13.0% of the Company's gross loan portfolio at June 30, 1999. In addition,
the Company originates consumer and other loans, including home equity loans,
home improvement loans and loans secured by deposits. At June 30, 1999,
consumer and other loans totaled $11.4 million, or 14.5% of the Company's gross
loan portfolio. The Company's commercial loan portfolio, which consists of
small business loans and commercial leases, totaled $8.3 million, or 10.6% 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 Maryland market area with limited home improvement loan
origination in the Delaware, Pennsylvania and Northern Virginia markets.
The Company's loan originations are derived from a number of sources,
including referrals by realtors, depositors and borrowers and advertising, as
well as loan brokers. The Company's solicitation programs consist of
advertisements in local media, in addition to occasional participation in
various community organizations and events. 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 and loan brokers, 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, 1999 and 1998, the
Company purchased whole loans and loan participation interests totaling $337,000
and $2.5 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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LoanUnderwriting 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 $248,000, $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 $1.4
million at June 30, 1999. At that date, the Company had no lending
relationships in excess of the loans-to-one-borrower limit. At June 30, 1999,
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, 1999
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, 1999, residential mortgage
loans, excluding home improvement loans, and home equity loans totaled $48.5
million, or 61.9% of the Company's gross loan portfolio. Of such loans, $5.9
million were secured by nonowner-occupied investment properties.
The Company originates fixed-rate and adjustable rate mortgage loans at
competitive interest rates. At June 30, 1999, $30.0 million, or 53.2% of the
Company's residential and commercial real estate loan portfolio was comprised of
fixed-rate mortgage loans and $26.4 million or 46.8% of the Company's
residential and commercial real estate loan portfolio was comprised of
adjustable rate mortgage loans
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, 1999, the Company had $712,000 of multi-
family residential real estate loans, which amounted to .91% 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 seeks 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 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, 1999, $2.4 million, or 3.0%, of the
Company's gross loan portfolio consisted of construction loans.
Prior to making a commitment to fund a loan, the Bank requires both an
appraisal of the property by appraisers approved by the Board of Directors and a
study of the feasibility of the proposed project. The Bank also reviews and
inspects each project at the commencement of construction and prior to payment
of draw requests during the term of the construction loan. The Bank generally
charges a construction fee between 1% and 2%.
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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, 1999, the
Company had $7.9 million of commercial real estate loans, which amounted to
10.0% 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 seeks to
expand commercial real estate lending.
Commercial real estate lending entails additional risks as compared with
single-family residential property lending. Commercial real estate loans
typically involve larger loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans typically is dependent on the
successful operation of the real estate project, retail establishment or
business. These risks can be significantly impacted by supply and demand
conditions in the market for office, retail and residential space, and, as such,
may be subject to a greater extent to adverse conditions in the economy
generally. To minimize these risks, the Company generally limits itself to its
market area or to borrowers with which it has prior experience or who are
otherwise known to the Company. It has been the Company's policy to obtain
annual financial statements of the business of the borrower or the project for
which commercial real estate loans are made. In addition, in the case of
commercial mortgage loans made to a partnership or a corporation, the Company
seeks, whenever possible, to obtain personal guarantees and annual financial
statements of the principals of the partnership or corporation.
Consumer Lending. The consumer loans currently in the Company's loan
portfolio consist of home improvement loans, home equity loans, loans secured by
savings deposits and overdraft protection for checking accounts. At June 30,
1999, consumer and other loans totaled $11.4 million, or 14.5% 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, Delaware and Pennsylvania. 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%,
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depending on the type of project financed. At June 30, 1999, home improvement
loans amounted to $8.8 million, or 11.1% of the Company's gross loan portfolio,
with $1.5 million of such loans being secured by real estate.
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.
During fiscal 1996 the Company began a commercial lending program. At June
30, 1999 the Company's commercial loans totaled $6.8 million, or 8.7% 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
- ---- ------ -------
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.
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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 30, 1999, commercial lease finance transaction loans totaled $1.5 million,
or 1.9% of the Company's gross loan portfolio.
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, 1999 the Company was
servicing loans for others totaling approximately $2.2 million.
Nonperforming Loans and Other Problem Assets. It is management's policy to
continually monitor its loan portfolio to anticipate and address potential and
actual delinquencies. When a borrower fails to make a payment on a loan, the
Company takes immediate steps to have the delinquency cured and the loan
restored to current status. Loans which are delinquent 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 4 of Notes to Consolidated
Financial Statements.
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The following table sets forth information with respect to the Company's
nonperforming assets at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------
1999 1998
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<S> <C> <C>
(In thousands)
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential................................... $ 173 $ 462
Commercial.................................... -- --
Construction.................................. -- --
Consumer....................................... -- --
Commercial..................................... 9 --
------ ------
Total......................................... $ 182 $ 462
====== ======
Accruing loans which are contractually past due
90 days or more................................. $ -- $ --
------ ------
Total......................................... $ -- $ --
====== ======
Total nonperforming loans..................... $ 182 $ 462
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Percentage of total loans........................ 0.23% .60%
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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, 1999, gross interest income of $17,200 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 $0.
At June 30, 1999, nonaccrual loans consisted of 2 mortgage loans secured by
single-family residential real estate properties aggregating $173,000 and one
commercial lease transaction totaling $9,000. 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, 1999, 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
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. 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
9
<PAGE>
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, among
others: lending risks associated with new products and markets, loss allocations
for specific problem credits, the level of the allowance to nonperforming loans,
historical loss experience, economic conditions, portfolio trends and credit
concentrations and management's judgment with respect to current and expected
economic conditions and their impact on the existing loan portfolio. Additional
provisions for losses on loans are made in order to bring the allowance to a
level deemed adequate. 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. 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.
Banking regulatory agencies have adopted a policy statement regarding
maintenance of an adequate allowance for loan and lease losses and an effective
loan review system. This policy includes an arithmetic formula for checking the
reasonableness of an institution's allowance for loan loss estimate compared to
the average loss experience of the industry as a whole. Examiners will review an
institution's allowance for loan losses and compare it against the sum of: (i)
50% of the portfolio that is classified doubtful; (ii) 15% of the portfolio that
is classified as substandard; and (iii) for the portions of the portfolio that
have not been classified (including those loans designated as special mention),
estimated credit losses over the upcoming 12 months given the facts and
circumstances as of the evaluation date. This amount is considered neither a
"floor" nor a "safe harbor" of the level of allowance for loan losses an
institution should 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,
-------------------
1999 1998
------ ------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period............... $ 554 $397
Loans charged off:
Residential real estate mortgage............ 48 5
Consumer.................................... 126 87
----- ----
Total charge-offs.......................... 174 92
Recoveries:
Single-family residential mortgage.......... 5 4
Consumer.................................... 1 5
----- ----
Total recoveries........................... 6 9
----- ----
Net loans charged off........................ 167 83
Provision for loan losses.................... 245 240
----- ----
Balance at end of period..................... $ 631 $554
===== ====
Ratio of net charge-offs to average
loans outstanding during the period......... .21% .11%
===== ====
</TABLE>
10
<PAGE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------
1999 1998
------------------------------ ------------------------
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....................... $ 117 61.83% $ 139 72.06%
Commercial........................ 83 10.02 44 6.66
Construction...................... 18 2.99 28 2.87
Consumer and other................. 144 14.54 138 11.75
Commercial......................... 85 10.62 55 6.66
Unallocated........................ 184 -- 150 --
------ ------ ------ ------
Total allowance for loan losses.. $ 631 100.00% $ 554 100.00%
====== ====== ====== ======
</TABLE>
Investment Activities
General. The Company makes investments in order to maintain the levels of
liquid assets required by regulatory authorities and manage cash flow, diversify
its assets, obtain yield and to satisfy certain requirements for favorable tax
treatment. The investment activities of the Company consist primarily of
investments in mortgage-backed securities and other investment securities,
consisting primarily of securities issued or guaranteed by the U.S. government
or agencies thereof. Typical investments include federally sponsored agency
mortgage pass-through and federally sponsored agency and mortgage-related
securities. Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the Company's
investment policy. The Company performs 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, 1999, the Company's entire portfolio of investment
securities was classified as available for sale and had an aggregate carrying
value of $5.9 million and an unrealized net loss after tax of $109,000. 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
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
11
<PAGE>
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 may 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 HONOR Automatic Teller Machine network at
locations throughout the United States, through which customers can gain access
to their accounts at any time.
Borrowings. While savings deposits historically have been the primary
source of funds for the Company's lending, investments and general operating
activities, the Company in recent years has used 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 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 22% 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,
1999, the Company had outstanding Federal Home Loan Bank of Atlanta advances of
$13.9 million with an average rate of 5.71%.
Subsidiary Activities
The Bank has two subsidiaries, PFSL Holding Corp. ("PFSL"), which it formed
in November 1995 to hold certain real estate owned at that time and which is
currently is inactive and Prime Business Leasing that was formed in October
1998.
Competition
The Company faces strong competition both in originating real estate and
consumer loans and in attracting deposits. The Company competes for 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 loans comes primarily from
other commercial banks, savings institutions and mortgage bankers, credit unions
and finance companies.
Management considers its market area for gathering deposits to be eastern
Baltimore County in Maryland. The Company originates loans throughout much of
the Mid-Atlantic 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.
12
<PAGE>
Employees
As of June 30, 1999, the Company had 32 full-time and 3 part-time
employees, none of whom were represented by a collective bargaining agreement.
Management considers the Company's relationships with its employees to be good.
Depository Institution Regulation
General. The Bank is a Maryland commercial bank and its deposit accounts
are insured by the SAIF. The Bank also is a member of the Federal Reserve
System. The Bank is subject to supervision, examination and regulation by the
State of Maryland Commissioner of Financial Regulation ("Commissioner") and the
Federal Reserve Board and to Maryland and federal statutory and regulatory
provisions governing such matters as capital standards, mergers and
establishment of branch offices, and it is subject to the FDIC's authority to
conduct special examinations. The Bank is required to file reports with the
Commissioner and the Federal Reserve Board concerning its activities and
financial condition and is required to obtain regulatory approvals prior to
entering into certain transactions, including mergers with, or acquisitions of,
other depository institutions.
As a federally insured depository institution, the Bank is subject to
various regulations promulgated by the Federal Reserve Board, including
Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements),
Regulations E (Electronic Fund Transfers), Regulation Z (Truth in Lending),
Regulation CC (Availability of Funds and Collection of Checks) and Regulation DD
(Truth in Savings).
The system of regulation and supervision applicable to the Bank establishes
a comprehensive framework for the operations of the Bank and is intended
primarily for the protection of the FDIC and the depositors of the Bank.
Changes in the regulatory framework could have a material effect on the Bank and
their respective operations that in turn, could have a material adverse effect
on the Company.
Proposed Legislative and Regulatory Changes. The U.S. Congress is in the
process of drafting legislation which may have a profound effect on the
financial services industry. In January 1999 legislation restructuring the
activities and regulations oversight of the financial services industry was
reintroduced in both houses of the U.S. Congress. The stated purposes of the
legislation are to enhance consumer choice in the financial services
marketplace, level the playing field among providers of financial services and
increase competition and would permit affiliations between commercial banks,
securities firms, insurance companies and, subject to certain limitations, other
commercial enterprises allowing holding companies to offer new services and
products. In particular, the legislation repeals the Glass-Steagall Act
prohibitions on bank affiliating with securities firms and thereby allow holding
companies to engage in securities underwriting and dealing without limits and to
sponsor and act as distributor for mutual funds. The legislation also removes
the Bank Holding Company Act's prohibitions on insurance underwriting allowing
holding companies to underwrite and broker any type of insurance product, calls
for a new regulatory framework for financial institutions and their holding
companies and preserves the thrift charter and all existing thrift powers. The
House and Senate have each approved different versions of H.R. 10 and the House
and Senate are expected to meet during the summer of 1999 to reconcile their
versions of the legislation. The Senate version of financial services
modernization differs from H.R. 10 principally with respect to the powers of
operating subsidiaries, permissible activities of well-managed holding companies
and restrictions on nonfinancial activities of unitary thrift holding companies.
At this time, it is unknown how the legislation will be modified, or if enacted,
what form the final version of the legislation might take and how it will affect
the Company's and the Bank's business and operations and competitive
environment.
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 that
would otherwise
13
<PAGE>
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.
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.
14
<PAGE>
<TABLE>
<CAPTION>
Regulatory
Requirements
Regulatory To Be Well
Requirements 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, 1999:
Total Capital (to Risk Weighted Assets)... $9,120 15.35% $4,752 8.00% $5,941 10.00%
Tier 1 Capital (to Risk Weighted Assets).. 8,489 14.29 2,376 4.00 3,564 6.00
Tier 1 Capital (to Average Assets)........ 8,489 9.35 3,630 4.00 4,537 5.00
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
</TABLE>
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that did not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total
assets falls below a "critical capital level," the institution will be subject
to conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
Federal banking regulators have adopted regulations implementing the prompt
corrective action provisions of FDICIA. Under these regulations, the federal
banking regulators will generally measure a depository institution's capital
adequacy on the basis of the institution's total risk-based capital ratio (the
ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital
ratio (the ratio of its core capital to risk-weighted 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;
15
<PAGE>
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, 1999, the Bank
was classified as "well capitalized" under Federal Reserve regulations.
