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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File No. 0-24589
BCSB BANKCORP, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
UNITED STATES 52-2108333
- - --------------------------------- -------------------
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4111 E. JOPPA ROAD, SUITE 300, BALTIMORE, MARYLAND 21236
- - -------------------------------------------------- -------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (410) 256-5000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
--------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or such
shorter period that the registrant was required to file such reports) and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
For the fiscal year ended September 30, 1998, the registrant had $19,721,140 in
revenues.
As of December 23, 1998, the aggregate market value of voting stock held by non-
affiliates was approximately $17,133,588, computed by reference to the most
recent sales price on December 23, 1998 as reported on the Nasdaq National
Market System. For purposes of this calculation, it is assumed that directors,
executive officers and beneficial owners of more than 5% of the registrant's
outstanding voting stock are affiliates.
Number of shares of Common Stock outstanding as of December 23, 1998: 6,116,562.
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the
Part of the Form 10-KSB into which the document is incorporated:
1. Portions of the registrant's Annual Report to Stockholders for
the Fiscal Year ended September 30, 1998. (Parts II and III)
2. Portions of Proxy Statement for registrant's 1999 Annual Meeting
of Stockholders. (Part III)
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
- - --------------------------------
GENERAL
BCSB Bankcorp, Inc. BCSB Bankcorp, Inc. (the "Company") was incorporated
under Federal law in May 1998. On July 8, 1998, Baltimore County Savings Bank,
F.S.B. ( the "Bank") converted from mutual to stock form and reorganized into
the mutual holding company form of ownership as a wholly owned subsidiary of the
Company, which in turn became a majority-owned subsidiary of Baltimore County
Savings Bank, M.H.C. (the "MHC"), a mutual holding company (the
"Reorganization"). In connection with the Reorganization, the Company issued and
sold 2,286,602 shares of its common stock at a price of $10.00 per share to the
Bank's depositors, the Company's employee stock ownership plan and the public,
thereby recognizing net proceeds of $22.7 million. The Company also issued at no
cost 3,754,960 shares to the MHC, representing 61.4% of the Company's issued and
outstanding common stock, and 75,000 shares to the Baltimore County Savings Bank
Foundation, Inc., a nonstock corporation dedicated to charitable and educational
purposes in the Baltimore metropolitan area.
The Company has no significant assets other than its investment in the
Bank. The Company is primarily engaged in the business of directing, planning
and coordinating the business activities of the Bank. Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to the Bank. In the future, the Company may become an
operating company or acquire or organize other operating subsidiaries, including
other financial institutions. Currently, the Company does not maintain offices
separate from those of the Bank or employ any persons other than its officers
who are not separately compensated for such service. At September 30, 1998, the
Company had total assets of $268.8 million, total deposits of $220.8 million and
stockholders' equity of $45.1 million.
The Company's and the Bank's executive offices are located at 4111 E. Joppa
Road, Suite 300, Baltimore, Maryland 21236, and its main telephone number is
(410) 256-5000.
Baltimore County Savings Bank, F.S.B. The Bank is a federally chartered
stock savings bank operating through six banking offices serving Baltimore and
Harford Counties in Maryland. The Bank was chartered by the State of Maryland
in 1955 under the name Baltimore County Building and Loan Association. The Bank
received federal insurance of its deposit accounts in 1985 and received a
federal charter in 1987, at which time it adopted its present name of Baltimore
County Savings Bank, F.S.B.
The Bank's principal business consists of attracting deposits from the
general public and investing these funds in loans secured by first mortgages on
owner-occupied, single-family residences in the Bank's market area, and, to a
lesser extent, other real estate loans, consisting of construction loans,
single-family rental property loans and commercial real estate loans, and
consumer loans, particularly automobile loans. The Bank derives its income
principally from interest earned on loans and, to a lesser extent, interest
earned on mortgage-backed securities and investment securities and other income.
Funds for these activities are provided principally by operating revenues,
deposits and repayments of outstanding loans and investment securities and
mortgage-backed securities.
MARKET AREA
The Bank's market area consists of Baltimore County and Harford County,
Maryland, which are part of the Baltimore metropolitan area. At September 30,
1998, management estimates that more than 95% of deposits and 90% of all lending
came from its market area.
The economy of the Bank's market area is diversified, with a mix of
services, manufacturing, wholesale/retail trade, and federal and local
government. Once the backbone of the regional economy, the manufacturing
industry is relatively stable after almost two decades of decline. Baltimore
County currently maintains 36 percent of the regional
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manufacturing base. Manufacturing in the market area is dominated by high
technology, particularly within the defense industry. Similar to national
trends, most of the job growth in the Bank's market area has been realized in
service related industries, and service jobs account for the largest portion of
the workforce. Based on the most recent data available, service jobs accounted
for 32.8% of Baltimore County's employment in 1995 as compared to 30.5% in 1991.
Comparatively, from 1991 to 1995, manufacturing jobs declined from 11.3% to 9.7%
of Baltimore County's labor force.
Based on data provided by the Maryland Department of Business and Economic
Development, the Bank estimates the population of the market area to be 934,000,
compared to a population of 874,000 in 1990. The median household income in
Baltimore and Harford Counties are $36,000 and $39,000, respectively, compared
to $36,000 for the State of Maryland and $29,000 for the United States as a
whole.
LENDING ACTIVITIES
General. The Bank's gross loan portfolio totaled $182.0 million at
September 30, 1998, representing 67.7% of total assets at that date. At
September 30, 1998, $126.3 million, or 66.5% of the Bank's gross loan portfolio,
consisted of single-family, residential mortgage loans. Other loans secured by
real estate include construction loans, single-family rental property and
commercial real estate loans, which amounted to $7.9 million, $5.3 million and
$9.5 million, respectively, or 4.2%, 2.8% and 5.0%, respectively, of the Bank's
gross loan portfolio at September 30, 1998. The Bank also originates consumer
loans, consisting primarily of automobile loans, as well as home equity lines of
credit and savings account loans which totaled $33.7 million, $6.5 million and
$681,000, respectively, or 17.8%, 3.5% and .4%, respectively, of the Bank's
gross loan portfolio. In addition, the Bank originates a limited amount of loans
pursuant to commercial lines of credit. At September 30, 1998, such loans
amounted to $50,000, which was less than .1% of the Bank's gross loan portfolio.
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Loan Portfolio Composition. The following table sets forth selected data
relating to the composition of the Bank's loan portfolio by type of loan at the
dates indicated. At September 30, 1998, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------------------------
1998 1997 1996
----------------- ------------------- -------------------
Amount % Amount % Amount %
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
Single-family residential (1)........................ $126,272 66.46% $103,677 62.30% $ 94,275 56.74%
Single-family rental property loans.................. 5,253 2.76 6,409 3.85 7,065 4.25
Commercial........................................... 9,497 5.00 10,169 6.11 10,316 6.21
Construction (2)..................................... 7,936 4.18 8,645 5.19 11,427 6.87
Commercial lines of credit............................ 50 .03 60 .04 262 .16
Consumer loans:
Automobile........................................... 33,748 17.76 32,633 19.61 39,925 24.03
Home equity lines of credit.......................... 6,549 3.45 3,986 2.40 1,855 1.12
Savings account...................................... 681 .36 825 .50 1,029 .62
-------- ------- -------- ------- -------- -------
189,986 100.00% 166,404 100.00% 166,154 100.00%
======= ======= =======
Less:
Undisbursed portion of loans in process.............. 2,963 2,807 5,088
Deferred loan origination fees....................... 278 567 823
Unearned interest.................................... 3,742 3,376 4,757
Allowance for loan losses............................ 1,034 978 926
-------- -------- --------
Total............................................... $181,969 $158,676 $154,560
======== ======== ========
<CAPTION>
At September 30,
-----------------------------------------
1995 1994
------------------- -----------------
Amount % Amount %
-------- ------- -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single-family residential (1)........................ $ 87,575 55.87% $ 82,594 59.86%
Single-family rental property loans.................. 8,045 5.13 8,593 6.23
Commercial........................................... 11,174 7.13 10,921 7.91
Construction (2)..................................... 7,065 4.51 9,853 7.14
Commercial lines of credit............................ 234 .15 110 .08
Consumer loans:
Automobile........................................... 40,793 26.02 24,797 17.97
Home equity lines of credit.......................... 842 .54 125 .09
Savings account...................................... 1,022 .65 995 .72
-------- ------- -------- ------
156,750 100.00% 137,988 100.00%
======= ======
Less:
Undisbursed portion of loans in process.............. 3,425 3,509
Deferred loan origination fees....................... 1,166 1,539
Unearned interest.................................... 5,576 3,188
Allowance for loan losses............................ 788 542
-------- --------
Total............................................... $145,795 $129,210
======== ========
</TABLE>
______________
(1) Includes fixed-rate second mortgage loans.
(2) Includes acquisition and development loans.
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Loan Maturity Schedules. The following table sets forth certain information
at September 30, 1998 regarding the dollar amount of loans maturing in the
Bank's portfolio based on their contractual terms to maturity, including
scheduled repayments of principal. Demand loans, loans having no stated schedule
of repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The table does not include any estimate of prepayments which
significantly shorten the average life of mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
Due During the Year Ending Due After Due After
September 30, 3 Through 5 Through
--------------------------- 5 Years After 10 Years After
1999 2000 2001 September 30, 1998 September 30, 1998
------- ------- ------ ------------------ ------------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Real estate loans:
Single-family residential... $ 8,807 $ 8,826 $ 8,286 $14,783 $33,045
Single-family rental
property................... 247 262 261 530 1,258
Commercial.................. 648 691 753 1,454 2,642
Construction................ 3,293 100 108 244 810
Commercial lines of credit.. 50 -- -- -- --
Consumer:
Automobiles................. 10,925 9,068 6,521 6,965 269
Home equity................. 1,186 974 803 663 549
Savings accounts............ 498 139 44 -- --
------- ------- ------- ------- -------
Total...................... $25,654 $20,060 $16,776 $24,639 $38,573
======= ======= ======= ======= =======
<CAPTION>
Due After
10 Through Due After 15
15 Years After Years After
September 30, 1998 September 30, 1998 Total
------------------ ------------------ --------
<S> <C> <C> <C>
Real estate loans:
Single-family residential... $20,136 $26,389 $126,272
Single-family rental
property................... 1,326 1,369 5,253
Commercial.................. 2,304 1,005 9,497
Construction................ 1,212 2,169 7,936
Commercial lines of credit.. -- -- 50
Consumer:
Automobiles................. -- -- 33,748
Home equity................. 456 1,918 6,549
Savings accounts............ -- -- 681
------- ------- --------
Total...................... $31,434 $32,850 $189,986
======= ======= ========
</TABLE>
The following table sets forth at September 30, 1998, the dollar amount of
all loans due one year or more after September 30, 1998 which have predetermined
interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
------------- ----------------
(In thousands)
<S> <C> <C>
Real estate loans:
Single-family residential....... $112,114 $ 5,351
Single-family rental property... 2,356 2,650
Commercial...................... 6,489 2,360
Construction.................... 4,643 --
Commercial lines of credit........ -- --
Consumer:
Automobiles..................... 22,823 --
Home equity..................... -- 5,363
Savings accounts................ 183 --
-------- -------
Total......................... $148,608 $15,724
======== =======
</TABLE>
5
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Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare a loan immediately
due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid. The average
life of mortgage loans tends to increase when current mortgage loan market rates
are substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
Originations, Purchases and Sales of Loans. The Bank generally has
authority to originate and purchase loans secured by real estate located
throughout the United States. Consistent with its emphasis on being a
community-oriented financial institution, the Bank concentrates its lending
activities in its market area.
The following table sets forth certain information with respect to the
Bank's loan origination, purchase and sale activity for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------
1998 1997 1996
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Loans originated:
Real estate loans:
Single-family residential............. $36,905 $22,507 $27,594
Single-family rental property loans... -- 135 157
Commercial............................ 351 1,650 91
Construction.......................... 1,550 1,228 2,969
Commercial lines of credit............. -- -- 68
Consumer loans:
Automobiles........................... 21,267 14,070 21,677
Home equity........................... 17,453 11,871 8,347
Savings account....................... 478 319 495
------- ------- -------
Total loans originated............... $78,004 $51,780 $61,398
======= ======= =======
Loans purchased:
Real estate loans...................... $ -- $ -- $ --
Other loans............................ -- -- --
------- ------- -------
Total loans purchased................ $ -- $ -- $ --
======= ======= =======
Loans sold:
Whole loans............................ $ -- $ -- $ --
Participation loans.................... 133 225 4,914
------- ------- -------
Total loans sold..................... $ 133 $ 225 $ 4,914
======= ======= =======
</TABLE>
The Bank's loan originations are derived from a number of sources,
including referrals by realtors or automobile dealers, depositors and borrowers
and advertising, as well as walk-in customers. The Bank's solicitation programs
consist of advertisements in local media, in addition to occasional
participation in various community organizations and events. Real estate loans
are originated by the Bank's loan personnel. All of the Bank's loan personnel
are salaried, and the Bank does not compensate loan personnel on a commission
basis for loans originated. With the exception of applications for automobile
loans, which loans may be originated on an indirect basis through a limited
number of approved dealers, loan applications are accepted at the Bank's
offices. The Bank has not purchased loans in the past five years and has no
plans to purchase loans in the future.
The Bank has not sold whole loans in recent years. However, the Bank
occasionally sells participation interests in acquisition and development loans
to reduce its risk on any individual loan and to comply with regulatory
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loans-to-one borrower limitations. The Bank sold loan participations totaling
$133,000, $225,000 and $4.9 million during the years ended September 30, 1998,
1997 and 1996, respectively.
Loan Underwriting Policies. The Bank's lending activities are subject to
the Bank's written, non-discriminatory underwriting standards and to loan
origination procedures prescribed by the Bank's Board of Directors and its
management. Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. Real estate loans up to $400,000, as well as all requests for
lines of credit up to $25,000, may be approved by the Bank's Loan Committee,
which consists of the Bank's President and two outside directors and meets
weekly. All loans in excess of these amounts must be approved by the full
Board of Directors. Individual officers of the Bank have been granted authority
by the Board of Directors to approve consumer loans up to varying specified
dollar amounts, depending upon the type of loan. Automobile loans are approved
by the Bank's car loan manager or assistant manager and reviewed by the Bank's
Vice President who supervises lending operations.
Applications for single-family real estate loans generally are underwritten
and closed in accordance with the standards of FHLMC and FNMA. Upon receipt of
a loan application from a prospective borrower, a credit report and
verifications are ordered to verify specific information relating to the loan
applicant's employment, income and credit standing. If a proposed loan is to be
secured by a mortgage on real estate, an appraisal of the real estate is
undertaken by an appraiser approved by the Bank and licensed by the State of
Maryland. In the case of single-family residential mortgage loans, except when
the Bank becomes aware of a particular risk of environmental contamination, the
Bank generally does not obtain a formal environmental report on the real estate
at the time a loan is made. A formal environmental report may be required in
connection with commercial real estate loans, and the Bank obtains a Phase I
environmental study in connection with its underwriting of acquisition and
development loans.
It is the Bank's policy to record a lien on the real estate securing a loan
and to obtain title insurance or an attorney's certification which ensures that
the property is free of prior encumbrances and other possible title defects.
Borrowers must also obtain hazard insurance policies prior to closing and, when
the property is in a flood plain as designated by Federal Emergency Management
Agency, pay flood insurance policy premiums.
With respect to single-family residential mortgage loans, the Bank makes a
loan commitment of between 30 and 60 days for each loan approved. If the
borrower desires a longer commitment, the commitment may be extended for good
cause and upon written approval. No fees are charged in connection with the
issuance of a commitment letter. The interest rate is guaranteed until closing.
The Bank is permitted to lend up to 95% of the lesser of the appraised
value or the purchase price of the real property securing a mortgage loan.
However, if the amount of a residential loan originated or refinanced exceeds
80% of the appraised value, the Bank's policy is to obtain private mortgage
insurance at the borrower's expense on the principal amount of the loan. The
Bank will make a single-family residential mortgage loan with up to a 95% loan-
to-value ratio if the required private mortgage insurance is obtained. The
Bank generally limits the loan-to-value ratio on commercial real estate mortgage
loans to 75%, although the loan-to-value ratio on commercial real estate loans
in limited circumstances has been as high as 80%. The Bank limits the loan-to-
value ratio on single-family rental property loans to 80%. Home equity loans
are made in amounts which, when added to any senior indebtedness, do not exceed
80% of the value of the property.
Under applicable law, with certain limited exceptions, loans and extensions
of credit by a savings institution to a person outstanding at one time shall not
exceed 15% of the institution's unimpaired capital and surplus. Loans and
extensions of credit fully secured by readily marketable collateral may comprise
an additional 10% of unimpaired capital and surplus. Under these limits, the
Bank's loans to one borrower were limited to $5.3 million at September 30, 1998.
Applicable law additionally authorizes savings institutions to make loans to one
borrower, for any purpose, in an amount not to exceed $500,000 or in an amount
not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus
to develop residential housing, provided: (i) the purchase price of each single-
family dwelling in the
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development does not exceed $500,000; (ii) the savings institution is and
continues to be in compliance with its fully phased-in regulatory capital
requirements; (iii) the loans comply with applicable loan-to-value requirements;
(iv) the aggregate amount of loans made under this authority does not exceed
150% of unimpaired capital and surplus; and (v) the Director of OTS, by order,
permits the savings institution to avail itself of this higher limit. At
September 30, 1998, the Bank had no lending relationships in excess of the
loans-to-one-borrower limit. At September 30, 1998, the Bank's largest lending
relationship was a $2.6 million relationship consisting of a commercial real
estate loan and a one-third participation interest in a loan and letter of
credit. The Bank had a $1.0 million loan to a developer to acquire and develop
land for sale to builders who will construct single-family residences. The Bank
also has outstanding $855,000 in letters of credit to this borrower. As of
September 30, 1998, 44 of the 116 developed lots had been sold, and all 116 lots
were developed. This borrower also had a $548,000 loan secured by commercial
real estate. At September 30, 1998, the loans were current and performing in
accordance with its terms.
Interest rates charged by the Bank on loans are affected principally by
competitive factors, the demand for such loans and the supply of funds available
for lending purposes. These factors are, in turn, affected by general economic
conditions, monetary policies of the federal government, including the Federal
Reserve Board, legislative tax policies and government budgetary matters.
Single-Family Residential Real Estate Lending. The Bank historically has
been and continues to be an originator of single-family, residential real estate
loans in its market area. At September 30, 1998, single-family, residential
mortgage loans, excluding single-family rental property loans and home equity
loans, totaled $126.3 million, or 66.5% of the Bank's gross loan portfolio.
The Bank originates fixed-rate mortgage loans at competitive interest
rates. At September 30, 1998, the Bank had $120.8 million of fixed-rate single-
family mortgage loans, which amounted to 63.6% of the Bank's single-family
mortgage loans. The Bank emphasizes the origination of fixed-rate single-family
residential mortgage loans with maturities of 15 years or less by offering more
competitive rates on these loans as compared to the rates it offers on fixed-
rate mortgage loans with terms in excess of 15 years.
The Bank also offers adjustable-rate, single-family residential mortgage
loans. As of September 30, 1998, $5.5 million, or 2.9% of the Bank's single-
family mortgage loans carried adjustable rates. After the initial term, the
rate adjustments on the Bank's adjustable-rate loans are indexed to a rate which
adjusts annually based upon changes in an index based on the weekly average
yield on U.S. Treasury securities adjusted to a constant comparable maturity of
one year, as made available by the Federal Reserve Board. The interest rates on
most of the Bank's adjustable-rate mortgage loans are adjusted once a year, and
the Bank offers loans that have an initial adjustment period of one, three or
five years. The maximum adjustment is 2% per adjustment period with a maximum
aggregate adjustment of 6% over the life of the loan. The Bank offers
adjustable-rate mortgage loans that provide for initial rates of interest below
the rates that would prevail when the index used for repricing is applied, i.e.,
"teaser" rates. All of the Bank's adjustable-rate loans require that any
payment adjustment resulting from a change in the interest rate be sufficient to
result in full amortization of the loan by the end of the loan term and, thus,
do not permit any of the increased payment to be added to the principal amount
of the loan, known as "negative amortization."
The retention of adjustable-rate loans in the Bank's portfolio helps reduce
the Bank's exposure to increases in prevailing market interest rates. However,
there are unquantifiable credit risks resulting from potential increases in
costs to borrowers in the event of upward repricing of adjustable-rate loans.
It is possible that during periods of rising interest rates, the risk of default
on adjustable-rate loans may increase due to increases in interest costs to
borrowers. Further, although adjustable-rate loans allow the Bank to increase
the sensitivity of its interest-earning assets to changes in interest rates, the
extent of this interest sensitivity is limited by the initial fixed-rate period
before the first adjustment and the lifetime interest rate adjustment
limitations. Accordingly, there can be no assurance that yields on the Bank's
adjustable-rate loans will fully adjust to compensate for increases in the
Bank's cost of funds. Finally, adjustable-rate loans increase the Bank's
exposure to decreases in prevailing market interest rates, although decreases in
the Bank's cost of funds tend to offset this effect.
8
<PAGE>
Single-family Rental Property Loans. The Bank also offers single-family
residential mortgage loans secured by properties that are not owner-occupied,
although it has significantly reduced the originations of such loans during the
past five years. As of September 30, 1998, single-family rental property loans
totaled $5.3 million, or 2.8%, of the Bank's gross loan portfolio. Originations
of single-family rental property loans were $0, $135,000 and $157,000 for the
years ended September 30, 1998, 1997 and 1996, respectively. Single-family
residential mortgage loans secured by nonowner-occupied properties are made on a
fixed-rate or an adjustable-rate basis and carry interest rates generally from
.5% to 1.0% above the rates charged on comparable loans secured by owner-
occupied properties. The maximum term on such loans is 20 years.
Construction Lending. A substantial portion of the Bank's construction
loans are originated for the construction of owner-occupied, single-family
dwellings in the Bank's primary market area. Residential construction loans are
offered primarily to individuals building their primary or secondary residence,
as well as to selected local developers to build single-family dwellings.
Generally, loans to owner/occupants for the construction of owner-occupied,
single-family residential properties are originated in connection with the
permanent loan on the property and have a construction term of up to 12 months.
Such loans are offered on a fixed-rate or adjustable-rate basis. Interest rates
on residential construction loans made to the owner/occupant have interest rates
during the construction period equal to the same rate on the permanent loan
selected by the customer. Interest rates on residential construction loans to
builders are set at the prime rate plus a margin of between .5% and 1.5%.
Interest rates on commercial construction loans are based on the prime rate plus
a negotiated margin of between .5% and 1.5% and adjust monthly, with
construction terms generally not exceeding 18 months. Advances are made on a
percentage of completion basis. At September 30, 1998, $7.9 million, or 42%, of
the Bank's gross loan portfolio consisted of construction loans, virtually all
of which was secured by single-family residences.
Prior to making a commitment to fund a loan, the Bank requires both an
appraisal of the property by appraisers approved by the Board of Directors and a
study of projected construction costs. The Bank also reviews and inspects each
project at the commencement of construction and as needed prior to disbursements
during the term of the construction loan.
The Bank's originations of construction loans have declined in recent
years. Recent consolidation within the building industry and the increasing
presence in the Bank's market of large builders that are not locally based have
limited the Bank's ability to compete for some loans to builders because the
Bank's loans-to-one-borrower limitation limits its ability to meet the volume
requirements of the large builders. The Bank's construction loans totaled $7.9
million, $8.6 million, $11.4 million, $7.1 million and $9.8 million at September
30, 1998, 1997, 1996, 1995 and 1994, respectively, and construction loan
originations were $1.6 million, $1.2 million and $3.0 million during the years
ended September 30, 1998, 1997 and 1996, respectively.
