U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________ to _________
Commission file number 000-23847
SHORE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 54-1873994
- ------------------------------- --------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
25253 Lankford Highway
Onley, Virginia 23418
- ------------------------------- ----------------------
(Address of Principal (Zip Code)
Executive Offices)
Issuer's telephone number: (757) 787-1335
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for 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
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes ___ No ___
Number of shares of Common Stock outstanding as of November 13, 1998: 1,810,812
Transitional Small Business Disclosure Format: Yes ____ No X
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Index - Form 10-QSB
PART I - FINANCIAL INFORMATION
Item 1 - Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997
Consolidated Statements of Income for the Three Months and
Nine Months Ended September 30, 1998 and 1997
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997
Consolidated Statement of Stockholders' Equity for the Nine
Months Ended September 30, 1998
Notes to Unaudited Consolidated Financial Statements
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations
Results of Operations
Financial Condition
Asset Quality
Liquidity and Capital Resources
Interest Sensitivity
Impact of Accounting Pronouncements
Year 2000 Project
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
Item 2 - Changes in Securities
Item 3 - Defaults Upon Senior Securities
Item 4 - Submission of Matters to Vote of Security Holders
Item 5 - Other Information
Item 6 - Exhibits and Reports on Form 8-K
SIGNATURES
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
- -----------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
Assets
Cash (including interest - earning deposits of
approximately $3,957,000 and $1,841,000, respectively) $ 5,967,284 $ 4,190,551
Investment securities:
Held to maturity (fair value of $3,038,000 and
$5,219,000, respectively 3,027,235 5,232,587
Available for sale (amortized cost of $23,677,000 and
$20,761,000, respectively) 24,390,884 21,029,952
Investment in Federal Home Loan Bank stock,
at cost 580,500 580,500
Investment in Federal Reserve Bank stock, at cost 124,800 -
Loans receivable, net 77,307,896 72,889,907
Premises and equipment, net 2,357,291 2,420,457
Real estate owned 46,677 445,912
Accrued interest receivable 849,903 915,271
Prepaid income taxes 63,493 124,586
Prepaid expenses and other assets 347,884 262,791
-----------------------------
$ 115,063,847 $ 108,092,514
-----------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 100,647,970 $ 95,213,440
Advances from Federal Home Loan Bank 73,853 75,000
Advance payments by borrowers for taxes
and insurance 341,142 215,029
Income taxes payable:
Current - -
Deferred 265,906 103,218
Accrued interest payable 54,010 35,755
Accrued expenses and other liabilities 144,713 120,045
-----------------------------
Total liabilities 101,527,594 95,762,487
-----------------------------
Stockholders' equity
Preferred stock, par value $1 per share, 500,000
shares authorized; none issued and
outstanding - -
Common stock, par value $.33 per share, 5,000,000
shares authorized; 1,810,812 and 1,804,812 shares
issued and outstanding, respectively 597,568 595,588
Additional capital 3,584,652 3,563,592
Retained earnings, substantially restricted 8,916,444 8,000,729
Accumulated other comprehensive income 437,589 170,118
------------------------------
Total stockholders' equity 13,536,253 12,330,027
------------------------------
$ 115,063,847 $ 108,092,514
==============================
</TABLE>
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Income
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------------------------------------
1998 1997 1998 1997
- ---------------------------------------------------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Interest income
Loans $ 1,689,477 $ 1,690,869 $ 5,043,886 $ 4,965,316
Investments 426,021 416,251 1,271,971 1,146,132
-------------------------------- ---------------------------------
Total interest income 2,115,497 2,107,120 6,315,857 6,111,448
-------------------------------- ---------------------------------
Interest expense
Deposits 1,082,235 1,115,364 3,240,737 3,219,689
FHLB advances 594 1,114 1,728 50,770
-------------------------------- ---------------------------------
Total interest expense 1,082,829 1,116,478 3,242,465 3,270,459
-------------------------------- ---------------------------------
Net interest income 1,032,668 990,642 3,073,392 2,840,989
Provision for loan losses 42,300 36,000 117,900 208,000
-------------------------------- ---------------------------------
Net interest income after
provision for loan losses 990,368 954,642 2,955,492 2,632,989
-------------------------------- ---------------------------------
Noninterest income
Deposit account fees 164,037 116,935 420,192 339,350
Loan fees 34,322 26,977 94,029 75,402
Other 28,658 27,657 120,622 168,760
-------------------------------- ---------------------------------
Total noninterest income 227,016 171,569 634,842 583,512
-------------------------------- ---------------------------------
Noninterest expense
Compensation and employee
benefits 291,289 282,882 912,440 861,033
Occupancy and equipment 171,144 148,719 492,798 422,223
Advertising 9,149 15,026 41,227 41,054
Data processing 114,219 95,011 345,501 274,958
Federal insurance premium 14,881 14,574 44,858 43,298
Other 94,276 65,202 284,396 246,536
-------------------------------- ---------------------------------
Total noninterest expense 694,958 621,414 2,121,219 1,889,102
-------------------------------- ---------------------------------
Income before income taxes 522,426 504,797 1,469,115 1,327,399
Income taxes 198,523 185,327 553,400 377,993