Safety and Soundness Guidelines. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal banking agency was required to establish safety and soundness
standards for institutions under its authority. The federal banking agencies,
including the Federal Reserve Board, have released Interagency Guidelines
Establishing Standards for Safety and Soundness. The guidelines require
depository institutions to maintain internal controls and information systems
and internal audit systems that are appropriate for the size, nature and scope
of the institution's business. The guidelines also establish certain basic
standards for loan documentation, credit underwriting, interest rate risk
exposure, and asset growth. The guidelines further provide that depository
institutions should maintain safeguards to prevent the payment of compensation,
fees and benefits that are excessive or that could lead to material financial
loss, and should take into account factors such as comparable compensation
practices at comparable institutions. In addition, a depository institution
should maintain systems, commensurate with its size and the nature and scope of
its operations, to identify problem assets and prevent deterioration in those
assets as well as to evaluate and monitor earnings and ensure that earnings are
sufficient to maintain adequate capital and reserves. If the appropriate
federal banking agency determines that a depository institution is not in
compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A depository institution must submit an acceptable compliance plan
to its primary federal regulator within 30 days of receipt of a request for such
a plan. Failure to submit or implement a compliance plan may subject the
institution to regulatory sanctions. Management believes that the Bank meets
substantially all the standards adopted in the interagency guidelines.
Federal Home Loan Bank System. The FHLB System consists of 12 district
FHLBs subject to supervision and regulation by the Federal Housing Finance Board
("FHFB"). The FHLBs provide a central credit facility primarily for member
institutions. As a member of the FHLB of Atlanta, the Bank is required to
acquire and hold shares of capital stock in the FHLB of Atlanta in an amount at
least equal to 1% of the aggregate unpaid principal of its home mortgage loans,
home purchase contracts, and similar obligations at the beginning of each year,
or 1/20 of its advances (borrowings) from the FHLB of Atlanta, whichever is
greater. The Bank was in compliance with this requirement with investment in
FHLB of Atlanta stock at June 30, 1999 of $695,000. 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, 1999,
the Bank had $13.9 million in advances outstanding from the FHLB of Atlanta.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a financial institution must maintain average daily reserves equal to 3%
on transaction accounts of between $4.9 million and $46.5 million, plus
16
<PAGE>
10% on the amount over $46.5 million. This percentage is subject to adjustment
by the Federal Reserve Board. Because required reserves must be maintained in
the form of vault cash or in a non-interest 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. As of June 30, 1999, 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 of the
FDIC. The FDIC is required to set semi-annual assessments for SAIF-insured
institutions at a level necessary to maintain the designated reserve ratio of
the SAIF at 1.25% of estimated insured deposits, or at a higher percentage of
estimated insured deposits that the FDIC determines to be justified for that
year by circumstances indicating a significant risk of substantial future losses
to the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See " -- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority, and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
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.
17
<PAGE>
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
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
18
<PAGE>
the Association at the time of the Association's conversion to stock form. See
Note 9 of the Notes to Consolidated Financial Statements contained in the
Company's Annual Report to Stockholders attached hereto as Exhibit 13.
Uniform Lending Standards. Under Federal Reserve Board regulations, state
member banks must adopt and maintain written policies that establish appropriate
limits and standards for extensions of credit that are secured by liens or
interests in real estate or are made for the purpose of financing permanent
improvements to real estate. These policies must establish loan portfolio
diversification standards, prudent underwriting standards, including loan-to-
value limits, that are clear and measurable, loan administration procedures and
documentation, approval and reporting requirements. The real estate lending
policies of state member banks must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies (the "Interagency Guidelines") that
have been adopted by the federal banking agencies.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multifamily or other nonresidential property, the supervisory limit is 80%; (iv)
for loans for the construction of one-to-four family properties, the supervisory
limit is 85%; and (v) for loans secured by other improved property (e.g.,
farmland, completed commercial property and other income-producing property
including non-owner-occupied, one-to-four family property), the limit is 85%.
Although no supervisory loan-to-value limit has been established for owner-
occupied, one-to-four family and home equity loans, the Interagency Guidelines
state that for any such loan with a loan-to-value ratio that equals or exceeds
90% at origination, an institution should require appropriate credit enhancement
in the form of either mortgage insurance or readily marketable collateral.
The Interagency Guidelines state that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits, based on the support provided by other credit
factors. The aggregate amount of loans in excess of the supervisory loan-to-
value limits, however, should not exceed 100% of total capital and the total of
such loans secured by commercial, agricultural, multifamily and other non-one-
to-four family residential properties should not exceed 30% of total capital.
The supervisory loan-to-value limits do not apply to certain categories of loans
including loans insured or guaranteed by the U.S. government and its agencies or
by financially capable state, local or municipal governments or agencies, loans
backed by the full faith and credit of a state government, loans that are to be
sold promptly after origination without recourse to a financially responsible
party, loans that are renewed, refinanced or restructured without the
advancement of new funds, loans that are renewed, refinanced or restructured in
connection with a workout, loans to facilitate sales of real estate acquired by
the institution in the ordinary course of collecting a debt previously
contracted and loans where the real estate is not the primary collateral.
Management will periodically evaluate its lending policies to assure
conformity to the Interagency Guidelines and does not anticipate that the
Interagency Guidelines will have a material effect on its lending activities.
Limits on Loans to One Borrower. The Bank has chosen to be subject to
federal law with respect to limits on loans to one borrower. Generally, under
federal law, the maximum amount that a commercial bank may loan to one borrower
at one time may not exceed 15% of the unimpaired capital and surplus of the
commercial bank. The Bank's lending limit to one borrower as of June 30, 1999
was $1.4 million.
19
<PAGE>
Transactions with Related Parties. Transactions between a state member
bank and any affiliate are governed by Sections 23A and 23B of the Federal
Reserve Act. An affiliate of a state member bank is any company or entity which
controls, is controlled by or is under common control with the state member
bank. In a holding company context, the parent holding company of a state
member bank and any companies which are controlled by such parent holding
company are affiliates of the state member bank. Generally, Sections 23A and
23B (i) limit the extent to which an institution or its subsidiaries may engage
in "covered transactions" with any one affiliate to an amount equal to 10% of
such institution's capital stock and surplus, and contain an aggregate limit on
all such transactions with all affiliates to an amount equal to 20% of such
capital stock and surplus and (ii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar other types of transactions. In addition to the restrictions imposed by
Sections 23A and 23B, no state member bank may (i) loan or otherwise extend
credit to an affiliate, except for any affiliate which engages only in
activities which are permissible for bank holding companies, or (ii) purchase or
invest in any stocks, bonds, debentures, notes or similar obligations of any
affiliate, except for affiliates which are subsidiaries of the state member
bank.
State member banks also are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve's Regulation O
thereunder on loans to executive officers, directors and principal stockholders.
Under Section 22(h), loans to a director, executive officer and to a greater
than 10% stockholder of a state member bank and certain affiliated interests of
such persons, may not exceed, together with all other outstanding loans to such
person and affiliated interests, the institution's loans-to-one-borrower limit
(generally equal to 15% of the institution's unimpaired capital and surplus) and
all loans to such persons may not exceed the institution's unimpaired capital
and unimpaired surplus. Section 22(h) also prohibits loans, above amounts
prescribed by the appropriate federal banking agency, to directors, executive
officers and greater than 10% stockholders of a state member bank, and their
respective affiliates, unless such loan is approved in advance by a majority of
the board of directors of the institution with any "interested" director not
participating in the voting. Regulation O prescribes the loan amount (which
includes all other outstanding loans to such person) as to which such prior
board of director approval is required as being the greater of $25,000 or 5% of
capital and surplus (up to $500,000). Further, Section 22(h) requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons. Section 22(h) also generally prohibits a depository institution from
paying the overdrafts of any of its executive officers or directors.
State member banks also are subject to the requirements and restrictions of
Section 22(g) of the Federal Reserve Act on loans to executive officers and the
restrictions of 12 U.S.C. 1972 on certain tying arrangements and extensions of
credit by correspondent banks. Section 22(g) of the Federal Reserve Act requires
loans to executive officers of depository institutions not be made on terms more
favorable than those afforded to other borrowers, requires approval by the board
of directors of a depository institution for extension of credit to executive
officers of the institution, and imposes reporting requirements for and
additional restrictions on the type, amount and terms of credits to such
officers. Section 1972 (i) prohibits a depository institution from extending
credit to or offering any other services, or fixing or varying the consideration
for such extension of credit or service, on the condition that the customer
obtain some additional service from the institution or certain of its affiliates
or not obtain services of a competitor of the institution, subject to certain
exceptions, and (ii) prohibits extensions of credit to executive officers,
directors, and greater than 10% stockholders of a depository institution by any
other institution which has a correspondent banking relationship with the
institution, unless such extension of credit is on substantially the same terms
as those prevailing at the time for comparable transactions with other persons
and does not involve more than the normal risk of repayment or present other
unfavorable features.
Additionally, Maryland statutory law imposes restrictions on certain
transactions with affiliates of Maryland commercial banks. Generally, under
Maryland law, a director, officer or employee of a commercial bank may not
borrow, directly or indirectly, any money from the bank, unless the loan has
been approved by a resolution adopted at and recorded in the minutes of the
board of directors of the bank, or the executive committee of the bank, if that
committee is authorized to make loans. If such a loan is approved by the
executive committee, the loan approval must be reported to the board of
directors at its next meeting. Certain commercial loans made to non-employee
directors of a
20
<PAGE>
bank and certain consumer loans made to non-officer and non-director employees
of the bank are exempt from the statute's coverage.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank
holding company and is registered as such with the Federal Reserve Board. Bank
holding companies are subject to comprehensive regulation by the Federal Reserve
Board under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and
the regulations of the Federal Reserve Board. As a bank holding company, the
Company is required to file with the Federal Reserve Board annual reports and
such additional information as the Federal Reserve Board may require, and is
subject to regular examinations by the Federal Reserve Board. The Federal
Reserve Board also has extensive enforcement authority over bank holding
companies, including, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to require that a
holding company divest subsidiaries (including its bank subsidiaries). In
general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.
Under the BHCA, a bank holding company must obtain Federal Reserve Board
approval before: (i) acquiring, directly or indirectly, ownership or control of
any voting shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (ii) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(iii) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company which is not a bank or bank holding company, or
from engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by Federal Reserve Board regulation or order, have been
identified as activities closely related to the business of banking or managing
or controlling banks. The list of activities permitted by the Federal Reserve
Board includes, among other things, operating a savings institution, mortgage
company, finance company, credit card company or factoring company; performing
certain data processing operations; providing certain investment and financial
advice; underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers' checks and United States Savings Bonds;
real estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing securities
brokerage services for customers.
Acquisitions of Bank Holding Companies and Banks. Under the BHCA, any
company must obtain approval of the Federal Reserve Board prior to acquiring
control of the Company or the Bank. For purposes of the BHCA, control is
defined as ownership of more than 25% of any class of voting securities of the
Company or the Bank, the ability to control the election of a majority of the
directors, or the exercise of a controlling influence over management or
policies of the Company or the Bank.
Under the Holding Company Act, a bank holding company must obtain the prior
approval of the Federal Reserve Board before (1) 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
21
<PAGE>
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 authorizes out-of-state banks to
establish branch offices in Maryland by means of merger, branch acquisition or
de novo branching, provided that the home state of the out-of-state bank
- -- ----
provides reciprocal interstate branching authority to Maryland banks. 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
22
<PAGE>
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, 1999.
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.
Earnings appropriated to the Bank's bad debt reserve and claimed as a tax
deduction are not available for the payment of cash dividends or for
distribution to stockholders (including distributions made on dissolution or
liquidation), unless the Bank includes the amount in taxable income, along with
the amount deemed necessary to pay the resulting federal income tax.
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, 1999.
<TABLE>
<CAPTION>
Book Value at
Year Owned or June 30, Approximate
Opened Leased 1999 Square Footage
------ -------- ---------------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
1301 Merritt Boulevard 1970 Owned $ 676 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, 1999. 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, 1999, there were no legal proceedings to
which the Company or the Bank was a party, or to which any of their property was
23
<PAGE>
subject, which were expected by management to result in a material loss to the
Company or the Bank. There are no pending regulatory proceedings to which the
Company, the Bank or its subsidiary is a party or to which any of their
properties is subject which are currently expected to result in a material loss.
Item 4. Submission of Matters to Vote of Security Holders.
