-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KFx5FQkJInadn6DhE3kdfLA1x5lbGpsqljTHaAIEegzT6F+tInor1tik88l/WvnJ Ciq8SFHl0dv/95N2NWQ2kg== 0000950168-99-001056.txt : 19990402 0000950168-99-001056.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950168-99-001056 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ANNAPOLIS NATIONAL BANCORP INC CENTRAL INDEX KEY: 0001041429 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 521648903 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-22961 FILM NUMBER: 99583350 BUSINESS ADDRESS: STREET 1: 180 ADMIRAL COCHRANE DRIVE SUITE 300 CITY: ANNAPOLIS STATE: MD ZIP: 21401 BUSINESS PHONE: 4102244455 MAIL ADDRESS: STREET 1: 180 ADMIRAL COCHRANE DRIVE SUITE 300 CITY: ANNAPOLIS STATE: MD ZIP: 21401 10KSB 1 ANNAPOLIS NATIONAL BANCORP, INC. SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-KSB Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended DECEMBER 31, 1998 Commission File No.: 0-22961 ANNAPOLIS NATIONAL BANCORP, INC. (Name of small business issuer in its charter) MARYLAND 52-1648903 (State or other jurisdiction of (I.R.S. Employer I.D. No.) incorporation or organization) 108 ADMIRAL COCHRANE DRIVE, SUITE 300, ANNAPOLIS, MARYLAND 21401 (Address of principal executive offices) (Zip Code) Issuer's telephone number: (410) 224-4455 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK PAR VALUE $0.01 PER SHARE (Title of class) THE NASDAQ SMALLCAP MARKET (Name of exchange on which registered) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for past 90 days. Yes: X No: Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B contained in this form and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB Yes: X No: Issuer's revenues for its fiscal year ended December 31, 1998 were $1,002,844. The aggregate market value of the voting stock held by non-affiliates of the registrant, I.E., persons other than directors and executive officers of the registrant is $7,644,564 and is based upon the last sales price as quoted on The Nasdaq Stock Market for March 26, 1999. The Registrant had 2,313,506 shares of Common Stock outstanding as of March 26, 1999. Transitional Small Business Disclosure Format. Yes: NO: X DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1998, ARE INCORPORATED BY REFERENCE INTO PART I AND PART II OF THIS FORM 10-KSB. PORTIONS OF THE PROXY STATEMENT FOR THE 1999 ANNUAL MEETING OF SHAREHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-KSB. INDEX PART I PAGE Item 1. Description of Business.............................. 3 Item 2. Properties .......................................... 3 Item 3. Legal Proceedings.................................... 4 Item 4. Submission of Matters to a Vote of Security Holders.. 4 Additional Item. Executive Officers of the Registrant................. 5 PART II Item 5. Market for Common Equity and Related Stockholder Matters.......................... 6 Item 6. Management's Discussion and Analysis or Plan of Operation................................. 6 Item 7. Financial Statements................................. 6 Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.................. 6 PART III Item 9. Directors, Officers, Promoters and Control Persons; Compliance with Section 16 of the Exchange Act....... 7 Item 10. Executive Compensation............................... 7 Item 11. Security Ownership of Certain Beneficial Owners and Management....................................... 7 Item 12. Certain Relationships and Related Transactions....... 7 Item 13. Exhibits and Reports on Form 8-K..................... 8 SIGNATURES PART I ITEM 1. DESCRIPTION OF BUSINESS The information relating to the description of business of the Registrant is incorporated herein by reference on page 29 of the Registrant's Annual Report to Shareholders. ITEM 2. PROPERTIES The executive offices of the Company and the Bank are located at 180 Admiral Cochrane Drive, Suite 300, Annapolis, Maryland 21401. The following table sets forth the location of and certain additional information regarding the offices of the Company and the Bank at December 31, 1998.
- ----------------------------------------------------------------------------------------------------- ORIGINAL NET BOOK VALUE YEAR OF PROPERTY OR LEASED YEAR OF LEASEHOLD LEASED/ OR LEASE IMPROVEMENTS AT OWNED LOCATIOACQUIRED EXPIRATION DECEMBER 31, 1998 - ----------------------------------------------------------------------------------------------------- Administration Leased 1995 2005 $ 49,963 Bestgate Leased 1997 2001 18,975 Edgewater Land Leased 1996 2006(1) 419,057 Cape St. Claire Leased 1995 2000(1) 50,480 Kent Island Leased 1990 1998(1) 0 Severna Park Leased 1996 2006(1) 18,067 - -----------------------------------------------------------------------------------------------------
(1) These leases may be extended at the option of the Company for periods ranging from three to twenty years. 3 ITEM 3. LEGAL PROCEEDINGS The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company's financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ADDITIONAL ITEM. The information relating to directors and named executive officers of the Registrant is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 1999 at pages 4 through 7. In addition, information concerning Executive Officers who are not directors is set forth below:
NAME AGE AT POSITION WITH THE COMPANY AND BANK - ---- 12/31/98 AND PAST FIVE YEARS EXPERIENCE -------- ------------------------------------------------- Russell J. Grimes, Jr. 42 Chief Financial Officer and Treasurer of the Company and Senior Vice President, Chief Financial Officer and Treasurer of the Bank. Prior to joining the Company in 1997, Mr. Grimes was Vice President, Treasurer and Chief Financial Officer of Annapolis Bancshares, Inc. and Bank of Annapolis from 1994 to 1996. Mr. Grimes held similar positions with First Virginia Banks, Inc. and American National Savings Bank, F.S.B. prior to 1994. Lori J. Mueller 35 Secretary of the Company and Senior Vice President, Administration and Marketing and Secretary of the Company. Ms. Mueller has been an officer of the Bank since 1990 and is responsible for retail banking, deposit account administration, marketing, employee benefits and general bank administration.
4 Robert E.Mann 40 Senior Vice President, Business Banking of the Bank. Mr. Mann has been an officer of the Bank since 1997 and is primarily responsible for business development and relationship management. He has held similar positions with Key Federal Savings Bank. Michael L. Irwin 39 Senior Vice President, Credit Administration of the Bank. Mr. Irwin has been an officer of the Bank since February 1997 and is primarily responsible for the administration of credit standards for the Bank. He held similar positions with Taneytown Bank and Trust. Kevin J. Barron 43 Senior Vice President, Real Estate Lending, of the Bank. Mr. Barron has been an officer of the Bank since December 1997, and is primarily responsible for the Bank's Commercial and Residential real estate lending activities and the Bank's Mortgage banking division. His prior thirteen years of related experience included ten years with Signet Bank, culminating as Senior Vice President in charge of real estate lending for the Baltimore and Washington regions. Prior to joining Signet, Mr. Barron served as a real estate lender at a Mellon Bank subsidiary for three years.
5 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information relating to the market for Registrant's common equity and related stockholder matters appears in the Registrant's 1998 Annual Report to Stockholders on page 22, and is incorporated herein by reference. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The above-captioned information appears under Management's Discussion and Analysis of Results of Operations and Financial Condition in the Registrant's 1998 Annual Report to Stockholders on pages 5 through 22 and is incorporated herein by reference. ITEM 7. FINANCIAL STATEMENTS The Consolidated Financial Statements of Annapolis National Bancorp, Inc. and its subsidiary, together with the report thereon by Rowles & Company, LLP for the year ended December 31 1998 appears in the Registrant's 1998 Annual Report to Stockholders on pages 23 through 44 and are incorporated herein by reference. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 6 PART III ITEM 9. DIRECTORS, OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16 OF THE EXCHANGE ACT The information relating to directors, officers, promoters and control persons is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 1999 at pages 4 through 7. In addition, the information concerning director Stanley J. Klos Jr. is set forth below. Stanley J. Klos Jr........ Mr. Klos, age 47, has been a practicing attorney in Anne Arundel and Prince George's counties since 1977. He is currently a principal of the Annapolis law firm of Klos & Selle, P.A. He has been a Director of the Company and the Bank since April 1997. Mr. Klos is active in community affairs and serves on the Boards of Directors of Leadership Anne Arundel, the American Heart Association, Anne Arundel County Chapter and the Anne Arundel County WMCA. ITEM 10. EXECUTIVE COMPENSATION The information relating to directors' and executive compensation is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 1999 at pages 7 through 10. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 1999 on pages 2 through pages 4. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information relating to certain relationships and related transactions is incorporated herein by reference to the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 1999 at page 11. 7 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: (1) Financial Statements Consolidated Financial Statements of the Company are incorporated by reference to the following indicated pages of the 1998 Annual Report to Stockholders PAGE Independent Auditors' Report.................................. 23 Consolidated Balance Sheet as of December 31, 1998 ............................................ 24 Consolidated Statements of Income for the years ended December 31, 1998 and 1997 ....................... 25 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998 and 1997................ 26 Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1997 ....................... 27-28 Notes to Consolidated Financial Statements.................... 29-44 The remaining information appearing in the Annual Report to Stockholders is not deemed to be filed as part of this report, except as expressly provided herein. (2) Exhibits The following exhibits are filed as part of this report. 3.1 Articles of Incorporation of Annapolis National Bancorp, Inc.* 3.2 Bylaws of Annapolis National Bancorp, Inc.* 8 4.0 Stock Certificate of Annapolis National Bancorp, Inc.* 10.1 Employment Agreement between Annapolis National Bancorp, Inc. and John W. Marhefka, Jr.* 10.2 Promissory Note between Annapolis National Bancorp, Inc. and Lawrence E. Lerner dated January 31, 1995* 10.3 Annapolis National Bancorp, Inc. Employee Stock Option Plan* 11.0 Computation of earnings per share (filed herewith) 13.0 Portions of 1998 Annual Report to Stockholders (filed herewith) 21.0 Subsidiary information is incorporated herein by reference to "Part I - Subsidiaries" 27.0 Financial Data Schedule (filed herewith) 99.0 1998 Proxy Statement** * Incorporated herein by reference to the Exhibits to Form SB-2, Registration Statement, filed on June 23, 1997 and any amendments thereto, Registration No. 333-29841. ** Incorporated herein by reference to the Form DEF 14A, Proxy Statement, filed on March 30, 1999, File Number 000-22961. (b) Reports on Form 8-K: None. 9 CONFORMED SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized. ANNAPOLIS NATIONAL BANCORP, INC. By: /s/ John W. Marhefka, Jr. __________________________________ John W. Marhefka, Jr. President, Chief Executive Officer and Director Date: March 30, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates stated.