On occasion, the Bank makes acquisition and development loans to local
developers to acquire and develop land for sale to builders who will construct
single-family residences. Acquisition and development loans, which are
considered by the Bank to be construction loans, are made at a rate that adjusts
monthly, based on the prime rate plus a negotiated margin, for terms of up to
three years. Interest only is paid during the term of the loan, and the
principal balance of the loan is paid down as developed lots are sold to
builders. Generally, in connection with acquisition and development loans, the
Bank issues a letter of credit to secure the developer's obligation to local
governments to complete certain work. If the developer fails to complete the
required work, the Bank would be required to fund the cost of completing the
work up to the amount of the letter of credit. Letters of credit generate fee
income for the Bank but create additional risk. At September 30, 1998, the Bank
had one such loans outstanding totaling $1.0 million. All acquisition and
development loans were performing in accordance with their terms at such date.
Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. During
the construction phase, a number of factors could result in delays and cost
9
<PAGE>
overruns. If the estimate of construction costs proves to be inaccurate and the
borrower is unable to meet the Bank's requirements of putting up additional
funds to cover extra costs or change orders, then the Bank will demand that the
loan be paid off and, if necessary, institute foreclosure proceedings, or
refinance the loan. If the estimate of value proves to be inaccurate, the Bank
may be confronted, at or prior to the maturity of the loan, with collateral
having a value which is insufficient to assure full repayment. The Bank has
sought to minimize this risk by limiting construction lending to qualified
borrowers (i.e., borrowers who satisfy all credit requirements and whose loans
satisfy all other underwriting standards which would apply to the Bank's
permanent mortgage loan financing for the subject property) in the Bank's market
area. On loans to builders, the Bank works only with selected builders with
whom it has experience and carefully monitors the creditworthiness of the
builders.
Commercial Real Estate Lending. The Bank's commercial real estate loan
portfolio includes loans to finance the acquisition of small office buildings,
churches, medical condominiums, small shopping centers and small commercial and
industrial buildings. Such loans generally range in size from $100,000 to $2
million, with the largest having an outstanding principal balance of $1.4
million at September 30, 1998. At September 30, 1998, the Bank had $9.5 million
of commercial real estate loans, which amounted to 5.0% of the Bank's gross loan
portfolio. Commercial real estate loans are originated on a fixed-rate or
adjustable-rate basis with terms of up to 20 years at a rate that is at least 1%
above the rate charged by the Bank on single-family residential mortgage loans
having comparable terms and interest rate adjustment periods.
Commercial real estate lending entails significant additional risks as
compared with single-family residential property lending. Commercial real
estate loans typically involve larger loan balances to single borrowers or
groups of related borrowers. The payment experience on such loans typically is
dependent on the successful operation of the real estate project, retail
establishment or business. These risks can be significantly impacted by supply
and demand conditions in the market for office and retail space and, as such,
may be subject to a greater extent to adverse conditions in the economy
generally. To minimize these risks, the Bank generally limits itself to its
market area or to borrowers with which it has prior experience or who are
otherwise known to the Bank. It is the Bank's policy generally to obtain annual
financial statements of the business of the borrower or the project for which
commercial real estate loans are made. In addition, in the case of commercial
real estate loans made to a partnership or a corporation, the Bank seeks,
whenever possible, to obtain personal guarantees and annual financial statements
of the principals of the partnership or corporation.
Commercial Lines of Credit. On a limited basis and as an accommodation to
its customers, the Bank offers lines of credit to small businesses. Loans in
amounts of up to $25,000 are made on an unsecured basis at an adjustable rate
equal to the prime rate plus a margin of 2%. Up to an additional $25,000 may be
loaned, provided the additional amount is secured. The secured portion of the
loan is made at an adjustable rate equal to the prime rate plus a margin of 1%.
At September 30, 1998, the Bank had $50,000 of outstanding loans and commitments
to fund $25,000 in loans pursuant to unused lines of credit.
Consumer Lending. The consumer loans currently in the Bank's loan
portfolio consist of automobile loans, home equity lines of credit and loans
secured by savings deposit.
Automobile loans totaled $33.7 million, or 17.8% of the Bank's gross loan
portfolio, at September 30, 1998. Automobile loans are secured by both new and
used cars and, depending on the creditworthiness of the borrower, may be made
for up to 90% of the "sticker price" or purchase price, whichever is lower, or,
with respect to used automobiles, the loan values as published by a wholesale
value listing utilized by the automobile industry. Automobile loans are made
directly to the borrower-owner or indirectly, where the financing is arranged by
the car dealer. Management of the Bank estimates that approximately 80% of
automobile loans are originated on an indirect basis through various dealerships
located in its market area. Automobile loans originated on an indirect basis
are considered to entail greater credit risk than automobile loans originated on
a direct basis. New and relatively new cars (less than two years old or 20,000
miles or less) are financed for a period generally of up to five years, while
used cars are financed for a period generally of up to four years, or less,
depending on the age of the car. Collision insurance is required for all
automobile loans. The
10
<PAGE>
Bank also maintains a blanket collision insurance policy that provides insurance
for any borrower who allows his insurance to lapse. Any expense under the
blanket insurance policy of covering a borrower is billed to the borrower.
The Bank recently has begun placing greater emphasis on the origination of
second mortgage loans and home equity lines of credit. As of September 30,
1998, home equity lines of credit totaled $6.5 million, or 3.5% of the Bank's
gross loan portfolio. Second mortgage loans are made at fixed rates and for
terms of up to 15 years and totaled $18.9 million, or 9.9% of the Bank's gross
loans at September 30, 1998.
The Bank's home equity lines of credit currently have adjustable interest
rates tied to the prime rate and are offered anywhere from as low as the prime
rate less .25% up to the prime rate. The interest rate may not adjust to a
rate higher than 18%. The home equity lines of credit require monthly payments
until the loan is paid in full, with a loan term not to exceed 20 years. The
minimum monthly payment is 1.5% of the outstanding principal balance. Home
equity lines of credit are secured by subordinate liens against residential real
property. The Bank requires that fire and extended coverage casualty insurance
(and, if appropriate, flood insurance) be maintained in an amount at least
sufficient to cover its loan.
The Bank makes savings account loans for up to 90% of the depositor's
savings account balance. The interest rate is normally 2.0% above the rate paid
on a passbook savings account, and the account must be pledged as collateral to
secure the loan. Interest generally is billed on a monthly basis. At September
30, 1998, savings account loans accounts totaled $681,000, or .4% of the Bank's
gross loan portfolio.
Consumer lending affords the Bank the opportunity to earn yields higher
than those obtainable on single-family residential lending. However, consumer
loans entail greater risk than do residential mortgage loans, particularly in
the case of loans which are unsecured or secured by rapidly depreciable assets.
Repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by events
such as job loss, divorce, illness or personal bankruptcy. Indirect automobile
lending generally is considered to entail greater risk than direct automobile
lending due to the higher down payments generally made by direct borrowers and
the level of sophistication of the borrowers.
Loan Fees and Servicing. The Bank receives fees in connection with late
payments and for miscellaneous services related to its loans. The Bank also
charges fees in connection with loan originations typically from 0 to 3 points
(one point being equal to 1% of the loan amount) on residential mortgage loan
originations. The Bank generally does not service loans for others, except for
participation loans originated and sold by the Bank with servicing retained, and
earns minimal income from this activity.
Nonperforming Loans and Other Problem Assets. It is management's policy to
continually monitor its loan portfolio to anticipate and address potential and
actual delinquencies. When a borrower fails to make a payment on a loan, the
Bank takes immediate steps to have the delinquency cured and the loan restored
to current status. Loans which are past due 15 days incur a late fee of 5% of
principal and interest due. As a matter of policy, the Bank will send a late
notice to the borrower after the loan has been past due 15 days and again after
30 days. If payment is not promptly received, the borrower is contacted again,
and efforts are made to formulate an affirmative plan to cure the delinquency.
Generally, after any loan is delinquent 90 days or more, formal legal
proceedings are commenced to collect amounts owed. In the case of automobile
loans, late notices are sent after loans are ten days delinquent, and the
collateral is seized after a loan is delinquent 60 days. Repossessed cars
subsequently are sold at auction.
Loans generally are placed on nonaccrual status if the loan becomes past
due more than 90 days, except in instances where in management's judgment there
is no doubt as to full collectibility of principal and interest, or
11
<PAGE>
management concludes that payment in full is not likely. Consumer loans are
generally charged off, or any expected loss is reserved for, after they become
more than 120 days past due. All other loans are charged off when management
concludes that they are uncollectible. See Note 1 of Notes to Financial
Statements.
Real estate acquired by the Bank as a result of foreclosure is classified
as real estate acquired through foreclosure until such time as it is sold. When
such property is acquired, it is initially recorded at the lower of cost or
estimated fair value and subsequently at the lower of book value or fair value
less estimated costs to sell. Costs relating to holding such real estate are
charged against income in the current period, while costs relating to improving
such real estate are capitalized until a saleable condition is reached. Any
required write-down of the loan to its fair value less estimated selling costs
upon foreclosure is charged against the allowance for loan losses. See Note 1
of Notes to Financial Statements.
12
<PAGE>
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
-----------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate:
Single-family residential....................... $ 769 $1,757 $2,056 $ 717 $1,000
Single-family rental property................... -- -- -- -- --
Commercial...................................... 150 86 231 188 47
Construction.................................... 193 -- -- -- --
Commercial lines of credit....................... -- -- -- -- --
Consumer......................................... -- -- -- -- --
------ ------ ------ ------ ------
Total........................................... $1,112 $1,843 $2,287 $ 905 $1,047
====== ====== ====== ====== ======
Accruing loans which are contractually past due
90 days or more:
Real estate:
Single-family residential....................... $ -- $ -- $ -- $ -- $ --
Single-family rental property................... -- -- -- -- --
Commercial...................................... -- -- -- -- --
Construction.................................... -- -- -- -- --
Commercial lines of credit....................... -- -- -- -- --
Consumer......................................... -- -- -- -- --
------ ------ ------ ------ ------
Total........................................... $ -- $ -- $ -- $ -- $ --
====== ====== ====== ====== ======
Total non-performing loans...................... $1,112 $1,843 $2,287 $ 905 $1,047
====== ====== ====== ====== ======
Percentage of gross loans......................... 0.59% 1.11% 1.38% 0.58% 0.76%
====== ====== ====== ====== ======
Percentage of total assets........................ 0.41% 0.73% 0.88% 0.38% 0.48%
====== ====== ====== ====== ======
Other non-performing assets (2)................... $ 441 $ 61 $ 489 $1,410 $2,011
====== ====== ====== ====== ======
Loans modified in troubled debt restructuring.... $ -- $ -- $ -- $ -- $ --
====== ====== ====== ====== ======
</TABLE>
- - ------------------
(1) Non-accrual status denotes loans on which, in the opinion of management,
the collection of additional interest is unlikely. Payments received on a
non-accrual loan are either applied to the outstanding principal balance or
recorded as interest income, depending on management's assessment of the
collectibility of the loan.
(2) Other nonperforming assets include the Bank's inventory of repossessed
cars, and at September 30, 1996, 1995 and 1994, real estate developed and
held for sale.
During the year ended September 30, 1998, gross interest income of $71,000,
would have been recorded on loans accounted for on a nonaccrual basis if the
loans had been current throughout the year. Interest on such loans included in
income during the year ended September 30, 1998 amounted to $45,000.
At September 30, 1998, the Bank had no loans which were not classified as
non-accrual, 90 days past due or restructured but where known information about
possible credit problems of borrowers caused management to have serious concerns
as to the ability of the borrowers to comply with present loan repayment terms
and may result in disclosure as nonaccrual, 90 days past due or restructured.
At September 30, 1998, nonaccrual loans consisted of 13 single-family
residential mortgage loans aggregating $1.1 million.
Real estate acquired through foreclosure is initially recorded at the lower
of cost or estimated fair value and subsequently at the lower of book value or
fair value less estimated costs to sell. Fair value is defined as the amount
13
<PAGE>
in cash or cash-equivalent value of other consideration that a real estate
parcel would yield in a current sale between a willing buyer and a willing
seller, as measured by market transactions. If a market does not exist, fair
value of the item is estimated based on selling prices of similar items in
active markets or, if there are no active markets for similar items, by
discounting a forecast of expected cash flows at a rate commensurate with the
risk involved. Fair value is generally determined through an appraisal at the
time of foreclosure. The Bank records a valuation allowance for estimated
selling costs of the property immediately after foreclosure. Subsequent to
foreclosure, real estate acquired through foreclosure is periodically evaluated
by management and an allowance for loss is established if the estimated fair
value of the property, less estimated costs to sell, declines. At September 30,
1998, the Bank had $371,000 in real estate owned, which consisted of two single-
family residences. The Bank also had $1.1 million of other nonperforming assets,
which consisted of non-accrual loans and the Bank's inventory of repossessed
cars.
Federal regulations require savings institutions to classify their assets
on the basis of quality on a regular basis. An asset meeting one of the
classification definitions set forth below may be classified and still be a
performing loan. An asset is classified as substandard if it is determined to
be inadequately protected by the current retained earnings and paying capacity
of the obligor or of the collateral pledged, if any. An asset is classified as
doubtful if full collection is highly questionable or improbable. An asset is
classified as loss if it is considered uncollectible, even if a partial recovery
could be expected in the future. The regulations also provide for a special
mention designation, described as assets which do not currently expose a savings
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's close
attention. Such assets designated as special mention may include nonperforming
loans consistent with the above definition. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings
institution must either establish a specific allowance for loss in the amount of
the portion of the asset classified loss, or charge off such amount. Federal
examiners may disagree with a savings institution's classifications. If a
savings institution does not agree with an examiner's classification of an
asset, it may appeal this determination to the OTS Regional Director. The Bank
regularly reviews its assets to determine whether any assets require
classification or re-classification. At September 30, 1998, the Bank had $3.1
million in classified assets consisting of $1.6 million in assets classified as
special mention, $1.4 million in assets classified as substandard, no assets
classified as doubtful and $56,000 in assets classified as loss. Special
mention assets consisted of 20 single-family residential mortgage loans 60 to 89
days delinquent at September 30, 1998, and substandard assets consisted of the
$1.1 million in nonaccrual loans described above.
Allowance for Loan Losses. In originating loans, the Bank recognizes that
credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan, general economic conditions and, in the case
of a secured loan, the quality of the security for the loan. It is management's
policy to maintain an adequate allowance for loan losses based on, among other
things, the Bank's and the industry's historical loan loss experience,
evaluation of economic conditions, regular reviews of delinquencies and loan
portfolio quality and evolving standards imposed by federal bank examiners. The
Bank increases its allowance for loan losses by charging provisions for loan
losses against the Bank's income.
Management will continue to actively monitor the Bank's asset quality and
allowance for loan losses. Management will charge off loans and properties
acquired in settlement of loans against the allowances for losses on such loans
and such properties when appropriate and will provide specific loss allowances
when necessary. Although management believes it uses the best information
available to make determinations with respect to the allowances for losses and
believes such allowances are adequate, future adjustments may be necessary if
economic conditions differ substantially from the economic conditions in the
assumptions used in making the initial determinations.
The Bank's methodology for establishing the allowance for loan losses takes
into consideration probable losses that have been identified in connection with
specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of the Bank's assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a monthly basis based on
an assessment of risk in the Bank's assets taking into consideration the
composition and quality of the portfolio,
14
<PAGE>
delinquency trends, current charge-off and loss experience, loan concentrations,
the state of the real estate market, regulatory reviews conducted in the
regulatory examination process and economic conditions generally. Additional
provisions for losses on loans are made in order to bring the allowance to a
level deemed adequate. Specific reserves will be provided for individual
assets, or portions of assets, when ultimate collection is considered improbable
by management based on the current payment status of the assets and the fair
value of the security. At the date of foreclosure or other repossession, the
Bank would transfer the property to real estate acquired in settlement of loans
initially at the lower of cost or estimated fair value and subsequently at the
lower of book value or fair value less estimated selling costs. Any portion of
the outstanding loan balance in excess of fair value less estimated selling
costs would be charged off against the allowance for loan losses. If, upon
ultimate disposition of the property, net sales proceeds exceed the net carrying
value of the property, a gain on sale of real estate would be recorded.
The following table sets forth an analysis of the Bank's allowance for loan
losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------
1998 1997 1996 1995 1994
------- ------ ------ ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.............. $ 978 $ 926 $ 788 $ 542 $ 613
------- ------ ------ ------ -----
Loans charged-off:
Real estate mortgage:
Single-family residential................. -- -- -- -- --
Multi-family residential.................. -- -- -- -- --
Commercial................................ -- -- (4) -- --
Construction.............................. -- -- -- -- --
Consumer................................... (278) (392) (394) (178) (71)
------- ------ ------ ------ -----
Total charge-offs........................... (278) (392) (398) (178) (71)
Recoveries:
Real estate mortgage:
Single-family residential................. -- -- -- -- --
Multi-family residential.................. -- -- -- -- --
Commercial................................ -- -- -- -- --
Construction.............................. -- -- -- -- --
Consumer................................... 215 158 102 169 137
------- ------ ------ ------ -----
Total recoveries............................ 215 158 102 169 137
Net loans charged off....................... (63) (234) (296) (9) 66
Provision for (reduction of) loan losses... 119 286 434 255 (137)
------- ------ ------ ------ -----
Balance at end of period.................... $ 1,034 $ 978 $ 926 $ 788 $ 542
======= ====== ====== ====== =====
Ratio of net charge-offs to average
loans outstanding during the period........ (0.04)% (.15)% (.20)% (.01)% .05%
======= ====== ====== ====== =====
</TABLE>
15
<PAGE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------------------------------------
1998 1997 1996
-------------------- ------------------- --------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate:
Single-family residential.. $ 413 66.46% $432 62.30% $ 276 56.74%
Single-family rental
property.................. 10 2.76 13 3.85 4 4.25
Commercial................. 124 5.00 79 6.11 120 6.21
Construction............... 78 4.18 28 5.19 36 6.87
Commercial lines of credit... -- .03 -- .04 -- .16
Consumer..................... 409 21.57 426 22.51 490 25.77
------ ------ ---- ------ ----- ------
Total allowance for loan
losses.................. $1,034 100.00% $978 100.00% $ 926 100.00%
====== ====== ==== ====== ===== ======
<CAPTION>
At September 30,
----------------------------------------
1995 1994
------------------ -------------------
Percent of Percent of
Loans in Loans in
Category to Category to
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate:
Single-family residential.. $141 55.87% $214 59.86%
Single-family rental
property.................. 4 5.13 4 6.23
Commercial................. 158 7.13 56 7.91
Construction............... 40 4.51 41 7.14
Commercial lines of credit... -- .15 -- .08
Consumer..................... 445 27.21 227 18.78
---- ------ ---- ------
Total allowance for loan
losses.................. $788 100.00% $542 100.00%
==== ====== ==== ======
</TABLE>
16
<PAGE>
INVESTMENT ACTIVITIES
General. The Bank is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of Atlanta,
certificates of deposit in federally insured institutions, certain bankers'
acceptances and federal funds. It may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest investment
rating categories of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds. Federal regulations
require the Bank to maintain an investment in FHLB stock and a minimum amount of
liquid assets which may be invested in cash and specified securities. From time
to time, the OTS adjusts the percentage of liquid assets which savings banks are
required to maintain. See "Regulation -- Depository Institution Regulation --
Liquidity Requirements."
The Bank makes investments in order to maintain the levels of liquid assets
required by regulatory authorities and manage cash flow, diversify its assets,
obtain yield and to satisfy certain requirements for favorable tax treatment.
The investment activities of the Bank consist primarily of investments in
mortgage-backed securities and other investment securities, consisting primarily
of securities issued or guaranteed by the U.S. government or agencies thereof.
Typical investments include federally sponsored agency mortgage pass-through and
federally sponsored agency and mortgage-related securities. In addition, until
September 1995, the Bank maintained an investment in a mutual fund that
purchased U.S. government and agency mortgage-backed securities. Investment and
aggregate investment limitations and credit quality parameters of each class of
investment are prescribed in the Bank's investment policy. The Bank performs
analyses on mortgage-related securities prior to purchase and on an ongoing
basis to determine the impact on earnings and market value under various
interest rate and prepayment conditions. Under the Bank's current investment
policy, securities purchases are made by the Bank's President. The Bank's
President and Treasurer have limited authority to sell investment securities and
purchase comparable investment securities with similar characteristics. The
Board of Directors reviews all securities transactions on a monthly basis.
Securities designated as "held to maturity" are those assets which the Bank
has the ability and intent to hold to maturity. Upon acquisition, securities
are classified as to the Bank's intent, and a sale would only be effected due to
deteriorating investment quality. The held to maturity investment portfolio is
not used for speculative purposes and is carried at amortized cost. In the
event the Bank sells securities from this portfolio for other than credit
quality reasons, all securities within the investment portfolio with matching
characteristics may be reclassified as assets available for sale. Securities
designated as "available for sale" are those assets which the Bank may not hold
to maturity and thus are carried at market value with unrealized gains or
losses, net of tax effect, recognized in retained earnings. All of the Bank's
securities at September 30, 1998 were designated as held to maturity.
Mortgage-Backed and Related Securities. Mortgage-backed securities
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators through intermediaries that pool and repackage the
participation interest in the form of securities to investors such as the Bank.
Such intermediaries may include quasi-governmental agencies such as FHLMC, FNMA
and GNMA which guarantee the payment of principal and interest to investors.
Mortgage-backed securities generally increase the quality of the Bank's assets
by virtue of the guarantees that back them, are more liquid than individual
mortgage loans and may be used to collateralize borrowings or other obligations
of the Bank.
Mortgage-related securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans with
interest rates that are within a range and have similar maturities. The
underlying pool of mortgages can be composed of either fixed-rate or adjustable-
rate mortgage loans. Mortgage-backed securities generally are referred to as
mortgage participation certificates or pass-through certificates. As a result,
the interest rate risk characteristics of the underlying pool of mortgages,
i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on
to the certificate holder. The life of a mortgage-backed pass-through security
is equal to the life of the underlying mortgages.
17
<PAGE>
The actual maturity of a mortgage-backed security varies, depending on when
the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the mortgage-
backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accredited over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates is an important
determinant in the rate of prepayments. During periods of falling mortgage
interest rates, prepayments generally increase, and, conversely, during periods
of rising mortgage interest rates, prepayments generally decrease. If the
coupon rate of the underlying mortgage significantly exceeds the prevailing
market interest rates offered for mortgage loans, refinancing generally
increases and accelerates the prepayment of the underlying mortgages.
Prepayment experience is more difficult to estimate for adjustable-rate
mortgage-backed securities.
Mortgage-related securities, which include collateralized mortgage
obligations ("CMOs"), are typically issued by a special purpose entity, which
may be organized in a variety of legal forms, such as a trust, a corporation or
a partnership. The entity aggregates pools of pass-through securities, which
are used to collateralize the mortgage-related securities. Once combined, the
cash flows can be divided into "tranches" or "classes" of individual securities,
thereby creating more predictable average lives for each security than the
underlying pass-through pools. Accordingly, under this security structure, all
principal paydowns from the various mortgage pools are allocated to a mortgage-
related securities' class or classes structured to have priority until it has
been paid off. These securities generally have fixed interest rates, and, as a
result, changes in interest rates generally would affect the market value and
possibly the prepayment rates of such securities.
Some mortgage-related securities instruments are like traditional debt
instruments due to their stated principal amounts and traditionally defined
interest rate terms. Purchasers of certain other mortgage-related securities
instruments are entitled to the excess, if any, of the issuer's cash flows.
These mortgage-related securities instruments may include instruments designated
as residual interest and are riskier in that they could result in the loss of a
portion of the original investment. Cash flows from residual interests are very
sensitive to prepayments and, thus, contain a high degree of interest rate risk.
