.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2011
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 No. 0-18279
TRI-COUNTY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Maryland | 52-1652138 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
3035 Leonardtown Road, Waldorf, Maryland | 20601 | |
(Address of principal 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 $0.01 per share
(Title of Class)
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ | Accelerated filer ¨ | |
Non-accelerated filer ¨ | Smaller reporting company x | |
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ¨ No x
The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $36.9 million based on the closing price ($16.80 per share) at which the common stock was sold on the last business day of the Company’s most recently completed second fiscal quarter. For purposes of this calculation only, the shares held by directors, executive officers and the Company’s Employee Stock Ownership Plan of the registrant are deemed to be shares held by affiliates.
Number of shares of common stock outstanding as of February 29, 2012: 3,023,613.
DOCUMENTS INCORPORATED BY REFERENCE
1. | Portions of the Annual Report to Stockholders for the year ended December 31, 2011. (Part II) |
2. | Portions of the Proxy Statement for the 2012 Annual Meeting of Stockholders. (Part III) |
INDEX
Page | ||||
Part I | ||||
Item 1. | Business | 1 | ||
Item 1A. | Risk Factors | 22 | ||
Item 1B. | Unresolved Staff Comments | 28 | ||
Item 2. | Properties | 28 | ||
Item 3. | Legal Proceedings | 28 | ||
Item 4. | Mine Safety Disclosures | 28 | ||
Part II | ||||
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 28 | ||
Item 6. | Selected Financial Data | 29 | ||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operation | 29 | ||
Item 7A. | Quantitative and Qualitative Disclosures about Market Risk | 29 | ||
Item 8. | Financial Statements and Supplementary Data | 29 | ||
Item 9. | Changes In and Disagreements with Accountants on Accounting and Financial Disclosure | 30 | ||
Item 9A | Controls and Procedures | 30 | ||
Item 9B. | Other Information | 30 | ||
Part III | ||||
Item 10. | Directors, Executive Officers and Corporate Governance | 30 | ||
Item 11. | Executive Compensation | 31 | ||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 31 | ||
Item 13. | Certain Relationships and Related Transactions and Director Independence | 32 | ||
Item 14. | Principal Accountant Fees and Services | 32 | ||
Part IV | ||||
Item 15. | Exhibits and Financial Statement Schedules | 32 |
PART I
This report contains certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on Tri-County Financial Corporation’s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.
Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors that could affect actual results include interest rate trends, the general economic climate in the market area in which Tri-County Financial Corporation operates, as well as nationwide, Tri-County Financial Corporation’s ability to control costs and expenses, competitive products and pricing, loan delinquency rates and changes in federal and state legislation and regulation. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Tri-County Financial Corporation assumes no obligation to update any forward-looking statement after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
Item 1. Business
Tri-County Financial Corporation (the “Company”) is a bank holding company organized in 1989 under the laws of the State of Maryland. It owns all the outstanding shares of capital stock of Community Bank of Tri-County (the “Bank”), a Maryland-chartered commercial bank. The Bank was originally organized in 1950 as Tri-County Building and Loan Association of Waldorf, a mutual savings and loan association, and in 1986 converted to a federal stock savings bank and adopted the name Tri-County Federal Savings Bank. In 1997, the Bank converted to a Maryland-chartered commercial bank and adopted its current name. The Company engages in no significant activity other than holding the stock of the Bank and operating the business of the Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank and its subsidiaries.
The Bank serves the Southern Maryland counties of Charles, Calvert and St. Mary’s, (the “Tri-County area”) through its main office and nine branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Lusby, Charlotte Hall, Prince Frederick and Lexington Park, Maryland. The Bank operates fifteen automated teller machines (“ATMs”) including five stand-alone locations in the Tri-County area. The Bank offers telephone and internet banking services. The Bank is engaged in the commercial and retail banking business as authorized by the banking statutes of the State of Maryland and applicable federal regulations, including the acceptance of deposits, and the origination of loans to individuals, associations, partnerships and corporations. The Bank’s real estate financing consists of residential first and second mortgage loans, home equity lines of credit and commercial mortgage loans. Commercial lending consists of both secured and unsecured loans. The Bank is a member of the Federal Reserve and Federal Home Loan Bank (the “FHLB”) system and its deposits are insured up to applicable limits by the Deposit Insurance Fund administered by the Federal Deposit Insurance Corporation (the “FDIC”).
The Company’s executive offices are located at 3035 Leonardtown Road, Waldorf, Maryland. Its telephone number is (301) 645-5601.
Available Information
The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and any amendments to such reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on its website, www.cbtc.com, as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission. Information on the website should not be considered a part of this Form 10-K.
Market Area
The Bank considers its principal lending and deposit market area to consist of the Tri-County area. These counties have experienced significant population growth during the past decade due to their proximity to the growing Washington, DC and Baltimore metropolitan areas. Southern Maryland is generally considered to have more affordable housing than many other Washington and Baltimore area suburbs. In addition, the area has experienced rapid growth in the last decade in businesses and federal facilities located in the area. Major federal facilities include the Patuxent Naval Air Station in St. Mary’s County. The Patuxent Naval Air Station has undergone significant expansion in the last several years and is projected to continue to expand for several more years.
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In the last several years, residential housing and population growth in the Tri-County area has been constrained by certain government policies designed to limit growth. Growth has also been dampened as the demand for new housing in the Tri-County area has fallen as the overall housing market has fallen. Future regulatory events may adversely affect the Bank’s loan growth.
Competition
The Bank faces strong competition in the attraction of deposits and in the origination of loans. Its most direct competition for deposits and loans comes from other banks, savings and loan associations and federal and state credit unions located in its primary market area. There are currently 13 FDIC-insured depository institutions operating in the Tri-County area including subsidiaries of several regional and super-regional bank holding companies. According to statistics compiled by the FDIC, the Bank was ranked second in deposit market share in the Tri-County area as of June 30, 2011, the latest date for which such data is available. The Bank faces additional significant competition for investors’ funds from mutual funds, brokerage firms, and other financial institutions. The Bank competes for loans by providing competitive rates, flexibility of terms and service. It competes for deposits by offering depositors a wide variety of account types, convenient office locations and competitive rates. Other services offered include tax deferred retirement programs, brokerage services, cash management services and safe deposit boxes. The Bank has used targeted direct mail, print and online advertising and community outreach to increase its market share of deposits, loans and other services in its market area. It provides ongoing training for its staff in an attempt to ensure high-quality service.
Lending Activities
General. The Bank offers a wide variety of real estate, consumer and commercial loans. The Bank’s lending activities include residential and commercial real estate loans, construction loans, land acquisition and development loans, equipment financing and commercial and consumer loans. Most of the Bank’s customers are residents of, or businesses located in, the Tri-County area. The Bank’s primary market for commercial loans consists of small and medium-sized businesses located in Southern Maryland. The Bank believes that this market is responsive to the Bank’s ability to provide personal service and flexibility. The Bank attracts customers for its consumer lending products based upon its ability to offer service, flexibility and competitive pricing and by leveraging other banking relationships such as soliciting deposit customers for loans.
Commercial Real Estate and Other Non-Residential Real Estate Loans. The permanent financing of commercial and other improved real estate projects, including office buildings, retail locations, churches, and other special purpose buildings is the largest single component of the Bank’s loan portfolio. Commercial real estate loans amounted to $370.4 million, or 51.6% of the loan portfolio, at December 31, 2011. This was an increase in both absolute size and as a percentage of the loan portfolio from the previous year. The commercial real estate and residential first mortgage and commercial equipment loan portfolios increased as a percentage of total loans during 2011. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. The Bank generally limits its exposure to a single borrower to 15% of the Bank’s capital and participates with other lenders on larger projects. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price and have an initial contractual loan payment period ranging from three to 20 years. Virtually all of the Bank’s commercial real estate loans are secured by real estate located in the Bank’s primary market area. At December 31, 2011, the largest outstanding commercial real estate loan was a $7.9 million loan, which is secured by a hotel. This loan was performing according to its terms at December 31, 2011.
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Loans secured by commercial real estate are larger and involve greater risks than one-to-four family residential mortgage loans. Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. As a result of the greater emphasis that the Bank places on commercial real estate loans, the Bank is increasingly exposed to the risks posed by this type of lending. To monitor cash flows on income properties, the Bank requires borrowers and loan guarantors, if any, to provide annual financial statements on multi-family or commercial real estate loans. In reaching a decision on whether to make a multi-family or commercial real estate loan, the Bank considers the net operating income of the property, the borrower’s expertise, credit history and profitability, and the value of the underlying property, as well as the borrower’s global cash flows. Environmental surveys are generally required for commercial real estate loans over $250,000.
Residential First Mortgage Loans. Residential first mortgage loans made by the Bank are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The initial contractual loan payment period for residential loans typically ranges from ten to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter time periods than their contractual terms. Borrowers may refinance or prepay loans at their option, without penalty. The Bank originates both fixed-rate and adjustable-rate residential first mortgages.
The Bank offers fixed-rate residential first mortgages on a variety of terms including loan periods from ten to 30 years and bi-weekly payment loans. Total fixed-rate loan products in our residential first mortgage portfolio amounted to $164.5 million as of December 31, 2011. Fixed-rate loans may be packaged and sold to investors or retained in the Bank’s loan portfolio. Depending on market conditions, the Bank may elect to retain the right to service the loans sold for a payment based upon a percentage (generally 0.25% of the outstanding loan balance). These servicing rights may be sold to other qualified servicers. As of December 31, 2011, the Bank serviced $45.6 million in residential mortgage loans for others.
The Bank also offers mortgages that are adjustable on a one-, three- and five-year basis generally with limitations on upward adjustments of two percentage points per repricing period and six percentage points over the life of the loan. The Bank primarily markets adjustable-rate loans with rate adjustments based upon a United States Treasury Bill Index. As of December 31, 2011, the Bank had $19.5 million in adjustable-rate residential mortgage loans. The retention of adjustable-rate mortgage loans in the Bank’s loan portfolio helps reduce the negative effects of increases in interest rates on the Bank’s net interest income. Under certain conditions, however, the annual and lifetime limitations on interest rate adjustments may limit the increases in interest rates on these loans. There are also unquantifiable credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. In addition, the initial interest rate on adjustable-rate loans is generally lower than that on a fixed-rate loan of similar credit quality and size.
The Bank makes residential first mortgage loans of up to 97% of the appraised value or sales price of the property, whichever is less, to qualified owner-occupants upon the security of single-family homes. Non-owner occupied one- to four-family loans are generally permitted to a maximum 80% loan-to-value of the appraised value depending on the overall strength of the application. The Bank currently requires that substantially all residential first mortgage loans with loan-to-value ratios in excess of 80% carry private mortgage insurance (PMI) to lower the Bank’s exposure to approximately 80% of the value of the property. The Bank had fewer than 10 loans with PMI at December 31, 2011. In certain cases, the borrower may elect to borrow amounts in excess of 80% loan-to-value in the form of a second mortgage. The second mortgage will generally have a higher interest rate and shorter repayment period than the first mortgage on the same property.
All improved real estate that serves as security for a loan made by the Bank must be insured, in the amount and by such companies as may be approved by the Bank, against fire, vandalism, malicious mischief and other hazards. Such insurance must be maintained through the entire term of the loan and in an amount not less than that amount necessary to pay the Bank’s indebtedness in full.
Construction and Land Development Loans. The Bank offers construction loans to individuals and building contractors for the construction of one-to-four family dwellings. Construction loans totaled $10.9 million at December 31, 2011. Loans to individuals primarily consist of construction/permanent loans, which have fixed rates, payable monthly for the construction period and are followed by a 30-year, fixed or adjustable-rate permanent loan. The Bank also provides construction financing to home builders. Generally, these loans are secured by the real estate under construction as well as by guarantees of the principals involved. Draws are made upon satisfactory completion of predefined stages of construction. The Bank will typically lend up to the lower of 80% of the appraised value or the contract purchase price of the homes to be constructed.
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In addition, the Bank offers loans to acquire and develop land, as well as loans on undeveloped, subdivided lots for home building by individuals. Land acquisition and development loans totaled $25.8 million at December 31, 2011. Bank policy requires that zoning and permits must be in place prior to making development loans. The Bank will typically lend up to the lower of 75% of the appraised value or cost.
The Bank’s ability to originate all types of residential construction and development loans is heavily dependent on the continued demand for single-family housing construction in the Bank’s market areas. As demand for newly constructed housing has fallen, the Bank’s investment in these loans has slowed. The net portfolio decreased $5.8 million from $42.5 million at December 31, 2010 to $36.7 million at December 31, 2011. Additionally, construction and land development loans as a percentage of the total loan portfolio fell from 10% at December 31, 2009 to 6.4% at December 31, 2010 to 5.1% at December 31, 2011. If the demand for new houses in the Bank’s market areas continues to decline, this portion of its loan portfolio may also decline. In addition, a continued decline in demand for new housing might adversely affect the ability of borrowers to repay these loans. The Bank may not be able to grow its construction lending activities in the event of a continued decline. Construction and land development loans have been particularly affected by recent economic factors that have slowed absorption of finished lots and homes.
Construction and land development loans are inherently riskier than providing financing on owner-occupied real estate. The Bank’s risk of loss is affected by the accuracy of the initial estimate of the market value of the completed project as well as the accuracy of the cost estimates made to complete the project. In addition, the volatility of the real estate market has made it increasingly difficult to ensure that the valuation of land associated with these loans is accurate. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or before the maturity of the loan, with a project having a value that is insufficient to assure full repayment. As a result of these factors, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the project rather than the ability of the borrower or guarantor to repay principal and interest. If the Bank forecloses on a project, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Home Equity and Second Mortgage Loans. The Bank maintains a portfolio of home equity and second mortgage loans. Home equity loans, which totaled $19.4 million at December 31, 2011, are generally made in the form of lines of credit with minimum amounts of $5,000, have terms of up to 20 years, variable rates priced at prime or some margin above prime, and require an 80% or 90% loan-to-value ratio (including any prior liens), depending on the specific loan program. Second mortgage loans, which totaled $4.7 million at December 31, 2011, are fixed and variable-rate loans that have original terms between five and 15 years. Loan-to-value ratios of up to 80% or 95% are allowed depending on the specific loan program.
These products contain a higher risk of default than residential first mortgages as in the event of foreclosure, the first mortgage would need to be paid off prior to collection of the second mortgage. This risk has been heightened as the market value of residential property has declined. The Bank is monitoring the property values which secure its second mortgages and is lowering credit availability where prudent. The Bank believes that its policies and procedures are sufficient to mitigate the additional risk posed by these loans at the current time.
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Commercial Loans. The Bank offers commercial loans to its business customers. The Bank offers a variety of commercial loan products including term loans and lines of credit. Such loans are generally made for terms of five years or less. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. While commercial loans remain an important class of the Bank’s loan portfolio at 14.2% of total loans, the commercial loan portfolio decreased by $2.6 million from $104.6 million at December 31, 2010 to $102.0 million at December 31, 2011. When making commercial business loans, the Bank considers the financial condition of the borrower, the borrower’s payment history of both corporate and personal debt, the projected cash flows of the business as well the borrower’s global cash flows, the viability of the industry in which the consumer operates, the value of the collateral, and the borrower’s ability to service the debt from income. These loans are primarily secured by equipment, real property, accounts receivable, or other security as determined by the Bank. The higher interest rates and shorter loan terms available on commercial lending make these products attractive to the Bank. Commercial business loans, however, entail greater risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized nature of collateral equipment would make full recovery from the sale of collateral problematic. The Bank attempts to control these risks by establishing guidelines that provide for loans with low loan-to-value ratios. At December 31, 2011, the largest outstanding commercial loan was $9.5 million, which was secured by commercial real estate, cash and investments. This loan was performing according to its terms at December 31, 2011.
Consumer Loans. The Bank has developed a number of programs to serve the needs of its customers with primary emphasis upon loans secured by automobiles, boats, recreational vehicles and trucks. The Bank also makes home improvement loans and offers both secured and unsecured personal lines of credit. Consumer loans totaled $1.0 million at December 31, 2011. The higher interest rates and shorter loan terms available on consumer lending make these products attractive to the Bank. Consumer loans entail greater risk than residential mortgage loans, particularly in the case of consumer loans, which are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral may not provide an adequate source of repayment of the outstanding loan balance. Further collection efforts may be hampered by the borrower’s lack of current income or other assets. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee such as the Bank, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral.
Commercial Equipment Loans. The Bank also maintains a commercial equipment financing portfolio. Commercial equipment loans totaled $19.8 million, or 2.8% of the total loan portfolio, at December 31, 2011. These loans consist primarily of fixed-rate, short-term loans collateralized by customers’ equipment including trucks, cars, construction equipment, and other more specialized equipment. When making commercial equipment loans, the Bank considers the same factors it considers when underwriting a commercial business loan. The higher interest rates and shorter loan terms available on commercial equipment lending make these products attractive to the Bank. These loans entail greater risk than loans such as residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized nature of collateral equipment would make full recovery from the sale of collateral problematic. The Bank attempts to control these risks by establishing guidelines that provide for over collateralization of the loans.
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Loan Portfolio Analysis. Set forth below is selected data relating to the composition of the Bank’s loan portfolio by type of loan on the dates indicated.
At December 31, | ||||||||||||||||||||||||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||||||||||||||||||||||
Amount | % | Amount | % | Amount | % | Amount | % | Amount | % | |||||||||||||||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||||||||||||||||||
Real Estate Loans | ||||||||||||||||||||||||||||||||||||||||
Commercial | $ | 370,384 | 51.55 | % | $ | 336,300 | 50.72 | % | $ | 292,988 | 46.88 | % | $ | 236,410 | 43.11 | % | $ | 190,484 | 41.55 | % | ||||||||||||||||||||
Residential first mortgage | 164,543 | 22.90 | % | 136,048 | 20.52 | % | 116,226 | 18.59 | % | 104,607 | 19.07 | % | 90,932 | 19.83 | % | |||||||||||||||||||||||||
Construction and land development | 36,745 | 5.11 | % | 42,504 | 6.41 | % | 62,509 | 10.00 | % | 57,565 | 10.50 | % | 50,577 | 11.03 | % | |||||||||||||||||||||||||
Home equity and second mortgage | 24,138 | 3.36 | % | 24,380 | 3.68 | % | 25,133 | 4.02 | % | 25,412 | 4.63 | % | 24,650 | 5.38 | % | |||||||||||||||||||||||||
Commercial loans | 101,968 | 14.19 | % | 104,566 | 15.77 | % | 108,658 | 17.38 | % | 101,936 | 18.59 | % | 75,247 | 16.41 | % | |||||||||||||||||||||||||
Consumer loans | 1,001 | 0.14 | % | 1,273 | 0.19 | % | 1,608 | 0.26 | % | 2,046 | 0.37 | % | 2,465 | 0.54 | % | |||||||||||||||||||||||||
Commercial equipment | 19,761 | 2.75 | % | 17,984 | 2.71 | % | 17,917 | 2.87 | % | 20,458 | 3.73 | % | 24,113 | 5.26 | % | |||||||||||||||||||||||||
Total loans | 718,540 | 100.00 | % | 663,055 | 100.00 | % | 625,039 | 100.00 | % | 548,434 | 100.00 | % | 458,468 | 100.00 | % | |||||||||||||||||||||||||
Less: Deferred loan fees | 796 | 936 | 975 | 311 | 371 | |||||||||||||||||||||||||||||||||||
Loan loss reserve | 7,655 | 7,669 | 7,471 | 5,146 | 4,482 | |||||||||||||||||||||||||||||||||||
Loans receivable, net | $ | 710,089 | $ | 654,450 | $ | 616,593 | $ | 542,977 | $ | 453,614 |
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Loan Originations, Purchases and Sales. The Bank solicits loan applications through marketing by commercial and residential mortgage loan officers, its branch network, and referrals from customers. Loans are processed and approved according to guidelines deemed appropriate for each product type. Loan requirements such as income verification, collateral appraisal, and credit reports vary by loan type. Loan processing functions are generally centralized except for small consumer loans.
Loan Approvals, Procedures and Authority. Loan approval authority is established by Board policy and delegated as deemed necessary and appropriate. Loan approval authorities vary by individual with the Chief Executive Officer having approval authority up to $1.25 million, the President $1.0 million, the Chief Lending Officer $1.0 million, the Chief Credit Officer $1.0 million and the Chief Operating Officer $1.0 million. The individual lending authority of the other lenders is set by management and based on their individual abilities. The loan approval authorities of the Chief Executive Officer, the President, the Chief Lending Officer, the Chief Credit Officer, the Chief Operating Officer and the Senior Credit Officer may be combined and a minimum of at least three of the five need to be present in an officers’ loan committee to approve loans up to $2.0 million. In cases where time is of the essence, the officers’ loan committee consisting of any three members may unanimously approve loans to relationships in excess of the $2.0 million up to the Bank’s in house lending limit with a later ratification by the Board Credit Review Committee. A loan committee consisting of at least three members of the Board (the “Directors Loan Committee”) ratifies and approves or renews all loans to relationships that exceed $2.0 million, except for those noted above that exceed the $2.0 million limit in certain cases. Depending on the loan and collateral type, conditions for protecting the Bank’s collateral are specified in the loan documents. Typically these conditions might include requirements to maintain hazard and title insurance and to pay property taxes.
Depending on market conditions, mortgage loans may be originated primarily with the intent to sell to third parties such as Fannie Mae or Freddie Mac. Mortgage loans in the amount of $9.7 million were sold by the Bank in 2011. To comply with internal and regulatory limits on loans to one borrower, the Bank may sell portions of commercial and commercial real estate loans to other lenders. The Bank sold no participations in 2011. The Bank also buys loans, portions of loans, or participation certificates from other lenders. The Bank only purchases loans or portions of loans after reviewing loan documents, underwriting support, and other procedures, as necessary. The Bank did not purchase any participations in 2011. Purchased participation loans are subject to the same regulatory and internal policy requirements as other loans in the Bank’s portfolio.
Loans to One Borrower. Under Maryland law, the maximum amount that the Bank is permitted to lend to any one borrower and his or her related interests may generally not exceed 10% of the Bank’s unimpaired capital and surplus, which is defined to include the Bank’s capital, surplus, retained earnings and 50% of its reserve for possible loan losses. Under this authority, the Bank would have been permitted to lend up to $8.9 million to any one borrower at December 31, 2011. By interpretive ruling of the Commissioner of Financial Regulation, Maryland banks have the option of lending up to the amount that would be permissible for a national bank, which is generally 15% of unimpaired capital and surplus (defined to include a bank’s total capital for regulatory capital purposes plus any loan loss allowances not included in regulatory capital). Under this formula, the Bank would have been permitted to lend up to $13.9 million to any one borrower at December 31, 2011. At December 31, 2011, the largest amount outstanding to any one borrower and his or her related interests was $11.3 million.
Loan Commitments. The Bank does not normally negotiate standby commitments for the construction and purchase of real estate. Conventional loan commitments are granted for a one-month period. The Bank’s outstanding commitments to originate loans at December 31, 2011 were approximately $22.3 million, excluding undisbursed portions of loans in process. It has been the Bank’s experience that few commitments expire unfunded.
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Maturity of Loan Portfolio. The following table sets forth certain information at December 31, 2011 regarding the dollar amount of loans maturing in the Bank’s portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.
Due within one | Due after one year through | Due more than | ||||||||||
year after | five years from | five years from | ||||||||||
December 31, 2011 | December 31, 2011 | December 31, 2011 | ||||||||||
(Dollars in Thousands) | ||||||||||||
Real Estate Loans | ||||||||||||
Commercial | $ | 82,081 | $ | 136,453 | $ | 151,850 | ||||||
Residential first mortgage | 29,277 | 57,805 | 77,461 | |||||||||
Construction and land development | 35,331 | 1,414 | - | |||||||||
Home equity and second mortgage | 4,104 | 10,674 | 9,360 | |||||||||
Commercial loans | 101,968 | - | - | |||||||||
Consumer loans | 618 | 335 | 48 | |||||||||
Commercial equipment | 7,665 | 10,335 | 1,761 | |||||||||
Total loans | $ | 261,044 | $ | 217,016 | $ | 240,480 |
The following table sets forth the dollar amount of all loans due after one year from December 31, 2011, which have predetermined interest rates and have floating or adjustable interest rates.
Floating or | ||||||||||||
Fixed Rates | Adjustable Rates | Total | ||||||||||
(Dollars in Thousands) | ||||||||||||
Real Estate Loans | ||||||||||||
Commercial | $ | 71,899 | $ | 216,404 | $ | 288,303 | ||||||
Residential first mortgage | 117,780 | 17,486 | 135,266 | |||||||||
Construction and land development | - | 1,414 | 1,414 | |||||||||
Home equity and second mortgage | 2,453 | 17,581 | 20,034 | |||||||||
Commercial loans | - | - | - | |||||||||
Consumer loans | 383 | - | 383 | |||||||||
Commercial equipment | 1,127 | 10,969 | 12,096 | |||||||||
$ | 193,642 | $ | 263,854 | $ | 457,496 |
Delinquencies. The Bank’s collection procedures provide that when a loan is 15 days delinquent, the borrower is contacted by mail and payment is requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower and obtain payment. If these efforts prove unsuccessful, the Bank will pursue appropriate legal action including repossession of the collateral and other actions as deemed necessary. In certain instances, the Bank will attempt to modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs.
Impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.
8 |
Loan loss reserves of $2.0 million relate to impaired loans at December 31, 2011.
Non-Performing Assets and Asset Classification. The Bank’s non-performing assets include foreclosed real estate and non-accrual loans. Troubled debt restructured loans (“TDRs”) are only considered non-performing assets if they are not performing in accordance with the terms of their restructured agreements.
Foreclosed Real Estate. Real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as foreclosed real estate until such time as it is sold. When such property is acquired, it is recorded at its fair market value. Subsequent to foreclosure, the property is carried at the lower of cost or fair value less selling costs. Additional write-downs as well as carrying expenses of the foreclosed properties are charged to expenses in the current period. The Bank had foreclosed real estate with a carrying value of approximately $5.0 million at December 31, 2011.
Non-accrual Loans. Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Consumer loans are typically charged-off no later than 90 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Non-accrual loans are evaluated for impairment on a loan by loan basis in accordance with the Company’s impairment methodology.
All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Troubled Debt Restructured Loans. The Company considers all TDRs to be impaired and defines TDRs as loans whose terms have been modified to provide for a reduction of either interest or principal because of deterioration in the financial condition of the borrower. A loan extended or renewed at a stated interest rate equal to the current interest rate for new debt with similar risk is not considered a TDR. Once an obligation has been classified as a TDR it continues to be considered a TDR until paid in full or until the loan returns to performing status and yields a market interest rate equal to the current interest rate for new debt with similar risk. TDRs are evaluated by management on a regular basis utilizing the Company’s risk grading scale and must have a passing loan grade to be removed as a TDR. TDRs are evaluated for impairment on a loan by loan basis in accordance with the Company’s impairment methodology. The Company does not participate in any specific government or Company sponsored loan modification programs. All restructured loan agreements are individual contracts negotiated with a borrower.
The following table sets forth information with respect to the Bank’s foreclosed real estate, non-accrual loans and TDRs. The table includes a breakdown between non-performing and impaired loans.
9 |
At December 31, | ||||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||
Foreclosed real estate | $ | 5,029 | $ | 10,469 | $ | 923 | $ | - | $ | - | ||||||||||
Non-performing loans | ||||||||||||||||||||
Non-accrual loans with impairment | $ | 4,517 | $ | 4,506 | $ | 8,947 | $ | 1,743 | $ | - | ||||||||||
Non-accrual loans with no impairment | 4,194 | 8,715 | 10,340 | 3,193 | 414 | |||||||||||||||
TDRs not performing according to terms | 800 | 297 | - | - | - | |||||||||||||||
Total non-performing loans | $ | 9,511 | $ | 13,518 | $ | 19,287 | $ | 4,936 | $ | 414 | ||||||||||
Total non-performing assets | $ | 14,540 | $ | 23,987 | $ | 20,210 | $ | 4,936 | $ | 414 | ||||||||||
Impaired loans | ||||||||||||||||||||
Non-accrual loans with impairment | $ | 4,517 | $ | 4,506 | $ | 8,947 | $ | 1,743 | $ | - | ||||||||||
Performing loans with impairment | 4,287 | - | - | - | - | |||||||||||||||
TDRs not performing according to terms | 800 | 297 | - | - | - | |||||||||||||||
TDRs performing according to terms | 11,113 | 16,585 | 11,601 | - | 755 | |||||||||||||||
Total impaired loans | $ | 20,717 | $ | 21,388 | $ | 20,548 | $ | 1,743 | $ | 755 | ||||||||||
Non-performing loans to total loans | 1.32 | % | 2.04 | % | 3.09 | % | 0.90 | % | 0.25 | % | ||||||||||
Allowance for loan losses to nonperforming loans | 80.49 | % | 56.73 | % | 38.74 | % | 104.25 | % | 383.40 | % | ||||||||||
Nonperforming assets to total assets | 1.48 | % | 2.71 | % | 2.48 | % | 0.69 | % | 0.07 | % | ||||||||||
Nonperforming assets and TDRs to total assets | 2.61 | % | 4.58 | % | 3.90 | % | 0.69 | % | 0.20 | % |
Foreclosed real estate has decreased as the Bank continues to resolve problem loans. At December 31, 2011, $2.5 million or 49.8% of foreclosed real estate was related to one acquisition and development project. Decreases in both non-accrual loans and foreclosed real estate were the primary factors in the current year decrease in nonperforming assets from 2.71% to 2.48%. The $5.4 million or 65.2% decrease in non-accrual commercial real estate loans attributed to the largest decrease in non-performing loans. Other non-performing loan types increased a net of $1.4 million compared to December 31, 2010. At December 31, 2011, the Bank had 35 non-performing loans, which were predominantly collateralized. Management continues to monitor these loans and is working to resolve these loans in a manner which will, in our opinion, preserve the most value for the Company. The below schedule provides the details by loan portfolio of non-performing loans for the dates indicated. The Company recognized $792,725 and $860,754 in interest income on impaired loans outstanding at year end for the years ended December 31, 2011 and 2010.
At December 31, | ||||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||
Loans accounted for on a nonaccrual basis: | ||||||||||||||||||||
Real Estate Loans | ||||||||||||||||||||
Commercial | $ | 2,866 | $ | 8,243 | $ | 6,367 | $ | 1,208 | $ | - | ||||||||||
Residential first mortgage | 2,439 | 1,747 | 339 | - | 274 | |||||||||||||||
Construction and land development | 1,414 | 984 | 9,504 | 1,840 | - | |||||||||||||||
Home equity and second mortgage | 291 | 233 | - | - | - | |||||||||||||||
Commercial loans | 2,264 | 2,262 | 2,192 | 903 | 60 | |||||||||||||||
Consumer loans | 1 | 1 | 23 | 148 | 80 | |||||||||||||||
Commercial equipment | 236 | 48 | 862 | 837 | - | |||||||||||||||
Total | $ | 9,511 | $ | 13,518 | $ | 19,287 | $ | 4,936 | $ | 414 |
10 |
During the years ended December 31, 2011 and December 31, 2010, gross interest income of $415,104 and $875,170, respectively, would have been recorded on loans accounted for on a non-accrual basis if the loans had been current throughout the period.