- ----------------------------------------------------------
Not applicable.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
- -----------------------------------------------------------------
The information contained under the sections captioned "Market Information"
in the Company's Annual Report to Stockholders for the Fiscal Year Ended June
30, 1999 (the "Annual Report") filed as Exhibit 13 hereto is incorporated herein
by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
- ------------------------------------------------------------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" on pages 5
through 19 in the Annual Report is incorporated herein by reference.
Item 7. Financial Statements
- -----------------------------
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements, Independent Auditors' Report and Selected Financial Data contained
on pages 21 through 47 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 10 in the Company's definitive proxy statement
for the Company's 1999 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,"
and " -- 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
24
<PAGE>
Information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and Principal
Holders thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the sections captioned "Security Ownership of
Management" in the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors -- Transactions
with Management" in the Proxy Statement.
Item 13. Exhibits List and Reports on Form 8-K.
- -----------------------------------------------
(a) List of Documents Filed as Part of this Report
----------------------------------------------
(1) Financial Statements. The following consolidated financial
statements are incorporated by reference from Item 7 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Statement of Financial Condition as of June 30, 1999
and 1998
Consolidated Statements of Income for the Years Ended June 30, 1999
and 1998
Consolidated Statements of Stockholders' Equity for the Years Ended
June 30, 1999 and 1998
Consolidated Statements of Cash Flows for the Years Ended June 30,
1999 and 1998
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.
No. Description
---- -----------
* 3.1 Articles of Incorporation of Patapsco Bancorp, Inc.
* 3.2 Bylaws of Patapsco Bancorp, Inc.
** 4 Form of Common Stock Certificate of Patapsco Bancorp, Inc.
*** 10.1 Patapsco Bancorp, Inc. 1996 Stock Option and Incentive Plan
*** 10.2 Patapsco Bancorp, Inc. Management Recognition Plan
* 10.3(a) Employment Agreement between Patapsco Federal Savings and
Loan Association and Joseph J. Bouffard
* 10.3(b) Employment Agreement between Patapsco Bancorp, Inc. and
Joseph J. Bouffard
* 10.4(a) Severance Agreements between Patapsco Federal Savings and
Loan Association and Debra Penczek, John McClean and Joseph Sallese
* 10.4(b) Severance Agreements between Patapsco Bancorp, Inc. and Debra
Penczek, Timothy King, John McClean and Joseph Sallese for the year
ended June 30, 1999.
* 10.5 Patapsco Federal Savings and Loan Association Retirement Plan
for Non-Employee Directors
25
<PAGE>
* 10.6 Patapsco Federal Savings and Loan Association Incentive
Compensation Plan
* 10.7 Deferred Compensation Agreements between Patapsco Federal
Savings and Loan Association and each of Directors McGowan and
Patterson
* 10.8(a) Severance Agreement between Patapsco Federal Savings and Loan
Association and Frank J. Duchacek
* 10.8(b) Severance Agreement between Patapsco Bancorp, Inc. and Frank
J. Duchacek
**** 10.9 The Patapsco Bank Retirement Plan for Non-Employee Directors
13 1999 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Anderson Associates, LLP
27 Financial Data Schedule
* Incorporated herein by reference from the Company's Registration Statement
on Form SB-2 (File No. 33-99734).
** Incorporated herein by reference from the Company's Registration Statement
on Form 8-A (File No. 0-28032).
*** Incorporated herein by reference from the Company's Annual Report on Form
10-KSB for the year ended June 30, 1996 (File No. 0-28032)
**** Incorporated herein by reference from the Company's Annual Report on Form
10-KSB for the year ended June 30, 1998 (File No. 0-28032).
(b) Reports on Form 8-K. None.
-------------------
26
<PAGE>
SIGNATURES
Pursuant to the requirements of 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 16, 1999
By: /s/ Joseph J. Bouffard
----------------------
Joseph J. Bouffard
President and Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
/s/ Joseph J. Bouffard September 16, 1999
- --------------------------------------------
Joseph J. Bouffard
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Michael J. Dee September 16, 1999
- --------------------------------------------
Michael J. Dee
Chief Financial Officer and Controller
(Principal Financial and Accounting Officer)
/s/ Thomas P. O'Neill September 16, 1999
- --------------------------------------------
Thomas P. O'Neill
Chairman of the Board
/s/ Theodore C. Patterson September 16, 1999
- --------------------------------------------
Theodore C. Patterson
Director and Secretary
/s/ Douglas H. Ludwig September 16, 1999
- --------------------------------------------
Douglas H. Ludwig
Director
/s/ Nicole N. Glaeser September 16, 1999
- --------------------------------------------
Nicole N. Glaeser
Director
/s/ William R. Waters September 16, 1999
- --------------------------------------------
William R. Waters
Director
<PAGE>
Exhibit 13
PATAPSCO BANCORP, INC.
[LOGO]
1999 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. Principally
operating revenues, deposits and repayments of outstanding loans and investment
securities and mortgage-backed securities provide funds for these activities.
MARKET INFORMATION
================================================================================
The Company's common stock trades under the symbol "PATD" on the OTC
Bulletin Board. There are currently 344,426 shares of the common stock
outstanding and approximately 395 holders of record of the common stock.
Following are the high and low closing sale prices, by fiscal quarter, as
reported on the Bulletin Board 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 1999:
First Quarter $ 34.25 $ 28.125 $ .12
Second Quarter 30.00 26.50 .12
Third Quarter 31.50 28.25 .12
Fourth Quarter 30.125 28.75 .12
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
</TABLE>
The stated high and low closing sale prices reflect inter-dealer prices,
without retail mark-up, markdown or commission, and may not represent actual
transactions.
TABLE OF CONTENTS
================================================================================
<TABLE>
<S> <C>
Patapsco Bancorp, Inc. (i)
Market Information (i)
Letter to Stockholders..................................................... 1
Selected Consolidated Financial and Other Data............................. 3
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 5
Consolidated Financial Statements.......................................... 21
Corporate Information...................................................... 48
</TABLE>
(i)
<PAGE>
Dear Stockholder:
The Directors, officers and staff of Patapsco Bancorp, Inc. and The
Patapsco Bank proudly present you with our fourth Annual Report.
During fiscal year 1999 we continued to grow and diversify our assets,
increase our loan loss reserves and control our expenses.
In the past twelve months our shareholders received four quarterly
dividends of $.12 per share. For eight consecutive quarters the Company has paid
a quarterly dividend in addition to the return of capital distribution in June
1997. In September the Company's Board of Directors declared a $.14 per share
dividend payable in October 1999, representing a 17% increase over the previous
quarterly dividend.
As a result of the recent bear market for small cap stocks and,
particularly for small bank stocks, your Board of Directors considered Patapsco
Bancorp shares to be an attractive investment. Therefore, in November 1998 the
Company announced the first of two stock repurchase programs. The initial
program was completed in May 1999. A total of 18,000 shares, or 5% of Company's
outstanding stock, was repurchased at an average price of $28.87. In July 1999
the Board of Directors approved a second stock repurchase program to acquire an
additional 5% of the Company's outstanding shares. These programs will increase
the Company's earnings per share and return on equity. Any shareholders
interested in selling their stock as part of this repurchase program, are
encouraged to contact their brokers or the Company directly.
Our transformation into a commercial bank continues. This was most
dramatically shown by increases in our higher yielding loan business. Consumer
loans increased by 27% and business related loans increased by 43%. At year end
our loans to deposits ratio stood at 113%, a statistic made more remarkable by
the fact that the bank experienced record payoffs in the residential portfolio.
Most importantly we continued our expansion into new areas with the
creation of Prime Business Leasing. This new venture, which is off to a very
successful start, invests in small equipment leases in our continued effort to
expand our presence in the small and medium size business markets.
Despite the expansion in the number and types of loans, asset quality
remained extremely high with non-performing loans at .23% of total loans. In
addition the Company continued to increase the loan loss reserve, this year by
14% to .80% of total loans.
<PAGE>
Along with good news, there was some bad news; at the very end of our
fiscal year we concluded it was necessary to terminate our agreement to complete
a merger conversion with Belmar Federal Savings and Loan Association. Despite
our considerable efforts over a period that exceeded one year, it became
apparent that the federal regulators would not approve a transaction involving
the merger of a mutual organization (Belmar) with a stock Company (Patapsco) on
terms that would make the transaction economically viable.
The termination resulted in an $89,000 charge against earnings. Had it not
been for these expenses the Company would have earned $716,000 for the year, an
increase of 5.6% over the $678,000 we earned the previous the previous year.
Return on Assets and Return on Equity adjusted for this expense were .79% and
7.64%, respectively.
Also in July 1999 we lost our Chairman S. Robert Kinghorn to cancer. Bob
was our champion in many ways and was very instrumental in steering the company
towards its present course. Most of all he was our friend and we will miss him
tremendously.
Our new Chairman is Thomas P. O'Neill, the former Vice Chairman and a
member of the Board since 1995. He is also chairman of the Company's Investor
Relations committee and serves on its Asset Liability and Compensation
committees. Tom is a CPA and a Managing Director of American Express Tax and
Business Services, Inc., in Baltimore. We look forward to continued growth and
diversification under his guidance.
The Company also announced the appointment of William R. Waters as a
Director of the Company. He is an owner of Scott Pontiac in Bel Air, Maryland
and a former director of the company's predecessor, Patapsco Federal Savings and
Loan Association. Bill is also an original shareholder and a long term customer
of the Company.
Fiscal year 2000 will present new challenges. The concern about the
possible Y2K computer problem at year end has eased tremendously as we continue
to test and fine tune our contingency plans. Nevertheless it is an event that we
continue to address. The industry as a whole continues to change rapidly with
mega mergers, Internet banking, and sweeping legislation. Competition for
deposit dollars and quality loans continues to intensify. Nevertheless, your
Company is prepared to work within this environment in its quest to become a
leading provider of independent financial services throughout the Baltimore
marketplace.
On behalf of our Directors, Officers and staff we would like to express our
collective appreciation to our stockholders and customers for their confidence
and support during the year. We are confident of our future and look forward to
another successful year.
Joseph J. Bouffard
President and Chief Executive Officer
2
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
==============================================================================
Selected Consolidated Financial Condition Data
<TABLE>
<CAPTION>
At June 30,
--------------------
1999 1998
-------- -------
(In thousands)
<S> <C> <C>
Total assets................................. $95,328 $92,371
Loans receivable, net........................ 77,777 75,871
Cash, federal funds sold and other interest
bearing deposits............................ 9,352 8,538
Investment securities........................ 214 5,119
Mortgage-backed securities................... 4,879 --
Deposits..................................... 69,671 70,327
Borrowings................................... 14,056 10,200
Stockholders' equity......................... 9,218 9,123
</TABLE>
- ------------------------------------------------------------------------------
Selected Consolidated Income Data
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------
1999 1998
------- -----
(In thousands)
<S> <C> <C>
Interest income........................................ $ 7,240 $ 7,038
Interest expense....................................... 3,306 3,444
------- -------
Net interest income before provision
for loan losses....................................... 3,934 3,594
Provision for loan losses.............................. 245 240
------- -------
Net interest income after provision
for loan losses........................................ 3,689 3,354
Noninterest income...................................... 246 274
Noninterest expenses:
Compensation and employee benefits..................... 1,797 1,597
Insurance.............................................. 67 72
Professional fees...................................... 94 134
Equipment expenses..................................... 115 117
Net occupancy costs.................................... 81 90
Advertising............................................ 45 53
Data processing........................................ 122 114
Merger-related expenses................................ 89 -
Net loss on disposal of fixed assets................... 23 -
Other.................................................. 443 372
------- -------
Total noninterest expenses............................ 2,876 2,549
Income before provision (benefit) for income taxes...... 1,059 1,079
Income tax provision (benefit).......................... 399 401
------- -------
Net income.............................................. $ 660 $ 678
======= =======
</TABLE>
3
<PAGE>
Key Operating Ratios
<TABLE>
<CAPTION>
At or for the
Year Ended June 30,
--------------------
1999 1998
----- -----
<S> <C> <C>
Performance Ratios:
Return on average assets (net income divided by
average total assets.................................. 0.73% 0.76%
Return on average stockholders' equity (net income
divided by average stockholders' equity).............. 7.05 7.88
Interest rate spread (combined weighted average
interest rate earned less combined weighted
average interest rate cost)........................... 3.93 3.54
Net interest margin (net interest income
divided by average interest-earning assets)........... 4.46 4.10
Ratio of average interest-earning assets to
average interest-bearing liabilities.................. 114.08 114.12
Ratio of noninterest expense to average total assets... 3.17 2.85
Asset Quality Ratios:
Nonperforming assets to total assets at
end of period......................................... 0.22 0.53
Nonperforming (nonaccrual) loans to loans
receivable, net at end of period...................... 0.23 0.61
Allowance for loan losses to total loans
at end of period...................................... 0.80 0.72
Allowance for loan losses to nonperforming
loans at end of period................................ 347.19 119.81
Net charge-offs to average loans outstanding........... 0.21 0.11
Capital Ratios:
Stockholders' equity to total assets at end of period.. 9.67 9.88
Average stockholders' equity to average assets......... 10.33 9.62
</TABLE>
4
<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 and advances from the
Federal Home Loan Bank of Atlanta. The net interest income earned on interest-
earning assets ("net interest margin") and the ratio of interest-earning assets
to interest-bearing liabilities significantly impact net interest income. The
Company's net interest margin is affected by regulatory, economic and
competitive factors that influence interest rates, loan and deposit flows. The
Company, like other financial institutions, is subject to interest rate risk to
the degree that its interest-earning assets mature or reprice at different
times, or on a different basis, than its interest-bearing liabilities. To a
lesser extent, the Company's results of operations are also affected by the
amount of its noninterest income, including loan fees and service charges, and
levels of noninterest expense, which consists principally of compensation and
employee benefits, insurance premiums, professional fees, equipment expense,
occupancy, costs, advertising, data processing and other operating expenses.