The Bank does not purchase residual interests in mortgage-related securities.
The Bank's mortgage-backed securities portfolio consists primarily of
seasoned fixed-rate mortgage-backed securities. The Bank makes such investments
in order to manage cash flow, diversify assets, obtain yield, to satisfy certain
requirements for favorable tax treatment and to satisfy the qualified thrift
lender test. See "Regulation -- Depository Institution Regulation -- Qualified
Thrift Lender Test."
At September 30, 1998, mortgage-backed securities with an amortized cost of
$34.2 million were classified as held to maturity. At September 30, 1998, the
Bank's mortgage-backed securities had a weighted average yield of 6.5%.
At September 30, 1998, the Bank did not have any CMOs, and the Bank's
investment policy does not permit investments in individual issues of CMOs or
Real Estate Mortgage Investment Conduits ("REMICs").
18
<PAGE>
The following table sets forth the carrying value of the Bank's investments
at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
---------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Securities available for sale:
Mutual funds.................... $ -- $ -- $ --
Equity securities............... -- -- 101
Securities held to maturity:
U.S. government and agency
securities.................... 12,611 30,323 36,298
Mortgage-backed securities...... 34,198 37,189 39,771
FHLB stock...................... 1,512 1,433 1,301
------- ------- -------
Total.......................... $48,321 $68,945 $77,471
======= ======= =======
</TABLE>
19
<PAGE>
The following table sets forth information in the scheduled maturities,
amortized cost, market values and average yields for the Bank's investment
portfolio at September 30, 1998.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years
------------------- ------------------- -------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities held to maturity:
U.S. government and agency
obligations................ $1,000 5.6% $ 5,060 6.19% $6,551 6.89%
Mortgage-backed securities.. 1,179 6.3 26,564 6.53 1,888 6.56
FHLB stock.................. -- -- --
------ ------- ------
Total...................... $2,179 $31,624 $8,439
====== ======= ======
<CAPTION>
More than Ten Years Total Investment Portfolio
------------------- -----------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Securities held to maturity:
U.S. government and agency
obligations................ $ -- -- % $12,611 $12,662 6.51%
Mortgage-backed securities.. 4,567 7.88 34,198 34,874 6.70
FHLB stock.................. 1,512 7.35 1,512 1,512 7.35
------ ------- -------
Total...................... $6,079 $48,321 $49,048
====== ======= =======
</TABLE>
20
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
General. Deposits are the primary source of the Bank's funds for lending,
investment activities and general operational purposes. In addition to
deposits, the Bank derives funds from loan principal and interest repayments,
maturities of investment securities and mortgage-backed securities and interest
payments thereon. Although loan repayments are a relatively stable source of
funds, deposit inflows and outflows are significantly influenced by general
interest rates and money market conditions. Borrowings may be used on a short-
term basis to compensate for reductions in the availability of funds, or on a
longer term basis for general operational purposes. The Bank has access to
borrow from the FHLB of Atlanta.
Deposits. The Bank attracts deposits principally from within its market
area by offering a variety of deposit instruments, including checking accounts,
money market accounts, statement and passbook savings accounts, Individual
Retirement Accounts, and certificates of deposit which range in maturity from
seven days to five years. Deposit terms vary according to the minimum balance
required, the length of time the funds must remain on deposit and the interest
rate. Maturities, terms, service fees and withdrawal penalties for its deposit
accounts are established by the Bank on a periodic basis. The Bank reviews its
deposit mix and pricing on a weekly basis. In determining the characteristics of
its deposit accounts, the Bank considers the rates offered by competing
institutions, lending and liquidity requirements, growth goals and federal
regulations. Management believes it prices its deposits comparably to rates
offered by its competitors. The Bank does not accept brokered deposits.
The Bank attempts to compete for deposits with other institutions in its
market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of the
Bank's depositors are Maryland residents. To provide additional convenience,
the Bank participates in the HONOR Automated Teller Machine ("ATM") network at
locations throughout the mid-Atlantic and the South and the CIRRUS Automated
Teller Machine network at locations throughout the United States, through which
customers can gain access to their accounts at any time. The Bank currently has
ATM machines in three of its five offices. In addition, in 1998, the Bank added
drive-in facilities at the Bel Air and Dundalk facilities.
21
<PAGE>
Savings deposits in the Bank at September 30, 1998 were represented by the
various types of savings programs described below.
<TABLE>
<CAPTION>
Interest Minimum Minimum Balances Percentage of
Rate Term Category Amount (In thousands) Total Savings
- - -------- ------- -------- -------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Demand deposits:
1.44% None NOW and Super NOW accounts $ 250 $ 25,343 11.48%
3.20 None Money market 250 8,728 3.95
-------- ------
Total demand deposits 34,071 15.43
Passbook savings deposits:
2.96 None Regular passbook 25 29,111 13.18
3.39 None Money market passbook 10,000 25,701 11.64
-------- ------
Total passbook savings deposits 54,812 24.82
Certificates of Deposit
----------------------
4.78 3 months or less Fixed-term, fixed-rate 1,000 15,590 7.06
5.27 6 months Fixed-term, fixed-rate 1,000 10,794 4.89
5.45 12 months Fixed-term, fixed-rate 100 46,500 21.06
5.38 18 months Fixed-term, fixed-rate 100 5,610 2.54
5.53 24 months Fixed-term, fixed-rate 100 13,799 6.25
5.49 30 months Fixed-term, fixed-rate 100 2,505 1.13
5.71 36 months Fixed-term, fixed-rate 100 3,219 1.46
6.52 42 months Fixed-term, fixed-rate 100 924 .42
5.88 48 months Fixed-term, fixed-rate 100 633 .29
6.18 60 months Fixed-term, fixed-rate 100 19,184 8.69
5.63 $100,000 and over Fixed-term, fixed-rate N/A 12,438 5.63
-------- ------
Total certificates of deposit $131,196 59.42
Accrued interest payable 726 .33
-------- ------
Total deposits $220,805 100.00%
======== ======
</TABLE>
_______________
* Represents weighted average interest rate.
22
<PAGE>
The following table sets forth the change in dollar amount of deposits in
the various types of accounts offered by the Bank between the dates indicated.
<TABLE>
<CAPTION>
Balance at Balance at Balance at
September % of Increase September % of Increase September % of
30, 1998 Deposits (Decrease) 30, 1997 Deposits (Decrease) 30, 1996 Deposits
---------- --------- --------- --------- --------- --------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NOW.......................... $ 25,343 11.48% $ 1,140 $ 24,203 10.77% $ 207 $ 23,996 10.28%
Money market deposit......... 8,728 3.95 (1,327) 10,055 4.48 (516) 10,571 4.54
Passbook savings deposits.... 54,812 24.82 (5,845) 60,657 27.00 (3,841) 64,498 27.64
Certificates of deposit...... 118,758 53.79 249 118,509 52.75 (8,669) 127,178 54.51
Certificates of deposit
$100,000 and over........... 12,438 5.63 1,953 10,485 4.67 3,959 6,526 2.80
Accrued interests payable.... 726 .33 (21) 747 .33 205 542 .23
-------- ------- ------- -------- ------ ------- -------- ------
$220,805 100.00% $(3,851) $224,656 100.00% $(8,655) $ 233,311 100.00%
======== ======= ======= ======== ====== ======= ========= ======
</TABLE>
23
<PAGE>
The following tables set forth the average balances and average interest
rates based on month-end balances for various types of deposits as of the dates
indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------------------------
1998 1997 1996
------------------ ------------------ ------------------
Average Average Average Average Average Average
Balance Rate (1) Balance Rate Balance Rate
-------- -------- -------- -------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW........................... $ 25,192 1.59% $ 21,277 2.01% $ 20,470 2.14%
Money market deposits......... 9,360 3.35 10,147 3.44 10,481 3.51
Passbook savings deposits..... 57,383 3.79 62,963 3.72 65,253 3.75
Non-interest-bearing demand
deposits..................... 6,581 -- 4,646 -- 3,715 --
Certificates of deposit....... 129,840 5.50 133,896 5.37 128,994 5.71
-------- -------- --------
Total....................... $224,356 4.32 $232,929 4.43 $228,913 4.64
======== ======== ========
</TABLE>
________
(1) Annualized.
The following table sets forth the time deposits in the Bank classified by
rates at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
---------------------------------
1998 1997 1996
------ -------- --------
(In thousands)
<S> <C> <C> <C>
4.01 - 6%...................... $116,691 $116,029 $ 89,543
6.01 - 8%...................... 14,376 12,838 44,045
8.01 - 10%...................... 129 127 116
-------- -------- --------
$131,196 $128,994 $133,704
======== ======== ========
</TABLE>
The following table sets forth the amount and maturities of time deposits
at September 30, 1998.
<TABLE>
<CAPTION>
Amount Due
------------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- - ---- -------- --------- --------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
4.01 - 6%.......... $98,417 $ 8,718 $4,214 $ 5,342 $116,691
6.01 - 8%.......... 921 9,908 1,858 1,689 14,376
8.01 - 10%.......... -- 129 -- -- 129
------- ------- ------ ------ --------
$99,338 $18,755 $6,092 $7,031 $131,196
======= ======= ====== ====== ========
</TABLE>
24
<PAGE>
The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity as of September 30,
1998. At such date, such deposits represented 5.63% of total deposits and had a
weighted average rate of 5.63%.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
- - --------------- ----------
(In thousands)
<S> <C>
Three months or less............ $ 4,531
Over three through six months... 2,453
Over six through 12 months...... 2,626
Over 12 months.................. 2,828
-------
Total.......................... $12,438
=======
</TABLE>
The following table sets forth the savings activities of the Bank for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------
1998 1997 1996
--------- -------- --------
(In thousands)
<S> <C> <C> <C>
Deposits............................................ $ 462,996 $417,685 $420,336
Deposits sold....................................... (6,166) -- --
Withdrawals......................................... (470,538) 436,652 415,514
--------- -------- --------
Net increase (decrease) before interest credited... (13,708) (18,967) 4,822
Interest credited................................... 9,857 10,312 10,621
--------- -------- --------
Net increase (decrease) in savings deposits....... $ (3,851) $ (8,655) $ 15,443
========= ======== ========
</TABLE>
In the unlikely event the Bank is liquidated after the Stock Issuance,
depositors will be entitled to full payment of their deposit accounts prior to
any payment being made to the sole stockholder of the Bank.
Borrowings. Savings deposits historically have been the primary source of
funds for the Bank's lending, investments and general operating activities. The
Bank is authorized, however, to use advances from the FHLB of Atlanta to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB of Atlanta functions as a central reserve bank providing
credit for savings institutions and certain other member financial institutions.
As a member of the FHLB System, the Bank is required to own stock in the FHLB of
Atlanta and is authorized to apply for advances. Advances are pursuant to
several different programs, each of which has its own interest rate and range of
maturities. The Bank has a Blanket Agreement for advances with the FHLB under
which the Bank may borrow up to 25% of assets subject to normal collateral and
underwriting requirements. Advances from the FHLB of Atlanta are secured by the
Bank's stock in the FHLB of Atlanta and other eligible assets. During the years
ended September 30, 1998, 1997 and 1996, the Bank had no borrowings other than
FHLB advances. At September 30, 1998, the Bank had no outstanding FHLB
advances.
25
<PAGE>
SUBSIDIARY ACTIVITIES
As a federally chartered savings bank, the Bank is permitted to invest an
amount equal to 2% of its assets in subsidiaries, with an additional investment
of 1% of assets where such investment serves primarily community, inner-city and
community development purposes. Under such limitations, as of September 30,
1998, the Bank was authorized to invest up to approximately $5.4 million in the
stock of or loans to subsidiaries, including the additional 1% investment for
community inner-city and community development purposes. Institutions meeting
their applicable minimum regulatory capital requirements may invest up to 50% of
their regulatory capital in conforming first mortgage loans to subsidiaries in
which they own 10% or more of the capital stock.
The Bank has two subsidiary service corporations, Baltimore County Service
Corp. ("BCSC") and Ebenezer Road, Inc. ("Ebenezer Road"). Further, BCSC has a
wholly owned subsidiary, Route 543, Incorporated ("Route 543"). BCSC was formed
in the mid 1970's for the purpose of participating in joint ventures for the
development of real estate. The last development project was completed during
the year ended September 30, 1996, and at September 30, 1998, BCSC conducted
immaterial activities. Route 543 was formed for the purpose of participating in
joint ventures with BCSC. The activities of Route 543 were completed during the
year ended September 30, 1996, and Route 543 currently is inactive. At
September 30, 1998, BCSC had substantially no assets or liabilities, except that
it may receive a refund, that would not exceed $13,000, of amounts owed to it by
a utility company in connection with a development project completed
approximately ten years ago. The Bank does not intend to conduct real estate
development activities in the future. Ebenezer Road is an insurance agency that
sells primarily vendor's single interest insurance on automobile loans, as well
as mortgage life insurance and annuity products. The fees from the activities
of its subsidiaries were immaterial during the year ended September 30, 1998.
COMPETITION
The Bank faces strong competition both in originating real estate and
consumer loans and in attracting deposits. The Bank competes for real estate
and other loans principally on the basis of interest rates, the types of loans
it originates, the deposit products it offers and the quality of services it
provides to borrowers. The Bank also competes by offering products which are
tailored to the local community. Its competition in originating real estate
loans comes primarily from other savings institutions, commercial banks and
mortgage bankers. Commercial banks, credit unions and finance companies provide
vigorous competition in consumer lending. Competition may increase as a result
of the continuing reduction of restrictions on the interstate operations of
financial institutions.
The Bank attracts its deposits through its offices primarily from the local
community. Consequently, competition for deposits is principally from other
savings institutions, commercial banks, credit unions and brokers in the local
community. The Bank competes for deposits and loans by offering what it
believes to be a variety of deposit accounts at competitive rates, convenient
business hours, a commitment to outstanding customer service and a well-trained
staff. The Bank believes it has developed strong relationships with local
realtors and the community in general.
Management considers its market area for gathering deposits and making
loans to be Baltimore County and Harford County in Maryland. The Bank estimates
that it competes with numerous banks and savings and loan associations for
deposits and loans. Based on data provided by a private marketing firm, the
Bank estimates that at September 30, 1998, it had approximately 2% of deposits
held by all banks and savings institutions in each of Baltimore County and
Harford County.
EMPLOYEES
As of September 30, 1998, the Company had 71 full-time and 15 part-time
employees, none of whom were represented by a collective bargaining agreement.
Management considers the Bank's relationships with its employees to be good.
26
<PAGE>
DEPOSITORY INSTITUTION REGULATION
General. The Bank is a federally chartered savings institution, is a
member of the FHLB of Atlanta and its deposits are insured by the FDIC through
the SAIF. As a federal savings institution, the Bank is subject to regulation
and supervision by the OTS and the FDIC and to OTS regulations governing such
matters as capital standards, mergers, establishment of branch offices,
subsidiary investments and activities and general investment authority. The OTS
periodically examines the Bank for compliance with various regulatory
requirements and for safe and sound operations. The FDIC also has the authority
to conduct special examinations of the Bank because its deposits are insured by
the SAIF. The Bank must file reports with the OTS describing its activities and
financial condition and must obtain the approval of the OTS prior to entering
into certain transactions, such as mergers with or acquisitions of other
depository institutions.
Regulatory Capital Requirements. Under OTS capital standards, a savings
institution must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3% of adjusted total assets and a combination of
core and "supplementary" capital equal to 8% of "risk-weighted" assets. In
addition, the OTS regulations impose certain restrictions on savings
institutions that have a total risk-based capital ratio that is less than 8%, a
ratio of Tier 1 capital to risk-weighted assets of less than 4% or a ratio of
Tier 1 capital to adjusted total assets of less than 4% (or 3% if the
institution is rated Composite 1 under the OTS examination rating system). See
"-- Prompt Corrective Regulatory Action." For purposes of this regulation, Tier
1 capital has the same definition as core capital which is defined as common
stockholders' equity (including retained earnings), noncumulative perpetual
preferred stock and related surplus, minority interests in the equity accounts
of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged
deposits and "qualifying supervisory goodwill." Core capital is generally
reduced by the amount of the savings institution's intangible assets for which
no market exists. Limited exceptions to the deduction of intangible assets are
provided for mortgage servicing rights, purchased credit card relationships and
qualifying supervisory goodwill held by an eligible savings institution.
Tangible capital is given the same definition as core capital but does not
include an exception for qualifying supervisory goodwill and is reduced by the
amount of all the savings institution's intangible assets with only a limited
exception for mortgage servicing rights and purchased credit card relationships.
Both core and tangible capital are further reduced by an amount equal to a
percentage of the savings institution's debt and equity investments in
subsidiaries engaged in activities not permissible for national banks, other
than subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or holding
companies therefor. At September 30, 1998, the Bank had no such investments.
Adjusted total assets are a savings institution's total assets as
determined under generally accepted accounting principles, increased for certain
goodwill amounts and by a pro-rated portion of the assets of subsidiaries in
which the savings institution holds a minority interest (and which are not
engaged in activities for which the capital rules require the savings
institution to net its debt and equity investments in such subsidiaries against
capital), as well as a pro-rated portion of the assets of other subsidiaries for
which netting is not fully required under phase-in rules. Adjusted total assets
are reduced by the amount of assets that have been deducted from capital, the
portion of savings institution's investments in subsidiaries that must be netted
against capital under the capital rules and, for purposes of the core capital
requirement, qualifying supervisory goodwill. At September 30, 1998, the Bank's
adjusted total assets for purposes of core and tangible capital requirements
were $268.8 million.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to include both core capital and supplementary
capital in its total capital, provided the amount of supplementary capital used
does not exceed the savings institution's core capital. Supplementary capital
is defined to include certain preferred stock issues, nonwithdrawable accounts
and pledged deposits that do not qualify as core capital, certain approved
subordinated debt, certain other capital instruments and a portion of the
savings institution's general loss allowances.
27
<PAGE>
Total core and supplementary capital are reduced by the amount of capital
instruments held by other depository institutions pursuant to reciprocal
arrangements and by an increasing percentage of the savings institution's high
loan-to-value ratio land loans, non-residential construction loans and equity
investments other than those deducted from core and tangible capital. As of
September 30, 1998, the Bank had no high ratio land or non-residential
construction loans and no equity investments for which OTS regulations require a
deduction from total capital.
The risk-based capital requirement is measured against risk-weighted assets
which equal the sum of each asset and the credit-equivalent amount of each off-
balance sheet item after being multiplied by an assigned risk weight. Under the
OTS risk-weighting system, one-to-four family first mortgages not more than 90
days past due with loan-to-value ratios under 80% and average annual occupancy
rates of at least 80% and certain qualifying loans for the construction of one-
to-four-family residences pre-sold to home purchasers are assigned a risk weight
of 50%. Consumer and residential construction loans are assigned a risk weight
of 100%. Mortgage-backed securities issued, or fully guaranteed as to principal
and interest by the FNMA or FHLMC are assigned a 20% risk weight. Cash and U.S.
Government securities backed by the full faith and credit of the U.S. Government
(such as mortgage-backed securities issued by GNMA) are given a 0% risk weight.
For information with respect to the Bank's compliance with its regulatory
capital requirements at September 30, 1998, see Note 13 of Notes to Consolidated
Financial Statements.
The risk-based capital requirements of the OTS also require that savings
institutions with more than a "normal" level of interest rate risk to maintain
additional total capital. A savings institution's interest rate risk is
measured in terms of the sensitivity of its "net portfolio value" to changes in
interest rates. Net portfolio value is defined, generally, as the present value
of expected cash inflows from existing assets and off-balance sheet contracts
less the present value of expected cash outflows from existing liabilities. A
savings institution is considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than two percent of the current estimated economic
value of its assets. A savings institution with a greater than normal interest
rate risk will be required to deduct from total capital, for purposes of
calculating its risk-based capital requirement, an amount (the "interest rate
risk component") equal to one-half the difference between the institution's
measured interest rate risk and the normal level of interest rate risk,
multiplied by the economic value of its total assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS requires any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis and may be subject to
an additional capital requirement based upon its level of interest rate risk as
compared to its peers. The Bank is exempt from filing the interest rate risk
schedule with its Thrift Financial Reports and the OTS has not required it to
file such a schedule. The interest rate risk rule did not have a material
effect on the Bank's risk based capital at September 30, 1998.
In addition to requiring generally applicable capital standards for savings
institutions, the OTS is authorized to establish the minimum level of capital
for a savings institution at such amount or at such ratio of capital-to-assets
as the OTS determines to be necessary or appropriate for such institution in
light of the particular circumstances of the institution. Such circumstances
would include a high degree of exposure to interest rate risk, concentration of
credit risk and certain risks arising from non-traditional activity. The OTS
may treat the failure of any savings institution to maintain capital at or above
such level as an unsafe or unsound practice and may issue a directive requiring
any savings institution which fails to maintain capital at or above the minimum
level required by the OTS to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.
28
<PAGE>
Liquidity Requirements. The Bank generally is required to maintain average
daily balances of liquid assets (generally, cash, certain time deposits,
bankers' acceptances, highly rated corporate debt and commercial paper,
securities of certain mutual funds, and specified United States government,
state or federal agency obligations) equal to 4% of its net withdrawable
accounts plus short-term borrowings either at the end of the preceding calendar
quarter or on an average daily basis during the preceding quarter. The Bank
also is required to maintain sufficient liquidity to ensure its safe and sound
operation. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average daily balance of liquid assets ratio of the Bank for
September 1998 was 31.8%.
Qualified Thrift Lender Test. A savings institution that does not meet the
Qualified Thrift Lender ("QTL") test must either convert to a bank charter or
comply with the following restrictions on its operations: (i) the institution
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for both a
national bank and a savings institution; (ii) the branching powers of the
institution shall be restricted to those of a national bank; (iii) the
institution shall not be eligible to obtain any advances from its FHLB; and (iv)
payment of dividends by the institution shall be subject to the rules regarding
payment of dividends by a national bank. In addition, any company that controls
a savings institution that fails to qualify as a QTL will be required to
register as, and to be deemed, a bank holding company subject to all of the
provisions of the Bank Holding Company Act of 1956 (the "BHCA") and other
statutes applicable to bank holding companies. Upon the expiration of three
years from the date the institution ceases to be a QTL, it must cease any
activity and not retain any investment not permissible for a national bank and a
savings institution and immediately repay any outstanding FHLB advances (subject
to safety and soundness considerations).
To meet the QTL test, an institution's "Qualified Thrift Investments" must
total at least 65% of "portfolio assets." Under OTS regulations, portfolio
assets are defined as total assets less intangibles, property used by a savings
institution in its business and liquidity investments in an amount not exceeding
20% of assets. Qualified Thrift Investments consist of (i) loans, equity
positions or securities related to domestic, residential real estate or
manufactured housing, (ii) 50% of the dollar amount of residential mortgage
loans subject to sale under certain conditions, and (iii) stock in an FHLB or
the FHLMC or FNMA. In addition, subject to a 20% of portfolio assets limit,
savings institutions are able to treat as Qualified Thrift Investments 200% of
their investments in loans to finance "starter homes" and loans for
construction, development or improvement of housing and community service
facilities or for financing small businesses in "credit-needy" areas. In order
to maintain QTL status, the savings institution must maintain a weekly average
percentage of Qualified Thrift Investments to portfolio assets equal to 65% on a
monthly average basis in nine out of 12 months. A savings institution that
fails to maintain QTL status will be permitted to requalify once, and if it
fails the QTL test a second time, it will become immediately subject to all
penalties as if all time limits on such penalties had expired.
At September 30, 1998, the percentage of the Bank's portfolio assets
invested in Qualified Thrift Investments was in excess of the percentage
required to qualify the Bank under the QTL test.