At December 31, 2011, the Bank had 15 troubled debt restructured loans of which $11.1 million or 93.3% were performing according to the terms of their restructured agreements. At December 31, 2010, there were three non-performing TDRs totaling $799,715, which had specific loan loss reserves of $250,000. Management continues to monitor these loans and is working to resolve these loans in a manner which will, in our opinion, preserve the most value for the Company. The below schedule provides the details by loan portfolio of TDRs for the dates indicated.
At December 31, | ||||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||
Real Estate Loans | ||||||||||||||||||||
Commercial | $ | 7,697 | $ | 6,848 | $ | 6,706 | $ | - | $ | 755 | ||||||||||
Residential first mortgage | - | 929 | 394 | - | - | |||||||||||||||
Construction and land development | 1,717 | - | - | - | - | |||||||||||||||
Commercial loans | 2,369 | 8,834 | 4,441 | - | - | |||||||||||||||
Commercial equipment | 130 | 271 | 60 | - | - | |||||||||||||||
Total | $ | 11,913 | $ | 16,882 | $ | 11,601 | $ | - | $ | 755 |
The following table sets forth an analysis of activity in the Bank’s allowance for loan losses for the periods indicated.
At December 31, | ||||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||
Balance at beginning of period | $ | 7,669 | $ | 7,471 | $ | 5,146 | $ | 4,482 | $ | 3,784 | ||||||||||
Charge-offs: | ||||||||||||||||||||
Real Estate Loans | ||||||||||||||||||||
Commercial | 1,249 | 526 | - | - | 29 | |||||||||||||||
Residential first mortgages | 49 | 63 | - | - | - | |||||||||||||||
Construction and land development | 213 | 2,249 | 187 | 287 | - | |||||||||||||||
Home equity and second mortgage | - | 71 | 98 | - | - | |||||||||||||||
Commercial loans | 2,441 | 569 | 608 | 202 | 73 | |||||||||||||||
Consumer loans | 3 | 10 | 32 | 67 | 56 | |||||||||||||||
Commercial equipment | 150 | 256 | 223 | 83 | - | |||||||||||||||
Total Charge-offs: | 4,105 | 3,744 | 1,148 | 639 | 158 | |||||||||||||||
Recoveries: | ||||||||||||||||||||
Residential first mortgages | 1 | - | - | - | - | |||||||||||||||
Construction and land development | - | 1 | - | - | - | |||||||||||||||
Consumer loans | 1 | 7 | - | 2 | 2 | |||||||||||||||
Commercial loans | 2 | - | - | - | - | |||||||||||||||
Total Recoveries | 4 | 8 | - | 2 | 2 | |||||||||||||||
Net charge-offs | 4,101 | 3,736 | 1,148 | 637 | 156 | |||||||||||||||
Provision for Possible Loan Losses | 4,087 | 3,934 | 3,473 | 1,301 | 855 | |||||||||||||||
Balance at End of Period | $ | 7,655 | $ | 7,669 | $ | 7,471 | $ | 5,146 | $ | 4,482 | ||||||||||
Allowance for loan losses to total loans | 1.07 | % | 1.16 | % | 1.20 | % | 0.94 | % | 0.98 | % | ||||||||||
Net charge-offs to average loans | 0.61 | % | 0.61 | % | 0.20 | % | 0.13 | % | 0.04 | % |
11 |
The following table allocates the allowance for loan losses by loan category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
At December 31, | ||||||||||||||||||||||||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||||||||||||||||||||||
Amount | Percent
of Loans in Each Category to Total Loans | Amount | Percent
of Loans in Each Category to Total Loans | Amount | Percent
of Loans in Each Category to Total Loans | Amount | Percent
of Loans in Each Category to Total Loans | Amount | Percent
of Loans in Each Category to Total Loans | |||||||||||||||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||||||||||||||||||
Real Estate Loans | ||||||||||||||||||||||||||||||||||||||||
Commercial | $ | 2,525 | 51.55 | % | $ | 3,314 | 50.72 | % | $ | 2,660 | 46.88 | % | $ | 2,009 | 43.11 | % | $ | 1,739 | 41.55 | % | ||||||||||||||||||||
Residential first mortgage | 539 | 22.90 | % | 204 | 20.52 | % | 128 | 18.59 | % | 105 | 19.07 | % | 266 | 19.83 | % | |||||||||||||||||||||||||
Construction and land development | 354 | 5.11 | % | 1,267 | 6.41 | % | 1,696 | 10.00 | % | 1,295 | 10.50 | % | 1,125 | 11.03 | % | |||||||||||||||||||||||||
Home equity and second mortgage | 144 | 3.36 | % | 98 | 3.68 | % | 131 | 4.02 | % | 102 | 4.63 | % | 98 | 5.38 | % | |||||||||||||||||||||||||
Commercial loans | 3,850 | 14.19 | % | 2,551 | 15.77 | % | 2,110 | 17.38 | % | 1,248 | 18.59 | % | 930 | 16.41 | % | |||||||||||||||||||||||||
Consumer loans | 20 | 0.14 | % | 32 | 0.19 | % | 64 | 0.26 | % | 43 | 0.37 | % | 96 | 0.54 | % | |||||||||||||||||||||||||
Commercial equipment | 223 | 2.75 | % | 203 | 2.71 | % | 682 | 2.87 | % | 344 | 3.73 | % | 228 | 5.26 | % | |||||||||||||||||||||||||
Total allowance for loan losses | $ | 7,655 | 100.00 | % | $ | 7,669 | 100.00 | % | $ | 7,471 | 100.00 | % | $ | 5,146 | 100.00 | % | $ | 4,482 | 100.00 | % |
12 |
The Bank closely monitors the payment activity of all its loans. The Bank periodically reviews the adequacy of the allowance for loan losses based on an analysis of the size and composition of the loan portfolio, the Bank’s historical loss experience, including trends in non-performing and classified loans and charge-offs, economic conditions in the Bank’s market area, and a review of selected individual loans. Loan losses are charged off against the allowance when individual loans are deemed uncollectible. Subsequent recoveries, if any, are credited to the allowance. The Bank believes it has established its existing allowance for loan losses in accordance with accounting principles generally accepted in the United States of America and is in compliance with appropriate regulatory guidelines. However, the establishment of the level of the allowance for loan losses is highly subjective and dependent on incomplete information as to the ultimate disposition of loans. Accordingly, there can be no assurance that actual losses may not vary from the amounts estimated or that the Bank’s regulators will not require the Bank to significantly increase or decrease its allowance for loan losses, thereby affecting the Bank’s financial condition and earnings. For a more complete discussion of the allowance for loan losses, see the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the Company’s 2011 Annual Report to Stockholders.
Investment Activities
The Bank maintains a portfolio of investment securities to provide liquidity as well as a source of earnings. The Bank’s investment securities portfolio consists primarily of mortgage-backed and other securities issued by U.S. government-sponsored enterprises (“GSEs”), including Freddie Mac and Fannie Mae. The Bank also has smaller holdings of privately issued mortgage-backed securities, U.S. Treasury obligations, and other equity and debt securities. As a member of the Federal Reserve and FHLB system, the Bank is required to maintain investments in the Federal Reserve Bank as a condition of membership and the Federal Home Loan Bank based upon levels of borrowings.
The following table sets forth the carrying value of the Company’s investment securities portfolio and FHLB of Atlanta and Federal Reserve Bank stock at the dates indicated. At December 31, 2011, 2010, and 2009, their estimated fair value was $201 million, $168 million, and $148 million, respectively.
At December 31, | ||||||||||||
(Dollars in Thousands) | ||||||||||||
2011 | 2010 | 2009 | ||||||||||
Asset-backed securities: | ||||||||||||
Freddie Mac and Fannie Mae | $ | 180,638 | $ | 144,861 | $ | 121,510 | ||||||
Other | 9,839 | 12,463 | 19,006 | |||||||||
Total asset-backed securities | 190,477 | 157,324 | 140,516 | |||||||||
Corporate equity securities | 37 | 37 | 39 | |||||||||
Bond mutual funds | 4,080 | 3,820 | 3,654 | |||||||||
Treasury bills | 750 | 753 | - | |||||||||
Other Investments | - | - | 5 | |||||||||
Total investment securities | 195,344 | 161,934 | 144,214 | |||||||||
FHLB and Federal Reserve Bank stock | 5,587 | 6,316 | 6,936 | |||||||||
Total investment securities and FHLB and Federal Reserve Bank stock | $ | 200,931 | $ | 168,250 | $ | 151,150 |
13 |
The maturities and weighted average yields for investment securities available for sale (AFS) and held to maturity (HTM) at December 31, 2011 are shown below.
After One | After Five | |||||||||||||||||||||||||||||||
One Year or Less | Through Five Years | Through Ten Years | After Ten Years | |||||||||||||||||||||||||||||
Amortized | Average | Amortized | Average | Amortized | Average | Amortized | Average | |||||||||||||||||||||||||
Cost | Yield | Cost | Yield | Cost | Yield | Cost | Yield | |||||||||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||||||||||
AFS Investment securities: | ||||||||||||||||||||||||||||||||
Corporate equity securities | $ | 37 | 0.00 | % | $ | - | 0.00 | % | $ | - | 0.00 | % | $ | - | 0.00 | % | ||||||||||||||||
Asset-backed securities | 21,591 | 1.64 | % | 13,001 | 1.70 | % | 2,368 | 1.82 | % | 302 | 3.25 | % | ||||||||||||||||||||
Mutual funds | 3,840 | 3.41 | % | - | 0.00 | % | - | 0.00 | % | - | 0.00 | % | ||||||||||||||||||||
Total AFS investment securities | $ | 25,468 | 1.91 | % | $ | 13,001 | 1.70 | % | $ | 2,368 | 1.82 | % | $ | 302 | 3.25 | % | ||||||||||||||||
HTM Investment securities: | ||||||||||||||||||||||||||||||||
Asset-backed securities | $ | 65,186 | 1.98 | % | $ | 61,169 | 2.10 | % | $ | 19,882 | 2.05 | % | $ | 6,530 | 2.10 | % | ||||||||||||||||
Treasury bills | 750 | 0.09 | % | - | 0.00 | % | - | 0.00 | % | - | 0.00 | % | ||||||||||||||||||||
Other investments | - | 0.00 | % | - | 0.00 | % | - | 0.00 | % | - | 0.00 | % | ||||||||||||||||||||
Total HTM investment securities | $ | 65,936 | 1.96 | % | $ | 61,169 | 2.10 | % | $ | 19,882 | 2.05 | % | $ | 6,530 | 2.09 | % |
The Bank’s investment policy provides that securities that will be held for indefinite periods of time, including securities that will be used as part of the Bank’s asset/liability management strategy and that may be sold in response to changes in interest rates, prepayments and similar factors are classified as available for sale and accounted for at fair value. Management’s intent is to hold securities reported at amortized cost to maturity. Certain of the Company’s asset-backed securities are issued by private issuers (defined as an issuer that is not a government or a government-sponsored entity). The Company had no investments in any private issuer’s securities that aggregate to more than 10% of the Company’s equity.
Deposits and Other Sources of Funds
General. The funds needed by the Bank to make loans are primarily generated by deposit accounts solicited from the communities surrounding its main office and nine branches in the Southern Maryland area. Total deposits were $827.3 million as of December 31, 2011. The Bank uses borrowings and other sources to supplement funding from deposits.
Deposits. The Bank’s deposit products include savings, money market, demand deposit, IRA, SEP, Christmas clubs, and time deposit accounts. Variations in service charges, terms and interest rates are used to target specific markets. Ancillary products and services for deposit customers include safe deposit boxes, travelers checks, night depositories, automated clearinghouse transactions, wire transfers, ATMs, and online and telephone banking. The Bank is a member of ACCEL/Exchange, Cirrus, Maestro and Star ATM networks. The Bank has occasionally used deposit brokers to obtain funds. At December 31, 2011, the Bank had $19.0 million in deposits from brokers compared to $25.0 million at December 31, 2010. In addition the Bank utilizes the Certificate of Deposit Account Registry Service (CDARS) to provide existing customers with additional access to FDIC insurance. At December 31, 2011, the Bank maintained CDARS deposits of $34.9 million compared to $35.2 million at December 31, 2010.
14 |
The following table sets forth for the periods indicated the average balances outstanding and average interest rates for each major category of deposits.
For the Year Ended December 31, | ||||||||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||
2011 | 2010 | 2009 | ||||||||||||||||||||||
Average | Average | Average | Average | Average | Average | |||||||||||||||||||
Balance | Rate | Balance | Rate | Balance | Rate | |||||||||||||||||||
Savings | $ | 31,446 | 0.35 | % | $ | 30,355 | 0.41 | % | $ | 28,486 | 0.16 | % | ||||||||||||
Interest-bearing demand and money market accounts | 217,183 | 1.00 | % | 161,494 | 0.94 | % | 142,513 | 1.02 | % | |||||||||||||||
Certificates of deposit | 434,811 | 1.94 | % | 421,525 | 2.21 | % | 355,489 | 3.02 | % | |||||||||||||||
Total interest-bearing deposits | 683,440 | 613,374 | 526,488 | |||||||||||||||||||||
Noninterest-bearing demand deposits | 66,105 | 65,041 | 53,584 | |||||||||||||||||||||
$ | 749,545 | 1.43 | % | $ | 678,415 | 1.61 | % | $ | 580,072 | 2.11 | % |
The following table indicates the amount of the Bank’s certificates of deposit and other time deposits of $100,000 or more and $250,000 or more by time remaining until maturity as of December 31, 2011.
Time Deposit Maturity Period | $100,000 or More | $250,000 or More | ||||||
(Dollars in Thousands) | ||||||||
Three months or less | $ | 45,992 | $ | 6,906 | ||||
Three through six months | 33,920 | 13,043 | ||||||
Six through twelve months | 61,171 | 19,930 | ||||||
Over twelve months | 95,540 | 41,937 | ||||||
Total | $ | 236,623 | $ | 81,816 |
Borrowings. Deposits are the primary source of funds for the Bank’s lending and investment activities and for its general business purposes. The Bank uses advances from the FHLB of Atlanta to supplement the supply of funds it may lend and to meet deposit withdrawal requirements. Advances from the FHLB are secured by the Bank’s stock in the FHLB, a portion of the Bank’s loan portfolio , and certain investments. Generally, the Bank’s ability to borrow from the FHLB of Atlanta is limited by its available collateral and also by an overall limitation of 40% of assets. Further, short-term credit facilities are available at the Federal Reserve Bank of Richmond and other commercial banks. Other short-term debt consists of notes payable to the U.S. Treasury on treasury, tax and loan accounts. Long-term debt consists of adjustable-rate advances with rates based upon LIBOR, fixed-rate advances, and convertible advances. The table below sets forth information about borrowings for the years indicated.
At or for the Year Ended December 31, | ||||||||||||
(Dollars in Thousands) | ||||||||||||
2011 | 2010 | 2009 | ||||||||||
Long-term debt | ||||||||||||
Long-term debt outstanding at end of period | $ | 60,577 | $ | 70,624 | $ | 75,670 | ||||||
Weighted average rate on outstanding long-term debt at end of period | 3.33 | % | 3.24 | % | 3.26 | % | ||||||
Maximum outstanding long-term debt of any month end | 60,620 | 70,666 | 100,692 | |||||||||
Average outstanding long-term debt, during period | 61,421 | 70,823 | 94,745 | |||||||||
Approximate average rate paid on long-term debt during period | 3.32 | % | 3.22 | % | 3.70 | % | ||||||
Short-term borrowings | ||||||||||||
Short-term borrowings outstanding at end of period at end of period | $ | - | $ | 816 | $ | 13,081 | ||||||
Weighted average rate on short-term borrowings at end of period | 0.00 | % | 0.00 | % | 0.34 | % | ||||||
Maximum outstanding short-term borrowings at any month end during period | 15,703 | 11,322 | 13,081 | |||||||||
Average outstanding short-term borrowings | 2,168 | 2,973 | 1,421 | |||||||||
Approximate average rate paid on short-term borrowings | 1.91 | % | 1.41 | % | 2.06 | % |
15 |
For more information regarding the Bank’s borrowings, see Note 10 of Notes to Consolidated Financial Statements.
Subsidiary Activities
In April 1997, the Bank formed a wholly owned subsidiary, Community Mortgage Corporation of Tri-County, to offer mortgage banking, brokerage, and other services to the public. This corporation is currently inactive.
The Company has two direct subsidiaries other than the Bank. In July 2004, Tri-County Capital Trust I was established as a statutory trust under Delaware law as a wholly-owned subsidiary of the Company to issue trust preferred securities. Tri-County Capital Trust I issued $7.0 million of trust preferred securities on July 22, 2004. In June 2005, Tri-County Capital Trust II was also established as a statutory trust under Delaware law as a wholly owned subsidiary of the Company to issue trust preferred securities. Tri-County Capital Trust II issued $5.0 million of trust preferred securities on June 15, 2005.
16 |
SUPERVISION AND REGULATION
Regulation of the Company
General. As a bank holding company, the Company is subject to comprehensive regulation, examination and supervision by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the regulations of the Federal Reserve Board. The Federal Reserve Board also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders, and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
The following discussion summarizes certain of the regulations applicable to the Company but does not purport to be a complete description of such regulations and is qualified in its entirety by reference to the actual laws and regulations involved.
Acquisition of Control. A bank holding company, with certain exceptions, must obtain Federal Reserve Board approval before (1) acquiring ownership or control of another bank or bank holding company if it would own or control more than 5% of such shares or (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging with another bank holding company. In evaluating such application, the Federal Reserve Board considers factors such as the financial condition and managerial resources of the companies involved, the convenience and needs of the communities to be served and competitive factors. Federal law provides that no person may acquire “control” of a bank holding company or insured bank without the approval of the appropriate federal regulator. Control is defined to mean direct or indirect ownership, control of 25% or more of any class of voting stock, control of the election of a majority of the bank’s directors or a determination by the Federal Reserve Board that the acquirer has or would have the power to exercise a controlling influence over the management or policies of the institution.
Permissible Activities. A bank holding company is limited in its activities to banking, managing or controlling banks, or providing services for its subsidiaries. Other permitted non-bank activities have been identified as closely related to banking. Bank holding companies that are “well capitalized” and “well managed” and whose financial institution subsidiaries have satisfactory Community Reinvestment Act records can elect to become “financial holding companies,” which are permitted to engage in a broader range of financial activities than are permitted to bank holding companies. The Company has not opted to become a financial holding company.
The Federal Reserve Board has the power to order a holding company or its subsidiaries to terminate any activity, or to terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that the continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that holding company.
The Maryland Financial Institutions Code prohibits a bank holding company from acquiring more than 5% of any class of voting stock of a bank or bank holding company without the approval of the Commissioner of Financial Regulation. The Maryland Financial Institutions Code additionally prohibits any person from acquiring voting stock in a bank or bank holding company without 60 days prior notice to the Commissioner if such acquisition will give the person control of 25% or more of the voting stock of the bank or bank holding company. The Commissioner may deny approval of the acquisition if the Commissioner determines it to be anti-competitive or to threaten the safety or soundness of a banking institution.
Dividends. The Federal Reserve Board has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board’s view that a bank holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay dividends. Under the prompt corrective action regulations adopted by the Federal Reserve Board, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.” See “Regulation of the Bank – Capital Adequacy.”
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Sources of Strength. The Dodd-Frank Act codified the source of strength doctrine requiring bank holding companies to serve as a source of strength for their depository subsidiaries, by providing capital, liquidity and other support in times of financial stress. The regulatory agencies are required, under the Act, to issue implementing regulations.
Stock Repurchases. The Company is required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Company’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption. This requirement does not apply to bank holding companies that are “well capitalized,” “well-managed” and are not the subject of any unresolved supervisory issues.
Capital Requirements. Bank holding companies are required to maintain on a consolidated basis, specified minimum ratios of capital to total assets and capital to risk-weighted assets. These requirements, which generally apply to bank holding companies with consolidated assets of $500 million or more, are substantially similar to, but somewhat more generous than, those applicable to the Bank. See “– Regulation of the Bank – Capital Adequacy.” The Dodd-Frank Act required the Federal Reserve Board to adopt consolidated capital requirements for holding companies that are equally as stringent as those applicable to the depository institution subsidiaries. That means that certain instruments that had previously been includable in Tier 1 capital for bank holding companies, such as trust preferred securities, will no longer be eligible for inclusion. The revised capital requirements are subject to certain grandfathering and transition rules. The Company is currently considered a grandfathered institution under these rules.
Regulation of the Bank
General. The Bank is a Maryland commercial bank and its deposit accounts are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. The Bank is a member of the Federal Reserve and FHLB systems. The Bank is subject to supervision, examination and regulation by Commissioner of Financial Regulation of the State of Maryland (the “Commissioner”) and the Federal Reserve Board.
The Dodd-Frank Act established the Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board. The Consumer Financial Protection Bureau assumed responsibility for implementing federal consumer financial protection and fair lending laws and regulations, a function currently handled by federal bank regulatory agencies. However, institutions of less than $10 billion, such as the Bank, will continue to be examined for compliance with consumer protection or fair lending laws and regulations by, and be subject to enforcement authority of their potential regulators.
The following discussion summarizes certain regulations applicable to the Bank but does not purport to be a complete description of such regulations and is qualified in its entirety by reference to the actual laws and regulations involved.
Capital Adequacy. The regulations of the Federal Reserve Board require bank holding companies and state member banks, respectively, to maintain a minimum leverage ratio of “Tier 1 capital” (as defined in the risk-based capital guidelines discussed in the following paragraphs) to total assets of 4.0%. The Federal Reserve Board has broad authority to require a higher level of Tier 1 capital.
The risk-based capital rules of the Federal Reserve Board require bank holding companies and state member banks to maintain minimum regulatory capital levels based upon risk weighted assets. Risk-based capital is composed of two elements: Tier 1 capital and Tier 2 capital. Tier 1 capital consists primarily of common stockholders’ equity, certain perpetual preferred stock less intangible assets. Tier 2 capital elements include, subject to limitations, the allowance for losses on loans and leases; perpetual preferred stock that does not qualify as Tier 1 capital and long-term preferred stock with an original maturity of at least 20 years from issuance; hybrid capital instruments, subordinated debt and intermediate-term preferred stock and up to 45% of unrealized gains on available for sale equity securities.
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The risk-based capital regulations assign balance sheet assets and off-balance sheet obligations to one of four broad risk categories. The assets and off-balance sheet items in the four risk categories are weighted at 0%, 20%, 50% and 100%. These computations result in the total risk-weighted assets. The risk-based capital regulations require all banks and bank holding companies to maintain a minimum ratio of total capital (Tier 1 capital plus Tier 2 capital) to total risk-weighted assets of 8%, with at least 4% as Tier 1 capital. In calculating these ratios: (1) Tier 2 capital is limited to no more than 100% of Tier 1 capital; and (2) the aggregate amount of certain types of Tier 2 capital is limited. In addition, the risk-based capital regulations limit the allowance for loan losses includable as capital to 1.25% of total risk-weighted assets. The Federal Reserve Board also has authority to establish individual minimum capital requirements for an institution.
Prompt Corrective Regulatory Action. The Federal Reserve Board classifies state member banks by capital levels and is authorized to take various prompt corrective actions to resolve the problems of any bank that fails to satisfy the capital standards. A well capitalized bank is one that is not subject to any regulatory capital order to meet specific capital levels and has or exceeds the following capital levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. An adequately capitalized bank is one that does not qualify as well capitalized but meets or exceeds the following capital requirements: a total risk-based capital ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (1) 4% or (2) 3% if the bank has the highest composite examination rating. A bank not meeting these criteria is treated as undercapitalized, significantly undercapitalized, or critically undercapitalized depending on the extent to which the bank’s capital levels are below these standards. A state member bank that falls within any of the three undercapitalized categories established by the prompt corrective action regulation will be subject to regulatory sanctions. As of December 31, 2011, the Bank was well capitalized as defined by the Federal Reserve Board’s regulations.
Branching. Maryland law provides that, with the approval of the Commissioner, Maryland banks may establish branches within Maryland and may establish branches in other states by any means permitted by the laws of such state or by federal law. The Federal Reserve Board may approve interstate branching by merger by state member banks in any state that did not opt out and de novo in states that specifically allow for such branching.
Dividend Limitations. Maryland banks may only pay dividends from undivided profits or, with the prior approval of the Commissioner, their surplus in excess of 100% of required capital stock. Maryland banks are further prohibited from declaring a dividend on its shares of 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.
Without the approval of the Federal Reserve Board, a state member bank may not declare or pay a dividend if the total of all dividends declared during the year exceeds its net income during the current calendar year and retained net income for the prior two years. The Bank is further prohibited from making a capital distribution if it would be undercapitalized after payment of the dividend. within the meaning of the prompt corrective action regulations discussed above.
Insurance of Deposit Accounts. Under the Federal Deposit Insurance Corporation’s existing assessment system, insured institutions are assigned to one of four categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned. Effective April 1, 2009, assessment rates ranged from 7 to 77.5 basis points. On February 7, 2011, the Federal Deposit Insurance Corporation issued a final rule regarding the risk-based deposit insurance assessment system that better reflects the risks to the Deposit Insurance Fund. Under the final rule, effective April 1, 2011 assessment rates ranged from 2.5 to 45 basis points. The rate schedules will automatically adjust in the future when the Deposit Insurance Fund reaches certain milestones. No institution may pay a dividend if in default of the federal deposit insurance assessment.
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The Federal Deposit Insurance Corporation imposed on all insured institutions a special emergency assessment of five basis points of total assets minus Tier 1 capital, as of June 30, 2009 (capped at ten basis points of an institution’s deposit assessment base), to cover losses to the Deposit Insurance Fund. That special assessment was collected on September 30, 2009. In lieu of further special assessments, the Federal Deposit Insurance Corporation required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012. That prepayment, which include an assumed annual assessment base increase of 5%, was recorded as a prepaid expense asset as of December 30, 2009.
The deposit insurance per account owner was recently raised to $250,000 for all types of accounts. In addition, the Federal Deposit Insurance Corporation adopted an optional Temporary Liquidity Guarantee Program (“TLGP”) under which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until December 31, 2010. The Dodd-Frank Act extended the unlimited coverage of certain noninterest-bearing transaction accounts until December 31, 2012 without providing an opt out.
Reserve Requirements. Under Federal Reserve Board regulations, the Bank currently must maintain average daily reserves equal to 3% on aggregate transaction, plus 10% on the remainder. The first $10.7 million of transaction accounts are exempt. This percentage is subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets. At December 31, 2011, the Bank met applicable Federal Reserve Board reserve requirements.
Transactions with Affiliates. A state member bank is limited in the amount of “covered transactions” with any affiliate. All such transactions must also be on terms substantially the same, or at least as favorable, to the Bank or subsidiary as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and similar types of transactions. Certain covered transactions, such as loans to affiliates, must meet collateral requirements. At December 31, 2011, we had no transactions with affiliates.
Loans to directors, executive officers and principal stockholders of a state member bank must be made on substantially the same terms as those prevailing for comparable transactions with persons who are not executive officers, directors, principal stockholders or employees of the bank. Loans to any executive officer, director and principal stockholder together with all other outstanding loans to such person and affiliated interests generally may not exceed 15% of the Bank’s unimpaired capital and surplus and all loans to such persons may not exceed the institution’s unimpaired capital and unimpaired surplus. Loans to directors, executive officers and principal stockholders, and their respective affiliates, in excess of the greater of $25,000 or 5% of capital and surplus, or any loans cumulatively aggregating $500,000 or more, must be approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. State member banks are prohibited from paying the overdrafts of any of their executive officers or directors unless payment is made pursuant to a written, pre-authorized interest-bearing extension of credit plan that specifies a method of repayment or transfer of funds from another account at the bank. In addition, loans to executive officers may not be made on terms more favorable than those afforded other borrowers and are restricted as to type, amount and terms of credit.
Enforcement. The Commissioner has extensive enforcement authority over Maryland banks. Such authority includes the ability to issue cease and desist orders and civil money penalties and to remove directors or officers. The Commissioner may also take possession of a Maryland bank whose capital is impaired and seek to have a receiver appointed by a court.
The Federal Reserve Board has primary federal enforcement responsibility over state banks under its jurisdiction, including the authority to bring enforcement action against all “institution-related parties,” including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution. Formal enforcement action may range from the issuance of capital directive or a cease and desist order for the removal of officers and/or directors, receivership, conservatorship or termination of deposit insurance. Civil money penalties cover a wide range of violations and actions, and range up to $25,000 per day or even up to $1 million per day (in the most egregious cases). Criminal penalties for most financial institution crimes include fines of up to $1 million and imprisonment for up to 30 years.
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Personnel
As of December 31, 2011, the Bank had 144 full-time employees and 10 part-time employees. The employees are not represented by a collective bargaining agreement. The Bank believes its employee relations are good.
Executive Officers of the Registrant
The executive officers of the Company are as follows:
Michael L. Middleton (64 years old) is Chairman, President and Chief Executive Officer of the Company and Chairman and Chief Executive Officer of the Bank. Mr. Middleton joined the Bank in 1973 and served in various management positions until 1979 when he became President of the Bank until April 1, 2010. Mr. Middleton is a Certified Public Accountant and holds a Masters of Business Administration. From 1996 to 2004, Mr. Middleton served on the Board of Directors of the Federal Home Loan Bank of Atlanta, serving as Chairman of the Board in 2004. Mr. Middleton served on the Board of Directors of the Federal Reserve Bank, Baltimore Branch, from 2004 to 2009. He is Chairman Elect of the Maryland Bankers Association, a trustee for the College of Southern Maryland, and serves on the Federal Reserve’s Community Depository Institutions Advisory Council. He also serves on several philanthropic and civic boards.
William J. Pasenelli (53 years old) is Executive Vice President and Chief Financial Officer of the Company and President and Chief Financial Officer of the Bank. Mr. Pasenelli joined the Bank as Chief Financial Officer in April 2000 and was named President in 2010. Before joining the Bank, Mr. Pasenelli had been Chief Financial Officer of Acacia Federal Savings Bank, Annandale, Virginia, since 1987. Mr. Pasenelli is a member of the American Institute of Certified Public Accountants, the Greater Washington Society of Certified Public Accountants and other civic groups.
Gregory C. Cockerham (57 years old) joined the Bank in 1988. He serves as the Bank’s Executive Vice President – Chief Lending Officer. Prior to joining the Company he was retail Vice President of Maryland National Bank. Mr. Cockerham serves as Chairman of the College of Southern Maryland Foundation and the Maryland Title Center. He is a Paul Harris Fellow and Foundation Chair with the Rotary Club of Charles County and serves on various civic boards in Charles County.