The Company's operating results are significantly affected by general
economic and competitive conditions, in particular, changes in market interest
rates, government policies and actions taken by regulatory authorities. Lending
activities are influenced by the demand for and supply of housing, competition
among lenders, the level of interest rates and the availability of funds.
Deposit flows and costs of funds are influenced by prevailing market rates of
interest, primarily on competing investments, account maturities and the level
of personal income and savings in the Company's market area.
Forward-Looking Statements
When used in this Annual Report, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in the Company's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Company's market area, and competition that could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected. The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made. The
Company wishes to advise readers that the factors listed above could affect the
Company's financial performance and could cause the Company's actual results for
future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements.
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions that 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.
Year 2000 Readiness Disclosure
The following information constitutes "Year 2000 Readiness Disclosure"
under the Year 2000 Information and Readiness Disclosure Act.
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
5
<PAGE>
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 service 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
testing of internal mission-critical systems was substantially complete as of
December 31, 1998 and it is currently developing and testing contingency plans.
However, if the service bureau were 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. Our
contingency plan will address alternative methods to provide basic services to
our customers. The Company estimates costs related to the year 2000 are less
than $25,000.
6
<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. Dividing income or expense by the average
daily balance of assets or liabilities, respectively, derives such yields and
costs for the periods presented. Average balances are derived from daily
balances.
The table also presents information for the periods indicated with respect
to the institution's net interest margin, which is net interest income divided
by the average balance of interest earning assets. This is an important
indicator of commercial bank profitability. The net interest margin is affected
by yields on interest earning assets, the costs of interest bearing liabilities
and the relative amounts of interest earning assets and interest bearing
liabilities. Another indicator of an institution's net interest income is the
interest rate spread or the difference between the average yield on interest
earning assets and the average rate paid on interest bearing liabilities.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------------------
1999 1998
---------------------------- --------------------------
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)...................................... $78,779 $ 6,690 8.49% $73,476 $ 6,153 8.37%
Investment securities..................................... 3,272 201 6.13 5,911 412 6.97
Mortgage-backed securities................................ 963 64 6.70 1,881 104 5.48
Short-term investments and other interest-earning assets.. 5,286 285 5.39 6,435 370 5.75
------- -------- ------- --------
Total interest-earning assets............................ 88,300 7,240 8.20 87,703 7,038 8.02
Non-interest-earning assets................................ 2,449 1,666
------- -------
Total assets............................................. $90,749 $89,369
======= =======
Interest-bearing liabilities:
Deposits (2).............................................. $67,087 2,696 4.02 $66,952 2,840 4.24
Borrowings................................................ 10,315 610 5.91 9,902 604 6.10
------- -------- ------- --------
Total interest-bearing liabilities....................... 77,402 3,306 4.27 76,854 3,444 4.48
-------- ---- -------- ----
Non-interest-bearing liabilities........................... 3,975 3,914
------- -------
Total liabilities........................................ 81,377 80,768
Retained earnings.......................................... 9,372 8,601
------- -------
Total liabilities and retained earnings.................. $90,749 $89,369
======= =======
Net interest income........................................ $ 3,934 $ 3,594
======== ========
Interest rate spread....................................... 3.93% 3.54%
==== ====
Net interest margin........................................ 4.46% 4.10%
==== ====
Ratio of average interest-earning assets to average
interest-bearing liabilities.............................. 114.08% 114.12%
======== ========
</TABLE>
_______________
(1) Includes nonaccrual loans.
(2) Includes interest-bearing escrow accounts.
7
<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).
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------
1999 vs. 1998
------------------------------------
Increase (Decrease) Due to
------------------------------------
Volume Rate Total
---------- -------- ------------
(In thousands)
<S> <C> <C> <C>
Interest income:
Loans receivable...................... $ 469 $ 68 $ 537
Investment securities................. (169) (42) (211)
Mortgage-backed securities............ (70) 31 (39)
Short-term investments and other
interest-earning assets.............. (63) (22) (85)
----- ----- -----
Total interest-earning assets....... 167 35 202
----- ----- -----
Interest expense:
Deposits (1).......................... (17) (128) (145)
Borrowings............................ 20 (13) 7
----- ----- -----
Total interest-bearing liabilities.. 3 (141) (138)
----- ----- -----
Change in net interest income.......... $ 164 $ 176 $ 340
===== ===== =====
</TABLE>
_______________
(1) Includes interest-bearing escrow accounts.
(2) Combined Rate/volume variances, a third element of the calculation, are
allocated to the volume and rate variances based on their relative size.
Comparison of Financial Condition at June 30, 1999 and 1998
General. Total assets increased by $2.9 million or 3.2% to $95.3 million at
June 30, 1999 from $92.4 million at June 30, 1998. The increase was primarily
due to increases of $1.9 million and $813 thousand in loans receivable and cash
and cash equivalents, respectively.
Loans Receivable. Total loans receivable increased by $1.9 million or 2.6%
to $78.5 million at June 30, 1999 from $76.6 million at June 30, 1998. Increases
in commercial loans and leases of $3.2 million, commercial real estate loans of
$2.8 million and consumer loans of $2.5 million were partially offset by a $6.6
million decrease in the residential mortgage portfolio. Since the conversion of
the Company's primary subsidiary from a mutual savings and loan association to a
stock savings bank and later into a commercial bank, the Company has continued
to diversify its lending away from the traditional single family mortgage
market.
8
<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,
1999, the Company had no concentrations of loans exceeding 10% of gross loans
other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------
1999 1998
-------------------------- -----------------------
Amount % Amount %
------- ------ ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential................................... $48,549 61.83% $55,212 72.08%
Commercial.................................... 7,870 10.02 5,106 6.67
Construction (1).............................. 2,351 2.99 2,204 2.88
Consumer loans:
Home improvement.............................. 8,770 11.17 6,726 8.78
Home equity loans............................. 1,698 2.16 1,227 1.60
Loans secured by deposits..................... 285 0.36 385 0.50
Other consumer loans.......................... 668 0.85 649 0.85
Commercial loans:
Commercial loans.............................. 6,849 8.72 4,775 6.23
Commercial leases............................. 1,495 1.90 313 0.41
------- ------ ------- ------
78,535 100.00% 76,597 100.00%
====== ======
Less:
Deferred loan origination fees, net of costs.. 73 172
Unearned Interest............................. 54 -
Allowance for loan losses..................... 631 554
------- -------
Total........................................ $77,777 $75,871
======= =======
</TABLE>
_______________
(1) Less loans in process.
The following table sets forth certain information at June 30, 1999
regarding the dollar amount of loans maturing or repricing in the Company's
portfolio. Demand loans, loans having no stated schedule of repayments and any
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 that 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, 2000 June 30, 1999 June 30, 1999 Total
--------------- ------------- ------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Residential........ $14,107 $ 5,039 $29,403 $48,549
Commercial......... 7,175 - 695 7,870
Construction....... 2,351 - - 2,351
Consumer loans...... 2,122 4,060 5,239 11,421
Commercial loans.... 4,461 3,309 574 8,344
------- ------- ------- -------
Total............... $30,216 $12,408 $35,911 $78,535
======= ======= ======= =======
</TABLE>
9
<PAGE>
The following table sets forth at June 30, 1999 the dollar amount of all
loans which may reprice or are due one year or more after June 30, 1999 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...... $29,870 $4,501 $34,371
Commercial....... 378 317 695
Consumer............ 9,369 - 9,369
Commercial.......... 3,884 - 3,884
------- ------ -------
Total............ $43,501 $4,818 $48,319
======= ====== =======
</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. U.S. government and
agency securities decreased by $4.6 million in the year ended June 30, 1999 as a
result of the FHLB note being called. During the year, the Company purchased a
$5.1 million mortgage-backed security funded with the proceeds from a $5.0
million FHLB advance and scheduled to mature at the same time as the FHLB
advance.
The following table sets forth the carrying value of the Company's
investments at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-------------------------
1999 1998
------ ------
<S> <C> <C>
(Dollars in thousands)
Securities available for sale, at fair value:
U.S. government and agency securities........ $ -- $5,014
Equity securities............................ 214 105
Mortgage-backed securities................... 4,879 --
------ ------
Total securities available for sale........ 5,093 5,119
------ ------
Investments required by law, at cost:
FHLB of Atlanta stock......................... 695 570
FRB of Richmond stock......................... 106 106
------ ------
Total investments required by law, at cost.. 801 676
------ ------
Total investments........................... $5,894 $5,795
====== ======
</TABLE>
10
<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, 1999.
<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:
Mortgage-backed securities..... $ -- --% $ -- --% $ -- --%
Investments required by law.... -- -- -- -- -- --
Equity securities.............. 214 1.47 -- -- -- --
-------- -------- --------
Total......................... $ 214 1.47 $ -- -- $ -- --
======== ======== ========
<CAPTION>
More than Ten Years Total Investment Portfolio
-------------------- -------------------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- ---------- -------- ------ -------
<S> <C> <C> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities..... $ 4,879 6.68% $ 4,879 $4,879 6.68%
Investments required by law.... 801 7.30 801 801 7.30
Equity securities.............. -- -- 214 214 1.47
-------- -------- ------
Total......................... $ 5,680 6.77 $ 5,894 $5,894 6.58
======== ======== ======
</TABLE>
11
<PAGE>
Deposits. Deposits decreased by $656,000 or .9% to $69.7million at June 30,
1999 from $70.3 million at June 30, 1998. A $945,000 decrease in interest
bearing deposits was somewhat offset by a $289,000 increase in noninterest
bearing deposits. Within the interest bearing deposit category, a $466,000
decrease in certificates of deposit and a $572,000 decrease in savings and money
market accounts was somewhat offset by a $94,000 increase in interest checking.
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.
Year Ended June 30,
------------------------------------------
1999 1998
---------------- ----------------
Average Average Average Average
Balance Rate Balance Rate
------- ------- ------- -------
(Dollars in thousands)
Passbook, statement savings
and Christmas Club........... $20,035 2.84% $20,061 2.88%
NOW checking.................. 3,837 1.63 3,398 1.82
Money market.................. 4,789 3.07 4,696 3.25
Certificates of deposit....... 37,682 5.08 38,797 5.28
Noninterest-bearing checking.. 2,933 -- 2,351 --
------- -------
Total....................... $69,276 $69,303
======= =======
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,
1999. At such date, such deposits represented 4.87% of total deposits and had a
weighted average rate of 5.28%.
Certificates
Maturity Period of Deposits
--------------- --------------
(In thousands)
Three months or less............... $ 957
Over three through 12 months....... 2,124
Over 12 months..................... 298
--------------
Total.......................... $ 3,379
==============
Borrowings. The Company's borrowings increased by $3.8 million to $14.1
million at June 30, 1999 from June 30, 1998. During the year, the Company paid
down $2,300,000 in borrowings from the Federal Home Loan Bank of Atlanta and
borrowed $6.0 million to fund loan demand and the purchase of a $5.1 million
mortgage-backed security.