NAME Title Date ---- ----- ---- /s/ John W. Marhefka, Jr. President, Chief Executive Officer and March 30, 1999 ________________________ Director (principal executive officer) John W. Marhefka, Jr. /s/ Russell J. Grimes, Jr. Senior Vice President, Treasurer and March 30, 1999 __________________________ Chief Financial Officer (principal Russell J. Grimes, Jr. accounting and financial officer) /s/ Albert Phillips Director March 30,1999 ________________________ Albert Phillips /s/ Stanley H. Katsef Director March 30, 1999 ________________________ Stanley H. Katsef /s/ Ronald E. Gardner Director March 30, 1999 ________________________ Ronald E. Gardner /s/ Stanley J. Klos, Jr. Director March 30, 1999 ________________________ Stanley J. Klos, Jr. /s/ Lawrence E. Lerner Director March 30, 1999 ________________________ Lawrence E. Lerner /s/ Richard M. Lerner Director March 30, 1999 ________________________ Richard M. Lerner /s/ Dimitri P. Mallios Director March 30, 1999 ________________________ Dimitri P. Mallios /s/ Lawrence M. Schwartz Director March 30, 1999 ________________________ Lawrence M. Schwartz
12 EX-11 2 EXHIBIT 11 Exhibit 11 Calculation of Earnings per Share
December 31 1998 1997 1996 ----------------------------------------- Weighted Average Shares Outstanding 2,312,422 1,691,301 1,478,972 Common Stock Equivalents 6,731 16,865 -0- Average Common Shares and Equivalents, Fully diluted 2,319,153 1,708,166 1,478,972 Net income $1,002,844 $1,084,197 $422,540 Basic Earnings per Share $0.43 $0.64 $0.29 Diluted Earnings per Share $0.43 $0.63 $0.29
13 EX-13 3 EXHIBIT 13 [ANNAPOLIS NATIONAL BANCORP, INC. LOGO] Annual Report 1998 ANNAPOLIS NATIONAL BANCORP, INC. A Year of Climbing the Ladder The process of restructuring Annapolis National Bancorp, Inc. (the "Company") and Annapolis National Bank (the "Bank") has been similar to climbing a tall ladder, with each step a milestone of accomplishment resulting from persistence, effort, and commitment. The year of 1998 will be remembered as a time when we climbed to new heights by making great strides toward reaching the top of the performance ladder. Following 1997's year of restructuring virtually every area of the Company and the Bank, 1998 was highlighted by record loan growth, record core earnings, a second consecutive million-dollar net income year, improved asset quality, efforts to enhance shareholder value, undertaking new initiatives, and a commitment to our future. Loan Growth Net Loans Receivable grew by 22.4% during the year to $86.9 Million as of December 31, 1998 from $71.0 Million at December 31, 1997. Loan growth was and continues to be a priority of ours because current period loan growth is what fuels future period earnings growth. We improved our balance sheet during 1998 by investing our excess liquidity in higher yielding loans. Net Loans Receivable grew to 72.2% of Total Assets as of December 31, 1998, up from only 58.7% of Total Assets a year earlier. As the only independent commercial bank headquartered in Annapolis, we attribute our loan growth to more and more customers seeing us as the preferred alternative to large, impersonal out-of-town banks. Earnings The Company's core earnings also rose to record levels. Income Before Taxes for the year ended December 31, 1998 rose by 384.1% to $1,525,000 from $315,000 in 1997. Additionally, the 1998 Income Before Taxes is nearly double the Company's previous best year, when it recorded $798,000 of pre-tax earnings in 1995. We are also pleased with the increasing 1998 core earnings trends of Total Interest Income (up 7.1% from 1997), Net Interest Income (up 7.1%), and Non Interest Income (up 13.8%). The Company's 1997 Net Income figures do not lend themselves to direct comparison because they include both $796,000 of one-time restructuring expenses related to a revised business strategy implemented by the Company, and a one-time tax benefit of $769,000 attributable to net operating loss carryforwards. As a result, Net Income of $1,003,000, or $0.43 per basic share, for the year ended December 31, 1998 decreased slightly from $1,084,000, or $0.64 per basic share, for the year ended December 31, 1997. The decrease in earnings per share was attributable in part to an additional 833,334 shares of common stock being issued in September, 1997 as a result of the successful completion of the Company's initial public stock offering. We are pleased that the Company was able to record its second consecutive million-dollar earnings year in 1998. 1 ANNAPOLIS NATIONAL BANCORP, INC. Asset Quality The quality of the Company's assets continued to climb up the performance ladder during 1998 as Non-Performing Assets were reduced to $808,000, or 0.67% of Total Assets as of December 31, 1998, down from $1,200,000, or 0.99% of Total Assets a year earlier. As a result of improving asset quality, the Provision for Credit Losses was reduced to $300,000 during 1998, down from $748,000 in 1997. Non-Performing Assets have now been reduced to their lowest level since the Company's inception, having been 2.13% of Assets at December 31, 1996, 2.32% at December 31, 1995, and 1.57% at December 31, 1994. Improving asset quality was a large part of the revised business strategy we began implementing more than two years ago and continues to be a top management priority. Shareholder Value We have continued to pursue initiatives designed to enhance shareholder value. Since our debut on the NASDAQ Stock Market in October of 1997, we have worked to ensure that our investors have liquidity in their shares. First and foremost, we have improved the fundamental operations of the Company, as noted above. Additionally, we have recruited additional market makers for our shares. The number of investment firms making a market in our stock by posting daily "bid" and "ask" prices for our shares increased from five at December 31, 1997 to eight at December 31, 1998. As a result, the trading volume of our shares reached an all-time high of 2,997 shares per day on average during 1998, assuring most of our investors the opportunity to divest of their shares with only a telephone call. Please be assured that our goal of building shareholder value remains at the forefront of our decision making. New Initiatives & Our Commitment to the Future We have continued to undertake new initiatives designed to improve the Company now and position it to attain higher rungs on the ladder in the future. We strengthened our management team during 1998 by adding Robert E. Mann as Senior Vice President of Business Banking and Jo Ann Pyles as Vice President of Mortgage Banking. . . both seasoned local market professionals who have added experienced leadership to the solid nucleus which we built in 1997. We have assembled a dedicated and enthusiastic management team which serves the Company with pride and efficiency. During 1998, we reinforced our commitment to the local community by purchasing a premier parcel of land on Bestgate Road, directly across from the Annapolis Mall, which will become home to our new corporate headquarters and a full-service, state-of-the-art banking facility. We expect to begin construction in the spring of 1999. When completed, this new headquarters facility will accomplish multiple goals of greatly increasing our market presence in Annapolis, lowering our operating expenses, and joining our executive offices with a retail banking operation, allowing our customers to gain easier access to senior management decision makers. 2 ANNAPOLIS NATIONAL BANCORP, INC. We invested considerable time and effort during 1998 conducting a major computer system conversion which was completed in January of 1999. Annapolis National Bank's customers now benefit from an enhanced level of personal service and an array of state-of-the-art products which we were simply unable to offer with our prior system, including home based PC banking, Visa Check Cards, and a new line of checking account products. Additionally, this conversion has been instrumental in preparing the Bank for Year 2000 issues. We anticipate that our system's Year 2000 compliance will be fully tested and operational by June 30, 1999. Experts rank the financial services industry as "Number One" for Year 2000 readiness. You may be assured that Annapolis National Bank will continue to operate as an efficient and profitable provider of financial services. That is our commitment to you as our valued shareholder. Further up the Ladder 1998 was a year when we climbed to new heights in many areas. We have carved a niche in the highly competitive local banking market by adhering to a philosophy of providing quality financial products and first rate personal service to our increasing customer base. Consolidation within the banking industry has created a wealth of opportunity for us to continue to grow and prosper as a locally owned and managed community bank. We are succeeding in attracting many new customers who prefer to bank with one of the few remaining local banks, giving added meaning to our slogan "Your Hometown Bank". However, we still have much work to do before we feel that we have reached the top of the ladder. . . a place where we can feel that we have been successful in completing the repositioning of the Company which we began in 1997. . . a place where we become recognized as the premier community bank in our market in terms of both shareholder returns and customer satisfaction. Although we became a better Company in 1998 than we were in 1997, we remain focused on stepping up to the top of the ladder one rung at a time during 1999 and beyond. We are committed to building Annapolis National into a market force which is a valuable asset to its stockholders, its customers, and its local community. We appreciate your confidence and support. /s/ John W. Marhefka, Jr. /s/ Albert Phillips _________________________ _____________________ John W. Marhefka, Jr. Albert Phillips Chief Executive Officer Chairman of the Board March 26, 1999 This document constitutes a Year 2000 Readiness Disclosure Document. 3 ANNAPOLIS NATIONAL BANCORP, INC. Corporate Profile ANNAPOLIS NATIONAL BANCORP, INC., formerly 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 Annapolis National Bank, a federally insured community oriented bank and the only independent commercial bank 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 issued by or guaranteed by the federal government. 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's lending operations are centered in Anne Arundel County, but extend throughout Central 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'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 59 full time and 5 part time individuals at December 31, 1998. The Bank continually evaluates new products, and implements such new products as deemed appropriate by management. 4 ANNAPOLIS NATIONAL BANCORP, INC. 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 National Bancorp, Inc. on a consolidated basis with its wholly owned subsidiary, Annapolis National Bank, for the periods presented, and should be read in conjunction with the consolidated statements and the related notes thereto appearing elsewhere in this annual report. The Company reported net income for 1998 of $1,002,844, a 7.50% decrease over 1997 earnings of $1,084,197. The decrease in 1998 earnings was primarily due to the Company recording federal income tax expense of $522,000, compared to an income tax benefit in 1997 of $769,000, which was partially offset by restructuring expenses of $796,000. Basic earnings per share decreased to $0.43 per share compared to $0.64 per share in 1997. The decrease in earnings per share was due in part to an additional 833.334 shares issued as a result of the Company's stock offering that closed in September 1997. 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 $5.9 million for 1998, an increase of $393,000 or 7.10% compared to $5.5 million in 1997. Total assets were $120.5 million as of December 31, 1998, a .30% decrease over the December 31, 1997 total assets of $120.8 million. The Company's return on average assets was 0.82% and 0.99% at December 31, 1998, and 1997 respectively. The Company's return on average equity was 8.64% and 14.83% at December 31, 1998, and 1997 respectively. The decrease in the return on average equity for 1998 was mainly due to the $4.3 million average increase in stockholder's equity from 1997 due to net proceeds from the stock offering of $3.5 million and $1.0 million of net earnings for 1998. At December 31, 1998, the Bank's loan portfolio totaled $88.4 million. Of this amount, $26.9 million or 30.43% were commercial loans, $29.4 million or 33.25% were commercial real estate loans, $17.9 million or 20.22% were construction loans, $8.6 million or 9.75% were one- to four-family residential mortgage loans, and $3.2 million or 3.64% were home equity loans, and $2.4 million or 2.71% were consumer and other loans. 5 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued The following table shows selected consolidated financial highlights for the Company at and for the five years ended December 31, 1994, through December 31, 1998. Selected Consolidated Financial Data At and for year ended December 31, (Dollars in thousands, except per share data)
- ---------------------------------------------------------------------------------------------------------------------------------- Selected Financial Data 1998 1997 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------------- Total assets $ 120,457 $ 120,827 $ 100,227 $ 95,296 $ 75,859 Total loans, net 86,924 70,985 68,800 56,036 56,650 Total deposits 100,742 96,062 87,106 82,096 66,118 Securities sold under agreement to repurchase 7,174 13,306 6,345 6,970 4,741 Note payable -- -- 1,004 925 4,004 Stockholders' equity 12,091 11,087 5,471 5,046 760 Selected Operating Data Interest income $ 9,813 $ 9,161 $ 8,021 $ 7,651 $ 5,552 Interest expense 3,890 3,630 3,362 3,099 2,260 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income 5,923 5,531 4,659 4,552 3,292 Provision for credit losses 300 748 452 318 300 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for credit losses 5,623 4,783 4,207 4,234 2,992 Restructuring expense -- 796 -- -- -- Non-interest income 867 762 587 521 394 Non-interest expense 4,965 4,434 4,371 3,957 3,313 - ---------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 1,525 315 423 798 73 Income tax benefit (expense) (522) 769 -- (6) -- Net income before minority interest in earnings of consolidated subsidiary 1,003 1,084 423 792 73 Minority interest in earnings of consolidated subsidiary -- -- -- -- 55 - ---------------------------------------------------------------------------------------------------------------------------------- Net income $ 1,003 $ 1,084 $ 423 $ 792 $ 18 - ---------------------------------------------------------------------------------------------------------------------------------- Key Financial Ratios and Other Data Return on average assets 0.82% 0.99% 0.44% 0.94% 0.03% Net income divided by average assets Return on average equity 8.64% 14.83% 7.98% 19.26% 1.97% Net income divided by average equity Equity to asset ratio (1) 9.54% 6.70% 5.46% 4.88% 1.30% Average equity divided by average assets Basic earnings per share $0.43 $0.64 $0.29 $0.57 $0.03 Book value per share $5.23 $4.79 $3.70 $3.41 $1.40 Tangible book value per share $5.17 $4.70 $3.17 $2.78 $(0.58) Number of shares outstanding 2,313,506 2,312,306 1,478,972 1,478,972 541,300 Efficiency ratio (2) 73.19% 83.11% 83.34% 78.00% 89.88% Interest rate spread 4.52% 4.88% 4.68% 5.29% 4.74% Net interest margin 5.11% 5.37% 5.10% 5.73% 4.98% Risk based capital ratio--Tier 1 12.70% 15.16% 7.46% 7.68% (0.12%) Risk based capital ratio--Total 14.00% 16.42% 8.68% 8.83% 1.13% - ----------------------------------------------------------------------------------------------------------------------------------