-------------------------------- ---------------------------------
Net income $ 323,903 $ 319,470 $ 915,715 $ 949,406
================================ =================================
Earnings Per Common Share:
Basic $ 0.18 $ 0.20 $ 0.51 $ 0.66
================================ =================================
Diluted $ 0.18 $ 0.20 $ 0.50 $ 0.65
================================ =================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statement of Stockholders' Equity
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1998
- ---------------------------------------------------------------------------------------------------------
Net Unrealized
Gain on
Common Additional Retained Securities
Stock Capital Earnings Available for Sale Total
------------ ------------ ------------ ---------------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 595,588 $ 3,563,592 $ 8,000,729 $ 170,118 $ 12,330,027
Proceeds from sale of common stock
upon exercise of stock options 1,980 21,060 23,040
Comprehensive income - - 915,715 267,471 1,183,186
-----------------------------------------------------------------------
Balance, September 30, 1998 $ 597,568 $ 3,584,652 $ 8,916,444 $ 437,589 $ 13,536,253
======================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1998 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 915,715 $ 949,406
Adjustments to reconcile to net cash
provided by operating activities:
Provision for loan losses 117,900 208,000
Depreciation and amortization 199,955 155,707
Amortization of premium and accretion
of discount on securities, net 8,651 (4,912)
(Gain) loss on sale of securities (30,646) 23,000
(Gain) loss on sale of premises and
equipment 3,450 (77,865)
Change in net deferred loan fees (92,506) 13,298
Loss on sale of repossessed assets 11,494 -
(Increase) decrease in other assets 36,189 (59,921)
Increase in other liabilities 169,036 410,286
---------------------------
Net cash provided by operating activities 1,339,238 1,616,999
---------------------------
Cash flows from investing activities
Purchase of available-for-sale securities (12,406,683) (13,766,629)
Proceeds from maturities and sales of
available-for-sale securities 10,621,732 9,048,806
Purchase of held-to-maturity securities - -
Proceeds from maturities of held-to-maturity
securities 1,081,525 440,332
Purchase of Federal Reserve Bank stock (124,800) -
Loan origination, net of repayments (4,553,653) (2,237,707)
Proceeds from sale of premises and equipment 1,439 99,000
Purchase of premises and equipment (136,499) (280,724)
Proceeds from sale of real estate owned 498,011 146,032
---------------------------
Net cash used by investing activities (5,018,928) (6,550,890)
---------------------------
Cash flows from financing activities
Net increase in demand deposits 5,157,968 2,294,600
Net increase in time deposits 276,562 5,071,565
Proceeds from FHLB advances 200,000 12,500,000
Repayments of FHLB advances (201,147) (16,500,000)
Proceeds from the sale of common stock 23,040 3,105,143
---------------------------
Net cash provided by financing activities 5,456,423 6,471,308
---------------------------
Increase in cash and cash equivalents 1,776,733 1,537,417
Cash and cash equivalents, beginning of period 4,190,551 2,571,553
---------------------------
Cash and cash equivalents, end of period $ 5,967,284 $ 4,108,970
===========================
Supplemental disclosure of cash flow information
Cash paid during the period for interest $ 3,224,210 $ 3,307,951
Cash paid for income taxes $ 490,498 $ 244,144
Supplemental schedule of non-cash investing and
financing activities
Transfers from loans to real estate acquired
through foreclosure $ 110,269 $ 567,559
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Notes to Unaudited Consolidated Financial Statements
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements of Shore Financial
Corporation and Subsidiary (the "Company") have been prepared in accordance with
generally accepted accounting principles ("GAAP") and with the instructions to
Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include
all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) necessary for a fair presentation of the consolidated
financial statements have been included.
In preparing the consolidated financial statements in conformity with GAAP,
management is required to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates. The consolidated results of
operations and other data for the three and nine month periods ended September
30, 1998 are not necessarily indicative of the results that may be expected for
any other interim period or the entire year ending December 31, 1998. The
unaudited consolidated financial statements presented herein should be read in
conjunction with the audited consolidated financial statements and related notes
thereto in the Company's Annual Report on Form 10-K for the year ended December
31, 1997.
Principles of Consolidation
The consolidated financial statements of the Company include and primarily
consist of the accounts of its wholly-owned subsidiary Shore Bank (the "Bank").
All significant intercompany balances and transactions have been eliminated in
consolidation.
NOTE 2 - ORGANIZATION
The Company is a Virginia corporation organized in September 1997 by the Bank
for the purpose of becoming a unitary holding company of the Bank. In February
and March 1998, the Bank received all necessary federal and state regulatory
approvals to consummate the reorganization of the Bank into the holding company
form of organization (the "Reorganization") and, in connection therewith, the
subsequent conversion of the Bank from a federally chartered savings bank to a
Virginia chartered, Federal Reserve member, commercial bank. On March 16, 1998,
the Bank effected the Reorganization and on April 1, 1998 the Bank completed the
charter conversion.
