<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
Mark One FORM 10-K/A
(Amendment No. 1)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
[_] 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 incorporation (I.R.S. Employer
or organization) Identification No.)
3035 Leonardtown Road, Waldorf, Maryland 20601
- ---------------------------------------- --------
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (301) 645-5601
----------------
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.
As of March 22, 1999, there were issued and outstanding 793,563 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 $24.31 per share for an approximate aggregate market
value of voting stock held by non-affiliates of the registrant of $14.3 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, 1998. (Parts I and II)
2. Portions of Proxy Statement for the 1999 Annual Meeting of Stockholders.
(Part III)
<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: April 13, 1999 By: /s/ Michael L. Middleton
-------------------------------------
Michael L. Middleton
President and Chief Executive Officer
(Duly Authorized Representative)
Date: April 13, 1999 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.
<TABLE>
<S> <C>
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: April 13, 1999 Date: April 13, 1999
By: /s/ Henry A. Shorter, Jr. By: /s/ W. Edelen Gough, Jr.
-------------------------------------- ----------------------------
Henry A. Shorter, Jr. W. Edelen Gough, Jr.
(Director) (Director)
Date: April 13, 1999 Date: April 13, 1999
By: /s/ C. Marie Brown By: /s/ Gordon A. O'Neill
-------------------------------------- ----------------------------
C. Marie Brown Gordon A. O'Neill
(Director and Chief Operating Officer) (Director)
Date: April 13, 1999 Date: April 13, 1999
By: /s/ Beaman Smith
--------------------------------------
Beaman Smith
(Director and Secretary/Treasurer)
Date: April 13, 1999
</TABLE>
29
<PAGE>
EXHIBIT 10(b)
TRI-COUNTY FINANCIAL CORPORATION
1995 STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS
1. Purpose of the Plan.
The purpose of this Tri-County Financial Corporation 1995 Stock Option
Plan for Non-Employee Directors (the "Plan") is to advance the interests of the
Company through providing Directors of the Company and its Affiliates with the
opportunity to acquire Shares. By encouraging such stock ownership, the Company
seeks to attract, retain, and motivate the best available personnel for
positions of substantial responsibility and to provide additional incentive to
Directors to promote the success of the business.
2. Definitions.
As used herein, the following definitions shall apply.
(a) "Affiliate" shall mean any "parent corporation" or "subsidiary
corporation" of the Company, as such terms are defined in Section 424(e) and
(f), respectively, of the Code.
(b) "Agreement" shall mean a written agreement entered into in
accordance with Paragraph 5(c).
(c) "Board" shall mean the Board of Directors of the Company.
(d) "Change in Control" shall mean the acquisition of the beneficial
ownership (as that term is defined in Rule 13d-3 of the General Rules and
Regulations under the Securities Exchange Act of 1934, as amended) of 25% or
more of the voting securities of the Company by any person or by persons acting
as a "group" (within the meaning of Section 13(d) of the Securities Exchange Act
of 1934). For purposes of this subparagraph only, the term "person" refers to an
individual or a corporation, partnership, trust, association, joint venture,
pool, syndicate, sole proprietorship, unincorporated organization or any other
form of entity not specifically listed herein. The decision of the Board as to
whether a change in control has occurred shall be conclusive and binding.
(e) "Code" shall mean the Internal Revenue Code of 1986, as amended.
(f) "Common Stock" shall mean the common stock, par value $.01 per
share, of the Company.
(g) "Company" shall mean Tri-County Financial Corporation.
(h) "Continuous Service" shall mean the absence of any interruption
or termination of service as a Director of the Company or an Affiliate.
Continuous Service shall not be considered
<PAGE>
interrupted in the case of sick leave, military leave or any other leave of
absence approved by the Company or in the case of transfers between payroll
locations of the Company or between the Company, an Affiliate or a successor.
(i) "Director" shall mean any member of the Board or of the Board of
Directors of an Affiliate, including advisory director Gough.
(j) "Effective Date" shall mean the date specified in Paragraph 13
hereof.
(k) "Employee" shall mean any person employed on a full-time basis by
the Company or an Affiliate.
(l) "Exercise Price" shall mean the price per Optioned Share at which
an Option may be exercised.
(m) "Market Value" shall mean the fair market value of the Common
Stock, as determined under Paragraph 7(b) hereof.
(n) "Option" means an option to purchase Common Stock which meets the
requirements set forth in the Plan. Such Options shall not constitute "incentive
stock options" within the meaning of Section 422 of the Code.
(o) "Optioned Shares" shall mean Shares subject to an Option granted
pursuant to this Plan.
(p) "Participant" shall mean any person who receives an Option
pursuant to the Plan.
(q) "Plan" shall mean this Tri-County Financial Corporation 1995
Stock Option Plan for Non-Employee Directors.
(r) "Share" shall mean one share of Common Stock.
3. Term of the Plan and Options.
(a) Term of the Plan. The Plan shall continue in effect for a term of
five years from the Effective Date, unless sooner terminated pursuant to
Paragraph 14 hereof. No Option shall be granted under the Plan after five years
from the Effective Date.
(b) Term of Options. The term of each Option granted under the Plan
shall be 10 years.
2
<PAGE>
4. Shares Subject to the Plan.
Except as otherwise required by the provisions of Paragraph 10 hereof,
the aggregate number of Shares deliverable pursuant to Options shall not exceed
7,000 Shares. Such Shares may either be authorized but unissued Shares or Shares
held in treasury. If Options should expire, become unexercisable or be forfeited
for any reason without having been exercised or become vested in full, the
Optioned Shares shall, unless the Plan shall have been terminated, be available
for the grant of additional Options under the Plan.
5. Administration of the Plan.
(a) General Rule. The Plan shall be administered by the Board,
provided that the Board may appoint a committee of Directors to make any
determinations required pursuant to the Plan.
(b) Powers. Except as limited by the express provisions of the Plan,
the Board shall have sole and complete authority and discretion (i) to determine
the form and content of Options to be issued in the form of Agreements under the
Plan, (ii) to interpret the Plan, (iii) to prescribe, amend and rescind rules
and regulations relating to the Plan, and (iv) to make other determinations
necessary or advisable for the administration of the Plan.
(c) Agreement. Each Option shall be evidenced by a written agreement
containing such provisions as may be approved by the Board. Each such Agreement
shall constitute a binding contract between the Company and the Participant, and
every Participant, upon acceptance of such Agreement, shall be bound by the
terms and restrictions of the Plan and of such Agreement. The terms of each such
Agreement shall be in accordance with the Plan. In particular, the Board shall
set forth in each Agreement (i) the Exercise Price of an Option, (ii) the number
of Shares subject to, and the expiration date of, the Option, (iii) the manner,
time, and rate (cumulative or otherwise) of exercise or vesting of such Option,
and (iv) the restrictions, if any, to be placed upon such Option, or upon Shares
which may be issued upon exercise of such Option.
The President of the Company and such Directors as shall be designated
by the Board are hereby authorized to execute Agreements on behalf of the
Company, and to cause them to be delivered to the recipients of Options.
(d) Effect of the Board's Decisions. All decisions, determinations
and interpretations of the Board shall be final and conclusive on all persons
affected thereby.
(e) Indemnification. In addition to such other rights of
indemnification as they may have, the members of the Board shall be indemnified
by the Company in connection with any claim, action, suit or proceeding relating
to any action taken or failure to act under or in connection with the Plan or
any Option, granted hereunder to the full extent provided for under the
Company's governing instruments with respect to the indemnification of
Directors.
3
<PAGE>
(f) Certain Mandatory Abstentions. Notwithstanding anything herein to
the contrary, no Director shall have any vote with regard to any Option
previously granted to himself or herself.
6. Grant of Options.
Each Director who is not an Employee but is a Director on the Effective
Date shall receive, on said date, an Option to purchase 1,400 Shares at an
Exercise Price per Share equal to its Market Value on the Effective Date.
7. Exercise Price for Options.
(a) General Rule. The Exercise Price as to any particular Option
shall be the Market Value of the Optioned Shares on the date of grant, as
determined by the Board.
(b) Standards for Determining Exercise Price. If the Common Stock is
listed on a national securities exchange (including the NASDAQ National Market
System) on the date in question, then the Market Value per Share shall be the
average of the highest and lowest selling price on such exchange on such date,
or if there were no sales on such date, then the Exercise Price shall be the
mean between the bid and asked price on such date. If the Common Stock is traded
otherwise than on a national securities exchange on the date in question, then
the Market Value per Share shall be the mean between the bid and asked price on
such date, or, if there is no bid and asked price on such date, then on the next
prior business day on which there was a bid and asked price. If no such bid and
asked price is available, then the Market Value per Share shall be its fair
market value as determined by the Board, in its sole and absolute discretion.
8. Exercise of Options.
(a) Generally. Each Option shall be fully (100%) exercisable
immediately upon the date of its grant.
