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, 1999
- ----- 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 23418
Onley, Virginia ------------
------------------- (Zip Code)
(Address of Principal
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 12, 1999: 1,822,812
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, 1999
and December 31, 1998
Consolidated Statements of Income for the Three
Months and Nine Months Ended September 30, 1999 and
1998
Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 1999 and 1998
Consolidated Statement of Stockholders' Equity for
the Nine Months Ended September 30, 1999
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
1
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash (including interest - earning deposits of
approximately $2,291,000 and $1,442,000, respectively) $ 4,439,257 $ 3,900,861
Investment securities:
Held to maturity (fair value of $2,363,000 and
$3,702,000, respectively) 2,369,383 3,696,685
Available for sale (amortized cost of $26,427,000 and
$27,836,000, respectively) 25,522,396 28,352,312
Investment in Federal Home Loan Bank stock,
at cost 491,800 580,500
Investment in Federal Reserve Bank stock, at cost 124,800 124,800
Loans receivable, net 87,861,501 79,659,005
Premises and equipment, net 2,942,261 2,308,181
Real estate owned 181,630 49,177
Accrued interest receivable 926,604 1,023,522
Prepaid expenses and other assets 743,546 252,805
------------- -------------
$ 125,603,178 $ 119,947,848
--------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 108,918,359 $ 104,308,906
Advances from Federal Home Loan Bank 2,339,302 1,073,853
Advance payments by borrowers for taxes
and insurance 333,070 205,815
Accrued interest payable 63,783 37,292
Accrued expenses and other liabilities 221,097 533,195
--------------- -------------
Total liabilities 111,875,611 106,159,061
--------------- -------------
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; 1,822,812 and 1,810,812 shares
issued and outstanding, respectively 601,528 597,568
Additional capital 3,632,392 3,584,652
Retained earnings, substantially restricted 10,106,147 9,265,567
Accumulated other comprehensive income (612,500) 341,000
------------- -------------
Total stockholders' equity 13,727,567 13,788,787
------------- -------------
$ 125,603,178 $ 119,947,848
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Income
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
1999 1998 1999 1998
---------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Interest income
Loans $1,806,520 $ 1,689,477 $ 5,285,764 $ 5,043,886
Investments 414,386 426,021 1,281,613 1,271,971
---------- ----------- ------------ ------------
Total interest income 2,220,906 2,115,498 6,567,377 6,315,857
---------- ----------- ------------ ------------
Interest expense
Deposits 1,048,914 1,082,235 3,202,438 3,240,737
FHLB advances 25,151 594 72,558 1,728
---------- ----------- ------------ ------------
Total interest expense 1,074,065 1,082,829 3,274,996 3,242,465
---------- ----------- ------------ ------------
Net interest income 1,146,841 1,032,669 3,292,381 3,073,392
Provision for loan losses 42,300 42,300 367,900 117,900
---------- ----------- ------------ ------------
Net interest income after
provision for loan losses 1,104,541 990,369 2,924,481 2,955,492
---------- ----------- ------------ ------------
Noninterest income
Deposit account fees 172,188 164,037 506,401 420,192
Loan fees 35,233 34,322 118,000 94,029
Gains on sales of securities -- -- 242,199 30,646
Other 33,008 28,658 88,301 89,976
---------- ----------- ------------ ------------
Total noninterest income 240,429 227,017 954,901 634,843
---------- ----------- ------------ ------------
Noninterest expense
Compensation and employee
benefits 372,353 291,289 1,030,981 912,440
Occupancy and equipment 229,179 171,144 603,669 492,798
Advertising 15,587 9,149 45,075 41,227
Data processing 147,572 114,219 412,189 345,501
Federal insurance premium 15,656 14,881 46,270 44,858
Other 99,194 94,276 275,536 284,396
---------- ----------- ------------ ------------
Total noninterest expense 879,541 694,958 2,413,720 2,121,220
---------- ----------- ------------ ------------
Income before income taxes 465,429 522,428 1,465,662 1,469,115