<PAGE>
NOTE 3 - EARNINGS PER SHARE
The following is an unaudited reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations for the periods ended
September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income (numerator, basic and diluted) $ 323,903 $ 319,470 $ 915,715 $ 949,406
Weighted average shares outstanding
(denominator) 1,810,812 1,570,437 1,808,834 1,439,908
----------- ----------- ----------- -----------
Earnings per common share - basic $0.18 $0.20 $0.51 $0.66
=========== =========== =========== ===========
Effect of dilutive securities:
Weighted average shares outstanding 1,810,812 1,570,437 1,808,834 1,439,908
Effect of stock options 15,088 17,458 16,115 14,701
----------- ----------- ----------- -----------
Diluted average shares outstanding
(denominator) 1,825,900 1,587,895 1,824,949 1,454,609
----------- ----------- ----------- -----------
Earnings per common share -
assuming dilution $0.18 $0.20 $0.50 $0.65
=========== =========== =========== ===========
</TABLE>
NOTE 4 - COMPREHENSIVE INCOME
On January 1, 1998, the Company adopted Financial Accounting Standards Board
(FASB) Statement No. 130, Reporting Comprehensive Income. FASB No. 130
establishes standards for reporting and displaying comprehensive income and its
components. The adoption of FASB No. 130 did not have a material impact on the
Company. All of the Company's other comprehensive income relates to net
unrealized gains (losses) on available-for-sale securities.
Total comprehensive income consists of the following for the nine months ended
September 30, 1998:
Net income $ 915,715
Net unrealized gains on available-
for-sale securities 267,471
-----------
Total comprehensive income $1,183,186
===========
<PAGE>
The following is an unaudited reconciliation of the related tax effects
allocated to each component of other comprehensive income at September 30, 1998.
<TABLE>
<CAPTION>
Tax
Before-Tax (Expense) Net-of-Tax
Amount or Benefit Amount
----------- ----------- -----------
<S> <C> <C> <C>
Unrealized gains on securities:
Unrealized holding gains
arising during the period $460,805 ($174,333) $286,471
Less: reclassification adjustment
for gains included in income 30,646 (11,645) 19,000
----------- ----------- -----------
Net unrealized gains $430,159 ($162,688) $267,471
=========== =========== ===========
</TABLE>
NOTE 5 - STOCKHOLDERS' EQUITY
During the period ended September 30, 1998, 6,000 stock options were exercised
at $3.84 per share and 16,000 stock options were granted at $10.00 per share. At
September 30, 1998, 50,000 stock options were outstanding at a weighted average
exercise price of $7.01 per share.
<PAGE>
Item 2 - Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations
Results of Operations
General
Net income for the nine months ended September 30, 1998 decreased $33,000, or
3.5%, to $916,000, compared to net income of $949,000 for the same period in the
prior year. Earnings for the 1998 nine month period include approximately
$92,000 in losses associated with the operation of the newest branch office,
located in Salisbury, Maryland, which opened in November 1997. Net income for
the nine months ended September 30, 1997 includes approximately $50,000
(after-tax) of net nonrecurring items that positively affected earnings for that
period. These items primarily consist of gains from the sale of real estate,
enterprise zone tax credits, and special charitable contributions. Earnings were
positively impacted during the 1998 period by the $3.1 million in additional
available capital raised during August 1997, $4.4 million in net loan growth,
net gains on sale of securities of $31,000 and increased deposit account and
loan fees.
Net Interest Income
Net interest income increased $232,000 for the nine months ended September 30,
1998 as compared to the same period in 1997. The net interest margin increased
to 4.02% from 3.88% for the nine month period. The interest rate spread remained
relatively flat at 3.40% for the nine months ended September 30, 1998 as
compared to 3.42% for the 1997 nine month period. The interest rate spread does
not reflect the impact of noninterest bearing deposits on the Bank's cost of
funds and the corresponding net interest spread. Noninterest bearing demand
deposits increased to $7.3 million at September 30, 1998 as compared $5.3
million at September 30, 1997. Including average noninterest deposits in
calculating the cost of funds results in an interest rate spread of 3.71% for
the nine months ended September 30, 1998 as compared to 3.67% for the same
period in 1997. This increase more accurately reflects the impact of
management's efforts to reduce the Bank's overall cost of funds and the Bank's
shift towards operating as a commercial bank.
Interest income increased $204,000 for the nine months ended September 30, 1998
as compared to the same period in 1997. The increase resulted from the average
balance of loans increasing by $1.3 during the period, primarily in commercial
and consumer lending and home equity lines. Additionally, the average balance of
securities increased by $4.6 million resulting from approximately $3.1 million
in additional capital raised in the Bank's public and subscription offerings of
common stock (the "Offering") during August 1997 and deposit growth during the
period.
