<PAGE>
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
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FORM 10-K
Mark One
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
[_] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to _______________
Commission File Number: 0-18279
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TRI-COUNTY FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Maryland 52-1652138
- --------------------------------------------- -------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
3035 Leonardtown Road, Waldorf, Maryland 20601
- ---------------------------------------- ------------
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (301) 645-5601
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of Class)
Indicate by check mark whether the registrant (l) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 10, 1997, there were issued and outstanding 754,984
shares of the registrant's common stock.
The registrant's voting stock is not regularly and actively traded in
any established market and there are no regularly quoted bid and asked prices
for the registrant's common stock. The registrant believes the approximate
trading price for the stock to be $22.11 per share for an approximate aggregate
market value of voting stock held by non-affiliates of the registrant of $12.9
million. For purposes of this calculation, the shares held by directors and
executive officers of the registrant and by any stockholder beneficially owning
more than 5% of the registrant's outstanding common stock are deemed to be
shares held by affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended
December 31, 1996. (Parts I and II)
2. Portions of Proxy Statement for the 1997 Annual Meeting of Stockholders.
(Part III)
<PAGE>
PART I
ITEM 1. BUSINESS
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The Corporation. Tri-County Financial Corporation (the "Corporation")
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was incorporated under the laws of the State of Maryland on September 13, 1989
for the purpose of becoming the holding company of Tri-County Federal Savings
Bank of Waldorf ("Tri-County Federal" or the "Savings Bank"). Prior to the
acquisition of all of the outstanding stock of the Savings Bank on February 2,
1990, the Corporation had no assets or liabilities and engaged in no business
activities. Following its acquisition of Tri-County Federal, the Corporation has
engaged in no significant activity other than holding the stock of the Savings
Bank and operating the business of a savings institution through the Savings
Bank. Accordingly, the information set forth in this report, including
financial statements and related data, relates primarily to the Savings Bank and
its subsidiary.
The Corporation's executive offices are located at 3035 Leonardtown
Road, Waldorf, Maryland. Its telephone number is (301) 645-5601.
The Savings Bank. Tri-County Federal was originally chartered by the
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State of Maryland in 1951. The Savings Bank has been a member of the Federal
Home Loan Bank System since 1957 and its savings deposits are insured by the
Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance
Corporation ("FDIC"). In November 1986 the Savings Bank converted to a capital
stock savings and loan association and in May 1988 Tri-County Federal converted
from a federal savings and loan association to a federal savings bank. The
Savings Bank is subject to comprehensive regulation, examination and supervision
by the Office of Thrift Supervision ("OTS") and the FDIC.
Tri-County Federal is primarily engaged in the business of obtaining
funds in the form of savings deposits and investing such funds in mortgage loans
on residential, construction and commercial real estate and various types of
consumer and other loans, mortgage-backed securities, and investment and money
market securities.
RECENT DEVELOPMENTS
Pending Charter Conversion. On October 30, 1996, the Board of
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Directors of the Savings Bank unanimously adopted a Plan of Conversion whereby
the Savings Bank will convert to a Maryland-chartered commercial bank (the
"Charter Conversion") to be known as "Community Bank of Tri-County" (the
"Bank"). The Savings Bank filed the required applications with the Maryland
Commissioner of Financial Regulation and preliminary approval of the Charter
Conversion was granted on January 24, 1997. The Bank has also applied to become
a member of the Federal Reserve System. As a result of the Charter Conversion,
the Corporation will become a bank holding company. The Corporation filed an
application to become a bank holding company with the Board of Governors of the
Federal Reserve ("FRB"). The Bank's Federal Reserve Membership Application and
the Corporation's Bank Holding Company Application were approved on March 7,
1997. Following the Charter Conversion, both the Bank and the Corporation will
be regulated by the FRB. See "Regulation." The Charter Conversion will allow
the Bank more flexibility in the types of loans it is permitted to make as it
will no longer be required to meet the Qualified Thrift Lender Test. See
"Regulation -- Qualified Thrift Lender Test." Specifically, the Bank will be
permitted to increase its consumer and commercial lending and will be better
able to offer products to its small business and retail customers. For further
discussion regarding expected changes in asset composition and deposit accounts,
see "Management's Discussion and Analysis -- General" in the Registrant's Annual
Report to Stockholders for the Fiscal Year Ended December 31, 1996 (the "Annual
Report"), incorporated herein by reference.
Branch Openings. The Savings Bank opened a new branch in Bryans Road,
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Maryland on October 18, 1996. In February 1997, the Bank opened its first
"micro" branch, utilizing limited square footage to provide full customer
service, at a local community college. This brings eight full service
facilities to its southern Maryland network. Additionally, the Bank has a stand
alone ATM at a local convenience store and is investigating future locations
throughout its market.
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LENDING AND INVESTMENT ACTIVITIES
GENERAL. The principal lending activity of Tri-County Federal is the
origination of single family conventional mortgage loans (i.e., loans that are
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neither insured nor partially guaranteed by government agencies). To a lesser
extent, the Savings Bank also makes second mortgage loans, consumer loans, home
equity loans, construction loans, and loans secured by multi-family dwellings
and commercial real estate.
The Savings Bank offers real estate loans with both fixed and
adjustable rates. The Savings Bank's fixed-rate real estate loans may be
packaged for resale in the secondary market or securitized for outside
borrowings. The Savings Bank has also purchased mortgage-backed securities.
GEOGRAPHIC LENDING AREA. Tri-County Federal is authorized to make
real estate loans throughout the United States, provided the Savings Bank
continues to meet the provisions of the Community Reinvestment Act to serve the
communities in which it operates offices. The Savings Bank's lending area
consists of Charles, Calvert and St. Mary's counties in Maryland.
RESIDENTIAL REAL ESTATE LOANS. The primary lending activity of the
Savings Bank is the granting of conventional loans to enable borrowers to
purchase existing homes. At December 31, 1996, approximately 79% of the Savings
Bank's total loan portfolio consisted of loans secured by single family
dwellings, including those underlying mortgage-backed securities.
Mortgage loans made by the Savings Bank are generally long-term loans,
amortized on a monthly basis, with principal and interest due each month. The
initial contractual loan payment period for residential loans typically ranges
from 10 to 30 years. The Savings Bank's experience indicates that real estate
loans remain outstanding for significantly shorter periods than their
contractual terms. Borrowers may refinance or prepay loans at their option,
subject to any prepayment penalty provisions included in the note.
Tri-County Federal aggressively markets adjustable-rate loans. Loans
originated in 1996 have rate adjustments based upon a United States Treasury
bill index; certain of the Savings Bank's loans originated prior to 1996 have
rate adjustments based upon the Savings Bank's cost of funds. As of December
31, 1996, the Savings Bank had $453,687 in loans using the cost of funds index
and $37 million in loans using a U.S. Treasury bill index. The Savings Bank
offers mortgages which are adjustable on a one, a three and a five year basis
with limitations on upward adjustments of 2% per year and 6% over the life of
the loan. The Savings Bank also offers long term fixed rate loans. The fixed
rate loans may be packaged and sold in the secondary market, primarily to the
Federal Home Loan Mortgage Corporation ("FHLMC"), private mortgage
correspondents and the Federal National Mortgage Association ("FNMA") or are
exchanged for FHLMC participation certificates or FNMA mortgage-backed
securities.
The retention of adjustable-rate mortgage loans in the Savings Bank's
loan portfolio helps reduce the Savings Bank's exposure to increases in interest
rates. However, there are unquantifiable credit risks resulting from potential
increased costs to the borrower as a result of repricing of adjustable-rate
mortgage loans. It is possible that during periods of rising interest rates,
the risk of default on adjustable-rate mortgage loans may increase due to the
upward adjustment of interest cost to the borrower.
The Savings Bank makes loans up to 95% of appraised value or sales
price of the property, whichever is less, to qualified owner occupants upon the
security of single family homes. Non-owner occupied one to four family loans
and loans secured by other than residential real estate are generally permitted
to a maximum 70% loan-to-value of the appraised value depending on the overall
strength of the application. The Savings Bank currently requires that all
residential loans with loan to value ratios in excess of 80% carry private
mortgage insurance down to 67% of the value of the property.
All improved real estate which serves as security for a loan made by
the Savings Bank must be insured, in the amount and by such companies as may be
approved by the Savings Bank, against fire, vandalism, malicious
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mischief and other hazards. Such insurance must be maintained through the entire
term of the loan and in an amount not less than that amount necessary to pay the
Savings Bank's indebtedness in full.
The Savings Bank has maintained a stable level of home equity loans in
recent years. These loans, which totalled $14.1 million at December 31, 1996,
are generally made in minimum amounts of $5,000, have terms of up to 20 years,
variable rates priced at prime or some margin above prime and require an 80% or
90% loan-to-value ratio, depending on the specific loan program. It is expected
that under the business plan of the Community Bank, management will focus its
efforts to grow this product by 20% per year over the next five years.
COMMERCIAL REAL ESTATE AND OTHER NON-RESIDENTIAL REAL ESTATE LOANS.
Under applicable law, a federally chartered savings association is permitted to
make loans on the security of liens on non-residential real property in an
amount not exceeding 400% of the institution's capital. The Director of the OTS
may permit savings associations to exceed this limit in certain circumstances.
Following the Charter Conversion, this limit will not apply to the Bank.
The Savings Bank has been giving increased emphasis to loans for the
construction and permanent financing of commercial and other improved real
estate projects, including, to a limited extent, office buildings, as well as
churches and other special purpose projects. As a result, commercial real
estate loans increased $1.5 million or 13% during 1996. The primary security on
a commercial real estate loan is the real property and the leases which produce
income for the real property. Commercial real estate loans amounted to
approximately $13.1 million or 8.4% of the Savings Bank's loan portfolio at
December 31, 1996. The Savings Bank generally limits its portion of these loans
to $1.5 million and frequently participates with other lenders on larger
projects. Loans secured by commercial real estate are generally limited to 75%
of appraised value and generally have an initial contractual loan payment period
ranging from three to 20 years. Virtually all of the Savings Bank's commercial
real estate loans, as well as its construction loans discussed below, are
secured by real estate located in the Savings Bank's primary market area.
Loans secured by commercial real estate are larger and involve greater
risks than one- to four-family residential mortgage loans. Because payments on
loans secured by such properties are often dependent on the successful operation
or management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Savings Bank restricts its commercial real estate lending primarily to owner
occupied buildings as opposed to speculative rental projects.
CONSTRUCTION LOANS. Tri-County Federal offers construction loans to
individuals and building contractors primarily for the construction of one- to
four-family dwellings. These loans have constituted a significant portion of
the Savings Bank's loan originations in recent years. Most of these loans are
construction/permanent loans which have fixed rates, payable monthly for the
construction period and are followed by a 30 year fixed or adjustable rate
permanent loan. Most construction loans provide for disbursement of loan funds
based on draw requests submitted by the builder during construction and site
inspections by independent inspectors. The Savings Bank will also make a
construction loan if the borrower has a commitment from another lender for a
permanent loan at the completion of the construction. These loans typically
have terms of six months. The application process includes the same items which
are required for other mortgage loans and also requires the borrower to submit
to the Savings Bank accurate plans, specifications, and costs of the property to
be constructed. These items are used as a basis to determine the appraised
value of the subject property. Construction loans totalled $10.2 million, or
6.5% of the Savings Bank's loan portfolio, at December 31, 1996.
Construction financing involves a higher degree of risk than long-term
financing on improved, occupied real estate. Tri-County Federal's risk of loss
on a construction loan is dependent primarily upon the accuracy of the initial
estimate of the property's value at completion of construction or development
and the estimated cost, including interest, of completion. If the estimate of
construction costs proves to be inaccurate, the Savings Bank may be required to
advance funds beyond the amount originally committed to permit completion of the
project. If the estimate of value proves to be inaccurate, the project may have
a value which is insufficient to assure full repayment of the loan.
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The Savings Bank also offers builders lines of credit, which are
revolving notes generally secured by real property. Outstanding builders lines
of credit amounted to approximately $3.8 million at December 31, 1996. The
Savings Bank offers a builder's master note program in which the builder
receives a revolving line of credit at a rate over prime and the Savings Bank
obtains security in the form of a first lien on home sites under construction.
At December 31, 1996, $2.8 million in such loans were outstanding. The
increased activity in builders lines of credit in 1996 was largely due to the
favorable economic conditions and growth in the Savings Bank's market area.
In addition, the Savings Bank offers loans for the purpose of
acquisition and development of land, as well as loans on undeveloped, subdivided
lots for home building by individuals. Land acquisition and development loans
totalled $11 million at December 31, 1996. The Savings Bank originated
approximately $1.2 million of lot loans during 1996, which consisted of 25 loans
secured by land in the Savings Bank's market area, the largest of which had a
balance of $93,000 at December 31, 1996.
Land acquisition and development lending generally involves a higher
degree of credit risk than lending on existing residential properties due to the
concentration of principal in a limited number of loans and borrowers and the
effects of general economic conditions on development projects.
CONSUMER AND COMMERCIAL LOANS. Federal regulations generally permit
Tri-County Federal to make secured and unsecured consumer loans up to 35% of its
assets, and commercial loans up to 10% of its assets. These limitations will
not apply following the Charter Conversion. The Savings Bank has developed a
number of programs to serve the needs of its customers with primary emphasis
upon loans secured by automobiles, boats, recreational vehicles and trucks and
heavy equipment. The Savings Bank also makes home improvement loans and offers
both secured and unsecured lines of credit.
The Savings Bank also offers a variety of commercial loan services
including term loans, lines of credit and equipment financing. The Savings
Bank's commercial loans are primarily underwritten on the basis of the
borrower's ability to service the debt from income. Such loans are generally
made for terms of five years or less at interest rates which adjust
periodically.
The Savings Bank believes that the shorter terms and the normally
higher interest rates available on various types of consumer and commercial
business loans have been helpful in maintaining a profitable spread between the
Savings Bank's average loan yield and its cost of funds. Consumer and
commercial business loans do, however, entail greater risk than do residential
mortgage loans, particularly in the case of consumer loans which are unsecured
or secured by rapidly depreciable assets such as automobiles. In such cases,
any repossessed collateral may not provide an adequate source of repayment of
the outstanding loan balance as a result of the greater likelihood of damage,
loss or depreciation. The remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by 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 such as the
Savings Bank, and a borrower may be able to assert against such assignee claims
and defenses which it has against the seller of the underlying collateral.
4
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LOAN PORTFOLIO ANALYSIS. Set forth below is selected data relating to
the composition of the Savings Bank's loan and mortgage-backed certificates
portfolio by type of loan and type of security on the dates indicated.
<TABLE>
<CAPTION>
At December 31,
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1996 1995 1994
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(In thousands)
<S> <C> <C> <C>
TYPE OF LOAN:
Conventional Real Estate Loans --
Interim Construction Loans............ $ 15,486 $ 18,965 $ 17,680
Loans on Existing Property(1)(2)...... 131,787 126,273 123,060
Builders Line of Credit................. 3,810 3,540 3,416
Commercial Line of Credit............... 4,061 3,543 3,620
Mortgage-Backed Certificates............ 43,354 31,955 29,934
Consumer Loans --
Home Improvement Loans................ 40 58 86
Automobile and other Vehicle
and Equipment Loans.................. 5,326 4,747 3,690
Other................................. 56 36 27
Less --
Participations Sold................... 40,996 42,842 46,011
Loans in Process...................... 5,327 4,599 5,086
Deferred Loan Fees.................... 1,086 1,172 1,228
Loan Loss Reserve..................... 1,120 733 564
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Total............................... $155,391 $139,771 $128,624
======== ======== ========
TYPE OF SECURITY:
Residential --
1-to-4 Family(1)...................... $125,778 $129,447 $121,374
Other Dwelling Units.................. 4 22 32
Mortgage-Backed Certificates.......... 43,354 31,955 29,934
Commercial and other Real Estate(3)..... 13,079 11,656 13,664
Developed Lots, Acquisition and
Development of Land, Unimproved Land.. 12,222 7,807 9,215
Automobile and other Vehicle and
Equipment Loans....................... 5,326 4,747 3,690
Unsecured Consumer Loans................ 96 36 27
Commercial Loans........................ 4,061 3,447 3,577
Less --
Participations Sold................... 40,996 42,842 46,011
Loans in Process...................... 5,327 4,599 5,086
Deferred Loan Fees.................... 1,086 1,172 1,228
Loan Loss Reserve..................... 1,120 733 564
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Total............................... $155,391 $139,771 $128,624
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</TABLE>
(1) Includes construction loans converted to permanent loans.
(2) Includes $14.1 million, $12.2 million and $12.4 million in home equity
loans at December 31, 1996, 1995 and 1994, respectively.
(3) Includes church loans.
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LOAN SOLICITATION AND PROCESSING. The Savings Bank actively solicits
mortgage loan applications from existing customers, local real estate agents,
contractors and real estate developers. In addition, the Bank has several
commissioned loan officers who originate loans with laptop computers to produce
additional loan volume. Loan processing is centralized at the Savings Bank's
main office. Upon receipt of a loan application from a prospective borrower, a
credit report and verifications are ordered to verify specific information
relating to the loan applicant's employment, income and credit standing. An
appraisal of the real estate intended to secure the proposed loan is undertaken
by a staff or an independent fee appraiser. The Savings Bank recently
contracted with FHLMC to utilize its Prospector Software and Purchase program.
This provides the Savings Bank with faster loan approval turnaround and
competitive pricing of loans.
The Savings Bank's President has the authority to approve loans in amounts
up to $500,000. The Savings Bank's Senior Vice Presidents individually have the
authority to approve loans in amounts up to $207,000 and any two can approve
loans up to $300,000. Vice Presidents have loan authority of $100,000. A loan
committee, consisting of the President and two members of the Board of Directors
on a rotating basis, ratify all real estate mortgage loans and all other large
(in excess of $100,000) loans.
Loan applicants are promptly notified of the decision of the Savings Bank
by a letter setting forth the terms and conditions of the decision. If
approved, these terms and conditions include the amount of the loan, interest
rate, amortization term, a brief description of real estate to be mortgaged to
the Savings Bank, and the notice of requirement of insurance coverage to be
maintained to protect the Savings Bank's interest. Title insurance is required
on all loans except second mortgages and home equity loans. Hazard insurance
policies are required on all loans in an amount equal to the lesser of the loan
balance or the replacement value of the structure.
LOAN ORIGINATIONS, PURCHASES AND SALES. The Savings Bank actively
originates mortgage loans primarily for its own portfolio, and, periodically,
for sale in the secondary mortgage market. At December 31, 1996, the Savings
Bank was servicing approximately $41 million of loans for others. Fee income
from loan servicing totalled approximately $150,000 during 1996. The Savings
Bank has periodically purchased whole loans, participation interests in loans
and participation certificates. In recent years, the Savings Bank has
participated in several residential home construction loans with other well
capitalized lenders. Approximately $1.2 million of such loans was outstanding at
December 31, 1996. These participation loans are for commercial real estate as
well as the acquisition and development of residential properties located in
Maryland and the construction of housing stock on a pre sold basis. These loans
have competitively priced terms and various maturity structures.
The following table sets forth the Savings Bank's loan origination and
sales activity for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
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1996 1995 1994
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(In thousands)
<S> <C> <C> <C>
Loans originated:
Conventional real estate loans:
Construction loans............. $ 9,885 $12,180 $11,106
Loans on existing property..... 18,092 18,996 17,011
Loans refinanced............... 2,182 2,805 9,018
Land loans..................... 1,167 1,142 6,000
Builder lines of credit.......... 15,360 10,752 11,051
Commercial lines of credit....... 3,594 3,096 2,218
Non-residential mortgage loans... 6,691 1,920 3,800
Consumer loans................... 3,175 3,246 2,991
Other............................ 115 146 113
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Total loans originated.......... $60,261 $54,283 $63,308
======= ======= =======
Loans sold:
Participation loans.............. $ -- $ -- --
Whole loans...................... 8,695 5,284 2,410
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Total loans sold................ $ 8,695 $ 5,284 $ 2,410
======= ======= =======
</TABLE>
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The Savings Bank occasionally packages some fixed rate loans it
originates into mortgage participation certificates or direct sales utilizing
the FHLMC, FNMA and private mortgage correspondents as its secondary market
buyer. During 1996, the Savings Bank sold $8.7 million of loans under direct
sales agreements. Following the Charter Conversion, management anticipates that
originations of consumer and business loans will increase. For further
information, see "Management's Discussion and Analysis" in the Annual Report.
LOAN COMMITMENTS. The Savings Bank does not normally negotiate
standby commitments for the construction and purchase of real estate.
Conventional loan commitments are granted for a one month period. The total
amount of the Savings Bank's outstanding commitments to originate real estate
loans at December 31, 1996, was approximately $1.2 million, excluding
undisbursed portions of loans in process. It has been the Savings Bank's
experience that few commitments expire unfunded.
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain
information at December 31, 1996 regarding the dollar amount of loans maturing
in the Savings Bank's portfolio based on their contractual terms to matu rity.
Demand loans (loans having no stated schedule of repayments and no stated
maturity) are reported as due in one year or less.
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<TABLE>
<CAPTION>
Due after Due after Due after Due after Due more
Due within 1 through 3 3 through 5 5 through 10 10 through 15 than 20
1 year after years from years from years from years from years from
December December December December December December
31, 1996 31, 1996 31, 1996 31, 1996 31, 1996 31, 1996 Total
------------ ----------- ----------- ------------ ------------- ---------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Real Estate Mortgage......... $ 11,827 $ 28,477 $ 45,958 $ 17,987 $ 50,604 $ 16,640 $171,493
Real Estate Construction(1) 15,486 -- -- -- -- -- 15,486
Installment 277 2,186 2,109 720 55 -- 5,347
Commercial, Financial
and Agricultural............ 4,061 -- -- -- -- -- 4,061
Participations sold (1,460) -- (1,988) (8,326) (29,222) -- (40,996)
--------- --------- --------- --------- --------- ---------- --------
$ 30,191 $ 30,663 $ 46,079 $ 10,381 $ 21,437 $ 16,640 $155,391
========= ========= ========= ========= ========= ========== ========
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</TABLE>
(1) Includes builder lines of credit.
The next table sets forth the dollar amount of all loans due after one year
from December 31, 1996 which have predetermined interest rates and have floating
or adjustable interest rates.
<TABLE>
<CAPTION>
Floating or
Fixed Rates Adjustable Rates Total
------------ ---------------- ---------
(In thousands)
<S> <C> <C> <C>
Real Estate Mortgage...... $133,922 $25,744 $159,666
Real Estate Construction.. -- -- --
Installment............... 5,070 -- 5,070
Commercial, Financial
and Agricultural......... -- -- --
Participations Sold....... (39,536) -- (39,536)
-------- ------- --------
$ 99,456 $25,744 $125,200
======== ======= ========
</TABLE>
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LOAN ORIGINATION FEES. In addition to interest earned on loans, the
Savings Bank receives loan origination fees and discounts for originating loans
which are computed as a percentage of the principal amount of the mortgage loan
and are charged to the borrower for creation of the loan.
The Savings Bank's loan origination fees and discounts are generally
2% to 3% on conventional residential mortgages and 1% to 2% for commercial real
estate loans. Loan origination and loan commitment fees are volatile sources of
income. Such fees vary with the volume and type of loans and commitments made
and purchased and with competitive conditions in mortgage markets which, in
turn, tend to vary in response to the demand and availability of money. The
Savings Bank has experienced a decrease in loan fee income during periods of
unusually high interest rates due to the resulting lack of demand for mortgage
loans.
