EX-13 4 dex13.txt EXHIBIT 13 Exhibit 13.0 ANNAPOLIS BANCORP, INC. Corporate Profile Annapolis Bancorp, Inc., (the "Company") formerly Annapolis National Bancorp, Inc. and Maryland Publick Banks, Inc., is a bank holding company, incorporated in May 1988 for the purpose of acquiring and holding all of the outstanding stock of BankAnnapolis (the "Bank") (formerly Annapolis National Bank), a federally insured community oriented bank and one of two independent commercial banks headquartered in Annapolis, Maryland. The Bank currently operates as a full service commercial bank from its headquarters in Annapolis, and its four branches located in Anne Arundel County, Maryland and one branch located on Kent Island in Queen Anne's County, Maryland. The Bank's principal business consists of originating loans and attracting deposits. The Bank originates commercial loans, commercial real estate loans, construction loans, one- to four-family real estate loans, home equity and consumer loans. The Bank also invests in U.S. Treasury and U.S. Government agency securities and other securities including mortgage backed securities issued by or guaranteed by the federal government. The Bank's lending operations are centered in Anne Arundel County, but extend throughout Central Maryland. The Bank conducts a general commercial and retail banking business in its market area, emphasizing the banking needs of small businesses, professional concerns and individuals. The Bank draws most of its customer deposits from Anne Arundel County, Maryland, and to a lesser extent, Queen Anne's County, Maryland. The Bank competes with numerous other financial intermediaries, commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in Anne Arundel County and elsewhere. The Bank continually evaluates new products, and implements such new products as deemed appropriate by management. The Bank's Anne Arundel County service area is a highly concentrated, highly branched banking market. Competition in Anne Arundel County for loans to small businesses and professionals, the Bank's target market, is intense and pricing, service and access to decision-makers are important. Deposit competition among institutions in Anne Arundel County also is strong. The Bank employed 67 full time and 12 part time individuals at December 31, 2001. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following is management's discussion and analysis of the historical financial condition and results of operations of Annapolis Bancorp, Inc. on a consolidated basis with its wholly owned subsidiary, BankAnnapolis, for the periods presented, and should be read in conjunction with the consolidated financial statements and the related notes thereto appearing elsewhere in this annual report. Results of Operations for the Years Ended December 31, 2001 and 2000 The Company reported net income for 2001 of $506 thousand a 47.9% decrease from 2000 earnings of $972. The decrease in 2001 earnings was primarily due to contraction in the net interest margin as a result of unprecedented Federal Reserve Board rate reductions and higher noninterest expense. Basic earnings per share, adjusted for the August 24, 2001 four for three stock split in the form of a stock dividend, was $0.17 per share compared to $0.32 per share in 2000, also adjusted for the split. The primary source of income of the Bank is interest on its loan and investment portfolios. The principal expense of the Bank is interest on its deposit accounts and borrowings. The difference between interest income on interest earning assets and interest expense on interest bearing liabilities is referred to as net interest income. Net interest income was $6.3 million for 2001, a decrease of $467 thousand or 6.9% compared to $6.8 million in 2000. Total assets were $166.7 million as of December 31, 2001, a 21.6% increase over the December 31, 2000 total assets of $137.0 million. The Company's return on average assets was 0.33% and 0.75% for December 31, 2001, and 2000 respectively. The Company's return on average equity was 3.70% and 7.59% for December 31, 2001, and 2000 respectively. At December 31, 2001 the Bank's gross loan portfolio totaled $112.9 million. Of this amount, $24.3 million or 21.5% were commercial loans, $38.3 million or 33.9% were commercial real estate loans, $17.6 million or 15.6% were construction loans, $17.1 million or 15.1% were one- to four-family residential mortgage loans, $6.6 million or 5.9% were home equity loans, and $9.0 million or 8.0% were consumer and other loans. Financial Condition The Company, through its Bank subsidiary, functions as a financial intermediary, and as such its financial condition can be examined in terms of developing trends in its sources and uses of funds. These trends are the result of both external environmental factors, such as changing economic conditions, regulatory changes and competition, and also internal environmental factors such as management's evaluation as to the best use of funds in these changing conditions. Total assets increased by 21.6% during 2001 to $166.7 million from $137.0 million at December 31, 2000. Total deposits and securities sold under agreements to repurchase, the Company's primary source of funds, increased $29.2 million or 23.7% to $152.6 from $123.4 million at December 31, 2000. Time deposits comprise the largest portion of the Bank's total deposits, totaling $62.0 million or 42.8% of the Bank's total deposits at December 31, 2001, compared to $51.2 million or 43.4% in 2000. Savings and money market accounts totaled $40.0 million or 27.6% of the Bank's total deposits at December 31, 2001, compared to $31.2 million or 26.4% in 2000. NOW accounts total $19.1 million or 13.2% and $21.9 million or 18.6% of total deposits at December 31, 2001 and 2000, respectively. Demand, noninterest bearing accounts totaled $23.7 million or 16.4% of total deposits at December 31, 2001 and $13.7 million or 11.7% at December 31, 2000. Securities sold under agreements to repurchase increased $2.3 million to $7.7 million from $5.4 million at December 31, 2000. The Company's primary uses of funds are for loans and investments. Loans, less net deferred fees and the allowance for credit losses, increased by $23.9 million or 27.3% to $111.3 million at December 31, 2001 from $87.4 million a year earlier. The increase in loan balances occurred primarily in the real estate sector, which increased $14.1 million or 27.8% from 2000. Operating Results The following discussion outlines some of the more important factors and trends affecting the earnings of the Company, as presented in its consolidated statements of income. Net Interest Income Net interest income is the difference between interest revenue and interest expense and is generally affected by increases or decreases in the amount of outstanding interest earning assets and interest bearing liabilities (volume variance). This volume variance coupled with changes in interest rates on these same assets and liabilities (rate variance) equates to the total change in net interest income in any given period. The table below, sets forth certain information regarding changes in interest income and interest expense attributable to (1) changes in volume (change in volume multiplied by the old rate); (2) changes in rates (change in rate multiplied by the old volume); and (3) changes in rate/volume (change in rate multiplied by change in volume). Net interest income for the year ended December 31, 2001, was $6.3 million, representing a decrease of $467 thousand or 6.9% from net interest income of $6.8 million for the year ended December 31, 2000. The decrease in net interest income is due primarily to the effect of the Federal Reserve Board interest rate reductions on the Bank's yield on its investment and loans portfolios. The net interest margin was 4.41% and 5.57% for the years ended December 31, 2001 and 2000 respectively. Net interest income for 2001 includes $45 thousand of interest collected on the cash basis related to loans on a nonaccrual status, compared to $145 thousand of interest collected on various nonaccrual loans in 2000. Interest Income The Company's interest income increased $447 thousand or 4.3% to $10.9 million at December 31, 2001, compared to $10.5 million at December 31, 2000. The increase in interest income can be attributed to an increase in the level of average loans and federal funds sold. Average loans increased $18.8 million or 23.1% and average federal funds sold increased $7.9 million or 95.5%. Offsetting these increases was a decrease in average investment securities of $5.3 million or 16.5%. Interest Expense The Company's interest expense increased $914 thousand or 24.8% to $4.6 million at December 31, 2001, compared to $3.7 million at December 31, 2000. The increase in interest expense can be attributed to an increase in the cost of interest bearing liabilities to 3.87% at December 31, 2001, compared to 3.57% in 2000. The increase in rate was primarily due to an increase in certificate of deposit rates to 5.65% in 2001 from 5.22% in 2000. The rates paid on certificates of deposit in 2001 were largely associated with a marketing campaign held late in 2000. The majority of the higher rate certificates of deposit matured in the fourth quarter of 2001. Offsetting the increase in the cost of time deposits was lower rates on all other deposit products. Noninterest Income The Company's primary sources of noninterest income is fees charged on deposit products and those generated by the Bank's VISA check card, fees recognized on the broker origination of residential mortgage loans and rental income from leasing space at the Bank's headquarters building. Noninterest income increased $278,000 to $1.2 million or 31.6% from $884 thousand in 2000. Noninterest Expense Noninterest expense increased $551 thousand or 9.0% to $6.7 million at December 31, 2001, compared to $6.2 million at December 31, 2000. The increase in noninterest expense was primarily due to increases in compensation expense related to the full year salary impact of business development staff hired at the end of 2000 and additions to staff due to extending branch hours. Also contributing to the increase in noninterest expense is higher data processing expenses associated with the increased loan and deposit volumes. Personnel expense increased $578 thousand or 19.1% due to full year salaries for positions open for portions of 2000. Occupancy and equipment expense decreased $114 thousand or 11.9% due to decreased rental costs for the headquarters and the Bestgate branch location due to the move to the Bank owned corporate headquarters building. Other expense increased $87 thousand or 4.0% due to higher data processing expense and moving expenses associated with the new headquarters offset by lower marketing and legal expenses. Provision for Income Taxes The Company and the Bank file consolidated federal income tax returns and separate Maryland income tax returns. The Company recognized $266 thousand and $504 thousand in income tax expense for the years ended December 31, 2001 and 2000 respectively, for an effective tax rate of 34.5% in 2001 and 34.1% in 2000. Results of Operations For The Years Ended December 31, 2000 and 1999 Net Income Net income for the year ended December 31, 2000, totaled $972 thousand or $0.32 per basic share compared to $690 thousand or $0.22 per basic share for the year ended December 31, 1999. Operating Results The following discussion outlines some of the more important factors and tends affecting the earnings of the Company, as presented in its consolidated statements of income. Net Interest Income Net interest income increased $638 thousand or 10.5% at December 31, 2000, to $6.8 million from $6.1 million at December 31, 1999. This increase was the result of an overall increase in the Bank's overall yield on loans and investment securities. Interest Income Interest income increased $842 thousand or 8.8% in 2000 compared to 1999, primarily due to an increase in the yield on investment securities offset by a decrease in the average balance of loans outstanding. Average loans outstanding decreased $5.6 million or 6.4% during 2000, however the average yield on loans increased to 9.72% in 2000 from 9.25% in 1999. Interest Expense Interest expense increased $204 thousand in 2000 as compared to 1999. The increase reflected an increase in the average cost of certificates of deposit to 5.22% in 2000 from 5.07% in 1999. During this period the average cost of interest bearing liabilities increased to 3.57% at December 31, 2000, from 3.48% at December 31, 1999. Noninterest Income Noninterest income increased $64 thousand or 7.8% during 2000 as compared to 1999. The increase was attributable to fees generated by the broker origination of residential mortgage loans. Noninterest Expense Noninterest expense increased $688 thousand or 12.6% to $6.2 million at December 31, 2000, from $5.5 million at December 31, 1999. Personnel expense increased $528 thousand or 21.1% due to the effect of full year salaries for positions filled late in 1999. Occupancy and equipment expense increased $39 thousand or 4.2% due to increased maintenance cost at the branches and normal annual rental increases. Other expense increased $121 thousand or 6.0% due mainly to legal and consulting expense related to changing the Bank charter and marketing expenses related to a new advertising campaign. Selected Consolidated Financial Highlights Selected Consolidated Financial Data at and for years ended December 31, (Dollars in thousands, except per share data)
