<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Mark One
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
|_| TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to _____
Commission File Number: 0-18279
TRI-COUNTY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-1652138
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 Leonardtown Road,
Waldorf, Maryland 20601
(Address of principal Zip Code
executive offices)
Registrant's telephone number, including area code (301) 645-5601
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
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 [ ]
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. [X]
As of March 23, 1998, there were issued and outstanding 782,866 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 $22.38 per share for an approximate aggregate market
value of voting stock held by non-affiliates of the registrant of $13.3 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, 1997. (Parts I and II)
2. Portions of Proxy Statement for the 1998 Annual Meeting of Stockholders.
(Part III)
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PART I
Item 1. Business
The Corporation. Tri-County Financial Corporation (the "Corporation") is a
Maryland corporation that serves as the holding company of Community Bank of
Tri-County ("Community Bank" or the "Bank"). The Corporation engages in no
significant activity other than holding the stock of Tri-County Federal and
operating the business of a Maryland chartered commercial bank through the Bank.
Accordingly, the information set forth in this report, including financial
statements and related data, relates primarily to the 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 Bank. The Bank is a Maryland chartered commercial bank which conducts
full service commercial banking operations throughout the southern Maryland
area. The primary financial services provided include mortgage loans on
residential, construction and commercial real estate and various types of
consumer lending, as well as offering demand deposits, savings products and safe
deposit boxes. Since its conversion from a federally chartered savings and loan
association to a state commercial bank on March 29, 1997, the Bank's business
plan has focused on expanding its business and consumer loan portfolios and
increasing the level of its transactional accounts and business deposits.
The Bank also recently entered into an agreement with a local insurance
company under which the Bank will sell insurance as agent to its customers and
others from its branch office located in Bryans Road, Maryland. Under this
arrangement, a dual employee of the insurance company and the Bank will sell
various insurance products including automobile insurance, life and casualty,
health and property and credit. The Bank and the insurance company will share
commission income attributable to these activities. In the future, the Bank may
also seek to sell title insurance and variable annuities.
In the first quarter of 1998, the Bank closed a small satellite branch and
simultaneously acquired a branch at southern Maryland's only regional mall. See
"Management's Discussion and Analysis" included in the Company's Annual Report
to Stockholders which is incorporated herein by reference.
On April 16, 1997, the Bank formed a wholly owned subsidiary, Community
Mortgage Corporation of Tri-County, to offer mortgage banking and brokerage
services to the public. See "Subsidiary Activity" herein.
Lending and Investment Activities
General. The principal lending activity of the Bank is the origination of
single family conventional mortgage loans (i.e., loans that are neither insured
nor partially guaranteed by government agencies). To a lesser extent, the Bank
also makes second mortgage loans, home equity loans, construction loans, and
loans secured by multi-family dwellings. Since its conversion to a commercial
bank, the Bank has put more emphasis on attracting and servicing consumer and
commercial customers.
The Bank offers real estate loans with both fixed and adjustable rates. The
Bank's fixed-rate real estate loans may be packaged for resale in the secondary
market or securitized for outside borrowings. The Bank has also purchased
mortgage-backed securities.
Geographic Lending Area. The Bank is authorized to make real estate loans
throughout the United States, provided the Bank continues to meet the provisions
of the Community Reinvestment Act to serve the communities in which it operates
offices. The 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 Bank is
the granting of conventional loans to enable borrowers to purchase existing
homes. At December 31, 1997, approximately 77% of the Bank's total loan
portfolio consisted of loans secured by single family dwellings.
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Mortgage loans made by the 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 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.
The Bank aggressively markets adjustable-rate loans with rate adjustments
based upon a United States Treasury bill index. As of December 31, 1997, the
Bank had $43.4 million in loans using a U.S. Treasury bill index. The 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 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 Bank's loan
portfolio helps reduce the 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 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 Bank currently requires that substantially all
residential loans with loan to value ratios in excess of 80% carry private
mortgage insurance to bring the Bank's exposure down to approximately 70% of the
value of the property.
All improved real estate which serves as security for a loan made by the
Bank must be insured, in the amount and by such companies as may be approved by
the Bank, against fire, vandalism, malicious 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 Bank's indebtedness in
full.
The Bank has maintained a growing level of home equity loans in recent
years. These loans, which totaled $17.4 million at December 31, 1997, 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.
Commercial Real Estate and Other Non-Residential Real Estate Loans. The
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 $5
million or 36% during 1997. 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 $19.2 million
or 15.8% of the Bank's loan portfolio at December 31, 1997. The Bank generally
limits its exposure to a single borrower to 15% of the Bank's net worth 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 Bank's commercial real estate loans, as well as
its construction loans discussed below, are secured by real estate located in
the 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
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the real estate market or the economy. The Bank restricts its commercial real
estate lending primarily to owner occupied buildings which will, to some extent,
be occupied by the borrower as opposed to speculative rental projects.
Construction Loans. The Bank 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 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 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 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
totaled $14.7 million, or 12.1% of the Bank's loan portfolio, at December 31,
1997.
Construction financing involves a higher degree of risk than long-term
financing on improved, occupied real estate. The Bank'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 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.
The Bank also offers builders lines of credit, which are revolving notes
generally secured by real property. Outstanding builders lines of credit
amounted to approximately $5.1 million at December 31, 1997. The 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 Bank obtains security in the form of a first
lien on home sites under construction. At December 31, 1997, $4.2 million in
such loans were outstanding.
In addition, the 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 totaled $8.1
million at December 31, 1997. The Bank originated approximately $1.3 million of
lot loans during 1997, which consisted of 22 loans secured by land in the Bank's
market area, the largest of which had a balance of $150,000 at December 31,
1997.
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.
The Bank's ability to originate all types of construction loans is heavily
dependent on the continued demand for single family housing construction in the
Bank's market areas. In the event the demand for new houses in the Bank's market
areas were to decline, the Bank may be forced to shift a portion of its lending
emphasis. There can be no assurance of the Bank's ability to continue growth and
profitability in its construction lending activities in the event of such a
decline.
Consumer and Commercial Loans. The 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
Bank also makes home improvement loans and offers both secured and unsecured
lines of credit.
The Bank also offers a variety of commercial loan services including term
loans, lines of credit and equipment financing. The Bank's commercial loans are
primarily underwritten on the basis of the borrower's ability to service the
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debt from income. Such loans are generally made for terms of five years or less
at interest rates which adjust periodically.
The 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 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 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.
Loan Portfolio Analysis. Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan and type of security on
the dates indicated.
<TABLE>
<CAPTION>
At December 31,
------------------------------------
1997 1996 1995
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Type of Loan:
Real Estate Loans --
Residential construction ........... $ 9,652 $ 7,946 $ 6,787
Mortgage ........................... 80,831 77,845 78,729
Builders Line of Credit ............ 5,054 3,810 3,191
Home Equity ........................ 17,428 14,147 12,155
Commercial Lines of Credit ........... 4,852 3,887 3,389
Consumer Loans ....................... 6,420 5,422 4,841
Less: Deferred Loan Fees ........... 1,060 1,086 1,172
Loan Loss Reserve ............ 1,310 1,120 733
-------- -------- --------
Total ........................ $121,867 $110,851 $107,187
======== ======== ========
</TABLE>
Loan Solicitation and Processing. The 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 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 Bank recently contracted with FHLMC to utilize
its Prospector Software and Purchase program. This provides the Bank with faster
loan approval turnaround and competitive pricing of loans.
The Bank's President has the authority to approve loans in amounts up to
$500,000. The Bank's Senior Vice Presidents individually have the authority to
approve loans in amounts up to $250,000 and any two can approve loans up to
$300,000. One Vice President has loan authority of $215,000 and the Business
Development Officer has loan authority of $100,000. Any two of the
aforementioned individuals may jointly approve a loan up to the combined total
of their respective lending limits. Selected branch personnel have lending
limits ranging from $10,000 to $50,000 depending on loan type and the employee's
position. A loan committee, consisting of the President and two members
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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 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
Bank, and the notice of requirement of insurance coverage to be maintained to
protect the 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 Bank actively originates
mortgage loans primarily for its own portfolio, and, periodically, for sale in
the secondary mortgage market. At December 31, 1997, the Bank was servicing
approximately $47.8 million of loans for others. Fee income from loan servicing
totaled approximately $165,000 during 1997. The Bank has periodically purchased
whole loans, participation interests in loans and participation certificates. In
recent years, the Bank has participated in several residential home construction
loans with other well capitalized lenders. Approximately $2 million of such
loans was outstanding at December 31, 1997. 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.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Loans originated:
Real estate loans:
Construction loans .................... $17,549 $ 9,157 $12,666
Loans on existing property ............ 11,542 18,092 18,996
Loans refinanced ...................... 4,081 2,182 2,805
Land loans ............................ 1,337 1,167 1,142
Builder lines of credit ............... 19,691 15,360 10,752
Non-residential mortgage loans ........ 2,898 6,691 1,920
Commercial lines of credit .............. 4,357 3,594 3,096
Consumer loans .......................... 4,234 3,175 3,254
------- ------- -------
Total loans originated ............. $65,689 $59,418 $54,631
======= ======= =======
Loans sold:
Participation loans ................... $ -- $ -- --
Whole loans ........................... 11,876 8,965 5,284
------- ------- -------
Total loans sold ................... $11,876 $ 8,965 $ 5,284
======= ======= =======
</TABLE>
The 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 1997,
the Bank sold $11.9 million of loans under direct sales agreements. For further
information, see "Management's Discussion and Analysis" in the Annual Report.
Loan Commitments. The 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 Bank's outstanding
commitments to originate real estate loans at December 31, 1997, was
approximately $2.8 million, excluding undisbursed portions of loans in process.
It has been the Bank's experience that few commitments expire unfunded.
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Maturity of Loan Portfolio. The following table sets forth certain
information at December 31, 1997 regarding the dollar amount of loans maturing
in the Bank's portfolio based on their contractual terms to maturity. Demand
loans (loans having no stated schedule of repayments and no stated maturity) and
home equity loans which reprice within one year are reported as due in one year
or less.
<TABLE>
<CAPTION>
Due after Due more
Due within 1 through 5 than 5
1 year after years from years from
December December December
31, 1997 31, 1997 31, 1997 Total
----------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C>
Mortgage................... $ 844 $ 44,538 $ 33,604 $ 78,986
Residential construction... 9,555 -- -- 9,555
Builder line of credit..... 4,974 -- -- 4,974
Commercial line of credit.. 4,765 -- -- 4,765
Home equity................ 14,371 442 2,441 17,254
Consumer .................. 249 4,717 1,367 6,333
----------- ---------- ---------- ----------
$ 34,758 $ 49,697 $ 37,412 $ 121,867
=========== ========== ========== ==========
</TABLE>
The next table sets forth the dollar amount of all loans due after one year
from December 31, 1997 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>
Mortgage ....................... $42,188 $35,954 $78,142
Home equity .................... 2,883 -- 2,883
Consumer ....................... 6,084 -- 6,084
------- ------- -------
$51,155 $35,954 $87,109
======= ======= =======
</TABLE>
Loan Origination Fees. In addition to interest earned on loans, the 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 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 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 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 Bank.
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Delinquencies. The 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 Bank will modify the loan or
grant a limited moratorium on loan pay ments to enable the borrower to
reorganize his financial affairs. If the loan continues in a delinquent status
for 90 days or more, the 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 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 loan losses. The Bank had no foreclosed real
estate at December 31, 1997.
The following table sets forth information with respect to the Bank's
non-performing assets for the periods indicated. During the periods shown, the
Bank had no impaired loans within the meaning of Statement of Financial
Accounting Standards No. 114 and 118.
<TABLE>
<CAPTION>
At December 31,
----------------------------------
1997 1996 1995
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Accruing loans which are
contractually past
due 90 days or more:
Real Estate:
Residential ...................... $ 165 $ 262 $ 226
Commercial ....................... -- -- --
Commercial Business ................ -- -- --
Consumer ........................... -- 79 --
------ ------ ------
Total ............................ $ 165 $ 341 $ 226
====== ====== ======
Percentage of Total Loans ............ .14% .32% .21%
====== ====== ======
Loans accounted for on a
nonaccrual basis: (1)
Real Estate:
Residential ...................... $ 34 $ 358 $ 323
Commercial Business .............. 30 -- --
Consumer ......................... 95 -- 17
------ ------ ------
Total ............................ 159 358 340
------ ------ ------
Total nonperforming loans ............ $ 324 $ 699 $ 566
====== ====== ======
</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.
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During the fiscal year ended December 31, 1997, gross interest income of
$28,902 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 1997.
