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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission File No. 0-28032
PATAPSCO BANCORP, INC.
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(Exact name of registrant as specified in its charter)
MARYLAND 52-1951797
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(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
1301 MERRITT BOULEVARD, DUNDALK, MARYLAND 21222-2194
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(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (410) 285-1010
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
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(Title of Class)
Check whether the 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, 2000, the registrant had $8,245,532 in
revenues.
As of September 16, 2000, the aggregate market value of voting stock held by
non-affiliates was approximately $5,199,369, computed by reference to the most
recent sales price on September 16, 2000 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, 2000: 327,390.
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, 2000. (Parts II and III)
2. Portions of Proxy Statement for registrant's 2000 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 $9.3 million of such loans, or 10.1% of total
loans outstanding at June 30, 2000. 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, 2000, the Bank had $9.9 million, $1.6 million, $11.8 million, $1.8 million
and $7.1 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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PENDING ACQUISITION
On May 16, 2000, the Company announced that it had agreed to purchase
Northfield Bancorp, Inc., the parent company of Northfield Federal Savings Bank.
Under the terms of the agreement of merger, each share of Northfield Bancorp
common stock outstanding at the effective time of the merger will be canceled
and converted into the right to receive $12.50 in cash and .24 shares of
Patapsco Bancorp's Series A Noncumulative Convertible Perpetual Preferred Stock.
At any time after issuance, this preferred stock will be convertible into shares
of Patapsco Bancorp common stock, on a one for one basis. Each share of Patapsco
Bancorp's outstanding preferred stock will earn dividends at the annual rate of
7.5% of its liquidation preference of $25.00 per share. Dividends are
noncumulative, which means that if the Company's Board does not pay dividends
for a quarterly period, it is not obligated to pay a dividend for that period at
a later date. After five years from the date of issuance of the Patapsco Bancorp
preferred stock, Patapsco Bancorp may redeem some or all of the outstanding
Patapsco Bancorp preferred stock at $25.00 per share plus any declared but
unpaid dividends for the then current quarter.
The merger is subject to the approval of the Board of Governors of the
Federal Reserve System, the Commissioner of Financial Regulation of the Maryland
Department of Labor, Licensing and Regulation, and the approval of the
stockholders of Northfield Bancorp. If all approvals are received, the merger is
expected to close some time in the fourth quarter of calendar year 2000.
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.
LENDING ACTIVITIES
General. The Company's gross loan portfolio totaled $92.7 million at
June 30, 2000, representing 90.3% of total assets at that date. It is the
Company's policy to concentrate its lending within its market area. At June 30,
2000, $49.9 million, or 53.9% 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 $13.4 million,
or 14.6% of the Company's gross loan portfolio at June 30, 2000. In addition,
the Company originates consumer and other loans, including home equity loans,
home improvement loans and loans secured by deposits. At June 30, 2000, consumer
and other loans totaled $12.3 million, or 13.4% of the Company's gross loan
portfolio. The Company's commercial loan portfolio, which consists of small
business loans and commercial leases, totaled $16.9 million, or 18.3% 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
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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 year ended June 30, 2000 the company did not
purchase any whole loans or participation interests. In the year ended June 30,
1999, the Company purchased whole loans and loan participation interests
totaling $337,000 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.
Loan Underwriting Policies. The Company's lending activities are
subject to the Company's non-discriminatory underwriting standards and to loan
origination procedures prescribed by the Company's Board of Directors and
management. Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. First mortgage loans in amounts of up to $252,700, $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 typically
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, 2000. At that date, the Company had no
lending relationships in excess of the loans-to-one-borrower limit. At June 30,
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2000, 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, 2000.
Interest rates charged by the Company on loans are affected principally
by competitive factors, the demand for such loans and the supply of funds
available for lending purposes. These factors are, in turn, affected by general
economic conditions, monetary policies of the federal government, including the
Federal Reserve Board, legislative tax policies and government budgetary
matters.