The following table sets forth certain information regarding short-term
borrowings by the Company at the dates and for the periods indicated:
At June 30,
----------------------
1999 1998
-------- --------
(Dollars in thousands)
Amounts outstanding at end of period:
FHLB advances.................................. $ 13,900 $ 10,200
Other borrowings............................... 156 --
Weighted average rate paid on:
FHLB advances.................................. 5.71% 6.12%
Other borrowings............................... --% --%
12
<PAGE>
Year Ended June 30,
----------------------
1999 1998
-------- --------
(Dollars in thousands)
Maximum amount of borrowings outstanding
at any month end:
FHLB advances................................. $ 13,900 $ 10,200
Other borrowings.............................. 156 --
At June 30,
----------------------
1999 1998
-------- --------
(Dollars in thousands)
Approximate average short-term borrowings
outstanding with respect to:
FHLB advances.................................. $ -- $ 9,902
Other borrowings............................... -- --
Approximate weighted average rate paid on: (1)
FHLB advances.................................. --% 6.10%
Other borrowings............................... --% --%
_________________
(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, 1999 and 1998
General. The Company had net income of $660,000 for the year ended June 30,
1999 as compared to net income of $678,000 for the year ended June 30, 1998. The
$18,000 decrease in net income was significantly influenced by two events in
June 1999. First, the Company recognized $89,000 in expenses incurred as a
result of the terminated merger agreement with Belmar Federal Savings and Loan
Association. Second, the Company took a loss on the disposal of fixed assets of
$23,000, primarily in computer equipment, after the installation of new personal
computers throughout the Company.
Net Interest Income. The Company's net interest income increased by
$340,000 or 9.5% to $3.9 million in the year ended June 30, 1999 from $3.6
million in the year ended June 30, 1998.
The increase in net interest income is attributable to loan growth,
continued diversification to higher yielding loan products such as commercial
real estate, commercial business, commercial leasing and consumer loans and a
decrease in the cost of funds. As shown in the Rate/Volume Analysis above,
changing interest rates, primarily the decreased cost of funds, was responsible
for $176,000 of the increase in net interest income and changes in volume,
primarily the increase in loans, was responsible for $164,000 of the increase in
net interest income.
The Company's net interest margin increased to 4.46% for the year ended
June 30, 1999 from 4.10% for the year ended June 30, 1998. Of this 36 basis
point increase in the net interest margin, approximately 59% is due to higher
yields on earning assets and 41% is a result of a lower cost of funds.
Interest Income. The Company's total interest income increased by $202,000,
or 2.9% to $7.2 million in the year ended June 30, 1999 from $7.0 million in the
year ended June 30, 1998. The increase in the volume of interest earning assets
is responsible for $167,000 of the increase in interest income and increased
yields is responsible for $35,000 of the increase in interest income.
13
<PAGE>
Interest income on loans increased $537,000, or 8.7% during fiscal year
1999. The increase is attributable to the $5.3 million increase in the average
balance of loans receivable to $78.8 million in fiscal 1999 from $73.5 million
in fiscal 1998 and the 12 basis point increase in average yield to 8.49% in
fiscal 1999 from 8.37% in fiscal 1998.
Interest income on investment securities decreased by $211,000 or 51.3% to
$201,000 in fiscal year 1999 as compared to $412,000 in fiscal year 1998. The
decrease was primarily the result of a decrease in the average balance to $3.3
million during fiscal year 1999 from $5.9 million in fiscal year 1998. The
decrease in the average yield on investment securities from 6.97% in fiscal 1998
to 6.13 % also contributed to the decrease in interest income.
Interest income on mortgage-backed securities decreased $39,000 or 37.5% to
$65,000 in fiscal 1999 from $104,000 in the fiscal year ended June 30, 1998. The
average balance in mortgage-backed securities decreased $918,000 from $1.9
million during fiscal year 1998 to $963,000 in fiscal year 1999. This decrease
in average balance was somewhat offset by an increased in yield to 6.70% in the
fiscal year ended June 30, 1999 from 5.48% in fiscal 1998.
Interest income on short-term investments and other interest earning assets
decreased $85,000 or 23.1% to $285,000 in the fiscal year ended June 30, 1999
from $370,000 in the fiscal year ended June 30, 1998. The decrease in interest
income is primarily the result of lower average balances; however, the decreased
yield also contributed to the decline.
The increase in loan interest income and the decrease in interest income on
other, lower-yielding investments reflect management's concerted effort to
invest the Company's resources in higher yielding loans.
Interest Expense. The Company's interest expense decreased by $138,000 or
4.0% to $3.3 million in fiscal year 1999 from $3.4 million during the fiscal
year ended June 30, 1998. As shown in the rate/volume table above, changing
interest rates were responsible for a decrease in interest expense of $141,000
and the increase in average borrowings resulted in an increase in interest
expense of $3,000.
Interest expense on deposits decreased $145,000 or 5.1% to $2.7 million in
fiscal year 1999 from $2.8 million in fiscal 1998. Lower interest rates are
responsible for $128,000 of the decrease and lower average deposits are
responsible for $17,000 of the decrease.
Interest expense on borrowed money increased $7,000 or 1.0 % to $610,000 in
the year ended June 30, 1999 from $604,000 in the year ended June 30, 1999. The
$20,000 increase in interest expense due to higher average balances was somewhat
offset by a decrease in interest expense on borrowed money of $13,000 due to
lower interest rates.
Provision for Loan losses. The allowance for loan losses is a valuation
reserve established by management in an amount it deems adequate to provide for
losses in the loan portfolio. Provisions for loan losses are charged to earnings
in order to maintain the total allowance for loan losses at a level considered
adequate by management to provide for probable loan losses. Management assesses
the adequacy of the allowance for loan losses based on a number of factors
including, among others: lending risks associated with new products and markets,
loss allocations for specific problem credits, the level of the allowance to
nonperforming loans, historical loss experience, economic conditions, portfolio
trends and credit concentrations and management's judgment with respect to
current and expected economic conditions and their impact on the existing loan
portfolio.
The provision for loan losses was $245,000 in fiscal year 1999, an increase
of $5,000 or 2.1% over the fiscal year 1998 provision of $240,000. The Company
has increased the allowance for loan losses as a percentage of total loans
outstanding to 0.80% at June 30, 1999 from 0.72% at June 30, 1998 as a result of
the greater inherent risk in the loan portfolio caused by the shifts to higher
yielding loans as discussed earlier. The Company's allowance for loan losses as
a percentage of nonperforming loans was 347.2% at June 30, 1999 as compared to
119.8% at June 30, 1998.
14
<PAGE>
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 decreased by $28,000 or
10.1% to $246,000 in fiscal year 1999 as compared to $274,000 in fiscal year
1998. The decrease is primarily attributable to the closing of a high-risk
commercial deposit account. The lost fees from this account were somewhat offset
by additional fees from the increased number of interest and noninterest bearing
checking accounts. In the year ended June 30, 1999, there were no gains on sale
of investment securities as compared to a $5,000 gain in fiscal year 1998.
Noninterest Expense. The Company's total noninterest expense increased by
$326,000, or 12.8%, to $2.9 million during fiscal 1999, as compared to $2.6
million in fiscal 1998. The Company experienced a $200,000, or 12.5% increase in
compensation and employee benefits expense during fiscal 1999 primarily a result
of higher staffing levels and normal salary increases. Additionally, as
previously noted, the company recognized $89,000 in expenses incurred as a
result of the terminated merger agreement with Belmar Federal Savings and Loan
Association as well as a $23,000 loss on disposal of obsolete equipment. Without
these two items, the Company's noninterest expense would have increased
$214,000, or 8.4% for the year.
Asset/Liability Management
The Company's net income is largely dependent on the Bank's net interest
income. Net interest income is susceptible to interest rate risk to the degree
that interest-bearing liabilities mature or reprice on a different basis than
interest-earning assets. When interest-bearing liabilities mature or reprice
more quickly than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest income.
Similarly, when interest-earning assets mature or reprice more quickly than
interest bearing liabilities, falling interest rates could result in a decrease
in net interest income. Net interest income is also affected by changes in the
portion of interest-earning assets that are funded by interest-bearing
liabilities rather than by other sources of funds, such as noninterest bearing
deposits and stockholders' equity.
The Bank's interest rate sensitivity, as measured by the repricing of its
interest sensitive assets and liabilities at June 30, 1999, is presented in the
following table. The table was derived using assumptions which management
believes to be reasonable. The table indicates a moderate amount of interest
rate risk based on the Bank's having approximately equal amounts of rate
sensitive assets and rate sensitive liabilities subject to maturity or repricing
within a one-year period from June 30, 1999.
The Company has established an Asset/Liability Management Committee "ALCO"
that 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
net interest margin 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, 1999. 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.
In addition to shortening the average repricing period of its assets, the
Company has sought to lengthen the average maturity of its liabilities by
offering higher rates of interest on its longer-term certificates and utilizing
long-term borrowings from the Federal Home Loan Bank of Atlanta.
15
<PAGE>
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.
16
<PAGE>
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1999 that 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>
Rate sensitive assets:
Loans receivable........................ $ 8,726 $17,221 $27,425 $16,691 $7,619 $ 853 $78,535
Mortgage-Backed & Inv. securities....... 1,359 898 2,154 819 559 107 5,894
Short-term investments and other
Interest-earning assets................ 5,580 2,170 0 0 0 0 7,750
------- ------- ------- ------- ------ ------ -------
Total................................. 15,665 20,288 29,580 17,510 8,178 959 92,180
------- ------- ------- ------- ------ ------ -------
Rate sensitive liabilities:
Deposits (1)............................ 9,444 27,938 18,973 13,721 0 0 70,076
Borrowings.............................. 0 0 13,900 0 0 0 13,900
------- ------- ------- ------- ------ ------ -------
Total.................................. 9,444 27,938 32,873 13,721 0 0 83,976
------- ------- ------- ------- ------ ------ -------
Interest sensitivity gap................. $ 6,221 $(7,650) $(3,292) $ 3,789 $8,178 $ 959 $ 8,204
======= ======= ======= ======= ====== ====== =======
Cumulative interest sensitivity gap...... $ 6,221 $(1,429) $(4,721) $ (933) $7,245 $8,204
======= ======= ======= ======= ====== ======
Ratio of cumulative gap to total assets.. 6.53% (1.50)% (4.95)% (0.98)% 7.60% 8.61%
======= ======= ======= ======= ====== ======
</TABLE>
- -------------------------
(1) Includes $405,000 of interest-bearing escrows.
17
<PAGE>
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 that 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.
The Company utilizes two additional measures of risk. These are
quantitative measures of the percentage change in net interest income and equity
capital resulting from a hypothetical change of plus or minus 200 basis points
in market interest rates for maturities from one day to thirty years. As of June
30, 1999, the Bank had the following estimated sensitivity profile for net
interest income and fair value of equity:
<TABLE>
<CAPTION>
+ 200 basis points -200 basis points Policy Limit
------------------- ------------------ -------------------
<S> <C> <C> <C>
% Change in Net Interest Income 5.0% -8.0% plus or minus 10.0%
% Change in Fair Value of Equity -5.0% -3.0% plus or minus 25.0%
</TABLE>
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.
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, 1999, the Company's cash on hand, interest bearing deposits and
Federal funds sold totaled $9.2 million.
The Company anticipates that it will have sufficient funds available to
meet its current loan origination, and unused lines-of-credit commitments of
approximately $1.5 million and $1.8 million, respectively. Certificates of
deposit that are scheduled to mature in less than one year at June 30, 1999
totaled $33.6 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.
18
<PAGE>
At June 30, 1999, the Bank exceeded all regulatory minimum capital
requirements. The table below presents certain information relating to the
Bank's regulatory compliance at June 30, 1999.
<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)... $9,120 15.35% $4,752 8.0% $5,941 10.0%
Tier 1 Capital (to Risk Weighted Assets).. 8,489 14.29 2,376 4.0 3,564 6.0
Tier 1 Capital (to Average Assets)........ 8,489 9.35 3,630 4.0 4,537 5.0
</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.
Accounting Pronouncements with future effective dates
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 r to the extent practicable. The Statement, which is effective for
fiscal years beginning after July 1, 1998 will not effect the Company's
financial position or its results of operations.
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities"
was issued in June 1998.. The 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 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.
Statement of Position ("SOP") 98-5, "Reporting the Costs of Start-Up
Activities." This Statement provides guidance on the financial reporting of
start-up cost and organizational cost. It requires costs of start-up activities
and organization cost to be expensed as incurred. The "SOP" also requires that
initial application to be reported as a cumulative effect of a change in
accounting principals. This "SOP" which is effective for fiscal years beginning
after December 15, 1998 will not affect the Company's financial position or
results of operations.
Appointment of Auditor
On March 11, 1998, the Company, with the approval of its Board of
Directors, dismissed its independent public auditors, KPMG Peat Marwick L.L.P.
("KPMG") and engaged Anderson effective March 11, 1998 to perform such function.
During the fiscal year ended June 30, 1997 and the interim period through March
11, 1998 (the date of dismissal), there were not any disagreements between the
Company and KPMG on any matter of accounting principles or practices,
consolidated financial statement disclosure or audit scope or procedure.
19
<PAGE>
PATAPSCO BANCORP, INC.
[LOGO]
<PAGE>
[LETTERHEAD OF ANDERSON ASSOCIATES, LLP]
Independent Auditors' Report
The Stockholders and The Board of Directors
Patapsco Bancorp, Inc.