Dividend Limitations. Federal regulations impose additional limitations on
the payment of dividends and other capital distributions (including stock
repurchases and cash mergers) by the Bank. Under these regulations, a savings
institution that, immediately prior to, and on a pro forma basis after giving
effect to, a proposed capital distribution, has total capital (as defined by OTS
regulation) that is equal to or greater than the amount of its fully phased-in
capital requirements (a "Tier 1 Association") is generally permitted, without
OTS approval after notice, to make capital distributions during a calendar year
in the amount equal to the greater of: (i) 75% of its net income for the
previous four quarters; or (ii) up to 100% of its net income to date during the
calendar year plus an amount that would reduce by one-half the amount by which
its capital-to-assets ratio exceeded regulatory requirements at the beginning of
the calendar year. A savings institution with total capital in excess of
current minimum capital ratio requirements (a "Tier 2 Association") is permitted
after notice to make capital distributions without OTS approval of up to 75% of
its net income for the previous four quarters, less dividends already paid for
such period. A savings institution that fails to meet current minimum capital
requirements (a "Tier 3 Association") is prohibited from making any capital
distributions without the prior approval of the OTS. A Tier 1 Association that
has been notified by the OTS that it is in need of more
29
<PAGE>
than normal supervision will be treated as either a Tier 2 or Tier 3
Association. The Bank is a Tier 1 Association. Under the OTS' prompt corrective
action regulations, the Bank is also prohibited from making any capital
distributions if after making the distribution, the Bank would have: (i) a total
risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital
ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%. The OTS,
after consultation with the FDIC, however, may permit an otherwise prohibited
stock repurchase if made in connection with the issuance of additional shares in
an equivalent amount and the repurchase will reduce the institution's financial
obligations or otherwise improve the institution's financial condition. See "--
Prompt Corrective Regulatory Action."
The OTS has proposed amendments to its capital distribution regulations
which would conform OTS regulations to the existing requirements of other
banking agencies, as well as simplify the existing OTS regulations. These
proposed rules would eliminate the requirement of notifying the OTS when cash
dividends of a certain amount will be paid for institutions that will remain at
least adequately capitalized. However, applications for capital distributions
will be required for all distributions over a specified amount. Notices will
still be required for distributions that would "reduce the amount of or retire
common or preferred stock, or debt instruments included in the capital.
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes are not available for
payment of cash dividends or other distributions to the Company without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions. See "Item I. Description of
Business -- Taxation." The Company intends to make full use of this favorable
tax treatment afforded to the Bank and the Company and does not contemplate use
of any earnings of the Bank in a manner which would limit either institution's
bad debt deduction or create federal tax liabilities.
Deposit Insurance. FDCIA required the FDIC to establish a risk-based
assessment system for insured depository associations that takes into account
the risks attributable to different categories and concentrations of assets and
liabilities. Under the rule, the FDIC assigns an association to one of three
capital categories consisting of (i) well capitalized, (ii) adequately
capitalized, or (iii) undercapitalized, and one of three supervisory
subcategories. The supervisory subgroup to which an association is assigned is
based on a supervisory evaluation provided to the FDIC by the association's
primary federal regulator and information which the FDIC determines to be
relevant to the association's financial condition and the risk posed to the
deposit insurance funds (which may include, if applicable, information provided
by the association's state supervisor). An association's assessment rate
depends on the capital category and supervisory category to which it is
assigned. There are nine assessment risk classifications (i.e., combinations of
capital groups and supervisory subgroups) to which different assessment rates
are applied. Assessment rates range from zero basis points for an association
in the highest category (i.e., well-capitalized and healthy) to 27 basis points
for an association in the lowest category (i.e., undercapitalized and of
substantial supervisory concern.)
Federal Home Loan Bank System. The Bank is a member of the FHLB System,
which consists of 12 district Federal Home Loan Banks subject to supervision and
regulation by the Federal Housing Finance Board ("FHFB"). The Federal Home Loan
Banks provide a central credit facility primarily for member institutions. As a
member of the FHLB of Atlanta, the Bank is required to acquire and hold shares
of capital stock in the FHLB of Atlanta in an amount at least equal to 1% of the
aggregate unpaid principal of its home mortgage loans, home purchase contracts,
and similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB of Atlanta, whichever is greater. The Bank was in
compliance with this requirement with investment in FHLB of Atlanta stock at
September 30, 1998, of $1.5 million. The FHLB of Atlanta serves as a reserve or
central bank for its member institutions within its assigned district. It is
funded primarily from proceeds derived from the sale of consolidated obligations
of the FHLB System. It offers advances to members in accordance with policies
and procedures established by the FHFB and the Board of Directors of the FHLB of
Atlanta. Long-term advances may only be made for the purpose of providing funds
for residential housing finance. At September 30, 1998, the Bank had no
advances outstanding from the FHLB of Atlanta.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts. No reserves are required on the
first
30
<PAGE>
$4.7 million of transaction accounts maintained; reserves of 3% are required on
the next $47.8 million of transaction accounts and a reserve of 10% must be
maintained against all remaining transaction accounts. These reserve
requirements are subject to adjustment by the Federal Reserve Board. Because
required reserves must be maintained in the form of vault cash or in a non-
interest bearing account at a Federal Reserve Bank, the effect of the reserve
requirement is to reduce the amount of the institution's interest-earning
assets. As of September 30, 1998, the Bank met its reserve requirements.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements, including a
leverage limit, a risk-based capital requirement, and any other measure of
capital deemed appropriate by the federal banking regulators for measuring the
capital adequacy of an insured depository institution. All institutions,
regardless of their capital levels, are restricted from making any capital
distribution or paying any management fees if the institution would thereafter
fail to satisfy the minimum levels for any of its capital requirements. An
institution that fails to meet the minimum level for any relevant capital
measure (an "undercapitalized institution") may be: (i) subject to increased
monitoring by the appropriate federal banking regulator; (ii) required to submit
an acceptable capital restoration plan within 45 days; (iii) subject to asset
growth limits; and (iv) required to obtain prior regulatory approval for
acquisitions, branching and new lines of businesses. The capital restoration
plan must include a guarantee by the institution's holding company that the
institution will comply with the plan until it has been adequately capitalized
on average for four consecutive quarters, under which the holding company would
be liable up to the lesser of 5% of the institution's total assets or the amount
necessary to bring the institution into capital compliance as of the date it
failed to comply with its capital restoration plan. A "significantly
undercapitalized" institution, as well as any undercapitalized institution that
did not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution could also
be required to divest the institution or the institution could be required to
divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total
assets falls below a "critical capital level," the institution will be subject
to conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
Federal banking regulators, including the OTS, have adopted regulations
implementing the prompt corrective action provisions of FDICIA. Under these
regulations, the federal banking regulators will generally measure a depository
institution's capital adequacy on the basis of the institution's total risk-
based capital ratio (the ratio of its total capital to risk-weighted assets),
Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted
assets) and leverage ratio (the ratio of its core capital to adjusted total
assets). Under the regulations, a savings institution that is not subject to an
order or written directive to meet or maintain a specific capital level will be
deemed "well capitalized" if it also has: (i) a total risk-based capital ratio
of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater;
and (iii) a leverage ratio of 5.0% or greater. An "adequately capitalized"
savings institution is a savings institution that does not meet the definition
of well capitalized and has: (i) a total risk-based capital ratio of 8.0% or
greater; (ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and (iii) a
leverage ratio of 4.0% or greater (or 3.0% or greater if the savings institution
has a composite 1 CAMEL rating). An "undercapitalized institution" is a savings
institution that has (i) a total risk-based capital ratio less than 8.0%; or
(ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage
ratio of less than 4.0% (or 3.0% if the institution has a composite 1 CAMEL
rating). A "significantly
31
<PAGE>
undercapitalized" institution is defined as a savings institution that has: (i)
a total risk-based capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based
capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A
"critically undercapitalized" savings institution is defined as a savings
institution that has a ratio of "tangible equity" to total assets of less than
2.0%. "Tangible equity" is defined as core capital plus the institution's
outstanding cumulative perpetual preferred stock (and related surplus) less all
intangibles other than qualifying supervisory goodwill and certain mortgage
servicing rights. The OTS may reclassify a well capitalized savings institution
as adequately capitalized and may require an adequately capitalized or
undercapitalized institution to comply with the supervisory actions applicable
to institutions in the next lower capital category (but may not reclassify a
significantly undercapitalized institution as critically undercapitalized) if
the OTS determines, after notice and an opportunity for a hearing, that the
savings institution is in an unsafe or unsound condition or that the institution
has received and not corrected a less-than-satisfactory rating for any CAMEL
rating category. As of September 30, 1998, the Bank was classified as "well-
capitalized" under these prompt corrective action regulations.
Safety and Soundness Standards. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. On July 10, 1995, the Federal
banking agencies, including the OTS, released Interagency Guidelines
Establishing Standards for Safety and Soundness and published a final rule
establishing deadlines for submission and review of safety and soundness
compliance plans. The guidelines require savings institutions to maintain
internal controls and information systems and internal audit systems that are
appropriate for the size, nature and scope of the institution's business. The
guidelines also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure, and asset growth. The guidelines
further provide that savings institutions should maintain safeguards to prevent
the payment of compensation, fees and benefits that are excessive or that could
lead to material financial loss, and should take into account factors such as
comparable compensation practices at comparable institutions. If the OTS
determines that a savings institution is not in compliance with the safety and
soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A savings institution must
submit an acceptable compliance plan to the OTS within 30 days of receipt of a
request for such a plan. Failure to submit or implement a compliance plan may
subject the institution to regulatory sanctions. Under the guidelines, a
savings institution should maintain systems, commensurate with its size and the
nature and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that these regulatory standards do not materially affect the
Bank's operations.
Lending Limits. Savings institutions generally are subject to the lending
limits applicable to national banks. With certain limited exceptions, the
maximum amount that a savings institution or a national bank may lend to any
borrower outstanding at one time and not fully secured by collateral having a
market value at least equal to the amount of the loan or extension of credit
(including certain related entities of the borrower) outstanding at one time and
not fully secured by collateral having a market value at least equal to the
amount of the loan or extension of credit may not exceed 15% of the unimpaired
capital and surplus of the institution. Loans and extensions of credit fully
secured by readily marketable collateral may comprise an additional 10% of
unimpaired capital and surplus. Savings institutions are additionally
authorized to make loans to one borrower, for any purpose: (i) in an amount not
to exceed $500,000, or (ii) by order of the Director of OTS, in an amount not to
exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus to
develop residential housing, provided: (a) the purchase price of each single-
family dwelling in the development does not exceed $500,000; (b) the savings
institution is and continues to be in compliance with its fully phased-in
capital requirements; (c) the loans comply with applicable loan-to-value
requirements, and; (d) the aggregate amount of loans made under this authority
does not exceed 150% of unimpaired capital and surplus, or (iii) loans to
finance the sale of real property acquired in satisfaction of debts previously
contracted in good faith, not to exceed 50% of unimpaired capital and surplus of
the institution.
At September 30, 1998, the maximum amount that the Bank could have loaned
to any one borrower without prior OTS approval was $5.3 million. At such date,
the largest aggregate amount of loans that the Bank had outstanding to any one
borrower was $2.6 million.
32
<PAGE>
Uniform Lending Standards. Under OTS regulations, savings institutions
must adopt and maintain written policies that establish appropriate limits and
standards for extensions of credit that are secured by liens or interests in
real estate or are made for the purpose of financing permanent improvements to
real estate. These policies must establish loan portfolio diversification
standards, prudent underwriting standards, including loan-to-value limits, that
are clear and measurable, loan administration procedures and documentation,
approval and reporting requirements. The real estate lending policies must
reflect consideration of the Interagency Guidelines for Real Estate Lending
Policies (the "Interagency Guidelines") that have been adopted by the federal
bank regulators.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multifamily or other nonresidential property, the supervisory limit is 80%; (iv)
for loans for the construction of one-to-four family properties, the supervisory
limit is 85%; and (v) for loans secured by other improved property (e.g.,
farmland, completed commercial property and other income-producing property
including non-owner-occupied, one-to-four family property), the limit is 85%.
Although no supervisory loan-to-value limit has been established for owner-
occupied, one-to-four family and home equity loans, the Interagency Guidelines
state that for any such loan with a loan-to-value ratio that equals or exceeds
90% at origination, an institution should require appropriate credit enhancement
in the form of either mortgage insurance or readily marketable collateral.
The Interagency Guidelines state that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits, based on the support provided by other credit
factors. The aggregate amount of loans in excess of the supervisory loan-to-
value limits, however, should not exceed 100% of total capital and the total of
such loans secured by commercial, agricultural, multifamily and other non-one-
to-four family residential properties should not exceed 30% of total capital.
The supervisory loan-to-value limits do not apply to certain categories of loans
including loans insured or guaranteed by the U.S. government and its agencies or
by financially capable state, local or municipal governments or agencies, loans
backed by the full faith and credit of a state government, loans that are to be
sold promptly after origination without recourse to a financially responsible
party, loans that are renewed, refinanced or restructured without the
advancement of new funds, loans that are renewed, refinanced or restructured in
connection with a workout, loans to facilitate sales of real estate acquired by
the institution in the ordinary course of collecting a debt previously
contracted and loans where the real estate is not the primary collateral.
Management believes that the Bank's current lending policies conform to the
Interagency Guidelines.
Transactions with Related Parties. Generally, transactions between a
savings bank or its subsidiaries and its affiliates must be on terms as
favorable to the Bank as transactions with non-affiliates. In addition, certain
of these transactions are restricted to a percentage of the Bank's capital.
Affiliates of the Bank include the Company, the MHC and any company which would
be under common control with the Bank.
The Bank's authority to extend credit to executive officers, trustees and
10% shareholders, as well as entities under such persons control are currently
governed by Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O
promulgated by the Federal Reserve Board. Among other things, these regulations
require such loans to be made on terms substantially similar to those offered to
unaffiliated individuals, place limits on the amount of loans the Bank may make
to such persons based, in part, on the Bank's capital position, and require
certain approval procedures to be followed.
Proposed Legislative and Regulatory Changes. On May 13, 1998, the U.S.
House of Representatives passed H.R. 10 (the "Act"), the Financial Services
Competition Act of 1998, "which calls for a sweeping modernization of the
banking system that would permit affiliations between commercial banks,
securities firms, insurance companies and,
33
<PAGE>
subject to certain limitations, other commercial enterprises. The stated
purposes of the Act are to enhance consumer choice in the financial services
marketplace, level the playing field among providers of financial services and
increase competition. H.R. 10 removes the restrictions contained in the Glass-
Steagall Act of 1933 and the Bank Holding Company Act of 1956, thereby allowing
qualified financial holding companies to control banks, securities firms,
insurance companies, and other financial firms. Conversely, securities firms,
insurance companies and financial firms would be allowed to own or affiliate
with a commercial bank. Under the new framework, the Federal Reserve would
serve as an umbrella regulator to oversee the new financial holding company
structure. Securities affiliates would be required to comply with all
applicable federal securities laws, including registration and other
requirements applicable to broker-dealers. The Act also provides the insurance
affiliates be subject to applicable state insurance regulations and supervision.
The Act preserves the thrift charter and all existing thrift powers, but
restricts the activities of new unitary thrift holding companies.
At the adjournment of Congress in October 1998, the Senate had not voted on
the legislation and the Act had been returned to the Senate Banking Committee
for further review A bill similar to the Act was introduced for consideration
by Congress when it reconvenes in 1999. At this time, it is unknown whether the
Act will be enacted, or if enacted, what form the final version of such
legislation might take.
REGULATION OF THE COMPANY
Upon consummation of the Reorganization, the Company will be a savings and
loan holding company within the meaning of Section 10 of the HOLA. As such, the
Company will be required to register with and be subject to OTS examination and
supervision as well as certain reporting requirements. In addition, because the
Bank's deposits are insured by the SAIF maintained by the FDIC, the Bank is
subject to certain restrictions in dealing with the Company and with other
persons affiliated with the Bank.
One of the requirements for OTS approval of the Reorganization is that the
Company will operate under the activities restrictions applicable to multiple
savings and loan holding companies. The HOLA limits the activities of a
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities specifically permissible by statute for
multiple savings and loan holding companies and to activities of bank holding
companies which the Federal Reserve Board has deemed permissible by regulation
under Section 4(c)(8) of the Bank Holding Company Act, as amended the ("BHCA"),
subject to prior approval of the OTS, and to other activities authorized by OTS
regulation. In addition, under the terms of the Company's federal stock
charter, the purpose of the Company is to pursue any or all of the lawful
objectives of a federal mutual holding company.
The Company is permitted to, among other things: (i) invest in the stock of
a savings institution; (ii) acquire a mutual institution through the merger of
such institution into a savings institution subsidiary of such mutual holding
company or an interim savings institution of such mutual holding company; (iii)
merge with or acquire another mutual holding company, one of whose subsidiaries
is a savings institution; (iv) acquire non-controlling amounts of the stock of
savings institutions and savings institution holding companies, subject to
certain restrictions; (v) invest in a corporation the capital stock of which is
available for purchase by a savings institution under Federal law or under the
law of any state where the subsidiary savings institution or institutions have
their home offices; (vi) furnish or perform management services for a savings
institution subsidiary of such company; (vi) hold, manage, or liquidate assets
owned or acquired from a savings institution subsidiary of such company; (viii)
hold or manage properties used or occupied by a savings institution subsidiary
of such company; and (ix) acting as a trustee under deed or trust.
The HOLA prohibits a savings and loan holding company, such as the Company,
directly or indirectly, from (1) acquiring control (as defined) of a savings
institution (or holding company thereof) without prior OTS approval, (2)
acquiring more than 5% of the voting shares of a savings institution (or holding
company thereof) which is not a subsidiary, subject to certain exceptions,
without prior OTS approval, or (3) acquiring through merger, consolidation or
purchase of assets, another savings institution (or holding company thereof) or
acquiring all or substantially all of the assets, another savings institution
(or holding company thereof) without prior OTS approval, or (4) acquiring
control of an uninsured institution. A savings and loan holding company may not
acquire as a separate subsidiary a savings
34
<PAGE>
institution which has its principal offices outside of the state where the
principal offices of its subsidiary institution is located, except (i) in the
case of certain emergency acquisitions approved by the FDIC, (ii) if the holding
company controlled (as defined) such savings institution as of March 5, 1987,
(iii) when the laws of the state in which the savings institution to be acquired
is located specifically authorize such an acquisition. No director or officer
of a savings and loan holding company or person owning or controlling more than
25% of such holding company's voting shares may, except with the prior approval
of the OTS, acquire control of any savings institution which is not a subsidiary
of such holding company.
TAXATION
General. It is expected that the Company and the Bank, together with the
Bank's subsidiaries, will file a consolidated federal income tax return based on
a fiscal year ending September 30. Consolidated returns have the effect of
deferring gain or loss on intercompany transactions and allowing companies
included within the consolidated return to offset income against losses under
certain circumstances.
Federal Income Taxation. Thrift institutions are subject to the
provisions of the Code in the same general manner as other corporations. Prior
to recent legislation, institutions such as the Bank which met certain
definitional tests and other conditions prescribed by the Code benefitted from
certain favorable provisions regarding their deductions from taxable income for
annual additions to their bad debt reserve. For purposes of the bad debt
reserve deduction, loans were separated into "qualifying real property loans,"
which generally are loans secured by interests in certain real property, and
nonqualifying loans, which are all other loans. The bad debt reserve deduction
with respect to nonqualifying loans was based on actual loss experience,
however, the amount of the bad debt reserve deduction with respect to qualifying
real property loans could be based upon actual loss experience (the "experience
method") or a percentage of taxable income determined without regard to such
deduction (the "percentage of taxable income method"). Legislation recently
signed by the President repealed the percentage of taxable income method of
calculating the bad debt reserve. The Bank historically has elected to use the
percentage method.
Earnings appropriated to an institution's bad debt reserve and claimed as a
tax deduction were not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount was included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
Beginning with the first taxable year beginning after December 31, 1995,
savings institutions, such as the Bank, will be treated the same as commercial
banks. Associations with $500 million or more in assets will only be able to
take a tax deduction when a loan is actually charged off. Associations with
less than $500 million in assets will still be permitted to make deductible bad
debt additions to reserves, but only using the experience method.
The Bank's tax returns were last audited for the year ended September 30,
1994.
Under provisions of the Revenue Reconciliation Act of 1993 ("RRA"), enacted
on August 10, 1993, the maximum federal corporate income tax rate was increased
from 34% to 35% for taxable income over $10.0 million, with a 3% surtax imposed
on taxable income over $15.0 million. Also under provisions of RRA, a separate
depreciation calculation requirement has been eliminated in the determination of
adjusted current earnings for purposes of determining alternative minimum
taxable income, rules relating to payment of estimated corporate income taxes
were revised, and certain acquired intangible assets such as goodwill and
customer-based intangibles were allowed a 15-year amortization period.
Beginning with tax years ending on or after January 1, 1993, RRA also provides
that securities dealers must use mark-to-market accounting and generally reflect
changes in value during the year or upon sale as taxable gains or losses. The
IRS has indicated that financial institutions which originate and sell loans
will be subject to the rule.
35
<PAGE>
State Income Taxation. The State of Maryland imposes an income tax of
approximately 7% on income measured substantially the same as federally taxable
income. In addition, Maryland imposes a franchise tax, at a rate of 0.013% of
the total withdrawal value of the deposits that a savings and loan association
holds in Maryland at December 31 each year.
For additional information regarding taxation, see Note 14 of Notes to
Financial Statements.
ITEM 2. DESCRIPTION OF PROPERTY
- - --------------------------------
The following table sets forth the location and certain additional
information regarding the Bank's offices at September 30, 1998.
<TABLE>
<CAPTION>
Book Value at Deposits at
Year Owned or Expiration Date September 30, Approximate September 30,
Opened Leased (If Leased) (1) 1998 Square Footage 1998
-------- ---------- ---------------- ------------- -------------- -------------
(Deposits in
thousands)
<S> <C> <C> <C> <C> <C> <C>
MAIN OFFICE:
Perry Hall 1955 Leased (2) $406,780 8,000 $96,985
BRANCH OFFICES:
Bel Air 1975 Leased June 2000 -- 2,000 26,656
Dundalk (3) 1976 Leased June 2001 -- 1,700 34,137
York Road 1977 Leased September 1998 -- 1,155 12,670
Timonium 1978 Leased July 2003 -- 1,250 28,160
Catonsville 1981 Leased February 2001 -- 1,750 22,197
FUTURE SITES:
Abingdon 1999 (5) Leased (2) -- 1,800 --
Forest Hilll 1999 (5) Leased (2) -- 1,800 --
Hickory 2000 (5) Leased (2) -- 1,800 --
ADMINISTRATIVE OFFICE:
4111 E. Joppa Road 1994 Owned 1,311,811 18,000 --
Warehouse (4) 1998 Leased June 1999 -- 1,800 --
</TABLE>
_______________
(1) All leases have at least one five-year renewal option.
(2) Building is owned, but land is leased.
(3) The Bank also is leasing a kiosk and drive-in ATM facility at this
location.
(4) Lease has one year renewal option.
(5) Expected opening date
The book value of the Bank's investment in premises and equipment totaled
$3.0 million at September 30, 1998. See Note 7 of Notes to Financial
Statements.