(b) Procedure for Exercise. Options may be exercised from time to
time by (i) written notice of intent to exercise the Option with respect to all
or a specified number of the Optioned Shares, and (ii) payment to the Company
(contemporaneously with the delivery of such notice), in cash, in Common Stock,
or a combination of cash and Common Stock, of the amount of the Exercise Price
for the number of the Optioned Shares with respect to which the Option is then
being exercised. Each such notice and payment shall be delivered, or mailed by
prepaid registered or certified mail, addressed to the Treasurer of the Company
at the Company's executive offices. A Director who exercises Options may
satisfy all applicable federal, state and local income and employment tax
withholding obligations, in whole or in part, by irrevocably electing to have
the Company withhold shares of Common Stock, or to deliver to the Company shares
of Common Stock that he already owns, having a value equal to the amount
required to be withheld.
4
<PAGE>
(c) Exercisability. Options granted under this Paragraph may be
exercised only while the Participant is a Director of the Company, or within one
year after termination of the Participant's Continuous Service as a Director,
but in no event later than the date on which such Options would otherwise
expire. In the event of such Director's death during the term of his
directorship, Options granted under this Paragraph may be exercised within one
year from the date of his death by the personal representatives of his estate or
person or persons to whom his rights under such Option shall have passed by will
or by laws of descent and distribution, but in no event later than the date on
which such Options would otherwise expire.
9. Change in Control
At the time of a Change in Control, each holder of an Option shall be
entitled to receive cash from the Company in an amount equal to the excess of
the Market Value of the Common Stock subject to the Option over the Exercise
Price of the Optioned Shares, in exchange for the cancellation of such Option.
10. Effect of Changes in Common Stock Subject to the Plan.
(a) Recapitalizations; Stock Splits, Etc. The number and kind of
shares reserved for issuance under the Plan, and the number and kind of shares
subject to outstanding Options (and the Exercise Price thereof) shall be
proportionately adjusted for any increase, decrease, change or exchange of
Shares for a different number or kind of shares or other securities of the
Company which results from a merger, consolidation, recapitalization,
reorganization, reclassification, stock dividend, split-up, combination of
shares, or similar event in which the number or kind of shares is changed
without the receipt or payment of consideration by the Company.
(b) Transactions in which the Company is Not the Surviving Entity.
Subject to Paragraph 9 hereof, in the event of (i) the liquidation or
dissolution of the Company, (ii) a merger or consolidation in which the Company
is not the surviving entity, or (iii) the sale or disposition of all or
substantially all of the Company's assets (any of the foregoing to be referred
to herein as a "Transaction"), all outstanding Options shall be surrendered.
With respect to each Option so surrendered, the holder of the surrendered Option
may elect to receive --
(1) for each Share then subject to an outstanding Option the
number and kind of shares into which each outstanding Share (other than
Shares held by dissenting stockholders) is changed or exchanged,
together with an appropriate adjustment to the Exercise Price; or
(2) a cash payment (from the Company or the successor
corporation), in an amount equal to the Market Value of the Shares
subject to the Option on the date of the Transaction, less the Exercise
Price of the Option.
5
<PAGE>
(c) Conditions and Restrictions on New, Additional, or Different
Shares or Securities. If, by reason of any adjustment made pursuant to this
Paragraph, a Participant becomes entitled to new, additional, or different
shares of stock or securities, such new, additional, or different shares of
stock or securities shall thereupon be subject to all of the conditions and
restrictions which were applicable to the Shares pursuant to the Option before
the adjustment was made.
(d) Other Issuances. Except as expressly provided in this Paragraph,
the issuance by the Company or an Affiliate of shares of stock of any class, or
of securities convertible into Shares or stock of another class, for cash or
property or for labor or services either upon direct sale or upon the exercise
of rights or warrants to subscribe therefor, shall not affect, and no adjustment
shall be made with respect to, the number, class, or Exercise Price of Shares
then subject to Options or reserved for issuance under the Plan.
11. Non-Transferability of Options.
Options may not be sold, pledged, assigned, hypothecated, transferred
or disposed of in any manner other than by will or by the laws of descent and
distribution.
12. Time of Granting Options.
The date of grant of an Option shall, for all purposes, be the date on
which the Board makes the determination granting such Option. Notice of the
determination shall be given to each Participant to whom an Option is so granted
within a reasonable time after the date of such grant.
13. Effective Date.
The Plan shall become effective immediately upon its approval by the
Board.
14. Amendment and Termination of the Plan.
The Board may from time to time amend the terms of the Plan and, with
respect to any Shares at the time not subject to Options, suspend or terminate
the Plan; provided that no provision hereof may be amended more than once every
six months (other than to comport with changes in the Code, the Employee
Retirement Income Security Act of 1974, as amended, or the rules thereunder). No
amendment, suspension or termination of the Plan shall, without the consent of
any affected holders of an Option, alter or impair any rights or obligations
under any Option theretofore granted.
15. Conditions Upon Issuance of Shares.
(a) Compliance with Securities Laws. Shares of Common Stock shall not
be issued with respect to any Option unless the issuance and delivery of such
Shares shall comply with all
6
<PAGE>
relevant provisions of law, including, without limitation, the Securities Act of
1933, as amended, the rules and regulations promulgated thereunder, any
applicable state securities law, and the requirements of any stock exchange
upon which the Shares may then be listed.
(b) Special Circumstances. The inability of the Company to obtain
approval from any regulatory body or authority deemed by the Company's counsel
to be necessary to the lawful issuance and sale of any Shares hereunder shall
relieve the Company of any liability in respect of the non-issuance or sale of
such Shares. As a condition to the exercise of an Option, the Company may
require the person exercising the Option to make such representations and
warranties as may be necessary to assure the availability of an exemption from
the registration requirements of federal or state securities law.
16. Reservation of Shares.
The Company, during the term of the Plan, will reserve and keep
available a number of Shares sufficient to satisfy the requirements of the Plan.
17. Withholding Tax.
The Company's obligation to deliver Shares upon exercise of Options
shall be subject to the Participant's satisfaction of all applicable federal,
state and local income and employment tax withholding obligations. Each
Participant may satisfy the obligation, in whole or in part, by irrevocably
electing to have the Company withhold Shares, or to deliver to the Company
Shares that he already owns, having a value equal to the amount required to be
withheld. The value of Shares to be withheld, or delivered to the Company, shall
be based on the Market Value of the Shares on the date the amount of tax to be
withheld is to be determined. As an alternative, the Company may retain, or sell
without notice, a number of such Shares sufficient to cover the amount required
to be withheld.
18. No Employment or Other Rights.
In no event shall a Director's eligibility to participate or
participation in the Plan create or be deemed to create any legal or equitable
right of the Director, or any other party to continue service with the Company
or any Affiliate. No Director shall have a right to be granted an Option or,
having received an Option, the right to again be granted an Option. However, a
Director who has been granted an Option may, if otherwise eligible, be granted
an additional Option or Options.
19. Governing Law.
The Plan shall be governed by and construed in accordance with the laws
of the State of Maryland, except to the extent that federal law shall be deemed
to apply.
7
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
1995 STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS
---------------------
1998 Amendment
---------------------
WHEREAS, Tri-County Financial Corporation (the "Company") maintains the
Tri-County Financial Corporation 1995 Stock Option Plan for Non-Employee
Directors (the "Plan"); and
WHEREAS, the Company has determined that said Plan should be amended to
increase the number of shares reserved for future awards.
NOW, THEREFORE, pursuant to Paragraph 14 of the Plan, the Plan is
hereby amended as follows, effective immediately:
1. Paragraph 4 of the Plan shall be amended by inserting the
following sentence immediately after its first sentence:
The number of shares reserved under the Plan shall be increased by
11,000 Shares.
2. Nothing contained herein shall be held to alter, vary or affect
any of the terms, provisions, or conditions of the Plan or any Option entered
into thereunder, other than as stated above.
WHEREFORE, on this 30th day of October, 1998, the Company hereby
executes this 1998 Amendment to the Plan.
TRI-COUNTY FINANCIAL CORPORATION
By
------------------------------
Its
---------------------------
- -----------------
Date Attest:______________________________(Seal)
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
REPORT ON AUDITS OF
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
No extracts from this report may be published without our written consent.