Residential Real Estate Lending. The Company historically has been and
continues to be an originator of residential real estate loans in its market
area. Residential real estate loans consist of both single-family and
multi-family residential real estate loans. At June 30, 2000, residential
mortgage loans, excluding home improvement loans, and home equity loans totaled
$49.9 million, or 53.9% of the Company's gross loan portfolio. Of such loans,
$4.6 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, 2000, $36 million, or 57.7% of the
Company's residential and commercial real estate loan portfolio was comprised of
fixed-rate mortgage loans and $26.2 million or 42.3% 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, 2000, the Company had $1.6
million of multi-family residential real estate loans, which amounted to 1.71%
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, 2000, $1.6 million, or 1.7%, of the
Company's gross loan portfolio consisted of construction loans.
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Prior to making a commitment to fund a loan, the Bank requires both an
appraisal of the property by appraisers approved by the Board of Directors and a
study of the feasibility of the proposed project. The Bank also reviews and
inspects each project at the commencement of construction and prior to payment
of draw requests during the term of the construction loan. The Bank generally
charges a construction fee between 1% and 2%.
Construction financing generally is considered to involve a higher
degree of risk of loss than long-term financing on improved, occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of construction costs proves to be
inaccurate and the borrower is unable to meet the Bank's requirements of putting
up additional funds to cover extra costs or change orders, then the Bank will
demand that the loan be paid off and, if necessary, institute foreclosure
proceedings, or refinance the loan. If the estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with collateral having a value which is insufficient to assure full repayment.
The Bank has sought to minimize this risk by limiting construction lending to
qualified borrowers (i.e., borrowers who satisfy all credit requirements and
whose loans satisfy all other underwriting standards which would apply to the
Bank's permanent mortgage loan financing for the subject property) in the Bank's
market area. On loans to builders, the Bank works only with selected builders
with whom it has experience and carefully monitors the creditworthiness of the
builders.
Commercial Real Estate Lending. The Company's commercial real estate
loan portfolio consists of loans to finance the acquisition of small office
buildings, shopping centers and commercial and industrial buildings. Such loans
generally range in size from $100,000 to $900,000. At June 30, 2000, the Company
had $11.8 million of commercial real estate loans, which amounted to 12.9% 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,
2000, consumer and other loans totaled $12.3 million, or 13.4% of the Company's
gross loan portfolio.
In July 1995, the Company instituted a home improvement loan program.
Such loans are made to finance a variety of other home improvement projects,
such as replacement windows, siding and room additions. The Company's policy is
to originate home improvement loans throughout Maryland, except for the western
portion of the state, and northern Virginia, 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
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improvement loans are made on both secured and unsecured bases. However, the
majority of home improvement loans with a principal loan amount over $10,000 or
which have a term longer than 84 months are made on a secured basis with
loan-to-value ratios up to 80% or 90%, depending on the type of project
financed. At June 30, 2000, home improvement loans amounted to $9.3 million, or
10.1% of the Company's gross loan portfolio, with $1.8 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, 2000 the Company's commercial loans totaled $9.9 million, or 10.8% 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
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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.
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, 2000, commercial lease finance transaction loans totaled $7.1million,
or 7.6% 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, 2000 the Company
was servicing loans for others totaling approximately $2.1 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,
-----------------------------
2000 1999
---------- ----------
(In thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential............................................. $ 279 $ 173
Commercial.............................................. -- --
Construction............................................ -- --
Consumer................................................... 14 --
Commercial................................................. 10 --
--------- ---------
Total................................................... $ 303 $ 173
========= =========
Accruing loans which are contractually past due
90 days or more............................................. $ -- $ --
--------- ---------
Total................................................... $ -- $ --
--------- =========
Total nonperforming loans............................... $ 303 $ 173
========= =========
Percentage of total loans...................................... 0.33% 0.23%
========= =========
Other non-performing assets (2)................................ $ 72 $ 31
========= =========
<FN>
-------------
(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.
</FN>
</TABLE>
During the year ended June 30, 2000, gross interest income of $11,000
would have been recorded on loans accounted for on a nonaccrual basis if the
loans had been current throughout the respective periods. Interest on such loans
included in income during that period amounted to $8,600.