The Savings Bank receives other fees and charges relating to existing
loans, late charges, and fees collected in connection with a change in borrower
or other loan modifications. These fees and charges have not constituted a
material source of income for the Savings Bank.
DELINQUENCIES. The Savings Bank's collection procedures provide that
when a loan is 15 days delinquent, the borrower is contacted by mail and payment
is requested. If the delinquency continues, subsequent efforts will be made to
contact the delinquent borrower. In certain instances, the Savings Bank will
modify the loan or grant a limited moratorium on loan payments to enable the
borrower to reorganize his financial affairs. If the loan continues in a
delinquent status for 90 days or more, the Savings Bank will generally initiate
foreclosure proceedings.
NON-PERFORMING ASSETS AND ASSET CLASSIFICATION. Loans are reviewed on
a regular basis and are placed on a non-accrual status when, in the opinion of
management, the collection of additional interest is doubtful. Residential
mortgage loans are placed on non-accrual status when either principal or
interest is 90 days or more past due unless they are adequately secured and
there is reasonable assurance of full collection of principal and interest.
Consumer loans generally are charged off when the loan becomes over 120 days
delinquent. Commercial business and real estate loans are placed on non-accrual
status when the loan is 90 days or more past due. Interest accrued and unpaid
at the time a loan is placed on non-accrual status is charged against interest
income. Subsequent payments are either applied to the outstanding principal
balance or recorded as interest income, depending on the assessment of the
ultimate collectibility of the loan.
Real estate acquired by the Savings Bank as a result of foreclosure or
by deed in lieu of foreclosure is classified as foreclosed real estate until
such time as it is sold. When such property is acquired, it is recorded at its
fair market value. Subsequent to foreclosure, the property is carried at the
lower of cost or fair value less selling costs. Any write-down of the property
at foreclosure is charged to the allowance for losses. The Savings Bank had
foreclosed real estate with a fair market value of approximately $155,000 at
December 31, 1996.
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The following table sets forth information with respect to the Savings
Bank's non-performing assets for the periods indicated. During the periods
shown, the Savings Bank had no restructured loans within the meaning of
Statement of Financial Accounting Standards No. 15.
<TABLE>
<CAPTION>
At December 31,
-----------------------
1996 1995 1994
------ ------ -------
(In thousands)
<S> <C> <C> <C>
Accruing loans which are contractually
past due 90 days or more:
Real Estate:
Residential.................................. $ 262 $ 226 $ --
Commercial................................... -- -- --
Commercial Business........................... -- -- --
Consumer...................................... 79 -- --
----- ----- ------
Total....................................... $ 341 $ 226 $ --
===== ===== ======
Percentage of Total Loans....................... .32% .21% --%
===== ===== ======
Loans accounted for on a nonaccrual basis: (1)
Real Estate:
Residential.................................. $ 358 $ 323 $1,023
Commercial Business.......................... -- -- 98
Consumer..................................... -- 17 19
----- ----- ------
Total....................................... 358 340 1,140
----- ----- ------
Total nonperforming loans....................... $ 699 $ 566 $1,140
===== ===== ======
- --------------------
</TABLE>
(1) Nonaccrual status denotes loans on which, in the opinion of management, the
collection of additional interest is unlikely, or loans that meet
nonaccrual criteria as established by regulatory authorities.
During the fiscal year ended December 31, 1996, gross interest income of
$14,000 would have been recorded on loans accounted for on a non-accrual basis
if the loans had been current throughout the period. No interest on such loans
was included in income during 1996.
10
<PAGE>
The following table sets forth an analysis of the Savings Bank's allowance
for possible loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1996 1995 1994
--------- ------- ------
(In thousands)
<S> <C> <C> <C>
Balance at Beginning of Period............. $ 734 $ 564 $ 450
------ ----- -----
Loans Charged-Off:
Real Estate:
Residential.............................. 17 34 28
Commercial............................... -- -- --
Commercial Business....................... -- -- 10
Consumer.................................. 5 12 4
------ ----- -----
Total Charge-Offs.......................... 22 46 42
------ ----- -----
Recoveries:
Real Estate:
Residential............................ -- 2 --
Commercial............................. -- -- --
Commercial Business...................... -- -- --
Consumer................................. -- 4 2
------ ----- -----
Total Recoveries........................... -- 6 2
------ ----- -----
Net Loans Charged-Off...................... 22 40 40
------ ----- -----
Provision for Possible Loan Losses........ 408 210 154
------ ----- -----
Balance at End of Period................... $1,120 $ 734 $ 564
====== ===== =====
Ratio of Net Charge-Offs to Average Loans
Outstanding During the Period............ .02% .04% .03%
====== ===== =====
</TABLE>
11
<PAGE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------
1996 1995 1994
---------------------- ---------------------- ----------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ -------------- ------ -------------- ------ --------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real Estate:
Residential........................... $ 786 78.6% $694 81.1% $527 78.3%
Commercial and other.................. 240 15.4 -- 13.1 -- 16.1
Commercial and unsecured................ 41 2.6 -- 2.5 -- 2.8
Consumer................................ 53 3.4 40 3.3 37 2.8
------ ----- ------ ----- ------ -----
Total allowance for loan losses.. $1,120 100.0% $734 100.0% $564 100.0%
====== ===== ====== ===== ====== =====
</TABLE>
12
<PAGE>
The Savings Bank closely monitors the loan payment activity of all its
loans. Any consumer loan which is determined to be uncollectible is charged off
against the loss reserve. A loan loss reserve is provided by a monthly accrual
based on analysis of the loan portfolio characteristics and industry norms. The
reserve was increased by the Savings Bank at year end to approximately 1% of
outstanding loan balances. This measure was deemed prudent to achieve a
sufficient reserve level commensurate with the Bank's portfolio risk.
Federal regulations require each savings association to classify its
own assets on a regular basis. In addition, in connection with examinations of
savings associations, OTS examiners have authority to identify problem assets
and, if appropriate, classify them. The regulations provide for three asset
classification categories (i.e., substandard, doubtful and loss). The
----
regulations also have a "special mention" category, described as assets which do
not currently expose an insured institution to a sufficient degree of risk to
warrant classification, but do possess credit deficiencies or potential
weaknesses deserving management's close attention. Assets classified as
substandard or doubtful require the institution to establish general allowances
for loan losses. If an asset or portion thereof is classified loss, the savings
association must either establish specific allowances for loan losses in the
amount of 100% of the portion of the asset classified loss, or charge off such
amount. General loss allowances established to cover possible losses related to
assets classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital. OTS examiners may disagree with
the insured institution's classifications and amounts reserved. Based on
management's review of the Savings Bank's loan portfolio, $684,000 and $15,000
of assets were classified as substandard and doubtful, respectively, and no
assets were classified as loss at December 31, 1996.
Real estate market conditions in the Savings Bank's market have
experienced an increase in activity in recent months, due primarily to increases
in job creation in the Savings Bank's market area caused by action taken on the
recommendation of the Base Closure and Realignment Committee of Congress which
has increased employment at the local naval base.
While the Savings Bank believes it has established its existing
allowances for loan losses in accordance with generally accepted accounting
principles, there can be no assurance that regulators, in reviewing the Savings
Bank's loan portfolio, will not request the Savings Bank to significantly
increase its allowance for loan losses, thereby negatively affecting the Savings
Bank's financial condition and earnings.
INVESTMENT ACTIVITIES
Interest income from cash deposits and investment securities generally
provides the second largest source of income for Tri-County Federal after
interest payments on loans. At December 31, 1996, Tri-County Federal's
interest-bearing cash and investment securities portfolio of $16 million
consisted of deposits in other financial institutions, corporate equity
securities, mutual funds and obligations of U.S. Government Corporations and
agencies. The Savings Bank is in compliance with applicable liquidity
requirements. Following the Charter Conversion, the Bank will be subject to
regulations severely restricting its ability to purchase and hold equity
securities. See "Regulation -- Investment Restrictions."
Tri-County Federal is required under federal regulations to maintain a
minimum amount of liquid assets which may be invested in specified short-term
securities and is also permitted to make certain other investments. See
"Regulation -- Liquidity Requirements" below and "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity" in the
Corporation's Annual Report. It has been Tri-County Federal's policy in the
past to maintain a liquidity portfolio above federal regulatory requirements,
and at December 31, 1996, the Savings Bank's liquidity exceeded federal
requirements by $1.5 million. Investment decisions are made by authorized
officers of the Savings Bank under the supervision of the Savings Bank's Board
of Directors. Brokers periodically approved by the Board of Directors are used
to effect securities transactions. See Notes 1 and 2 of Notes to Consolidated
Financial Statements.
13
<PAGE>
The following table sets forth the carrying value of the Corporation's
investment securities portfolio, interest-bearing cash, and FHLB stock at the
dates indicated. At December 31, 1996, the market value of the Corporation's
investment securities portfolio and FHLB Stock was $13.4 million.
<TABLE>
<CAPTION>
At December 31,
-------------------------
1996 1995 1994
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Investment securities:
Investment in Asset Management Funds.. $ 4,531 $ 4,195 $ 2,814
FHLMC, FNMA, SLMA, FHLB and Federal
Farm Credit Notes................... 5,320 9,388 11,406
Federal Home Loan Bank of Atlanta
and Federal Home Loan Mortgage
Corporation Stock................... 2,267 1,781 1,635
Treasury Bills........................ 640 421 291
Other investments..................... 671 -- --
------- ------- -------
Total Investment Securities and
FHLB Stock...................... $13,429 $15,785 $16,146
------- ------- -------
Interest bearing cash................... $ 2,792 $ 3,264 $ 3,191
------- ------- -------
Total investment securities,
interest-bearing cash and FHLB
Stock............................. $16,221 $19,049 $19,337
======= ======= =======
</TABLE>
The following table sets forth the carrying values, market values and
average yields for the Company's investment securities at December 31, 1996.
<TABLE>
<CAPTION>
Total Investment Securities
----------------------------
Carrying Market Average
Value Value Yield
--------- ------- --------
(Dollars in Thousands)
<S> <C> <C> <C>
Obligations of U.S. Government
Corporations.................. $ 5,320 $ 5,320 6.39%
Mutual Funds.................... 4,531 4,531 6.06
Interest Earning Cash........... 2,792 2,792 5.30
Treasury Bills.................. 640 640 5.19
FHLB, FHLMC and FNMA Stock...... 2,267 2,267 6.77
Other investments............... 671 671 8.30
------- ------- ----
Total....................... $16,221 $16,221 6.20%
======= ======= ====
</TABLE>
The Savings Bank's investment policy provides that securities that
will be held for indefinite periods of time, including securities that will be
used as part of the Savings Bank's asset/liability management strategy and that
may be sold in response to changes in interest rates, prepayments and similar
factors, are classified as available for sale and accounted for at the fair
value. Management's intent is to hold securities reported at amortized cost to
maturity.
For further information regarding the Corporation's investment
securities, see Notes 1 and 2 of Notes to Consolidated Financial Statements.
14
<PAGE>
SAVINGS ACTIVITIES AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the major source of Tri-County Federal's funds
for lending and other investment purposes. In addition to deposits, Tri-County
Federal derives funds from loan principal repayments, advances from the FHLB of
Atlanta and other borrowings. Loan repayments are a relatively stable source of
funds, while deposit inflows are significantly influenced by general interest
rates and money market conditions. Borrowings may be used on a short term basis
to compensate for reductions in the availability of other sources of funds.
They may also be used on a longer term basis for general business purposes.
DEPOSITS. Deposits are solicited throughout the Savings Bank's market
area through the Savings Bank's branch system. The Savings Bank offers a wide
variety of deposit accounts with terms that vary, with the principal differences
being the minimum balance required, the time periods the funds must remain on
deposit and the interest rate. To date, the Savings Bank has not obtained any
funds through brokers. In recent years, the Savings Bank has relied
increasingly on newly authorized types of short-term accounts and other savings
alternatives that are responsive to changes in market rates of interest. For a
more detailed discussion of anticipated changes in deposit account activity
following the Charter Conversion, refer to "Management's Discussion and Analysis
- -- General" in the Annual Report.
ADVANCES. With its membership in the FHLB, the Bank utilizes
wholesale borrowings to fund specific loans, such as acquisition and development
loans. In addition, to prudently leverage its net worth, the Bank matches
certain authorized investments with corresponding borrowings from the FHLB for a
managed spread.
15
<PAGE>
The following table sets forth the change in dollar amount of savings
deposits in the various types of savings accounts offered by the Savings Bank
between the dates indicated.
<TABLE>
<CAPTION>
Balance at Balance at Balance at
December 31, % of Increase December 31, % of Increase December 31, % of
1996 Deposits (Decrease) 1995 Deposits (Decrease) 1994 Deposits
------------ --------- ----------- ------------ ----------- ---------- ------------ ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NOW checking accounts....... $ 18,581 13.8% $ 2,214 $ 16,367 12.6% $ 318 $ 16,049 12.7%
Jumbo certificates.......... 2,411 1.8 344 2,067 1.6 200 1,867 1.5
Passbook and regular
savings................... 28,190 20.9 (10,666) 38,856 30.0 (6,102) 44,958 35.7
Money market deposit
accounts.................. 10,844 8.0 7,869 2,975 2.3 (201) 3,176 2.5
6-month money market
certificates.............. 236 .2 (1,141) 1,377 1.1 (1,679) 3,056 2.4
IRA and Keough Accounts..... 1,041 .8 (332) 1,373 1.1 (352) 1,725 1.4
Other certificate accounts.. 73,516 54.5 7,183 66,333 51.3 11,095 55,238 43.8
-------- ----- -------- -------- ----- ------- -------- -----
$134,819 100.0% $ 5,471 $129,348 100.0% $ 3,279 $126,069 100.0%
======== ===== ======== ======== ===== ======= ======== =====
</TABLE>
16
<PAGE>
The following table indicates the amount of the Savings Bank's
certificates of deposit and other time deposits of $100,000 or more by time
remaining until maturity as of December 31, 1996.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- --------------
(In thousands)
<S> <C>
One through three months... $ 1,278
Three through six months... 3,066
Six through twelve months.. 3,303
Over twelve months......... 5,837
-------
Total.................... $13,484
=======
</TABLE>
The $13.5 million balance in the Savings Bank's certificates and other
time deposits of $100,000 or more differs from the balance of the Savings Bank's
jumbo certificates of deposit because jumbo certificates represent a separate
category of deposits which are negotiated by the Savings Bank for a specific
term and rate.
The following table sets forth the Savings Bank's certificates of
deposits classified by rates as of the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-------------------------
1996 1995 1994
------- ------- -------
(In thousands)
<S> <C> <C> <C>
2.00 - 3.99%.. $ 5,347 $ 7,241 $13,936
4.00 - 5.99... 56,305 43,116 39,917
6.00 - 7.99... 15,552 20,483 6,649
8.00 - 9.99... -- 309 1,384
------- ------- -------
$77,204 $71,149 $61,886
======= ======= =======
</TABLE>
The following table sets forth the amount and maturities of the Savings
Bank's time deposits at December 31, 1996.
<TABLE>
<CAPTION>
Amount Due
-------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
---- --------- --------- --------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C>
2.00 - 3.99%.. $ 5,347 $ -- $ -- $ -- $ 5,347
4.00 - 5.99... 24,446 18,845 8,734 4,280 56,305
6.00 - 7.99... 5,791 5,841 217 3,703 15,552
------- ------- ------ ------ -------
$35,584 $24,686 $8,951 $7,983 $77,204
======= ======= ====== ====== =======
</TABLE>
17
<PAGE>
The following table sets forth the savings activities of the Savings
Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1996 1995 1994
-------- --------- --------
(In thousands)
<S> <C> <C> <C>
Deposits........................................... $362,188 $318,549 $272,606
Withdrawals........................................ 362,163 320,445 271,104
-------- -------- --------
Net increase (decrease) before interest credited.. $ 25 $ (1,896) $ 1,502
Interest credited.................................. 5,446 5,175 4,550
-------- -------- --------
Net increase (decrease) in savings deposits...... $ 5,471 $ 3,279 $ 6,052
======== ======== ========
</TABLE>
BORROWINGS. Savings deposits are the primary source of funds for Tri-
County Federal's lending and investment activities and for its general business
purposes. The Savings Bank does, however, rely upon advances from the FHLB of
Atlanta to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB of Atlanta has served as the Savings Bank's
primary borrowing source. Advances from the FHLB are typically secured by the
Savings Bank's stock in the FHLB and a portion of the Savings Bank's first
mortgage loans. At December 31, 1996, advances from the FHLB of Atlanta were as
follows:
<TABLE>
<CAPTION>
Year Due Interest Rate Balance
--------- -------------- -----------
<S> <C> <C>
1997 5.57% - 5.738% $13,000,000
1998 5.00% 5,000,000
1999 5.21% 6,000,000
-----------
$24,000,000
</TABLE>
The advances due in 1998 and 1999 have call provisions under which the
FHLB may require payment prior to the stated maturity date.
The FHLB of Atlanta functions as a central reserve bank providing
credit for member savings institutions. As a member, Tri-County Federal is
required to own capital stock in the FHLB and is authorized to apply for
advances on the security of such stock and certain of its home mortgages and
other assets (principally, securities which are obligations of, or guaranteed
by, the United States government) provided certain standards related to
creditworthiness have been met. Advances are made pursuant to several different
programs. Each credit program has its own interest rate and range of
maturities. Depending on the program, limitations on the amount of advances are
based either on a fixed percentage of an association's net worth or on the
FHLB's assessment of the association's creditworthiness. Under its current
credit policies, the FHLB limits advances to 30% of a member's assets, but there
are no other limitations on the amount of advances which may be made to an
association.
The Savings Bank, through a finance subsidiary, has also borrowed
funds through a collateralized mortgage obligation program. For further
information, see Note 7 of Notes to Consolidated Financial Statements.
In previous years, the Savings Bank utilized its portfolio of
mortgage-backed securities to generate short-term funds by leveraging them
through dollar rolls and reverse repurchase agreements. The Savings Bank had
outstanding collateralized borrowings of $0 million and $3.4 million at December
31, 1996 and 1995, respectively.
18
<PAGE>
For more information regarding the Bank's borrowings, see Note 7 of
Notes to Consolidated Financial Statements.
YIELDS EARNED AND RATES PAID
The pre-tax earnings of Tri-County Federal depend significantly upon
the spread between the income it receives from its loan and investment
portfolios and its cost of money, consisting of the interest paid on deposit
accounts and borrowings.
The following table sets forth for the periods and at the dates indicated, the
weighted average yields earned on the Savings Bank's assets, the weighted
average interest rates paid on the Savings Bank's liabilities, together with the
interest rate spread and net yield on interest-earning assets.
<TABLE>
<CAPTION>
At Years Ended December 31,
December 31, ---------------------------
1996 1996 1995 1994
------------- -------- -------- -------
<S> <C> <C> <C> <C>
Weighted average yield on loan and mortgage-backed
security portfolio....................................... 8.02% 8.55% 8.80% 8.44%
Weighted average yield on investment securities
portfolio................................................ 6.20 5.52 5.90 5.24
Weighted average yield on all interest-
earning assets.......................................... 7.85 8.24 8.44 8.03
Weighted average rate paid on savings deposits and escrow.. 4.16 4.05 4.06 3.67
Weighted average rate paid on Federal Home Loan
Bank advances and other borrowings....................... 5.46 5.46 6.21 7.02
Weighted average rate paid on all interest-
bearing liabilities.................................. 4.36 4.22 4.28 3.87
Interest rate spread (spread between weighted
average rate on all interest-earning assets
and all interest-bearing liabilities).................... 3.49 4.02 4.16 4.16
Net yield (net interest income as a percentage
of average interest-earning assets)...................... 4.32 4.45 4.38
</TABLE>
19
<PAGE>
AVERAGE BALANCE SHEET
The following table presents for the periods indicated the Savings
Bank's average balance sheet and reflects the amount of interest income from
average interest-earning assets and the resultant yields, as well as the amount
of interest expense on average interest-bearing liabilities and the resultant
costs, expressed both in dollars and rates. Interest income includes fees which
are considered adjustments to yields. Average balances are based on average
month-end balances.
<TABLE>
<CAPTION>
For the Year Ended December 31,
------------------------------------------------------------------------------------------------------
At December 31, 1996 1995 1994
1996 --------------------------- -------------------------- --------------------------
-----------------
Average Average Average Average
Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- ------- ------- -------- ------- ------- -------- ------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loan and mortgage-
backed
security
portfolio............ $155,391 8.02% $146,741 $12,548 8.55% $133,726 $11,774 8.80% $122,180 $10,312 8.44%
Investment
securities............ 16,221 6.20 16,722 923 5.52 19,105 1,127 5.90 18,165 951 5.24
-------- ---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total
interest-
earning
assets............ 171,612 7.85% 163,463 13,471 8.24 152,831 12,901 8.44% $140,345 11,263 8.03%
-------- ---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Interest-bearing
liabilities:
Savings deposits and
escrow............... $135,534 4.16% $133,331 $ 5,397 4.05% $128,041 $ 5,198 4.06% $124,030 $ 4,553 3.67%
FHLB advances and
other
borrowings.......... 24,733 5.46 18,493 1,010 5.46 14,435 897 6.21 8,035 564 7.02
-------- ---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total............... $160,267 4.36% $151,824 6,407 4.22% $142,476 6,095 4.28% $132,065 5,117 3.87%
======== ==== ======== ------- ---- ======== ------- ---- ======== ------- ----
Net interest income..... $ 7,064 $ 6,806 $ 6,146
======= ======= =======
Interest rate spread.... 3.49% 4.02% 4.16% 4.16%
==== ==== ==== ====
Net yield on
interest-earning
assets................ 4.32% 4.45% 4.38%
==== ==== ====
Ratio of average
interest-earning
assets
to average
interest-bearing
liabilities........... 107.7% 107.3% 106.3%
======= ======= =======
</TABLE>
20
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Savings Bank for the periods
indicated. For each category of interest-earning asset and interest-bearing
liability, infor mation is provided on changes attributable to (1) changes in
volume (changes in volume multiplied by old rate); (2) changes in rate (changes
in rate multiplied by old volume); (3) changes in rate-volume (changes in rate
multiplied by the change in volume).
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------
1995 vs. 1996 1994 vs. 1995
---------------------------- ------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------------------ -------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------- ------ ------- ------ ------ ------ ------- ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loan and mortgage-backed
security portfolio................ $1,142 $(334) $ (33) $ 775 $ 980 $ 440 $ 42 $1,462
Investments......................... (140) (73) 9 (204) 50 120 6 176
------ ----- ----- ----- ------ ----- ---- ------
Total interest-earning assets....... $1,002 $(407) $ (24) $ 571 $1,030 $ 560 $ 48 $1,638
------ ----- ----- ----- ------ ----- ---- ------
Interest expense:
Savings deposits and escrow......... $ 213 $ (13) $ (1) $ 199 $ 145 $ 484 $ 16 $ 645
Borrowings and Federal
Home Loan Bank advances............ 251 (108) (30) 113 450 (65) (52) 333
------ ----- ----- ----- ------ ----- ---- ------
Total interest-bearing
liabilities.. $ 464 $(121) $ (31) $ 312 $ 595 $ 419 $(36) $ 978
====== ===== ===== ===== ====== ===== ==== ======
</TABLE>
KEY OPERATING RATIOS
The table below sets forth certain performance ratios of the Savings
Bank and the Corporation for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1996 1995 1994
------- ------- --------
<S> <C> <C> <C>
Return on Assets
(Net Income Divided by Average
Total Assets).......................... .77% 1.28% 1.08%
Return on Equity
(Net Income Divided by Average Equity).. 7.94% 13.8% 12.41%
Equity-to-Assets Ratio
(Average Equity Divided by Average
Total Assets).......................... 9.70% 9.25% 8.72%
</TABLE>
SUBSIDIARY ACTIVITY
In 1985, the Savings Bank formed Tri-County Federal Finance One as a finance
subsidiary for the purpose of issuing a $6.5 million collateralized mortgage
obligation. For further information, see Notes 1 and 7 to Consolidated
Financial Statements.