Stegman & Company
<PAGE>
TABLE OF CONTENTS
INDEPENDENT AUDITORS' REPORT
CONSOLIDATED FINANCIAL STATEMENTS Page
----
Balance Sheets 1
Statements of Income 2
Statements of Stockholders' Equity 3
Statements of Cash Flows 4 - 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6 - 27
<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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the
results of its operations and cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Stegman & Company
Baltimore, Maryland
February 26, 1999
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
ASSETS
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Cash and due from banks $ 906,658 $ 650,923
Interest-bearing deposits with banks 4,152,816 5,169,830
Investment securities available-for-sale - at fair value 55,976,606 52,878,583
Investment securities held-to-maturity - at amortized cost 2,139,069 1,149,137
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 2,005,350 1,724,000
Loans held for sale 2,266,697 1,698,872
Loans receivable - net of allowance for loan losses
of $1,540,551 and $1,310,365, respectively 132,645,936 121,866,762
Premises and equipment, net 4,316,207 4,189,222
Accrued interest receivable 1,486,776 1,276,376
Other assets 1,123,675 584,655
------------ ------------
TOTAL ASSETS $207,019,790 $191,188,360
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 9,750,153 $ 7,196,053
Interest-bearing deposits 142,065,211 135,080,024
------------ ------------
Total deposits 151,815,364 142,276,077
Other borrowed funds 16,937,882 12,523,210
Long-term debt 16,496,450 16,678,610
Accrued expenses and other liabilities 638,128 624,384
------------ ------------
Total liabilities 185,887,824 172,102,281
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 789,334 and 782,699 shares, respectively 7,893 7,827
Surplus 7,309,901 6,574,162
Retained earnings 13,372,441 12,256,443
Accumulated other comprehensive income 648,614 442,032
Unearned ESOP shares (206,883) (194,385)
------------ ------------
Total stockholders' equity 21,131,966 19,086,079
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $207,019,790 $191,188,360
============ ============
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $11,642,029 $11,056,220 $10,045,429
Taxable interest and dividends on investment securities 3,941,744 3,782,205 3,301,725
Interest on deposits with banks 142,259 154,836 124,441
----------- ----------- -----------
Total interest income 15,726,032 14,993,261 13,471,595
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 5,693,385 5,683,348 5,397,181
Interest on other borrowed funds 958,119 925,084 774,617
Interest on long-term debt 945,223 742,216 234,958
----------- ----------- -----------
Total interest expense 7,596,727 7,350,648 6,406,756
----------- ----------- -----------
NET INTEREST INCOME 8,129,305 7,642,613 7,064,839
PROVISION FOR LOAN LOSSES 240,000 240,000 408,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 7,889,305 7,402,613 6,656,839
----------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 223,326 158,945 147,561
Net gains on sale of loans held for sale 416,838 240,407 192,468
Net realized loss on sales of investment
securities available-for-sale (391) (17,502) -
Service charges 600,067 496,972 382,228
Other income 180,696 51,923 76,148
----------- ----------- -----------
Total noninterest income 1,420,536 930,745 798,405
----------- ----------- -----------
NONINTEREST EXPENSES:
Salaries and employee benefits 3,114,748 2,624,131 2,432,293
Occupancy expense 494,113 396,378 353,246
Deposit insurance 85,598 70,000 1,120,669
Data processing expense 259,025 253,677 262,375
Depreciation of furniture, fixtures, and equipment 204,230 185,548 144,512
Other 1,308,923 1,347,613 1,037,222
----------- ----------- -----------
Total noninterest expenses 5,466,637 4,877,347 5,350,317
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,843,204 3,456,011 2,104,927
Income tax expense 1,457,000 1,372,000 785,200
----------- ----------- -----------
NET INCOME $ 2,386,204 $ 2,084,011 $ 1,319,727
=========== =========== ===========
INCOME PER COMMON SHARE (1):
Basic earnings per share $3.00 $2.57 $1.65
Diluted earnings per share 2.80 2.40 1.53
</TABLE>
(1) Restated to reflect 1998 stock dividends
See notes to consolidated financial statements.
2
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
Accumu-
lated
Other
Compre- Unearned
Common Paid-in Retained hensive ESOP
Stock Capital Earnings Income Shares Total
----------- ------------- ------------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, JANUARY 1, 1996 $6,851 $5,021,350 $10,710,824 $ 232,123 $ (138,223) $15,832,925
Comprehensive income:
Net income - - 1,319,727 - - 1,319,727
Unrealized loss on
investment securities
net of tax of $(90,190) - - - (143,345) - (143,345)
-------------
Total comprehensive income - - - - - 1,176,382
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)
----------- ------------- ------------ ---------- ---------- -------------
BALANCES, DECEMBER 31, 1996 7,510 5,724,729 11,430,666 88,778 (174,231) 17,077,452
Comprehensive income:
Net income - - 2,084,011 - - 2,084,011
Unrealized gain on
investment securities
net of tax of $222,265
and reclassification
adjustments of $16,950 - - - 353,254 - 353,254
-------------
Total comprehensive income - - - - - 2,437,265
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)
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
Comprehensive income:
Net income - - 2,386,204 - - 2,386,204
Unrealized gains on investment
securities
net of tax of $129,980 - - - 206,582 - 206,582
-------------
Total comprehensive income - - - - - 2,592,786
Cash dividend - $0.125 per share - - (97,627) - - (97,627)
4% stock dividend 310 693,962 (694,272) - - -
Cash paid in lieu of stock dividend for
fractional shares - - (4,871) - - (4,871)
Exercise of stock options 58 41,777 - - - 41,835
Repurchase of common stock (200) - (473,436) - - (473,636)
Net change in unearned
ESOP shares (102) - - - (12,498) (12,600)
----------- ------------- ------------ ---------- ------------ -------------
BALANCES, DECEMBER 31, 1998 $7,893 $7,309,901 $13,372,441 $ 648,614 $ (206,883) $21,131,966
=========== ============= ============ ========== ============ =============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ----------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,386,204 $ 2,084,011 $ 1,319,727
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 240,000 240,000 408,000
Depreciation and amortization 301,238 324,134 264,492
Amortization of premium/discount on mortgage-
backed securities and investments 33,346 (50,456) (96,060)
Deferred income tax benefit (131,000) 2,000 (143,800)
Increase in accrued interest receivable (210,400) (111,185) (72,078)
Decrease in deferred loan fees (130,320) (25,905) (85,781)
Increase (decrease) in accrued expenses and other liabilities 14,765 (314,242) 257,778
Decrease in other assets (539,020) (219,661) (200,921)
(Gain) loss on disposal of premises and equipment (66,813) 41,660 (9,610)
Loss on sale of investment securities 391 17,502 -
Origination of loans held for sale (23,740,825) (12,562,767) (8,812,925)
Gain on sales of loans held for sale (416,839) (240,407) (192,468)
Proceeds from sale of loans held for sale 23,589,839 12,116,232 8,887,468
Gain on sale of foreclosed real estate (61,654) (7,000) -
------------ ------------ ------------
Net cash provided by operating activities 1,268,912 1,293,916 1,523,822
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing
deposits with banks 1,017,014 (2,378,112) 472,388
Purchase of investment securities available-for-sale (90,192,914) (47,628,227) (27,637,617)
Proceeds from sale, redemption or principal payments
of investment securities available-for-sale 87,391,528 49,084,708 19,559,529
Purchase of investment securities held-to-maturity (3,110,963) (189,525) (990,273)
Proceeds from maturities or principal payments
of investment securities held-to-maturity 2,127,218 797,119 334,682
Purchase of FHLB stock and Federal Reserve Bank stock (281,350) (424,000) (418,400)
Loans originated or acquired (54,084,255) (53,126,555) (50,605,301)
Principal collected on loans 42,431,995 41,896,388 46,238,710
Purchase of premises and equipment (478,661) (680,078) (859,884)
Proceeds from sales of premises and equipment 117,251 - 9,610
Proceeds from disposition of foreclosed real estate 825,060 162,135 -
------------ ------------ ------------
Net cash used in investing activities (14,238,077) (12,486,147) (13,896,556)
------------ ------------ ------------
</TABLE>
4
<PAGE>
Tri-County Financial Corporation
Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
<S> <C> <C> <C>
Net increase in deposits $ 9,539,287 $ 6,741,914 $ 5,500,120
Net increase (decrease) in other borrowed funds 4,414,672 (746,749) (2,497,413)
Dividends paid (102,498) (81,008) (74,045)
Exercise of stock options 41,835 20,795 178,198
Net change in unearned ESOP shares (12,600) (20,154) (36,008)
Redemption of common stock (473,636) (348,271) -
Proceeds from long-term borrowings - 22,400,000 11,000,000
Retirement of long-term borrowings (182,160) (17,235,267) (1,372,337)
----------- ------------ -----------
Net cash provided by financing activities 13,224,900 10,731,260 12,698,515
----------- ------------ -----------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 255,735 (460,971) 325,781
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 650,923 1,111,894 786,113
----------- ------------ -----------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 906,658 $ 650,923 $ 1,111,894
=========== ============ ===========
Supplementary cash flow information:
Cash paid during the year for:
Interest $ 7,942,034 $ 7,284,916 $ 6,414,832
Income taxes 1,502,868 1,625,000 803,000
Transfers from loans receivable to
foreclosed real estate 763,406 - 207,409
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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 1998.
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 fair
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 - 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 experiences.
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 1998, 1997 or
1996.
Mortgage Servicing Rights
-------------------------
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
$546,000 and $170,000 at December 31, 1998 and 1997, 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>
Income Per Common Share
-----------------------
Basic net income per common share is computed by dividing net income
available to common shareholders by the weighted average number of common shares
outstanding during the year. Diluted net income per common share is computed by
dividing net income available to common shareholders by the weighted average
number of common shares outstanding during the year including any potential
dilutive common shares outstanding, such as options and warrants.
Stock-Based Compensation
------------------------
Stock-based compensation is recognized using the intrinsic value
method. For disclosure purposes, pro forma net income and earnings per share
impacts are provided as if the fair value method had been applied.