Selected Financial Data 2001 2000 1999 1998 1997 ----------------------- ---- ---- ---- ---- ---- Total assets $ 166,681 $ 137,040 $ 126,733 $ 120,457 $ 120,827 Total loans, net 111,347 87,411 81,198 86,924 70,985 Total deposits 144,884 118,020 105,094 100,742 96,062 Securities sold under agreement to repurchase 7,674 5,369 8,497 7,174 13,306 Notes payable -- -- -- -- -- Total stockholder's equity 13,860 13,362 12,727 12,091 11,087 Selected Operating Data ----------------------- Interest income $ 10,901 $ 10,455 $ 9,612 $ 9,813 $ 9,161 Interest expense 4,593 3,680 3,474 3,890 3,630 ---------- ---------- ---------- ---------- ---------- Net interest income 6,308 6,775 6,138 5,923 5,531 Provision for credit losses - 36 432 300 748 - -- --- --- --- Net interest income after provision for credit 6,308 6,739 5,706 5,623 4,783 losses Restructuring expense -- -- -- -- 796 Noninterest income 1,162 884 820 867 762 Noninterest expense 6,698 6,147 5,460 4,965 4,434 ---------- ---------- ---------- ---------- ---------- Income before income taxes 772 1,476 1,066 1,525 315 Income tax benefit (expense) (266) (504) (376) (522) 769 ---------- ---------- ---------- ---------- ---------- Net income $ 506 $ 972 $ 690 $ 1,003 $ 1,084 ---------- ---------- ---------- ---------- ---------- Key Financial Ratios and Other Data ----------------------------------- Return on average assets 0.33% 0.75% 0.55% 0.82% 0.99% Net income divided by average assets Return on average equity 3.70% 7.59% 5.69% 8.64% 14.83% Net income divided by average equity Equity to asset ratio (1) 8.88% 9.93% 9.69% 9.54% 6.70% Average equity to average assets ratio Basic earnings per share (3) $ 0.17 $ 0.32 $ 0.22 $ 0.33 $ 0.44 Book value per share (3) $ 4.62 $ 4.44 $ 4.15 $ 3.95 $ 3.62 Tangible book value per share (3) $ 4.62 $ 4.44 $ 4.13 $ 3.91 $ 3.55 Number of shares outstanding 2,996,629 2,262,406 2,323,506 2,313,506 2,312,306 Efficiency ratio (2) 89.67% 80.26% 78.55% 73.19% 83.11% Interest rate spread 3.76% 5.03% 4.76% 4.52% 4.88% Net interest margin 4.41% 5.57% 5.26% 5.11% 5.37% Risk based capital ratio - Tier 1 11.14% 13.60% 13.70% 12.70% 15.16% Risk based capital ratio - Total 12.64% 14.80% 15.00% 14.00% 16.42%
(1) The Company's initial public stock offering closed on September 30, 1997 with net proceeds of $3.5 million. The average capital used to calculate this ratio reflects the increase in capital for the last quarter of 1997. (2) Includes restructuring expense of $796,000 for the year ended December 31, 1997. (3) Adjusted to effect four for three stock split in the form of a stock dividend issued on August 24, 2001. The following table presents a condensed average balance sheet as well as income/expense and yields/costs of funds thereon for the years ended December 31, 2001, 2000 and 1999. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities for the periods shown. Average balances are derived from average daily balances. The yields and costs include loan fees that are considered adjustments to yields. Net interest spread the difference between the average rate on interest bearing assets and the average rate on interest bearing liabilities, decreased to 3.76% for the year ended December 31, 2001, compared to 5.03% at December 31, 2000. Consolidated Average Balances, Yields and Rates (Dollars in thousands)
Years ended December 31, 2001 December 31, 2000 December 31, 1999 ----------------- ----------------- ----------------- Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate ------- -------- ---- ------- -------- ---- ------- -------- ---- Assets Interest Earning Assets: Federal funds sold $ 16,088 $ 616 3.83% $8,229 $ 509 6.19% $ 9,456 $ 462 4.89% Investment Securities 26,530 1,558 5.87% 31,789 2,020 6.35% 20,042 1,090 5.44% Loans 100,341 8,727 8.70% 81,544 7,925 9.72% 87,126 8,060 9.25% -------- -------- -------- -------- -------- -------- Total interest-earning assets 142,959 10,901 7.63% 121,562 10,454 8.60% 116,624 9,612 8.24% -------- -------- -------- -------- -------- -------- -------- -------- -------- Noninterest Earning Assets Cash and due from banks 4,065 3,647 4,196 Other assets 6,894 3,793 4,455 -------- ----- -------- Total Assets $153,918 $129,002 $125,275 -------- -------- -------- Liabilities and Stockholders' Equity Interest Bearing Deposits NOW accounts $17,367 $ 132 0.76% $ 19,952 $ 228 1.14% $ 19,810 $ 269 1.36% Money market accounts 19,567 583 2.98% 12,984 438 3.37% 11,960 334 2.79% Savings accounts 5,166 283 1.89% 16,149 377 2.33% 14,634 341 2.33% Certificates of deposit 59,403 3,357 5.65% 44,055 2,301 5.22% 43,236 2,191 5.07% Repurchase agreements 7,395 238 3.22% 9,851 335 3.40% 9,970 323 3.24% Notes payable -- -- 0.00% -- -- 0.00% 105 17 16.19% -------- -------- -------- -------- -------- -------- Total interest bearing liabilities 118,898 4,593 3.87% 102,991 3,679 3.57% 99,715 3,475 3.48% -------- -------- -------- -------- -------- -------- -------- -------- -------- Noninterest Bearing Liabilities Demand deposit accounts 20,986 12,715 12,646 Other liabilities 373 489 772 Stockholders' Equity 13,661 12,807 12,142 -------- -------- -------- Total Liabilities and Stockholders' Equity $153,918 $129,002 $125,275 -------- -------- -------- Interest rate spread 3.76% 5.03% 4.76% -------- -------- -------- Ratio of interest earning assets to interest bearing liabilities 120.24% 118.03% 116.96% Net interest income and net interest margin $ 6,308 4.41% $ 6,775 5.57% $ 6,137 5.26% -------- -------- -------- -------- -------- --------
Rate/Volume Analysis (Dollars in thousands)
2001 vs. 2000 2000 vs. 1999 ------------- ------------- Due to Change Due to Change Increase or in Rate/ Increase or in Rate/ (Decrease) Volume Rate Volume (Decrease) Volume Rate Volume ------ ---- ------ ------ ---- ------ Interest income on: Loans $ 802 $ 1,827 $ (833) $ (192) $ (135) $ (634) $ 542 $ (43) Investment securities (462) (334) (153) 25 930 640 183 107 Federal funds sold and other overnight investments 107 486 (194) (185) 47 (59) 122 (16) -------- -------- -------- -------- -------- -------- -------- -------- Total interest income 447 1,979 (1,180) (352) 842 (53) 847 48 Interest expense on: NOW accounts (96) (30) (76) 10 (41) 2 (43) -- Money market accounts 145 222 (51) (26) 104 28 70 6 Savings accounts (94) (23) (76) 5 36 33 3 -- Certificates of deposit 1,056 801 189 66 110 41 68 1 Repurchase agreements (97) (83) (18) 4 12 (4) 16 -- Notes payable -- -- -- -- (17) (17) -- -- -------- -------- -------- -------- -------- -------- -------- -------- Total interest expense 914 887 (32) 59 204 83 114 7 -------- -------- -------- -------- -------- -------- -------- -------- Net interest income $ (467) $ 1,092 $ (1,148) $ (411) $ 638 $ (136) $ 733 $ 41 -------- -------- -------- -------- -------- -------- -------- --------
Liquidity and Capital Resources Deposits, commercial reverse repurchase agreements, and lines of credit are the primary source of the Bank's funds for lending and investing activities. Secondary sources of funds are derived from loan repayments and investment maturities. Loan repayments and investment maturities can be considered a relatively stable funding source, while deposit activity is greatly influenced by interest rates, general market conditions and competition. The Bank offers a variety of retail deposit account products to both consumer and commercial deposit customers. The Bank's deposit accounts consist of savings, NOW accounts, checking accounts, money market accounts and certificate of deposit accounts. The Bank also offers individual retirement accounts. Time deposits comprised 42.8% of the deposit portfolio at December 31, 2001. Core deposits, considered to be noninterest bearing and interest bearing demand deposit accounts, savings deposits and money market accounts increased to 57.2% of the deposit portfolio at December 31, 2001 compared to 56.6% at December 31, 2000. The Bank intends to continue to emphasize retail deposit accounts as its primary source of funds. Deposit products are promoted in periodic newspaper advertisements, along with notices provided in customer account statements. The Bank does not pay a fee for brokered deposits. The Bank's market strategy is based on its reputation as a community bank that provides quality products and personal customer service. The Bank pays interest rates on its interest bearing deposit products that are competitive with rates offered by other financial institutions in its market area, and in certain deposit categories may lead the market. Interest rates on deposits are reviewed by management who consider a number of factors including: (1) the Bank's internal cost of funds; (2) rates offered by competing financial institutions; (3) investing and lending opportunities; and (4) the Bank's liquidity position. Jumbo certificates of deposit are accounts of $100,000 or more. These accounts totaled $14.0 million at December 31, 2001 and consisted principally of time certificates of deposit. The following table sets forth the amount and maturity of jumbo certificates of deposit at December 31, 2001: (Dollars in thousands)
Three Months or Greater than Greater than Greater Less Three Months to Six Months to than One Six Months One Year Year Total $1,315 $1,483 $6,107 $5,098 $14,003 ------ ------ ------ ------ -------