Dundalk, Maryland
We have audited the consolidated statements of financial condition of
Patapsco Bancorp, Inc. and Subsidiaries as of June 30, 1999 and 1998, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the two years in the two year period ended June 30, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Patapsco Bancorp, Inc. and Subsidiaries as of June 30, 1999 and 1998, and the
consolidated results of its operations and its cash flows for each of the two
years in the two year period ended June 30, 1999, in conformity with generally
accepted accounting principles.
/s/ Anderson Associates LLP
August 25, 1999
21
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
June 30, 1999 and 1998
<TABLE>
<CAPTION>
===========================================================================================================
1999 1998
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash:
On hand and due from banks $ 1,601,598 970,218
Interest bearing deposits 2,170,254 419,583
Federal funds sold 5,580,098 7,148,619
Investment securities at fair value (note 2) 213,761 5,118,910
Mortgage-backed securities at fair value (note 3) 4,879,359 -
Loans receivable, net (note 4) 77,777,163 75,870,779
Investment required by law, at cost (note 9) 800,850 675,650
Property and equipment, net (note 5) 1,052,618 1,095,621
Deferred taxes (note 8) 441,000 336,000
Accrued interest, prepaid expenses and other assets 811,660 735,576
- -----------------------------------------------------------------------------------------------------------
$ 95,328,361 92,370,956
===========================================================================================================
Liabilities and Stockholders' Equity
Liabilities:
Interest bearing deposits $ 66,792,156 67,736,810
Non-interest bearing deposits 2,879,263 2,590,571
Borrowings (note 7) 13,900,000 10,200,000
Checks written in excess of bank balance 156,276 -
Accrued expenses and other liabilities 2,357,570 2,378,936
Income taxes payable 25,236 341,799
- -----------------------------------------------------------------------------------------------------------
Total liabilities 86,110,501 83,248,116
Stockholders' equity (notes 9, 10 and 11):
Common stock $0.01 par value; authorized 4,000,000 shares;
issued and outstanding 344,426 shares at June 30, 1999 and
362,553 shares at June 30, 1998 3,445 3,626
Additional paid-in capital 1,888,962 2,330,681
Contra equity - Employee Stock Option Plan (ESOP) (325,100) (396,341)
Contra equity - Management Recognition Plan (MRP) (257,095) (339,225)
Retained earnings, substantially restricted 8,017,059 7,525,501
Unrealized net holding losses on available-for-sale portfolios,
net of taxes (109,411) (1,402)
- -----------------------------------------------------------------------------------------------------------
9,217,860 9,122,840
Commitments (notes 4, 10 and 11)
- -----------------------------------------------------------------------------------------------------------
$ 95,328,361 92,370,956
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
Years Ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
1999 1998
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Loans receivable $ 6,689,710 6,152,735
Mortgage-backed securities 64,546 103,517
Investment securities 200,549 411,551
Federal funds sold and other investments 284,860 370,327
- -----------------------------------------------------------------------------------------------------------
Total interest income 7,239,665 7,038,130
- -----------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 2,691,024 2,836,124
Interest on short term borrowing 5,328 47,959
Interest on long term debt 609,183 559,555
- -----------------------------------------------------------------------------------------------------------
Total interest expense 3,305,535 3,443,638
- -----------------------------------------------------------------------------------------------------------
Net interest income 3,934,130 3,594,492
Provision for losses on loans (note 4) 245,000 240,000
- -----------------------------------------------------------------------------------------------------------
Net interest income after provision for losses on loans 3,689,130 3,354,492
- -----------------------------------------------------------------------------------------------------------
Noninterest income:
Fees and service charges 229,134 251,791
Net gain on sales of securities - 5,015
Other 17,029 17,162
- -----------------------------------------------------------------------------------------------------------
Total noninterest income 246,163 273,968
- -----------------------------------------------------------------------------------------------------------
Noninterest expenses:
Compensation and employee benefits 1,797,183 1,597,100
Insurance 67,285 72,488
Professional fees 93,966 133,956
Equipment expenses 115,026 117,417
Net occupancy costs 81,615 89,890
Advertising 44,671 52,550
Data processing 121,703 113,801
Merger-related expenses 89,000 -
Net loss on disposal of fixed assets 22,606 -
Other 443,008 372,451
- -----------------------------------------------------------------------------------------------------------
Total noninterest expenses 2,876,063 2,549,653
- -----------------------------------------------------------------------------------------------------------
Income before income taxes 1,059,230 1,078,807
Income tax provision (note 8) 399,000 401,000
- -----------------------------------------------------------------------------------------------------------
Net income $ 660,230 677,807
- -----------------------------------------------------------------------------------------------------------
Net income per share of common stock (note 1):
Basic $ 2.03 2.05
Diluted 1.87 1.95
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years Ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
=================================================================================================================================
Additional
Common Paid-In Contra- Contra-
Stock Capital Equity ESOP Equity MRP
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at June 30, 1997 $ 3,626 2,249,725 (464,064) (423,724)
Comprehensive income
Net income - - - -
Adjustment to unrealized net holding losses on
available-for-sale portfolios, net (note 1) - - - -
Comprehensive income - - - -
Compensation under stock-based benefit plans - 80,956 67,723 84,499
Cash dividends declared ($0.40 per share) - - - -
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 3,626 2,330,681 (396,341) (339,225)
Comprehensive income
Net income - - - -
Adjustment to unrealized net holding losses on
available-for-sale portfolios, net (note 1) - - - -
Comprehensive income - - - -
Compensation under stock-based benefit plans - 81,480 71,241 82,130
Cash dividends declared ($.48 per share) - - - -
Purchase of common stock (181) (523,199) - -
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1999 $ 3,445 1,888,962 (325,100) (257,095)
=================================================================================================================================
<CAPTION>
Accumulated
Other
Comprehensive Total
Retained Income, Net Stockholders'
Earnings of Taxes Equity
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at June 30, 1997 6,992,716 (24,276) 8,334,003
Comprehensive income
Net income 677,807 - -
Adjustment to unrealized net holding losses on - 22,874 -
available-for-sale portfolios, net (note 1)
Comprehensive income - - 700,681
Compensation under stock-based benefit plans - - 233,178
Cash dividends declared ($0.40 per share) (145,022) - (145,022)
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 7,525,501 (1,402) 9,122,840
Comprehensive income
Net income 660,230 - -
Adjustment to unrealized net holding losses on
available-for-sale portfolios, net (note 1) - (108,009) -
Comprehensive income - - 552,221
Compensation under stock-based benefit plans - - 234,851
Cash dividends declared ($.48 per share) (168,672) - (168,672)
Purchase of common stock - - (523,380)
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 1999 8,017,059 (109,411) 9,217,860
================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
===========================================================================================================
1999 1998
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 660,230 677,807
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 119,384 118,169
Provision for losses on loans 245,000 240,000
Non-cash compensation under stock-based benefit plans 234,851 233,178
Amortization of premiums and discounts, net 10,406 6,362
Deferred loan origination fees, net of costs 16,266 148,969
Gain on sales of investment securities and
mortgage-backed securities - (5,015)
Loss on disposal of fixed assets 22,606 -
Increase (decrease) in income taxes payable (316,563) 117,799
Change in deferred taxes (37,000) (114,000)
Increase in accrued interest on investments,
prepaid expenses and other assets (76,084) (79,173)
Increase (decrease) in accrued expenses and other liabilities (21,367) 103,463
- -----------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 857,729 1,447,559
- -----------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of investment securities (133,406) (5,134,610)
Maturities of investment securities 5,000,000 2,000,000
Purchase of mortgage-backed security (5,063,556) -
Principal repayments on mortgage-backed securities 36,377 2,651,087
Sales of mortgage-backed securities - 5,068,433
Loan principal disbursements, net of repayments (1,830,344) (7,542,267)
Purchase of loans (337,345) (2,481,355)
Purchase of investment required by law (125,200) (53,600)
Purchases of property and equipment (98,987) (96,336)
- -----------------------------------------------------------------------------------------------------------
Net cash used in investing activities $(2,552,461) (5,588,648)
- -----------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
See accompanying notes to consolidated financial statements.
25
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
===========================================================================================================
1999 1998
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from financing activities:
Net increase (decrease) in deposits $ (655,962) 175,088
Purchase of common stock (523,380) -
Additional borrowings 6,000,000 10,200,000
Repayments of borrowings (2,300,000) (2,700,000)
Increase in checks written in excess of bank balance 156,276 -
Dividends paid (168,672) (108,766)
- -----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,508,262 7,566,322
- -----------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 813,530 3,425,233
Cash and cash equivalents at beginning of year 8,538,420 5,113,187
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 9,351,950 8,538,420
===========================================================================================================
Supplemental information:
Interest paid on savings deposits and borrowed funds $ 3,273,716 3,457,723
Income taxes paid 672,200 395,000
===========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(1) Basis of Presentation and Summary of Significant Accounting Policies
Description of Business
Patapsco Bancorp, Inc. (the Company) is the holding company of The Patapsco
Bank (Patapsco). Patapsco owns 100% of Prime Business Leasing, Inc. (Prime
Leasing). The primary business of Patapsco is to attract deposits from
individual and corporate customers and to originate residential and
commercial mortgage loans, commercial loans and consumer loans. Patapsco is
subject to competition from other financial and mortgage institutions in
attracting and retaining deposits and in making loans. Patapsco is subject
to the regulations of certain agencies of the federal government and
undergoes periodic examination by those agencies. The primary business of
Prime Leasing is the origination and servicing of commercial leases. The
company has not yet commenced operations.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Patapsco and Prime Leasing. 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 losses may be necessary based on
changes in economic conditions, particularly in Baltimore and the State of
Maryland. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review Patapsco's allowance for
loan losses. Such agencies may require Patapsco to recognize additions to
the allowance based on their judgments about information available to them
at the time of their examination.
Cash and Cash Equivalents
Cash equivalents include short-term investments, which consists of Federal
funds sold. Cash equivalents and other liquidity and short-term investments
are carried at cost, which approximates market value.
(Continued)
27
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(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.
Loan Fees
Loan origination fees are deferred and amortized to income over the
contractual lives of the related loans using the interest method. Certain
incremental direct loan origination costs are deferred and recognized over
the contractual lives of the related loans using the interest method as a
reduction of the loan yield. Deferred fees and costs are combined where
applicable and the net amount is amortized.
(Continued)
28
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(1) Continued
Provision for Losses on Loans
Provisions for losses on loans receivable are charged to income, based on
management's judgment with respect to the risks inherent in the portfolio.
Such judgment considers a number of factors including historical loss
experience, the present and prospective financial condition of borrowers,
the estimated value of underlying collateral, geographic concentrations,
current and prospective economic conditions, delinquency experience and
status of 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"), Patapsco determines and recognizes impairment of certain
loans. A loan is determined to be impaired when, based on current
information and events, it is probable that Patapsco will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. A loan is not considered impaired during a period of delay in
payment if Patapsco expects to collect all amounts due, including past-due
interest. Patapsco generally considers a period of delay in payment to
include delinquency up to and including 90 days. Statement 114 requires
that impaired loans be measured at the present value of its expected future
cash flows discounted at the loan's effective interest rate, or at the
loan's observable market price or the fair value of the collateral if the
loan is collateral dependent.
Statement 114 is generally applicable for all loans except large groups or
smaller-balance homogeneous loans that are evaluated collectively for
impairment, including residential first and second mortgage loans and
consumer installment loans. Impaired loans are therefore generally
comprised of commercial mortgage, real estate development, and certain
restructured residential loans. In addition, impaired loans are generally
loans which management has placed in 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.
Patapsco 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.
(Continued)
29
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(1) Continued
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.
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. Basics 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:
(Continued)
30
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(1) Continued
<TABLE>
<CAPTION>
Year ended
--------------------------------------------------------------
June 30, 1999 June 30, 1998
Basic Diluted Basic Diluted
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $660,230 660,230 677,807 677,807
Weighted average shares outstanding 325,300 325,300 331,125 331,125
Diluted securities:
MRP shares - 11,319 - 16,155
Options - 15,554 - 432
---------------------------------------------------------------------------------------------------------
Adjusted weighted average shares 325,300 352,173 331,125 347,712
---------------------------------------------------------------------------------------------------------
Per share amount $ 2.03 1.87 2.05 1.95
=========================================================================================================
</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.
Merger Conversion
On May 22, 1998 the Bancorp entered into a merger conversion agreement with
Belmar Federal Savings and Loan Association. The transaction was terminated
in June 1999. All expenses associated with the merger have been included in
the current year and amounted to $89,000.
Reclassification and Restatement
Certain prior year's amounts have been reclassified to conform to the
current year's presentation.
31
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(2) Investment Securities
Investment securities, classified as available-for-sale, are summarized as
follows as of June 30:
<TABLE>
<CAPTION>
1999
--------------------------------------------------------------------
Amortized Unrealized Unrealized Fair Carrying
Cost gains losses value Value
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Equity securities $ 246,410 - 32,649 213,761 213,761
==========================================================================================================
1998
--------------------------------------------------------------------
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
==========================================================================================================
</TABLE>
Accrued interest receivable at June 30, 1999 and 1998 was $-0- and $2,908,
respectively.