Income taxes 158,246 198,523 498,325 553,400
---------- ----------- ------------ ------------
Net income $ 307,183 $ 323,905 $ 967,337 $ 915,715
========== ========= ========== ==========
Earnings Per Common Share:
Basic $ 0.17 $ 0.18 $ 0.53 $ 0.51
========== ========= ========== ==========
Diluted $ 0.17 $ 0.18 $ 0.53 $ 0.50
========== ========= ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statement of Stockholders' Equity
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1999
- ------------------------------------------------------------------------------------------------------------
Accumulated
Other
Common Additional Retained Comprehensive
Stock Capital Earnings Income Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1998 $ 597,568 $ 3,584,652 $ 9,265,567 $ 341,000 $ 13,788,787
Common stock dividend declared -- -- (126,757) -- (126,757)
Proceeds from exercise of
stock options 3,960 47,740 -- -- 51,700
Comprehensive income -- -- 967,337 (953,500) 13,837
------------ ------------ ------------ ------------- -------------
Balance, September 30, 1999 $ 601,528 $ 3,632,392 $ 10,106,147 $ (612,500) $ 13,727,567
============ ============ ============ ============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
SHORE FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Nine Months Ended September 30,
--------------------------------
1999 1998
-------------- ----------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 967,337 $ 915,715
Adjustments to reconcile to net cash
provided by operating activities:
Provision for loan losses 367,900 117,900
Depreciation and amortization 211,266 199,955
Amortization of premium and accretion
of discount on securities, net 7,635 8,651
Gain on sale of securities (242,199) (30,646)
Loss on sale of premises and
equipment -- 3,450
Change in net deferred loan fees (24,383) (92,506)
Loss on sale of repossessed assets -- 11,494
(Increase) decrease in other assets 83,280 36,189
Increase in other liabilities (150,472) 169,036
------------ ------------
Net cash provided by operating activities 1,220,364 1,339,238
------------ ------------
Cash flows from investing activities
Purchase of available-for-sale securities (4,780,428) (12,406,683)
Proceeds from maturities and sales of
available-for-sale securities 6,400,068 10,621,732
Purchase of held-to-maturity securities (1,300,000) --
Proceeds from maturities of held-to-maturity
securities 2,627,341 1,081,525
Redemption of Federal Home Loan Bank stock 88,700 (124,800)
Loan origination, net of repayments (8,718,015) (4,553,653)
Proceeds from sale of premises and equipment -- 1,439
Purchase of premises and equipment (839,028) (136,499)
Proceeds from sale of real estate owned 49,177 498,011
Improvements to real estate owned (9,628) --
------------ ------------
Net cash used by investing activities (6,481,813) (5,018,928)
------------ ------------
Cash flows from financing activities
Net increase in demand deposits 3,393,385 5,157,968
Net increase in time deposits 1,216,068 276,562
Proceeds from FHLB advances 9,800,000 200,000
Repayments of FHLB advances (8,534,551) (201,147)
Payment of dividend on common stock (126,757) --
Proceeds from exercise of stock options 51,700 23,040
------------ ------------
Net cash provided by financing activities 5,799,845 5,456,423
------------ ------------
Increase in cash and cash equivalents 538,396 1,776,733
Cash and cash equivalents, beginning of period 3,900,861 4,190,551
------------ ------------
Cash and cash equivalents, end of period $ 4,439,257 $ 5,967,284
------------ ------------
Supplemental disclosure of cash flow information
Cash paid during the period for interest $ 3,248,504 $ 3,224,210
Cash paid for income taxes $ 777,000 $ 490,498
Supplemental schedule of non-cash investing and
financing activities
Transfers from loans to real estate acquired
through foreclosure $ 172,002 $ 110,269
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<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 nine month period ended September 30, 1999 are
not necessarily indicative of the results that may be expected for any other
interim period or the entire year ending December 31, 1999. 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-KSB for the year ended December 31, 1998.