The following table sets forth an analysis of the Bank's allowance for
possible loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1997 1996 1995
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Balance at Beginning
of Period .......................... $ 1,120 $ 734 $ 564
-------- -------- --------
Loans Charged-Off:
Real Estate:
Residential ........................ 11 17 34
Commercial ......................... -- -- --
Commercial Business ................. 21 -- --
Consumer ............................ 18 5 12
-------- -------- --------
Total Charge-Offs .................... 50 22 46
-------- -------- --------
Recoveries:
Real Estate:
Residential ...................... -- -- 2
Commercial ....................... -- -- --
Commercial Business ................ -- -- --
Consumer ........................... -- -- 4
-------- -------- --------
Total Recoveries ..................... -- -- 6
-------- -------- --------
Net Loans Charged-Off ................ 50 22 40
-------- -------- --------
Provision for Possible
Loan Losses ........................ 240 408 210
-------- -------- --------
Balance at End of Period ............. $ 1,310 $ 1,120 $ 734
======== ======== ========
Ratio of Net Charge-Offs
to Average Loans
Outstanding During
the Period ......................... .04% .02% .04%
======== ======== ========
</TABLE>
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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,
----------------------------------------------------------------------------
1997 1996 1995
------------------------ ------------------------ ------------------------
Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each
Category to Category to Category to
Total Total Total
Amount Loans Amount Loans Amount Loans
-------- ------------ -------- ------------ -------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real Estate:
Residential ................................... $ 881 75.7% 786 79.3% $ 694 81.1%
Commercial and other .......................... 255 15.2 240 12.5 -- 11.4
Commercial and unsecured ........................ 87 5.2 41 3.4 -- 3.1
Consumer ........................................ 87 3.9% 53 4.8 40 4.4
-------- -------- -------- -------- -------- --------
Total allowance for loan losses ......... $ 1,310 100.0% $ 1,120 100.0% $ 734 100.0%
======== ======== ======== ======== ======== ========
</TABLE>
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The 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
allowance for loan losses. A loan loss provision is provided by a monthly
accrual based on analysis of the loan portfolio characteristics and industry
norms. The allowance for loan losses was approximately 1% of outstanding loan
balances. This measure was deemed prudent to achieve a sufficient reserve level
commensurate with the Bank's portfolio risk.
While the 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 Bank's loan portfolio, will not
request the Bank to significantly increase its allowance for loan losses,
thereby negatively affecting the 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 the Bank after interest
payments on loans. At December 31, 1997, the Bank's interest-bearing cash and
investment securities portfolio of $59.2 million consisted of deposits in other
financial institutions, corporate equity securities, money market funds,
obligations of U.S. Government Corporations and agencies and asset-backed
securities. The Bank is in compliance with applicable liquidity requirements.
The Bank is required under Maryland regulations to maintain a minimum
amount of liquid assets sufficient to meet the operating needs of the Bank and
its customers. These assets may be invested in interest and noninterest-bearing
cash and 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 the Bank's policy in the past to maintain a liquidity portfolio above
regulatory requirements, and at December 31, 1997, the Bank's liquidity was in
compliance with Maryland requirements. Investment decisions are made by
authorized officers of the Bank under the supervision of the Bank's Board of
Directors. Brokers periodically approved by the Board of Directors are used to
effect securities transactions. See Notes 2 and 3 of Notes to Consolidated
Financial Statements in the Annual Report.
The following table sets forth the carrying value of the Corporation's
investment securities portfolio and FHLB and Federal Reserve Bank stock at the
dates indicated. At December 31, 1997, their market value was $55.8 million.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Investment securities:
Asset-backed securities ............ $44,035 $43,354 $31,954
Money market funds ................. 4,011 4,531 4,195
FHLMC, FNMA, SLMA
and FHLB notes ................... 5,003 5,320 9,388
Federal Home Loan Bank of
Atlanta, Federal Reserve,
Federal Home Loan
Mortgage Corporation and
Federal National Mortgage
Corporation Stock ................ 2,229 2,267 1,781
Treasury bills ..................... 192 640 421
Other investments .................. 281 671 --
------- ------- -------
Total investment
securities and FHLB
and Federal Reserve
Bank stock ..................... $55,752 $56,783 $47,739
======= ======= =======
</TABLE>
10
<PAGE>
The maturities and weighted average yields for investment securities
available for sale and held to maturity at December 31, 1997 are shown below.
<TABLE>
<CAPTION>
After One After Five After Ten
One Year or Less Through Five Years Through Ten Years After Ten Years
-------------------- --------------------- -------------------- --------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- ------- -------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment securities
available for sale:
Corporate equity securities.... $ 505 4.50% $ -- % $ -- % $ -- %
Asset-backed securities........ -- -- -- -- 2,204 6.61 41,156 6.97
Money market funds............. 4,011 6.00 -- -- -- -- -- --
Obligations of U.S. government
sponsored enterprises (GSE).. -- -- 1,004 6.37 3,999 6.81 -- --
-------- -------- ------- --------
Total investment securities
available for sale........ $ 4,516 6.00 $ 1,004 6.37 $ 6,203 6.81 $ 41,156 6.97
======== ======== ======= ========
Investment securities
held-to-maturity:
Asset-backed securities........ $ -- --% $ -- --% $ -- --% $ 676 8.50%
Treasury bills................. 192 5.30 -- -- -- -- -- --
Other investments.............. 281 8.98 -- -- -- -- -- --
-------- ------ -------- ----- ------- ----- -------- ------
Total investment securities
held-to-maturity.......... $ 473 7.87 $ -- --% $ -- --% $ 676 8.50
======== ======== ======= ========
</TABLE>
11
<PAGE>
The 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 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 2 and 3 of Notes to Consolidated Financial Statements in the Annual
Report.
Savings Activities and Other Sources of Funds
General. Deposits are the major source of the Bank's funds for lending and
other investment purposes. In addition to deposits, the Bank 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 Bank's market area through
the Bank's branch system. The 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 Bank has not obtained any funds through brokers. In recent
years, the 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.
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.
The following table indicates the amount of the Bank's certificates of
deposit and other time deposits of more than $100,000 by time remaining until
maturity as of December 31, 1997.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- ----------
(In thousands)
<S> <C>
One through three months............................... $ 2,350
Three through six months............................... 1,646
Six through twelve months.............................. 3,151
Over twelve months..................................... 4,188
-----------
Total............................................. $ 11,335
===========
</TABLE>
12
<PAGE>
Borrowings. Savings deposits are the primary source of funds for the Bank's
lending and investment activities and for its general business purposes. The
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 Bank's primary borrowing source. Advances from
the FHLB are typically secured by the Bank's stock in the FHLB and a portion of
the Bank's first mortgage loans. At December 31, 1997, advances from the FHLB of
Atlanta were as follows:
<TABLE>
<CAPTION>
Weighted Average
Year Due Interest Rate Balance
-------- ------------- ---------------
<S> <C> <C> <C>
1998 6.0% $ 12,000,000
1999 5.7% 5,000,000
2002 6.0% 11,400,000
--------------
$ 28,400,000
</TABLE>
The FHLB of Atlanta functions as a central reserve bank providing credit
for member institutions. As a member, the Bank 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 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.
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 the Bank 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.
13
<PAGE>
The following table sets forth for the periods and at the dates indicated,
the weighted average yields earned on the Bank's assets, the weighted average
interest rates paid on the 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, ------------------------------------
1997 1997 1996 1995
----------- -------- -------- --------
<S> <C> <C> <C> <C>
Weighted average yield on loan portfolio ............................... 8.57% 9.20% 9.13% 9.38%
Weighted average yield on interest-bearing cash and
investment securities portfolio ...................................... 6.76 6.48 6.42 6.45
Weighted average yield on all interest-earning assets .............. 7.97 8.29 8.25 8.45
Weighted average rate paid on savings deposits and escrow .............. 4.14 4.06 4.05 4.06
Weighted average rate paid on Federal Home Loan Bank
advances and other borrowings ........................................ 6.08 5.91 5.46 6.21
Weighted average rate paid on all interest-bearing
liabilities ...................................................... 4.46 4.37 4.22 4.28
Interest rate spread (spread between weighted average rate on
all interest-earning assets and all interest-bearing liabilities) .... 3.51 3.92 4.03 4.17
Net yield (net interest income as a percentage of average
interest-earning assets) ............................................. 4.23 4.32 4.46
</TABLE>
14
<PAGE>
Average Balance Sheet
The following table presents for the periods indicated the 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, 1997 1997 1996 1995
--------------- ----------------------- ------------------------ ------------------------
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 portfolio ..................... $123,566 8.57% $120,178 $11,056 9.20% $110,024 $10,045 9.13% $104,186 $ 9,772 9.38%
Cash and investment securities ..... 60,922 6.76 60,716 3,937 6.48 53,335 3,426 6.42 48,547 3,129 6.45
-------- ----- -------- ------- ----- -------- ------- ----- -------- ------- -----
Total interest-earning assets ... 184,488 7.97 180,894 14,993 8.29 163,359 13,471 8.25 152,733 12,901 8.45%
-------- ----- -------- ------- ----- -------- ------- ----- -------- ------- -----
Interest-bearing liabilities:
Savings deposits and escrow ........ $142,276 4.14% $139,941 $ 5,683 4.06% $133,331 $ 5,397 4.05% $128,041 $ 5,198 4.06%
FHLB advances and other borrowings . 29,202 6.08 28,184 1,667 5.91 18,493 1,010 5.46 14,435 897 6.21
-------- ----- -------- ------- ----- -------- ------- ----- -------- ------- -----
Total ........................... $171,478 4.46% $168,125 7,350 4.37% $151,824 6,407 4.22% $142,476 6,095 4.28%
======== ----- ======== ------- ----- ======== ------- ----- ======== ------- -----
Net interest income .................. $ 7,643 $ 7,064 $ 6,806
======= ======= =======
Interest rate spread ................. 3.51% 3.92% 4.03% 4.17%
==== ===== ===== =====
Net yield on interest-earning assets . 4.23% 4.32% 4.46%
===== ===== =====
Ratio of average interest-earning
assets to average interest-
bearing liabilities ................ 107.6% 107.6% 107.2%
===== ===== =====
</TABLE>
15
<PAGE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated. For
each category of interest-earning asset and interest-bearing liability,
information 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,
-------------------------------------------------------------------------------------
1996 vs. 1997 1995 vs. 1996
--------------------------------------- -----------------------------------------
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 portfolio ....................... $ 927 $ 77 $ 7 $1,011 $ 548 $ (260) $ (15) $ 273
Interest-earning cash and
investment portfolio ............... 475 32 4 511 313 (15) (1) 297
------ ------ ------ ------ ------ ------ ------ ------
Total interest-earning assets .......... $1,402 $ 109 $ 11 $1,522 $ 861 $ (275) $ (16) $ 570
------ ------ ------ ------ ------ ------ ------ ------
Interest expense:
Savings deposits and escrow .......... $ 272 $ 13 $ 1 $ 286 $ 213 $ (13) $ (1) $ 199
FHLB advances and other
borrowings ......................... 530 83 44 657 251 (108) (30) 113
------ ------ ------ ------ ------ ------ ------ ------
Total interest-bearing liabilities ..... $ 802 $ 96 $ 45 $ 943 $ 464 $ (121) $ (31) $ 312
====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
Key Operating Ratios
The table below sets forth certain performance ratios of the Corporation
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Return on Assets
(Net Income Divided by Average Total Assets) .. 1.13% .77% 1.28%
Return on Equity
(Net Income Divided by Average Equity) ........ 11.53% 7.94% 13.8%
Equity-to-Assets Ratio
(Average Equity Divided by Average
Total Assets) ................................ 9.79% 9.70% 9.25%
</TABLE>
Subsidiary Activity
In 1985, the Bank formed Tri-County Federal Bank Finance One as a finance
subsidiary for the purpose of issuing a $6.5 million collateralized mortgage
obligation. On April 16, 1997, the Bank formed a wholly owned subsidiary,
Community Mortgage Corporation of Tri-County, to offer mortgage banking and
brokerage services to the public. To date, this corporation has been inactive.
16
<PAGE>
Depository Institution Regulation
General. The Bank is a Maryland commercial bank and its deposit accounts
are insured by the Savings Association Insurance Fund ("SAIF"). The Bank is a
member of the Federal Reserve System. The Bank is subject to supervision,
examination and regulation by the State of Maryland Commissioner of Financial
Regulation ("Commissioner") and the Board of Governors of the Federal Reserve
(the "FRB") and to Maryland and federal statutory and regulatory provisions
governing such matters as capital standards, mergers and establishment of branch
offices. The Bank is subject to the FDIC's authority to conduct special
examinations. The Bank is required to file reports with the Commissioner and the
FRB 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 Bank is subject to
various regulations promulgated by the FRB, including Regulation B (Equal Credit
Opportunity), Regulation D (Reserve Requirements), Regulation 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 Bank establishes
a comprehensive framework for the operations of the Bank and is intended
primarily for the protection of the FDIC and the depositors of the Bank. Changes
in the regulatory framework could have a material effect on the Bank and its
respective operations that in turn, could have a material effect on the
Corporation.
Liquidity Requirements. The Bank is 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. As of December
31, 1997 the Bank was in compliance with Maryland's reserve requirements.
Regulatory Capital Requirements. The Bank is subject to FRB capital
requirements as well as statutory capital requirements imposed under Maryland
law. FRB 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 FRB regulations. A bank that fails to satisfy the capital
requirements established under the FRB's regulations will be subject to such
administrative action or sanctions as the FRB deems appropriate.
The leverage ratio adopted by the FRB requires a minimum ratio of "Tier 1
capital" to adjusted total assets of 5% 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 FRB's leverage
requirement, Tier 1 capital generally consists of 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.