(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. 6 ANNAPOLIS NATIONAL BANCORP, INC. 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, 1998, 1997 and 1996. 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 which 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 4.52% for the year ended December 31, 1998, compared to 4.88% at December 31, 1997. Consolidated Average Balances, Yields and Rates
- --------------------------------------------------------------------------------------------------------------------------------- Years Ended December 31, 1998 December 31, 1997 - --------------------------------------------------------------------------------------------------------------------------------- Average Yield/ Average Yield/ balance Interest RATE balance Interest rate - --------------------------------------------------------------------------------------------------------------------------------- Assets Interest Earning Assets: Federal Funds Sold and other overnight investments $ 21,999 $ 1,195 5.43% $ 14,447 $ 776 5.37% Investment Securities 16,644 963 5.79% 16,253 937 5.77% Loans 77,245 7,655 9.91% 72,385 7,448 10.29% - --------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 115,888 9,813 8.47% 103,085 9,161 8.89% - --------------------------------------------------------------------------------------------------------------------------------- Noninterest Earning Assets Cash and Due From Banks 3,612 3,830 Other Asets 2,186 2,176 - --------------------------------------------------------------------------------------------------------------------------------- Total Assets 121,686 $109,091 Liabilities and Stockholders' Equity Interest Bearing Deposits Now Accounts $ 18,488 $ 361 1.95% $15,475 $ 324 2.09% Money Market Accounts 14,427 496 3.44% 14,088 484 3.44% Savings Accounts 13,374 392 2.93% 12,005 367 3.06% Certificates of Deposit 40,844 2,272 5.56% 37,829 2,081 5.51% Repurchase Agreements 11,330 369 3.26% 10,570 315 2.98% Note Payable 0 0 0% 632 60 9.49% - --------------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 98,463 3,890 3.95% 90,599 3,631 4.01% - --------------------------------------------------------------------------------------------------------------------------------- Noninterest Bearing Liabilities Demand deposit accounts 11,118 10,510 Other Liabilities 500 668 Stockholders' Equity 11,605 7,314 - --------------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity 121,686 $109,091 - --------------------------------------------------------------------------------------------------------------------------------- Interest rate spread 4.52% 4.88% - --------------------------------------------------------------------------------------------------------------------------------- Ratio of interest earning assets to interest bearing liabilities 117.70% 113.78% Net interest income and net interest margin $ 5,923 5.11% $5,531 5.37% - ---------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------- December 31, 1996 - ------------------------------------------------------------------------------------- Average Yield/ balance Interest rate - ------------------------------------------------------------------------------------- Assets Interest Earning Assets: Federal Funds Sold and other overnight investments $10,935 $ 565 5.17% Investment Securities 18,339 975 5.32% Loans 62,144 6,481 10.43% - ------------------------------------------------------------------------------------- Total interest-earning assets 91,418 8,021 8.77% - ------------------------------------------------------------------------------------- Noninterest Earning Assets Cash and Due From Banks 3,210 Other Asets 2,424 - ------------------------------------------------------------------------------------- Total Assets $97,052 Liabilities and Stockholders' Equity Interest Bearing Deposits Now Accounts $14,583 $ 363 2.49% Money Market Accounts 15,819 558 3.53% Savings Accounts 10,995 354 3.22% Certificates of Deposit 32,207 1,776 5.51% Repurchase Agreements 7,762 232 2.99% Note Payable 848 79 9.32% - ------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 82,214 3,362 4.09% - ------------------------------------------------------------------------------------- Noninterest Bearing Liabilities Demand deposit accounts 9,158 Other Liabilities 383 Stockholders' Equity 5,297 - ------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $97,052 - ------------------------------------------------------------------------------------- Interest rate spread 4.68% - ------------------------------------------------------------------------------------- Ratio of interest earning assets to interest bearing liabilities 111.20% Net interest income and net interest margin $4,659 5.10% - -------------------------------------------------------------------------------------
7 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued 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 decreased by .30% during 1998 to $120.5 million from $120.8 million at December 31, 1997. Total deposits and securities sold under agreements to repurchase, the Company's primary source of funds, decreased $1.5 million or 1.35% to $107.9 million at December 31, 1998, from $109.4 million at December 31, 1997. Time deposits comprise the largest portion of the Bank's total deposits, totaling $37.6 million or 37.3% of the Bank's total deposits at December 31, 1998, compared to $41.7 million or 43.4% in 1997. Savings and Money Market accounts totaled $30.8 million or 30.5% of the Bank's total deposits at December 31, 1998, compared to $24.7 million or 25.7% in 1997. NOW accounts total $21.1 million or 20.9% and $19.3 million or 20.1% of total deposits at December 31, 1998 and 1997, respectively. Demand, non interest bearing accounts total $11.3 million or 11.2% of total deposits at December 31, 1998 and $10.3 million or 10.8% at December 31, 1997. Securities sold under agreements to repurchase decreased $6.1 million to $7.2 million from $13.3 million at December 31, 1997, respectively. The Company's primary use of funds are for loans and investments. Loans, less deferred fees and discounts and the allowance for loan losses, increased by $15.9 million or 22.4% to $86.9 million at December 31, 1998, from $71.0 million a year earlier. The loan growth was mainly concentrated in real estate related loans which increased 51.1% over 1997 and was partially offset by a decrease of 12.8% in commerical loans as the Company continues to benefit from the revised business strategy implemented in 1997. 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 income and interest expense and is generally impacted 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 found on page 9 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, 1998, was $5.9 million, representing an increase of $392,000 or 7.08% from net interest income of $5.5 million for the year ended December 31, 1997. The increase in net interest income is due primarily to an increase in the balance of interest earning assets, offset in part by an increase in interest bearing liabilities, and is largely responsible for the Company's profitability. The net yield on interest earning assets was 5.11% and 5.37% for the years ended December 31, 1998, and 1997 respectively. Net interest income for 1998 includes $18,439 of interest collected on cash basis related to loans on a non accrual status, compared to $98,000 of interest collected on various non accrual loans in 1997. 8 ANNAPOLIS NATIONAL BANCORP, INC. Rate/Volume Analysis (Dollars in thousands)
- -------------------------------------------------------------------------------------------------------------------------------- 1998 vs 1997 1997 vs 1996 - -------------------------------------------------------------------------------------------------------------------------------- Increase or Due to Change in rate/ Increase or Due to Change in rate/ (decrease) Volume Rate volume (decrease) Volume Rate volume - -------------------------------------------------------------------------------------------------------------------------------- Interest Income On: Loans $207 $500 $(275) (18) $ 967 $1,068 $(87) (14) Investment Securities 26 23 3 -- (38) (111) 82 (9) Federal Funds Sold and other overnight investments 419 406 9 4 211 181 22 7 - -------------------------------------------------------------------------------------------------------------------------------- Total interest income 652 929 (263) (14) 1,140 1,138 17 (16) Interest Expense On: Now Accounts 37 63 (22) (4) (39) 22 (58) (1) Money Market Accounts 12 12 -- -- (74) (61) (15) 2 Savings Accounts 25 42 (15) (2) 13 33 (18) (2) Certificates of Deposit 192 166 24 2 304 310 (5) (1) Repurchase Agreements 54 23 29 2 83 84 (1) -- Note Payable (60) (60) -- -- (19) (20) -- 1 - -------------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 260 246 16 (2) 268 368 (97) (3) - -------------------------------------------------------------------------------------------------------------------------------- Net Interest Income $392 $683 $(279) (12) $ 872 $ 770 $114 (13) - --------------------------------------------------------------------------------------------------------------------------------
Interest Income The Company's interest income increased $652,000 or 7.12% to $9.8 million at December 31, 1998, compared to $9.2 million at December 31, 1997. The increase in interest income can be attributed to an increase of $12.8 million in average earning assets, and was partially offset by a decrease in the average yield on earning assets to 8.47% in 1998 compared to 8.89% in 1997. Average loans increased $4.9 million or 6.71%, and average federal funds and other overnight investments increased $7.6 million or 52.2% which contributed to the increase in interest income. Interest Expense The Company's interest expense increased $260,000 or 7.16% to $3.9 million at December 31, 1998, compared to $3.6 million at December 31, 1997. The increase in interest expense can be attributed to an increase of $7.9 million in average interest bearing liabilities offset by a decrease in the cost of interest bearing liabilities to 3.95% at December 31, 1998, compared to 4.01% in 1997. The increased growth in deposits were used to fund loan growth and for general liquidity purposes. Noninterest Income The Company's primary source of non-interest income are fees charged for services and gains and fees recognized on the sale of residential mortgage loans. Non-interest income increased $105,000 or 13.78% to $867,000 at December 31, 1998, as compared to $762,000 in 1997. The growth in non-interest income was primarily the result of a one time gain of $125,000 relating to the Company's waiving its exclusive right to operate its branch office in the Edgewater Shopping Center. 9 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Noninterest Expense Noninterest expense decreased $264,000 or 5.04% to $5.0 million at December 31, 1998, compared to $5.2 million at December 31, 1997. The decrease in noninterest expense was primarily due to a one time restructuring expense of $796,000 during 1997, resulting from implementation of a revised business strategy by the Board of Directors and senior management in February 1997. The decrease in expense includes a reduction of approximately $471,000 relating to intangible assets acquired in the June 1990 acquisition of a failed savings and loan association, severance payments and benefits of $102,000, branch consolidation expense of $119,000, and $50,000 of other expense. Personnel expense increased $371,000 or 17.57% due primarily to incentive compensation paid to originate loans and additional staff relating to the mortgage banking and commercial real estate departments.The increase in compensation expense corresponds to the increase in net loan growth of 22.45% in 1998 as the Company implements the revised business strategy that began in 1997. Occupancy expense decreased $20,000 or 2.4% due to the consolidation of two branch locations to a single Annapolis branch in the third quarter of 1997. Other expense increased $109,000 or 8.39% due mainly to additional data processing expense of approximately $98,000 or 18.7%. This was the result of a higher volume of transaction accounts and additional expense related to the conversion of the bank's core data processing that was completed in January 1999. Amortization of intangible assets decreased $15,000 or 14.85% due to the accelerated write off of the intangible assets related to the restructuring expenses incurred in 1997. The amortization recorded for the year ended December 31, 1998, reflects a lower intangible asset balance amortized in 1997 and subsequent years. The remaining intangible asset balance of $130,000 relates to the core deposit premium paid for deposits and still retained by the Bank at December 31, 1998. Provision for Income Taxes The Company and the Bank file consolidated federal income tax returns and separate Maryland income tax returns. The Company paid $522,000 in federal income tax in 1998 and paid no state income tax in 1998. Financial Analysis For The Years Ended December 31, 1997 and 1996 Net income for the year ended December 31, 1997, totaled $1,084,197 or $0.64 per basic share compared to $422,540 or $0.29 per basic share for the year ended December 31, 1996. Net interest income increased $871,000 or 18.69% at December 31, 1997, to $5.5 million from $4.7 million at December 31, 1996. This increase was the result of an increase in interest income of $1.2 million which was partially offset by an