James M. Burke (43 years old) joined the Bank in 2006. He serves as the Bank’s Executive Vice President – Chief Credit Officer. Before his appointment as Executive Vice President in 2007, he served as the Bank’s Senior Credit Officer. Prior to joining the Bank, Mr. Burke served as Executive Vice President of Mercantile Southern Maryland Bank. Mr. Burke has almost 20 years of banking experience. Mr. Burke is the former Chairman of the Board of Directors of Civista Medical Center and is active in other civic groups.
James F. DiMisa (52 years old) joined the Bank in 2006. He serves as Executive Vice President- Chief Operating Officer. Prior to joining the Bank, Mr. DiMisa served as Executive Vice President of Mercantile Southern Maryland Bank. Mr. DiMisa has over 30 years of banking experience. Mr. DiMisa is Chairman of the Board of Trustees for the Maryland Bankers School and a member of several other civic and professional groups. Mr. DiMisa is a Stonier Graduate School of Banking graduate and holds a Masters of Business Administration.
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Item 1A. Risk Factors
An investment in shares of our common stock involves various risks. Our business, financial condition and results of operations could be harmed by any of the following risks or by other risks that have not been identified or that we may believe are immaterial or unlikely. The value or market price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
Our provision for loan losses has increased during each of the last five years and we may be required to make further increases in our provision for loan losses and to charge-off additional loans in the future. Further, our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
For 2011, we recorded a provision for loan losses of $4.1 million. We also recorded net loan charge-offs of $4.1 million. Our non-performing assets, including troubled debt restructures and other real estate owned, decreased in 2011 from $40.6 million, or 4.58% of total assets, at December 31, 2010 to $26.5 million, or 2.61% of total assets, at December 31, 2011. Additionally, at December 31, 2011, loans that were classified as either special mention, substandard, doubtful or loss totaled $68.5 million. If the economy and/or the real estate market continue to weaken, more of our classified loans may become non-performing and we may be required to add further reserves to our allowance for loan losses for these assets as the value of the collateral may be insufficient to pay any remaining net loan balance, which could have a negative effect on our results of operations. We maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results.
In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and classified loans, troubled debt restructures and foreclosed real estate. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, anticipated duration of the current business cycle, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are, by nature, more subjective and fluid. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates.
Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs. Any such additional provisions for loan losses or charge-offs, as required by our regulators, could have a material adverse effect on our financial condition and results of operations.
Changes in interest rates could reduce our net interest income and earnings.
Our largest component of earnings is net interest income, which could be negatively affected by changes in interest rates. Changing interest rates impact customer actions and may limit the options available to the Company to maximize earnings or increase the costs to minimize risk. We do not have control over market interest rates and the Company’s focus to mitigate potential earnings risk centers on controlling the composition of our asset and liability holdings.
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Our net interest income is the interest we earn on loans and investment less the interest we pay on our deposits and borrowings. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to increase or decrease. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yield catches up. Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. Our procedures for managing exposure to falling net interest income involve modeling possible scenarios of interest rate increases and decreases to interest-earning assets and interest-bearing liabilities.
Our increased emphasis on commercial lending may expose us to increased lending risks.
At December 31, 2011, our loan portfolio consisted of $370.4 million, or 51.5%, of commercial real estate loans, $102.0 million, or 14.2%, of commercial business loans and $19.8 million, or 2.8%, of commercial equipment loans. We intend to maintain our emphasis on these types of loans. These types of loans generally expose a lender to greater risk of non-payment and loss and require a commensurately higher loan loss allowance than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrowers. Such loans typically involve larger loan balances compared to one- to four-family residential mortgage loans. Commercial business and equipment loans expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flows of the borrower’s business and are secured by non-real estate collateral that may depreciate over time. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan.
Our residential mortgage loans and home equity loans expose us to a risk of loss due to declining real estate values.
At December 31, 2011 $164.5 million, or 22.9% of our total loan portfolio consisted of one- to four-family residential mortgage loans, and $24.1 million, or 3.4%, of our total loan portfolio consisted of home equity loans and lines of credit. Recent declines in the housing market have resulted in declines in real estate values in our market areas. These declines in real estate values could cause some of our mortgage and home equity loans to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral.
A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which would lead to lower revenue, higher loan losses and lower earnings.
A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and continued high unemployment levels may result in higher than expected loan delinquencies, increases in our levels of nonperforming and classified assets and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.
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The unseasoned nature of our commercial loan portfolio may result in changes in estimating collectability, which may lead to additional provisions or charge-offs, which could hurt our profits.
Our commercial real estate, commercial business and commercial equipment loans increased $133.3 million, or 37.2%, from $358.8 million at December 31, 2008 to $492.1 million at December 31, 2011. A large portion of our commercial loan portfolio is unseasoned and does not provide us with a significant payment history pattern from which to judge future collectability, especially in this period of continued declining and unfavorable economic conditions. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our historical experience, which could adversely affect our future performance. Further, these types of loans generally have larger balances and involve a greater risk than one- to four-family residential mortgage loans. Accordingly, if we make any errors in judgment in the collectability of our commercial loans, any resulting charge-offs may be larger on a per loan basis than those incurred historically with our residential mortgage loan or consumer loan portfolios.
Our asset valuation may include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect our results of operations or financial condition.
We must use estimates, assumptions, and judgments when financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, we estimate fair value primarily by using cash flows and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact our future financial condition and results of operations.
During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation.
Our continued pace of growth may require us to raise additional capital in the future, which will be dilutive to existing shareholders and could dilute our per share book value.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that we have sufficient capital resources to satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth. If we raise capital through the issuance of additional shares of our common stock or other securities, it would dilute the ownership interests of existing shareholders and may dilute the per share book value of our common stock. New investors may also have rights, preferences and privileges senior to our current shareholders, which may adversely impact our current shareholders.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. Accordingly, we may not be able to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth could be materially impaired.
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The cost of the capital we received from the Series C Preferred Stock will increase significantly if the level of our “Qualified Small Business Lending” does not represent an increase from our “baseline” level.
The dividend rate on the Series C Preferred Stock we issued to the United States Department of Treasury (the “Treasury”) under the Small Business Lending Fund Program can fluctuate on a quarterly basis during the first 10 quarters during which the Series C Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” or “QSBL” by the Bank. Based upon the increase in the Bank’s level of QSBL over the baseline level calculated under the terms of the Securities Purchase Agreement entered into in connection with the issuance of the Series C Preferred Stock, the dividend rate for the initial dividend period has been set at one percent. For the second through ninth calendar quarters, the dividend rate may be adjusted to between one percent and five percent per annum, to reflect the amount of change in the Bank’s level of QSBL. If the level of the Bank’s qualified small business loans declines so that the percentage increase in QSBL as compared to the baseline level is less than 10%, then the dividend rate payable on the Series C Preferred Stock would increase. For the tenth calendar quarter through four and one half years after issuance, the dividend rate will be fixed between one percent and seven percent based upon the increase in QSBL as compared to the baseline. After four and one half years from issuance, the dividend rate will increase to nine percent. In addition, beginning on January 1, 2014, and on all Series C Preferred Stock dividend payment dates thereafter ending on April 1, 2016, the Company will be required to pay to the Secretary of the Treasury, on each share of Series C Preferred Stock outstanding, but only out of assets legally available, a fee equal to 0.5% of the liquidation amount per share of Series C Preferred Stock.
Strong competition within our market area could hurt our profits and slow growth.
We face intense competition both in making loans and attracting deposits. This competition may make it more difficult for us to originate new loans and may force us to offer higher deposit rates than currently. Price competition for loans and deposits might result in lower interest rates earned on our loans and higher interest rates paid on our deposits, which would reduce net interest income. According to the Federal Deposit Insurance Corporation, as of June 30, 2011, we held 19.3% of the deposits in Calvert, Charles and St. Mary’s counties, Maryland, which was the second largest market share of deposits out of the 13 financial institutions that held deposits in these counties. Our profitability depends upon our continued ability to compete successfully in our market area.
If the value of real estate in Southern Maryland were to continue to decline, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us.
Real estate values in Southern Maryland have experienced declines over the past few years. A continued decline in local economic conditions could adversely affect the value of the real estate collateral securing our loans. A continued decline in property values would diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer losses on defaulted loans. Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would hurt our profits. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters.
We may be adversely affected by economic conditions in our market area, which is significantly dependent on federal government and military employment, as well as national and international economic conditions.
Our marketplace is primarily in the counties of Charles, Calvert and St. Mary’s, Maryland and the neighboring communities. Many, if not most, of our customers live and/or work in those counties or in the greater Washington, D.C. metropolitan area. Because our services are concentrated in this market, we are affected by the general economic conditions in the greater Washington, D.C. and Southern Maryland area. Changes in the economy may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing. A significant decline in economic conditions caused by inflation, recession, unemployment or other factors beyond our control could decrease the demand for banking products and services generally and/or impair the ability of existing borrowers to repay their loans, which could negatively affect our financial condition and performance.
A significant portion of the population in our market area is affiliated with or employed by the federal government or at military facilities located in the area. As a result, a downturn in federal government or military employment could have a negative impact on local economic conditions and real estate collateral values, and could also negatively affect the Company’s profitability.
Increased and/or special FDIC assessments will hurt our earnings.
The recent economic recession has caused a high level of bank failures, which has dramatically increased Federal Deposit Insurance Corporation’s resolution costs and led to a significant reduction in the balance of the Deposit Insurance Fund. As a result, the Federal Deposit Insurance Corporation has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the Federal Deposit Insurance Corporation imposed a special assessment on all insured institutions and required all institutions to prepay their assessments for all of 2010, 2011 and 2012, which for us totaled $2.7 million. Additional increases in the base assessment rate or additional special assessments would negatively impact our earnings.
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The trading history of our common stock is characterized by low trading volume and volatility.
Although our common stock trades on OTC Electronic Bulletin Board, it has not been regularly traded. We cannot predict the extent to which investor interest in us will lead to a more active trading market in our common stock or how liquid that market might become. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of willing buyers and sellers of our common stock at any given time, which presence is dependent upon the individual decisions of investors, over which we have no control.
The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:
Ø | actual or anticipated fluctuations in our operating results; |
Ø | changes in interest rates; |
Ø | changes in the legal or regulatory environment in which we operate; |
Ø | press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry; |
Ø | changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors; |
Ø | future sales of our common stock; |
Ø | changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and |
Ø | other developments affecting our competitors or us. |
These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent you from selling your common stock at or above the price you desire. In addition, the stock markets, from time to time, experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. These broad fluctuations may adversely affect the market price of our common stock, regardless of our trading performance.
Beginning in 2007 and through the present, the business environment for financial services firms has been extremely challenging. During this period, many publicly traded financial services companies have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance or prospects of such companies. We may experience market fluctuations that are not directly related to our operating performance but are influenced by the market’s perception of the state of the financial services industry in general and, in particular, the market’s assessment of general credit quality conditions, including default and foreclosure rates in the industry.
While the U.S. and other governments continue efforts to restore confidence in financial markets and promote economic growth, we cannot assure you that further market and economic turmoil will not occur in the near- or long-term, negatively affecting our business, financial condition and results of operations, as well as the price, trading volume and volatility of our common stock.
26 |
We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.
The Company and the Bank are subject to extensive regulation, supervision and examination as noted in the Supervision and Regulation section of this Form 10K. The regulation and supervision by the Commissioner of Financial Regulation of the State of Maryland, the Federal Reserve Board and the Federal Deposit Insurance Corporation are not intended to protect the interests of investors in Tri-County Financial Corporation common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.
Regulatory reform may have a material impact on our operations.
On July 21, 2010, the President signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act restructures the regulation of depository institutions. The Dodd-Frank Act also creates a new federal agency to administer consumer protection and fair lending laws, a function that is now performed by the depository institution regulators. The federal preemption of state laws currently accorded federally chartered depository institutions will be reduced as well, and State Attorneys General will have greater authority to bring a suit against a federally chartered institution for violations of certain state and federal consumer protection laws. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs.
In addition to the enactment of the Dodd-Frank Act, the federal regulatory agencies have taken stronger supervisory actions against financial institutions that have experienced increased loan losses and other weaknesses as a result of the recent economic crisis. The actions include the entering into of written agreements and cease and desist orders that place certain limitations on their operations. Federal bank regulators have also been using with more frequency their ability to impose individual minimal capital requirements on banks, which requirements may be higher than those required under the Dodd-Frank Act or that would otherwise qualify the Bank as being “well capitalized” under applicable prompt corrective action regulations. If we were to become subject to a supervisory agreement or higher individual capital requirements, such action may have a negative impact on our ability to execute our business plans, as well as our ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in our operations.
Provisions of our articles of incorporation, bylaws and Maryland law, as well as state and federal banking regulations, could delay or prevent a takeover of us by a third party.
Provisions in our articles of incorporation and bylaws and Maryland corporate law could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our shareholders, or otherwise adversely affect the price of our common stock. These provisions include: supermajority voting requirements for certain business combinations; the election of directors to staggered terms of three years; and advance notice requirements for nominations for election to our board of directors and for proposing matters that shareholders may act on at shareholder meetings. In addition, we are subject to Maryland laws, including one that prohibits us from engaging in a business combination with any interested shareholder for a period of five years from the date the person became an interested shareholder unless certain conditions are met. These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors other than the candidates nominated by our Board.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and fund distribution. While we have selected these third party vendors carefully, we cannot control their actions. Any problems caused by these third parties, including those which result from their failure to provide services for any reason or their poor performance of services, could adversely affect our ability to deliver products and services to its customers and otherwise to conduct its business. Replacing these third party vendors could also entail significant delay and expense.
27 |
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
The Bank maintains its main office in Waldorf, Maryland, in addition to its branch offices in Lexington Park, Leonardtown, La Plata, Dunkirk, Bryans Road, Waldorf, Charlotte Hall, Prince Frederick and Lusby, Maryland. The Bank owns all of its branches except for the Dunkirk, Maryland branch and the land on which the Waldorf, Charlotte Hall, Prince Frederick and Lusby, Maryland branches are located. Lease expiration dates range from 2020 to 2028 with renewal options of 5 to 10 years. The total net book value of the properties at December 31, 2011 was $12.7 million which included $7.8 million related to buildings and improvements.
The Bank is building an operations center in Waldorf, Maryland and a branch in King George, Virginia. Both projects are scheduled for completion in the second quarter of 2012.
Item 3. Legal Proceedings
Neither the Company, the Bank, nor any subsidiary is engaged in any legal proceedings of a material nature at the present time. From time to time, the Bank is a party to legal proceedings in the ordinary course of business.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Security Holder Matters and Issuer Purchases of Equity Securities
Market Price and Dividends on Registrant’s and Related Stockholder Matters.
The information contained under the section captioned “Market for the Registrant’s Common Stock and Related Security Holder Matters” in the Company’s Annual Report to Stockholders for the fiscal year ended December 31, 2011 (the “Annual Report”) filed as Exhibit 13 hereto is incorporated herein by reference.
Stock Performance Graph.
Not required as the Company is a smaller reporting company.
Recent Sales of Unregistered Securities.
Not applicable.
28 |
Purchases of Equity Securities by the Issuer.
On September 25, 2008, the Company announced a repurchase program under which it would repurchase up to 5% of its outstanding common stock or approximately 147,435 shares. The following table presents information regarding the Company’s stock repurchases during the three months ended December 31, 2011.
(c) | ||||||||||||||||
Total Number | ||||||||||||||||
of Shares | (d) | |||||||||||||||
Purchased | Maximum | |||||||||||||||
(a) | as Part of | Number of Shares | ||||||||||||||
Total | (b) | Publicly | that May Yet Be | |||||||||||||
Number of | Average | Announced Plans | Purchased Under | |||||||||||||
Shares | Price Paid | or | the Plans or | |||||||||||||
Period | Purchased | per Share | Programs | Programs | ||||||||||||
October 1-31, 2011 | - | - | - | 115,006 | ||||||||||||
November 1-30, 2011 | - | - | - | 115,006 | ||||||||||||
December 1-31, 2011 | - | - | - | 115,006 | ||||||||||||
Total | - | - | - | 115,006 |
Item 6. Selected Financial Data
The information contained under the section captioned “Selected Financial Data” of the Annual Report filed as Exhibit 13 hereto is incorporated herein by reference.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
The information contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Annual Report filed as Exhibit 13 hereto is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Not applicable as the Company is a smaller reporting company.
Item 8. Financial Statements and Supplementary Data
The Consolidated Financial Statements, Notes to Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm included in the Annual Report filed as Exhibit 13 hereto are incorporated herein by reference.
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a) Disclosure Controls and Procedures
The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
(b) Internal Controls Over Financial Reporting
Management’s annual report on internal control over financial reporting is incorporated herein by reference to the Company’s audited Consolidated Financial Statements in this Annual Report on Form 10-K.
(c) Changes to Internal Control Over Financial Reporting
Except as indicated herein, there were no changes in the Company’s internal control over financial reporting during the three months ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B. Other Information
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
For information concerning the Company’s directors, the information contained under the section captioned “Items to be voted on by Stockholders Item 1 – Election of Directors” in the Company’s definitive proxy statement for the Company’s 2012 Annual Meeting of Stockholders (the “Proxy Statement”) is incorporated herein by reference. For information concerning the executive officers of the Company, see “Item 1 – Business – Executive Officers of the Registrant” under Part I of this Annual Report on Form 10-K.
For information regarding compliance with Section 16(a) of the Exchange Act, the cover page of this Annual Report on Form 10-K and the information contained under the section captioned “Other Information Relating to Directors and Executive Officers Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement are incorporated herein by reference.
For information concerning the Company’s code of ethics, the information contained under the section captioned “Corporate Governance – Code of Ethics” in the Proxy Statement is incorporated by reference. A copy of the code of ethics and business conduct is filed as Exhibit 14 hereto.
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For information regarding the audit committee and its composition and the audit committee financial expert, the section captioned “Corporate Governance – Committees of the Board of Directors – Audit Committee” in the Proxy Statement is incorporated by reference.
Item 11. Executive Compensation
For information regarding executive compensation, the information contained under the sections captioned “Executive Compensation” and “Directors’ Compensation” in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Security Ownership of Certain Owners
The information required by this item is incorporated herein by reference to the section captioned “Principal Holders of Voting Securities” in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned “Principal Holders of Voting Securities” in the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may, at a subsequent date, result in a change in control of the registrant.
(d) Equity Compensation Plan Information
The Company maintains the Tri-County Financial Corporation 2005 Equity Compensation Plan. This plan covers employees and non-employee directors. The following table sets forth certain information with respect to the Company’s Equity Compensation Plan as of December 31, 2011.
(a) | (b) | (c ) | ||||||||||
Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants, and rights | Weighted average exercise price of outstanding options, warrants, and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a) | |||||||||
Equity plans approved by security holders | 218,144 | $ | 18.59 | 114,855 | ||||||||
Equity compensation plans not approved by security holders (1) | 46,012 | $ | 14.64 | - | ||||||||
Total | 264,156 | $ | 17.90 | 114,855 |
(1) Consists of the Company’s 1995 Stock Option Plan for Non-Employee Directors, which expired in 2005 and which provided grants of non-incentive stock options to directors who are not employees of the Company or its subsidiaries. Options were granted at an exercise price equal to their fair market value at the date of grant and had a term of ten years. Options are generally exercisable while an optionee serves as a director or within one year thereafter.
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Item 13. Certain Relationships, Related Transactions and Director Independence
The information regarding certain relationships and related transactions, the section captioned “Other Information Relating to Directors and Executive Officers – Policies and Procedures for Approval and Related Parties Transactions and Relationships and Transactions with the Company and the Bank” in the Proxy Statement is incorporated herein by reference.
For information regarding director independence, the section captioned “Proposal 1 – Election of Directors” in the Proxy Statement is incorporated by reference.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated herein by reference to the section captioned “Audit Related Matters – Audit Fees” and “— an Pre-Approval of Services by the Independent Registered Public Accounting Firm” in the Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) List of Documents Filed as Part of this Report
(1) Financial Statements. The following consolidated financial statements and notes related thereto are incorporated by reference from Item 8 hereof:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2011 and 2010
Consolidated Statements of Income for the Years Ended December 31, 2011 and 2010
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2011 and 2010
Consolidated Statements of Cash Flows for the Years Ended December 31, 2011 and 2010
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements and related notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of this Annual Report on Form 10-K and is also the Exhibit Index.
Exhibit No |
Description | Incorporated by Reference to | ||
3.1 |
Articles of Incorporation of Tri-County Financial Corporation
|
Form S-4 (Registration No. 333-31287). | ||
3.2 |
Amended and Restated Bylaws of Tri-County Financial Corporation
|
Form 8-K as filed on August 27, 2010 | ||
4.1 |
Amended and Restated Articles Supplementary establishing Senior Non-cumulative Perpetual Preferred Stock, Series C, of Tri-County Financial Corporation
|
Form 8-K as filed on September 23, 2011 | ||
10.1* |
Tri-County Financial Corporation 1995 Stock Option and Incentive Plan, as amended
|
Form 10-K for the year ended December 31, 2000 as filed on March 30, 2001. |
32 |
10.2* |
Tri-County Financial Corporation 1995 Stock Option Plan for Non-Employee Directors, as amended
|
Form 10-K for the year ended December 31, 2000 as filed on March 30, 2001. | ||
10.3* |
Employment Agreement with Michael L. Middleton
|
Form 10-Q for the quarter ended September 30, 2006 as filed on November 14, 2006. | ||
10.4* | Amended and Restated Executive Incentive Compensation Plan | Form 10-K/A for the year ended December 31, 2008 as filed on April 20, 2009. | ||
10.5* | Retirement Plan for Directors |
Form 10-K for the year ended December 31, 2006 as filed on March 27, 2007.
| ||
10.6* |
Split Dollar Agreements with Michael L. Middleton
|
Form 10-K for the year ended December 31, 2000 as filed on March 30, 2001. | ||
10.7* |
Split Dollar Agreement with William J. Pasenelli
|
Form 10-K for the year ended December 31, 2001 as filed on April 1, 2002. | ||
10.8* |
Salary Continuation Agreement with Michael L. Middleton, dated September 6, 2003
|
Form 10-K for the year ended December 31, 2003 as filed on March 26, 2004. | ||
10.9* |
First Amendment to the Salary Continuation Agreement, dated September 6, 2003, with Michael L. Middleton
|
Form 10-K for the year ended December 31, 2008 as filed on March 9, 2009. | ||
10.10* |
Tri-County Financial Corporation 2005 Equity Compensation Plan
|
Definitive Proxy Statement as filed on April 11, 2005 | ||
10.11* |
Amendment No. 1 to the Tri-County Financial Corporation 2005 Equity Compensation Plan
|
Form 10-Q for the quarter ended September 30, 2007 as filed on November 13, 2007. | ||
10.12* |
Community Bank of Tri-County Executive Deferred Compensation Plan
|
Form 10-K for the year ended December 31, 2006 as filed on March 27, 2007. | ||
10.13* |
Amended and Restated Employment Agreement by and among Community Bank of Tri-County, William J. Pasenelli and Tri-County Financial Corporation, as guarantor
|
Form 10-Q for the quarter ended March 31, 2007 as filed on May 11, 2007. | ||
10.14* |
Amended and Restated Employment Agreement by and among Community Bank of Tri-County, Gregory C. Cockerham and Tri-County Financial Corporation, as guarantor
|
Form 10-Q for the quarter ended March 31, 2007 as filed on May 11, 2007. | ||
10.15* |
Salary Continuation Agreement with Gregory C. Cockerham, dated August 21, 2006
|
Form 10-Q for the quarter ended September 30, 2006 as filed on November 14, 2006. | ||
10.16* |
First Amendment to the Salary Continuation Agreement, dated August 21, 2006, with Gregory C. Cockerham
|
Form 10-K/A for the year ended December 31, 2008 as filed on April 20, 2009. |
33 |
10.17* |
Second Amendment to the Salary Continuation Agreement, dated August 21, 2006, with Gregory C. Cockerham
|
Form 10-K/A for the year ended December 31, 2008 as filed on April 20, 2009. | ||
10.18* |
Salary Continuation Agreement with William J. Pasenelli, dated August 21, 2006
|
Form 10-Q for the quarter ended September 30, 2006 as filed on November 14, 2006. | ||
10.19* |
First Amendment to the Salary Continuation Agreement, dated August 21, 2006, with William J. Pasenelli
|
Form 10-K/A for the year ended December 31, 2008 as filed on April 20, 2009. | ||
10.20* |
Second Amendment to the Salary Continuation Agreement, dated August 21, 2006, with William J. Pasenelli
|
Form 10-K/A for the year ended December 31, 2008 as filed on April 20, 2009. | ||
10.21* |
Securities Purchase Agreement dated September 22, 2011, between Tri-County Financial Corporation and the Secretary of the United States Department of the Treasury
|
Form 8-K as filed on September 23, 2011 | ||
10.22* |
Repurchase Letter dated September 22, 2011 between Tri-County Financial Corporation and the United States Department of the Treasury with respect to the Series A Preferred Stock and Series B Preferred Stock
|
Form 8-K as filed on September 23, 2011 | ||
10.23* |
Form of Letter Agreement between Tri-County Financial Corporation and each of Michael L. Middleton, Gregory C. Cockerham and William J. Pasenelli
|
Form 8-K as filed on September 23, 2011 | ||
10.24* |
Salary Continuation Agreement between Gregory C. Cockerham and Community Bank of Tri-County, dated September 6, 2003, as amended on December 22, 2008
|
Form 10-K/A for the year ended December 31, 2008 as filed on April 20, 2009. | ||
10.25* |
Salary Continuation Agreement between William J. Pasenelli and Community Bank of Tri-County, dated September 6, 2003, as amended on June 11, 2004 and December 22, 2008
|
Form 10-K/A for the year ended December 31, 2008 as filed on April 20, 2009. | ||
13.0 |
Annual Report to Stockholders for the year ended December 31, 2011
|
|||
14.0 | Code of Ethics | Form 10-K for the year ended December 31, 2005 as filed on March 30, 2006. | ||
21.0 |
List of Subsidiaries
|
|||
23.1 |
Consent of Stegman & Company
|
34 |
31.1 |
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
|
|||
31.2 |
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
|
|||
32.0 |
Section 1350 Certification of Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer
|
|||
99.1 |
Principal Executive Officer Certification regarding TARP
|
|||
99.2 |
Principal Executive Officer Certification regarding TARP
|
|||
101.0** | The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Changes In Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements, tagged as blocks of text. |
(*) | Management contract or compensating arrangement. |
(**) | Furnished not filed. |
(b) Exhibits. The exhibits required by Item 601 of Regulation S-K are either filed as part of this Annual Report on Form 10-K or incorporated by reference herein.
(c) Financial Statements and Schedules Excluded From Annual Report. There are no other financial statements and financial statement schedules which were excluded from this Annual Report pursuant to Rule 14a-3(b)(1) which are required to be included herein.
35 |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TRI-COUNTY FINANCIAL CORPORATION | ||
Date: March 9, 2012 | By: | /s/ Michael L. Middleton |
Michael L. Middleton | ||
President and Chief Executive Officer | ||
(Duly Authorized Representative) |
Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By: | /s/ Michael L. Middleton | By: | /s/ William J. Pasenelli | |
Michael L. Middleton | William J. Pasenelli | |||
Director, President and Chief Executive Officer | Director, Executive Vice President and Chief | |||
(Principal Executive Officer) | Financial Officer | |||
(Principal Financial and Accounting Officer) | ||||
Date: March 9, 2012 | Date: March 9, 2012 |
By: | /s/ H. Beaman Smith | By: | /s/ Austin J. Slater, Jr. | |
H. Beaman Smith | Austin J. Slater, Jr. | |||
Director | Director | |||
Date: March 9, 2012 | Date: March 9, 2012 |
By: | /s/ Louis P. Jenkins, Jr. | By: | /s/ James R. Shepherd | |
Louis P. Jenkins, Jr. | James R. Shepherd | |||
Director | Director | |||
Date: March 9, 2012 | Date: March 9, 2012 |
By: | /s/ Philip T. Goldstein | By: | /s/ Joseph V. Stone, Jr. | |
Philip T. Goldstein | Joseph V. Stone, Jr. | |||
Director | Director | |||
Date: March 9, 2012 | Date: March 9, 2012 |
By: | /s/ Mary Todd Peterson | |
Mary Todd Peterson | ||
Director | ||
Date: March 9, 2012 |
36 |
EXHIBIT 13
ANNUAL REPORT TO STOCKHOLDERS
Dear Shareholder:
Tri-County Financial Corporation continued its successful growth by increasing total assets to $983,479,723 at December 31, 2011, an 11% increase over the previous year. The double digit growth was primarily due to an increase of $55,638,839 of loans created by $269,796,000 in originations during that year. I am proud to note that during the Great Recession and the thirty months of post recession recovery, your Bank lent over $1 billion in new loans to support businesses and families living in Southern Maryland.
While our growth of earning assets produced a greater volume of revenue, we continued our focus on reducing the level of nonperforming assets. As a result of the increased noninterest expenses associated with this effort, net income available to common shareholders for the year ended December 31, 2011 decreased by $1,429,795 to $2,488,976, or $0.82 per common share (diluted), compared to $3,918,771, or $1.30 per common share (diluted), for the previous year. Your Company has remained profitable for every quarter during the crisis and the ensuing recovery. Over the year, we resolved many nonperforming assets and redeployed the funds into earning assets. Our nonperforming assets to total assets declined from 2.71% at December 31, 2010 to 1.48% at December 31, 2011, which is significantly below peer banks. We continue to work with customers to restructure viable loans and to foreclose on properties that merit such an action.
In consideration of our earnings for 2011 and improving nonperforming asset trends, your Board approved an annual cash dividend of $0.40 per share.
The growth in our earning assets was funded by an increase in total deposits of 14%, or $102,670,875, to $827,235,201 at December 31, 2011. Our strategy to use deposits to fund banking operations and to reduce wholesale funding has helped decrease our overall cost of funding to 1.23% at year end. We continue to reduce the cost of deposits as multi-year certificates of deposit mature. Our deposit growth moved the Bank into the second place for overall deposit share in Southern Maryland according to the recent FDIC Deposit Survey. To expand our retail banking footprint, we expect to open our eleventh branch in King George, Virginia in March 2012.
Your Company has successfully weathered the recession and slow recovery and remains well capitalized to continue its strategic business plan. With your continued support and advocacy, we look forward to building on our success and remaining one of Southern Maryland’s largest economic engines.
Yours truly,
/s/ Michael L. Middleton
Michael L. Middleton
Chairman of the Board
Management’s Discussion and Analysis
Forward-Looking Statements
This annual report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of Tri-County Financial Corporation (the “Company”) and Community Bank of Tri-County (the “Bank”). These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions.
The Company and the Bank’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company and the Bank’s market area, changes in real estate market values in the Company and the Bank’s market area and changes in relevant accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
As a state chartered Federal Reserve member Bank, the Bank has sought to organically increase total assets through its targeted loan product lines. The Bank believes that its ability to offer fast, flexible, local decision-making will continue to attract significant new business relationships and enhance asset growth. The Bank’s marketing is directed towards increasing its balances of both consumer and business transaction deposit accounts. The Bank believes that increases in these account types will lessen the Bank’s dependence on higher-cost funding, such as certificates of deposit and borrowings. Although management believes that this strategy will increase financial performance over time, increasing the balances of certain products, such as commercial lending and transaction accounts, may also increase the Bank’s noninterest expense. It recognizes that certain lending and deposit products increase the possibility of losses from credit and other risks.
