UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2005
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to_________.
Commission File Number 0-25923
EAGLE BANCORP, INC
(Exact name of registrant as specified in its charter)
Maryland 52-2061461
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7815 Woodmont Avenue, Bethesda, Maryland 20814
(Address of principal executive offices) (Zip Code)
(301) 986-1800
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act Yes (X) No ( )
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of July 26, 2005, the registrant had 7,096,047 shares of Common
Stock outstanding.
ITEM 1 - FINANCIAL STATEMENTS
EAGLE BANCORP, INC.
Consolidated Balance Sheets
June 30, 2005 and December 31, 2004
(dollars in thousands)
June 30, December 31,
ASSETS 2005 2004
--------------- ---------------
Cash and due from banks $ 24,577 $ 31,100
Interest bearing deposits with banks and other short term
investments 10,689 9,594
Federal funds sold 2,002 15,035
Investment securities available for sale, at fair value 71,035 64,098
Loans held for sale 3,646 2,208
Loans 481,769 415,509
Less allowance for credit losses (5,155) (4,240)
--------------- ---------------
Loans, net 476,614 411,269
Premises and equipment, net 5,962 5,726
Accrued interest, taxes and other assets 15,575 14,423
--------------- ---------------
$ 610,100 $ 553,453
TOTAL ASSETS =============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing demand $ 146,039 $ 130,309
Interest bearing transaction 74,525 57,063
Savings and money market 128,201 126,299
Time, $100,000 or more 116,183 99,882
Other time 51,492 48,734
--------------- ---------------
Total deposits 516,440 462,287
Customer repurchase agreements
and federal funds purchased 26,352 23,983
Other short-term borrowings 4,333 6,333
Other liabilities 1,920 2,316
--------------- ---------------
Total liabilities 549,045 494,919
--------------- ---------------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; shares authorized 20,000,000,
shares issued and outstanding 7,095,397 (2005)
and 5,421,730 (2004) 71 54
Additional paid in capital 47,505 47,014
Retained earnings 13,584 11,368
Accumulated other comprehensive (loss) gain (105) 98
--------------- ---------------
Total stockholders' equity 61,055 58,534
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 610,100 $ 553,453
=============== ===============
See notes to consolidated financial statements.
2
EAGLE BANCORP, INC.
Consolidated Statements of Operations
For the Six and Three Month Periods Ended June 30, 2005 and 2004 (unaudited)
(dollars in thousands, except per share data)
Six months Six months Three months Three months
Ended Ended Ended Ended
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
-------------- -------------- -------------- --------------
INTEREST INCOME
Interest and fees on loans $ 14,859 $ 9,753 $ 7,862 $ 4,966
Taxable interest and dividends on investment securities 1,256 1,052 641 587
Interest on balances with other banks & short term investments 119 61 77 38
Interest on federal funds sold 128 123 72 25
-------------- -------------- -------------- --------------
Total interest income 16,362 10,989 8,652 5,616
-------------- -------------- -------------- --------------
INTEREST EXPENSE
Interest on deposits 2,734 1,716 1,593 905
Interest on customer repurchase agreements
and federal funds purchased 103 34 70 18
Interest on short-term borrowings 105 85 44 28
Interest on long-term borrowings - 178 - 96
-------------- -------------- -------------- --------------
Total interest expense 2,942 2,013 1,707 1,047
-------------- -------------- -------------- --------------
NET INTEREST INCOME 13,420 8,976 6,945 4,569
PROVISION FOR CREDIT LOSSES 887 230 470 76
-------------- -------------- -------------- --------------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 12,533 8,746 6,475 4,493
-------------- -------------- -------------- --------------
NONINTEREST INCOME
Service charges on deposits 592 709 323 363
Gain on sale of loans 642 389 147 217
Gain on sale of investment securities 12 253 12 -
Other income 680 556 405 245
-------------- -------------- -------------- --------------
Total noninterest income 1,926 1,907 887 825
-------------- -------------- -------------- --------------
NONINTEREST EXPENSE
Salaries and employee benefits 5,234 3,901 2,674 1,947
Premises and equipment expenses 1,617 1,270 816 672
Advertising 207 159 111 103
Outside data processing 385 286 204 144
Other expenses 1,933 1,508 1,096 765
-------------- -------------- -------------- --------------
Total noninterest expense 9,376 7,124 4,901 3,631
-------------- -------------- -------------- --------------
INCOME BEFORE INCOME TAX EXPENSE 5,083 3,529 2,461 1,687
INCOME TAX EXPENSE 1,874 1,277 905 614
-------------- -------------- -------------- --------------
NET INCOME $ 3,209 $ 2,252 $ 1,556 $ 1,073
============== ============== ============== ==============
EARNINGS PER SHARE
Basic $ 0.45 $ 0.32 $ 0.22 $ 0.15
Diluted $ 0.43 $ 0.31 $ 0.21 $ 0.15
See notes to consolidated financial statements.
3
EAGLE BANCORP, INC.
Consolidated Statements of Cash Flows
For the Six Month Periods Ended June 30, 2005 and 2004 (unaudited)
(dollars in thousands)
Six months Ended Six months Ended
June 30, 2005 June 30, 2004
------------------ -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,209 $ 2,252
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
(Decrease) in deferred income taxes - (1)
Provision for credit losses 887 230
Depreciation and amortization 522 448
Gains on sale of loans (642) (389)
Origination of loans held for sale (17,983) (13,948)
Proceeds from sale of loans held for sale 17,187 14,120
Gain on sale of investment securities (12) (253)
Decrease in other assets (1,152) (796)
(Decrease) Increase in other liabilities (281) 176
------------------ -----------------
Net cash provided by operating activities 1,735 1,839
------------------ -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in interest bearing deposits with other banks (1,095) (1,604)
Purchases of available for sale investment securities (13,029) (165,550)
Proceeds from maturities of available for sale securities 2,786 152,792
Proceeds from sale / called of available for sale securities 3,000 30,340
Decrease (Increase) in federal funds sold 13,033 (23,980)
Net increase in loans (66,232) (31,432)
Bank premises and equipment acquired (758) (1,792)
Purchase of BOLI - (4,000)
------------------ -----------------
Net cash used in investing activities (62,295) (45,226)
------------------ -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 54,153 67,734
Increase (decrease) in customer repurchase agreements and
federal funds purchased 2,369 (16,548)
Decrease in other short-term borrowings (2,000) -
Decrease in long-term borrowings - (2,060)
Issuance of common stock 512 338
Payment of dividends (997) -
------------------ -----------------
Net cash provided by financing activities 54,037 49,464
------------------ -----------------
NET (DECREASE) INCREASE IN CASH (6,523) 6,077
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 31,100 25,103
------------------ -----------------
CASH AND DUE FROM BANKS AT END OF YEAR $ 24,577 $ 31,180
================== =================
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid $ 2,709 $ 1,916
================== =================
Income taxes paid $ 2,410 $ 1,009
================== =================
4
EAGLE BANCORP, INC.