17
<PAGE>
The risk-based capital requirements established by the FRB'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"
defined to include certain preferred stock issues, nonwithdrawable accounts and
pledged deposits that do not qualify as Tier 1 capital, certain approved
subordinated debt, certain other capital instruments and a portion of the bank's
general loss allowance.
Total risk-weighted assets 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 assigned risk weight. The FRB's regulations establish four
risk weights, 0%, 20%, 50% and 100%.
In addition, the Bank is 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.
Prompt Corrective Regulatory Action. Under requirements implementing the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the
federal banking regulators 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,
an institution that is not subject to an order or written directive to meet or
maintain a specific capital level will be deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1
risk-based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0%
or greater. An "adequately capitalized" institution is an institution that does
not meet the definition of well capitalized and has: (i) a total risk-based
capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0%
or greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if
the institution has a composite 1 CAMEL rating). An "undercapitalized
institution" is an institution that has (i) a total risk-based capital ratio
less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or
(iii) a leverage ratio of less than 4.0% (or 3.0% if the association has a
composite 1 CAMEL rating). A "significantly undercapitalized" institution is
defined as an institution that has: (i) a total risk-based capital ratio of less
than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii)
a leverage ratio of less than 3.0%. A "critically undercapitalized" institution
is defined as an institution 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 FRB may reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized or
undercapitalized institution to comply with the supervisory actions applicable
to institutions in the next lower capital category (but may not reclassify a
significantly undercapitalized institution as critically under-capitalized) if
the FRB determines, after notice and an opportunity for a hearing, that the
institution is in an unsafe or unsound condition or that the institution has
received and not corrected a less-than-satisfactory rating for any CAMEL rating
category. At December 31, 1997, the Bank was classified as "well capitalized"
under these regulations.
Deposit Insurance. The 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. 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 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
18
<PAGE>
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 Bank is currently classified as "well
capitalized" under these regulations.
Federal Reserve System. Pursuant to regulations of the FRB, all
FDIC-insured depository institutions must maintain average daily reserves
against their transaction accounts. 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 require ment is to reduce the amount of
the institution's interest-earning assets. At December 31, 1997, the Bank met
its reserve requirements.
The Bank is a member of the Federal Reserve System and has subscribed for
stock in the Federal Reserve Bank of Richmond in an amount equal to 6% of the
Bank's common stock and surplus.
The monetary policies and regulations of the FRB have a significant effect
on the operating results of commercial banks. The FRB'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 state member banks and
any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act.
An affiliate of a state member bank is any company or entity which controls, is
controlled by or is under common control with the state member bank. In a
holding company context, the parent holding company of a state member bank (such
as the Corporation) and any companies which are controlled by such 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 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 state member bank.
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 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 state member bank, and their respective affiliates, unless
such loan is approved in advance by a majority of the board of directors of the
institution with any "interested" director not participating in the voting. The
FRB 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 FRB 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.
19
<PAGE>
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. ss. 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. The Bank's ability to pay dividends is governed by
the Maryland Financial Institutions Code and the regulations of the FRB. 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 are subject to the FRB'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
FRB 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 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 its mutual to stock
conversion.
Regulation of the Corporation
General. The Corporation, as the sole shareholder of the Bank, is a bank
holding company and registered as such with the FRB. Bank holding companies are
subject to comprehensive regulation by the FRB under the Bank Holding Company
Act of 1956, as amended (the "BHCA"), and the regulations of the FRB. As a bank
holding company, the Corporation is required to file with the FRB annual reports
and such additional information as the FRB may require, and is subject to
regular examinations by the FRB. The FRB 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 FRB 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 FRB 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 FRB includes, among other things,
operating a savings institution, mortgage company, finance company, credit card
company or factoring company;
20
<PAGE>
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.
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 FRB 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 FRB 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 FRB 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 FRB 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 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 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 FRB has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the FRB'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 FRB 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 FRB pursuant to FDICIA, the FRB 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."
21
<PAGE>
Bank holding companies are required to give the FRB 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
FRB 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, FRB order, or any condition imposed by, or written agreement
with, the FRB.
Capital Requirements. The FRB 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. As of
December 31, 1997, the Corporation's levels of consolidated regulatory capital
exceeded the FRB's minimum requirements.
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.
The Bank is subject to the provisions of the Internal Revenue Code of 1986,
as amended (the "Code") in the same general manner as other corporations. In its
form as a savings bank until March 1997, through tax years beginning before
December 31, 1995, savings associations such as the Bank which met certain
definitional tests and other conditions prescribed by the Code benefitted from
certain favorable provisions regarding their deductions from taxable income for
annual additions to their bad debt reserve. For purposes of the bad debt reserve
deduction, loans 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 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 required the Bank 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 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 Bank's federal income tax returns have been
audited during the past five years.
For 1997, the Bank is required to file a franchise tax return with the
State of Maryland which computes the tax at a rate of 7% on the Bank's net
earnings. For the purposes of the 1997 franchise tax, net earnings are defined
as net income for federal corporate purposes adjusted as follows: (1) less 75%
of the interest income from obligations of the United States, (2) plus 25% of
interest from obligations of the State of Maryland or any of its counties,
municipal or public corporation authority, special district or political
subdivision and any profit realized from the sale or exchange of bonds issued by
the State of Maryland or any of its political subdivisions, (3) plus 100% of the
interest from obligations of any state or political subdivisions other than the
State of Maryland. Due to the State tax legislation passed in 1995, the Bank
will no longer be subject to the franchise tax starting in 1998, but will file a
corporate return with the State of Maryland.
For additional information regarding federal and state taxes payable by the
Corporation, see Note 8 of the Notes to Consolidated Financial Statements.
22
<PAGE>
Competition
The Bank faces strong competition in the attraction of deposits (its
primary source of lendable funds) and in the origination of real estate loans.
Its most direct competition for deposits and loans comes from other banks, from
savings and loan associations, federal and state credit unions located in its
primary market area. The Bank faces additional significant competition for
investors' funds from short-term money market securities and other corporate and
government securities.
The 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 deposits by
offering depositors a wide variety of savings accounts, checking accounts,
convenient office locations, tax-deferred retirement programs, and other
miscellaneous services. The Bank has also utilized direct mail, 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, 1997, the Bank had 66 full-time employees and 9
part-time employees. The employees are not represented by a collective
bargaining agreement. The Bank believes its employee relations are good.
23
<PAGE>
Item 2. Properties
The following table sets forth the location of the Bank's offices, as well
as certain additional information relating to these offices as of December 31,
1997.
<TABLE>
<CAPTION>
Year
Facility Leased Approximate
Office Commenced or Square
Location Operation Owned Footage
- -------- --------- ----- -------
<S> <C> <C> <C>
Main Office 1974 Owned 16,500
3035 Leonardtown Road
Waldorf, Maryland
Branch Office (1) 1974 Owned 1,000
502 Great Mills Road
Lexington Park, Maryland
Branch Office (1) 1992 Owned 2,500
Rt. 235 and Maple Road
Lexington Park, Maryland
Branch Office 1961 Owned 2,500
Route 5 and Lawrence Avenue
Leonardtown, Maryland
Branch Office (3) 1987 Leased 2,100
Business Park Dr. & Route 301
Waldorf, Maryland
Branch Office (2) 1990 Leased 24,200
Potomac Square
729 North 301 Highway
La Plata, Maryland
Branch Office 1991 Leased 1,400
10321 Southern Md. Blvd.
Dunkirk, Maryland
Branch Office 1996 Owned 2,500
8010 Matthews Road
Bryans Road, Maryland
Branch Office 1998 Leased
20 Patricks Drive
Waldorf, Maryland
</TABLE>
- ----------
(1) The 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 is under contract to sell the site for
$400,000. Settlement is anticipated in the second quarter of 1998.
(2) Includes land purchased in February 1993 as potential branch location.
(3) The Bank closed this location in January 1998.
24
<PAGE>
NCR currently maintains all accounting records for the Bank's deposits and
loans. The Bank's general ledger and other accounting needs are met through the
use of internal computer systems. The net book value of the Bank's investment in
premises and equipment less accumulated depreciation totaled $4.2 million at
December 31, 1997. See Note 5 of the Notes to Consolidated Financial Statements.
Item 3. Legal Proceedings
Neither the Corporation, the Bank, nor any subsidiary is engaged in any
legal proceedings of a material nature at the present time. From time to time
the 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, 1997.
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
The information required by this Item is incorporated by reference to the
Company's Current Report on Form 8-K dated September 19, 1997.
25
<PAGE>
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 1998 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
The executive officers of the Corporation are as follows:
Michael L. Middleton (50 years old) is Chief Executive Officer of the
Corporation and the Bank. He joined the Bank in 1973 and served in various
management positions until 1979 when he became president of the Bank. Mr.
Middleton is a Certified Public Accountant and holds a Masters of Business
Administration. As President and Chief Executive Officer of the Bank, Mr.
Middleton is responsible for the overall operation of the 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. (67 years old) is the Secretary of the Corporation
and the Bank. He has served in this capacity with the 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 (55 years old) has been employed with the Bank 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 Bank.
Beaman Smith (52 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 (41 years old) joined the 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.
Gregory C. Cockerham (43 years old) joined the Bank in November 1988 and
has served as Senior Vice President of Lending since 1996. Prior to his
appointment as Senior Vice President, Mr. Cockerham served as Vice President of
the Bank. Mr. Cockerham has been in banking for 22 years. He is a Paul Harris
Fellow with the Rotary Club of Charles County and serves on various civic boards
in the County.
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
26
<PAGE>
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.
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 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*
Tri-County Financial Corporation*
(a) Consolidated Statements of Financial Condition at December 31,
1997 and 1996
(b) Consolidated Statements of Income for the Years Ended December
31, 1997, 1996 and 1995
(c) Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995
(d) Consolidated Statements of Cash Flow for the Years Ended December
31, 1997, 1996 and 1995
(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, 1997
(21) Subsidiaries of the Registrant
27
<PAGE>
(23) Consent of Stegman & Company
(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.
28
<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 25, 1998 By: /s/ Michael L. Middleton
------------------------------------
Michael L. Middleton
President and Chief Executive Officer
(Duly Authorized Representative)
Date: March 25, 1998 By: /s/ Eileen M. Ramos
------------------------------------
Eileen M. Ramos
Chief Financial 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/ Herbert N. Redmond, Jr.
----------------------------- -----------------------------
Michael L. Middleton Herbert N. Redmond, Jr.
(Director, President and Chief (Director)
Executive Officer)
Date: March 25, 1998 Date: March 25, 1998
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 25, 1998 Date: March 25, 1998
By: /s/ C. Marie Brown By: /s/ Gordon A. O'Neill
----------------------------- -----------------------------
C. Marie Brown Gordon A. O'Neill
(Director and Senior (Director)
Vice President)
Date: March 25, 1998 Date: March 25, 1998
By: /s/ Beaman Smith
-----------------------------
Beaman Smith
(Director and Treasurer)
Date: March 25, 1998
29
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description Page
- ----------- ----------- ----
(3)(a) Articles of Incorporation of Tri-County
Financial Corporation* N/A
(3)(b) Bylaws of Tri-County Financial Corporation* N/A
(10)(a) Tri-County Federal Savings Bank of Waldorf 1986 Stock N/A
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, 1997
(21) Subsidiaries of the Registrant
(23) Consent of Stegman & Company
(27) Financial Data Schedule
- ----------
* 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.
30
<PAGE>
Exhibit 13
TRI-COUNTY FINANCIAL CORP.
Dear Shareholder:
I am pleased to report to you the activities of Tri-County Financial
Corporation and its banking subsidiary, Community Bank of Tri-County. In March
1997, we introduced the new logo to our market and customer acceptance has been
above all expectations.
The Company ended the year with net income of $2.1 million, up 58% over
the year ended December 31, 1996. Of course, one must remember that 1996 was the
year that the FDIC was paid $1.1 million in deposit insurance by the thrift. The
earnings of 1997 are particularly noteworthy in light of the costs involved in
the conversion to a Federal Reserve member bank as well as those of an extensive
advertising campaign.
Total assets of the Company reached $191.2 million at December 31, 1997,
with average net worth to average assets of over 9.8% for 1997. This solid base
of core capital will permit the bank to function under the "well capitalized"
rules of the regulators and to pay the lowest available cost of deposit
insurance. It also will serve as the platform for growth as the new bank begins
to penetrate the market share held by large regional banks.
To that point, further promotion of our new commercial banking structure
will be facilitated by the Bank's recent purchase of a large strategically
located branch. It was opened on January 23, 1998 to serve the business
community around the regional mall in Charles County. A smaller satellite branch
at Acton Lane was consolidated into the home office branch to gain economy in
our network operations.
An issue also being addressed is the Year 2000 (Y2K) problem and its
unknown effects on the world of commerce. I am pleased to inform you that your
Board and management have been actively engaged in the resolution of the effects
of Y2K on the Company. During the last several years, over $300,000 in hardware
costs were incurred and all of our software systems were upgraded.
As you read the financial statements and management's discussion and
analysis, you will find that Community Bank has begun its mission to serve the
financial needs of its market in such a way to allow it to grow and prosper in
the future. We are exploring new financial products, including property and
casualty insurance for which we are now licensed agents, for its many customers.
