<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
() TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to _________________
Commission File Number 0-18279
----------------------------------------------------
TRI-COUNTY FINANCIAL CORPORATION
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1652138
- ------------------------------- ---------------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 Leonardtown Road, Waldorf, Maryland 20601
- ----------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(301) 645-5601
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(Registrant's telephone number, including area code)
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) 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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
As of November 9, 1998 registrant had outstanding 783,239 shares of Common
Stock.
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
FORM 10-Q
INDEX
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<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION PAGE
<S> <C>
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets - September 30, 1998
and December 31, 1997 2
Consolidated Statements of Income and Comprehensive Income -
Three and Nine Months Ended September 30, 1998 and 1997 3
Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 1998 and 1997 4 - 5
Notes to Consolidated Financial Statements 6 - 7
Management's Discussion and Analysis of Financial Condition
and Results of Operations 8 - 12
PART II - OTHER INFORMATION 13 - 14
Item 6 - Exhibits
SIGNATURES 15
</TABLE>
FORWARD-LOOKING INFORMATION
Portions of this Quarterly Report on Form 10-Q contain forward-looking
statements with respect to the adequacy of the allowance for loan losses,
interest rate risk, and the Year 2000 issue which, by their nature, are subject
to significant uncertainties. Because of these uncertainties and the
assumptions on which statements in this report are based, the actual future
results may differ materially from those indicated in this report.
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS (UNAUDITED)
TRI-COUNTY FINANCIAL CORPORATION
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
- --------------------------------------------------------------------------------------------------
SEPTEMBER DECEMBER
30, 1998 31, 1997
ASSETS
<S> <C> <C>
Cash and due from banks $ 1,065,153 $ 650,923
Interest-bearing deposits with banks 2,011,282 5,169,830
Investment securities available for sale - at fair value 63,723,233 52,878,583
Investment securities held to maturity - at amortized cost 2,421,697 1,149,137
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 1,930,350 1,724,000
Loans held for sale 704,000 1,698,872
Loans receivable - net of allowance for loan losses
of $1,496,669 and $1,425,536, respectively 130,734,104 121,866,762
Premises and equipment, net 4,358,892 4,189,222
Accrued interest receivable 1,530,592 1,276,376
Other assets 888,650 584,655
------------ ------------
TOTAL ASSETS $209,367,953 $191,188,360
============ ============
LIABILITIES:
Noninterest-bearing deposits $ 8,151,332 $ 7,196,053
Interest-bearing deposits 137,309,237 135,080,024
------------ ------------
Total deposits 145,460,569 142,276,077
Other borrowed funds 27,144,913 12,523,210
Long-term debt 15,026,078 16,678,610
Accrued expenses and other liabilities 875,413 624,384
------------ ------------
Total liabilities 188,506,973 172,102,281
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 783,239 and 782,866 shares, respectively 7,832 7,827
Surplus 7,269,292 6,574,162
Retained earnings 12,872,080 12,256,443
Accumulated other comprehensive income 918,655 442,032
Unearned ESOP shares (206,879) (194,385)
------------ ------------
Total stockholders' equity 20,860,980 19,086,079
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $209,367,953 $191,188,360
============ ============
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
1998 1997 1998 1997
<S> <C> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $2,844,841 $2,828,379 $ 8,598,048 $ 8,183,391
Taxable interest and dividends on investment securities 1,076,065 1,012,144 2,918,117 2,902,978
Interest on deposits with banks 48,584 30,763 111,665 108,538
---------- ---------- ----------- -----------
Total interest income 3,969,490 3,871,286 11,627,830 11,194,907
