SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 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 number 0-18265.
COMMUNITY FINANCIAL CORPORATION
(Exact Name of Small Business Issuer as Specified in its Charter)
Virginia 54-1532044
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
38 North Central Avenue, Staunton, Virginia 24401
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (540) 886-0796
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 Exchange Act during the past twelve months (or for
such shorter period that the Issuer was required to file such reports), and (2)
has been subject to such 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 Issuer'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/
The Issuer had $14,715,897 in gross income for the year ended March 31,
1998.
<PAGE>
As of May 29, 1998, there were issued and outstanding 2,568,446 shares of the
Issuer's Common Stock. The aggregate market value of the voting stock held by
non-affiliates of the Issuer, computed by reference to the average of the
closing bid and asked price of such stock as of May 29, 1998, was approximately
$30,700,000. (The exclusion from such amount of the market value of the shares
owned by any person shall not be deemed an admission by the Issuer that such
person is an affiliate of the Issuer.)
DOCUMENTS INCORPORATED BY REFERENCE
PART III of Form 10-KSB--Proxy Statement for the 1998 Annual Meeting of
Stockholders.
Transitional Small Business Disclosure Format:
Yes [ ] No[X]
2
<PAGE>
PART I
Item 1. Description of Business
- --------------------------------
General
- -------
Community Financial Corporation ("Community" or the "Company") is a
Virginia corporation which owns Community Bank (the "Bank"). The Bank was
organized in 1928 as a Virginia-chartered building and loan association,
converted to a federally-chartered savings and loan association in 1955 and to a
federally-chartered savings bank in 1983. In 1988, the Bank converted to the
stock form of organization through the sale and issuance of shares of its Common
Stock. The Company effected a two-for-one stock split in the form of a 100%
stock dividend in November 1994 and March 1998.
The principal asset of the Company is the outstanding stock of the Bank,
its wholly owned subsidiary. The Company presently has no separate operations
and its business consists only of the business of the Bank. The Company's Common
Stock trades on The Nasdaq Stock Market under the symbol "CFFC." In November,
1997 the Bank established Community First Mortgage Corporation ("Community
First"), a wholly owned mortgage banking subsidiary to originate and sell
mortgage loans. Community First has yet to fully begin operations.
The Company and the Bank are subject to comprehensive regulation,
examination and supervision by the Office of Thrift Supervision, Department of
the Treasury ("OTS") and by the Federal Deposit Insurance Corporation ("FDIC").
The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its
deposits are backed by the full faith and credit of the United States Government
and are insured by the Savings Association Insurance Fund ("SAIF") to the
maximum extent permitted by the FDIC.
At March 31, 1998, Community had $183.9 million in assets, deposits of
$138.2 million and stockholders' equity of $25.5 million. Community's primary
business consists of attracting deposits from the general public and originating
real estate loans and other types of investments through its offices located in
Staunton, Waynesboro, Stuart Drafts and Virginia Beach, Virginia.
Like all financial institutions, Community's operations are materially
affected by general economic conditions, the monetary and fiscal policies of the
federal government and the policies of the various regulatory authorities,
including the OTS and the Board of Governors of the Federal Reserve System
("Federal Reserve Board"). Its results of operations are largely dependent upon
its net interest income, which is the difference between the interest it
receives on its loan portfolio and its investment securities portfolio and the
interest it pays on its deposit accounts and borrowings.
Community's main office is located at 38 North Central Avenue, Staunton,
Virginia 24401. The Company's telephone number is (540) 886-0796.
3
<PAGE>
Forward-Looking Statements
This Quarterly Report on Form 10-K contains certain forward-looking statements
with respect to the financial condition, results of operations and business of
the Company. These forward-looking statements involve certain risks and
uncertainties. When used in this Quarterly Report on Form 10-K or future filings
by the Company with the Securities and Exchange Commission, in the Company's
press releases or other public or shareholder communications, or in oral
statements made with the approval of an authorized executive officer, the words
or phrases "will likely result", "are expected to", "will continue", "is
anticipated", "estimate", "project", "believe" or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. 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, and to advise readers that various factors
including regional and national economic conditions, changes in levels of market
interest rates, credit risks of lending activities, and competitive and
regulatory factors could affect the Company's financial performance and could
cause the Company's actual results for future periods to differ materially from
those anticipated or projected.
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 the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Year 2000
- ---------
The Corporation is conducting a formal review of its systems and systems
providers, due to concerns regarding possible consequences that the year 2000
may pose to computer and other operating systems utilized in its business
activities. While a preliminary review has resulted in the identification of
certain issues which require resolution, management believes that appropriate
plans are in place to resolve these issues in a timely manner. Management does
not believe the resolution of these issues will significantly impair the
Corporation's ability to provide necessary services to our customers, nor are
the costs involved in this program expected to have a material impact on the
Corporations earnings or financial condition.
4
<PAGE>
Lending Activities
- ------------------
General. The Company, like most other thrift institutions, concentrates its
lending activities on first mortgage conventional loans secured by residential
and, to a lesser extent, commercial real estate with an emphasis on multi-family
housing. The Company makes construction loans secured by commercial real estate
and one-to four-family residential properties. Additionally, the Company makes
consumer loans in order to increase the diversification and decrease interest
rate sensitivity of its loan portfolio and to increase interest income.
Substantially, all of the Company's loans are originated within its market area
which includes Shenandoah, Rockingham, Page, Highland, Augusta, Albemarle, Bath,
Rockbridge and Nelson Counties in Virginia. The Company opened an office in
Virginia Beach, Virginia in April, 1997 which will expand the Bank's market to
the Hampton Roads area.
Residential loan originations come primarily from walk-in customers, real
estate brokers and builders. Commercial real estate loan originations are
obtained through broker referrals, direct solicitation of developers and
continued business from customers. All completed loan applications are reviewed
by the Company's salaried loan officers. As part of the application process,
information is obtained concerning the income, financial condition, employment
and credit history of the applicant. If commercial real estate is involved,
information is also obtained concerning cash flow after debt service. The
quality of loans is analyzed based on Company experience and on the Company's
guidelines with respect to credit underwriting as well as the guidelines issued
by the Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National
Mortgage Association ("FNMA") and other purchasers of loans, depending on the
type of loans involved. The one-to four-family adjustable-rate mortgage loans
originated by the Company, however, are not readily saleable in the secondary
market due to the fact that the Company does not typically require surveys,
title insurance or written verifications of employment history and deposit
relationships. All real estate is appraised by independent fee appraisers who
have been pre-approved by the Board of Directors.
The Company's loan commitments are approved at different levels, depending
on the size and type of the loan being sought. One-to four-family and commercial
real estate loans in the amount of $150,000 or less may be approved by the
Vice-President/Director of Lending. Loans in excess of $150,000 but less than
$250,000 must be approved by a majority of the Company's Loan Committee. All
mortgage loans in excess of $250,000 must be approved by the Board of Directors.
Consumer loans in excess of $100,000 on a secured basis and $50,000 on an
unsecured basis require the approval of the President of the Company with the
concurrence of another member of senior management. Regardless of the individual
loan approval authority, the Board of Directors generally approves or ratifies
all loans.
The aggregate amount of loans that the Bank is permitted to make to any one
borrower, including related entities, and the aggregate amount that the Bank may
invest in any one real estate project, with certain exceptions, is limited to
the greater of 15% of unimpaired capital and surplus or $500,000. At March 31,
1998, the maximum amount which the Bank could have loaned to one borrower and
the borrower's related entities and invested in any one project
5
<PAGE>
was approximately $3.4 million. At March 31, 1998, the Bank had no borrower, or
groups of borrowers, with loans outstanding in excess of $2.7 million.
6
<PAGE>
Loan Portfolio Composition. The following table sets forth the composition
of the Company's total loan portfolio in dollars and percentages as of the dates
indicated.
<TABLE>
<CAPTION>
March 31,
-----------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-----------------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-----------------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate Loans:
- -----------------
Residential $ 94,962 56.92 $ 96,968 63.83% $ 91,212 62.92% $ 86,331 62.90% $ 77,485 61.59%
Commercial 40,115 24.04 37,508 24.69 38,433 26.51 39,667 28.90 41,144 32.71
Construction 10,071 6.04 5,204 3.42 6,415 4.43 4,336 3.15 2,992 2.38
-------- ------ -------- ------ -------- ------ -------- ------ -------- -------
Total real estate 145,148 87.00 139,680 91.94 136,060 93.86 130,334 94.95 121,621 96.68
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer Loans:
- --------------
Unsecured personal 1,935 1.16 4,418 2.91 3,616 2.50 3,600 2.62 1,922 1.53
Secured personal 3,066 1.84 546 .36 --- --- --- --- --- ---
Automobile 3,970 2.38 1,646 1.08 1,470 1.01 1,072 .78 687 .55
Home equity 7,086 4.25 1,630 1.07 380 .26 412 .30 505 .40
Deposit account 277 .16 339 .22 234 .16 267 .20 259 .21
Other 35 .02 76 .05 496 .34 1,577 1.15 809 .63
-------- ------ -------- ----- -------- ------ -------- ------ -------- ------
Total consumer 16,369 9.81 8,655 5.69 6,196 4.27 6,928 5.05 4,182 3.32
Commercial business 5,321 3.19 3,588 2.37 2,709 1.87 --- --- --- ---
-------- ----- -------- ----- -------- ------ -------- ------ ------- ------
Total loans
receivable $166,838 100.00% $151,923 100.00% $144,965 100.00% $137,262 100.00% $125,803 100.00%
-------- ====== -------- =====- -------- ====== -------- ====== -------- ======
Less:
Undisbursed loans in
process 3,003 1,619 1,830 1,477 1,330
Deferred fees and
unearned discounts 247 361 396 507 625
Allowance for losses 1,117 1,038 1,000 763 703
-------- -------- -------- -------- --------
Total net items 4,367 3,018 3,226 2,747 2,658
-------- -------- -------- -------- --------
Total loans
receivable, net $162,471 $148,905 $141,739 $134,515 $123,145
======== ======== ======== ======== =========
</TABLE>
7
<PAGE>
The following table shows the composition of the Company's loan portfolio
by fixed and adjustable rate at the dates indicated.
<TABLE>
<CAPTION>
March 31,
-------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed-Rate Loans:
Real Estate:
Residential $ 13,539 8.12% $ 11,161 7.34% $ 12,863 8.87% $ 12,896 9.40% $ 14,880 11.83%
Commercial 6,442 3.86 6,223 4.10 5,548 3.83 2,765 2.01 3,832 3.05
-------- ------ -------- ------ -------- ------ --------- ------ -------- ------
Total real
estate loans(1) 19,981 11.98 17,384 11.44 18,411 12.70 15,661 11.41 18,712 14.88
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer 14,716 8.82 8,114 5.33 5,902 4.07 6,516 4.75 3,677 2.92
Commercial business 4,767 2.86 3,588 2.37 2,709 1.87 --- --- --- ---
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total fixed-rate
loans 39,464 23.66 29,086 19.14 27,022 18.64 22,177 16.16 22,389 17.80
-------- ------ -------- ------ -------- ------ ------- ----- ------ -----
Adjustable-Rate
Loans:
Real Estate:
Residential 86,074 51.59 87,336 57.49 80,773 55.72 75,023 54.66 64,532 51.30
Commercial 39,093 23.43 34,960 23.01 36,876 25.44 39,650 28.88 38,377 30.50
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate
loans(2) 125,167 75.02 122,296 80.50 117,649 81.16 114,673 83.54 102,909 81.80
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer 1,653 .99 541 .36 294 .20 412 .30 505 .40
Commercial Business 554 .33 --- --- --- --- --- --- --- ---
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total adjustable-
rate loans 127,374 76.34 122,837 80.86 117,943 81.36 115,085 83.84 103,414 82.20
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans
receivable $166,838 100.00% $151,923 100.00% $144,965 100.00% $137,262 100.00% $125,803 100.00%
-------- ====== -------- ====== -------- ====== -------- ======= -------- =======
</TABLE>
CONTINUED NEXT PAGE
8
<PAGE>
<TABLE>
<CAPTION>
March 31,
--------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Less:
Undisbursed loans
in process 3,003 1,619 1,830 1,477 1,330
Deferred fees and
unearned discounts 247 361 396 507 625
Allowance for losses 1,116 1,038 1,000 763 703
-------- -------- -------- -------- --------
Total net items 4,366 3,018 3,226 2,747 2,658
-------- -------- -------- -------- --------
Total loans
receivable, net $162,472 $148,905 $141,739 $134,515 $123,145
======== ======== ======== ======== =========
</TABLE>
- ----------------
(1) Includes residential real estate construction loans of $818,000,
$1,529,000, $2,424,000, $1,588,000 and $1,927,000 and commercial real
estate construction loans of $4,321,000, $3,675,000, $3,991,000,
$2,748,000, and $1,065,000 at March 31, 1998, 1997, 1996, 1995 and 1994,
respectively. (2) Includes residential real estate construction loans of
$3,833,000 and commercial real estate construction loans of $1,099,000 at
March 31, 1998.
9
<PAGE>
Loan Maturity and Repricing
- ---------------------------
The following table illustrates the contractual maturity of the Company's
loan portfolio at March 31, 1998. Mortgages which have adjustable interest rates
are shown as maturing based on contractual maturity and demand loans are shown
as maturing in one year or less. This schedule does not reflect the effects of
possible prepayments or enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
------------------------
Mortgage(1) Construction Consumer Total
-----------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Due During Years Ended
- ----------------------
04/01/98 - 03/31/99 $ 8,977 $ 9,917 $ 14,087 $ 34,109
04/01/99 - 03/31/03 15,263 154 4,723 20,140
04/01/03 and following 110,837 0 2,880 112,589
-------- -------- -------- --------
Total $135,077 $ 10,071 $ 21,690 $166,838
======== ======== ======== ========
</TABLE>
- -----------
(1) Includes residential and commercial real estate loans.
The total amount of loans due after March 31, 1999 which have predetermined
interest rates is $14.0 million, while the total amount of loans due after such
date which have floating or adjustable interest rates is $118.7 million.
10
<PAGE>
One-to Four-Family Residential Real Estate Lending
- ---------------------------------------------------
The Company's primary lending program is the origination of loans secured
by one-to four-family residences, substantially all of which are located in the
Company's market area. The Company evaluates both the borrower's ability to make
principal and interest payments and the value of the property that will secure
the loan. Although federal law permits the Company to make loans in amounts of
up to 100% of the appraised value of the underlying real estate, the Company
generally makes one-to-four-family residential real estate loans in amounts of
80% or less of the appraised value thereof. In certain instances, the Company
will lend up to 90% of the appraised value of the underlying real estate and
requires the borrower to purchase private mortgage insurance in an amount to
reduce the Company's exposure to 80% or less.
Most savings institutions, including Community, historically made one- to
four-family residential mortgage loans on a 30-year fixed-rate basis. Due to
prepayments and refinancings, the average actual maturity of 30-year loans is
generally substantially shorter.
In order to reduce its exposure to changes in interest rates, the Company has
de-emphasized the origination of 30-year fixed-rate one-to-four-family
residential mortgage loans for retention in its own portfolio. For the year
ended March 31, 1998, 79.5% of all one-to-four-family residential loans
originated by the Company had adjustable interest rates. Although, due to
competitive market pressures, the Company does originate fixed-rate mortgage
loans, it currently underwrites and documents all such loans to permit their
sale in the secondary mortgage market, with a third-party purchase commitment
for the loan being required prior to origination. At March 31, 1998, $12.7
million (excluding $818,000 of residential construction loans) or 12.8%, of the
Company's one-to-four-family residential mortgage loan portfolio consisted of
fixed-rate mortgage loans.
The Company's current one-to-four-family residential adjustable-rate mortgages
("ARMs") have interest rates that adjust primarily every year, generally in
accordance with the rates on one-year U.S. Treasury Bills. Although the
Company's primary one-to-four-family residential loan is one year adjustable,
the Company has begun to offer a residential loan which adjusts every three
years generally in accordance with the rates on three year U.S. Treasury Bills.
The Company's ARMs generally limit interest rate increases to 2% each rate
adjustment period and have an established ceiling rate at the time the loans are
made of up to 6% over the original interest rate. To compete with other lenders
in its market area, Community makes one and three-year ARMs at interest rates
which, for the initial period, are below the index rate which would otherwise
apply to these loans. Borrowers are qualified, however, at the fully indexed
interest rate. At March 31, 1998, ARM loans totaled $86.0 million, or 51.6%, of
the Company's total loans receivable before net items. There are unquantifiable
risks resulting from potential increased costs to the borrower as a result of
repricing. It is possible, therefore, that during periods of rising interest
rates, the risk of defaults on ARMs may increase due to the upward adjustment of
interest costs to borrowers.
All one-to-four-family real estate mortgage loans being originated by the
Company contain a "due-on-sale" clause providing that the Company may declare
11
<PAGE>
the unpaid principal balance due and payable upon the sale of the mortgaged
property. It is the Company's policy to enforce these due-on-sale clauses
concerning fixed-rated loan and to permit assumptions of ARMs, for a fee, by
qualified borrowers.
The Company requires, in connection with the origination of residential real
estate loans, title opinions and fire and casualty insurance coverage, as well
as flood insurance where appropriate, to protect the Company's interest. The
cost of this insurance coverage is paid by the borrower. The Company generally
does not require escrows for taxes and insurance.
Commercial Real Estate and Construction Lending
- -----------------------------------------------
The Company has originated and, in the past has purchased, commercial real
estate loans and loan participations. The Company also makes commercial real
estate construction loans. The Company's commercial real estate and construction
loans are secured by various types of commercial real estate, including
multi-family residential buildings, hotels and motels, convenience stores,
commercial and industrial buildings, shopping centers and churches. The Company
has in recent years placed more emphasis on multi-family housing loans for its
commercial real estate loan portfolio. At March 31, 1998, commercial real estate
and construction loans aggregated $50.2 million or 30.5% of the Company's total
loans receivable before net items. The Company's commercial real estate and
construction loans are secured by properties located in the Company's market
area.
The Company's commercial real estate loans are generally made at interest
rates that adjust based on yields for one-year U.S. Treasury securities, with a
2% annual cap on rate adjustments and a 6% cap on interest rates over the life
of the loan. Typically, the Company charges fees ranging from 1% to 2% on these
loans. At March 31, 1998, the Company had $6.4 million in fixed-rate commercial
real estate and construction loans. Commercial real estate loans made by the
Company are fully amortizing with maturities ranging from five to 30 years.
At March 31, 1998, the Company had $5.4 million or 3.2% of its total loans
receivable before net items invested in commercial construction loans compared
to $3.7 million or 2.4% at March 31, 1997. At March 31, 1998, the Company had
eleven commercial construction loans, the largest one having an outstanding
balance of $1.1 million at March 31, 1998. All of these loans are presently
performing in accordance with their terms. The Company's commercial construction
loans are generally made for a one year term or less, with a requirement that
the borrower have a commitment for permanent financing prior to funding the
construction loan. The Company's construction loans generally provide for a
fixed rate of interest at the prevailing prime rate or slightly above. Such
loans are secured by the personal guarantees of the borrowers and by first
mortgages on the projects.