It is expected that the Bank will be able to leverage its customer knowledge and
contacts to develop new lines of business and non-interest sources of income.
Over time, one can begin to see structure taking place through well
thought out and carefully implemented strategies. At Tri-County Financial, a
long term planning horizon is embraced to maximize the value to our
shareholders. While rapid consolidation is occurring all around us, there is an
ever increasing need to bring banking and other financial services down to the
local level. As in the past, I sincerely appreciate the support offered over
the many years and look forward to serving you in the coming year.
Yours truly,
/s/ Michael L. Middleton
Michael L. Middleton
President
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
The year ended December 31,1997 marked the first year of corporate
restructuring by the Company of its banking subsidiary, Community Bank of
Tri-County. Based on critical analysis of the potential market growth for
providers of financial services, the Board of Directors of the Company
determined that the optimal vehicle for future growth would be that of a
community banking institution. On March 27, 1997 the newly chartered commercial
bank began its mission in Southern Maryland.
The business plan of the new bank targeted specific areas of portfolio
growth and marketing programs were developed to achieve these targets. The key
component of this strategy was to increase commercial and consumer loan products
to levels normally found in established commercial banks. The Board set
reasonable time horizons to effect the evolution of the portfolio. Utilizing the
existing delivery systems previously developed in anticipation of the enabling
legislation of 1996, the Bank's management began to capitalize on the lucrative
niche for community based lending. This void was created by recent mergers of
Maryland banks with large regional banks. The market acceptance of this strategy
was most favorable and name recognition is gaining momentum.
Another strategy implemented in the restructuring effort by the Board was
to embark on a program to change the Bank into a sales and quality service
culture. After one year of progress in team building, information tracking and
data warehouse building, the Bank's staff is achieving the skills necessary to
compete for market share gains.
The results of the restructuring of the Bank were positive in the first
nine months of the new bank's year. An analysis of line items shows that
considerable progress toward growth in commercial and consumer products was
achieved during 1997. Net loans receivable increased by $11.0 million or 10%
while commercial real estate loans grew by $5.0 million or 36 %. Second
mortgages increased by $3.3 million or 23% and lines of credit grew by $1
million or 25%.
On the deposit side of the balance sheet, non-interest bearing demand
accounts grew by $1.2 million or 20% during the year.
Residential mortgage lending continued to be a profit center for the Bank
and has produced a volume of $52.4 million in loans, up 18% over 1996's level.
The majority of fixed rate long term loans were sold in the secondary market,
while adjustable rate mortgages and certain shorter maturity fixed rate loans
were originated for the Bank's portfolio. In 1997, with long term rates dropping
to their lowest levels in several years, the Bank began to sell its fixed rate
originations with the servicing retained. This was done to increase its
servicing portfolio with lower rate mortgages that may experience a longer
expected average life to produce servicing income for the Bank. The portfolio of
loans serviced for others increased 17% or $6.8 million over 1996's level.
27
<PAGE>
Another restructuring measure was taken the last quarter of the year to
consolidate a small satellite branch into the home office branch.
Simultaneously, a larger banking facility at the entrance to Southern Maryland's
only regional mall was acquired. The restructuring allowed a highly visible
commercial branch to be opened without undue disruption of the customers of the
smaller satellite branch.
Earlier in 1997, the Bank created a "micro branch" at the Charles County
Community College to provide low cost banking services to the college community.
The Bank is aggressively pursuing locations for ATM services in an effort to
generate fee income and further advance the name recognition of the new Bank. It
currently has nine ATM'S situated throughout the market and has three more under
contract to be placed in high traffic public areas.
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's net income for 1997 increased $764,284 or $.92 in basic
earnings per share over 1996 levels. This compared favorably to the decrease in
net income of $708,087 or $.97 in basic earnings per share for 1996 over 1995.
In 1996, net income was adversely affected by two events during the course of
the year. The first was the recapitalization of the SAIF fund of the FDIC. This
accounted for a pre-tax charge to income of $820,000 for an after tax cost of
$504,000 or a $.63 reduction in basic earnings per share.
The second factor impacting net income in 1996 was the increase in the
provision for loan losses of $198,000 or $.25 in basic earnings per share
compared to 1995. The Board of the Bank elected to increase the allowance for
loan losses to achieve a sufficient reserve level commensurate with the Bank's
portfolio risks and business plan in anticipation of the impending conversion to
a commercial bank.
The weighted average yield on all interest-earning assets was 8.29% in
1997, 8.25% in 1996 and 8.45% in 1995. The interest rate yield curve during the
year was flat and experienced very little variance over the period. This
resulted in a small increase in the weighted average yield as minimal yield gain
was available through 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 current economic expansion is entering
its sixth year without significant inflationary pressure. As evidenced in the
"Gap" chart in the "Market Risk Analysis" section of this discussion, the Bank
has some exposure to continued lowering of rates, particulary in the long term
sector. 1997 saw several periods when short term rates exceeded long term rates,
an "inverted yield curve", and this situation could be repeated in the near
future. The inverted yield curve puts additional pressure on the Bank's net
spread because no appreciable relief is obtained in the cost of money with short
and intermediate term rates tracking so close to the long term rates. The
weighted average rate paid on all interest-bearing liabilities was 4.37% in
1997, 4.22% in 1996 and 4.28% in 1995. The Board of Directors of the Bank
monitors the situation carefully to develop a balance in the portfolio that will
conservatively position the Bank for a continuation of the trend without undue
risk to market rate turns in either direction.
28
<PAGE>
The net interest rate spread was 3.92% in 1997 compared to 4.03% in 1996
and 4.17% in 1995. While the trend has been narrowing over the past several
years, it is possible that interest rates could increase in the near future if a
normal business cycle is regained in the economy. That is, if the classic
pattern of inflationary pressures and interest rate volatility return to the
economic front, the Bank's costs of funds will increase. An interest rate
sensitivity analysis follows this section and will provide a more detailed
discussion.
Another negative effect of the low long term rate environment is the
acceleration in refinancing activity of the fixed rate portfolio and of the
loans serviced for others. Further, the Bank's ARM portfolio is repricing at
levels consistent with or above the current fixed rates found in the market.
This exposes the ARM portfolio to a faster runoff of loans as well as a flat
yield from those which do not pay off.
The loan portfolio continues to hold its quality and has no loans
identified as impaired under the criteria established by the scope of SFAS 114.
The nonaccrural loans for 1997 totaled $160,000 compared to $400,000 for 1996
and $ 300,000 for 1995. The Bank owned no real estate acquired through
foreclosure at the end of the year.
OPERATIONAL ANALYSIS
Noninterest expense increased by 8.6% or $400,000 to $5,062,427 compared to
an operating expense level of $4,663,000 after adjustment for the $820,000 SAIF
recapitalization charge in 1996. This compares with $4,098,561 in 1995. Other
expenses included start up staffing and promotional expense associated with the
new branch opened in Bryans Road, Maryland, the Charles County Community College
and anticipated staffing levels for the new St. Patrick's Lane branch opened in
January 1998. It is expected that personnel expense will continue to increase in
the future as the Bank staffs to a level necessary to handle the expected
increase in transactional and business activity.
In an effort to control future personnel costs, the Board of Directors of
the Bank studied the projected long term costs associated with the defined
benefit pension plan. As the result of the study, the Board elected to terminate
the Defined Benefit Pension Trust of the Bank and to transfer the assets into
the participants' 401(k) plan. The benefit to the Company resulting from this
plan curtailment was $105,000. No future costs are expected with this plan. This
continues the strategy of the Bank to link compensation with performance for its
employees.
YEAR 2000 ISSUES
The Bank's management and Board of Directors has been monitoring the
problems created by the year 2000 (Y2K) and its effect on data processing
systems. The Bank's capitalized cost of new technology and software over the
last three years has exceeded $300,000. All software systems have been upgraded.
These software costs were expensed during the years as a part of ongoing data
operations expense. The current technology utilized by the Bank and its eight
locations has been subjected to periodic reviews by its regulators. Testing of
the systems with its third party provider is scheduled for April 1998. The Board
is closely involved with this project and is aware that third party providers of
data processing services are conducting their own Y2K projects to ensure that
their users have adequate coverage of the problem. However, the Board also
realizes that third party providers' compliance is largely out of the Bank's
control and is monitoring their progress. Because of the Company's reliance on
third party data processing services, it does not anticipate any material
expenditures associated with the Y2K issue. There can be no assurance that the
Bank and its third party providers will be successful in making all necessary
changes to avoid computer system failure related to the year 2000.
29
<PAGE>
NET PREMISES AND EQUIPMENT
Net premises and equipment increased by 9.5% or $364,654 for the year. This
reflects the purchase of the St. Patrick's Lane branch building during the
fourth quarter of 1997 and increased investment in technology platforms.
WHOLESALE BORROWINGS
The Bank's wholesale borrowing, consisting mainly of advances from the
Federal Home Loan Bank of Atlanta, increased to $28.4 million from $24.0 million
during 1997. 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' EQUITY
Stockholders' equity grew by 11.8% or $2,009,000 to $19,086,000 at year end
1997. This represents an average net worth to total assets ratio of 9.8%.
The net unrealized gain on investment and mortgage-backed securities
available for sale increased by $353,254 due to the effects of the lower long
term rate environment on the mortgage portfolio. The 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 Company's total risk based capital ratio for 1997 was 17.38% or
$19,953,000 compared to 17.47% or $18,353,000 in 1996. The Tier I risk based
capital level for 1997 was $18,643,000 or 16.24% compared to $17,233,000 or
16.4% in 1996. A discussion of the quantitative measures of capitalization and
regulatory capital requirements of the Company and its banking subsidiary may be
found in Footnote 14 "Regulatory Matters" of the Consolidated Financial
Statements. At December 31,1997, the Company and the Bank exceeded all capital
requirements and were considered to be "well-capitalized" under regulatory
definitions.
During the year, the Board of Directors of the Company elected to provide
liquidity to its shareholder base through stock repurchases. The Company
purchased and retired 17,000 shares for $348,271.
LIQUIDITY
The Company's liquidity management policies for the Bank are designed to
provide for prudent levels of liquidity to be maintained at all times,
consistent with the nature of the business being conducted by the Bank. The
assets classified as Investment Securities Available-for-Sale are available for
leveraging as well as for immediate sale if the situation dictates that course
of action. Additionally, the Federal Home Loan Bank of Atlanta is extensively
utilized as the Bank's liquidity source in its asset/liability management
strategy. The Bank currently has approval to borrow up to thirty percent (30%)
of its assets. At December 31,1997, it had $28.4 million outstanding or 15% of
its assets.
30
<PAGE>
MARKET RISK ANALYSIS
The market risk of the Bank is managed through the Board's Asset and
Liability Committee (ALCO). Together with the Bank's management, the committee
reviews the sensitivity of the market value of the portfolio equity and interest
rate sensitivity of net income. The changes in the market value of portfolio
equity as well as the interest income sensitivity are caused by shifts in the
market rates of interest and can cause a negative as well as a positive impact
in given scenarios. The portfolio is subjected to periodic modeling to test the
effects of sudden and sustained interest rate shocks on the market value and the
net interest income sensitivity. The Basle Committee on Banking Supervision has
set standard measures of portfolio market value equity and interest income
sensitivity in a shock environment of an up or down 200 basis point shift in
assumed interest rates. The impact of such a shock on the Bank's portfolio is as
follows:
<TABLE>
1997 1996
------ ------
<S> <C> <C>
Market value of portfolio equity:
Interest rate changes - adverse scenario:
Up 200 basis points -4% -10%
Down 200 basis points -5% +3%
Interest rate sensitivity:
Interest rate changes - adverse scenario:
Up 200 basis points +7% +5%
Down 200 basis points -9% -6%
</TABLE>
The change in percentage for the Market Value of Portfolio Equity improved
at the adverse scenario of up 200 basis points in interest rate movement, while
the equity declined at a greater rate in the down 200 basis shock. Because the
net income of the Bank and Company is derived through the interest spread of the
portfolio, the ALCO committee 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 levels of change for both the market value of the portfolio
equity and the net interest income sensitivity fall within the policy benchmarks
established by the Board.
Interest rate sensitivity reflects the change in the Bank's net interest
income given assumed interest rate shifts. In the scenarios presented, the most
detrimental for the Bank is a downward movement of rates. Management feels that
a more difficult situation for the Bank to control would exist with rising
interest rates. This is due to the composition of the cost of funds and the
percentage of wholesale borrowings needed to finance the activities of the Bank.
Typically, wholesale borrowings are in large denominations and reprice quickly
to reflect sudden changes in the global market. Retail deposits typically are in
smaller amounts and are less likely to respond to shifts in rates in a short
time period. Therefore, the Bank's portfolio has been structured with an attempt
to reasonably minimize the impact from sudden and prolonged upward shifts in
interest rates.
31
<PAGE>
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.