36
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
- - -------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At September 30, 1998, there were no legal proceedings
to which the MHC, the Company or the Bank was a party, or to which any of their
property was subject, which were expected by management to result in a material
loss to the MHC, the Company or the Bank. There are no pending regulatory
proceedings to which the MHC, the Company, the Bank or their subsidiaries is a
party or to which any of their properties is subject which are currently
expected to result in a material loss.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
- - ----------------------------------------------------------
Not applicable.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- - -----------------------------------------------------------------
The information contained under the sections captioned "Market Information"
in the Company's Annual Report to Stockholders for the Fiscal Year Ended
September 30, 1998 (the "Annual Report") filed as Exhibit 13 hereto is
incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
- - ------------------------------------------------------------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" on pages F-1
through F-30 in the Annual Report is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
- - -----------------------------
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements, Independent Auditors' Report and Selected Consolidated Financial
Data in the Annual Report, which are listed under Item 13 herein, are
incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- - ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- - --------------------
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
- - ----------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
- - -------------------------------------------------
For information concerning the Board of Directors and executive officers of
the Company, the information contained under the section captioned "Proposal I -
- - - Election of Directors" in the Company's Proxy Statement is incorporated herein
by reference.
ITEM 10. EXECUTIVE COMPENSATION
- - --------------------------------
The information contained under the sections captioned "Proposal I --
Election of Directors -- Executive Compensation," " -- Director Compensation," "
- - -- Employment Agreements" in the Proxy Statement is incorporated herein by
reference.
37
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- - ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference
to the section captioned "Voting Securities and Principal Holders
thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference
to the sections captioned "Security Ownership of Management" in the
Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- - --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors -- Transactions
with Management" in the Proxy Statement.
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K.
- - -----------------------------------------------
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following consolidated financial statements
are incorporated by reference from Item 7 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Statement of Financial Condition as of September 30, 1998
and 1997
Consolidated Statements of Operations for the Years Ended September
30, 1998 and 1997
Consolidated Statements of Retained Earnings for the Years Ended
September 30, 1998 and 1997
Consolidated Statements of Cash Flows for the Years Ended September
30, 1998 and 1997
Notes to Consolidated Financial Statements
(2) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-KSB and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
--- -------------------------------------------------------
<S> <C> <C>
* 3.1 Charter of BCSB Bankcorp, Inc.
* 3.2 Bylaws of BCSB Bankcorp, Inc.
** 4 Form of Common Stock Certificate of BCSB Bankcorp, Inc.
* 10.1 BCSB Bankcorp, Inc. 1998 Stock Option and Incentive Plan
* 10.2 BCSB Bankcorp, Inc. Management Recognition Plan and
Trust Agreement
* 10.3 Amended and Restated Form of Change-in-Control Severance
Agreements between Baltimore County Savings Bank, F.S.B. and
Michael J. Dietz, Gary C. Loraditch and William M. Loughran
* 10.4 Baltimore County Savings Bank, F.S.B. Deferred Compensation Plan
* 10.5 Baltimore County Savings Bank, F.S.B. Incentive Compensation Plan
</TABLE>
38
<PAGE>
<TABLE>
<S> <C>
13 1998 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of Anderson Associates, LLP
27 Financial Data Schedule
</TABLE>
- - ------------------
* Incorporated herein by reference from the Company's Registration Statement
on Form SB-2 (File No. 333-44831).
** Incorporated herein by reference from the Company's Registration Statement
on Form 8-A (File No. 0-24589).
(b) REPORTS ON FORM 8-K. During the last quarter of this report, the
-------------------
Registrant filed one Current Report on Form 8-K. In that Current Report on Form
8-K, dated June 12, 1998, the Company reported under Item 5 that it had reached
agreements to open three additional branch offices in Abington, Forest Hill and
Hickory in Harford County, Maryland. In addition, the Bank announced the
closure of its 6368 York Road office, which will be consolidated into an
expanded facility in Timonium, Maryland.
39
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
BCSB BANKCORP, INC.
December 28, 1998
By: /s/ Michael J. Dietz
---------------------------
Michael J. Dietz
President and Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
/s/ Michael J. Dietz December 28, 1998
- - -----------------------------------------------
Michael J. Dietz
President, Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Gary C. Loraditch December 28, 1998
- - -----------------------------------------------
Gary C. Loraditch
Vice President, Secretary and Treasurer
(Principal Financial and Accounting Officer)
/s/ Henry V. Kahl December 28, 1998
- - -----------------------------------------------
Henry V. Kahl
Chairman of the Board
/s/ H. Adrian Cox December 28, 1998
- - -----------------------------------------------
H. Adrian Cox
Vice Chairman of the Board
December 28, 1998
- - -----------------------------------------------
Frank W. Dunton
Director
/s/ William M. Loughran December 28, 1998
- - -----------------------------------------------
William M. Loughran
Vice President and Director
December 28, 1998
- - -----------------------------------------------
Martin F. Meyers
Director
December 28, 1998
- - -----------------------------------------------
John J. Panzer, Jr.
Director
December 28, 1998
- - -----------------------------------------------
P. Louis Rohe, Jr.
Director
<PAGE>
EXHIBIT 13
BCSB BANKCORP, INC.
[LOGO]
1998 ANNUAL REPORT
<PAGE>
BCSB BANKCORP, INC.
- - --------------------------------------------------------------------------------
BCSB Bankcorp, Inc. (the "Company") was incorporated under Federal law in
May 1998. On July 8, 1998, Baltimore County Savings Bank, F.S.B. ( the "Bank")
converted from mutual to stock form and reorganized into the mutual holding
company form of ownership as a wholly owned subsidiary of the Company, which in
turn became a majority-owned subsidiary of Baltimore County Savings Bank, M.H.C.
(the "MHC"), a mutual holding company (the "Reorganization"). In connection
with the Reorganization, the Company issued and sold 2,286,602 shares of its
common stock at a price of $10.00 per share to the Bank's depositors, the
Company's employee stock ownership plan and the public, thereby recognizing net
proceeds of $22.4 million. The Company also issued at no cost 3,754,960 shares
to the MHC, representing 61.4% of the Company's issued and outstanding common
stock, and 75,000 shares to the Baltimore County Savings Bank Foundation, Inc.,
a nonstock corporation dedicated to charitable and educational purposes in the
Baltimore metropolitan area. The Company has no significant assets other than
its investment in the Bank. The Company is primarily engaged in the business of
directing, planning and coordinating the business activities of the Bank.
The Bank is a federal mutual savings bank operating through six banking
offices serving Baltimore and Harford Counties in Maryland. The Bank's
principal business consists of attracting deposits from the general public and
investing these funds in loans secured by first mortgages on owner-occupied,
single-family residences in the Bank's market area, and, to a lesser extent,
other real estate loans, consisting of construction loans, single-family rental
property loans and commercial real estate loans, and consumer loans,
particularly automobile loans. The Bank derives its income principally from
interest earned on loans and, to a lesser extent, interest earned on mortgage-
backed securities and investment securities and other income. Funds for these
activities are provided principally by operating revenues, deposits and
repayments of outstanding loans and investment securities and mortgage-backed
securities.
MARKET INFORMATION
- - --------------------------------------------------------------------------------
The Company's common stock began trading under the symbol "BCSB" on the
Nasdaq National Market System on July 9, 1998. There are currently 6,116,562
shares of the common stock outstanding and approximately 1,278 holders of record
of the common stock. No dividends have been paid on the common stock.
Following are the high and low bid prices, by fiscal quarter, as reported on the
Nasdaq National Market System during the periods indicated.
Fiscal 1998
-------------------------
High Low
---- ---
Fourth quarter.................. $ 12.625 $ 10.00
The stated high and low closing sale prices reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not represent actual
transactions.
TABLE OF CONTENTS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
BCSB Bankcorp, Inc.................................................................................... (i)
Market Information.................................................................................... (i)
Letter to Stockholders................................................................................ 1
Selected Consolidated Financial and Other Data........................................................ 2
Management's Discussion and Analysis of Financial Condition and Results of Operations................. 4
Consolidated Financial Statements..................................................................... F-1
Corporate Information..................................................................... Inside Back Cover
</TABLE>
(i)
<PAGE>
[LETTERHEAD]
To Our Depositors, Shareholders and Friends,
As I write this letter, snow is falling and Christmas 1998 is but 2 days
away. Much has happened during the past year. The fiscal year for us began
October 1997. Soon after, the Board's decision to convert to the mutual holding
company form of corporate organization was announced. Applications were filed,
approvals granted, meetings were held with you, stock orders were received, all
culminating in the raising of $22,000,000 in capital. Trading began on the
NASDAQ under the symbol "BCSB" on July 8, 1998.
Raising the capital will allow us to expand and better compete in the
market for financial services. We truly believe that there will be a place for
community owned financial institutions. All of us live and work in the same
neighborhoods. When you come to us for a loan or to open an account, that
personal service that is missing in so many instances today, will always be
provided at BCSB. Additional branches in Abingdon and Forest Hill are planned
to open in the 2nd quarter 1999. A third new office in Hickory is expected to
open in late 1999 or early 2000. We intend to relocate our Timonium office to a
free standing full service facility on the same site in late 1999. All of these
offices will have drive-in and ATM facilities.
During the year, our Bel Air office relocated to a free standing facility
in the same shopping center where we have been doing business since 1975. The
Dundalk branch received a needed renovation and a separate drive-in with ATM was
added. These improvements allow us to better serve our existing and new
customers in these neighborhoods.
To further support our community, the Baltimore County Savings Bank
Foundation was formed. Its purpose is to aid those organizations and people who
help those in need or improve the quality of life for all of us.
Many of you know the bank was founded in 1955. Three of the founders still
serve on the Board of Directors. The knowledge and experience of P. Louis Rohe,
Frank W. Dunton and Martin F. Meyers are invaluable to the Bank. However, Martin
Meyers will be leaving the Board at the end of December 1998 and the Bank's
President, Michael J. Dietz is retiring at the end of December 1998. Mike has
been associated with the Bank since 1966 and has been its CEO since 1972. We
wish both of them the best.
While still in college, I began my career with BCSB in February 1974.
Starting in the Accounting Department, I have served in many different
capacities including Branch Manager, Accounting Manager, Treasurer and Secretary
to the Board of Directors. In 1991, I was elected to the Board. Along the way,
I became a CPA and obtained my law degree. Now the Board has selected me to
guide the Bank into the future. I appreciate the trust and confidence they have
shown. I want you to know that we will continue to offer the financial services
you expect with friendly, personal service.
What follows is a full discussion of our financial condition and results in
the fiscal year ended September 30, 1998. Your Bank has had a good year and
looks forward to many more in the future.
Very truly yours,
/s/ Gary C. Loraditch
Gary C. Loraditch
President
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
- - --------------------------------------------------------------------------------
SELECTED CONSOLIDATED FINANCIAL CONDITION DATA
<TABLE>
<CAPTION>
At September 30,
----------------
1998 1997
---- ----
(In thousands)
<S> <C> <C>
Total assets....................................... $268,840 $251,738
Loans receivable, net.............................. 181,969 158,676
Cash............................................... 3,572 3,909
Interest-bearing deposits in other banks........... 20,300 8,206
Federal funds sold................................. 9,134 7,102
Investment securities:
Available for sale................................ -- --
Held to maturity.................................. 12,611 30,323
Mortgage-backed securities:
Available for sale................................ -- --
Held to maturity.................................. 34,198 37,189
FHLB stock......................................... 1,512 1,433
Deposits........................................... 220,805 224,656
FHLB advances...................................... -- --
Stockholders' equity - substantially restricted... 45,143 23,858
</TABLE>
SELECTED CONSOLIDATED OPERATIONS DATA
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------
1998 1997
---- ----
(In thousands)
<S> <C> <C>
Interest income............................. $18,810 $19,458
Interest expense............................ 9,867 10,323
------- -------
Net interest income before
provision for loan losses................. 8,943 9,135
Provision for (reduction of) loan losses... 119 286
------- -------
Net interest income......................... 8,824 8,849
Other income (loss)......................... 911 686
Non-interest expense........................ 7,013 6,257
------- -------
Income before income taxes.................. 2,721 3,278
Income tax provision........................ 1,073 1,301
------- -------
Net Income.................................. $ 1,648 $ 1,977
======= =======
</TABLE>
2
<PAGE>
KEY OPERATING RATIOS:
<TABLE>
<CAPTION>
At or for the Year Ended September 30,
---------------------------------------
1998 1997
---- ----
(In thousands)
<S> <C> <C>
PERFORMANCE RATIOS:
Return on average assets (net income
divided by average total assets).......... .63% .76%
Return on average equity (net income
divided by average equity)................ 5.71 8.64
Interest rate spread (combined
weighted average interest rate
earned less combined weighted
average interest rate cost)............... 3.10 3.41
Net interest margin (net interest
income divided by average
interest-earning assets).................. 3.53 3.67
Ratio of average interest-earning assets
to average interest-bearing liabilities... 110.20 106.20
Ratio of non-interest expense to
average total assets...................... 2.67 2.39
ASSET QUALITY RATIOS:
Nonperforming assets to total assets at
end of period............................. .57 .76
Nonperforming loans to gross loans at
end of period............................. .59 1.11
Allowance for loan losses to gross loans
at end of period.......................... .54 .59
Allowance for loan losses to nonperforming
loans at end of period.................... 92.99 53.07
Provision for loan losses to gross loans..... .06 .17
Net charge-offs to average loans
outstanding............................... .04 .15
CAPITAL RATIOS:
Equity to total assets at end
of period................................. 16.79 9.48
Average equity to average
assets.................................... 10.97 8.75
</TABLE>
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- - --------------------------------------------------------------------------------
GENERAL
The Company was formed in June 1998 by the Bank to become the holding
company of the Bank following the Reorganization. The Reorganization was
consummated on July 8, 1998. All references to the Company prior to July 8,
1998, except where otherwise indicated, are to the Bank.
The Company's net income is dependent primarily on its net interest income,
which is the difference between interest income earned on its loan, investment
securities and mortgage-backed securities portfolio and interest paid on
interest-bearing liabilities. Net interest income is determined by (i) the
difference between yields earned on interest-earning assets and rates paid on
interest-bearing liabilities ("interest rate spread") and (ii) the relative
amounts of interest-earning assets and interest-bearing liabilities. The
Company's interest rate spread is affected by regulatory, economic and
competitive factors that influence interest rates, loan demand and deposit
flows. To a lesser extent, the Company's net income also is affected by the
level of other income, which primarily consists of fees and charges, and levels
of non-interest expenses such as salaries and related expenses.
The operations of the Company are significantly affected by prevailing
economic conditions, competition and the monetary, fiscal and regulatory
policies of governmental agencies. Lending activities are influenced by the
demand for and supply of housing, competition among lenders, the level of
interest rates and the availability of funds. Deposit flows and costs of funds
are influenced by prevailing market rates of interest, primarily on competing
investments, account maturities and the levels of personal income and savings in
the Company's market area.
FORWARD-LOOKING STATEMENTS
When used in this Annual Report, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in the Company's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Company's market area, competition and information provided by third-party
vendors that could cause actual results to differ materially from historical
earnings and those presently anticipated or projected. The Company wishes to
caution readers not to place undue reliance on any such forward-looking
statements, which speak only as of the date made. The Company wishes to advise
readers that the factors listed above could affect the Company's financial
performance and could cause the Company's actual results for future periods to
differ materially from any opinions or statements expressed with respect to
future periods in any current statements.
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
YEAR 2000 READINESS DISCLOSURE
The following information constitutes "Year 2000 Readiness Disclosure"
under the Year 2000 Information and Readiness Disclosure Act.
The Company's operations, like those of most financial institutions, are
substantially dependent upon computer systems for lending and deposit
activities. The Company is addressing the potential problems associated with
the
4
<PAGE>
possibility that the computers which control its data processing activities,
facilities and networks may not be programmed to read four-digit dates and, upon
the arrival of the year 2000, may recognize the two-digit code "00" as the year
1900 rather than 2000. This could cause systems to fail to function or generate
erroneous information.
The Company has formed a Year 2000 Committee with senior representatives
from every functional area of the Company. At the direction of the Board, this
Committee is leading the efforts to ensure that the Company is ready for the
Year 2000. The Board of Directors has approved the Company's five phase Year
2000 Plan that was developed in accordance with the guidelines set forth by the
Federal Financial Institutions Examination Council.
The first phase, awareness, was intended to provide on-going information to
employees, directors and customers of the impact of the Year 2000 issue. The
Company has conducted Year 2000 training for all directors and employees.
The second phase, assessment, required the review of all systems that are
believed to be potential risks in order to minimize any Year 2000 operating
difficulties. This review included all major computer and non-computer based
systems, such as vaults, security systems and telephone systems. This phase is
complete.
The third phase, renovation and/or replacement, includes obtaining vendor
certification and/or the necessary upgrades and enhancements to ensure that
existing systems are Year 2000 compliant. The Company is continuing to follow
up with third party vendors as necessary. At this time the Company believes
that all mission critical systems are compliant.
The fourth phase, testing, is currently underway. The hardware has been
successfully tested, and the Company has begun testing the software. The
Company has received representations from mission critical third party vendors
that they are Year 2000 compliant. All testing is expected to be completed by
March 31, 1999.
The last phase, implementation, has commenced and is expected to be
completed in the third quarter of calendar year 1999. The Company has developed
contingency plans for processes that are not yet Year 2000 compliant. This plan
is updated as test results are obtained. The contingency plan sets forth the
procedures that would allow the Company to conduct operations in the event of
one or more system failures, should such a failure occur notwithstanding prior
assurance from third party vendors.
The Company estimates that the total future cost of Year 2000 compliance,
excluding internal staffing costs, will not exceed $50,000. The Company
believes that its policies, plans and actions are in compliance with regulatory
guidelines and milestone dates.
The Bank's customers may also experience Year 2000 problems, which could
adversely affect their ability to comply with their obligations to the Bank.
Management does not believe that the failure of any single customer to be Year
2000 compliant would materially adversely affect the Company's financial
conditions or results of operations.
The Company believes that the potential effects on internal operations from
Year 2000 issues can and will be addressed prior to the Year 2000. However, as
unforeseen circumstances arise, the Year 2000 issue could disrupt the Company's
normal business operations. The most reasonably likely worst case Year 2000
scenarios foreseeable at this time would include the inability to systematically
process, in some combination, various types of customer transactions. This could
affect the Company's ability to accept deposits or process withdrawals,
originate new loans or accept loan payments in the automated manner currently
utilized. Depending upon how long this scenario lasted, this could have a
material adverse effect on the Company's operations. The contingency plan
addresses alternative methods to enable the Company to continue to offer basic
services to the Company's customers. The costs of the Year 2000 project and the
benchmark dates are based on management's best estimates, which are based on a
number of assumptions including future events. The Company cannot guarantee
that these estimates will be achieved at the cost disclosed or within the time
frames indicated.
5
<PAGE>
ASSET/LIABILITY MANAGEMENT
The Company strives to achieve consistent net interest income and reduce
its exposure to adverse changes in interest rates by attempting to match the
terms to repricing of its interest-sensitive assets and liabilities. Factors
beyond the Bank's control, such as market interest rates and competition, may
also have an impact on the Bank's interest income and interest expense.
In the absence of any other factors, the overall yield or return associated
with the Bank's earning assets generally will increase from existing levels when
interest rates rise over an extended period of time, and conversely interest
income will decrease when interest rates decrease. In general, interest expense
will increase when interest rates rise over an extended period of time, and
conversely interest expense will decrease when interest rates decrease. By
controlling the increases and decreases in its interest income and interest
expense which are brought about by changes in market interest rates, the Bank
can significantly influence its net interest income.
The three senior officers of the Bank meet on a weekly basis to monitor the
Bank's interest rate risk position and to set prices on loans and deposits to
manage interest rate risk within the parameters set by the Board of Directors.
The President of the Bank reports to the Board of Directors on a regular basis
on interest rate risk and trends, as well as liquidity and capital ratios and
requirements. The Board of Directors reviews the maturities of the Bank's
assets and liabilities and establishes policies and strategies designed to
regulate the Bank's flow of funds and to coordinate the sources, uses and
pricing of such funds. The first priority in structuring and pricing the Bank's
assets and liabilities is to maintain an acceptable interest rate spread while
reducing the net effects of changes in interest rates. The Bank's management is
responsible for administering the policies and determinations of the Board of
Directors with respect to the Bank's asset and liability goals and strategies.
The Bank's principal strategy in managing interest rate risk has been to
emphasize the acquisition of short- and intermediate-term assets, including
locally originated 15-year fixed-rate mortgage loans and consumer loans,
particularly automobile loans. In addition, in managing its portfolio of
investment securities and mortgage-backed securities, the Bank in recent periods
has purchased short-term investment securities so as to reduce the Bank's
exposure to increases in interest rates. The Bank currently retains all loans
originated in its portfolio, although the Bank's loans generally conform to
secondary market requirements.
In addition to shortening the average repricing period of its assets, the
Bank has sought to lengthen the average maturity of its liabilities by adopting
a tiered pricing program for its certificates of deposit, which provides higher
rates of interest on its longer term certificates in order to encourage
depositors to invest in certificates with longer maturities.
MARKET RISK
Management measures the Bank's interest rate risk by computing estimated
changes in the net portfolio value ("NPV") of its cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates. NPV represents the market value of portfolio
equity and is the difference between incoming and outgoing discounted cash flows
from assets and liabilities, with adjustments made for off-balance sheet items.
These computations estimate the effect on the Bank's NPV of sudden and sustained
1% to 4% increases and decreases in market interest rates. The Bank's Board of
Directors has adopted an interest rate risk policy which establishes maximum
decreases in the Bank's estimated NPV of 25%, 50%, 75% and 90% in the event of
1%, 2%, 3% and 4% increases in market interest rates, respectively, and of 25%,
25%, 25% and 25% in the event of 1%, 2%, 3% and 4% decreases in market interest
rates, respectively. The following table presents the Bank's projected change
in NPV for the various rate shock levels at September 30, 1998.
6
<PAGE>
<TABLE>
<CAPTION>
Net Portfolio Value NPV as % of PV of Assets
Change -------------------------------------------- ---------------------------
in Rates $ Amount $ Change (1) % Change (2) NPV Ratio (3) Change (4)
- - -------- -------- ------------ ------------ ------------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
+400 bp $29,507 $(10,350) (26)% 11.64% (329) bp
+300 bp 32,545 (7,312) (18) 12.65 (228) bp
+200 bp 35,457 (4,400) (11) 13.59 (134) bp
+100 bp 37,861 (1,996) (5) 14.33 (60) bp
0 bp 39,857 14.93
- - -100 bp 41,546 1,689 4 15.42 49 bp
- - -200 bp 43,845 3,988 10 16.08 115 bp
- - -300 bp 47,116 7,259 18 17.03 210 bp
- - -400 bp 50,388 10,530 26 17.95 302 bp
- - ---------------
</TABLE>
(1) Represents the excess (deficiency) of the estimated NPV assuming the
indicated change in interest rates minus the estimated NPV assuming no
change in interest rates.
(2) Calculated as the amount of change in the estimated NPV divided by the
estimated NPV assuming no change in interest rates.
(3) Calculated as the estimated NPV divided by average total assets.
(4) Calculated as the excess (deficiency) of the NPV ratio assuming the
indicated change in interest rates over the estimated NPV ratio assuming no
change in interest rates.
<TABLE>
<CAPTION>
***Risk Measures: 200 bp rate shock*** At At
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
Pre-Shock NPV Ratio: NPV as % of PV of Assets................. 14.93% 10.98%
Exposure Measure: Post Shock NPV Ratio........................ 13.59 8.89
Sensitivity Measure: Change in NPV Ratio...................... 134 bp 210 bp
</TABLE>
The above table indicates that at September 30, 1998, in the event of
sudden and sustained increases in prevailing market interest rates, the Bank's
NPV would be expected to decrease, and that in the event of sudden and sustained
decreases in prevailing market interest rates, the Bank's NPV would be expected
to increase. The Bank's Board of Directors reviews the Bank's NPV position
quarterly, and, if estimated changes in NPV are not within the targets
established by the Board, the Board may direct management to adjust its asset
and liability mix to bring interest rate risk within Board approved targets. At
September 30, 1998, the Bank's estimated changes in NPV were within the targets
established by the Board of Directors.
NPV is calculated by the OTS by using information provided by the Bank.