---------- ---------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 1,426,206 1,437,825 4,259,888 4,235,624
Interest on other borrowed funds 251,144 259,841 599,441 730,423
Interest on long-term debt 270,332 220,627 728,080 498,158
---------- ---------- ----------- -----------
Total interest expense 1,947,682 1,918,293 5,587,409 5,464,205
---------- ---------- ----------- -----------
NET INTEREST INCOME 2,021,808 1,952,993 6,040,421 5,730,702
PROVISION FOR LOAN LOSSES 60,000 60,000 180,000 180,000
---------- ---------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 1,961,808 1,892,993 5,860,421 5,550,702
---------- ---------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit and miscellaneous charges 101,018 84,792 323,308 262,034
Net gains on sale of loans held for sale 60,981 68,562 282,002 151,809
Net losses on sale of investment securities (391) (17,502) (391) (17,502)
Service charges 165,305 126,630 421,391 361,047
Other 17,633 19,126 131,310 69,761
---------- ---------- ----------- -----------
Total noninterest income 344,546 281,608 1,157,620 827,149
---------- ---------- ----------- -----------
NONINTEREST EXPENSES:
Salaries and employee benefits 711,105 586,855 2,192,485 1,913,959
Occupancy expense 131,404 117,544 345,468 303,169
Deposit insurance and surety bond premium 34,099 35,016 107,957 88,016
Data processing expense 63,368 60,051 227,916 175,643
Advertising 30,583 32,242 94,459 115,751
Depreciation of furniture, fixtures, and equipment 40,575 35,750 116,356 109,875
Other 318,127 407,900 914,770 1,038,155
---------- ---------- ----------- -----------
Total noninterest expenses 1,329,261 1,275,358 3,999,411 3,744,568
---------- ---------- ----------- -----------
INCOME BEFORE INCOME TAXES 977,093 899,243 3,018,630 2,633,283
INCOME TAXES 408,764 322,100 1,132,764 1,006,500
---------- ---------- ----------- -----------
NET INCOME 568,329 577,143 1,885,866 1,626,783
OTHER COMPREHENSIVE INCOME, NET OF TAX -
Net unrealized holding gains arising during the period 389,302 194,316 476,623 283,241
---------- ---------- ----------- -----------
COMPREHENSIVE INCOME $ 957,631 $ 771,459 $ 2,362,489 $ 1,910,024
========== ========== =========== ===========
EARNINGS PER SHARE /(1)/ (Note 2):
Basic $.73 $.71/(1)/ $2.37 $2.01/(1)/
Diluted $.68 $.67/(1)/ $2.22 $1.88/(1)/
</TABLE>
/(1)/ Restated to reflect 1998 4% stock dividend
See notes to consolidated financial statements.
3
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
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<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,885,866 $ 1,626,783
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 180,000 180,000
Depreciation and amortization 185,243 209,828
Net amortization of premium/discount on
investment securities 60,102 (42,537)
Deferred income tax benefit (128,000) (52,500)
Increase in interest receivable (254,216) (101,604)
(Decrease) increase in deferred loan fees (56,989) 3,671
Increase (decrease) in accounts payable,
accrued expenses, and other liabilities 80,524 (477,658)
Increase in other assets (305,379) (108,248)
Gain on sale of premises and equipment (7,051) -
Origination of loans held for sale (14,394,128) (7,274,575)
Gain on sales of loans held for sale (282,002) (151,809)
Proceeds from sale of loans held for sale 15,671,002 7,387,132
Gain on sale of foreclosed real estate (61,654) -
Loss on sale of investment securities 391 17,502
------------ ------------
Net cash provided by operating activities 2,573,709 1,215,985
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in interest-bearing deposits with banks 3,158,548 -
Purchase of investment securities available for sale (52,141,617) (24,622,942)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 42,007,808 25,574,578
Purchase of investment securities held to maturity (2,915,007) -
Proceeds from maturities or principal payments
of investment securities held to maturity 1,647,623 431,179
Purchase of FHLB and Federal Reserve Bank stock (206,350) (424,000)
Loans originated or acquired (43,051,669) (41,076,412)
Principal collected on loans 33,297,910 27,630,519
Purchase of premises and equipment (347,014) (273,829)
Proceeds from sales of premises and equipment 7,051 -
Proceeds from disposition of foreclosed real estate 825,060 155,135
------------ ------------
Net cash used in investing activities (17,717,657) (12,605,772)