The following table illustrates the "gap" position of the Bank at December 31,
1997:
<TABLE>
0 to 90 91 to 365 Over 1 to Over 3 to Over 5
(amounts in thousands) days days 3 years 5 years years
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Rate Sensitive Assets:
Interest bearing deposits with banks $ 5,169 $ -- $ -- $ -- $ --
Investment securities 20,336 -- 1,263 -- 34,154
Loans 32,041 10,579 28,976 11,272 40,308
-------- -------- -------- -------- --------
Total assets 57,546 10,579 30,239 11,272 74,462
Rate Sensitive Liabilities:
Noninterest bearing deposits 7,196 -- -- -- --
Interest bearing demand deposits 15,550 -- -- -- --
Money market deposits 11,479 -- -- -- --
Regular savings deposits 26,339 -- -- -- --
Time deposits 13,370 28,297 32,936 7,109 --
Other borrowed funds and
long-term debt 523 12,000 5,000 11,679 --
-------- -------- -------- -------- --------
Total liabilities 74,457 40,297 37,936 18,788 --
Interest rate sensitivity gap (16,911) (29,718) (7,697) (7,516) 74,462
Cumulative interest rate
sensitivity gap (16,911) (46,629) (54,326) (61,842) 12,620
</TABLE>
While a perfectly matched portfolio of assets and borrowings would seem
optimal, in community banking enterprises, there exists too little margin for
normal profitability and coverage of the cost of operations to attempt a
complete match. Therefore, the Board of Directors, through its ALCO committee,
monitors certain levels of mismatch in the portfolio consistent with the net
worth leveraging policies to maintain a profitable level of mismatched assets
and their funding costs.
32
<PAGE>
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 1997, the Company was made aware of several trades which occurred.
During l997, a total of 43,551 shares traded, with a high price of $25 and
a low price of $19. The weighted average price was $20.33. The number of
shareholders at March 23, 1998 was 525 and the total outstanding shares was
782,866. On February 25, 1998, the Board of Directors declared a 4% stock
dividend and a $.125 per share cash dividend, both payable on April 13, 1998 to
shareholders of record on March 13, 1998. On January 24, 1997, the Board of
Directors declared a 5% stock dividend and a $.10 per share cash dividend which
were distributed to holders of record on March 7, 1997.
Federal regulations impose certain limitations on the payment of dividends
and other capital distributions by the Bank.
The Bank's ability to pay dividends is 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 is also 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 is not
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.
33
<PAGE>
COMMUNITY BANK OF TRI-COUNTY
RATE SPREAD BETWEEN INTEREST-EARNING LOANS AND INTEREST-
BEARING DEPOSITS AT DECEMBER 31,
[CHART APPEARS HERE]
1993 4.39%
1994 4.59%
1995 4.38%
1996 4.28%
1997 4.41%
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
RETURN ON ASSETS
[CHART APPEARS HERE]
1993 1.39%
1994 1.08%
1995 1.28%
1996 0.77%
1997 1.13%
NET INCOME
[CHART APPEARS HERE]
1993 $1,879,089
1994 $1,583,057
1995 $2,027,814
1996 $1,319,727
1997 $2,084,011
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
AT DECEMBER 31,
----------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
TOTAL AMOUNT OF:
Loans Outstanding.................................. $123,565,634 $111,862,620 $107,678,852 $98,646,221 $85,506,126
Interest and Noninterest-bearing Cash.............. 5,820,753 3,903,612 4,050,219 3,471,953 4,020,960
Investment Securities.............................. 55,751,720 56,783,231 46,858,152 44,526,381 43,852,603
Assets............................................. 191,188,360 178,146,326 164,124,420 153,008,090 139,570,352
Savings Deposits................................... 142,276,077 135,534,163 130,034,043 126,840,279 120,783,275
Borrowed Money..................................... 29,201,820 24,733,466 17,552,845 12,480,128 6,543,919
Stockholders' Equity............................... 19,086,079 17,077,452 15,832,925 13,325,589 12,135,593
NUMBER OF:
Loans Outstanding.................................. 3,203 2,854 2,792 2,667 2,597
Savings Accounts................................... 15,303 14,849 14,090 14,409 13,816
Offices Open - All Full Service.................... 8 8 6 6 6
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED AVERAGE YIELD ON:
Loan Portfolio..................................... 9.20% 9.13% 9.38% 8.44% 9.18%
Investment Portfolio............................... 6.48 6.42 6.45 5.24 4.38
All Interest-earning Assets........................ 8.29 8.25 8.45 8.03 8.65
WEIGHTED AVERAGE RATE PAID ON:
Savings Deposits and Escrow........................ 4.06 4.05 4.06 3.67 3.94
Federal Home Loan Bank Advances and Other
Borrowings........................................ 5.91 5.46 6.21 7.02 9.60
All Interest-bearing Liabilities................... 4.37 4.22 4.28 3.87 4.29
INTEREST RATE SPREAD (Spread Between Weighted
Average Rate on All Interest-earning Assets
and All Interest-bearing Liabilities).............. 3.92 4.03 4.17 4.16 4.36
NET YIELD (Net Interest Income as a
Percentage of Average Interest-earning Assets)..... 4.23 4.32 4.46 4.38 4.53
</TABLE>
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (CONTINUED)
SUMMARY OF OPERATIONS
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Interest Income.............................................. $14,993,261 $13,471,595 $12,900,876 $11,262,969 $11,337,676
Interest Expense............................................. 7,350,648 6,406,756 6,094,968 5,117,503 5,390,004
----------- ----------- ----------- ----------- -----------
Net Interest Income.......................................... $ 7,642,613 $ 7,064,839 6,805,908 6,145,466 $ 5,947,672
Loss Provision and Charge offs of Loans...................... 240,000 408,000 210,000 154,000 144,000
----------- ----------- ----------- ----------- -----------
Net Interest Income
After Provision for Loss on Loans......................... $ 7,402,613 $ 6,656,839 $ 6,595,908 5,991,466 5,803,672
Other Income................................................. 1,115,825 930,970 857,467 562,297 823,159
Less Noninterest Expense..................................... 5,062,427 5,482,882 4,098,561 3,928,991 3,514,998
----------- ----------- ----------- ----------- -----------
Income Before Federal Income Tax............................. $ 3,456,011 $ 2,104,927 $ 3,354,814 $ 2,624,772 $ 3,111,833
Income Tax Expense........................................... 1,372,000 785,200 1,327,000 1,041,715 1,289,852
Income Tax Benefit-Change in Accounting for Deferred Taxes... - - - - 57,108
----------- ----------- ----------- ----------- -----------
Net Income................................................... $ 2,084,011 $ 1,319,727 $ 2,027,814 $ 1,583,057 $ 1,879,089
=========== =========== =========== =========== ===========
Net Income Per Common Share(1)............................... $ 2.57 $ 1.65 $ 2.62 $ 1.98 $ 2.45
Cash Dividends Declared Per Common Share(2).................. 75,498 70,574 $ 64,751 60,545 -
</TABLE>
- -------------
(1) Restated to reflect 1994, 1995, 1996, 1997 and 1998 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;
a $0.125 per common share cash dividend was declared on February 15, 1998,
payable to shareholders of record March 13, 1998;
s
<PAGE>
Stockholders and Board of Directors
Tri-County Financial Corporation
Waldorf, Maryland
We have audited the accompanying consolidated balance sheets of Tri-County
Financial Corporation as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. 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, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Tri-County Financial Corporation as of December 31, 1997 and 1996, and the
results of its operations and cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Stegman & Company
Baltimore, Maryland
March 26, 1998
<PAGE>
<TABLE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
ASSETS
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Cash and due from banks $ 650,923 $ 1,111,894
Interest-bearing deposits with banks 5,169,830 2,791,718
Investment securities available-for-sale - at fair value 52,878,583 53,735,677
Investment securities held-to-maturity - at amortized cost 1,149,137 1,747,644
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 1,724,000 1,300,000
Loans held for sale 1,698,872 1,011,930
Loans receivable - net of allowance for loan losses
of $1,310,365 and $1,120,102, respectively 121,866,762 110,850,690
Premises and equipment, net 4,189,222 3,824,568
Accrued interest receivable 1,276,376 1,165,191
Other assets 584,655 607,014
------------ ------------
TOTAL ASSETS $191,188,360 $178,146,326
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 7,196,053 $ 5,972,171
Interest-bearing deposits 135,080,024 129,561,992
------------ ------------
Total deposits 142,276,077 135,534,163
Other borrowed funds 12,523,210 13,269,959
Long-term debt 16,678,610 11,463,507
Accrued expenses and other liabilities 624,384 801,245
------------ ------------
Total liabilities 172,102,281 161,068,874
------------ -------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 782,699 and 750,960 shares, respectively 7,827 7,510
Surplus 6,574,162 5,724,729
Retained earnings 12,256,443 11,430,666
Net unrealized gain on investment securities
available-for-sale, net of deferred taxes 442,032 88,778
Unearned ESOP shares (194,385) (174,231)
------------ ------------
Total stockholders' equity 19,086,079 17,077,452
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $191,188,360 $178,146,326
============ ============
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
<TABLE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $11,056,220 $10,045,429 $ 9,771,990
Taxable interest and dividends on investment securities 3,782,205 3,301,725 3,031,632
Interest on deposits with banks 154,836 124,441 97,254
----------- ----------- -----------
Total interest income 14,993,261 13,471,595 12,900,876
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 5,683,348 5,397,181 5,198,160
Interest on other borrowed funds 925,084 774,617 575,604
Interest on long-term debt 742,216 234,958 321,204
----------- ----------- -----------
Total interest expense 7,350,648 6,406,756 6,094,968
----------- ----------- -----------
NET INTEREST INCOME 7,642,613 7,064,839 6,805,908
PROVISION FOR LOAN LOSSES 240,000 408,000 210,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 7,402,613 6,656,839 6,595,908
----------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 344,025 280,126 284,635
Net gains on sale of loans held for sale 240,407 192,468 88,437
Net realized (loss) gain on sales of investment
securities available-for-sale (17,502) -- 1,802
Service charges 496,972 382,228 399,079
Other income 51,923 76,148 83,514
----------- ----------- -----------
Total noninterest income 1,115,825 930,970 857,467
----------- ----------- -----------
NONINTEREST EXPENSES:
Salaries and employee benefits 2,624,131 2,432,293 2,141,438
Occupancy expense 396,378 353,246 341,449
Deposit insurance and surety bond premiums 119,861 1,165,816 348,025
Data processing expense 253,677 262,375 207,632
Advertising 157,131 99,466 78,934
Depreciation of furniture, fixtures, and equipment 185,548 144,512 105,732
Other 1,325,701 1,025,174 875,351
----------- ----------- -----------
Total noninterest expenses 5,062,427 5,482,882 4,098,561
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,456,011 2,104,927 3,354,814
Income tax expense 1,372,000 785,200 1,327,000
----------- ----------- -----------
NET INCOME $ 2,084,011 $ 1,319,727 $ 2,027,814
=========== =========== ===========
INCOME PER COMMON SHARE (1):
Basic earnings per share $2.57 $1.65 $2.62
Diluted earnings per share 2.40 1.53 2.47
</TABLE>
(1) Restated to reflect 1998 stock dividends
See notes to consolidated financial statements.