In its underwriting of commercial real estate and construction loans, the
Company may lend, under federal regulations, up to 100% of the security
property's appraised value, although the Company's loan to original appraised
value ratio on such properties is generally 80% or less. The Company's
commercial real estate and construction loan underwriting criteria require an
12
<PAGE>
examination of debt service coverage ratios, the borrower's creditworthiness and
prior credit history and reputation, and the Company generally requires personal
guarantees or endorsements of borrowers. The Company also carefully considers
the location of the security property.
At March 31, 1998, the Company had 17 commercial real estate loans (or
multiple loans to one borrower) in excess of $1.0 million with an aggregate
balance of $31.6 million. Management is monitoring one commercial real estate
borrower with a balance of $1.4 million which was delinquent at March 31, 1998.
Based on a current appraisal of the property, no allowance for loan losses has
been recorded. The largest was a group of loans to a single borrower for $2.7
million secured primarily by multi-unit apartments, single family rental houses
and a restaurant.
The following table presents information as to Community's commercial real
estate and construction lending portfolio as of March 31, 1998 by type of
project.
<TABLE>
<CAPTION>
Number
of Principal
Loans Balance
------ -----------
(Dollars in Thousands)
<S> <C> <C>
Permanent financing:
Multi-family residential
building 49 $18,586
Hotel and motel 1 222
Commercial and industrial building 87 20,103
Raw land 14 1,074
Church 2 130
--- -------
153 40,115
--- -------
Acquisition and construction
financing:
Commercial and industrial building 11 5,420
--- -------
Total 164 $45,535
=== =======
</TABLE>
Commercial real estate and construction lending is generally considered to
involve a higher level of credit risk than one-to four-family residential
lending due to the concentration of principal in a limited number of loans and
borrowers and the effects of general economic conditions on real estate
developers and managers. The Company's risk of loss on a construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
sell out value upon completion of the project and the estimated cost of the
project. If the estimated cost of construction or development proves to be
inaccurate, the Company may be required to advance funds beyond the amount
originally committed to permit completion of the project. If the estimate of
13
<PAGE>
value proves to be inaccurate, the Company may be confronted, at or prior to the
maturity of the loan, with a project with value which is insufficient to assure
full repayment. Because the Company usually provides loans to a developer for
the entire estimated cost and interest of the project, defaults in repayment
generally do not occur during the construction period and it is therefore
difficult to identify problem loans at an early stage. When loan payments become
due, borrowers may experience cash flow from the project which is not adequate
to service total debt. This cash flow shortage can result in the failure to make
loan payments. In such cases, the Company may be compelled to modify the terms
of the loan. In addition, the nature of these loans is such that they are
generally less predictable and more difficult to evaluate and monitor.
Consumer Lending
- ----------------
Federal thrift institutions are permitted to make both secured and unsecured
consumer loans reasonably incident to personal or household purposes. In
general, loans made under these investment powers may not exceed 30% of a
federally-chartered thrift institution's total assets.
The Company offers various secured and unsecured consumer loans, including
unsecured personal loans, automobile loans, deposit account loans, installment
and demand loans, and home equity loans and credit card receivables. At March
31, 1998, the Company had $16.4 million or 9.8% of its total loans receivable
before net items invested in consumer loans. With the exception of $1.7 million
home equity loans at March 31, 1998, the Company's consumer loans have fixed
interest rates and generally have terms ranging from 90 days to five years. The
largest component of consumer loans are home equity loans. Community originates
all of its consumer loans in its market area and intends to continue its
consumer lending in this geographic area.
The Company offers VISA credit card accounts. At March 31, 1998, 1,113 credit
card accounts had been issued, with an aggregate outstanding balance of $370,233
and unused credit available of $2.5 million. The Company presently charges no
annual membership fee and an annual rate of interest of 15.98%.
The underwriting standards employed by the Company for consumer loans include
a determination of the applicant's payment history on other debts and an
assessment of ability to meet existing obligations and payments on the proposed
loan. The stability of the applicant's monthly income may be determined by
verification of gross monthly income from primary employment, and additionally
from any verifiable secondary income. Although creditworthiness of the applicant
is of primary consideration, the underwriting process also includes a comparison
of the value of the security in relation to the proposed loan amount.
Consumer loans may entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured, such as credit
card receivables, or secured by rapidly depreciable assets such as automobiles.
In such cases, any 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
14
<PAGE>
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 job loss, divorce, illness or
personal bankruptcy. Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans. Such loans may also give rise to
claims and defenses by a consumer loan borrower against an assignee of such loan
such as the Company, and a borrower may be able to assert against such assignee
claims and defenses which it has against the seller of the underlying
collateral. The Company adds general provisions to its loan loss allowance, in
amounts determined in accordance with industry standards, at the time the loans
are originated. Consumer loan delinquencies often increase over time as the
loans age. Accordingly, although the level of non-performing assets in the
Company's consumer loan portfolio has generally been low ($45,000 at March 31,
1998), there can be no assurance that delinquencies will not increase in the
future.
Commercial Business Lending
- ---------------------------
The Company also orginiates commercial business loans. At March 31,
1998 the Company had $5.3 million in commercial business loans outstanding,
representing 3.2% of the Company's gross loan portfolio. The Company offers
commercial business loans to service existing customers, to consolidate its
banking relationships with these customers, and to further its asset/liability
management goals.
Unlike residential mortgage loans which generally are made on the basis
of the borrower's ability to make repayment from his or her employment and other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial business loans are of higher risk and typically
are made on the basis of the borrower's ability to make repayment from the cash
flow of the borrower's business. As a result, the availability of funds for the
repayment of commercial business loans may be dependent upon the success of the
business itself. The Company's commercial business loans almost always include
personal guarantees and are usually, but not always, secured by business assets.
However, the collateral securing the loans may depreciate over time, may be
difficult to appraise and may fluctuate in value based on the success of the
business. At March 31, 1998, the Company has $3.7 million of secured commercial
business loans and $1.6 million of unsecured commercial business loans.
The Company recognizes the generally increased credit risk associated
with commercial business lending. The Company's commercial business lending
practice emphasizes credit file documentation and analysis of the borrower's
character, management capabilities, capacity to repay the loan, the adequacy of
the borrower's capital and collateral. Analysis of the borrower's past, present
and future cash flows is also an important aspect of the Company's credit
analysis.
Loan Originations, Purchases and Sales
- --------------------------------------
Federal regulations authorize the Company to make real estate loans anywhere
in the United States. However, at March 31, 1998, substantially all
15
<PAGE>
of the Company's real estate loans were secured by real estate located in the
Company's market area.
Management believes that purchases of loans and loan participations are
generally desirable only when local mortgage demand is less than the supply of
funds available for local mortgage origination. The Company purchased $629,000
in loans in fiscal 1998.
Generally, the Company originates fixed-rate residential mortgage loans for
sale in the secondary market and retains adjustable-rate mortgage loans for the
Company's portfolio. Prior to fiscal 1997 the Company retained the servicing for
mortgage loans sold. During fiscal 1997 the Company began to sell loans with
servicing released to be more competitive in that market.
16
<PAGE>
The following table shows the loan origination, purchase, sale and repayment
activities of the Company for the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------
1998 1997 1996
----------------------------
(In Thousands)
<S> <C> <C> <C>
Origination by Type:
- -------------------
Adjustable Rate:
Real estate - one- to four-family
residential $20,724 $21,687 $16,132
- commercial 9,693 5,974 1,449
- home equity 390 230 311
------- ------- -------
Total adjustable rate 30,807 27,891 17,892
------- ------- -------
Fixed Rate:
- ----------
Real estate - one- to four-family
residential 5,345 3,280 4,636
- commercial --- 1,092 2,109
Non-real estate - consumer(1) 22,009 10,857 8,163
------- ------- -------
Total fixed rate 27,354 15,229 14,908
------- ------- -------
Sales and Repayments
- --------------------
Real estate loans 4,001 1,418 1,085
Principal repayments 23,552 23,836 19,750
------- ------- -------
Total reductions 27,553 25,254 20,835
------- ------- -------
Increase (decrease) in other
items, net (17,041) (10,699) (4,741)
------- ------- -------
Net increase (decrease) $13,567 $ 7,167 $ 7,224
======= ======= =======
</TABLE>
- -----------------
(1) Consumer loans include the amounts outstanding on credit card accounts
opened by the Company and outstanding lines of credit on home equity loans.
The total credit available was $4.6 million, $4.1 million and $3.6 million
at March 31, 1998, 1997 and 1996, respectively, which would have increased
fixed-rate consumer loans to $24.1 million, $14.9 million and $12.2 million
at such dates, respectively.
17
<PAGE>
Income From Lending Activities
- ------------------------------
Community realizes interest and loan fee income from its lending activities.
The Company receives loan fees on both commercial real estate and one-to
four-family residential loans. The Company receives loan fees and charges
related to existing loans, which include late charges. Interest on loans, loan
fees and service charges together comprised 96.1% of the Company's total
revenues for the year ended March 31, 1998. Income from loan fees and other fees
is a volatile source of income, varying with the volume and type of loans and
commitments made and with competitive and economic conditions.
Loan fees and loan origination cost are deferred and amortized over the life
of the loans to which they relate. The remaining deferred fees are amortized
into income over the estimated remaining lives of the loans to which they
relate, using a method which approximates level yield. The Company had deferred
fees net of direct underwriting costs of $247,322 at March 31, 1998.
Delinquent and Problem Loans
- ----------------------------
When a borrower fails to make a required payment on a loan, the Company
attempts to cause the deficiency to be cured by contacting the borrower. A
notice is mailed to the borrower after a payment is 16 days past due and again
when the loan is 28 days past due. For most loans, if the delinquency is not
cured within 30 days the Company issues a notice of intent to foreclose on the
property and if the delinquency is not cured within 60 days, the Company may
institute foreclosure action. If foreclosed on, real property is sold at a
public sale and may be purchased by the Company. Historically, deficiencies have
been cured promptly.
18
<PAGE>
The following table sets forth information concerning delinquent mortgage and
other loans at March 31, 1998. The amounts presented represent the total
remaining principal balances of the related loans, rather than the actual
payment amounts which are overdue.
<TABLE>
<CAPTION>
Residential Commercial
Real Estate Real Estate Consumer
------------------ ------------------ -----------------
Number Amount Number Amount Number Amount
--------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Loans Delinquent for:
- --------------------
30-59 days 7 $908 1 $1,368 15 $510
60-89 days 1 83 0 0 4 28
90 days and over 4 590 0 0 2 45
--- ----- --- ----- ---- ----
Total delinquent loans 12 $1,581 1 $1,368 21 $583
=== ===== === ===== ==== ====
</TABLE>
Federal regulations provide for the classification of loans, debt, equity
securities and other assets considered to be of lesser quality as "substandard,"
"doubtful" or "loss" assets. The regulations require insured institutions to
classify their own assets and to establish prudent general allowances for losses
for assets classified "substandard" or "doubtful." For the portion of assets
classified as "loss," an institution is required to either establish specific
allowances of 100% of the amount classified or charge such amount off its books.
Assets which do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
potential weaknesses are required to be designated "special mention" by
management. In addition, the OTS may require the establishment of a general
allowance for losses based on assets classified as "substandard" and "doubtful"
or based on the general quality of the asset portfolio of an institution. In
connection with the filing of its periodic reports with the OTS and in
accordance with its classification of assets policy, the Company regularly
reviews the loans in its portfolio to determine whether any loans require
classification in accordance with applicable regulations. On the basis of
management's review of its assets, at March 31, 1998, the Company had classified
$2.3 million of its assets as substandard, none as doubtful or loss. All assets
of the Company that have been classified are included below in either the table
of non-performing assets or under "Other Loans of Concern." In addition, the
Company had $1.4 million in special mention assets. See "- Non-Performing
Assets."
19
<PAGE>
Non-Performing Assets
- ---------------------
The table below sets forth the amounts and categories of non-performing assets
in the Company's loan portfolio. Non-performing assets include non-accruing
loans, accruing loans delinquent 90 days or more as to principal or interest
payments and real estate acquired through foreclosure, which include assets
acquired in settlement of loans. Typically, a loan becomes nonaccruing when it
is 90 days delinquent. All consumer loans more than 120 days delinquent are
charged against the consumer loan allowance for loan losses. Accruing mortgage
loans delinquent more than 90 days are loans that the Company considers to be
well secured and in the process of collection. For the years presented, the
Company has had no troubled debt restructurings (which involve forgiving a
portion of interest or principal on any loans or making loans at a rate
materially less than that of market rates).
<TABLE>
<CAPTION>
March 31,
--------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Real Estate $ 590 $ 400 $ --- $ 3 $ ---
Consumer 45 103 --- --- ---
Accruing Loans Delinquent
More Than 90 Days:
Residential 52 15
Commercial --- --- --- --- 23
Consumer --- --- 541 --- 18
Real estate acquired --- --- --- --- ---
through foreclosure 303 173 148 350 380
------ ------ ------- ------ ------
Total $ 938 $ 676 $ 741 $ 353 $ 436
====== ====== ======= ====== ======
Total as a percentage
of total assets .51% .40% .46% .23% .32%
====== ====== ======= ====== ======
Unallocated allowance for
loan losses $1,080 $ 783 $ 791 $ 728 $ 628
====== ====== ======= ====== ======
</TABLE>
At March 31, 1998, the Company's non-performing assets were comprised of three
single family residential properties, a combination single family house and farm
which were more than ninety days past due, real estate acquired through
foreclosure of three single family dwellings, two rental properties of three and
two units respectively, and a five acre lot. Based on current market
20
<PAGE>
values of the properties securing these loans, management anticipates no
significant losses in excess of the reserves for losses previously recorded.
Other Loans Of Concern
- ----------------------
As of March 31, 1998, there were $1.4 million in loans with respect to which
known information about the possible credit problems of the borrowers or the
cash flows of the security properties have caused management to have doubts as
to the ability of the borrowers to comply with present loan repayment terms and
which may result in the future inclusion of such items in the non-performing
asset categories.
The $1.4 million in other loans of concern referred to above is comprised
primarily of 10 residential real estate loans. Seven of the loans are one-to
four family rental properties with three borrowers and with an aggregate loan
balance of $880,000. One loan is a multi-family property with a loan balance of
$384,000. The remaining two real estate loans are residential construction loans
to one borrower with a total balance of $112,000. The balance of the $1.4
million in other loans is one consumer loan. The Company is closely monitoring
the status of these loans.
Although management believes that these loans are adequately secured and no
material loss is expected, certain circumstances may cause the borrower to be
unable to comply with the present loan repayment terms at some future date.
Allowance for Losses on Loans and Real Estate
- ---------------------------------------------
The Company provides valuation reserves for anticipated losses on loans and
real estate when its management determines that a significant decline in the
value of the collateral has occurred, as a result of which the value of the
collateral is less than the amount of the unpaid principal of the related loan
plus estimated costs of acquisition and sale. In addition, the Company also
provides reserves based on the dollar amount and type of collateral securing its
loans, in order to protect against unanticipated losses. Although management
believes that it uses the best information available to make such
determinations, future adjustments to reserves may be necessary, and net income
could be significantly affected, if circumstances differ substantially from the
assumptions used in making the initial determinations. During 1998, the Company
increased its allowance for losses on loans by $78,000 due primarily to the
increased loan volume, especially in commercial real estate, construction and
consumer loan. At March 31, 1998, the Company had an allowance for loan losses
of $1.1 million which represent .58% of total loans receivable and 119% of
nonperforming loans.
21
<PAGE>
The following table sets forth an analysis of the Company's allowance for loan
losses.
<TABLE>
<CAPTION>
Year Ended March 31,
------------------------------------------------
1998 1997 1996 1995 1994
------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning
of period $ 1,039 $1,000 $ 763 $ 661 $ 613
Provision charged to
operations 499 181 307 109 74
------- ------- ------- ------- -------
Charge-offs:
- -----------
Residential real
estate 116 59 --- --- ---
Consumer 376 110 71 7 28
Recoveries:
Consumer 71 27 1 --- 2
------- ------- ------- ------- -------
Net charge-offs 421 142 70 7 26
------- ------- ------- ------- -------
Balance at end
of period $ 1,117 $1,039 $1,000 $ 763 $ 661
======= ====== ======= ======= =======
Ratio of net charge-
offs during the
period to average
loans outstanding
during the period .27% .10% .01% .01% .01%
</TABLE>
22
<PAGE>
The distribution of the allowance for losses on loans at the dates indicated
is summarized as follows:
<TABLE>
<CAPTION>
Commercial
Residential Real Estate Construction Consumer Total
--------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
March 31, 1998
- --------------
Amount of loan loss
allowance $ 376 $ 161 $ 116 $ 464 $ 1,117
Loan amounts by
category 94,962 40,115 10,071 21,690 166,838
Percent of loans in
each category to
total loans 56.92% 24.04% 6.04% 13.00% 100.0%
March 31, 1997
- --------------
Amount of loan loss
allowance $ 385 $ 140 $ 78 $ 436 $ 1,039
Loan amounts by 96,968 37,508 5,204 12,243 151,923
category
Percent of loans in
each category to
total loans 63.83% 24.69% 3.42% 8.06% 100.0%
March 31, 1996
- --------------
Amount of loan loss
allowance $ 381 $ 242 $ 83 $ 294 $ 1,000
Loan amounts by
category 91,212 38,433 6,415 8,905 144,965
Percent of loans in
each category to
total loans 62.9% 26.5% 4.5% 6.1% 100.0%
March 31, 1995
- --------------
Amount of loan loss
allowance $ 216 $ 374 $ 72 $ 101 $ 763
Loan amounts by
category 86,331 39,667 4,336 6,928 137,262
Percent of loans in
each category to
total loans 62.9% 28.9% 3.2% 5.0% 100.0%
March 31, 1994
- --------------
Amount of loan loss
allowance $ 193 $ 408 $ 23 $ 79 $ 703
Loan amounts by
category 77,583 41,046 2,992 4,182 125,803
Percent of loans in
each category to
total loans 61.7% 32.6% 2.4% 3.3% 100.0%
</TABLE>
23
<PAGE>
Subsidiary Activities
- ---------------------
The Bank established Community First, a mortgage banking subsidiary, in
November, 1997. Community First is located in Richmond, Virginia and originates
mortgage loans to sell to investors. At March 31, 1998, Communitiy First had no
material operations.
Investment Activities
- ---------------------
Federal thrift institutions have authority to invest in various types of
liquid assets, including U.S. Treasury obligations and securities of various
federal agencies, certificates of deposit at insured institutions, bankers'
acceptances and federal funds.
Federal thrift institutions may also invest a portion of their assets in
certain commercial paper and corporate debt securities. Federal thrift
institutions are also authorized to invest in mutual funds whose assets conform
to the investments that a federal thrift institution is authorized to make
directly. There are, however, various restrictions on the foregoing investments.