------------ ------------
</TABLE>
4
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1998 1997
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 3,184,492 $ 4,855,496
Proceeds from long-term borrowings - 17,400,000
Payments of long-term borrowings (1,660,431) (155,108)
Net increase (decrease) in other borrowed funds 14,621,703 (7,743,123)
Exercise of stock options 1,058 18,236
Net change in unearned ESOP shares (12,600) (127,254)
Redemption of common stock (473,637) (270,580)
Dividends paid (102,407) (81,008)
----------- -----------
Net cash provided by financing activities 15,558,178 13,896,659
----------- -----------
INCREASE IN CASH AND CASH EQUIVALENTS 414,230 2,506,872
CASH AND CASH EQUIVALENTS - JANUARY 1 650,923 3,903,612
----------- -----------
CASH AND CASH EQUIVALENTS - SEPTEMBER 30 $ 1,065,153 $ 6,410,484
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION:
Cash paid during the nine months for:
Interest $ 5,575,044 $ 5,375,129
=========== ===========
Income taxes $ 1,150,634 $ 1,200,000
============ =========== ===========
</TABLE>
Tri-County Financial Corporation declared a 4% and 5% stock dividend payable
April 13, 1998 and April 15, 1997, to shareholders of record on March 13, 1998
and March 7, 1997, respectively. Retained earnings in the amount of $694,384 in
1998 and $834,635 in 1997 was transferred to capital in excess of par and common
stock to reflect these dividends.
See notes to consolidated financial statements.
5
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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1. BASIS OF PRESENTATION
General - The consolidated financial statements of Tri-County Financial
Corporation (the Company) and its wholly owned subsidiary, Community Bank
of Tri-County (the Bank) included herein are unaudited; however, they
reflect all adjustments consisting only of normal recurring accruals that,
in the opinion of Management, are necessary to present fairly the results
for the periods presented. Certain information and note disclosures
normally included in financial statements prepared in accordance with
Generally Accepted Accounting Principles have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange
Commission. The Company believes that the disclosures are adequate to make
the information presented not misleading. The results of operations for
the nine months ended September 30, 1998 are not necessarily indicative of
the results of operations to be expected for the remainder of the year.
Certain previously reported amounts have been restated to conform to the
1998 presentation.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report for the year ended December 31,
1997.
2. EARNINGS PER SHARE
Basic and diluted earnings per share, as adjusted for the stock dividend,
have been computed based on weighted-average common and common equivalent
shares outstanding as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1998 1997 1998 1997
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Basic 786,836 810,655 796,188 810,551
Diluted 841,586 860,963 850,938 861,292
</TABLE>
3. NEW ACCOUNTING PRONOUNCEMENTS
Effective for periods ending after December 15, 1997, Statement of
Financial Accounting Standards (SFAS) No. 128, Earnings Per Share, is
applicable for computing and presenting earnings per share (EPS) for
entities, such as the Company, with publicly held common stock or potential
common stock. This statement simplifies the standards for computing EPS,
making them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also
requires dual presentation of basic and diluted EPS on the face of the
income statement for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS
computation.
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income. This statement
establishes standards for reporting the components of comprehensive income
and requires that all items that are to be recognized as components of
comprehensive income be included in a financial statement that is displayed
with the same prominence as other financial statements. Comprehensive
income includes net income as well as certain items that are reported
directly within a separate component of shareholders' equity and bypass net
income. The adoption of Statement 130 did not have a material impact on
the Company's financial condition or results of operations.