2
<PAGE>
<TABLE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
Net
Unrealized
Gain
(Loss) on
Investment
Securities Unearned
Common Paid-in Retained Available- ESOP
Stock Capital Earnings for-Sale Shares Total
----------- ------------ ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, JANUARY 1, 1995 $ 6,424 $ 4,247,767 $ 9,460,027 $ (345,724) $ (42,908) $ 13,325,586
Net income -- -- 2,027,814 -- -- 2,027,814
Cash dividend - $0.10 per share -- -- (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
Net change in unearned ESOP shares -- -- -- -- (95,315) (95,315)
Change in net unrealized gain
(loss) on investment securities
available-for-sale -- -- -- 577,847 -- 577,847
----------- ------------ ------------ ------------ ----------- ------------
BALANCES, DECEMBER 31, 1995 6,851 5,021,350 10,710,824 232,123 (138,223) 15,832,925
Net income -- -- 1,319,727 -- -- 1,319,727
Cash dividend - $0.10 per share -- -- (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
Net change in unearned ESOP shares -- -- -- -- (36,008) (36,008)
Change in net unrealized gain
(loss) on investment securities
available-for-sale -- -- -- (143,345) -- (143,345)
------------ ------------ ------------ ----------- ------------
BALANCES, DECEMBER 31, 1996 7,510 5,724,729 11,430,666 88,778 (174,231) 17,077,452
Net income -- -- 2,084,011 -- -- 2,084,011
Cash dividend - $0.10 per share -- -- (75,498) -- -- (75,498)
5% stock dividend 375 828,750 (829,125) -- -- --
Cash paid in lieu of stock dividend
for fractional shares -- -- (5,510) -- -- (5,510)
Exercise of stock options 112 20,683 -- -- -- 20,795
Repurchase of common stock (170) -- (348,101) -- -- (348,271)
Change in net unrealized gain (loss)
on investment securities available-
for-sale - -- -- 353,254 -- 353,254
Net change in unearned ESOP shares -- -- -- -- (20,154) (20,154)
----------- ------------ ------------ ------------ ----------- ------------
BALANCES, DECEMBER 31, 1997 $ 7,827 $ 6,574,162 $ 12,256,443 $ 442,032 $ (194,385) $ 19,086,079
=========== ============ ============ ============ =========== ============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
<TABLE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,084,011 $ 1,319,727 $ 2,027,814
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 240,000 408,000 210,000
Depreciation and amortization 324,134 264,492 232,589
Amortization of premium/discount on mortgage-
backed securities and investments (50,456) (96,060) (87,102)
Deferred income tax benefit 2,000 (143,800) (73,000)
Increase in accrued interest receivable (111,185) (72,078) (14,446)
(Decrease) increase in deferred loan fees (25,905) (85,781) 4,720
(Decrease) increase in accounts payable,
accrued expenses, and other liabilities (314,242) 257,778 327,372
(Decrease) increase in other assets (219,661) (200,921) 378,203
Loss (gain) on disposal of premises and equipment 41,660 (9,610) (3,790)
Loss (gain) on sale of investment securities 17,502 -- (1,802)
Origination of loans held for sale (12,562,767) (8,812,925) (5,731,850)
Gain on sales of loans held for sale (240,407) (192,468) (88,437)
Proceeds from sale of loans held for sale 12,116,232 8,887,468 5,284,394
Gain on sale of foreclosed real estate (7,000) -- --
Capitalization of interest expense on notes payable -- -- 38,553
FHLB stock dividends -- -- (10,200)
------------ ------------ ------------
Net cash provided by operating activities 1,293,916 1,523,822 2,493,018
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing
deposits with banks (2,378,112) 472,388 (73,113)
Purchase of investment securities available-for-sale (47,628,227) (27,637,617) (7,395,830)
Proceeds from sale, redemption or principal payments
of investment securities available-for-sale 49,084,708 19,559,529 9,205,978
Purchase of investment securities held-to-maturity (189,525) (990,273) (4,922,455)
Proceeds from maturities or principal payments
of investment securities held-to-maturity 797,119 334,682 2,281,637
Purchase of FHLB stock and Federal Reserve
Bank stock (424,000) (418,400) --
Loans originated or acquired (53,126,555) (50,605,301) (48,899,460)
Principal collected on loans 41,896,388 46,238,710 40,177,854
Purchase of premises and equipment (680,078) (859,884) (511,290)
Proceeds from sales of premises and equipment -- 9,610 101,446
Proceeds from disposition of foreclosed real estate 162,135 -- 200,437
Investment in real estate -- -- (232,305)
------------ ------------ ------------
Net cash used in investing activities (12,486,147) (13,896,556) (10,067,101)
------------ ------------ ------------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Tri-County Financial Corporation
Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 1997, 1996 and 1995
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 6,741,914 $ 5,500,120 $ 3,193,764
Net increase (decrease) in other
borrowed funds (746,749) (2,497,413) 9,033,067
Payments on notes payable -- (372,337) (299,273)
Dividends paid (81,008) (74,045) (69,013)
Exercise of stock options 20,795 178,198 66,006
Net change in unearned ESOP shares (20,154) (36,008) (95,315)
Redemption of common stock (348,271) -- --
Proceeds from long-term borrowings 22,400,000 11,000,000 --
Retirement of long-term borrowings (17,235,267) (1,000,000) (3,750,000)
------------ ------------ ------------
Net cash provided by financing activities 10,731,260 12,698,515 8,079,236
------------ ------------ ------------
(DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (460,971) 325,781 505,153
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 1,111,894 786,113 280,960
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 650,923 $ 1,111,894 $ 786,113
============ ============ ============
Supplementary cash flow information: Cash paid during the year for:
Interest $ 7,284,916 $ 6,414,832 $ 6,067,478
Income taxes 1,625,000 803,000 940,786
Transfers from loans receivable to
foreclosed real estate -- 207,409 52,000
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Tri-County
Financial Corporation and its wholly owned subsidiary, Community Bank of
Tri-County (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 accounting and reporting policies of the Company conform
with generally accepted accounting principles and to general practices within
the banking industry. Certain reclassifications have been made to amounts
previously reported to conform with classifications made in 1997.
Nature of Operations
The Company, through its bank subsidiary, conducts full service commercial
banking operations throughout the Southern Maryland area. The primary financial
services provided include mortgage loans on residential, construction and
commercial real estate and various types of consumer lending as well as offering
demand deposits, savings products, and safe deposit boxes.
Use of 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. These instruments are
presented as cash and due from banks.
6
<PAGE>
Investment Securities
Investment securities are classified 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 noninterest
income. Securities classified as held-to-maturity are reported 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 holding
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 securities
are recognized at the time of sale using the specific identification method and
are classified as noninterest income in the accompanying consolidated statements
of income.
The Company invests in Federal Home Loan Bank and Federal Reserve Bank
stock which are considered restricted as to marketability.
Loans Receivable
Loans - 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 principal reduced by any charge-offs or specific valuation allowance
accounts and 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. A gain is recognized on the sale of
these loans through collection of a premium over the adjusted carrying value,
and through retention of an on-going rate differential as a normal servicing fee
between the rate paid by the borrower to the Company and the rate paid by the
Company to the purchaser.
Income Recognition on Loans - Interest on commercial loans, real estate
mortgages, and certain installment loans is accrued at the contractual rate on
the principal amounts outstanding. When scheduled principal or interest payments
are past due 90 days or more on any loan not fully secured by collateral and not
in the process of collection, the accrual of interest income is discontinued and
recognized only as collected. The loan is restored to an accruing status when
all amounts past due have been paid and the borrower has demonstrated the
ability to service the debt on a current basis. Loan fees and related direct
costs of loan origination are deferred and recognized over the life of the loan
as a component of interest income.
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 and decreased by
charge-offs (net of recoveries). 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.
7
<PAGE>
Impairment of Loans - In accordance with Statement of Financial Accounting
Standard No. 114, Accounting by Creditors for Impairment of a Loan (SFAS No.
114), as amended by SFAS No. 118, Accounting by Creditors for Impairment of a
Loan-Income Recognition and Disclosures, the Company evaluates its loan
portfolios for impairment. When deemed necessary, a valuation allowance is
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 15 - 50 years
Furniture and equipment 5 - 15 years
Automobiles 5 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 1997, 1996 or 1995.
Mortgage Servicing Rights
Mortgage servicing rights are accounted for under the provisions of SFAS
No. 125 Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, which became effective January 1, 1997. The
rights to service certain mortgages, including those purchased as well as
originated, are amortized in proportion to and over the estimated period of the
related net servicing revenues and are evaluated for impairment based on their
fair value. Total capitalized mortgage servicing rights approximated $170,000
and $10,000 at December 31, 1997 and 1996, respectively.
Income Taxes
The Company files a consolidated federal income tax return with its
subsidiary. Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. As changes in tax
laws or rates are enacted, deferred tax assets and liabilities are adjusted
through the provision for income taxes. Any deferred tax asset is reduced by the
amount of any tax benefit that more likely than not will not be realized.
8
<PAGE>
Earnings Per Share
Basic and diluted net income per common share are accounted for under the
provisions of SFAS No. 128 Earnings Per Share which became effective for periods
ending December 1997. Previously reported amounts have been restated to give
effect to this new accounting pronouncement.
Prospective Accounting Changes
SFAS No. 127, Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125, was issued in December 1996. This statement defers, for one
year, the effective date of Statement No. 125 for repurchase agreements,
dollar-rolls, securities lending and similar transactions. This statement was
adopted prospectively as of January 1, 1998 and will not have a material effect
on the Company's financial condition or results of operations.
SFAS No. 130, Reporting Comprehensive Income was issued in June 1997. This
statement established standards for reporting and displaying of comprehensive
income and its components in the financial statements. This disclosure
requirement, which is effective for years beginning after December 31, 1997,
will not affect the Company's financial condition or results of operations.
SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information, was also issued in June 1997. This statement requires that public
business enterprises report financial and descriptive information about their
reportable operating segments. Reportable operating segments are defined as
components of an enterprise about which separate financial information is
available and is evaluated regularly by the chief operating decision maker as a
basis for allocating resources and assessing performance. The statement, which
is effective for periods beginning after December 15, 1997, is currently being
evaluated by management as to its relevance to the Company. In the future, the
Company may be required to report information relating to existing or acquired
enterprises. The implementation and adoption of this disclosure requirement will
not have a material effect on the Company's financial condition or results of
operations.
2. INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated fair values of investment securities
available-for-sale at December 31 are as follows:
<TABLE>
December 31, 1997
-----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Corporate equity securities $ 263,166 $ 241,930 $ -- $ 505,096
Money Market funds 4,010,505 -- -- 4,010,505
Obligations of U.S. Government
Sponsored Enterprises (GSE's) 5,000,000 14,200 10,800 5,003,400
Asset-backed securities issued by:
GSE's 29,291,769 423,525 15,389 29,699,905
Other 13,586,982 86,830 14,135 13,659,677
----------- ----------- ----------- -----------
$52,152,422 $ 766,485 $ 40,324 $52,878,583
=========== =========== =========== ===========
</TABLE>
9
<PAGE>
<TABLE>
December 31, 1996
-----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Corporate equity securities $ 763,166 $ 203,479 $ -- $ 966,645
Money Market and mutual funds 4,571,297 -- 40,184 4,531,113
Obligations of U.S. Government
Agencies and U.S. Government
Sponsored Enterprises (GSE's) 8,782,600 2,500 75,625 8,709,475
Asset-backed securities issued by:
GSE's 26,920,686 150,910 102,759 26,968,837
Other 12,583,979 9,281 33,653 12,559,607
----------- ----------- ----------- -----------
$53,621,728 $ 366,170 $ 252,221 $53,735,677
=========== =========== =========== ===========
</TABLE>
The scheduled maturities of investment securities available-for-sale at
December 31, 1997 are as follows:
<TABLE>
Available-for-Sale
---------------------------
Amortized Fair
Cost Value
----------- -----------
<S> <C> <C>
Due in one year or less $ 4,010,505 $ 4,010,505
Due after one year through five years 1,263,166 1,505,096
Due after five years through ten years 4,000,000 4,003,400
Asset-backed securities 42,878,751 43,359,582
----------- -----------
$52,152,422 $52,878,583
=========== ===========
</TABLE>
Sales of investment securities available-for-sale during 1997, 1996 and
1995 resulted in the following:
<TABLE>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Proceeds $ 3,369,000 $ -- $ 2,891,000
Gross gains 2,111 -- 11,802
Gross losses (19,613) -- (10,000)
</TABLE>
Asset-backed securities are comprised of mortgage-backed securities as well
as mortgage derivatives such as collateralized mortgage obligations and real
estate mortgage investment conduits. The outstanding balance of no single
issuer, except for U.S. Government-Sponsored Enterprise Securities, exceeded
five percent of the Company's stockholders' equity at December 31, 1997 and
1996.
10
<PAGE>
3. INVESTMENT SECURITIES HELD-TO-MATURITY
The amortized cost and estimated fair values of investments
held-to-maturity at December 31 are as follows:
<TABLE>
<CAPTION>
December 31, 1997
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Obligations of U.S.
Government Agencies $ 192,025 $ -- $ -- $ 192,025
Asset-backed securities 675,720 29,813 -- 705,533
Other investments 281,392 -- -- 281,392
---------- ---------- ---------- ----------
$1,149,137 $ 29,813 $ -- $1,178,950
========== ========== ========== ==========
<CAPTION>
December 31, 1996
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Obligations of U.S.
Government Agencies $ 193,257 $ -- $ -- $ 193,257
Asset-backed securities 883,887 35,462 -- 919,349
Other investments 670,500 -- -- 670,500
---------- ---------- ---------- ----------
$1,747,644 $ 35,462 $ -- $1,783,106
========== ========== ========== ==========
</TABLE>
4. LOANS RECEIVABLE AND LOANS HELD FOR SALE
Loans receivable at December 31, 1997 and 1996 consist of the following;
<TABLE>
1997 1996
------------ ------------
<S> <C> <C>
Commercial real estate $ 19,200,554 $ 14,171,610
Residential real estate 61,629,570 63,673,569
Residential construction 14,706,519 11,755,807
Second mortgage loans 17,428,330 14,147,267
Lines of credit - commercial 4,852,193 3,887,113
Consumer loans 6,420,219 5,421,590
------------ ------------
124,237,385 113,056,956
------------ ------------
Less:
Deferred loan fees 1,060,258 1,086,164
Allowance for loan losses 1,310,365 1,120,102
------------ ------------
2,370,623 2,206,266
------------ ------------
Total $121,866,762 $110,850,690
============ ============
</TABLE>
11
<PAGE>
The following table sets forth the activity in the allowance for loan
losses:
<TABLE>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Balance, January 1 $1,120,102 $ 733,573 $ 563,624
Add:
Provision charged to operations 240,000 408,000 210,000
Recoveries 105 180 5,687
Less:
Charge-offs 49,842 21,651 45,738
---------- ---------- ----------
Balance, December 31 $1,310,365 $1,120,102 $ 733,573
========== ========== ==========
</TABLE>
No loans included within the scope of SFAS 114 were identified as being
impaired at December 31, 1997 or 1996.