The Bank conducts business through its main office in Waldorf, Maryland and nine branch offices in the Southern Maryland counties of Charles, Calvert and St. Mary’s. The Bank is the second largest overall deposit holder in the Tri-County area according to the most recent 2011 FDIC Summary of Deposit Survey. The Bank is building an operations center in Waldorf, Maryland and a branch in King George, Virginia. Both projects are scheduled for completion in the second quarter of 2012.
The U.S. economy continued to experience slow growth during 2011. Locally, real estate values appear to have stabilized while in some areas home foreclosures continued to rise and unemployment levels remained above trend levels. As a whole, the Southern Maryland economy has been less impacted by the recent recession due to presence of federal government agencies and defense facilities.
The Company remained profitable every quarter since the inception of the economic crisis and core operations were sufficient to fully absorb losses and expenses related to nonperforming assets during this time. During the recession and post crisis period of 2008 to 2011, the Bank originated approximately $1 billion of new loans in our market. The growth of the Company’s balance sheet from $716 million at December 31, 2008 to $983 million at December 31, 2011 was fueled by commercial and residential lending in Southern Maryland.
1 |
Management’s Discussion and Analysis
On September 23, 2011, the U.S. Department of Treasury purchased $20.0 million in the Company’s preferred stock under the Small Business Lending Fund (the “SBLF”). The SBLF is a program intended to encourage small business lending by providing capital to qualified community banks at favorable rates. SBLF dividend rates can fluctuate between 1% and 7% during the first four and one half years, depending on the level of the Bank’s small business lending. As of December 31, 2011, the Company’s dividend rate on the SBLF funds was 1%. The Company used $16.4 million of the proceeds from this investment to redeem all of the preferred stock that it sold to the Treasury under the TARP Capital Purchase Program (“TARP”) on December 19, 2008 as well as to pay any accrued but unpaid dividends. The net proceeds, after repurchasing the TARP securities, were invested by the Company in the Bank. During 2012, if the Company maintains its current investment in qualified small business lending, annual preferred dividends will decrease to $200,000 compared with previously paid annual TARP preferred dividends of $846,930.
Critical Accounting Policies
Critical accounting policies are defined as those that involve significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. The Company considers its determination of the allowance for loan losses, the valuation of foreclosed real estate and the valuation of deferred tax assets to be critical accounting policies.
The Company’s Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America and the general practices of the United States banking industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.
Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When these sources are not available, management makes estimates based upon what it considers to be the best available information.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that exist in the loan portfolio. The allowance is based on two principles of accounting: (1) Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 450 “Contingencies,” which requires that losses be accrued when they are probable of occurring and are estimable and (2) FASB ASC 310 “Receivables”, which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan. The loss, if any, is determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows and values observable in the secondary markets.
The allowance for loan loss balance is an estimate based upon management’s evaluation of the loan portfolio. The allowance is comprised of a specific and a general component. The specific component consists of management’s evaluation of certain classified and non-accrual loans and their underlying collateral. Management assesses the ability of the borrower to repay the loan based upon all information available. Loans are examined to determine a specific allowance based upon the borrower’s payment history, economic conditions specific to the loan or borrower and other factors that would impact the borrower’s ability to repay the loan on its contractual basis. Depending on the assessment of the borrower’s ability to pay and the type, condition and value of collateral, management will establish an allowance amount specific to the loan.
2 |
Management’s Discussion and Analysis
Management utilizes a risk scale to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Commercial loan relationships with an aggregate exposure to the Bank of $750,000 or greater are risk rated. Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned or higher risk rating due to a delinquent payment history. Management engages a third-party firm to perform loan reviews of its commercial loan portfolio.
In establishing the general component of the allowance, management analyzes non-classified and non-impaired loans in the portfolio including changes in the amount and type of loans. Management also examines the Bank’s historical loss experience (charge-offs and recoveries) within each loan category. The state of the local and national economy is also considered. Based upon these factors, the Bank’s loan portfolio is categorized and a loss factor is applied to each category. These loss factors may be higher or lower than the Bank’s actual recent average losses in any particular loan category, particularly in loan categories that are increasing or decreasing in size. Based upon these factors, the Bank will adjust the loan loss allowance by increasing or decreasing the provision for loan losses.
Management has significant discretion in making the judgments inherent in the determination of the allowance for loan losses, including in connection with the valuation of collateral, a borrower’s prospects of repayment and in establishing loss factors on the general component of the allowance. Changes in loss factors will have a direct impact on the amount of the provision and a corresponding effect on net income. Errors in management’s perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs. At December 31, 2011, the allowance for loan losses was $7,655,041 or 1.07% of total loans. An increase or decrease in the allowance could result in a charge or credit to income before income taxes that materially impacts earnings. For additional information regarding the allowance for loan losses, refer to Notes 1 and 5 to the Consolidated Financial Statements and the discussion under the caption “Provision for Loan Losses” below.
Other-Than-Temporary-Impairment (“OTTI”)
Debt securities are evaluated quarterly to determine whether a decline in their value is other-than-temporary. The term “other-than-temporary” is not necessarily intended to indicate a permanent decline in value. It means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Under the revised guidance, for recognition and presentation of other-than-temporary impairments the amount of other-than-temporary impairment that is recognized through earnings for debt securities is determined by comparing the present value of the expected cash flows to the amortized cost of the security. The discount rate used to determine the credit loss is the expected book yield on the security.
Foreclosed Real Estate (Other Real Estate Owned “OREO”)
The Company maintains a valuation allowance on its foreclosed real estate. As with the allowance for loan losses, the valuation allowance on foreclosed real estate is based on FASB ASC 450 “Contingencies,” as well as the accounting guidance on impairment of long-lived assets. These statements require that the Company establish a valuation allowance when it has determined that the carrying amount of a foreclosed asset exceeds its fair value. Fair value of a foreclosed asset is measured by the cash flows expected to be realized from its subsequent disposition. These cash flows are reduced for the costs of selling or otherwise disposing of the asset.
3 |
Management’s Discussion and Analysis
In estimating the cash flows from the sale of foreclosed real estate, management must make significant assumptions regarding the timing and amount of cash flows. For example, in cases where the real estate acquired is undeveloped land, management must gather the best available evidence regarding the market value of the property, including appraisals, cost estimates of development and broker opinions. Due to the highly subjective nature of this evidence, as well as the limited market, long time periods involved and substantial risks, cash flow estimates are highly subjective and subject to change. Errors regarding any aspect of the costs or proceeds of developing, selling or otherwise disposing of foreclosed real estate could result in the allowance being inadequate to reduce carrying costs to fair value and may require an additional provision for valuation allowances.
Deferred Tax Assets
The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. FASB ASC 740 requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or the entire deferred tax asset will not be realized.
At December 31, 2011 and 2010, the Company had deferred tax assets in excess of deferred tax liabilities of $5,832,472 and $5,061,557, respectively. At December 31, 2011 and 2010, management determined that it is more likely than not that the entire amount of such assets will be realized in the future.
The Company periodically evaluates the ability of the Company to realize the value of its deferred tax assets. If the Company were to determine that it was not more likely than not that the Company would realize the full amount of the deferred tax assets, it would establish a valuation allowance to reduce the carrying value of the deferred tax asset to the amount it believes would be realized. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax-planning strategies that could be implemented to realize the net deferred tax assets.
Failure to achieve forecasted taxable income might affect the ultimate realization of the net deferred tax assets. Factors that may affect the Company’s ability to achieve sufficient forecasted taxable income include, but are not limited to, the following: increased competition, a decline in net interest margin, a loss of market share, decreased demand for financial services and national and regional economic conditions.
The Company’s provision for income taxes and the determination of the resulting deferred tax assets and liabilities involve a significant amount of management judgment and are based on the best information available at the time. The Company operates within federal and state taxing jurisdictions and is subject to audit in these jurisdictions. For additional information regarding the deferred tax assets, refer to Note 11 to the Consolidated Financial Statements.
Comparison of Results of Operations For the Years Ended December 31, 2011 and 2010
General
For the year ended December 31, 2011, the Company reported consolidated net income of $3,161,464 ($0.83 basic and $0.82 diluted earnings per common share) compared to consolidated net income of $4,765,701 ($1.31 basic and $1.30 diluted earnings per common share) for the year ended December 31, 2010. Consolidated net income available to common shareholders for the year ended December 31, 2010 decreased $1,429,795, or 36.49%, to $2,488,976 compared to $3,918,771 for the year ended December 31, 2010.
The decrease in net income available to common shareholders for the year ended December 31, 2011 was primarily attributable to increased costs related to OREO to reflect current appraisals or contracted sales amounts for nonperforming assets and costs in order to facilitate the ultimate disposition of these properties. Other expenses, including an increase to the provision for loan losses, FDIC insurance for the increase in average customer deposits, increased costs for regulatory compliance, data processing and employee compensation to support the growth of the Bank contributed to the decline. These costs were partially offset by increases in net interest income and noninterest income, as well as a decrease in preferred stock dividends paid.
4 |
Management’s Discussion and Analysis
Increases in noninterest expense of $4,054,019 and the provision for loan losses of $153,703 were partially offset by increases in net interest income of $881,580 and noninterest income of $612,864 and a reduction in income tax expense of $1,109,041. The Company’s preferred stock dividends decreased $174,442 to $672,488 for the year ended December 31, 2011 from $846,930 for the year ended December 31, 2010. The decrease was due to the Bank’s participation in the SBLF and payoff of TARP during the third quarter (See Notes 1 and 18 to the Consolidated Financial Statements).
Net Interest Income
The primary component of the Company’s net income is its net interest income, which is the difference between income earned on assets and interest paid on the deposits and borrowings used to fund them. Net interest income is affected by the difference between the yields earned on the Company’s interest-earning assets and the rates paid on interest-bearing liabilities, as well as the relative amounts of such assets and liabilities. Net interest income, divided by average interest-earning assets, represents the Company’s net interest margin.
Net interest income for the year ended December 31, 2011 was $26,838,352 compared to $25,956,772 for the year ended December 31, 2010. The $881,580 increase was due to an increase in interest income of $422,407 and a decrease in interest expense of $459,173. Changes in the components of net interest income due to changes in average balances of assets and liabilities and to changes caused by changes in interest rates are presented in the rate volume analysis.
Interest and dividend income increased to $39,959,394 for the year ended December 31, 2011 compared to $39,536,987 for the year ended December 31, 2010. The increase in interest and dividend income was attributable to growth in the average balance of interest-earning assets partially offset by a reduction in average yields. Average balances of interest-earning assets increased $54,570,243 from $781,640,192 for the year ended December 31, 2010 to $836,210,435 for the year ended December 31, 2011. Average yields on interest-earning assets decreased from 5.06% for the year ended December 31, 2010 to 4.78% for the year ended December 31, 2011. The $1,388,339 increase in loan interest income was due to additional interest earned of $3,001,893 as a result of larger average loan balances offset by a decrease of $1,613,555 due to a decrease in average loan yields from 5.68% for the year ended December 31, 2010 to 5.42% for the year ended December 31, 2011. Since 2008, the average balance of loans increased $180 million or 36.68% to $671,241,819 for the year ended December 31, 2011. The $965,932 decrease for interest and dividends earned on investments and was primarily the result of reductions in average investment yields of $949,915 to 2.17% for the year ended December 31, 2011 from 2.74% for the comparable period in 2010.
Interest expense decreased to $13,121,042 for the year ended December 31, 2011 compared to $13,580,215 for the year ended December 31, 2010. The average cost of funds on interest-bearing liabilities decreased from 1.94% for the year end December 31, 2010 to 1.73% for the year ended December 31, 2011 primarily due to a decrease in interest rates paid on certificates of deposit (“CD”), which declined from 2.21% to 1.94%. The reduction in CD rates represented $1,116,421 of the total interest-bearing liability rate variance of $955,360. Interest expense also decreased $320,121 due to a reduction in average outstanding debt of $9.9 million from $73.8 million for the year ended December 31, 2010 to $63.9 million for the year ended December 31, 2011. Decreased interest expense for CDs and debt were partially offset by $816,308 in increased interest expense due to higher average balances of deposits. The Company increased average customer interest-bearing deposits by $70.1 million from $613.4 million for the year ended December 31, 2010 to $683.5 million for the year ended December 31, 2011.
The Company has been successful in increasing its core deposits and reducing the cost of funds in the low interest rate environment over the last several years and has limited the effect of the lower interest rate environment on loan rates through pricing and interest rate floors. For the year ended December 31, 2011, the Company’s interest rate spread and net interest margin decreased seven basis points and 11 basis points, respectively.
5 |
Management’s Discussion and Analysis
The following table presents information on the average balances of the Company’s interest-earning assets and interest-bearing liabilities and interest earned or paid thereon for the past two fiscal years. There are no tax equivalency adjustments.
2011 | 2010 | |||||||||||||||||||||||
Average | Average | |||||||||||||||||||||||
Average | Yield/ | Average | Yield/ | |||||||||||||||||||||
dollars in thousands | Balance | Interest | Cost | Balance | Interest | Cost | ||||||||||||||||||
Assets | ||||||||||||||||||||||||
Interest-earning assets | ||||||||||||||||||||||||
Loan portfolio (1) | $ | 671,242 | $ | 36,383 | 5.42 | % | $ | 615,887 | $ | 34,995 | 5.68 | % | ||||||||||||
Investment securities, federal funds sold and interest-bearing deposits | 164,969 | 3,576 | 2.17 | % | 165,753 | 4,542 | 2.74 | % | ||||||||||||||||
Total interest-earning assets | 836,211 | 39,959 | 4.78 | % | 781,640 | 39,537 | 5.06 | % | ||||||||||||||||
Cash and cash equivalents | 15,148 | 13,709 | ||||||||||||||||||||||
Other assets | 54,324 | 45,107 | ||||||||||||||||||||||
Total Assets | $ | 905,683 | $ | 840,456 | ||||||||||||||||||||
Liabilities and Stockholders' Equity | ||||||||||||||||||||||||
Interest-bearing liabilities | ||||||||||||||||||||||||
Savings | $ | 31,446 | $ | 109 | 0.35 | % | $ | 30,355 | $ | 123 | 0.41 | % | ||||||||||||
Interest-bearing demand and money market accounts | 217,183 | 2,162 | 1.00 | % | 161,494 | 1,510 | 0.94 | % | ||||||||||||||||
Certificates of deposit | 434,811 | 8,447 | 1.94 | % | 421,525 | 9,305 | 2.21 | % | ||||||||||||||||
Long-term debt | 61,421 | 2,037 | 3.32 | % | 70,823 | 2,278 | 3.22 | % | ||||||||||||||||
Short-term borrowings | 2,563 | 49 | 1.91 | % | 2,973 | 42 | 1.41 | % | ||||||||||||||||
Guaranteed preferrred beneficial interest in junior subordinated debentures | 12,000 | 317 | 2.64 | % | 12,000 | 322 | 2.68 | % | ||||||||||||||||
Total interest-bearing liabilities | 759,424 | 13,121 | 1.73 | % | 699,170 | 13,580 | 1.94 | % | ||||||||||||||||
Noninterest-bearing demand deposits | 66,105 | 65,041 | ||||||||||||||||||||||
Other liabilities | 7,168 | 5,772 | ||||||||||||||||||||||
Stockholders' equity | 72,986 | 70,473 | ||||||||||||||||||||||
Total Liabilities and Stockholders' Equity | $ | 905,683 | $ | 840,456 | ||||||||||||||||||||
Net interest income | $ | 26,838 | $ | 25,957 | ||||||||||||||||||||
Interest rate spread | 3.05 | % | 3.12 | % | ||||||||||||||||||||
Net yield on interest-earning assets | 3.21 | % | 3.32 | % | ||||||||||||||||||||
Ratio of average interest-earning assets to average interest-bearing liabilities | 110.11 | % | 111.80 | % |
(1) Average balance includes non-accrual loans
6 |
Management’s Discussion and Analysis
The table below sets forth certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); and (2) changes in rate (changes in rate multiplied by old volume). Changes in rate-volume (changes in rate multiplied by the change in volume) have been allocated to changes due to volume.
Year ended December 31, 2011 | ||||||||||||
compared to year ended | ||||||||||||
December 31, 2010 | ||||||||||||
Due to | ||||||||||||
dollars in thousands | Volume | Rate | Total | |||||||||
Interest-Earning Assets | ||||||||||||
Loan portfolio (1) | $ | 3,000 | $ | (1,612 | ) | $ | 1,388 | |||||
Investment securities, federal funds sold and interest bearing deposits | (17 | ) | (949 | ) | (966 | ) | ||||||
Total Interest-Earning Assets | $ | 2,983 | $ | (2,561 | ) | $ | 422 | |||||
Interest-Bearing Liabilities | ||||||||||||
Savings | $ | 4 | $ | (18 | ) | $ | (14 | ) | ||||
Interest-bearing demand and money market accounts | 554 | 98 | 652 | |||||||||
Certificates of deposit | 258 | (1,116 | ) | (858 | ) | |||||||
Long-term debt | (312 | ) | 71 | (241 | ) | |||||||
Short-term debt | (8 | ) | 15 | 7 | ||||||||
Guaranteed preferrred beneficial interest in junior subordinated debentures | - | (5 | ) | (5 | ) | |||||||
Total Interest-Bearing Liabilities | $ | 496 | $ | (955 | ) | $ | (459 | ) | ||||
Net Change in Net Interest Income | $ | 2,487 | $ | (1,606 | ) | $ | 881 |
(1) Average balance includes non-accrual loans
Provision for Loan Losses
Provision for loan losses for the year ended December 31, 2011 was $4,087,151, compared to $3,933,448 for the year ended December 31, 2010. The loan loss provision increased in 2011 primarily due to increases in net charge-offs which increased $361,183 from $3,743,945 (0.61% of average loans) for the year ended December 31, 2010 to $4,105,128 (0.61% of average loans)for the year ended December 31, 2010. The loan loss provision also increased as the Bank continued to add loans to its portfolio particularly in commercial real estate, which carry a higher risk of default than other loans in the Bank’s portfolio. The Company’s allowance for loan losses decreased from $7,669,147 or 1.16% of loan balances at December 31, 2010 to $7,655,041 or 1.07% of loan balances at December 31, 2011, as specific loans were restructured, foreclosed or charged-off and nonperforming loans and overall delinquency declined. Nonperforming loans decreased $4,008,162 to $9,510,617 or 1.32% at December 31, 2011 from $13,518,779 or 2.04% at December 31, 2010. Overall delinquency decreased to 2.09% of gross loans from 2.21% for the same comparative periods. The loan loss allowance and the provision for loan losses is determined based upon an analysis of individual loans and the application of certain loss factors to different loan categories. Individual loans are analyzed for impairment as the facts and circumstances warrant. In addition, a general component of the loan loss allowance is added based on a review of the portfolio’s size and composition. At December 31, 2011, the ratio of the allowance for loan loss to nonperforming loans was 80% compared to 57% at December 31, 2010.
7 |
Management’s Discussion and Analysis
Noninterest Income
Years Ended December 31, | % change | Dollar change | ||||||||||||||
2011 | 2010 | 2011 vs. 2010 | 2011 vs. 2010 | |||||||||||||
Loan appraisal, credit and miscellaneous charges | $ | 789,883 | $ | 676,805 | 16.71 | % | $ | 113,078 | ||||||||
Income from bank owned life insurance | 650,393 | 504,296 | 28.97 | % | 146,097 | |||||||||||
Service charges | 1,988,947 | 1,905,949 | 4.35 | % | 82,998 | |||||||||||
Gain on sale of asset | 22,500 | 22,500 | 0.00 | % | - | |||||||||||
Gain on sale of loans held for sale | 286,978 | 470,626 | (39.02 | )% | (183,648 | ) | ||||||||||
Net gain on the sale of foreclosed property | 454,339 | - | n/a | 454,339 | ||||||||||||
Total Noninterest Income | $ | 4,193,040 | $ | 3,580,176 | 17.12 | % | $ | 612,864 |
The increase of $612,864 was primarily due to net gains of $454,339 on disposals of $10,750,768 of foreclosed real estate for the year ended December 31, 2011 compared to no gains or losses for the year ended December 31, 2010. At December 31, 2011, the Company had deferred gains of $410,268 for two foreclosed real estate properties that did not qualify for full accrual sales treatment.
Service charges and fees are primarily generated by the Bank’s ability to attract and retain transaction based deposit accounts and by loan servicing fees. In 2011, service charges increased as the Bank increased its average transaction account balances during the year. These increases were offset by decreased fees due to new regulatory guidance that limits the amount of customer fees on certain customer transactions. The increase in bank owned life insurance income represented the increase in cash surrender value during 2011.
Gains on loan sales decreased as loans sales decreased from $14,248,912 for the year ended December 31, 2010 to $9,747,000 for the year ended December 31, 2011. The Bank’s residential loan efforts during 2011 focused on shorter-term amortizing residential loans that were retained in its loan portfolio.
Noninterest Expenses
Years Ended December 31, | % change | Dollar change | ||||||||||||||
2011 | 2010 | 2011 vs. 2010 | 2011 vs. 2010 | |||||||||||||
Salary and employee benefits | $ | 11,082,386 | $ | 9,769,401 | 13.44 | % | $ | 1,312,985 | ||||||||
Occupancy expense | 1,833,466 | 1,772,394 | 3.45 | % | 61,072 | |||||||||||
Advertising | 491,789 | 399,802 | 23.01 | % | 91,987 | |||||||||||
Data processing expense | 1,305,601 | 1,044,972 | 24.94 | % | 260,629 | |||||||||||
Depreciation of furniture, fixtures, and equipment | 435,551 | 541,642 | (19.59 | )% | (106,091 | ) | ||||||||||
Telephone communications | 174,748 | 170,566 | 2.45 | % | 4,182 | |||||||||||
Office supplies | 184,820 | 170,447 | 8.43 | % | 14,373 | |||||||||||
Professional fees | 997,114 | 799,377 | 24.74 | % | 197,737 | |||||||||||
FDIC insurance | 1,428,949 | 1,338,305 | 6.77 | % | 90,644 | |||||||||||
Valuation allowance on foreclosed real estate | 1,963,227 | 287,934 | 581.83 | % | 1,675,293 | |||||||||||
Other | 2,351,551 | 1,900,343 | 23.74 | % | 451,208 | |||||||||||
Total Noninterest Expenses | $ | 22,249,202 | $ | 18,195,183 | 22.28 | % | $ | 4,054,019 |
Noninterest expense increased from the prior year ended primarily due to growth in employee compensation and increased foreclosure related costs compared to 2010. The increase in salary and employee benefit costs reflect growth in the Bank’s workforce to fully staff branches and offices to support the Bank’s balance sheet growth, an increasing need for highly skilled employees due to more complex nature of the Bank’s business and regulatory burden and continued increases in the Bank’s benefit costs. Foreclosure related costs, which include valuation allowance and expenses to maintain OREO properties, increased from $416,399 for the year ended December 31, 2010 to $2,452,391 for the year ended December 31, 2011. Data processing increased from the prior year due mostly to one-time conversion related costs for a planned change to the Bank’s core service provider. Depreciation expense decreased as $1.8 million of assets became fully depreciated during 2011. FDIC insurance costs increased due an increase in average assets. Additionally, regulatory compliance costs continue to rise from the prior year reflecting the legacy regulatory burden, as well as the initial impact of the Dodd-Frank Act, impacting salaries and employee benefits, data processing, professional fees and other expenses.
8 |
Management’s Discussion and Analysis
Income Tax Expense
For the year ended December 31, 2011, the Company recorded income tax expense of $1,533,575 compared to $2,642,616 in the prior year. The Company’s effective tax rates for the years ended December 31, 2011 and 2010 were 32.67% and 35.67%, respectively. The tax rate decreased due to an increase in the relative size of non-taxable income items and lower pre-tax income in 2011.
Comparison of Financial Condition at December 31, 2011 and 2010
Assets
December 31, | % change | Dollar change | ||||||||||||||
2011 | 2010 | 2011 vs. 2010 | 2011 vs. 2010 | |||||||||||||
Cash and due from banks | $ | 13,074,091 | $ | 8,695,590 | 50.35 | % | $ | 4,378,501 | ||||||||
Federal funds sold | 5,040,000 | 615,000 | 719.51 | % | 4,425,000 | |||||||||||
Interest-bearing deposits with banks | 1,004,098 | 512,846 | 95.79 | % | 491,252 | |||||||||||
Securities available for sale (AFS), at fair value | 41,827,612 | 34,946,225 | 19.69 | % | 6,881,387 | |||||||||||
Securities held to maturity (HTM), at amortized cost | 153,516,839 | 126,988,316 | 20.89 | % | 26,528,523 | |||||||||||
Federal Home Loan Bank and Federal Reserve Bank stock | 5,587,000 | 6,315,600 | (11.54 | )% | (728,600 | ) | ||||||||||
Loans receivable - net of allowance for loan losses of $7,655,041 and $7,669,147 | 710,088,775 | 654,449,936 | 8.50 | % | 55,638,839 | |||||||||||
Premises and equipment, net | 16,440,902 | 12,132,141 | 35.52 | % | 4,308,761 | |||||||||||
Foreclosed real estate | 5,028,513 | 10,469,302 | (51.97 | )% | (5,440,789 | ) | ||||||||||
Accrued interest receivable | 3,027,784 | 2,784,396 | 8.74 | % | 243,388 | |||||||||||
Investment in bank owned life insurance | 18,098,085 | 17,447,692 | 3.73 | % | 650,393 | |||||||||||
Other assets | 10,746,024 | 10,579,058 | 1.58 | % | 166,966 | |||||||||||
Total Assets | $ | 983,479,723 | $ | 885,936,102 | 11.01 | % | $ | 97,543,621 |
The increase in total assets was primarily due to growth in the loan and investment portfolios during the last three quarters of the year.
The increases in loans receivable reflect the Bank’s continuing efforts to build its market share in Southern Maryland. Gross loan growth of $55,484,909 from $663,055,266 at December 31, 2010 to $718,540,175 at December 31, 2011, was due to net new loans of $34,084,049 in commercial real estate and $28,494,732 in residential mortgages offset by decreases of $5,759,335 in construction and land development and a net decrease in other loan categories of $1,334,537. The majority of commercial real estate loan growth was amortizing loans secured by owner occupied real estate. Construction and land development loans decreased from $62,509,558 at December 31, 2009 to $36,744,865 at December 31, 2011, as the Bank has deemphasized this type of lending.
Nonperforming loans decreased $4,008,162 from the prior year end to $9,510,617 at December 31, 2011. Nonperforming loans as a percentage of total loans declined to 1.32% at December 31, 2011 compared to 2.04% at December 31, 2010. The Bank had 35 nonperforming loans at December 31, 2011 compared to 32 nonperforming loans at December 31, 2010.
Foreclosed real estate decreased as disposals of $10,750,768 and valuation allowances of $1,963,227 were offset by additions of $7,273,206. The December 31, 2011 balance of $5,028,513 is at its lowest level since December 31, 2009. Foreclosed real estate carrying amounts reflect management’s estimate of the realizable value of these properties incorporating current appraised values, local real estate market conditions and related costs.
9 |
Management’s Discussion and Analysis
The Company’s overall delinquency rate declined 12 basis points to 2.09% at December 31, 2011 from the prior year end, as problem loans were charged-off, transferred to foreclosed real estate or worked out. Loans 31-90 days delinquent increased from 0.17% at December 31, 2010 to 0.76% at December 31, 2011. Loans greater than 90 days delinquent decreased from 2.04% at December 31, 2010 to 1.32% at December 31, 2011. The Company’s allowance for loan losses decreased from 1.16% of loans at December 31, 2010 to 1.07% of loans at December 31, 2011.
At December 31, 2011, the Bank had 15 troubled debt restructured loans (“TDRs”) totaling $11,913,041 compared to 19 TDRs totaling $16,881,803 as of December 31, 2010. At year end 93.3% of TDRs were performing according to the terms of their restructured agreements compared to 98.2% for the comparable period end. Interest income in the amount of $524,397 and $720,570 was recognized on these loans for the years ended December 31, 2011 and 2010, respectively.
The securities available for sale (AFS) portfolio and held to maturity (HTM) portfolio increased due to additional purchases of securities offset by principal paydowns, primarily of asset-backed securities issued by government-sponsored entities. The differences in allocations between the different cash and investment categories reflect operational needs.
Premises and equipment increased primarily due to the construction of an operations center in Waldorf, Maryland and a branch in King George, Virginia. Both projects are scheduled for completion in the second quarter of 2012.
10 |
Management’s Discussion and Analysis
Liabilities
December 31, | % change | Dollar change | ||||||||||||||
2011 | 2010 | 2011 vs. 2010 | 2011 vs. 2010 | |||||||||||||
Deposits | ||||||||||||||||
Noninterest-bearing | $ | 81,097,622 | $ | 75,642,197 | 7.21 | % | $ | 5,455,425 | ||||||||
Interest-bearing | 746,155,579 | 648,940,129 | 14.98 | % | 97,215,450 | |||||||||||
Total deposits | 827,253,201 | 724,582,326 | 14.17 | % | 102,670,875 | |||||||||||
Short-term borrowings | - | 816,422 | (100.00 | )% | (816,422 | ) | ||||||||||
Long-term debt | 60,576,595 | 70,624,044 | (14.23 | )% | (10,047,449 | ) | ||||||||||
Guaranteed preferred beneficial interest in junior subordinated debentures | 12,000,000 | 12,000,000 | 0.00 | % | - | |||||||||||
Accrued expenses and other liabilities | 8,195,829 | 6,808,383 | 20.38 | % | 1,387,446 | |||||||||||
Total Liabilities | $ | 908,025,625 | $ | 814,831,175 | 11.44 | % | $ | 93,194,450 |
The Bank increased its deposit base through marketing efforts focused on small and medium-sized businesses and retail customers in the Southern Maryland area. According to statistics compiled by the FDIC, the Bank was ranked second in deposit market share in the Tri-County area as of June 30, 2011, the latest date for which such data is available. During 2011, transaction accounts increased $85,354,028 and certificates of deposits increased $17,316,847. Transaction accounts increased from 39.52% of deposits at December 31, 2010 to 44.94% of deposits at December 31, 2011. Deposits have grown 57.52% or $302,085,635 since January 1, 2009 and have been a critical factor in decreasing funding costs. Total long-term debt decreased as liquidity available from retail deposits and maturing securities was used to pay debt.