Consolidated Statements of Changes in Stockholders' Equity
For the Six Month Periods Ended June 30, 2005 and 2004 (unaudited)
(dollars in thousands)
Accumulated
Paid Other Total
Common Additional Paid Retained Comprehensive Stockholders'
Stock in Capital Earnings Income (Loss) Equity
---------- --------------- -------- -------------- -------------
Balance, January 1, 2005 $ 54 $ 47,014 $ 11,368 $ 98 $ 58,534
Net Income 3,209 3,209
Cash Dividend ($ .14 per share) (993) (993)
1.3 to one stock split in the form
of a 30% stock dividend 17 (17) 0
Cash paid in lieu of fractional shares (4) (4)
Exercise of options for 48,214 shares
of common stock 454 454
Tax benefit on non-qualified options exercise 58 58
Other Comprehensive Income
Unrealized loss on securities available
for sale (net of taxes) (203) (203)
---------- ------------ ---------- -------------- -------------
Balance, June 30, 2005 $ 71 $ 47,505 $ 13,584 $ (105) $ 61,055
========== ============ ========== ============== =============
Balance, January 1, 2004 $ 54 $ 46,406 $ 6,281 $ 271 $ 53,012
Net Income 2,252 2,252
Exercise of options for 44,954 shares
of common stock 338 338
Other Comprehensive Income
Unrealized gain on securities available
for sale (net of taxes) (880) (880)
---------- ------------ ---------- -------------- -------------
Balance, June 30, 2004 $ 54 $ 46,744 $ 8,533 $ (609) $ 54,722
========== ============ ========== ============== =============
5
EAGLE BANCORP, INC
Notes to Consolidated Financial Statements
For the six and three months ended June 30, 2005 and 2004
(unaudited)
1. BASIS OF PRESENTATION
General - The financial statements of Eagle Bancorp, Inc. (the
"Company") included herein are unaudited; however, they reflect all adjustments
consisting only of normal recurring accruals that, in the opinion of Management,
are necessary to present fairly the results for the periods presented. The
amounts as of December 31, 2004 were derived from audited consolidated financial
statements. Certain information and note disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission. There
have been no significant changes to the Company's Accounting Policies as
disclosed in the 2004 Annual Report. The Company believes that the disclosures
are adequate to make the information presented not misleading. The results of
operations for the six and three months ended June 30, 2005 are not necessarily
indicative of the results of operations to be expected for the remainder of the
year, or for any other period.
2. NATURE OF BUSINESS
The Company, through its bank subsidiary, provides domestic financial
services primarily in Montgomery County, Maryland and Washington, DC. The
primary financial services include real estate, commercial and consumer lending,
as well as traditional deposit and repurchase agreement products. The Bank is
also active in the origination and sale of residential mortgages and small
business loans. A new noninterest income business was organized in the first
quarter of 2005, which provides professional services in connection with loan
settlement processes.
3. INVESTMENT SECURITIES
Amortized cost and estimated fair value of securities available for
sale are summarized as follows:
(in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
JUNE 30, 2005 Cost Gains Losses Value
------------- ------------- -------------- ------------- -------------
U. S. Government agency securities $ 44,005 $ 23 $ 441 $ 43,587
GNMA mortgage backed securities 20,557 32 303 20,286
Federal Reserve and Federal Home Loan Bank stock 2,304 - - 2,304
Other equity investments 4,339 522 3 4,858
------------- ------------- ------------ ------------
$ 71,205 $ 577 $ 747 $ 71,035
============= ============= ============ ============
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
DECEMBER 31, 2004 Cost Gains Losses Value
----------------- -------------- ------------- ----------- ------------
U. S. Government agency securities $ 34,478 $ - $ 294 $ 34,184
GNMA mortgage backed securities 23,177 77 188 23,066
Federal Reserve and Federal Home Loan Bank stock 1,956 - - 1,956
Other equity investments 4,339 555 2 4,892
------------- -------------- ------------- ------------
$ 63,950 $ 632 $ 484 $ 64,098
============= ============== ============= ============
Gross unrealized losses and fair value by length of time that the individual
available securities have been in a continuous unrealized loss position as of
June 30, 2005 are as follows:
6
Estimated Less than More than Gross
Fair 12 months 12 months Unrealized
JUNE 30, 2005 (IN THOUSANDS) Value Losses
---------------------------- -------------- --------------- ------------- -------------
U. S. Government agency securities $ 43,587 $ 104 $ 337 $ 441
GNMA mortgage backed securities 20,286 30 273 303
Federal Reserve and Federal Home Loan Bank stock 2,304 - - -
Other equity investments 4,858 - 3 3
------------- -------------- ------------- -------------
$ 71,035 $ 134 $ 613 $ 747
============= ============== ============= =============
Estimated Less than More than Gross
Fair 12 months 12 months Unrealized
DECEMBER 31, 2004 (IN THOUSANDS) Value Losses
-------------------------------- ------------- -------------- ------------- -------------
U. S. Government agency securities $ 34,184 $ 221 $ 73 $ 294
GNMA mortgage backed securities 23,066 21 167 188
Federal Reserve and Federal Home Loan Bank stock 1,956 - - -
Other equity investments 4,892 - 2 2
------------- -------------- ------------- -------------
$ 64,098 $ 242 $ 242 $ 484
============= ============== ============= =============
The unrealized losses that exist are the result of market changes in
interest rates since the original purchases. All of the bonds are rated AAA.
These factors coupled with the Company's ability and intent to hold these
investments for a period of time sufficient to allow for any anticipated
recovery in fair value substantiates that the unrealized losses are temporary in
nature.
4. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by Statement of Financial Accounting Standards No. 109 (SFAS109),
"Accounting for Income Taxes." Under the liability method, deferred-tax assets
and liabilities are determined based on differences between the financial
statement carrying amounts and the tax bases of existing assets and liabilities
(i.e., temporary differences) and are measured at the enacted rates that will be
in effect when these differences reverse.
5. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per common share is computed by dividing net income by the weighted
average number of common shares outstanding during the period, including any
potential dilutive common shares outstanding, such as options and warrants. As
of June 30, 2005 there were no option shares excluded from the diluted net
income per share computation. Earnings per share for the six and three month
periods ended June 30, 2004, have been adjusted to reflect a 1.3 for one stock
split in the form of a 30% stock dividend effected on February 28, 2005.
6. STOCK BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation" and applies the intrinsic value method
of recognition and measurement principles of Accounting Principles Board Opinion
No.25 and related interpretations in accounting for its Plan. No compensation
expense related to the Plan was recorded during the six or three month period
ended June 30, 2005 and 2004. If the Company had elected to recognize
compensation cost based on fair value at the grant dates for awards under the
Plan consistent with the method prescribed by SFAS No. 123, net income and
earnings per share would have been changed to the pro forma amounts as follows
for the six and three month periods ended June 30, 2005 and 2004.
7
Stock Based Compensation
Six Months Three Months
Ended June 30, Ended June 30,
----------------------------- ----------------------------
(in thousands) 2005 2004 2005 2004
------------- ------------ ------------- -------------
Net income, as reported $ 3,209 $ 2,252 $ 1,556 $ 1,073
Less pro forma stock-based compensation expenses
determined under the fair value method, net of
related tax effects (513) (718) (81) -
------------- ----------- ------------ ------------
Pro forma net income $ 2,696 $ 1,534 $ 1,475 $ 1,073
============= =========== ============ ============
Net income per share:
Basic - as reported $ 0.45 $ 0.32 $ 0.22 $ 0.15
Basic - pro forma $ 0.38 $ 0.22 $ 0.21 $ 0.15
Diluted - as reported $ 0.43 $ 0.31 $ 0.21 $ 0.15
Diluted - proforma $ 0.36 $ 0.22 $ 0.20 $ 0.15
8
7. NEW ACCOUNTING PRONOUNCEMENT
In May 2005, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 154 "Accounting Changes and Error Corrections" (Statement 154), which
replaces APB Opinion No. 20 "Accounting Changes" and SFAS No. 3 "Reporting
Accounting Changes in Interim Financial Statements". This Statement changes the
requirements for and reporting of a change in accounting principle, and all
voluntary changes in accounting principles, as well as changes required by an
accounting pronouncement in the unusual instance it does not include specific
transition provisions. Specifically, this statement requires retrospective
application to prior periods' financial statements, unless it is impracticable
to determine the period-specific effects or the cumulative effect of the change.
When it is impractical to determine the effects of the change, the new
accounting principle must be applied to the balances of assets and liabilities
as of the beginning of the earliest period for which retrospective application
is practicable and a correspondent adjustment must be made to the opening
balance of retained earnings for that period rather than being reported in an
income statement. When it is impracticable to determine the cumulative effect of
the change, the new principle must be applied as if it were adopted
prospectively from the earliest date practicable. This statement is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December 31, 2005. This statement does not change the transition
provisions of any existing pronouncements. The Company does not believe that the
adoption of Statement No. 154 will have a significant impact on its consolidated
statement of income or financial condition.