As a member of the FHLB System, Community Bank must maintain minimum levels of
investments that are liquid assets as specified by the OTS. See "Regulation
- -Liquidity." Liquidity may increase or decrease depending upon the availability
of funds and comparative yields on investments in relation to the return on
loans. See "Regulation - Liquidity."
Historically, the Bank has maintained its liquid assets above the minimum
requirements imposed by federal regulations and at a level believed adequate to
meet requirements of normal daily activities, repayment of maturing debt and
potential deposit outflows. Cash flow projections are regularly reviewed and
updated to assure that adequate liquidity is provided. As of March 31, 1998, the
Bank's liquidity ratio (liquid assets as a percentage of net withdrawable
savings and current borrowings) was 7.7%. See "Regulation Federal Home Loan Bank
System."
24
<PAGE>
The contractual maturities and weighted average yields of the investment
securities portfolio, excluding FHLB of Atlanta stock and FHLMC common stock,
are indicated in the following table. At March 31, 1995, the Company did not
have any investment securities with contractual maturities in excess of five
years.
<TABLE>
<CAPTION>
March 31, 1998
--------------------------------------------------
Within 1 to 5 Total Investment
1 Year Years Securities
---------- ---------- -------------------------
Book Value Book Value Book Value Market Value
---------- ---------- ---------- ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Federal agency
obligations $ 500 $ 1,361 $ 1,861 $ 1,866
State agency
obligations and
commercial paper 323 1,000 1,323 1,355
------ ------- ------- -------
Total investment
securities $ 823 $ 2,361 $ 3,184 $ 3,221
====== ======= ======= =======
Weighted average
yield 5.67% 6.59% 6.35% 6.28%
=== === === ===
</TABLE>
25
<PAGE>
The following table sets forth the composition of the Company's investment
portfolio at the dates indicated.
<TABLE>
<CAPTION>
March 31,
----------------------------------------------
1998 1997 1996
----------------------------------------------
Book % of Book % of Book % of
Value Total Value Total Value Total
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing
deposits with
banks $2,866 100.0% $1,015 100.0% $1,147 100.0%
Total $2,866 100.0% $1,015 100.0% $1,147 100.0%
====== ===== ====== ===== ====== =====
Investment securities:
Federal agency
obligations $1,861 55.2% $4,876 55.2% $5,749 62.7%
Floating-rate notes
and commercial
paper 1,323 3.6 321 3.6 319 3.5
FHLMC common
stock 3,905 25.4 2,243 25.4 1,754 19.1
----- ----- ----- ----- ----- -----
Subtotal 7,089 84.2 7,440 84.2 7,822 85.3
FHLB stock 1,600 15.8 1,400 15.8 1,350 14.7
----- ----- ----- ----- ----- -----
Total investment
securities and
FHLB stock $8,689 100.0% $8,840 100.0% $9,172 100.0%
====== ===== ====== ===== ====== =====
Average remaining life
or term to repricing,
excluding FHLMC common
stock, FHLB stock and
other marketable equity
securities 3 years 2 years 2 years
</TABLE>
During fiscal 1998 the market rates paid on investment securities declined.
During fiscal 1998, the Company invested primarily in federal and state agency
securities with maturities of one to five years some of which are callable
within three months to two years from date of purchase.
26
<PAGE>
Sources of Funds
- ----------------
General. Deposit accounts have traditionally been the principal source of the
Company's funds for use in lending and for other general business purposes. In
addition to deposits, the Company derives funds from loan repayments, cash flows
generated from operations, which includes interest credited to deposit accounts,
repurchase agreements entered into with commercial banks and FHLB of Atlanta
advances.
Contractual loan payments are a relatively stable source of funds, while
deposit inflows and outflows and the related cost of such funds have varied
widely. Borrowings may be used on a short-term basis to compensate for
reductions in deposits or deposit inflows at less than projected levels and may
be used on a longer-term basis to support expanded lending activities.
Deposits. The Company attracts both short-term and long-term deposits from the
general public by offering a wide assortment of accounts and rates. The Company
has been required by market conditions to rely on short-term accounts and other
deposit alternatives that are more responsive to market interest rates than the
passbook accounts and fixed interest rate, fixed-term certificates that were the
Company's primary source of deposits in the past. The Company offers regular
passbook accounts, checking accounts, various money market accounts, fixed-rate
certificates with varying maturities, $100,000 or above jumbo certificates of
deposit and individual retirement accounts. Certain of the Company's jumbo
certificates which have matured revert to a passbook rate and are reflected in
the tables as passbook accounts. The Company does not solicit brokered deposits.
27
<PAGE>
The following table sets forth the dollar amount of savings deposits in the
various types of deposit programs offered by the Company at the periods
indicated.
<TABLE>
OPTION> At March 31,
----------------------------
1998 1997 1996
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Passbook and statement accounts $12,443 $ 12,578 $ 12,179
NOW and Super NOW accounts 21,080 15,576 13,583
Money market accounts 8,349 9,935 10,232
One- to five-year fixed-rate
certificates 91,996 73,817 66,649
Six-month money market certificates 3,232 4,059 6,403
Jumbo certificates 1,050 614 435
91-day certificates 14 16 21
-------- -------- --------
Total $138,164 $116,595 $109,502
======== ======== ========
</TABLE>
The following table sets forth the change in the dollar amount of savings
deposits in the various types of deposit programs offered by the Company for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------
1998 1997 1996
--------- --------- --------
(In Thousands)
<S> <C> <C> <C>
Passbook and statement accounts $ (135) $ 399 $ 9
NOW and Super NOW accounts 5,504 1,993 1,203
Money market accounts (1,586) (297) (1,388)
One-to five-year fixed-rate
certificates 18,179 7,168 4,630
Six-month money market certificates (827) (2,344) 108
Jumbo certificates 436 179 (65)
91-day certificates (2) (5) (9)
-------- ------- -------
Total increase $21,569 $ 7,093 $ 4,488
======== ======= =======
</TABLE>
28
<PAGE>
The following table contains information pertaining to the average amount of
and the average rate paid on each of the following deposit categories for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
-------------------------------------------------------
1998 1997 1996
----------------- ---------------- -----------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
------- ------- ------- ------- ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Deposit Category
- ----------------
Noninterest bearing
demand deposits $ 2,944 ---% $ 2,145 ---% $ 2,653 ---%
Interest bearing
demand deposits 23,715 2.96 21,412 3.03 20,486 3.05
Savings deposits 12,358 2.99 12,063 2.98 11,808 3.00
Time deposits 87,672 5.45 75,687 5.34 72,934 5.48
-------- ----- -------- ----- ------- ----
Total deposits $126,689 4.61 $111,307 4.54% $107,881 4.61%
======== ===== ======== ===== ======= ====
</TABLE>
The variety of deposit accounts offered by the Company has allowed it to be
competitive in obtaining funds and has allowed it to respond with flexibility
(by paying rates of interest more closely approximating market rates of
interest) to, although not eliminate the threat of, disintermediation (the flow
of funds away from depository institution such as thrift institutions into
direct investment vehicles such as government and corporate securities). In
addition, the Company has become much more subject to short-term fluctuations in
deposit flows, as customers have become more interest rate conscious. The
ability of the Company to attract and maintain deposits, and its cost of funds,
has been, and will continue to be, significantly affected by money market
conditions.
29
<PAGE>
The following table sets forth the deposit flows of the Company during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------
1998 1997 1996
--------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
Opening balance $116,595 $109,502 $105,014
Net deposits (withdrawals) 16,718 2,983 (248)
Interest credited 4,851 4,110 4,736
--------- -------- --------
Ending balance $138,164 $116,595 $109,502
--------- -------- --------
Net increase $ 21,569 $ 7,093 $ 4,488
--------- -------- --------
Percent increase 18.50% 6.47% 4.27%
====== ====== ======
</TABLE>
During the fiscal year ended March 31, 1998 the Company increased marketing
efforts and was more competitive in regard to rates which contributed to the
increase in deposits. The Company experienced an increase in both demand and
time deposits during fiscal March 31, 1998. To the extent that the Company may
rely on sources of funds other than deposits, the Company's earnings may be
adversely affected. The Company may use borrowings as an alternative source of
funds. See "- Borrowings."
30
<PAGE>
The following table shows rate information for the Company's certificates of
deposit as indicated.
<TABLE>
<CAPTION>
2.00- 3.00- 5.00- 6.01- 7.01- 8.01-
3.00% 5.00% 6.00% 7.00% 8.00% 9.00% Total
- ------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
March 31, 1998 $ 49 $ 5,729 $74,113 $16,402 $ --- $ --- $96,293
March 31, 1997 68 17,980 52,466 7,992 --- --- 78,506
March 31, 1996 159 15,948 40,512 16,572 317 --- 73,508
</TABLE>
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of March 31, 1998.
<TABLE>
<CAPTION>
Maturity
3 Months Over Over Over
or 3 to 6 6 to 12 12
less Months Months Months Total
-------- -------- --------- ------ ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit
less than $100,000 $21,506 $13,910 $26,689 $23,192 $85,298
Certificates of deposit
of $100,000 or more. 3,405 2,467 2,888 2,235 10,995
------- ------ ------- ------- -------
Total certificates
of deposit $24,911 $16,377 $29,577 $25,427 $96,293
======= ====== ======= ======= =======
</TABLE>
Borrowings
- ----------
As a member of the FHLB of Atlanta, the Company is required to own capital
stock in the FHLB of Atlanta and is authorized to apply for advances from the
FHLB of Atlanta. Each FHLB credit program has its own interest rate, which may
be fixed or variable, and range of maturities. The FHLB of Atlanta may prescribe
the acceptable uses to which these advances may be put, as well as limitations
on the size of the advances and repayment provisions. See Note 6 of the Notes to
Consolidated Financial Statements contained in Part II, Item 7 of this report
for information regarding the maturities and rate structure of the Company's
FHLB advances.
31
<PAGE>
The Company's borrowings, from time to time, also include securities sold
under agreements to repurchase, with mortgage-backed securities or other
securities pledged as collateral. The proceeds are utilized by the Company for
general corporate purposes. At March 31, 1998, the Company had no securities
sold under agreements to repurchase.
The Company generally utilizes borrowings to supplement deposits when they are
available at a lower overall cost to the Company or they can be invested at a
positive rate of return.
The following table sets forth the maximum month-end balance, and average
balance and weighted average rate, of FHLB advances for the periods indicated.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------------------
1998 1997 1996
-------------- ------------- --------------
(In Thousands)
<S> <C> <C> <C>
Maximum Balance:
FHLB $32,000 $28,000 $27,000
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
Average Balance:
FHLB advances $25,917 5.7% $26,542 5.6% $25,347 6.1%
</TABLE>
32
<PAGE>
The following table sets forth information as to the Company's borrowings and
the weighted average interest rate paid on such borrowings at the dates
indicated.
<TABLE>
<CAPTION>
At March 31,
-------------------------
1998 1997 1996
------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C>
FHLB advances $18,000 $26,000 $27,000
------- ------- -------
Total borrowings $18,000 $26,000 $27,000
======= ======= =======
Weighted average interest
rate of FHLB advances 5.77% 6.85% 5.88%
</TABLE>
Competition
- -----------
Community faces strong competition both in originating real estate loans and
in attracting deposits. Competition in originating real estate loans comes
primarily from other thrift institutions, commercial banks and mortgage bankers
who also make loans secured by real estate located in the Company's market area.
The Company competes for real estate loans principally on the basis of the
interest rates and loan fees it charges, the types of loans it originates and
the quality of services it provides to borrowers.
The Company faces substantial competition in attracting deposits from other
thrift institutions, commercial banks, money market and mutual funds, credit
unions and other investment vehicles. The ability of the Company to attract and
retain deposits depends on its ability to provide an investment opportunity that
satisfies the requirements of investors as to rate of return, liquidity, risk
and other factors. The Company competes for these deposits by offering a variety
of deposit accounts at competitive rates and convenient business hours.
The authority to offer money market deposits, and expanded lending and other
powers authorized for thrift institutions by federal legislation, have resulted
in increased competition for both deposits and loans between thrift institutions
and other financial institutions such as commercial banks.
The Company considers its primary market for savings to be Augusta County and
for mortgage loans to be Augusta and Rockingham Counties. At March 31, 1998,
there was one thrift institution and twelve commercial banks with
33
<PAGE>
offices in the Company's two-county primary market area. The Company estimates
that its market share of savings deposits in Augusta County is approximately 10%
and its share of mortgage loans in Augusta and Rockingham Counties is less than
10%. The opening of an office by the Bank in April, 1997 in Virginia Beach,
Virginia expanded the Bank's market area to the Hampton Roads area of Virginia
in the fiscal year March 31, 1998.
Regulation
- ----------
General. Community Bank is a federally chartered financial institution, the
deposits of which are federally insured and backed by the full faith and credit
of the United States Government. Accordingly, Community Bank is subject to broad
federal regulation and oversight extending to all its operations. The Bank is a
member of the FHLB of Atlanta and is subject to certain limited regulation by
the Board of Governors of the Federal Reserve System ("Federal Reserve Board").
As the savings and loan holding company of Community Bank, the Company also is
subject to federal regulation and oversight. The purpose of the regulation of
the Company and other holding companies is to protect subsidiary savings
associations. Community Bank is a member of the Savings Association Insurance
Fund ("SAIF") which together with the Bank Insurance Fund (the "BIF") are the
two deposit insurance funds administered by the FDIC, and the deposits of
Community Bank are insured by the FDIC. As a result, the FDIC has certain
regulatory and examination authority over the Bank.
Certain of these regulatory requirements and restrictions are discussed below
or elsewhere in this document.
Federal Regulation of Savings Associations. The OTS has extensive authority over
the operations of savings associations. As part of this authority, Community is
required to file periodic reports with the OTS and is subject to periodic
examinations by the OTS and the FDIC. When these examinations are conducted by
the OTS and the FDIC, the examiners may require the Company to provide for
higher general or specific loan loss reserves. The last regular OTS examination
of Community was in January, 1998 and the examiners did not require the Company
to provide for higher general or specific loan loss reserves.
All savings associations are subject to a semi-annual assessment, based upon
the savings association's total assets, to fund the operations of the OTS. The
Company's OTS assessment for the fiscal year ended March 31, 1998, was $50,815.
The OTS also has extensive enforcement authority over all savings institutions
and their holding companies, including Community Bank and the Company. This
enforcement authority includes, among other things, the ability to assess civil
money penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS. Except under certain
circumstances, public disclosure of final enforcement actions by the OTS is
required.
34
<PAGE>
In addition, the investment, lending and branching authority of the Bank is
prescribed by federal laws, and it is prohibited from engaging in any activities
not permitted by such laws. For instance, no savings institution may invest in
non-investment grade corporate debt securities. In addition, the permissible
level of investment by federal associations in loans secured by non-residential
real property may not exceed 400% of total capital, except with approval of the
OTS. Federal savings associations are also generally authorized to branch
nationwide. Community is in compliance with the noted restrictions.
The Company's general permissible lending limit for loans-to-one-borrower is
equal to the greater of $500,000 or 15% of unimpaired capital and surplus of the
Bank (except for loans fully secured by certain readily marketable collateral,
in which case this limit is increased to 25% of unimpaired capital and surplus).
At March 31, 1998, the Company's lending limit under this restriction was $3.4
million.
The OTS, as well as the other federal banking agencies, has adopted guidelines
establishing safety and soundness standards on such matters as loan underwriting
and documentation, asset quality, earnings standards, internal controls and
audit systems, interest rate risk exposure and compensation and other employee
benefits. Any institution which fails to comply with these standards must submit
a compliance plan. A failure to submit a plan or to comply with an approved plan
will subject the institution to further enforcement action. The OTS and other
federal banking agencies have also proposed additional guidelines on asset
quality and earnings standards. No assurance can be given as to whether or in
what form the proposed regulations will be adopted.
Insurance of Accounts and Regulation by the FDIC. Community Bank is a member of
the SAIF, which is administered by the FDIC. Deposits are insured up to
applicable limits by the FDIC and such insurance is backed by the full faith and
credit of the United States Government. As insurer, the FDIC imposes deposit
insurance premiums and is authorized to conduct examinations of and to require
reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured
institution from engaging in any activity the FDIC determines by regulation or
order to pose a serious risk to the SAIF or the BIF. The FDIC also has the
authority to initiate enforcement actions against savings associations, after
giving the OTS an opportunity to take such action, and may terminate the deposit
insurance if it determines that the institution has engaged in unsafe or unsound
practices, or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system, under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums, based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions will be made by the FDIC for each semi-annual
35
<PAGE>
assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual basis, if
it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.
As is the case with the SAIF, the FDIC is authorized to adjust the
insurance premium rates for banks that are insured by the BIF of the FDIC in
order to maintain the reserve ratio of the BIF at 1.25% of BIF insured deposits.
As a result of the BIF reaching its statutory reserve ratio the FDIC revised the
premium schedule for BIF insured institutions. The SAIF rates, however, were not
adjusted. At the time the FDIC revised the BIF premium schedule, it noted that,
absent legislative action (as discussed below),the SAIF would not attain its
designated reserve ratio until the year 2002. As a result, SAIF insured members
would continue to be generally subject to higher deposit insurance premiums than
BIF insured institutions until, all things being equal, the SAIF attained its
required reserve ratio.
In order to eliminate this disparity and any competitive disadvantage
between BIF and SAIF member institutions with respect to deposit insurance
premiums, legislation to recapitalize the SAIF was enacted in September 1996.
The legislation provided for a one-time assessment to be imposed on all deposits
assessed at the SAIF rates as of March 31, 1995, in order to recapitalize the
SAIF. It also provided for the merger of the BIF and the SAIF on January 1, 1999
if no savings associations then exist. The special assessment rate was
established at .657% of deposits (as of March 31, 1995) insured by the FDIC,
which resulted in an assessment of $670,765 being paid by the Bank in November
1996. This special assessment significantly increased noninterest expense and
adversely affected the Bank's and the Company's results of operations for the
year ended March 31, 1997. As a result of the special assessment, the Bank's
deposit insurance premiums was reduced to zero based upon its current risk
classification and the new assessment schedule for SAIF insured institutions.
These premiums are subject to change in future periods.
Prior to the enactment of the legislation, a portion of the SAIF
assessment imposed on savings associations was used to repay obligations issued
by a federally chartered corporation to provide financing ("FICO") for resolving
the thrift crisis in the 1980s. Although the FDIC has proposed that the SAIF
assessment be equalized with the BIF assessment schedule, effective October 1,
1996, SAIF-insured institutions will continue to be subject to a FICO assessment
as a result of this continuing obligation. Although the legislation also now
requires assessments to be made on BIF-assessable deposits for this purpose,
effective January 1, 1997, that assessment was limited to 20% of the rate
imposed on SAIF assessable deposits until the earlier of December 31, 1999 or
when no savings association continues to exist, thereby imposing a greater
burden on SAIF member institutions such as the Bank. Thereafter, however,
assessments on BIF-member institutions will be made on the same basis as
SAIF-member institutions. The rates established by the FDIC to implement this
requirement are a 6.48 basis points assessment on
36
<PAGE>
SAIF deposits and 1.3 basis points on BIF deposits until BIF insured
institutions participate fully in the assessment.