Equity
December 31, | % change | Dollar change | ||||||||||||||
2011 | 2010 | 2011 vs. 2010 | 2011 vs. 2010 | |||||||||||||
Fixed Rate Senior Non-Cumulative Perpetual, Series C - par value $1,000; authorized 20,000; issued 20,000 | $ | 20,000,000 | $ | - | n/a | $ | 20,000,000 | |||||||||
Fixed Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000; authorized 15,540; issued 15,540 | - | 15,540,000 | (100.00 | )% | (15,540,000 | ) | ||||||||||
Fixed Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000; authorized 777; issued 777 | - | 777,000 | (100.00 | )% | (777,000 | ) | ||||||||||
Common stock - par value $.01; authorized - 15,000,000 shares; issued 3,026,557 and 3,002,616 shares, respectively | 30,266 | 30,026 | 0.80 | % | 240 | |||||||||||
Additional paid in capital | 17,367,403 | 16,962,460 | 2.39 | % | 404,943 | |||||||||||
Retained earnings | 38,712,194 | 37,892,557 | 2.16 | % | 819,637 | |||||||||||
Accumulated other comprehensive gain | 289,599 | 411,188 | (29.57 | )% | (121,589 | ) | ||||||||||
Unearned ESOP shares | (945,364 | ) | (508,304 | ) | 85.98 | % | (437,060 | ) | ||||||||
Total Stockholders' Equity | $ | 75,454,098 | $ | 71,104,927 | 6.12 | % | $ | 4,349,171 |
During the year ended December 31, 2011, stockholders’ equity increased $4,349,171 to $75,454,098. The increase in stockholders’ equity was due to net income of $3,161,464 and net proceeds of $3,683,000 from the SBLF investment partially offset by the payments of common stock dividends of $1,209,856, preferred stock dividends of $722,243, net stock related activities of $441,605 and adjustments to other comprehensive income of $121,589. Common stockholders' equity increased to $55,454,098 at December 31, 2011 compared to $54,787,927 at December 31, 2010. Book value increased $0.07 per share to $18.32 from $18.25 for the same comparable period ends. The Company remains well-capitalized at December 31, 2011 with a Tier 1 capital to average asset ratio of 9.17%.
11 |
Management’s Discussion and Analysis
Liquidity and Capital Resources
The Company has no business other than holding the stock of the Bank and does not currently have any material funding requirements, except for the payment of dividends on preferred and common stock, and the payment of interest on subordinated debentures.
The Company’s principal sources of liquidity are cash on hand and dividends received from the Bank. The Bank is subject to various regulatory restrictions on the payment of dividends.
The Bank’s principal sources of funds for investment and operations are net income, deposits, sales of loans, borrowings, principal and interest payments on loans, principal and interest received on investment securities and proceeds from the maturity and sale of investment securities. Its principal funding commitments are for the origination or purchase of loans, the purchase of securities and the payment of maturing deposits. Deposits are considered the primary source of funds supporting the Bank’s lending and investment activities. The Bank also uses borrowings from the Federal Home Loan Bank (FHLB) of Atlanta to supplement deposits. The amount of FHLB advances available to the Bank is limited to the lower of 40% of Bank assets or the amount supportable by eligible collateral including FHLB stock, loans and securities. In addition, the Bank has established lines of credit with the Federal Reserve Bank and commercial banks. For a discussion of these agreements including collateral see Note 10 to the Consolidated Financial Statements.
The Bank’s most liquid assets are cash, cash equivalents and federal funds sold. The levels of such assets are dependent on the Bank’s operating, financing and investment activities at any given time. The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows.
Cash and cash equivalents as of December 31, 2011 totaled $19,118,189, an increase of $9,294,753 or 94.62%, from the December 31, 2010 total of $9,823,436. Changes to the level of cash and cash equivalents have minimal impact on operational needs as the Bank has substantial sources of funds available from other sources.
The Bank’s principal sources of cash flows are its financing activities including deposits and borrowings. In 2011, the Bank continued to increase its deposits and market share. During 2011, all financing activities provided $92,862,834 in cash inflows compared to $64,876,506 during 2010. The increase in cash flows from financing activity in 2011 of $27,986,328 was principally due to an increase in net deposit growth from $84,163,537 in 2010 to $102,670,875 in 2011. Cash increased $3,683,000 for the net increase in capital related to the SBLF investment in Series C Preferred Stock and the redemption of all TARP Series A and Series B Preferred Stock. Net pay downs on borrowings decreased and increased cash provided by $6,445,823 from $17,309,694 in 2010 to $10,863,871 in 2011. Other financing activities net use of cash for dividends and other equity transactions amounted to $1,977,337 in 2010 compared to $2,627,170 in 2011.
The Bank’s principal use of cash has been in investing activities including its investments in loans, investment securities and other assets. In 2011, the level of net cash used in investing increased to $93,890,549 from $75,128,499 in 2010. The increase in net investing activity of $18,762,050 in 2011 was primarily due to additional investments in securities and the funding of more loans compared to the prior year. Loans originated or acquired increased from $244,552,180 in 2010 to $269,796,003 in 2011. This increase in cash used was offset by an increase to cash provided of $10,934,568 for principal payments on loans from $193,319,561 in 2010 compared to $204,254,129 in 2011. In addition, net cash used in security transactions increased from $16,731,319 in 2010 to $33,111,184 in 2011 to fund purchases of both AFS and HTM investments. Additionally cash used increased $4,025,803 for expenditures related to software and equipment for the Bank’s new core operating platform and construction of the Bank’s new operations center and its branch in King George, Virginia. These cash uses were partially offset by proceeds from the sale of foreclosed real estate of $9,952,873 in 2011 and purchases not made in 2011 that were made in 2010 for the purchase of $6,000,000 in bank owned life insurance.
12 |
Management’s Discussion and Analysis
At December 31, 2011, the Bank had $22,295,675 in loan commitments outstanding. Certificates of deposit due within one year of December 31, 2011 totaled $268,584,607, representing 58.96% of certificates of deposit at December 31, 2011. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowing than we currently pay on the certificates of deposit due on or before December 31, 2012. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
Federal banking regulations require the Company and the Bank to maintain specified levels of capital. At December 31, 2011, the Company was in compliance with these requirements with a Tier 1 Capital to average assets ratio of 9.17%, a Tier 1 Capital to risk weighted assets ratio of 11.65% and a Total Capital to risk weighted assets ratio of 12.69%. At December 31, 2011, the Bank met the criteria for designation as a well-capitalized depository institution under Federal Reserve Bank regulations. See Note 15 of the Consolidated Financial Statements.
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, letters of credit and lines of credit. For a discussion of these agreements, including collateral and other arrangements, see Note 12 to the Consolidated Financial Statements.
For the years ended December 31, 2011 and 2010, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on its financial condition, results of operations or cash flows.
Contractual Obligations
In the normal course of its business, the Bank commits to make future payments to others to satisfy contractual obligations. These obligations include commitments to repay short and long-term borrowings and commitments incurred under operating lease agreements.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and notes thereto presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
13 |
Management’s Discussion and Analysis
Selected Financial Data
Dollars in thousands except share data | Year Ended December 31, | |||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
Operations Data | ||||||||||||||||||||
Net interest income | $ | 26,838 | $ | 25,957 | $ | 21,721 | $ | 19,223 | $ | 18,992 | ||||||||||
Provision for loan losses | 4,087 | 3,933 | 3,473 | 1,301 | 855 | |||||||||||||||
Noninterest income | 4,193 | 3,580 | 2,810 | 2,519 | 3,402 | |||||||||||||||
Noninterest expense | 22,249 | 18,195 | 16,580 | 14,582 | 13,459 | |||||||||||||||
Net income | 3,161 | 4,766 | 2,867 | 3,815 | 5,106 | |||||||||||||||
Net income available to common shareholders | $ | 2,489 | $ | 3,919 | $ | 2,020 | $ | 3,789 | $ | 5,106 | ||||||||||
Share Data: | ||||||||||||||||||||
Basic net income per common share | $ | 0.83 | $ | 1.31 | $ | 0.68 | $ | 1.29 | $ | 1.92 | ||||||||||
Diluted net income per common share | $ | 0.82 | $ | 1.30 | $ | 0.68 | $ | 1.24 | $ | 1.79 | ||||||||||
Cash dividends paid per common share | $ | 0.40 | $ | 0.40 | $ | 0.40 | $ | 0.40 | $ | 0.40 | ||||||||||
Book value per common share | $ | 18.32 | $ | 18.25 | $ | 17.43 | $ | 17.23 | $ | 16.79 | ||||||||||
Common shares outstanding | 3,026,557 | 3,002,616 | 2,976,046 | 2,947,759 | 2,909,974 | |||||||||||||||
Weighted average common shares outstanding | ||||||||||||||||||||
Basic | 3,016,286 | 2,985,080 | 2,961,293 | 2,943,002 | 2,664,036 | |||||||||||||||
Diluted | 3,052,810 | 3,008,279 | 2,987,901 | 3,053,690 | 2,852,494 | |||||||||||||||
Financial Condition Data | ||||||||||||||||||||
Total assets | $ | 983,480 | $ | 885,936 | $ | 815,043 | $ | 716,685 | $ | 598,406 | ||||||||||
Loans receivable, net | 710,089 | 654,450 | 616,593 | 542,977 | 453,614 | |||||||||||||||
Foreclosed real estate (OREO) | 5,029 | 10,469 | 923 | - | - | |||||||||||||||
Total deposits | 827,253 | 724,582 | 640,419 | 525,168 | 444,994 | |||||||||||||||
Long and short term debt | 60,577 | 71,440 | 88,750 | 106,486 | 87,561 | |||||||||||||||
TARP preferred stock | - | 16,317 | 16,317 | 16,317 | - | |||||||||||||||
Small Business Lending Fund preferred stock | 20,000 | - | - | - | - | |||||||||||||||
Total stockholders’ equity | $ | 75,454 | $ | 71,105 | $ | 68,190 | $ | 67,114 | $ | 48,847 | ||||||||||
Other Financial Information | ||||||||||||||||||||
Nonperforming loans (NPLs) | $ | 9,511 | $ | 13,518 | $ | 19,287 | $ | 4,936 | $ | 414 | ||||||||||
Troubled debt restructures (TDRs) | 11,913 | 16,882 | 11,601 | - | 755 | |||||||||||||||
Performance Ratios | ||||||||||||||||||||
Return on average assets | 0.35 | % | 0.57 | % | 0.38 | % | 0.59 | % | 0.87 | % | ||||||||||
Return on average equity | 4.33 | % | 6.76 | % | 4.19 | % | 7.57 | % | 12.62 | % | ||||||||||
Net interest margin | 3.21 | % | 3.32 | % | 3.02 | % | 3.13 | % | 3.41 | % | ||||||||||
Efficiency ratio | 71.70 | % | 61.60 | % | 67.59 | % | 67.07 | % | 60.10 | % | ||||||||||
Efficiency ratio (1) | 64.74 | % | 60.19 | % | 66.98 | % | 67.07 | % | 63.72 | % | ||||||||||
Common dividend payout ratio | 48.78 | % | 30.77 | % | 58.82 | % | 31.04 | % | 20.80 | % | ||||||||||
Capital Ratios | ||||||||||||||||||||
Tier 1 capital to average assets | 9.17 | % | 9.44 | % | 10.03 | % | 11.54 | % | 10.41 | % | ||||||||||
Total capital to risk weighted assets | 12.69 | % | 12.94 | % | 13.46 | % | 14.73 | % | 13.80 | % | ||||||||||
Asset Quality Ratios | ||||||||||||||||||||
Allowance for loan losses to total loans | 1.07 | % | 1.16 | % | 1.20 | % | 0.94 | % | 0.98 | % | ||||||||||
Nonperforming loans to total loans | 1.32 | % | 2.04 | % | 3.09 | % | 0.90 | % | 0.25 | % | ||||||||||
Allow. for loan losses to nonperforming loans | 80.49 | % | 56.73 | % | 38.74 | % | 104.25 | % | 383.40 | % | ||||||||||
Net charge-offs to average loans | 0.61 | % | 0.61 | % | 0.20 | % | 0.13 | % | 0.04 | % | ||||||||||
Nonperforming assets (NPLs + OREO) to gross loans + OREO | 2.01 | % | 3.56 | % | 3.23 | % | 0.90 | % | 0.09 | % | ||||||||||
Nonperforming assets to total assets | 1.48 | % | 2.71 | % | 2.48 | % | 0.69 | % | 0.07 | % | ||||||||||
Nonperforming assets and TDRs to total assets (2) | 2.61 | % | 4.58 | % | 3.90 | % | 0.69 | % | 0.20 | % |
(1) Excludes OREO gains, losses and expenses.
(2) Ratio was adjusted to remove duplication of loans that are both nonperforming and troubled debt restructures.
14 |
Management’s Discussion and Analysis
Market for the Registrant’s Common Stock and Related Security Holder Matters
Market Information
The following table sets forth high and low bid quotations reported on the OTC Bulletin for the Company’s common stock for each quarter during 2011 and 2010. These quotes reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily reflect actual transactions.
High | Low | |||||||
2010 | ||||||||
Fourth Quarter | $ | 18.00 | $ | 13.25 | ||||
Third Quarter | $ | 15.00 | $ | 11.20 | ||||
Second Quarter | $ | 12.01 | $ | 11.25 | ||||
First Quarter | $ | 15.25 | $ | 10.55 |
High | Low | |||||||
2011 | ||||||||
Fourth Quarter | $ | 18.50 | $ | 15.00 | ||||
Third Quarter | $ | 19.05 | $ | 16.50 | ||||
Second Quarter | $ | 17.25 | $ | 16.10 | ||||
First Quarter | $ | 20.00 | $ | 16.10 |
Holders
The number of stockholders of record of the Company at February 29, 2012 was 3,023,613.
Dividends
The Company has paid annual cash dividends since 1994. For each of fiscal years 2011 and 2010, the Company paid an annual cash dividend of $0.40 per share. As part of the Company’s participation in the Capital Purchase Program of the U.S. Department of Treasury’s Troubled Asset Relief Program, the Company had significant dividend restrictions that required the consent of the Treasury to increase its per share cash dividend above $0.40. On September 22, 2011, these dividend restrictions were removed with the redemption of 100% of all Series A and Series B TARP Preferred Stock and the purchase by the U.S. Department of Treasury of $20.0 million in the Company’s Series C Preferred Stock under the Small Business Lending Fund.
SBLF dividend rates can fluctuate between 1% and 7% during the first four and one half years, depending on the level of the Bank’s small business lending. The Company is permitted to repay its SBLF funding in increments of 25% or $5.0 million, subject to the approval of our federal banking regulator. As of December 31, 2011, the Company’s dividend rate on the SBLF funds was 1%. After four and one half years from issuance, the dividend rate will increase to 9%. See Note 18 to the Consolidated Financial Statements.
The Company’s ability to pay dividends is governed by the policies and regulations of the Federal Reserve Board (the “FRB”), which prohibits the payment of dividends under certain circumstances dependent on the Company’s financial condition and capital adequacy. The Company’s ability to pay dividends is also dependent on the receipt of dividends from the Bank.
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 FRB. Under the Maryland Financial Institutions Code, a Maryland bank (1) may only pay dividends from undivided profits or, with prior regulatory approval, its surplus in excess of 100% of required capital stock and, (2) may not declare dividends on its common stock until its surplus funds 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.
15 |
Management’s Discussion and Analysis
Without the approval of the FRB, a state member bank may not declare or pay a dividend if the total of all dividends declared during the year exceeds its net income during the current calendar year and retained net income for the prior two years. The Bank is further prohibited from making a capital distribution if it would not be adequately capitalized thereafter. In addition, the Bank may not make a capital distribution that would reduce its net worth below the amount required to maintain the liquidation account established for the benefit of its depositors at the time of its conversion to stock form.
16 |
Tri-County Financial Corporation
Report on Audits of Consolidated Financial Statements
For the Years Ended December 31, 2011 and 2010
17 |
Tri-County Financial Corporation
TABLE OF CONTENTS
Management’s Report on Internal Control Over Financial Reporting | 19 | |||
Report of Independent Registered Public Accounting Firm | 20 | |||
Consolidated Financial Statements | ||||
Balance Sheets | 21 | |||
Statements of Income | 22 | |||
Statements of Changes in Stockholders’ Equity | 23 | |||
Statements of Cash Flows | 24 | |||
Notes to Consolidated Financial Statements | 26 |
18 |
Tri-County Financial Corporation
Management’s Report on Internal Control Over Financial Reporting
The management of Tri-County Financial Corporation (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011, utilizing the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2011, is effective.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements are prevented or timely detected.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only the management’s report in this annual report.
19 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Tri-County Financial Corporation
Waldorf, Maryland
We have audited the accompanying consolidated balance sheets of Tri-County Financial Corporation. (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, 2011 and 2010, and the results of their consolidated operations and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ Stegman & Company
Baltimore, Maryland
March 8, 2012
20 |
Tri-County Financial Corporation
CONSOLIDATED BALANCE SHEETS
December 31, | ||||||||
2011 | 2010 | |||||||
Assets | ||||||||
Cash and due from banks | $ | 13,074,091 | $ | 8,695,590 | ||||
Federal funds sold | 5,040,000 | 615,000 | ||||||
Interest-bearing deposits with banks | 1,004,098 | 512,846 | ||||||
Securities available for sale (AFS), at fair value | 41,827,612 | 34,946,225 | ||||||
Securities held to maturity (HTM), at amortized cost | 153,516,839 | 126,988,316 | ||||||
Federal Home Loan Bank and Federal Reserve Bank stock - at cost | 5,587,000 | 6,315,600 | ||||||
Loans receivable - net of allowance for loan losses of $7,655,041 and $7,669,147 | 710,088,775 | 654,449,936 | ||||||
Premises and equipment, net | 16,440,902 | 12,132,141 | ||||||
Foreclosed real estate | 5,028,513 | 10,469,302 | ||||||
Accrued interest receivable | 3,027,784 | 2,784,396 | ||||||
Investment in bank owned life insurance | 18,098,085 | 17,447,692 | ||||||
Other assets | 10,746,024 | 10,579,058 | ||||||
Total Assets | $ | 983,479,723 | $ | 885,936,102 | ||||
Liabilities and Stockholders' Equity | ||||||||
Deposits | ||||||||
Noninterest-bearing deposits | $ | 81,097,622 | $ | 75,642,197 | ||||
Interest-bearing deposits | 746,155,579 | 648,940,129 | ||||||
Total deposits | 827,253,201 | 724,582,326 | ||||||
Short-term borrowings | - | 816,422 | ||||||
Long-term debt | 60,576,595 | 70,624,044 | ||||||
Guaranteed preferred beneficial interest in junior subordinated debentures | 12,000,000 | 12,000,000 | ||||||
Accrued expenses and other liabilities | 8,195,829 | 6,808,383 | ||||||
Total Liabilities | 908,025,625 | 814,831,175 | ||||||
Stockholders' Equity | ||||||||
Preferred Stock, Senior Non-Cumulative Perpetual, Series C - par value $1,000; authorized 20,000; issued 20,000 | 20,000,000 | - | ||||||
Fixed Rate Cumulative Perpetual Preferred Stock, Series A - par value $1,000; authorized 15,540; issued 15,540 | - | 15,540,000 | ||||||
Fixed Rate Cumulative Perpetual Preferred Stock, Series B - par value $1,000; authorized 777; issued 777 | - | 777,000 | ||||||
Common stock - par value $.01; authorized - 15,000,000 shares; | ||||||||
issued 3,026,557 and 3,002,616 shares, respectively | 30,266 | 30,026 | ||||||
Additional paid in capital | 17,367,403 | 16,962,460 | ||||||
Retained earnings | 38,712,194 | 37,892,557 | ||||||
Accumulated other comprehensive gain | 289,599 | 411,188 | ||||||
Unearned ESOP shares | (945,364 | ) | (508,304 | ) | ||||
Total Stockholders’ Equity | 75,454,098 | 71,104,927 | ||||||
Total Liabilities and Stockholders' Equity | $ | 983,479,723 | $ | 885,936,102 |
See notes to Consolidated Financial Statements
21 |
Tri-County Financial Corporation
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Interest and Dividend Income | ||||||||
Loans, including fees | $ | 36,383,142 | $ | 34,995,425 | ||||
Taxable interest and dividends on investment securities | 3,559,903 | 4,524,204 | ||||||
Interest on deposits with banks | 16,349 | 17,358 | ||||||
Total Interest and Dividend Income | 39,959,394 | 39,536,987 | ||||||
Interest Expenses | ||||||||
Deposits | 10,718,170 | 10,938,385 | ||||||
Short-term borrowings | 49,223 | 42,151 | ||||||
Long-term debt | 2,353,649 | 2,599,679 | ||||||
Total Interest Expenses | 13,121,042 | 13,580,215 | ||||||
Net Interest Income | 26,838,352 | 25,956,772 | ||||||
Provision for loan losses | 4,087,151 | 3,933,448 | ||||||
Net Interest Income After Provision For Loan Losses | 22,751,201 | 22,023,324 | ||||||
Noninterest Income | ||||||||
Loan appraisal, credit and miscellaneous charges | 789,883 | 676,805 | ||||||
Income from bank owned life insurance | 650,393 | 504,296 | ||||||
Service charges | 1,988,947 | 1,905,949 | ||||||
Gain on sale of asset | 22,500 | 22,500 | ||||||
Gain on sale of loans held for sale | 286,978 | 470,626 | ||||||
Net gains on the sale of foreclosed real estate | 454,339 | - | ||||||
Total Noninterest Income | 4,193,040 | 3,580,176 | ||||||
Noninterest Expenses | ||||||||
Salary and employee benefits | 11,082,386 | 9,769,401 | ||||||
Occupancy expense | 1,833,466 | 1,772,394 | ||||||
Advertising | 491,789 | 399,802 | ||||||
Data processing expense | 1,305,601 | 1,044,972 | ||||||
Depreciation of furniture, fixtures and equipment | 435,551 | 541,642 | ||||||
Telephone communications | 174,748 | 170,566 | ||||||
Office supplies | 184,820 | 170,447 | ||||||
Professional fees | 997,114 | 799,377 | ||||||
FDIC insurance | 1,428,949 | 1,338,305 | ||||||
Valuation allowance on foreclosed real estate | 1,963,227 | 287,934 | ||||||
Other | 2,351,551 | 1,900,343 | ||||||
Total Noninterest Expenses | 22,249,202 | 18,195,183 | ||||||
Income before income taxes | 4,695,039 | 7,408,317 | ||||||
Income tax expense | 1,533,575 | 2,642,616 | ||||||
Net Income | $ | 3,161,464 | $ | 4,765,701 | ||||
Preferred stock dividends | 672,488 | 846,930 | ||||||
Net Income Available to Common Shareholders | $ | 2,488,976 | $ | 3,918,771 | ||||
Earnings Per Common Share | ||||||||
Basic | $ | 0.83 | $ | 1.31 | ||||
Diluted | $ | 0.82 | $ | 1.30 | ||||
Cash dividend paid per common share | $ | 0.40 | $ | 0.40 | ||||
See notes to Consolidated Financial Statements |
22 |
Tri-County Financial Corporation
Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31, 2011 and 2010 |
Accumulated | ||||||||||||||||||||||||||||
Other | Unearned | |||||||||||||||||||||||||||
Preferred | Common | Paid-in | Retained | Comprehensive | ESOP | |||||||||||||||||||||||
Stock | Stock | Capital | Earnings | Income | Shares | Total | ||||||||||||||||||||||
Balance at January 1, 2010 | $ | 16,317,000 | $ | 29,760 | $ | 16,754,627 | $ | 35,193,958 | $ | 284,474 | $ | (389,970 | ) | $ | 68,189,849 | |||||||||||||
Comprehensive Income | ||||||||||||||||||||||||||||
Net income | 4,765,701 | 4,765,701 | ||||||||||||||||||||||||||
Unrealized holding gains on investment securities net of tax of $61,452 | 119,463 | 119,463 | ||||||||||||||||||||||||||
Other than temporary impairment amortization on HTM securities net of tax of $3,735 | 7,251 | 7,251 | ||||||||||||||||||||||||||
Total Comprehensive Income | 4,892,415 | |||||||||||||||||||||||||||
Cash dividend $0.40 per share | (1,196,187 | ) | (1,196,187 | ) | ||||||||||||||||||||||||
Preferred stock dividends | (846,930 | ) | (846,930 | ) | ||||||||||||||||||||||||
Exercise of stock options | 237 | 147,562 | 147,799 | |||||||||||||||||||||||||
Net change in unearned ESOP shares | 44 | (118,334 | ) | (118,290 | ) | |||||||||||||||||||||||
Repurchase of common stock | (15 | ) | (23,985 | ) | (24,000 | ) | ||||||||||||||||||||||
Tax effect of ESOP dividend | 55,713 | 55,713 | ||||||||||||||||||||||||||
Tax effect of Non-ISO shares | - | - | 4,558 | - | - | - | 4,558 | |||||||||||||||||||||
Balance at December 31, 2010 | 16,317,000 | 30,026 | 16,962,460 | 37,892,557 | 411,188 | (508,304 | ) | 71,104,927 | ||||||||||||||||||||
Comprehensive Income | ||||||||||||||||||||||||||||
Net income | 3,161,464 | 3,161,464 | ||||||||||||||||||||||||||
Unrealized holding loss on investment securities net of tax of $64,419 | (128,840 | ) | (128,840 | ) | ||||||||||||||||||||||||
Other than temporary impairment amortization on HTM securities net of tax of $3,735 | 7,251 | 7,251 | ||||||||||||||||||||||||||
Total Comprehensive Income | 3,039,875 | |||||||||||||||||||||||||||
Cash dividend $0.40 per share | (1,209,856 | ) | (1,209,856 | ) | ||||||||||||||||||||||||
Preferred stock dividends | (722,243 | ) | (722,243 | ) | ||||||||||||||||||||||||
Exercise of stock options | 238 | 121,081 | 121,319 | |||||||||||||||||||||||||
Net change in unearned ESOP shares | 87 | (437,060 | ) | (436,973 | ) | |||||||||||||||||||||||
Repurchase of common stock | (237 | ) | (409,728 | ) | (409,965 | ) | ||||||||||||||||||||||
Stock based compensation | 152 | 253,314 | 253,466 | |||||||||||||||||||||||||
Tax effect of ESOP dividend | 30,548 | 30,548 | ||||||||||||||||||||||||||
Redemption of capital purchase program series A and series B preferred stock | (16,317,000 | ) | (16,317,000 | ) | ||||||||||||||||||||||||
Proceeds from issuance of series C preferred stock to Small Business Lending Fund | 20,000,000 | - | - | - | - | - | 20,000,000 | |||||||||||||||||||||
Balance at December 31, 2011 | $ | 20,000,000 | $ | 30,266 | $ | 17,367,403 | $ | 38,712,194 | $ | 289,599 | $ | (945,364 | ) | $ | 75,454,098 |
See notes to Consolidated Financial Statements
23 |
Tri-County Financial Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2011 and 2010
2011 | 2010 | |||||||
Cash Flows from Operating Activities | ||||||||
Net income | $ | 3,161,464 | $ | 4,765,701 | ||||
Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
Provision for loan losses | 4,087,151 | 3,933,448 | ||||||
Depreciation and amortization | 904,103 | 1,042,610 | ||||||
Loans originated for resale | (9,747,000 | ) | (14,248,912 | ) | ||||
Proceeds from sale of loans held for sale | 9,968,715 | 14,653,649 | ||||||
Gain on sale of loans held for sale | (286,978 | ) | (470,626 | ) | ||||
Gain on sale of asset | (22,500 | ) | (22,500 | ) | ||||
Net gain on the sale of foreclosed real estate | (454,339 | ) | - | |||||
Net amortization of premium/discount on mortgage-backed securities and investments | 245,650 | (177,420 | ) | |||||
Increase in foreclosed real estate valuation allowance | 1,963,227 | 287,934 | ||||||
Increase in cash surrender of bank owned life insurance | (650,393 | ) | (504,296 | ) | ||||
Deferred income tax benefit | (646,717 | ) | (761,235 | ) | ||||
Stock based compensation | 253,466 | - | ||||||
(Increase) Decrease in accrued interest receivable | (243,388 | ) | 140,875 | |||||
Decrease in deferred loan fees | (139,826 | ) | (38,265 | ) | ||||
Increase in accounts payable, accrued expenses and other liabilities | 1,387,446 | 1,124,647 | ||||||
Decrease (Increase) in other assets | 542,387 | (898,148 | ) | |||||
Net Cash Provided by Operating Activities | 10,322,468 | 8,827,462 | ||||||
Cash Flows from Investing Activities | ||||||||
Purchase of investment securities available for sale | (18,994,828 | ) | (129,159 | ) | ||||
Proceeds from redemption or principal payments of investment securities available for sale | 11,983,674 | 19,522,952 | ||||||
Purchase of investment securities held to maturity | (72,541,253 | ) | (93,208,717 | ) | ||||
Proceeds from maturities or principal payments of investment securities held to maturity | 45,712,623 | 56,463,705 | ||||||
Net decrease of FHLB and Federal Reserve stock | 728,600 | 619,900 | ||||||
Loans originated or acquired | (269,796,003 | ) | (244,552,180 | ) | ||||
Principal collected on loans | 204,254,129 | 193,319,561 | ||||||
Purchase of bank owned life insurance policies | - | (6,000,000 | ) | |||||
Proceeds from sale of foreclosed real estate | 9,952,873 | - | ||||||
Proceeds from disposal of asset | 22,500 | 22,500 | ||||||
Purchase of premises and equipment | (5,212,864 | ) | (1,187,061 | ) | ||||
Net Cash Used in Investing Activities | (93,890,549 | ) | (75,128,499 | ) |
24 |
Tri-County Financial Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2011 and 2010
(continued)
2011 | 2010 | |||||||
Cash Flows from Financing Activities | ||||||||
Net increase in deposits | $ | 102,670,875 | $ | 84,163,537 | ||||
Proceeds from long-term borrowings | - | 15,000,000 | ||||||
Payments of long-term borrowings | (10,047,449 | ) | (20,045,586 | ) | ||||
Net decrease in short-term borrowings | (816,422 | ) | (12,264,108 | ) | ||||
Exercise of stock options | 121,319 | 147,799 | ||||||
Excess tax benefits on stock based compensation | - | 4,558 | ||||||
Dividends paid | (1,932,099 | ) | (2,043,117 | ) | ||||
Net change in unearned ESOP shares | (406,425 | ) | (62,577 | ) | ||||
Proceeds from Small Business Lending Fund Preferred Stock | 20,000,000 | - | ||||||
Redemption of Troubled Asset Relief Program Preferred Stock | (16,317,000 | ) | - | |||||
Redemption of common stock | (409,965 | ) | (24,000 | ) | ||||
Net Cash Provided by Financing Activities | 92,862,834 | 64,876,506 | ||||||
Increase (Decrease) in Cash and Cash Equivalents | 9,294,753 | (1,424,531 | ) | |||||
Cash and Cash Equivalents - January 1 | 9,823,436 | 11,247,967 | ||||||
Cash and Cash Equivalents - December 31 | $ | 19,118,189 | $ | 9,823,436 | ||||
Supplemental Disclosures of Cash Flow Information | ||||||||
Cash paid during the year for | ||||||||
Interest | $ | 13,223,072 | $ | 13,808,041 | ||||
Income taxes | $ | 2,381,137 | $ | 4,597,711 | ||||
Supplemental Schedule of Non-Cash Operating Activities | ||||||||
Issuance of common stock for payment of accrued compensation | $ | 253,466 | $ | - | ||||
Transfer of loans to foreclosed real estate | $ | 7,878,778 | $ | 11,480,843 | ||||
Transfer of foreclosed real estate to loans | $ | 3,177,855 | $ | - |
See notes to Consolidated Financial Statements
25 |
Tri-County Financial Corporation
NOTE 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 Community Mortgage Corporation of Tri-County (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America and to general practices within the banking industry.