New Accounting Standards
------------------------
In June 1997, Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive Income (SFAS 130), was issued and establishes standards
for reporting and displaying comprehensive income and its components. SFAS 130
requires comprehensive income and its components, as recognized under the
accounting standard, to be displayed in a financial statement with the same
prominence as other financial statements. The Company adopted the standard, as
required, beginning in 1998; adoption of this disclosure requirement had no
impact on the financial position or results of operations of the Company.
Statement of Financial Accounting Standards No. 131, Disclosures About
Segments of an Enterprise and Related Information (SFAS 131), which was issued
in June 1997 established new standards for reporting information about operating
segments in annual and interim financial statements. The standard requires
descriptive information about the way that operating segments are determined,
the products and services provided by the segments and the nature of differences
between reportable years beginning after December 15, 1997. Operating segments
are defined under the Standard based on the availability and utilization of
discrete financial information as well as the necessity for this discrete
financial information to meet certain quantitative thresholds. Management
believes that it has no reportable components that qualify as an operating
segment under SFAS 131 for the year ended December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Standards No. 133, Accounting for Derivative Instruments and
Hedging Activities (SFAS 133). The provisions of this statement require that
derivative instruments be carried at fair value on the balance sheet. The
statement allows derivative instruments to be used to hedge various risks and
sets forth specific criteria to be used to determine when hedge accounting can
be used. The statement also provides for offsetting changes in fair value or
cash flows of both the derivative and the hedged asset or liability to be
recognized in earnings in the same period; however, any changes in fair value or
cash flow that represent the ineffective portion of a hedge are required to be
recognized in earnings and cannot be deferred. For derivative instruments not
accounted for as hedges, changes in fair value are required to be recognized in
earnings. The provisions of this statement become effective for quarterly and
annual reporting beginning January 1, 2000, and allow for early adoption in any
quarterly period after June 1998. The Company will adopt SFAS 133 as required
in 2000. It is expected that adoption of this standard will have no material
impact.
9
<PAGE>
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>
<CAPTION>
December 31, 1998
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ----------- ---------- -----------
<S> <C> <C> <C> <C>
Corporate equity securities $ 763,166 $458,123 $ - $1,221,289
Money Market and mutual funds 292,502 - - 292,502
Obligations of U.S. Government
Agencies and U.S. Government
Sponsored Enterprises (GSE's) 9,000,000 53,215 8,260 9,044,955
Asset-backed securities issued by:
GSE's 31,299,272 465,934 41,235 31,723,971
Other 13,523,847 171,792 1,750 13,693,889
----------- ---------- ------- -----------
$54,878,787 $1,149,064 $51,245 $55,976,606
=========== ========== ======= ===========
<CAPTION>
The amortized cost and estimated fair values of investment securities
available-for-sale at December 31 are as follows:
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 and mutual funds 4,010,505 - - 4,010,505
Obligations of U.S. Government
Agencies and 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>
10
<PAGE>
The scheduled maturities of investment securities available-for-sale at
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Available-for-Sale
------------------------
<S> <C> <C>
Amortized Fair
Cost Value
----------- -----------
Due in one year or less $ 4,055,668 $ 4,545,580
Due after one year through five years 3,000,000 3,021,426
Due after five years through ten years 3,000,000 2,991,740
Asset-backed securities 44,823,119 45,417,860
----------- -----------
$54,878,787 $55,976,606
=========== ===========
<CAPTION>
Sales of investment securities available-for-sale during 1998, 1997 and
1996 resulted in the following:
1998 1997 1996
---------- ------------ ---------
<S> <C> <C> <C>
Proceeds $408,500 $3,369,000 $ -
Gross gains - 2,111 -
Gross losses (391) (19,613) -
</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, 1998 and
1997.
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, 1998
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gain Losses Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Obligations of U.S. Government
Agencies $ 196,967 $ - $ - $ 196,967
Asset-backed securities 544,696 19,966 - 564,662
Other investments 1,397,406 - - 1,397,406
----------- ----------- ------------ ----------
$2,139,069 $19,966 $ - $2,159,035
=========== =========== ============ ==========
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998
----------------------------------------------------
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
=========== ========== =========== ===========
</TABLE>
4. LOANS RECEIVABLE AND LOANS HELD FOR SALE
Loans receivable at December 31, 1998 and 1997 consist of the following:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Commercial real estate $ 19,732,432 $ 15,153,167
Residential real estate 64,243,146 62,107,569
Residential construction 20,776,294 18,275,907
Second mortgage loans 16,313,728 17,428,330
Lines of credit - commercial 6,161,033 4,852,193
Consumer loans 7,889,792 6,420,219
------------ ------------
135,116,425 124,237,385
------------ ------------
Less:
Deferred loan fees 929,938 1,060,258
Allowance for loan losses 1,540,551 1,310,365
------------ ------------
2,470,489 2,370,623
------------ ------------
Total $132,645,936 $121,866,762
============ ============
</TABLE>
The following table sets forth the activity in the allowance for loan
losses:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- ------------ ------------
<S> <C> <C> <C>
Balance, January 1 $1,310,365 $1,120,102 $ 733,573
Add:
Provision charged to operations 240,000 240,000 408,000
Recoveries 275 105 180
Less:
Charge-offs 10,089 49,842 21,651
---------- ---------- -----------
Balance, December 31 $1,540,551 $1,310,365 $1,120,102
========== ========== ===========
</TABLE>
12
<PAGE>
No loans included within the scope of SFAS 114 were identified as being
impaired at December 31, 1998 or 1997 and for the years then ended.
Loans on which the recognition of interest has been discontinued, which
were not included within the scope of SFAS 114, amounted to approximately
$269,000, $160,000, and $400,000 at December 31, 1998, 1997, and 1996,
respectively. If interest income had been recognized on nonaccrual loans at
their stated rates during 1998, 1997, and 1996, interest income would have been
increased by approximately $21,000, $29,000, and $14,000, respectively. No
income was recognized for these loans in 1998, 1997 and 1996.
Included in loans receivable at December 31, 1998 and 1997, is $1,347,263
and $1,206,615 due from officers and directors of the Bank. Activity in loans
outstanding to officers and directors is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Balance, beginning of year $1,206,615 $ 918,566
New loans made during year 226,547 337,462
Repayments made during year (85,899) (49,413)
------------- -------------
Balance, end of year $1,347,263 $1,206,615
============= =============
</TABLE>
Loans serviced for others and not reflected in the balance sheets are
$56,040,000 and $47,816,000 at December 31, 1998 and 1997, 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.
5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 1998 and 1997 is as
follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Cost:
Land $1,437,761 $1,486,879
Building and improvements 2,769,246 2,648,684
Furniture and equipment 1,810,221 1,496,586
Automobiles 105,394 81,000
---------- ----------
Total cost 6,122,622 5,713,149
Less accumulated depreciation 1,806,415 1,523,927
---------- ----------
Premises and equipment, net $4,316,207 $4,189,222
========== ==========
</TABLE>
13
<PAGE>
Certain bank facilities are leased under various operating leases. Rent
expense was $161,167, $118,556 and $106,708 in 1998, 1997 and 1996,
respectively.
Future minimum rentals commitments under noncancellable leases are as
follows:
1999 $ 164,155
2000 137,808
2001 118,336
2002 125,859
2003 125,124
Thereafter 498,547
----------
Total $1,169,829
==========
6. DEPOSITS
Deposits outstanding at December 31 consist of:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Noninterest-bearing demand $ 9,750,153 $ 7,196,053
------------ ------------
Interest-bearing:
Demand 16,963,000 15,550,241
Money market deposits 20,775,000 11,479,000
Savings 25,771,211 26,338,783
Certificates of deposit of $100,000 or more 12,989,000 14,235,000
Other certificates of deposit 65,567,000 67,477,000
------------ ------------
Total interest-bearing 142,065,211 135,080,024
------------ ------------
Total deposits $151,815,364 $142,276,077
============ ============
</TABLE>
7. ADVANCES FROM THE FEDERAL HOME LOAN BANK
OF ATLANTA AND OTHER BORROWINGS
The advances from the Federal Home Loan Bank are as follows:
Weighted
Average
Interest
Year Due Rate 1998
-------- ---------- -----------
1999 5.18 $21,500,000
2002 5.81 11,400,000
14
<PAGE>
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, 1998 and 1997, of its
outstanding Federal Home Loan Bank advances. These amounts were $43,900,000 and
$37,900,000 at December 31, 1998 and 1997, 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, 1998 and 1997,
totaling $544,696 and $675,720, 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, 1998 and 1997, are as follows:
Unpaid Principal
(Net of Discount)
December 31,
---------------------- Interest Maturity
1998 1997 Rate Date
--------- ----------- -------- ----------------
$96,450 $278,610 8.50% July 1, 2010
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.
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>
<CAPTION>
1998 1997
--------------- ---------------
<S> <C> <C>
Balance outstanding at December 31 $16,937,882 $12,523,210
Average balance during the year 16,743,325 15,388,329
Average interest rate during the year 5.72% 5.77%
Maximum outstanding balance at any
month end during the year 26,619,724 20,905,025
</TABLE>
15
<PAGE>
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, 1998 and 1997, such borrowings were $437,882 and $523,210, respectively.