ITEM 2 - MANAGEMENTS' DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following discussion provides information about the results of
operations, and financial condition, liquidity, and capital resources of the
Company and its subsidiary, the Bank. This discussion and analysis should be
read in conjunction with the unaudited Consolidated Financial Statements and
Notes thereto, appearing elsewhere in this report and the Management Discussion
and Analysis in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004.
This report contains forward looking statements within the meaning of
the Securities Exchange Act of 1934, as amended, including statements of goals,
intentions, and expectations as to future trends, plans, events or results of
Company operations and policies and regarding general economic conditions. In
some cases, forward looking statements can be identified by use of such words as
"may", "will", "anticipate", "believes", "expects", "plans", "estimates",
"potential", "continue", "should", and similar words or phases. These statements
are based upon current and anticipated economic conditions, nationally and in
the Company's market, interest rates and interest rate policy, competitive
factors and other conditions which, by their nature, are not susceptible to
accurate forecast, and are subject to significant uncertainty. Because of these
uncertainties and the assumptions on which this discussion and the forward
looking statements are based, actual future operations and results in the future
may differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward looking statements.
GENERAL
Eagle Bancorp, Inc. is a growth oriented, one-bank holding company
headquartered in Bethesda, Maryland. We provide general commercial and consumer
banking services through our wholly owned banking subsidiary EagleBank, a
Maryland chartered bank which is a member of the Federal Reserve System. We were
organized in October 1997, to be the holding company for the Bank. The Bank was
organized as an independent, community oriented, full service banking
alternative to the super regional financial institutions, which dominate our
primary market area. The cornerstone of our philosophy is to provide superior,
personalized service to our customers. We focus on relationship banking,
providing each customer with a number of services, becoming familiar with and
addressing customer needs in a proactive, personalized fashion. The Bank
currently has five offices serving Montgomery County and three offices in the
District of Columbia. In February 2004, the Company executed a lease for a new
office to be opened in the first quarter 2006 in Chevy Chase, Montgomery County,
Maryland. In February 2005, Eagle Land Title, LLC, a Bank subsidiary which
performs professional services in connection with loan settlements, commenced
operations.
9
The Company offers a broad range of commercial banking services to our
business and professional clients as well as full service consumer banking
services to individuals living and/or working in the service area. We emphasize
providing commercial banking services to sole proprietors, small and
medium-sized businesses, partnerships, corporations, non-profit organizations
and associations, and investors living and working in and near our primary
service area. A full range of retail banking services are offered to accommodate
the individual needs of both corporate customers as well as the community we
serve. These services include the usual deposit functions of commercial banks,
including business and personal checking accounts, "NOW" accounts and savings
accounts, business, construction, and commercial loans, equipment leasing,
residential mortgages and consumer loans and cash management services. We have
developed significant expertise and commitment as an SBA lender, have been
designated a Preferred Lender by the Small Business Administration (SBA), and
are one of the largest community bank SBA lenders in the Washington Metropolitan
area.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and follow general practices within the 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.
The allowance for credit losses is an estimate of the losses that may
be sustained in our loan portfolio. The allowance is based on two principles of
accounting: (a) Statement on Financial Accounting Standards ("SFAS") 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", 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, can
be determined by the difference between the loan balance and the value of
collateral, the present value of expected future cash flows, or values
observable in the secondary markets.
Three components comprise our allowance for credit losses: a specific
allowance, a formula allowance and a nonspecific or environmental factors
allowance. Each component is determined based on estimates that can and do
change when the actual events occur.
The specific allowance individually allocates an allowance to
identified loans. A loan for which reserves are individually allocated may show
deficiencies in the borrower's overall financial condition, payment record,
support available from financial guarantors and or the fair market value of
collateral. When a loan is identified as impaired, a specific reserve is
established based on the Company's assessment of the loss that may be associated
with the individual loan.
The formula allowance is used to estimate the loss on internally risk
rated loans, exclusive of those identified as requiring specific reserves. Loans
identified as special mention, substandard, doubtful and loss, are segregated
from non-rated loans. Each loan type is assigned an allowance factor based on
management's estimate of the risk, complexity and size of individual loans
within a particular category. Classified loans are assigned higher allowance
factors than non-rated loans due to management's concerns regarding
collectibility or management's knowledge of particular elements regarding the
borrower. Allowance factors increase with the worsening of the internal risk
rating.
The nonspecific or environmental factors allowance is used to estimate
the loss of remaining loans (those not identified as either requiring specific
reserves or having classified risk ratings). The loss estimates are based on
more global factors incident to the overall portfolio, such as delinquency
trends, loss history, trends in the volume and size of individual credits,
effects of changes in lending policy, the experience and depth of management,
national and local economic trends, any concentrations of credit, the quality of
loan review system and the effect of external factors such as competition and
regulatory requirements. The environmental factors allowance captures losses
whose impact on the portfolio may have occurred but have yet to be recognized in
either the formula or specific allowance.
10
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses,
including, in connection with the valuation of collateral, a borrower's
prospects of repayment, and in establishing allowance factors on the formula
allowance and nonspecific allowance components of the allowance. The
establishment of allowance factors is a continuing evaluation, based on
management's ongoing assessment of the global factors discussed above and their
impact on the portfolio. The allowance factors may change from period to period,
resulting in an increase or decrease in the amount of the provision or
allowance, based upon the same volume and classification of loans. Changes in
allowance factors will have a direct impact on the amount of the provision, and
a related, after tax 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. For additional information
regarding the allowance for credit losses, refer to the discussion under the
caption "Allowance for Credit Losses" below.
RESULTS OF OPERATIONS OVERVIEW
The Company reported net income of $3.2 million for the six months
ended June 30, 2005, as compared to net income of $2.3 million for the six
months ended June 30, 2004. Income per basic share was $0.45 for the six month
period ended June 30, 2005, as compared to $0.32 for the same period in 2004.
Income per diluted share was $0.43 for the six months ended June 30, 2005, as
compared to $0.31 for the same period in 2004. For the three months ended June
30, 2005, the Company reported net income of $1.6 million as compared to $1.1
million for the same period in 2004. Income per basic share was $.22 and $.21
per diluted share for the three months ended June 30, 2005, as compared to $.15
per basic and diluted share for the same period in 2004. Earnings per share for
the three and six months ended June 30, 2004 have been adjusted to reflect a 1.3
for one stock spilt in the form of a 30% stock dividend affected on February 28,
2005
The Company had an annualized return on average assets of 1.12% and an
annualized return on average equity of 10.83% for the first six months of 2005,
as compared to returns on average assets and average equity of 0.99% and 8.30%,
respectively, for the same six months of 2004.
The increase in net income for the six months ended June 30, 2005 as
compared to the same period in 2004 can be attributed substantially to an
increase of 50% in net interest income, resulting from an increase of 28% in
average earning assets and an increase in the net interest spread of 59 basis
points and the net interest margin of 76 basis points between the comparable
periods. Since June 2004, the Federal Reserve Bank has increased the federal
funds target rate by 225 basis points to 3.25% in nine interest rate increases
of 25 basis points each. The impact of these interest rate increases has
contributed to the improvement in the Company's margin in the past several
quarters. While the average rate on earning assets for the six month period has
risen by 87 basis points from 5.21% to 6.08%, the cost of interest bearing
liabilities has increased by only 28 basis points from 1.29% to 1.57%.
Additionally, the growth in average noninterest bearing funding sources for the
six months ended June 30, 2005 as compared to 2004 has been $53 million or 47%.
This significant growth in noninterest bearing funding sources has increased the
value of noninterest sources funding earning assets from 31 basis points for the
first six months in 2004 to 48 basis points for the six months ended June 30,
2005. Thus, the Company has been able to increase its primary source of funds
(core deposits) at rates which have allowed its net interest spread and margin
to increase in the first six months of 2005 as compared to the same period in
2004. As a result of competitive pressures, rates paid on deposits, which have
not increased as much or as rapidly as interest rates on earning assets, may
result in a higher cost of funding in future periods, which may not be offset by
further increases in interest rates on earning assets. As a result of such
potential margin compression, the Company's earnings could be adversely
impacted.