Proceeds from redemption of investment securities was $5,000,000 and
$2,000,000 in 1999 and 1998, respectively.
(3) Mortgage-backed securities, classified as available-for-sale, are
summarized as follows as of June 30, 1999:
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Fair Carrying
Cost gains losses value Value
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Government National Mortgage
Association (GNMA) $5,024,962 - 145,603 - 4,879,359
==========================================================================================================
</TABLE>
Accrued interest receivable at June 30, 1999 was $28,952.
In 1998, the Company sold mortgage-backed securities classified available-
for-sale with an amortized cost of $5,063,418 and realized a net gain of
$5,015. There were no sales in 1999.
32
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(4) Loans Receivable
Loans receivable and accrued interest receivable thereon are summarized as
follows as of June 30:
<TABLE>
<CAPTION>
1999 1998
-------------------------------------------------------------------------------------------
<S> <C> <C>
Real estate secured by first mortgage:
Residential $48,548,487 55,212,243
Commercial 7,870,045 5,106,188
Construction, net of loans in process 2,351,161 2,203,407
-------------------------------------------------------------------------------------------
58,769,693 62,521,838
Home improvement loans 8,769,816 6,726,365
Commercial loan 6,849,368 4,774,645
Home equity loans 1,698,066 1,227,088
Commercial leases 1,495,358 313,163
Loans secured by deposits 284,813 384,975
Consumer loans 668,307 649,011
-------------------------------------------------------------------------------------------
78,535,421 76,597,085
Less:
Deferred loan origination fees, net of costs 73,090 172,793
Unearned interest 53,929 -
Allowance for loan losses 631,239 553,513
-------------------------------------------------------------------------------------------
Loans receivable, net $77,777,163 75,870,779
===========================================================================================
</TABLE>
Accrued interest receivable on loans was $480,785 and $419,310 at June 30,
1999 and 1998, 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)
33
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(4) Continued
Impairment of loans having recorded investments of $9,300 and $194,000 at
June 30, 1999 and 1998, respectively has been recognized in conformity with
SFAS No. 114. The average recorded investment in impaired loans during 1999
and 1998, respectively was $9,200 and $190,000. There was no allowance for
losses related to those loans as of June 30, 1999. The total allowance for
loan losses related to these loans at June 30, 1998 was $38,900. The amount
of interest that would have been recorded on impaired loans at June 30,
1999 and 1998, respectively had the loans performed in accordance with
their terms was approximately $500 and $16,000, respectively. The actual
interest income recorded on these loans during 1999 and 1998 was $ -0- and
$12,000, respectively.
Nonaccrual loans amounted to approximately $182,000 and $268,000 at June
30, 1999 and 1998, respectively. The amount of interest income that would
have been recorded on loans in nonaccrual status at June 30, 1999 and 1998
had such loans performed in accordance with their terms, was approximately
$17,200 and $6,300, respectively. The actual interest income recorded on
these loans during 1999 and 1998 was approximately $ -0- and $13,400,
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, 1999, loans classified special
mention and substandard totaled approximately $2,116,665 and $181,800. No
loans were classified doubtful or loss at June 30, 1999.
The activity in the allowance for loan losses is summarized as follows for
the years ended June 30:
<TABLE>
<CAPTION>
1999 1998
-------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $ 553,513 397,012
Provision for losses on loans 245,000 240,000
Charge-offs (173,888) (91,935)
Recoveries 6,614 8,436
-------------------------------------------------------------------------
Balance at end of year $ 631,239 553,513
=========================================================================
</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, 1999
and 1998 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)
34
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999and 1998
________________________________________________________________________________
(4) Continued
Outstanding commitments to extend credit, which generally expire within 60
days, are as follows at June 30, 1999:
Fixed rate Floating rate
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Residential mortgage loans $ 433,500 205,400
Commercial business and lease loans - 879,000
Undisbursed lines of credit 1,670,878 97,000
================================================================================
</TABLE>
As of June 30, 1999 and 1998, Patapsco was servicing loans for the benefit
of others, approximately $2,193,646 and $2,570,632, respectively.
(5) Property and Equipment
Property and equipment are summarized as follows at June 30:
<TABLE>
<CAPTION>
Estimated
1999 1998 useful lives
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Land $ 92,684 92,684 -
Building and improvements 988,807 982,653 40 years
Furniture, fixtures and equipment 1,166,002 1,141,957 5 - 10 years
- ----------------------------------------------------------------------- -------------
Total, at cost 2,247,493 2,217,294
Less accumulated depreciation 1,194,875 1,121,673
- -----------------------------------------------------------------------
Property and equipment, net $1,052,618 1,095,621
=======================================================================
</TABLE>
The Company has no obligations under long-term operating leases.
(6) Deposits
The aggregate amount of short-term jumbo certificates, each with a minimum
denomination of $100,000, was approximately $3,379,000 and $2,601,000 in
1999 and 1998, respectively.
At June 30, 1999, the scheduled maturities of certificates are as follows:
<TABLE>
<CAPTION>
<S> <C>
Under 12 months $33,517,465
12 months to 24 months 3,457,979
24 months to 36 months 1,113,830
36 months to 48 months 84,461
48 months to 60 months 171,129
------------------------------------------------------------------------
$38,344,864
========================================================================
</TABLE>
35
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(7) Borrowings
At June 30, 1999 and 1998, 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.
At June 30, the scheduled maturities of borrowings are as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------------------
Weighted Weighted
Balance Average Rate Balance Average Rate
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Under 12 months $ - - $ 1,800,000 5.99
12 months to 24 900,000
months 5.47 - -
24 months to 36
months 1,000,000 6.55 400,000 6.15
36 months to 48
months 7,000,000 6.27 1,000,000 6.55
48 months to 60
months 5,000,000 5.01 7,000,000 6.02
--------------------------------------------------------------------------------------
$13,900,000 5.71 $10,200,000 6.12
======================================================================================
</TABLE>
(8) Income Taxes
The provision for income taxes is composed of the following for the years
ended June 30:
<TABLE>
<CAPTION>
1999 1998
-----------------------------------------------------------------------------
<S> <C> <C>
Current:
Federal $ 367,000 442,000
State 69,000 73,000
-----------------------------------------------------------------------------
436,000 515,000
-----------------------------------------------------------------------------
Deferred:
Federal (30,000) (93,000)
State (7,000) (21,000)
-----------------------------------------------------------------------------
(37,000) (114,000)
-----------------------------------------------------------------------------
$ 399,000 401,000
=============================================================================
</TABLE>
(Continued)
36
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(8) Continued
The net deferred tax assets consist of the following at June 30:
<TABLE>
<CAPTION>
1999 1998
------------------------------------------------------------------------
<S> <C> <C>
Allowance for losses on loans $ 244,000 214,000
Unrealized holding gains 69,000 1,000
Deferred compensation 248,000 253,000
Deferred loan fees 37,000 37,000
Other, net 8,000 9,000
-------------------------------
Total deferred tax assets 606,000 514,000
Tax bad debt reserve (39,000) (52,000)
Federal home Loan Bank stock dividends (101,000) (101,000)
Accumulated depreciation (25,000) (25,000)
-------------------------------
Total deferred tax liabilities (165,000) (178,000)
----------------------------------------------------------------------
Net deferred tax assets $ 441,000 336,000
========================================================================
</TABLE>
A reconciliation of the income tax provision 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>
1999 1998
---------------------------------------------------------------------
<S> <C> <C>
Tax at statutory rate $360,000 367,000
State income taxes, net of Federal
income tax benefit 41,000 34,000
Other (2,000) -
---------------------------------------------------------------------
Income tax provision $399,000 401,000
=====================================================================
</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.
(9) Regulatory Matters
The Federal Deposit Insurance Corporation (FDIC) insures deposits of
account holders up to $100,000. Patapsco pays an annual premium to provide
for this insurance. Patapsco is also a member of the Federal Home Loan
Bank System and is required to maintain an investment in the stock of the
Federal Home Loan Bank of Atlanta equal to at least 1% of the unpaid
principal balances of its residential mortgage loans, .3% of its total
assets or 5% of its outstanding advances to Patapsco, whichever is
greater. Purchases and sales of stock are made directly with Patapsco at
par value.
(Continued)
37
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(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, 1999, the Bank met its reserve requirements.
Patapsco is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken,
could have a direct material effect on Patapsco's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, Patapsco must meet specific capital guidelines that
involve quantitative measures of Patapsco's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. Patapsco's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Patapsco to maintain minimum amounts and ratios (as defined in the
regulations and as set forth in the table below, as defined) of total and
Tier I capital (as defined) to risk-weighted assets (as defined), and of
Tier I capital to average assets (as defined). Management believes, as of
June 30, 1999, that Patapsco meets all capital adequacy requirements to
which it is subject.
As of June 30, 1999, the most recent notification from banking regulators
categorized Patapsco as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as adequately capitalized
Patapsco must maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set forth in table. There are no conditions or
events since that notification that management believes have changed the
institution's category.
(Continued)
38
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(9) Continued
Patapsco's actual capital amounts and ratios are also presented in the
table (in thousands).
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Total Capital (to Risk
Weighted Assets) $9,120 15.35% $4,752 8.00% $5,941 10.00%
Tier I Capital (to Risk
Weighted Assets) 8,489 14.29% 2,376 4.00% 3,564 6.00%
Tier I Capital (to Average
Assets) 8,489 9.35% 3,630 4.00% 4,537 5.00%
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%
=======================================================================================
</TABLE>
(10) Stockholders' Equity and Related Matters
On September 14, 1995, the Board of Directors approved a plan of
reorganization from a mutual savings association to a capital stock
savings bank and the concurrent formation of a holding company. The
conversion was accomplished through amendment of Patapsco's charter and
the sale of the Company's common stock in an amount equal to the
consolidated pro forma market value of the Company and Patapsco after
giving effect to the conversion. A subscription offering of the shares of
common stock was offered initially to employee benefit plans of the
Company, depositors, borrowers, directors, officers and employees of the
Company and to certain other eligible subscribers. In connection with the
Conversion, the Company publicly issued 362,553 shares of its common
stock, par value $.01 per share (the "Common Stock"), for gross proceeds
of $7,251,060 and net proceeds of $6,745,810, of which $3,372,905 was
contributed to Patapsco in exchange for all of its outstanding common
stock.
Federal regulations require that, upon conversion from mutual to stock
form of ownership, a "liquidation account" be established by restricting a
portion of net worth for the benefit of eligible savings account holders
who maintain their savings accounts with Patapsco after conversion. In the
event of complete liquidation (and only in such event), each savings
account holder who continues to maintain his savings account shall be
entitled to receive a distribution from the liquidation account after
payment to all creditors, but before any liquidation distribution with
respect to capital stock. This account will be proportionately reduced for
any subsequent reduction in the eligible holders' savings accounts. At
conversion the liquidation account totaled approximately $6,088,000.
(Continued)
39
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Junes 30, 1999 and 1998
________________________________________________________________________________
(10) Continued
In addition to the foregoing, certain bad debt reserves deducted from
income for federal income tax purposes and included in retained income of
Patapsco, are not available for the payment of cash dividends or other
distributions to stockholders without payment of taxes at the then-current
tax rate by Patapsco, on the amount removed from the reserves for such
distributions.
(11) Benefit Plans
Employee Stock Ownership Plan
Patapsco has established an Employee Stock Ownership Plan (ESOP) for its
employees. On April 1, 1996 the ESOP acquired 29,004 shares of the
Company's common stock in connection with Patapsco's conversion to a
capital stock form of organization. The ESOP purchased an additional
12,861 shares 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 Patapsco to the
ESOP and earnings thereon.
All employees of Patapsco who attain the age of 21 and complete six months
of service with Patapsco will be eligible to participate in the ESOP.
Participants will become 100% vested in their accounts after three years
of service with Patapsco or, if earlier, upon death, disability or
attainments of normal retirement age. Participants receive credit for
service with Patapsco prior to the establishment of the ESOP.
Patapsco recognizes the cost of the ESOP in accordance with AICPA
Statement of Position 93-6 Employers' Accounting for Employee Stock
Ownership Plans. As shares are released from collateral, Patapsco reports
compensation expense equal to the current market price of the shares and
the shares become outstanding for earnings-per-share computations.
Dividends on allocated shares are recorded as a reduction of retained
earnings; dividends on unallocated shares are recorded as a reduction of
debt. For the years ended June 30, 1999 and 1998 compensation expense
recognized related to the ESOP and Patapsco's contribution to the ESOP was
$134,237 and $148,679, respectively.