The aggregate scheduled principal maturities on all borrowings outstanding
at December 31, 1998 are as follows:
1999 $21,937,882
2000 -
2001 -
2002 11,400,000
2003 96,450
-----------
Total $33,434,332
===========
8. INCOME TAXES
Income tax expense was as follows:
1998 1997 1996
---------- ----------- ---------
Current:
Federal $1,317,000 $ 1,122,000 $ 761,000
State 271,000 248,000 168,000
---------- ----------- ---------
1,588,000 1,370,000 929,000
---------- ----------- ---------
Deferred:
Federal (107,000) 1,600 (117,800)
State (24,000) 400 (26,000)
---------- ----------- ---------
(131,000) 2,000 (143,800)
---------- ----------- ---------
Total income tax expense $1,457,000 $1,372,000 $785,200
========== =========== =========
Total income tax expense differed from the amounts computed by applying
the federal income tax rate of 34% to income before income taxes as a result of
the following:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------- ------------------------ ------------------------
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 $1,307,000 34.0% $1,175,000 34.0% $715,700 34.0%
State taxes, net of federal benefit 178,000 4.6 154,000 4.5 96,000 4.6
Nondeductible expenses 5,400 .1 5,000 .1 10,000 .4
Other (33,400) (.8) 38,000 1.1 (36,500) (1.7)
---------- ----- ------------ ----- ------------ -----
Total income tax expense $1,457,000 37.9% $1,372,000 39.7% $785,200 37.3%
========== ===== ============ ===== ============ =====
</TABLE>
16
<PAGE>
The net deferred tax liabilities in the accompanying balance sheets
include the following components:
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Deferred tax assets:
Deferred fees $ 119,091 $ 177,886
Allowance for loan losses 327,407 196,594
Deferred compensation 58,982 -
----------- ------------
Total deferred assets 505,480 374,480
----------- ------------
Deferred tax liabilities:
FHLB stock dividends 152,896 152,896
Depreciation 80,840 80,840
Unrealized gain on investment
securities available-for-sale 408,104 278,125
----------- ------------
Total deferred liabilities 641,840 511,861
----------- ------------
Net deferred liabilities $(136,360) $(137,381)
=========== ============
</TABLE>
Retained earnings at December 31, 1998, 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, 1998.
Prior to January 1, 1996, the Bank computed its tax bad debt deduction
based upon the percentage of taxable income method as defined by the Internal
Revenue Code. The bad debt deduction allowable under this method equaled 8% of
taxable income determined without regard to the bad debt deduction and with
certain adjustments. The tax bad debt deduction differed from the bad debt
expense used for financial accounting purposes.
In August 1996, the Small Business Job Protection Act (the "Act") repealed
the percentage of taxable income method of accounting for bad debts effective
for years beginning after December 31, 1995. The Act requires the Bank to
change its method of computing reserves for bad debts to the experience method.
This method is available to banks with assets less than $500 million and will
allow the Bank to maintain a tax reserve for bad debts and to take bad debt
deductions for reasonable additions to the reserve. As a result of this change,
the Bank will have to recapture into income a portion of its existing tax bad
debt reserve. This recapture will occur ratably over a six-taxable year period,
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.
17
<PAGE>
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, 1998 and 1997, in addition to the undisbursed portion
of loans receivable, the Company had outstanding loan commitments approximating
$1,713,949 and $2,790,000, 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 $4,397,000 and $4,800,000 at December 31, 1998 and 1997,
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.
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 1998 or 1997.
18
<PAGE>
Net pension cost for the Company's plan consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
--------- ----------- -----------
<S> <C> <C> <C>
Service cost $ - $ 49,239 $ 68,705
Interest cost - 71,313 61,651
Actual return on plan assets - (76,268) (98,075)
All other components - (6,618) 28,140
Charge resulting from plan curtailment - 73,314 -
Credit resulting from plan settlement - (215,633) -
--------- ----------- -----------
Net pension (credit) cost $ - $ (104,653) $ 60,421
========= =========== ===========
</TABLE>
Assumptions used to develop the net periodic pension cost were:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Discount rate N/A 7.5% 7.5%
Expected long-term rate of return on plan assets N/A 8.0% 8.0%
Rate of increase in compensation levels N/A 5.0% 5.0%
</TABLE>
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, 1998, 120,946 shares of stock have been authorized
for grants of options for this plan.
The following table provides the pro forma disclosures:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -------------
<S> <C> <C> <C> <C>
Net income As reported $2,386,204 $2,084,011 $1,319,727
Pro forma 2,284,225 2,084,011 1,319,727
Basic earnings per share As reported 3.00 2.57 1.65
Pro forma 2.88 2.57 1.65
Diluted earnings per share As reported 2.80 2.40 1.53
Pro forma 2.68 2.40 1.53
</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 Black-
Scholes pricing model with the following weighted-average assumptions used for
the 1998 grants: dividend yield of 0.5%, expected volatility of 15%, a risk-
free rate of 4.97%, 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 1998 was $10.20.
19
<PAGE>
Substantially all options are 100% vested when granted, and all options
expire after 10 years. The following tables summarize activity in the plan:
<TABLE>
<CAPTION>
1998 1997 1996
---------------- ---------------- -----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 85,566 $ 9.19 97,464 $8.56 131,233 $7.33
Granted 22,006 24.18 - .00 - .00
Exercised 7,627 7.08 11,898 5.69 33,625 5.30
Rescission of exercise 1,873 6.50 - .00 - -
Forfeitures - - 144 3.58
------- ------ -------
Outstanding at end of year 101,818 12.61 85,566 9.19 97,464 8.56
======= ====== =======
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- --------------------------------
Weighted Weighted
Number Remaining Number Average
Outstanding Contractual Exercisable Exercise
12/31/98 Life 12/31/98 Price
------------- ----------- ------------ ----------
<S> <C> <C> <C>
$ 18,141 1 year $ 18,141 $ 6.50
61,671 7 years 60,298 10.28
1,006 9 years 1,006 21.51
21,000 10 years 21,000 24.31
------------- ------------
$101,818 $100,445 12.64
============= ============
</TABLE>
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, 1998, the Plan owns
59,744 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, 1998, 1997, and 1996, the Company charged $186,000, $102,000, and
$46,000 against earnings to fund the Plans.
20
<PAGE>
13. STOCK DIVIDENDS
On January 22, 1999, the Board of Directors declared a $.20 per share cash
dividend to be distributed to holders of record on March 17, 1999.
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, 1998, the Board of Directors declared a 5% stock dividend
that was distributed to holders of record on March 7, 1998. The stock
distribution increased the Corporation's issued stock by approximately 37,500
shares.
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, 1998, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 1998, 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.
21
<PAGE>
The Company's and the Bank's actual capital amounts and ratios for 1998
and 1997 are presented in the tables below:
<TABLE>
<CAPTION>
To be Considered
Well Capitalized
Required for Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
------------------ ------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
At December 31, 1998:
Total capital (to risk-
weighted assets):
The Company $22,023 18.27% $9,640 8.0%
The Bank 21,791 18.08% 9,640 8.0% $12,050 10.0%
Tier 1 Capital (to risk-
weighted assets):
The Company 20,483 17.00% 4,820 4.0%
The Bank 20,251 16.80% 4,820 4.0% 7,230 6.0%
Tier 1 Capital (to
average assets):
The Company 20,483 10.28% 7,964 4.0%
The Bank 20,251 10.17% 7,964 4.0% 6,025 5.0%
At December 31, 1997:
Total capital (to risk-
weighted assets):
The Company 19,953 17.38% 9,184 8.0%
The Bank 19,855 17.29% 9,184 8.0% 11,480 10.0%
Tier 1 capital (to risk-
weighted assets):
The Company 18,643 16.24% 4,592 4.0%
The Bank 18,545 16.15% 4,592 4.0% 6,888 6.0%
Tier 1 capital (to
average assets):
The Company 18,643 9.68% 7,702 4.0%
The Bank 18,545 9.64% 7,692 4.0% 9,615 5.0%
</TABLE>
22
<PAGE>
Earnings Per Share
------------------
The calculations of basic and diluted earnings per share are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Basic earnings per share:
Net income $2,386,204 $2,084,011 $1,319,727
Average common shares outstanding 793,458 811,694 799,804
Net income per common share - basic $ 3.00 $ 2.57 $ 1.65
Diluted earnings per share:
Net income 2,386,204 2,084,011 1,319,727
Average common shares outstanding 793,458 811,694 799,804
Stock option adjustment 59,687 55,809 62,222
Average common shares outstanding - diluted 853,145 867,503 862,026
Net income per common share - diluted $ 2.80 $ 2.40 $ 1.53
</TABLE>
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.
23
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
--------------------------- --------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 906,658 $ 906,658 $ 650,923 $ 650,923
Interest-bearing deposits
with banks 4,152,816 4,152,816 5,169,830 5,169,830
Investment securities and
stock in FHLB and FRB 60,121,025 60,140,991 55,751,720 55,781,533
Loans receivable, net 132,645,936 134,181,574 121,866,762 124,180,547
Loans held for sale 2,266,697 2,266,697 1,698,872 1,698,872
Liabilities:
Savings, NOW and money
market accounts 73,229,364 73,259,364 60,564,077 60,564,077
Time certificates 78,556,000 78,085,030 81,712,000 81,339,062
Long-term debt and other
borrowed funds 33,434,332 33,367,035 29,201,820 29,275,120
</TABLE>
At December 31, 1998 and 1997, the Company had outstanding loan commitments and
standby letters of credit of $6.1 million and $5.3 million, respectively. Based
on the short-term lives of these instruments, the Company does not believe that
the fair value of these instruments differs significantly from their carrying
values.