The calculation is based on the net present value of discounted cash flows
utilizing market prepayment assumptions and market rates of interest provided by
Bloomberg quotations and surveys performed during the quarter ended September
30, 1998, with adjustments made to reflect the shift in the Treasury yield curve
between the survey date and the quarter-end date.
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the Bank may undertake in response to changes in interest rates.
Certain shortcomings are inherent in the method of analysis presented in
the computation of NPV. Actual values may differ from those projections set
forth in the table, should market conditions vary from assumptions used
7
<PAGE>
in the preparation of the table. Additionally, certain assets, such as
adjustable-rate loans, have features which restrict changes in interest rates on
a short-term basis and over the life of the asset. In addition, the proportion
of adjustable-rate loans in the Bank's portfolio could decrease in future
periods if market interest rates remain at or decrease below current levels due
to refinance activity. Further, in the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from
those assumed in the tables. Finally, the ability of many borrowers to repay
their adjustable-rate debt may decrease in the event of an interest rate
increase.
AVERAGE BALANCE, INTEREST AND AVERAGE YIELDS AND RATES
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods and at the date indicated. Such yields and costs are derived by
dividing income or expense by the average monthly balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from month-end balances. Management does not believe that the use of
month-end balances instead of daily balances has caused any material difference
in the information presented.
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------------------------------
1998 1997
-------------------------------------- -----------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1).......................... $166,612 $13,462 8.08% $156,227 $13,240 8.47%
Mortgage backed securities.................... 35,627 2,298 6.45 37,440 2,428 6.49
Investment securities (2) and FHLB stock...... 19,898 1,393 7.00 39,177 2,773 7.08
Other interest-earning assets................. 31,315 1,657 5.29 16,150 1,016 6.29
-------- ------- -------- -------
Total interest-earning assets............. 253,452 18,810 7.42 248,994 19,457 7.81
Non-interest-earning assets..................... 9,672 12,317
-------- --------
Total assets.............................. $263,124 $261,311
======== ========
Interest-bearing liabilities:
Deposits...................................... $228,356 9,857 4.32 $232,929 10,312 4.43
Other liabilities............................. 1,640 10 .61 1,523 10 0.66
-------- ------- -------- -------
Total interest-bearing liabilities........ 229,996 9,867 4.29 234,452 10,322 4.40
------- -------
Non-interest-bearing liabilities................ 4,072 3,989
-------- --------
Total liabilities......................... 234,068 238,441
Stockholders' equity............................ 29,056 22,870
-------- --------
Total liabilities and retained earnings... $263,124 $261,311
======== ========
Net interest income............................. $ 8,943 $ 9,135
======= =======
Interest rate spread............................ 3.13% 3.41%
======= =======
Net interest margin (3)......................... 3.53% 3.67%
======= =======
Ratio of average interest-earning assets
to average interest-bearing liabilities....... 110.17% 107.20%
======= ======
- - -------------------------
</TABLE>
(1) Includes nonaccrual loans.
(2) Consists of U.S. Government and agency securities.
(3) Represents net interest income divided by the average balance of interest-
earning assets.
8
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); (ii) changes in rates (change in
rate multiplied by old volume); and (iii) changes in rate/volume (changes in
rate multiplied by the changes in volume).
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------
1998 vs. 1997
--------------------------------------
Increase (Decrease)
Due to
--------------------------------------
Rate/
Volume Rate Volume Total
-------- ------ ------- --------
<S> <C> <C> <C> <C>
Interest income:
Loans receivable......................... $ 880 $(616) $ (41) $ 223
Mortgage-backed securities............... (118) (13) 1 (130)
Investment securities and
FHLB Stock........................... (1,365) (36) 20 (1,381)
Other interest-earning assets............ 1,009 (177) (191) 641
------- ----- ----- -------
Total interest-earning assets.......... 406 (842) (211) (647)
Interest expense:
Deposits................................. (202) (258) 5 (455)
Other liabilities........................ -- -- -- --
------- ----- ----- -------
Total interest-bearing liabilities... (202) (258) 5 (455)
------- ----- ----- -------
Change in net interest income.............. $ 403 $(584) $ (11) $ (192)
======= ===== ===== =======
</TABLE>
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 1998 AND 1997
Total assets increased by $17.1 million, or 6.8%, to $268.8 million at
September 30, 1998. The asset increase during 1998 reflected the receipt of
the net proceeds from the Company's stock issuance undertaken in connection with
the Reorganization.
Loans receivable, net increased by $23.3 million, or 14.7%, from $158.7
million at September 30, 1997 to $182.0 million at September 30, 1998. The
increases in the Company's loan portfolio were due primarily to increased
originations of single-family residential mortgage loans as a result of
increased loan demand. Single-family residential mortgage loans increased by
$22.6 million, or 21.8%, from $103.7 million at September 30, 1997 to $126.3
million at September 30, 1998. The Company has emphasized the origination of
automobile loans because of the higher rates and shorter terms to maturity of
those loans. Automobile loans totaled $32.6 million and $33.7 million at
September 30, 1997 and 1998, respectively, which comprised 19.6% and 17.8%,
respectively, of the Bank's gross loan portfolio.
The Company's investment securities decreased by $17.7 million, or 58.4%,
from $30.3 million at September 30, 1997 to $12.6 million at September 30, 1998,
as proceeds from maturing investment securities were utilized to meet a
reduction in deposits.
The Company's mortgage-backed securities decreased by $3.0 million, or
8.0%, from $37.2 million at September 30, 1997 to $34.1 million at September 30,
1998, as funds from maturing mortgage-backed securities were utilized to meet a
reduction in deposits.
9
<PAGE>
The Company's cash, interest-bearing deposits in other banks and federal
funds sold increased by $13.8 million, or 71.8%, to $33.0 million at September
30, 1998, due to the receipt of the net proceeds from the stock issuance
undertaken as part of the Reorganization.
Deposits decreased by $3.9 million, or 1.7%, to $220.8 million at September
30, 1998 due to the sale of the deposits of the Severna Park branch office. The
Bank utilized minimal amounts of FHLB advances during the years ended September
30, 1998 and 1997.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1998 AND 1997
Net Income. Net income decreased by $329,000, from $2.0 million for the
year ended September 30, 1997 to $1.6 million for the year ended September 30,
1998. The decrease was due to the establishment of a charitable foundation (the
"Foundation") during 1998 in connection with the Reorganization. The Company
incurred a $457,000 after-tax expense during the second quarter of calendar year
1998 in connection with the establishment of the Foundation. The decrease in
net income during the year ended September 30, 1998 also reflected a $225,000
increase in other income and a $192,000 decrease in net interest income.
Net Interest Income. Net interest income was $8.9 million for the year
ended September 30, 1998, as compared to $9.1 million for the year ended
September 30, 1997, representing a decrease of $192,000, or 2.1%. The decrease
in net interest income was the result of a decrease in the Company's interest
rate spread during the year. The interest rate spread decreased from 3.4% for
the year ended September 30, 1997 to 3.1% for the year ended September 30, 1998.
The Company's interest rate spread decreased as the yield on interest-earning
assets, primarily loans receivable, decreased during a decreasing market
interest rate environment while competitive pressures did not permit the Company
to lower deposit rates as quickly. The Company's ratio of average interest-
earning assets to average interest-bearing liabilities increased from 106.2% for
the year ended September 30, 1997 to 110.2% for the year ended September 30,
1998 primarily due to the investment of the proceeds from the stock issuance
into interest-earning assets.
Interest Income. Interest income decreased by $648,000, or 3.3%, from
$19.5 million for the year ended September 30, 1997 to $18.8 million for the
year ended September 30, 1998. This decrease was due primarily to a 39 basis
point decrease in the average yield on interest-earning assets.
Interest Expense. Interest expense decreased by $456,000, or 4.4%, from
$10.3 million for the year ended September 30, 1997 to $9.9 million for the year
ended September 30, 1998. This decrease was due primarily to a $4.6 million, or
2.0%, decrease in the average balance of deposits from $232.9 million for the
year ended September 30, 1997 to $228.4 million for the year ended September 30,
1998, primarily due to decreases in the average balances of passbook savings
accounts and certificates of deposits as a result of the sale of the deposits of
the Severna Park branch office in October 1997.
Provision for Loan Losses. Provisions for loan losses are charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate by management to provide for probable loan losses, based on prior loss
experience, volume and type of lending conducted by the Company, industry
standards and past due loans in the Company's loan portfolio. The Company
established provisions for loan losses of $119,000 and $286,000 for the years
ended September 30, 1998 and 1997, respectively. In establishing such
provisions, management considered the level of the Company's non-performing
loans which were $1.1 million and $1.8 million at September 30, 1998 and 1997,
respectively, and the levels of the Company's net charge-offs, which totaled
$63,000 and $234,000 during the years ended September 30, 1998 and 1997,
respectively.
Other Income. Total other income increased by $225,000, or 32.8%, from
$686,000 for the year ended September 30, 1997 to $911,000 for the year ended
September 30, 1998. The increase in other income for the year ended September
30, 1998 was attributable to a gain on sale of branch deposits, as the Bank sold
the deposits of its Severna Park branch in October 1997. In connection with
such sale, the Bank sold deposits totaling $6.2 million and
10
<PAGE>
recognized a gain of $339,000 representing a premium paid by the buyer on the
deposits sold. Such increase was offset, in part, by the absence during the year
ended September 30, 1998 of a gain on sale of investment securities; the Bank
earned a $51,000 gain on sale of investment securities during the year ended
September 30, 1997.
Non-interest Expenses. Total non-interest expenses increased by $756,000,
or 12.1%, from $6.3 million for the year ended September 30, 1997 to $7.0
million for the year ended September 30, 1998. The increase was due to the
establishment of the Foundation during 1998 in connection with the
Reorganization. The Company incurred a pre-tax $750,000 expense during the
second quarter of calendar year 1998 in connection with the establishment of the
Foundation. The increase in non-interest expenses was offset, in part, by a
decrease during the year in salaries and related expenses and occupancy
expenses, as the Bank closed its Severna Park branch office following the sale
of the deposits of that office in October 1997, as well as to reduced pension
plan costs.
Management believes that salaries and related expense will increase in
future periods as a result of the adoption of the ESOP and other stock benefit
plans, if adopted. Furthermore, the Company expects other expenses will
increase as a result of the costs associated with being a public institution.
Income Taxes. The Company's income tax expense was $1.3 million and $1.1
million for the years ended September 30, 1997 and 1998, respectively. The
Company's effective tax rates were 39.7% and 39.4% for the years ended September
30, 1997 and 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company initially has no business other than that of the Bank and
investing the net stock issuance proceeds retained by it. The Bank is subject
to certain regulatory limitations with respect to the payment of dividends to
the Company.
At September 30, 1998, the Bank exceeded all regulatory minimum capital
requirements. For information reconciling the Bank's retained earnings as
reported in its financial statements at September 30, 1998 to its tangible, core
and risk-based capital levels and compares such totals to the regulatory
requirements, see Note 13 of Notes to Consolidated Financial Statements.
The Company's primary sources of funds are deposits and proceeds from
maturing investment securities and mortgage-backed securities and principal and
interest payments on loans. While maturities and scheduled amortization of
mortgage-backed securities and loans are a predictable source of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest rates,
economic conditions, competition and other factors.
The primary investing activity of the Company are the origination of loans
and the purchase of investment securities and mortgage-backed securities.
During the years ended September 30, 1998 and 1997, the Bank had $78.0 million
and $51.8 million, respectively, of loan originations. During the years ended
September 30, 1998 and 1997, the Company purchased investment securities in the
amounts of $22.4 million and $44.0 million, respectively, and mortgage-backed
securities in the amounts of $9.6 million and $4.0 million, respectively. Other
investing activities include originations of loans and purchases of mortgage-
backed securities. The primary financing activity of the Company is the
attraction of savings deposits.
The Company has other sources of liquidity if there is a need for funds.
The Bank has the ability to obtain advances from the FHLB of Atlanta. In
addition, the Company maintains a portion of its investments in interest-bearing
deposits at other financial institutions that will be available, if needed.
The Bank is required to maintain minimum levels of liquid assets as defined
by OTS regulations. This requirement, which may be changed at the direction of
the OTS depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required minimum ratio is
currently 4.0%. The
11
<PAGE>
Bank's average daily liquidity ratio for the month of September 1998 was
approximately 31.8%, which exceeded the required level for such period.
Management seeks to maintain a relatively high level of liquidity in order to
retain flexibility in terms of investment opportunities and deposit pricing.
Because liquid assets generally provide for lower rates of return, the Bank's
relatively high liquidity will, to a certain extent, result in lower rates of
return on assets.
The Company's most liquid assets are cash, interest-bearing deposits in
other banks and federal funds sold, which are short-term, highly liquid
investments with original maturities of less than three months that are readily
convertible to known amounts of cash. The levels of these assets are dependent
on the Company's operating, financing and investing activities during any given
period. At September 30, 1998, cash, interest-bearing deposits in other banks
and federal funds sold totaled $3.6 million, $20.3 million and $9.1 million,
respectively.
The Company anticipates that it will have sufficient funds available to
meet its current commitments. Certificates of deposit which are scheduled to
mature in less than one year at September 30, 1998 totaled $42.0 million. Based
on past experience, management believes that a significant portion of such
deposits will remain with the Bank. The Bank is a party to financial instruments
with off-balance-sheet risk made in the normal course of business to meet the
financing needs of its customers. These financial instruments are standby
letters of credit, lines of credit and commitments to fund mortgage loans and
involve to varying degrees elements of credit risk in excess of the amount
recognized in the statement of financial position. The contract amounts of
those instruments express the extent of involvement the Bank has in this class
of financial instruments and represents the Bank's exposure to credit loss from
nonperformance by the other party.
The Bank generally requires collateral or other security to support
financial instruments with off-balance-sheet credit risk. At September 30,
1998, the Bank had commitments under standby letters of credit and lines of
credit and commitments to originate mortgage loans of $2.1 million, $14.7
million and $2.9 million, respectively. See Note 3 of Notes to Consolidated
Financial Statements.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time and due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations.
Unlike most industrial companies, nearly all the assets and liabilities of the
Company are monetary in nature. As a result, interest rates have a greater
impact on the Company's performance than do the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or to
the same extent as the price of goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
SFAS No. 130, "Reporting Comprehensive Income" was issued in June 1997.
This Statement requires that comprehensive income -- made up of all revenues,
expenses, gains and losses -- be reported and displayed in an entity's financial
statements with the same prominence as its other financial statements.
Currently, the only item that would be presented as a component of the Company's
comprehensive income which is not also a component of its net income is the
change during the year in unrealized gain or loss on available for sale
securities. The Statement, which is effective for years beginning after
December 15, 1997, will not affect the Company's financial position or its
results of operations.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" was also issued in June 1997. This Statement requires that public
business enterprises report financial and descriptive information about their
reportable operating segments. Reportable operating segments are defined as
components of an enterprise about which separate financial information is
available and is evaluated regularly by the chief operating decision maker as a
basis for allocating resources and assessing performance. It also requires
those enterprises to report information about
12
<PAGE>
countries in which they do business and about major customers. The Statement
which is effective for financial statements for periods beginning after December
15, 1997, will not affect the Company's financial position or its results of
operations.
SFAS No. 132, "Employers' Disclosures About Pensions and Other
Postretirement Benefits" was issued in February 1998. This Statement
standardizes the disclosure requirements for pensions and other postretirement
benefits to the extent practicable. The Statement, which is effective for
fiscal years beginning after December 15, 1997, will not affect the Company's
financial position or its results of operations.
SFAS No. 133, "Accounting For Derivative Instruments and Hedging
Activities" was issued in June 1998. This Statement standardizes the accounting
for derivative instruments including certain derivative instruments embedded in
other contracts, by requiring that an entity recognize these items as assets or
liabilities in the statement of financial position and measure them at fair
value. This Statement generally provides for matching the timing of gain or
loss recognition on the hedging instrument with the recognition of the changes
in the fair value of the hedged asset or liability that are attributable to the
hedged risk or the earning effect of the hedged forecast transaction. The
Statement, which is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999, will not affect the Company's financial position
or its results of operations.
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities." This Statement provides guidance on the financial reporting of
start-up cost and organization cost. It requires cost of start-up activities
and organization cost to be expensed as incurred. The "SOP" also requires the
initial application to be reported as a cumulative effect of a change in
accounting principle. This "SOP" which is effective for fiscal years beginning
after December 15, 1998 will not affect the Company's financial position or
results of operations.
13
<PAGE>
INDEPENDENT AUDITOR'S REPORT
----------------------------
Board of Directors
BCSB Bankcorp, Inc.
Baltimore, Maryland
We have audited the consolidated statements of financial condition of BCSB
Bankcorp, Inc. and Subsidiaries as of September 30, 1998 and September 30, 1997
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the two years in the two year period ended September 30,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of BCSB
Bankcorp, Inc. and Subsidiaries as of September 30, 1998 and 1997, and the
results of its operations and its cash flows for each of the two years in the
two year period ended September 30, 1998, in conformity with generally accepted
accounting principles.
/s/ Anderson Associates, LLP
December 3, 1998
Baltimore, Maryland
F-1
<PAGE>
BCSB BANKCORP, INC.
-------------------
AND SUBSIDIARIES
----------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
----------------------------------------------
<TABLE>
<CAPTION>
September 30,
-------------
1998 1997
---- ----
<S> <C> <C>
Assets
------
Cash $ 3,572,309 $ 3,909,276
Interest bearing deposits in other banks 20,299,970 8,206,119
Federal funds sold 9,134,202 7,102,231
Investment securities, held to maturity (Note 2) 12,610,823 30,323,460
Loans receivable, net (Note 3) 181,969,226 158,676,168
Mortgage backed securities, held to maturity (Note 4) 34,197,844 37,189,081
Foreclosed real estate, net (Note 5) 370,690 -
Investment in real estate development and
loans to joint ventures (Note 6) 8,195 12,732
Premises and equipment, net (Note 7) 2,988,558 2,856,988
Federal Home Loan Bank of Atlanta stock 1,511,900 1,433,200
Accrued interest receivable - loans 725,065 738,906
- investments 528,231 456,687
- mortgage backed securities 196,136 218,686
Prepaid income taxes 175,870 314,384
Intangible assets acquired, net 24,497 51,209
Other assets 526,733 249,097
------------ ------------
Total assets $268,840,249 $251,738,224
============ ============
Liabilities and Stockholders' Equity
------------------------------------
Liabilities
- - -----------
Deposits (Note 8) $220,804,724 $224,656,081
Advance payments by borrowers for
taxes and insurance 850,397 727,272
Income taxes payable (Note 14) 60,792 1,909
Deferred income taxes (Note 14) 143,929 83,538
Payables to disbursing agents 249,430 120,459
Other liabilities 1,587,929 2,290,516
------------ ------------
Total liabilities 223,697,201 227,879,775
Commitments and contingencies (Notes 3, 7 and 11)
Stockholders' Equity (Notes 12 and 13)
- - --------------------
Common stock (Par value $.01 - 13,500,000 authorized,
6,116,562 shares issued and outstanding) 61,166 -
Additional paid-in capital 22,645,088 -
Retained earnings (substantially restricted) 25,221,308 23,858,449
------------ ------------
47,927,562 23,858,449
Employee Stock Ownership Plan (1,829,280) -
Stock held by Rabbi Trust (955,234) -
------------ ------------
45,143,048 23,858,449
------------ ------------
Total liabilities and stockholders' equity $268,840,249 $251,738,224
============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-2
<PAGE>
BCSB BANKCORP, INC. AND SUBSIDIARIES
------------------------------------
BALTIMORE, MARYLAND
-------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
<TABLE>
<CAPTION>
For Years Ended
September 30,
--------------------------
1998 1997
---- ----
<S> <C> <C>
Interest and fees on loans (Note 3) $13,462,636 $13,239,659
Interest on mortgage backed securities 2,297,838 2,427,932
Interest and dividends on investment securities 1,393,167 2,773,223
Other interest income 1,656,594 1,016,695
----------- -----------
Total interest income 18,810,235 19,457,509
Interest on deposits (Note 8) 9,856,690 10,312,464
Interest on borrowings - short term 10,670 10,474
----------- -----------
Total interest expense 9,867,360 10,322,938
----------- -----------
Net interest income 8,942,875 9,134,571
Provision for losses on loans (Note 3) 118,995 285,942
----------- -----------
Net interest income after provision for losses on loans 8,823,880 8,848,629
Other Income (Loss)
- - -------------------
Loss on sale of foreclosed real estate - (694)
Servicing fee income 13,600 17,928
Fees and charges on loans 179,224 191,596
Fees on transaction accounts 161,375 167,888
Rental income 124,254 144,395
Gain from real estate development and joint venture - 34,900
Gain on sale of investment securities - 51,376
Gain on sale of branch deposits 339,000 -
Miscellaneous income 93,452 79,128
----------- -----------
Net other income (loss) 910,905 686,517
Non-Interest Expenses
- - ---------------------
Salaries and related expense 3,488,964 3,746,128
Provision for losses on foreclosed real estate 33,248 -
Occupancy expense 588,352 570,539
Deposit insurance premiums 228,419 289,038
Data processing expense 425,746 407,501
Property and equipment expense 400,655 338,764
Professional fees 116,703 78,203
Advertising 327,907 197,642
Telephone, postage and office supplies 308,441 288,975
Baltimore County Savings Bank Foundation contribution (Note 12) 750,000 -
Amortization of excess of cost over fair value of net assets acquired 26,712 27,259
Other expenses 318,268 313,191
----------- -----------
Total non-interest expenses 7,013,415 6,257,240
----------- -----------
Income before tax provision 2,721,370 3,277,906
Income tax provision (Note 14) 1,073,088 1,300,913
----------- -----------
Net income $ 1,648,282 $ 1,976,993
=========== ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-3
<PAGE>
BCSB BANKCORP, INC.