21
<PAGE>
DEPOSITORY INSTITUTION REGULATION
GENERAL. As a federal savings bank, Tri-County Federal is subject to
extensive regulation by the OTS. The lending activities and other investments
of the Savings Bank must comply with various federal regulatory requirements.
The OTS periodically examines the Savings Bank for compliance with various
regulatory requirements. The FDIC also has the authority to conduct special
examinations of SAIF members. The Savings Bank must file reports with the OTS
describing its activities and financial condition. This regulatory oversight
will continue to apply until consummation of the Charter Conversion.
Upon consummation of the Charter Conversion, the Bank will be a Maryland
commercial bank and its deposit accounts will continue to be insured by the
SAIF. The Bank also will become a member of the Federal Reserve System. The
Bank will be subject to supervision, examination and regulation by the State of
Maryland Commissioner of Financial Regulation ("Commissioner") (rather than the
OTS) and the Federal Reserve Board and to Maryland and federal statutory and
regulatory provisions governing such matters as capital standards, mergers and
establishment of branch offices, and it will remain subject to the FDIC's
authority to conduct special examinations. The Bank will be required to file
reports with the Commissioner and the Federal Reserve Board concerning its
activities and financial condition and will be required to obtain regulatory
approvals prior to entering into certain transactions, including mergers with,
or acquisitions of, other depository institutions.
As a federally insured depository institution, the Savings Bank is, and the
Bank will be, subject to various regulations promulgated by the Federal Reserve
Board, including Regulation B (Equal Credit Opportunity), Regulation D (Reserve
Requirements), Regulations E (Electronic Fund Transfers), Regulation Z (Truth in
Lending), Regulation CC (Availability of Funds and Collection of Checks) and
Regulation DD (Truth in Savings).
The system of regulation and supervision applicable to the Savings Bank, and
that will be applicable to the Bank, establishes a comprehensive framework for
the operations of the Savings Bank and is intended primarily for the protection
of the FDIC and the depositors of the Savings Bank and, upon completion of the
Charter Conversion, the Bank. Changes in the regulatory framework could have a
material effect on the Savings Bank and the Bank and their respective operations
that in turn, could have a material effect on the Corporation.
FEDERAL HOME LOAN BANK SYSTEM. The Savings Bank is a member of the FHLB
System. The FHLB System consists of 12 regional Federal Home Loan Banks subject
to supervision and regulation by the Federal Housing Finance Board ("FHFB").
The Federal Home Loan Banks provide a central credit facility primarily for
member institutions. As a member of the FHLB of Atlanta, the Savings Bank is
required to acquire and hold shares of capital stock in the FHLB of Atlanta in
an amount at least equal to the greater of 1% of the Savings Bank's aggregate
unpaid principal of its residential mortgage loans, home purchase contracts, and
similar obligations at the beginning of each year, or 5% of its then outstanding
advances (borrowings) from the FHLB of Atlanta, whichever is greater. The
Savings Bank was in compliance with this requirement at December 31, 1996, with
investment in FHLB of Atlanta stock of $1.3 million.
The FHLB of Atlanta serves as a reserve or central bank for its member
institutions within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
advances to members in accordance with policies and procedures established by
the FHFB and the Board of Directors of the FHLB of Atlanta. As of December 31,
1996, the Savings Bank had advances of $24 million from the FHLB of Atlanta.
Upon completion of the Charter Conversion, the Bank will continue to be a member
of the FHLB of Atlanta.
LIQUIDITY REQUIREMENTS. Federal regulations require savings associations to
maintain an average daily balance of liquid assets (cash, deposits maintained
pursuant to Federal Reserve Board requirements, time and savings deposits in
certain institutions, obligations of states and political subdivisions thereof,
shares in mutual funds with certain restricted investment policies, highly rated
corporate debt, and mortgage loans and mortgage-related securities with less
than one year to maturity or subject to purchase within one year) equal to a
monthly average of not less than a specified percentage of its net withdrawable
savings deposits plus short-term borrowings. This liquidity requirement, which
was 5% at December 31, 1996, may be changed from time to time by the OTS to any
22
<PAGE>
amount within the range of 4% to 10% depending upon economic conditions and the
savings flows of savings associations. Regulations also require each savings
association to maintain an average daily balance of short-term liquid assets at
a specified percentage (currently 1%) of the total of its net withdrawable
savings accounts and borrowings payable in one year or less. Monetary penalties
may be imposed for failure to meet liquidity requirements.
Upon consummation of the Charter Conversion, the Bank will be subject to the
reserve requirements imposed by the State of Maryland. A Maryland commercial
bank is required to have at all times a reserve equal to at least 15% of its
demand deposits. The board of directors of a Maryland commercial bank must by
resolution direct the commercial bank to maintain this reserve ratio in: (i)
cash on hand; (ii) demand deposits in a bank of good standing in any state; or
(iii) as to 5% of its demand deposits, on approval of the Commissioner, (a)
registered or coupon bonds, or (b) general obligations guaranteed by the United
States government, an agency of the United States government, the State of
Maryland, or any political subdivision. Additionally, a Maryland commercial
bank must have at all times a reserve equal to at least 3% of all time deposits.
Time deposit reserves must be kept in: (i) cash on hand; (ii) deposits in a
bank of good standing in any state; or (iii) direct obligations of the United
States government or of the State of Maryland. Under the Maryland statute,
"demand deposits" are defined as deposits payable within 30 days and "time
deposits" are defined to be deposits that are payable after 30 days, including a
savings account or certificate of deposit that requires at least a 30-day notice
before payment. Assuming completion of the Charter Conversion, the Bank would
(as of December 31, 1996) be in compliance with Maryland's reserve requirements.
QUALIFIED THRIFT LENDER TEST. The Home Owners' Loan Act (the "HOLA")
requires savings institutions to meet a qualified thrift lender ("QTL") test. A
savings institution that does not meet the QTL test must either convert to a
bank charter or comply with the following restrictions on its operations: (i)
the institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution shall be restricted
to those of a national bank; (iii) the institution shall not be eligible to
obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank. Upon the expiration of three years from the date the institution
ceases to be a QTL, it must cease any activity and not retain any investment not
permissible for a national bank and immediately repay any outstanding FHLB
advances (subject to safety and soundness considerations).
To meet the QTL test, an institution's "Qualified Thrift Investments" must
total at least 65% of "portfolio assets." Under OTS regulations, portfolio
assets are defined as total assets less intangibles, property used by a savings
institution in its business and liquidity investments in an amount not exceeding
20% of assets. Qualified Thrift Investments consist of (i) loans, equity
positions or securities related to domestic, residential real estate or
manufactured housing, (ii) 50% of the dollar amount of residential mortgage
loans subject to sale under certain conditions, and (iii) stock in an FHLB or
FHLMC or FNMA. In addition, subject to a 20% of portfolio assets limit, savings
institutions are able to treat as Qualified Thrift Investments 200% of their
investments in loans to finance "starter homes" and loans for construction,
development or improvement of housing and community service facilities or for
financing small businesses in "credit-needy" areas. In order to maintain QTL
status, the savings institution must maintain a weekly average percentage of
Qualified Thrift Investments to portfolio assets equal to 65% on a monthly
average basis in nine out of 12 months. A savings institution that fails to
maintain QTL status will be permitted to requalify once, and if it fails the QTL
test a second time, it will become immediately subject to all penalties as if
all time limits on such penalties had expired.
At December 31, 1996, approximately 70.72% of the Bank's portfolio assets
were invested in Qualified Thrift Investments, which was in excess of the
percentage required to qualify Tri-County Federal under the QTL test. The QTL
test, and the penalties for failing to maintain QTL status, will not be
applicable following the Charter Conversion.
LOANS-TO-ONE-BORROWER LIMITATIONS. The Savings Bank's loans and extensions
of credit to one person outstanding at one time generally may not exceed 15% of
Tri-County Federal's unimpaired capital and surplus. Loans and extensions of
credit fully secured by readily marketable collateral may comprise an additional
10% of unimpaired capital and surplus. Savings associations are also authorized
to make loans to one borrower, for any purpose, in an amount not to exceed
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$500,000 or, by order of the Director of the OTS, in an amount not to exceed the
lesser of $30.0 million or 30% of unimpaired capital and surplus to develop
residential housing, provided (i) the purchase price of each single-family
dwelling in the development does not exceed $500,000, (ii) the savings
association is in compliance with its fully phased-in capital requirements,
(iii) the loans comply with applicable loan-to-value requirements, and (iv) the
aggregate amount of loans made under this authority does not exceed 150% of
unimpaired capital and surplus.
REGULATORY CAPITAL REQUIREMENTS. OTS regulations require savings
associations to satisfy three different capital requirements. Specifically,
savings associations must maintain "tangible" capital equal to 1.5% of adjusted
total assets, "core" capital equal to 3% of adjusted total assets and a
combination of core and "supplementary" capital equal to 8.0% of "risk-weighted"
assets. In addition, the OTS has recently adopted regulations which impose
certain restrictions on savings associations that have a total risk-based
capital ratio that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted
assets of less than 4.0% or a ratio of Tier 1 capital to adjusted total assets
of less than 4.0% (or 3.0% if the institution is rated composite 1 under the OTS
examination rating system). See "-- Prompt Corrective Regulatory Action." For
purposes of the regulation, Tier 1 capital has the same definition as core
capital which is defined as common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include qualifying supervisory
goodwill and is reduced by the amount of all the savings association's
intangible assets with only a limited exception for purchased mortgage servicing
rights. Both core and tangible capital are further reduced by an amount equal
to a gradually increasing percentage of the savings association's debt and
equity investments in subsidiaries engaged in activities not permissible to
national banks other than subsidiaries engaged in activities undertaken as agent
for customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies. As of December 31, 1996, the Savings
Bank had no investments in or extensions of credit to subsidiaries engaged in
activities not permitted to national banks.
Adjusted total assets are a savings association's total assets as determined
under generally accepted accounting principles increased by certain goodwill
amounts and by a pro rated portion of the assets of subsidiaries in which the
savings association holds a minority interest and which are not engaged in
activities for which the capital rules require the savings association to net
its debt and equity investments in such subsidiaries against capital as well as
a pro rated portion of the assets of other subsidiaries for which netting is not
fully required under phase-in rules and, for purposes of the risk-based capital
requirement, general valuation loan and lease loss allowances. Adjusted total
assets are reduced by the amount of assets that have been deducted from capital,
the portion of the savings association's investments in subsidiaries whose
assets are added to capital for purposes of the capital requirements, as well as
the portion of investments in subsidiaries that must be netted against capital
under the capital rules, and, for purposes of the core capital requirement,
qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a savings
association is allowed to use both core capital and supplementary capital
provided the amount of supplementary capital used does not exceed the savings
association's core capital. Supplementary capital is defined to include certain
preferred stock issues, nonwithdrawable accounts and pledged deposits that do
not qualify as core capital, certain approved subordinated debt, certain other
capital instruments and a portion of the savings association's general loss
allowances. Total core and supplementary capital is reduced in the amount of
(i) reciprocal holdings of depository institution capital instruments, (ii) all
equity investments, and (iii) that portion of land loans and nonresidential
loans with loan to value ratios in excess of 80%.
As of December 31, 1996, the Savings Bank had no high ratio land or non-
residential construction loans and no equity investments for which OTS
regulations require a deduction from total capital.
The risk-based capital requirement is measured against risk-weighted assets
which equal the sum of the amount of each asset and credit-equivalent amount of
each off-balance sheet item after such asset or item is multiplied by an
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<PAGE>
assigned risk weight. Under the OTS risk-weighting system, qualifying mortgage
loans (one- to four-family first mortgages not more than 90 days past due with
loan-to-value ratios under 80%) are assigned a risk weight of 50%. Non-
qualifying mortgage loans, consumer loans (including home equity loans),
commercial loans and residential construction loans are assigned a risk weight
of 100%. Mortgage-backed securities issued, or fully guaranteed as to principal
and interest, by the FNMA or FHLMC as well as FHLB stock are assigned a 20% risk
weight. Cash reserves at Federal Reserve Banks and U.S. Government securities
backed by the full faith and credit of the U.S. Government are given a 0% risk
weight.
The tables below present the Savings Bank's historical capital position
relative to its various minimum regulatory capital requirements at December 31,
1996.
<TABLE>
<CAPTION>
December 31, 1996
--------------------
Percent of
Amount Assets (1)
------- -----------
(In thousands)
<S> <C> <C>
Tangible capital................ $16,447 9.3%
Tangible capital requirement.... 2,661 1.5
------- ----
Excess.......................... $13,786 7.8%
======= ====
Core capital.................... $16,447 9.3%
Core capital requirement........ 5,322 3.0
------- ----
Excess.......................... $11,125 6.3%
======= ====
Risk-based capital (i.e., core
and supplementary capital)..... $17,567 16.7%
Risk-based capital requirement.. 8,404 8.0
------- ----
Excess.......................... $ 9,163 8.7%
======= ====
- --------------------
</TABLE>
(1) Based upon adjusted total assets for purposes of the tangible capital and
core capital requirements, and risk-weighted assets for purposes of the
risk-based capital requirements.
The OTS's risk-based capital requirements require institutions with more
than a "normal" level of interest rate risk to maintain additional total
capital. A savings institution's interest rate risk is measured for this
purpose in terms of the sensitivity of its "net portfolio value" to changes in
interest rates. Net portfolio value is defined, generally, as the present value
of expected cash inflows from existing assets and off-balance sheet contracts
less the present value of expected cash outflows from existing liabilities. A
savings association is considered to have a "normal" level of interest rate risk
if the decline in the market value of its portfolio equity after an immediate
200 basis point increase or decrease in market interest rates (whichever leads
to the greater decline) is less than two percent of the current estimated market
value of its assets. The amount of additional capital that an institution with
more than normal interest rate risk is required to maintain (the "interest rate
risk component") equals one-half of the dollar amount by which its measured
interest rate risk exceeds the normal level of interest rate risk. This
interest rate risk component is in addition to the capital otherwise required to
satisfy the risk-based capital requirement.
The OTS calculates the sensitivity of an institution's market value
portfolio equity from data submitted by the institution in a schedule to its
quarterly Thrift Financial Report and using the interest rate risk measurement
model adopted by the OTS. The amount of the interest rate risk component, if
any, to be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS requires any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. The Savings Bank has
not been deemed to have more than a normal level of interest rate risk under
this rule and believes that it will not be required to increase its level of
risk-based capital as a result of the rule.
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In addition to requiring generally applicable capital standards for savings
associations, applicable law authorizes the Director of the OTS to establish the
minimum level of capital for a savings institution at such amount or at such
ratio of capital-to-assets as the Director of the OTS determines to be necessary
or appropriate for such institution in light of the particular circumstances of
the institution. The Director of the OTS may treat the failure of any savings
institution to maintain capital at or above such level as an unsafe or unsound
practice and may issue a directive requiring any savings institution which fails
to maintain capital at or above the minimum level required by the Director of
the OTS to submit and adhere to a plan for increasing capital. Such an order
may be enforced in the same manner as an order issued by the FDIC. The Savings
Bank was not subject to any such agreement with the Director of the OTS at
December 31, 1996.
Upon consummation of the Charter Conversion, the Bank will be subject to
Federal Reserve Board capital requirements as well as statutory capital
requirements imposed under Maryland law. Federal Reserve Board regulations
establish two capital standards for state-chartered banks that are members of
the Federal Reserve System ("state member banks"): a leverage requirement and a
risk-based capital requirement. In addition, the Federal Reserve may on a case-
by-case basis, establish individual minimum capital requirements for a bank that
vary from the requirements which would otherwise apply under Federal Reserve
Board regulations. A bank that fails to satisfy the capital requirements
established under the Federal Reserve Board's regulations will be subject to
such administrative action or sanctions as the Federal Reserve Board deems
appropriate.
The leverage ratio adopted by the Federal Reserve Board requires a minimum
ratio of "Tier 1 capital" to adjusted total assets of 3% for banks rated
composite 1 under the CAMEL rating system for banks. Banks not rated composite
1 under the CAMEL rating system for banks are required to maintain a minimum
ratio of Tier 1 capital to adjusted total assets of 4% to 5%, depending upon the
level and nature of risks of their operations. For purposes of the Federal
Reserve Board's leverage requirement, Tier 1 capital generally consists of the
same components as core capital under the OTS's capital regulations, except that
no intangibles except certain mortgage servicing rights and purchased credit
card relationships may be included in capital.
The risk-based capital requirements established by the Federal Reserve
Board's regulations require state member banks to maintain "total capital" equal
to at least 8% of total risk-weighted assets. For purposes of the risk-based
capital requirement, "total capital" means Tier 1 capital (as described above)
plus "Tier 2 capital" (as described below), provided that the amount of Tier 2
capital may not exceed the amount of Tier 1 capital, less certain assets. The
components of Tier 2 capital under the Federal Reserve Board's regulations
generally correspond to the components of supplementary capital under OTS
regulations. Total risk-weighted assets generally are determined under the
Federal Reserve Board's regulations in the same manner as under the OTS's
regulations, except that the Federal Reserve Board regulations establish only
four risk categories, with risk weights of 0%, 20%, 50% and 100%.
In addition, the Bank will be subject to the statutory capital requirements
imposed by the State of Maryland. Under Maryland statutory law, if the surplus
of a Maryland commercial bank at any time is less than 100% of its capital
stock, then, until the surplus is 100% of the capital stock, the commercial
bank: (i) must transfer to its surplus annually at least 10% of its net
earnings; and (ii) may not declare or pay any cash dividends that exceed 90% of
its net earnings. In addition, the Bank will be subject to Federal Reserve
Board capital requirements. Federal Reserve Board regulations establish two
capital standards for state member banks: a leverage requirement and a risk-
based capital requirement.
PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
26
<PAGE>
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that did not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total
assets falls below a "critical capital level," the institution will be subject
to conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized. If a savings association is in
compliance with an approved capital plan on the date of enactment of FDICIA,
however, it will not be required to submit a capital restoration plan if it is
undercapitalized or become subject to the statutory prompt corrective action
provisions applicable to significantly and critically undercapitalized
institutions prior to July 1, 1994.
Effective December 19, 1992, the federal banking regulators, including the
OTS, adopted regulations implementing the prompt corrective action provisions of
FDICIA. Under these regulations, the federal banking regulators will generally
measure a depository institution's capital adequacy on the basis of the
institution's total risk-based capital ratio (the ratio of its total capital to
risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core
capital to risk-weighted assets) and leverage ratio (the ratio of its core
capital to adjusted total assets). Under the regulations, a savings association
that is not subject to an order or written directive to meet or maintain a
specific capital level will be deemed "well capitalized" if it also has: (i) a
total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based
capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or greater.
An "adequately capitalized" savings association is a savings association that
does not meet the definition of well capitalized and has: (i) a total risk-based
capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0%
or greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if
the savings association has a composite 1 MACRO rating). An "undercapitalized
institution" is a savings association that has (i) a total risk-based capital
ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than
4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the association
has a composite 1 MACRO rating). A "significantly undercapitalized" institution
is defined as a savings association that has: (i) a total risk-based capital
ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than
3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically
undercapitalized" savings association is defined as a savings association that
has a ratio of "tangible equity" to total assets of less than 2.0%. Tangible
equity is defined as core capital plus cumulative perpetual preferred stock (and
related surplus) less all intangibles other than qualifying supervisory goodwill
and certain purchased mortgage servicing rights. The OTS may reclassify a well
capitalized savings association as adequately capitalized and may require an
adequately capitalized or undercapitalized association to comply with the
supervisory actions applicable to associations in the next lower capital
category (but may not reclassify a significantly undercapitalized institution as
critically under-capitalized) if the OTS determines, after notice and an
opportunity for a hearing, that the savings association is in an unsafe or
unsound condition or that the association has received and not corrected a less-
than-satisfactory rating for any MACRO rating category. At December 31, 1996,
the Savings Bank was classified as "well capitalized" under these regulations.
27
<PAGE>
DEPOSIT INSURANCE. The Savings Bank is required to pay assessments based
on a percentage of its insured deposits to the FDIC for insurance of its
deposits by the SAIF. Following the Charter Conversion, the Bank's deposits
will continue to be insured by the SAIF. Under the FDIC's risk-based deposit
insurance assessment system, the assessment rate for an insured depository
institution depends on the assessment risk classification assigned to the
institution by the FDIC, which is determined by the institution's capital level
and supervisory evaluations. Based on the data reported to regulators for the
date closest to the last day of the seventh month preceding the semi-annual
assessment period, institutions are assigned to one of three capital groups --
well capitalized, adequately capitalized or undercapitalized -- using the same
percentage criteria as in the prompt corrective action regulations. See "--
Prompt Corrective Regulatory Action." Within each capital group, institutions
are assigned to one of three subgroups on the basis of supervisory evaluations
by the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund. Subgroup A consists of
financially sound institutions with only a few minor weaknesses. Subgroup B
consists of institutions that demonstrate weaknesses which, if not corrected,
could result in significant deterioration of the institution and increased risk
of loss to the deposit insurance fund. Subgroup C consists of institutions that
pose a substantial probability of loss to the deposit insurance fund unless
effective corrective action is taken. The assessment rate for SAIF members had
ranged from 0.23% of deposits for well capitalized institutions in Subgroup A to
0.31% of deposits for undercapitalized institutions in Subgroup C while
assessments for over 90% of members of the Bank Insurance Fund ("BIF") had been
the statutory minimum of $2,000. Recently enacted legislation provided for a
one-time assessment of 65.7 basis points of insured deposits as of March 31,
1995, that fully capitalized the SAIF and had the effect of reducing future SAIF
assessments. Accordingly, although the special assessment resulted in a one-
time charge to the Savings Bank of approximately $820,000 pre-tax, the
recapitalization of the SAIF had the effect of reducing the Savings Bank's
future deposit insurance premiums to the SAIF. Under the recently enacted
legislation, both BIF and SAIF members will be assessed an amount for the
Financing Corporation Bond payments. BIF members will be assessed approximately
1.3 basis points while the SAIF rate will be approximately 6.4 basis points
until January 1, 2000. At that time, BIF and SAIF members will begin pro rata
sharing of the payment at an expected rate of 2.43 basis points.
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts. No reserves are required to be
maintained on the first $4.3 million of transaction accounts, reserves equal to
3% must be maintained on the next $52.0 million of transaction accounts, and a
reserve of 10% must be maintained against all remaining transaction accounts.
These reserve requirements are subject to adjustment by the Federal Reserve
Board. Because required reserves must be maintained in the form of vault cash
or in a noninterest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's interest-
earning assets. At December 31, 1996, the Savings Bank met its reserve
requirements.