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. The Company
became a unitary holding company of the Bank on March 16, 1998. The business and
management of the Company consists of the business and management of the Bank.
The Bank became a Virginia chartered, Federal Reserve member, commercial bank on
March 31, 1998. Prior to that the Bank was a federally chartered savings bank.
The Company and the Bank are headquartered on the Eastern Shore in Onley,
Virginia.
6
<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, 1999 and 1998.
<TABLE>
<CAPTION>
Nine Months Ended
Three Months Ended September 30, September 30,
------------------------------------- ----------------------------
1999 1998 1999 1998
-------------- ------------- -------------- ------------
<S> <C> <C> <C> <C>
Net income (numerator, basic and diluted) $ 307,185 $ 323,905 $ 967,337 915,715
Weighted average shares outstanding
(denominator) 1,813,551 1,810,812 1,811,735 1,808,834
-------------- ------------- -------------- ------------
Earnings per common share - basic $ 0.17 $ 0.18 $ 0.53 0.51
============== ============= ============== ============
Effect of dilutive securities:
Weighted average shares outstanding 1,813,551 1,810,812 1,811,735 1,808,834
Effect of stock options 9,352 18,206 12,319 20,373
Diluted average shares outstanding -------------- ------------- -------------- ------------
(denominator) 1,822,903 1,829,018 1,824,054 1,829,207
-------------- ------------- -------------- ------------
Earnings per common share -
assuming dilution $ 0.17 $ 0.18 $ 0.53 0.50
============== ============= ============== ============
</TABLE>
NOTE 4 - COMPREHENSIVE INCOME
Total comprehensive income consists of the following for the nine months ended
September 30, 1999 and 1998:
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------------
1999 1998
---------------- --------------
<S> <C> <C>
Net income $ 967,337 $ 915,715
Other comprehensive income (953,500) 267,471
-------------- ------------
Total comprehensive income $ 13,837 $ 1,183,186
============== ============
</TABLE>
7
<PAGE>
The following is an unaudited reconciliation of the related tax effects
allocated to each component of other comprehensive income at September 30, 1999
and 1998.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------------
1999 1998
----------------- -------------
<S> <C> <C>
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during the period $ (1,202,600) $ 460,800
Less: reclassification adjustment
for gains (losses) included in income 242,200 30,600
---------------- ------------
Total other comprehensice income (loss)
before income tax expense (1,444,800) 430,200
Income tax (expense) benefit 491,300 (162,700)
---------------- ------------
Net unrealized gains (losses) $ (953,500) $ 267,500
================ ============
</TABLE>
NOTE 5 - STOCKHOLDERS' EQUITY
During the period ended September 30, 1999, 12,000 stock options were exercised
at $4.31 per share. At September 30, 1999, 38,000 stock options were outstanding
at a weighted average exercise price of $7.91 per share.
8
<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, 1999 increased $51,600, or
5.6%, to $967,300, compared to net income of $915,700 for the same period in the
prior year. Earnings were positively impacted by loan growth of $8.5 million, or
10.6%, during the 1999 nine month period and a 18.0% increase in noninterest
income, excluding gains on sales of securities of $242,200 and $30,600 during
the nine months ended September 30, 1999 and 1998, respectively. Conversely,
earnings were negatively impacted by additional noninterest expense associated
with the recent opening of the bank's seventh branch office in Parksley,
Virginia, and the additional cost of the bank's new operations center in
Accomac, Virginia. The operations center provides item processing and check
imaging for the bank, a service that through August was outsourced to an
independent provider. The cost of continuing to outsouce item processing during
the conversion accounted for approximately $85,000 in non interest expense since
April 1999 and had a negative impact on earnings in the third quarter. Earnings
for the September 1998 period include approximately $141,000 in pretax losses
associated with operating the newest branch office, located in Salisbury,
Maryland, which opened in November 1997. This branch operated at break-even
during most of the 1999 and currently is accretive to earnings.