Regulatory Capital Requirements. Federally insured savings associations, such as
the Bank, are required to maintain a minimum level of regulatory capital. The
OTS has established capital standards, including a tangible capital requirement,
a leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis.
See Note 8 of the Notes to Consolidated Financial Statements contained in Part
II, Item 7 of this report for information on the Bank's regulatory capital
levels and applicable OTS requirements.
The OTS and the FDIC are authorized and, under certain circumstances required,
to take certain actions against savings associations that fail to meet their
capital requirements. The OTS is generally required to take action to restrict
the activities of an "undercapitalized association" (generally defined to be one
with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital
ratio or an 8% risk-based capital ratio). Any such association must submit a
capital restoration plan and until such plan is approved by the OTS may not
increase its assets, acquire another institution, establish a branch or engage
in any new activities, and generally may not make capital distributions. The OTS
is authorized to impose the additional restrictions that are applicable to
significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any company
controlling an undercapitalized association must agree that it will enter into a
limited capital maintenance guarantee with respect to the institution's
achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or is
"significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of its operations and include a forced
merger or acquisition of the association.
An association that becomes "critically undercapitalized" (i.e., a tangible
capital ratio of 2% or less) is subject to further mandatory restrictions on its
activities in addition to those applicable to significantly undercapitalized
associations. In addition, the OTS must appoint a receiver (or conservator with
the concurrence of the FDIC) for a savings association, with certain limited
exceptions, within 90 days after it becomes critically undercapitalized.
Any undercapitalized association is also subject to the general enforcement
authority of the OTS and the FDIC, including the appointment of a conservator or
a receiver.
The OTS is also generally authorized to reclassify an association into a lower
capital category and impose the restrictions applicable to such category
37
<PAGE>
if the institution is engaged in unsafe or unsound practices or is in an
unsafe or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the Company
may have a substantial adverse effect on the Company's operations and
profitability and the value of its Common Stock. Company shareholders do not
have preemptive rights, and therefore, if the Company is directed by the OTS or
the FDIC to issue additional shares of Common Stock, such issuance may result in
the dilution in the percentage of ownership of the Company by stockholders.
Limitations on Dividends and Other Capital Distributions. OTS regulations impose
various restrictions on savings associations with respect to their ability to
make distributions of capital, which include dividends, stock redemptions or
repurchases, cash-out mergers and other transactions charged to the capital
account. OTS regulations also prohibit a savings association from declaring or
paying any dividends or from repurchasing any of its stock if, as a result, the
regulatory capital of the association would be reduced below the amount required
to be maintained for the liquidation account established in connection with its
mutual to stock conversion.
Generally, savings associations, such as Community that before and after the
proposed distribution meet their capital requirements, may make capital
distributions during any calendar year equal to the greater of 100% of net
income for the year-to-date plus 50% of the amount by which the lesser of the
association's tangible, core or risk-based capital exceeds its capital
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of their net income for the most recent four quarter
period. However, an association deemed to be in need of more than normal
supervision by the OTS may have its dividend authority restricted by the OTS.
Community may pay dividends in accordance with this general authority.
Savings associations proposing to make any capital distribution need only
submit written notice to the OTS 30 days prior to such distribution. Savings
associations that do not, or would not meet their current minimum capital
requirements following a proposed capital distribution, however, must obtain OTS
approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period notice based on safety and soundness
concerns.
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings association may make a
capital distribution without notice to the OTS (unless it is a subsidiary of a
holding company) provided that it has a CAMEL 1 or 2 rating, is not of
supervisory concern and would remain adequately capitalized (as defined in the
OTS prompt corrective action regulations) following the proposed distribution.
Savings associations that would remain adequately capitalized following the
proposed distribution but do not meet the other noted requirements must notify
the OTS 30 days prior to declaring a capital distribution. The OTS stated it
will generally regard as permissible that amount of capital distributions that
do not exceed 50% of the institution's excess regulatory capital plus net income
to date during the calendar year. A savings association may not make a capital
distribution without prior approval of the OTS and the
38
<PAGE>
FDIC if it is undercapitalized before, or as a result of, such a distribution.
As under the current rule, the OTS may object to a capital distribution if it
would constitute an unsafe or unsound practice. No assurance may be given as to
whether or in what form the regulations may be adopted.
Liquidity. All savings associations, including Community, are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what the Company
includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources"
contained in Part II, Item 6 of this report.
Qualified Thrift Lender Test. All savings associations, including Community
Bank, are required to meet a qualified thrift lender ("QTL") test to avoid
certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. As an alternative, the savings association
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code. Under either test, such assets primarily consist
of residential housing related loans and investments. At March 31, 1998,
Community Bank met the test and has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. At March 31, 1998, Community Bank met the test and has always met the
test since its effectiveness. See "- Holding Company Regulation."
Community Reinvestment Act. Under the Community Reinvestment Act ("CRA"), every
FDIC insured institution has a continuing and affirmative obligation consistent
with safe and sound banking practices to help meet the credit needs of its
entire community, including low and moderate income neighborhoods. The CRA does
not establish specific lending requirements or programs for financial
institutions nor does it limit an institution's discretion to
39
<PAGE>
develop the types of products and services that it believes are best suited to
its particular community, consistent with the CRA. The CRA requires the OTS, in
connection with the examination of the Bank, to assess the institution's record
of meeting the credit needs of its community and to take such record into
account in its evaluation of certain applications, such as a merger or the
establishment of a branch, by the Bank. An unsatisfactory rating may be used as
the basis for the denial of an application by the OTS.
The federal banking agencies, including the OTS, have recently revised the CRA
regulations and the methodology for determining an institution's compliance with
the CRA. Due to the heightened attention being given to the CRA in the past few
years, the Bank may be required to devote additional funds for investment and
lending in its local community. The Bank was examined for CRA compliance in
October, 1996 and received a rating of "Satisfactory".
Transactions with Affiliates. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain of these transactions, such as loans to an affiliate, are
restricted to a percentage of the association's capital. Affiliates of Community
Bank include the Company and any company which is under common control with the
Bank. In addition, a savings association may not lend to any affiliate engaged
in activities not permissible for a bank holding company or acquire the
securities of most affiliates. The Bank's subsidiaries are not deemed
affiliates, however; the OTS has the discretion to treat subsidiaries of savings
associations as affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons are also
subject to conflict of interest regulations enforced by the OTS. These conflict
of interest regulations and other statutes also impose restrictions on loans to
such persons and their related interests. Among other things, such loans must be
made on terms substantially the same as for loans to unaffiliated individuals.
Holding Company Regulation. The Company is a unitary savings and loan holding
company subject to regulatory oversight by the OTS. As such, the Company is
required to register and file reports with the OTS and is subject to regulation
and examination by the OTS. In addition, the OTS has enforcement authority over
the Company and its non-savings association subsidiaries which also permits the
OTS to restrict or prohibit activities that are determined to be a serious risk
to the subsidiary savings association.
As a unitary savings and loan holding company, the Company generally is not
subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company, and the activities of the Company and any of its
subsidiaries (other than the Bank or any other SAIF-insured savings association)
would become subject to such restrictions unless such other associations each
qualify as a QTL and were acquired in a supervisory acquisition.
If the Bank fails the QTL test, the Company must obtain the approval
40
<PAGE>
of the OTS prior to continuing after such failure, directly or through its other
subsidiaries, any business activity other than those approved for multiple
savings and loan holding companies or their subsidiaries. In addition, within
one year of such failure the Company must register as, and will become subject
to, the restrictions applicable to bank holding companies. The activities
authorized for a bank holding company are more limited than are the activities
authorized for a unitary or multiple savings and loan holding company. See
"--Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control of any
other SAIF-insured association. Such acquisitions are generally prohibited if
they result in a multiple savings and loan holding company controlling savings
associations in more than one state. However, such interstate acquisitions are
permitted based on specific state authorization or in a supervisory acquisition
of a failing savings association.
Federal Securities Law. The stock of the Company is registered with the SEC
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
Federal and State Taxation
- --------------------------
Federal Taxation. Savings associations such as the Bank that meet certain
definitional tests relating to the composition of assets and other conditions
prescribed by the Internal Revenue Code of 1986, as amended (the "Code"), had
been permitted to establish reserves for bad debts and to make annual additions
thereto which could, within specified formula limits, be taken as a deduction in
computing taxable income for federal income tax purposes. The amount of the bad
debt reserve deduction for "non-qualifying loans" was computed under the
experience method. The amount of the bad debt reserve deduction for "qualifying
real property loans" (generally loans secured by improved real estate) could be
computed under either the experience method or the percentage of taxable income
method (based on an annual election).
Under the experience method, the bad debt reserve deduction was an amount
determined under a formula based generally upon the bad debts actually sustained
by the savings association over a period of years.
The percentage of specially computed taxable income that was used to compute a
savings association's bad debt reserve deduction under the percentage of taxable
income method (the "percentage bad debt
41
<PAGE>
deduction") was 8%. The percentage bad debt deduction thus computed was reduced
by the amount permitted as a deduction for non-qualifying loans under the
experience method. The availability of the percentage of taxable income method
permitted qualifying savings associations to be taxed at a lower effective
federal income tax rate than that applicable to corporations generally
(approximately 31.3% assuming the maximum percentage bad debt deduction).
Under the percentage of taxable income method, the percentage bad debt
deduction cannot exceed the amount necessary to increase the balance in the
reserve for "qualifying real property loans" to an amount equal to 6% of such
loans outstanding at the end of the taxable year or the greater of (i) the
amount deductible under the experience method or (ii) the amount which when
added to the bad debt deduction for "non-qualifying loans" equals the amount by
which 12% of the amount comprising savings accounts at year-end exceeds the sum
of surplus, undivided profits and reserves at the beginning of the year.
In August 1996, legislation was enacted that repealed the above-described
reserve method of accounting (including the percentage of taxable income method)
used by many thrift institutions to calculate their bad debt reserve for federal
income tax purposes. Thrift institutions with $500 million or less in assets
may, however, continue to use the experience method. As a result, the Bank must
recapture that portion of the reserve that exceeds the amount that could have
been taken under the experience method for post- 1987 tax years. At March 31,
1998, the Bank's post-1987 excess reserves amounted to approximately $1,267,000.
The recapture will occur over a six-year period, commencing with the fiscal year
ending March 31, 1999, provided the institution meets certain residential
lending requirements. The legislation also requires thrift institutions to
account for bad debts for federal income tax purposes on the same basis as
commercial banks for tax years beginning after December 31, 1995.
In addition to the regular income tax, corporations, including savings
associations such as the Bank, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the association's supplemental reserves
for losses on loans ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of March 31, 1998, the Bank's Excess for tax purposes totaled
approximately $2.9 million.
42
<PAGE>
The Company and the Bank file consolidated federal income tax returns on a
calendar year basis. Savings associations, such as the Bank, that file federal
income tax returns as part of a consolidated group are required by applicable
Treasury regulations to reduce their taxable income for purposes of computing
the percentage bad debt deduction for losses attributable to activities of the
non-savings association members of the consolidated group that are functionally
related to the activities of the savings association member.
The federal income tax returns of the Company and its consolidated subsidiary
for the last three years are open to possible audit by the Internal Revenue
Service (the "IRS"). No returns are being audited by the IRS at the current
time. In the opinion of management, any examination of still open returns
(including returns of subsidiaries and predecessors of, or entities merged into,
Community Bank) would not result in a deficiency which could have a material
adverse effect on the financial condition of Community Federal and its
consolidated subsidiaries.
Virginia Taxation. Community conducts its business in Virginia and
consequently is subject to the Virginia corporate income tax. The Commonwealth
of Virginia imposes a corporate income tax on a basis similar to federal income
tax at a rate of 6% on Virginia taxable income.
Executive Officers
- ------------------
The following information as to the business experience during the past five
years is supplied with respect to executive officers of the Company. Except as
otherwise indicated, the persons named have served as officers of Community
since it became the holding company of the Bank, and all offices and positions
described below are also with the Bank. There are no arrangements or
understandings between the persons named and any other person pursuant to which
such officers were selected.
Thomas W. Winfree. Mr. Winfree, age 53, is the Company's President and Chief
Executive Officer. He was elected in October 1995. Prior to joining the Company,
Mr. Winfree was President and Chief Executive Officer of Jefferson Savings and
Loan in Warrenton, Virginia.
R. Jerry Giles. Mr. Giles, age 49, is the Company's Chief Financial Officer.
He was elected in April 1994. Prior to joining the Company, Mr. Giles was a
Certified Public Accountant in public accounting and the Chief Financial Officer
with a savings bank for eleven years.
Shirley V. Lovegrove. Ms. Lovegrove, age 59, is the Company's Vice President,
Operations and Savings, a position she has held since 1985. Ms. Lovegrove has
been employed by the Company since 1974 and was previously an Assistant Vice
President of the Company.
Angel Negron, Jr. Mr. Negron, age 51, is the Company's Vice President and
Chief Lending Officer, a position he has held since February, 1996.
43
<PAGE>
Prior to his employment by the Company, Mr. Negron was a commercial loan officer
with a commercial bank for 21 years.
Paul K. Martin. Mr. Martin, age 34, is the Company's Vice President of
Administration, a position he has held since March 31, 1997, and was Assistant
Vice-President and Branch Manager of the Company and of the Bank from October
1991 to March, 1996.
Sarah A. Ralston. Ms. Ralston, age 64, has been the Company's Secretary and
Treasurer for the past 17 years. Ms. Ralston has been employed by the Company in
various capacities since 1956.
Patsy Clem. Ms. Clem, age 58, is the Company's Controller, a position she has
held since July, 1986. Ms. Clem has been employed by the Company since 1983 in
the Accounting Department.
P. Douglas Richard. Mr. Richard, age 53, is the Company's Vice President and
Regional President, a position he has held since January, 1997. Prior to joining
the Company Mr. Richard was Chief Executive Officer of Seaboard Savings Bank in
Virginia Beach, Virginia.
Chris P. Kyriakides. Mr. Kyriakides, age 35, is the Company's Vice President
and Regional Executive Vice President, a position he has held since January,
1997. Prior to joining the Company Mr. Kyriakides was Chief Operations Officer
of Seaboard Savings Bank in Virginia Beach, Virginia.
Employees
- ---------
At March 31, 1998, the Company had a total of 57 employees, including eight
hourly employees. None of the Company's employees are represented by any
collective bargaining group. Management considers its employee relations to be
good.
Item 2. Description of Property
- ---------------------------------
The following table sets forth information at March 31, 1998, with respect to
the Company's offices, furniture and equipment.
Owned
or Gross Net Book
Leased Square Value at
Location Opened Expiration Footage March 31, 1998
- ----------------------------------------------------------------------------
38 North Central Avenue 1956 Owned 17,000 $2,196,000
Staunton, Virginia
Rte. 250 West 1989 Owned 5,300 986,000
Waynesboro, Virginia
Routes 340 and 608 1993 Owned 2,074 372,000
44
<PAGE>
Stuart's Draft, Virginia
5300 Kemps River Drive 1997 2002 2,400 88,000
Virginia Beach, Virginia
Community First Mortgage
9011 Arboretum Parkway
Richmond, Virginia 1997 1998 1,800 10,000
The Company's accounting and record-keeping activities are maintained on an
on-line basis with an independent service bureau. The net book value of the
Company's computer equipment at March 31, 1998 was $169,347.
Item 3. Legal Proceedings
- ---------------------------
There are no material pending legal proceedings to which the Company or its
subsidiary is a party or to which any of its property is subject.
Item 4. Submission of Matters to a Vote of Security Holders
- -------------------------------------------------------------
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended March 31, 1998.
PART II
Item 5. Market for Common Equity and Related Security
Holder Matters
- -------------------------------------------------------
As of May 29, 1998, there were approximately 585 holders of record of
Community Common Stock. Community's stock is quoted on the Nasdaq Stock Market
under the symbol "CFFC."
The following tables present the Corporation's high and low, bid and ask
prices as reported by the Nasdaq Stock Market during the last two fiscal years
and the dividends declared by the Corporation for the stated periods. This
information reflects interdealer prices, without retail mark-up, markdown or
commissions and may not represent actual transactions.
<TABLE>
<CAPTION>
Bid Ask
---------------- ----------------
1998 High Low High Low Dividends Declared
- -------------- ------ ------ ------ ------ -----------------
<S> <C> <C> <C> <C> <C>
1st Quarter $10.75 $10.75 $11.75 $11.63 $.070
2nd Quarter 10.75 10.75 11.75 11.50 .070
3rd Quarter 13.75 10.75 14.25 11.69 .070
4th Quarter 15.25 14.50 16.50 15.50 .070
45
<PAGE>
Bid Ask
---------------- ----------------
1997 High Low High Low Dividends Declared
- -------------- ------ ------ ------ ------ -----------------
<S> <C> <C> <C> <C> <C>
1st Quarter $ 9.56 $ 9.50 $10.50 $10.50 $.065
2nd Quarter 10.25 9.50 11.25 10.50 .065
3rd Quarter 10.25 10.25 11.25 11.25 .065
4th Quarter 11.25 10.25 11.75 11.13 .070
</TABLE>
Dividend payment decisions are made with consideration of a variety of
factors, including earnings, financial condition, market considerations and
regulatory restrictions. The ability of the Corporation to pay dividends is
limited by restrictions imposed by the Virginia Stock Corporation Act, and
indirectly, by the OTS. In general, dividends paid by Virginia corporations may
be paid only if, after giving effect to the distribution the corporation is
still able to pay its debts as they become due in the usual course of business,
or the corporation's total assets are greater than or equal to the sum of its
total liabilities plus the amount that would be needed (if the corporation were
to be dissolved at the time of the distribution) to satisfy the preferential
rights, upon the dissolution, of stockholders whose preferential rights are
superior to those receiving the distribution. Restrictions on dividend payments
from the Bank to the Corporation (the Corporation's primary source of funds for
the payment of dividends to its stockholders) are described in Note 8 of the
Notes to Consolidated Financial Statements contained in Part II, Item 7 of this
report.
Item 6. Management's Discussion and Analysis or Plan of Operation
- -----------------------------------------------------------------
Community Financial Corporation ("Community" or the "Corporation") is a
Virginia corporation. Certain of the information presented herein relates to
Community Bank (the "Bank"), a wholly owned subsidiary of the Corporation and
Community First Mortgage Corporation, a wholly owned subsidiary of the Bank.
46
<PAGE>
The Corporation and the Bank, like all thrift institutions and their
holding companies, are subject to comprehensive regulation, examination and
supervision by the Office of Thrift Supervision, Department of the Treasury
("OTS") and the Federal Deposit Insurance Corporation ("FDIC").