Upon completion of the Charter Conversion, the Bank will become a member of
the Federal Reserve System and will subscribe for stock in the Federal Reserve
Bank of Richmond in an amount equal to 6% of the Bank's paid-up capital and
surplus. The Bank will continue to be subject to the reserve requirements to
which the Savings Bank is presently subject under Federal Reserve Board
regulations.
The monetary policies and regulations of the Federal Reserve Board have a
significant effect on the operating results of commercial banks. The Federal
Reserve Board's policies affect the levels of bank loans, investments and
deposits through its open market operation in United States government
securities, its regulation of the interest rate on borrowings of member banks
from Federal Reserve Banks and its imposition of non-earning reserve
requirements on all depository institutions, such as the Bank, that maintain
transaction accounts or non-personal time deposits.
TRANSACTIONS WITH AFFILIATES. Transactions between savings associations or
state member banks and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings association or state member bank
is any company or entity which controls, is controlled by or is under common
control with the savings association or state member bank. In a holding company
context, the parent holding company of a savings association or a state member
bank (such as the Corporation) and any companies which are controlled by such
28
<PAGE>
parent holding company are affiliates of the savings association or state member
bank. Generally, Sections 23A and 23B (i) limit the extent to which the
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a non-
affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association or state member bank may (i) loan or otherwise extend
credit to an affiliate, except for any affiliate which engages only in
activities which are permissible for bank holding companies, or (ii) purchase or
invest in any stocks, bonds, debentures, notes or similar obligations of any
affiliate, except for affiliates which are subsidiaries of the savings
association or state member bank.
Savings associations or state member banks are also subject to the
restrictions contained in Section 22(h) of the Federal Reserve Act on loans to
executive officers, directors and principal stockholders. Under Section 22(h),
loans to an executive officer and to a greater than 10% stockholder of a savings
association or state member bank (18% in the case of institutions located in an
area with less than 30,000 in population), and certain affiliated entities of
either, may not exceed, together with all other outstanding loans to such person
and affiliated entities the institution's loan to one borrower limit (generally
equal to 15% of the institution's unimpaired capital and surplus and an
additional 10% of such capital and surplus for loans fully secured by certain
readily marketable collateral). Section 22(h) also prohibits loans, above
amounts prescribed by the appropriate federal banking agency, to directors,
executive officers and greater than 10% stockholders of a savings association or
state member bank, and their respective affiliates, unless such loan is approved
in advance by a majority of the board of directors of the association with any
"interested" director not participating in the voting. The Federal Reserve
Board has prescribed the loan amount (which includes all other outstanding loans
to such person), as to which such prior board of director approval if required,
as being the greater of $25,000 or 5% of capital and surplus (up to $500,000).
Further, the Federal Reserve Board pursuant to Section 22(h) requires that loans
to directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons.
Savings associations or state member banks are also subject to the
requirements and restrictions of Section 22(g) of the Federal Reserve Act on
loans to executive officers and the restrictions of 12 U.S.C. (S) 1972 on
certain tying arrangements and extensions of credit by correspondent banks.
Section 22(g) of the Federal Reserve Act requires that loans to executive
officers of depository institutions not be made on terms more favorable than
those afforded to other borrowers, requires approval for such extensions of
credit by the board of directors of the institution, and imposes reporting
requirements for and additional restrictions on the type, amount and terms of
credits to such officers. Section 1972 prohibits (i) a depository institution
from extending credit to or offering any other services, or fixing or varying
the consideration for such extension of credit or service, on the condition that
the customer obtain some additional service from the institution or certain of
its affiliates or not obtain services of a competitor of the institution,
subject to certain exceptions, and (ii) extensions of credit to executive
officers, directors, and greater than 10% stockholders of a depository
institution by any other institution which has a correspondent banking
relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
DIVIDEND LIMITATIONS. Under OTS regulations, the Savings Bank is not
permitted to pay dividends on its capital stock if its regulatory capital would
thereby be reduced below the amount then required for the liquidation account
established for the benefit of certain depositors of the Savings Bank at the
time of its conversion to stock form. In addition, savings association
subsidiaries of savings and loan holding companies are required to give the OTS
30 days' prior notice of any proposed declaration of dividends to the holding
company.
Federal regulations impose certain limitations on the payment of dividends
and other capital distributions (including stock repurchases and cash mergers)
by the Savings Bank. Under these regulations, a savings association that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulation)
that is equal to or greater than the amount of its fully phased-in capital
requirements (a "Tier 1 Association") is generally permitted without OTS
29
<PAGE>
approval, after notice, to make capital distributions during a calendar year in
the amount equal to the greater of (i) 75% of net income for the previous four
quarters or (ii) up to 100% of its net income to date during the calendar year
plus an amount that would reduce by one-half the amount by which its total
capital to assets ratio exceeded its fully phased-in capital requirement to
assets ratio at the beginning of the calendar year. A savings association with
total capital in excess of current minimum capital requirements but not in
excess of the fully phased-in requirements (a "Tier 2 Association") is
permitted, after notice, to make capital distributions without OTS approval of
up to 75% of its net income for the previous four quarters, less dividends
already paid for such period. A savings association that fails to meet current
minimum capital requirements (a "Tier 3 Association") is prohibited from making
any capital distributions without the prior approval of the OTS. Tier 1
Associations that have been notified by the OTS that they are in need of more
than normal supervision will be treated as either a Tier 2 or Tier 3
Association. Unless the OTS determines that the Savings Bank is an institution
requiring more than normal supervision, the Savings Bank is authorized to pay
dividends in accordance with the provisions of the OTS regulations discussed
above as a Tier 1 Association. Under regulations which took effect on December
19, 1992, the Savings Bank is prohibited from making any capital distributions
if after making the distribution, the Savings Bank would have: (i) a total risk-
based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of
less than 4.0%; or (iii) a leverage ratio of less than 4.0%.
In addition to the foregoing, earnings of the Savings Bank appropriated to
bad debt reserves and deducted for Federal income tax purposes are not available
for payment of cash dividends or other distributions to stockholders without
payment of taxes at the then current tax rate by the Savings Bank on the amount
of earnings removed from the reserves for such distributions. See "Federal and
State Taxation." The Savings Bank intends to make full use of this favorable
tax treatment afforded to the Savings Bank and does not contemplate use of any
earnings of the Savings Bank in a manner which would limit the Savings Bank's
bad debt deduction or create federal tax liabilities.
Following the Charter Conversion, the Bank's ability to pay dividends will
be governed by the Maryland Financial Institutions Code and the regulations of
the Federal Reserve Board. Under the Maryland Financial Institutions Code, a
Maryland bank (1) may only pay dividends from undivided profits or, with prior
regulatory approval, its surplus in excess of 100% of required capital stock and
(2) may not declare dividends on its common stock until its surplus fund equals
the amount of required capital stock or, if the surplus fund does not equal the
amount of capital stock, in an amount in excess of 90% of net earnings.
The Bank's payment of dividends will also be subject to the Federal Reserve
Board's Regulation H, which limits the dividends payable by a state member bank
to the net profits of the Bank then on hand, less the Bank's losses and bad
debts. Additionally, the Federal Reserve Board has the authority to prohibit
the payment of dividends by a Maryland commercial bank when it determines such
payment to be an unsafe and unsound banking practice. Finally, the Bank, like
the Savings Bank, would not be able to pay dividends on its capital stock if its
capital would thereby reduced below the remaining balance of the liquidation
account established in connection with the Stock Conversion.
REGULATION OF THE CORPORATION PRIOR TO THE CHARTER CONVERSION
SAVINGS AND LOAN HOLDING COMPANY REGULATIONS. The Corporation is a savings
and loan holding company within the meaning of the Home Owners' Loan Act. As
such, it is registered with the OTS and is subject to OTS regulations,
examinations, supervision and reporting requirements.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Corporation
presently operates the Corporation as a unitary savings and loan holding
company. There are generally no restrictions on the activities of a unitary
savings and loan holding company. However, if the director of OTS determines
that there is reasonable cause to believe that the continuation by a savings and
loan holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director of OTS may impose such restrictions as deemed necessary to address such
risk by limiting (i) payment of dividends by the savings association, (ii)
transactions between the savings association and its affiliates, and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association.
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<PAGE>
Notwithstanding the above rules as to permissible business activities of
unitary savings and loan holding companies, if the savings association
subsidiary of such a holding company fails to meet the QTL test, then such
unitary holding company shall also become subject to the activities restrictions
applicable to multiple holding companies and, unless the savings association
requalified as a Qualified Thrift Lender within one year thereafter, register
as, and become subject to, the restrictions applicable to bank holding
companies. See "Qualified Thrift Lender Test" above.
If the Corporation were to acquire control of another savings institution,
other than through merger or other business combinations with Tri-County
Federal, the Corporation would thereupon become a multiple savings and loan
holding company. Except where such acquisition is pursuant to the authority to
approve emergency thrift acquisitions and where each subsidiary savings
institution meets the Qualified Thrift Lender test, the activities of the
Corporation and any of its subsidiaries (other than Tri-County Federal or other
subsidiary savings institutions) would thereafter be subject to further
restrictions. The Home Owners' Loan Act, as amended, provides that, among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a savings institution shall commence or continue for a limited period of
time after becoming a multiple savings and loan holding company or subsidiary
thereof, any business activity other than (i) furnishing or performing
management services for a subsidiary savings institution, (ii) conducting an
insurance agency or escrow business, (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution, (iv) holding
or managing properties used or occupied by a subsidiary savings institution, (v)
acting as trustee under deeds of trust, (vi) those activities previously
directly authorized by the Federal Savings and Loan Insurance Corporation by
regulation as of March 5, 1987 to be engaged in by multiple holding companies or
(vii) those activities authorized by the Federal Reserve Board as permissible
for bank holding companies, unless the Director of OTS by regulation prohibits
or limits such activities for savings and loan holding companies. Those
activities described in (vii) above must also be approved by the Director of OTS
prior to being engaged in by a multiple holding company.
RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the OTS, (i) control of any
savings association or savings and loan holding company or substantially all the
assets thereof, or (ii) more than 5% of the voting shares of a savings
association or holding company thereof which is not a subsidiary. Under certain
circumstances, a registered savings and loan holding company is permitted to
acquire, with the approval of the OTS, up to 15% of the voting shares of an
under-capitalized savings association pursuant to a "qualified stock issuance"
without that savings association being deemed controlled by the holding company.
In order for the shares acquired to constitute a "qualified stock issuance," the
shares must consist of previously unissued stock or treasury shares; the shares
must be acquired for cash; the holding company's other subsidiaries must have
tangible capital of at least 6 1/2% of total assets; there must not be more than
one common director or officer between the holding company and the issuing
savings association and transactions between the savings association and the
holding company and any of its affiliates must conform to certain regulatory
restrictions. Except with the prior approval of the OTS, no director or officer
of a savings and loan holding company or person owning or controlling by proxy
or otherwise more than 25% of such company's stock, may acquire control of any
savings association, other than a subsidiary savings association, or of any
other savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
association in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings association which operated a home or
branch office in the state of the association to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by state-chartered associations or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institution).
OTS regulations permit federal associations to branch in any state or
states of the United States and its territories. Except in supervisory cases or
when interstate branching is otherwise permitted by state law or other statutory
provision, a federal association may not establish an out-of-state branch unless
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<PAGE>
(i) the federal association qualifies as a "domestic building and loan
association" under (S)7701(a)(19) of the Internal Revenue Code and the total
assets attributable to all branches of the association in the state would
qualify such branches taken as a whole for treatment as a domestic building and
loan association and (ii) such branch would not result in (a) formation of a
prohibited multi-state multiple savings and loan holding company or (b) a
violation of certain statutory restrictions on branching by savings association
subsidiaries of banking holding companies. Federal associations generally may
not establish new branches unless the association meets or exceeds minimum
regulatory capital requirements. The OTS will also consider the association's
record of compliance with the Community Reinvestment Act of 1977 in connection
with any branch application.
REGULATION OF THE CORPORATION FOLLOWING THE CHARTER CONVERSION
GENERAL. Upon consummation of the Charter Conversion, the Corporation, as
the sole shareholder of the Bank, will become a bank holding company and will
register as such with the Federal Reserve Board. Bank holding companies are
subject to comprehensive regulation by the Federal Reserve Board under the Bank
Holding Company Act of 1956, as amended (the "BHCA"), and the regulations of the
Federal Reserve Board. As a bank holding company, the Corporation will be
required to file with the Federal Reserve Board annual reports and such
additional information as the Federal Reserve Board may require, and will be
subject to regular examinations by the Federal Reserve Board. The Federal
Reserve Board also has extensive enforcement authority over bank holding
companies, including, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to require that a
holding company divest subsidiaries (including its bank subsidiaries). In
general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.
Under the BHCA, a bank holding company must obtain Federal Reserve Board
approval before: (i) acquiring, directly or indirectly, ownership or control of
any voting shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (ii) acquiring all or
substantially all of the assets of another bank or bank holding company; or
(iii) merging or consolidating with another bank holding company.
The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company which is not a bank or bank holding company, or
from engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by Federal Reserve Board regulation or order, have been
identified as activities closely related to the business of banking or managing
or controlling banks. The list of activities permitted by the Federal Reserve
Board includes, among other things, operating a savings institution, mortgage
company, finance company, credit card company or factoring company; performing
certain data processing operations; providing certain investment and financial
advice; underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers' checks and United States Savings Bonds;
real estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing securities
brokerage services for customers.
Under Maryland statutory law, acquisitions of 25% or more of the voting
stock of a commercial bank or a bank holding company and other acquisitions of
voting stock of such entities which affect the power to direct or to cause the
direction of the management or policy of a commercial bank or a bank holding
company must be approved in advance by the Commissioner. Any person proposing
to make such an acquisition must file an application with the Commissioner at
least 60 days before the acquisition becomes effective. The Commissioner may
deny approval of any such acquisition if the Commissioner determines that the
acquisition is anticompetitive or threatens the safety or soundness of a banking
institution. Any voting stock acquired without the approval required under the
statute may not be voted for a period of 5 years. This restriction is not
applicable to certain acquisitions by bank holding companies of the stock of
Maryland banks or Maryland bank holding companies which are governed by
Maryland's holding company statute.
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<PAGE>
RIEGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994 AND ITS
APPLICATION IN MARYLAND. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Act") was enacted to ease restrictions on
interstate banking. Effective September 29, 1995, the Act allows the Federal
Reserve Board to approve an application of an adequately capitalized and
adequately managed bank holding company to acquire control of, or acquire all or
substantially all of the assets of, a bank located in a state other than such
holding company's home state, without regard to whether the transaction is
prohibited by the laws of any state. The Federal Reserve Board may not approve
the acquisition of a bank that has not been in existence for the minimum time
period (not exceeding five years) specified by the statutory law of the host
state. The Act also prohibits the Federal Reserve Board from approving an
application if the applicant (and its depository institution affiliates)
controls or would control more than 10% of the insured deposits in the United
States or 30% or more of the deposits in the target bank's home state or in any
state in which the target bank maintains a branch. The Act does not affect the
authority of states to limit the percentage of total insured deposits in the
state which may be held or controlled by a bank or bank holding company to the
extent such limitation does not discriminate against out-of-state banks or bank
holding companies. Individual states may also waive the 30% state-wide
concentration limit contained in the Act.
Pursuant to the Act, the Federal Reserve Board may approve an application
of an adequately capitalized and adequately managed non-Maryland bank holding
company to acquire control of, or acquire all or substantially all of the assets
of, a Maryland bank, as long as certain requirements of the Act are met.
Additionally, the Act authorizes the federal banking agencies, effective
June 1, 1997, to approve interstate merger transactions without regard to
whether such transaction is prohibited by the law of any state, unless the home
state of one of the banks opts out of the Act by adopting a law after the date
of enactment of the Act and prior to June 1, 1997 that applies equally to all
out-of-state banks and expressly prohibits merger transactions involving out-of-
state banks. The State of Maryland has enacted legislation, effective September
29, 1995, that authorizes interstate mergers involving Maryland banks. The
Maryland statute also authorizes out-of-state banks to establish branch offices
in Maryland by means of merger, branch acquisition or de novo branching.
-- ----
DIVIDENDS. The Federal Reserve Board has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve Board's view that a bank holding company should pay cash dividends only
to the extent that the company's net income for the past year is sufficient to
cover both the cash dividends and a rate of earning retention that is consistent
with the company's capital needs, asset quality and overall financial condition.
The Federal Reserve Board also indicated that it would be inappropriate for a
company experiencing serious financial problems to borrow funds to pay
dividends. Furthermore, under the prompt corrective action regulations adopted
by the Federal Reserve Board pursuant to FDICIA, the Federal Reserve Board may
prohibit a bank holding company from paying any dividends if the holding
company's bank subsidiary is classified as "undercapitalized". See "Depository
Institution Regulation -- Prompt Corrective Regulatory Action."
Bank holding companies are required to give the Federal Reserve Board prior
written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of the their
consolidated retained earnings. The Federal Reserve Board may disapprove such a
purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation, Federal Reserve
Board order, or any condition imposed by, or written agreement with, the Federal
Reserve Board.
CAPITAL REQUIREMENTS. The Federal Reserve Board has established capital
requirements, similar to the capital requirements for state member banks
described above, for bank holding companies with consolidated assets of $150
million or more. These requirements will not apply to the Corporation until the
Charter Conversion, however, assuming the application of such requirements to
the Corporation, as of December 31, 1996, the Corporation's levels of
consolidated regulatory capital would exceed the Federal Reserve Board's minimum
requirements.
33
<PAGE>
FEDERAL AND STATE TAXATION
The Corporation and its subsidiaries currently file a consolidated federal
income tax return based on a fiscal year ending December 31.
Savings associations are subject to the provisions of the Internal Revenue
Code of 1986, as amended (the "Code") in the same general manner as other
corporations. Through tax years beginning before December 31, 1995, savings
associations such as Tri-County Federal which meet certain definitional tests
and other conditions prescribed by the Code benefitted from certain favorable
provisions regarding their deductions from taxable income for annual additions
to their bad debt reserve. For purposes of the bad debt reserve deduction,
loans are separated into "qualifying real property loans," which generally are
loans secured by interests in real property, and nonqualifying real property
loans, which are all other loans. The bad debt reserve deduction with respect
to nonqualifying loans must be based on actual loss experience. The amount of
the bad debt reserve deduction with respect to qualifying real property loans
may be based upon actual loss experience (the "experience method") or a
percentage of taxable income determined without regard to such deduction (the
"percentage of taxable income method"). The Savings Bank generally elected to
use the method which resulted in the greatest deduction for federal income tax
purposes in any given year.
Legislation that is effective for tax years beginning after December 31, 1995
requires institutions to recapture into taxable income over a six taxable year
period the portion of the tax loan reserve that exceeds the pre-1988 tax loan
loss reserve. The Savings Bank will no longer be allowed to use the reserve
method for tax loan loss provisions, but would be allowed to use the experience
method of accounting for bad debts. There will be no future effect on net
income from the recapture because the taxes on these bad debt reserves has
already been accrued as a deferred tax liability.
Neither the Corporation nor the Savings Bank's federal income tax returns
have been audited during the past five years.
The State of Maryland imposes a franchise tax computed at a rate of 7% of
thrift institutions' net earnings. For purposes of the 7% franchise tax, net
earnings are defined as the net income of the thrift institution as determined
for federal corporate income tax purposes, plus (i) interest income from
obligations of the United States, of any state, including Maryland and of any
county, municipal or public corporation authority, special district or political
subdivision of any state, including Maryland, and (ii) any profit realized from
the sale or exchange of bonds issued by the State of Maryland of any of its
political subdivisions.
For additional information regarding federal and state taxes payable by the
Corporation, see Note 8 of the Notes to Consolidated Financial Statements.
COMPETITION
The Savings Bank faces strong competition in the attraction of savings
deposits (its primary source of lendable funds) and in the origination of real
estate loans. Its most direct competition for savings deposits has historically
come from other savings banks, from savings and loan associations, federal and
state credit unions and from commercial banks located in its primary market
area. The Savings Bank faces additional significant competition for investors'
funds from short-term money market securities and other corporate and government
securities. The Savings Bank's competition for real estate loans comes
principally from other savings banks, savings and loan associations, federal and
state credit unions, commercial banks and mortgage banking companies.
The Savings Bank competes for loans principally through the interest rates
and loan fees it charges and the efficiency and quality of the services it
provides borrowers, real estate brokers, and home builders. It competes for
savings by offering depositors a wide variety of savings accounts, checking
accounts, convenient office locations, tax-deferred retirement programs, and
other miscellaneous services. The Savings Bank has also utilized direct mail,
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<PAGE>
telemarketing and newspaper advertising to help increase deposits. It provides
ongoing training for its staff in an attempt to ensure high quality service.
PERSONNEL
As of December 31, 1996, the Savings Bank had 64 full-time employees and
seven part-time employees. The employees are not represented by a collective
bargaining agreement. The Savings Bank believes its employee relations are
good.
ITEM 2. PROPERTIES
- -------------------
The following table sets forth the location of the Savings Bank's offices, as
well as certain additional information relating to these offices as of December
31, 1996.
<TABLE>
<CAPTION>
Year
Facility Leased Net Book Approximate
Office Commenced or Total Value as of Square
Location Operation Owned Investment December 31, 1996 Footage
-------- --------- ------ ---------- ----------------- -----------
<S> <C> <C> <C> <C> <C>
Main Office 1974 Owned $1,214,232 $795,070 16,500
3035 Leonardtown Road
Waldorf, Maryland
Branch Office (1) 1974 Owned 326,173 223,787 1,000
502 Great Mills Road
Lexington Park, Maryland
Branch Office (1) 1992 Owned 604,275 503,087 2,500
Rt. 235 and Maple Road
Lexington Park, Mayland
Branch Office 1961 Owned 278,309 201,270 2,500
Route 5 and Lawrence Avenue
Leonardtown, Maryland
Branch Office 1987 Leased 16,599 10,770 2,100
Business Park Dr. &
Route 301
Waldorf, Maryland
Branch Office (2) 1990 Leased 418,390 402,773 24,200
Potomac Square
729 North 301 Highway
La Plata, Maryland
Branch Office 1991 Leased 26,878 19,817 1,400
10321 Southern Md. Blvd.
Dunkirk, Maryland
Branch Office 1996 Owned 849,145 845,880 2,500
8010 Matthews Road
Bryans Road, Maryland
</TABLE>
- ---------------------
(1) The Savings Bank purchased land early in 1992, and built a new Lexington
Park branch office which opened in August 1992. The Bank is currently
leasing out the former office space and has received an offer to purchase
the site for $400,000 pending the availability of right of way.
(2) Includes land purchased in February 1993 as potential branch location.