6
<PAGE>
Statement of Financial Accounting Standards No. 131, Disclosure about
Segments of an Enterprise and Related Information, was issued in September
1997. This statement establishes standards for disclosing information
about operating segments in financial statements. Operating segments are
components of a business about which separate financial information is
available that is evaluated by management in deciding how to allocate
resources and in assessing performance. Management has not determined yet
whether additional disclosure will be necessary under the requirements of
SFAS No. 131. For year-end disclosure, this statement is effective for
fiscal years beginning after December 15, 1998. Interim reporting
disclosures would not be required in the first year of adoption, but would
begin the first quarter immediately after the first year of providing year-
end disclosures. For interim reporting, the preceding year's interim
information must be presented on a comparative basis.
In February 1998, the Financial Accounting Standards Board issued Statement
132, Employers' Disclosures about Pension and Other Postretirement
Benefits-an amendment of FASB Statements No. 87, 88, and 106. This
statement revises employers' disclosures about pension and other
postretirement benefit plans, but does not change the measurement or
recognition of those plans. It standardizes the disclosure requirements to
the extent practicable, requires additional information on changes in the
benefit obligations and fair values of plan assets that will facilitate
financial analysis and eliminates certain disclosures that are no longer as
useful as they were when Statements 87, 88 and 106 were issued. This
statement is effective for fiscal years beginning after December 15, 1997.
Restatement of disclosures for previous periods provided for comparative
purposes is required unless the information is not readily available, in
which case the notes to the financial statements should include all
available information and a description of the information not available.
These disclosure requirements will have no material impact on the Company's
financial position or results of operations.
In June 1998, Statement No. 133, Accounting for Derivative Instruments and
for Hedging Activities, (Statement 133), was issued by the Financial
Accounting Standards Board. Statement 133 provides a comprehensive and
consistent standard for the recognition and measurement of derivatives and
hedging activities. It requires all derivatives to be recorded on the
balance sheet at fair value and establishes unique accounting treatment for
the following three different types of hedges; hedges of changes in the
fair value of assets, liabilities or firm commitments, referred to as fair
value hedges; hedges of the variable cash flows of forecasted transactions,
referred to as cash flow hedges; and hedges of foreign currency exposures
of net investments in foreign operations. The accounting for each of the
three types of hedges results in recognizing offsetting changes in value or
cash flows of both the hedge and the hedged item in earnings in the same
period. Changes in the fair value of derivatives that do not meet the
criteria of one of these three types of hedges are included in earnings in
the period of change. Statement 133 is effective for fiscal years
beginning after June 15, 1999. Management anticipates that the adoption of
Statement 133 will have no material impact on the Company's financial
position or results of operations.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
Tri-County Financial Corporation operates under the Federal Reserve's Bank
Holding Company regulations. 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 referred to as "the
Company". Community Bank of Tri-County is in its second year of operating as a
commercial bank following its thrift charter conversion on March 29, 1997.
The Bank has been successful in its evolution from a thrift to a community
based commercial bank. All product lines were subjected to analysis for
relevance and profitability. Specific areas of portfolio growth were targeted,
specifically commercial and consumer loan products, for concentrated efforts to
bring the balances to levels normally found in established commercial banks.
Strategies were implemented to broaden the scope of services to attract
transactional accounts of local business as well as consumers. The Bank
received a favorable reaction from its customers and potential customers in its
market area as well as national recognition by Veribanc, an independent bank
rating service, as a "Blue Ribbon" bank.
The Bank conducts operations through eight full-service offices in its market
area consisting of Charles, St. Mary's and Calvert counties in Maryland. In
January 1998, a new, highly visible location was acquired adjacent to Southern
Maryland's only regional shopping mall and a small satellite branch was closed.
The Bank is capitalizing on the lucrative niche for community based banking
activities which was created through mergers of Maryland banks with large
regional banks.