The Corporation's net income is primarily dependent on the difference
or spread between the average yield earned on loans and investments and the
average rate paid on deposits and borrowings, as well as the relative amounts of
such assets and liabilities. The interest rate spread is affected by regulatory,
economic, and competitive factors that influence interest rates, loan demand and
deposit flows. The Corporation, like other financial institutions, is subject to
interest rate risk to the degree that its interest-bearing liabilities,
primarily deposits and borrowings with short-and medium-term maturities, mature
or reprice more rapidly, or on a different basis, than its interest-earning
assets, primarily loans with longer term maturities than deposits and
borrowings. While having liabilities that mature or reprice more frequently on
average than assets may be beneficial in times of declining interest rates, such
an asset/liability structure may result in lower net income or net losses during
periods of rising interest rates, unless offset by other non-interest income.
The Corporation's net income is also affected by, among other things, gains on
sale of loans, mortgage-backed securities and investment securities, fee income,
provision for loan and real estate losses, operating expenses and income taxes.
Forward Looking Statement
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 Corporation's market area, and
competition, that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. The
Corporation wishes to caution readers not to place undue reliance on any such
forward-looking statements which speak only as of the date made. The Corporation
wishes to advise readers that the factors listed above could affect the
Corporation's financial performance and could cause the Corporation's actual
results for future periods to differ materially from any opinions of statements
expressed with respect to future periods in any current statements.
The Corporation does not undertake, and specfically 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.
Asset/Liability Management
Management of Community believes it is critical to manage the
relationship between interest rates and the effect on the Corporation's net
portfolio value ("NPV"). This approach calculates the difference between the
present value of expected cash flows from assets and the present value of
expected cash flows from liabilities, as well as cash flows from off-balance
sheet contracts. Management of the Corporation's assets and liabilities is done
within the context of the marketplace, but also within limits established by the
Board of Directors on the amount of change in NPV which is acceptable given
certain interest rate changes.
Presented in the following table, as of March 31, 1998 and 1997, is an
analysis of the Bank's interest rate risk as measured by changes in NPV for
instantaneous and sustained parallel shifts in the yield curve, in 100 basis
point increments, up and down 300 basis points and compared to Board policy
limits and in accordance with OTS regulations, based on the assumptions
described below. The Board limits have been established with consideration of
the dollar impact of various rate changes and the Corporation's strong capital
position. As illustrated in the table, NPV is more sensitive to rising rates
than declining rates. This occurs principally because, as rates rise, the market
value of fixed-rate loans decline due to both the rate increase and slowing
prepayments. When rates decline, the Corpora-tion does not experience a
significant rise in market value for these loans because borrowers prepay at
relatively high rates. The value of the Corporation's deposits and borrowings
change in approximately the same proportion in rising or falling rate scenarios.
47
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
March 31, 1998 March 31, 1997
-------------------- ------------------
Change in
Interest Rate Board Limit $ Change % Change $ Change % Change
(Basis Points) % Change in NPV in NPV in NPV in Npv
-------------- -------- ------ ------ ------ ------
(Dollars in Thousands)
+300 -25% $-1,296 -4% $-4,294 -15%
+200 -15 -251 -1 -2,301 -8
+100 -10 217 1 -833 -3
-0- -- -- -- -- --
-100 -10 -506 -2 198 +1
-200 -15 -825 -3 74 0
-300 -25 -773 -3 280 +1
Management continually works to maintain a neutral position regarding
interest rate risk. In the current interest rate environment, Community
customers are interested in obtaining long term credit products and short term
savings products. Management has taken action to counter this trend. A
significant effort has been made to reduce the duration and average life of the
Corporation's interest earnings assets. As of March 31, 1998, approximately 75%
of the Corporation's gross loan portfolio consisted of loans which reprice
during the life of the loan. The Corporation emphasizes adjustable rate mortgage
loans and has increased its portfolio of short term consumer loans. Longer term
fixed-rate mortgage loans, 20 to 30 years, are generally sol in the secondary
market. The Corporaiton is currently originating fixed-rate loans for immediate
sale only.
On the deposit side, management has worked to reduce the impact of
interest rate changes by emphasizing non-interest bearing or low interest
deposit products and maintaining competitive pricing on longer term
certificates of deposit. The Corporation has also used Federal Home Loan Bank
advances to provide funding for loan originations and provide liqudity.
As with any method of measuring interest rate risk, certain
short-comings are inherent in the method of analysis presented in the foregoing
table. For example, although certain assets and liabilities may have similar
maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain asssets, such as ARM loans, have features which
restrict changes in interest rates on a short-term basis and over the life of
the asset. Further, in the event of a change in interest rates, expected rates
of prepayments on loans and early withdrawals from certificates could likely
deviate significantly from those assumed in calculating the table.
48
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Average Balances, Interest Rates and Yields
The following table sets forth certain information relating to categories of the
Corporation's interest-earning assets and its interest-bearing liabilities for
the periods indicated. All average balances are computed on a monthly basis.
Non-accruing loans have been included in the table as loans carrying a zero
yield.
<TABLE>
<CAPTION>
Year Ended March 31,
----------------------------------------------------------------------------------------------
1998 1997 1996
---------------------------- ----------------------------- -----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in Thousands)
Interest-Earning Assets
- -----------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans .......................... $158,057 $ 13,344 8.44% $144,409 $ 12,189 8.44% $138,127 $ 11,816 8.55%
Investment securities
and other investments .......... 11,665 605 5.18 10,700 589 5.51 9,254 571 6.17
-------- -------- ------- -------- ------- --------
Total interest-earning
assets ......................... 169,722 13,949 8.22 155,109 12,778 8.24 147,381 12,387 8.41
-------- -------- ------- -------- ------- -------
Interest-Bearing Liabilities
- ----------------------------
Deposits ....................... 126,689 5,845 4.61 111,307 5,055 4.54 105,093 4,977 4.74
FHLB advances and
other borrowings ............... 25,572 1,471 5.75 26,321 1,481 5.63 25,349 1,538 6.07
------- ------- ------- -------- ------- ------
Total interest-
bearing liabilities ............ 152,261 7,316 4.80 137,628 6,536 4.75 130,442 6,515 4.99
------- ------- ------- -------- ------- ------
Net interest income/
interest rate spread ........... $ 6,633 3.42 $ 6,242 3.49 $ 5,872 3.42
======= ======== ========
Net interest-earning
assets/net yield on
interest-earning assets ........ $ 17,461 3.80 $ 17,481 3.57 $ 16,939 3.47
======= ======== ========
Percentage of interest
earning assets to interest-
bearing liabilities ............ 111.47% 112.70% 112.99%
</TABLE>
49
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Interest rate spread
The following table sets forth the Corporation's interest rate spread at the
dates indicated.
March 31,
---------------------------
1998 1997 1996
---- ---- ----
Yield On
- --------
Loans .......................................... 8.29% 8.15% 8.32%
Investment securities and other investments .... 4.49% 6.08% 5.60%
Total interest-earning assets ............... 8.04% 8.03% 8.14%
Cost Of
- -------
Deposits ....................................... 4.60% 4.54% 4.62%
FHLB of Atlanta advances and other borrowings .. 5.77% 6.85% 5.88%
Total interest-bearing liabilities .......... 4.74% 4.96% 4.87%
Interest rate spread ........................... 3.30% 3.07% 3.27%
Rate/Volume Analysis
The following table describes the extent to which changes in interest rates and
changes in volume of interest-related assets and liabilities have affected
Community's interest income and expense during the periods indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (change
in volume multiplied by prior year rate), (ii) changes in rate (change in rate
multiplied by prior year volume), and (iii) total changes in rate and volume.
The combined effect of changes in both volume and rate, which cannot be
separately identified, has been allocated proportionately to the change due to
volume and the change due to rate.
<TABLE>
<CAPTION>
Year Ended March 31,
---------------------------------------------------------------
1998 v. 1997 1997 v. 1996
------------------------------ ------------------------------
Increase Increase
(Decrease) (Decrease)
Due to Total Due to Total
----------------- Increase ---------------- Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------- ----- ---------- ------- ---- ----------
(Dollars in Thousands)
Interest-Earning Assets
<S> <C> <C> <C> <C> <C> <C>
Loans ............................... $ 1,155 -- $ 1,155 $ 532 $ (159) $ 373
Investment securities
and other investments ............... 55 (39) 16 83 (65) 18
------- ------- ------- ------- ------- -------
Total interest-earnings assets ... $ 1,210 (39) $ 1,171 $ 615 $ (224) 391
======= ======= ------- ======= ======= -------
Interest-Bearing Liabilities
Deposits ............................ $ 701 $ 89 $ 790 $ 298 $ (220) $ 78
FHLB advances and other borrowings .. (41) 31 (10) 59 (116) (57)
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities $ 660 $ 120 780 $ 357 $ (336) 21
======= ======= ------- ======= ======= -------
Net interest income ................. $ 391 $ 370
======= =======
</TABLE>
50
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Asset Quality
Asset quality is an important factor in the successful operation of a
financial institution. The loss of interest income and principal that may result
from non-performing assets has an adverse effect on earnings, while the
resolution of those assets requires the use of capital and managerial resources.
The Corporation maintains strict underwriting guidelines, loan quality
monitoring policies and systems that require detailed monthly and quarterly
analyses of delinquencies and non-performing assets.
At March 31, 1998, the Corporation's total non-performing assets were
$938,000 or .51% of total assets compared to $676,000 or .40% at March 31, 1997.
Non-performing assets at March 31, 1998 were comprised of three single family
residential properties, a combination single family house and farm which were
more than ninety-days past due, real estate acquired through foreclosure of
three single family dwellings, two rental properties of three and two units
respectively, and a five acre lot. Based on current market values of the
collateral securing these loans, management anticipates no significant losses in
excess of the reserves for losses previously recorded. Due to an uncertain real
estate market and the economy in general no assurances can be given that the
Corporation's level of non-performing assets may not increase in the future.
The Corporation maintains an allowance for loan losses provide for
estimated potential losses in its loan portfolio. Management determines the
level of reserves based on loan performance, the value of the collateral,
economic and market conditions, and previous experience. Management reviews the
adequacy of the allowance at least quarterly, utilizing its internal loan
classifications systems. During fiscal 1998, the Corporation increased its
allowance for losses on loans $78,000 to $1,117,000, due to the Corporation's
increased loan volume, especially in commercial real estate, construction and
consumer loans. See "Asset/Liability Management." Management believes that the
loan loss reserve is adequate. The Corporation has had net charge-offs to its
loan loss reserve of $421,000, $142,000, and $70,000, for the years ended March
31, 1998, 1997 and 1996, respectively. The increase in net charge-offs is
related primarily to one commercial loan. Although management believes it uses
the best information available, future adjustments to reserves may be necessary.
See "Results of Operations - Comparison of Years Ended March 31, 1998 and 1997 -
Provision for Loan Losses."
Financial Condition
The Corporation's total assets increased $16.2 million to $183.9
million at March 31, 1998 primarily as a result of loans receivable which
increased $13.6 million. The increase in loans receivable was funded by an
increase in deposits of $21.6 million. The increase in deposits can be
attributed to both an increase in time deposits of $17.8 million and an increase
in checking accounts of $5.4 million. Management believes the increase in time
deposits is primarily attributable to a special time deposit promotion and the
increase in checking assounts is related to an increased marketing effort. The
increase in loans receivable was due to the origination of commercial and
construction real estate and more competitive pricing on consumer loans.
The Corporaiton's principal use of funds is to originate loans. The
principal source of funds for loan disbursements is loan principal repayments,
net growth in deposits and borrowings. In fiscal 1998 net loans increased by
$13.6 million. While borrowing for fiscal 1998 decreased by $8.0 million, the
increase in the loan portfolio was funded through increased deposits of $21.6
million.
Stockholders' equity increased $2.2 million to $25.5 million at March
31, 1998 compared to March 31, 1997. The increase was the result of $1.8
million of net income in fiscal 1998 and net unrealized gains of $1.0 million on
available for sale securities, partially offset by dividends paid to
stockholders of $715,000.
Results of Operations
The Corporation's results of operations depend primarily on the level
of its net interest income and noninterest income and the level of its operating
expenses. Net interest income depends upon the value of interest-earning assets
and interest-bearing liabilities and the interest rate earned or paid on them.
<PAGE>
Comparsion of Year Ended March 31, 1998 and 1997
General. Net income for the year ended March 31, 1998 was $1,805,483 or
$.70 per share compared to $1,734,734 or $.68 per share for the year ended March
31, 1997. Net income increased due primarily to the increase in net interest
income of $390,926 during the year ended March 31, 1998.
Interest Income. Total interest income increased to $13,949,307 for the
year ended March 31, 1998 as compared to $12,777,987 for the year ended March
31, 1997. The increase in total interest income can be attributed to an increase
in the dollar volume of interest earning assets, primarily $13.6 million in
dollar volume of interest earning assets, primarily $13.6 million in mortgage
and consumer loans, which was offset by a decrease in the yield on interest
earning assets. Average yields on total interest-earning assets remained
relatively constant at 8.22% in fiscal 1998.
51
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Interest Expense. Total interest expense increased to $7,316,025 for
the year ended March 31, 1998, from $6,535,631 for the year ended March 31,
1997. While the cost of funds increased from 4.75% for the year ended March 31,
1997 to 4.80% for fiscal 1998, the increase in interest expense is attributable
primarily to an increase in the average balance of deposits during fiscal year
1998. The increase in deposit balances was due to increases in both certificates
of deposit and checking accounts for the current fiscal year.
Provision for Loan Losses. The provision increased to $498,764 for the
fiscal year ended March 31, 1998, from $180,561 for the fiscal year ended March
31, 1997. The Corporation monitors its loan loss reserve on a quarterly basis
and makes allocations as necessary. Management believes that the level of its
loan loss reserve is adequate. As of March 31, 1998, the total allowance for
loan losses amounted to $1,117,131 of which $1,080,000 was not specifically
allocated to identified problem loans. At March 31, 1998, the Corporation's
total allowance as a percentage of total loans receivable was .68% and as a
percentage of total non-performing loans was 119%. See "Asset Quality."
Noninterest Income. Noninterest income increased to $766,590 in fiscal
1998 as compared to $518,742 for the year ended March 31, 1997, primarily due to
an increase in the number of checking accounts and the related charges. The
Corporation increased marketing in regard to its checking account products and
increased its checking account base by approximately 1,400 accounts during the
year ended March 31, 1998.
Noninterest Expense. Total noninterest expense increased to $4,016,955
during the year ended March 31, 1998 from $3,805,739 for the year ended March
31, 1997 due primarily to the opening of a branch in Virginia Beach, Virginia in
April of 1997 and the organization of a mortgage banking subsidiary in November
of 1997. The increase in noninterest expense in the fiscal year 1998 was
significant, particularly in view of a special one-time assessment by the FDIC
of $671,000 in fiscal 1997.
The Corporation is conducting a formal review of its systems and system
providers, due to concerns regarding possible consequences that the year 2000
may pose to computer and other operating systems utilized in its business
activities. While a preliminary review has resulted in the identification of
certain issues which require resolution, management believes that appropriate
plans are in place to resolve these issues in a timely manner. Management does
not believe the resolution of these issues will significantly impair the
Corporation's ability to provide necessary services to our customers, nor are
the costs involved in this program expected to have a material impact on the
Corporations earnings or financial condition.
Taxes. Total taxes increased to $1,078,670 during the year ended March
31, 1998 from $1,040,064 during fiscal 1997. The effective tax rate for the year
ended March 31, 1998 was 37.4% as compared to 37.5% for the year ended March 31,
1997. The increase in taxes is attributable to an increase in income before
income taxes.
Comparison of Years Ended March 31, 1997 and 1996
General. Net income for the year ended March 31, 1997 was $1,734,735 or
$.68 per share compared to $2,011,538 or $.80 per share for the year March 31,
1996. Net income decreased due to a special one-time assessment by the FDIC of
$671,000 which had a tax affected effect of approximately $416,000. Net income
for the year ended March 31, 1997, excluding the special assessment, would have
been approximately $2,150,000 or $.85 per share.
Interest Income. Total interest income increased to $12,777,987 for the
year ended March 31, 1997 as compared to $12,387,722 for the year ended March
31, 1996. The increase in total interest income can be attributed to an increase
in the dollar volume of interest-earning assets, primarily $7.2 million in
mortgage and consumer loans which was offset by a decrease in the yield on
interest earning assets. Average yields on total interest-earning assets
decreased from 8.41% in fiscal 1996 to 8.24% for the 1997 fiscal year due
primarily to a more competitive and lower rate environment.
Interest Expense. Total interest expense increased to $6,535,631 for
the year ended March 31, 1997, from $6,515,234 for the year ended March 31,
1996. The increase in total interest expense was attributable to an increase in
the average balances of interest-bearing liabilities, primarily $7.1 million in
deposits, which was offset by a decrease in the cost of funds. The cost of funds
for the 1997 fiscal year decreased to 4.75% as compared to 4.99% for the year
ended March 31, 1996 due to a lower interest rate environment and maintaining
shorter maturities on borrowings.
Provision for Loan Losses. The provision decreased to $180,561 for the
fiscal year ended March 31, 1997 from $307,361 for the fiscal year ended March
31, 1996. The Corporation monitors its loan loss reserve on a quarterly basis
and makes allocations as necessary. Management believes that the level of its
loan loss reserve is adequate. As of March 31, 1997, the total allowance for
loan losses amounted to $1,039,013 of which $783,700 was not specifically
allocated to
52
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
identified problem loans. At March 31, 1997, the Corporation's total allowance
as a percentage of total loans receivable was .69% and as a percentage of total
non-performing loans was 154%. See "Asset Quality."
Noninterest Income. Noninterest income increased to $518,742 in fiscal
1997 as compared to $455,706 for the year ended March 31, 1996, primarily due to
an increase in the number of checking accounts and the related charges. The
Corporation increased marketing in regard to a package of checking account
products which was initiated in fiscal 1993 and increased its checking account
base by approximately 1,000 accounts during the year ended March 31, 1997.
Noninterest Expense. Total noninterest expense increased to $3,805,739
during the year ended March 31, 1997 from $2,808,924 for the year March 31, 1996
due primarily to the special one-time assessment by the FDIC. The increase in
noninterest expenses other than the special one-time assessment relates to
preparation for the opening of a branch in Virginia Beach, Virginia in April,
1997 and the general growth of the Corporation.
Taxes. Total taxes decreased to $1,040,064 during the year ended March
31, 1997 from $1,200,371 during fiscal 1996. The effective tax rate for the year
ended March 31, 1997 was 37.5% as compared to 37.4% for the year ended March 31,
1996. The decrease in taxes is attributable to a decrease in income before
income taxes.
Liquidity and Capital Resources
The Corporation's principal sources of funds are customer deposits,
advances from the FHLB of Atlanta, amortization and prepayment of loans,
proceeds from the sale of loans and funds provided from operations. Management
of the Corporation maintains investments in liquid assets based upon its
assessment of (i) the Corporation's need for funds, (ii) expected deposit flows,
(iii) the yields available on short-term liquid assets, (iv) the liquidity of
the Corporation's loan portfolio and (v) the objectives of the Corporation's
asset/liability management program.