Commercial reverse repurchase agreements represent transactions with customers for correspondent or commercial account cash management services. These are overnight borrowing arrangements with interest rates discounted from the federal funds sold rate. Securities underlying the repurchase agreements are maintained in the Company's control. At December 31, 2001, and 2000, the average cost of these borrowings were 3.22% and 3.40% respectively. The Bank maintains a secured borrowing line with the Federal Home Loan Bank (FHLB) with the ability to draw up to $16.7 million, and may borrow up to $8.3 million under secured and unsecured lines established with correspondent commercial banks. In addition, the Bank has the ability to borrow directly from the Federal Reserve Bank discount window. At December 31, 2001, there were no outstanding advances under these lines of credit. Potential adverse impacts on liquidity can occur as a result of changes in the estimated cash flows from investment, loan, and deposit portfolios. The Bank manages this inherent risk by maintaining a portfolio of available for sale investments, and secondary sources of liquidity from FHLB advances and reverse repurchase agreements. In addition, the Bank has the ability to increase its liquidity by raising interest rates on deposit accounts, selling loans in the secondary market or curtailing the volume of loan originations. The Bank maintains the majority of the assets held for liquidity purposes in overnight federal funds. Interest Rate Risk Sensitivity Interest rate sensitivity is an important factor in the management of the composition and maturity configurations of the Company's interest earning assets and funding sources. Additionally, the Bank's profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest bearing assets, such as loans and investments, and its interest expense on its funding sources, such as deposits and borrowings. Accordingly, the Bank's results of operations and financial condition are largely dependent on movements in market interest rates and its ability to manage its assets and liabilities in response to such movements. The Bank attempts to manage fluctuations in interest rates by matching the maturities and repricing schedules of its interest earning assets and interest bearing liabilities. The Bank's current strategy is to lengthen the maturity or repricing frequency of its earning assets to reduce asset sensitivity to short term interest rate fluctuations. Additionally, the Bank has introduced an indexed money market account where the rate changes weekly to provide better matching with variable priced loans, principally loans tied to the Wall Street Journal Prime Rate. The Bank has a limited appetite for long term (greater than five years) fixed rate portfolio lending. The following table summarizes the anticipated maturities or repricing of the Company's interest earning assets and interest bearing liabilities as of December 31, 2001, and the Company's interest sensitivity gap (i.e., interest earning assets less interest bearing liabilities). A positive gap for any time period indicates that more interest earning assets will mature or reprice during that period than interest bearing liabilities. Based on the composition of deposits the Company's goal is to maintain a cumulative gap position for the period of one year or less of plus or minus fifteen percent in order to mitigate the impact of changes in interest rates on liquidity, interest margins and operating results. The analysis presented below represents a static gap position for interest sensitive assets and liabilities at December 31, 2001, and does not give effect to prepayment or extension of loans as a result of changes in general market rates. Interest Sensitivity Gap Analysis December 31, 2001 (Dollars in thousands)
After three but After one but Within three within twelve within five After five months months years years Total ------ ------ ----- ----- ----- Assets Federal funds sold and other overnight investments $ 13,710 $ -- $ -- $ -- $ 13,710 Investment securities (1) -- -- 20,185 8,092 28,277 Loans (2), (3) 43,761 17,535 41,269 10,451 113,016 -------- -------- -------- -------- -------- $ 57,471 $ 17,535 $ 61,454 $ 18,543 $155,003 -------- -------- -------- -------- -------- Liabilities Interest bearing liabilities NOW accounts $ 19,142 $ -- $ -- $ -- $ 19,142 Money market accounts 25,611 -- -- -- 25,611 Savings accounts 14,432 -- -- -- 14,432 Certificates of deposit (4) 9,975 29,991 21,899 113 61,978 Repurchase agreements 7,674 -- -- -- 7,674 -------- -------- -------- -------- -------- $ 76,834 $ 29,991 $ 21,899 $ 113 $128,837 -------- -------- -------- -------- -------- Interest sensitivity gap (19,363) (12,456) 39,555 18,430 26,166 Cumulative interest sensitivity gap (19,363) (31,819) 7,736 26,166 Cumulative interest sensitivity gap as a percentage of total assets (12.49%) (20.53)% 4.99% 16.88% -------- -------- -------- --------
(1) Net of Federal Reserve Bank and Federal Home Loan Bank stock. (2) Loans scheduled by contractual maturities. (3) Net of non-accrual loans of $100 thousand. (4) Certificates of deposits scheduled by contractual maturities. Investment Portfolio At December 31, 2000, the Bank's investment portfolio, which totaled $29.0 million, consisted of U.S. government agency securities and mortgage-backed securities. The Company invests primarily in state tax exempt U.S. Government Agency securities in order to minimize its state income tax liability. Additionally, the Company owns $357,950 in stock of the Federal Reserve Bank of Richmond and $360,400 in stock of the Federal Home Loan Bank of Atlanta (FHLB). Management generally maintains an investment portfolio with relatively short maturities to minimize overall interest rate risk. At December 31, 2001, approximately 71.4% of the investment securities portfolio had maturities of five years or less. Investment decisions are made within policy guidelines established by the Board of Directors. It is the Bank's policy to invest in non-speculative debt instruments, particularly debt instruments that are guaranteed by the U.S. Government or an agency thereof, to maintain a diversified investment portfolio which complements the overall asset/liability and liquidity objectives of the Bank, while limiting the related credit risk to an acceptable level. To meet the credit risk objectives, non-government debt instruments must have a rating of "B" or better to be held in the portfolio. The Bank's investment policy designates the investment portfolio to be classified as "available-for-sale", unless otherwise designated. At December 31, 2001, 100% of the investment portfolio was classified available-for-sale. The composition of securities at December 31, for each of the past five fiscal years was: December 31, 2001 (Dollars in thousands)
2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Available for Sale U. S. Treasury $ -- $ -- $ -- $ -- $ 1,974 U. S. Agency 23,346 33,565 23,048 13,511 12,991 Mortgage-backed 4,931 -- -- 980 980 Equity Securities 718 718 721 699 620 -------- -------- -------- -------- -------- Total 28,995 34,283 23,769 15,190 16,565 Held to Maturity U. S. Treasury -- -- -- -- 3,975 -------- -------- -------- -------- -------- Total -- -- -- -- 3,975 -------- -------- -------- -------- -------- Total Securities $ 28,995 $ 34,283 $ 23,769 $ 15,190 $ 20,540 -------- -------- -------- -------- --------
The following table presents maturities and weighted average yields for investments in available for sale and held to maturity securities. Mortgage-backed securities are classified based upon their stated maturities rather than expected maturities. YEARS TO MATURITY
WITHIN ONE WITHIN 1 WITHIN 5 YEAR TO 5 YEARS TO 10 YEARS AMOUNT/ YIELD AMOUNT/ YIELD AMOUNT/ YIELD ------- ----- ------- ----- ------- ----- Available for Sale U. S. Treasury $ -- --% $ -- --% $ -- --% U. S. Agency -- --% 20,185 5.08% 3,161 5.59% Mortgage-backed -- --% -- --% 2,983 5.52% -------- -------- -------- -------- -------- -------- Total Debt Securities $ -- --% $ 20,185 5.08% $ 6,144 5.56% GREATER THAN TEN YEARS AMOUNT YIELD TOTAL ------ ----- ----- Available for Sale U. S. Treasury $ -- --% $ -- U. S. Agency -- --% 23,346 Mortgage-backed 1,948 5.92% 4,931 -------- -------- -------- Total Debt Securities $ 1,948 5.92% $ 28,277
Lending Activities The types of loans that the Bank may originate are subject to federal laws and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors. These factors are, in turn, affected by, among other things, economic conditions, monetary policies of the federal government, including the Federal Reserve Board, and legislative tax policies. Analysis of Loans The following table presents the composition of the loan portfolio over the previous five years: Years ended December 31, (Dollars in thousands)
2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent Commercial loans $24,368 21.5% $ 19,323 21.6% $ 19,261 23.2% $ 26,895 30.4% $ 30,860 42.6% Real estate loans: Commercial 38,498 34.0% 33,434 37.5% 35,032 42.3% 29,373 33.3% 20,448 28.3% Construction 17,712 15.7% 16,945 19.0% 15,030 18.1% 17,875 20.2% 10,191 13.9% One-to four-family 17,083 15.1% 11,036 12.4% 7,329 8.8% 8,620 9.8% 5,232 7.3% Home equity 6,568 5.8% 4,372 4.9% 3,686 4.5% 3,219 3.6% 3,393 4.7% Consumer loans 8,887 7.9% 4,107 4.6% 2,565 3.1% 2,400 2.7% 2,305 3.2% -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- Total loans 113,116 100.0% 89,217 100.0% 82,903 100.0% 88,382 100.0% 72,429 100.0% Less: Unearned income (193) (250) (222) (299) (267) Allowance for credit losses (1,576) (1,556) (1,483) (1,159) (1,177) -------- -------- -------- -------- -------- Net loans receivable $111,347 $ 87,411 $81,198 $ 86,924 $ 70,985 -------- -------- -------- -------- --------
The Bank's loan portfolio consists of commercial, commercial real estate, residential construction, one- to four-family residential mortgage, home equity and consumer loans. At December 31, 2001 the Bank's loan portfolio totaled $113.1 million, of which $24.4 million, or 21.5%, were commercial loans; $38.5 million, or 34.0%, were commercial real estate loans; $17.7 million, or 15.7%, were construction loans; $17.0 million, or 15.1%, were one- to four-family residential mortgage loans; $6.6 million, or 5.8% were home equity loans and $8.9 million, or 7.9%, were consumer and other loans. All of the loans in the Bank's portfolio are either adjustable-rate or short term fixed-rate loans with terms to maturity of 30 days to 30 years. The Bank does not engage in longer term fixed-rate portfolio lending. Any long-term fixed-rate loans made by the Bank are sold in the secondary market. Commercial Lending. The Bank offers commercial loans to businesses operating in the Bank's primary market area. These loans consist of lines of credit, which typically require an annual repayment, adjustable-rate loans with terms of five to seven years, and short-term fixed-rate loans with terms of up to five years. Such loans are generally secured by receivables, inventories, equipment and other assets of the business. The Bank generally requires personal guarantees on its commercial loans. The Bank also offers unsecured commercial loans to businesses on a selective basis. These types of loans are made to existing customers and are of a short duration, generally one year or less. The Bank also originates commercial loans which are guaranteed by the Small Business Administration ("SBA"). The Bank has been an active participant in a variety of SBA loan programs. Year Ended December 31, 2001 (Dollars in thousands)
DUE AFTER DUE IN ONE YEAR ONE YEAR BUT BEFORE DUE AFTER NON ACCRUAL 90 DAYS OR LESS FIVE YEARS FIVE YEARS LOANS PAST DUE TOTAL ---- ---------- ---------- ----- -------- ----- Real estate loans Construction $ 17,712 $ -- $ -- $ -- $ -- $ 17,712 Mortgage 2,732 10,886 3,465 -- -- 17,083 Commercial 15,462 21,019 2,017 -- -- 38,498 Commercial loans 17,579 5,469 1,244 76 -- 24,368 Home equity loans 6,368 -- 200 -- -- 6,568 Consumer loans 1,443 3,895 3,525 24 -- 8,887 -------- -------- -------- -------- -------- -------- Total loans $ 61,296 $ 41,269 $ 10,451 $ 100 $ -- $113,116 -------- -------- -------- -------- -------- --------
DUE AFTER ONE YEAR
FIXED VARIABLE RATE RATE TOTAL ---- ---- ----- Real estate loans Construction $ -- $ -- $ -- Mortgage 4,725 9,626 14,351 Commercial 3,717 19,319 23,036 Commercial loans 5,713 1,000 6,713 Home equity loans 200 -- 200 Consumer loans 2,868 4,552 7,420 -------- -------- -------- Total loans $ 17,158 $ 34,497 $ 51,720 -------- -------- --------
