<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2000
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from_______________to
Commission File Number 0-18279
------------------------------
Tri-County Financial Corporation
--------------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1652138
----------------------------- --------------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 Leonardtown Road, Waldorf, Maryland 20601
------------------------------------------ ---------
(Address of principal executive offices) (Zip Code)
(301) 645-5601
------------------------------
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes x No
---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
As of October 31, 2000 registrant had outstanding 778,388 shares of Common
Stock.
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
FORM 10-Q
INDEX
-----
PART I - FINANCIAL INFORMATION Page
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets - September 30, 2000
and December 31, 1999 2
Consolidated Statements of Income and Comprehensive Income -
Three and Nine Months Ended September 30, 2000 and 1999 3
Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 2000 and 1999 4 - 5
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial Condition
and Results of Operations 7 - 12
PART II - OTHER INFORMATION 13 - 14
Item 6 - Exhibits
SIGNATURES 15
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS (UNAUDITED)
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2000 AND DECEMBER 31, 1999
<TABLE>
<CAPTION>
ASSETS
September 30, December 31,
2000 1999
<S> <C> <C>
Cash and due from banks $ 362,796 $ 3,469,304
Interest-bearing deposits with banks 4,255,187 3,063,279
Investment securities available for sale - at fair value 57,375,855 56,655,300
Investment securities held to maturity - at amortized cost 1,212,467 1,946,772
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 2,679,250 2,287,700
Loans held for sale 224,000 773,099
Loans receivable - net of allowance for loan losses
of $1,869,266 and $1,653,290, respectively 164,779,140 146,710,367
Premises and equipment, net 4,552,930 4,516,386
Foreclosed real estate 176,626 176,626
Accrued interest receivable 1,304,845 1,146,520
Other assets 2,013,569 2,151,927
----------------- -----------------
$ 238,936,665 $ 222,897,280
----------------- -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 11,640,615 $ 10,102,479
Interest-bearing deposits 151,778,800 145,639,321
----------------- -----------------
Total deposits 163,419,415 155,741,800
Short-term borrowings 35,344,861 13,398,378
Long-term debt 16,400,000 31,400,000
Accrued expenses and other liabilities 1,607,782 1,241,719
----------------- -----------------
Total liabilities 216,772,058 201,781,897
----------------- -----------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 783,294 and 788,173 shares, respectively 7,833 7,882
Surplus 7,487,901 7,447,240
Retained earnings 15,666,738 14,555,324
Accumulated other comprehensive loss (858,266) (718,498)
Unearned ESOP shares (139,599) (176,565)
----------------- -----------------
Total stockholders' equity 22,164,607 21,115,383
----------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 238,936,665 $ 222,897,280
----------------- -----------------
</TABLE>
See accompanying notes to unaudited consolidated financial statements
2
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2000 1999 2000 1999
<S> <C> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $ 3,555,423 $ 2,849,085 $ 10,247,145 $ 8,674,029
Taxable interest and dividends on investment securities 1,057,890 1,075,146 3,138,972 3,088,650
Interest on bank deposits 24,126 30,644 74,045 63,362
------------- -------------- -------------- --------------
Total interest income 4,637,439 3,954,875 13,460,162 11,826,041
------------- -------------- -------------- --------------
INTEREST EXPENSE:
Interest on deposits 1,666,387 1,386,524 4,589,295 4,123,337
Interest on long term debt 523,235 109,123 1,288,375 329,494
Interest on other borrowings 280,881 378,017 930,318 995,785
------------- -------------- -------------- --------------
Total interest expenses 2,470,503 1,873,664 6,807,988 5,448,616
------------- -------------- -------------- --------------
NET INTEREST INCOME 2,166,936 2,081,211 6,652,174 6,377,425
PROVISION FOR LOAN LOSSES 90,000 60,000 270,000 180,000