Loans, which generally have higher yields than securities and other
earning assets, increased from 78% of average earning assets in the first six
months of 2004 to 82% of average earning assets for the same period of 2005.
Investment securities for the first six months of 2005 amounted to 13% of
average earning assets as compared to 16% for the first six months in 2004. This
decline was directly related to average loan growth over the past twelve month
period exceeding the growth of average deposit and other funding sources.
11
The provision for credit losses was $887 thousand for the first six
months in 2005 as compared to $230 thousand for the same period in 2004. This
increase was largely attributable to growth in the loan portfolio in the first
six months of 2005, which was very favorable. As discussed in the section on
Allowance for Credit Losses, the Company had $28 thousand of net recoveries on
previously charged off loans in the first six months of 2005. This compared to
net recoveries of $47 thousand for the first six months of 2004. At June 30,
2005, the allowance for credit losses was $5.2 million or 1.07% of total loans,
as compared to $4.0 million or 1.14% of total loans at June 30, 2004 and $4.2
million or 1.02% of total loans at December 31, 2004. The provision for credit
losses was $470 thousand for the three months ended June 30, 2005 as compared to
$76 thousand for the same period in 2004, the increase being attributable
primarily to growth in the level of outstanding loans.
Total noninterest income was $1.9 million for both the first six months
of 2005 and 2004. However, noninterest income for the first six months of 2004
included investment securities gains of $253 thousand, while the first six
months of 2005 had investment securities gains of just $12 thousand. Excluding
gains on the sale of investment securities, noninterest income was $1.9 million
in 2005 versus $1.7 million for 2004, an increase of 16%. This increase was due
primarily to increased gains on the sale of SBA loans which amounted to $517
thousand for the first six months in 2005 versus $241 thousand for 2004. For the
three months ended June 30, 2005, total noninterest income was $887 thousand as
compared to $825 thousand for the same period in 2004. This modest overall
increase was due substantially to an increase in other income relating primarily
to loan prepayment fees being substantially offset by declines in the gain on
sale of loans in the period.
Noninterest expenses increased from $7.1 million in the first six of
2004 to $9.4 million for the first six months of 2005, an increase of 32%. The
increase was attributable primarily to increases in staff levels, and related
personnel cost increases, higher amounts of incentive based compensation,
increased occupancy costs, due in part to new banking offices, and to higher
marketing and data processing costs associated with a larger organization. In
spite of higher amounts of noninterest expenses, the Company's stronger growth
in revenue as compared to noninterest expenses resulted in the efficiency ratio
improving in the first six months of 2005 to 61.09% as compared to 65.46% for
the first six months in 2004. For the three months ended June 30, 2005, total
noninterest expenses were $4.9 million, as compared to $3.6 million for the same
period in 2004. This increase was due to the same factors mentioned above which
affected the increase for the six month period.
The combination of increases in net interest income from both increased
volume and favorable interest rate effects and noninterest income, offset in
part by increases in the provision for credit losses due to growth, and
increases in noninterest expenses, resulted in significant improvement in net
income for the first six months of 2005 versus 2004 of 42% and for the three
months ended June 30, 2005 of 45%.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income is the difference between interest income on
earning assets and the cost of funds supporting those earning assets. Earning
assets are composed primarily of loans and investment securities. The cost of
funds represents interest expense on deposits, customer repurchase agreements
and other borrowings, which comprise federal funds purchased and advances from
the Federal Home Loan Bank of Atlanta. Noninterest bearing deposits and capital
are other components representing funding sources. Changes in the volume and mix
of assets and funding sources, along with the changes in yields earned and rates
paid, determine changes in net interest income. Net interest income for the
first six months of 2005 was $13.4 million compared to $9.0 million for the
first six months of 2004, a 50% increase. For the three months ended June 30,
2005, net interest income amounted to $6.9 million, as compared to $4.6 million
for the same period in 2004, a 52% increase.
The following table labeled "Average Balances, Interest Yields and
Rates and Net Interest Margin" presents the average balances and rates of the
various categories of the Company's assets and liabilities. Included in the
table is a measurement of interest rate spread and margin. Interest spread is
the difference (expressed as a percentage) between the interest rate earned on
earning assets less the interest expense on interest bearing liabilities. While
net interest spread provides a quick comparison of earnings rates versus cost of
funds, management believes that the net interest margin provides a better
measurement of performance, since the net interest margin includes the effect of
noninterest bearing sources in its calculation, which are significant factors in
the Company's financial performance. The net interest margin is net interest
income (annualized) expressed as a percentage of average earning assets.
12
AVERAGE BALANCES, INTEREST YIELDS AND RATES, AND NET INTEREST MARGIN
(dollars in thousands)
-----------------------------------------------------------------------
Six Months Ended June 30
-----------------------------------------------------------------------
2005 2004
-----------------------------------------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
-----------------------------------------------------------------------
ASSETS:
Interest earning assets:
Interest bearing deposits with other banks
and other short-term investments $ 18,576 $ 308 3.34% $ 5,033 $ 61 2.44%
Loans (1) 446,026 14,859 6.72% 332,108 9,753 5.90%
Investment securities available for sale 68,439 1,067 3.14% 69,190 1,052 3.05%
Federal funds sold 9,739 128 2.65% 17,928 123 1.38%
-------------------------------- ---------------------------------
Total interest earning assets 542,780 16,362 6.08% 424,259 10,989 5.21%
-------------------------------- ---------------------------------
Total noninterest earning assets 37,925 36,028
Less: allowance for credit losses 4,596 3,792
----------- ------------
Total noninterest earning assets 33,329 32,236
----------- ------------
TOTAL ASSETS $ 576,109 $ 456,495
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing liabilities:
Interest bearing transaction $ 55,427 $ 41 0.15% $ 49,853 $ 32 0.13%
Savings and money market 133,215 803 1.22% 116,425 552 0.95%
Time deposits 155,958 1,890 2.44% 114,321 1,137 1.99%
Customer repurchase agreements and
federal funds purchased 28,527 88 0.62% 15,224 34 0.45%
Other short-term borrowings 5,442 120 4.45% 7,384 85 2.40%
Long term borrowings - - 9,648 173 3.64%
-------------------------------- ---------------------------------
Total interest bearing liabilities 378,569 2,942 1.57% 312,855 2,013 1.29%
-------------------------------- ---------------------------------
Noninterest bearing liabilities:
Noninterest bearing demand 135,039 87,772
Other liabilities 2,753 1,571
----------- ------------
Total noninterest bearing liabilities 137,792 89,343
Stockholders' equity 59,748 54,297
----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $ 576,109 $ 456,495
=========== ============
Net interest income $ 13,420 $ 8,976
========= ========
Net interest spread 4.51% 3.92%
Net interest margin 4.99% 4.23%
(1) includes Loans held for Sale
13
ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses represents the amount of expense
charged to earnings to fund the allowance for credit losses. The amount of the
allowance for credit losses is based on many factors which reflect management's
assessment of the risk in the loan portfolio. Those factors include economic
conditions and trends, the value and adequacy of collateral, volume and mix of
the portfolio, performance of the portfolio, and internal loan processes of the
Company and Bank.
Management has developed a comprehensive analytical process to monitor
the adequacy of the allowance for credit losses. This process and guidelines
were developed utilizing among other factors, the guidance from federal banking
regulatory agencies. The results of this process, in combination with
conclusions of the Bank's outside loan review consultant, support management's
assessment as to the adequacy of the allowance at the balance sheet date. Please
refer to the discussion under the caption "Critical Accounting Policies" for an
overview of the methodology management employs on a quarterly basis to assess
the adequacy of the allowance and the provisions charged to expense.