Interest expense decreased $28,000 for the nine months ended September 30, 1998
as compared to the same period in 1997. This is due to the average rate on
interest-bearing liabilities decreasing from 4.87% in 1997 to 4.71% for the
September 1998 period while average interest-bearing liabilities outstanding
during the period increased $2.2 million. An increased emphasis on commercial
and consumer relationships has resulted in an increase in lower costing
interest-bearing and noninterest-bearing checking and savings accounts.
The following table illustrates average balances of total interest-earning
assets and total interest-bearing liabilities for the periods indicated, showing
the average distribution of assets, liabilities, stockholders' equity and the
related income, expense and corresponding weighted average yields and costs. The
average balances used in these tables and other statistical data were calculated
using daily averages.
<PAGE>
Average Balances, Income and Expenses, Yields and Rates
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-----------------------------------------------------------------------
1998 1997
----------------------------------- -----------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Assets:
Securities (1) $ 26,685 $1,272 6.35% $ 21,919 $1,097 6.67%
Loans (net of unearned income):
Real Estate Mortgage 46,523 2,989 8.57% 49,614 3,208 8.62%
Real Estate Construction 1,370 84 8.18% 1,741 105 8.06%
Commercial 16,889 1,178 9.30% 14,539 1,003 9.20%
Home Equity Lines 5,515 382 9.24% 4,558 335 9.79%
Consumer 5,668 411 9.67% 4,259 314 9.83%
----------- ----------- ----------- -----------
Total loans 75,965 5,044 8.85% 74,711 4,965 8.86%
----------- ----------- ----------- -----------
Federal funds sold 0 0 0.00% 0 0 0.00%
Interest-bearing deposits
in other banks 3,121 116 4.96% 2,316 87 5.01%
----------- ----------- ----------- -----------
Total earning assets 105,771 6,432 8.11% 98,946 6,149 8.29%
----------- ----------- ----------- -----------
Less: allowance for loan losses (770) (738)
Total nonearning assets 6,892 6,084
----------- -----------
Total assets $111,893 $104,292
=========== ===========
Liabilities
Interest-bearing deposits:
Checking and savings $ 23,956 $ 441 2.45% $ 19,808 $ 377 2.54%
Time deposits 67,740 2,799 5.51% 68,500 2,843 5.53%
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing
deposits 91,696 3,240 4.71% 88,308 3,220 4.86%
FHLB advances 75 2 3.56% 1,252 51 5.43%
----------- ----------- ----------- -----------
Total interest-bearing
liabilities 91,771 3,242 4.71% 89,560 3,271 4.87%
----------- -----------
Non-interest bearing liabilities:
Demand deposits 6,536 4,889
Other liabilities 777 899
----------- -----------
Total liabilities 99,084 95,348
Stockholders' equity 12,809 8,943
----------- -----------
Total liabilities and stockholders'
equity $111,893 $104,292
=========== ===========
Net interest income $3,190 $2,878
=========== ===========
Interest rate spread (1) 3.40% 3.42%
Net interest margin (1) 4.02% 3.88%
</TABLE>
(1) Tax equivalent basis.
<PAGE>
Noninterest Income
Noninterest income was $635,000 during the nine months ended September 30, 1998
as compared to $574,000 for the same period in 1997, an increase of $51,000 or
10.63%. This was due primarily to increases in deposit account and loan fees
resulting from the additional commercial and consumer relationships obtained
during the period. Additionally, the Bank realized gains on sales of investments
totaling $36,000 during the September 1998 period. Excluding a $79,000 pretax
gain on sale of real estate realized during the nine months ended September 30,
1997, 1998 noninterest income would have increased approximately $130,000 or
24.74% over the 1997 amount.
Noninterest Expense
Noninterest expense was $2.1 million during the nine months ended September 30,
1998 as compared to $1.9 million for the same period in 1997, an increase of
$200,000 or 10.53%. The increase was due primarily to additional expenses
associated with operating the new Salisbury branch location. Compensation and
benefits expense increased as a result of normal salary adjustments and the
addition of personnel to accommodate the Bank's growth and the new branch.
Occupancy and equipment expenses increased as a result of normal growth and the
new branch location while data processing expenses increased due to planned
technological and other bank equipment upgrades primarily relating to Year 2000
requirements.
Financial Condition
During the nine months ended September 30, 1998, the Bank increased its assets
$7.0 million from $108.1 million at December 31, 1997, to $115.1 million at
September 30, 1998. This increase was due primarily to increases in net loans
and investments of $4.4 million and $1.2 million, respectively. Consolidation
and other changes in the local banking market have created increased lending
opportunities for the Bank in recent months. Additionally, overall growth in the
Bank's Maryland market resulting from the new branch has improved lending
activity during 1998. Interest-earning deposits increased $2.1 million during
the period. Growth in securities and interest-earning deposits resulted from
$5.4 million in deposit growth that was not fully offset by loan demand and
gains on available-for-sale securities.