------------- -------------- -------------- --------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 2,076,936 2,021,211 6,382,174 6,197,425
------------- -------------- -------------- --------------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 23,888 38,045 63,016 151,827
Net gain on sale of loans held for sale 20,661 31,913 79,209 207,492
Service charges 249,872 194,614 736,930 564,294
Other 6,237 17,868 22,897 45,252
------------- -------------- -------------- --------------
Total noninterest income 300,658 282,440 902,052 968,865
------------- -------------- -------------- --------------
NONINTEREST EXPENSE:
Salary and employee benefits 885,926 890,112 2,690,305 2,542,333
Occupancy expense 173,475 126,660 477,407 381,942
Deposit insurance and surety bond premiums 7,940 36,047 23,865 107,602
Data processing expense 60,884 61,968 217,544 197,624
Advertising 65,075 66,471 196,047 170,986
Depreciation 53,301 55,149 161,318 184,346
Other 307,377 296,765 984,947 852,605
------------- -------------- -------------- --------------
Total noninterest expense 1,553,978 1,533,172 4,751,433 4,437,438
------------- -------------- -------------- --------------
INCOME BEFORE INCOME TAXES 823,616 770,479 2,532,793 2,728,852
INCOME TAXES 279,000 271,752 855,000 1,007,271
------------- -------------- -------------- --------------
NET INCOME 544,616 498,727 1,677,793 1,721,581
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
Net unrealized holding gains (losses) arising during the period 41,344 (399,656) (139,768) (962,531)
COMPREHENSIVE INCOME $ 585,960 $ 99,071 $ 1,538,025 $ 759,050
EARNINGS PER SHARE
Basic .69 .72 2.13 2.19
Diluted .66 .67 2.04 2.05
</TABLE>
See Accompanying Notes to Unaudited Consolidated Financial Statements.
3
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
---------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------
2000 1999
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,677,793 $ 1,721,581
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 270,000 180,000
Depreciation and amortization 234,300 272,550
Net amortization of premium/discount on
investment securities (86,055) (174,425)
Deferred income tax benefit (70,000) (44,000)
(Increase) decrease in accrued interest receivable (158,325) 60,841
(Decrease) increase in deferred loan fees (65,682) (82,560)
Increase in accounts payable, accrued expenses,
and other liabilities 366,063 321,051
Decrease (Increase) in other assets 283,729 (26,916)
Gain on sale of premises and equipment - (12,150)
Loss on sale of investment securities - 605
Origination of loans held for sale (1,611,775) (7,780,628)
Gain on sales of loans held for sale (79,209) (207,492)
Proceeds from sale of loans held for sale 2,240,082 9,679,417
------------- -------------
Net cash provided by operating activities 3,000,921 3,907,874
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing deposits with banks (1,191,908) 1,489,104
Purchase of investment securities available for sale (14,991,734) (52,086,274)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 14,139,816 49,401,043
Purchase of investment securities held to maturity (200,000) (1,170,436)
Proceeds from maturities or principal payments
of investment securities held to maturity 936,584 1,199,887
Loans originated or acquired (50,091,738) (41,498,077)
Principal collected on loans 31,818,648 36,780,102
Proceeds from the sale of premise and equipment 12,150
Purchase of premises and equipment (270,844) (476,866)
Acquisition of foreclosed real estate - (166,626)
Purchase of FHLB and Federal Reserve stock (391,550) (779,850)
------------- -------------
Net cash used in investing activities (20,242,726) (7,295,843)
------------- -------------
</TABLE>
4
<PAGE>
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
---------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------
2000 1999
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 7,677,615 $ 1,344,037
Proceeds from long-term borrowings - 35,000,000
Payments of long-term borrowings (15,000,000) (20,096,450)
Net increase (decrease) in other borrowed funds 21,946,483 (4,485,264)
Exercise of stock options 40,711 107,394
Net change in unearned ESOP shares 36,984 30,333
Dividends paid (236,595) (158,713)
Redemption of common stock (329,901) (657,150)