Loans on which the recognition of interest has been discontinued, which
were not included within the scope of SFAS 114, amounted to approximately
$160,000, $400,000, and $300,000 at December 31, 1997, 1996, and 1995,
respectively. If interest income had been recognized on nonaccrual loans at
their stated rates during 1997, 1996, and 1995, interest income would have been
increased by approximately $29,000, $14,000, and $60,000, respectively. No
income was recognized for these loans in 1997, 1996 and 1995.
Included in loans receivable at December 31, 1997 and 1996, is $1,284,098
and $1,001,511 due from officers and directors of the Bank. Activity in loans
outstanding to officers and directors is summarized as follows:
<TABLE>
1997 1996
----------- -----------
<S> <C> <C>
Balance, beginning of year $ 1,001,511 $ 997,945
New loans made during year 337,462 209,300
Repayments made during year (54,875) (205,734)
----------- -----------
Balance, end of year $ 1,284,098 $ 1,001,511
=========== ===========
</TABLE>
Loans serviced for others and not reflected in the balance sheets are
$47,816,000 and $40,996,000 at December 31, 1997 and 1996, 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 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.
12
<PAGE>
5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 1997 and 1996 is as
follows:
<TABLE>
1997 1996
---------- ----------
<S> <C> <C>
Cost:
Land $1,486,879 $1,486,879
Building and improvements 2,648,684 2,247,122
Furniture and equipment 1,496,586 1,477,536
Automobiles 81,000 81,000
---------- ----------
Total cost 5,713,149 5,292,537
Less accumulated depreciation 1,523,927 1,467,969
---------- ----------
Premises and equipment, net $4,189,222 $3,824,568
========== ==========
</TABLE>
Certain bank facilities are leased under various operating leases. Rent
expense was $118,556, $106,708 and $103,198 in 1997, 1996 and 1995,
respectively.
Future minimum rentals commitments under noncancellable leases are as
follows:
<TABLE>
<S> <C>
1998 $152,338
1999 128,272
2000 104,806
2001 61,056
2002 66,735
Thereafter 264,000
--------
Total $777,207
========
</TABLE>
6. DEPOSITS
Deposits outstanding at December 31 consist of:
<TABLE>
1997 1996
------------ ------------
<S> <C> <C>
Noninterest-bearing demand $ 7,196,053 $ 5,972,171
------------ ------------
Interest-bearing:
Demand 15,550,241 13,329,000
Money market deposits 11,479,000 10,970,000
Savings 26,338,783 28,020,992
Certificates of deposit of $100,000 or more 14,235,000 10,365,000
Other certificates of deposit 67,477,000 66,877,000
------------ ------------
Total interest-bearing 135,080,024 129,561,992
------------ ------------
Total deposits $142,276,077 $135,534,163
============ ============
</TABLE>
13
<PAGE>
7. ADVANCES FROM THE FEDERAL HOME LOAN BANK
OF ATLANTA AND OTHER BORROWINGS
The advances from the Federal Home Loan Bank are as follows:
<TABLE>
Weighted
Average
Interest
Year Due Rate 1997
-------- -------- -----------
<S> <C> <C>
1998 6.00% $12,000,000
1999 5.70 5,000,000
2002 5.99 11,400,000
-----------
$28,400,000
===========
</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, 1997 and 1996, of its
outstanding Federal Home Loan Bank advances. These amounts were $37,900,000 and
$32,000,000 at December 31, 1997 and 1996, respectively. The advances due in
2002 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, 1997 and 1996, totaling
$675,720 and $883,887, 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 date and interest rate, which are subject to adjustment based
on prepayments of the participation certificates, for the notes payable at
December 31, 1997 and 1996, are as follows:
<TABLE>
Unpaid Principal
(Net of Discount)
December 31,
------------------------------ Interest Maturity
1997 1996 Rate Date
---------- ---------- -------- ---------
<S> <C> <C> <C>
$278,610 $463,507 8.50% July 1, 2010
</TABLE>
The Company enters into sales of securities under agreements to repurchase
with terms to maturity of less than one month and short-term borrowings from the
Federal Home Loan Bank. The repurchase 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 were delivered by
appropriate entry into the counterparties' accounts maintained at the purchasing
securities dealer's safekeeping house.
14
<PAGE>
The repurchase agreements subject the Company 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 short-term borrowings and repurchase
agreements is as follows:
<TABLE>
1997 1996
----------- ----------
<S> <C> <C>
Balance outstanding at December 31 $12,000,000 $ --
Average balance during the year 15,000,000 1,068,698
Average interest rate during the year 5.80% 5.05%
Maximum outstanding balance at any
month end during the year 21,000,000 4,774,000
</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, 1997 and 1996, such borrowings were $523,210 and $269,959, respectively.
The aggregate scheduled principal maturities on all borrowings outstanding
at December 31, 1997 are as follows:
<TABLE>
<S> <C>
1998 $12,523,210
1999 5,000,000
2000 --
2001 --
2002 11,400,000
After 2002 278,610
-----------
Total $29,201,820
===========
</TABLE>
8. INCOME TAXES
Income tax expense was as follows:
<TABLE>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Current:
Federal $ 1,122,000 $ 761,000 $ 1,146,000
State 248,000 168,000 254,000
----------- ----------- -----------
1,370,000 929,000 1,400,000
----------- ----------- -----------
Deferred:
Federal 1,600 (117,800) (60,000)
State 400 (26,000) (13,000)
----------- ----------- -----------
2,000 (143,800) (73,000)
----------- ----------- -----------
Total income tax expense $ 1,372,000 $ 785,200 $ 1,327,000
=========== =========== ===========
</TABLE>
15
<PAGE>
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>
1997 1996 1995
----------------------- ------------------------ -----------------------
Percent of Percent of Percent of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Expected income tax expense at
federal tax rate $1,175,000 34.0% $ 715,700 34.0% $1,141,000 34.0%
State taxes, net of federal benefit 154,000 4.5 96,000 4.6 155,000 4.6
Amortization and other nondeductible
expenses 5,000 .1 10,000 .4 14,000 .5
Other 38,000 1.1 (36,500) (1.7) 17,000 .5
---------- ---------- ---------- ---------- ---------- ----------
Total income tax expense $1,372,000 39.7% $ 785,200 37.3% $1,327,000 39.6%
========== ========== ========== ========== ========== ==========
</TABLE>
The net deferred tax asset (liability) in the accompanying balance sheets
include the following components:
<TABLE>
1997 1996
--------- ---------
<S> <C> <C>
Deferred tax assets:
Deferred fees $ 177,886 $ 209,372
Loan loss reserves 196,594 137,674
Pension plan -- 40,417
Other assets -- 3,058
--------- ---------
Total deferred assets 374,480 390,521
--------- ---------
Deferred tax liabilities:
FHLB stock dividends 152,896 152,896
Depreciation 80,840 94,516
Unrealized gain on investment
securities available-for-sale 278,125 55,859
--------- ---------
Total deferred liabilities 511,861 303,271
--------- ---------
Net deferred asset (liability) $(137,381) $ 87,250
========= =========
</TABLE>
Retained earnings at December 31, 1997, 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, 1997.
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.
16
<PAGE>
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,
beginning with the 1998 tax year. 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, 1997 and 1996, in addition to the undisbursed portion of
loans receivable, the Company had outstanding loan commitments approximating
$2,790,000 and $1,157,000, respectively. These commitments are normally met from
deposit 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. These
guarantees are issued primarily 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 these commitments
for which collateral is deemed necessary. Outstanding standby letters of credit
amounted to $4,800,000 and $4,130,000 at December 31, 1997 and 1996,
respectively.
10. PENSION PLAN
On May 28, 1997, the Board of Directors, after due consideration of the
projected cost of the Company's defined benefit pension plan, voted to terminate
the Plan effective August 31, 1997. The present value of current benefits, plus
any remaining pension assets, net of costs, were transferred into the Company's
401(k) plan on behalf of all defined benefit plan participants. The final
benefit to the Company resulting from this plan curtailment was determined to be
$104,653 by the plan administrator. This credit is reflected in the 1997
salaries and employee benefits in the accompanying financial statements.
17
<PAGE>
The Company's qualified, noncontributory defined benefit pension plan
covered substantially all of its employees. Benefits were 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 was the individual aggregate actuarial cost
method. An employee became fully vested upon completion of seven years of
qualifying service. It was the policy of the Company to fund the amount required
to meet minimum funding standards. No contributions were required to be made in
1997 or 1996.
Net pension cost for the Company's plan consists of the following:
<TABLE>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Service cost $ 49,239 $ 68,705 $ 49,913
Interest cost 71,313 61,651 48,577
Actual return on plan assets (76,268) (98,075) (125,440)
All other components (6,618) 28,140 60,307
Charge resulting from plan curtailment 73,314 -- --
Credit resulting from plan settlement (215,633) -- --
--------- --------- ---------
Net pension (credit) cost $(104,653) $ 60,421 $ 33,357
========= ========= =========
</TABLE>
The reconciliation of the funded status of the plan to the amount reported
in the Company's balance sheets as of December 31 is as follows:
<TABLE>
1997 1996
------- -----------
<S> <C> <C>
Actuarial present value of benefit obligation:
Vested benefit obligation $ -- $ (438,363)
Nonvested accumulated benefits -- (15,167)
------- -----------
Accumulated benefit obligation -- (453,530)
Effect of projected salary increases -- (553,712)
------- -----------
Projected benefit obligation -- (1,007,242)
Fair value of plan assets, primarily
cash, equity securities, and bonds -- 941,602
------- -----------
Funded status -- (65,640)
Deferred transition asset to be
amortized over 17 years -- (125,585)
Unrecognized prior service cost -- 32,150
Unrecognized net loss -- 54,422
------- -----------
Accrued pension cost $ -- $ (104,653)
======= ===========
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 8.0% 8.0%
Rate of increase in compensation levels 5.0% 5.0%
</TABLE>
18
<PAGE>
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, 1997, 120,946 shares of stock have been authorized for
grants of options for this plan.
The Company adopted SFAS No. 123, Accounting for Stock-Based
Compensation,in 1996. 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:
<TABLE>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income As reported $2,084,011 $1,319,727 $2,027,814
Pro forma 2,084,011 1,319,727 1,720,590
Basic earnings per share As reported 2.57 1.65 2.62
Pro forma 2.57 1.65 2.23
Diluted earnings per share As reported 2.40 1.53 2.47
Pro forma 2.40 1.53 2.10
</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 1997 or 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>
1997 1996
------------------ ------------------
Weighted- Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ ------- ------- -------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 97,464 $ 8.56 131,233 $ 7.33
Granted -- .00 -- .00
Exercised 11,898 5.69 33,625 5.30
Forfeited or canceled -- 144 3.58
------ -------
Outstanding at end of year 85,566 9.19 97,464 8.56
====== =======
Options exercisable at year-end 82,925 9.16
</TABLE>
19
<PAGE>
<TABLE>
Options Outstanding Options Exercisable
Weighted- Weighted-
Number Remaining Number Average
Exercise Outstanding Contractual Exercisable Exercise
Price 12/31/97 Life 12/31/97 Price
-------- ----------- ------------------- ----------- -------------------
<S> <C> <C> <C> <C>
$ 6.44 $22,721 2 years $22,721 $ 6.44
10.18 62,845 8 years 60,204 10.18
------- -------
$85,566 $82,925
======= =======
</TABLE>
All share and dollar amounts are reflected at amounts giving effect to the
4% stock dividend declared February 1998.
12. EMPLOYEE BENEFIT PLANS
The Bank has an Employee Stock Ownership Plan (ESOP) that acquires 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, unencumbered shares held by the ESOP are treated as outstanding in
computing earnings per share. Shares issued to the ESOP but pledged as
collateral for loans obtained to provide funds to acquire the shares are not
treated as outstanding in computing earnings per share. Dividends on ESOP shares
are recorded as a reduction of retained earnings. The ESOP may acquire in the
open market up to 195,700 shares. At December 31, 1997, the Plan owns 56,740
shares. The Company also has a 401(k) plan. Employee contributions are matched
by the Bank at a ratio determined annually by the Board of Directors, currently
one-half of an employee's 6% elective deferral. All employees who have completed
one year of service and have reached the age of 21 are covered under these
defined contribution plans. Contributions are determined at the discretion of
management and the Board of Directors. For the years ended December 31, 1997,
1996, and 1995, the Company charged $102,000, $46,000, and $159,000 against
earnings to fund the Plans.
13. STOCK DIVIDENDS
On February 15, 1998, the Board of Directors declared a 4% stock dividend
and a $.125 per share cash dividend that was distributed to holders of record on
March 13, 1998. The stock distribution increased the Corporation's issued stock
by approximately 31,000 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.
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.
20
<PAGE>
14. REGULATORY MATTERS
The Company and the Bank are 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 Company's and 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 Company and 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, 1997, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 1997, the most recent notification from the Office of
Thrift Supervision (the last regulatory body to issue a report on the Bank's
capital adequacy) 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 total risk-based, Tier 1 risk-based, and Tier 1
leverage ratios as set forth in the table. There are no conditions or events
since that notification that management believes have changed the Company's or
the Bank's category.