Net Interest Income
Net interest income increased $219,000 for the nine months ended September 30,
1999 as compared to the same period in 1998. This increase occurred despite a
decrease in net interest margin to 3.90% during the September 1999 period as
compared to 4.02% for the September 1998 period. The interest rate spread
decreased to 3.27% for the nine months ended September 30, 1999, as compared to
3.40% for the 1998 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 $8.7 million at September 30, 1999 as compared $7.3 million at September 30,
1998. Including average noninterest-bearing deposits in calculating the cost of
funds results in an interest rate spread of 3.60% for the nine months ended
September 30, 1999 as compared to 3.72% for the same period in 1998. Decreases
in net interest margin and net interest spread for the nine months ended
September 30, 1999 reflect the lower interest rate environment in existence
during the September 1999 period as compared to the same period of 1998.
Interest income increased $251,500 for the nine months ended September 30, 1999
as compared to the same period in 1998. The increase resulted from the average
balance of loans increasing by $10.3 million during the period, primarily in
commercial and consumer lending and home equity lines. Additionally, the average
balance of securities increased by $2.9 million. Although outstanding loans
increased significantly during the period, lower interest rates caused a
decrease in the yield on loans to 8.17% for the nine months ended September 30,
1999 as compared to 8.85% for the 1998 period.
Interest expense increased $32,500 for the nine months ended September 30, 1999
as compared to the same period in 1998. This is due to increased borrowings from
the Federal Home Loan Bank to fund the significant loan growth that occurred
during the 1999 period. Average interest-bearing deposits increased by $7.1
million during the nine months ended September 30, 1999 as compared to the same
period of 1998, but this increase was not sufficient to fund loan growth. This
increase was offset by a decrease in
9
<PAGE>
the average rate on interest-bearing liabilities from 4.71% in 1998 to 4.34% for
the September 1999 period. An increased emphasis on attracting lower costing
interest-bearing and noninterest-bearing commercial and consumer deposit
relationships and a lower interest rate environment have contributed to the
lower deposit rates.
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.
10
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
--------------------------------------------------------------------------
1999 1998
------------------------------------ ---------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Assets:
Securities (1) $29,549 $1,364 6.16% $26,685 $1,272 6.35%
Loans (net of unearned income):
Real Estate Mortgage 44,357 2,512 7.55% 46,523 2,989 8.57%
Real Estate Construction 1,557 92 7.88% 1,370 84 8.18%
Commercial 25,824 1,661 8.57% 16,889 1,178 9.30%
Home Equity Lines 5,665 371 8.73% 5,515 382 9.24%
Consumer 8,824 649 9.81% 5,668 411 9.67%
----- --- ----- ---
Total loans 86,227 5,285 8.17% 75,965 5,044 8.85%
------ ----- ------ -----
Federal funds sold - - - - - -
Interest-bearing deposits
in other banks 1,867 65 4.64% 3,121 116 4.96%
------ -- ----- ---
Total earning assets 117,643 6,714 7.61% 105,771 6,432 8.11%
------- ----- ------- -----
Less: allowance for loan losses (1,042) (770)
Total nonearning assets 7,033 7,110
------- -----
Total assets $123,634 $112,111
======== ========
Liabilities
Interest-bearing deposits:
Checking and savings $32,070 $606 2.52% $23,956 $441 2.45%
Time deposits 66,717 2,597 5.19% 67,740 2,799 5.51%
------- ----- ------ -----
Total interest-bearing deposits 98,787 3,203 4.32% 91,696 3,240 4.71%
FHLB advances 1,853 73 5.25% 75 2 3.56%
------- ----- ------ -----
Total interest-bearing liabilities 100,640 3,276 4.34% 91,771 3,242 4.71%
----- -----
Non-interest bearing liabilities:
Demand deposits 8,189 6,536
Other liabilities 867 777
------- ---
Total liabilities 109,696 99,084
Stockholders' equity 13,938 12,809
------- ------
Total liabilities and stockholders' equity $123,634 $111,893
======== ========
Net interest income $3,438 $3,190
====== =======
Interest rate spread (1) 3.27% 3.40%
Net interest margin (1) 3.90% 4.02%
</TABLE>
(1) Tax equivalent basis.