------------- ---------------
Net cash provided by financing activities 14,135,297 11,084,187
------------- ---------------
(DECREASE) INCREASE IN CASH AND DUE FROM BANKS (3,106,508) 7,696,218
CASH AND DUE FROM BANKS - JANUARY 1 3,469,304 906,658
------------- ---------------
CASH AND DUE FROM BANKS - SEPTEMBER 30 $ 362,796 $ 8,602,876
------------- ---------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the six months for:
Interest $ 6,413,408 $ 5,772,672
------------- -------------
Income taxes $ 725,000 $ 1,100,949
------------- -------------
</TABLE>
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. BASIS OF PRESENTATION
General - The consolidated financial statements of Tri-County Financial
Corporation (the Company) and its wholly owned subsidiary, Community Bank
of Tri-County (the Bank) included herein are unaudited; however, they
reflect all adjustments consisting only of normal recurring accruals that,
in the opinion of Management, are necessary to present fairly the results
for the periods presented. Certain information and note disclosures
normally included in financial statements prepared in accordance with
Generally Accepted Accounting Principles have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange
Commission. The Company believes that the disclosures are adequate to make
the information presented not misleading. The results of operations for the
nine months ended September 30, 2000 are not necessarily indicative of the
results of operations to be expected for the remainder of the year. Certain
previously reported amounts have been restated to conform to the 2000
presentation.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report for the year ended December 31,
1999.
2. EARNINGS PER SHARE
Basic and diluted earnings per share, as adjusted for the stock dividend,
have been computed based on weighted-average common and common equivalent
shares outstanding as follows:
Nine Months Ended
September 30,
------------------------
2000 1999
Basic 786,397 784,014
Diluted 824,072 838,439
3. PROSPECTIVE ACCOUNTING PRONOUNCEMENTS
Statements of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended by SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement No.133, requires derivative
instruments to be carried at fair value on the balance sheet. The statement
continues to allow 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 Company plans to adopt the provisions of this statement, as amended,
for its quarterly and annual reporting beginning January 1, 2001, the
statement's effective date. The impact of adopting the statement on the
Company's financial position, results of operations and cash flows
subsequent to the effective date is not currently estimable and will depend
on the financial position of the Company and the nature and purpose of any
derivative instrument in use at that time.
6
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
This document contains forward-looking statements, including discussions of
Tri-County Financial Corporation's (the "Company's") goals, strategies and
expected outcomes; estimates of risks and future costs; and reports of the
Company's ability to achieve its financial and other goals. These
forward-looking statements are subject to significant known and unknown risks
and uncertainties because they are based upon future economic conditions,
particularly interest rates, competition within and without the banking
industry, changes in laws and regulations applicable to the Company and various
other matters. Because of these uncertainties, there can be no assurance that
actual results, performance or achievements of the Company will not differ
materially from any future results, performance or achievements expressed or
implied by these forward-looking statements.
GENERAL
Tri-County Financial Corporation operates under the Federal Reserve's Bank
Holding Company regulations. The consolidated financial statements include the
accounts of Tri-County Financial Corporation and its wholly owned subsidiary,
Community Bank of Tri-County ("the Bank") and the Bank's wholly owned
subsidiary, Tri-County Investment Corporation, collectively referred to as "the
Company". Community Bank of Tri-County has completed its third year of
operations as a commercial bank, following its thrift charter conversion on
March 29, 1997.