Deposits increased $5.4 million during the nine months ended September 30, 1998.
The increase was due primarily to growth in demand deposit accounts. FHLB
advances remained flat during the period due to liquidity needs being met by
other sources.
Stockholders' equity increased $1.2 million during the nine months ended
September 30, 1998. The increase was due primarily to net income of $916,000
during the period and unrealized gains on available-for-sale securities.
Asset Quality
Loans are placed on nonaccrual status when, in the judgment of management, the
probability of collection of interest is deemed to be insufficient to warrant
further accrual or the loan reaches 90 days delinquent whereby the loan no
longer accrues interest.
Total nonperforming assets, which consist of nonaccrual loans and foreclosed
properties, adjusted for estimated losses upon sale and the related selling
expenses and holding costs, were $625,000 at September 30, 1998, compared to
$823,000 at December 31, 1997. As to nonaccrual loans existing at September 30,
1998, approximately $24,000 of interest income would have been recognized during
the nine months then ended if interest thereon had accrued. A significant
portion of the total nonperforming assets at December 31, 1997 was composed of a
$600,000 real estate loan that was foreclosed on in June 1997. Since the
foreclosure, the Bank has sold all property obtained, with the primary remaining
piece of real estate being sold during June 1998. Properties were sold at
amounts approximating their carrying values, resulting in no significant gains
or losses to the Bank. Other real estate owned at September 30, 1998 consisted
of one parcel of real estate of which management anticipates that net proceeds
from the sale of the collateral will cover the remaining carrying value.
<PAGE>
As of September 30, 1998, all loans 60 days or more delinquent, including
nonperforming loans, totaled $977,000. Performing loans totaling $1.3 million
exist that have possible credit problems and cause management to have concerns
about the borrowers continuing ability to comply with existing repayment terms.
Loans in this category, along with the delinquent loans, are subject to constant
management attention, and their status is reviewed on a regular basis.
The following table details information concerning nonaccrual and past due
loans, as well as foreclosed assets.
Nonperforming Assets
September 30, December 31,
1998 1997
------------- ---------------
Nonaccrual loans:
Commercial $0 $0
Real Estate Construction 0 0
Real Estate Mortgage $513 $306
Home equity lines of credit 0 0
Consumer 65 71
------------- ---------------
Total nonaccrual loans 578 377
Other real estate owned 47 446
------------- ---------------
Total nonperforming assets $625 $823
============= ===============
Loans past due 90 or more days
accruing interest $0 $0
Allowance for loan losses to
nonaccrual loans 134.43% 204.24%
Nonperforming assets to period end
loans and other real estate owned 0.80% 1.11%
<PAGE>
Set forth below is a table detailing the allowance for loan losses for the
periods indicated.
Allowance for Loan Losses
Nine Months Ended
September 30,
-----------------------------
1998 1997
------------- ---------------
Balance, beginning of period $770 $702
Loans charged off:
Commercial 26 115
Real estate construction 0 6
Real estate mortgage 24 0
Home equity lines of credit 0 0
Consumer 64 12
------------- ---------------
Total loans charged-off 114 133
------------- ---------------
Recoveries:
Commercial 0 0
Real estate construction 0 0
Real estate mortgage 0 0
Home equity lines of credit 0 0
Consumer 3 3
------------- ---------------
Total recoveries 3 3
------------- ---------------
Net charge-offs (111) (130)
Provision for loan losses 118 208
------------- ---------------
Balance, end of period $777 $780
============= ===============
Allowance for loan losses to loans
outstanding at end of period 0.99% 1.03%
Allowance for loan losses to nonaccrual
loans outstanding at end of period 134.43% 206.90%
Net charge-offs to average loans
outstanding during period -0.15% -0.17%
<PAGE>
Liquidity and Capital Resources
Liquidity represents the Bank's ability to meet present and future obligations
through the sale and maturity of existing assets or the acquisition of
additional funds through liability management. Liquid assets include cash,
interest-bearing deposits with banks, federal funds sold, available-for-sale
investments and investments and loans maturing within one year. The Bank's
ability to obtain deposits and purchase funds at favorable rates determines its
liability liquidity.
At September 30, 1998, the Bank had outstanding loan and line of credit
commitments of $11.7 million. Scheduled maturities of certificate of deposits
during the twelve months following September 30, 1998 amounted to $42.5 million.
Historically, the Bank has been able to retain a significant amount of their
deposits as they mature. As a result of the Bank's management of liquid assets
and the ability to generate liquidity through liability funding, management
believes that the Bank maintains overall liquidity that is sufficient to satisfy
its depositor's requirements and meet its customers' credit needs.
Total cash and cash equivalents increased $1.8 million for the nine months ended
September 30, 1998, compared to a increase of $1.5 million for the nine months
ended September 30, 1997. Net cash provided by operating activities was $1.3
million for the nine months ended September 30, 1998, compared to $1.6 million
during the same period in 1997. The fluctuations in amounts during the period
from September 30, 1997 to September 30, 1998 were primarily the result of
fluctuations in earnings, assets and liabilities and the impact of noncash
transactions during the periods.