At June 30, 2000, nonaccrual loans consisted of 3 mortgage loans
secured by single-family residential real estate properties aggregating $279,000
and one commercial lease transaction totaling $10,000 and two consumer loans
totaling $14,000. 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, 2000, the Company had $72,000 in real estate owned, which
consisted of one residential property 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
losses and believes such allowances are adequate, future adjustments may be
necessary if economic
9
<PAGE>
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,
--------------------------------
2000 1999
--------- ----------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period.................................. $ 631 $ 554
Loans charged off:
Residential real estate mortgage............................. -- 48
Commercial Loan/Lease....................................... 29 --
Consumer..................................................... 225 126
--------- ---------
Total charge-offs......................................... 254 174
Recoveries:
Single-family residential mortgage........................... 1 5
Commercial Loan/Lease........................................ 18
Consumer..................................................... 21 1
--------- ---------
Total recoveries.......................................... 41 6
--------- ---------
Net loans charged off........................................... 213 167
Provision for loan losses....................................... 325 245
--------- ---------
Balance at end of period........................................ $ 743 $ 631
========= =========
Ratio of net charge-offs to average
loans outstanding during the period.......................... .25% .21%
========= =========
</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,
--------------------------------------------------------------
2000 1999
----------------------------- -------------------------------
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...................................... $ 125 54.35% $ 117 61.83%
Commercial....................................... 103 12.87 83 10.02
Construction..................................... 24 1.71 18 2.99
Consumer and other.................................. 159 13.42 144 14.54
Commercial.......................................... 199 17.65 85 10.62
Unallocated......................................... 133 0.00 184 0.00
------- -------- ------- --------
Total allowance for loan losses................ $ 743 100.00% $ 631 100.00%
======= ====== ======= ======
</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, 2000, 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 $112,000. 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
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.
11
<PAGE>
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,
2000, the Company had outstanding Federal Home Loan Bank of Atlanta advances of
$14.9 million with an average rate of 5.92%.
SUBSIDIARY ACTIVITIES
The Bank has three 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, Prime Business Leasing that was formed in October 1998
and Patapsco Financial Services, Inc., which was formed in March 2000 in order
to sell alternative investment products to the Company's customers. As of June
30, 2000, Patapsco Financial Services, Inc had not yet commenced operations.
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, 2000, the Company had 33 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.
Financial Modernization Legislation. On November 12, 1999, President
Clinton signed legislation which could have a far-reaching impact on the
financial services industry. The Gramm-Leach-Bliley ("G-L-B") Act authorizes
affiliations between banking, securities and insurance firms and authorizes bank
holding companies and national banks to engage in a variety of new financial
activities. Among the new activities that will be permitted to bank holding
companies are securities and insurance brokerage, securities underwriting,
insurance underwriting and merchant banking. The Federal Reserve Board, in
consultation with the Secretary of the Treasury, may approve additional
financial activities. The G-L-B Act, however, prohibits future acquisitions of
existing unitary savings and loan holding companies by firms which are engaged
in commercial activities and limits the permissible activities of unitary
holding companies formed after May 4, 1999.
The G-L-B Act imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the
G-L-B Act. The G-L-B Act directs the federal banking agencies, the National
Credit Union Administration, the Secretary of the Treasury, the Securities and
Exchange Commission and the Federal Trade Commission, after consultation with
the National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions will become
effective in November 2000, with full compliance required by July 1, 2001.
The G-L-B Act contains significant revisions to the FHLB System. The
G-L-B Act imposes new capital requirements on the FHLBs and authorizes them to
issue two classes of stock with differing dividend rates and redemption
requirements. The G-L-B Act deletes the current requirement that the FHLBs
annually contribute $300 million to pay interest on certain government
obligations in favor of a 20% of net earnings formula. The G-L-B Act expands the
permissible uses of FHLB advances by community financial institutions (under
$500 million in assets) to include funding loans to small businesses, small
farms and small agri-businesses. The G-L-B Act makes membership in the FHLB
voluntary for federal savings associations.
13
<PAGE>
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company is unable to predict the impact of the G-L-B Act on its
operations at this time.
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 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 CAMELS rating system for banks. Banks not rated composite
1 under the CAMELS 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 and up to 45% of unrealized gains on equity securities. 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
14
<PAGE>
system, exceeds 1% of the bank's total assets, the bank would be required under
the proposed rule to hold additional capital equal to the dollar amount of the
excess. Management of the Bank has not determined what effect, if any, the
Federal Reserve Board's proposed interest rate risk component would have on the
Bank's capital if adopted as proposed.