In its business plan as a newly chartered commercial bank, the Bank targeted
commercial and consumer product lines to augment its financial performance in a
variety of interest rate environments. Generally, the Bank is seeking to bring
its investment in these products to amounts comparable to similarly sized
commercial banks. To date, growth in these targeted product lines has exceeded
internal expectations. The Bank's focus on the local business and consumer
markets has resulted in strong commercial and consumer loan and transactional
deposit growth. While these areas have been targeted for expansion, the Bank
anticipates that, over time, residential mortgage banking activity and
investment securities will represent a smaller portion of the total operations
of the Company. The Bank also anticipates that, over time, a broader array of
deposit types including checking and other transaction accounts will be employed
to supplant the traditional certificate of deposit funding associated with a
thrift institution. In decreasing reliance on CD's, and focusing on transaction
deposit products, the Bank hopes to make its deposit base less interest rate
sensitive. A deposit base less sensitive to changes in interest rates may, over
time, help to mitigate the impact of overall interest rate movements on the
Bank's net interest income.
The Bank conducts operations through eight full-service and one micro branch
offices in its market area consisting of Charles, St. Mary's and Calvert
counties in Maryland. Further full service or microbranch locations may be
sought depending on favorable market, cost, and other developments, in addition,
current branch locations may be moved to better serve our market. The Bank is
developing plans for other distribution methods to complement its traditional
branch structure including expanding its internet and electronic banking
capabilities. The Bank continues to capitalize on its niche in community based
banking activities. The Bank also continues to pursue opportunities to offer fee
based services which are complimentary to its lending and deposit business.
The Bank is primarily engaged in the business of obtaining funds in the form of
deposits from the general public in the Bank's market area as well as certain
wholesale borrowings from its correspondents and capital markets. It invests
such funds in loans collateralized by residential and commercial real estate,
mortgage-backed securities and related investments as well as unsecured and
secured commercial and consumer loans. The Company's earnings, therefore, are
primarily dependent upon its net interest income. This is determined by the
Company's interest rate spread (the difference between the yields earned on its
loan and investment portfolios, and the rates paid on its deposits and borrowed
funds) and the relative holdings of interest-earning assets and interest-bearing
liabilities. This spread is affected by changes in the overall interest rate
environment as well as by competitors pricing for similar products.
Because the majority of the Bank's income is dependent upon the repayment of
loan interest and principal, the Bank's ability to manage the risk of repayment
of its loans is critical to continued success. The Bank is required to estimate
its exposure due to loan losses and to provide an allowance for such losses.
This estimate is inherently inexact and reflects management's expectations as to
current and future economic conditions in the Southern Maryland area as well as
individual borrower's circumstances. Management believes that its allowance for
loan losses is adequate.
Noninterest income including sales of loans, transaction and other fees, and
other income is a significant part of the Company's income. The Company's
ability to earn noninterest income is dependent on outside factors such as
market conditions in mortgage lending, and internal factors such as the
Company's expertise in offering attractive products to its customers. The
Company believes that its emphasis on consumer transaction accounts and
commercial lending and deposit
7
<PAGE>
services will enable it to compete for increasing amounts of noninterest income.
Noninterest expenses include the expenses necessary for the delivery of the
Banks products and services including the cost of operating the Bank's branches.
Noninterest expense also includes the general and administrative expenses of the
Corporation. The majority of noninterest expense consists of personnel related
costs. Other large components consist of occupancy expense related to the Bank's
branches and headquarters and depreciation on equipment and buildings.
SELECTED FINANCIAL DATA
Nine Months Ended
September 30,
-------------
2000 1999
Condensed Income Statement
Interest Income $13,460,162 $11,826,041
Interest Expense 6,807,988 5,448,616
Net Interest Income 6,652,174 6,377,425
Provision for Loan Losses 270,000 180,000
Noninterest Income 902,052 968,865
Noninterest Expenses 4,751,433 4,437,438
Income Before Income Taxes 2,532,793 2,728,852
Income Tax Expense 855,000 1,007,271
Net Income 1,677,793 1,721,581
Per Common Share
Basic Earnings $ 2.13 $ 2.19
Diluted Earnings 2.04 2.05
Book Value 28.30 27.24
FINANCIAL CONDITION
Assets
Total assets as of September 30, 2000 grew $16.0 million to $238.9 million from
the December 31, 1999 level of $222.9 million. This reflects growth of 7.2% as
compared to 5.6% asset growth during the same period in 1999. Residential first
mortgage assets decreased slightly by $225 thousand in the current period to
$69.0 million. During the same period other loans increased from $79.9 million
to $98.3 million reflecting the Bank's increased emphasis on other lending
product lines. Overall loan balances including allowances and deferred income
increased during the first three quarters of 2000 from $146.7 million to $164.8
million. Currently loans (excluding loans held for sale) are 69.0% of total
assets compared with 65.8% at December 31, 1999. Management believes that the
continued development of Southern Maryland as both a commuter community and an
employment base provides the Company with many opportunities to profitably
expand its franchise.