The Bank is primarily engaged in the business of obtaining funds in the form of
deposits from the general public in the Bank's market area as well as certain
wholesale borrowings from its correspondents and capital markets, and investing
such funds in loans collateralized by residential and commercial real estate,
mortgage-backed securities and related investments, and, to a lesser, but
growing, extent, various types of consumer and other loans, investment and money
market securities. The Company's earnings, therefore, are primarily dependent
upon its net interest income. This is determined by the Company's interest rate
spread (the difference between the yields earned on its loan and investment
portfolios, and the rates paid on its deposits and borrowed funds) and the
relative holdings of interest-earning assets and interest-bearing liabilities.
Also of significance to the Company's net income is its provision for estimated
loan losses, as well as the amount of noninterest income derived from activities
that are not dependent on spread based lending. Transaction charges, nondeposit
products and additional services are under review to augment the noninterest
income contribution to the net earnings of the Bank.
The Company's deposit flows and cost of funds are determined by interest rates
on competing investments and general market rates of interest. Lending
activities are affected by consumer demand, the interest rates in the market and
the level of funds available. The Company grants loans throughout the Southern
Maryland area. Its borrowers' ability to repay is, therefore, dependent upon
the economy of Southern Maryland.
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1998 1997
<S> <C> <C>
Condensed Income Statement:
Interest income $11,627,830 $11,194,907
Interest expense 5,587,409 5,464,205
Net interest income 6,040,421 5,730,702
Provision for loan losses 180,000 180,000
Noninterest income 1,157,620 827,149
Noninterest expenses 3,999,411 3,744,568
Income before income taxes 3,018,630 2,633,283
Income tax expense 1,132,764 1,006,500
Net income 1,885,866 1,626,783
Per Common Share:
Basic earnings $ 2.37 $ 2.01/(1)/
Diluted earnings $ 2.22 $ 1.88/(1)/
Book value $ 26.63 $ 22.73/(1)/
</TABLE>
/(1)/ Restated to reflect the 1998 4% stock dividend.
8
<PAGE>
RESULTS OF OPERATIONS
The Company net income for the nine months ended September 30, 1998 increased
$259,083 or 15.9% over 1997's levels. As described in more detail in following
sections of this analysis, significant changes in specific income and expense
line items generated this increase, rather than an overall trend applicable to
all areas. The increase in net income for the nine months ended September 30,
1998 resulted from a $309,719 increase in net interest income, a $330,471
increase in noninterest income, an increase of $254,843 in noninterest expenses
and a $126,264 increase in income tax expense relating to the increased
earnings. Earnings for the three months ended September 30, 1998 were $568,329
as compared to $577,143 for the three months ended September 30, 1997. This
reflects a decline of $8,814, or 1.5%. While both interest and noninterest
income have increased over 1997's levels, noninterest expenses have increased as
the higher operating costs associated with a commercial bank are incurred. The
most notable areas of increase are in employee salaries and related costs and in
building occupancy costs as a result of the branch network expansion.
Interest and Dividend Income
Interest and dividend income on investment securities remained at the same
level in 1998 as in 1997, despite significant increases in the balances
invested. Since December of 1997, the Bank's holdings of investment securities
grew by $12.1 million, or 22.4%. The rates earned on individual securities
continued a generally declining trend during 1998 as a result of the exercise of
calls imbedded in several of the Bank's securities and the maturity of some
others. The majority of these securities are replaced with similar types of
assets. However, as new investment securities are acquired, the overall
interest rate level of the portfolio is reduced because the market dictates
lower rates on these securities at this time. The Bank has utilized a strategy
of leveraging since the fourth quarter of 1996. When opportunities become
available, an investment is purchased with maturity and rate terms that can be
reasonably matched with available borrowing to generate a specified net yield.
The Bank benefitted from the Federal Reserve Board's rate increase in March of
1997 as the adjustable rate investment and loan portfolio items repriced to
higher yields. The asset side repriced at a slightly faster rate than
liabilities, both deposits and borrowings, further increasing the net yield.