In addition, the Bank is subject to the statutory capital requirements
imposed by the State of Maryland. Under Maryland statutory law, if the surplus
of a Maryland commercial bank at any time is less than 100% of its capital
stock, then, until the surplus is 100% of the capital stock, the commercial
bank: (i) must transfer to its surplus annually at least 10% of its net
earnings; and (ii) may not declare or pay any cash dividends that exceed 90% of
its net earnings.
The table below provides information with respect to the Bank's
compliance with its regulatory capital requirements at the dates indicated.
<TABLE>
<CAPTION>
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, 2000:
Total Capital (to Risk Weighted Assets)..... $ 9,822 14.31% $ 5,490 8.00% $ 6,863 10.00%
Tier 1 Capital (to Risk Weighted Assets).... 9,079 13.23 2,745 4.00 4,118 6.00
Tier 1 Capital (to Average Assets)......... 9,079 8.89 4,083 4.00 5,104 5.00
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 14.19 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
</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
15
<PAGE>
or receivership within 90 days unless periodic determinations are made that
forbearance from such action would better protect the deposit insurance fund.
Unless appropriate findings and certifications are made by the appropriate
federal bank regulatory agencies, a critically undercapitalized institution must
be placed in receivership if it remains critically undercapitalized on average
during the calendar quarter beginning 270 days after the date it became
critically undercapitalized.
Federal banking regulators have adopted regulations implementing the
prompt corrective action provisions of FDICIA. Under these regulations, the
federal banking regulators will generally measure a depository institution's
capital adequacy on the basis of the institution's total risk-based capital
ratio (the ratio of its total capital to risk-weighted assets), Tier 1
risk-based capital ratio (the ratio of its core capital to risk-weighted assets)
and leverage ratio (the ratio of its core capital to adjusted total assets).
Under the regulations, an institution that is not subject to an order or written
directive by its primary federal regulator to meet or maintain a specific
capital level will be deemed "well capitalized" if it also has: (i) a total
risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital
ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or greater. An
"adequately capitalized" depository institution is an institution that does not
meet the definition of well capitalized and has: (i) a total risk-based capital
ratio of 8.0% or greater; (ii) a Tier 1 risk-based capital ratio of 4.0% or
greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if
the depository institution has a composite 1 CAMELS 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 CAMELS 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 CAMELS rating category. At June 30, 2000, 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
16
<PAGE>
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, 2000 of $845,000. 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 and small businesses and small farms and small
agri-businesses. At June 30, 2000, the Bank had $14.9 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 $44.3 million, plus 10% on
the remainder. 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, 2000, 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.
Regular semi-annual SAIF assessment rates set by the FDIC range from 0
to 27 basis points. Until December 31, 1999, however, SAIF-insured institutions
were 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
17
<PAGE>
members were 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.
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 FDIC 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 meets 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 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.
18
<PAGE>
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, 2000
was $1.3 million.
Transactions with Related Parties. Transactions between a state member
bank and any affiliate are governed by Sections 23A and 23B of the Federal
Reserve Act. An affiliate of a state member bank is any company or entity which
controls, is controlled by or is under common control with the state member
bank. In a holding company context, the parent holding company of a state member
bank and any companies which are controlled by such parent holding company are
affiliates of the state member bank. Generally, Sections 23A and 23B (i) limit
the extent to which an institution or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus and (ii) require that all such transactions be on terms
substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar other types of transactions. In addition to the restrictions imposed by
Sections 23A and 23B, no state member bank may (i) loan or otherwise extend
credit to an affiliate, except for any affiliate which engages only in
activities which are permissible for bank holding companies, or (ii) purchase or
invest in any stocks, bonds, debentures, notes or similar obligations of any
affiliate, except for affiliates which are subsidiaries of the state member
bank.
State member banks also are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve's Regulation O
thereunder on loans to executive officers, directors and principal stockholders.
Under Section 22(h), loans to a director, executive officer and to a greater
than 10% stockholder of a state member bank and certain affiliated interests of
such persons, may not exceed, together with all other
19
<PAGE>
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. ss. 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 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.