11
<PAGE>
Noninterest Income
- ------------------
Noninterest income was $954,900 during the nine months ended September 30, 1999
as compared to $634,800 for the same period in 1998, an increase of $320,100 or
50.4%. Included in these amounts are gains on sales of securities of $242,200
and $30,600 for the nine months ended September 30, 1999 and 1998, respectively.
Excluding these amounts noninterest income increased $108,500 or 18.0% during
the September 1999 period as compared to the 1998 period. Increases in deposit
account and loan fees resulting from the additional commercial and consumer
relationships obtained during the period contributed significantly to this
increase in income.
Provision for Loan Losses
- -------------------------
Provision for loan losses was $367,900 for the nine months ended September 30,
1999 as compared to $117,900 for the same period in 1998, an increase of
$250,000. This increase primarily relates to provisions established for two
specific loan customers in the bank's commercial loan portfolio that management
has concluded the risk of loss to be probable. General loan loss reserves
maintained by the Bank normally would be sufficient to absorb losses incurred on
impaired loans. However, with the bank's significant loan growth over the past
twelve months and the need to reserve for these two loans, management decided an
increase in loan loss reserves was warranted. See Asset Quality for additional
discussions of these loans.
Noninterest Expense
- -------------------
Noninterest expense was $2.41 million during the nine months ended September 30,
1999 as compared to $2.12 million for the same period in 1998, an increase of
$290,000 or 13.9%. This increase is primarily due to additional noninterest
expense associated with the recent opening of the bank's seventh branch office
in Parksley, Virginia, and the additional cost of the bank's new operations
center in Accomac, Virginia. The operations center provides item processing and
check imaging for the bank, a service that through August was outsourced to an
independent provider. The cost of continuing to outsouce item processing during
the conversion accounted for approximately $85,000 in non interest expense since
April 1999 and had a negative impact on earnings in the third quarter.
Additionally, the Bank incurred added telecommunication expense while converting
the bank's data processing system to a network environment. The bank's old
system and its new network system ran concurrently with the Bank's data
processing provider for approximately forty-five days during the second quarter
of 1999.
FINANCIAL CONDITION
During the nine months ended September 30, 1999, the Company increased its
assets $5.7 million from $119.9 million at December 31, 1998, to $125.6 million
at September 30, 1999. This increase was due primarily to increases in net loans
of $8.5 million. Consolidation and other changes in the local banking market
during 1998 created increased lending opportunities for the Bank. These
opportunities along with a lower interest rate environment have continued to
positively affect loan demand through the first nine months of 1999.
Additionally, continued growth in the Bank's Maryland market has improved
lending activity. Increased loan demand more than offset the $4.6 million in
deposit growth during the period. Securities and interest-earning deposits
decreased $3.3 million during the period due to funding requirements resulting
from the significant loan growth incurred and fair market value adjustments to
available-for-sale securities within the portfolio.
12
<PAGE>
Deposits increased $4.6 million during the nine months ended September 30, 1999.
The increase was due primarily to growth in demand deposit accounts. During the
period, the Bank borrowed $1.0 million from the Federal Home Loan Bank to fund
fixed rate loans with terms of up to fifteen years. The Bank also had
outstanding at September 1999 approximately $1.3 million of additional
short-term Federal Home Loan Bank advances used to meet loan funding
requirements during the period.