Net cash used in investing activities was $5.0 million during the nine months
ended September 30, 1998, compared to $6.6 million for the nine months ended
September 30, 1997. The fluctuations in amounts during these periods were
primarily the result of increased security purchases and loan growth offset by
sales of real estate owned during the nine months ended September 30, 1998, as
compared to the same period of 1997. The Bank raised approximately $3.1 million
in its initial public offering during August 1997 with this amount being
invested in securities during the 1997 period.
Net cash provided by financing activities was $5.5 million for the nine months
ended September 30, 1998, compared to $6.5 million for the nine months ended
September 30, 1997. The fluctuations in amounts during these periods were
primarily the result of the $3.1 million the Bank raised in its August 1997
public offering offset by FHLB advance repayments exceeding borrowings by
approximately $4.0 million during 1997.
The Federal Reserve, the Bank's primary federal regulator, have defined various
tests for assessing the capital strength and adequacy of financial institutions,
based on various definitions of capital. "Tier 1 capital" is a combination of
common and qualifying preferred stockholders' equity less goodwill and
available-for-sale security adjustments. "Tier 2 capital" is defined as
qualifying subordinated debt and a portion of allowances for loan losses. "Total
capital" is defined as Tier 1 capital plus Tier 2 capital. Certain risk-based
capital ratios are computed using the above capital definitions, total assets
and risk-weighted assets and are measured against regulatory minimums to
ascertain adequacy. All assets and off-balance sheet risk items are grouped into
categories according to degree of risk and assigned a risk weighting and the
resulting total is risk-weighted assets. "Tier 1 risk-based capital" is Tier 1
capital divided by risk-weighted assets. "Total risk-based capital" is total
capital divided by risk-weighted assets.
The required minimum capital ratios for capital adequacy purposes, as defined
collectively by the federal banking agencies, for Tier 1 risk-based capital,
total risk-based capital, and Tier 1 capital are 4.0%, 8.0% and 4.0%,
respectively. To be considered "well capitalized" under federal regulation,
these same required ratios are 6.0%, 10.0% and 5.0%, respectively.
<PAGE>
Core and tangible capital, as defined by federal regulations, are substantially
equivalent to Tier 1 capital, as disclosed above. The core and tangible capital
requirements were 3.0% and 1.5%, respectively, during the indicated periods.
The following table details the components of Tier 1 and Tier 2 capital and
related ratios at September 30, 1998.
Analysis of Capital
<TABLE>
<CAPTION>
September 30 December 31,
1998 1997
-------------- --------------
<S> <C> <C>
Tier 1 Capital:
Common stock $ 598 $ 596
Additional paid-in capital 3,585 3,564
Retained earnings 9,353 8,170
-------------- --------------
Total capital (GAAP) 13,536 12,330
Less Intangibleses (42) (45)
Unrealized (gains) losses (438) (170)
-------------- --------------
Total Tier 1 capital $13,056 $12,115
-------------- --------------
Tier 2 Capital:
Allowances for loan losses 777 732
-------------- --------------
Total Tier 2 capital 13,833 12,847
-------------- --------------
Risk-weighted assets $70,986 $58,521
Capital Ratios:
Tier 1 risk-based capital ratio 18.39% 20.70%
Total risk-based capital ratio 19.49% 21.95%
Tier 1 capital to average adjusted
total assets 11.67% 11.91%
</TABLE>
Interest Sensitivity
An important element of both earnings performance and the maintenance of
sufficient liquidity is proper management of the interest sensitivity gap. The
interest sensitivity gap is the difference between interest sensitive assets and
interest sensitive liabilities at a specific time interval. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities, and is considered negative when the amount
of interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets during a given period. Generally, during a period of rising
interest rates, a negative gap within shorter maturities would adversely affect
the net interest income, while a positive gap within shorter maturities would
result in an increase in net interest income. Conversely, during a period of
falling interest rates, a negative gap within shorter maturities would result in
an increase in net interest income while a positive gap within shorter
maturities would have the opposite effect. This gap can be managed by repricing
assets or liabilities, by selling investments available for sale, by replacing
assets or liability at maturity, or by adjusting the interest rate during the
life of an asset or liability. Matching amounts of assets and liabilities
maturing in the same time interval helps hedge the risk and minimize the impact
on net interest income in periods of rising or falling interest rates.
<PAGE>
The Bank determines the overall magnitude of interest sensitivity risk and then
formulates policies governing asset generation and pricing, funding sources and
pricing, and off-balance-sheet commitments in order to reduce sensitivity risk.
These decisions are based on management's outlook regarding future interest rate
movements, the state of the local and national economy, and other financial and
business risk factors.
The following table presents the Bank's interest sensitivity position at
September 30, 1998. This one-day position, which continually is changing, is not
necessarily indicative of the Bank's position at any other time.