increase in interest expense of $269,000. Interest income increased $1.2 million or 15.0% in 1997 compared to 1996, primarily due to an increase in the average balance of loans outstanding. Average loans outstanding, net of unearned income, increased $10.2 million or 16.48% during 1997. In addition, the average yield on loans decreased to 10.29% in 1997 from 10.43% in 1996. Interest expense increased $269,000 in 1997 as compared to 1996. The increase generally reflected an increase in the balance of interest bearing liabilities to $90.6 million from $82.2 million at December 31, 1996. During this period the average cost of interest bearing liabilities decreased to 4.01% at December 31, 1997, from 4.09% at December 31, 1996. Non-interest income increased $175,000 or 29.81% during 1997 as compared to 1996. The increase was attributable to an increase in service fees and other charges of $127,000 or 21.60% due to growth in the Bank's deposit base. Non-interest expense increased $858,000 or 19.62% to $5.2 million at December 31, 1997, 10 ANNAPOLIS NATIONAL BANCORP, INC. from 4.4 million at December 31, 1997. The primary reason for the increase relates to a one time restructuring expense of $796,000 during 1997, resulting from implementation of a revised business strategy by the Board of Directors and senior management in February 1997. The increase in expense includes a reduction of approximately $471,0000 relating to intangible assets acquired in the June 1990 acquision of a failed savings and loan association, severence payments and benefits of $102,000, branch consolidation expense of $119,000 and $50,000 of other expense. Personnel expense decreased $108,000 or 4.88% due to general staff reductions. Occupancy expense increased $104,000 or 14.23% due to scheduled rate increases, the opening of the Bank's Severna Park branch Office in September 1996 and additional maintenance expenses. Other expense increased $127,000 or 10.83% due mainly to additional data processing expense of approximately $111,000 or 26.6%. Year 2000 Issues As a financial institution, the Company is dependent on computer systems and applications to conduct its business. The year 2000 (Y2K) issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. Many of the Company's computer programs that are date sensitive may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculation causing disruption of operations, including among other things, a temporary inability to process transactions or engage in normal business activities for both the Company and its customers who rely on its financial products and services. The Company is actively engaged and is currently executing certain critical steps designed to make its computer systems, applications and facilities Y2K ready. The steps include: (i) awareness; (ii) assessment (iii) renovation (iv) validation and (v) implementation. During the awareness phase, the Company identified the project team and responsibilities, prepared and allocated the project budget, defined the project scope and established program and management policies. This phase although complete continues to be reviewed. The assessment phase which entailed an inventory of software, hardware, vendors, material customers, and facilities has been completed. The renovation phase was completed and the Company used internal resources to test all major mission critical systems (deposits, loans, general ledger) which are provided by an outside service bureau. The Company completed the process of converting these mission critical systems to a new service bureau on January 25, 1999. In conjunction with the conversion, the bank has implemented a new year 2000 ready system. This new service bureau platform is currently in the testing phase, and was approximately 50% complete as of December 31, 1998, with testing targeted to be completed by March 31, 1999. Completion of the renovation process for the Bank's new internal systems was completed by January 31, 1999. Another mission critical system is the Federal Reserve software system, which was tested in November 1998. The hardware and telecommunications software supporting this software system was renovated in October 1998. The validation phase will use test strategies that include testing of internal systems as they relate to each other, and testing external interfaces with business partners. The final phase is implementation which involves the replacement of the hardware or software that is not compliant or requires updates. The bank anticipates completing this phase by June 30, 1999. An institution wide contingency plan has been developed with Y2K issues incorporated as part of the business contingency planning. These plans, which are intended to enable the Company to continue to operate to the extent they can safely, include performing certain processes manually, repairing or obtaining replacement systems, and changing suppliers. The Company believes, however, that due to the widespread nature of the potential Y2K issues, the contingency planning process is an ongoing one which will require further modification as the Company obtains additional information regarding the Company's internal systems and equipment during the renovation and testing phases of its Y2K program and the status of third party Y2K readiness. The Company budgeted $675,000 for the costs to convert the third party data processing system and internal data processing systems including expenses relating to the Y2K effort. To date, the 11 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Company has incurred approximately $625,000 towards this project. All costs to date and any remaining costs related to Y2K will be funded through operating cash flows. The Company does not expect these costs to have a material effect on its operations. The Company believes that conversions, renovations and modifications of its internal systems and equipment will allow it to be Y2K ready in a timely manner. There can be no assurances however, that the Company's internal systems or equipment or those of third parties on which the Company relies will be Y2K ready in a timely manner or that the Company's or third parties contingency plans will mitigate the effects of non-compliance. The Company is part of a regulated industry which has issued standards for Y2K and is conducting audits to ensure compliance with Y2K guidelines. The Company believes its most likely worst case scenario is that customers could experience some manual processes or an inability to access their cash immediately. Although, there can be no assurances, the Company does not believe this scenario will occur, and is assessing the effect of such scenarios. The Company does not expect that this would have a material averse effect on the Company's financial position, liquidity and results of operations. The preceding Y2K issue discussion contains various forward looking statements which represent the Company's belief or expectations regarding future events. When used in the Y2K discussion, the words "believes," "expects," "estimates" and similar expressions are intended to identify forward-looking statements. Forward looking statements include, without limitation, the Company's expectations as to when it will complete the renovation and testing phase of its Y2K program as well as its Y2K contingency plans, its estimated cost of achieving Y2K readiness; and the Company's belief that its internal systems and equipment will be Y2K compliant in a timely manner. 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 37.35% of the deposit portfolio at December 31, 1998. Core deposits, considered to be non-interest bearing and interest bearing demand deposit accounts, savings deposits and money market accounts accounted for 62.65% of the deposit portfolio at December 31, 1998. This represents a 6.09% increase over the core deposits of 56.56% at December 31, 1997. 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 accept brokered deposits and held no such deposits at December 31, 1998. 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 weekly 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 Deposits. Jumbo certificates of deposit are accounts of $100,000 or more. These accounts totaled $4.7 million at December 31, 1998 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, 1998. 12 ANNAPOLIS NATIONAL BANCORP, INC.
- -------------------------------------------------------------------------------------------------------- Greater Than Greater Than Three Months Three Months Six Months to Greater Than or Less to six months one year one Year Total - -------------------------------------------------------------------------------------------------------- (Dollars in thousands) $1,335 $1,357 1,843 $202 $4,737 - --------------------------------------------------------------------------------------------------------
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, 1998, and 1997, the average cost of these borrowings were 3.26% and 2.98% respectively. The Bank maintains a borrowing line with the Federal Home Loan Bank (FHLB), and may borrow up to $5.0 million under a reverse repurchase line established with a local correspondent commercial bank. In addition, the Bank has the ability to borrow directly from the Federal Reserve Bank discount window. At December 31, 1998, 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 in response to such movements. The Bank attempts to manage fluctuations in interest rates by matching the maturities of its interest earning assets and interest bearing liabilities. The Bank's current strategy to manage its sensitivity to interest rate fluctuations is to emphasize short term and adjustable rate loans and to invest in short term U.S. Government agency securities with maturities or call dates of two years or less. Additionally, all of the loans in the Bank's portfolio are either adjustable or short term fixed rate loans with terms to maturity of 30 days to 30 years. The Bank does not engage in long term fixed rate portfolio lending. Any long term fixed rate loans made by the Bank are sold in the secondary market. The following table summarizes the anticipated maturities or repricing of the Company's interest earning assets and interest bearing liabilities as of December 31, 1998, 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. The Company's goal is generally to maintain a balanced cumulative gap position for the period of one year or less 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, 1998, and does not give effect to prepayment or extension of loans as a result of changes in general market rates. 13 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Interest Sensitivity Gap Analysis (Dollars in thousands) December 31, 1998
- -------------------------------------------------------------------------------------------------------------------------------- After three Within but within After one three twelve but within After months months five years five years Total - -------------------------------------------------------------------------------------------------------------------------------- Assets Interest sensitivity gap analysis Federal funds sold and other overnight investments $10,284 $ -- $ -- $ -- $ 10,284 Investment securities (1) 6,491 5,018 2,002 980 14,491 Loans (2), (3) 50,594 12,799 19,357 5,126 87,876 - -------------------------------------------------------------------------------------------------------------------------------- $67,369 $17,817 $21,359 $ 6,106 $112,651 - -------------------------------------------------------------------------------------------------------------------------------- Liabilities Interest-bearing deposits NOW Accounts $21,050 $ -- $-- $ -- $ 21,050 Savings Accounts 14,330 -- -- -- 14,330 Money Market Accounts 16,437 -- -- -- 16,437 Certificate of deposits (4) 12,516 21,181 3,819 104 37,620 Repurchase Agreements 7,174 -- -- -- 7,174 - -------------------------------------------------------------------------------------------------------------------------------- $71,507 $21,181 $ 3,819 $ 104 $ 96,611 - -------------------------------------------------------------------------------------------------------------------------------- Interest sensitivity gap $(4,138) $(3,364) $17,540 $ 6,002 $ 16,040 Cumulative interest sensitivity gap $(4,138) $(7,502) $10,038 $16,040 Cumulative interest sensitivity gap as a percentage of total assets (3.44)% (6.23)% 8.33% 13.32% 13.74% - --------------------------------------------------------------------------------------------------------------------------------
(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 $505,576. (4) Certificates of deposits scheduled by contractual maturities. Investment Portfolio At December 31, 1998, the Bank's investment portfolio, which totaled $15.2 million, consisted of U.S. government agency securities and one mortgage-backed security. Of this amount, $13.5 million, or 88.9%, were U.S. government agency obligations. The Company invests primarily in state tax exempt U.S. Government Agency securities in order to minimize its state income tax liability. The company did not pay state income tax in 1998 or 1997. The mortgage-backed security totaled $980,000 which was issued by Freddie Mac. Additionally, the Company owns $337,800 in stock of the Federal Reserve Bank of Richmond and $361,400 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, 1998, approximately 75.8% of the investment securities portfolio had maturities of one year 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, nongovernment debt 14 ANNAPOLIS NATIONAL BANCORP, INC. 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, 1998, 100% of the investment portfolio was classified available-for-sale. The composition of securities at December 31, for each of the past four fiscal years was:
- ------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------- Available-for-Sale U.S. Treasury $-- $ 1,974 $ 9,157 $16,186 U.S. Agency 13,511 12,991 996 978 Mortgage-backed 980 980 987 984 Equity securities 699 620 194 175 - ------------------------------------------------------------------------------------------------- Total 15,190 16,565 11,334 18,323 Held-to-Maturity U.S. Treasury -- 3,975 1,993 -- - ------------------------------------------------------------------------------------------------- Total -- 3,975 1,993 -- - ------------------------------------------------------------------------------------------------- Total Securities $15,190 $20,540 $13,327 $18,323 - -------------------------------------------------------------------------------------------------
The following table presents maturties and weighted average yields for investments in available for sale and held to maturity securities.