Nature of Operations
The Company provides a variety of financial services to individuals and businesses through its offices in Southern Maryland. Its primary deposit products are demand, savings and time deposits, and its primary lending products are commercial and consumer mortgage loans, commercial loans, construction and land development loans, home equity and second mortgages and commercial equipment loans.
Use of Estimates
In preparing Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets.
Significant Group Concentrations of Credit Risk
Most of the Company’s activities are with customers located in the Southern Maryland area comprising Calvert, Charles and St. Mary’s counties. Note 4 discusses the types of securities held by the Company. Note 5 discusses the type of lending in which the Company is engaged. The Company does not have any significant concentration to any one customer or industry.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less when purchased to be cash equivalents.
Securities
Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity (HTM)” and recorded at amortized cost. Securities purchased and held principally for trading in the near term are classified as “trading securities.” Securities not classified as held to maturity or trading securities, including equity securities with readily determinable fair values, are classified as “available for sale (AFS)” and recorded at estimated fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the estimated fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers: (1) the length of time and the extent to which the fair value has been less than cost; (2) the financial condition and near term prospects of the issuer; and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Investments in Federal Reserve Bank and Federal Home Loan Bank of Atlanta stocks are recorded at cost and are considered restricted as to marketability. The Bank is required to maintain investments in the Federal Reserve Bank as a condition of membership and the Federal Home Loan Bank based upon levels of borrowings.
26 |
Tri-County Financial Corporation
Debt securities are evaluated quarterly to determine whether a decline in their value is other-than-temporary. The term “other-than-temporary” is not necessarily intended to indicate a permanent decline in value. It means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Under the revised guidance, for recognition and presentation of other-than-temporary impairments the amount of other-than-temporary impairment that is recognized through earnings for debt securities is determined by comparing the present value of the expected cash flows to the amortized cost of the security. The discount rate used to determine the credit loss is the expected book yield on the security.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, in the aggregate. Fair value is derived from secondary market quotations for similar instruments. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold, using the specific identification method.
Loans Receivable
The Company originates real estate mortgages, construction and land development loans, commercial loans and consumer loans. A substantial portion of the loan portfolio is comprised of loans throughout Southern Maryland. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.
Loans that the Company has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding unpaid principal balances, adjusted for the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Non-accrual loans are evaluated for impairment on a loan-by-loan basis in accordance with the Company’s impairment methodology.
Consumer loans are typically charged-off no later than 90 days past due. Mortgage and commercial loans are fully or partially charged-off when in management’s judgment all reasonable efforts to return a loan to performing status have occurred. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
27 |
Tri-County Financial Corporation
Allowance for Loan Losses
The allowance for loan losses is established as probable losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes that the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the composition and size of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance for loan losses consists of a specific component and a general component. The specific component relates to loans that are classified as doubtful, substandard or special mention and impaired loans, which include nonperforming loans and troubled debt restructured loans (TDRs). For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than carrying value of that loan. The general component covers the non-classified loans by loan category and is based on historical loss experience, peer group comparisons, industry data and loss percentages used for similarly graded loans adjusted for qualitative factors.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent.
Large groups of smaller homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures unless such loans are the subject of a restructuring agreement.
Interest payments made on impaired loans are applied to principal unless collectability of the principal amount is reasonably assured. Interest recognized on impaired loans is on a cash basis.
The Company considers all troubled debt restructured loans (TDRs) to be impaired and defines TDRs as loans whose terms have been modified to provide for a reduction of either interest or principal because of deterioration in the financial condition of the borrower. A loan extended or renewed at a stated interest rate equal to the current interest rate for new debt with similar risk is not considered a TDR. Once an obligation has been classified as a TDR it continues to be considered a TDR until paid in full or until the loan returns to performing status and yields a market interest rate equal to the current interest rate for new debt with similar risk. TDRs are evaluated by management on a regular basis utilizing the Company’s risk grading scale and must have a passing loan grade to be removed as a TDR. TDRs are evaluated for impairment on a loan by loan basis in accordance with the Company’s impairment methodology.
The Company does not participate in any specific government or Company-sponsored loan modification programs. All restructured loan agreements are individual contracts negotiated with a borrower. The Company’s TDR contracts include the use of temporary reductions of interest and extensions of time.
28 |
Tri-County Financial Corporation
Servicing
Servicing assets are recognized as separate assets when rights are acquired through purchase or through the sale of financial assets. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing based on relative estimated fair value. Estimated fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the estimated fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan, and recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.
Premises and Equipment
Land is carried at cost. Premises, improvements and equipment are carried at cost, less accumulated depreciation and amortization, computed by the straight-line method over the estimated useful lives of the assets, which are as follows:
Buildings and Improvements: 10 - 50 years |
Furniture and Equipment: 3 - 15 years |
Automobiles: 5 years |
Maintenance and repairs are charged to expense as incurred, while improvements that extend the useful life of premises and equipment are capitalized.
Foreclosed Real Estate
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of cost or estimated fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management, and the assets are carried at the lower of carrying amount or estimated fair value less the cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in noninterest expense.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company; (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Advertising Costs
The Company expenses advertising costs as incurred.
29 |
Tri-County Financial Corporation
Income Taxes
The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. It is the Company’s policy to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense.
Off Balance Sheet Credit Related Financial Instruments
In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under commercial lines of credit, letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.
Stock-Based Compensation
The Company has stock option and incentive arrangements to attract and retain key personnel in order to promote the success of the business. In May 2005, the 2005 Equity Compensation Plan (the “Plan”) was approved by the shareholders, and authorizes the issuance of restricted stock, stock appreciation rights, stock units and stock options to the Board of Directors and key employees.
Compensation cost for all stock-based awards is measured at fair value on date of grant and recognized over the service period for awards expected to vest. Such value is recognized as expense over the service period, net of estimated forfeitures. The estimation of stock awards that ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience.
The Company and the Bank currently maintain incentive compensation plans which provide for payments to be made in cash, stock options or other share-based compensation. The Company has accrued the full amounts due under these plans, but as of year-end, it is not possible to identify the portion that will be paid out in the form of share-based compensation.
Earnings Per Common Share
Basic earnings per common share represents income available to common stockholders, divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method. As of December 31, 2011 and 2010, there were 102,524 and 190,479 options respectively, which were excluded from the calculation as their effect would be anti-dilutive, because the exercise price of the options were greater than the average market price of the common shares.
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Net Income | $ | 3,161,464 | $ | 4,765,701 | ||||
Less: dividends paid and accrued on preferred stock | (672,488 | ) | (846,930 | ) | ||||
Net income available to common shareholders | $ | 2,488,976 | $ | 3,918,771 | ||||
Average number of common shares outstanding | 3,016,286 | 2,985,080 | ||||||
Effect of dilutive options | 36,524 | 23,199 | ||||||
Average number of shares used to calculate diluted earnings per share | 3,052,810 | 3,008,279 |
30 |
Tri-County Financial Corporation
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
Reclassification
Certain reclassifications have been made in the Consolidated Financial Statements for 2010 to conform to the classification presented in 2011.
Recent Accounting Pronouncements
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) TOPIC 310, “Receivables” - In April 2010, FASB issued Accounting Standards Update (“ASU”) No. 2010-18, Effect of a Loan Modification When the Loan is Part of a Pool That is Accounted for as a Single Asset. Modifications of loans that are accounted for within a pool do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. ASU No. 2010-18 is effective for modifications of loans accounted for within pools for the first interim or annual period ending on or after July 15, 2010 and are to be applied prospectively although early application is permitted. The Company adopted this guidance effective July 1, 2010, and adoption did not have an impact on the Company’s consolidated financial statements.
ASU No. 2010-20, Receivables (Topic 310); Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. In July 2010, the Financial Accounting Standards board (“FASB”) issued ASU No. 2010-20 which requires that more information be disclosed about the credit quality of a company’s loans and the allowance for loan losses held against those loans. Existing disclosures to be presented on a disaggregated basis include a roll-forward of the allowance for loan losses, the related recorded investment in such loans, the nonaccrual status of loans, and impaired loans. Additional disclosure is also required about the credit quality indicators of loans by class at the end of the reporting period, the aging of past due loans, information about troubled debt restructurings, and significant purchases and sales of loans during the reporting period by class. For public companies, ASU 2010-20 requires certain disclosures as of the end of a reporting period effective for periods ending on or after December 15, 2010. Other required disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The Company adopted the applicable required additional disclosures effective December 31, 2010, and adoption of these additional disclosures did not have a material effect on the Company’s consolidated financial statements.
FASB ASC Topic 820, “Fair Value Measurements and Disclosures” defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Additional guidance (ASU No. 2010-06) issued under ASC Topic 820 requires expanded disclosures related to fair value measurements including (1) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (2) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (3) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (4) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. ASU 2010-06 further clarifies that (1) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (2) company’s should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy were required for the Company beginning January 1, 2011. The remaining disclosure requirements and clarifications made by ASU 2010-06 became effective for the Company on January 1, 2010.
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Tri-County Financial Corporation
FASB ASC TOPIC 860, “Transfers and Servicing” provides guidance that eliminates the concept of a “qualifying special-purpose entity” from the original accounting guidance and removes the exception from applying FASB guidance on consolidation of variable interest entities, to qualifying special-purpose entities. This guidance is effective at the beginning of a reporting entity’s first fiscal year that begins after November 15, 2009. Adoption of this new guidance, effective January 1, 2010, did not have a material impact on the Company’s consolidated financial statements.
ASU No. 2011-02; A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (“TDR”). In April, 2011, FASB issued ASU No. 2011-02 intended to provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. This ASU was effective for the first interim or annual period beginning on or after June 15, 2011, and was applied retrospectively to the beginning of the annual period of adoption. As a result of applying the ASU, the Company may identify receivables that are newly considered impaired. The Company adopted the applicable guidance during the third quarter ended September 30, 2011 and it did not have a material impact on required disclosures in the Company’s consolidated financial statements.
ASU No. 2011-03; Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements. ASU 2011-03 is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 removes from the assessment of effective control (i) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance guidance related to that criterion. ASU 2011-03 will be effective for the Company on January 1, 2012 and is not expected to have a material impact on the Company’s consolidated financial statements.
ASU 2011-04; “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 is effective for annual periods beginning after December 15, 2011, and is not expected to have a material impact on the Company’s consolidated financial statements.
ASU No. 2011-05; Presentation of Comprehensive Income. In June, 2011, the FASB issued ASU No. 2011-05 requiring companies to present comprehensive income in a single statement below net income or in a separate statement of comprehensive income immediately following the income statement. The guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity, which is our current presentation. This guidance does not change which items are reported in other comprehensive income or the requirement to report reclassifications of items from other comprehensive income to net income. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011 and will require retrospective application for all periods presented.
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Tri-County Financial Corporation
NOTE 2 - FAIR VALUE MEASUREMENTS
The Company adopted FASB ASC Topic 820, “Fair Value Measurements” and FASB ASC Topic 825, “The Fair Value Option for Financial Assets and Financial Liabilities”, which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. FASB ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).
FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:
Level 1 inputs - Unadjusted quoted process in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.
Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly or quarterly valuation process.
There were no transfers between levels of the fair value hierarchy and the Company had no Level 3 fair value assets or liabilities for the years ended December 31, 2011 and 2010, respectively.
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
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Tri-County Financial Corporation
Securities Available for Sale
Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities (“GSEs”), municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Loans Receivable
The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Management estimates the fair value of impaired loans using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2011, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.
Foreclosed Real Estate
Foreclosed real estate is adjusted for fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed real estate is carried at the lower of carrying value and fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset at nonrecurring Level 3.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets as of December 31, 2011 and December 31, 2010 measured at fair value on a recurring basis.
December 31, 2011 | ||||||||||||||||
Description of Asset | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Available for sale securities | ||||||||||||||||
Asset-backed securities issued by GSEs | ||||||||||||||||
CMOs | $ | 35,062,072 | $ | - | $ | 35,062,072 | $ | - | ||||||||
MBS | 2,648,043 | - | 2,648,043 | - | ||||||||||||
Corporate equity securities | 37,262 | - | 37,262 | - | ||||||||||||
Bond mutual funds | 4,080,235 | - | 4,080,235 | - | ||||||||||||
Total available for sale securities | $ | 41,827,612 | $ | - | $ | 41,827,612 | $ | - |
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Tri-County Financial Corporation
December 31, 2010 | ||||||||||||||||
Description of Asset | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Available for sale securities | ||||||||||||||||
Asset-backed securities issued by GSEs | ||||||||||||||||
CMOs | $ | 27,584,731 | $ | - | $ | 27,584,731 | $ | - | ||||||||
MBS | 3,504,215 | - | 3,504,215 | - | ||||||||||||
Corporate equity securities | 37,390 | - | 37,390 | - | ||||||||||||
Bond mutual funds | 3,819,889 | - | 3,819,889 | - | ||||||||||||
Total available for sale securities | $ | 34,946,225 | $ | - | $ | 34,946,225 | $ | - |
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The Company may be required from time to time to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of December 31, 2011 and December 31, 2010 are included in the table below.
December 31, 2011 | ||||||||||||||||
Description of Asset | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Loans with impairment | ||||||||||||||||
Commercial real estate | $ | 1,170,467 | $ | - | $ | 1,170,467 | $ | - | ||||||||
Construction and land development | 1,313,550 | - | 1,313,550 | - | ||||||||||||
Residential first mortgage | 505,206 | - | 505,206 | - | ||||||||||||
Commercial loans | 5,110,241 | - | 5,110,241 | - | ||||||||||||
Total loans with impairment | $ | 8,099,464 | $ | - | $ | 8,099,464 | $ | - | ||||||||
Foreclosed Real Estate | $ | 5,028,513 | $ | - | $ | 5,028,513 | $ | - |
December 31, 2010 | ||||||||||||||||
Description of Asset | Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
Loans with impairment | ||||||||||||||||
Commercial real estate | $ | 4,742,982 | $ | - | $ | 4,742,982 | $ | - | ||||||||
Commercial loans | 4,647,399 | - | 4,647,399 | - | ||||||||||||
Total loans with impairment | $ | 9,390,381 | $ | - | $ | 9,390,381 | $ | - | ||||||||
Foreclosed Real Estate | $ | 10,469,302 | $ | - | $ | 10,469,302 | $ | - |
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Tri-County Financial Corporation
Loans with impairment have unpaid principal balances of $10,096,399 and $11,388,016 at December 31, 2011 and 2010, respectively and include impaired loans with a specific allowance.
NOTE 3 - RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS
The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2011 and 2010, these reserve balances amounted to $471,000 and $314,000, respectively.
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Tri-County Financial Corporation
NOTE 4 – SECURITIES
December 31, 2011 | ||||||||||||||||
Amortized | Gross Unrealized | Gross Unrealized | Estimated | |||||||||||||
Cost | Gains | Losses | Fair Value | |||||||||||||
Securities available for sale (AFS) | ||||||||||||||||
Asset-backed securities issued by GSEs | ||||||||||||||||
Residential MBS | $ | 2,412,959 | $ | 235,084 | $ | - | $ | 2,648,043 | ||||||||
Residentail CMOs | 34,848,180 | 248,508 | 34,616 | 35,062,072 | ||||||||||||
Corporate equity securities | 37,310 | 241 | 289 | 37,262 | ||||||||||||
Bond mutual funds | 3,840,473 | 239,762 | - | 4,080,235 | ||||||||||||
Total securities available for sale | $ | 41,138,922 | $ | 723,595 | $ | 34,905 | $ | 41,827,612 | ||||||||
Securities held to maturity (HTM) | ||||||||||||||||
Asset-backed securities issued by GSEs | ||||||||||||||||
Residential MBS | $ | 35,929,199 | $ | 854,497 | $ | 10,960 | $ | 36,772,736 | ||||||||
Residential CMOs | 106,998,467 | 1,104,141 | 27,411 | 108,075,197 | ||||||||||||
Asset-backed securities issued by Others | ||||||||||||||||
Residential CMOs | 9,839,222 | 15,364 | 1,421,477 | 8,433,109 | ||||||||||||
Total debt securities held to maturity | 152,766,888 | 1,974,002 | 1,459,848 | 153,281,042 | ||||||||||||
U.S. government obligations | 749,951 | - | - | 749,951 | ||||||||||||
Total securities held to maturity | $ | 153,516,839 | $ | 1,974,002 | $ | 1,459,848 | $ | 154,030,993 |
December 31, 2010 | ||||||||||||||||
Amortized | Gross Unrealized | Gross Unrealized | Estimated | |||||||||||||
Cost | Gains | Losses | Fair Value | |||||||||||||
Securities available for sale (AFS) | ||||||||||||||||
Asset-backed securities issued by GSEs | ||||||||||||||||
Residential MBS | $ | 3,246,588 | $ | 257,627 | $ | - | $ | 3,504,215 | ||||||||
Residential CMOs | 27,081,220 | 503,511 | - | 27,584,731 | ||||||||||||
Corporate equity securities | 37,310 | 80 | - | 37,390 | ||||||||||||
Bond mutual funds | 3,697,208 | 122,681 | - | 3,819,889 | ||||||||||||
Total securities available for sale | $ | 34,062,326 | $ | 883,899 | $ | - | $ | 34,946,225 | ||||||||
Securities held to maturity (HTM) | ||||||||||||||||
Asset-backed securities issued by GSEs | ||||||||||||||||
Residential MBS | $ | 33,252,667 | $ | 453,900 | $ | 518,124 | $ | 33,188,443 | ||||||||
Residential CMOs | 80,519,344 | 1,307,909 | 264,146 | 81,563,107 | ||||||||||||
Asset-backed securities issued by Others | ||||||||||||||||
Residential CMOs | 12,463,500 | 132,928 | 1,709,386 | 10,887,042 | ||||||||||||
Total debt securities held to maturity | 126,235,511 | 1,894,737 | 2,491,656 | 125,638,592 | ||||||||||||
U.S. government obligations | 752,805 | - | - | 752,805 | ||||||||||||
Total securities held to maturity | $ | 126,988,316 | $ | 1,894,737 | $ | 2,491,656 | $ | 126,391,397 |
At December 31, 2011, certain asset-backed securities with a carrying value of $26.4 million were pledged to secure certain deposits. At December 31, 2011, asset-backed securities with a carrying value of $14.0 million were pledged as collateral for advances from the Federal Home Loan Bank of Atlanta.
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Tri-County Financial Corporation
At December 31, 2011, the AFS and HTM asset-backed securities investment portfolio was $190,477,003, or 98%, of the Company’s total AFS and HTM portfolios. Ninety-six percent of the asset-backed securities portfolio was rated AAA by Standard & Poor’s or equivalent credit rating from other major rating agency. AFS asset-backed securities issued by GSEs had an average life of 1.65 years and average duration of 1.61 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs had an average life of 2.72 years and average duration of 2.57 years and are guaranteed by their issuer as to credit risk.
At December 31, 2011, the AFS investment portfolio had a fair value of $41,827,612 with unrealized losses from their amortized cost of $34,905 on asset-backed securities and corporate securities with a fair value of $18,170,977. All unrealized losses were for less than twelve months. At December 31, 2010, the AFS investment portfolio had a fair value of $34,946,225 with no unrealized losses from their amortized cost.
Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at December 31, 2011 and 2010, are as follows:
December 31, 2011 | Less Than 12 | More Than 12 | ||||||||||||||||||||||
Months | Months | Total | ||||||||||||||||||||||
Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Losses | |||||||||||||||||||
Asset-backed securities issued by GSEs | $ | 30,220,777 | $ | 33,796 | $ | 2,847,703 | $ | 4,575 | $ | 33,068,480 | $ | 38,371 | ||||||||||||
Asset-backed securities issued by other | 131,301 | 11,507 | 6,632,200 | 1,409,970 | 6,763,501 | 1,421,477 | ||||||||||||||||||
$ | 30,352,078 | $ | 45,303 | $ | 9,479,903 | $ | 1,414,545 | $ | 39,831,981 | $ | 1,459,848 |
December 31, 2010 | Less Than 12 | More Than 12 | ||||||||||||||||||||||
Months | Months | Total | ||||||||||||||||||||||
Fair Value | Unrealized Loss | Fair Value | Unrealized Loss | Fair Value | Unrealized Losses | |||||||||||||||||||
Asset-backed securities issued by GSEs | $ | 37,344,330 | $ | 782,192 | $ | 200,072 | $ | 78 | $ | 37,544,402 | $ | 782,270 | ||||||||||||
Asset-backed securities issued by other | - | - | 8,573,411 | 1,709,386 | 8,573,411 | 1,709,386 | ||||||||||||||||||
$ | 37,344,330 | $ | 782,192 | $ | 8,773,483 | $ | 1,709,464 | $ | 46,117,813 | $ | 2,491,656 |
The HTM investment portfolio has an estimated fair value of $154,030,993, of which $39,831,981, or 26% of the securities, had some unrealized losses from their amortized cost. Of these securities, $33,068,480, or 83%, are mortgage-backed securities issued by GSEs and the remaining $6,763,501, or 17%, were asset-backed securities issued by others.
HTM securities issued by GSEs are guaranteed by the issuer. Total unrealized losses on the asset-backed securities issued by GSEs were $38,371, or 0.03%, of the amortized cost of $142,927,666. HTM asset-backed securities issued by GSEs with unrealized losses have an average life of 2.06 years and an average duration of 1.96 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.
HTM asset-backed securities issued by others are mortgage-backed securities. All of the securities have credit support tranches that absorb losses prior to the tranches which the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $1,421,477, or 14.45%, of the amortized cost of $9,839,222. HTM asset-backed securities issued by others with unrealized losses have an average life of 2.35 years and an average duration of 1.61 years. We believe that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity. We believe that the losses are the result of general perceptions of safety and creditworthiness of the entire sector and a general disruption of orderly markets in the asset class.
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Tri-County Financial Corporation
No charges related to other-than-temporary impairment were made during the years ended December 31, 2011 and 2010. During the year ended December 31, 2009, the Company recorded a charge of $148,000 related to other-than-temporary impairment on a single CMO issue. At December 31, 2011, the CMO issue has a par value of $1,036,000, a market fair value of $642,000 and a carrying value of $638,000.
Management has the ability and intent to hold the securities with unrealized losses classified as held to maturity until they mature, at which time the Company will receive full value for the securities. Because our intention is not to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, management considers the unrealized losses in the held-to-maturity portfolio to be temporary, except for the single CMO issue noted above, for which an other-than-temporary charge was recorded in 2009 in the amount of $148,000.
The amortized cost and estimated fair value of debt securities at December 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
Available for Sale | Held to Maturity | |||||||||||||||
Estimated | Estimated | |||||||||||||||
Amortized | Fair | Amortized | Fair | |||||||||||||
Cost | Value | Cost | Value | |||||||||||||
Within one year | $ | 3,840,473 | $ | 4,080,235 | $ | 749,951 | $ | 749,951 | ||||||||
Over one year through five years | - | - | - | - | ||||||||||||
Asset-backed securites | ||||||||||||||||
Within one year | 21,565,658 | 21,825,513 | 65,535,589 | 65,756,156 | ||||||||||||
Over one year through five years | 13,021,759 | 13,178,664 | 60,924,975 | 61,130,025 | ||||||||||||
Over five years through ten years | 2,371,454 | 2,400,028 | 19,802,567 | 19,869,215 | ||||||||||||
After ten years | 302,268 | 305,910 | 6,503,757 | 6,525,646 | ||||||||||||
Total asset-backed securities | 37,261,139 | 37,710,115 | 152,766,888 | 153,281,042 | ||||||||||||
$ | 41,101,612 | $ | 41,790,350 | $ | 153,516,839 | $ | 154,030,993 |
During 2011 and 2010, there were no sales of available for sale securities or held to maturity securities.
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Tri-County Financial Corporation
The table below presents the Standard & Poor’s or equivalent credit rating from other major rating agencies for AFS and HTM asset-backed securities issued by GSEs and others at December 31, 2011 by carrying value. GSE asset-backed securities that were downgraded by Standard and Poor’s during 2011 were treated as AAA based on regulatory guidance.
Credit Rating | Amount | |||
AAA | $ | 181,958,323 | ||
A+ | 142,808 | |||
BBB | 1,258,268 | |||
BBB- | 1,061,017 | |||
BB+ | 1,240,901 | |||
BB | 337,998 | |||
BB- | 615,716 | |||
B+ | 246,345 | |||
CCC+ | 3,615,627 | |||
Total | $ | 190,477,003 |
NOTE 5 - LOANS
Loans consist of the following:
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Commercial real estate | $ | 370,383,885 | $ | 336,299,836 | ||||
Residential first mortgages | 164,543,309 | 136,048,577 | ||||||
Construction and land development | 36,744,865 | 42,504,200 | ||||||
Home equity and second mortgage | 24,138,324 | 24,379,664 | ||||||
Commercial loans | 101,968,056 | 104,566,261 | ||||||
Consumer loans | 1,000,983 | 1,273,080 | ||||||
Commercial equipment | 19,760,753 | 17,983,648 | ||||||
718,540,175 | 663,055,266 | |||||||
Less: | ||||||||
Deferred loan fees | 796,359 | 936,183 | ||||||
Allowance for loan loss | 7,655,041 | 7,669,147 | ||||||
8,451,400 | 8,605,330 | |||||||
$ | 710,088,775 | $ | 654,449,936 |
At December 31, 2011, the Bank’s allowance for loan losses totaled $7,655,041 or 1.07% of loan balances as compared to $7,669,147 or 1.16% of loan balances, at December 31, 2010. 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.
At December 31, 2011, gross loans included $2,356,196 from the sale of two foreclosed real estate properties that the Bank financed during 2011 that did not qualify for full accrual sales treatment under ASC Topic 360-20-40 “Property Plant and Equipment – Derecognition”. The Bank utilized the cost recovery method and deferred gain of $410,268. At December 31, 2011, the deferred gain balance for these transactions was $410,268.
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Tri-County Financial Corporation
Risk Characteristics of Portfolio Segments
The Company manages its credit products and exposure to credit losses (credit risk) by the following specific portfolio segments (classes) which are levels at which the Company develops and documents its allowance for loan loss methodology. These segments are:
Commercial Real Estate
Commercial and other real estate projects include office buildings, retail locations, churches, and other special purpose buildings. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. The Bank generally limits its exposure to a single borrower to 15% of the Bank’s capital. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price and have an initial contractual loan payment period ranging from three to 20 years.
Loans secured by commercial real estate are larger and involve greater risks than one-to-four family residential mortgage loans. Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.
Residential First Mortgages
Residential first mortgage loans made by the Bank are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The initial contractual loan payment period for residential loans typically ranges from ten to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter time periods than their contractual terms. Borrowers may refinance or prepay loans at their option, without penalty. The Bank originates both fixed-rate and adjustable-rate residential first mortgages.
The annual and lifetime limitations on interest rate adjustments may limit the increases in interest rates on these loans. There are also unquantifiable credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower.
Construction and Land Development
The Bank offers construction loans for the construction of one-to-four family dwellings. Generally, these loans are secured by the real estate under construction as well as by guarantees of the principals involved. In addition, the Bank offers loans to acquire and develop land, as well as loans on undeveloped, subdivided lots for home building by individuals.
A decline in demand for new housing might adversely affect the ability of borrowers to repay these loans. Construction and land development loans are inherently riskier than providing financing on owner-occupied real estate. The Bank’s risk of loss is affected by the accuracy of the initial estimate of the market value of the completed project as well as the accuracy of the cost estimates made to complete the project. In addition, the volatility of the real estate market has made it increasingly difficult to ensure that the valuation of land associated with these loans is accurate. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, a projects value might be insufficient to assure full repayment. As a result of these factors, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the project rather than the ability of the borrower or guarantor to repay principal and interest. If the Bank forecloses on a project, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
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Tri-County Financial Corporation
Home Equity and Second Mortgage Loans
The Bank maintains a portfolio of home equity and second mortgage loans. These products contain a higher risk of default than residential first mortgages as in the event of foreclosure, the first mortgage would need to be paid off prior to collection of the second mortgage. This risk has been heightened as the market value of residential property has declined.
Commercial Loans
The Bank offers commercial loans to its business customers. The Bank offers a variety of commercial loan products including term loans and lines of credit. Such loans are generally made for terms of five years or less. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. When making commercial business loans, the Bank considers the financial condition of the borrower, the borrower’s payment history of both corporate and personal debt, the projected cash flows of the business, the viability of the industry in which the consumer operates, the value of the collateral, and the borrower’s ability to service the debt from income. These loans are primarily secured by equipment, real property, accounts receivable, or other security as determined by the Bank.
Commercial loans are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself.
Consumer Loans
The Bank has developed a number of programs to serve the needs of its customers with primary emphasis upon loans secured by automobiles, boats, recreational vehicles and trucks. The Bank also makes home improvement loans and offers both secured and unsecured personal lines of credit. Consumer loans entail greater risk from other loan types due to being secured by rapidly depreciating assets or the reliance on the borrower’s continuing financial stability.
Commercial Equipment Loans
These loans consist primarily of fixed-rate, short-term loans collateralized by a commercial customers’ equipment. When making commercial equipment loans, the Bank considers the same factors it considers when underwriting a commercial business loan. Commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized nature of collateral equipment would make full recovery from the sale of collateral problematic.
Related Party Loans
Included in loans receivable at December 31, 2011 and 2010 were $6,475,004 and $6,250,097, respectively, for loans made to executive officers and directors of the Bank. These loans were made in the ordinary course of business at substantially the same terms and conditions as those prevailing at the time for comparable transactions with persons not affiliated with the Bank and are not considered to involve more than the normal risk of collectability. For the years ended December 31, 2011 and 2010, all loans to directors and executive officers of the Bank performed according to original loan terms.
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Tri-County Financial Corporation
Activity in loans outstanding to executive officers and directors for the years ended December 31, 2011 and 2010 are summarized as follows:
2011 | 2010 | |||||||
Balance, beginning of year | $ | 6,250,097 | $ | 5,509,870 | ||||
New loans made during year | 815,681 | 1,796,909 | ||||||
Repayments made during year | (590,774 | ) | (1,056,682 | ) | ||||
Balance, end of year | $ | 6,475,004 | $ | 6,250,097 |
Allowance for Loan Losses
The following table details activity in the allowance for loan losses and year-end loan receivable balances for the years ended December 31, 2011 and 2010. An allocation of the allowance to one category of loans does not prevent the Company’s ability to utilize the allowance to absorb losses in a different category. The loan receivables are disaggregated on the basis of the Company’s impairment methodology.