Stockholders' equity was $13.7 million at September 30, 1999, compared to $13.8
million at December 31, 1998. Net income of $967,300 and the exercise of 12,000
stock options for the period were offset by the $127,000 common stock dividend
declared and reductions in 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 $1.58 million at September 30, 1999, compared
to $717,000 at December 31, 1998. As to nonaccrual loans existing at September
30, 1999, approximately $69,000 of interest income would have been recognized
during the nine months then ended if interest thereon had accrued. Included in
nonperforming assets are two loan relationships totaling $457,000 that
management has categorized as impaired under the guidelines established by SFAS
No. 114, ACCOUNTING FOR CREDITORS FOR IMPAIRMENT OF A LOAN, as amended by SFAS
No. 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN - INCOME RECOGNITION
AND DISCLOSURES. The loan relationships are secured by real estate, vehicles
and/or accounts receivable. Approximately $15,000 has been recovered during the
nine months ended September 30, 1999 from the sale of collateral securing these
loans. As of September 30, 1999 the Bank had specifically reserved approximately
$300,000 towards these loans. Subsequent to September 30, 1999, the Bank wrote
off approximately $146,000 related to one of these loans. Management believes
that the remaining specific reserve will be adequate to absorb any deficiencies
in the collateral and costs associated with collection proceedings.
At September 30, 1999, all loans 60 days or more delinquent, including
nonperforming loans, totaled $2.4 million. Performing loans totaling $1.8
million existed 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.
13
<PAGE>
The following table details information concerning nonaccrual and past due
loans, as well as foreclosed assets.
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---- ----
<S> <C> <C>
Nonaccrual loans:
Commercial $ 258 $ -
Real Estate Construction - -
Real Estate Mortgage 1072 555
Home equity lines of credit - -
Consumer 68 113
-------- ---------
Total nonaccrual loans 1,398 668
Other real estate owned 182 49
-------- ---------
Total nonperforming assets $ 1,580 $ 717
======== ==========
Loans past due 90 or more days
accruing interest - -
Allowance for loan losses to
nonaccrual loans 87.98% 137.72%
Nonperforming assets to period end
loans and other real estate owned 1.75% 0.89%
</TABLE>
14
<PAGE>
Set forth below is a table detailing the allowance for loan losses for the
periods indicated.
ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
Nine Months Ended September 30,
----------------------------------------------
1999 1998
------------------- ----------------------
<S> <C> <C>
Balance, beginning of period $ 920 $ 770
Loans charged off:
Commercial - 26
Real estate construction - -
Real estate mortgage 14 24
Home equity lines of credit - -
Consumer 63 64
---------- -----------
Total loans charged-off 77 114
---------- -----------
Recoveries:
Commercial - -
Real estate construction - -
Real estate mortgage - -
Home equity lines of credit - -
Consumer 19 3
---------- -----------
Total recoveries 19 3
---------- -----------
Net charge-offs (58) (111)
Provision for loan losses 368 118
---------- -----------
Balance, end of period $ 1,230 $ 777
========== ===========
Allowance for loan losses to loans
outstanding at end of period 1.38% 0.99%
Allowance for loan losses to nonaccrual
loans outstanding at end of period 87.98% 132.64%
Net charge-offs to average loans
outstanding during period -0.07% -0.15%
</TABLE>
15
<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, 1999, the Bank had outstanding loan and line of credit
commitments of $9.4 million. Scheduled maturities of certificate of deposits
during the twelve months following September 30, 1999 amounted to $43.6 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 $538,000 for the nine months ended
September 30, 1999, compared to a increase of $1.8 million for the nine months
ended September 30, 1998. Net cash provided by operating activities was $1.2
million for the nine months ended September 30, 1999, compared to $1.3 million
during the same period in 1998. The fluctuations in amounts during these periods
were primarily the result of normal operating activities.
Net cash used in investing activities was $6.5 million during the nine months
ended September 30, 1999, compared to $5.0 million for the nine months ended
September 30, 1998. The fluctuations in amounts during these periods were
primarily the result of increased loan growth and capital expenditures related
to the new operations center and the new Parksley branch offset by maturities of
investment securities during the nine months ended September 30, 1999, as
compared to the same period of 1998.