During the first three quarters of the year, the Company's investment securities
portfolio was flat at $58.6 million. This lack of growth reflects management's
emphasis on building the loan portfolio, particularly in targeted lending areas
rather than increasing our reliance on investment securities. Investment
securities continue to be primarily invested in mortgage related securities such
as collateralized mortgage obligations, REMIC's, and mortgage backed securities.
The Company purchased $6 million in mortgage related securities during the nine
months ended September 30, 2000 as compared to $26 million for the same period
in the prior year. The Company may elect to increase the size of its investment
portfolio in the future based upon available investment opportunities.
8
<PAGE>
The allowance for loan losses was maintained at a level believed by management
to be adequate to absorb potential losses consistent with the risk profile of
the loan portfolio. Management's determination of the adequacy of the allowance
is based on a periodic evaluation of the portfolio with consideration given to
the overall loss experience; current economic conditions; volume, growth and
composition of the loan portfolio; financial condition of the borrowers; and
other relevant factors that, in management's judgment, warrant recognition in
providing an adequate allowance. The Bank's allowance for loan losses increased
$216 thousand during the first nine months of 2000 in accordance with
management's policy described above. Currently the Bank's allowance for loan
losses totals $1.9 million or 1.13% of loan balances as compared to $1.6 million
or 1.13% of loan balances at December 31, 1999.
Cash levels declined substantially during the first nine months of 2000. Cash
and due from banks totaled $363 thousand down from $3.5 million at December 31,
1999. Cash levels were higher than normal at December 31, 1999 due to concerns
that problems with the century date change would lead to cash needs in excess of
normal. No unusual cash needs were noted as a result of the century date change.
The net level of property and equipment balances increased $37 thousand during
the first 9 months of the year due to routine upgrades of computer equipment and
premises partially offset by continued depreciation of these assets.
Liabilities
Liability growth was managed to reflect the change in asset levels. Deposit
balances increased by $7.1 million or 4.6% for the nine months ended September
30, 2000. The Bank continues to aggressively market its deposit products in the
Southern Maryland area. Rate competition has been intense and stock market
returns realized for the last several years have caused some customers to change
their deposit philosophy and move their money to uninsured investment vehicles.
The Company believes that recent uncertainty in equity markets may encourage
some customers to increase balances in bank or other insured investments.
Funding demands in excess of deposit growth have been met by the use of other
borrowed funds. Long and short term borrowings increased by a total of $6.9
million or 15.5% over December 1999 balances. Other liabilities also increased
by $900 thousand or 73%.
Stockholders' Equity
Stockholders' equity increased $1.0 million or 5.0% to $22.2 million at
September 30, 2000 compared to $21.1 million at December 31, 1999. This reflects
the net income of $1,677,793 for the nine month period and a $139,768 decrease
in accumulated other comprehensive income. Other reductions in equity occurred
as a result of a $.30 per share cash dividend paid to shareholders and the use
of $330 thousand to purchase shares in the open market and retire them. The cash
dividends were distributed to shareholders on April 17, 2000. Book value on a
per share basis, $28.30 at September 30, 2000, as compared to $26.79 at December
31, 1999, reflects a 5.6% increase, as opposed to the 5.0% increase in
Stockholder's Equity. This disparity reflects the continuing purchase of the
Company's stock at below book value as noted below.