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<PAGE>
NCR currently maintains all accounting records for the Savings Bank's
deposits and loans . The Savings Bank's general ledger and other accounting
needs are met thro ugh the use of internal computer systems. The net book value
of the Savings Bank's investment in premises and equipment less accumulated
depreciation totalled $3.8 million at December 31, 1996. See Note 5 of the
Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
Neither the Corporation, the Savings Bank, nor any subsidiary is engaged in
any legal proceedings of a material nature at the present time. From time to
time the Savings Bank is a party to legal proceedings in the ordinary course of
business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1996.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
- -----------------------------------------------------------------------------
MATTERS
-------
The information contained under the section caption "Stock Information" in
the Annual Report is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The information contained in the table captioned "Selected Consolidated
Financial and Other Data" in the Annual Report is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
-------------
The information contained in the section captioned "Results of Operations"
in the Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The financial statements contained in the Annual Report which are listed
under Item 14 herein, are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors" in the Corporation's definitive proxy statement for the
Corporation's 1997 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
36
<PAGE>
The executive officers of the Corporation are as follows:
MICHAEL L. MIDDLETON (49 years old) is Chief Executive Officer of the
Corporation and the Savings Bank. He joined the Savings Bank in 1973 and served
in various management positions until 1979 when he became president of the
Savings Bank. Mr. Middleton is a Certified Public Accountant and holds a
Masters of Business Administration. As President and Chief Executive Officer of
the Savings Bank, Mr. Middleton is responsible for the overall operation of the
Savings Bank pursuant to the policies and procedures established by the Board of
Directors. Mr. Middleton has been elected to the Board of Directors of the FHLB
of Atlanta and will serve until December 1998. Mr. Middleton is a member of the
Rotary Club of Waldorf and is a Paul Harris Fellow.
HENRY A. SHORTER, JR. (66 years old) is the Secretary of the Corporation
and the Savings Bank. He has served in this capacity with the Savings Bank
since 1968. Mr. Shorter is a past member of the Board of Directors of the
Physicians Memorial Hospital located in La Plata, Maryland.
C. MARIE BROWN (54 years old) has been employed with Tri-County Federal for
over 20 years and has served as Senior Vice President of operations since 1988.
Prior to her appointment as Senior Vice President, Ms. Brown served as Vice
President of the Savings Bank.
BEAMAN SMITH (51 years old) is the Treasurer of the Corporation and has
been the president of Accosystems, Inc., a computer software company, since
1989. Prior to that time, Mr. Smith was a majority owner of the Smith's Family
Honey Company in Bryans Road, Maryland. Mr. Smith is a Vice President of Fry
Plumbing Company of Washington, D.C., a Trustee of the Ferguson Foundation, a
member of the Bryans Road Sports Council and the Treasurer of the Mayaone
Association.
EILEEN M. RAMOS (40 years old) joined the Savings Bank as Chief Financial
Officer in September 1994. Prior to that time, Ms. Ramos was a partner with the
accounting firm of Councilor, Buchanan & Mitchell, P.C. She is a member of the
American Institute of CPAs, the District of Columbia Institute of CPAs and the
Financial Managers Society.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors - Executive Compensation" in the Proxy Statement is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Owners
The information required by this item is incorporated herein by reference
to the sections captioned "Proposal I -- Election of Directors" and "Voting
Securities and Principal Holders Thereof" of the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to
the section captioned "Proposal I -- Election of Directors" of the Proxy
Statement.
(c) Changes in Control
Management of the Corporation knows of no arrangements, including any
pledge by any person of securities of the Corporation, the operation of which
may at a subsequent date result in a change in control of the registrant.
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<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal I -- Election of Directors" and "Transactions
with the Corporation and the Savings Bank" of the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a)1. Report of Independent Certified Public Accountants*
Report of Predecessor Independent Certified Public Accountants*
Tri-County Financial Corporation*
(a) Consolidated Statements of Financial Condition at December 31,
1996 and 1995
(b) Consolidated Statements of Income for the Years Ended December
31, 1996, 1995 and 1994
(c) Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1996, 1995 and 1994
(d) Consolidated Statements of Cash Flow for the Years Ended December
31, 1996, 1995 and 1994
(e) Notes to Consolidated Financial Statements
- --------------------
* Incorporated by reference to the Annual Report.
2. All schedules have been omitted as the required information is either
inapplicable or included in the Notes to Consolidated Financial
Statements.
3. Exhibits
(3)(a) Articles of Incorporation of Tri-County Financial
Corporation**
(3)(b) Bylaws of Tri-County Financial Corporation **
(10)(a) Tri-County Federal Savings Bank of Waldorf 1986 Stock Option
Plan, as amended ***
(10)(b) Employment Agreement with Michael L. Middleton, as
amended ****
(13) Annual Report to Stockholders for the Fiscal Year Ended
December 31, 1996
(21) Subsidiaries of the Registrant.
(23)(a) Consent of Deloitte & Touche LLP
(23)(b) Consent of Councilor, Buchanan & Mitchell, P.C.
(27) Financial Data Schedule
(b) No reports on Form 8-K have been filed during the last quarter of the
fiscal year covered by this report.
(c) The exhibits required by Item 601 of Regulation S-K are either filed
as part of this Annual Report on Form 10-K or incorporated by
reference herein.
(d) There are no other financial statements and financial statement
schedules which were excluded from the Annual Report pursuant to Rule
14a-3(b)(1) which are required to be included herein.
- --------------------
** Incorporated by reference to the registrant's Form S-4 Registration
Statement No. 33-31287.
*** Incorporated by reference to Exhibit (10)(a) of the registrant's Form
10-K for the fiscal year ended December 31, 1989.
**** Incorporated by reference to Exhibit (10)(b) of the registrant's Form
10-K for the fiscal year ended December 31, 1990.
38
<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.
TRI-COUNTY FINANCIAL CORPORATION
Date: March 28, 1997 By: /s/ Michael L. Middleton
-----------------------------------------
Michael L. Middleton
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirement 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/ Michael L. Middleton By: /s/ M. William Runyon
----------------------------- ---------------------------
Michael L. Middleton M. William Runyon
(Director, Chief Executive, (Director)
Accounting and Financial
Officer)
Date: March 28, 1997 Date: March 28, 1997
By: /s/ Henry A. Shorter, Jr. By: /s/ W. Edelen Gough, Jr.
----------------------------- ---------------------------
Henry A. Shorter, Jr. W. Edelen Gough, Jr.
(Director and Secretary) (Director)
Date: March 28, 1997 Date: March 28, 1997
By: /s/ C. Marie Brown By: /s/ Gordon A. O'Neill
----------------------------- ---------------------------
C. Marie Brown Gordon A. O'Neill
(Director and Senior Vice (Director)
President)
Date: March 28, 1997 Date: March 28, 1997
By: /s/ Beaman Smith
-------------------------
Beaman Smith
(Director and Treasurer)
Date: March 28, 1997
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
(3)(a) Articles of Incorporation of Tri-County Financial Corporation*
(3)(b) Bylaws of Tri-County Financial Corporation*
(10)(a) Tri-County Federal Savings Bank of Waldorf 1986 Stock
Option Plan, as amended **
(10)(b) Employment Agreement with Michael L. Middleton, N/A
as amended ***
(13) Annual Report to Stockholders for the Fiscal Year Ended
December 31, 1996
(21) Subsidiaries of the Registrant
(23)(a) Consent of Deloitte & Touche LLP
(23)(b) Consent of Councilor, Buchanan & Mitchell, P.C.
(27) Financial Data Schedule
</TABLE>
- --------------------
* Incorporated by reference to the registrant's Form S-4 Registration
Statement No. 33-31287.
** Incorporated by reference to Exhibit (10)(a) of the registrant's Form 10-K
for the fiscal year ended December 31, 1989.
*** Incorporated by reference to Exhibit (10)(b) to the registrant's Form 10-K
for the fiscal year ended December 31, 1990.
<PAGE>
Dear Shareholder:
On the tenth anniversary of this company's existence as a publicly held
financial institution, I am pleased to report to you the activities of
Tri-County Financial Corporation and its banking subsidiary, Tri-County Federal
Savings Bank. The year closed with the resolution of several major legislative
initiatives and the refocusing of our strategic business plan.
The first occurrence to impact the Company was the legislation passed by
Congress to protect the thrift's bad debt reserves previously recorded under
then current IRS guidelines. This watershed bill permitted those institutions
who wished to restructure as a bank charter to do so without incurring material
tax liabilities. Secondly, Congress passed a bill to recapitalize the FDIC's
Savings Association Insurance Fund (SAIF). That action expropriated an
additional $820,000 of our pre-tax income to fund the SAIF reserves.
The most exciting event was the result of the first legislative action, in
that Tri-County Federal Savings Bank was now able to convert its charter to that
of a commercial bank. I am pleased to announce that as of this writing, approval
of the charter has been granted and the conversion to the Community Bank of
Tri-County will occur on March 31,1997.
Our business plan, as a community bank, will be to grow the business and
consumer portion of the portfolio while maintaining our most profitable lines in
the residential lending field. In addition, our plan includes a concentration of
effort to attract more transactional accounts and business deposits. To assist
us in this challenge, we have contracted with a national bank consulting group
to implement a quality sales, quality service culture on a bank wide basis.
What your Board proposes to accomplish with these bold changes in the
business plan of the Company is to prevent a migration of the franchise value as
the new world order of providing financial services rearranges itself in the
marketplace. With most financial products reduced to that of a commodity, we
believe that new strategies have to be put in place to bundle those products
into a service that will add long term value to a financial institution like the
Community Bank.
As you will see in the following financial statements, the Company
continues its growth and profitability trend with sound earnings potential and
quality assets. The net income was down due to the FDIC recapitalization
mentioned above and an increase in the loan loss reserve to achieve an adequate
reserve level in light of the Bank's portfolio risk. Even with these
extraordinary charges, the Company returned 7.9% on equity while earning .77
basis points on average assets. This return was earned despite paying over $1.1
million dollars in FDIC assessments and $198,000 in additional loan loss
reserves. To put this in perspective, a bank like NationsBank, would have paid
only $2,000 for the same FDIC coverage! Without these charges, earnings were on
track to be close to the record year of 1995.
It is with excitement that we begin our new journey as a community bank and
I sincerely appreciate the support and confidence that our shareholders have
shown over these last ten years. On behalf of your Board of Directors and our
staff of community bankers, I look forward to serving you in the coming year.
Yours truly
Michael L. Middleton
President and Chairman
1
<PAGE>
Tri-County Federal Savings Bank
-------------------------------
Peer Group Comparative Performance Ratios
-----------------------------------------
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------------------------------------------------------------------------------------
TCFSB MD Thrifts TCFSB MD Thrifts TCFSB MD Thrifts TCFSB MD Thrifts TCFSB MD Thrifts
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Yield on Interest-earning Assets 8.30% 7.92% 8.44% 8.09% 8.11% 7.73% 8.83% 8.16% 9.46% 8.97%
Cost of Funds 4.29% 4.92% 4.31% 4.88% 3.92% 4.17% 4.35% 4.37% 5.30% 5.42%
Yield Spread 4.01% 3.04% 4.14% 3.30% 4.20% 3.57% 4.47% 3.75% 4.16% 3.49%
Net Operating Margin 1.30% 0.65% 2.11% 1.17% 1.93% 1.45% 2.14% 1.65% 1.72% 1.40%
Net Income before Taxes 1.33% 0.66% 2.17% 1.21% 1.85% 1.46% 2.31% 1.66% 1.96% 1.42%
Return on Average Assets 0.84% 0.40% 1.30% 0.79% 1.08% 0.96% 1.42% 1.10% 1.22% 0.92%
Return on Average Tangible Capital 8.88% 3.53% 14.54% 8.03% 12.99% 9.69% 18.29% 13.31% 18.30% 12.36%
Nonperforming Loans and REO 0.48% 2.20% 0.34% 2.33% 0.88% 3.18% 0.98% 3.63% 0.96% 4.55%
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Source: FHLB Comparative Performance
Reports
2
<PAGE>
[Bar Graphs showing:
Regulatory Capital Position (1992 through 1996);
Rate Spread Between Interest-Earning Loans and Interest-Bearing Deposits
(1992 through 1996);
Return of Assets(1992 through 1996);
Net Income (1992 through 1996);
and Primary Net Income Per Common Share (1992 through 1996).]
3
<PAGE>
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total Amount of:
Loans Outstanding............................ $112,036,851 $107,817,075 $ 98,689,129 $ 85,506,126 $ 84,225,071
Mortgage-backed Securities.................... 43,354,206 31,954,354 29,796,793 33,583,509 30,344,094
Interest and Noninterest-bearing Cash......... 3,903,612 4,050,219 3,471,953 4,020,960 5,342,331
Investment Securities......................... 13,429,115 14,903,798 14,729,588 10,269,094 7,111,972
Assets........................................ 178,320,557 164,262,643 153,050,998 139,570,352 130,484,013
Savings Deposits.............................. 134,818,992 129,348,276 126,069,320 120,016,995 111,771,247
Borrowed Money................................ 24,733,466 17,552,845 12,480,128 6,543,919 7,474,823
Stockholders' Equity.......................... 17,251,683 15,971,148 13,368,494 12,135,593 10,261,697
Number of:
Loans Outstanding............................. 2,854 2,792 2,667 2,597 2,644
Savings Accounts.............................. 14,849 14,090 14,409 13,816 13,542
Offices Open - All Full Service............... 8 6 6 6 6
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended December 31,
----------------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Weighted Average Yield on:
Loan and Mortgage-backed Security Portfolio... 8.55% 8.80% 8.44% 9.18% 9.67%
Investment Portfolio.......................... 5.52 5.90 5.24 4.38 5.15
All Interest-earning Assets................... 8.24 8.44 8.03 8.65 9.32
Weighted Average Rate Paid on:
Savings Deposits and Escrow................... 4.05 4.06 3.67 3.94 4.84
Federal Home Loan Bank Advances and Other
Borrowings.................................... 5.46 6.21 7.02 9.60 9.62
All Interest-bearing Liabilities.............. 4.22 4.28 3.87 4.29 5.21
Interest Rate Spread (Spread Between Weighted
Average Rate on All Interest-earning Assets
and All Interest-bearing Liabilities)......... 4.02 4.16 4.16 4.36 4.11
Net Yield (Net Interest Income as a
Percentage of Average Interest-earning Assets) 4.32 4.45 4.38 4.53 4.21
</TABLE>
4
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (CONTINUED)
SUMMARY OF OPERATIONS
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest Income............................. $13,471,595 $12,900,876 $11,262,969 $11,337,676 $11,578,297
Interest Expense............................ 6,406,756 6,094,968 5,117,503 5,390,004 6,322,559
------------------------------------------------------------------------
Net Interest Income.......................... $ 7,064,839 $ 6,805,908 $ 6,145,466 $ 5,947,672 $ 5,255,738
Loss Provision and Charge offs of Loans...... 408,000 210,000 154,000 144,000 151,000
------------------------------------------------------------------------
Net Interest Income
After Provision for Loss on Loans....... $ 6,656,839 $ 6,595,908 $ 5,991,466 $ 5,803,672 $ 5,104,738
Other Income................................. 930,970 857,467 562,297 823,159 803,834
Less Noninterest Expense..................... 5,482,882 4,098,561 3,928,991 3,514,998 3,353,613
------------------------------------------------------------------------
Income Before Federal Income Tax............ $ 2,104,927 $ 3,354,814 $ 2,624,772 $ 3,111,833 $ 2,554,959
Income Tax Expense........................... 785,200 1,327,000 1,041,715 1,289,852 963,328
Income Tax Benefit - Change in Accounting
for Deferred Taxes... - - - 57,108 -
-------------------------------------------------------------------------
Net Income................................... $ 1,319,727 $ 2,027,814 $ 1,583,057 $ 1,879,089 $ 1,591,631
-------------------------------------------------------------------------
Net Income Per Common Share (1) - Primary... $ 1.61 $ 2.62 $ 2.08 $ 2.57 $ 2.09
Fully-Diluted... $ 1.60 $ 2.59 $ 2.00 $ 2.40 $ 2.06
Cash Dividends Declared Per Common Share(2) 70,574 64,751 60,545 - -
</TABLE>
(1) Restated to reflect 1993, 1994, 1995, 1996 and 1997 stock dividends.
(2) A $0.10 per common share cash dividend was declared on January 27, 1994,
payable to shareholders of record March 5, 1994;
a $0.10 per common share cash dividend was declared on January 31, 1995,
payable to shareholders of record March 3, 1995;
a $0.10 per common share cash dividend was declared on January 24, 1996,
payable to shareholders of record March 4, 1996;
a $0.10 per common share cash dividend was declared on January 24,
1997, payable to shareholders of record March 7, 1997;
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
Management believes that the year ended December 31, 1996 will be
recorded as one of the most significant years for the thrift industry in its
endeavor to compete in the financial markets of this country. Several
legislative initiatives were resolved in favor of those thrifts whose business
plans include structural change to address the emerging needs of a financial
institution's primary customer base. The United States Congress approved a bill
preserving bad debt reserves previously recorded under Internal Revenue Service
regulations then in force. This created an opportunity for thrifts, who were
previously constrained by the threat of a material bad debt recapture situation,
to convert to banking charters which would best fit their business plans. With
that obstacle removed, the Board of Directors of Tri-County Financial
Corporation ("the Company") authorized a feasibility study of converting to a
commercial bank charter. The optimum charter appeared to be that of a state
chartered, Federal Reserve member bank. The Board then directed the Bank's
management to initiate the effort to convert to a bank charter. In December
1996, the required documents were filed with the appropriate authorities. On
March 7, 1997 regulatory approval was granted and the new bank will open on
March 31,1997.
BUSINESS STRATEGY TO IMPLEMENT COMMERCIAL BANKING
Management believes that this business strategy should allow the newly
chartered bank, named "Community Bank of Tri-County", to capture more market
share from the larger regional banks who appear to have lost the community bank
image. For several years, the Bank's management has been implementing the
technology and staffing required to meet the demands of a commercial bank
operation. It feels well prepared to begin full scale operations immediately
after conversion.
The conversion to a state chartered, Federal Reserve member bank will
affect the business of the Bank in that certain asset allocation regulations,
such as the Qualified Thrift Lender Test (QTL) will no longer apply to the
capital asset allocation strategies utilized by management. Over time, the asset
allocation of the Bank will evolve from a thrift portfolio to that of a typical
community bank. Management and the Board of Directors do not anticipate the
conversion to result in changes in the Bank's historically profitable and
increasingly efficient residential mortgage and builder business product lines.
Attention has been given to new delivery systems designed to help the growth of
consumer and small business lending. These product lines are expected to expand
in an effort to capitalize on what management perceives as the void created by
the merger of larger community banks into larger super regional institutions.
In addition, it is expected that more transactional accounts will be
attracted to the new Community Bank and should help reduce the overall cost of
funds in the future.
Management has recently contracted the services of a national banking
consultant to create a bank wide Quality Sales, Quality Service Culture to
assist it in its change from
5
<PAGE>
that of a thrift to a dynamic, sales oriented, financial services company. It is
anticipated that future product lines will evolve around the total financial
service needs of its customer rather than a fragmented product offering that was
typical of a thrift. The new bank anticipates that it will invest heavily in
technology and engage in building affiliations with financial service providers
to accomplish this objective.
OTHER DEVELOPMENTS
The second major legislative initiative to be resolved was the
re-capitalization of the FDIC's Savings Association Insurance Fund (SAIF).
Thrifts were assessed a 65.7 basis point special insurance fee that was payable
on September 30, 1996. The fund became fully capitalized and the future FDIC
assessment fee for the Bank dropped from 23.5 basis points per year to 6.5 basis
points in 1997. This will allow SAIF insured institutions such as the Community
Bank of Tri-County to better compete with other financial institutions for
deposits. This fee, coupled with the current annual assessment, translated into
$1.1 million dollars in FDIC insurance expense charged to operations for the
Bank in 1996.
The economic environment has not changed considerably over the last
year and the flat yield curve in the interest rates is expected to continue in
the near term. At this writing, the Federal Reserve has openly hinted of an
interest rate change to cool off any heating up of the economy through monetary
policy. This bears watching in that any shift in short term rates will directly
impact the net interest margin of the Company and its subsidiary Bank.
The local market of Southern Maryland continues to benefit from the
enhanced naval presence in St. Mary's county as well as in Charles county, two
of the primary markets of the Bank. However, with growth comes intensified
competitive pressures from financial institutions desiring to capitalize on
these growth sectors of the State. Merger and acquisitions of mid sized
financial institutions by large regional and money center banks will bring to
the market a presence that previously did not exist in this area. With the trend
toward total financial product delivery systems of the super regional banks,
community banks will have to quickly adjust their sales and technology
strategies to outmaneuver the larger providers.
In that light, the Bank has opened its newest stand alone branch in
Bryans Road, Maryland. It brings the count of free standing branches throughout
the Southern Maryland area to seven. Each is geographically located to permit
coverage of the major business areas in the marketplace. To augment the delivery
systems employed by the Bank, it opened its first "micro" branch, utilizing
limited square footage to provide full customer service, at the Charles County
Community College on February 28, 1997. This strategy of utilizing lower cost
delivery systems supported by larger stand alone branches will be followed until
sufficient penetration of the market is achieved to enable the Bank to bring its
services to the customers in a cost effective manner.
6
<PAGE>
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net income for the Company was down by $708,087 or $1.01 per share.
This compared negatively to the increase of $444,757 or $.54 per share in net
income for the year ended December 1995 over the comparable year in 1994. Net
income was adversely affected primarily by two events during the course of the
year. The first, mentioned above, was the effect of the re-capitalization of the
SAIF fund of the FDIC. The special 65.7 basis point assessment resulted in a
pre-tax charge to income of $820,000 for an after tax cost of $504,000. This
represents $.61 per primary share. For the year, the Bank paid out $1,120,668 in
FDIC insurance compared to $287,628 in 1995 and $275,339 in 1994.
The second factor impacting net income was the increase in the Provision
for Loan Losses by $198,000 or $.24 per share over the same period in 1995. The
Board of the Bank elected to increase the Reserve for Loan Loss to achieve a
sufficient reserve level commensurate with the Bank's portfolio risk. With the
loan loss charge in 1996, the Reserve for Loan Loss approximates one percent of
the loan portfolio at December 31, 1996. The coverage ratio of net loan charge
offs for 1996 was 19.0 while it was 5.24 in 1995 and 3.86 in 1994. It is the
intent of the Bank to continue to add to the reserve as its product mix expands
and changes to reflect increased portfolio risk. As this shift occurs, the
reserve is likely to be more closely aligned with the commercial bank average of
1.4 % of loans outstanding. Because the transition from thrift assets, which
generally have a lower risk profile, to those of a traditional commercial bank
will take several years, management believes that a constant level of annual
provisions will achieve the desired reserve within two years.
The weighted average yield on all interest-earning assets was 8.24% in
1996, 8.44% in 1995 and 8.03% in 1994. The interest rate trend during the year
was flat and experienced very little variance over the period. This resulted in
an erosion of the weighted average yield as little yield gain was available by
extending maturities of investments. Management's asset/liability strategy was
to protect against upside movements in interest rates, therefore, maturity
extension of investments would have been counterproductive to the strategy.
The most significant increase among the asset categories occurred in
mortgage-backed securities available for sale, which increased by $11.7 million.
This reflects a strategy employed by the bank to leverage its net worth with
matched investments and wholesale borrowings to provide additional revenue to
the Bank. The investments are risk rated below those of whole mortgage loans and
therefore more effectively leverage the risk-based capital ratio maintained by
the Bank to comply with overall capital requirements of the Office of Thrift
Supervision.
The weighted average rate paid on all interest-bearing liabilities was
4.22% in 1996, 4.28% in 1995 and 3.87% in 1994. Thus while declining slightly in
1996, the rate paid on liabilities continues to reflect the negative pressure
exerted by a flat yield curve which offers little relief to short term
borrowings or core deposits.