Commercial Real Estate Lending. The Bank originates adjustable-rate commercial real estate loans that are generally secured by properties used for business purposes such as small office buildings or a combination of residential and retail facilities located in the Bank's primary market area. The Bank's underwriting procedures provide that commercial real estate loans may generally be made in amounts up to 80-85% of the lower of the appraised value or sales price of the property, subject to the Bank's current loans-to-one-borrower limit, which at December 31, 2001, was $2.2 million. These loans may be made with terms up to 25 years and are generally offered at interest rates, which adjust annually or annually after an initial five-year period in accordance with the prime rate or the 3 and 5 year U.S. Constant Maturity Indices as reported in the Wall Street Journal. In reaching a decision as to whether or not to make a commercial real estate loan, the Bank considers the value of the real estate to be financed and the credit strength of the borrower and/or the lessee of the real estate project. The Bank has generally required that the properties securing commercial real estate loans have debt service coverage ratios of at least 1.2:1. Loans secured by commercial real estate properties generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards, which require such loans to be qualified on the basis of the property's value, debt service ratio and, under certain circumstances, additional collateral. The Bank generally requires personal guarantees on its commercial real estate loans. Construction Lending. The Bank originates construction loans on both one- to four-family residences and on commercial real estate properties. The Bank originates two types of residential construction loans, consumer and builder. The Bank originates consumer construction loans to build a primary residence, a secondary residence, or an investment or rental property. The Bank will originate builder construction loans to companies engaged in the business of constructing homes for sale. These loans may be for homes currently under contract for sale, model homes from which other homes will be marketed within a subdivision or, on a very limited basis, homes built for speculative purposes to be marketed for sale during construction. The Bank offers permanent end-financing to the Bank's construction loans customer generally on a 3/1 or 5/1 ARM basis. The Bank originates land acquisition and development loans with the source of repayment being either the sale of finished lots or the sale of homes to be constructed on the finished lots. The Bank will originate land acquisition, development, and construction loans on a revolving line of credit basis for subdivisions whereby the borrower may draw upon such line of credit as lots are sold for the purpose of improving additional lots. Construction loans are generally offered with terms up to twelve months for consumer and builder loans, and up to twenty-four months for land development loans. Construction loans are generally made in amounts up to 80% to 90% of the appraised market value of the security property. During construction, loan proceeds are disbursed in draws as construction progresses based upon inspections of work in place by independent construction inspectors. At December 31, 2001, the Bank had construction loans, including land acquisition and development loans totaling $17.7 million, or 15.7% of the Bank's total loan portfolio, of which $6.0 million consisted of one- to four-family residential construction loans, $6.1 million consisted of commercial real estate construction loans and $5.6 million consisted of land acquisition and development loans. Construction loans are generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security property's value upon completion of construction as compared to the estimated costs of construction, including interest. Also, the Bank assumes certain risks associated with the borrowers' ability to complete construction timely and in a workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is not performed timely or accurately, the Bank may be confronted with a project which, when completed, has a value that is insufficient to assure full repayment. One- to Four-Family Residential Mortgage Lending. The Bank currently offers both fixed-rate and adjustable-rate mortgage loans, first and second mortgage loans secured by one- to four-family residences and lots for one- to four-family residences located throughout Baltimore-Washington Metropolitan areas. It is currently the general policy of the Bank to originate for sale in the secondary market one- to four-family fixed-rate residential mortgage loans which conform, except as to size, to the underwriting standards of Fannie Mae, and Freddie Mac, and to originate for investment adjustable rate one- to four-family residential mortgage loans. The Bank generally does not retain the servicing rights of loans it sells and sells such loans without recourse, with the exception of a recourse in the event of breaches for any representations or warranties made by the Bank. The Bank recognizes, at the time of sale, the cash gain or loss on the sale of the loans based on the difference between the net cash proceeds received and the carrying value of the loans sold. One- to four-family mortgage loan originations are generally obtained from the Bank's loan representatives and their contacts with the local real estate industry, direct contacts made by the Bank's and the Company's directors, existing or past customers, and members of the local communities. At December 31, 2001, one- to four-family residential mortgage loans totaled $17.0 million, or 15.1%, of total loans. Of the one-to four-family mortgage loans outstanding at that date, $2.5 million were fixed-rate loans with terms of up to three years with a balloon payment at the end of the term and $8.6 of up to 30 years and interest rates which adjust annually from the outset of the loan or which adjust annually after a 1 or 3 year initial period during which the loan has a fixed rate. The interest rates for the majority of the Bank's adjustable-rate mortgage loans are indexed to the one-year Treasury Constant Maturity Index. Interest rate adjustments on such loans are limited to a 2% annual adjustment cap with a maximum adjustment of 6% over the life of the loan. The origination of adjustable-rate residential mortgage loans, as opposed to fixed-rate residential mortgage loans, helps to reduce the Bank's exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Although the Bank offers adjustable-rate loans at below market interest rates, all loans are underwritten to assure that the borrower is qualified on a fully indexed basis. Periodic and lifetime caps on interest rate increases help to reduce the risks associated with the Bank's adjustable-rate loans, but also limit the interest rate sensitivity of its adjustable-rate mortgage loans. The Bank currently originates one- to four-family residential mortgage loans in amounts up to 80% (or higher with private mortgage insurance) of the lower of the appraised value or the selling price of the property securing the loan. Mortgage loans originated by the Bank generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the Bank's consent. Due-on-sale clauses are an important means of adjusting the yields on the Bank's fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses. Home Equity Lending. As of December 31, 2000, home equity loans totaled $6.6 million, or 5.8% of the Bank's total loan portfolio. Fixed-rate, fixed-term home equity loans and adjustable rate home equity lines of credit are generally offered in amounts up to 85% of the market value of the security property. Fixed-rate, fixed-term home equity loans are offered with terms up to ten years and home equity lines of credit are offered with terms up to twenty years. Substantially all of the Bank's home equity loans are adjustable rate and reprice with changes in the Wall Street Journal prime rate. Consumer Lending. The Bank's portfolio of consumer loans primarily consists of adjustable rate, personal lines of credit and installment loans secured by new or used automobiles, new or used boats, and loans secured by deposit accounts. Unsecured consumer loans are made with a maximum term of three years and a maximum loan amount based on a borrower's financial condition. At December 31, 2001, consumer loans totaled $8.9 million or 7.9% to total loans outstanding. Consumer loans are generally originated in the Bank's primary market area. Credit Risk Management The Bank's allowance for credit losses is established through a provision for credit losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for credit losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. The Bank estimates a range of acceptable allowance for credit loss based upon loan risk ratings, prior periods' charge-offs and specific loss reserves. This methodology is appropriate as the Bank has ten years of loan loss history, has a sufficient number of loans for broader base estimation processes to be meaningful and has a risk rating review system established for the purpose of maintaining accurate risk ratings on individual loans. Management believes this approach effectively measures the associated risk with any particular loan or group of loans. Management also considers other factors including current economic conditions, actual loss experience and industry trends. Management has also instituted a policy to engage an independent loan review consultant to evaluate the adequacy of the Bank's allowance for credit losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for credit losses. Such agencies may require the Bank to make additional provisions for estimated credit losses based upon judgments different from those of management. As of December 31, 2001, the Bank's allowance for credit losses was $1.6 million or 1.40% of total loans and 1,581.0% of non-performing loans as compared to $1.6 million, or 1.75% of total loans and 519.8% of non-performing loans as of December 31, 2000. The Bank had total non-performing loans of $100 thousand and $299 thousand at December 31, 2001 and December 31, 2000, respectively, and non-performing loans to total loans of 0.09% and 0.34%, at December 31, 2001, and December 31, 2000, respectively. The Bank places loans on a nonaccrual status after 90 days of not having received contractual principal or interest payments unless the loan is well secured and in the process of collection. In addition the Bank maintains a watch list of loans on a monthly basis that warrant more than the normal level of management supervision. At December 31, 2001 the Bank had approximately $6.6 million in watch list loans. The Bank continues to monitor and modify its allowances for credit losses as conditions dictate. While management believes that, based on information currently available, the Bank's allowance for credit losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Bank's level of allowance for credit losses will be sufficient to cover future credit losses incurred by the Bank or that future adjustments to the allowance for credit losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions at the time management determined the current level of the allowance for credit losses. Management may in the future increase its level of loan loss allowances as a percentage of total loans and non-performing loans as its loan portfolio increases or as circumstances dictate. The following table represents a three-year history for the allocation of the allowance for credit losses, reflecting use of the methodology presented above, along with the percentage of total loans and leases in each category. At December 31, (Dollars in thousands)
2001 2000 1999 Amount Loan Mix Amount Loan Mix Amount Loan Mix Amount applicable to: Commercial $ 475 21.5% $484 21.6% $ 563 23.2% Real estate: Commercial 692 34.0% 626 37.5% 625 42.3% Residential 103 20.9% 68 17.3% 17 13.3% Construction 33 15.7% 20 19.0% 2 18.1% Consumer 60 7.9% 37 4.6% 25 3.1% Unallocated 213 321 251 ------ ------ ------ Total allowance $1,576 $1,556 $1,483 ------ ------ ------
Analysis of Credit Risk Activity in the allowance for credit losses for the preceding three years ended December 31 is shown below: At December 31, (Dollars in thousands)
2001 2000 1999 ---- ---- ---- Total loans outstanding $112,923 $88,967 $82,681 Average loans outstanding $100,341 $81,544 $87,126 Allowance for credit losses at beginning of period $ 1,556 $ 1,483 $ 1,159 Provision charged to expense - 36 432 --------- -------- -------- Chargeoffs: Commercial loans 4 - 202 Consumer and other loans - - 8 --------- -------- -------- Total 4 - 210 Recoveries: Residential/commercial real estate loans -- -- 31 Commercial loans 24 36 71 Consumer and other loans - 1 -- --------- -------- -------- Total 24 37 102 --------- -------- -------- Net chargeoffs (recoveries) (20) (37) 108 Allowance for credit losses at end of period $1,576 $1,556 $ 1,483 --------- -------- -------- Allowance for credit losses as a percent of 1.40% 1.75% 1.79% --------- -------- -------- total loans Net chargeoffs (recoveries) as a percent of average loans (0.02)% (0.04)% 0.12% --------- -------- --------
The following table presents nonperforming assets at year-end for the last three years: At December 31, (Dollars in thousands)