-------------------
AND SUBSIDIARIES
----------------
BALTIMORE, MARYLAND
-------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
FOR THE YEARS ENDED SEPTEMBER 30, 1998 AND 1997
-----------------------------------------------
<TABLE>
<CAPTION>
Net Unrealized Employee
Additional Gains (Losses) Stock Stock Total
Common Paid-In Retained on Investment Ownership Held By Stockholders'
Stock Capital Earnings Securities Plan Rabbi Trust Equity
---------- ----------- ----------- -------------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance - September 30, 1996 $ - $ - $21,881,456 $ 31,535 $ - $ - $21,912,991
Change in net unrealized
gains on investment
securities available for sale - - - (31,535) - - (31,535)
Net income for the year ended
September 30, 1997 - - 1,976,993 - - - 1,976,993
---------- ----------- ----------- ---------- ----------- --------- -----------
Balance - September 30, 1997 - - 23,858,449 - - - 23,858,449
Proceeds from stock offering 61,166 22,645,088 - - - - 22,645,088
Borrowings for Employee Stock
Ownership Plan (ESOP) - - - - (1,829,280) - (1,829,280)
Stock held by Rabbi Trust - - - - - (955,234) (955,234)
Capitalize Baltimore County
Savings Bank, MHC - - (285,423) - - - (285,423)
Net income for the year ended
September 30, 1998 - - 1,648,282 - - - 1,648,282
---------- ----------- ----------- ---------- ----------- --------- -----------
Balance - December 31, 1998 $61,166 $22,645,088 $25,221,308 $ - $(1,829,280) $(955,234) $45,143,048
========== =========== =========== ========== =========== ========= ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-4
<PAGE>
BCSB BANKCORP, INC. AND SUBSIDIARIES
------------------------------------
BALTIMORE, MARYLAND
-------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------
1998 1997
---- ----
<S> <C> <C>
Operating Activities
- - --------------------
Net income $1,648,282 $1,976,993
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities
------------------------------------------
Accretion of discount on investments (31,341) (162,705)
Gain on sale of investment securities - (51,376)
Loans originated for sale (133,000) (225,000)
Proceeds from loans originated for sale 133,000 225,000
Loan fees deferred 84,774 118,796
Amortization of deferred loan fees (304,079) (374,439)
Provision for losses on loans 118,995 285,942
Amortization of premium on mortgage backed
securities 31,280 48,313
Loss on sale of foreclosed real estate - 694
Provision for losses on foreclosed real estate 33,248 -
Gain from real estate development and joint venture - (34,900)
Provision for depreciation 291,980 269,711
(Increase) decrease in accrued interest receivable
on loans 13,841 (4,935)
(Increase) decrease in accrued interest receivable
on investments (71,544) 304,472
Decrease in accrued interest receivable on
mortgage backed securities 22,550 19,996
Decrease in prepaid income taxes 138,514 219,069
Increase in deferred income tax liabilities 60,391 631,628
Amortization of excess of cost over fair value of
net assets acquired 26,712 26,712
(Increase) decrease in other assets (277,636) 465,322
Gain on sale of branch deposits (339,000) -
Increase (decrease) in accrued interest payable
on deposits (21,399) 205,738
Increase (decrease) in income taxes payable 58,883 (934)
Decrease in other liabilities and payables to
disbursing agents (573,616) (557,268)
---------- ----------
Net cash provided by operating activities 910,835 3,386,829
</TABLE>
F-5
<PAGE>
BCSB BANKCORP, INC. AND SUBSIDIARIES
------------------------------------
BALTIMORE, MARYLAND
-------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------
1998 1997
---- ----
<S> <C> <C>
Cash Flows from Investing Activities
- - ------------------------------------
Proceeds from maturing interest bearing deposits $ 5,347,000 $ 1,882,000
Purchase of interest bearing deposits (198,000) -
Purchases of investment securities - held to
maturity (22,435,091) (44,022,489)
Proceeds from maturities of investment securities -
held to maturity 40,179,069 50,160,000
Proceeds from sale of investment securities -
available for sale - 101,376
Longer term loans originated (36,905,088) (25,519,948)
Principal collected on longer term loans 16,903,601 17,212,666
Net (increase) decrease in short-term loans (3,523,739) 4,185,132
Principal collected on mortgage backed securities 12,540,919 6,554,445
Purchase of mortgage backed securities (9,580,962) (4,020,831)
Proceeds from sales of foreclosed real estate - 139,477
Investment in foreclosed real estate (71,460) -
Net investment and loans to joint ventures 4,537 357,401
Investment in premises and equipment (423,550) (435,590)
Purchase of Federal Home Loan Bank of Atlanta stock (78,700) (132,000)
------------ ------------
Net cash provided by investing activities 1,758,536 6,461,639
Cash Flows from Financing Activities
- - ------------------------------------
Proceeds from sale of branch deposits (5,827,235) -
Proceeds from stock offering 22,420,831 -
Employee Stock Ownership Plan (1,829,280) -
Stock held in Rabbi Trust (955,234) -
Net decrease in demand deposits, money market,
passbook accounts and advances by borrowers
for taxes and insurance (3,300,013) (4,113,692)
Net increase (decrease) in certificates of deposit 5,759,415 (4,709,883)
------------ ------------
Net cash provided (used) by financing activities 16,268,484 (8,823,575)
------------ ------------
Increase in cash and cash equivalents 18,937,855 1,024,893
Cash and cash equivalents at beginning of period 12,136,626 11,111,733
------------ ------------
Cash and cash equivalents at end of period $ 31,074,481 $ 12,136,626
============ ============
</TABLE>
F-6
<PAGE>
BCSB BANKCORP, INC.
-------------------
AND SUBSIDIARIES
----------------
BALTIMORE, MARYLAND
-------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------
1998 1997
---- ----
<S> <C> <C>
The following is a summary of cash
and cash equivalents:
Cash $ 3,572,309 $ 3,909,276
Interest bearing deposits in other banks 20,299,970 8,206,119
Federal funds sold 9,134,202 7,102,231
----------- -----------
Balance of cash items reflected on Statement of
Financial Condition 33,006,481 19,217,626
Less - certificate of deposit with a maturity
of more than three months 1,932,000 7,081,000
----------- -----------
Cash and cash equivalents reflected on the
Statement of Cash Flows $31,074,481 $12,136,626
=========== ===========
Supplemental Disclosures of Cash Flows Information:
Cash paid during the period for:
Interest $ 9,878,997 $10,117,200
=========== ===========
Income taxes $ 815,300 $ 574,491
=========== ===========
Transfer from loans to real estate acquired
through foreclosure $ 332,478 $ -
=========== ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
F-7
<PAGE>
BCSB BANKCORP, INC.
-------------------
AND SUBSIDIARIES
----------------
BALTIMORE, MARYLAND
-------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
Note 1 - Summary of Significant Accounting Policies
------------------------------------------
A. Principles of Consolidation BCSB Bankcorp, Inc. (the "Company")
owns 100% of Baltimore County Savings Bank, F.S.B. (the "Bank").
The Bank owns 100% of Baltimore County Service Corporation and
Ebenezer Road, Inc. Baltimore County Service Corporation owns 100%
of Route 543, Inc. The accompanying consolidated financial
statements include the accounts and transactions of these companies
on a consolidated basis since date of acquisition. All intercompany
transactions have been eliminated in the consolidated financial
statements. Ebenezer Road, Inc. sells insurance products. Baltimore
County Service Corporation and Route 543, Inc. have invested in
several joint ventures formed for the purpose of developing real
estate. Route 543, Inc. ceased all operations as of September 30,
1997. These investments have been accounted for on the equity
method and separate summary statements are not presented since the
data contained therein is not material in relation to the
consolidated financial statements.
B. Business The Company's primary purpose is ownership of the Bank.
The Bank's primary business activity is the acceptance of deposits
from the general public in their market area and using the proceeds
for investments and loan originations. The Bank is subject to
competition from other financial institutions. The Bank is subject
to the regulations of certain federal agencies and undergoes
periodic examinations by those regulatory authorities.
C. Basis of Financial Statement Presentation - The consolidated
financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the
financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and
liabilities as of the date of the statement of financial condition
and revenues and expenses for the period. Actual results could
differ significantly from those estimates. Material estimates that
are particularly susceptible to significant change in the near-term
relate to the determination of the allowance for loan losses and
the valuation of foreclosed real estate and real estate
development.
D. Federal Funds - Federal funds sold are carried at cost which
approximates market.
F-8
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 1 - Summary of Significant Accounting Policies - Continued
------------------------------------------
E. Investments and Mortgage Backed Securities - Investment securities
in equity mutual funds may be held for an indefinite period of time
and are carried at fair value. Investment securities consisting of
federal agency notes and bonds and all of the mortgage backed
securities are carried at cost, since management has the ability and
intention to hold them to maturity. Amortization of related premiums
and discounts are computed using the level yield method over the
life of the security. Gains and losses on all investments and
mortgage backed securities are determined using the specific
identification method.
F. Loans Receivable - Loans receivable are stated at unpaid principal
balances, less undisbursed portion of loans in process, unearned
interest on consumer loans, deferred loan origination fees and the
allowance for loan losses, since management has the ability and
intention to hold them to maturity.
Loans held for sale are carried at the lower of cost or estimated
market value, determined in the aggregate. In computing cost,
deferred loan origination fees are deducted from the principal
balances of the related loans. There were no loans held for sale at
September 30, 1998 and 1997.
The Bank services loans for others and pays the participant its
share of the Bank's collections, net of a stipulated servicing fee.
Loan servicing fees are credited to income when earned and servicing
costs are charged to expense as incurred.
Unearned interest on consumer loans is amortized to income over the
terms of the related loans on the level yield method.
G. Allowance for Loan Losses - An allowance for loan losses is provided
through charges to income in an amount that management believes will
be adequate to absorb losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of loans
and prior loan loss experience. The evaluations take into
consideration such factors as changes in the nature and volume of
the loan portfolio, overall portfolio quality, review of specific
problem loans, and current economic conditions that may affect the
borrowers' ability to pay. Management believes the allowance for
losses on loans is adequate. While management uses available
information to estimate losses on loans, future additions to the
allowances may be necessary based on changes in economic conditions,
particularly in the State of Maryland. In addition, various
regulatory agencies, as an
F-9
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 1 - Summary of Significant Accounting Policies - Continued
------------------------------------------
G. integral part of their examination process, periodically review the
Bank's allowances for losses on loans. Such agencies may require the
Bank to recognize additions to the allowances based on their
judgments about information available to them at the time of their
examination.
Accrual of interest is discontinued on a loan when management
believes, after considering economic and business conditions and
collection efforts, that the borrower's financial condition is such
that collection of interest is doubtful or when payment of principal
and interest has become ninety days past due unless the obligation
is well secured and in the process of collection. When a payment is
received on a loan on non-accrual status, the amount received is
allocated to principal and interest in accordance with the
contractual terms of the loan.
Loan origination fees and certain direct loan origination costs are
deferred and recognized by the interest method over the contractual
life of the related loan as an adjustment of yield.
H. Foreclosed Real Estate - Real estate acquired through foreclosure is
recorded at the lower of cost or fair value. Management periodically
evaluates the recoverability of the carrying value of the real
estate acquired through foreclosure using estimates as described
above in Allowance for Loan Losses. In the event of a subsequent
decline, management provides an additional allowance to reduce real
estate acquired through foreclosure to its fair value less estimated
disposal cost. Costs relating to holding such real estate are
charged against income in the current period while costs relating to
improving such real estate are capitalized until a saleable
condition is reached.
I. Investment in Real Estate Development and Loans to Joint Ventures -
Land development costs not in excess of net realizable value are
capitalized and charged to expense as revenue is recognized.
Revenues are recognized when a sale has been consummated. Indirect
costs and administrative expenses are charged as incurred to
periodic income and are not allocated to land development costs. The
Bank capitalizes interest on land development projects in accordance
with Statement 34 of the Financial Accounting Standards Board. No
interest was capitalized for the years ended September 30, 1998 and
1997.
F-10
<PAGE>
BCSB BANKCORP, INC. AND SUBSIDIARIES
- - ------------------------------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 1 - Summary of Significant Accounting Policies - Continued
------------------------------------------
J. Premises and Equipment - Premises and equipment are recorded at
cost. Depreciation is computed on the straight-line method, based on
the useful lives of the respective assets.
K. Intangible Assets Acquired, Net - On September 16, 1994, Baltimore
County Savings Bank, F.S.B. purchased the deposits and certain
assets from the Resolution Trust Corporation, receiver of Second
National Federal Savings Association. The Bank classified as an
intangible asset the fair market value assigned to the capacity of
existing savings accounts acquired to generate future earnings ("the
Core Deposit Value"). The core deposit value of $133,572 is being
amortized on a straight-line method over five years, the estimated
life of the core deposit value. Accumulated amortization was
$109,075 and $82,363 at September 30, 1998 and 1997, respectively.
L. Income Taxes - Deferred income taxes are recognized for temporary
differences between the financial reporting basis and income tax
basis of assets and liabilities based on enacted tax rates expected
to be in effect when such amounts are realized or settled. Deferred
tax assets are recognized only to the extent that is more likely
than not that such amounts will be realized based on consideration
of available evidence. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
M. On October 19, 1997, the Bank sold the deposits of one of its
branches and closed that branch. Deposits sold were approximately
$6,166,000. A gain of $339,000 was realized on the sale.
N. Statement of Cash Flows - In the statement of cash flows, cash and
equivalents include cash, Federal Home Loan Bank of Atlanta
overnight deposits, federal funds and certificates of deposit and
Federal Home Loan Bank of Atlanta time deposits with an original
maturity date less than ninety days.
O. Earnings Per Share - Earnings per share data is not presented for
the year ended September 30, 1998, since the Bank converted to stock
form in July 1998, and such information would not be meaningful.
P. Employee Stock Ownership Plan -The Company accounts for its Employee
Stock Ownership Plan ("ESOP") in accordance with Statement of
Position 93-6 of the Accounting Standards Division of the American
Institute of Certified Public Accountants. (See Note 12)
Q. Reclassification and Restatement - Certain prior years' amounts have
been reclassified to conform to the current year's method of
presentation.
F-11
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 2 - Investment Securities
---------------------
The amortized cost and fair values of investment securities are as
follows as of September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Held to Maturity:
September 30, 1998
U.S. Government and Agency
Obligations, held to maturity $12,610,823 $ 50,228 $ - $12,661,051
=========== =========== =========== ===========
September 30, 1997
U.S. Government and Agency
Obligations, held to maturity $30,323,460 $ 100,524 $ 42,194 $30,381,790
=========== =========== =========== ===========
</TABLE>
The following is a summary of investment securities:
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997
------------------------- -------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Held to Maturity:
U.S. Government and Agency Obligations
--------------------------------------
Due within 12 months $ 1,000,000 $ 1,000,313 $10,981,268 $10,961,904
Due beyond 12 months but
within five years 5,060,823 5,073,727 4,250,000 4,244,197
Due beyond five years but
within ten years 6,550,000 6,587,011 14,343,038 14,429,664
Due beyond ten years - - 749,154 746,025
----------- ----------- ----------- -----------
$12,610,823 $12,661,051 $30,323,460 $30,381,790
=========== =========== =========== ===========
</TABLE>
F-12
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 2 - Investment Securities - Continued
---------------------
Proceeds from maturities of held to maturity securities were
$40,179,069 and $50,160,000 for the years ended September 30, 1998 and
1997, respectively. Proceeds from sales and maturities of available for
sale securities was $101,376 for the year ended September 30, 1997. There
were no gross gains or losses realized for the year ended September 30,
1998. Gross gains realized were $51,376 for the year ended September 30,
1997. There were no gross losses realized for the year ended September
30, 1997.
Note 3 - Loans Receivable
----------------
Loans receivable at September 30, 1998 and 1997 consist of the
following:
<TABLE>
<CAPTION>
September 30,
-----------------------------
1998 1997
---- ----
<S> <C> <C>
Single-family residential mortgages $126,272,171 $103,677,278
Single-family rental property loans 5,252,511 6,408,729
Commercial loans 9,496,991 10,169,090
Construction loans 7,935,958 8,644,642
Commercial lines of credit 50,000 60,000
Automobile loans 33,747,553 32,632,981
Home equity loans 6,549,261 3,985,840
Savings account loans 680,899 825,154
------------ ------------
189,985,344 166,403,714
Less - undisbursed portion of
loans in process 2,962,757 2,807,231
- unearned interest 3,741,821 3,375,711
- deferred loan origination
fees 277,633 566,965
- allowance for loan
losses 1,033,907 977,639
------------ ------------
$181,969,226 $158,676,168
============ ============
</TABLE>
F-13
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 3 - Loans Receivable - Continued
----------------
The following is a summary of the allowance for loan losses:
<TABLE>
<CAPTION>
September 30,
------------------------
1998 1997
---- ----
<S> <C> <C>
Balance - beginning of year $ 977,639 $ 926,491
Provision for losses on loans 118,995 285,942
Charge-offs (278,215) (392,963)
Recoveries 215,488 158,169
---------- ---------
Balance - end of year $1,033,907 $ 977,639
========== =========
</TABLE>
Residential lending is generally considered to involve less risk than
other forms of lending, although payment experience on these loans is
dependent to some extent on economic and market conditions in the Bank's
lending area. Multifamily residential, commercial, construction and
other loan repayments are generally dependent on the operations of the
related properties or the financial condition of its borrower or
guarantor. Accordingly, repayment of such loans can be more susceptible
to adverse conditions in the real estate market and the regional economy.
A significant portion of the Bank's loans receivable are mortgage
loans secured by residential and commercial real estate properties
located in the State of Maryland. Loans are extended only after
evaluation by management of customers' creditworthiness and other
relevant factors on a case-by-case basis. The Bank generally does not
lend more than 90% of the appraised value of a property and requires
private mortgage insurance on residential mortgages with loan-to-value
ratios in excess of 80%. In addition, the Bank generally obtains
personal guarantees of repayment from borrowers and/or others for
multifamily residential, commercial and construction loans and disburses
the proceeds of construction and similar loans only as work progresses on
the related projects. Automobile loans are secured by vehicles and home
equity loans are secured by subordinated real estate properties.
Repayments of automobile loans and home equity loans are expected
primarily from the cash flows of the borrowers.
Non-accrual loans for which interest has been reduced totaled
approximately $1,111,798 and $1,843,000 at September 30, 1998 and 1997,
respectively. There were no impaired loans as defined by SFAS No. 114 at
September 30, 1998 and 1997. There was no interest income recognized on
impaired loans during these periods. The Bank was not committed to fund
additional amounts on these loans.
F-14
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 3 - Loans Receivable - Continued
----------------
Interest income that would have been recorded under the original terms
of non-accrual loans and the interest actually recognized for the years
ended September 30, are summarized below:
<TABLE>
<CAPTION>
September 30,
-------------------
1998 1997
---- ----
<S> <C> <C>
Interest income that would have been recognized $71,415 $96,732
Interest income recognized 26,805 29,727
------- -------
Interest income not recognized $44,610 $67,005
======= =======
</TABLE>
The following table set forth the amount and activity of the loans
outstanding to officers and directors at September 30, 1998 and 1997.
<TABLE>
<CAPTION>
September 30,
---------------------
1998 1997
---- ----
<S> <C> <C>
Beginning balance $509,375 $ 468,331
New loans 155,600 144,390
Loan repayments (89,509) (103,346)
-------- ---------
Ending balance $575,466 $ 509,375
======== =========
</TABLE>
The Bank services loans for others. The amount of such loans serviced
at September 30, 1998 and 1997 was $5,553,596 and $8,155,940,
respectively. At September 30, 1998 and 1997, the balance of loans sold
by the Bank with recourse amounted to $798,365 and $1,082,187,
respectively.
Custodial escrow balances maintained in connection with the foregoing
loan servicings were approximately $41,083 and $54,466 at September 30,
1998 and 1997, respectively.
The Bank is a party to financial instruments with off-balance-sheet
risk made in the normal course of business to meet the financing needs of
its customers. These financial instruments are standby letters of
credit, lines of credit and commitments to fund mortgage loans and
involve to varying degrees elements of credit risk in excess of the
amount recognized in the statement of financial position. The contract
amounts of those instruments express the extent of involvement the Bank
has in this class of financial instruments and represents the Bank's
exposure to credit loss from nonperformance by the other party.
F-15
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 3 - Loans Receivable - Continued
----------------
Unless noted otherwise, the Bank does not require collateral or other
security to support financial instruments with off-balance-sheet credit
risk.
<TABLE>
<CAPTION>
Contract Amount At
Financial Instruments Whose Contract ---------------------------------------
Amounts Represent Credit Risk September 30, 1998 September 30, 1997
- - ------------------------------------ ------------------ ------------------
<S> <C> <C>
Standby letters of credit $ 2,171,615 $2,744,487
Lines of credit $14,737,500 $8,240,400
Mortgage loan commitments, fixed rate $ 2,222,100 $1,146,600
Mortgage loan commitments, variable rate $ 631,000 $ 564,000
</TABLE>
Standby letters of credit are conditional commitments issued by the
Bank guaranteeing performance by a customer to a third party. Those
guarantees are issued primarily to support private borrowing
arrangements, generally limited to real estate transactions. Unless
otherwise noted, the standby letters of credit are not collateralized.
The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers.
Lines of credit are loan commitments to individuals and companies and
have fixed expiration dates as long as there is no violation of any
condition established in the contract. The Bank evaluates each
customer's credit worthiness on a case-by-case basis.
Rates on mortgage loan commitments for fixed rate loans ranged from
6.500% to 7.50% and 7.125% to 7.5% at September 31, 1998 and 1997,
respectively. Rates on mortgage loan commitments for variable rate loans
ranged from 1/4% under prime to prime at September 30, 1998.
No amount was recognized in the statement of financial position at
September 30, 1998 and 1997, as liability for credit loss nor was any
liability recognized for fees received for standby letters of credit.
The Bank grants loans to customers, substantially all of whom are
residents of the Metropolitan Baltimore and Harford County areas.
F-16
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 4 - Mortgage Backed Securities
--------------------------
The amortized cost and fair values of mortgage backed securities are
as follows as of September 30, 1998 and 1997:
Held to Maturity:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ---------- ---------- -------------
<S> <C> <C> <C> <C>
September 30, 1998
------------------
GNMA certificates $ 441,742 $ 17,115 $ - $ 458,857
FNMA certificates 24,099,992 479,986 - 24,579,978
FHLMC participating
certificates 9,656,110 179,047 171 9,834,986
----------- -------- -------- -----------
$34,197,844 $676,148 $ 171 $34,873,821
=========== ======== ======== ===========
September 30, 1997
-----------------
FNMA certificates $27,473,254 $ 8,278 $511,521 $26,970,011
FHLMC participating
certificates 9,715,827 96,236 30,352 9,781,711
----------- -------- -------- -----------
$37,189,081 $104,514 $541,873 $36,751,722
=========== ======== ======== ===========
</TABLE>
No gains or losses were realized during the years ended September 30,
1998 and 1997, respectively.
Note 5 - Foreclosed Real Estate
----------------------
Foreclosed real estate at September 30, 1998 and 1997 is summarized by
major classification as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------
1998 1997
---- ----
<S> <C> <C>
EPIC loans $ 55,903 $ 55,903
Residential real estate 403,937 -
Allowance for losses (89,151) (55,903)
-------- --------
$370,689 $ -
======== ========
</TABLE>
F-17
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 5 - Foreclosed Real Estate - Continued
----------------------
The following is a summary of the allowances for losses on foreclosed
real estate:
<TABLE>
<CAPTION>
September 30,
-------------------
1998 1997
---- ----
<S> <C> <C>
Balance - beginning of year $55,903 $ 87,965
Provision for losses 33,248 -
Recoveries - (32,062)
------- --------
Balance - end of year $89,151 $ 55,903
======= ========
</TABLE>
Note 6 - Investment in Real Estate Development and Loans to Joint Ventures
-----------------------------------------------------------------
The subsidiaries are parties to joint ventures formed for the purpose
of developing lots for resale. The subsidiaries' interest in the profits
or losses of the joint ventures range from 20% to 50%. The subsidiaries'
equity in the joint ventures is $8,195 and $12,732 at the periods ended
September 30, 1998 and 1997, respectively.
During the periods ended September 30, 1998 and 1997, the Bank made no
acquisition, development and construction loans to the joint ventures
mentioned above.
The following is a summary of the allowance for losses on loans to the
joint venture:
<TABLE>
<CAPTION>
September 30,
------------------
1998 1997
---- ----
<S> <C> <C>
Balance - beginning of year $ - $(34,900)
Reduction of provision for losses - 34,900
----- --------
Balance - end of year $ - $ -
===== ========
</TABLE>
F-18
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 6 - Investment in Real Estate Development and Loans to Joint Ventures -
-----------------------------------------------------------------
Continued
Gain from real estate development and joint ventures consisted of a
reduction of provision for loss on real estate development and joint
venture in the amount of $34,900 for the year ended September 30, 1997.