7
<PAGE>
The net interest rate spread was 4.02% in 1996 compared to 4.16% in
1995 and 4.16% in 1994 . While the trend has been level over the past several
years, it is the belief of management that there exists an upside rate movement
risk in the near future and therefore, the Bank is shifting the portfolio to
protect against cyclical interest rate shifts. The interest rate sensitivity
analysis follows this section and will provide a more detailed discussion.
The loan portfolio continues to hold its quality and has a relatively
low amount of non-performing loans for 1996 at $699,000 or .6% of total loans
compared to $ 566,000 or .5% of total loans for 1995. The Bank owned real estate
acquired through foreclosure with a fair market value of $155,000 at December
31,1996. This property was sold in early l997 at a small profit.
Operating expense increased by 34% or $1,384,321 compared to an
increase of $169,570 or 4% for 1995. Included in this total is the previously
mentioned SAIF assessment of $820,000. Other expenses included start up staffing
and promotional expense associated with the new branch opened in Bryans Road,
Maryland during the year. It is expected that personnel expense will increase in
the future as the Bank staffs to a level necessary to handle the expected
increase in transactional and business activity. In order to better link
performance with pay, the Board of the Bank approved an incentive plan for all
branch managers in 1997. This measure brings the percentage of personnel who are
compensated based on Bank performance to over 50%.
Net premises and equipment increased by 20% or $645,762 for the year. This
reflects the completion of the new Bryans Road facility and increased investment
in technology platforms to assist in lower cost delivery of services in the
future. The ongoing investment in technology is expected to increase as services
become more standardized and computer driven. The Bank purchased software to
upgrade several of its branch office retail platforms and anticipates completing
the task at the remaining branches during 1997. In addition, the Bank purchased
software to automate its consumer loan processing activities in anticipation of
the increase in that line of business as a community bank.
The Bank's wholesale borrowing, consisting mainly of advances from the
Federal Home Loan Bank of Atlanta, increased from $13,250,000 in 1995 to
$24,000,000 or 81% in 1996. These borrowings were used to fund specific loan
projects or to create arbitrages with authorized investments matched to the
borrowings for a managed spread. This strategy allows for the prudent leveraging
of net worth to maximize revenue production while managing asset and liability
interest rate risk.
Stockholders' average equity for the year ended 1996 grew by 8% or
$1,280,535 to $17,251,683. This represents an average net worth to total assets
ratio of 9.7%. For historical comparison, the net worth to total assets at
December 31,1986, the end of the year which the Bank converted to stock form,
was 5.6% with a total net worth of $4,323,600.
The net unrealized gain on investment and mortgage-backed securities
available for sale declined by 62% or $143,345 due to the effects of the flat
yield curve on interest
8
<PAGE>
rates. The prolonged flat curve produces little opportunity to improve yield
unless one increases the duration of investments or loans. When the long term
rate moves up, the impact on the market value of the securities declines. This
valuation allowance is subject to the fluctuations in the money markets on a
monthly basis and will be reflected in the quarterly statements to the
regulatory agencies and shareholders.
The Bank's capital position relative to regulatory requirements was as
follows:
<TABLE>
<S> <C>
Tangible capital required to be held $ 2,661,000
Actual tangible capital on hand 16,447,000
----------
Excess capital $13,786,000
Minimum core capital required $ 5,322,000
Core capital on hand 16,447,000
----------
Excess core capital $11,125,000
Risk based capital required $ 8,404,000
Actual risk based capital held 17,567,000
----------
Excess risk based capital $ 9,163,000
</TABLE>
The Bank's capital position exceeds all levels of required regulatory
capital and the Bank is considered a well capitalized institution by the FDIC.
INTEREST RATE SENSITIVITY ANALYSIS
The interest rate sensitivity of the Bank's portfolio is continually
monitored by the Bank's management and regularly reported to its board of
directors. The sensitivity of the market value of the portfolio equity and
interest rate sensitivity of net income are calculated as follows:
<TABLE>
<CAPTION>
Market value of portfolio equity
Interest rate changes: Adverse scenario 1995 1996
------------------
<S> <C> <C>
Up 200 basis points -10% -10%
Up 400 basis points -24% -30%
Down 200 basis points + 9% + 3%
Down 400 basis points +19% +10%
Interest rate sensitivity
Interest rate changes: Adverse scenario 1995 1996
------------------
Up 200 basis points + 1% + 5%
Up 400 basis points + 4% + 9%
Down 200 basis points - 3% - 6%
Down 400 basis points - 6% -15%
</TABLE>
The change in percentage for the Market Value of Portfolio Equity remained
constant at the adverse scenario of 200 basis points in interest rate movement.
The 400 basis point movement reflects a more exaggerated shift in market value
loss of 30% in
9
<PAGE>
market value of the portfolio. The management of the Bank is less concerned with
the shock of interest rates on the market value than it is on the interest rate
sensitivity because the assets are employed for their income production rather
that value appreciation upon sale.
The sensitivity of Net Interest Income shows a significant change in the
outcome of assumed interest rate changes. In those scenarios, the adverse
scenario is the result of downward movement of rates. It is the opinion of
management that the most probable damage to the institution would be the
greatest from upside rate movements. Therefore, the portfolio has been
structured in an attempt to reasonably minimize the impact from sudden and
prolong upward shifts in interest rates.
Interest rate sensitivity may also be analyzed by examining the extent to
which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap". An asset or
liability is said to be interest rate sensitive within a specific period if it
will mature or reprice within that period. The interest rate sensitivity gap is
defined as the difference between the amount of interest earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. Gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities, and is considered negative when the amount
of interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap would adversely affect net interest income and a positive gap would
result in an increase in net interest income while, conversely, during a period
of falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
10
<PAGE>
The following table sets forth the amounts of interest-earning
assets and interest-bearing liabilities outstanding at December 31, 1996 which
are expected to mature or reprice in each of the time periods shown.
INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
(000's)
<TABLE>
<CAPTION>
THREE THREE SIX MONTHS ONE THRU MORE THAN OVER FIVE
MONTHS MONTHS THRU THRU ONE THREE YEARS THREE THRU YEARS
OR LESS SIX MONTHS YEAR FIVE YEARS
------------- ------------- ------------- ------------ ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS:
MORTGAGE LOANS AND
MORTGAGE-BACKED
SECURITIES $ 25,042 $ 8,863 $ 14,616 $ 55,477 $ 16,017 $35,376
INVESTMENTS $ 16,221 - - - - -
TOTAL $ 41,263 $ 8,863 $ 14,616 $ 55,477 $ 16,017 $35,376
INTEREST EARNING LIABILITIES:
SAVINGS DEPOSITS $ 15,575 $ 5,428 $ 34,762 $ 48,408 $ 15,036 $15,610
BORROWED MONEY $ 13,270 - 5,000 6,000 463 -
TOTAL $ 28,845 $ 5,428 $ 39,762 $ 54,408 $ 15,499 $15,610
INTEREST SENSITIVITY GAP $ 12,418 $ 3,435 $ (25,146) $ 1,069 $ 518 $19,766
CUMULATIVE INTEREST
SENSITIVITY GAP $ 12,418 $ 15,853 $ (9,293) $ (8,224) $ (7,706) $12,060
PERCENT OF CUMULATIVE
GAP TO TOTAL ASSETS 6.9% 8.9% (5.2)% (4.6%) (4.3%) 6.8%
</TABLE>
The Realm and Bank models compute the market value of portfolio equity by
discounting the projected asset, liability and off-balance sheet cash flows,
with adjustments for amortization, prepayments, and decay factors. Discount
rates and prepayment rates vary across the interest rate scenarios. For income
sensitive measures, the size and composition of the balance sheet are held
constant, in accordance with Thrift Bulletin 13. The positions estimated in the
maturity gap report are the maturity and repricing sensitivities calculated from
the starting base scenario.
Certain shortcomings are inherent in the method of analysis presented in
the above table. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes
11
<PAGE>
in market interest rates, while interest rates on other types of assets and
liabilities may lag behind changes in market interest rates. Certain assets,
such as adjustable-rate mortgages, have features which restrict changes in
interest rates on a short-term basis and over the life of the asset. In the
event of a change in interest rates, prepayment and early withdrawal levels
would likely deviate significantly from those assumed in calculating the table.
The ability of many borrowers to service their debt may decrease in the event of
an interest rate increase.
IMPACT OF INFLATION
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in the
relative purchasing power of money over time due to 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 in the same magnitude as the price
of goods and services. In the current interest rate risk environment, liquidity
and the maturity structure of the Bank's assets and liabilities are critical to
the maintenance of acceptable performance levels.
STOCK INFORMATION
Tri-County Financial Corporation's stock is not traded or listed on any
public exchange. However, stock does change hands over the course of the year.
In 1996, the Company was made aware of several trades which occurred.
A total of 10,285 shares traded, with a high price of $24 and a low price
of $15. The weighted average price was $19.63. The number of shareholders at
March 7, 1997 was 502 and the total outstanding shares was 754,894. On January
24, 1997, the Board of Directors declared a 5% stock dividend and a $.10 per
share cash dividend, both payable on April 15, 1997 to shareholders of record on
March 7,1997. On January 24, 1996, the Board of Directors declared a 5% stock
dividend and a $.10 per share cash dividend which were distributed to holders of
record March 4, 1996.
Federal regulations impose certain limitations on the payment of dividends
and other capital distributions by the Bank.
Following the Bank's conversion to a commercial bank, the Bank's ability to
pay dividends will be governed by the Maryland Financial Institutions Code and
the regulations of the Federal Reserve Board. Under the Maryland Financial
Institutions Code, a Maryland bank (1) may only pay dividends from undivided
profits or, with prior regulatory approval, its surplus in excess of 100% of
required capital stock and (2) may not declare dividends on its common stock
until its surplus fund equals the amount of required capital stock or, if the
surplus fund does not equal the amount of capital stock, in an amount in excess
of 90% of net earnings.
The Bank's payment of dividends will also be subject to the Federal Reserve
Board's Regulation H, which limits the dividends payable by a state member bank
to the net profits of the Bank then on hand, less the Bank's losses and bad
debts. Additionally, the Federal Reserve Board has the authority to prohibit the
payment of dividends by a Maryland commercial bank when it determines such
payment to be an unsafe and unsound banking practice. Finally, the Bank, like
the Savings Bank, would not be able to pay dividends on its capital stock if its
capital would thereby reduced below the remaining balance of the liquidation
account established in connection with the Stock Conversion.
The Company's ability to pay dividends will be governed by the policies and
regulations of the Federal Reserve Board which prohibit the payment of dividends
under certain circumstances involving the bank holding company's financial
condition and capital adequacy.
12
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
Consolidated Financial Statements at December 31, 1996 and 1995
and for the Three Years Ended December 31, 1996 and Independent
Auditors' Report
13
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
TABLE OF CONTENTS
- -------------------------------------------------------------------------------
Page
INDEPENDENT AUDITORS' REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS AT DECEMBER 31, 1996 AND 1995,
AND FOR THE THREE YEARS ENDED DECEMBER 31, 1996
Consolidated Statements of Financial Condition 2
Consolidated Statements of Income 3
Consolidated Statements of Stockholders' Equity 4
Consolidated Statements of Cash Flows 5-7
Notes to Consolidated Financial Statements 8-30
14
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Tri-County Financial Corporation
Waldorf, Maryland
We have audited the accompanying consolidated statements of financial condition
of Tri-County Financial Corporation and subsidiary (the Company) as of December
31, 1996 and 1995, and the related consolidated statements of income,
stockholders' equity, and cash flows for the years then ended. These financial
statements are the responsibility of the Company'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, such consolidated financial statements present fairly, in all
material respects, the financial position of Tri-County Financial Corporation
and subsidiary as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
/S/ DELOITTE & TOUCHE LLP
March 14, 1997
Washington, D.C.
15
<PAGE>
[LETTERHEAD OF CB&M APPEARS HERE]
March 3, 1995
Independent Auditors' Report
----------------------------
The Board of Directors
Tri-County Financial Corporation
Waldorf, Maryland
We have audited the accompanying consolidated statement of financial condition
of Tri-County Financial Corporation and Subsidiary as of December 31, 1994, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides 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 Tri-County Financial
Corporation and Subsidiary as of December 31, 1994, and the results of their
operations and their cash flows for the year then ended, in conformity with
generally accepted accounting principles.
/s/ Councilor, Buchanan & Mitchell, P.C.
Certified Public Accountants
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 AND 1995
- -----------------------------------------------------------------------------------------------------------
ASSETS 1996 1995
<S> <C> <C>
CASH AND CASH EQUIVALENTS:
Noninterest-bearing $ 1,111,894 $ 786,113
Interest-bearing 2,791,718 3,264,106
------------- -----------
Total cash and cash equivalents 3,903,612 4,050,219
Investment securities available for sale at fair value, (amortized
cost of $11,117,063 and $14,798,529, respectively) 11,265,358 14,903,798
Investment securities held-to-maturity at amortized cost,
(fair value of $863,757 in 1996) 863,757 -
Mortgage-backed securities available for sale at fair value, (amortized
cost of $42,473,979 and $30,549,744, respectively) 42,470,319 30,793,682
Mortgage-backed securities held-to-maturity at amortized cost,
(fair value of $919,349 and $1,160,672, respectively) 883,887 1,160,672
Loans receivable, net of allowance for loan losses of $1,120,102 and
$733,573, respectively 111,024,921 107,340,325
Stock in Federal Home Loan Bank - at cost 1,300,000 881,600
Loans held for sale 1,011,930 476,750
Accrued interest receivable 1,165,191 1,093,113
Premises and equipment, net 3,824,568 3,178,806
Other assets 607,014 383,678
-------------- --------------
$ 178,320,557 $ 164,262,643
TOTAL ASSETS ============== ==============
</TABLE>
See notes to consolidated financial statements.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
<S> <C> <C>
LIABILITIES:
Deposits $ 134,818,992 $ 129,348,276
Advances from Federal Home Loan Bank 24,000,000 13,250,000
Notes payable and other borrowings 733,466 4,302,845
Advance payments by borrowers for taxes and insurance 715,171 685,767
Accounts payable, accrued expenses, and other liabilities 724,055 614,952
Current and deferred income taxes 77,190 89,655
------------ ------------
Total liabilities 161,068,874 148,291,495
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value - 15 million shares
authorized; 750,960 and 685,112 shares issued and
outstanding respectively 7,510 6,851
Additional paid-in capital 5,724,729 5,021,350
Retained earnings 11,430,666 10,710,824
Net unrealized gain on investment and mortgage-backed
securities available for sale, net of taxes 88,778 232,123
---------- ----------
Total stockholders' equity 17,251,683 15,971,148
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 178,320,557 $ 164,262,643
============== ==============
</TABLE>
See notes to consolidated financial statements.
16
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- -----------------------------------------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
INTEREST INCOME:
Interest on loans $10,045,429 $ 9,771,990 $ 8,317,111
Interest on mortgage-backed securities 2,502,968 2,001,872 1,995,402
Interest and dividends on investment securities 923,198 1,127,014 950,456
----------- ----------- -----------
Total interest income 13,471,595 12,900,876 11,262,969
----------- ----------- -----------
INTEREST EXPENSES:
Deposits 5,397,181 5,198,160 4,553,471
Federal Home Loan Bank advances 850,612 492,004 341,208
Notes payable and other borrowings 158,963 404,804 222,824
----------- ----------- -----------
Total interest expenses 6,406,756 6,094,968 5,117,503
----------- ----------- -----------
Net interest income 7,064,839 6,805,908 6,145,466
Provision for loan losses 408,000 210,000 154,000
----------- ----------- -----------
Net interest income after 6,656,839 6,595,908 5,991,466
provision for loan losses
OTHER INCOME:
Loan service charges 280,126 284,635 261,140
Gain (loss) on sale of investments and
mortgage-backed securities available for sale -- 1,802 (70,877)
Gain (loss) on sale of loans 192,468 88,437 (40,546)
Service charges 382,228 399,079 293,596
Other 76,148 83,514 118,984
----------- ----------- -----------
Total other income 930,970 857,467 562,297
----------- ----------- -----------
OPERATING EXPENSES:
Employee compensation and benefits 2,432,293 2,141,438 1,972,787
Occupancy expense 353,246 341,449 357,830
Federal insurance premiums and surety
bond premiums 1,165,816 348,025 328,175
Data processing expenses 262,375 207,632 222,511
Other 1,269,152 1,060,017 1,047,688
----------- ----------- -----------
Total operating expenses 5,482,882 4,098,561 3,928,991
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 2,104,927 3,354,814 2,624,772
INCOME TAX EXPENSE:
Current 929,000 1,400,000 859,915
Deferred (143,800) (73,000) 181,800
----------- ----------- -----------
Total income tax expense 785,200 1,327,000 1,041,715
----------- ----------- -----------
$ 1,319,727 $ 2,027,814 $ 1,583,057
NET INCOME =========== =========== ===========
EARNINGS PER SHARE:
Primary $ 1.61 $ 2.62 $ 2.08
On a Fully Diluted Basis 1.60 2.59 2.00
</TABLE>
See notes to consolidated financial statements
17
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ----------------------------------------------------------------------------------------------------------------------------------
Net Unrealized
Additional Gain (Loss) on
Common Paid In Securities Available Retained
Stock Capital for Sale Earnings Total
<S> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1994 $ 6,051 $ 3,605,425 $ (18,856) $ 8,542,973 $ 12,135,593
Net income -- -- -- 1,583,057 1,583,057
$.10 per share cash dividend -- -- -- (60,545) (60,545)
5% stock dividend 300 599,700 -- (600,000) --
Cash paid in lieu of stock
dividend for fractional shares -- -- -- (5,458) (5,458)
Exercise of stock options 73 42,642 -- -- 42,715
Change in unrealized gain (loss)
on mutual funds -- -- (326,868) -- (326,868)
------ ----------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1994 6,424 4,247,767 (345,724) 9,460,027 13,368,494
Net income -- -- -- 2,027,814 2,027,814
$.10 per share cash dividend -- -- -- (64,751) (64,751)
5% stock dividend 322 707,682 -- (708,004) --
Cash paid in lieu of stock
dividend for fractional shares -- -- -- (4,262) (4,262)
Exercise of stock options 105 65,901 -- -- 66,006
Change in unrealized gain (loss)
on investment and mortgage-backed
securities available for sale -- -- 577,847 -- 577,847
------ ----------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1995 6,851 5,021,350 232,123 10,710,824 15,971,148
Net income -- -- -- 1,319,727 1,319,727
$.10 per share cash dividend -- -- -- (70,574) (70,574)
5% stock dividend 351 525,489 -- (525,840) --
Cash paid in lieu of stock
dividend for fractional shares -- -- -- (3,471) (3,471)
Exercise of stock options 308 177,890 -- -- 178,198
Change in unrealized gain (loss)
on investment and mortgage-backed
securities available for sale -- -- (143,345) -- (143,345)
------ ----------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 1996 $7,510 $ 5,724,729 $ 88,778 $ 11,430,666 $ 17,251,683
</TABLE>
See notes to consolidated financial statements.
18
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income $ 1,319,727 $ 2,027,814 $ 1,583,057
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 408,000 210,000 154,000
Provision for depreciation and amortization 264,492 232,589 314,798
Amortization of premium/discount on
mortgage-backed securities
and investment securities (96,060) (87,102) (34,615)
Capitalization of interest expense on notes
payable - 38,553 72,407
Provision for deferred income tax (benefit) (143,800) (73,000) 181,800
Increase in interest receivable (72,078) (14,446) (196,234)
(Decrease) increase in interest payable (24,314) 26,235 10,671
(Decrease) increase in deferred loan fees (85,781) 4,720 110,146
Increase in other liabilities 282,092 301,137 243,860
(Increase) decrease in other assets (200,921) 378,203 (47,398)
(Gain) loss on sale of premises and equipment (9,610) (3,790) 15,278
Originations of loans held for sale (8,812,925) (5,731,850) (2,416,000)
Proceeds from sales of mortgage-backed 14,791,250
securities held for trading - -
Purchase of mortgage-backed securities (14,725,313)
held for trading - -
(Gain) loss on sales of investment securities
and mortgage-backed securities
available for sale - (1,802) 70,877
(Gain) loss on sales of loans held for sale (192,468) (88,437) 40,546
Proceeds from sales of loans held for sale 8,887,468 5,284,394 2,917,000
Federal Home Loan Bank stock dividends - (10,200) (10,800)
-------- --------- ---------
Net cash provided by operating
activities 1,523,822 2,493,018 3,075,330
----------- ----------- ---------
</TABLE>
(Continued)
19
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM INVESTING
ACTIVITIES:
Proceeds from sale or redemption of investments - - 594,201
Purchases of investments - - (9,291,447)
Purchase of Federal Home Loan Bank Stock (418,400) - -
Purchase of investment securities available
for sale (13,607,756) (7,395,830) -
Proceeds from sale of investment
securities available for sale 17,313,408 5,989,044 -
Purchase of investment securities
held-to-maturity (990,273) - -
Proceeds from maturities of investment
securities held-to-maturity 126,515 2,018,385 -
Purchase of mortgage-backed securities
held to maturity - (4,922,455) (5,933,913)
Purchase of mortgage-backed securities
available for sale (14,029,861) - (2,000,000)
Proceeds from sale of mortgage-backed
securities available for sale - 1,805,572 7,067,315
Principal collected on mortgage-backed
securities 2,454,288 1,674,614 6,165,854
Net decrease in short-term investments - - 3,573,176
Principal collected on loans 46,317,302 40,220,762 45,404,454
Loans originated or acquired (50,719,901) (49,037,683) (60,895,293)
Proceeds from sale of real estate - 200,437 -
Purchases of premises and equipment (859,884) (511,290) (120,798)
Proceeds from sale of premises and equipment 9,610 101,446 -
Investment in real estate - (232,305) -
----------- ------------ ------------
Net cash used in investing activities (14,404,952) (10,089,303) (15,436,451)
----------- ------------ ------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net increase in deposits 5,470,716 3,278,956 6,052,325
Net increase (decrease) in short-term borrowings 110,587 (107,933) (275,495)
Net increase (decrease) in advance payments
by borrowers for taxes and insurance 29,404 (85,192) 4,679
Proceeds from Federal Home Loan Bank 84,500,000 36,750,000 10,500,000
advances
Payments of maturing Federal Home Loan
Bank advances (73,750,000) (30,750,000) (7,500,000)
</TABLE>
(Continued)
20
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING
ACTIVITIES (Continued):
Net (decrease) increase in securities sold
under agreement to repurchase (3,358,000) (609,000) 3,967,000
Dividends paid (74,045) (69,013) (66,003)
Exercise of stock options 178,198 66,006 42,715
Repayments on notes payable (372,337) (299,273) (913,107)
------------ ------------ ------------
Net cash provided by financing
activities 12,734,523 8,174,551 11,812,114
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (146,607) 578,266 (549,007)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 4,050,219 3,471,953 4,020,960
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 3,903,612 $ 4,050,219 $ 3,471,953
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid during the year for:
Interest $ 6,414,832 $ 6,067,478 $ 5,116,244
Income taxes 803,000 940,786 1,048,771
</TABLE>
NON-CASH TRANSACTIONS:
Mortgage-backed securities totaling $2.0 million were received in 1994 in
exchange for equal amounts of loans receivable. No such exchanges occurred
in 1996 and 1995.
Mortgage-backed securities and investments totaling $28,704,461 and
$9,387,415, respectively, were transferred from the held-to-maturity
category to the available-for-sale category on December 31, 1995.