As part of its capital management strategy, the Board has approved certain
purchases, for retirement, of shares offered for sale by its stockholders. For
the nine months ended September 30, 2000, the Company purchased 11,703 shares
for $329 thousand. Additional stock acquisitions and retirements may be
considered in the future. The Company has $400 thousand of cash available at the
holding company level available for such purchases or for other cash needs of
the holding company. Funds for these and other future stock purchases were
provided to the company by a $500 thousand dividend from the Bank. This dividend
was declared at the July 26, 2000 meeting of the Board of Directors of the Bank.
RESULTS OF OPERATIONS
The Company's net income for the nine months ended September 30, 2000 decreased
$44 thousand or 2.5% from 1999's levels. The decrease is reflective of several
trends including the effect of an increased interest rate environment on the
Bank's net interest and noninterest income items as well as continued investment
in the Bank's resources to serve our customers. As noted in the "General"
section above, the Bank continues to emphasize the gathering of noninterest
sensitive liabilities, the production of loans which reprice quickly, and the
marketing of services which produce noninterest income such as fees. These
changes in its operations may decrease, but will not eliminate, the effect of
changes in the overall interest rate environment on its income.
9
<PAGE>
For the past several quarters, the Company has dealt with the effects of a
series of Federal Reserve interest rate increases designed to slow the pace of
economic growth. These increases have led to higher short term interest rates
which are reflected in our cost of funds in the current year versus the prior
year. The Company believes that the Federal Reserve increases may have already
achieved a significant slowing of the economy, although it is no yet fully
apparent. As such, we believe that the likelihood of significant short term rate
hikes in the next few quarters is lower, conversely, rate cuts by the Federal
Reserve or inaction on short term rates seems more likely in the short term. The
effects of cuts in short term rates or inaction on short term rates could result
in higher long term interest rates. Based on these factors, the Company believes
that long term interest rates may be lower now than in the near future. The
Company may move to increase its amount of long term borrowings in the next
several months. As noted above, the economy may already be slowing in response
to the Federal Reserve interest rate increases. A slowing economy generally will
manifest itself in higher levels of non-performing loans as well as associated
increases in charge-offs and other negative effects on loan performance.
Interest and Dividend Income
Interest and dividend income on investment securities increased $50 thousand or
1.6% in the first nine months of 2000 compared to the same period in 1999. This
increase reflects the increased average yield on the investment portfolio which
more than offset a decline in average investment balances of .8%. Interest
income on loans also increased by $1.6 million or 18.1%. This reflects a higher
rate environment, an increase in average loan assets of 15%, and an increasing
emphasis on consumer and commercial loan products which carry a higher interest
rate than residential first mortgage loans.
Interest Expense
Interest expense increased by $1.4 million or 25.0% reflecting the higher
interest rate environment and higher interest bearing liabilities average
balances. Interest expenses related to deposits increased by $466 thousand, an
increase of 11.3% over the same period in the prior year. This reflects an
increase in interest bearing deposits of $6.1 million or 4.2% combined with an
increase in the level of interest rates. Interest expense related to long and
short term debt increased by $893 thousand or 68%. This reflects an increase in
the average balances from $38.6 million to $48.3 million, an increase of 25%,
combined with an increase in interest rates.
Net Interest Income
Total net interest income increased by $275 thousand or 4.3% over the same
period in the prior year. This is a reflection of the 8.5% increase in average
assets from the same period in the prior year, from $213 million in the first
three quarters of 1999 to $231 million in the first three quarters of 2000,
offset by a decrease in the average spread on earning assets in the current
quarter. Total portfolio spread for the current quarter is 3.50% versus 3.67%
for the same period in the prior year.