The combination of the increased net yield and the balance sheet growth
contributed to the 5.6% overall growth in net interest income for the nine
months ended September 30, 1998 over the comparable period results in 1997.
There has been little variance in interest rates over the last five years. The
Bank's yield on loans has hovered within a range of 8.7% to 8.4% while its cost
of savings ranged from 4.3% to 3.7% resulting in a net spread of 4.5% to 4.3%.
Recent actions by Federal Reserve Chairman Greenspan have been lowering the
yield that can be obtained on loans and investments. The Bank's cost of
obtaining funds through customer deposits and borrowing has been slower to
adjust downward. The interest rate yield curve has been relatively flat, with
little difference in the rates on long term versus short term products. This
puts pressure on the Bank's net spread because no relief is obtained in the cost
of money with short and intermediate rates tracking so closely to the long term
rates. If this situation does not change, the Bank's net spread could decline.
The low interest rates continue to generate high refinancing activity in the
fixed rate portfolio and the loans serviced for others. The Bank's adjustable
rate mortgages are repricing at levels consistent with or above the current
fixed rates found in the market, resulting in higher payoff activity.
Noninterest Income
Contributing to the increase in earnings were increases in noninterest income
of $330,471 resulting from a heavy volume of mortgage originations as consumers
reacted to lower market rates and increased gains on sales of loans originated
for the purpose of resale. Loan originations for the nine months of 1998
increased $9.1 million, or 18.8%, over the level in the same period in 1997.
The conversion to a commercial bank charter resulted in a change in the
composition of originations, with an increased proportion of originations
occurring in the commercial real estate and line of credit loans. In addition,
the Bank has increased its activity in originating and selling fixed rate
mortgage loans, accounting for $7.1 million of the increased loan volume. Bank
mergers and residential mortgage company restructurings have left the Bank as
one of a few long-standing, stable and reputable sources of funds for the
Southern Maryland market. Commission-based mortgage loan originators are
utilized to further strengthen the Bank's presence in its market.
9
<PAGE>
During the second quarter of 1998, a participation with another lender that was
in default was sold and the Bank's portion of the proceeds were received. The
sale resulted in the recovery of all outstanding fees and interest as well as
generating a profit of approximately $62,000.
An effort has been made to identify the customer services provided by the Bank
which can be used to generate additional revenues. This led to the imposition
of user fees for the use of the Bank's ATMs by noncustomers. In the current
period of operations at the Bank's new facility near the mall, that location has
had its ATM volume surpass every other existing branch in individual transaction
levels. The Bank has been actively seeking lucrative outlets for installation
of its ATM machines throughout its market with the recent installation of three
stand alone ATMs at convenience food markets. In addition, Bank customers have
been utilizing certain negotiable order of withdrawal account features which
have a related service fee while the conversion to a commercial bank has
generated a small but increasing commercial deposit account base.
Noninterest Expense
The Bank experienced an increase in noninterest expenses of $254,843 or 6.8%
for the nine months ended September 30, 1998 compared to the nine months ended
September 30, 1997. Compensation related expenses increased $278,526, or 14.6%,
as the Bank increased its salary level commensurate with market pressures for
professional staff and reached a full staffing level for its new, larger branch
which replaced a satellite branch. Data processing expense increased by $52,276
or 29.8% over the comparable period in 1997. This reflects the ongoing cost
associated with the Bank's efforts to implement its Year 2000 century date
compliance.
In connection with the 1997 conversion to a commercial bank, substantial
advertising costs were incurred to publicize and promote the conversion and its
ensuing benefits to the customers and community. Advertising costs have
returned to a more normal level for a bank of our size, reflecting a $21,292, or
18.4%, decrease in costs incurred in 1998 compared to those incurred in 1997.
Income Tax Expense
Income tax expenses increased 12.6% as a result of the increase in pretax
income.
Earnings Per Share
Basic earning per share for the nine months were $2.37 per share or $.36 higher
than for the corresponding period in 1997.