Net cash provided by financing activities was $5.8 million for the nine months
ended September 30, 1999, compared to $5.5 million for the nine months ended
September 30, 1998. The fluctuations in amounts during these periods were
primarily the result of increased deposit growth and increased borrowings from
the Federal Home Loan Bank during September 1999 period as compared to the
September 1998 period.
The Company is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and its Banking
Subsidiary must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and its Banking Subsidiary to maintain minimum amounts and
ratios of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). At September 30, 1999, the Company meets all capital
adequacy requirements to which it is subject.
16
<PAGE>
The following table details the components of Tier 1 and Tier 2 capital and
related ratios at September 30, 1999.
Analysis of Capital
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
<S> <C> <C>
Tier 1 Capital:
Common stock $ 602 $ 598
Additional paid-in capital 3,632 3,585
Retained earnings 10,106 9,265
Comprehensive income (613) 341
----- ---
Total capital (GAAP) 13,727 13,789
Less: Intangibles (39) (41)
Unrealized (gains) losses 387 (341)
---- -----
Total Tier 1 capital $ 14,075 $ 13,407
-------- ---------
Tier 2 Capital:
Allowances for loan losses 1,074 1,080
Other required deductions - (33)
------ -------
Total Tier 2 capital $ 15,149 $ 14,454
-------- ---------
Risk-weighted assets $ 86,403 $ 74,400
Capital Ratios (1):
Tier 1 risk-based capital ratio 16.29% 18.02%
Total risk-based capital ratio 17.53% 19.43%
Tier 1 capital to average adjusted
total assets 11.38% 11.80%
</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.
17
<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, 1999. This one-day position, which continually is changing, is not
necessarily indicative of the Bank's position at any other time.
<TABLE>
<CAPTION>
Interest Sensitivity Analysis
September 30, 1999
-------------------------------------------------------------------
With-in 91-365 1 to 5 Over
90 Days Days Years 5 Years Total
------- ---- ----- ------- -----
<S> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Loans $ 14,894 $ 22,340 $ 30,336 $ 21,446 $ 89,016
Securities 991 3,283 13,988 8,986 27,248
Money market and other
short term securities 2,289 - - - 2,289
--------- --------- --------- --------- ---------
Total earning assets $ 18,174 $ 25,623 $ 44,324 $ 30,432 $ 118,553
--------- --------- --------- --------- ---------
Cummulative earning assets $ 18,174 $ 43,797 $ 88,121 $ 118,553 $ 118,553
--------- --------- --------- --------- ---------
Interest-Bearing Liabilities:
Money market savings 9,153 - - - 9,153
Interest checking - - 11,935 - 11,935
Savings - - 13,165 - 13,165
Certificates of deposit 11,322 32,273 16,329 4,984 64,908
FHLB advances 1,300 - - 1,039 2,339
--------- --------- --------- --------- ---------
Total interest-bearing liabilities $ 21,775 $ 32,273 $ 41,429 $ 6,023 $ 101,500
========= ========= ========= ========== ==========
Cummulative interest-bearing liabilities 21,775 54,048 95,477 101,500 101,500
========= ========== ========= ========== ==========
Period gap $ (3,601) $ (6,650) $ 2,895 $ 24,409 $ 17,053
Cummulative gap $ (3,601) $ (10,251) $ (7,356) $ 17,053 $ 17,053
Ratio of cummulative interest-earning
assets to interest-bearing liabilities 83.46% 81.03% 92.30% 116.80% 116.80%
Ratio of cummulative gap to total
earning assets -3.04% -8.65% -6.20% 14.38% 14.38%
</TABLE>
18
<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, 1999. The Company's adoption of this SOP on July
1, 1999 did not materially impact the Company's consolidated financial condition
or consolidated results of operations.
The American Institute of Certified Public Accountants issued Statement of
Position (SOP) 98-1, ACCOUNTING FOR COSTS OF COMPUTER SOFTWARE DEVELOPED OR
OBTAINED FOR INTERNAL USE. This SOP is effective for financial statements for
fiscal years beginning after December 31, 1998. The SOP requires entities to
capitalize certain internal-use software costs once certain criteria are met.