20
<PAGE>
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 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
21
<PAGE>
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 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, 2000.
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.
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<PAGE>
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, 2000.
<TABLE>
<CAPTION>
Book Value at
Year Owned or June 30, Approximate
Opened Leased 2000 Square Footage
------ -------- ------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
1301 Merritt Boulevard 1970 Owned $651 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, 2000. 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, 2000, there were no legal proceedings to
which the Company or the Bank was a party, or to which any of their property was
subject, which were expected by management to result in a material loss to the
Company or the Bank. There are no pending regulatory proceedings to which the
Company, the Bank or its subsidiary is a party or to which any of their
properties is subject which are currently expected to result in a material loss.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
----------------------------------------------------------
Not applicable.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
-----------------------------------------------------------------
The information contained under the sections captioned "Market
Information" in the Company's Annual Report to Stockholders for the Fiscal Year
Ended June 30, 2000 (the "Annual Report") filed as Exhibit 13 hereto is
incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
------------------------------------------------------------------------
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" on
pages 5 through 18 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 19 through 46 in the Annual Report, which are listed under Item 13
herein, are incorporated herein by reference.
23
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
-------------------------------------------------------------------------
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
-------------------------------------------------------------
For information concerning the Board of Directors and executive
officers of the Company, the information contained under the section captioned
"Proposal I -- Election of Directors" in the Company's 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
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.
24
<PAGE>
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K.
-----------------------------------------------
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following consolidated financial statements
are incorporated by reference from Item 7 hereof (see Exhibit 13):
Independent Auditors' Report Consolidated
Statement of Financial Condition as of June 30, 2000 and 1999
Consolidated Statements of Income for the Years Ended June 30, 2000
and 1999
Consolidated Statements of Stockholders' Equity for the Years Ended
June 30, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended June 30,
2000 and 1999 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. and Articles
Supplementary
* 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 and John McClean
* 10.4(b)Severance Agreements between Patapsco Bancorp, Inc. and Debra
Penczek and John McClean
* 10.5 Patapsco Federal Savings and Loan Association Retirement Plan
for Non-Employee Directors
* 10.6 Patapsco Federal Savings and Loan Association Incentive
Compensation Plan
* 10.7 Deferred Compensation Agreements between Patapsco Federal Savings
and Loan Association and each of Directors McGowan and Patterson
* 10.8(a)Severance Agreement between Patapsco Federal Savings and Loan
Association and Frank J. Duchacek
* 10.8(b)Severance Agreement between Patapsco Bancorp, Inc. and Frank J.
Duchacek, Jr.
**** 10.9 The Patapsco Bank Retirement Plan for Non-Employee Directors
10.10 Patapsco Bancorp, Inc. 2000 Stock Option and Incentive Plan
10.11 Severance Agreements between The Patapsco Bank and Michael J.
Dee and Frank J. Duchacek, Jr.
13 2000 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, 1999 (File No. 0-28032).
25
<PAGE>
(B) REPORTS ON FORM 8-K.
-------------------
On May 19, 2000, the Company filed a Current Report on Form 8-K under Item
5 announcing that it had entered into an Agreement of Merger with Northfield
Bancorp, Inc. pursuant to which Northfield Bancorp, Inc. would be acquired by
the Company.
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, 2000
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, 2000
------------------------------------------------
Joseph J. Bouffard
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Michael J. Dee September 16, 2000
------------------------------------------------
Michael J. Dee
Vice-President and Treasurer
(Principal Financial and Accounting Officer)
/s/ Thomas P. O'Neill September 16, 2000
------------------------------------------------
Thomas P. O'Neill
Chairman of the Board
/s/ Theodore C. Patterson September 16, 2000
------------------------------------------------
Theodore C. Patterson
Director and Secretary
/s/ Douglas H. Ludwig September 16, 2000
------------------------------------------------
Douglas H. Ludwig
Director
/s/ Nicole N. Glaeser September 16, 2000
------------------------------------------------
Nicole N. Glaeser
Director
/s/ William R. Waters September 16, 2000
------------------------------------------------
William R. Waters
Director