Provision for Loan Losses
Total provision for loan losses in the current period increased by $90 thousand
or 50% over the same period in the prior year. This is a reflection of the
Bank's changing loan focus from residential first mortgage loans to other loan
types which historically have both higher interest and loan loss rates. It also
reflects expectations that several quarters of Federal Reserve interest rate
hikes may have already significantly slowed economic growth.
Noninterest Income
Total noninterest income for the first nine months of 2000 decreased by $67
thousand or 7% compared to the same period in the prior year. The largest
components of this decrease were the reductions in income related to the strong
residential mortgage loan refinance market of the prior year. Loan appraisal and
other loan fees declined by $88 thousand or 58% from $152 thousand in the first
9 months of 1999 to $63 thousand in the current period. Similarly, gain on sales
of mortgage loans declined by $128 thousand or 62% to $79 thousand in the
current period from $207 thousand in the same period last year. These declines
were partially offset by an increase in service charge income of $173 thousand
or 31% to $737 thousand over the same period in the prior year. This increase
was due to the increased amount of services provided to consumer and commercial
customers and an increase in demand deposit accounts which generate more income
than time deposits.
Noninterest Expense
The Bank experienced an increase in noninterest expenses of $314 thousand or
7.1% for the nine months ended September
10
<PAGE>
30, 2000 compared to the same period in the prior year. Compensation related
expenses increased $148 thousand, or 5.8%, as the Bank has created new positions
to meet the needs of a commercial bank and its customers. Occupancy costs
increased $95 thousand or 25% as a result of adding the branch location near the
St. Charles mall and expanding its Dunkirk branch facility. Data processing
expense increased by $20 thousand or 10.1% over the comparable period in 1999.
This reflects continued investment in the systems capability to serve our
customers. Depreciation expense decreased $23 thousand or 12.5%.
Income Taxes
The Company's income tax expense for the period was 33.8% of net income as
opposed to 36.9% in the prior year. The reduction in the overall tax rate from
year to year is reflective of the movement of a large percentage of its
investment assets to its investment subsidiary, Tri County Investment
Corporation in Delaware. Income from these investments is not subject to
Maryland income taxes, reducing overall tax rates. Other reductions in tax rates
were the result of increased investment in assets that produced nontaxable
income.
Earnings Per Share
Primary earnings per share for the nine months were $2.13 per share or $.06
lower than for the corresponding period in 1999. This is reflective of the
changes in net income as noted above. Diluted earnings per share for the period
was $2.04 or $.01 lower than the total from 1999.
RESULTS OF OPERATIONS -- THIRD QUARTER
The Company's net income for the third quarter of 2000 as compared to the same
period for the prior year increased to $545 thousand from $498 thousand for the
third quarter of 1999, an increase of 9.2%. This increase was due to
improvements in most of the components of net income as detailed below. Interest
income increased by $683 thousand or 17.3% from the same quarter in the prior
year. During the same period, interest expense increased by $597 thousand or
31.9%. Net interest income increased by $86 thousand or 4.1% from the same
period in 1999. This increase was due to increases in average assets of close to
10% partially offset by lower interest rate margins. Provision for loan loss
increased by 50% or $30 thousand from the third quarter of 1999. Noninterest
income increased by $18 thousand or 6.5% in the third quarter of 2000, compared
to the third quarter of 1999. This increase was due to the Bank's increasing
success in offering demand deposit accounts and other products and services to
its customers in the current quarter. These increases were partially offset by
decreases in residential mortgage lending activity in the current quarter as
opposed to the prior year. These declines in residential mortgage lending led to
smaller gains on sale of loans, down by $11 thousand or 35% from the third
quarter of 1999. Loan appraisal and other charges also declined by $14 thousand
or 37% to $24 thousand in the quarter compared to $38 thousand in the third
quarter of 1999. Noninterest expenses were slightly higher compared to the third
quarter of the prior year. Total noninterest expense increased by $21 thousand
or 1.4% for the third quarter compared to the same period last year. Basic
earnings per share decreased from $.72 per share in 1999, to $.69 in the current
year.