2001 2000 1999 Nonaccrual loans and leases $ 100 $ 299 $1,499 Loans and leases 90 days past due - - - Total nonperforming loans and leases 100 299 1,499 Other real estate owned, net - - 57 Total nonperforming assets $ 100 $ 299 $1,556 Nonperforming loans and leases to total loans and leases 0.09% 0.34% 1.88% Nonperforming assets to total assets 0.06% 0.22% 1.23%
Capital Management During 2001, Stockholders' Equity increased $498 thousand or 3.7% to $13.9 million from $13.4 million at December 31, 2000. The increase was primarily due to net income of $506 thousand. Additionally, the Company's number of common shares outstanding increased by 11,983 due to options and restricted shares exercised, and 745,860 shares due to a 4 for 3 stock split in the form of a stock dividend and decreased by 24,500 due to a stock repurchase program, bringing total shares outstanding to 2,996,629 at December 31, 2001. In April 1997, the Company's employee incentive stock option plan was approved by shareholders at the Company's annual meeting. Under the plan, up to 133,333 shares of the Company's common stock may be awarded under the direction of the Company's compensation committee. Incentive stock options vest over a five year period. During April 2000, a new Company's incentive stock option plan was approved by shareholders at the Company's annual meeting. Under the plan, up to 266,666 shares of the Company's common stock may be awarded under the direction of the Company's compensation committee. Incentive stock options and grants vest over a five-year period. During 2001, 167,481 shares of common stock were granted under the 2000 Stock Incentive Plan. Also during 2001, 5,317 restricted shares were issued, 11,000 shares granted in prior years were forfeited and 6,666 shares were exercised. At December 31, 2001, the Company had a total of 249,315 options and 11,468 restricted shares granted and outstanding. See Note 12 to the Consolidated Financial Statements for more information on the Company's stock option plan. Regulatory Capital Requirements The Federal Reserve's capital regulations require state member banks to meet two minimum capital standards: a 4% Tier 1 capital to total adjusted assets ratio for the most highly rated banks (at least 100 to 200 basis points more for other national banks) (the "leverage" ratio) and an 8% risk-based capital ratio. Tier 1 capital is defined as common stockholders' equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The risk-based capital standard requires the maintenance of Tier 1 and total capital (which is defined as Tier 1 capital plus Tier 2 capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, as assigned by the Federal Reserve capital regulations based on the risks the agency believes are inherent in the type of asset. The regulators have recently added a market risk adjustment to cover a bank's trading account, foreign exchange and commodity positions. The components of Tier 1 capital are equivalent to those discussed above. Tier 2 capital may include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of Tier 2 capital included as part of total capital cannot exceed 100% of Tier 1 capital. At December 31, 2001, the Bank's Tier 1 and total risk-based capital ratio were 11.1% and 12.6% respectively. The Bank was considered well capitalized for regulatory purposes. See Note 17 of the Consolidated Financial Statements for more information on the Bank's risk-based capital ratios. Regulation and Supervision The Company, by virtue of its control of the Bank, is a registered bank holding company as amended under the Bank Holding Company Act of 1956 ("the Act"). As a bank holding company, the Company is required to file certain reports with, and otherwise comply with the rules and regulations of, the Federal Reserve Board ("FRB") under the Act. Effective November 1, 2000, the Company changed the Bank charter from a national charter to a state charter. As a result, the Bank is now regulated by the State of Maryland Department of Labor, Licensing and Regulation. The Bank is subject to extensive regulation, examination and supervision by the State of Maryland as its primary regulator, the Federal Reserve Bank of Richmond as its secondary regulator and the FDIC, as the deposit insurer. The Bank's deposit accounts are insured up to applicable limits by the FDIC's Bank Insurance Fund ("BIF"). The Bank must file reports with the Federal Reserve and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of other institutions. The state and the Federal Reserve conduct periodic examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. Many aspects of the Bank's operations are regulated by federal law including allowable activities, reserves against deposits, branching, mergers and investments. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the state of Maryland, the Federal Reserve, the FDIC or the Congress, could have a material adverse impact on the Company or the Bank and their operations. On October 26, 2001, the USA PATRIOT (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism) Act of 2001 became law. The Act, passed in response to the September 11 tragedy, includes several money laundering and banking provisions that significantly impact financial institutions. The most important of which is the requirement for all financial institutions to develop anti-money laundering programs. Over the next few months the Treasury Department intends to release additional regulations that will further define the requirements of financial institutions under the Act. The Bank intends to comply with the provisions of the Act. Market Value and Dividend Information The Company's Common stock is listed on "The NASDAQ Stock Market(R) SmallCap Market" under the symbol "ANNB". The Company's stock began trading on October 1, 1997. The Company has traded an average daily volume of 4,569 shares during 2001. At December 31, 2001 the closing price was $4.40 per share. The Company's high and low stock price during the last quarter of 2001 was $5.35 and $4.20, respectively. As of March 22, 2002 the Company has outstanding 2,996,629 shares of common stock and no preferred stock issued or outstanding. The Company paid dividends for the first time to its stockholders during 1999. Annual Dividends paid to the stockholders equaled $0.04 per share. The Company also declared a 4 for 3 stock split in the form of a stock dividend on August 24, 2001. The split added 745,860 shares those previously outstanding. Quarterly Average Stock Information:
2001 2000 1999 Stock Price Range Per Share Stock Price Range Per Share Stock Price Range Per Share Quarter High Low Dividend High Low Dividend High Low Dividend 1/st/ $4.30 $3.23 $0.0075 $3.75 $2.63 $0.0075 $5.72 $4.55 $0.0000 2/nd/ 4.49 3.75 0.0150 3.70 2.91 0.0075 5.53 4.31 0.0075 3/rd/ 6.38 4.28 * 4.31 3.00 0.0075 4.88 3.56 0.0075 4th 5.35 4.20 0.0100 4.13 2.91 0.0075 3.75 2.95 0.0075
*Four for three stock split in the form of a stock dividend. ANNAPOLIS BANCORP, INC. Report of Independent Auditors The Board of Directors and Stockholders Annapolis Bancorp, Inc. and Subsidiary We have audited the accompanying consolidated balance sheets of Annapolis Bancorp, Inc. and Subsidiary as of December 31, 2001 and 2000 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of Annapolis Bancorp, Inc. and Subsidiary for the year ended December 31, 1999 were audited by other auditors whose report dated January 28, 2000 expressed an unqualified opinion on those statements. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Annapolis Bancorp, Inc. and Subsidiary as of December 31, 2001 and 2000 and the results of their operations and their 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 January 11, 2002 ANNAPOLIS BANCORP, INC. Consolidated Balance Sheets (Dollars in thousands)
December 31, 2001 2000 1999 Assets Cash and due from banks $ 3,632 $ 3,177 $ 5,665 Federal funds sold 13,710 4,724 11,432 Investment securities available for sale 28,995 34,283 23,769 Loans, less allowance for credit losses of $1,576; $1,556 and $1,483 111,347 87,411 81,198 Premises and equipment, net 7,375 5,302 2,742 Accrued interest receivable 855 1,152 822 Other real estate owned - - 57 Deferred income taxes 335 461 494 Core deposit premium - - 43 Other assets 432 530 511 Total assets $ 166,681 $ 137,040 $ 126,733 Liabilities and Stockholders' Equity Deposits Noninterest bearing $ 23,721 $ 13,752 $ 13,321 Interest bearing 121,163 104,268 91,773 Securities sold under agreements to repurchase 7,674 5,369 8,497 Accrued interest payable and other liabilities 263 289 415 Total liabilities 152,821 123,678 114,006 Stockholders' Equity Common stock, par value $0.01 per share; authorized 10,000,000 shares; issued and outstanding 2,996,629 shares in 2001, 2,262,406 shares in 2000 and 2,323,506 shares in 1999 30 23 23 Capital surplus 12,796 12,881 13,192 Retained earnings (deficit) 833 425 (454) Accumulated other comprehensive income (loss) 201 33 (34) Total stockholders' equity 13,860 13,362 12,727 Total liabilities and stockholders' equity $ 166,681 $ 137,040 $ 126,733
The accompanying notes are an integral part of these financial statements. ANNAPOLIS BANCORP, INC. Consolidated Statements of Income (Dollars in thousands, except per share data)
Years Ended December 31, 2001 2000 1999 Interest Income Loans, including fees $ 8,727 $ 7,925 $ 8,060 Federal funds sold 616 509 462 Mortgage-backed securities 69 - - U.S. Treasury securities and obligations of other U.S. Government agencies 1,489 2,020 1,090 Total interest income 10,901 10,454 9,612 Interest Expense Certificates of deposit, $100,000 or more 744 394 324 Other deposits 3,610 2,950 2,811 Securities sold under agreements to repurchase 239 335 323 Interest on borrowed funds - - 17 Total interest expense 4,593 3,679 3,475 Net interest income 6,308 6,775 6,137 Provision for Credit Losses - 36 432 Net interest income after provision for credit losses 6,308 6,739 5,705 Noninterest Income Loss on disposal/sale of equipment (24) (51) (16) Loss on sale of securities - - (9) Service charges and other 1,186 935 845 Total noninterest income 1,162 884 820 Noninterest Expense Personnel 3,612 3,034 2,506 Occupancy and equipment 845 959 920 Data processing 682 603 697 Marketing and advertising 325 391 194 Other operating 1,234 1,117 1,055 Amortization of core deposit premium - 43 87 Total noninterest expense 6,698 6,147 5,459 Income before income taxes 772 1,476 1,066 Income tax expense 266 504 376 Net income $ 506 $ 972 $ 690 Basic earnings per share $ 0.17 $ 0.32 $ 0.22 Diluted earnings per share $ 0.17 $ 0.32 $ 0.22
The accompanying notes are an integral part of these financial statements. ANNAPOLIS BANCORP, INC. Consolidated Statements of Changes in Stockholders' Equity (Dollars in thousands, except share data)
Accumulated Other Total Common Stock Retained Comprehensive Stockholders' Comprehensive Shares Par value Surplus Earnings Income Equity Income BALANCE, JANUARY 1, 1999 2,313,506 $ 23 $13,142 $(1,075) - $12,091 Net income - - - 690 - 690 690 Stock options exercised 10,000 - 50 - - 50 Dividends paid (2.25 cents per share) - - - (70) - (70) Unrealized (loss) on investment securities available for sale net of income taxes - - - - (34) (34) (34) BALANCE, DECEMBER 31, 1999 2,323,506 23 13,192 (454) (34) 12,727 656 === Net income - - - 972 - 972 972 Dividends paid (3.00 cents per share) - - - (93) - (93) Stock repurchase (61,100) (311) - - (311) Unrealized gain on investment securities available for sale net of income taxes - - - - 67 67 67 BALANCE, DECEMBER 31, 2000 2,262,406 $ 23 $12,881 $ 425 $ 33 $13,362 1,039 ====== Net income - - - 506 - 506 506 Dividends paid (3.25 cents per share) - - - (98) - (98) 4:3 stock split in the form of a stock dividend 745,860 8 (8) - - - Stock repurchase (24,500) (1) (127) - - (128) Stock options exercised 6,666 - 24 - - 24 Issuance of restricted stock 6,197 - 26 - - 26 Unrealized gain on investment securities available for sale net of income taxes - - - - 168 168 168 BALANCE DECEMBER 31, 2001 2,996,629 $ 30 $12,796 $ 833 $ 201 $13,860 $ 674 ======
The accompanying notes are an integral part of these financial statements. ANNAPOLIS BANCORP, INC.