Liquidity represents the ability of the Corporation to meet its
on-going funding requirements for contractual obligations, the credit needs of
customers, withdrawal of customers' deposits and operating expenses. Savings
associations are required to maintain minimum levels of liquid assets. OTS
regulations currently require the Bank to maintain an average daily balance of
liquid assets equal to at least 4% of the sum of its average daily balance of
net withdrawable deposit accounts and borrowings payable in one year or less. At
March 31, 1998, the Bank's liquid asset ratio was 7.7%.
The Corporation's dominant source of funds during the year ended March
31, 1998 was from deposits which increased by $21.6 million, due primarily to an
increase in time deposits of $17.8 million and a $3.7 million increase in demand
deposits. FHLB advances decreased from March 31, 1997 by $8.0 million.
Management believes this shift in deposit categories is attributable primarily
to a time deposit promotion during the fiscal year which offered a rate of
interest greater than the prevailing market and the increase in demand deposits
was due to increased marketing of the Corporation's free checking account.
The Corporation's cash increased $2.4 million from $4.9 million at
March 31, 1997 to $7.3 million at March 31, 1998. The increase in cash was
related to the increase in deposits and a decrease in securities held to
maturity of $2.0 million.
At March 31, 1998, the Corporation had commitments to purchase or
originate $8.3 million of loans. Certificates of deposit scheduled to mature in
one year or less at March 31, 1998, totaled $70.9 million. Based on its
historical experience, management believes that a significant portion of such
deposits will remain with the Corporation. Management further believes that loan
repayments and other sources of funds will be adequate to meet the Corporation's
foreseeable short- and long-term liquidity needs.
At March 31, 1998, the Bank was in compliance with all of its
regulatory capital requirements.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented herein
have been prepared in accordance with generally accepted accounting principles
which require the measurement of financial position and results of operations in
terms of historical dollars without considering changes in the relative
purchasing power of money over time because of inflation. Unlike most industrial
companies, virtually all of the assets and liabilities of a financial
institution are monetary in nature. As a result, interest rates have a more
significant impact on a financial institution's performance than the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or the same magnitude as the price of goods and services. In the
current interest-rate environment, equity, maturity structure and quality of the
Corporation's assets and liabilities are critical to the maintenance of
acceptable performance levels.
<PAGE>
Accounting Pronouncements
For a discussion of certain accounting pronouncements implemented by
the Corporation during fiscal 1998 and new pronouncements which will be
implemented in the future, see Summary of Accounting Policies to Consoli-dated
Financial Statements.
53
<PAGE>
[BDO SEIDMAN LETTERHEAD]
Report of Independent Certified Public Accountants
To the Board of Directors of
Community Financial Corporation
Staunton, Virginia
We have audited the accompanying consolidated balance sheets of
Community Financial Corporation and subsidiary as of March 31, 1998 and 1997,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended March 31, 1998. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these 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 audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall 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 Community
Financial Corporation and subsidiary at March 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended March 31, 1998 in conformity with generally accepted accounting
principles.
Richmond, Virginia
April 24, 1998
/s/ BDO Seidman, LLP
----------------------------
54
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Consolidated Balance Sheets
March 31, 1998 1997
- --------- ---- ----
Assets
Cash (including interest bearing deposits of
approximately $2,866,000 and $1,015,000) ..... $ 7,266,145 $ 4,922,213
Securities (Note 1)
Held to maturity ............................. 3,184,241 5,197,437
Available for sale ........................... 3,905,055 2,243,220
Investment in Federal Home Loan Bank stock,
at cost (Note 6) ............................. 1,600,000 1,400,000
Loans receivable, net (Note 2) ................... 162,471,219 148,905,485
Real estate owned, net ........................... 303,365 173,245
Property and equipment, net (Note 3) ............. 3,634,223 3,542,108
Accrued interest receivable ...................... 1,031,789 989,438
Prepaid expenses and other assets ................ 498,137 334,036
- --------------------------------------------------------------------------------
$183,894,174 $167,707,182
- --------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Liabilities
Deposits (Note 4) ................................ $138,164,173 $116,594,885
Advances from Federal Home Loan Bank (Note 6) .... 18,000,000 26,000,000
Advance payments by borrowers
for taxes and insurance ...................... 175,053 135,561
Other liabilities (Notes 7 and 9) ................ 2,040,188 1,639,740
- --------------------------------------------------------------------------------
Total liabilities ................................ 158,379,414 144,370,186
- --------------------------------------------------------------------------------
Commitments and Contingencies (Notes 9, 10 and 11)
- --------------------------------------------------------------------------------
Stockholders' Equity (Notes 8 and 10)
Preferred stock, $.01 par value, authorized
3,000,000 shares, none outstanding ........... -- --
Common stock, $.01 par value, 10,000,000
authorized shares, 2,559,446 and 1,275,348
shares outstanding ........................... 25,594 12,753
Additional paid-in capital ....................... 4,773,634 4,716,677
Retained earnings ................................ 18,344,373 17,266,745
Net unrealized gain on securities
available for sale (Note 1) .................. 2,371,159 1,340,821
- --------------------------------------------------------------------------------
Total stockholders' equity ....................... 25,514,760 23,336,996
- --------------------------------------------------------------------------------
$183,894,174 $167,707,182
- --------------------------------------------------------------------------------
See accompanying summary of accounting policies and notes to consolidated
financial statements.
55
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Consolidated Statements of Income
Year Ended March 31, 1998 1997 1996
- -------------------- ---- ---- ----
Interest income
Loans ........................... $13,344,490 $12,188,714 $11,816,368
Investment securities ........... 410,909 471,864 447,619
Other investments ............... 193,908 117,409 123,735
- --------------------------------------------------------------------------------
Total interest income ............. 13,949,307 12,777,987 12,387,722
- --------------------------------------------------------------------------------
Interest expense
Deposits (Note 4) ............... 5,844,535 5,054,884 4,977,188
Borrowed money .................. 1,471,490 1,480,747 1,538,046
- --------------------------------------------------------------------------------
Total interest expense ............ 7,316,025 6,535,631 6,515,234
- --------------------------------------------------------------------------------
Net interest income ............... 6,633,282 6,242,356 5,872,488
Provision for loan losses
(Note 2) ......................... 498,764 180,561 307,361
- --------------------------------------------------------------------------------
Net interest income after
provision for loan losses ....... 6,134,518 6,061,795 5,565,127
- --------------------------------------------------------------------------------
Noninterest income
Service charges, fees and
commissions ................... 757,462 509,748 430,945
Other ........................... 9,128 8,994 24,761
- --------------------------------------------------------------------------------
Total noninterest income .......... 766,590 518,742 455,706
- --------------------------------------------------------------------------------
Noninterest expense
Compensation and employee
benefits (Notes 9 and 10) .... 1,956,187 1,333,550 1,183,016
Occupancy ....................... 481,063 399,290 372,560
Data processing (Note 11) ....... 407,925 349,150 308,814
BIF/SAIF premium disparity
assessment (Note 8) ........... -- 670,765 --
Insurance ....................... 74,222 189,143 242,076
Other ........................... 1,097,558 863,841 702,458
- --------------------------------------------------------------------------------
Total noninterest expense ......... 4,016,955 3,805,739 2,808,924
- --------------------------------------------------------------------------------
Income before income taxes ........ 2,884,153 2,774,798 3,211,909
- --------------------------------------------------------------------------------
Income taxes (Note 7)
Current ......................... 1,013,576 971,179 1,139,733
Deferred ........................ 65,094 68,885 60,638
- --------------------------------------------------------------------------------
Total income taxes ................ 1,078,670 1,040,064 1,200,371
- --------------------------------------------------------------------------------
Net income ........................ $ 1,805,483 $ 1,734,734 $ 2,011,538
- --------------------------------------------------------------------------------
Earnings per share (Note 10)
Basic ........................... $ .71 $ .68 $ .80
Diluted ......................... $ .70 $ .68 $ .80
- --------------------------------------------------------------------------------
See accompanying summary of accounting policies and notes to consolidated
financial statements.
56
<PAGE>
Item 7. Financial Statements
- ------------------------------
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Net Unrealized
Gain on
Additional Securities Total
Common Paid-in Retained Available Stockholders'
Stock Capital Earnings For Sale Equity
----- ------- -------- -------- ------
<S> <C> <C> <C> <C> <C>
Balance, March 31, 1995 ......... $ 12,419 $ 4,540,632 $ 14,723,799 $ 275,584 $ 19,552,434
Net income ...................... -- -- 2,011,538 _ 2,011,538
Cash dividends, $.21 per share .. -- -- (529,100) _ (529,100)
Exercise of stock options
(Note 10) ................... 278 111,002 -- -- 111,280
Net unrealized gain on
securities available for sale
(Note 1) .................... -- -- -- 753,828 753,828
- -------------------------------------------------------------------------------------------------------------
Balance, March 31, 1996 ......... 12,697 4,651,634 16,206,237 1,029,412 21,899,980
Net income ...................... -- -- 1,734,734 -- 1,734,734
Cash dividends, $.26 per share .. -- -- (674,226) -- (674,226)
Exercise of stock options
(Note 10) ................... 56 65,043 -- -- 65,099
Net unrealized gain on
securities available for sale
(Note 1) .................... -- -- -- 311,409 311,409
- -------------------------------------------------------------------------------------------------------------
Balance, March 31, 1997 ......... 12,753 4,716,677 17,266,745 1,340,821 23,336,996
Net income ...................... -- -- 1,805,483 -- 1,805,483
Two-for-one stock split ......... 12,797 -- (12,797) -- --
Cash dividends, $.28 per share .. -- -- (715,058) -- (715,058)
Exercise of stock options
(Note 10) ................... 44 56,957 -- -- 57,001
Net unrealized gain on
securities available for sale
(Note 1) .................... -- -- -- 1,030,338 1,030,338
- -------------------------------------------------------------------------------------------------------------
Balance, March 31, 1998 ......... $ 25,594 $ 4,773,634 $ 18,344,373 $ 2,371,159 $ 25,514,760
- -------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
Consolidated Statements of Cash Flows
Year Ended March 31, 1998 1997 1996
- -------------------- ---- ---- ----
Operating activities
Net income ........................ $ 1,805,483 $ 1,734,734 $ 2,011,538
Adjustments to reconcile net
income to net cash provided
by operating activities
Provision for loan losses ....... 498,764 180,561 307,361
Provision for real estate losses -- -- 25,000
Depreciation .................... 234,007 216,462 212,750
Amortization of premium and
accretion of discount on
securities, net ................ (586) (3,683) (351)
Decrease in net deferred loan
origination fees ............... (115,671) (33,289) (110,561)
57
<PAGE>
COMMUNITY FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended March 31, 1998 1997 1996
- -------------------- ---- ---- ----
<S> <C> <C> <C>
Loans originated for resale ................ (4,805,000) (1,587,470) (1,422,000)
Proceeds from loan sales ................... 3,816,000 1,568,470 1,299,000
Increase (decrease) in deferred
income taxes .............................. (24,394) 66,316 62,327
Loss (gain) on sale of real estate ......... (9,755) 4,274 --
(Increase) decrease in other assets ........ (206,452) 69,579 (298,374)
Increase (decrease) in other liabilities ... 464,334 317,805 (13,929)
- ----------------------------------------------------------------------------------------------
Net cash provided by operating activities .... 1,656,730 2,533,759 2,072,761
- ----------------------------------------------------------------------------------------------
Investing activities
Proceeds from maturities of held to maturity
securities ............................... 3,742,267 2,071,892 2,979,871
Purchase of held to maturity securities .... (2,359,982) (1,375,234) (4,791,147)
Net increase in loans ...................... (13,232,234) (7,494,061) (7,068,723)
Purchases of property and equipment ........ (326,123) (66,527) (72,735)
Proceeds from sale of real estate owned .... 152,043 145,002 --
Redemption of FHLB stock ................... -- 150,000 --
Purchase of FHLB stock ..................... (200,000) (200,000) (100,000)
- ----------------------------------------------------------------------------------------------
Net cash absorbed by investing activities .... (12,224,029) (6,768,928) (9,052,734)
- ----------------------------------------------------------------------------------------------
Financing activities
Net increase in certificates of
deposit .................................. 17,787,000 4,998,000 4,665,694
Net increase (decrease) in savings and
checking deposits ........................ 3,782,288 2,095,424 (177,799)
Proceeds from issuance of common stock ..... 57,001 65,099 111,280
Dividends paid ............................. (715,058) (674,226) (529,100)
Proceeds from advances ..................... 76,000,000 33,000,000 78,000,000
Repayments of advances ..................... (84,000,000) (34,000,000) (76,000,000)
- ----------------------------------------------------------------------------------------------
Net cash provided by financing activities .... 12,911,231 5,484,297 6,070,075
- ----------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash
equivalents .................................. 2,343,932 1,249,128 (909,898)
Cash and cash equivalents - beginning
of year ..................................... 4,922,213 3,673,085 4,582,983
- ----------------------------------------------------------------------------------------------
Cash and cash equivalents - end of year ...... $ 7,266,145 $ 4,922,213 $ 3,673,085
- ----------------------------------------------------------------------------------------------
Supplemental Disclosures of Cash
Flow Information
- ----------------------------------------------------------------------------------------------
Cash payments of interest expense ............ $ 7,340,052 $ 6,553,835 $ 6,482,210
- ----------------------------------------------------------------------------------------------
Cash payments of income taxes ................ $ 1,207,076 $ 852,296 $ 1,151,092
- ----------------------------------------------------------------------------------------------
Supplemental Schedule of Non-Cash
Investing and Financing Activities
- ----------------------------------------------------------------------------------------------
Transfers from loans to real estate
acquired through foreclosure ............... $ 331,237 $ 131,718 $ 298,334
- ----------------------------------------------------------------------------------------------
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
58
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of Community Financial Cor-poration (the "Corporation") and its wholly-owned
subsidiary, Community Bank (the "Bank") and Community First Mortgage
Corporation, a wholly-owned subsidiary of the Bank. All material intercompany
accounts and transactions have been eliminated in consolidation.
Nature of Business and Regulatory Environment
The Bank is a federally chartered thrift and the primary asset of the
Corporation. The Corporation provides a full range of banking services to
individual and corporate customers through its wholly-owned subsidiary.
The Office of Thrift Supervision ("OTS"), is the primary regulator for
federally chartered savings associations, as well as savings and loan holding
companies.
The Bank's deposits are insured up to applicable limits by the Savings
Association Insurance Fund ("SAIF"), which is administered by the Federal
Deposit Insurance Corporation ("FDIC"). The FDIC has specific authority to
prescribe and enforce such regulations and issue such orders as it deems
necessary to prevent actions or practices by savings associations that pose a
serious threat to the SAIF.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") was effective January 1, 1993. FDICIA contained provisions which
allow regulators to impose prompt corrective action on undercapitalized
institutions in accordance with a categorized capital-based system.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Securities
Investments in debt securities classified as held-to-maturity are
stated at cost, adjusted for amortization of premiums and accretion of discounts
using the level yield method. Management has a positive intent and ability to
hold these securities to maturity and, accordingly, adjustments are not made for
temporary declines in their market value below amortized cost. Investment in
Federal Home Loan Bank stock is stated at cost.
Investments in debt and equity securities classified as
available-for-sale are stated at market value with unrealized holding gains and
losses excluded from earnings and reported as a separate component of
stockholders' equity, net of tax effect, until realized.
Investments in debt and equity securities classified as trading are
stated at market value. Unrealized holding gains and losses for trading
securities are included in the statement of income. Gains and losses on the sale
of securities are determined using the specific identification method.
Loans Receivable
Loans receivable consists primarily of long-term real estate loans
secured by first deeds of trust on single family residences, other residential
property, commercial property and land located primarily in the state of
Virginia. Interest income on mortgage loans is recorded when earned and is
recognized based on the level yield method. The Corporation provides an
allowance for accrued interest deemed to be uncollectible, which is netted
against accrued interest receivable in the consolidated balance sheets.
The Corporation defers loan origination and commitment fees, net of
certain direct loan origination costs, and the net deferred fees are amortized
into interest income over the lives of the related loans as yield adjustments.
Any unamortized net fees on loans fully repaid or sold are recognized as income
in the year of repayment or sale.
The Corporation places loans on nonaccrual status after being
delinquent greater than 90 days or earlier if the Corporation becomes aware that
the borrower has entered bankruptcy proceedings, or in situations in which the
loans have developed inherent problems prior to being 90 days delinquent that
indicate payments of principal or interest will not be made in full. Whenever
the accrual of interest is stopped, previously accrued
59
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
but uncollected interest income is reversed. Thereafter, interest is recognized
only as cash is received until the loan is reinstated to accrual status.
The allowance for loan losses is maintained at a level considered by
management to be adequate to absorb future loan losses currently inherent in the
loan portfolio. Management's assessment of the adequacy of the allowance is
based upon type and volume of the loan portfolio, past loan loss experience,
existing and anticipated economic conditions, and other factors which deserve
current recognition in estimating future loan losses. Additions to the allowance
are charged to operations. Loans are charged-off partially or wholly at the time
management determines collectibility is not probable. Management's assessment of
the adequacy of the allowance is subject to evaluation and adjustment by the
Corporation's regulators.
The allowance for loan losses related to loans identified as impaired
is primarily based on the excess of the loan's current outstanding principal
balance over the estimated fair market value of the related collateral. A loan
is considered to be impaired when it is probable that the Corporation will be
unable to collect all principal and interest amounts according to the
contractual terms of the loan agreement. A performing loan may be considered
impaired. For a loan that is not collateral-dependent, the allowance is recorded
at the amount by which the outstanding principal balance exceeds the current
best estimate of the future cash flows on the loan discounted at the loan's
original effective interest rate.
For impaired loans that are on nonaccrual status, cash payments
received are generally applied to reduce the outstanding principal balance.
However, all or a portion of a cash payment received on a nonaccrual loan may be
recognized as interest income to the extent allowed by the loan contract,
assuming management expects to fully collect the remaining principal balance on
the loan.
Real Estate Owned
Real estate acquired through foreclosure is initially recorded at the
lower of fair value, less selling costs, or the balance of the loan on the
property at date of foreclosure. Costs relating to the development and
improvement of property are capitalized, whereas those relating to holding the
property are charged to expense.
Valuations are periodically performed by management, and an allowance
for losses is established by a charge to operations if the carrying value of a
property exceeds its estimated fair value.
Sale of Loans and Participation in Loans
The Corporation is able to generate funds by selling loans and
participations in loans to the Federal Home Loan Mortgage Corporation and other
investors. Under participation service agreements, the Corporation continues to
service the loans and the participant is paid its share of principal and
interest collections.
The Corporation allocates the cost of acquiring or originating mortgage
loans between the mortgage servicing rights and the loans, based on their
relative fair values, if the bank sells or securitizes the loans and retains the
mortgage servicing rights.
The cost of mortgage servicing rights is amortized in proportion to,
and over the period of, estimated net servicing revenues. Impairment of mortgage
servicing rights is assessed based on the fair value of those servicing rights.