Following are tables of comparative charge-offs and recoveries data as
well as information on the Company's non-performing and potential problem loans.
During the first six months of 2005, a provision for credit losses was
made in the amount of $887 thousand and the allowance for credit losses
increased $915 thousand, including the impact of $28 thousand in net recoveries
during the period. The provision for credit losses of $887 thousand in the first
six months of 2005 compared to a provision for credit losses of $230 thousand in
the first six months of 2004. The higher level of the provision in 2005 is
primarily attributable to significant growth in the loan portfolio in the six
months of 2005. For the three months ended June 30, 2005, a provision for credit
losses was made in the amount of $470 thousand, as compared to $76 thousand for
the same period in 2004, the substantially higher provision being due primarily
to substantial growth in the portfolio in the three months ended June 30, 2005.
Net recoveries amounted to $22 thousand in the three months ended June 30, 2005
as compared to $131 thousand for the same period in 2004.
At June 30, 2005, the Company had $132 thousand of loans classified as
nonaccrual as compared to $156 thousand at December 31, 2004 and $151 thousand
at March 31, 2005. The Company had no restructured loans or real estate owned at
June 30, 2005, December 31, 2004 or June 30, 2004. Significant variation in
these amounts may occur from period to period because the amount of
nonperforming loans depends largely on the condition of a small number of
individual credits and borrowers relative to the total loan portfolio. The
balance of impaired loans was $132 thousand at June 30, 2005, with specific
reserves against those loans of $57 thousand, compared to $156 thousand at
December 31, 2004 with specific reserves of $31 thousand. The allowance for loan
losses represented 1.07% of total loans at June 30, 2005, as compared to 1.02%
at December 31, 2004. This increase was due to a slight mix shift in the loan
portfolio composition toward more commercial real estate loans (49% versus 46%)
which category tends to have larger transactions in the assessment of risk,
resulting in an increase in the allocation factors contained in the allowance
methodology and to modifications in the environmental factors allowance.
As part of its comprehensive loan review process, the Company's Board
of Directors and the Bank Director's Loan Committee and or Board of Director's
Credit Review Committee carefully evaluates loans which are past due 30 days or
more. The Committee(s) make a thorough assessment of the conditions and
circumstances surrounding each delinquent loan. The Bank's loan policy requires
that loans be placed on nonaccrual if they are ninety days past due, unless they
are well secured and in the process of collection.
The maintenance of a high quality loan portfolio, with an adequate
allowance for possible loan losses will continue to be a primary management
objective in the Company.
14
The following table sets forth activity in the allowance for credit
losses for the periods indicated.
Six Months Ended
(dollars in thousands) June 30,
-------------------------
2005 2004
----------- -----------
Balance at beginning of year $ 4,240 $ 3,680
Charge-offs:
Commercial - (81)
Real estate - commercial - -
Construction - -
Home equity - -
Other consumer (11) (18)
----------- ---------
Total (11) (99)
----------- ---------
Recoveries:
Commercial 39 146
Real estate - commercial - -
Construction - -
Home equity - -
Other consumer - -
----------- ---------
Total 39 146
----------- ---------
Net recoveries (charge-offs) 28 47
----------- ---------
Additions charged to operations 887 230
----------- ---------
Balance at end of period $ 5,155 $ 3,957
=========== =========
Annualized ratio of net
charge-offs (recoveries) during
the period to average loans
outstanding during the period (.01)% (.03)%
----------- ---------
The following table reflects the allocation of the allowance for credit
losses at the dates indicated. The allocation of the allowance to each category
is not necessarily indicative of future losses or charge-offs and does not
restrict the use of the allowance to absorb losses in any category.
As of June 30, As of December 31,
-------------------------------------------------
2005 2004
-------------------------------------------------
Amount % (1) Amount % (1)
-------------------------------------------------
Commercial $ 2,154 24% $ 1,963 25%
Real estate - commercial 2,125 50% 1,426 46%
Real estate - residential 55 1% 105 3%
Construction 408 14% 431 14%
Home equity 168 10% 223 11%
Other consumer 82 1% 58 1%
Unallocated 163 34
-------------------------------------------------
Total loans $ 5,155 100% $ 4,240 100%
=================================================
(1) Represents the percent of loans in each category to total loans and not the
allowance allocations.
15
NON-PERFORMING ASSETS
The Company's non-performing assets, which are comprised of loans
delinquent 90 days or more, non-accrual loans, restructured loans and other real
estate owned, totaled $132 thousand at June 30, 2005 compared to $464 thousand
at June 30, 2004 and $156 thousand at December 31, 2004. The percentage of
non-performing loans to total loans was 0.03% at June 30, 2005, compared to .13%
at June 30, 2004, and .04% at December 31, 2004.
The following table shows the amounts of non-performing assets at the
dates indicated.
June 30, 2005 December 31
------------------------- ------------
(dollars in thousands) 2005 2004 2004
------------ ----------- ------------
Nonaccrual Loans
Commercial $ 132 $ 399 $ 156
Consumer - 65 -
Real estate - - -
Accrual loans-past due 90 days
Commercial - - -
Consumer - - -
Real estate - - -
Restructured loans - - -
Real estate owned - - -
----------- ----------- ------------
Total non-performing assets $ 132 $ 464 $ 156
=========== =========== ============
At June 30, 2005, there were $3.3 million of performing loans considered
potential problem loans, defined as loans which are not included in the past
due, nonaccrual or restructured categories, but for which known information
about possible credit problems causes management to be uncertain as to the
ability of the borrowers to comply with the present loan repayment terms which
may in the future result in disclosure in the past due, non-accrual or
restructured loan categories.
NONINTEREST INCOME
Noninterest income consists primarily of deposit account service charges, gains
on the sale of SBA and residential mortgage loans, other noninterest loan fees,
income from bank owned life insurance ("BOLI") and other service fees. For the
six months ended June 30, 2005, noninterest income was $1.9 million. This
compared to $1.9 million of noninterest income for the six months ended June 30,
2004, which included $253 thousand in net gains on the sale of investment
securities.
The Company is an active originator of SBA loans and its current practice is to
sell the insured portion of those loans at a premium. Income from this source
was $517 thousand for the six months ended June 30, 2005 compared to $241
thousand for the six months ended June 30, 2004, as the Company emphasized this
lending activity in the first half of 2005. The Company also originates
residential mortgage loans on a pre-sold basis, servicing released. Sales of
these mortgage loans yielded gains of $125 thousand in the first six months of
2005 compared to $148 thousand in the same period in 2004. Income for the six
months ended June 30, 2005 included $592 thousand from deposit account service
charges, $98 thousand from SBA loan service fees and $204 thousand from BOLI,
versus $709 thousand from deposit account service charges, $65 thousand from SBA
service fees and $173 thousand from BOLI for the six months ended June 30, 2004.
Other noninterest income amounted to $378 thousand for the first six months of
2005, as compared to $318 thousand in the first six months of 2004. The decline
in deposit service charges was primarily related to a decline in overdraft fees.
Noninterest income was $887 thousand for the three months ended June 30, 2005
compared to $825 thousand for the three months ended June 30, 2004, an increase
of 8%.
16
NONINTEREST EXPENSES
Noninterest expense was $9.4 million for the six months ended June 30, 2005
compared to $7.1 million for the six months ended June 30, 2004, an increase of
32%.
Salaries and benefits were $5.2 million for the first six of 2005, as compared
to $ 3.9 million for 2004, a 34% increase. This increase was due to staff
additions and related personnel costs as well as to increases in incentive based
compensation. At June 30, 2005 the Bank had 137 full time equivalent employees
as compared to 111 at June 30, 2004.
Premises and equipment expenses amounted to $1.6 million for the first six
months of 2005 versus $1.3 million for the same period in 2004. This increase of
27% was due in part to a new banking office opened in the first quarter of 2005
and one in the second quarter of 2004 and to ongoing operating expense increases
associated with the Company's facilities, all of which are leased, and to
increased equipment costs.