Interest Sensitivity Analysis
<TABLE>
<CAPTION>
September 30, 1998
-----------------------------------------------------------------
With-in 91-365 3 to 5 Over
90 Days Days Years 5 Years Total
------------- --------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Loans $12,906 $24,745 $33,975 $ 6,459 $ 78,085
Securities 803 7,170 10,977 8,468 27,418
Money market and other
short term securities 3,957 0 0 0 3,957
------------- ------------- ----------- ----------- -----------
Total earning assets $17,666 $31,915 $44,952 $ 14,927 $109,460
============= ============= =========== =========== ===========
Cummulative earning assets $17,666 $49,581 $94,533 $109,460 $109,460
============= ============= =========== =========== ===========
Interest-Bearing Liabilities:
Money market savings $ 5,247 $ 0 $ 0 $ 0 $ 5,247
Interest checking 0 0 9,063 0 9,063
Savings 0 0 12,198 0 12,198
Certificates of deposit 11,614 30,913 19,909 4,403 66,839
FHLB advances 0 0 0 74 74
------------- ------------- ----------- ----------- -----------
Total interest-bearing liabilities $16,861 $30,913 $41,170 $ 4,477 $ 93,421
============= ============= =========== =========== ===========
Cummulative interest-bearing liabilities $16,861 $47,774 $88,944 $ 93,422 $ 93,422
============= ============= =========== =========== ===========
Period gap $ 805 $ 1,002 $ 3,781 $ 10,449 $ 16,038
Cummulative gap $ 805 $ 1,807 $ 5,588 $ 16,038 $ 16,038
Ratio of cummulative interest-earning
assets to interest-bearing liabilities 104.77% 103.78% 106.28% 117.17% 117.17%
Ratio of cummulative gap to total
earning assets 4.56% 5.66% 12.43% 107.44% 14.65%
</TABLE>
<PAGE>
Impact of Accounting Pronouncements
Financial Accounting Standards Board Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities, was issued in June 1998. This
Statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. This Statement is effective for all fiscal quarters of fiscal
years beginning after June 15, 1998. Management has studied this Statement and
concluded that it does not materially affect the Company's financial condition
or results of operations.
The American Institute of Certified Public Accountants issued Statement of
Position (SOP) 98-5, Reporting on the Costs of Startup Activities, in April
1998. The SOP requires such costs to be expensed as incurred instead of being
capitalized and amortized. It applies to startup activities and costs of
organization of both development state and established operating activities, and
it changes existing practice for some industries. The SOP broadly defines
startup activities as those one-time activities that relate to the opening of a
new facility, introduction of a new product or service, doing business in a new
territory, initiating a new process in an existing facility, doing business with
a new class of customer or beneficiary, or commencing some new operation. The
SOP is effective for financial statements for fiscal years beginning after
December 15, 1998. Consistent with banking industry practice its is the
Company's policy to expense such costs. Therefore, this SOP is not expected to
materially affect the Company's financial position or results of operations.
Year 2000 Project
The Year 2000 presents problems for businesses that are dependent on computer
hardware and software to perform date dependent calculations and logic
comparisons. A great deal of software and microchip technology was developed
utilizing two digit years rather than four digit years (example: 97 instead of
1997). Technology utilizing two digit years most likely will not be able to
distinguish the year 2000 from 1900, and therefore may shut down or perform
miscalculations and comparisons as much as 100 years off. Management is fully
aware this presents a potential business disruption, and is well into a program
of due diligence in addressing the impact of the Year 2000 on the Company and
the Bank.
The Company and the Bank (collectively the Company) have adopted the five phase
plan of action developed by the Federal Financial Institutions Examination
Council to address Year 2000 issues. During phase one, awareness, the Company
developed an overall strategy and timetable for the completion of all Year 2000
requirements by mid 1999. Phase two, assessment, involved analyzing,
prioritizing and putting each computer driven system on track for Year 2000
compliance according to the timetable establish in the awareness phase. During
the third phase, renovation, necessary upgrades were ordered for hardware and
software. In addition, each vendor was contacted regarding their Year 2000
progress. Phases one through three have been completed. Currently, the Company
is heavily involved with the fourth phase, validation. This phase is the actual
real life testing of all the new upgrades and components. Furthermore, the
Company is testing with its third party service providers to make sure all new
or updated year 2000 compliant systems work with its business partners. Due to
the complexity and enormity of this phase, it is anticipated that it will take
until June 30, 1999 for exhaustive testing to be completed. The final phase is
the actual implementation of the new systems at the turn of the century, with
the readiness to execute contingency plans if needed.
<PAGE>
The number one priority is to minimize or eliminate the impact the Year 2000
date change will have on the Company's customers and shareholders. The Company
has been working with due diligence on this challenge since 1996. The Company is
in the enviable position of having a technologically advanced computer system
already in place. The Manager of Information Systems has tested all the in house
hardware and software for Year 2000 compliance. Management is working in
conjunction with the Company's major service provider to perform Year 2000
application testing for its day-to-day bank operations. Using a simulated
customer base, the Company will be testing virtually every type of banking
transaction it performs for Year 2000 compatibility. Management has analyzed
infrastructure components, like ATMs, security systems, telephones, vaults, and
has acquired necessary upgrades and installations when necessary. It is
anticipated that company-wide systems will be deemed Year 2000 compliant with
testing which will occur through mid-1999.