The Company's and the Bank's actual capital amounts and ratios for 1997 and
1996 are presented in the tables below:
<TABLE>
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, 1997:
Total capital (to risk-
weighted assets):
The Company $19,953,000 17.38% $9,184,000 8.0% $11,480,000 10.0%
The Bank 19,855,000 17.29 9,184,000 8.0 11,480,000 10.0
Tier 1 Capital (to risk-
weighted assets):
The Company 18,643,000 16.24 4,592,000 4.0 6,888,000 6.0
The Bank 18,545,000 16.15 4,592,000 4.0 6,888,000 6.0
Tier 1 Capital (to
average assets):
The Company 18,643,000 9.68 7,702,000 4.0 9,627,000 5.0
The Bank 18,545,000 9.64 7,692,000 4.0 9,615,000 5.0
</TABLE>
21
<PAGE>
<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:
Total capital (to risk-
weighted assets):
The Company $18,353,000 17.47% $8,404,000 8.0% $10,505,000 10.0%
The Bank 17,517,000 16.67 8,404,000 8.0 10,505,000 10.0
Tier 1 capital (to risk-
weighted assets):
The Company 17,233,000 16.40 4,202,000 4.0 6,303,000 6.0
The Bank 16,397,000 15.60 4,202,000 4.0 6,303,000 6.0
Tier 1 capital (to
average assets):
The Company 17,233,000 9.88 6,971,000 4.0 8,714,000 5.0
The Bank 16,397,000 9.46 6,933,000 4.0 8,666,000 5.0
</TABLE>
Earnings Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, Earnings Per Share, which is effective for reporting periods ending after
December 15, 1997. Under the provisions of SFAS No. 128, primary and fully
diluted earnings per share were replaced with basic and diluted earnings per
share in an effort to simplify the computation and more closely align earnings
per share definitions with international rules. Basic earnings per share is
computed by dividing net income by the weighted average number of common shares
outstanding and does not include the impact of any potentially dilutive common
stock equivalents. Diluted earnings per share is arrived at by dividing net
income by the weighted average number of shares outstanding, adjusted for the
dilutive effect of outstanding stock options and the conversion impact of any
convertible equity securities.
The calculations of basic and diluted earnings per share are as follows:
<TABLE>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Basic earnings per share:
Net income $2,084,011 $1,319,727 $2,027,814
Average common
shares outstanding 811,694 799,804 772,737
Net income per common
share - basic $ 2.57 $ 1.65 $ 2.62
Diluted earnings per share:
Net income 2,084,011 1,319,727 2,027,814
Average common shares outstanding 811,694 799,804 772,737
Stock option adjustment 55,809 62,222 47,907
Average common shares
outstanding - diluted 867,503 862,026 820,644
Net income per common
share - diluted $ 2.40 $ 1.53 $ 2.47
</TABLE>
22
<PAGE>
Charter Conversion
When the Small Business Job Protection Act was signed into law on August
20, 1996, all savings banks and savings associations became 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 management
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
mode of operations was revisited.
On October 30, 1996, the Board of Directors unanimously adopted a Plan of
Conversion whereby the Savings Bank converted to a Maryland-chartered commercial
bank to be known as "Community Bank of Tri-County." Following the Charter
Conversion, effected March 29, 1997, both the Bank and the Corporation are
regulated by the Federal Reserve Bank. The Charter Conversion allows the Bank
more flexibility in the types of loans it is permitted to make as it is no
longer required to meet the Qualified Thrift Lender Test. Specifically, the Bank
can increase its consumer and commercial lending and is better able to offer
products to its small business and retail customers.
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>
December 31, 1997 December 31, 1996
---------------------------------- ----------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 5,820,753 $ 5,820,753 $ 3,903,612 $ 3,903,612
Investment securities and
stock in FHLB and FRB 55,751,720 55,781,533 56,783,321 56,818,783
Loans receivable, net 121,866,762 124,180,547 110,850,690 117,534,500
Loans held for sale 1,698,872 1,698,872 1,011,930 1,011,930
Liabilities:
Savings, NOW and money
market accounts 60,564,077 60,564,077 57,614,810 57,614,810
Time certificates 81,712,000 81,339,062 77,204,182 77,421,687
Long-term debt and other
borrowed funds 29,201,820 29,201,820 24,733,466 24,733,466
</TABLE>
At December 31, 1997 and 1996, 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.
23
<PAGE>
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.
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, 1997 and 1996. 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 purpose of these financial statement since that date and,
therefore, current estimates of fair value may differ significantly from the
amount presented herein.
16. SAIF RECAPITALIZATION
The Federal Deposit Insurance Corporation administers two separate deposit
insurance funds, the Bank 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.
24
<PAGE>
17. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Condensed Balance Sheets:
<TABLE>
ASSETS
1997 1996
------------ ------------
<S> <C> <C>
Cash $ 120,288 $ 131,782
Accounts receivable 1,383 1,383
Investment securities available-for-sale -- 447,565
Investment in wholly owned subsidiary 19,004,345 16,536,386
------------ ------------
TOTAL ASSETS $ 19,126,016 $ 17,117,116
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $ 39,937 $ 39,664
Stockholders' equity:
Common stock 7,827 7,510
Surplus 6,574,162 5,724,729
Retained earnings 12,256,443 11,430,666
Unearned ESOP shares (194,385) (174,231)
Net realized gain on investment
securities, net of deferred taxes 442,032 88,778
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 19,126,016 $ 17,117,116
============ ============
</TABLE>
Condensed Statements of Income:
<TABLE>
Year Ended December 31,
-------------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Interest revenues $ 41,879 $ 38,463 $ 35,790
Loss on sale of
investment securities (250) -- --
Amortization and
miscellaneous expenses 72,323 53,981 48,364
----------- ----------- -----------
Loss before income
taxes and equity in
undistributed net
income of subsidiary (30,694) (15,518) (12,574)
Federal and state income
tax benefit 10,436 5,276 4,275
Equity in undistributed
net income of subsidiary 2,104,269 1,329,969 2,036,113
----------- ----------- -----------
NET INCOME $ 2,084,011 $ 1,319,727 $ 2,027,814
=========== =========== ===========
</TABLE>
25
<PAGE>
Condensed Statements of Cash Flows:
<TABLE>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,084,011 $ 1,319,727 $ 2,027,814
Adjustments to reconcile net income to net
cash provided by operating activities:
Increase in investment in wholly
owned subsidiary (2,114,705) (1,335,245) (2,040,388)
Loss on sale of investment securities 250 -- --
Amortization of discount on investments (25,140) (24,187) (25,866)
Decrease in current assets -- -- 875
Increase (decrease) in current liabilities 273 (30,936) 35,600
----------- ----------- -----------
Net cash used in operating activities (55,311) (70,641) (1,965)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities
available-for-sale (343,295) (431,598) (504,469)
Maturity or redemption of investment
securities available-for-sale 815,750 430,000 400,000
----------- ----------- -----------
Net cash provided (used) by
investing activities 472,455 (1,598) (104,469)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (81,008) (74,045) (69,013)
Exercise of stock options 20,795 178,198 66,066
Net change in ESOP loan (20,154) (36,008) (95,315)
Redemption of common stock (348,271) -- --
----------- ----------- -----------
Net cash (used) provided by
financing activities (428,638) 68,145 (98,262)
----------- ----------- -----------
DECREASE IN CASH (11,494) (4,094) (204,696)
CASH AT BEGINNING OF YEAR 131,782 135,876 340,572
----------- ----------- -----------
CASH AT END OF YEAR $ 120,288 $ 131,782 $ 135,876
=========== =========== ===========
</TABLE>
26
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CORPORATE INFORMATION: Tri-County Financial Corporation
Tri-County FSB succeeded by Community Bank of Tri-County
- --------------------------------------------------------------------------------
DIRECTORS OF BOTH
Michael L. Middleton
Chairman of the Board
C. Marie Brown W. Edelen Gough, Jr. Henry A. Shorter, Jr.
Herbert N. Redmond, Jr. Gordon A. O'Neill H. Beaman Smith
- --------------------------------------------------------------------------------
OFFICERS OF COMMUNITY BANK OF TRI-COUNTY
<TABLE>
<CAPTION>
Michael L. Middleton
President and Chief Executive Officer
<S> <C> <C>
C. Marie Brown Gregory C. Cockerham Eileen M. Ramos
Senior Vice President Senior Vice President Chief Financial Officer
Personnel & Data Processing Commercial and Consumer Lending
Elizabeth A. Kitts Charles R. Wood Henry A. Shorter, Jr.
Vice President Vice President Secretary
H. Beaman Smith
Treasurer
</TABLE>
- -------------------------------------------------------------------------------
COUNSEL
Corporate: Local Counsel:
Semmes, Bowen & Semmes Louis P. Jenkins, Esq.
250 West Pratt Street P.O. Box 280
Baltimore, Maryland 21201 La Plata, Maryland 20646
(410) 539-5040 (301) 934-9571
Special Counsel: Auditors:
Gary R. Bronstein, Esq. Stegman & Company
Housley Kantarian & Bronstein, P.C. 405 East Joppa Road, Suite 200
1220 19th Street, NW, Suite 700 Baltimore, MD 21286
Washington, DC 20036 (410) 823-8000
(202) 822-9611
FORM 10-K
A copy of Form 10-K, including financial statements as filed with the Securities
and Exchange Commission will be furnished without charge to stockholders as of
the record date upon written request to Henry A. Shorter, Jr., Secretary,
Tri-County Financial Corporation, P.O. Box 38, Waldorf, Maryland 20604.
STOCK TRANSFER AGENT: STOCK TRANSACTIONS AND INQUIRIES:
Bank of New York Barbara A. Lucas, Executive Secretary
101 Barclay Street Tri-County Federal Savings Bank
New York, NY 10286 P.O. Box 38
Waldorf, Maryland 20604
1-888-745-BANK, ext. 614
FAX (301) 843-3625
ANNUAL MEETING:
May 13, 1998, 10:00 a.m.
Community Bank of Tri-County
3035 Leonardtown Road
Waldorf, Maryland
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
[IMAGE OF BUILDING APPEARS HERE]
[COMMUNITY BANK LOGO APPEARS HERE]
COMMUNITY BANK OF TRI-COUNTY
<TABLE>
<S> <C>
Main Office St. Patrick's Drive Branch
- ----------- --------------------------
P.O. Box 38 20 St. Patrick's Drive
3035 Leonardtown Rd. Waldorf, MD 20603
Waldorf, MD 20604
Bryans Road Branch Campus Center Branch
- ------------------ --------------------
P.O. Box 522 Charles County Comm. College
8010 Matthews Road P.O. Box 1810
Bryans Road, MD 20616 8730 Mitchell Rd.
La Plata, MD 20646
Dunkirk Branch La Plata Branch
- -------------- ---------------
P.O. Box 373 P.O. Box 1810
10321 So. Maryland Blvd 9405 Chesapeake St.
Dunkirk, MD 20754 La Plata, MD 20646
Leonardtown Branch Lexington Park Branch
- ------------------ ---------------------
P.O. Box 241 P.O. Box 561
25395 Point Lookout Rd. 22730 Three Notch Rd.
Leonardtown, MD 20650 California, MD 20619
</TABLE>
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
Tri-County Financial Corporation
Percentage State of
Subsidiaries Owned Incorporation
- ------------ ---------- -------------
Community Bank of Tri-County 100% Maryland
Community Mortgage Corporation
of Tri-County (1) 100% Maryland
Tri-County Federal Finance One (1) 100% Maryland
- ----------
(1) Wholly-owned subsidiary of Community Bank of Tri-County
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation by reference in this Form 10-K of
Tri-County Financial Corporation for the year ended December 31, 1997 of our
report dated March 26, 1998, relating to the consolidated financial statements
of Tri-County Financial Corporation.
/s/ Stegman & Company
Baltimore, Maryland
March 30, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 650,923
<INT-BEARING-DEPOSITS> 5,169,830
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 52,878,583
<INVESTMENTS-CARRYING> 1,149,137
<INVESTMENTS-MARKET> 1,178,950
<LOANS> 124,875,999
<ALLOWANCE> 1,310,365
<TOTAL-ASSETS> 191,188,360
<DEPOSITS> 142,276,077
<SHORT-TERM> 12,523,210
<LIABILITIES-OTHER> 624,384
<LONG-TERM> 16,678,610
0
0
<COMMON> 19,078,252
<OTHER-SE> 7,827
<TOTAL-LIABILITIES-AND-EQUITY> 191,188,360
<INTEREST-LOAN> 11,056,220
<INTEREST-INVEST> 3,782,205
<INTEREST-OTHER> 154,836
<INTEREST-TOTAL> 14,993,261
<INTEREST-DEPOSIT> 5,683,348
<INTEREST-EXPENSE> 7,350,648
<INTEREST-INCOME-NET> 7,642,613
<LOAN-LOSSES> 240,000
<SECURITIES-GAINS> (17,502)
<EXPENSE-OTHER> 5,062,427
<INCOME-PRETAX> 3,456,011
<INCOME-PRE-EXTRAORDINARY> 3,456,011
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,084,011
<EPS-PRIMARY> 2.57
<EPS-DILUTED> 2.40
<YIELD-ACTUAL> 4.23
<LOANS-NON> 159,000
<LOANS-PAST> 165,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,120,102
<CHARGE-OFFS> 49,737
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 1,310,365
<ALLOWANCE-DOMESTIC> 1,310,365
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