Advertising costs increased from $159 thousand in the six months ended June 30,
2004 to $207 thousand in the same period in 2005, the increases associated
primarily with increased advertising for deposit products.
Outside data processing costs were $385 thousand for the first half of 2005, as
compared to $286 thousand in 2004, or an increase of 35%. The higher than usual
increase was due primarily to special charges associated with the Company's
conversion of certain core processing systems to new operating platforms and to
higher processing volumes.
Other expenses, increased from $1.5 million in the first six months of 2004 to
$1.9 million for the six months ended June 30, 2005. The major components of
costs in this category include professional and consulting fees, ATM expenses,
telephone, courier, printing, business development, office supplies, charitable
contributions, and dues. These costs have increased by 28% in the first six
months of 2005 as compared to 2004.
Noninterest expense was $4.9 million for the three months ended June 30, 2005
compared to $3.6 million for the three months ended June 30, 2004, an increase
of 35%. The same factors which contributed to increased noninterest expense for
the six month period mentioned above also contributed to the increase in
noninterest expenses for the three months ended June 30, 2005, as compared to
the same period in 2004.
FINANCIAL CONDITION OVERVIEW
At June 30, 2005, total assets were $610.1 million, loans were $481.8 million,
deposits were $516.4 million and stockholders' equity was $61.1 million. As
compared to December 31, 2004, assets grew by $56.6 million (10%), loans by
$66.3 million (16%), deposits by $54.1 million (12%) and stockholders' equity by
$2.5 million (4%).
The Company paid an initial cash dividend of $0.07 per share in the first
quarter of 2005, and $0.07 also for the second quarter of 2005.
17
LOANS
Loans, net of amortized deferred fees and costs, at June 30, 2005 and 2004 are
summarized by type as follows:
As of June 30, As of December 31, As of June 30,
----------------------------------------------------------------------------
2005 2004 2004
---------------------------------------------------------------------------
(dollars in thousands) Amount % Amount % Amount %
----------------------------------------------------------------------------
Commercial $ 114,080 24% $ 101,911 25% $ 84,248 24%
Real estate - commercial 239,301 50% 189,708 46% 173,935 50%
Real estate - residential 7,095 1% 11,717 3% - 0%
Construction 69,625 14% 60,258 14% 49,319 14%
Home equity 48,055 10% 49,632 11% 38,113 11%
Other consumer 3,613 1% 2,283 1% 3,397 1%
---------------------------------------------------------------------------
Total loans 481,769 100% 415,509 100% 349,012 100%
less: Allowance for Credit Losses (5,155) (4,240) (3,957)
---------------------------------------------------------------------------
Net Loans and Leases $ 476,614 $ 411,269 $ 345,055
===========================================================================
DEPOSITS AND OTHER BORROWINGS
The principal sources of funds for the Bank are core deposits, consisting of
demand deposits, NOW accounts, money market accounts, savings accounts and
certificates of deposits from the local market areas surrounding the Bank's
offices. The deposit base includes transaction accounts, time and savings
accounts and accounts which customers use for cash management and which provide
the Bank with a source of fee income and cross-marketing opportunities as well
as an attractive source of lower cost funds. Time and savings accounts,
including money market deposit accounts, also provide a relatively stable and
low-cost source of funding.
For the six months ending June 30, 2005 deposits grew $54.1 million, from $462.3
million to $516.4 million or 12%.
Approximately 32% of the Bank's deposits are made up of certificates of
deposits, which are generally the most expensive form of deposit because of
their fixed rate and term. Certificates of deposit in denominations of $100
thousand or more can be more volatile and more expensive than certificates of
less than $100 thousand. However, because the Bank focuses on relationship
banking, its historical experience has been that large certificates of deposit
have not been more volatile or significantly more expensive than smaller
denomination certificates. It has been the practice of the Bank to pay posted
rates on its certificates of deposit whether under or over $100 thousand. From
time to time, when appropriate in order to fund strong loan demand, the Bank
accepts certificates of deposits, generally in denominations of less than $100
thousand from bank and credit union subscribers to a wholesale deposit rate line
and may also accept brokered deposits, although none exists at June 30, 2005.
These deposits amounted to approximately $16 million or 3% of total deposits at
June 30, 2005, as compared to approximately $33 million of deposits at June 30,
2004 and approximately $25 million at December 31, 2004. The Bank has found
rates on these deposits to be generally competitive with rates in our market
given the speed and minimal noninterest cost at which deposits can be acquired.
During the first six months of 2005, the Bank reduced its wholesale deposits in
favor of its core sources, which provided adequate funding and liquidity and was
in accordance with planned amounts.
At June 30, 2005, the Company had approximately $146 million in noninterest
bearing demand deposits, representing 28% of total deposits. This compared to
approximately $130 million of these deposits at December 31, 2004 or 28% of
total deposits. These are primarily business checking accounts on which the
payment of interest is prohibited by regulations of the Federal Reserve.
Proposed legislation has been introduced in each of the last several sessions of
Congress which would permit banks to pay interest on checking and demand deposit
accounts established by businesses. If legislation effectively permitting the
payment of interest on business demand deposits is enacted, of which there can
be no assurance, it is likely that we may be required to pay interest on some
portion of our noninterest bearing deposits in order to compete with other
banks. Payment of interest on these deposits could have a significant negative
impact on our net interest income and net interest margin, net income, and the
return on assets and equity.
18
As an enhancement to the basic noninterest bearing demand deposit account, the
Company offers a sweep account, or "customer repurchase agreement", allowing
qualifying businesses to earn interest on short term excess funds which are not
suited for either a CD investment or a money market account. The balances in
these accounts were $26.4 million at June 30, 2005 compared to $24.0 million at
December 31, 2004. Customer repurchase agreements are not deposits and are not
insured but are collateralized by U.S. government agency securities. These
accounts are particularly suitable to businesses with significant fluctuation in
the levels of cash flows. Attorney and title company escrow accounts are an
example of accounts which can benefit from this product, as are customers who
may require collateral for deposits in excess of $100 thousand but do not
qualify for other pledging arrangements. This program requires the Company to
maintain a sufficient investment securities level to accommodate the
fluctuations in balances which may occur in these accounts.
At June 30, 2005, the Company had no outstanding balances under its lines of
credit provided by correspondent banks. The Bank had $4.3 million of FHLB
borrowings, as compared to $6.3 million at December 31, 2004. These advances are
secured 50% by U.S. government agency securities and 50% by a blanket lien on
qualifying loans in the Bank's commercial mortgage loan portfolio.
LIQUIDITY MANAGEMENT
Liquidity is a measure of the Bank's ability to meet loan demand and to satisfy
depositor withdrawal requirements in an orderly manner. The Bank's primary
sources of liquidity consist of cash and cash balances due from correspondent
banks, loan repayments, federal funds sold and other short term investments,
maturities and sales of investment securities and income from operations. The
Bank's entire investment securities portfolio is in an available for sale status
which allows it maximum flexibility to generate cash from sales as needed to
meet ongoing loan demand. These sources of liquidity are primary and are
supplemented by the ability of the Company and Bank to borrow funds, which are
termed secondary sources. The Company maintains secondary sources of liquidity,
which includes a $10 million line of credit with a correspondent bank, against
which there were no outstandings at June 30, 2005. Additionally, the Bank can
purchase up to $27 million in federal funds on an unsecured basis from its
correspondents, against which there were no borrowings outstanding at June 30,
2005 and may enter into reverse repurchase agreements up to $12.5 million,
provided adequate collateral exists to secure the lending relationship. At June
30, 2005, the Bank was also eligible to make advances from the Federal Home Loan
Bank of Atlanta (FHLB) up to $120 million, of which it had advances outstanding
of $4.3 million.