In addition to collaborating with outside service providers, the Company is
working with its banking customers to ensure a smooth transition into the new
millennium. The Company is a resource for commercial loan customers and
depositors that need guidance in preparing their own businesses for Year 2000.
The Company sponsored a seminar and has provided handouts and phone
consultations to assist its commercial customers and depositors in this
challenge.
The Company is also seeking the guidance of outside consultants regarding its
Year 2000 project plan. The Company's independent auditors will review its
testing and contingency plans in conjunction with their annual audit to be
conducted in early 1999. Furthermore, the Company's Year 2000 project plan will
meet all the guidelines and mandates from the Federal Reserve and the Federal
Financial Institutions Examination Council.
The Company has also addressed Year 2000 issues with its corporate insurance
carrier during the recent renewal period. Insurance policies have been reviewed
and steps have been taken to minimize the Company's insurance risk surrounding
the Year 2000.
To date, the Company has spent approximately $25,000 in expenses relating to
Year 2000. An estimated $15,000 more will be spent throughout the first quarter
1999. New hardware, new software, upgrades for the automated teller machines,
seminar training for the staff, and sophisticated testing services have
comprised the bulk of the Year 2000 expense. These costs are based on the best
estimates of management. It is impossible to accurately predict every expense
that may result from the Year 2000 issue; actual expenses could differ from the
estimated expenses.
At this time, the Company anticipates that even the worst case Year 2000
scenario would not have a long lasting, significant adverse effect on the
Company's financial condition and results of operations for the year ending
December 31, 2000 and beyond. The Company has been developing contingency plans
throughout each remediation phase, but it will not finalize these plans until
all testing is complete; most likely during the second quarter of 1999. Although
the Company has faith in the contingency plans being developed and the success
of the testing being conducted, it is the opinion of management that no one can
exactly predict all the possible ramifications of the Year 2000 issue.
To summarize, the Company has completed phases one through three (awareness,
assessment, and renovation) and will continue to be deeply involved with the
validation phase through mid 1999. All vendors and suppliers have been contacted
and have provided comprehensive and reassuring Year 2000 progress reports.
Presently, the Company sees no need to replace any vendor, although, alternative
vendors have been compiled for contingency planning. In addition, all commercial
loan and deposit customers have been contacted regarding their Year 2000
progress. The Company expects the adverse effect of Year 2000 on its commercial
customers to be immaterial.
<PAGE>
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
In the ordinary course of its operations, the Bank is a party to various legal
proceedings. Based upon information currently available, management believes
that such legal proceedings, in the aggregate, will not have a material adverse
effect on the business, financial condition, or results of operations of the
Bank.
Item 2 - Changes in Securities
None.
Item 3 - Defaults Upon Senior Securities
Not applicable.
Item 4 - Submission of Matters to a Vote of Stockholders
None.
Item 5 - Other Information
None.
Item 6 - Exhibits and Reports on Form 8-K
None.
<PAGE>
SIGNATURES
Pursuant to the requirements of 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.
Scott C. Harvard November 16, 1998
- -----------------------
Scott C. Harvard
President and
Chief Executive Officer
Steven M. Belote November 16, 1998
- ------------------------
Steven M. Belote
Treasurer and
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,010,000
<INT-BEARING-DEPOSITS> 3,957,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 24,391,000
<INVESTMENTS-CARRYING> 3,027,000
<INVESTMENTS-MARKET> 3,038,000
<LOANS> 78,085,000
<ALLOWANCE> 777,000
<TOTAL-ASSETS> 115,064,000
<DEPOSITS> 100,648,000
<SHORT-TERM> 0
<LIABILITIES-OTHER> 806,000
<LONG-TERM> 74,000
0
0
<COMMON> 598,000
<OTHER-SE> 12,938,000
<TOTAL-LIABILITIES-AND-EQUITY> 115,064,000
<INTEREST-LOAN> 1,689,000
<INTEREST-INVEST> 426,000
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 2,115,000
<INTEREST-DEPOSIT> 1,082,000
<INTEREST-EXPENSE> 1,083,000
<INTEREST-INCOME-NET> 1,032,000
<LOAN-LOSSES> 42,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 94,000
<INCOME-PRETAX> 522,000
<INCOME-PRE-EXTRAORDINARY> 522,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 324,000
<EPS-PRIMARY> 0.18
<EPS-DILUTED> 0.18
<YIELD-ACTUAL> 8.11
<LOANS-NON> 578,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 319,000
<ALLOWANCE-OPEN> 764,000
<CHARGE-OFFS> 29,000
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 777,000
<ALLOWANCE-DOMESTIC> 777,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