December 31, 1998 (Dollars in thousands) - ------------------------------------------------------------------------------------------------------------------------ YEARS TO MATURITY WITHIN WITHIN WITHIN 1 TO 5 5 TO 10 ONE YEAR YEARS YEARS AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD - ------------------------------------------------------------------------------------------------------------------------ Available-For-Sale U.S. Treasury $11,509 5.50% $2,002 5.64% $ -- --% U.S. Government Agency -- -- -- -- -- --% Mortgage-backed Securities -- -- -- -- 980 5.80% Total Debit Securities $11,509 5.49% $2,002 5.33% $980 5.80% - ------------------------------------------------------------------------------------------------------------------------ Held-To-Maturity U.S. Treasury $ -- --% $ -- --% $ -- --% U.S. Government Agency $ -- --% $ -- --% $ -- --% Mortgage-backed Securities Total $ -- --% $ -- --% $ -- --% - ------------------------------------------------------------------------------------------------------------------------
December 31, 1998 (Dollars in thousands) - ------------------------------------------------------------------------------------ GREATER THAN TEN YEARS YIELD TOTAL - ------------------------------------------------------------------------------------ Available-For-Sale U.S. Treasury $1--11 --% $13,511 U.S. Government Agency 1--11 --% -- Mortgage-backed Securities 1--11 --% 980 Total Debit Securities $1--11 .80--% $14,491 - ------------------------------------------------------------------------------------ Held-To-Maturity U.S. Treasury $1--11 .80--% $-- U.S. Government Agency $1--11 .8--% $-- Mortgage-backed Securities Total $1--11 .8--% $-- - ------------------------------------------------------------------------------------
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. 15 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued 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) - ---------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent - ---------------------------------------------------------------------------------------------------------------------------------- Commercial loans $26,895 30.43% $30,860 42.61% $30,801 43.80% $27,917 48.94% $27,025 47.14% Real estate: Commercial 29,373 33.25% 20,448 28.34% 17,845 25.65% 13,553 23.92% 5,601 9.77% Construction 17,875 20.22% 10,191 13.91% 10,173 14.62% 7,937 14.01% 8,672 15.12% One-to four-family 8,620 9.75% 5,232 7.25% 7,002 10.07% 4,391 7.75% 13,027 22.32% Home equity 3,219 3.64% 3,393 4.70% 1,744 2.51% 1,197 2.11% 1,016 1.77% Consumer loans 2,400 2.71% 2,305 3.19% 2,332 3.35% 1,848 3.27% 2,226 3.88% - ---------------------------------------------------------------------------------------------------------------------------------- Total loans 88,382 100.00% 72,429 100.00% 69,897 100.00% 56,843 100.00% 57,567 100.00% Less: Unearned income (299) (267) (332) (190) (230) Allowance for loan losses (1,159) (1,177) (765) (617) (687) - ---------------------------------------------------------------------------------------------------------------------------------- Net loans receivable $86,924 $70,985 $68,800 $56,036 $56,650 - ----------------------------------------------------------------------------------------------------------------------------------
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, 1998, the Bank's loan portfolio totaled $88.4 million, of which $26.9 million, or 30.43%, were commercial loans; $29.4 million, or 33.25%, were commercial real estate loans; $17.8 million, or 20.22%, were construction loans; $8.6 million, or 9.75%, were one- to four-family residential mortgage loans; $3.2 million, or 3.64% were home equity loans and $2.4 million, or 2.71%, 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 business loans to businesses operating in the Bank's primary market area. These loans consist of lines of credit which 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 three years. Such loans are offered in amounts up to $750,000 and are generally secured by receivable, 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, up to $500,000. The Bank also originates commercial loans which are guaranteed by the Small Business Administration. The Bank has been an active participant in a variety of SBA loan programs. Commercial business loans are generally of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. In order to reduce the overall risk and cost of its loan portfolio, the Bank intends to reduce the ratio of commercial loans to total loans and may reduce the level of its SBA loans. 16 ANNAPOLIS NATIONAL BANCORP, INC. YEARS ENDED DECEMBER 31, (Dollars in thousands)
- ------------------------------------------------------------------------------------------------------------------------ DUE AFTER DUE IN ONE YEAR NON 90 DAYS ONE YEAR BUT BEFORE DUE AFTER ACCRUAL PAST OR LESS FIVE YEARS FIVE YEARS LOANS DUE TOTAL - ------------------------------------------------------------------------------------------------------------------------ Real estate: Construction $16,748 $ 411 $ 284 $221 $211 $17,875 Mortgage 3,471 3,880 1,269 -- -- 8,620 Commercial 14,935 10,935 3,218 285 -- 29,373 Commercial loans 22,967 3,633 295 -- -- 26,895 Home equity loans 3,219 -- -- -- -- 3,219 Consumer loans 1,842 498 60 -- -- 2,400 - ------------------------------------------------------------------------------------------------------------------------ Total loans $63,182 $19,357 $5,126 $506 $211 $88,382 - ------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------- DUE AFTER DECEMBER 31, 1998 ----------------- FIXED VARIABLE RATE RATE TOTAL - ----------------------------------------------------------------------------- Real estate: Construction $ 761 $ 155 $ 916 Mortgage 1,049 4,100 5,149 Commercial 2,730 11,708 14,438 Commercial loans 1,456 2,472 3,928 Home equity loans -- -- -- Consumer loans 531 27 558 - ----------------------------------------------------------------------------- Total loans $6,527 $18,462 $24,989 - -----------------------------------------------------------------------------
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% 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, 1998, was $1.9 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 three year period in accordance with the prime rate 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 times. 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. 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 resale. 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. Although the Bank attempts to procure permanent end financing, many of the Bank's construction loans, at the time entered into with the Bank, have permanent end financing committed by other financial institutions. 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 17 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued to six months for consumer loans, up to twelve months for builder loans, and up to eighteen months for land development loans. Construction loans are generally made in amounts up to 80% of the 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, 1998, the Bank had construction loans, including land acquisition and development loans totaling $17.9 million, or 20.22% of the Bank's total loan portfolio, of which $11.6 million consisted of one- to four-family residential construction loans, $3.3 million consisted of commercial real estate construction loans and $3.0 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 which 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 Central Maryland. 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, 1998, one- to four-family residential mortgage loans totaled $8.6 million, or 9.75%, of total loans. Of the one- to four-family mortgage loans outstanding at that date, $1.0 million were fixed-rate loans with terms of up to three years with a balloon payment at the end of the term and $7.6 million were adjustable-rate mortgage loans. The Bank currently offers a number of adjustable-rate mortgage loans with terms 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 in 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. 18 ANNAPOLIS NATIONAL BANCORP, INC. The Bank currently originates one- to four-family residential mortgage loans in amounts up to 80% 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, 1998, home equity loans totaled $3.2 million, or 3.64% of the Bank's total loan portfolio. Fixed-rate, fixed-term home equity loans and adjustable rate home equity lines of credit are offered in amounts up to 100% of the appraised value with a maximum loan amount of $100,000. Fixed-rate, fixed-term home equity loans are offered with terms up to five 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 WSJ 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, 1998, consumer loans totaled $2.4 million or 2.71% to total loans outstanding. Consumer loans are generally originated in the Bank's primary market area. Credit Risk Management The Bank's allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for loan 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 amounts primarily based upon loan risk ratings, prior periods' chargeoffs and specific loss reserves. The adequacy of the allowance for credit lossesis evaluated based on the estimated range of acceptable allowance amounts established.This methodology is appropriate as the Bank has nine years of loan loss history, has 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 loans. The high and low loss ranges by risk rating are estimated based upon previous losses incurred. 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. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to make additional provisions for estimated loan losses based upon judgments different from those of management. As of December 31, 1998, the Bank's allowance for loan losses was $1.2 million or 1.31% of total loans and 161.51% of non-performing loans as compared to $1.2 million, or 1.63% of total loans and 102.44% of non-performing loans as of December 31, 1997. The Bank had total non-performing loans of $808,000 and $1.2 million at December 31, 1998 and December 31, 1997, respectively, and non-performing loans to total loans of 0.81% and 1.66%, at December 31, 1998, and December 31, 1997, respectively. The Bank places loans on a non accrual status after 90 days of not having received contractual principal or interest payments. 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, 1998 the Bank had approximately $3.9 million in watch list loans. The Bank continues to monitor and modify its allowances for loan losses as conditions dictate. While management believes that, based on information currently available, the Bank's allowance for 19 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued loan 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 loan losses will be sufficient to cover future loan losses incurred by the Bank or that future adjustments to the allowance for loan 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 loan 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. Analysis of Credit Risk Activity in the allowance for loan losses for the preceding three years ended December 31 is shown below:
At December 31, (Dollars in thousands) - -------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------- Total loans outstanding $88,382 $72,162 $69,565 Average loans outstanding 77,245 72,385 62,144 Allowance for loan losses at beginning of period 1,177 765 617 Provision charged to expense 300 748 452 - -------------------------------------------------------------------------------------------------------------------------- Chargeoffs: Residential/commercial real estate -- -- 15 Commercial loans 354 362 279 Consumer and other loans 9 6 28 - -------------------------------------------------------------------------------------------------------------------------- Total 363 368 322 - -------------------------------------------------------------------------------------------------------------------------- Recoveries: Residential/commercial real estate 24 9 8 Commercial loans 21 21 10 Consumer and other loans -- 2 -- - -------------------------------------------------------------------------------------------------------------------------- Total 45 32 18 - -------------------------------------------------------------------------------------------------------------------------- Net chargeoffs 318 336 304 Allowance for loan losses at end of period $ 1,159 $ 1,177 $ 765 - -------------------------------------------------------------------------------------------------------------------------- Allowance for loan losses as a percent of total loans 1.31% 1.63% 1.10% Net chargeoffs as a percent of average loans .41% .46% .49% - ---------------------------------------------------------------------------------------------------------------------------
Capital Management During 1998 Stockholders' Equity increased $1.0 million or 9.04% to $12.1 million from 11.1 million at December 31, 1997. The increase was due to net income of $1.0 million. Additionally, the Company's common shares outstanding increased by 1,200 to 2,313,506 at December 31, 1998, from 2,312,306 at December 31, 1997, due to exercising 1,200 shares of employee stock options. In April, 1997, the Company's employee incentive stock option plan was approved by shareholders at the annual meeting. Under the plan, up to 100,000 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 1998, 24,600 shares of common stock were granted under the plan, 12,300 shares were forfeited and 1,200 were exercised. At December 31, 1998, the company had 68,800 shares granted and outstanding. 20 ANNAPOLIS NATIONAL BANCORP, INC. See Note 12 to the Consolidated Financial Statements for more information on the Company's stock option plan. Regulatory Capital Requirements The OCC's capital regulations require national banks to meet two minimum capital standards: a 3% 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 noncumulative 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 OCC capital regulation 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, 1998, the Bank's tier 1 and total risk based capital ratio were 12.70% and 14.00% respectively. The Bank was considered well capitalized for regulatory purposes. See Note 18 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 BHCA. The activities of national banks, such as the Bank, are generally governed by the National Bank Act and the Federal Deposit Insurance Act. The Bank is subject to extensive regulation, examination and supervision by the Office of the Comptroller of the Currency (the "OCC"), as its primary federal 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 OCC 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 OCC and/or the FDIC 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 OCC, the FDIC or the Congress, could have a material adverse impact on the Company or the Bank and their operations. 21 ANNAPOLIS NATIONAL BANCORP, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Market Value and Dividend Information The Company's Common stock is listed on "The NASDAQ Stock Market(R)" under the symbol "ANNB". The Company's stock began trading on October 1, 1997. The Company has traded an average daily volume of 2,997 shares during 1998. At December 31, 1998 the closing price was $7.00 per share. The Company's high and low stock price during the last quarter of 1998 was $7.625 and $6.06, respectively. As of March 19, 1999 the Company has outstanding 2,313,506 shares of common stock and no preferred stock issued or outstanding. The Company has not paid a dividend to stockholders in the past and does not anticipate paying dividends in the near future. The Company intends to retain its capital to allow for balance sheet growth while maintaining adequate capital reserves. "The Nasdaq Stock Market(R), which began operation in 1971, is the world's first electronic securities market and the fastest growing stock market in the U.S. Nasdaq utilizes today's information technologies--computers and telecommunications--to unite its participants in a screen-based market. It enables market participants to compete with each other for investor orders in each Nasdaq security and, through the use of Nasdaq Workstation II(R) and other automated systems, it facilitates the trading and surveillance of thousands of securities. This competitive marketplace, along with the many products and services available to issuers and their shareholders, attracts today's largest and fastest growing companies to Nasdaq. These include industry leaders in computers, pharmaceuticals, telecommunications, biotechnology, and financial services. More domestic and foreign companies list on Nasdaq than on all other U.S. stock markets combined." 22 ANNAPOLIS NATIONAL BANCORP, INC. [ROWLES & COMPANY Logo] Report of Independent Auditors The Board of Directors and Stockholders Annapolis National Bancorp, Inc. and Subsidiary Annapolis, Maryland We have audited the accompanying consolidated balance sheets of Annapolis National Bancorp, Inc. and Subsidiary as of December 31, 1998 and 1997, and the related 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 National Bancorp, Inc. and Subsidiary for the year ended December 31, 1996, were audited by other auditors whose report dated January 23, 1997, expressed an unqualified opinion on those statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Annapolis National Bancorp, Inc. and Subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ Rowles & Company, LLP _________________________ Baltimore, Maryland February 18, 1999 23 ANNAPOLIS NATIONAL BANCORP, INC. Consolidated Balance Sheets December 31,