The loss of deposits, through disintermediation, is one of the greater risks to
liquidity. Disintermediation occurs most commonly when rates rise and depositors
withdraw deposits seeking higher rates than the Bank may offer. The Bank was
founded under a philosophy of relationship banking and, therefore, believes that
it has less of an exposure to disintermediation and resultant liquidity concerns
than do many banks. There is, however, a risk that some deposits would be lost
if rates were to increase and the Bank elected not to remain competitive with
its deposit rates. Under those conditions, the Bank believes that it is well
positioned to use other liability management instruments such as FHLB borrowing,
customer repurchase agreements and Bank lines to offset a decline in deposits in
the short run. Over the long term, an adjustment in assets and change in
business emphasis could compensate for a loss of deposits. The Bank also
maintains a marketable investment portfolio to provide flexibility in the event
of significant liquidity needs. The Bank's Asset Liability Board Committee
recently adopted policy guidelines which emphasize the importance of core
deposits and their continued growth.
At June 30, 2005, under the Bank's liquidity formula, it had $164 million of
primary and secondary liquidity representing 27.3% of total bank assets.
19
The following is a schedule of significant funding commitments at June 30, 2005:
(in thousands)
--------------
Unused lines of credit (consumer) $ 49,992
Other commitments to extend credit $ 144,870
Standby letters of credit $ 3,962
-------------
$ 198,824
=============
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK
A fundamental risk in banking is exposure to market risk, or interest rate risk,
since a bank's net income is largely dependent on net interest income. The
Bank's Asset Liability Committee (ALCO) of the Board of Directors formulates and
monitors the management of interest rate risk through policies and guidelines
established by it and the full Board of Directors. In its consideration of risk
limits, the ALCO considers the impact on earnings and capital, the level and
direction of interest rates, liquidity, local economic conditions, outside
threats and other factors. Banking is generally a business of managing the
maturity mismatch inherent in its asset and liability cash flows and to provide
net interest income growth consistent with the Company's profit objectives.
The Company, through its ALCO, monitors the interest rate environment in which
it operates and adjusts the rates and maturities of its assets and liabilities
to remain competitive and to achieve its overall financial objectives subject to
established risk limits. In the current interest rate environment, the Company
is managing its assets to be either variably priced or with relatively short
maturities, so as to mitigate the risk to earnings and capital should interest
rates increase from current levels. At the same time, the Bank seeks to acquire
longer-term core deposits to lock in relatively lower cost funds. In the current
market, due to competitive factors and customer preferences, the effort to
attract longer term fixed priced liabilities has not been as successful as the
Company's best case asset liability mix would prefer. There can be no assurance
that the Company will be able to successfully carry out this intention, as a
result of competitive pressures, customer preferences and the inability to
perfectly forecast future interest rates.
One of the tools used by the Company to manage its interest rate risk is a
static GAP analysis presented below. The Company also uses an earnings
simulation model on a quarterly basis to closely monitor interest sensitivity
and to model its balance sheet cash flows and its income statement effects in
different interest rate scenarios. The model is based on current Bank and
Company data and is adjusted for assumptions as to growth, noninterest income
and noninterest expense and interest rate sensitivity, based on historical data,
for both assets and liabilities. The data is then subjected to a "shock test",
which assumes a simultaneous change in interest rate up 200 basis points or down
200 basis points, along the entire yield curve, but not below zero. The results
are analyzed as to the impact on net interest income, net income over the next
twelve months and to the market value of equity. The Company analysis at June
30, 2005 shows a positive effect on income when interest rates are shocked up
200 basis points, due to the significant level of variable rate loans. A
negative impact occurs if rates were to decline. With rates at a relative low
level, further interest rate declines would reduce income on earning assets,
which could not be offset by a corresponding reduction in the cost of funds,
potentially resulting in significant net interest margin contraction. The
Company has recently concluded, based on market factors, that larger increases
in its retail deposit rate assumptions are probable in a rising interest rate
environment. While the impact of higher interest rates continues to be viewed as
positive to future net interest income and market values of equity, this change
in assumptions moderates the benefits of such higher interest rates, as
compared to analyses in prior periods.
The following table reflects the result of a shock simulation on the June 30,
2005 balances.
Change in Percentage Percentage Percentage change
interest rates change in net change in in Market Value of
(basis points) interest income net income Portfolio Equity
---------------- ----------------- ----------------- ------------------
+200 +5.2% +6.3% +5.2%
+100 +2.7% +12.1% +1.8%
0 - - -
-100 -7.4% -17.3% -4.9%
-200 -17.8% -41.3% -12.8%
20
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or repricing periods, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features that limit changes in interest rates on a short-term basis and over the
life of the loan. Further, in the event of a change in interest rates,
prepayment and early w.ithdrawal levels could deviate significantly from those
assumed in calculating the tables. Finally, the ability of many borrowers to
service their debt may decrease in the event of a significant interest rate
increase.
GAP POSITION
Banks and other financial institutions are dependent upon net interest income,
which is the difference between interest earned on earning assets and interest
expense on interest bearing liabilities.
In falling interest rate environments, net interest income is maximized with
longer term, higher yielding assets being funded by lower yielding short-term
funds, or what is referred to as a negative mismatch or GAP. Conversely, in a
rising interest rate environment, net interest income is maximized with shorter
term, higher yielding assets being funded by longer-term liabilities or what is
referred to as a positive mismatch or GAP.
The current interest rate environment is signaling steady to possibly higher
rates. Management has been emphasizing the acquisition of variable rate and
shorter term assets and has been attempting to secure longer-term core deposits.
While management believes that this overall position creates a good balance in
managing its interest rate risk and maximizing its net interest margin within
plan objectives, there can be no assurance as to actual results.
The GAP position, which is a measure of the difference in maturity and
re-pricing volume between assets and liabilities, is a means of monitoring the
sensitivity of a financial institution to changes in interest rates. The chart
below provides an indication of the rate sensitivity of the Company. A negative
GAP indicates the degree to which the volume of repriceable liabilities exceeds
repriceable assets in given time periods. At June 30, 2005, the Bank had a
positive GAP of 22% out to three months and a cumulative negative GAP of 5% out
to twelve months, as compared to a three month positive GAP of 38% and a
cumulative twelve month positive GAP of 8% at December 31, 2004. The change in
the GAP position at June 30, 2005 as compared to December 31, 2004 relates
primarily to a change in the repricing assumption related to money market
deposits to a shorter repricing timeframe. This change was made to reflect the
Company's actual practices and experience over the past six months.
If interest rates continue to rise at a measured pace, as forecasters are
predicting, the Bank's interest income and margin are expected to be stable to
slightly up because of the present positive mismatch position. Because
competitive market behavior does not necessarily track the trend of interest
rates but at times moves ahead of financial market influences, the rise in the
cost of liabilities may be greater than anticipated by the GAP model. If this
were to occur, the benefits of a rising interest rate environment would not be
as significant as management is expecting. Management has carefully considered
its strategy to maximize interest income by reviewing interest rate levels,
economic indicators and call features within its investment portfolio. These
factors have been discussed with the Board of Directors Asset Liability
Committee and management believes that current strategies are appropriate to
current economic and interest rate trends.
21
GAP ANALYSIS
JUNE 30, 2005
(dollars in thousand)
Repriceable in: 0-3 mos 4-12 mos 13-36 mos 37-60 mos over 60 mos Total
------------------------------------------------------------------------------
ASSETS:
Investments and bank deposits $ 7,149 $ 11,184 $ 26,591 $ 13,505 $ 8,144 $ 66,573
Loans 264,561 11,493 58,079 101,217 50,065 485,415
Fed funds/ equivalents/other equities 17,153 - - - - 17,153
------------------------------------------------------------------------------
Total repriceable assets $ 288,863 $ 22,677 $ 84,670 $114,722 $ 58,209 $569,141
LIABILITIES:
Now/escrow manager $ - $ 37,263 $ 7,453 $ 29,810 $ - $ 74,526
MMA 124,609 - - - - 124,609
CDs 28,597 122,752 15,214 1,110 - 167,673
Other - 3,593 - - - 3,593
Customer repurchase agree. 7,906 10,541 2,635 5,270 - 26,352
Federal funds purchased/rev repos 333 4,000 - - - 4,333
------------------------------------------------------------------------------
Total repriceable liabilites $ 161,455 $ 178,149 $ 25,302 $ 36,190 $ -
GAP $ 127,418 $(155,472) $ 59,368 $ 78,532 $ 58,209
Cumulative GAP $ 127,418 $ (28,054) $ 31,314 $109,846 $168,055
Interval gap/earnings assets 22.39% (27.32%) 10.43% 13.80% 10.23%
Cumulative gap/earning assets 22.39% (4.93%) 5.50% 19.30% 29.53%
Although NOW accounts are subject to immediate repricing, the Bank's GAP
model has incorporated a repricing schedule to account for a lag in rate changes
based on our experience, as measured by the amount of those deposit rate changes
relative to the amount of rate change in assets.