FINANCIAL CONDITION
Assets
Total assets as of September 30, 1998 grew $18.2 million to $209.1 million from
the December 31, 1997 level of $191.2 million. This reflects a growth rate of
9.5% as compared to 8.6% asset growth during the previous year. Increased
development of the Southern Maryland area as a bedroom community for Washington,
D.C. workers and military base expansion in the Bank's market area continued to
keep the real estate market strong. Loan growth was $7.9 million or 6.4% for
the nine months ended September 30, 1998 as compared to an increase of $9.5
million or 8.5% for the nine months ended September 30, 1997. In connection
with the charter conversion, the Bank adopted a business plan that focused on
more consumer and commercial loans, and increased its fixed rate residential
loan origination and sale activity in connection with the low fixed rate loan
environment. Loan demand slowed in the latter portion of the second quarter of
1998, but has resumed at high volume with the movement of rates to record low
levels.
The allowance for loan losses was maintained at a level believed by management
to be adequate to absorb potential losses consistent with the risk profile of
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 the year
2000 issue; and other relevant factors that, in management's judgment, warrant
recognition in providing an adequate allowance. The Bank's allowance for loan
losses was increased $180,000 during the first nine months of 1998 in accordance
with management's policy described above.
10
<PAGE>
The Company's holdings of investment securities increased $12.1 million, or
22.4%, since December 31, 1997. Several securities experienced early payoff
since the issuer was able to obtain better rates by calling the investment and
reissuing it at the more attractive long-term rates currently available in the
market. When possible, the funds received from payoff of these securities were
used to acquire similar investments, though generally at a lower yield in
response to the current market conditions at the time of purchase. With returns
in a declining trend, the Bank moved to lock in current rates before further
declines. These purchases were funded with short-term floating rate borrowings.
Rate movements are closely monitored so long-term fixed rate arrangements can be
made before the declining trend reverses.
The level of property and equipment balances increased $169,670 as the new
location was brought into operation and the Bank continued to upgrade its
computer equipment.
Liabilities
Liability growth was managed to reflect the change in asset levels. Deposit
growth was 2.2% for the nine months ended September 30, 1998. The Bank's
strategy has been to focus on attracting customers disenfranchised by the
shrinking pool of locally run banks in Southern Maryland. Loan demands were met
with the funds obtained through increased deposit account balances. Borrowed
funds have increased $13 million, comprised solely of short-term financing.
These funds were used to increase the Bank's investment securities portfolio.
Stockholders' Equity
Stockholders' equity increased $1.8 million or 9.3% to $20.8 million at
September 30, 1998 compared to $19.1 million at December 31, 1997. This reflects
the net income of $1.9 million for the nine-month period and a $.5 million
increase in accumulated other comprehensive income. Reductions in equity
occurred as a result of a $.125 per share cash dividend paid to shareholders and
the use of $474,000 to purchase treasury shares in the open market. A shift in
the components of stockholders' equity occurred as a result of the declaration
of a 4% stock dividend to shareholders; this resulted in a transfer of $694,384
from retained earnings to common stock and surplus. The cash and stock dividends
were distributed to shareholders on April 13, 1998.
Book value on a per share basis, $26.63 at September 30, 1998, as compared to
$24.38 at December 31, 1997, reflects a 9.2% increase. Beginning in the third
quarter of 1997, opportunities arose for the Corporation to acquire some of its
own stock. After evaluation of the offering price and consideration of
alternative uses of corporate assets, the Board approved, over the last twelve
months, the purchase of 23,510 shares. During the first nine months of 1998,
the Bank's Employee Stock Ownership Plan (ESOP) acquired additional shares,
utilizing the line of credit available from the Corporation when necessary.
When the ESOP purchases shares using such borrowed funds, the shares purchased
are pledged as collateral for the loan and the loan balance is reflected as a
reduction of stockholders' equity.