Consolidated Statements of Cash Flows (Dollars in thousands) Years Ended December 31, 2001 2000 1999 Cash Flows from Operating Activities Net income $ 506 $ 972 $ 690 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 424 314 308 Provision for credit losses - 36 432 Deferred income taxes 42 (6) (153) Amortization of premiums and accretion of discounts, net (24) (174) (508) Amortization of core deposit premium - 43 86 Loss (gain) on: Sale or disposal of equipment 24 51 16 Sale of securities - - 9 (Increase) decrease in: Accrued interest receivable 297 (331) (232) Other assets 117 (40) (31) Increase (decrease) in Accrued interest payable (16) 26 (6) Accrued income taxes, net of taxes refundable 49 (54) - Deferred loan origination fees 28 (77) (58) Other liabilities (57) (98) (33) Net cash provided from operations 1,304 767 501 Cash Flows from Investing Activities Proceeds from sales and maturities of securities available for sale 45,505 21,884 84,897 Purchase of securities available for sale (39,942) (32,117) (93,032) Net decrease (increase) in federal funds sold (8,986) 6,709 (1,148) Loans made, net of principal collected (23,898) (6,277) 5,372 Purchases of premises and equipment (2,521) (2,904) (464) Proceeds from sale and cost to dispose of equipment - (1) 5 Proceeds from sale of other real estate owned - 57 33 Net cash used by investing activities (29,842) (12,649) (4,337) Cash Flows from Financing Activities Net increase (decrease) in Time deposits 10,757 5,612 7,989 Other deposits 16,107 7,314 (3,637) Securities sold under agreements to repurchase 2,305 (3,128) 1,323 Payment of cash dividends (98) (92) (70) Proceeds from sale of stock and options exercised 24 50 Issuance of restricted stock 26 - - Repurchase of common stock (128) (312) - Net cash provided/(used) by financing activities 28,993 9,394 5,655 Net increase (decrease) in cash and cash equivalents 455 (2,488) 1,819 Cash and cash equivalents at beginning of year 3,177 5,665 3,846 Cash and cash equivalents at end of year $ 3,632 $ 3,177 $ 5,665 Supplemental Cash Flow Information Interest paid, including interest credited to accounts $ 4,609 $ 3,793 $ 3,481 Income taxes paid 240 557 530
The accompanying notes are an integral part of these financial statements. ANNAPOLIS BANCORP, INC. Notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies in the financial statements conform with accounting principles generally accepted in the United States of America and to general practices within the banking industry. Management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions may affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Certain reclassifications have been made to amounts previously reported to conform with the 2001 and 2000 presentation. Business The Company was incorporated on May 26, 1988, under the laws of the State of Maryland to serve as a bank holding company. The Company, registered as a bank holding company, formed Annapolis National Bank (the "Bank"), a nationally chartered financial institution. Effective June 1, 2001 the Company changed its name to Annapolis Bancorp, Inc. Effective November 1, 2000 the Bank changed its charter from a national charter to a state charter and joined the State of Maryland and the Federal Reserve banking systems. Also effective November 1, 2000 the Bank changed its name from Annapolis National Bank to BankAnnapolis. The Company (as a bank holding company) and the Bank are subject to governmental supervision, regulation, and control. The principal business of BankAnnapolis is to make loans and other investments and to accept time and demand deposits. The Bank's primary market area is in Anne Arundel County, Maryland, although the Bank's business development efforts generate business outside of the area. The Bank offers a broad range of banking products, including a full line of business and personal savings and checking accounts, money market demand accounts, certificates of deposit and other banking services. The Bank funds a variety of loan types including commercial and residential real estate loans, commercial term loans and lines of credit, consumer loans, and letters of credit. The Bank's customers are primarily individuals and small businesses. Principles of consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, BankAnnapolis. All significant intercompany balances and transactions have been eliminated in consolidation. The financial statements of Annapolis Bancorp, Inc. (Parent only) include its investment in the Bank under the equity method of accounting. Cash equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks. Investment securities As securities are purchased, management determines if the securities should be classified as held to maturity or available for sale. Securities which management has the intent and ability to hold to maturity are carried at amortized cost. Securities which may be sold before maturity are classified as available for sale and carried at fair value with unrealized gains and losses included in accumulated other comprehensive income, a separate component of stockholders' equity, on an after-tax basis. Investments in Federal Home Loan Bank and Federal Reserve stock are included with securities classified as available for sale and carried at cost. Premises and equipment Premises and equipment are recorded at cost less accumulated depreciation and amortization. Depreciation and amortization are computed over the estimated useful lives using the straight-line method. Leasehold improvements are amortized over the terms of the leases or the estimated useful lives of the improvements, whichever is shorter. Loans Loans are stated at face value, plus deferred origination costs, less unearned discounts, deferred origination fees, and the allowance for credit losses. Interest on loans is credited to income based on the principal amounts outstanding. Origination fees and costs are amortized to income over the contractual life of the related loans as an adjustment of yield. Discounts on the purchase of loans are amortized to income over the contractual lives of the loans. Accrual of interest on a loan is discontinued when the loan is delinquent more than ninety days unless the collateral securing the loan is sufficient to liquidate the loan. Management considers all loans where the accrual of interest has been discontinued to be impaired. Allowance for Credit Losses The allowance for credit losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans, actual and anticipated loss experience, current economic events and other pertinent factors including regulatory guidance and general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Credit losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors. The allowance for credit losses consists of an allocated component and an unallocated component. The components of allowance for credit losses represent an estimation done pursuant to either Statement of Financial Accounting Standards ("SFAS") No. 5 "Accounting for Contingencies", or SFAS No. 114 "Accounting by Creditors for Impairment of a Loan". The allocated component of the allowance for credit losses reflects expected losses resulting from analysis developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on a regular analysis of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The historical loan loss element is determined statistically using a loss migration analysis that examines loss experience and the related internal gradings of loans charged off. The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The allocated component of the allowance for credit losses also includes management's determination of the amounts necessary for concentrations and changes in portfolio mix and volume. The unallocated portion of the allowance is determined based on management's assessment of general economic conditions, as well as specific economic factors in the individual markets in which BankAnnapolis operates. This determination inherently involves a higher risk of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank's historical loss factors used to determine the allocated component of the allowance and it recognizes knowledge of the portfolio may be incomplete. Management believes that the allowance for credit losses is adequate. However, the determination of the allowance requires significant judgment, and estimates of probable losses inherent in the loan portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future additions to the allowance may be necessary based on changes in the credits comprising the loan portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank, periodically review the Bank's loan portfolio and allowance for credit losses. Such review may result in recognition of additions to the allowance based on the judgments of information available to them at the time of their examination. Real estate owned Real estate acquired in satisfaction of a debt is carried at the lower of cost or net realizable value. Costs incurred in maintaining foreclosed real estate and write-downs to reflect declines in the fair value of the properties after acquisition are included in noninterest expenses. Income taxes The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Stock based compensation The Company accounts for stock based compensation using the intrinsic value method set forth in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. For disclosure purposes, pro forma net income and earnings per share are provided as if the fair value method has been applied. Earnings per share Basic earnings per common share are determined by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per share are calculated by including the average dilutive common stock equivalents outstanding during the period. Dilutive common equivalent shares consist of stock options, calculated using the treasury stock method. New Accounting Pronouncements In July 2001, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues". SAB 102 summarizes certain SEC views on the development, documentation, and application of a systematic methodology as required by Financial Reporting Release No. 28 for determining allowances for loan losses in accordance with accounting principles generally accepted in the United States of America. In particular, the guidance focuses on the documentation the staff normally would expect registrants to prepare and maintain in support of their allowances for credit losses. SAB 102 provides parallel guidance to the federal banking agencies guidance issued through the Federal Financial Institutions Examination Council as interagency guidance, "Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions". Management believes the Company is in compliance with the provision of SAB 102. In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and Statement No. 142, "Goodwill and Other Intangible Assets". Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The adoption of SFAS No. 141 effective June 30, 2001 and SFAS No. 142 effective January 1, 2002 had no impact on the financial position or results of operations of the Company. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which supersedes both SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing and measuring impairment losses in long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS No. 121. The provisions of SFAS No. 144 are effective for years beginning after December 15, 2001, and its adoption is not expected to affect the financial position or results of operations of the Company. 2. CASH AND DUE FROM BANKS Banks are required to maintain cash reserves of specified percentages of deposit balances. The Bank's normal balances of cash on hand and on deposit with other banks are sufficient to satisfy these reserve requirements. The Bank normally carries balances with other banks that exceed the federally insured limit. The average balance carried in excess of the limit, including federal funds sold to the same bank, was approximately $6.1 million at December 31, 2001. 3. INVESTMENT SECURITIES Investment securities are summarized as follows: (Dollars in thousands)