Generally, internal costs with respect to software configuration and interface,
coding, installation to hardware, testing (including parallel processing), and
data conversion costs allowing access of old data by new systems should be
capitalized. All other data conversion costs, training, application maintenance,
and ongoing support activities should be expensed. The Company's adoption of
this SOP on January 1, 1999 did not materially impact the Company's consolidated
financial condition or consolidated 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, its adoption on January 1,
1999 did not 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 successfully
completing 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) 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
19
<PAGE>
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. Phase four, validation,
involved the actual real life testing of all the new upgrades and components.
Furthermore, the Company tested with its third party service providers to make
sure all new or updated year 2000 compliant systems worked with business
partners. Due to the complexity and enormity of this phase, it took until June
30, 1999 for the exhaustive testing to be completed. Phases one through four of
the Company's Y2K Project have been 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. During the quarter ended June 30, 1999,
contingency plans were drafted. Subsequent to June 1999, the contingency plans
were tested, independently approved by the Board and senior management, and all
employees were be trained on implementing the contingency policies and
procedures into branch operations if conditions warrant.
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 has contacted all significant commercial deposit
customers to assess their Year 2000 readiness and each quarter reviews its list
of new commercial deposit customers so that they may be contacted and assessed
also. The Company has assessed the risk of all its commercial loan customers and
monitors those risk. Loan officers assess the risk of new commercial loan
customers when they apply for the loan and monitor them accordingly.
To date, the Company has spent approximately $75,000 to $100,000 in expenses
directly relating to Year 2000. An estimated $10,000 more will be spent
throughout 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. The Company does not separately track the internal
costs incurred for the Y2K project; however, such costs are principally related
to payroll costs for information systems employees. 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. Although the Company has faith in the adequacy of
its contingency plans and the success of the testing, 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 five (awareness,
assessment, renovation, validation and implementation) and will continue to be
deeply involved with customer awareness projects throughout the remainder of
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 any adverse effect of Year 2000 on its commercial customers to be
immaterial.
20
<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.
21
<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 12, 1999
Scott C. Harvard
President and
Chief Executive Officer
Steven M. Belote November 12, 1999
- --------------------
Steven M. Belote
Treasurer and
Chief Financial Officer
22
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 2,148,000
<INT-BEARING-DEPOSITS> 2,291,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 25,522,000
<INVESTMENTS-CARRYING> 2,369,000
<INVESTMENTS-MARKET> 2,363,000
<LOANS> 89,092,000
<ALLOWANCE> 1,230,000
<TOTAL-ASSETS> 125,603,000
<DEPOSITS> 108,918,000
<SHORT-TERM> 1,300,000
<LIABILITIES-OTHER> 618,000
<LONG-TERM> 1,039,000
0
0
<COMMON> 602,000
<OTHER-SE> 13,126,000
<TOTAL-LIABILITIES-AND-EQUITY> 125,604,000
<INTEREST-LOAN> 1,807,000
<INTEREST-INVEST> 414,000
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 2,221,000
<INTEREST-DEPOSIT> 1,049,000
<INTEREST-EXPENSE> 1,074,000
<INTEREST-INCOME-NET> 1,147,000
<LOAN-LOSSES> 42,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 99,000
<INCOME-PRETAX> 465,000
<INCOME-PRE-EXTRAORDINARY> 465,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 307,000
<EPS-BASIC> 0.17
<EPS-DILUTED> 0.17
<YIELD-ACTUAL> 7.61
<LOANS-NON> 1,398,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 457,000
<ALLOWANCE-OPEN> 1,218,000
<CHARGE-OFFS> 40,000
<RECOVERIES> 10,000
<ALLOWANCE-CLOSE> 1,230,000
<ALLOWANCE-DOMESTIC> 1,230,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