As part of its capital management strategy, the Board has approved certain
purchases, for retirement, of shares offered for sale by its stockholders. For
the nine months ended September 30, 1998, the Corporation purchased 20,039
shares for $473,636. The cash for these purchases was provided to the Company
through a $750,000 cash dividend from the Bank.
INTEREST RATE RISK MATTERS
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 or 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:
11
<PAGE>
<TABLE>
<CAPTION>
SEPTEMBER SEPTEMBER
30, 1998 30, 1997
-------- --------
<S> <C> <C>
MARKET VALUE OF PORTFOLIO EQUITY:
Interest rate changes:
Up 200 basis points -11% -2%
Down 200 basis points +4% -3%
INTEREST RATE SENSITIVITY:
Interest rate changes:
Up 200 basis points +1% +7%
Down 200 basis points -6% -8%
</TABLE>
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 interest rates. In the
current flat yield curve environment, the risk of downward movement appears to
be the most probable because, historically, flat yield curves have preceded five
of the last six recessions. The ALCO committee has taken several measures to
mitigate the effects of this situation by lengthening the duration of the newly
acquired investments and shortening the duration of the underlying liabilities
to reflect the dynamics of the market. The changes in the market value as well
as the net interest income are well within the boundaries established by the
Board.
REGULATORY MATTERS
The Bank is subject to Federal Reserve Board capital requirements as well as to
statutory capital requirements imposed under Maryland law. At September 30,
1998, the Bank's tangible, leverage and risk-based capital was 9.04%, 10.29% and
17.75%, respectively. These levels are well in excess of the required 1.5%, 3.0%
and 8.0% ratios required by the Federal Reserve Board.
12
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
--------------------------------
PART II - OTHER INFORMATION
---------------------------
Item 6 - Exhibits
A. Exhibits
(27) Financial Data Schedule
13
<PAGE>
SIGNATURES
Pursuant to the requirements 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: November 16, 1998 By: /s/ Michael L. Middleton
---------------------- ---------------------------------
Michael L. Middleton, President
and Chairman of the Board
Date: November 16, 1998 By: /s/ Eileen M.Ramos
---------------------- ---------------------------------
Eileen M.Ramos
Chief Financial Officer
14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,065,153
<INT-BEARING-DEPOSITS> 2,011,282
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 63,723,233
<INVESTMENTS-CARRYING> 2,421,697
<INVESTMENTS-MARKET> 2,448,887
<LOANS> 131,438,104
<ALLOWANCE> 1,485,536
<TOTAL-ASSETS> 209,063,130
<DEPOSITS> 145,450,569
<SHORT-TERM> 27,144,913
<LIABILITIES-OTHER> 875,413
<LONG-TERM> 15,026,078
0
0
<COMMON> 7,938
<OTHER-SE> 20,853,042
<TOTAL-LIABILITIES-AND-EQUITY> 109,063,130
<INTEREST-LOAN> 8,598,048
<INTEREST-INVEST> 2,918,117
<INTEREST-OTHER> 111,665
<INTEREST-TOTAL> 11,627,830
<INTEREST-DEPOSIT> 4,259,888
<INTEREST-EXPENSE> 1,327,521
<INTEREST-INCOME-NET> 6,040,421
<LOAN-LOSSES> 180,000
<SECURITIES-GAINS> (391)
<EXPENSE-OTHER> 3,999,411
<INCOME-PRETAX> 3,018,630
<INCOME-PRE-EXTRAORDINARY> 3,018,630
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,885,866
<EPS-PRIMARY> 2.37
<EPS-DILUTED> 2.22
<YIELD-ACTUAL> 4.00
<LOANS-NON> 360,964
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,370,466
<CHARGE-OFFS> 4,930
<RECOVERIES> 101
<ALLOWANCE-CLOSE> 1,485,536
<ALLOWANCE-DOMESTIC> 1,485,536
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