- --------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 3,845,793 $ 5,611,407 $ 6,083,554 Federal funds sold and other overnight investments 10,284,419 20,743,973 4,378,730 Securities purchased under agreements to resell -- -- 4,750,000 Investment securities available for sale 15,190,949 16,565,290 11,334,273 Investment securities held to maturity (market value of $3,891,830 and $1,985,625) -- 3,975,296 1,992,835 Loans, less allowance for credit losses of $1,158,863 $1,177,437 and $765,000 86,924,416 70,985,232 68,800,397 Premises and equipment 2,678,786 1,238,887 1,334,825 Core deposit premium and other intangibles 129,789 216,315 788,301 Accrued interest receivable 590,159 515,549 436,722 Other real estate owned 90,539 42,637 140,000 Deferred income taxes 319,863 765,868 -- Other assets 402,202 166,848 187,544 - --------------------------------------------------------------------------------------------------------------------------------- Total assets $120,456,915 $120,827,302 $100,227,181 - --------------------------------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity Deposits $100,742,243 $ 96,061,762 $ 87,105,995 Securities sold under agreements to repurchase 7,173,980 13,305,780 6,344,959 Accrued interest payable and other liabilities 449,726 372,446 301,797 Note and accrued interest payable to stockholder -- -- 1,003,661 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities 108,365,949 109,739,988 94,756,412 - --------------------------------------------------------------------------------------------------------------------------------- Stockholders' Equity Commonstock, par value $.01 per share; authorized 10,000,000 shares; issued and outstanding 2,313,506 shares in 1998, 2,312,306 shares in 1997, and 1,478,972 shares in 1996 23,135 23,123 14,789 Capital surplus 13,142,508 13,135,320 8,633,560 Retained earnings (deficit) (1,075,000) (2,077,844) (3,162,041) - --------------------------------------------------------------------------------------------------------------------------------- 12,090,643 11,080,599 5,486,308 - --------------------------------------------------------------------------------------------------------------------------------- Accumulated other comprehensive income 323 6,715 (15,539) - --------------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 12,090,966 11,087,314 5,470,769 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $120,456,915 $120,827,302 $100,227,181 - ---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements. 24 ANNAPOLIS NATIONAL BANCORP, INC. Consolidated Statements Of Income Years Ended December 31,
- -------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------------- Interest Income Loans, including fees $7,655,050 $7,447,970 $6,481,532 Federal funds sold and securities purchased under agreements to resell 1,194,758 776,452 564,873 U.S. Treasury securities and obligations of other U.S. Government agencies 963,154 937,019 974,939 - -------------------------------------------------------------------------------------------------------------------------------- Total interest income 9,812,962 9,161,441 8,021,344 - -------------------------------------------------------------------------------------------------------------------------------- Interest Expense Certificates of deposit, $100,000 or more 300,714 283,053 237,863 Other deposits 3,220,267 2,973,123 2,813,535 Securities sold under agreements to repurchase 368,609 314,943 231,514 Interest on borrowed funds -- 59,574 78,759 - -------------------------------------------------------------------------------------------------------------------------------- Total interest expense 3,889,590 3,630,693 3,361,671 - -------------------------------------------------------------------------------------------------------------------------------- Net interest income 5,923,372 5,530,748 4,659,673 Provision for Credit Losses 300,000 747,908 452,190 - -------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for credit losses 5,623,372 4,782,840 4,207,483 - -------------------------------------------------------------------------------------------------------------------------------- Noninterest Income Gain (loss) on sale of loans, securities, equipment, intangibles, and other real estate 122,534 17,000 (31,696) Service charges and other 744,770 745,064 618,501 - -------------------------------------------------------------------------------------------------------------------------------- Total noninterest income 867,304 762,064 586,805 - -------------------------------------------------------------------------------------------------------------------------------- Noninterest Expense Personnel 2,481,507 2,111,176 2,219,380 Occupancy and equipment 814,625 834,943 730,927 Marketing and advertising 174,727 88,142 104,947 Other operating 1,408,518 1,299,398 1,172,854 Restructuring -- 795,570 -- Amortization of intangible assets acquired 86,526 100,805 143,640 - -------------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 4,965,903 5,230,034 4,371,748 - -------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 1,524,773 314,870 422,540 Income tax expense (benefit) 521,929 (769,327) -- - -------------------------------------------------------------------------------------------------------------------------------- Net income $1,002,844 $1,084,197 $ 422,540 - -------------------------------------------------------------------------------------------------------------------------------- Basic earnings per share $ 0.43 $ 0.64 $ 0.29 - -------------------------------------------------------------------------------------------------------------------------------- Diluted earnings per share $ 0.43 $ 0.63 $ 0.29 - --------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements. 25 ANNAPOLIS NATIONAL BANCORP, INC. Consolidated Statements of Changes in Stockholders' Equity
- --------------------------------------------------------------------------------------------------------- COMMON STOCK ----------------------- UNDIVIDED SHARES PAR VALUE SURPLUS PROFITS - --------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 1,478,972 $14,789 $ 8,633,560 $(3,584,581) Net income -- -- -- 422,540 Unrealized gain (loss) on investment securities available for sale net of income taxes -- -- -- -- - --------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 1,478,972 14,789 8,633,560 (3,162,041) Net income -- -- -- 1,084,197 Unrealized gain (loss) on investment securities available for sale net of income taxes -- -- -- -- Sale of stock, net of costs 833,334 8,334 4,501,760 -- - --------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 2,312,306 23,123 13,135,320 (2,077,844) Net income -- -- -- 1,002,844 Unrealized gain (loss) on investment securities available for sale net of income taxes -- -- -- -- Stock options exercised 1,200 12 7,188 -- - --------------------------------------------------------------------------------------------------------- Balance, December 31, 1998 2,313,506 $23,135 $13,142,508 $(1,075,000) - ---------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------- ACCUMULATED OTHER TOTAL COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE INCOME EQUITY INCOME - ------------------------------------------------------------------------------------------------- Balance, December 31, 1995 $ (17,946) $ 5,045,822 Net income -- 422,540 $ 422,540 Unrealized gain (loss) on investment securities available for sale net of income taxes 2,407 2,407 2,407 - ------------------------------------------------------------------------------------------------- Balance, December 31, 1996 (15,539) 5,470,769 $ 424,947 Net income -- 1,084,197 $1,084,197 Unrealized gain (loss) on investment securities available for sale net of income taxes 22,254 22,254 22,254 Sale of stock, net of costs -- 4,510,094 - ------------------------------------------------------------------------------------------------- Balance, December 31, 1997 6,715 11,087,314 $1,106,451 Net income -- 1,002,844 $1,002,844 Unrealized gain (loss) on investment securities available for sale net of income taxes (6,392) (6,392) (6,392) Stock options exercised -- 7,200 - ------------------------------------------------------------------------------------------------- Balance, December 31, 1998 $ 323 $12,090,966 $ 996,452 - -------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements. 26 ANNAPOLIS NATIONAL BANCORP, INC. Consolidated Statements Of Cash Flows Years Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ Reconciliation of Net Income to Net Cash Provided by Operating Activities Net income $ 1,002,844 $ 1,084,197 $ 422,540 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 196,580 197,955 187,311 Provision for credit losses 300,000 747,908 452,190 Deferred income taxes 449,297 (769,327) -- Amortization of premiums and accretion of discounts, net (257,550) (453,932) 10,152 Amortization of intangible assets 102,770 571,986 143,640 Loss on sales of loans, securities, equipment, and other real estate owned 2,466 43,826 31,696 Decrease (increase) in Accrued interest receivable (74,610) (78,827) (16,544) Other assets (210,053) 71,461 (203,523) Increase (decrease) in Accrued interest payable (7,539) (155,441) (16,787) Accrued income taxes, net of taxes refundable (22,402) (7,487) -- Deferred loan origination fees 32,754 (65,463) 141,367 Other liabilities 84,819 70,829 138,992 - ------------------------------------------------------------------------------------------------------------------------------ Net cash provided from operations 1,599,376 1,257,685 1,291,034 - ------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Investing Activities Proceeds from maturities of securities held to maturity 4,000,000 -- 22,642,605 Purchase of securities held to maturity -- (1,890,901) (1,946,528) Proceeds from sales and maturities of securities available for sale 62,954,062 52,960,000 1,979,884 Purchase of securities available for sale (61,356,247) (57,802,932) (17,687,193) Net decrease (increase) in federal funds 10,459,554 (16,365,243) 844,428 Loans made, net of principal collected (16,319,840) (2,867,280) (13,216,953) Purchases of and deposits on premises, equipment, and software (1,671,512) (206,121) (524,964) Proceeds from sale of equipment 13,112 17,000 -- Acquisition of other real estate owned -- (11,325) (140,000) Proceeds from sale of other real estate owned -- 108,688 463,523 Net decrease in securities purchased under agreements to resell -- 4,750,000 3,000,000 - ------------------------------------------------------------------------------------------------------------------------------ Net cash used by investing activities $(1,920,871) $ (21,308,114) $ (4,585,198) - ------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements. 27 ANNAPOLIS NATIONAL BANCORP, INC. Consolidated Statements Of Cash Flows Years Ended December 31,
- --------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities Net increase (decrease) in Time deposits $(4,108,419) $ 13,052,660 $ (4,235,342) Other deposits 8,788,900 (4,096,893) 9,245,080 Securities sold under repurchase agreements (6,131,800) 6,960,821 (625,264) Repayment of long-term debt principal -- (848,400) -- Proceeds from sale of stock and options exercised 7,200 4,510,094 -- - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities (1,444,119) 19,578,282 4,384,474 - --------------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (1,765,614) (472,147) 1,090,310 Cash and cash equivalents at beginning of year 5,611,407 6,083,554 4,993,244 - --------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 3,845,793 $ 5,611,407 $ 6,083,554 - --------------------------------------------------------------------------------------------------------------------------------- Supplemental Cash Flow Information Interest paid, including interest credited to accounts $ 3,897,129 $ 3,786,134 $ 3,282,912 Income taxes paid 95,034 7,487 -- Noncash Activities Other real estate reclassified from loans 47,902 -- --
The accompanying notes are an integral part of these financial statements. 28 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements December 31, 1998 Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies in the financial statements conform to generally accepted accounting principles 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. Business The Company was incorporated on May 26, 1988, under the laws of the State of Maryland to serve as a bank holding company and formed Annapolis National Bank (the Bank) as a wholly owned subsidiary. The Company is registered as a bank holding company and the Bank is chartered as a national bank. The Company (as a bank holding company) and the Bank (as a nationally chartered bank) are subject to governmental supervision, regulation, and control. In late 1993, the Bank formed a new company, ANB Mortgage Services, LLC (ANB Mortgage) for the purpose of originating and servicing residential construction loans. ANB Mortgage assets and liabilities and its results of operations are consolidated on the accompanying financial statements. This company was liquidated in 1997. The principal business of Annapolis National Bank 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, travelers checks, certified checks, U.S. Savings Bond application and redemption, Mastercard/VISA/American Express credit card and merchant deposit services, federal tax depository services, individual retirement accounts, money orders, money wire transfers, automated teller product, 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, Annapolis National Bank. All significant intercompany balances and transactions have been eliminated in consolidation. 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 recorded at amortized cost which is cost adjusted for amortization of premiums and accretion of discounts to maturity, or over the expected life of mortgage-backed securities. 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 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. 29 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements, continued December 31, 1998 Loans and allowance for credit losses 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 mortgage 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. The allowance for loan losses represents an amount which, in management's judgment, will be adequate to absorb possible losses on existing loans that may become uncollectible. Management's judgment in determining the adequacy of the allowance is based on evaluations of the collectibility of loans. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. If the current economy or real estate market were to suffer a severe downturn, the estimate for uncollectible accounts would need to be increased. Loans which are deemed uncollectible are charged off and deducted from the allowance. The provision for loan losses and recoveries on loans previously charged off are added to the allowance. 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. Intangible assets Net assets acquired in purchase transactions are recorded at fair value at the date of acquisition. Core deposit premiums are amortized on a straight line basis over the estimated period benefited. 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 operating 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. Prior to 1997, no deferred tax asset was recognized since the Company did not have a sustained history of profits and taxable income. Stock options The Company accounts for stock options under Accounting Principles Board Option No. 25, Accounting for Stock Issued to Employees. 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. Diluted earnings per share are calculated including the average dilutive common stock equivalents outstanding during the period. 30 ANNAPOLIS NATIONAL BANCORP, INC. Dilutive common equivalent shares consist of stock options, calculated using the treasury stock method. Comprehensive income The Company adopted Statement No. 130 of the Financial Accounting Standards Board, Reporting Comprehensive Income, in 1998. Comprehensive income includes net income and the unrealized gain and loss on investment securities available for sale. The statements of changes in stockholders' equity have been restated to include comprehensive income for the years ended December 31, 1997 and 1996. Note 2. INVESTMENT SECURITIES Investment securities are summarized as follows:
- -------------------------------------------------------------------------------------------------------------------- AMORTIZED UNREALIZED UNREALIZED MARKET DECEMBER 31, 1998 COST GAINS LOSSES VALUE - -------------------------------------------------------------------------------------------------------------------- Available for sale U.S. Government agency $13,491,259 $ 21,301 $ 811 $13,511,749 Mortgage-backed securities 1,000,000 -- 20,000 980,000 Federal Home Loan Bank stock 361,400 -- -- 361,400 Federal Reserve Bank stock 337,800 -- -- 337,800 - -------------------------------------------------------------------------------------------------------------------- $15,190,459 $ 21,301 $20,811 $15,190,949 - -------------------------------------------------------------------------------------------------------------------- December 31, 1997 - -------------------------------------------------------------------------------------------------------------------- Held to maturity U.S. Treasury securities $ 3,975,296 $-- $ 83,466 $ 3,891,830 - -------------------------------------------------------------------------------------------------------------------- Available for sale U.S. Treasury securities $ 1,970,565 $ 3,435 $-- $ 1,974,000 U.S. Government agency 12,964,401 27,088 349 12,991,140 Mortgage-backed securities 1,000,000 -- 20,000 980,000 Federal Home Loan Bank stock 292,900 -- -- 292,900 Federal Reserve Bank stock 327,250 -- -- 327,250 - -------------------------------------------------------------------------------------------------------------------- $16,555,116 $ 30,523 $20,349 $16,565,290 - -------------------------------------------------------------------------------------------------------------------- December 31, 1996 - -------------------------------------------------------------------------------------------------------------------- Held to maturity U.S. Treasury securities $ 1,992,835 $-- $ 7,210 $ 1,985,625 - -------------------------------------------------------------------------------------------------------------------- Available for sale U.S. Treasury securities $ 9,155,662 $ 2,211 $ 875 $ 9,156,998 U.S. Government agency 1,000,000 -- 3,750 996,250 Mortgage-backed securities 1,000,000 -- 13,125 986,875 Federal Reserve Bank stock 194,150 -- -- 194,150 - -------------------------------------------------------------------------------------------------------------------- $11,349,812 $ 2,211 $17,750 $11,334,273 - --------------------------------------------------------------------------------------------------------------------
31 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements, continued December 31, 1998 The amortized cost and market value of debt 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.