CAPITAL RESOURCES AND ADEQUACY
The assessment of capital adequacy depends on a number of factors such as asset
quality, liquidity, earnings performance, changing competitive conditions and
economic forces, and the overall level of growth. The adequacy of the Company's
current and future capital needs is monitored by management on an ongoing basis.
Management seeks to maintain a capital structure that will assure an adequate
level of capital to support anticipated asset growth and to absorb potential
losses.
22
The capital position of both the Company and the Bank continues to exceed
regulatory requirements to be considered well-capitalized. The primary
indicators used by bank regulators in measuring the capital position are the
tier 1 risk-based capital ratio, the total risk-based capital ratio, and the
tier 1 leverage ratio. Tier 1 capital consists of common and qualifying
preferred stockholders' equity less intangibles. Total risk-based capital
consists of Tier 1 capital, qualifying subordinated debt, and a portion of the
allowance for credit losses. Risk-based capital ratios are calculated with
reference to risk-weighted assets. The tier 1 leverage ratio measures the ratio
of tier 1 capital to total average assets for the most recent three month
period.
The ability of the Company to continue to grow is dependent on its earnings and
the ability to obtain additional funds for contribution to the Bank's capital,
through additional borrowing, the sale of additional common stock, the sale of
preferred stock, or through the issuance of additional qualifying equity
equivalents, such as subordinated debt or trust preferred securities.
The actual capital amounts and ratios for the Company and Bank as of June 30,
2005 and June 30, 2004 are presented in the table below:
Well Capitalized
Ratio Under
For Capital Prompt Corrective
Company Company Bank Bank Adequacy Action
Actual Actual Actual Actual Purposes Provisions**
Dollars in thousands Amount Ratio Amount Ratio Ratio Ratio
------ ----- ------ ----- ----- -----
As of June 30, 2005
Total capital to risk-weighted assets $66,316 12.5% $55,669 10.7% 8.00% 10.00%
Tier 1 capital to risk-weighted assets $61,160 11.5% $50,531 9.7% 4.00% 6.00%
Tier 1 capital to average assets (leverage) $61,160 10.6% $50,531 8.7% 3.00% 5.00%
As of June 30, 2004
Total capital to risk-weighted assets $59,288 16.2% $42,236 11.0% 8.00% 10.00%
Tier 1 to risk-weighted assets $55,331 15.1% $38,293 10.0% 4.00% 6.00%
Tier 1 capital to average assets (leverage) $55,331 12.1% $38,293 9.0% 3.00% 5.00%
** Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Bank, as well as restricting extension
of credit and transfers of assets between the Bank and the Company. At June 30,
2005, the Bank could pay dividends to the parent to the extent of its earnings
so long as it maintained required capital ratios.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to Item 2 of this report, "Management's Discussion and
Analysis of Financial Condition and Results of Operations", under the caption
"Asset/Liability Management and Quantitative and Qualitative Disclosure About
Market Risk".
23
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, evaluated as of the last day of the period covered by this report the
effectiveness of the operation of the Company's disclosure controls and
procedures, as defined in Rule 13a-14 under the Securities and Exchange Act of
1934. Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
effective.
There were no changes in the Company's internal control over financial
reporting (as defined in Rule 13a-15 under the Securities Act of 1934) during
the quarter ended June 30, 2005 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
From time to time the Company may become involved in legal proceedings.
At the present time there are no proceedings which the Company believes will
have an adverse impact on the financial condition or earnings of the Company.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Sales of Unregistered Securities. None
(b) Use of Proceeds. Not Applicable.
(c) Issuer Purchases of Securities. None
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES None
ITEM 4 - SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS
On May 17, 2005, the annual meeting of shareholders of the Company was held for
the purpose of (1) electing eight directors to serve three year terms or until
their successors are elected and (2) transact other business that may come
before the meeting, of which there was none.
The names of each director elected at the meeting, and the votes for and against
cast for such persons are set forth below:
Votes For Votes Withheld Broker Non-Votes
--------------------------------------------------------------------------------
Leonard L. Abel 5,739,984 139,252 None
Leslie M. Alperstein 5,878,936 300 None
Dudley C. Dworken 5,872,436 6,800 None
Michael T. Flynn 5,744,709 134,527 None
Eugene F. Ford Sr. 5,874,661 4,575 None
Philip N. Margolius 5,878,351 885 None
Ronald D. Paul 5,744,969 134,267 None
Leland M. Weinstein 5,878,936 300 None
24
ITEM 5 - OTHER INFORMATION
(a) Required 8-K Disclosures None
(b) Changes in Procedures for Director Nominations None
ITEM 6 - EXHIBITS
Exhibit No. Description of Exhibit
----------- ----------------------
3(a) Certificate of Incorporation of the Company, as amended (1)
3(b) Bylaws of the Company (2)
10.1 1998 Stock Option Plan (3)
10.2 Employment Agreement between Michael Flynn and the Company (4)
10.3 Employment Agreement between Thomas D. Murphy and the Bank (4)
10.4 Employment Agreement between Ronald D. Paul and the Company (4)
10.5 Director Fee Agreement between Leonard L. Abel and the Company (4)
10.6 Employment Agreement between Susan G. Riel and the Bank (4)
10.7 Employment Agreement between Martha F. Tonat and the Bank (4)
10.8 Employment Agreement between Wilmer L. Tinley and the Bank (4)
10.9 Employee Agreement for James H. Langmead (5)
10.10 Employee Stock Purchase Plan (6)
11 Statement Regarding Computation of Per Share Income
21 Subsidiaries of the Registrant
31.1 Rule 13a-14(a) Certification of Ronald D. Paul
31.2 Rule 13a-14(a) Certification of Wilmer L. Tinley
31.3 Rule 13a-14(a) Certification of Michael T. Flynn
31.4 Rule 13a-14(a) Certification of James H. Langmead
32.1 Section 1350 Certification of Ronald D. Paul
32.2 Section 1350 Certification of Wilmer L. Tinley
32.3 Section 1350 Certification of Michael T. Flynn
32.4 Section 1350 Certification of James H. Langmead
================================================================================
(1) Incorporated by reference to the exhibit of the same number to the
Company's Quarterly Report on Form 10-QSB for the period ended
September 30, 2002.
(2) Incorporated by reference to Exhibit 3(b) to the Company's Registration
Statement on Form SB-2, dated December 12, 1997.
(3) Incorporated by reference to Exhibit 10.1 to the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1998.
(4) Incorporated by reference to exhibits of the same number to the
Company's Annual Report on Form 10-K for the year ended December 31,
2003.
(5) Incorporated by reference to exhibits of the same number to the
Company's Annual Report on Form 10-K for the year ended December 31,
2004
(6) Incorporated by reference to Exhibit 4 to the Company's Registration
Statement on Form S-8 (No. 333-116352)
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EAGLE BANCORP, INC.
Date: August 5, 2005 By: /s/ Ronald D. Paul
---------------------------------------
Ronald D. Paul, President and CEO
Date: August 5, 2005 By: /s/ Wilmer L. Tinley
----------------------------------------
Wilmer L. Tinley, Senior Vice President
and Chief Financial Officer