Transfers from loans receivable to foreclosed real estate were $207,409,
$52,000, and $49,382 in 1996, 1995, and 1994, respectively.
(Concluded)
See notes to consolidated financial statements.
21
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Tri-County
Financial Corporation and its wholly owned subsidiary, Tri-County Federal
Savings Bank of Waldorf (the Bank) and the Bank's wholly owned subsidiary,
Tri-County Federal Finance One (collectively, "the Company"). All
significant intercompany balances and transactions between the parent
corporations and their subsidiaries have been eliminated.
The Company is primarily engaged in the business of obtaining funds in the
form of savings deposits and investing such funds in mortgage loans on
residential, construction and commercial real estate and various types of
consumer and other loans, mortgage-backed securities, and investment and
money market securities. The Company grants loans throughout the Southern
Maryland area. Its borrowers' ability to repay is, therefore, dependent
upon the economy of Southern Maryland.
Management 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 and disclosure of contingent 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.
Cash and Cash Equivalents - For purposes of the consolidated statements of
cash flows, the Company considers all highly liquid debt instruments with
original maturities when purchased of three months or less to be cash
equivalents.
Investment Securities and Mortgage-backed Securities - Investment and
equity securities are segregated into the following three categories:
trading, held-to-maturity, and available-for-sale. Trading securities are
purchased and held principally for the purpose of reselling them within a
short period of time. Their unrealized gains and losses are included in
earnings. Debt securities classified as held-to-maturity are accounted for
at amortized cost, and require the Company to have both the positive
intent and ability to hold those securities to maturity. Securities not
classified as either trading or held-to-maturity are considered to be
available-for-sale. Unrealized gains and losses on available-for-sale
securities are excluded from earnings and reported, net of deferred taxes,
as a separate component of stockholders' equity until realized. Realized
gains or losses on the sale of investment and mortgage-backed securities
are reported in earnings and determined using the adjusted cost of the
specific security sold.
In November 1995, the Financial Accounting Standards Board issued a
Special Report, A Guide to Implementation of Statement 115 on Accounting
for Certain Investments in Debt and Equity Securities. The Special Report
provided institutions with a one-time opportunity to reassess the
appropriateness of their categorization of all securities, and allowed the
institutions to transfer securities between categories on or before
December 31, 1995. The report also stated that transfers from the
held-to-maturity category that resulted from this one-time reassessment
would not call into question the institution's intent to hold other debt
securities to maturity in the future.
22
<PAGE>
When reassessing the appropriateness of current designations of securities
under the Special Report, the Company considered how it uses securities to
meet liquidity needs and manage interest-rate risk. By having a portion of
its securities portfolio categorized as available-for-sale, the Company
has the ability to respond, through the management of its portfolio, to
changes in market interest rates or to increases in loan demand or deposit
withdrawals.
Given the opportunity to reassess the portfolio, the Company transferred
certain investment and mortgage-backed securities classified as
held-to-maturity to available-for-sale. The investment and mortgage-backed
securities transferred had carrying values of $9.4 million and $28.7
million and market values of $9.4 million and $28.9 million, respectively.
The transfers resulted in an increase in stockholders' equity at December
31, 1995, of $151,000 for the unrealized gain net of income taxes of
$76,000.
Loan Fees and Costs - Loan origination fee revenues and certain costs
directly related to specified activities performed for a loan origination
are deferred and recognized over the contractual life of the loan using a
method approximating level yield. Any unamortized amount of fees and costs
on loans sold or paid off is included in revenue in the year of sale or
payoff.
Loans Receivable - Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or payoff are
reported at their outstanding unpaid principal balances reduced by any
charge-offs or specific valuation allowance accounts, and net of any
deferred fees or costs on originated loans.
Loans Held for Sale - Mortgage loans originated and intended for sale in
the secondary market are carried at the lower of cost or estimated market
value, determined in the aggregate. Market value considers commitment
agreements with investors and prevailing market prices.
Income Recognition on Loans - Interest on loans is credited to income as
earned on the principal amount outstanding using the interest method. An
allowance for accrued interest deemed to be uncollectible is provided.
Accrued interest receivable is reported net of the allowance for
uncollectible interest. For those loans which are carried on nonaccrual
status, interest is recognized on the cash basis. Loans are generally
placed on nonaccrual status when the collection of principal or interest
is 90 days or more past due, or earlier if collection is deemed uncertain.
Allowance for Loan Losses - The allowance for loan losses is maintained at
a level believed by management to be adequate to absorb potential losses
inherent in the loan portfolio. Management's determination of the adequacy
of the allowance is based on a periodic evaluation of the portfolio with
consideration given to the overall loss experience; current economic
conditions; volume, growth, and composition of the loan portfolio;
financial condition of the borrowers; and other relevant factors that, in
management's judgment, warrant recognition in providing an adequate
allowance. The allowance is increased by provisions for loan losses
charged against income. Changes in the allowance are recorded periodically
as conditions change or as more information becomes available. Such
changes could result in material adjustments to future results of
operations.
Impairment of Loans - On January 1, 1995, the Company adopted Statement of
Financial Accounting Standard No. 114, "Accounting by Creditors for
Impairment of a Loan" (SFAS 114), as amended by SFAS 118, "Accounting by
Creditors for Impairment of a Loan-Income Recognition and Disclosures."
These pronouncements require that an impaired loan be measured based on
the present value of expected future cash flows discounted at the
effective interest rate of the loan or, as a practical expedient, at the
loan's observable market price or the fair value of the collateral if the
loan is collateral
23
<PAGE>
dependent. The Company considers a loan impaired when it is probable that
the Company will be unable to collect all contractual interest and
principal payments as scheduled in the loan agreement. A loan is not
considered impaired during a period of delay in payment if the ultimate
collectibility of all amounts due is expected. A valuation allowance is
maintained to the extent that the measurement of the impaired loan is less
than the recorded investment.
The Company's residential mortgage and consumer loan portfolios are
collectively evaluated for impairment and are not included within the
scope of SFAS 114. A valuation allowance has been provided for these loans
based on management's estimates of the risks inherent in the portfolios
and analysis of prior loss experience.
Payments received relating to impaired loans and nonaccrual loans are
recorded on a cash basis and are either applied to the outstanding
principal balance or recorded as interest income, depending upon
management's assessment of the ultimate collectibility of the loan.
Premises and Equipment - Depreciation of premises and equipment, which are
carried at cost, is provided by the straight-line method over the
estimated useful lives as follows:
Buildings and improvements 10-50 years
Furniture and equipment 5-20 years
Automobiles 3 years
Foreclosed Real Estate - Real estate acquired through, or in lieu of, loan
foreclosure is initially recorded at the lower of the recorded investment
or fair value at the date of foreclosure. Costs relating to the development
and improvement of property are capitalized, whereas costs relating to the
holding of property are expensed. 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 less estimated costs to sell. No charge to operations was required as
a result of this review in 1996, 1995, or 1994.
Mortgage-Banking Activities - When the Bank purchases or originates
mortgage loans, the cost of acquiring these loans includes the cost of the
related mortgage servicing rights (MSRs). When the Bank sells or
securitizes mortgage loans and retains the MSRs, it allocates the total
cost of the mortgage loans between the MSRs and the loans (without MSRs)
based on their relative fair values, if practicable. Any cost allocated to
the MSRs is recognized as a separate asset. MSRs are amortized in
proportion to and over the period of estimated net servicing income and are
evaluated for impairment based on their fair value. Total capitalized
mortgage servicing rights approximated $10,000 at December 31, 1996.
Income Taxes - The Company files a consolidated Federal income tax return
with its subsidiary. Deferred tax assets and liabilities are recognized
for the future tax consequences attributed to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Any deferred tax asset is reduced by the
amount of any tax benefit that more likely than not will not be realized.
Earnings Per Share - Earnings per share was computed by dividing net
earnings by the weighted average number of shares of common stock and
common stock equivalents outstanding during the year. Earnings per share
for all years presented have been restated to reflect the effect of stock
dividends (see Note 13). Per share amounts have been computed based on
average common and common equivalent shares outstanding as follows:
24
<PAGE>
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Primary 818,222 774,860 761,085
Fully Diluted 823,016 783,311 791,528
</TABLE>
New Accounting Pronouncements -
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." This
Statement, which is effective for transactions occurring after December
31, 1996 (prospective basis only), provides accounting and reporting
standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial-components approach that focuses on control.
Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control
has been surrendered, and derecognizes liabilities when extinguished. This
Statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured
borrowings.
SFAS 125 also addresses accounting for mortgage-servicing rights and
requires an entity to recognize either a servicing asset or servicing
liability each time the entity undertakes an obligation to service
financial assets. The Statement requires that servicing assets and
liabilities be subsequently measured by (a) amortization in proportion to
and over the period of estimated net servicing income or loss and (b)
assessment for asset impairment or increased obligation based on their
fair values. Upon becoming effective, this Statement will supersede SFAS
122, "Accounting for Mortgage Servicing Rights".
In December 1996, the FASB amended SFAS 125, through its issuance of SFAS
127, "Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125 - an amendment of FASB Statement No. 125". SFAS 127
defers for one year the effective date of certain provisions of SFAS 125.
The Company does not anticipate that the implementation of SFAS 125 will
materially impact its financial position or results of operations.
In February 1997, the FASB issued Statement No. 128, "Earnings Per Share."
This Statement establishes standards for computing and presenting earnings
per share (EPS) and applies to entities with publicly held common stock or
potential common stock. This Statement simplifies the standards for
computing earnings per share previously found in APB Opinion No. 15,
Earnings per Share, and makes them comparable to international EPS
standards. It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS
on the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator
of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. This Statement is effective for financial
statements issued for periods ending after December 15, 1997, including
interim periods; earlier application is not permitted. This Statement
requires restatement of all prior-period EPS data presented. Management
has not yet determined the impact on earnings per share that will result
from implementation of the Statement.
Reclassifications - Certain reclassifications have been made to the prior
year consolidated financial statements to conform to the 1996
presentation.
25
<PAGE>
2. INVESTMENT SECURITIES
A summary of amortized cost and approximate fair values of investment
securities are as follows:
<TABLE>
<CAPTION>
December 31, 1996
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
AVAILABLE-FOR-SALE:
Corporate equity securities $ 763,166 $ 203,479 $ -- $ 966,645
Mutual funds 4,571,297 -- 40,184 4,531,113
Obligations of U.S. Government
Corporations and Agencies 5,782,600 -- 15,000 5,767,600
----------- ----------- --------- -----------
$11,117,063 $ 203,479 $ 55,184 $11,265,358
=========== =========== ========= ===========
HELD-TO-MATURITY:
U.S. Treasury Bills $ 193,257 $ -- $ -- $ 193,257
Other investments 670,500 -- -- 670,500
----------- ----------- --------- -----------
$ 863,757 $ -- $ -- $ 863,757
=========== =========== ========= ===========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
AVAILABLE-FOR-SALE:
Corporate equity securities $ 763,166 $ 136,330 $ -- $ 899,496
Mutual funds 4,226,167 -- 31,061 4,195,106
Obligations of U.S. Government
Corporations and Agencies 9,809,196 -- -- 9,809,196
----------- -------- -------- ------------
$14,798,529 $ 136,330 $ 31,061 $ 14,903,798
=========== ========== ========= =============
</TABLE>
There were no investment securities classified as held-to-maturity at December
31, 1995.
26
<PAGE>
The scheduled maturities of obligations of U.S. Government corporations
and agencies at December 31, 1996, are as follows:
<TABLE>
<CAPTION>
Available for Sale
---------------------------------
Amortized Fair
Cost Value
<S> <C> <C>
Due in one year or less $ 2,782,600 $ 2,766,350
Due after one year through five years 3,000,000 3,001,250
Due after five years through ten years - -
Due after ten years - -
------------- --------------
$ 5,782,600 $ 5,767,600
============== ==============
</TABLE>
Proceeds from sales or maturities of securities available for sale were
$17.3 million, $6.0 million, and $20.1 million for the years ended
December 31, 1996, 1995, and 1994, respectively.
No gross gains were realized on sales of securities available for sale
during 1996 or 1995. Gross gains of $65,938 were realized on these sales
for the year ended December 31, 1994. No gross losses were realized during
1996, 1995, or 1994.
3. MORTGAGE-BACKED SECURITIES
The amortized cost and approximate fair values of mortgage-backed and
related securities are as follows:
<TABLE>
<CAPTION>
December 31, 1996
-------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE:
FHLMC certificates $ 6,663,833 $ 111,354 $ 26,119 $ 6,749,068
GNMA certificates 305,468 5,345 - 310,813
REMICs:
FNMA $11,891,116 - - - -
FHLMC 6,060,269 - - - -
FHLB 3,000,000 - - - -
VA 2,000,000 - - - -
Other 12,553,293 35,504,678 74,176 168,416 35,410,438
----------- ----------- -------- -------- -----------
$42,473,979 $190,875 $194,535 $42,470,319
=========== ======== ======== ===========
HELD-TO-MATURITY:
FHLMC certificates $883,887 $ 35,462 $ - $919,349
=========== ======== ======== ===========
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
December 31, 1995
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C> <C>
AVAILABLE FOR SALE:
FHLMC certificates $ 7,365,066 $218,082 $ - $ 7,583,148
GNMA certificates 362,096 17,713 - 379,809
REMICs:
FNMA $12,179,983
FHLMC 3,702,316
FHLB 997,600
VA 2,028,350
Other 3,914,333 22,822,582 163,306 155,163 22,830,725
---------- ----------- -------- -------- -----------
$30,549,744 $399,101 $155,163 $30,793,682
=========== ======== ======== ===========
HELD-TO-MATURITY:
FHLMC certificates $ 1,160,672 $ - $ - $ 1,160,672
=========== ======== ======== ===========
</TABLE>
Proceeds from sales of mortgage-backed securities available for sale were
$-0-, $1.8 million, and $21.8 million for the years ended December 31,
1996, 1995, and 1994, respectively.
Gross gains of $-0-, $1,802, and $52,465 and gross losses of $-0-, $-0-,
and $189,280 were realized on these sales for the years ended December 31,
1996, 1995, and 1994, respectively.
4. LOANS RECEIVABLE AND LOANS HELD FOR SALE
Loans receivable at December 31, 1996 and 1995, consist of the following:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
First mortgage loans:
Conventional $ 116,786,351 $ 116,595,289
Construction 15,326,795 16,148,960
Second mortgage loans 14,147,267 12,155,434
Lines of credit - commercial and builders 7,927,495 6,981,433
Home improvement loans 39,638 57,714
Consumer loans 5,325,918 4,747,204
-------------- -------------
Total 159,553,464 156,686,034
-------------- -------------
Less:
Participations sold on conventional first
mortgage loans 40,995,589 42,841,437
Undisbursed portion of loans receivable 5,326,688 4,598,754
Deferred loan fees 1,086,164 1,171,945
Allowance for loan losses 1,120,102 733,573
----------- ---------
48,528,543 49,345,709
-------------- -------------
TOTAL $ 111,024,921 $ 107,340,325
============== =============
</TABLE>
28
<PAGE>
The following table sets forth the activity in the allowance for loan
losses:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
BALANCE, JANUARY 1 $ 733,573 $ 563,624 $ 449,460
Add:
Provision charged to operations 408,000 210,000 154,000
Recoveries 180 5,687 2,146
Less:
Charge-offs 21,651 45,738 41,982
------------ ---------- ----------
BALANCE, DECEMBER 31 $ 1,120,102 $ 733,573 $ 563,624
============ ========== ==========
</TABLE>
At December 31, 1996 and 1995, real estate loans held for sale aggregated
$1,011,930 and $476,750 respectively; all were fixed-rate, conventional
first mortgage loans.
No loans included within the scope of SFAS 114 were identified as being
impaired at December 31, 1996 or 1995.
Loans on which the recognition of interest has been discontinued, which
were not included within the scope of SFAS 114, amounted to approximately
$0.4 million, $0.3 million, and $1.1 million at December 31, 1996, 1995,
and 1994, respectively. If interest income has been recognized on
nonaccural loans at their stated rates during 1996, 1995, and 1994,
interest income would have been increased by approximately $14,000,
$60,000, and $161,000, respectively. No income was recognized for these
loans in 1996, 1995 and 1994.
Commercial real estate loans outstanding at December 31, 1996 and 1995,
aggregated $13.1 million and $3.3 million, respectively. These loans are
considered by management to be of a somewhat greater risk due to the
dependency on income production. At December 31, 1996 and 1995, all of the
outstanding commercial real estate loans were collateralized by real
estate in southern Maryland.
Included in loans receivable at December 31, 1996 and 1995, is $1,031,607
and $1,027,209 due from officers and directors of the Bank. Activity in
loans outstanding to officers and directors is summarized as follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
BALANCE, BEGINNING OF YEAR $ 1,027,209 $ 991,555
New loans made during year 222,106 98,953
Repayments made during year (217,708) (63,299)
------------ ------------
BALANCE, END OF YEAR $ 1,031,607 $ 1,027,209
============ ============
</TABLE>
Loans serviced for others and not reflected in the statements of financial
condition are $40,996,000, $41,681,000, and $44,588,000 at December 31,
1996, 1995, and 1994, respectively. Servicing loans for others generally
consists of collecting mortgage payments, maintaining escrow accounts,
disbursing payments to investors and foreclosure processing. Loan
servicing income is recorded on the accrual
29
<PAGE>
basis and includes servicing fees from investors and certain charges
collected from borrowers, such as late payment fees.
The Bank grants loans throughout the Southern Maryland area. Its
borrowers' ability to repay is, therefore, dependent upon the economy of
Southern Maryland.
5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 1996 and 1995, is as
follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Land $ 1,486,879 $ 1,504,524
Building and improvements 2,247,122 1,698,497
Furniture and equipment 1,477,536 1,176,522
Automobiles
81,000 70,708
---------- ---------
Total 5,292,537 4,450,251
Less accumulated depreciation 1,467,969 1,271,445
---------- ---------
Net $ 3,824,568 $ 3,178,806
========== =========
</TABLE>
Depreciation expense for the years ended December 31, 1996, 1995, and
1994, was $214,120, $182,219, and $201,794, respectively.
30
<PAGE>
6. DEPOSITS
A comparative summary of savings deposits at December 31, 1996 and 1995,
is as follows:
<TABLE>
<CAPTION>
1996 1995
------------------------------ --------------------------------
Amount % Amount %
<S> <C> <C> <C> <C>
BALANCE BY INTEREST RATE-
Passbook and Statement Accounts:
3.04% $ 23,527,050 17 % $ 27,494,577 21 %
2.89% 37,540 - 35,780 -
2.53% 4,018,539 3 4,577,734 4
2.53% 606,711 - 258,431 -
Negotiable Order of Withdrawal
Accounts:
2.02% 13,329,190 10 12,259,753 10
Noninterest-bearing 5,251,827 4 4,135,222 3
Money Market Deposit Accounts:
2.50 to 3.56% 10,843,953 8 9,436,894 7
---------------- ---- --------------- ----
57,614,810 42 % 58,198,391 45 %
---------------- ---- --------------- ----
Certificate Accounts:
2.00 to 2.99% 375,056 - % 505,305 - %
3.00 to 3.99% 4,972,382 4 6,736,138 5
4.00 to 4.99% 9,255,195 7 8,906,857 7
5.00 to 5.99% 47,050,343 35 34,209,134 27
6.00 to 6.99% 15,551,206 12 18,009,008 14
7.00 to 7.99% - - 2,474,469 2
8.00 to 8.99% - - 308,974 -
-------------- ---- --------------- ----
77,204,182 58 % 71,149,885 55 %
-------------- ---- --------------- ----
TOTAL $ 134,818,992 100 % $ 129,348,276 100 %
============== ==== ================ ====
</TABLE>
The weighted average rate paid on deposits at December 31, 1996 and 1995
is 4.18% and 4.32%, respectively.
Certificates of deposit of $100,000 or more aggregated $13,484,000 and
$8,683,993 at December 31, 1996 and 1995, respectively.
31
<PAGE>
At December 31, 1996, scheduled maturities of certificates of deposit are
as follows:
<TABLE>
<S> <C>
1997 $ 35,584,367
1998 24,685,802
1999 8,951,398
2000 5,181,210
2001 and thereafter 2,801,405
-------------
Total $ 77,204,182
=============
</TABLE>
7. ADVANCES FROM THE FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
The advances from the Federal Home Loan Bank are as follows:
<TABLE>
<CAPTION>
Weighted
Average
Year Due Interest Rate 1996 1995
<S> <C> <C> <C>
1996 5.76 % $ - $ 13,250,000
1997 5.65 % 13,000,000 -
1998 5.00 % 5,000,000 -
1999 5.21 % 6,000,000 -
------------ -----------
Total $ 24,000,000 $ 13,250,000
============ ===========
</TABLE>
Under the terms of an Agreement for Advances and Security Agreement with
Blanket Floating Lien, the Company maintains eligible collateral
consisting of 1-4 unit residential first mortgage loans, discounted at 75%
of the unpaid principal balance, equal to 100% at December 31, 1996 and
1995, of its outstanding Federal Home Loan Bank advances. These amounts
were $32,000,000 and $17,667,000 at December 31, 1996 and 1995,
respectively. The advances due in 1998 and 1999 have call provisions under
which the Federal Home Loan Bank may require payment prior to the stated
maturity date.
Tri-County Federal Finance One (Finance One) is obligated on a note
payable issued in connection with its participation in the Salomon Capital
Access Collateralized Mortgage Obligation Bond Program. Under this
program, Finance One has pledged Federal Home Loan Mortgage Corporation
participation certificates having unpaid principal balances at December
31, 1996 and 1995, totaling $883,887 and $1,160,672, respectively, as
security for the notes. The participation certificates are held in trust,
and the principal and interest payments required by the note payable are
made out of the monthly cash proceeds from the certificates.
The maturity dates and interest rates, which are subject to adjustment
based on prepayments of the participation certificates, for the notes
payable at December 31, 1996 and 1995, are as follows:
<TABLE>
<CAPTION>
Unpaid Principal
(Net of Discount)
December 31, Interest Maturity
------------------- Rate Date
1996 1995
<S> <C> <C> <C> <C>
Salomon Capital
Access Corp.
Series 1985-3 $ 463,507 $ 785,473 8.50 % July 1, 2010
</TABLE>
32
<PAGE>
The Company enters into sales of securities under agreements to repurchase
with terms to maturity of less than one month. These agreements are
treated as financings, and the obligations to repurchase securities sold
are reflected as a liability in the statements of financial condition. The
dollar amounts of securities underlying the agreements remain in the asset
accounts. The securities underlying the agreements are book-entry
securities and the securities were delivered by appropriate entry into the
counterparties' accounts maintained at the purchasing securities dealer's
safekeeping house.
The Company is subject to the risk that its interest in the sold
securities is inadequately protected in the event the purchasing
securities dealer fails to perform its obligations. The Company attempts
to reduce the effects of such risks by entering into such agreements only
with well-capitalized securities dealers who are primary dealers in
government securities and by limiting the maximum amount of agreements
outstanding at any time with any single securities dealer.
Additional information regarding repurchase agreements is as follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Balance outstanding at December 31 $ - $ 3,358,000
Average balance during the year $ 1,068,698 $ 4,269,704
Average interest rate during the year 5.05 % 6.35 %
Maximum outstanding balance at any
month end during the year $ 4,774,000 $ 6,198,000
Mortgage-backed securities underlying the agreements at year-end:
Carrying value $ - $ 4,710,516
Estimated fair value $ - $ 4,794,721
</TABLE>
Other borrowed funds consist of treasury tax and loan deposits that
generally mature within one to 120 days from the transaction date. At
December 31, 1996 and 1995, such borrowings were $269,959 and $159,372,
respectively.