Note 7 - Premises and Equipment
----------------------
Premises and equipment at September 30, 1998 and 1997 are summarized
by major classification as follows:
<TABLE>
<CAPTION>
September 30,
-----------------------
1998 1997 Life
---- ---- ----
<S> <C> <C> <C>
Office building $2,440,860 $2,440,860 50 Years
Leasehold improvements 144,768 88,703 7-31 Years
Furniture, fixtures and equipment 3,103,435 2,800,592 10 Years
---------- ----------
5,689,063 5,330,155
Accumulated depreciation 2,700,505 2,473,167
---------- ----------
$2,988,558 $2,856,988
========== ==========
</TABLE>
The Bank has entered into long-term leases for the land on which the
main office is located and the premises of its branch offices. Rental
expense under long-term leases for property for the years ended September
30, 1998 and 1997 was $191,945 and $187,434, respectively. At September
30, 1998, minimum rental commitments under noncancellable leases are as
follows:
<TABLE>
<CAPTION>
Years Ended September 30, Amount
- - ------------------------- ------
<S> <C>
1999 $ 322,718
2000 315,518
2001 283,900
After 2001 1,141,655
----------
$2,063,791
==========
</TABLE>
F-19
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 8 Deposits
--------
Deposits are summarized as follows at September 30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---------------------- ----------------------
Amount % Amount %
------ ------- ------ -------
Type of Account
---------------
Deposits
--------
<S> <C> <C> <C> <C>
NOW $ 19,689,552 8.92% $ 20,528,412 9.14%
Non-interest bearing NOW 5,652,964 2.56 3,674,511 1.63
Money market 8,727,537 3.95 10,054,713 4.48
Passbook savings 54,812,311 24.82 60,657,069 27.00
Certificates 131,196,477 59.42 128,994,405 57.42
------------ ------ ------------ ------
220,078,841 99.67 223,909,110 99.67
Accrued interest payable 725,883 .33 746,971 .33
------------ ------ ------------ ------
$220,804,724 100.00% $224,656,081 100.00%
============ ====== ============ ======
</TABLE>
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $12,438,466 and $10,485,518 at
September 30, 1998 and 1997, respectively. Deposits in excess of
$100,000 are not insured by the Savings Association Insurance Fund.
At September 30, 1998, scheduled maturities of certificates of deposit
are as follows:
<TABLE>
<S> <C>
1998 $ 41,963,517
1999 57,375,156
2000 18,754,645
2001 6,071,904
2002 and thereafter 7,031,255
------------
$131,196,477
============
</TABLE>
Interest expense on deposits for the years ended September 30, 1998
and 1997 is as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
NOW $ 401,288 $ 476,519
Money market 313,474 346,331
Passbooks savings 2,004,071 1,874,961
Certificates 7,137,857 7,614,653
---------- -----------
$9,856,690 $10,312,464
========== ===========
</TABLE>
F-20
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 9 - Borrowings
----------
At September 30, 1998 and 1997 and for the year ended September 30,
1998, the Bank had no outstanding borrowings. For the year ended
September 30, 1997, the Bank borrowed at various times on their line of
credit from the Federal Home Loan Bank of Atlanta. The line has no
predetermined limit and is secured by a blanket lien on mortgages. Each
borrowing is evaluated on a case-by-case basis by the lender.
Note 10- Pension Plan
------------
The Bank has a noncontributory, defined contribution, pension plan
covering substantially all employees. It is a money purchase plan with
contributions made each year for every participant in accordance with
actuarial recommended formula. There is no past service liability or
unfunded value of vested benefits as of December 31, 1997, the date of
latest available annual review and valuation of the plan.
The expense for the pension plan amounted to $238,844 and $271,826 for
the years ended September 30, 1998 and 1997, respectively.
Note 11- Directors Retirement Plan
-------------------------
Effective July 1995, the Bank adopted a Deferred Compensation Plan
covering all directors. The Plan provides benefits based upon certain
vesting requirements. During 1997, the amount of the Plan's benefit was
increased from $40,000 to $80,000 per director. During 1998, the Plan
was rescinded in favor of a Rabbi Trust that is invested primarily in the
Company's stock. No compensation expense was recognized for the Rabbi
Trust during 1998. Compensation expense recognized in connection with
the Deferred Compensation Plan prior to adoption of the Rabbi Trust for
the years ended September 30, 1998 and 1997 was $51,334 and $412,859,
respectively.
F-21
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 12- Common Stock
------------
In 1998, the Bank reorganized from a federally chartered mutual
savings bank to a federally chartered stock savings bank.
Simultaneously, the Bank consummated the formation of a new holding
company, BCSB Bankcorp, Inc. Also simultaneously, a mutual holding
company was formed, Baltimore County Savings Bank, M.H.C. In connection
with the reorganization, the Company issued 6,116,562 shares of its
common stock. A majority of that stock (3,754,960 shares) was issued to
Baltimore County Savings Bank, M.H.C. The remainder was issued to the
general public. Also, the Bank established the Baltimore County Savings
Bank Foundation through a contribution of 75,000 shares of its common
stock.
At the same time as the reorganization, the Bank established an
Employee Stock Ownership Plan ("ESOP") for its employees. On July 8,
1998 the ESOP acquired 182,928 shares of the Company's common stock in
connection with the Bank's Reorganization to a mutual holding company
form of organization. The ESOP holds the common stock in a trust for
allocation among participating employees, in trust or allocated to the
participants' accounts and an annual contribution from the Bank to the
ESOP and earnings thereon. All of the ESOP shares are unearned at
September 30, 1998. The fair value of ESOP shares at September 30, 1998
is $1,966,476.
All employees of the Bank who attain the age of 18 and complete one
year of service with the Bank will be eligible to participate in the
ESOP. Participants must be employed at least 500 hours in a plan year in
order to receive an allocation. Each participant's vested interest under
the ESOP is determined according to the following schedule: 0% for less
than 2 years of service with the Company or the Bank, 20% for 2 years of
service, 40% for 3 years of service, 60% for 4 years of service, 80% for
5 years of service, and 100% for 6 years of service. For vesting
purposes, a year of service means any plan year in which an employee
completes at least 1,000 hours of service (whether before or after the
ESOP's January 1, 1998 effective date). Vesting accelerates to 100% upon
a participant's attainment of age 65, death or disability.
The ESOP will be funded by contributions made by the Bank in cash or
common stock and dividends on the shares held in the Trust. The Bank
will recognize compensation expense as shares are committed for release
from collateral at their current market price. Dividends on allocated
shares are recorded as a reduction of retained earnings and dividends on
unallocated shares are recorded as a reduction of Debt. There was no
compensation cost for the year ended September 30, 1998.
F-22
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 13- Retained Earnings
-----------------
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory, and possible
additional discretionary, actions by the regulators that, if undertaken,
could have a direct material effect on the Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classifications are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) and risk-weighted assets (as defined), and of Tier I capital
(as defined) to average assets (as defined). Management believes, as of
September 30, 1998, that the Bank meets all capital adequacy requirements
to which it is subject.
As of September 30, 1998, the most recent notification from the Office
of Thrift Supervision categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as
well capitalized the Association must maintain minimum total risk-based,
Tier I risk-based, and Tier I leverage ratios as set forth in the table.
There are no conditions or events since that notification that management
believes have changed the Bank's category. The Bank's actual capital
amounts and ratios are also presented in the table.
The following table presents the Bank's capital position based on the
September 30, 1998 financial statements and the current capital
requirements.
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------------- --------------------- ------------------------
Actual % of Required % of Required % of
Amount Assets Amount Assets Amount Assets
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Tangible (1) $44,244,319 16.46% $ 4,031,889 1.50% $ N/A N/A %
Tier I capital (2) $44,244,319 29.95% $ N/A N/A % $ 8,862,799 6.00%
Core (1) $44,244,319 16.46% $ 8,063,777 3.00% $13,439,628 5.00%
Risk-weighted (2) $45,278,226 30.65% $11,817,065 8.00% $14,771,331 10.00%
</TABLE>
(1) To adjusted total assets.
(2) To risk-weighted assets.
F-23
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 13- Retained Earnings - Continued
-----------------
<TABLE>
<CAPTION>
September 30,
1998
--------------
<S> <C>
Total Stockholders' Equity $ 45,143,048
Less: Non-allowable items
Intangible assets acquired, net (24,497)
Investment in and advances to
non-includable subsidiaries (874,232)
------------
Tangible and core capital 44,244,319
General valuation allowance 1,033,907
------------
Risk-based capital $ 45,278,226
============
Total Assets $268,840,249
Less: Non-allowable items
Intangible assets acquired, net (24,497)
Assets of non-includable subsidiaries not
eliminated for regulatory capital purposes (23,184)
------------
Tangible and adjusted tangible assets $268,792,568
============
Risk-weighted assets $147,713,312
============
</TABLE>
The OTS has adopted an interest rate risk component of regulatory
capital requirements effective January 1, 1994. The rule requires
additional capital to be maintained if the Bank's interest rate risk
exposure, measured by the decline in the market value of the Bank's net
portfolio value, exceeds 2% of assets as a result of a 200 basis point
shift in interest rates. As of September 30, 1998, the Bank is not
subject to the interest rate risk requirement.
OTS regulations limit the payment of dividends and other capital
distributions by the Bank. The Bank is able to pay dividends during a
calendar year without regulatory approval to the extent of the greater of
(i) an amount which will reduce by one-half its surplus capital ratio at
the beginning of the year plus all its net income determined on the basis
of generally accepted accounting principles for that calendar year or
(ii) 75% of net income for the last four calendar quarters.
F-24
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 13- Retained Earnings - Continued
-----------------
The Bank is restricted in paying dividends on its stock to the greater
of the restrictions described in the preceding paragraph, or an amount
that would reduce its retained earnings below its regulatory capital
requirement or the accumulated bad debt deduction.
Note 14- Income Taxes
------------
The current tax provision consists of the following for the years
ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Current expense $1,012,697 $ 669,285
Deferred expense 60,391 631,628
---------- ----------
Total tax expense $1,073,088 $1,300,913
========== ==========
</TABLE>
The tax effects to temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred Tax Assets:
Deferred loan origination fees $ - $ 140,348
Allowance for loan losses 399,295 376,792
Allowance for uncollected interest 22,253 25,877
--------- ---------
Total gross deferred tax assets 421,548 543,017
Deferred Tax Liabilities:
Federal Home Loan Bank of Atlanta
stock dividends (151,928) (151,928)
Depreciation (108,903) (93,820)
Bad debt deduction in excess of
base year reserves (304,646) (380,807)
--------- ---------
Total gross deferred tax liabilities (565,477) (626,555)
--------- ---------
Net Deferred Tax Liabilities $(143,929) $ (83,538)
========= =========
</TABLE>
F-25
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 14- Income Taxes - Continued
------------
The amount computed by applying the statutory federal income tax rate
to income before taxes and extraordinary item is greater than the taxes
provided for the following reasons:
<TABLE>
<CAPTION>
For the Years Ended September 30,
--------------------------------------------------
1998 1997
-------------------------- ---------------------
Percent Percent Percent
of Pretax of Pretax of Pretax
Amount Income Amount Income
---------- ------------- ---------- --------
<S> <C> <C> <C> <C>
Statutory federal income
tax rate $ 925,266 34.00% $1,114,488 34.00%
Increases (Decreases)
Resulting From
--------------------
State income tax net of
federal income tax benefit 129,738 4.77 157,442 4.80
Other 18,084 .66 28,983 .88
---------- ------------ ---------- -------
$1,073,088 39.43% $1,300,913 39.68%
========== ============ ========== =======
</TABLE>
The Company and its subsidiaries file a consolidated income tax return
on a fiscal year basis. The returns have been audited by the Internal
Revenue Service through the year ended September 30, 1994.
The Bank was allowed a special bad debt deduction limited generally to
8% of otherwise taxable income for the year beginning January 1, 1988
through December 31, 1995. Beginning January 1, 1996 the percentage of
taxable income method of computing the Bank's tax bad debt deduction is
no longer allowed and the amount by which the tax reserve for bad debts
exceeds such amount at September 30, 1988 must be recaptured over a six
year period. A tax liability has been established for the recapture. If
the amounts which qualify as deductions for federal income tax purposes
are later used for purposes other than to absorb loan losses, including
distributions in liquidations, they will be subject to federal income tax
at the then current corporate rate. The accumulated amount of the
retained earnings for which income taxes have not been accrued at
September 30, 1998 and 1997 was $4,227,000. The unrecorded deferred tax
liability on the above amount is approximately $1,633,000 at September
30, 1998 and 1997.
F-26
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 15- Disclosures About Fair Value of Financial Instruments
-----------------------------------------------------
The estimated fair values of the Bank's financial instruments are
summarized below. The fair values of a significant portion of these
financial instruments are estimates derived using present value
techniques prescribed by the FASB and may not be indicative of the net
realizable or liquidation values. Also, the calculation of estimated
fair values is based on market conditions at a specific point in time and
may not reflect current or future fair values.
The carrying amount is a reasonable estimate of fair value for cash,
federal funds and interest-bearing deposits in other banks. Fair value is
based upon market prices quoted by dealers for investment securities and
mortgage backed securities. The carrying amount of Federal Home Loan
Bank of Atlanta stock is a reasonable estimate of fair value. Loans
receivable were discounted using a single discount rate, comparing the
current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities. These
rates were used for each aggregated category of loans as reported on the
Office of Thrift Supervision Quarterly Report. The fair value of demand
deposits, savings accounts and money market deposits is the amount
payable on demand at the reporting date. The fair value of fixed-
maturity certificates of deposit is estimated using the rates currently
offered on deposits of similar remaining maturities.
The estimated fair values of the Bank's financial instruments are as
follows:
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997
--------------------- ---------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
(Amounts in Thousands)
<S> <C> <C> <C> <C>
Financial Assets
- - ----------------
Cash $ 3,572 $ 3,572 $ 3,909 $ 3,909
Interest bearing deposits in other banks 20,300 20,300 8,206 8,206
Federal funds sold 9,134 9,134 7,102 7,102
Investment securities - held to maturity 12,611 12,661 30,323 30,382
Loans Receivable
----------------
Mortgage loans 145,141 153,242 125,034 127,858
Share loans 681 681 825 825
Consumer loans 36,147 36,380 32,818 33,280
Mortgage backed securities 34,198 34,874 37,189 36,752
Federal Home Loan Bank of Atlanta stock 1,512 1,512 1,433 1,433
Financial Liabilities
- - ---------------------
Deposits $220,805 $221,133 $224,656 $224,765
Mortgage loan commitments - 2,853 - 1,711
</TABLE>
F-27
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 16- Condensed Financial Information (Parent Company Only)
-----------------------------------------------------
Information as to the financial position of BCSB Bankcorp as of
September 30, 1998 and the results of operations and cash flows for the
year ended September 30, 1998 is summarized below.
<TABLE>
<CAPTION>
September 30,
1998
------------------
Statement of Financial Condition
Assets
------
<S> <C>
Cash $ 192,182
Interest bearing deposits in other banks 3,100,089
Federal funds 5,500,000
Employee Stock Ownership Plan loan 1,829,280
Account receivables - intercompany 802,449
Investment in subsidiary 33,725,488
-----------
Total assets $45,149,488
===========
Liabilities and Stockholders' Equity
------------------------------------
Liabilities
-----------
Accrued taxes payable $ 6,440
Stockholders' Equity
--------------------
Common stock (6,116,562 shares issued
and outstanding) 61,166
Paid-in capital 22,645,088
Retained earnings (substantially restricted) 25,221,308
-----------
47,927,562
Employee Stock Ownership Plan (1,829,280)
Stock held by Rabbi Trust (955,234)
-----------
Total stockholders' equity 45,143,048
-----------
Total liabilities and stockholders' equity $45,149,488
===========
</TABLE>
F-28
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 16- Condensed Financial Information (Parent Company Only) - Continued
-----------------------------------------------------
<TABLE>
<CAPTION>
September 30,
1998
--------------
<S> <C>
Statement of Operations
Other interest income $ 16,724
------------
Net interest income 16,724
Other Income
Income from subsidiary 1,638,047
------------
1,654,771
Non-Interest Expenses
Office expense 49
------------
Net income before tax provision 1,654,722
Income tax provision 6,440
------------
Net income 1,648,282
============
Statement of Cash Flows
Cash Flows from Operation Activities
Net income $ 1,648,282
Equity in net income of subsidiary (542,812)
Increase in accounts receivable intercompany (802,449)
------------
Total cash flows from operations 303,021
Cash Flows from Investing Activities
Purchase of stock of subsidiary (12,108,740)
Increase in accrued taxes payable 6,440
------------
Total cash flows from investing activities (12,102,300)
Cash Flows from Financing Activities
Proceeds from stock offering 22,420,831
Employee Stock Ownership Plan (1,829,280)
------------
Total cash flows from financing activities 20,591,551
Increase in cash and cash equivalents 8,792,272
Cash and cash equivalents at beginning of year -
------------
Cash and cash equivalents at end of year $ 8,792,272
============
</TABLE>
F-29
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 17- Recent Accounting Pronouncements
--------------------------------
SFAS No. 130, "Reporting Comprehensive Income" was issued in June
1997. This Statement requires that comprehensive income - made up of all
revenues, expenses, gains and losses - be reported and displayed in an
entity's financial statements with the same prominence as its other
financial statements. Currently, the only item that would be presented
as a component of the Company's comprehensive income which is not also a
component of its net income is the change during the year in unrealized
gain or loss on available for sale securities. The Statement, which is
effective for years beginning after December 15, 1997, will not affect
the Company's financial position or its results of operations.
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information" was also issued in June 1997. This Statement requires that
public business enterprises report financial and descriptive information
about their reportable operating segments. Reportable operating segments
are defined as components of an enterprise about which separate financial
information is available and is evaluated regularly by the chief
operating decision maker as a basis for allocating resources and
assessing performance. It also requires those enterprises to report
information about countries in which they do business and about major
customers. The Statement, which is effective for financial statements for
periods beginning after December 15, 1997, will not affect the Company's
financial position or its results of operations.
SFAS No. 132, "Employers' Disclosures About Pensions and Other
Postretirement Benefits" was issued in February 1998. This Statement
standardizes the disclosure requirements for pensions and postretirement
benefits to the extent practicable. The Statement, which is effective
for fiscal years beginning after December 15, 1997, will not affect the
Company's financial position or its results of operations.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" was issued in June, 1998. This Statement standardizes the
accounting for derivative instruments including certain derivative
instruments embedded in other contracts, by requiring that an entity
recognize these items as assets or liabilities in the statement of
financial position and measure them at fair value. This Statement
generally provides for matching the timing of gain or loss recognition on
the hedging instrument with the recognition of the changes in the fair
value of the hedged asset
F-30
<PAGE>
BCSB BANKCORP, INC.
- - -------------------
AND SUBSIDIARIES
- - ----------------
BALTIMORE, MARYLAND
- - -------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------
Note 17- Recent Accounting Pronouncements - Continued
--------------------------------
or liability that are attributable to the hedged risk or the earnings
effect of the hedged forecasted transaction. The Statement, which is
effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999, will not affect the Company's financial position or its
results of operations.
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-
Up Activities". This Statement provides guidance on the financial
reporting of start-up cost and organization cost. It requires costs of
start-up activities and organization cost to be expensed as incurred.
The "SOP" also requires the initial application to be reported as a
cumulative effect of a change in accounting principle. This "SOP" which
is effective for fiscal years beginning after December 15, 1998 will not
affect the Company's financial position or results of operations.
F-31
<PAGE>
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C> <C>
HENRY V. KAHL MICHAEL J. DIETZ MARTIN F. MEYERS
Chairman of the Board President and Chief Executive Officer of Retired
the Company and the Bank
H. ADRIAN COX
Vice Chairman of the Board GARY C. LORADITCH JOHN J. PANZER, JR.
Insurance Agent for Rohe and Rohe Vice President, Secretary and Treasurer Self Employed
Associates, Baltimore, Maryland of the Company and the Bank
FRANK W. DUNTON WILLIAM M. LOUGHRAN P. LOUIS ROHE, JR.
Retired Vice President of the Bank and Director Retired
EXECUTIVE OFFICERS
MICHAEL J. DIETZ WILLIAM M. LOUGHRAN GARY C. LORADITCH
President and Chief Executive Officer Vice President Vice President, Secretary and Treasurer
OFFICE LOCATION
4111 E. Joppa Road, Suite 300
Baltimore, Maryland 21236
CORPORATE INFORMATION
INDEPENDENT CERTIFIED ACCOUNTANTS SPECIAL COUNSEL ANNUAL REPORT ON FORM 10-KSB
Anderson Associates, LLP Housley Kantarian & Bronstein, P.C.
7621 Fitch Road 1220 19th Street, N.W., Suite 700 A COPY OF THE COMPANY'S ANNUAL
Baltimore, Maryland 21236 Washington, D.C. 20036 REPORT ON FORM 10-KSB FOR THE
FISCAL YEAR ENDED SEPTEMBER 30,
GENERAL COUNSEL ANNUAL MEETING 1998 AS FILED WITH THE SECURITIES AND
Moore, Carney, Ryan & Lattanzi The 1999 Annual Meeting of EXCHANGE COMMISSION, WILL BE
411 E. Joppa Road Stockholders will be held on February 10, FURNISHED WITHOUT CHARGE TO
Baltimore, Maryland 21236 1999 at 4:00 p.m. at the Bank's Perry Hall STOCKHOLDERS AS OF THE RECORD DATE
office located at 4208 Ebenezer Road, FOR THE 1999 ANNUAL MEETING UPON
Baltimore, Maryland WRITTEN REQUEST TO CORPORATE
TRANSFER AGENT AND REGISTRAR SECRETARY, BCSB BANKCORP, INC.,
Chase-Mellon Shareholder Services 4111 E. JOPPA ROAD, SUITE 300,
450 W. 33rd Street, 15th Floor BALTIMORE, MARYLAND 21236
New York, New York 10001
</TABLE>
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
State or Other
Jurisdiction of Percentage
Incorporation Ownership
------------- ---------
Parent
- - ------
<S> <C> <C>
BCSB Bankcorp, Inc. United States
Subsidiary (1)
- - ----------
Baltimore County Savings Bank, F.S.B. United States 100%
Subsidiaries of Baltimore County Savings Bank, F.S.B. (1)
- - -----------------------------------------------------
Baltimore County Service Corp. United States 100%
Ebenezer Road, Inc. United States 100%
</TABLE>
- - -------------------------
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the Annual Report to
Stockholders attached hereto as Exhibit 13.
<PAGE>
Exhibit 23
[LETTERHEAD OF ANDERSON ASSOCIATES, LLP]
We consent to the incorporation by reference in the registration statement
of BCSB Bankcorp, Inc. on Form S-8 (File No. 333-53295) of our report dated
December 3, 1998 on our audits of the consolidated financial statements of BCSB
Bankcorp, Inc. as of September 30, 1998 and 1997, and for each of the two years
in the period ended September 30, 1998, which report has been incorporated by
reference in BCSB Bankcorp, Inc.'s Annual Report on Form 10-KSB filed with the
Securities and Exchange Commission pursuant to the Securities Exchange Act of
1934.
/s/ Anderson Associates LLP
Baltimore, Maryland
December 29, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,572
<INT-BEARING-DEPOSITS> 20,300
<FED-FUNDS-SOLD> 9,134
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 46,809
<INVESTMENTS-MARKET> 47,535
<LOANS> 181,969
<ALLOWANCE> 1,034
<TOTAL-ASSETS> 269,795
<DEPOSITS> 220,805
<SHORT-TERM> 0
<LIABILITIES-OTHER> 1,588
<LONG-TERM> 0
0
0
<COMMON> 61,166
<OTHER-SE> 46,037
<TOTAL-LIABILITIES-AND-EQUITY> 46,098
<INTEREST-LOAN> 13,463
<INTEREST-INVEST> 3,691
<INTEREST-OTHER> 1,657
<INTEREST-TOTAL> 18,810
<INTEREST-DEPOSIT> 9,857
<INTEREST-EXPENSE> 9,867
<INTEREST-INCOME-NET> 8,943
<LOAN-LOSSES> 119
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 7,013
<INCOME-PRETAX> 2,721
<INCOME-PRE-EXTRAORDINARY> 2,721
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,648
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.42
<LOANS-NON> 1,112
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 978
<CHARGE-OFFS> 278
<RECOVERIES> 215
<ALLOWANCE-CLOSE> 1,034
<ALLOWANCE-DOMESTIC> 1,034
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