Valuation Methodology
---------------------
Cash and Cash Equivalents - For cash and cash equivalents, the carrying
amount is a reasonable estimate of fair value.
Investment Securities - Fair values are based on quoted market prices
or dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Mortgage-Backed Securities - Fair values are based on quoted market
prices or dealer quotes. If a quoted market price is not available, fair value
is estimated using quoted market prices for similar securities.
Loans Receivable and Loans Held for Sale - For conforming residential
first-mortgage loans, the market price for loans with similar coupons and
maturities was used. For nonconforming loans with maturities similar to
conforming loans, the coupon was adjusted for credit risk. Loans which did not
have quoted market prices were priced using the discounted cash flow method.
The discount rate used was the rate currently offered on similar products.
Loans priced using the discounted cash flow method included residential
construction loans, commercial real estate loans, and consumer loans. The
estimated fair value of loans held for sale is based on the terms of the related
sale commitments.
24
<PAGE>
Deposits - The fair value of checking accounts, saving accounts, and
money market accounts was the amount payable on demand at the reporting date.
Time Certificates - The fair value was determined using the discounted
cash flow method. The discount rate was equal to the rate currently offered on
similar products.
Long-Term Debt and Other Borrowed Funds - 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, 1998 and 1997. 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.
25
<PAGE>
17. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Condensed Balance Sheets:
ASSETS
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Cash $ 44,935 $ 120,288
Accounts receivable 11,734 1,383
Investment securities available-for-sale 224,970 -
Investment in wholly owned subsidiary 20,899,960 19,004,345
----------- -----------
TOTAL ASSETS $21,181,599 $19,126,016
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $ 49,633 $ 39,937
Stockholders' equity:
Common stock 7,893 7,827
Surplus 7,309,901 6,574,162
Retained earnings 13,372,441 12,256,443
Unearned ESOP shares (206,883) (194,385)
Accumulated other comprehensive income 648,614 442,032
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $21,181,599 $19,126,016
=========== ===========
Condensed Statements of Income:
<CAPTION>
Year Ended December 31,
------------------------------------------
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Dividends from subsidiary $750,000 $ - $ -
Interest income 13,882 41,879 38,463
Loss on sale of investment securities (391) (250) -
Amortization and miscellaneous expenses (76,671) (72,323) (53,981)
------------ ------------- -------------
Income (loss) before income taxes and equity
in undistributed net income of subsidiary 686,820 (30,694) (15,518)
Federal and state income tax benefit 10,350 10,436 5,276
Equity in undistributed net income of subsidiary 1,689,034 2,104,269 1,329,969
------------ ------------- -------------
NET INCOME $2,386,204 $2,084,011 $1,319,727
============ ============= =============
</TABLE>
26
<PAGE>
Condensed Statements of Cash Flows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,386,204 $ 2,084,011 $ 1,319,727
Adjustments to reconcile net income to net
cash provided by operating activities:
Increase in investment in wholly owned subsidiary (1,689,034) (2,114,705) (1,335,245)
Loss on sale of investment securities 391 250 -
Amortization of discount on investments - (25,140) (24,187)
Increase in current assets (10,350) - -
Increase (decrease) in current liabilities 9,696 273 (30,936)
----------- ----------- -----------
Net cash provided (used) by
operating activities 696,907 (55,311) (70,641)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment securities
available-for-sale (633,861) (343,295) (431,598)
Maturity or redemption of investment
securities available-for-sale 408,500 815,750 430,000
----------- ----------- -----------
Net cash (used) provided by
investing activities (225,361) 472,455 (1,598)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (102,498) (81,008) (74,045)
Exercise of stock options 41,835 20,795 178,198
Net change in ESOP loan (12,600) (20,154) (36,008)
Redemption of common stock (473,636) (348,271) -
----------- ----------- -----------
Net cash (used) provided by
financing activities (546,899) (428,638) 68,145
----------- ----------- -----------
DECREASE IN CASH (75,353) (11,494) (4,094)
CASH AT BEGINNING OF YEAR 120,288 131,782 135,876
----------- ----------- -----------
CASH AT END OF YEAR $ 44,935 $ 120,288 $ 131,782
=========== =========== ===========
</TABLE>
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
The year ended December 31, 1998 was the first complete year of operations as
a commercial banking institution. The Community Bank of Tri-County ("the Bank")
provided the Tri-County Financial Corporation ("the Company") with record
earnings of $2.4 million, an increase of 14.5% over the year ended December 31,
1997.
In the five year business plan of the Bank, specific areas of portfolio growth
and marketing programs were targeted to create an earnings stream comparable to
established community banks. The key component of this strategy was to increase
the levels of commercial and consumer loan products. Utilizing the Bank's
existing delivery systems, the management began to capitalize on the lucrative
niche for community based lending. Market response was favorable and the
initial momentum generated even greater increases in commercial and consumer
loans than management had expected.
The outcome of management's efforts to restructure its portfolio and lines of
business was evident in the percentages of growth in targeted lines. Net loans
receivable increased by $10.8 million, or 8.8%. Commercial real estate loans
grew by $2.9 million or 17.4% and lines of credit grew by $1.3 million or 27.0%.
Management failed to meet business plan target growth in the area of second
mortgages. With low fixed rate loans available, many borrowers paid off their
second mortgages while refinancing their first mortgages to a lower rate.
Second mortgages declined $1.1 million, or 6.0%.
On the deposit side of the balance sheet, non-interest bearing demand accounts
grew by $2.6 million or 35.0% during the year. Transactional accounts comprise
$38.5 million, or 25.3% of the deposit base of the Bank at December 31, 1998
compared to $22.7 million or 16% at December 31, 1997. This increase resulted
from the Bank's development of accounts geared for the small business customer
as well as the creation of a money market indexed account with check withdrawal
privileges.
Residential mortgage lending continued to be a profit center for the Bank and
has produced a volume of $54.8 million in loans, up 4.5% over 1997's level. The
low rate environment continued the high refinancing activity. The majority of
fixed rate long term loans were sold in the secondary market, with the servicing
retained by the Bank, while adjustable rate mortgages and certain shorter
maturity fixed rate loans were originated for the Bank's portfolio. In 1998, the
continuation of a flat yield curve and the downward pressure on long term
treasury rates due to the international flight to quality in fixed rate
investments increased the prepayment rate of the Bank's loan portfolio. The high
rate of prepayment and subsequent reinvestment of the proceeds in new loans
resulted in a marked decline in the overall yield of the loan portfolio. This
reduction will affect the future earning stream until the funding costs are able
to reprice under a falling rate scenario. The margin between rates earned on the
Bank's loan portfolio and the rates paid on its customer deposits was narrowed
by 5 basis points from 5.14% to 5.09%.
28
<PAGE>
The Bank is continuing to search for locations and platforms to deliver its
products to the region in a cost efficient manner. A prime location adjacent to
Southern Maryland's only regional mall was acquired in late 1997 and put into
operation in the first quarter of 1998. This provided a highly visible
commercial branch for further development of market share. The Bank is
expanding on its "micro-branching" concept by using lobbies connected with
convenience stores while providing full service drive-in hours and ATM access.
These micro-branches will be used as in-fill delivery sites and be supported by
our anchor branch staffs. Additional ATM sites have been acquired in several
retail establishments and management continues to seek such opportunities to
serve the local market. These steps are taken to generate fee income and
further advance the name recognition of the Bank.
In an effort to provide a wider range of services and products to Bank
customers and generate additional fee income, two new lines of business were
offered in 1998. First, an arrangement was made with a local insurance agency
so that property and casualty coverage will be offered, initially to loan
customers, but ultimately available to all. Second, with investment and
retirement planning of such importance to Bank customers, an investment
representative was hired to provide such services. Management anticipates that
fee income from these sources will develop slowly, but the customer
relationships established will solidify Community Bank's position in the area
market.
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's net income for 1998 increased $302,000 or $.43 in basic earnings
per share over 1997's record levels. This was a slowing of the earnings growth
momentum experienced in 1997 when net income increased $764,000 or $.92 in basic
earnings per share over 1996 levels.
The Board of the Bank has 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 Bank continues to provide for increased loan losses that can be
associated with more risky commercial and consumer lending. In both 1998 and
1997, $240,000 was charged against earnings to increase the allowance for loan
losses.
The weighted average yield on all interest-earning assets was 8.07% in 1998,
8.29% in 1997 and 8.25% in 1996. The interest rate yield curve during the year
was flat with a general decline in the level of rates earned. The decrease in
the weighted average yield occurred as principal curtailments or payoffs were
received and somewhat lower yields were available on the investments acquired
with the cash received. 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 seventh year without significant inflationary
pressure.