- -------------------------------------------------------------------------------------------------------------------------------- HELD TO MATURITY AVAILABLE FOR SALE - -------------------------------------------------------------------------------------------------------------------------------- AMORTIZED MARKET AMORTIZED MARKET DECEMBER 31, 1998 COST VALUE COST VALUE - -------------------------------------------------------------------------------------------------------------------------------- Due within one year $ -- $ -- $11,491,111 $11,509,350 Due after one through five years -- -- 2,000,148 2,002,399 Mortgage-backed securities -- -- 1,000,000 980,000 Equity securities -- -- 699,200 699,200 - -------------------------------------------------------------------------------------------------------------------------------- $ -- $ -- $15,190,459 $15,190,949 - -------------------------------------------------------------------------------------------------------------------------------- December 31, 1997 - -------------------------------------------------------------------------------------------------------------------------------- Due within one year 3,975,296 $3,891,830 $ 9,936,710 $ 9,942,937 Due after one through five years -- -- 4,998,256 5,022,203 Mortgage-backed securities -- -- 1,000,000 980,000 Equity securities -- -- 620,150 620,150 - -------------------------------------------------------------------------------------------------------------------------------- $3,975,296 $3,891,830 $16,555,116 $16,565,290 - -------------------------------------------------------------------------------------------------------------------------------- December 31, 1996 - -------------------------------------------------------------------------------------------------------------------------------- Due within one year $ -- $ -- $10,155,662 $10,153,248 Due after one through five years 1,992,835 1,985,625 -- -- Mortgage-backed securities -- -- 1,000,000 986,875 Equity securities -- -- 194,150 194,150 - -------------------------------------------------------------------------------------------------------------------------------- $1,992,835 $1,985,625 $11,349,812 $11,334,273 - --------------------------------------------------------------------------------------------------------------------------------
Proceeds from sale of securities during 1998 and 1996 were $2,484,062 and $1,979,884, respectively with realized gains of $312 and $304 on those sales. The unrealized gains and losses on investment securities included in comprehensive income are reported net of these realized gains. Securities were sold to commercial customers of the Bank under agreements for the Bank to repurchase the securities as follows:
- --------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Cost at December 31 $14,491,259 $13,459,429 $6,367,028 Fair value at December 31 14,491,749 13,508,000 6,352,152 Repurchase price 7,173,980 13,305,780 6,344,959 Average balance during the year 11,330,409 10,570,086 7,761,702 Average interest rate during the year 3.25% 2.98% 2.97% Maximum month-end balance $14,846,219 $14,666,790 $9,591,298 - ---------------------------------------------------------------------------------------------------------------------------
Note 3. CASH AND DUE FROM BANKS Banks are required to carry 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. 32 Note 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES Major classifications of loans are as follows:
- ----------------------------------------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------- Real estate Commercial $38,000,834 $20,447,677 $17,844,638 Residential 21,086,312 18,816,566 18,919,242 Commercial 26,895,218 30,860,360 30,801,220 Consumer 2,400,217 2,304,614 2,332,308 - ----------------------------------------------------------------------------------------------------------- 88,382,581 72,429,217 69,897,408 - ----------------------------------------------------------------------------------------------------------- Less Unearned income 299,302 266,548 332,011 Allowance for loan losses 1,158,863 1,177,437 765,000 - ----------------------------------------------------------------------------------------------------------- 1,458,165 1,443,985 1,097,011 Loans, net $86,924,416 $70,985,232 $68,800,397 - -----------------------------------------------------------------------------------------------------------
The maturity and rate repricing distribution of the loan portfolio is as follows:
- --------------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Repricing or maturing within one year $63,899,468 $55,913,146 $61,862,644 Maturing over one to five years 19,357,456 14,618,447 6,927,761 Maturing over five years 5,125,657 1,897,624 1,107,003 - --------------------------------------------------------------------------------------------------------- $88,382,581 $72,429,217 $69,897,408 - ---------------------------------------------------------------------------------------------------------
Transactions in the allowance for credit losses were as follows:
- --------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------- Balance, beginning of year $1,177,437 $ 765,000 $ 617,000 Provisions charged to operations 300,000 747,908 452,190 Recoveries 44,853 32,943 18,126 - --------------------------------------------------------------------------------------------------- 1,522,290 1,545,851 1,087,316 Charge-offs 363,427 368,414 322,316 - --------------------------------------------------------------------------------------------------- Balance, end of year $1,158,863 $1,177,437 $ 765,000 - ---------------------------------------------------------------------------------------------------
The balance of nonaccrual and impaired loans is as follows:
- ------------------------------------------------------------------------------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------------------- Total guaranteed by the Small Business Administration $ 101,089 $ 531,722 $1,076,000 Other nonaccrual loans 404,487 245,954 817,677 - ------------------------------------------------------------------------------------------------------- Total nonaccrual loans 505,576 777,676 1,893,677 Average impaired loans 1,109,333 1,271,093 1,276,500 Related allowance for credit losses 179,217 171,923 183,000 Interest collected 18,439 98,000 56,000 Balance of accrued interest not recorded 52,747 73,864 78,000 - -------------------------------------------------------------------------------------------------------
33 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements, continued December 31, 1998 Loans which were 90 days or more past due amounted to $717,169, $371,000, and $101,000 at December 31, 1998, 1997, and 1996, respectively. 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. 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:
- ------------------------------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------------------------------ Beginning balance $2,229,589 $ 3,071,471 $2,153,082 Advances 253,186 1,058,813 1,764,445 Repayments (576,776) (240,899) (846,056) Change in officers and directors -- (1,659,796) -- - ------------------------------------------------------------------------------------------------------ Ending balance $1,905,999 $ 2,229,589 $3,071,471 - ------------------------------------------------------------------------------------------------------
Note 5. CREDIT COMMITMENTS Outstanding loan commitments, unused lines of credit, and letters of credit are as follows:
- ---------------------------------------------------------------------------------------------------------------- 1998 1997 - ---------------------------------------------------------------------------------------------------------------- Loan commitments Construction $ 4,220,628 $ 4,319 Other 14,284,008 10,800 - ---------------------------------------------------------------------------------------------------------------- $18,504,636 $15,119 - ---------------------------------------------------------------------------------------------------------------- Letters of credit Deposit secured $ 591,862 $ 592 Other 570,366 473 - ---------------------------------------------------------------------------------------------------------------- $ 1,162,228 $ 1,065 - ----------------------------------------------------------------------------------------------------------------
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. Note 6. INTANGIBLE ASSETS In 1997, the intangible assets acquired in 1990 were evaluated for impairment. Except for the core deposit premium, the various other intangible assets were written off as part of the restructuring expense. The core deposit premium is being amortized over a period expiring in the year 2000. Amortization expense relating to the core deposit premium was $86,526 in 1998 and $87,527 in 1997 and 1996. 34 ANNAPOLIS NATIONAL BANCORP, INC. Note 7. PREMISES AND EQUIPMENT A summary of premises and equipment and the related depreciation is as follows:
- ------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Land and construction projects $1,399,862 $ -- $ -- Leasehold improvements 658,175 658,175 805,067 Furniture, fixtures, and equipment 1,306,962 1,077,546 1,046,101 - ------------------------------------------------------------------------------------------------------------------ 3,364,999 1,735,721 1,851,168 Accumulated depreciation 686,213 496,834 516,343 - ------------------------------------------------------------------------------------------------------------------ Net premises and equipment $2,678,786 $1,238,887 $1,334,825 Depreciation and amortization expense $ 196,580 $ 197,955 $ 187,311 - ------------------------------------------------------------------------------------------------------------------
The Company has purchased land on which it plans to construct a new branch and administrative facility. Preliminary site and planning costs have been capitalized. The Company has signed contracts related to this project totaling $160,000. Note 8. LEASE COMMITMENTS The Company leases facilities under the following terms:
- ------------------------------------------------------------------------------------------------------------------- CURRENT ANNUAL RENTAL EXPIRATION DATE RENEWAL OPTIONS - ------------------------------------------------------------------------------------------------------------------- Bestgate Branch $96,286 January, 1999 None Cape St. Claire Branch 13,200 February, 1999 3 terms of 5 years Edgewater Branch 40,000 April, 2005 2 terms of 10 years Kent Island Branch 31,073 August, 1998 1 year, 2 year terms Severna Park Branch 40,354 August, 2006 1 term of 10 years Administrative offices, Annapolis 131,800 September, 2005 None, early buyout 2000 - -------------------------------------------------------------------------------------------------------------------
Some of the leases provide for increases in the rental rates at specified times during the lease terms, prior to the expiration dates. All renewal options are exercisable at increased rates. Lease obligations will require rent payments as follows: - ------------------------------------------------------------------------------ PERIOD MINIMUM RENTALS - ------------------------------------------------------------------------------ 1999 $242,094 2000 205,502 2001 85,354 2002 85,354 2003 85,354 Remaining years 164,658 - ------------------------------------------------------------------------------ $868,315 - ------------------------------------------------------------------------------ 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 $454,411, $463,900, and $402,105 for 1998, 1997, and 1996, respectively. In January, 1999, the Company negotiated a two-year extension on its Bestgate Branch loca- 35 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements, continued December 31, 1998 tion. The new annual rent will be $176,800. Part of the space will be sublet, reducing the annual rent by $51,450. During 1998, the Company waived a clause in one of its contracts prohibiting other financial institutions from locating in the same shopping center. The Company was paid $125,000, which is included in gain on sale of loans, securities, equipment, intangibles, and other real estate. Note 9. DEPOSITS Major classifications of deposits are as follows:
- -------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Demand, non-interest bearing $ 11,304,382 $10,330,153 $10,051,957 - -------------------------------------------------------------------------------------------------------------------- NOW accounts 21,050,434 19,272,587 20,759,310 Savings and money market 30,767,081 24,730,257 27,618,623 Time deposits, $100,000 and over 4,737,379 5,897,484 3,617,185 Other time 32,882,967 35,831,281 25,058,920 - -------------------------------------------------------------------------------------------------------------------- $100,742,243 $96,061,762 $87,105,995 - --------------------------------------------------------------------------------------------------------------------
Time deposits mature as follows: - ------------------------------------------------------------------------------------ Three months or less $ 12,516,492 $10,308,033 Four months to one year 21,180,825 28,127,664 Over one year 3,923,029 3,293,068 - ------------------------------------------------------------------------------------ $ 37,620,346 $41,728,765 - ------------------------------------------------------------------------------------