Fair values are estimated using discounted cash flows based on a current market
interest rate. For purposes of measuring impairment, the rights are stratified
based on the predominant risk characteristics of the underlying loans. The
amount of impairment recognized is the amount by which the capitalized mortgage
servicing rights for a stratum exceed their fair value.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation.
Provisions for depreciation are computed using the straight-line method over the
estimated useful lives of the individual assets. Expenditures for betterments
and major renewals are capitalized and ordinary maintenance and repairs are
charged to operations as incurred. Estimated useful lives are three to ten years
for furniture and equipment and five to fifty years for buildings and
improvements.
60
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
Income Taxes
Deferred income taxes are recognized for the tax consequences of
"temporary differences" by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities.
For tax years beginning prior to January 1, 1996, savings banks that
met certain definitional tests and other conditions prescribed by the Internal
Revenue Code were allowed, within limitations, to deduct from taxable income an
allowance for bad debts using the "percentage of taxable income" method.
Section 1616 of the Small Business Job Protection Act of 1996 (the
"Act") repealed the percentage of taxable income method of computing bad debt
reserves, and required the recapture into taxable income of "excess reserves",
on a ratable basis over the next six years. Excess reserves are defined in
general, as the excess of the balance of the tax bad debt reserve (using the
percentage of taxable income method) as of the close of the last tax year
beginning before January 1, 1996 over the balance of the reserve as of the close
of the last tax year beginning before January 1, 1988. The recapture of the
reserves is deferred if the Corporation meets the "residential loan requirement"
exception, during either or both of the first two years beginning after December
31, 1995. The residential loan requirement is met, in general, if the principal
amount of residential loans made by the Corporation during the year is not less
than the Corporation's "base amount". The base amount is defined as the average
of the principal amounts of residential loans made during the six most recent
tax years beginning before January 1, 1996.
As a result of the Act, the Corporation must recapture into taxable
income approximately $1,267,000 ratably over six years. The residential loan
requirement exception was met for the taxable years ended March 31, 1997 and
1998, therefore the income will be includable over the six-year period beginning
with the year ending March 31, 1999.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
130"), which establishes standards for reporting and display of comprehensive
income, its components and accumulated balances. Compre-hensive income is
defined to include all changes in equity except those resulting from investments
by owners and distributions to owners. Among other disclosures, SFAS 130
requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. SFAS 130 is effective for financial statements for periods
beginning after December 15, 1997 and requires comparative information for
earlier years to be restated. Management does not expect the application of this
pronouncement to have a material effect on the financial statements of the
Corporation.
Earnings Per Share
Basic earnings per share include no dilution and is computed by
dividing income available to common shareholders by the weighted average number
of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution of stock options that could share in the earnings of the
Corporation. The weighted average number of shares of common stock outstanding
for the years ended March 31, 1998, 1997 and 1996 were 2,553,216; 2,544,170 and
2,516,136, respectively, for basic earnings per share and 2,583,631; 2,557,549
and 2,517,178, respectively, for diluted earnings per share.
Statement of Cash Flows
For purposes of this presentation, cash equivalents include federal
funds sold.
Other
Certain reclassifications have been made in the prior years'
consolidated financial statements to conform to the March 31, 1998 presentation.
61
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. Securities
A summary of the amortized cost and estimated market values of securities is as
follows:
March 31, 1998
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
Held to Maturity
United States government
and agency obligations $1,860,574 $ 6,069 $ 749 $1,865,894
Corporate obligations .... 1,298,644 30,471 -- 1,329,115
Other .................... 25,023 736 -- 25,759
- --------------------------------------------------------------------------------
3,184,241 37,276 749 3,220,768
Available for Sale
Federal Home Loan Mortgage
Corporation stock .... 80,605 3,824,450 -- 3,905,055
- --------------------------------------------------------------------------------
$3,264,846 $3,861,726 $ 749 $7,125,823
- --------------------------------------------------------------------------------
March 31, 1997
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
Held to Maturity
United States government
and agency obligations $4,876,286 $ 14,235 $ 34,287 $4,856,234
Corporate obligations .... 296,128 -- 628 295,500
Other .................... 25,023 460 -- 25,483
- --------------------------------------------------------------------------------
5,197,437 14,695 34,915 5,177,217
Available for Sale
Federal Home Loan Mortgage
Corporation stock .... 80,605 2,162,615 -- 2,243,220
- --------------------------------------------------------------------------------
$5,278,042 $2,177,310 $ 34,915 $7,420,437
- --------------------------------------------------------------------------------
The amortized cost and estimated market value of securities at March 31, 1998,
by contractual maturity, are shown below:
March 31, 1998
- --------------------------------------------------------------------------------
Estimated
Amortized Market
Cost Value
---------- ----------
Held to Maturity
Due in one year or less ................... $ 500,000 $ 499,062
Due in one through five years ............. 2,385,597 2,422,456
Other ..................................... 298,644 299,250
- --------------------------------------------------------------------------------
3,184,241 3,220,768
- --------------------------------------------------------------------------------
Available for Sale
Federal Home Loan Mortgage
Corporation stock ........................ 80,605 3,905,055
- --------------------------------------------------------------------------------
$3,264,846 $7,125,823
- --------------------------------------------------------------------------------
62
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
2. Loans Receivable
Loans receivable are summarized as follows:
March 31, 1998 1997
- --------- ---- ----
Real estate loans
First mortgage conventional
One to four family ............ $ 94,939,920 $ 96,968,331
Multi-family .................. 18,586,403 18,787,851
Commercial .................... 21,032,004 18,720,436
Construction .................. 10,070,882 5,204,235
- --------------------------------------------------------------------------------
Total real estate loans ............. 144,629,209 139,680,853
Less
Loans in process .................. 3,002,655 1,619,476
Deferred loan fees, net ........... 303,099 372,460
Allowance for loan losses ......... 654,457 602,910
- --------------------------------------------------------------------------------
Net real estate loans ............... 140,668,998 137,086,007
Consumer loans
Unsecured personal ................ 5,050,816 4,417,470
Automobile ........................ 3,433,609 1,645,893
Home equity ....................... 7,085,474 1,630,347
Deposit account ................... 301,656 338,976
Other ............................. 6,337,562 4,210,428
- --------------------------------------------------------------------------------
Total consumer loans ................ 22,209,117 12,243,114
Less
Deferred loan fees (origination
costs), net ...................... (55,778) (12,467)
Allowance for loan losses ......... 462,674 436,103
- --------------------------------------------------------------------------------
Net consumer loans .................. 21,802,221 11,819,478
- --------------------------------------------------------------------------------
$ 162,471,219 $ 148,905,485
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Loans serviced for others amounted to approximately $8,792,000, $10,513,000, and
$11,264,000 at March 31, 1998, 1997 and 1996, respectively. The loans were not
included in the accompanying consolidated statements of financial condition.
The weighted average interest rate on loans receivable was approximately 8.29%
and 8.15% at March 31, 1998 and 1997, respectively.
A summary of the allowance for loan losses is as follows:
Year Ended March 31, 1998 1997 1996
- -------------------- ---- ---- ----
Balance at beginning of year ...... $ 1,039,013 $ 1,000,278 $ 762,621
Provision charged to expense ...... 498,764 180,561 307,361
Losses charged to the allowance,
net of recoveries ............... (420,646) (141,826) (69,704)
- --------------------------------------------------------------------------------
Balance at end of year ............ $ 1,117,131 $ 1,039,013 $ 1,000,278
- --------------------------------------------------------------------------------
Of the total allowance for loan losses at March 31, 1998 and 1997, approximately
$1,080,131 and $783,700, respectively, is not specifically allocated to
identified problem loans.
63
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. Loans Receivable (continued)
The following information relates to the Corporation's impaired loans which
includes troubled debt restructurings that meet the definition of impaired
loans; there were no loans considered impaired at March 31, 1998.
As of and for the year ended March 31, 1997
- -------------------------------------- ----
Impaired loans with a specific allowance ....................... $416,882
Impaired loans with no specific allowance ...................... --
- --------------------------------------------------------------------------------
Total impaired loans ........................................... $416,882
- --------------------------------------------------------------------------------
Total allowance related to impaired loans ...................... $195,270
Average balance of impaired loans for the year ................. $420,956
Interest income on impaired loans for the year
recorded on a cash basis ..................................... $ 4,004
- --------------------------------------------------------------------------------
3. Property and Equipment
Property and equipment are summarized as follows:
March 31, 1998 1997
- --------- ---- ----
Buildings .................................. $3,275,898 $3,201,387
Land and improvements ...................... 876,276 876,276
Furniture and equipment .................... 977,220 757,018
- --------------------------------------------------------------------------------
5,129,394 4,834,681
Less accumulated depreciation .............. 1,495,171 1,292,573
- --------------------------------------------------------------------------------
$3,634,223 $3,542,108
- --------------------------------------------------------------------------------
4. Deposits
March 31, 1998 1997
- --------- ---- ----
Demand deposits
Savings accounts ................... $ 12,442,584 $ 12,577,540
NOW accounts ....................... 21,003,469 15,576,036
Money market deposit
accounts ......................... 8,425,120 9,935,309
- --------------------------------------------------------------------------------
Total demand deposits ................ 41,871,173 38,088,885
Time deposits ........................ 96,293,000 78,506,000
- --------------------------------------------------------------------------------
$138,164,173 $116,594,885
- --------------------------------------------------------------------------------
The aggregate amount of time deposit accounts with a minimum denomination of
$100,000 was approximately $10,255,517 and $6,594,000 at March 31, 1998 and
1997, respectively.
64
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
4. Deposits (continued)
Time deposits mature as follows:
March 31, 1998 1997
- --------- ---- ----
Within one year ...................... $70,867,000 $58,772,000
One to two years ..................... 17,968,000 10,715,000
More than two years .................. 7,458,000 9,019,000
- --------------------------------------------------------------------------------
$96,293,000 $78,506,000
- --------------------------------------------------------------------------------
Interest expense on deposits is summarized as follows:
Year Ended March 31, 1998 1997 1996
- -------------------- ---- ---- ----
Time deposits ........................... $4,773,241 $4,045,717 $3,999,200
Money market deposit and NOW accounts ... 701,547 649,194 624,182
Savings ................................. 369,747 359,973 353,806
- --------------------------------------------------------------------------------
$5,844,535 $5,054,884 $4,977,188
- --------------------------------------------------------------------------------
5. Fair Value of Financial Instruments
The estimated fair values of the Corporation's financial instruments are as
follows:
<TABLE>
<CAPTION>
March 31, 1998 1997
- --------- -------------------------- ---------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial assets
<S> <C> <C> <C> <C>
Cash and short-term investments $ 7,266,145 $ 7,266,000 $ 4,922,213 $ 4,922,000
Securities .................... 7,089,296 7,126,000 7,440,657 7,420,000
Loans, net of allowance for
loan losses .................. 162,471,219 162,682,000 148,905,485 148,509,000
Financial liabilities
Deposits ...................... 138,164,173 138,369,000 116,594,885 116,795,000
Advances from Federal Home
Loan Bank .................... 18,000,000 18,000,000 26,000,000 26,000,000
Notional Fair Notional Fair
Amount Value Amount Value
------ ----- ------ -----
Unrecognized financial instruments
Commitments to extend credit .... $ 11,825,000 $ 11,825,000 $ 11,179,000 $ 11,179,000
</TABLE>
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value.
Cash and short-term investments
For those short-term investments, the carrying amount is a reasonable estimate
of fair value.
65
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. Fair Value of Financial Instruments (continued)
Securities
Fair values are based on quoted market prices or dealer quotes. If a quoted
market price is not available, fair value is estimated using quoted market
prices for similar securities.
Loan receivables
The fair value of loans is estimated by discounting the future cash flows using
the current rates at which similar loans would be made to borrowers with similar
remaining maturities. This calculation ignores loan fees and certain factors
affecting the interest rates charged on various loans such as the borrower's
creditworthiness and compensating balances and dissimilar types of real estate
held as collateral.
Deposit liabilities
The fair value of demand deposits, savings accounts, and certain money market
deposits is the amount payable on demand at the balance sheet date. The fair
value of fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposits of similar remaining maturities.
Advances from Federal Home Loan Bank
For advances that mature within one year of the balance sheet date, carrying
value is considered a reasonable estimate of fair value. The fair values of all
other advances are estimated using discounted cash flow analysis based on the
Corporation's current incremental borrowing rate for similar types of advances.
Commitments to extend credit
The fair value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the borrowers. For fixed-rate
loan commitments, fair value also considers the difference between current
levels of interest rates and the committed rates. Because of the competitive
nature of the marketplace, loan fees vary greatly with no fees charged in many
cases. Therefore, management has concluded no value should be assigned.
6. Advances From Federal Home Loan Bank
Advances from the Federal Home Loan Bank are summarized as follows:
Due in year ending March 31,
- -----------------------------------
1999 $ 3,000,000
2000 --
2001 --
2002 15,000,000
-----------
$18,000,000
The weighted average interest rate on advances was 5.77% and 6.85% at March 31,
1998 and 1997, respectively. These advances are collateralized by the investment
in FHLB stock and the Corporation's portfolio of first mortgage loans under a
Blanket Floating Lien Agreement.
66
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
6. Advances From Federal Home Loan Bank (continued)
Information related to borrowing activity from the Federal Home Loan Bank is as
follows:
Year Ended March 31, 1998 1997 1996
- -------------------- ---- ---- ----
Maximum amount outstanding
during the year............... $32,000,000 $28,000,000 $27,000,000
- --------------------------------------------------------------------------------
Average amount outstanding
during the year............... $25,916,667 $26,541,667 $25,346,995
- --------------------------------------------------------------------------------
Average interest rate during
the year...................... 5.68% 5.58% 6.07%
- --------------------------------------------------------------------------------
7. Income Taxes
Deferred tax assets (liabilities), included in "Other liabilities" in the
consolidated balance sheets are as follows:
March 31, 1998 1997
- --------- ---- ----
Deferred tax assets
Deferred loan fees ................... $ -- $ 6,522
Other ................................ 5,426 7,364
- --------------------------------------------------------------------------------
5,426 13,886
- --------------------------------------------------------------------------------
Deferred tax liabilities
Depreciable assets ................... (149,419) (143,335)
FHLMC stock .......................... (1,453,291) (821,794)
FHLB stock ........................... (90,852) (90,852)
Allowance for losses ................. (56,901) (6,351)
Other ................................ (4,477) (93,965)
- --------------------------------------------------------------------------------
(1,754,940) (1,156,297)
- --------------------------------------------------------------------------------
Net deferred tax liability ............. $(1,749,514) $(1,142,411)
- --------------------------------------------------------------------------------
8. Stockholders' Equity and Regulatory Capital Requirements
Savings institutions must maintain specific capital standards that are no less
stringent than the capital standards applicable to national banks. The OTS
regulations currently have three capital standards including (i) a tangible
capital requirement, (ii) a core capital requirement, and (iii) a risk-based
capital requirement. The tangible capital standard requires savings institutions
to maintain tangible capital of not less than 1.5% of adjusted total assets. The
core capital standard requires a savings institution to maintain core capital of
not less than 4.0% at March 31, 1998 and 3% at March 31, 1997 of adjusted total
assets. The risk-based capital standard requires risk-based capital of not less
than 8.0% of risk-weighted assets.
67
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
8. Stockholders' Equity and Regulatory Capital Requirement (continued)
The following table presents the Bank's regulatory capital levels at March 31,
1998 and 1997, relative to the OTS requirements applicable at that date:
Amount Percent Actual Actual Excess
March 31, 1998 Required Required Amount Percent Amount
- -------------- -------- -------- ------ ------- ------
Tangible Capital .... $ 2,742,000 1.50% $21,632,000 11.83% $18,890,000
Core Capital ........ 7,313,000 4.00 21,632,000 11.83 14,319,000
Risk-based Capital .. 10,380,000 8.00 24,468,000 16.67 14,088,000
Amount Percent Actual Actual Excess
March 31, 1998 Required Required Amount Percent Amount
- -------------- -------- -------- ------ ------- ------
Tangible Capital .... $ 2,498,000 1.50% $19,779,000 11.88% $17,281,000
Core Capital ........ 4,996,000 3.00 19,779,000 11.88 14,783,000
Risk-based Capital .. 8,908,000 8.00 20,562,000 18.46 11,654,000
The Bank may not declare or pay a cash dividend, or repurchase any of its
capital stock, if the effect thereof would cause the net worth of the Bank to be
reduced below certain requirements imposed by federal regulations.
Capital distributions by OTS-regulated savings banks are limited by regulation
("Capital Distribution Regulation"). Capital distributions are defined to
include, in part, dividends, stock repurchases and cash-out mergers. The Capital
Distribution Regulation permits a "Tier 1" savings bank to make capital
distributions during a calendar year up to 100% of its net income to date plus
the amount that would reduce by one-half its surplus capital ratio at the
beginning of the calendar year. Any distributions in excess of that amount
require prior OTS notice, with the opportunity for OTS to object to the
distribution. A Tier 1 savings bank is defined as a savings bank that has, on a
pro forma basis after the proposed distribution, capital equal to or greater
than the OTS fully phased-in capital requirement and has not been deemed by the
OTS to be "in need of more than normal supervision". The Bank is currently
classified as a Tier 1 institution for these purposes. The Capital Distribution
Regulation requires that savings banks provide the applicable OTS District
Director with a 30-day advance written notice of all proposed capital
distributions whether or not advance approval is required by the regulation. The
Bank did not pay any dividends to the Corporation during the year ended March
31, 1998.
Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "Act");
during the year ended March 31, 1997, the FDIC imposed a special assessment on
SAIF members to capitalize the SAIF at the designated reserve level of 1.25% as
of September 30, 1996. Based on the Corporation's deposits as of March 31, 1995,
the date for measuring the amount of the special assessment, the Corporation
paid a special assessment of approximately $671,000. Excluding this special
assessment, net of tax effect, net income and earnings per share for the year
ended March 31, 1997 would have been approximately $2,151,000 and $.85,
respectively. The FDIC has lowered the premium for deposit insurance from that
prior to the special assessment to a level necessary to maintain the SAIF at its
required reserve level.
On February 23, 1998, the Board of Directors declared 100% stock dividend in the
form of a two-for-one stock split to be distributed March 25, 1998, to all
shareholders of record as of March 11, 1998. All applicable share and per share
data have been adjusted for the stock dividend.