29
<PAGE>
As evidenced in the "Gap" chart in the "Market Risk Analysis" section of this
discussion, the Bank has exposure to rising rates, particularly in the short to
moderate term sectors. There were periods during 1997 when short term rates
exceeded long term rates, an "inverted yield curve"; 1998 saw some improvement
in the yield curve. However, there is still significant pressure on the Bank's
net interest 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 decline in the level of rates reduced the Bank's cost of funds at a
slower pace than the decline in asset returns. The weighted average rate paid
on all interest-bearing liabilities was 4.24% in 1998, 4.37% in 1997 and 4.22%
in 1996. The Board of Directors of the Bank continually 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.
The net interest rate spread was 3.84% in 1998 compared to 3.92% in 1997 and
4.03% in 1996. The trend has been toward a narrowing of the yield over the past
several years; the interest rate spread will increase in the future only if a
normal interest rate cycle is regained in the economy. If the classic pattern
of inflationary pressures and interest rate volatility return to the economic
front, a restructuring of the Bank's assets will be necessary to realize
increased returns. An interest rate sensitivity analysis follows this section
and will provide a more detailed discussion.
The continued negative effect of the low long term rate environment on the
refinancing activity of the fixed rate portfolio and of the loans serviced for
others has decreased loan yields. Further, the Bank's adjustable rate mortgage
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 Statement of
Financial Accounting Standards Nos. 114 and 118. The nonaccrual loans for 1998
totaled $269,00 compared to $160,000 for 1997 and $400,000 for 1996. Increasing
levels of commercial and consumer loans are expected to create some additional
collection problems for the Bank, but these loans are still relatively new and
the Bank has not yet experienced an increase in delinquencies in these loan
groups. The Bank owned no real estate acquired through foreclosure at the end
of 1998 and 1997.
OPERATIONAL ANALYSIS
Noninterest expense increased by 12.1% or $589,000 to $5,467,000 for 1998
compared to $4,877,000 in 1997 and $4,530,000 after adjustment for the $820,000
SAIF recapitalization charge in 1996. Salaries and employee benefits generated
the largest line item dollar increase in 1998, $491,000, as higher personnel
levels were required to handle the increase in transactional and business
activity and to staff the growing branch network. The Bank has implemented a
branch wide incentive plan for its managers that is based on specific
operational goals as well as corporate rates of return and quality of loan
criteria. The managers may receive cash incentives as well as stock options
based on their success in obtaining strategic goals. This greatly expands the
coverage of employees under an incentive based pay structure and more closely
aligns the manager or executive to the overall performance of the Bank. Further
incentive plans for the remaining employees are currently under
development.
30
<PAGE>
During 1997, 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 net benefit to the Company
resulting from this plan curtailment was $105,000 in 1997. No future costs are
expected with this plan. This continued the strategy of the Bank to link
compensation with performance for its employees.
Occupancy expense is increasing as the branch network expands and as the
administrative office space is expanded within the home office facility.
Deposit insurance costs are incurred at a level just under $100,000 since the
conversion to a commercial bank. As a thrift prior to that, the normal
recurring costs approached $400,000 annually.
YEAR 2000 READINESS DISCLOSURE
The Bank's management and Board of Directors has been closely monitoring the
problems created by the year 2000 (Y2K) and its effect on data processing
systems. Banks are particularly aware of the potential problems due to the high
reliance on technology and computerized information systems. Whether an actual
threat exists or not, the Bank customer's perception of the problem will
directly affect Bank operations. If consumer confidence in general retail
operations is lacking, the bank may experience large cash withdrawal demands.
This cash would then be used, instead of checks or credit, to satisfy the
customer's needs for daily living supplies. Projections of customer withdrawal
demands are being made to adequately prepare for the maintenance of cash
balances in the branch system. Standby funding sources are being evaluated to
meet cash demands. At the same time, an ongoing information program has been
established to inform our customers of our state of readiness and of tips for
coping with the coming date change.
The Bank began its Y2K program in early 1997 and included complete analysis of
all Bank functions, documentation of the technology reliance and rating of the
systems in order of critical need. Contingency plans are being written and
timetables developed for the implementation of the contingency operations in the
event of failure in any given area. Testing of the plans will be performed for
critical areas.
The Bank's capitalized cost of new technology and software over the last three
years has exceeded $520,000. All mission critical software systems have been
evaluated and upgraded where necessary and possible. The majority of 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
branch locations has been subjected to periodic reviews by its regulators. It
has completed its Phase II examination by the Federal Reserve. No material
changes to the Bank's Y2K Readiness Plans were required. The Bank complies with
the Federal Financial Institutions Examination Council guidelines for Y2K
compliance. Continual testing of the systems with its third party provider is
ongoing and the testing of mission critical systems is scheduled for completion
by June 30, 1999. 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.
31
<PAGE>
Bank customers can put the Bank at risk by their failure to attain Y2K
compliance. In early 1998, borrowers were contacted about their readiness to
determine if the collection of loans may be adversely affected. New loan
approval procedures include an evaluation of the borrower's Y2K compliance and
loan documentation requires certification of the borrower's compliance.
The Bank is put at risk by outside parties due to its reliance on them for
electricity, telecommunications and other operating needs. The readiness of
these outside parties is beyond the Bank's control, though alternative sources
are evaluated where available.
NET PREMISES AND EQUIPMENT
Net premises and equipment increased by 3% or $127,000 in 1998 compared to a
9.5% or $365,000 increase in 1997 over 1996. Continued investment in technology
platforms, particularly to prepare for the Y2K situation, and various internal
office expansion and renovation required capital outlays in 1998. The purchase
of the St. Patrick's Drive branch building during the fourth quarter of 1997 and
investment in technology platforms required significant outlays in 1997.
BORROWINGS
The Bank's borrowing, consisting mainly of advances from the Federal Home Loan
Bank of Atlanta ("FHLB"), increased to $32.9 million from $28.4 million at
December 31, 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 equity to
maximize revenue production while managing asset and liability interest rate
risk.
STOCKHOLDERS' EQUITY
Stockholders' equity grew by 10.7%, or $2,046,000 during 1998 to $21,132,000
compared to 11.8% or $2,009,000 to $19,086,000 during 1997. This represents an
average net worth to total assets ratio of 10.1%, up from 9.8% in 1997.
The net unrealized gain on investment and mortgage-backed securities available
for sale included in accumulated other comprehensive income continued to grow,
increasing by $207,000 in 1998 in addition to the increase of $353,000 in 1997
due to the effects of the lower long term rate environment on the mortgage
portfolio. The valuation allowance is subject to the fluctuations in interest
rates and will be reflected in the quarterly statements to the regulatory
agencies and shareholders.
The Company's total risk based capital ratio for 1998 was 18.27% or
$22,023,000 compared to 17.38% or $19,953,000 in 1997. The Tier I risk based
capital level for 1998 was $20,483,000 or 17.00% compared to $18,643,000 or
16.24% in 1997. 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, 1998, the Bank exceeded all capital requirements
and was considered to be "well-capitalized" under regulatory definitions.
32
<PAGE>
During the year, the Board of Directors of the Company continued to provide
liquidity to its shareholder base through stock repurchases. The Company
purchased and retired 20,039 shares for $474,000 in 1998 and 17,000 shares for
$348,000 in 1997. With the downward shift in market values for financial
institution stock during 1998, the Company utilized its capital management
strategy to include repurchases and retirement of stock at levels that would be
antidilutive to the shareholder base.
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, 1998, it had $32.9 million outstanding or 15.9%
of its assets. Its year 2000 liquidity plan has been developed and is currently
being operated in conjunction with the guidelines of the Federal Reserve and
with the cooperation of the FHLB, its primary wholesale source.
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>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Sensitivity of market value of portfolio equity:
Interest rate changes - adverse scenario:
Up 200 basis points -12% -4%
Down 200 basis points +5% -5%
Sensitivity of net interest income:
Interest rate changes - adverse scenario:
Up 200 basis points -1% +7%
Down 200 basis points +1% -9%
</TABLE>
33
<PAGE>
The change in percentage for the Market Value of Portfolio Equity declined
at the adverse scenario of up 200 basis points in interest rate movement, while
the equity value improved in the down 200 basis shock. This reflects the impact
of multi-year flat yield curves at lower rate levels. As prepayments have
occurred, reinvestment of the proceeds was a lower yields. An immediate market
rate increase would made those new investments less valuable. 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 an upward movement of rates. Neither scenario,
however, generates a severe impact to the Bank's earnings. 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.