Amortized Unrealized Unrealized Estimated Fair December 31, 2001 Cost Gains Losses Value Available for sale U.S. Government agency $23,063 $286 $ 3 $23,346 Mortgage-backed securities 4,910 21 - 4,931 Federal Home Loan Bank stock 360 - - 360 Federal Reserve Bank stock 358 - - 358 $28,691 $307 $ 3 $28,995 December 31, 2000 Available for sale U.S. Government agency $33,512 $ 61 $ 8 $33,565 Federal Home Loan Bank stock 360 - - 360 Federal Reserve Bank stock 358 - - 358 $34,230 $ 61 $ 8 $34,283 December 31, 1999 Available for sale U.S. Government agency $23,103 $ 20 $75 $23,048 Federal Home Loan Bank stock 360 - - 360 Federal Reserve Bank stock 361 - - 361 $23,824 $ 20 $75 $23,769
Proceeds from sale of securities during 2001 and 2000 were zero, as compared to 1999 with proceeds of $1.9 million and realized losses of $8 thousand on those sales. Gains and losses are determined using the specific identification method. The amortized cost and estimated fair value of securities by contractual maturities are shown below. Actual maturities of these securities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties. Available for sale Amortized Estimated Fair December 31, 2001 cost value Due within one year $ -- $ -- Due after one through five years 19,941 20,185 Due after five years 8,032 8,092 Equity securities 718 718 $28,691 $28,995 December 31, 2000 Due within one year $22,592 $22,614 Due after one through five years 10,920 10,951 Equity securities 718 718 $34,230 $34,283 December 31, 1999 Due within one year $12,327 $12,345 Due after one through five years 10,776 10,703 Equity securities 721 721 $23,824 $23,769 At December 31, 2001, 2000 and 1999, investments available for sale with a carrying value of $10.9 million, $14.2 million and $8.5 million, respectively, were pledged as collateral for certain government deposits and for other purposes as required by law. 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES Major classifications of loans are as follows:
(Dollars in thousands) 2001 2000 1999 Real estate Commercial $ 50,232 $46,059 $38,461 Residential 29,629 19,728 22,615 Commercial 24,368 19,323 19,261 Consumer 8,887 4,107 2,566 113,116 89,217 82,903 Less Deferred loan origination fees 193 250 222 Allowance for credit losses 1,576 1,556 1,483 Loans, net $111,347 $87,411 $81,198 The maturity and rate repricing distribution of the loan portfolio is as follows: Repricing or maturing within one year $ 61,395 $51,308 $52,115 Maturing over one to five years 41,270 26,685 23,406 Maturing over five years 10,451 11,224 7,382 $113,116 $89,217 $82,903 Transactions in the allowance for credit losses were as follows: Balance, beginning of year $ 1,556 $ 1,483 $ 1,159 Provisions charged to operations 0 36 432 Recoveries 24 38 102 Chargeoffs (4) (1) ( 209) Balance, end of year $ 1,576 $ 1,556 $ 1,483 The balance of nonaccrual and impaired loans is as follows: Total guaranteed by the Small Business Administration $ 24 $ 36 $ 718 Other nonaccrual loans 76 263 781 Total nonaccrual and impaired loans 100 299 1,499 Average impaired loans 302 1,257 1,690 Related allowance for credit losses 33 171 271 Interest collected 45 145 195 Balance of accrued interest not recorded 68 98 119
The Bank lends to customers located primarily in Annapolis, Baltimore, and surrounding areas of central Maryland. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region. Loans that were 90 days or more past due, including nonaccrual loans amounted to $24 thousand at December 31, 2001 zero at December 31, 2000 and $73 thousand at December 31, 1999. Certain officers and directors (and companies which have a 10% or more beneficial ownership) have loans with the Bank. Such loans were made in the ordinary course of business on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties and are being repaid as agreed. A summary of the activity of these loans follows: 2001 2000 1999 Beginning balance $1,901 $ 2,824 $2,753 Advances 352 125 243 Repayments (497) (1,242) (172) Change in officers and directors 18 194 - Ending balance $1,774 $ 1,901 $2,824 5. CREDIT COMMITMENTS Outstanding loan commitments, unused lines of credit, and letters of credit are as follows: (Dollars in thousands) 2001 2000 1999 Loan commitments and lines of credit Construction $18,852 $18,722 $13,764 Other 20,898 14,271 9,740 $39,750 $32,993 $23,504 Letters of credit Deposit secured $ 349 $ 240 $ 330 Other 848 1,156 1,276 $ 1,197 $ 1,396 $ 1,606 Loan commitments including lines of credit are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have variable interest rates, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Loan commitments and lines and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss the Company will incur by the funding of these commitments. 6. INTANGIBLE ASSETS The core deposit premium was amortized over a period expiring in the year 2000. Amortization expense relating to the core deposit premium was zero in 2001, $43 thousand in 2000 and $87 thousand in 1999. As of December 31, 2001 the core deposit premium was fully amortized. 7. PREMISES AND EQUIPMENT A summary of premises and equipment and the related depreciation is as follows: (Dollars in thousands) 2001 2000 1999 Land, land improvements and building $6,075 $4,316 $1,517 Leasehold improvements 596 602 658 Furniture, fixtures, and equipment 2,219 1,564 1,520 8,890 6,482 3,695 Accumulated depreciation 1,515 1,180 953 Net premises and equipment $7,375 $5,302 $2,742 Depreciation and amortization expense $ 424 $ 314 $ 308 The Company constructed a new branch and administrative facility on a tract of land owned by the Company. The Company moved into the new facility in March 2001. The total cost of the project was approximately $6 million. For the years ended December 31, 2001 and 2000, $56 thousand and $139 thousand respectively of interest was capitalized in association with the new facility. 8. LEASE COMMITMENTS Lease obligations will require rent payments as follows: (Dollars in thousands) Minimum Period rentals 2002 $ 135 2003 115 2004 115 2005 100 2006 37 Remaining years -- ----- $ 502 ----- The leases generally provide for payment of property taxes, insurance, and maintenance costs by the Company. The total rental expense for all real property leases was $205 thousand, $480 thousand and $461 thousand for 2001, 2000, and 1999, respectively. During 2001, the Bank entered into a lease for the second floor space of the Bank's headquarters building with Heim & Associates, P.A., an accounting firm whose President is a Company and Bank Director. The initial lease term is for three years and commenced on July 1, 2001. The annual lease rate of $165 thousand was based on current market rates as determined by an independent commercial real estate services firm not affiliated with the Company or Bank. 9. DEPOSITS Major classifications of deposits are as follows: (Dollars in thousands) 2001 2000 1999 Demand, noninterest bearing $ 23,721 $ 13,752 $ 13,321 NOW accounts 19,142 21,892 20,750 Savings and money market accounts 40,043 31,155 25,413 Time deposits, $100,000 and over 14,003 9,923 6,795 Other time 47,975 41,298 38,815 -------- -------- -------- $144,884 $118,020 $105,094 -------- -------- -------- Time deposits mature as follows: Three months or less $ 9,975 $ 7,567 $ 8,289 Over three months to one year 29,990 32,998 29,866 Over one year 22,013 10,656 7,455 -------- -------- -------- $ 61,978 $ 51,221 $ 45,610 -------- -------- -------- At December 31, 2001, 2000, and 1999, time deposits with maturities in excess of five years totaled $113 thousand, $107 thousand and $109 thousand. 10. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS Securities sold under repurchase agreements are securities sold to the Bank's customers, at the customer's request, under a continuing "roll-over" contract that matures in one business day. The underlying securities sold are U.S. Treasury notes or U.S. Government agencies that are segregated in the Bank's correspondent safekeeping account from the Company's other investment securities. The following table presents certain information for repurchase agreements: (Dollars in thousands) 2001 2000 1999 Balance outstanding, at year end $7,674 $ 5,369 $ 8,497 Average balance during the year 7,395 9,851 9,970 Average interest rate during the year 3.22% 3.40% 3.24% Maximum month-end balance $9,581 $11,750 $13,027 11. PROFIT SHARING PLAN The Company has a profit sharing plan, qualifying under Section 401(k) of the Internal Revenue Code, for those employees who meet the eligibility requirements set forth in the plan. The plan does not require the Company to match the participants' contributions The Company contributions to the plan were $78 thousand in 2001, $24 thousand in 2000 and $35 thousand in 1999. 12. STOCK OPTIONS AND RESTRICTED SHARES In April, 1997, the Company adopted a stock option plan, covering 133,333 shares of common stock, intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code. The plan provided for granting options to purchase shares of the common stock to the officers and other key employees of the Corporation and the Bank. Options granted under this plan have ten-year expiration dates with vesting periods from immediate to five years. As of April 2000 no additional options shall be granted under this plan. During April 2000, a new incentive stock option plan was approved by the shareholders at the annual meeting. Under this plan the Company's compensation committee has discretionary authority to grant stock options, restricted stock awards, and deferred share awards to such employees and directors, including members of the committee. Under this plan, up to 266,666 shares of Company stock may be awarded under the direction of the committee. The new plan provides for the awards to vest over a five-year period of time. Options have a ten-year expiration period. A summary of the status of the Company's performance-based stock option plans follows: 2001 2000 1999 Options Outstanding Outstanding, beginning of year 132,666 115,333 91,466 Granted 135,981 53,333 77,333 Exercised (6,666) - (13,333) Forfeited (12,666) (36,000) (40,133) Outstanding, end of year 249,315 132,666 115,333 These options expire as follows: Weighted Average Exercise Options Expiration Date Price Vested Nonvested 2007 $4.96 9,732 2,933 2008 $7.22 4,133 7,865 2009 $3.53 18,666 27,999 2010 $3.23 9,332 37,330 2011 $3.64 - 131,325 - ------- Total 41,863 207,452 A summary of the status of the Company's restricted share awards follows: 2001 2000 1999 Restricted Shares Outstanding, beginning of year 17,665 - - Granted - 17,665 - Issued (6,197) - - Forfeited - - - Outstanding, end of year 11,468 17,665 - The Company applies APB No. 25 in accounting for the stock option plan. Accordingly, the Company does not recognize compensation expense for stock options granted. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), established new accounting and reporting standards for stock-based employee compensation plans. This standard defines a fair value based method for measuring compensation expense for stock-based plans to be recognized in the statement of income or disclosed in the notes to the financial statements. The weighted average fair value of options granted during 2001, 2000, and 1999 has been estimated using the Black-Scholes option-pricing model with the following assumptions: 2001 2000 1999 ---- ---- ---- Dividend yield 0.80% 0.00% 0.00% Risk-free interest rate 5.32% 6.46% 6.13% Expected volatility 30.0% 30.0% 22.00% Expected life in years 10 10 6 Had compensation been determined in accordance with the provisions of SFAS No. 123, the Company's net income and earning per share would have been reduced to the following pro forma amounts: 2001 2000 1999 ---- ---- ---- Net income As reported $ 506 $ 972 $ 690 Pro forma 459 941 671 Basic earnings per share As reported $ 0.17 $ 0.32 $ 0.22 Pro forma 0.15 0.31 0.22 Diluted earnings per share As reported $ 0.17 $ 0.32 $ 0.22 Pro forma 0.15 0.31 0.22 13. LINES OF CREDIT The Bank is a member of the Federal Home Loan Bank system and may borrow up to $16.7 million. If funded, this line is secured by one to four family residential mortgage loans held in the Bank's portfolio. In addition, the Bank has available secured and unsecured lines of credit of $8.3 million 14. PREFERRED STOCK The Company is authorized to issue up to 2,000,000 shares of preferred stock with a par value of $.01 per share. There were no preferred shares outstanding as December 31, 2001, 2000 or 1999. 15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED ------------------ (in thousands except per share amounts) December 31, September 30, June 30, March 31, 2001 Interest revenue $ 2,626 $ 2,711 $ 2,789 $ 2,775 Interest expense 1,032 1,215 1,219 1,127 Net interest income 1,594 1,496 1,570 1,648 Provision for credit losses - - - -- Net income 184 121 49 52 Comprehensive income 46 418 81 129 Earnings per share-basic 0.06 0.04 0.02 0.05 Earnings per share-diluted 0.06 0.04 0.02 0.05 2000 Interest revenue $ 2,731 $ 2,718 $ 2,575 $ 2,431 Interest expense 938 934 908 900 Net interest income 1,793 1,784 1,667 1,531 Provision for credit losses - - - 36 Net income 303 311 216 142 Comprehensive income 345 353 215 126 Earnings per share-basic 0.10 0.10 0.07 0.05 Earnings per share-diluted 0.10 0.10 0.07 0.05 1999 Interest revenue $ 2,392 $ 2,481 $ 2,407 $ 2,332 Interest expense 881 932 873 789 Net interest income 1,511 1,549 1,534 1,543 Provision for credit losses - - 27 405 Net income 185 227 218 60 Comprehensive income 175 224 215 42 Earnings per share-basic 0.06 0.07 0.07 0.02 Earnings per share-diluted 0.06 0.07 0.07 0.02
16. INCOME TAXES
The components of income tax expense are as follows: (Dollars in thousands) 2001 2000 1999 Current Federal $ 223 $ 510 $ 492 State - - 37 223 510 529 Deferred 43 (6) (153) $ 266 $ 504 $ 376 The components of the deferred taxes are as follows: Recognition of the benefit of the net operating loss carryover $ - $ 20 $ 5 Provision for credit losses - (12) (142) Revenues taxed not earned 36 1 6 Depreciation expense - - 7 Amortization and write down of intangible assets 7 (15) (29) Deferred tax benefit $ 43 $ (6) $ (153)
The components of the net deferred tax assets are as follows:
Deferred tax assets Allowance for credit losses $ 406 $ 406 $ 394 Revenue taxed not earned 82 118 118 Net operating loss and alternative minimum tax credit carryforward - - 21 Unrealized loss on securities available for - - 21 Total deferred tax assets 488 524 554 Deferred tax liabilities Depreciation 42 45 45 Intangible assets - - 15 Unrealized gain on securities available for sale 101 18 - Total deferred tax liabilities 153 63 60 Net deferred tax asset $ 335 $ 461 $ 494
The differences between federal income taxes and the amount reported by the Company follow:
2001 % 2000 % 1999 % Income before income taxes $ 772 $1,476 $1,066 Taxes computed at the federal income tax rate $ 262 34.0% $502 34.0% $363 34.0% Increases (decreases) resulting from State income taxes, net of federal benefit - - - - 4 0.4% Nondeductible expenses 4 0.5% 2 0.1% 2 0.2% Net operating loss carryforward - - - - 7 0.7% Income tax expense $ 266 34.5% $ 504 34.1% $ 376 35.3%
17. CAPITAL STANDARDS The Federal Reserve Board and the Federal Deposit Insurance Corporation have adopted risk-based capital standards for banking organizations. These standards require ratios of capital to assets for minimum capital adequacy and to be classified as well capitalized under prompt corrective action provisions. The capital ratios, and minimum capital requirements of the Company and the Bank, as of December 31, 2001 and for the Bank as of December 31, 2000 and 1999, are as follows:
Minimum capital To be well Actual adequacy capitalized (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio December 31, 2001 Total capital (to risk-weighted assets) Company $15,496 12.6% $9,809 8.0% Bank $15,496 12.6% $9,809 8.0% $12,261 10.0% Tier 1 capital (to risk-weighted assets) Company $13,659 11.1% $4,904 4.0% Bank $13,659 11.1% $4,904 4.0% $ 7,356 6.0% Tier 1 capital (to average assets) Company $13,659 8.4% $6,528 4.0% Bank $13,659 8.3% $6,528 4.0% $ 8,160 5.0% December 31, 2000 Total capital (to risk-weighted assets) $14,501 14.9% $7,789 8.0% $ 9,736 10.0% Tier 1 capital (to risk-weighted assets) $13,280 13.6% $3,894 4.0% $ 5,842 6.0% Tier 1 capital (to average assets) $13,280 9.7% $5,471 4.0% $ 6,838 5.0% December 31, 1999 Total capital (to risk-weighted assets) $13,487 15.0% $7,208 8.0% $ 9,010 10.0% Tier 1 capital (to risk-weighted assets) $12,357 13.7% $3,604 4.0% $ 5,406 6.0% Tier 1 capital (to average assets) $12,357 9.8% $5,035 4.0% $ 6,293 5.0%
Tier 1 capital consists of capital stock, surplus, and undivided profits. Total capital includes a limited amount of the allowance for credit losses. In calculating risk-weighted assets, specified risk percentages are applied to each category of asset and off-balance sheet items. Failure to meet the capital requirements could affect the Bank's ability to pay dividends and accept deposits and may significantly affect the operations of the Bank. 18. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of the Bank's financial instruments are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.
(Dollars in thousands) 2001 2000 1999 Carrying Fair Carrying Fair Carrying Fair December 31, Amount Value Amount Value Amount Value ------------------------------------------------------------------------------------------------------------------ Financial assets Cash and due from banks $ 3,632 $ 3,632 $ 3,177 $ 3,177 $ 5,665 $ 5,665 Federal funds sold 13,710 13,710 4,723 4,723 11,432 11,432 Investment securities (total) 28,995 28,995 34,283 34,283 23,769 23,769 Loans, net 113,116 113,151 87,411 87,360 81,198 81,001 Accrued interest receivable 885 885 1,152 1,152 822 822 2001 2000 1999 Carrying Fair Carrying Fair Carrying Fair December 31, Amount Value Amount Value Amount Value ------------------------------------------------------------------------------------------------------------------ Financial liabilities Noninterest-bearing deposits $ 23,721 $ 23,721 $ 13,752 $ 13,752 $13,321 $13,321 Interest-bearing deposits 121,163 121,495 104,268 104,266 91,773 92,191 Securities sold under agreements to repurchase 7,674 7,674 5,369 5,369 8,497 8,497 Accrued interest payable 30 30 48 48 22 22 ==================================================================================================================
The fair values of U.S. Treasury and Government agency securities are determined using market quotations. The fair value of fixed-rate loans is estimated to be the present value of scheduled payments discounted using interest rates currently in effect. The fair value of variable-rate loans, including loans with a demand feature, is estimated to equal the carrying amount. The valuation of loans is adjusted for possible credit losses. The fair value of interest-bearing checking, savings, and money market deposit accounts is equal to the carrying amount. The fair value of fixed-maturity time deposits is estimated based on interest rates currently offered for deposits of similar remaining maturities. 19. EARNINGS PER SHARE A summary of shares outstanding for basic and fully diluted earnings per share is as follows:
(In thousands) 2001 2000 1999 Weighted average shares outstanding, basic 2,990 3,049 3,066 Common stock equivalents - - - Average common shares and equivalents, fully diluted 2,990 3,049 3,066
20. PARENT COMPANY FINANCIAL INFORMATION The balance sheets and statements of income and cash flows for ANNAPOLIS BANCORP, INC. (Parent Company only) follow: (Dollars in thousands) Balance Sheets
December 31, 2001 2000 1999 Assets Cash and due from banks $ 1 $ 19 $ 361 Due from Bank - 29 - Investment in subsidiary 13,789 13,314 12,366 Deferred income taxes and other assets 70 - - Total assets $13,860 $13,362 $12,727 Liabilities and Stockholders' Equity Stockholders' equity Common stock $ 30 $ 23 $ 23 Capital surplus 12,796 12,881 13,192 Retained earnings (deficit) 833 425 (454) Accumulated other comprehensive income 201 33 (34) Total liabilities and stockholders' equity $13,860 $13,362 $12,727
Statements of Income
Years Ended December 31, 2001 2000 1999 Equity in undistributed income of subsidiary $ 308 $ 880 $ 690 Dividends from subsidiary 330 160 Expenses Compensation 56 55 Other operating 144 49 - Income before income taxes 438 936 690 Income tax benefit (68) (36) - Net income $ 506 $ 972 $ 690
Statements of Cash Flows
Years Ended December 31, 2001 2000 1999 Cash flows from operating activities Net income $ 506 $ 972 $ 690 Due from Bank 30 (30) - Deferred income taxes or other assets (70) - 374 Undistributed net income of subsidiary (638) (1,040) (690) Net cash provided (used) by operations (172) (98) 374 Cash flows from financing activities Dividends paid (98) (92) (70) Dividends received from Bank 330 160 - Proceeds from stock options exercised and restricted stock issued 50 - 50 Repurchase of common stock (128) (312) - Net cash used (provided) by financing operations 154 (244) (244) (20) Net (decrease) increase in cash (18) (342) 354 Cash and equivalents at beginning of year 19 361 7 Cash and equivalents at end of year $ 1 $ 19 $ 361