2011 | Commercial Real Estate | Residential First Mortgage | Construction and Land Development | Home Equity and Second Mtg. | Commercial Loans | Consumer Loans | Commercial Equipment | Total | ||||||||||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||||||||||
Balance at January 1, | $ | 3,313,983 | $ | 204,073 | $ | 1,266,625 | $ | 97,519 | $ | 2,552,039 | $ | 32,209 | $ | 202,699 | $ | 7,669,147 | ||||||||||||||||
Charge-offs | (1,249,038 | ) | (49,002 | ) | (213,007 | ) | - | (2,441,076 | ) | (3,000 | ) | (150,005 | ) | (4,105,128 | ) | |||||||||||||||||
Recoveries | - | 967 | - | - | 1,936 | 968 | - | 3,871 | ||||||||||||||||||||||||
Provisions | 460,254 | 383,167 | (699,233 | ) | 46,024 | 3,737,395 | (11,058 | ) | 170,602 | 4,087,151 | ||||||||||||||||||||||
Balance at September 30, | $ | 2,525,199 | $ | 539,205 | $ | 354,385 | $ | 143,543 | $ | 3,850,294 | $ | 19,119 | $ | 223,296 | $ | 7,655,041 | ||||||||||||||||
Ending balance: individually evaluated for impairment | $ | 423,093 | $ | 113,000 | $ | 100,000 | $ | 42,340 | $ | 1,318,502 | $ | - | $ | - | $ | 1,996,935 | ||||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 2,102,106 | $ | 426,205 | $ | 254,385 | $ | 101,203 | $ | 2,531,792 | $ | 19,119 | $ | 223,296 | $ | 5,658,106 | ||||||||||||||||
Loan receivables: | ||||||||||||||||||||||||||||||||
Ending balance | $ | 370,383,885 | $ | 164,543,309 | $ | 36,744,865 | $ | 24,138,324 | $ | 101,968,056 | $ | 1,000,983 | $ | 19,760,753 | $ | 718,540,175 | ||||||||||||||||
Ending balance: individually evaluated for impairment | $ | 31,166,090 | $ | 5,849,538 | $ | 9,057,433 | $ | 492,319 | $ | 23,896,287 | $ | 82,036 | $ | 371,936 | $ | 70,915,639 | ||||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 339,217,795 | $ | 158,693,771 | $ | 27,687,432 | $ | 23,646,005 | $ | 78,071,769 | $ | 918,947 | $ | 19,388,817 | $ | 647,624,536 |
2010 | Commercial Real Estate | Residential First Mortgage | Construction and Land Development | Home Equity and Second Mtg. | Commercial Loans | Consumer Loans | Commercial Equipment | Total | ||||||||||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||||||||||
Balance at January 1, | $ | 2,661,371 | $ | 127,848 | $ | 1,696,396 | $ | 130,692 | $ | 2,109,513 | $ | 63,989 | $ | 681,505 | $ | 7,471,314 | ||||||||||||||||
Charge-offs | (525,992 | ) | (62,999 | ) | (2,248,967 | ) | (70,999 | ) | (568,992 | ) | (10,000 | ) | (255,996 | ) | (3,743,945 | ) | ||||||||||||||||
Recoveries | - | - | 1,041 | - | - | 7,290 | - | 8,331 | ||||||||||||||||||||||||
Provisions | 1,178,604 | 139,224 | 1,818,155 | 37,826 | 1,011,518 | (29,070 | ) | (222,810 | ) | 3,933,447 | ||||||||||||||||||||||
Balance at December 31, | $ | 3,313,983 | $ | 204,073 | $ | 1,266,625 | $ | 97,519 | $ | 2,552,039 | $ | 32,209 | $ | 202,699 | $ | 7,669,147 | ||||||||||||||||
Ending balance: individually evaluated for impairment | $ | 500,000 | $ | - | $ | - | $ | - | $ | 1,449,179 | $ | - | $ | 48,456 | $ | 1,997,635 | ||||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 2,813,983 | $ | 204,073 | $ | 1,266,625 | $ | 97,519 | $ | 1,102,860 | $ | 32,209 | $ | 154,243 | $ | 5,671,512 | ||||||||||||||||
Loan receivables: | ||||||||||||||||||||||||||||||||
Ending balance | $ | 336,299,836 | $ | 136,048,577 | $ | 42,504,200 | $ | 24,379,664 | $ | 104,566,261 | $ | 1,273,080 | $ | 17,983,648 | $ | 663,055,266 | ||||||||||||||||
Ending balance: individually evaluated for impairment | $ | 20,800,730 | $ | 3,664,442 | $ | 12,221,463 | $ | 319,112 | $ | 19,991,537 | $ | 701 | $ | 319,770 | $ | 57,317,755 | ||||||||||||||||
Ending balance: collectively evaluated for impairment | $ | 315,499,106 | $ | 132,384,135 | $ | 30,282,737 | $ | 24,060,552 | $ | 84,574,724 | $ | 1,272,379 | $ | 17,663,878 | $ | 605,737,511 |
Non-accrual and Past Due Loans
Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. There were no accruing loans 90 days or greater past due at December 31, 2011 or 2010. Consumer loans are typically charged-off no later than 90 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Non-accrual loans are evaluated for impairment on a loan by loan basis in accordance with the Company’s impairment methodology.
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Tri-County Financial Corporation
All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Non-accrual loans as of December 31, 2011 and 2010 were as follows:
Years Ended December 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Dollars | Number of Loans | Dollars | Number of Loans | |||||||||||||
Commercial real estate | $ | 2,866,539 | 11 | $ | 8,244,683 | 12 | ||||||||||
Residential first mortgages | 2,438,771 | 7 | 1,746,786 | 6 | ||||||||||||
Construction and land development | 1,413,550 | 2 | 983,867 | 1 | ||||||||||||
Home equity and second mortgage | 291,285 | 7 | 232,644 | 5 | ||||||||||||
Commercial loans | 2,263,916 | 4 | 2,261,642 | 6 | ||||||||||||
Consumer loans | 500 | 1 | 701 | 1 | ||||||||||||
Commercial equipment | 236,056 | 3 | 48,456 | 1 | ||||||||||||
$ | 9,510,617 | 35 | $ | 13,518,779 | 32 |
Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $4,193,893 and $8,715,318 at December 31, 2011 and 2010, respectively. Interest due at stated rates, but not recognized on these balances at December 31, 2011 and 2010 was $172,399 and $598,603, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $5,316,724 and $4,803,461 at December 31, 2011 and 2010, respectively. Interest due at stated rates, but not recognized on these balances at December 31, 2011 and 2010 was $242,705 and $276,567, respectively.
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Tri-County Financial Corporation
An analysis of past due loans as of December 31, 2011 and 2010 were as follows:
December 31, 2011 | Current | 31-60 Days | 61-90 Days | Greater than 90 Days | Total Past Due | Total Loan Receivables | ||||||||||||||||||
Commercial real estate | $ | 367,415,647 | $ | 101,699 | $ | - | $ | 2,866,539 | $ | 2,968,238 | $ | 370,383,885 | ||||||||||||
Residential first mortgages | 160,785,337 | 1,319,201 | - | 2,438,771 | 3,757,972 | 164,543,309 | ||||||||||||||||||
Construction and land dev | 35,331,315 | - | - | 1,413,550 | 1,413,550 | 36,744,865 | ||||||||||||||||||
Home equity and second mtg | 23,618,693 | 228,346 | - | 291,285 | 519,631 | 24,138,324 | ||||||||||||||||||
Commercial loans | 95,961,076 | 49,781 | 3,693,283 | 2,263,916 | 6,006,980 | 101,968,056 | ||||||||||||||||||
Consumer loans | 991,838 | 8,645 | - | 500 | 9,145 | 1,000,983 | ||||||||||||||||||
Commercial equipment | 19,450,929 | 24,869 | 48,899 | 236,056 | 309,824 | 19,760,753 | ||||||||||||||||||
Total | $ | 703,554,835 | $ | 1,732,541 | $ | 3,742,182 | $ | 9,510,617 | $ | 14,985,340 | $ | 718,540,175 |
December 31, 2010 | Current | 31-60 Days | 61-90 Days | Greater than 90 Days | Total Past Due | Total Loan Receivables | ||||||||||||||||||
Commercial real estate | $ | 327,358,352 | $ | 696,801 | $ | - | $ | 8,244,683 | $ | 8,941,484 | $ | 336,299,836 | ||||||||||||
Residential first mortgages | 134,142,088 | 159,703 | - | 1,746,786 | 1,906,489 | 136,048,577 | ||||||||||||||||||
Construction and land dev | 41,520,333 | - | - | 983,867 | 983,867 | 42,504,200 | ||||||||||||||||||
Home equity and second mtg | 23,947,389 | 199,631 | - | 232,644 | 432,275 | 24,379,664 | ||||||||||||||||||
Commercial loans | 102,221,510 | 83,109 | - | 2,261,642 | 2,344,751 | 104,566,261 | ||||||||||||||||||
Consumer loans | 1,268,738 | 3,141 | 500 | 701 | 4,342 | 1,273,080 | ||||||||||||||||||
Commercial equipment | 17,935,192 | - | - | 48,456 | 48,456 | 17,983,648 | ||||||||||||||||||
Total | $ | 648,393,602 | $ | 1,142,385 | $ | 500 | $ | 13,518,779 | $ | 14,661,664 | $ | 663,055,266 |
There were no accruing loans 90 days or greater past due at December 31, 2011 or 2010.
Credit Quality Indicators
A risk grading scale is used to assign grades to commercial real estate, construction and land development, commercial loans and commercial equipment loans. Loans are graded at inception, annually thereafter when financial statements are received, and at other times when there is an indication that a credit may have weakened or improved. Only commercial loan relationships with an aggregate exposure to the Bank of $750,000 or greater are subject to being risk rated. Loans are graded on a scale of 1 to 10.
Ratings 1 thru 6 - Pass
Ratings 1 thru 6 have asset risks ranging from excellent low risk to adequate. The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks.
Rating 7 - OAEM (Other Assets Especially Mentioned) – Special Mention
These credits, while protected by the financial strength of the borrowers, guarantors or collateral, have reduced quality due to economic conditions, less than adequate earnings performance or other factors which require the Lending Officer to direct more than normal attention to the credit. Financing alternatives may be limited and/or command higher risk interest rates. OAEM classified loans are the first adversely classified assets on our Watch List. These relationships will be reviewed at least quarterly.
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Tri-County Financial Corporation
Rating 8 - Substandard
Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. The loans may have a delinquent history or combination of weak collateral, weak guarantor strength or operating losses. These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies. These relationships will be reviewed at least quarterly.
Rating 9 - Doubtful
Doubtful assets have many of the same characteristics of Substandard with the exception that the Bank has determined that loss is not only possible but is probable and the risk is close to certain that loss will occur. When a loan is assigned to this category the Bank will identify the probable loss and it will receive a specific reserve in the loan loss allowance analysis. These relationships will be reviewed at least quarterly.
Rating 10 - Loss
Once an asset is identified as a definite loss to the Bank, it will receive the classification of “loss”. There may be some future potential recovery; however it is more practical to write off the loan at the time of classification. Losses will be taken in the period in which they are determined to be uncollectable.
Residential first mortgages, home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an OAEM or higher risk rating due to a delinquent payment history. At December 31, 2011, $5,708,203 of these loans were rated OAEM or higher.
Management regularly reviews credit quality indicators as part of its individual loan reviews and on a monthly and quarterly basis. The overall quality of the Bank’s loan portfolio, including the composition of the loan portfolio, is assessed using the Bank’s risk grading scale, net charge-offs, nonperforming loans, delinquencies, performance of troubled debt restructured loans and the general economic conditions in the Southern Maryland market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. Credit quality indicators and allowance factors are adjusted based on management’s judgment during the monthly and quarterly review process.
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Tri-County Financial Corporation
Credit quality indicators as of December 31, 2011 and 2010 were as follows:
Credit Risk Profile by Internally Assigned Grade
Commercial Real Estate | Construction and Land Dev. | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Unrated | $ | 1,003,553 | $ | 1,074,330 | $ | - | $ | - | ||||||||
Pass | 338,952,446 | 317,579,637 | 27,687,432 | 30,274,737 | ||||||||||||
Special mention | - | 3,628,052 | - | 1,585,035 | ||||||||||||
Substandard | 30,391,213 | 14,017,818 | 9,057,433 | 10,644,428 | ||||||||||||
Doubtful | - | - | - | - | ||||||||||||
Loss | 36,673 | - | - | - | ||||||||||||
Total | $ | 370,383,885 | $ | 336,299,836 | $ | 36,744,865 | $ | 42,504,200 |
Commercial Loans | Commercial Equipment | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Unrated | $ | 586,124 | $ | 50,035 | $ | 391,786 | $ | 169,492 | ||||||||
Pass | 78,183,487 | 84,946,678 | 19,209,380 | 17,765,700 | ||||||||||||
Special mention | - | 2,814,668 | - | - | ||||||||||||
Substandard | 23,198,445 | 12,852,635 | 159,587 | - | ||||||||||||
Doubtful | - | 3,793,470 | - | 48,456 | ||||||||||||
Loss | - | 108,775 | - | - | ||||||||||||
Total | $ | 101,968,056 | $ | 104,566,261 | $ | 19,760,753 | $ | 17,983,648 |
Credit Risk Profile Based on Payment Activity
Residential First Mortgages | Home Equity and Second Mtg. | Consumer Loans | ||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Performing | $ | 162,104,538 | $ | 134,301,791 | $ | 23,847,039 | $ | 24,147,019 | $ | 1,000,483 | $ | 1,272,379 | ||||||||||||
Nonperforming | 2,438,771 | 1,746,786 | 291,285 | 232,645 | 500 | 701 | ||||||||||||||||||
Total | $ | 164,543,309 | $ | 136,048,577 | $ | 24,138,324 | $ | 24,379,664 | $ | 1,000,983 | $ | 1,273,080 |
Impaired Loans and Troubled Debt Restructures (TDRs)
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.
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Tri-County Financial Corporation
Large groups of smaller homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures unless such loans are the subject of a troubled debt restructuring agreement or are risk rated as OAEM or above or are part of a commercial relationship that requires grading.
Interest payments made on impaired loans are applied to principal unless collectability of the principal amount is reasonably assured. Interest recognized on impaired loans is on a cash basis. Impaired loans, including TDRs, at December 31, 2011 and 2010 were as follows:
December 31, 2011 | Unpaid Contractual Principal Balance | Recorded Investment With No Allowance | Recorded Investment With Allowance | Total Recorded Investment | Related Allowance | Average Recorded Investment | Year to Date Interest Income Recognized | |||||||||||||||||||||
Commercial real estate | $ | 8,405,656 | $ | 6,404,447 | $ | 1,593,560 | $ | 7,998,006 | $ | 423,093 | $ | 6,880,651 | $ | 375,203 | ||||||||||||||
Residential first mortgages | 618,206 | - | 618,206 | 618,206 | 113,000 | 618,835 | 10,294 | |||||||||||||||||||||
Construction and land dev | 3,130,466 | 1,716,915 | 1,413,550 | 3,130,466 | 100,000 | 3,193,938 | 84,107 | |||||||||||||||||||||
Home equity and second mtg | 42,340 | - | 42,340 | 42,340 | 42,340 | 42,340 | - | |||||||||||||||||||||
Commercial loans | 8,798,072 | 2,369,329 | 6,428,743 | 8,798,072 | 1,318,502 | 9,188,371 | 314,216 | |||||||||||||||||||||
Commercial equipment | 129,876 | 129,876 | - | 129,876 | - | 147,035 | 8,905 | |||||||||||||||||||||
Total | $ | 21,124,616 | $ | 10,620,567 | $ | 10,096,399 | $ | 20,716,966 | $ | 1,996,935 | $ | 20,071,170 | $ | 792,725 |
December 31, 2010 | Unpaid Contractual Principal Balance | Recorded Investment With No Allowance | Recorded Investment With Allowance | Total Recorded Investment | Related Allowance | Average Recorded Investment | Interest Income Recognized | |||||||||||||||||||||
Commercial real estate | $ | 11,254,896 | $ | 5,624,780 | $ | 5,222,466 | $ | 10,847,246 | $ | 500,000 | $ | 8,710,501 | $ | 329,446 | ||||||||||||||
Residential first mortgages | 928,847 | 928,847 | - | 928,847 | - | 924,163 | 52,516 | |||||||||||||||||||||
Commercial loans | 9,292,145 | 3,195,567 | 6,096,578 | 9,292,145 | 1,449,179 | 9,308,552 | 464,956 | |||||||||||||||||||||
Commercial equipment | 319,769 | 271,313 | 48,456 | 319,769 | 48,456 | 300,533 | 13,836 | |||||||||||||||||||||
Total | $ | 21,795,657 | $ | 10,020,507 | $ | 11,367,500 | $ | 21,388,007 | $ | 1,997,635 | $ | 19,243,749 | $ | 860,754 |
At December 31, 2011 and 2010, impaired loans totaled $20,716,966 and $21,388,007, respectively. Impaired loans had specific allocations within the allowance for loan losses or have been reduced by charge-offs to recoverable values. Allocations of the allowance for loan losses relative to impaired loans at December 31, 2011 and 2010 were $1,996,935 and $1,997,635, respectively.
The Company considers all troubled debt restructured loans (TDRs) to be impaired and defines TDRs as loans whose terms have been modified to provide for a reduction of either interest or principal because of deterioration in the financial condition of the borrower. A loan extended or renewed at a stated interest rate equal to the current interest rate for new debt with similar risk is not considered a TDR. Once an obligation has been classified as a TDR it continues to be considered a TDR until paid in full or until the loan returns to performing status and yields a market interest rate equal to the current interest rate for new debt with similar risk. TDRs are evaluated by management on a regular basis utilizing the Company’s risk grading scale and must have a passing loan grade to be removed as a TDR. TDRs are evaluated for impairment on a loan-by- loan basis in accordance with the Company’s impairment methodology. The Company does not participate in any specific government or Company-sponsored loan modification programs. All restructured loan agreements are individual contracts negotiated with a borrower.
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Tri-County Financial Corporation
TDRs, included in the impaired loan schedule above, as of December 31, 2011 and 2010 were as follows:
Years Ended December 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
Dollars | Number of Loans | Dollars | Number of Loans | |||||||||||||
Commercial real estate | $ | 7,696,921 | 10 | $ | 6,847,618 | 6 | ||||||||||
Residential first mortgages | - | - | 928,847 | 2 | ||||||||||||
Construction and land development | 1,716,915 | 1 | - | - | ||||||||||||
Commercial loans | 2,369,329 | 3 | 8,834,025 | 7 | ||||||||||||
Commercial equipment | 129,876 | 1 | 271,313 | 4 | ||||||||||||
$ | 11,913,041 | 15 | $ | 16,881,803 | 19 |
At December 31, 2011, $11,113,326 or 93.3% of TDRs were performing according to the terms of their restructured agreements compared to $16,584,546 or 98.2% as of December 31, 2010. Interest income in the amount of $524,397 and $720,570 was recognized on these loans for the years ended December 31, 2011 and 2010, respectively. There were no nonperforming TDRs for agreements agreed to in 2011 during the year ended December 31, 2011. For the year ended December 31, 2011, TDR loans charged-off or transferred to foreclosed real estate were $187,891. TDRs charged-off were for two commercial equipment loans totaling $76,592 and one TDR was transferred to foreclosed real estate for a commercial loan of $111,299.
NOTE 6 - LOAN SERVICING
Loans serviced for others are not reflected in the accompanying balance sheets. The unpaid principal balances of mortgages serviced for others were $45,598,885 and $43,317,605 at December 31, 2011 and 2010, 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 an accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. The following table presents the activity of the mortgage servicing rights.
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Balance, beginning of the year | $ | 196,648 | $ | 132,859 | ||||
Additions | 73,022 | 103,238 | ||||||
Amortization | (56,591 | ) | (39,449 | ) | ||||
Balance, end of year | $ | 213,079 | $ | 196,648 |
NOTE 7 - FORECLOSED REAL ESTATE
Foreclosed assets are presented net of the allowance for losses. An analysis of the activity in foreclosed assets is as follows:
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Balance at beginning of year | $ | 10,469,302 | $ | 922,934 | ||||
Additions of underlying property | 7,273,206 | 11,768,778 | ||||||
Disposals of underlying property | (10,750,768 | ) | (1,934,476 | ) | ||||
Valuation allowance | (1,963,227 | ) | (287,934 | ) | ||||
Balance at end of period | $ | 5,028,513 | $ | 10,469,302 |
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Tri-County Financial Corporation
Expenses applicable to foreclosed assets include the following:
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Valuation allowance | $ | 1,963,227 | $ | 287,934 | ||||
Operating expenses | 489,164 | 128,465 | ||||||
$ | 2,452,391 | $ | 416,399 |
NOTE 8 - PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation of premises and equipment at December 31, 2011 and 2010 follows:
2011 | 2010 | |||||||
Land | $ | 4,916,251 | $ | 3,515,200 | ||||
Building and improvements | 13,424,230 | 11,092,569 | ||||||
Furniture and equipment | 5,820,318 | 4,435,489 | ||||||
Automobiles | 245,363 | 223,326 | ||||||
Total cost | 24,406,162 | 19,266,584 | ||||||
Less accumulated depreciation | 7,965,260 | 7,134,443 | ||||||
Premises and equipment, net | $ | 16,440,902 | $ | 12,132,141 |
Certain Bank facilities are leased under various operating leases. Rent expense was $488,154 and $468,320 in 2011 and 2010, respectively. Future minimum rental commitments under non-cancellable operating leases are as follows:
2012 | $ | 498,312 | ||
2013 | 503,825 | |||
2014 | 509,463 | |||
2015 | 515,229 | |||
2016 | 529,927 | |||
Thereafter | 3,663,813 | |||
Total | $ | 6,220,569 |
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Tri-County Financial Corporation
NOTE 9 - DEPOSITS
Deposits at December 31 consist of the following:
2011 | 2010 | |||||||
Noninterest-bearing demand | $ | 81,097,622 | $ | 75,642,197 | ||||
Interest-bearing: | ||||||||
Demand | 68,312,048 | 56,727,102 | ||||||
Money market deposits | 191,540,190 | 122,330,785 | ||||||
Savings | 30,787,620 | 31,683,368 | ||||||
Certificates of deposit | 455,515,721 | 438,198,874 | ||||||
Total interest-bearing | 746,155,579 | 648,940,129 | ||||||
Total Deposits | $ | 827,253,201 | $ | 724,582,326 |
The aggregate amount of certificates of deposit in denominations of $100,000 or more at December 31, 2011, and 2010 was $236,622,465 and $232,534,791, respectively. The aggregate amount of certificates of deposit in denominations of $250,000 or more at December 31, 2011, and 2010 was $81,816,504 and $84,772,971, respectively.
At December 31, 2011, the scheduled maturities of certificates of deposit are as follows:
2012 | $ | 268,330,047 | ||
2013 | 103,807,688 | |||
2014 | 49,735,440 | |||
2015 | 24,207,325 | |||
2016 | 9,435,221 | |||
$ | 455,515,721 |
NOTE 10 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT
The Bank’s long-term debt consists of advances from the Federal Home Loan Bank (FHLB) of Atlanta. The Bank classifies debt based upon original maturity and does not reclassify debt to short-term status during its life. These include fixed-rate, fixed-rate convertible and variable-rate convertible advances. Rates and maturities on these advances at December 31, 2011 and 2010 were as follows:
Fixed- | Fixed-Rate | Variable | ||||||||||
Rate | Convertible | Convertible | ||||||||||
2011 | ||||||||||||
Highest rate | 4.04 | % | 4.30 | % | 4.00 | % | ||||||
Lowest rate | 0.84 | % | 3.47 | % | 4.00 | % | ||||||
Weighted average rate | 2.76 | % | 3.88 | % | 4.00 | % | ||||||
Matures through | 2036 | 2018 | 2020 | |||||||||
2010 | ||||||||||||
Highest rate | 4.04 | % | 4.30 | % | 4.00 | % | ||||||
Lowest rate | 0.84 | % | 3.47 | % | 4.00 | % | ||||||
Weighted average rate | 2.74 | % | 3.88 | % | 4.00 | % | ||||||
Matures through | 2036 | 2018 | 2020 |
51 |
Tri-County Financial Corporation
Average rates of long-term debt and short-term borrowings were as follows:
At or for the Year Ended December 31, | ||||||||
(dollars in thousands) | 2011 | 2010 | ||||||
Long-term debt | ||||||||
Long-term debt outstanding at end of period | $ | 60,577 | $ | 70,624 | ||||
Weighted average rate on outstanding long-term debt | 3.33 | % | 3.24 | % | ||||
Maximum outstanding long-term debt of any month end | 60,620 | 70,666 | ||||||
Average outstanding long-term debt | 61,421 | 70,823 | ||||||
Approximate average rate paid on long-term debt | 3.32 | % | 3.22 | % | ||||
Short-term borrowings | ||||||||
Short-term borrowings outstanding at end of period | $ | - | $ | 816 | ||||
Weighted average rate on short-term borrowings | 0.00 | % | 0.00 | % | ||||
Maximum outstanding short-term borrowings at any month end | 15,703 | 11,322 | ||||||
Average outstanding short-term borrowings | 2,168 | 2,973 | ||||||
Approximate average rate paid on short-term borrowings | 1.91 | % | 1.41 | % |
The Bank’s fixed-rate debt generally consists of advances with monthly interest payments and principal due at maturity.
The Bank’s fixed-rate convertible long-term debt is callable by the issuer, after an initial period ranging from six months to five years. The instruments are callable at the date ending the initial period. At December 31, 2011, the Bank had $10,000,000 in fixed-rate convertible debt callable in 2013. The balance of fixed-rate convertible debt has passed its call date. All advances have a prepayment penalty, determined based upon prevailing interest rates.
Variable convertible advances have an initial variable rate based on a discount to LIBOR. Variable convertible debt is scheduled to mature in 2020. During 2010, the FHLB exercised its option to convert a $10,000,000 variable convertible advance to a fixed-rate advance at a rate of 4.0% for a term of 10 years.
At December 31, 2011, $50,576,595 or 83% of the Bank’s long-term debt is fixed for rate and term, as the conversion optionality of the advances have either been exercised or expired. The contractual maturities of long-term debt are as follows:
December 31, 2011 | ||||||||||||||||
Fixed- | Fixed-Rate | Variable | ||||||||||||||
Rate | Convertible | Convertible | Total | |||||||||||||
Due in 2012 | $ | - | $ | - | $ | - | $ | - | ||||||||
Due in 2013 | 5,000,000 | - | - | 5,000,000 | ||||||||||||
Due in 2014 | 10,750,000 | 10,000,000 | - | 20,750,000 | ||||||||||||
Due in 2015 | 14,000,000 | - | - | 14,000,000 | ||||||||||||
Due in 2016 | - | - | - | - | ||||||||||||
Thereafter | 826,595 | 10,000,000 | 10,000,000 | 20,826,595 | ||||||||||||
$ | 30,576,595 | $ | 20,000,000 | $ | 10,000,000 | $ | 60,576,595 |
From time to time, the Bank also has daily advances outstanding, which are classified as short-term borrowings. These advances are repayable at the Bank’s option at any time and are re-priced daily. There were no amounts outstanding at December 31, 2011 or December 31, 2010.
Under the terms of an Agreement for Advances and Security Agreement with Blanket Floating Lien (the “Agreement”), the Bank maintains collateral with the FHLB consisting of one-to-four family residential first mortgage loans, second mortgage loans, commercial real estate and securities. The Agreement limits total advances to 40% of assets or $393 million.
52 |
Tri-County Financial Corporation
At December 31, 2011, $391 million of loans and securities were pledged or in safekeeping at the FHLB. Loans and securities are subject to collateral eligibility rules and are adjusted for market value and collateral value factors to arrive at lendable collateral values. At December 31, 2011, FHLB lendable collateral was valued at $289 million. At December 31, 2011, the Bank had total lendable pledged collateral at the FHLB of $145 million of which $84 million was available to borrow in addition to outstanding advances of $61 million. Unpledged lendable collateral was $144 million, bringing total available borrowing capacity to $228 million at December 31, 2011.
Additionally, the Bank has established a short-term credit facility with the Federal Reserve Bank of Richmond under its Borrower in Custody program. The Bank has segregated collateral sufficient to draw $22.4 million under this agreement. In addition, the Bank has established short-term credit facilities with other commercial banks totaling $7 million at December 31, 2011. No amounts were outstanding under the Borrower in Custody or commercial lines at December 31, 2011.
At December 31, 2011 and 2010, federal treasury tax and loan deposits were $0 and $816,422, respectively. During 2011, the Federal Reserve discontinued the treasury tax and loan program allowing financial institutions to retain funds until demanded for tax deposits processed electronically.
NOTE 11 - INCOME TAXES
Allocation of federal and state income taxes between current and deferred portions is as follows:
2011 | 2010 | |||||||
Current | ||||||||
Federal | $ | 1,663,022 | $ | 2,642,443 | ||||
State | 557,499 | 784,091 | ||||||
2,220,521 | 3,426,534 | |||||||
Deferred | ||||||||
Federal | (611,296 | ) | (671,587 | ) | ||||
State | (75,650 | ) | (112,331 | ) | ||||
(686,946 | ) | (783,918 | ) | |||||
Total income tax expense | $ | 1,533,575 | $ | 2,642,616 |
The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows:
2011 | 2010 | |||||||||||||||
Amount | Percent of Pre-Tax Income | Amount | Percent of Pre-Tax Income | |||||||||||||
Expected income tax expense at federal tax rate | $ | 1,596,313 | 34.00 | % | $ | 2,518,828 | 34.00 | % | ||||||||
State taxes net of federal benefit | 127,658 | 2.72 | % | 146,501 | 1.98 | % | ||||||||||
Nondeductible expenses | 21,246 | 0.45 | % | 24,108 | 0.33 | % | ||||||||||
Nontaxable income | (347,329 | ) | (7.40 | %) | (312,542 | ) | (4.22 | %) | ||||||||
Other | 135,687 | 2.89 | % | 265,721 | 3.59 | % | ||||||||||
Total income tax expense | $ | 1,533,575 | 32.66 | % | $ | 2,642,616 | 35.67 | % |
53 |
Tri-County Financial Corporation
The net deferred tax assets in the accompanying balance sheets include the following components:
2011 | 2010 | |||||||
Deferred tax assets | ||||||||
Deferred fees | $ | 1,410 | $ | 1,410 | ||||
Allowance for loan losses | 3,019,914 | 3,025,478 | ||||||
Deferred compensation | 1,739,075 | 1,624,462 | ||||||
Other | 1,408,612 | 872,426 | ||||||
6,169,011 | 5,523,776 | |||||||
Deferred tax liabilities | ||||||||
Unrealized gain on investment securities | 149,188 | 211,824 | ||||||
FHLB stock dividends | 156,182 | 156,182 | ||||||
Depreciation | 31,169 | 94,213 | ||||||
336,539 | 462,219 | |||||||
Net deferred tax assets | $ | 5,832,472 | $ | 5,061,557 |
Retained earnings at December 31, 2011 included 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 $463,000 at December 31, 2011.