The aggregate scheduled principal maturities on all borrowings outstanding
at December 31, 1996, are as follows:
<TABLE>
<S> <C>
1997 $ 13,269,959
1998 5,000,000
1999 6,000,000
2000 -
2001 -
After 2001 463,507
-------------
Total $ 24,733,466
=============
</TABLE>
33
<PAGE>
8. INCOME TAXES
Total income tax expense differed from the amounts computed by applying
the Federal income tax rate of 34% to income before income taxes as a
result of the following:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Expected income tax expense at
Federal tax rate $ 715,700 $ 1,141,000 $ 892,422
State taxes, net of Federal benefit 96,000 155,000 124,668
Amortization and other nondeductible
expenses (4,400) (2,000) (17,560)
Other (22,100) 33,000 42,185
--------- --------- ---------
Total income tax expense $ 785,200 $ 1,327,000 $ 1,041,715
========= ========= =========
</TABLE>
The net deferred tax asset (liability) in the accompanying balance sheets
include the following components:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
DEFERRED TAX ASSETS:
Deferred fees $ 209,372 $ 239,551
Bad debt reserves 137,674 (8,506)
Pension plan 40,417 -
Other assets 3,058 7,500
------- -------
Total deferred assets 390,521 238,545
------- -------
DEFERRED TAX LIABILITIES:
FHLB stock dividends 152,896 144,786
Depreciation 94,516 94,450
------- -------
Total deferred liabilities 247,412 239,236
------- -------
143,109 (691)
INVESTMENT VALUATION ALLOWANCE (55,859) (134,864)
-------- ---------
NET DEFERRED ASSET (LIABILITY) $ 87,250 $ (135,555)
======== ==========
</TABLE>
Retained earnings at December 31, 1996, include approximately $1.2 million
of bad debt deductions allowed for federal income tax purposes (the "base
year tax reserve") for which no deferred income tax has been recognized.
If, in the future, this portion of retained earnings is used for any
purpose other than to absorb bad debt losses, it would create income for
tax purposes only and income taxes would be imposed at the then prevailing
rates. The unrecorded income tax liability on the above amount was
approximately $458,000 at December 31, 1996.
34
<PAGE>
Prior to January 1, 1996, the Bank computed its tax bad debt deduction
based upon the percentage of taxable income method as defined by the
Internal Revenue Code. The bad debt deduction allowable under this method
equaled 8% of taxable income determined without regard to the bad debt
deduction and with certain adjustments. The tax bad debt deduction
differed from the bad debt expense used for financial accounting purposes.
In August 1996, the Small Business Job Protection Act (the "Act") repealed
the percentage of taxable income method of accounting for bad debts
effective for years beginning after December 31, 1995. The Act requires
the Bank to change its method of computing reserves for bad debts to the
experience method. This method is available to banks with assets less than
$500 million and will allow the Bank to maintain a tax reserve for bad
debts and to take bad debt deductions for reasonable additions to the
reserve. As a result of this change, the Bank will have to recapture into
income a portion of its existing tax bad debt reserve. This recapture will
occur ratably over a six-taxable year period, generally beginning with the
1996 tax year. However, the bank can delay the timing of this recapture
for a two-year period provided certain requirements are met. For financial
reporting purposes, this recapture will not result in additional tax
expense as the Bank adequately provided deferred taxes in prior years.
Furthermore, this change does not require the Bank to recapture its base
year tax reserve.
9. COMMITMENTS AND CONTINGENCIES
The Company is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its
borrowers. These financial instruments are commitments to extend credit.
These instruments may, but do not necessarily, involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the statements of financial condition. The Company's
exposure to credit loss in the event of nonperformance by the other party
to the financial instrument is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments as it does for on-balance-sheet loans receivable.
As of December 31, 1996 and 1995, in addition to the undisbursed portion
of loans receivable, the Company had outstanding loan commitments
approximating $1,157,000 and $1,516,000, respectively. These commitments
are normally met from savings account growth, loan payments, excess
liquidity, or borrowed money.
Standby letters of credit written are conditional commitments issued by
the Company to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support construction borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to
customers. The Company holds cash or a secured interest in real estate as
collateral to support those commitments for which collateral is deemed
necessary. Outstanding standby letters of credit amounted to $4,130,000
and $4,168,000 at December 31, 1996 and 1995, respectively.
The Company is obligated under four leases for branch office facilities
with minimum rentals as follows:
<TABLE>
<S> <C>
1997 $ 104,307
1998
97,338
1999
73,272
2000
47,112
2001
6,056
Total $ 328,085
=========
</TABLE>
<TABLE>
<CAPTION>
The composition of total rent expense is as follows:
1996 1995 1994
<S> <C> <C> <C>
Minimum rental $ 101,148 $ 95,758 $ 90,322
Contingent rental 5,560 7,440 16,650
-------- --------- ---------
Total $ 106,708 $ 103,198 $ 106,972
======== ========= =========
</TABLE>
The Company is a defendant in various lawsuits generally incidental to its
business. Management is of the opinion that the Company's financial
position and results of operations will not be materially affected by the
ultimate resolution of litigation pending or threatened at December 31,
1996.
10. PENSION PLAN
The Company has a qualified, noncontributory defined benefit pension plan
covering substantially all of its employees. The benefits are based on
each employee's years of service up to a maximum of 35 years, and the
average of the highest five consecutive annual salaries out of the ten
years prior to retirement.
The benefit formula used is the individual aggregate actuarial cost
method. An employee becomes fully vested upon completion of seven years of
qualifying service. It is the policy of the Company to fund the amount
required to meet minimum funding standards. No contributions were required
to be made in 1996 or 1995.
Net pension cost for the Company's plan consists of the following:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Service cost $ 68,705 $ 49,913 $ 55,125
Interest cost 61,651 48,577 52,022
Actual return on plan assets (98,075) (125,440) (71,150)
All other components 28,140 60,307 (10,895)
----------- ---------- ----------
Net pension cost $ 60,421 $ 33,357 $ 25,102
============ ========== ==========
</TABLE>
35
<PAGE>
The reconciliation of the funded status of the plan to the amount reported
in the Company's statements of financial condition as of December 31 is as
follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Actuarial Present Value of Benefit Obligation:
Vested benefit obligation $ (438,363) $ (359,933)
Nonvested accumulated benefits
(15,167) (7,487)
--------- -------
Accumulated benefit obligation (453,530) (367,420)
Effect of projected salary increases (553,712) (455,292)
--------- ---------
Projected benefit obligation (1,007,242) (822,712)
Fair value of Plan assets, primarily
cash, equity securities, and bonds 941,602 844,924
Funded status (65,640) 22,212
Deferred transition asset to be
amortized over 17 years (125,585) (133,569)
Unrecognized prior-service cost 32,150 33,516
Unrecognized net loss 54,422 33,609
-------- --------
Accrued pension cost on statements of
financial condition $ (104,653) $ (44,232)
======== ========
</TABLE>
Assumptions used to develop the net periodic pension cost were:
Discount rate 7.5% 7.5%
Expected long-term rate of return on plan assets 8% 8%
Rate of increase in compensation levels 5% 5%
11. STOCK OPTION AND INCENTIVE PLAN
The Company has a stock option and incentive plan to attract and retain
personnel and provide incentive to employees to promote the success of the
business. At December 31, 1996, 110,757 shares of stock have been
authorized for grants of options for this plan. In 1995 stock options
previously granted aggregating 9,345 shares at prices ranging from $14.25
- $22.00 per share were cancelled and replaced with 14,543 options at
$11.78 per share.
Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting
for Stock-Based Compensation." This Statement gave the Company the option
of either (1) continuing to account for stock options and other forms of
stock compensation in accordance with the accounting rules established by
APB No. 25, "Accounting for Stock Issued to Employees" while providing the
disclosures required under SFAS No. 123, or (2) adopting SFAS No. 123
accounting for all stock compensation arrangements. The Company opted to
continue to account for stock options and other forms of stock
compensation using the guidance in APB No. 25. The following table
provides the pro forma disclosures required by SFAS No. 123:
36
<PAGE>
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Net income As reported $ 1,319,727 $ 2,027,814
Pro forma 1,319,727 1,720,590
Primary earnings per share As reported 1.61 2.62
Pro forma 1.61 2.22
Fully diluted earning per share As reported 1.60 2.59
Pro forma 1.60 2.20
</TABLE>
For the purpose of computing the pro forma amounts indicated above, the
fair value of each option on the date of grant is estimated using the
Binomial Option pricing model with the following weighted-average
assumptions used for the 1995 grants: dividend yield of 0.8%, expected
volatility of 65%, a risk-free rate of 5.71%, and an expected option life
of 10 years. No stock options were granted in 1996. The weighted-average
fair value of each option granted during 1995 was $8.49. Substantially all
options are 100% vested when granted, and all options expire after 10
years. The following tables summarize activity in the plan.
<TABLE>
<CAPTION>
1996 1995
----------------------------- -------------------------
Weighted-Average Weighted-Average
Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
<S> <C> <C> <C> <C>
Outstanding at beginning
of year 120,207 8.00 85,842 6.45
Granted -- -- 61,911 10.69
Exercised 30,792 5.79 10,515 6.28
Forfeited or cancelled 132 3.90 17,031 12.09
------- -------
Outstanding at end of year 89,283 9.34 120,207 8.00
======= =======
Options exercisable
at year-end 85,508 9.28 114,544 7.87
Weighted-average fair value
of options granted during
the year -- -- -- 8.49
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ----------------------------------------
Weighted Average Weighted-Average
Exercise Number Outstanding Remaining Number Exercisable Exercise
Price 12/31/96 Contractual Life 12/31/96 Price
-------- ------------------ ---------------- ------------------ ----------------
<S> <C> <C> <C> <C>
$3.90 3,695 0.8 years 3,695 $3.90
6.76 24,367 3.0 24,367 6.76
10.69 61,221 8.0 57,446 10.69
----------- -----------
89,283 85,508
=========== ===========
</TABLE>
All share and dollar amounts are reflected at amounts giving effect to the
5% stock dividends declared through January 1997.
37
<PAGE>
12. EMPLOYEE STOCK OWNERSHIP PLAN
In December 1989, the Board of Directors of the Bank approved the adoption
of an Employee Stock Ownership Plan (ESOP) that will acquire stock of the
Bank's parent corporation, Tri-County Financial Corporation. The Company
accounts for its ESOP in accordance with AICPA Statement of Position 93-6.
Accordingly, all shares held by the ESOP are treated as outstanding in
computing earnings per share. In addition, dividends on ESOP shares are
recorded as a reduction of retained earnings. The ESOP may acquire in the
open market up to 187,700 shares. At December 31, 1996, the Plan owns
46,498 shares. All employees who meet length-of-service and age
requirements are covered under this defined contribution plan. Employee
contributions to this plan under a deferred compensation arrangement
(401k) are matched by the Bank, subject to a maximum of one-half of an
employee's 4% elective deferral. Additional contributions are determined
at the discretion of management and the Board of Directors. For the years
ended December 31, 1996, 1995, and 1994, the Company charged $46,000,
$159,000, and $100,000 against earnings to fund the Plan.
13. STOCK DIVIDENDS
On January 27, 1994, the Board of Directors declared a 5% stock dividend
and a $.10 per share cash dividend that was distributed to holders of
record on March 4, 1994. The stock distribution increased the
Corporation's issued stock by approximately 30,000 shares.
On January 31, 1995, the Board of Directors declared a 5% stock dividend
and a $.10 per share cash dividend that was distributed to holders of
record on March 3, 1995. The stock distribution increased the
Corporation's issued stock by approximately 32,000 shares.
On January 24, 1996, the Board of Directors declared a 5% stock dividend
and a $.10 per share cash dividend to be distributed to holders of record
on March 4, 1996. The stock distribution increased the Corporation's
issued stock by approximately 35,000 shares.
On January 24, 1997, the Board of Directors declared a 5% stock dividend
that was distributed to holders of record on March 7, 1997. The stock
distribution increased the Corporation's issued stock by approximately
37,500 shares.
14. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the federal and state banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory--and possible
additional discretionary--actions by regulators that, if undertaken, could
have a direct material effect on the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of tangible and core capital (as defined in the regulations)
to total adjusted assets (as defined), and of risk-based capital (as
defined) to risk-weighted assets (as defined). Management believes, as of
December 31, 1996, that the Bank meets all capital adequacy requirements
to which it is subject.
38
<PAGE>
As of December 31, 1996, the most recent notification from the Office of
Thrift Supervision categorized the Bank as well-capitalized under the
regulatory framework for prompt corrective action. To be categorized as
well-capitalized, the Bank must maintain minimum tangible, core and
risk-based ratios as set forth in the table. There are no conditions or
events since that notification that management believes have changed the
Bank's category.
The Bank's actual capital amounts and ratios for 1996 and 1995 are
presented in the tables below:
<TABLE>
<CAPTION>
To be Considered
Well Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
----------------- -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
At December 31, 1996:
Tangible $16,447 9.3 % $ 2,661 1.5 % N/A N/A
Core (Leverage) 16,447 9.3 5,322 3.0 $ 8,870 5.0 %
Tier 1 risk-based 16,447 15.7 N/A N/A 6,303 6.0
Total risk-based 17,567 16.7 8,404 8.0 10,505 10.0
</TABLE>
<TABLE>
<CAPTION>
To be Considered
Well Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
----------------- -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
At December 31, 1995:
Tangible $15,112 9.2 % $2,450 1.5 % N/A N/A
Core (Leverage) 15,112 9.2 4,901 3.0 $ 8,169 5.0 %
Tier 1 risk-based 15,112 15.6 N/A N/A 5,789 6.0
Total risk-based 15,846 16.4 7,719 8.0 9,649 10.0
</TABLE>
Charter Conversion - As a result of the enactment of the Small Business
Job Protection Act that was signed into law on August 20, 1996, all
savings banks and savings associations will be able to change to a
commercial bank charter without having to recapture any of their pre-1988
bad debt reserve accumulations. Prior to the passage of this law, when
Tri-County evaluated the benefits of changing to a commercial bank
charter, the recapture tax on these bad debt reserves represented a
material cost to be considered. With this significant obstacle removed,
the opportunity to change the Bank's model of operations was revisited.
On October 30, 1996, the Board of Directors of the Savings Bank
unanimously adopted a Plan of Conversion whereby the Savings Bank will
convert to a Maryland-chartered commercial bank to be known as "Community
Bank of Tri-County." On January 24, 1997, the Maryland Commissioner of
Financial Regulation granted preliminary approval of the Charter
Conversion and on March 7, 1997, the Bank's Federal Reserve Membership
Application and the Corporation's Bank Holding Company application were
approved. Following the charter Conversion, both the Bank and the
Corporation will be regulated by the Federal Reserve Bank. The Charter
Conversion will allow the Bank more flexibility in the types of loans it
is permitted to make as it will no longer be required to meet the
Qualified Thrift Lender Test. Specifically, the Bank will be permitted to
increase its consumer and commercial lending and will be better able to
offer products to its small business and retail customers.
39
<PAGE>
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required to interpret market
data to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the Company
could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts. Therefore, any aggregate unrealized
gains or losses should not be interpreted as a forecast of future earnings
or cash flows. Furthermore, the fair values disclosed should not be
interpreted as the aggregate current value of the Company.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 3,903,612 $ 3,903,612 $ 4,050,219 $ 4,050,219
Investment securities
and FHLB stock 13,429,115 13,429,115 15,785,398 15,785,398
Mortgage-backed securities 43,354,206 43,389,668 31,954,354 31,954,354
Loans receivable, net 111,024,921 117,708,731 107,340,325 113,085,292
Loans held for sale 1,011,930 1,011,930 476,750 476,750
Liabilities:
Savings, NOW and money
market accounts 57,614,810 57,614,810 58,198,391 58,198,391
Time certificates 77,204,182 77,421,687 71,149,885 71,767,932
FHLB advances 24,000,000 24,000,000 13,250,000 13,250,000
Notes Payable and other Borrowings 733,466 733,466 4,302,845 4,302,845
</TABLE>
At December 31, 1996 and 1995, the Company had outstanding loan
commitments and standby letters of credit of $5.3 million and $5.7
million, respectively. Based on the short-term lives of these instruments,
the Company does not believe that the fair value of these instruments
differs significantly from their carrying values.
Valuation Methodology
Cash and Cash Equivalents - For cash and cash equivalents, the carrying
amount is a reasonable estimate of fair value.
Investment 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.
Mortgage-Backed 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.
Loans Receivable and Loans Held for Sale - For conforming residential
first-mortgage loans, the market price for loans with similar coupons and
maturities was used. For nonconforming loans with maturities similar to
conforming loans, the coupon was adjusted for credit risk. Loans which did
not have quoted market prices were priced using the discounted cash flow
method. The discount rate used was the rate currently offered on similar
products. Loans priced using the discounted cash flow method included
residential construction loans, commercial real estate loans, and consumer
loans. The estimated fair value of loans held for sale is based on the
terms of the related sale commitments.
40
<PAGE>
Deposits - The fair value of checking accounts, saving accounts, and money
market accounts was the amount payable on demand at the reporting date.
Time Certificates - The fair value was determined using the discounted
cash flow method. The discount rate was equal to the rate currently
offered on similar products.
FHLB Advances - These were valued using the discounted cash flow method.
The discount rate was equal to the rate currently offered on similar
borrowings.
Notes Payable and Other Borrowings - These were valued using the
discounted cash flow method. The discount rate was equal to the rate
currently offered on similar borrowings.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1996 and 1995.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statement since
that date and, therefore, current estimates of fair value may differ
significantly from the amounts presented herein.
16. SAIF RECAPITALIZATION
The Federal Deposit Insurance Corporation administers two separate deposit
insurance funds, the Banking Insurance Fund (BIF) and Savings Association
Insurance Fund (SAIF). Congress passed legislation in August 1996, that
recapitalized the SAIF fund through a special assessment on FDIC-insured
institutions with SAIF deposits. This deposit assessment resulted in an
after-tax expense to the Company of approximately $504,000 for the year
ended December 31, 1996.
41
<PAGE>
17. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Condensed Statements of Financial Condition:
<TABLE>
<CAPTION>
December 31,
--------------------------
ASSETS 1996 1995
<S> <C> <C>
Cash $ 131,782 $ 120,838
Accounts receivable 1,383 1,383
Investment securities available for sale 447,565 421,781
Investment in loans 174,231 153,261
Investment in wholly owned subsidiary 16,536,386 15,344,485
----------- -----------
TOTAL ASSETS $17,291,347 $16,041,748
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $ 39,664 $ 70,600
Stockholders' equity:
Common stock 7,510 6,851
Capital in excess of par 5,724,729 5,021,350
Retained earnings 11,430,666 10,710,824
Net unrealized gain (loss) on investment
and mortgage-backed securities 88,778 232,123
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $17,291,347 $16,041,748
=========== ===========
</TABLE>
Condensed Statements of Income:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
Interest revenues $ 38,463 $ 35,790 $ 24,032
Amortization and miscellaneous expenses 53,981 48,364 52,337
------------ ------------- ------------
Income (loss) before income
taxes and equity in
undistributed
net income of subsidiary (15,518) (12,574) (28,305)
Federal and state income taxes - - (2,174)
Equity in undistributed net income of subsidiary 1,335,245 2,040,388 1,613,536
------------ ------------ ------------
NET INCOME $ 1,319,727 $ 2,027,814 $ 1,583,057
============ ============ ============
</TABLE>
42
<PAGE>
Condensed Statements of Cash Flows:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM:
Operating activities $ (70,641) $ (1,866) $ 16,673
Investing activities:
Loans originated (114,600) (138,223) (42,908)
Principal collected on loans 93,630 84,620 17,000
Purchase of investment securities
available for sale (431,598) (504,469) (291,447)
Maturities of investment securities
available for sale 430,000 400,000
Financing activities:
Dividends paid (74,045) (69,013) (66,003)
Exercise of stock options 178,198 66,006 42,715
------------- ------------ ------------
INCREASE (DECREASE) IN CASH $ 10,944 $ (162,945) $ (323,970)
============== ============ ============
</TABLE>
* * * * * *
43
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
Tri-County Financial Corporation
<TABLE>
<CAPTION>
Percentage State of
Subsidiaries (1) Owned Incorporation
- ---------------- ----------- -------------
<S> <C> <C>
Tri-County Federal Savings Bank of 100% United States
of Waldorf
Tri-County Federal Finance I(2) 100% Maryland
</TABLE>
- --------------------
(1) The operations of the subsidiary are included in the consolidated financial
statements contained in the annual report to stockholders attached hereto
as an exhibit.
(2) Wholly-owned subsidiary of Tri-County Federal Savings Bank of Waldorf.
<PAGE>
Exhibit 23(a)
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements of
Tri-County Financial Corporation on Form S-8 (SEC File Nos. 33-35292, 33-97174
and 333-2056) of our report dated March 14, 1997, which is incorporated by
reference in the Annual Report on Form 10-K of Tri-County Financial Corporation
for the year ended December 31, 1996.
/s/ Deloitte & Touche LLP
Washington, D.C.
April 10, 1997
<PAGE>
Exhibit 23(b)
[LETTERHEAD OF CB&M]
Independent Auditors' Consent
We consent to the incorporation by reference in the Registration Statements
of Tri-County Financial Corporation and Subsidiary on Form S-8 (SEC File Nos.
33-35292, 33-97174 and 333-2056) of our report dated March 3, 1995, which is
incorporated by reference in the Annual Report on Form 10K of Tri-County
Financial Corporation and Subsidiary for the year ended December 31, 1994.
/s/ Councilor, Buchanan & Mitchell, P.C.
Bethesda, Maryland
April 7, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 3,903,612
<INT-BEARING-DEPOSITS> 2,791,718
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 53,735,677
<INVESTMENTS-CARRYING> 1,747,644
<INVESTMENTS-MARKET> 1,783,106
<LOANS> 113,156,953
<ALLOWANCE> 1,120,102
<TOTAL-ASSETS> 178,320,557
<DEPOSITS> 134,818,992
<SHORT-TERM> 13,269,959
<LIABILITIES-OTHER> 1,516,416
<LONG-TERM> 11,463,507
0
0
<COMMON> 7,510
<OTHER-SE> 17,244,173
<TOTAL-LIABILITIES-AND-EQUITY> 178,320,557
<INTEREST-LOAN> 10,045,429
<INTEREST-INVEST> 923,198
<INTEREST-OTHER> 2,502,968
<INTEREST-TOTAL> 13,471,595
<INTEREST-DEPOSIT> 5,397,181
<INTEREST-EXPENSE> 6,406,756
<INTEREST-INCOME-NET> 7,064,839
<LOAN-LOSSES> 408,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 5,482,882
<INCOME-PRETAX> 2,104,927
<INCOME-PRE-EXTRAORDINARY> 2,104,927
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,319,727
<EPS-PRIMARY> 1.61
<EPS-DILUTED> 1.60
<YIELD-ACTUAL> 4.32
<LOANS-NON> 358,000
<LOANS-PAST> 341,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 733,573
<CHARGE-OFFS> 21,651
<RECOVERIES> 180
<ALLOWANCE-CLOSE> 1,120,102
<ALLOWANCE-DOMESTIC> 1,120,102
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