The ESOP shares were as follows as of June 30:
<TABLE>
<CAPTION>
1999 1998
------------------------------------------------------------------
<S> <C> <C>
Shares released and allocated 18,268 13,098
Unearned shares 23,597 28,767
------------------------------------------------------------------
41,865 41,865
==================================================================
Fair value of unearned shares $697,055 960,099
==================================================================
</TABLE>
Directors Retirement Plan
Effective September 28, 1995, Patapsco adopted a deferred compensation
plan covering all non-employee directors. The plan provides benefits based
upon certain vesting requirements. Compensation expense recognized in
connection with the Plan during the year ended June 30, 1999 and 1998 was
$21,959 and $44,446, respectively.
(Continued)
40
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(11) Continued
Stock Options
The Company's 1996 Stock Options and Incentive Plan (Plan) was approved by
the stockholders at the 1996 annual meeting. The Plan provides for the
granting of options to acquire common stock to directors and key employees.
Option prices are equal or greater than the estimated fair market value of
the common stock at the date of the grant. In October 1996 the Company
granted options to purchase 34,474 shares at $27.50 per share. Such 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.
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 1997 43,093 $18.91 - -
Granted -
Exercised -
------------------------------------------------------------------------------------
Outstanding at end of 1998 43,093 18.91 6,895 18.91
Granted -
Exercised -
------------------------------------------------------------------------------------
Outstanding at end of 1999 43,093 $18.91 15,514 18.91
====================================================================================
</TABLE>
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.
(Continued)
41
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(11) Continued
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, 1999 and 1998, compensation expense related to the MRP was $92,049 and
$129,924, 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 5%. 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 $27,800 and
$23,500 for the years ended June 30, 1999 and 1998, respectively.
(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, 1999 and 1998.
(Continued)
42
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(12) Continued
The carrying value and estimated fair value of financial instruments is
summarized as follows at June 30:
<TABLE>
<CAPTION>
1999 1998
---------------------------- ----------------------------
Carrying Carrying
value Fair value Value Fair value
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and interest-bearing deposits $ 3,771,852 3,772,000 1,389,801 1,390,000
Federal funds sold 5,580,098 5,580,000 7,148,619 7,149,000
Investment securities 213,761 214,000 5,118,910 5,119,000
Mortgage-backed securities 4,879,359 4,879,000 - -
Loans receivable, net 77,777,164 79,468,000 75,870,779 74,363,000
Liabilities:
Deposits 69,671,419 69,780,000 70,327,381 70,459,000
Borrowings 13,900,000 13,900,000 10,200,000 10,200,000
Advance payments by borrowers for
taxes, insurance and ground rents 1,210,651 1,211,000 1,403,884 1,404,000
Off balance sheet instruments:
Commitments to extend credit - - - -
==========================================================================================================
</TABLE>
Cash on Hand and in Banks
The carrying amount for cash on hand and in banks approximates fair value
due to the short maturity of these instruments.
Short-term Investments
The carrying amount for short-term investments which consists of Federal
funds sold, approximates fair value due to the overnight maturity of these
instruments.
Investment Securities and Mortgage-Backed Securities
The fair value of investment securities and mortgage-backed securities is
based on bid prices received from an external pricing service or bid
quotations received from securities dealers.
Loans
Loans were segmented into portfolios with similar financial
characteristics. Loans were also segmented by type such as residential,
multifamily and nonresidential, construction and land, second mortgage
loans, commercial, and consumer. Each loan category was further segmented
by fixed and adjustable rate interest terms and performing and
nonperforming categories.
(Continued)
43
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(12) Continued
The fair value of residential loans was calculated by discounting
anticipated cash flows based on weighted-average contractual maturity,
weighted-average coupon, prepayment assumptions and discount rate.
Prepayment speed estimates were derived from published historical
prepayment experience in the mortgage pass-through market and recent
issuance activity in the primary and secondary mortgage markets. The
discount rate for residential loans was calculated by adding to the
Treasury yield for the corresponding weighted average maturity associated
with each prepayment assumption a market spread as observed for mortgage-
backed securities with similar characteristics. The fair values of
multifamily and nonresidential loans were calculated by discounting the
contractual cash flows at Patapsco's current nonresidential loan
origination rate. Construction, land and commercial loans, loans secured by
savings accounts and mortgage lines of credit were determined to be at fair
value due to their adjustable rate nature. The fair value of second
mortgage loans was calculated by discounting scheduled cash flows through
the estimated maturity using estimated market discount rates that reflected
the credit and interest rate risk inherent in the portfolio. The fair value
of consumer loans was calculated by discounting the contractual cash flows
at the Company's current consumer loan origination rate.
The fair value for nonperforming loans was determined by reducing the
carrying value of nonperforming loans by the Company's historical loss
percentage for each specific loan category.
Accrued Interest Receivable
The carrying amount of accrued interest receivable approximates its fair
value.
Savings Accounts
Under SFAS 107, the fair value of deposits with no stated maturity, such as
noninterest bearing deposits, interest bearing NOW accounts, money market
and statement savings accounts, is equal to the carrying amounts. The fair
value of certificates of deposit was based on the discounted value of
contractual cash flows. The discount rate for certificates of deposit was
estimated using the rate currently offered for deposits of similar
remaining maturities.
Borrowed Funds
Borrowed funds, which are advances from the Federal Home Loan Bank of
Atlanta, 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.
(Continued)
44
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(12) Continued
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.
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 1999 1998
--------------------------------------------------------------------------
<S> <C> <C>
Cash $ 245,699 258,484
Investment securities 195,227 92,810
Equity in net assets of the bank 8,449,011 8,392,960
Note receivable - bank 325,100 396,341
Other assets 46,225 12,000
--------------------------------------------------------------------------
$9,261,262 9,152,595
==========================================================================
Accrued expenses and other liabilities $ 43,401 29,755
Stockholders' equity 9,217,861 9,122,840
--------------------------------------------------------------------------
$9,261,262 9,152,595
==========================================================================
</TABLE>
(Continued)
45
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(13) Continued
<TABLE>
<CAPTION>
Statements of Income 1999 1998
--------------------------------------------------------------------------------------
<S> <C> <C>
Income:
Loans receivable $ 33,689 39,445
Cash deposits 814 123
Investments 1,715 -
--------------------------------------------------------------------------------------
Net income before equity in net income
of subsidiary and income taxes 36,218 39,568
Net income of subsidiary 624,012 638,239
--------------------------------------------------------------------------------------
Income before income tax provision 660,230 677,807
Income tax provision - -
--------------------------------------------------------------------------------------
Net income $ 660,230 677,807
======================================================================================
Statements of Cash Flows 1999 1998
--------------------------------------------------------------------------------------
Operating activities:
Net income 660,230 677,807
Adjustments to reconcile net income to netsh
provided by operating activities:
Equity in net income of subsidiary (624,012) (638,239)
Other, net (44,769) (26,247)
--------------------------------------------------------------------------------------
Net cash provided by operating activities (8,551) 13,321
--------------------------------------------------------------------------------------
Investing activities:
Purchase of equity security (133,423) (94,453)
Dividends received 750,000 3,000,000
Loan repayment 71,241 67,723
--------------------------------------------------------------------------------------
Net cash used in investing activities 687,818 2,973,270
--------------------------------------------------------------------------------------
Financing activities:
Decrease in borrowings - (2,700,000)
Purchase of common stock (523,380) -
Cash dividend paid (168,672) (108,766)
--------------------------------------------------------------------------------------
Net cash used in financing activities (692,052) (2,808,766)
--------------------------------------------------------------------------------------
Increase (decrease) in cash and equivalents (12,785) 177,825
Cash and equivalents, beginning of year 258,484 80,659
--------------------------------------------------------------------------------------
Cash and equivalents, end of year $ 245,699 258,484
======================================================================================
</TABLE>
46
<PAGE>
PATAPSCO BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 1999 and 1998
________________________________________________________________________________
(14) Accounting Pronouncements With Future Effective Dates
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, 2000, will not affect the Company's financial position or its
results of operations.
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities". This Statement provides guidance on the financial reporting of
start-up cost and organization cost. It requires costs of start-up
activities and organization cost to be expensed as incurred. The "SOP" also
requires that initial application to be reported as a cumulative effect of
a change in accounting principles. This "SOP" which is effective for fiscal
years beginning after December 15, 1998 will not affect the Company's
financial position or results of operations.
47
<PAGE>
BOARD OF DIRECTORS
<TABLE>
<S> <C> <C>
Thomas P. O'Neill Nicole N. Glaeser Dr. Theodore C. Patterson
Chairman of the Board Budget Director for Baltimore County Retired Physician
Managing Director of American Police Department Secretary of the Company
Express Tax and Business Services
Douglas H. Ludwig
Joseph J. Bouffard Retired Principal of the Baltimore
President and Chief Executive County Public School System
Officer of the Company and the Bank
</TABLE>
EXECUTIVE OFFICERS
<TABLE>
<S> <C> <C>
Joseph J. Bouffard Debra L. Penczek Frank J. Duchacek, Jr.
President and Chief Executive Officer Vice President - Operations; Vice President - Commercial Lending
Assistant Secretary
Michael J. Dee John W. McClean Joseph R. Sallese
Chief Financial Officer and Controller Vice President - Real Estate Lending Vice President - Consumer Lending
</TABLE>
OFFICE LOCATION
1301 Merritt Boulevard
Dundalk, Maryland 21222-2194
Website:http:\\www.parapscobank.com
Telephone: (410) 285-1010
CORPORATE INFORMATION
<TABLE>
<S> <C> <C>
Independent Certified Accountant 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, 1999 as
General Counsel Annual Meeting filed with the Securities and
Nolan Plumhoff & Williams The 1999 Annual Meeting of Stockholders Exchange Commission, will be
Suite 700, Nottingham Centre will be held on October 28, 1999 at furnished without charge to
502 Washington Avenue 4:00 p.m. at the office of The Patapsco stockholders as of the record date
Towson, MD 21204-4528 Bank located at 1301 Merritt Boulevard, for the 1999 Annual Meeting upon
Dundalk, Maryland 21222. written request to: Corporate
Transfer Agent and Registrar Secretary, Patapsco Bancorp, Inc.,
Registrar and Transfer Co. 1301 Merritt Boulevard, Dundalk,
10 Commerce Drive Maryland 21222-21942
Cranford, New Jersey 07016-3572
1 (800) 368-5948
</TABLE>
48
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
State or Other
Jurisdiction of Percentage
Incorporation Ownership
------------- ---------
Parent
- ------
Patapsco Bancorp, Inc. Maryland --
Subsidiary (1)
- ----------
The Patapsco Bank Maryland 100%
Subsidiaries of The Patapsco Bank (1)
- ---------------------------------
PFSL Holding Corp. Maryland 100%
Prime Business Leasing Maryland 100%
- ----------------------
(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
[Anderson Associates, LLP]
[LETTERHEAD]
INDEPENDENT ACCOUNTANTS' CONSENT
The Board of Directors
Patapsco Bancorp, Inc.
1301 Merritt Boulevard
Baltimore, Maryland 21222
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 25,
1999, relating to the consolidated statements of financial condition of Patapsco
Bancorp, Inc. and Subsidiaries as of June 30, 1999, and the related consolidated
statements of income, stockholders' equity and cash flows for the year then
ended, which report appears in the June 30, 1999 Annual Report of Form 10-KSB of
Patapsco Bancorp, Inc.
/s/ Anderson Associates LLP
Baltimore, Maryland
September 17, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 1,601,598
<INT-BEARING-DEPOSITS> 2,170,254
<FED-FUNDS-SOLD> 5,580,098
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 4,879,359
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 77,145,924
<ALLOWANCE> 631,239
<TOTAL-ASSETS> 95,328,361
<DEPOSITS> 69,671,312
<SHORT-TERM> 156,276
<LIABILITIES-OTHER> 2,380,806
<LONG-TERM> 13,900,000
3,445
0
<COMMON> 0
<OTHER-SE> 9,214,415
<TOTAL-LIABILITIES-AND-EQUITY> 95,328,361
<INTEREST-LOAN> 6,689,710
<INTEREST-INVEST> 265,095
<INTEREST-OTHER> 284,860
<INTEREST-TOTAL> 7,239,665
<INTEREST-DEPOSIT> 2,691,024
<INTEREST-EXPENSE> 3,305,535
<INTEREST-INCOME-NET> 3,934,130
<LOAN-LOSSES> 245,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,876,063
<INCOME-PRETAX> 1,059,230
<INCOME-PRE-EXTRAORDINARY> 1,059,230
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 660,230
<EPS-BASIC> 2.03
<EPS-DILUTED> 1.87
<YIELD-ACTUAL> 4.46
<LOANS-NON> 182,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 9,300
<ALLOWANCE-OPEN> 553,513
<CHARGE-OFFS> 173,888
<RECOVERIES> 6,614
<ALLOWANCE-CLOSE> 631,239
<ALLOWANCE-DOMESTIC> 631,239
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 184,000
</TABLE>