The Company does not have uncertain tax positions that are deemed material, and did not recognize any adjustments for unrecognized tax benefits. The Company’s policy is to recognize interest and penalties on income taxes as other noninterest expense. The Company is no longer subject to U.S. Federal tax examinations by tax authorities for years before 2008.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. 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 on the balance sheets. The Bank’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 Bank uses the same credit policies in making commitments as it does for on-balance-sheet loans receivable.
As of December 31, 2011 and 2010, in addition to the undisbursed portion of loans receivable of $18,677,566 and $8,067,658, respectively, the Bank had outstanding loan commitments of approximately $22,295,675 and $18,619,662, respectively.
Standby letters of credit written are conditional commitments issued by the Bank 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 Bank holds cash or a secured interest in real estate as collateral to support those commitments for which collateral is deemed necessary. Standby letters of credit outstanding amounted to $19,426,823 and $25,053,811 at December 31, 2011 and 2010, respectively. In addition to the commitments noted above, customers had approximately $75,564,000 and $81,322,000 available under lines of credit at December 31, 2011 and 2010, respectively.
54 |
Tri-County Financial Corporation
NOTE 13 – STOCK-BASED COMPENSATION
The Company has stock option and incentive arrangements to attract and retain key personnel. In May 2005, the 2005 Equity Compensation Plan (the “Plan”) was approved by the shareholders, which authorizes the issuance of restricted stock, stock appreciation rights, stock units and stock options to the Board of Directors and key employees. Compensation expense for service based awards is recognized over the vesting period. Performance based awards are recognized based on a vesting, if applicable, and the probability of achieving the goals.
Stock-based compensation expense totaled $154,899 and $60,150 in 2011 and 2010, respectively, which consisted of grants of restricted stock and restricted stock units. 2011 stock-based compensation included director compensation of $36,461 for stock granted in lieu of cash compensation. All outstanding options were fully vested at December 31, 2011. There were no stock options granted in 2011 and 2010, respectively.
The fair value of the Company’s employee stock options granted is estimated on the date of grant using the Black-Scholes option pricing model. The Company estimates expected market price volatility and expected term of the options based on historical data and other factors.
The exercise price for options granted is set at the discretion of the committee administering the Plan, but is not less than the market value of the shares as of the date of grant. An option’s maximum term is 10 years and the options vest at the discretion of the committee.
Weighted | Weighted-Average | |||||||||||||||
Average | Aggregate | Contractual Life | ||||||||||||||
Exercise | Intrinsic | Remaining In | ||||||||||||||
Shares | Price | Value | Years | |||||||||||||
Outstanding at January 1, 2011 | 299,237 | $ | 16.86 | $ | 524,392 | |||||||||||
Granted at fair value | - | - | ||||||||||||||
Exercised | (33,163 | ) | 8.75 | 286,061 | ||||||||||||
Expired | (338 | ) | 8.44 | |||||||||||||
Forfeited | (1,580 | ) | 15.00 | |||||||||||||
Outstanding at December 31, 2011 | 264,156 | $ | 17.90 | $ | 175,911 | 1.7 | ||||||||||
Exercisable at December 31, 2011 | 264,156 | $ | 17.90 | $ | 175,911 | 1.7 |
Weighted | Weighted-Average | |||||||||||||||
Average | Aggregate | Contractual Life | ||||||||||||||
Exercise | Intrinsic | Remaining In | ||||||||||||||
Shares | Price | Value | Years | |||||||||||||
Outstanding at January 1, 2010 | 329,243 | $ | 16.04 | $ | 222,607 | |||||||||||
Granted at fair value | - | - | ||||||||||||||
Exercised | (29,413 | ) | 7.89 | 209,132 | ||||||||||||
Expired | - | - | ||||||||||||||
Forfeited | (593 | ) | 7.91 | |||||||||||||
Outstanding at December 31, 2010 | 299,237 | $ | 16.86 | $ | 524,392 | 2.0 | ||||||||||
Exercisable at December 31, 2010 | 299,237 | $ | 16.86 | $ | 524,392 | 2.0 |
55 |
Tri-County Financial Corporation
Options outstanding are all currently exercisable and are summarized as follows:
Number Outstanding | Weighted Average | Weighted Average | ||
December 31, 2011 | Remaining Contractual Life | Exercise Price | ||
15,398 | 1 years | $ | 11.56 | |
59,348 | 2 years | 12.93 | ||
86,886 | 3 years | 15.89 | ||
80,813 | 4 years | 22.29 | ||
21,711 | 6 years | 27.70 | ||
264,156 | 17.90 |
The aggregate intrinsic value of outstanding stock options and exercisable stock options was $175,911 at December 31, 2011. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $15.00 at December 31, 2011, and the exercise price multiplied by the number of options outstanding.
The Company has outstanding restricted stock and stock units granted in accordance with the Plan. The following tables below summarize the unvested restricted stock awards and units outstanding at December 31, 2011 and 2010.
Restricted Stock | Restricted Stock Units | |||||||||||||||
Number of Shares | Weighted Average Grant Date Fair Value | Number of Units | Fair Value | |||||||||||||
Nonvested at January 1, 2011 | 2,720 | $ | 11.90 | 3,739 | $ | 15.00 | ||||||||||
Granted | 12,934 | 16.49 | 3,106 | 15.00 | ||||||||||||
Vested | (7,541 | ) | 14.86 | - | - | |||||||||||
Nonvested at December 31, 2011 | 8,113 | $ | 16.47 | 6,845 | $ | 15.00 |
Restricted Stock | Restricted Stock Units | |||||||||||||||
Number of Shares | Weighted Average Grant Date Fair Value | Number of Units | Fair Value | |||||||||||||
Nonvested at January 1, 2010 | 5,360 | $ | 11.90 | - | $ | - | ||||||||||
Granted | - | - | 3,739 | 13.00 | ||||||||||||
Vested | (2,640 | ) | 11.90 | - | - | |||||||||||
Nonvested at December 31, 2010 | 2,720 | $ | 11.90 | 3,739 | $ | 16.10 |
56 |
Tri-County Financial Corporation
NOTE 14 - EMPLOYEE BENEFIT PLANS
The Company has an Employee Stock Ownership Plan (“ESOP”) that covers substantially all its employees. Employees qualify to participate after one year of service and vest in allocated shares after three (3) years of service. The ESOP acquires stock of Tri-County Financial Corporation by purchasing shares in the Over the Counter (“OTC”) securities market. 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. Contributions are made at the discretion of the Board of Directors. ESOP contributions recognized for the years ended 2011 and 2010 totaled $43,695 and $50,800, respectively. As of December 31, 2011, the ESOP plan held 199,264 allocated and 57,277 unallocated shares with an approximate market value of $2,988,960 and $859,155, respectively.
The Company also has a 401(k) plan. The Company matches a portion of the employee contributions after one year of employee service. This ratio is determined annually by the Board of Directors. In 2011 and 2010, the Company matched one-half of the employee’s first 8% of deferral. Employees who have completed six months of service are covered under this defined contribution plan. Employee’s vest in the Company’s matching contributions after three (3) years of service. Contributions are determined at the discretion of the Board of Directors. For the years ended December 31, 2011 and 2010, the expense recorded for this plan totaled $208,926 and $201,646, respectively.
The Company has a separate nonqualified retirement plan for non-employee directors. Directors are eligible for a maximum benefit of $3,500 a year for ten years following retirement from the Board of Community Bank of Tri-County. The maximum benefit is earned at 15 years of service as a non-employee director. Full vesting occurs after two years of service. Expense recorded for this plan was $46,353 and $13,407 for the years ended December 31, 2011 and 2010, respectively.
In addition, the Company has established individual supplemental retirement plans and life insurance benefits for certain key executives and officers of the Bank. These plans and benefits provide a retirement income payment for 15 years from the date of the employee’s expected retirement date. The payments are set at the discretion of the Board of Directors and vesting occurs ratably from the date of employment to the expected retirement date. Expense recorded for this plan totaled $347,000 and $303,000 for 2011 and 2010, respectively.
NOTE 15 - 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 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 following table) 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, 2011, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
57 |
Tri-County Financial Corporation
As of December 31, 2011, the most recent notification from the Federal Reserve categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company’s or the Bank’s category. The Company’s and the Bank’s actual capital amounts and ratios for 2011 and 2010 are presented in the following tables.
Actual | Required for Capital Adequacy Purposes | To be Considered Well Capitalized Under Prompt Corrective Action | ||||||||||||||||||||||
At December 31, 2011 | ||||||||||||||||||||||||
Total Capital (to risk weighted assets) | ||||||||||||||||||||||||
The Company | $ | 94,927 | 12.69 | % | $ | 59,859 | 8.00 | % | ||||||||||||||||
The Bank | $ | 92,515 | 12.42 | % | $ | 59,609 | 8.00 | % | $ | 74,511 | 10.00 | % | ||||||||||||
Tier 1 Capital (to risk weighted assets) | ||||||||||||||||||||||||
The Company | $ | 87,164 | 11.65 | % | $ | 29,930 | 4.00 | % | ||||||||||||||||
The Bank | $ | 84,860 | 11.39 | % | $ | 29,804 | 4.00 | % | $ | 44,707 | 6.00 | % | ||||||||||||
Tier 1 Capital (to average assets) | ||||||||||||||||||||||||
The Company | $ | 87,164 | 9.17 | % | $ | 38,021 | 4.00 | % | ||||||||||||||||
The Bank | $ | 84,860 | 8.96 | % | $ | 37,896 | 4.00 | % | $ | 47,370 | 5.00 | % | ||||||||||||
At December 31, 2010 | ||||||||||||||||||||||||
Total Capital (to risk weighted assets) | ||||||||||||||||||||||||
The Company | $ | 90,343 | 12.94 | % | $ | 55,857 | 8.00 | % | ||||||||||||||||
The Bank | $ | 88,021 | 12.65 | % | $ | 55,633 | 8.00 | % | $ | 69,542 | 10.00 | % | ||||||||||||
Tier 1 Capital (to risk weighted assets) | ||||||||||||||||||||||||
The Company | $ | 82,694 | 11.84 | % | $ | 27,928 | 4.00 | % | ||||||||||||||||
The Bank | $ | 80,372 | 11.56 | % | $ | 27,817 | 4.00 | % | $ | 41,725 | 6.00 | % | ||||||||||||
Tier 1 Capital (to average assets) | ||||||||||||||||||||||||
The Company | $ | 82,694 | 9.44 | % | $ | 35,030 | 4.00 | % | ||||||||||||||||
The Bank | $ | 80,372 | 9.20 | % | $ | 34,928 | 4.00 | % | $ | 43,661 | 5.00 | % |
NOTE 16 - 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 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.
58 |
Tri-County Financial Corporation
December 31, 2011 | December 31, 2010 | |||||||||||||||
Estimated | Estimated | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
Amount | Value | Amount | Value | |||||||||||||
Assets | ||||||||||||||||
Cash and cash equivalents | $ | 19,118,189 | $ | 19,118,189 | $ | 9,823,436 | $ | 9,823,436 | ||||||||
Investment securities and stock in FHLB and FRB | 200,931,451 | 201,482,605 | 168,250,141 | 167,654,621 | ||||||||||||
Loans receivable, net | 710,088,775 | 726,238,000 | 654,449,936 | 662,813,000 | ||||||||||||
Foreclosed real estate | 5,028,513 | 5,028,513 | 10,469,302 | 10,469,302 | ||||||||||||
Liabilities | ||||||||||||||||
Savings, NOW, and money market accounts | 371,737,480 | 371,737,480 | 286,383,452 | 286,383,452 | ||||||||||||
Time certificates | 455,515,721 | 462,192,000 | 438,198,874 | 444,601,000 | ||||||||||||
Long-term debt and other borrowed funds | 60,576,595 | 61,353,000 | 71,440,466 | 69,517,422 | ||||||||||||
Guaranteed preferred beneficial interest in junior subordinated securities | 12,000,000 | 2,400,000 | 12,000,000 | 2,400,000 |
At December 31, 2011, the Company had outstanding loan commitments and standby letters of credit of $22.3 million and $19.4 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.
Loans receivable - 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 that 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.
Foreclosed real estate - Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral.
Deposits - The fair value of checking accounts, saving accounts and money market accounts were 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.
Guaranteed preferred beneficial interest in junior subordinated securities - These were valued using discounted cash flows. The discount rate was equal to the rate currently offered on similar borrowings.
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Tri-County Financial Corporation
Off-balance sheet instruments - The Company charges fees for commitments to extend credit. Interest rates on loans for which these commitments are extended are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2011 and 2010. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amount presented herein.
NOTE 17 - GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES
On June 15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business trust formed, funded and wholly owned by the Company, issued $5,000,000 of variable-rate capital in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 1.70%. The Trust used the proceeds from this issuance, along with the $155,000 for Capital Trust II’s common securities, to purchase $5,155,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust II’s obligations with respect to the capital securities. These capital securities qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust II and the junior subordinated debentures are scheduled to mature on June 15, 2035, unless called by the Company.
On July 22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business trust formed, funded and wholly owned by the Company, issued $7,000,000 of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds from this issuance, along with the Company’s $217,000 capital contribution for Capital Trust I’s common securities, to purchase $7,217,000 of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. The Company has, through various contractual arrangements, fully and unconditionally guaranteed all of Capital Trust I’s obligations with respect to the capital securities. These debentures qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless called by the Company.
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Tri-County Financial Corporation
NOTE 18 - PREFERRED STOCK
Small Business Lending Fund Preferred Stock
On September 22, 2011, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with the Secretary of the Treasury (the “Secretary”), pursuant to which the Company issued 20,000 shares of the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $20,000,000. The Purchase Agreement was entered into, and the Series C Preferred Stock was issued, as authorized by the Small Business Lending Fund program.
The Series C Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the Series C Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” or “QSBL” (as defined in the Purchase Agreement) by the Bank. Based upon the increase in the Bank’s level of QSBL over the baseline level calculated under the terms of the Purchase Agreement, the dividend rate for the initial dividend period has been set at one percent (1%). For the second through ninth calendar quarters, the dividend rate may be adjusted to between one percent (1%) and five percent (5%) per annum, to reflect the amount of change in the Bank’s level of QSBL. If the level of the Bank’s qualified small business loans declines so that the percentage increase in QSBL as compared to the baseline level is less than 10%, then the dividend rate payable on the Series C Preferred Stock would increase. For the tenth calendar quarter through four and one half years after issuance, the dividend rate will be fixed at between one percent (1%) and seven percent (7%) based upon the increase in QSBL as compared to the baseline. After four and one half years from issuance, the dividend rate will increase to 9%. In addition, beginning on January 1, 2014, and on all Series C Preferred Stock dividend payment dates thereafter ending on April 1, 2016, the Company will be required to pay to the Secretary, on each share of Series C Preferred Stock, but only out of assets legally available, a fee equal to 0.5% of the liquidation amount per share of Series C Preferred Stock.
The Series C Preferred Stock is non-voting, except in limited circumstances. If the Company misses five dividend payments, whether or not consecutive, the holder of the Series C Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer on the Company’s Board of Directors. The Series C Preferred Stock may be redeemed at any time at the Company’s option, at a redemption price of 100% of the liquidation amount plus accrued but unpaid dividends to the date of redemption for the current period, subject to the approval of our federal banking regulator. The Company is permitted to repay its SBLF funding in increments of 25% or $5.0 million, subject to the approval of our federal banking regulator.
The Series C Preferred Stock was issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company has agreed to register the Series C Preferred Stock under certain circumstances set forth in Annex E to the Purchase Agreement. The Series C Preferred Stock is not subject to any contractual restrictions on transfer.
Redemption of Series A and B Preferred Stock - Troubled Asset Relief Program’s (TARP) Capital Purchase Program
On September 22, 2011, the Company entered into a letter agreement (the “Repurchase Letter”) with the United States Department of the Treasury (the “Treasury”), in which the Company agreed to redeem, out of the proceeds of the issuance of the Series C Preferred Stock, all 15,540 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation amount $1,000 per share (the “Series A Preferred Stock”), for a redemption price of $15,619,858.33, including accrued but unpaid dividends to the date of redemption and all 777 outstanding shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series B, liquidation amount $1,000 per share (the “Series B Preferred Stock”), for a redemption price of $784,187.25, including accrued but unpaid dividends to the date of redemption.
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Tri-County Financial Corporation
The Company issued Series A Preferred Stock and Series B Preferred Stock on December 19, 2008. It was outstanding until redemption of 100% of all Series A Preferred Stock and Series B Preferred Stock on September 22, 2011. The annual dividend rates paid for Series A Preferred Stock and Series B Preferred Stock were 5% and 9%, respectively.
NOTE 19 - CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Balance Sheets | ||||||||
December 31, | ||||||||
2011 | 2010 | |||||||
Assets | ||||||||
Cash - noninterest bearing | $ | 337,704 | $ | 583,660 | ||||
Investment in wholly owned subsidiaries | 85,521,824 | 81,155,647 | ||||||
Other assets | 2,755,040 | 2,417,496 | ||||||
Total assets | $ | 88,614,568 | $ | 84,156,803 | ||||
Liabilities and Stockholders' Equity | ||||||||
Current liabilities | $ | 788,470 | $ | 679,876 | ||||
Guaranteed preferred beneficial interest in junior subordinated debentures | 12,372,000 | 12,372,000 | ||||||
Total liabilities | 13,160,470 | 13,051,876 | ||||||
Stockholders' equity | ||||||||
Preferred Stock - Series C | 20,000,000 | - | ||||||
Preferred Stock - Series A | - | 15,540,000 | ||||||
Preferred Stock - Series B | - | 777,000 | ||||||
Common stock | 30,266 | 30,026 | ||||||
Additional paid in capital | 17,367,403 | 16,962,460 | ||||||
Retained earnings | 38,712,194 | 37,892,557 | ||||||
Accumulated other comprehensive income | 289,599 | 411,188 | ||||||
Unearned ESOP shares | (945,364 | ) | (508,304 | ) | ||||
Total Stockholders’ Equity | 75,454,098 | 71,104,927 | ||||||
Total Liabilities and Stockholders’ Equity | $ | 88,614,568 | $ | 84,156,803 |
Condensed Statements of Income | ||||||||
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Interest and Dividend Income | ||||||||
Dividends from subsidiary | $ | 3,275,000 | $ | 2,500,000 | ||||
Interest income | 33,307 | 29,068 | ||||||
Interest expense | 316,576 | 321,942 | ||||||
Net Interest Income | 2,991,731 | 2,207,126 | ||||||
Miscellaneous expenses | (703,332 | ) | (600,562 | ) | ||||
Income before income taxes and equity in undistributed net income of subsidiary | 2,288,399 | 1,606,564 | ||||||
Federal and state income tax benefit | 335,444 | 303,768 | ||||||
Equity in undistributed net income of subsidiary | 537,621 | 2,855,369 | ||||||
Net Income | $ | 3,161,464 | $ | 4,765,701 |
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Tri-County Financial Corporation
Condensed Statements of Cash Flows | ||||||||
Years Ended December 31, | ||||||||
2011 | 2010 | |||||||
Cash Flows from Operating Activities | ||||||||
Net income | $ | 3,161,464 | $ | 4,765,701 | ||||
Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
Equity in undistributed earnings of subsidiary | (537,621 | ) | (2,855,369 | ) | ||||
Stock based compensation | 253,466 | - | ||||||
Increase in other assets | (301,185 | ) | (401,159 | ) | ||||
Deferred income tax benefit | (36,357 | ) | (60,782 | ) | ||||
Increase in current liabilities | 108,595 | 249,301 | ||||||
Net Cash Provided by Operating Activities | 2,648,362 | 1,697,692 | ||||||
Cash Flows from Financing Activities | ||||||||
Dividends paid | (1,932,099 | ) | (2,043,117 | ) | ||||
Proceeds from Small Business Lending Fund Preferred Stock | 20,000,000 | - | ||||||
Redemption of Troubled Asset Relief Program Preferred Stock | (16,317,000 | ) | - | |||||
Downstream of capital to subsidiary | (3,950,148 | ) | - | |||||
Exercise of stock options | 121,319 | 147,799 | ||||||
Excess tax benefits on stock based compensation | - | 4,558 | ||||||
Net change in ESOP loan | (406,425 | ) | (62,577 | ) | ||||
Redemption of common stock | (409,965 | ) | (24,000 | ) | ||||
Net Cash Used in Financing Activities | (2,894,318 | ) | (1,977,337 | ) | ||||
Decrease in Cash | (245,956 | ) | (279,645 | ) | ||||
Cash at Beginning of Year | 583,660 | 863,305 | ||||||
Cash at End of Year | $ | 337,704 | $ | 583,660 |
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Tri-County Financial Corporation
NOTE 20 - QUARTERLY FINANCIAL COMPARISON (Unaudited)
2011 | ||||||||||||||||
Fourth | Third | Second | First | |||||||||||||
Quarter | Quarter | Quarter | Quarter | |||||||||||||
Interest and dividend income | $ | 10,088,665 | $ | 10,134,507 | $ | 9,904,432 | $ | 9,831,790 | ||||||||
Interest expense | 3,351,796 | 3,378,500 | 3,168,429 | 3,222,317 | ||||||||||||
Net interest income | 6,736,869 | 6,756,007 | 6,736,003 | 6,609,473 | ||||||||||||
Provision for loan loss | 545,806 | 644,654 | 890,861 | 2,005,830 | ||||||||||||
Net interest income after provision | 6,191,063 | 6,111,353 | 5,845,142 | 4,603,643 | ||||||||||||
Noninterest income | 1,443,758 | 1,026,356 | 952,599 | 770,327 | ||||||||||||
Noninterest expense | 6,937,286 | 5,277,394 | 4,923,298 | 5,111,224 | ||||||||||||
Income before income taxes | 697,535 | 1,860,315 | 1,874,443 | 262,746 | ||||||||||||
Provision for income taxes | 203,823 | 653,856 | 654,648 | 21,248 | ||||||||||||
Net income | $ | 493,712 | $ | 1,206,459 | $ | 1,219,795 | $ | 241,498 | ||||||||
Preferred stock dividends | 51,111 | 197,912 | 211,732 | 211,733 | ||||||||||||
Net income available to common shareholders | $ | 442,601 | $ | 1,008,547 | $ | 1,008,063 | $ | 29,765 | ||||||||
Earnings per common share1 | ||||||||||||||||
Basic | $ | 0.15 | $ | 0.33 | $ | 0.33 | $ | 0.01 | ||||||||
Diluted | $ | 0.15 | $ | 0.33 | $ | 0.33 | $ | 0.01 |
2010 | ||||||||||||||||
Fourth | Third | Second | First | |||||||||||||
Quarter | Quarter | Quarter | Quarter | |||||||||||||
Interest and dividend income | $ | 9,874,883 | $ | 9,805,485 | $ | 9,893,082 | $ | 9,963,537 | ||||||||
Interest expense | 3,398,511 | 3,372,947 | 3,329,856 | 3,478,901 | ||||||||||||
Net interest income | 6,476,372 | 6,432,538 | 6,563,226 | 6,484,636 | ||||||||||||
Provision for loan loss | 1,149,441 | 1,121,203 | 804,430 | 858,374 | ||||||||||||
Net interest income after provision | 5,326,931 | 5,311,335 | 5,758,796 | 5,626,262 | ||||||||||||
Noninterest income | 1,079,848 | 994,759 | 744,344 | 761,225 | ||||||||||||
Noninterest expense | 4,619,716 | 4,437,425 | 4,899,633 | 4,238,409 | ||||||||||||
Income before income taxes | 1,787,063 | 1,868,669 | 1,603,507 | 2,149,078 | ||||||||||||
Provision for income taxes | 621,204 | 669,335 | 567,423 | 784,654 | ||||||||||||
Net income | $ | 1,165,859 | $ | 1,199,334 | $ | 1,036,084 | $ | 1,364,424 | ||||||||
Preferred stock dividends | 211,732 | 211,733 | 211,732 | 211,733 | ||||||||||||
Net income available to common shareholders | $ | 954,127 | $ | 987,601 | $ | 824,352 | $ | 1,152,691 | ||||||||
Earnings per common share1 | ||||||||||||||||
Basic | $ | 0.32 | $ | 0.33 | $ | 0.28 | $ | 0.39 | ||||||||
Diluted | $ | 0.32 | $ | 0.33 | $ | 0.27 | $ | 0.38 |
1 Earnings per share are based upon quarterly results and may not be additive to the annual earnings per share amounts.
64 |
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
Tri-County Financial Corporation
Percentage | State of | |||
Subsidiary | Owned | Incorporation | ||
Community Bank of Tri-County | 100% | Maryland | ||
Tri-County Capital Trust I | 100% | Delaware | ||
Tri-County Capital Trust II | 100% | Delaware | ||
Subsidiaries of Community Bank of Tri-County | ||||
Community Mortgage Corporation of Tri-County | 100% | Maryland |
EXHIBIT 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUTING FIRM
We hereby consent to the incorporation of our report dated March 8, 2012, relating to the 2011 consolidated financial statements of Tri-County Financial Corporation, by reference in Registration Statements Nos. 33-97174, 333-79237, 333-70800, and 333-125103, each of Form S-8, and in the Annual Report on Form 10-K of Tri-County Financial Corporation, for the year ended December 31, 2011.
/s/ Stegman & Company
Baltimore, Maryland
March 9, 2012
EXHIBIT 31.1
Certification
I, Michael L. Middleton, certify that:
1. I have reviewed this Annual Report on Form 10-K of Tri-County Financial Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 9, 2012
/s/ Michael L. Middleton | |
Michael L. Middleton | |
President and Chief Executive Officer | |
(Principal Executive Officer) |
EXHIBIT 31.2
Certification
I, William J. Pasenelli, certify that:
1. I have reviewed this Annual Report on Form 10-K of Tri-County Financial Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 9, 2012
/s/ William J. Pasenelli | |
William J. Pasenelli | |
Executive Vice President and Chief Financial Officer | |
(Principal Financial and Accounting Officer) |
EXHIBIT 32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
The undersigned executive officers of Tri-County Financial Corporation (the “Registrant”) hereby certify that this Annual Report on Form 10-K for the year ended December 31, 2011 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
By: | /s/ Michael L. Middleton | |
Name: Michael L. Middleton | ||
Title: President and Chief Executive Officer |
By: | /s/ William J. Pasenelli | |
Name: William J. Pasenelli | ||
Title: Executive Vice President and Chief Financial Officer |
Date: March 9, 2012
EXHIBIT 99.1
CERTIFICATION
PURSUANT TO 31 C.F.R. § 30.15
I, Michael L. Middleton, certify, based on my knowledge, that:
(i) The compensation committee of Tri-County Financial Corporation has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (SEO) compensation plans and the employee compensation plans and the risks these plans pose to Tri-County Financial Corporation;
(ii) The compensation committee of Tri-County Financial Corporation has identified and limited during any part of the most recently completed fiscal year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of Tri-County Financial Corporation, and has identified any features of the employee compensation plans that pose risks to Tri-County Financial Corporation and has limited those features to ensure that Tri-County Financial Corporation is not unnecessarily exposed to risks;
(iii) The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of Tri-County Financial Corporation to enhance the compensation of an employee, and has limited any such features;
(iv) The compensation committee of Tri-County Financial Corporation will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;
(v) The compensation committee of Tri-County Financial Corporation will provide a narrative description of how it limited during any part of the most recently completed fiscal year that was a TARP period the features in
(a) SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of Tri-County Financial Corporation;
(b) Employee compensation plans that unnecessarily expose Tri-County Financial Corporation to risks; and
(c) Employee compensation plans that could encourage the manipulation of reported earnings of Tri-County Financial Corporation to enhance the compensation of an employee;
(vi) Tri-County Financial Corporation has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;
(vii) Tri-County Financial Corporation has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;
(viii) Tri-County Financial Corporation has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;
(ix) Tri-County Financial Corporation and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;
(x) Tri-County Financial Corporation will permit a non-binding shareholder resolution in compliance with any applicable Federal securities rules and regulations on the disclosures provided under the Federal securities laws related to SEO compensation paid or accrued during any part of the most recently completed fiscal year that was a TARP period;
(xi) Tri-County Financial Corporation will disclose the amount, nature, and justification for the offering, during any part of the most recently completed fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph (viii);
(xii) Tri-County Financial Corporation will disclose whether Tri-County Financial Corporation, the board of directors of Tri-County Financial Corporation, or the compensation committee of Tri-County Financial Corporation has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during such period;
(xiii) Tri-County Financial Corporation has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;
(xiv) Tri-County Financial Corporation has substantially complied with all other requirements related to employee compensation during any part of the most recently completed fiscal year that was a TARP period that are provided in the agreement between Tri-County Financial Corporation and Treasury, including any amendments;
(xv) I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both.
Date: March 9, 2012 | /s/ Michael L. Middleton |
Michael L. Middleton | |
President and Chief Executive Officer |
EXHIBIT 99.2
CERTIFICATION
PURSUANT TO 31 C.F.R. § 30.15
I, William J. Pasenelli, certify, based on my knowledge, that:
(i) The compensation committee of Tri-County Financial Corporation has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (SEO) compensation plans and the employee compensation plans and the risks these plans pose to Tri-County Financial Corporation;
(ii) The compensation committee of Tri-County Financial Corporation has identified and limited during any part of the most recently completed fiscal year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of Tri-County Financial Corporation, and has identified any features of the employee compensation plans that pose risks to Tri-County Financial Corporation and has limited those features to ensure that Tri-County Financial Corporation is not unnecessarily exposed to risks;
(iii) The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of Tri-County Financial Corporation to enhance the compensation of an employee, and has limited any such features;
(iv) The compensation committee of Tri-County Financial Corporation will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;
(v) The compensation committee of Tri-County Financial Corporation will provide a narrative description of how it limited during any part of the most recently completed fiscal year that was a TARP period the features in
(a) SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of Tri-County Financial Corporation;
(b) Employee compensation plans that unnecessarily expose Tri-County Financial Corporation to risks; and
(c) Employee compensation plans that could encourage the manipulation of reported earnings of Tri-County Financial Corporation to enhance the compensation of an employee;
(vi) Tri-County Financial Corporation has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;
(vii) Tri-County Financial Corporation has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;
(viii) Tri-County Financial Corporation has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;
(ix) Tri-County Financial Corporation and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;
(x) Tri-County Financial Corporation will permit a non-binding shareholder resolution in compliance with any applicable Federal securities rules and regulations on the disclosures provided under the Federal securities laws related to SEO compensation paid or accrued during any part of the most recently completed fiscal year that was a TARP period;
(xi) Tri-County Financial Corporation will disclose the amount, nature, and justification for the offering, during any part of the most recently completed fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph (viii);
(xii) Tri-County Financial Corporation will disclose whether Tri-County Financial Corporation, the board of directors of Tri-County Financial Corporation, or the compensation committee of Tri-County Financial Corporation has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during such period;
(xiii) Tri-County Financial Corporation has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;
(xiv) Tri-County Financial Corporation has substantially complied with all other requirements related to employee compensation during any part of the most recently completed fiscal year that was a TARP period that are provided in the agreement between Tri-County Financial Corporation and Treasury, including any amendments;
(xv) I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both.
Date: March 9, 2012 | /s/ William J. Pasenelli |
William J. Pasenelli | |
Executive Vice President and Chief Financial Officer |
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