INTEREST RATE RISK MATTERS
The interest rate risk of the Bank is managed through the Board's Asset and
Liability Committee (ALCO). Together with the Bank's management, the committee
reviews the sensitivity of the market value of the portfolio equity and interest
rate sensitivity of net income. The changes in the market value of portfolio
equity, as well as the interest income sensitivity are caused by shifts in the
market rates of interest and can cause a negative or a positive impact in given
scenarios. The portfolio is subjected to periodic modeling to test the effects
of sudden and sustained interest rate shocks on the market value and the net
interest income sensitivity. The Basle Committee on Banking Supervision has set
standard measures of portfolio market value equity and interest income
sensitivity in a shock environment of an immediate up or down 200 basis point
shift in assumed interest rates. The impact of such a shock on the Bank's
portfolio has been estimated as follows:
<TABLE>
<CAPTION>
September 30, 2000 September 30, 1999
<S> <C> <C>
Market value of portfolio equity:
Interest rate changes:
Up 200 basis points -23% -10%
Down 200 basis points +10% +1%
</TABLE>
11
<PAGE>
<TABLE>
<S> <C> <C>
Interest rate sensitivity:
Interest rate changes:
Up 200 basis points -8% +6%
Down 200 basis points +10% -4%
</TABLE>
The change in percentage for the Market Value of Portfolio Equity increased at
the adverse scenario of up 200 basis points in interest rate movement, while the
equity value improved slightly in the down 200 basis shock. This reflects the
impact of the cumulative effects of long term rate increases. The effect on
market value is asymmetrical because of the significant amount of customer
options embedded in various financial instruments on the Bank's balance sheet.
The fact that market value would rise if rates were to decline and fall if rates
rose means that the values of the Company's assets are more sensitive to changes
in interest rates than our liabilities.
Because the net income of the Bank and Company is derived through the interest
spread of the portfolio, the Asset/Liability 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 and liabilities are employed for their income
production rather than value appreciation. Again the Company's net interest
income shows a heightened sensitivity to higher rates. The levels of change for
both the market value of the portfolio and the net interest income sensitivity
fall within the policy benchmarks established by the Board. Management will
continue to take steps to quantify and control the interest rate risk inherent
in its business.
The Bank will have reduced earnings from dramatic upward movements in interest
rates. However, the Bank's shift to commercial, consumer and other lending types
from residential first mortgages and its efforts to build demand deposit
business will help to reduce the amounts of earnings loss.
2000 READINESS
The Bank's management and Board of Directors closely monitored the potential
problems associated with the year 2000's effect on the Company's and its
customers' data processing and other operating systems. No significant problems
were noted with either Company or customer systems related to the date change.
REGULATORY MATTERS
The Bank is subject to Federal Reserve Board capital requirements as well as
statutory capital requirements imposed under Maryland law. At September 30,
2000, the Bank's tangible, leverage and risk-based capital was 9.42%, 9.33% and
15.46%, respectively. These levels are well in excess of the required 4.0%, 4.0%
and 8.0% ratios required by the Federal Reserve Board. The Bank's capital level
will remain well in excess of the required ratios after payment of the $500,000
dividend to the Tri County Financial Corporation. As noted above, this dividend
was declared at the July 26, 2000 meeting of the Bank's board of directors.
12
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TRI-COUNTY FINANCIAL CORPORATION
--------------------------------
PART II - OTHER INFORMATION
---------------------------
Item 6 - Exhibits
A. Exhibits
(27) Financial Data Schedule
13
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Tri-County Financial Corporation:
Date: November 13, 2000 By: /s/ Michael L. Middleton
----------------- -----------------------------
Michael L. Middleton, President
and Chairman of the Board
Date: November 13, 2000 By: /s/ William J. Pasenelli
----------------- ----------------------------
William J. Pasenelli
Chief Financial Officer