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,
1998:
34
<PAGE>
<TABLE>
<CAPTION>
0 to 90 91 to 365 Over 1 to Over 3 to Over 5
days days 3 years 5 years years
------- --------- --------- --------- --------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Rate Sensitive Assets:
Interest bearing deposits with banks $ 4,152 $ - $ - $ - $ -
Investment securities 8,915 - - 10,640 36,852
Loans 33,387 16,908 59,518 12,079 13,021
--------- --------- --------- -------- -------
Total rate sensitive assets 46,454 16,908 59,518 22,719 49,873
Rate Sensitive Liabilities:
Noninterest bearing deposits 9,753 - - - -
Interest bearing demand deposits 17,005 - - - -
Money market deposits 20,775 - - - -
Regular savings deposits 25,771 - - - -
Time deposits 11,061 26,858 36,586 4,051 -
Other borrowed funds and
long-term debt 16,500 15,096 - 11,400 -
--------- --------- --------- -------- -------
Total rate sensitive liabilities 100,865 31,954 36,586 15,451 -
Interest rate sensitivity gap (54,411) (15,046) 22,933 7,268 49,873
Cumulative interest rate
sensitivity gap (54,411) (69,457) (46,524) (39,256) 10,617
</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 equity
leveraging policies to maintain a profitable level of mismatched assets and
their funding costs.
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.
35
<PAGE>
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 1998, the Company was made aware of several trades which occurred.
During 1998, a total of 29,176 shares traded, with a high price of $27.50 and
a low price of $20. The weighted average price was $23.40. The number of
shareholders at March 17, 1999 was 534 and the total outstanding shares was
793,563. On January 22, 1999, the Board of Directors declared a $.20 per share
cash dividend payable on April 17, 1999 to shareholders of record on March 17,
1999. 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.
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 is 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.
36
<PAGE>
Portfolio Net Spread
- --------------------------------------------------------------------------------
PORTFOLIO NET SPREAD
December 31, 1998
Weighted
Weighted average
average rate paid
on all on all
interest- interest-
earning bearing
Date assets liabilities Net Spread
------ ---------- ------------- ------------
1994 8.03% 4.16% 3.87%
1995 8.45% 4.28% 4.17%
1996 8.25% 4.22% 4.03%
1997 8.29% 4.37% 3.92%
1998 8.15% 4.24% 3.91%
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
RETURN ON ASSETS
1994 1.08%
1995 1.28%
1996 0.77%
1997 1.13%
1998 1.20%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NET INCOME
1994 $1,583,057
1995 $2,027,814
1996 $1,319,727
1997 $2,084,011
1998 $2,386,20
- --------------------------------------------------------------------------------
<PAGE>
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total Amount of:
Loans Outstanding ......................... $ 134,912,633 $ 123,565,634 $ 111,862,620 $ 107,678,852 $ 98,646,221
Interest and Noninterest-bearing Cash ..... 5,059,474 5,820,753 3,903,612 4,050,219 3,471,953
Investment Securities ..................... 60,121,025 55,751,720 56,783,231 46,858,152 44,526,381
Assets .................................... 207,019,790 191,188,360 178,146,326 164,124,420 153,008,090
Savings Deposits .......................... 151,815,364 142,276,077 135,534,163 130,034,043 126,840,279
Borrowed Money ............................ 33,434,332 29,201,820 24,733,466 17,552,845 12,480,128
Stockholders' Equity ...................... 21,131,966 19,086,079 17,077,452 15,832,925 13,325,589
Number of:
Loans Outstanding ......................... 3,063 3,023 2,854 2,792 2,667
Savings Accounts .......................... 15,565 15,303 14,849 14,090 14,409
Offices Open - All Full Service ........... 8 8 8 6 6
<CAPTION>
For the Year Ended December 31,
------------------------------------------------------------
1998 1997 1996 1995 1994
------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Weighted Average Yield on:
Loan Portfolio ............................................... 9.00% 9.20% 9.13% 9.38% 8.44%
Investment Portfolio .......................................... 6.42 6.48 6.42 6.45 5.24
All Interest-earning Assets ................................... 8.15 8.29 8.25 8.45 8.03
Weighted Average Rate Paid on:
Savings Deposits and Escrow ................................... 3.91 4.06 4.05 4.06 3.67
Federal Home Loan Bank Advances and Other Borrowings .......... 5.72 5.91 5.46 6.21 7.02
All Interest-bearing Liabilities .............................. 4.24 4.37 4.22 4.28 3.87
Interest Rate Spread (Spread Between Weighted
Average Rate on All Interest-earning Assets
and All Interest-bearing Liabilities) ......................... 3.91 3.92 4.03 4.17 4.16
Net Yield (Net Interest Income as a
Percentage of Average Interest-earning Assets) ................ 4.21 4.23 4.32 4.46 4.38
</TABLE>
<PAGE>
SUMMARY OF OPERATIONS
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest Income .............................................. $ 15,726,032 $ 14,993,261 $ 13,471,595 $ 12,900,876 $ 11,262,969
Interest Expense ............................................. 7,596,727 7,350,648 6,406,756 6,094,968 5,117,503
---------------------------------------------------------------------
Net Interest Income .......................................... $ 8,129,305 $ 7,642,613 $ 7,064,839 $ 6,805,908 $ 6,145,466
Loss Provision and Charge offs of Loans ...................... 240,000 240,000 408,000 210,000 154,000
---------------------------------------------------------------------
Net Interest Income
After Provision for Loss on Loans ....................... $ 7,889,305 $ 7,402,613 $ 6,656,839 $ 6,595,908 $ 5,991,466
Other Income ................................................. 1,420,536 930,745 798,405 857,467 562,297
Less Noninterest Expense ..................................... 5,466,637 4,877,347 5,350,317 4,098,561 3,928,991
---------------------------------------------------------------------
Income Before Federal Income Tax ............................. $ 3,843,204 $ 3,456,011 $ 2,104,927 $ 3,354,814 $ 2,624,772
Income Tax Expense ........................................... 1,457,000 1,372,000 785,200 1,327,000 1,041,715
Income Tax Benefit - Change in Accounting for Deferred Taxes . -- -- -- -- --
---------------------------------------------------------------------
Net Income ................................................... $ 2,386,204 $ 2,084,011 $ 1,319,727 $ 2,027,814 $ 1,583,057
---------------------------------------------------------------------
Net Income Per Common Share (1) .............................. $ 3.00 $ 2.57 $ 1.65 $ 2.62 $ 1.98
Cash Dividends Declared Per Common Share (2) ................. 158,712 97,627 75,498 70,574 64,751
</TABLE>
(1) Restated to reflect 1995, 1996, 1997 and 1998 stock dividends.
(2) 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;
a $0.20 per common share cash dividend was declared on January 22,1999,
payable to shareholders of record March 17, 1999
<PAGE>
Dear Shareholder:
I am pleased to report the operating results of Tri-County Financial
Corporation and its banking subsidiary, Community Bank of Tri-County, for the
year ended December 31, 1998. Net Income increased by 14.5% to $2.4 million
while basic earnings per share increased by $.53 or 21.4% to $3.00 per share.
At December 31,1999, the total assets of the company had increased 8.3% to
$207,000,000.
The success of the Company can be attributed to the excellent market
position of Community Bank and the growing awareness in the market that defines
it as "the" local bank. With eight locations strategically placed in three
counties, it enjoys the advantage of competing with the super regional banks by
using its closeness to the customer culture while being price sensitive to
competition. In utilizing a blend of wholesale investment strategies with
commercial banking operations, a consistent return on equity has been realized
by the Company over the last several years while the net worth of the Company
increased from strong earning streams. The Company's return on average assets
has improved to 1.20% in 1998, up from 1.13% in 1997 and .77% in 1996.
The bank is following its long-term business strategy by increasing lines
of business with higher profit potential than residential lending and
establishing fee generating divisions to broaden its relationship with each
customer. In 1999, it introduced an affiliation with UVEST, a brokerage service
that serves over 150 banks in providing full service brokerage sales. In
addition, an agreement with a local general insurance firm has resulted in the
increased marketing of property and casualty insurance to our customers.
Together, these divisions can begin to penetrate the insurance sector of
financial product lines for our customers. The current fee income stream, while
modest, is expected to become more substantial as these services gain customer
recognition.
As we approach the year 2000 date change issue, it is important for our
shareholders to know the state of readiness of the Company. For several years
your Board and management have closely attended to the issue of mission critical
data systems. The Bank's internal data processing systems have been tested and
upgraded where necessary. The third party providers of data services are in the
process of certifying that they will be ready to handle the date change. Our
correspondent banks have advised us of their state of readiness. Even our
commercial customers have been notified and are expressing an awareness that is
of reasonable comfort to the Bank. The Bank has recently completed the Federal
Reserve's Phase II examination without material changes in its readiness plan.
For the time available until the end of the year, what remains is the completion
and testing of contingency plans.
The economic environment in which we operate has created its own set of
opportunities as well as problems. While customer confidence in equities has
buoyed the stock market, the formation of deposits has virtually ceased in
America. This problem will be manifested in a greater dependence by banks on
wholesale funds. Further, banks will have to operate as a payment processing
entity instead of its more traditional role as a spread based lender. In order
to attract those payment streams, the Bank is redefining its traditional retail
center strategy and will focus on micro-delivery centers that will be supported
by its anchor centers. This should help increase its market share at an
efficient cost basis.
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In closing, our success results from the efforts of many stockholders, all
of whom feel an ownership in the Company. That philosophy helps balance long-
term growth objectives with short-term horizons, both in decision making and
operations. On behalf of the Board of Directors, management and staff, thank
you for your support. I am looking forward to serving you in the coming
century.
Yours truly
Michael L. Middleton
President and Chairman