68
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
9. Employee Benefit Plans
Pension Plan
The Corporation has a noncontributory defined benefit pension plan covering
substantially all of its employees. The benefits are based on years of service
and final average compensation. The Corporation's funding policy is to
contribute amounts to the pension trust at least equal to the minimum funding
requirements of the Employee Retirement Income Security Act of 1974 (ERISA), but
not in excess of the maximum tax deductible amount. Contributions are intended
to provide not only for benefits attributed to service to date but also for
those expected to be earned in the future. The following is a summary of
information with respect to the plan:
Year Ended March 31, 1998 1997 1996
- ------------------- ---- ---- ----
Net periodic pension cost
Service cost - benefits
earned during the period ............ $ 46,902 $ 30,176 $ 27,872
Interest cost on projected
benefit obligations ................. 39,573 34,077 38,884
Actual return on plan assets ......... (38,146) (37,684) (29,905)
Net amortization and deferral ........ (7,275) (6,695) (15,502)
- --------------------------------------------------------------------------------
$41,054 $ 19,874 $21,349
- --------------------------------------------------------------------------------
Accumulated benefit obligation
Vested benefits ...................... $520,012 $441,077 $393,678
Non-vested benefits .................. 9,945 5,743 27,792
- --------------------------------------------------------------------------------
$529,957 $446,820 $421,470
- --------------------------------------------------------------------------------
Year Ended March 31, 1998 1997
- -------------------- ---- ----
Accrued pension cost
Projected benefit obligation ......................... $ 665,004 $ 537,272
Fair value of plan assets, primarily
IPG insurance contracts ............................ 568,250 546,708
- --------------------------------------------------------------------------------
Assets in excess (deficit) of projected
benefit obligation ................................. (96,754) 9,436
Unrecognized prior service cost ...................... 15,504 18,604
Unrecognized net (gain) loss ......................... 18,875 (47,270)
Unrecognized net asset ............................... (49,597) (57,864)
- --------------------------------------------------------------------------------
$(111,972) $(77,094)
69
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. Employee Benefit Plans (continued)
The following assumed rates were used in determining the projected benefit
obligations:
Year Ended March 31, 1998 1997
- -------------------- ---- ----
Weighted average discount rate.............................. 6.8% 7.0%
- --------------------------------------------------------------------------------
Expected long-term rate of return on
plan assets .............................................. 7.5% 7.5%
- --------------------------------------------------------------------------------
Increase in future compensation levels ..................... 5.0% 5.0%
- --------------------------------------------------------------------------------
The measurement date used to value the plan assets was December 31, 1997, and
1996.
Employee Stock Ownership Plan
The Employee Stock Ownership and 401(k) Profit Sharing Plan (the "Plan") is a
combination of a profit sharing plan with 401(k) and a stock bonus plan. The
Plan provides for retirement, death, and disability benefits for all eligible
employees.
An employee becomes eligible for participation after completion of one year of
service. After meeting the eligibility requirements, an employee becomes a
member of the Plan on the earliest January 1, April 1, July 1, or October 1
occurring on or after his qualification.
The contributions to the Plan are discretionary and are determined by the Board
of Directors. The contributions are limited annually to the maximum amount
permitted as a tax deduction under the applicable Internal Revenue Code
provisions.
Profit-sharing, pension plan, and retirement expenses were as follows:
ESOP and Supplemental
Year Ended Pension Unfunded
March 31, Plan Retirement* Total
--------- ---- ----------- -----
1996 ................ $38,325 $1,749 $40,074
1997 ................ 43,513 -- 43,513
1998 ................ 49,967 -- 49,967
*For a former executive officer, amounts are authorized annually.
70
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
10. Stock Option Plan
The Corporation has a noncompensatory stock option plan (the "Plan") designed to
provide long-term incentives to employees.
The following table summarizes options outstanding:
Year Ending March 31, 1998 1997 1996
- --------------------- ----------------- ---------------- ---------------
Weighted- Weighted- Weighted-
average average average
exercise exercise exercise
Shares price Shares price Shares price
------ ----- ------ ----- ------ -----
Options outstanding at
beginning of year .. 127,300 $ 9.57 72,000 $ 8.02 99,260 $ 2.83
Options granted ...... 47,000 13.58 67,000 10.69 56,200 9.24
Options exercised .... (8,750) 6.52 (11,300) 10.00 (55,640) 4.00
Options forfeited .... (100) 10.00 (400) 5.76 (27,820) 2.00
- --------------------------------------------------------------------------------
Options outstanding at
end of year ........ 165,450 $10.80 127,300 $ 9.57 72,000 $ 8.02
- --------------------------------------------------------------------------------
The Corporation applies Accounting Principals Board Opinion 25 in
accounting for stock options granted to employees. Had compensation expense been
determined based upon the fair value of the awards at the grant date and
consistent with the method under Statement of Financial Accounting Standards
123, the Corporation's net earnings and net earnings per share would have been
decreased to the pro forma amounts as indicated in the following table:
Net income: 1998 1997 1996
- ----------- ---- ---- ----
As reported............. $1,805,483 $1,734,734 $2,011,538
Pro forma............... 1,696,279 1,611,900 1,914,873
Net income per share: Basic Diluted Basic Diluted Basic Diluted
- --------------------- ----- ------- ----- ------- ----- -------
As reported............. $0.71 $0.70 $.68 $.68 $.80 $.80
Pro forma............... 0.66 0.65 .63 .63 .76 .76
The fair value of each option granted is estimated on the date of grant using
the Black-Sholes option pricing model with the following assumptions used for
grants for the year ended March 31, 1998: a risk free interest rate of 5.24%,
dividend yield of 2.00%, expected weighted average term of 10 years, and a
volitality of 20.00%.
71
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding and
excercisable at March 31, 1998:
Options Outstanding
-----------------------
Weighted Weighted
Average Average
Remaining Excercise
Number of Contractual Price
Shares Life (Years) Per Share
------ ------------ ---------
$ 6.50 - 9.50 ............................. 38,000 8.32 $ 8.24
$10.00 - 15.00 ............................ 127,450 8.86 10.94
- --------------------------------------------------------------------------------
165,450 8.74 $10.80
- --------------------------------------------------------------------------------
11. Commitments and Contingencies
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The Corporation evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Corporation upon extension of credit, is based on
management's credit evaluation of the counterparty. Collateral held varies but
may include single family residences, other residential property, commercial
property and land. At March 31, 1998, the Corporation had outstanding
commitments to originate loans with variable interest rates of approximately
$6,590,000 and loans with fixed rates of approximately $1,720,000. In addition,
unused lines of credit amounted to approximately $5,235,000 at March 31, 1998.
Leases
The Corporation is obligated under a noncancellable operating lease beginning
April 1, 1997. Future minimum annual rental commitments under the lease is as
follows:
Year Ending
March 31 Amount
-------- ------
1999 $ 31,200
2000 33,600
2001 36,000
2002 38,400
--------
$139,200
--------
Total lease expense was $31,200 and $0 for the years ended March 31, 1998 and
1997, respectively, and total data processing expense was $408,000 and $349,000
for the years ended March 31, 1998 and 1997, respectively.
In the normal course of business, the Corporation has entered into employment
agreements with certain officers of the Bank.
72
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
12. Selected Quarterly Financial Data (Unaudited)
Condensed quarterly financial data is shown as follows:
(Dollars in thousands except per share data)
Year Ended March 31, 1998
- -------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Total interest income ...................... $3,363 $3,510 $3,538 $3,538
Total interest expense ..................... 1,729 1,874 1,884 1,829
- --------------------------------------------------------------------------------
Net interest income ........................ 1,634 1,636 1,654 1,709
Provision for loan losses .................. 25 368 25 81
- --------------------------------------------------------------------------------
Net interest income after provision
for loan losses .......................... 1,609 1,268 1,629 1,628
Other income ............................... 169 174 207 217
Other expenses ............................. 986 919 984 1,128
- --------------------------------------------------------------------------------
Income before income taxes ................. 792 523 852 717
Income taxes ............................... 297 195 313 274
- --------------------------------------------------------------------------------
Net income ................................. $ 495 $ 328 $ 539 $ 443
- --------------------------------------------------------------------------------
Earnings per share
Basic .................................... $ .20 $ .13 $ .21 $ .17
Diluted .................................. $ .20 $ .13 $ .21 $ .16
- --------------------------------------------------------------------------------
Year Ended March 31, 1997
- -------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Total interest income ...................... $3,144 $3,151 $3,232 $3,251
Total interest expense ..................... 1,633 1,600 1,653 1,650
- --------------------------------------------------------------------------------
Net interest income ........................ 1,511 1,551 1,579 1,601
Provision for loan losses .................. 33 70 53 25
- --------------------------------------------------------------------------------
Net interest income after provision
for loan losses .......................... 1,478 1,481 1,526 1,576
Other income ............................... 118 130 136 135
Other expenses ............................. 716 1,462 734 893
- --------------------------------------------------------------------------------
Income before income taxes ................. 880 149 928 818
Income taxes ............................... 330 54 349 307
- --------------------------------------------------------------------------------
Net income ................................. $ 550 $ 95 $ 579 $ 511
- --------------------------------------------------------------------------------
Basic and diluted earnings
per share ................................. $ .21 $ .04 $ .23 $ .20
- --------------------------------------------------------------------------------
73
<PAGE>
13. Condensed Financial Information of the Corporation (Parent Company Only)
Condensed financial information is shown for the parent company only as follows:
Condensed Statements of Financial Condition
March 31, 1998 1997
- --------- ---- ----
Assets
Investment in the Bank, at equity ............ $21,745,532 $19,905,521
Cash ......................................... 1,357,422 2,071,134
Prepaid expenses and other assets ............ 40,647 19,520
- --------------------------------------------------------------------------------
$23,143,601 $21,996,175
- --------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Liabilities .................................. $ -- $ --
- --------------------------------------------------------------------------------
Stockholders' Equity
Common stock ............................... 25,594 12,753
Additional paid-in capital ................. 4,773,634 4,716,677
Retained earnings .......................... 18,344,373 17,266,745
- --------------------------------------------------------------------------------
Total stockholders' equity ................... 23,143,601 21,996,175
- --------------------------------------------------------------------------------
$23,143,601 $21,996,175
- --------------------------------------------------------------------------------
Condensed Statements of Income
Year Ended March 31, 1998 1997 1996
- -------------------- ---- ---- ----
Income
Interest income ................. $ -- $ 4,900 $ 34,224
- --------------------------------------------------------------------------------
Total income ...................... -- 4,900 34,224
- --------------------------------------------------------------------------------
Noninterest expenses .............. (55,652) (83,187) (62,755)
- --------------------------------------------------------------------------------
Income (loss) before equity in
undistributed net income of
the Bank ......................... (55,652) (78,287) (28,531)
Equity in undistributed net
income of the Bank ............... 1,840,010 1,783,140 2,028,221
- --------------------------------------------------------------------------------
Income before income taxes ........ 1,784,358 1,704,853 1,999,690
Income taxes ...................... (21,125) (29,881) (11,848)
- --------------------------------------------------------------------------------
Net income ........................ $1,805,483 $1,734,734 $2,011,538
- --------------------------------------------------------------------------------
74
<PAGE>
COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARY
- --------------------------------------------------------------------------------
13. Condensed Financial Information of the Corporation (Parent Company Only)
(continued)
Condensed Statements of Cash Flows
Year Ended March 31 1998 1997 1996
- ------------------- ---- ---- ----
Operating activities
Net income ...................... $ 1,805,483 $ 1,734,734 $ 2,011,538
Adjustments
Equity in income of the Bank .. (1,840,010) (1,783,140) (2,028,221)
(Increase) decrease in prepaid
and other assets ............. (21,128) (10,224) 12,189
Increase (decrease) in other
liabilities .................. -- (16,823) 654
- --------------------------------------------------------------------------------
Net cash absorbed by operating
activities ....................... (55,655) (75,453) (3,840)
- --------------------------------------------------------------------------------
Investing activities
Proceeds from maturities of
investment securities .......... -- 249,931 996,776
- --------------------------------------------------------------------------------
Net cash provided by investing
activities ....................... -- 249,931 996,776
- --------------------------------------------------------------------------------
Financing activities
Cash dividends paid on common
stock .......................... (715,058) (674,226) (529,100)
Stock options exercised ......... 57,001 65,099 111,280
- --------------------------------------------------------------------------------
Net cash absorbed by financing
activities ...................... (658,057) (609,127) (417,820)
- --------------------------------------------------------------------------------
Increase (decrease) in cash ....... (713,712) (434,649) 575,116
Cash, beginning of year ........... 2,071,134 2,505,783 1,930,667
- --------------------------------------------------------------------------------
Cash, end of year ................. $ 1,357,422 $ 2,071,134 $ 2,505,783
- --------------------------------------------------------------------------------
75
<PAGE>
PART III
Item 9. Directors and Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act
- -------------------------------------------------------------------
Information concerning directors of the Registrant is incorporated herein by
reference from the Company's definitive Proxy Statement for the 1998 Annual
Meeting of Stockholders, a copy of which will be filed not later than 120 days
after the close of the fiscal year.
Information concerning executive officers is set forth in Part I of this
report under the caption "Executive Officers."
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than 10% of a
registered class of the Company's equity securities, to file with the SEC
initial reports of ownership and reports of changes in ownership of Common Stock
and other equity securities of the Company. Officers, directors and greater than
10% stockholders are required by SEC regulation to furnish the Company with
copies of all Section 16(a) forms they file.
To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, during the last fiscal year ended March 31, 1998, all
Section 16(a) filing requirements applicable to its officers, directors and
greater than 10 percent beneficial owners were complied with.
Item 10. Executive Compensation
- --------------------------------
Information concerning executive compensation is incorporated herein by
reference from the Company's definitive Proxy Statement for the 1998 Annual
Meeting of Stockholders, a copy of which will be filed not later than 120 days
after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owners and
Management
- -------------------------------------------------------------
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the Company's definitive
Proxy Statement for the 1998 Annual Meeting of Stockholders, a copy of which
will be filed not later than 120 days after the close of the fiscal year.
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
Information concerning certain relationships and transactions is incorporated
herein by reference from the Company's definitive Proxy Statement for the 1998
Annual Meeting of Stockholders, a copy of which will be filed not later than 120
days after the close of the fiscal year.
76
<PAGE>
PART IV
Item 13. Exhibits and Reports on 8-K
- -------------------------------------
(a) Exhibits:
Reference to
Prior Filing, Item
or Exhibit
Regulation Number
S-K Exhibit Attached
Number Document Hereto
- --------------------------------------------------------------
2 Plan of acquisition, reorganization,
arrangement, liquid, or succession None
3 Articles of Incorporation and Bylaws *
4 Instruments defining the rights of
security holders, including indentures:
Common Stock Certificate *
9 Voting trust agreement None
10 Material contracts:
Stock Option and Incentive Plan *
Employment Agreement *
Employee Stock Ownership Plan **
11 Statement re computation of per
share earnings Item 7
13 Annual Report to Security Holders None
16 Letter on change in certifying
accountant None
18 Letter on change in accounting
principles None
19 Previously unfiled documents None
21 Subsidiaries of Registrant 21
22 Published report regarding matters
submitted to vote of security
holders None
23 Consent of Experts and Counsel 23
24 Power of Attorney Not required
27 Financial Data Schedule 27
99 Additional exhibits None
- --------------------
* Filed on May 19, 1989 as exhibits to the Registrant's Registration
Statement No. 33-28817 on Form S-4. All of such previously filed documents
are hereby incorporated herein by reference in accordance with Item 601 of
Regulation S-B.
77
<PAGE>
** Filed on June 28, 1993, as Exhibit 10 to the Annual Report on Form 10-KSB
for the fiscal year ended March 31, 1993. Such previously filed document is
hereby incorporated herein by reference in accordance with Item 601 of
Regulation S-B.
(b) Reports on Form 8-K:
No reports on Form 8-K have been filed during the three-month period ended
March 31, 1998.
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
- ----------------------------------------------------------
There has been no Current Report on Form 8-K filed within 24 months prior to
the date of the most recent financial statements reporting a change in
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
78
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
COMMUNITY FINANCIAL CORPORATION
Date: June 26, 1998 By:/s/ Thomas W. Winfree
------------------------------
Thomas W. Winfree
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By:/s/Thomas W. Winfree By:/s/ James R. Cooke, Jr.
----------------------------- ------------------------------
Thomas W. Winfree James R.Cooke, Jr.
President and Chief Chairman of the Board
Executive Officer and Director
(Principal Executive Officer)
Date: June 26, 1998 Date: June 26, 1998
By: /s/Jane C. Hickok By: /s/Charles F. Andersen
----------------------------- ------------------------------
Jane C. Hickok Charles F. Andersen
Vice Chairman of the Board Director
and Director
Date: June 26, 1998 Date: June 26, 1998
By:/s/Dale C. Smith By:/s/Kenneth L. Elmore
----------------------------- ------------------------------
Dale C. Smith Kenneth L. Elmore
Director Director
Date: June 26, 1998 Date: June 26, 1998
By:/s/ R. Jerry Giles By:/s/Charles W. Fairchilds
----------------------------- ------------------------------
R. Jerry Giles Charles W. Fairchilds
Chief Financial Officer Director
(Principal Financial and
Accounting Officer)
Date: June 26, 1998 Date: June 26, 1998
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<PAGE>
Exhibit 21
SUBSIDIARIES OF THE REGISTRANT
Percent Jurisdiction of
of Incorporation
Parent Subsidiary Ownership or Organization
------ ---------- --------- ---------------
Community Financial Community Bank 100% Federal
Corporation
Community Bank Community First Mortgage 100 Virginia
CONSENT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Community Financial Corporation
38 North Central Avenue
Staunton, Virginia 24401
Gentlemen:
We hereby consent to the incorporation in the Registration Statement on Form S-8
our report dated April 24, 1998, relating to the consolidated financial
statements of Community Financial Corporation and subsidiary appearing in the
Company's Annual Report on Form 10-KSB for the year ended March 31, 1998.
/s/ BDO Seidman, LLP
--------------------
BDO Seidman, LLP
Richmond, Virginia
June 26, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 7,266,145
<INT-BEARING-DEPOSITS> 2,866,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 3,905,055
<INVESTMENTS-CARRYING> 3,184,241
<INVESTMENTS-MARKET> 0
<LOANS> 162,471,219
<ALLOWANCE> 1,117,131
<TOTAL-ASSETS> 183,894,174
<DEPOSITS> 138,164,176
<SHORT-TERM> 3,000,000
<LIABILITIES-OTHER> 2,040,188
<LONG-TERM> 15,000,000
0
0
<COMMON> 25,594
<OTHER-SE> 25,489,166
<TOTAL-LIABILITIES-AND-EQUITY> 183,894,174
<INTEREST-LOAN> 13,344,490
<INTEREST-INVEST> 410,909
<INTEREST-OTHER> 193,908
<INTEREST-TOTAL> 13,949,307
<INTEREST-DEPOSIT> 5,844,535
<INTEREST-EXPENSE> 7,316,025
<INTEREST-INCOME-NET> 6,633,282
<LOAN-LOSSES> 498,764
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 4,016,955
<INCOME-PRETAX> 2,884,153
<INCOME-PRE-EXTRAORDINARY> 2,884,153
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,805,483
<EPS-PRIMARY> .71
<EPS-DILUTED> .70
<YIELD-ACTUAL> 0
<LOANS-NON> 938,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,380,000
<ALLOWANCE-OPEN> 1,080,000
<CHARGE-OFFS> 421,000
<RECOVERIES> 71,000
<ALLOWANCE-CLOSE> 1,117,000
<ALLOWANCE-DOMESTIC> 1,117,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