At December 31, 1998 and 1997, time deposits with maturities in excess of five years totaled $104,151 and $127,064. Note 10. DUE TO STOCKHOLDER In June 1990, the Company borrowed $3,000,000 under an unsecured promissory note to a stockholder of the Company to provide sufficient regulatory capital to allow the Company to purchase and assume the assets and liabilities of Gibraltar Savings & Loan Association. Interest accrued, but not paid, on the note was at an annual rate equal to the Bank's prime rate less 2%. In December 1989, this same stockholder advanced funds to the Company to provide sufficient funds to start banking operations in January 1990. The stockholder acquired 907,143 shares of stock for $3,175,000 due him in a stock offering which terminated in January 1995. The Company issued a new note for $848,400 for the remaining amount owed the stockholder. Interest accrued on the note at an annual rate equal to the prime rate published in the Wall Street Journal plus 1%. The principal and interest, totaling $1,062,836, on the note were paid off in 1997. Interest expensed under this note was $59,574 and $78,759 for 1997 and 1996, respectively. Note 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 $24,612 in 1998, $25,874 in 1997, and $19,596 in 1996. 36 ANNAPOLIS NATIONAL BANCORP, INC. Note 12. STOCK OPTIONS The Company has adopted a stock option plan, covering 100,000 shares of common stock, intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code. The plan provides for granting options to purchase shares of the common stock to the officers and other key employees of the Company and the Bank. Options granted have ten year expiration dates with vesting periods from immediate to five years. No options shall be granted under the plan after March 28, 2007. A summary of the status of the Company's performance-based stock option plans follows: - ----------------------------------------------------------------------------- 1998 1997 - ----------------------------------------------------------------------------- Outstanding, beginning of year 57,500 -- Granted 24,600 64,000 Exercised (1,200) -- Forfeited (12,300) (6,500) - ----------------------------------------------------------------------------- Outstanding, end of year 68,600 57,500 - ----------------------------------------------------------------------------- These options expire as follows:
- ------------------------------------------------------------------------------------------------------------ OPTIONS EXERCISE ---------------------------------- PRICE VESTED NONVESTED - ------------------------------------------------------------------------------------------------------------ April, 2007 $ 5.00 10,000 -- July, 2007 $ 6.00 4,300 17,200 September, 2007 $ 6.00 200 800 November, 2007 $ 9.88 800 3,200 December, 2007 $ 9.75 2,000 8,000 January, 2008 $10.38 6,600 -- January, 20008 $10.63 -- 2,000 February, 20008 $11.00 -- 2,500 June, 2008 $10.63 -- 3,000 August, 2008 $ 8.50 -- 3,500 September, 2008 $ 7.85 -- 1,000 October, 2008 $ 7.75 -- 2,500 January, 2009 $ 6.69 -- 1,000 - ------------------------------------------------------------------------------------------------------------ Total 23,900 44,700 - ------------------------------------------------------------------------------------------------------------
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. 37 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements, continued December 31, 1998 The weighted average fair value of options granted during 1998 and 1997 has been estimated using the Black-Scholes option-pricing model with the following assumptions: - ---------------------------------------------------------------------------- 1998 1997 - ---------------------------------------------------------------------------- Dividend yield 0.00% 0.00% Risk-free interest rate 4.50% 5.75% Expected volatility 30.00% 10.00% Expected life in years 10 10 - ---------------------------------------------------------------------------- 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:
- --------------------------------------------------------------------------------------- 1998 1997 - --------------------------------------------------------------------------------------- Net income As reported $1,002,844 $1,084,197 Pro forma $ 946,667 $ 943,715 Basic earnings per share As reported $ 0.43 $ 0.64 Pro forma $ 0.41 $ 0.58 Diluted earnings per share As reported $ 0.43 $ 0.63 Pro forma $ 0.41 $ 0.57 - ---------------------------------------------------------------------------------------
Note 13. LINES OF CREDIT The Bank is a member of Federal Home Loan Bank system and may borrow up to $5,000,000. 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 lines of credit of $5,000,000 and unsecured lines of $2,000,000 from other banks. Note 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. Note 15. YEAR 2000 The Company has determined the scope of the Year 2000 issue as it relates to the operation of the Bank. The internal systems are being tested and those found not to be compliant will be compliant before the end of 1999. During 1998 and through the end of January, 1999, the Company spent approximately $675,000 upgrading its computer system as part of a conversion from one data processing vendor to another. Although the primary reason for the conversion was not to remedy noncompliant systems, the upgrade was to a Year 2000 compliant system. Management has budgeted $50,000 for 1999 to test and correct the system and to educate its customers about Year 2000. 38 ANNAPOLIS NATIONAL BANCORP, INC. Note 16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------------------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) - ---------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED - ---------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, - ---------------------------------------------------------------------------------------------------------------------------- 1998 Interest revenue $2,434 $2,497 $2,473 $2,409 Interest expense 909 989 1,006 986 Net interest income 1,525 1,508 1,467 1,423 Provision for loan losses 75 75 75 75 Net income 204 245 300 254 Comprehensive income 189 274 285 248 Earnings per share-basic 0.08 0.11 0.13 0.11 Earnings per share-diluted 0.08 0.11 0.13 0.11 - ---------------------------------------------------------------------------------------------------------------------------- 1997 Interest revenue $2,492 $2,422 $2,260 $1,987 Interest expense 976 1,008 893 754 Net interest income 1,516 1,414 1,367 1,233 Provision for loan losses 354 75 82 237 Net income 92 335 274 383 Comprehensive income 82 352 281 391 Earnings per share-basic 0.04 0.23 0.19 0.26 Earnings per share-diluted 0.04 0.23 0.19 0.26 - ----------------------------------------------------------------------------------------------------------------------------
Note 17. INCOME TAXES The components of income tax expense are as follows:
- ---------------------------------------------------------------------------------------------------- 1998 1997 1996 - ---------------------------------------------------------------------------------------------------- Current Federal $ 72,632 $ -- $ -- State -- -- -- - ---------------------------------------------------------------------------------------------------- 72,632 -- -- - ---------------------------------------------------------------------------------------------------- Deferred 449,297 (769,327) -- - ---------------------------------------------------------------------------------------------------- $521,929 $(769,327) $ -- - ----------------------------------------------------------------------------------------------------
39 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements, continued December 31, 1998 The components of the deferred taxes are as follows:
- ----------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- Recognition of the benefit of the net operating loss carryover $467,202 $449,614 $ -- Provision for credit losses 34,367 (101,996) -- Revenues taxed not earned (23,787) (9,770) -- Expenses deducted, incurred in prior years -- 65,000 -- Depreciation expense 934 34,878 -- Amortization and write down of intangible assets (29,419) (84,053) -- Elimination of the valuation allowance -- (1,123,000) -- - ----------------------------------------------------------------------------------------------------------------------------- Deferred tax benefit $449,297 $(769,327) $ -- - -----------------------------------------------------------------------------------------------------------------------------
The components of the net deferred tax assets are as follows:
- -------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------------- Deferred tax assets Allowance for credit losses $252,629 $286,996 $ 185,000 Revenue taxed not earned 124,557 100,770 91,000 Expenses incurred not deducted -- -- 65,000 Net operating loss and alternative minimum tax credit carryforward 25,184 492,386 942,000 - -------------------------------------------------------------------------------------------------------------------------------- Total deferred tax assets 402,370 880,152 1,283,000 - -------------------------------------------------------------------------------------------------------------------------------- Deferred tax liabilities Depreciation 38,212 37,278 2,400 Intangible assets 44,128 73,547 157,600 Unrealized gain on securities available for sale 167 3,459 -- - -------------------------------------------------------------------------------------------------------------------------------- Total deferred tax liabilities 82,507 114,284 160,000 - -------------------------------------------------------------------------------------------------------------------------------- Valuation allowance -- $(1,123,000) - -------------------------------------------------------------------------------------------------------------------------------- Net deferred tax asset $319,863 $765,868 $ -- - --------------------------------------------------------------------------------------------------------------------------------
The differences between federal income taxes and the amount reported by the Company follow:
- -------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Income before income taxes $1,524,773 $314,870 $422,540 Taxes computed at the federal income tax rate 518,423 107,056 143,664 Increases (decreases) resulting from State income taxes, net of federal benefit -- 14,547 19,521 Nondeductible expenses 3,506 1,720 14,856 Net operating loss carryforward -- (892,650) (178,041 - -------------------------------------------------------------------------------------------------------------------- Income tax expense $ 521,929 $(769,327) $ -- - --------------------------------------------------------------------------------------------------------------------
40 ANNAPOLIS NATIONAL BANCORP, INC. Note 18. 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 Bank, as of December 31, 1998, 1997, and 1996, are as follows:
- -------------------------------------------------------------------------------------------------------------------------------- MINIMUM TO BE WELL ACTUAL CAPITAL ADEQUACY CAPITALIZED - -------------------------------------------------------------------------------------------------------------------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO DECEMBER 31, 1998 - -------------------------------------------------------------------------------------------------------------------------------- Total capital (to risk-weighted assets) $12,176,375 14.0% $7,272,681 8.0% $9,090,851 10.0% Tier 1 capital (to risk-weighted assets) $11,579,741 12.7% $3,636,341 4.0% $5,454,511 6.0% Tier 1 capital (to average assets) $11,579,741 9.5% $4,852,527 4.0% $6,065,658 5.0% December 31, 1997 - -------------------------------------------------------------------------------------------------------------------------------- Total capital (to risk-weighted assets) $11,393,091 15.8% $5,772,738 8.0% $7,215,923 10.0% Tier 1 capital (to risk-weighted assets) $10,490,371 14.5% $2,886,369 4.0% $4,329,554 6.0% Tier 1 capital (to average assets) $10,490,371 8.8% $4,767,360 4.0% $5,959,200 5.0% December 31, 1996 - -------------------------------------------------------------------------------------------------------------------------------- Total capital (to risk-weighted assets) $6,445,903 10.2% $5,035,177 8.0% $6,293,972 10.0% Tier 1 capital (to risk-weighted assets) $5,680,903 9.0% $2,517,589 4.0% $3,776,383 6.0% Tier 1 capital (to average assets) $5,680,903 5.8% $3,898,339 4.0% $4,879,324 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. Note 19. 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. 41 ANNAPOLIS NATIONAL BANCORP, INC. Notes to Consolidated Financial Statements, continued December 31, 1998
- --------------------------------------------------------------------------------------------------------------------------------- 1998 1997 - --------------------------------------------------------------------------------------------------------------------------------- CARRYING FAIR CARRYING FAIR DECEMBER 31, AMOUNT VALUE AMOUNT VALUE - --------------------------------------------------------------------------------------------------------------------------------- Financial assets Cash and due from banks $ 3,845,793 $ 3,845,793 $ 5,611,407 $ 5,611,407 Federal funds sold 10,284,419 10,284,419 20,743,973 20,743,973 Investment securities (total) 15,190,949 15,190,949 20,540,586 20,457,120 Loans, net 86,924,416 86,992,223 70,985,232 70,793,572 Accrued interest receivable 590,159 590,159 515,549 515,549 Refundable income taxes 28,611 28,611 -- -- Financial liabilities Noninterest-bearing deposits $11,304,382 $11,304,382 $10,330,153 $10,330,153 Interest-bearing deposits 89,437,861 89,766,553 85,731,609 85,869,314 Securities sold under agreements to repurchase 7,173,980 7,173,980 13,305,780 13,305,780 Accrued interest payable 28,574 28,574 36,113 36,113 - ---------------------------------------------------------------------------------------------------------------------------------
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 for loans of the same class and term. 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. It is not practicable to estimate the fair value of outstanding loan commitments, unused lines, and letters of credit. In 1996, the Company considered disclosure of the fair value of its financial instruments, including off-balance sheet items and determined that the difference between its assets and liabilities and their carrying values was insignificant. The Company reached this conclusion after evaluating the repricing and terms of its financial instruments. A substantial portion of such instruments repriced annually and were short term in nature. As a result, the fair values approximated the value reported in the financial statements at December 31, 1996. Note 20. EARNINGS PER SHARE A summary of shares outstanding for basic and fully diluted earnings per share is as follows:
- ---------------------------------------------------------------------------------------------------------------- 1998 1997 - ---------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding, basic 2,312,422 1,691,301 Common stock equivalents 6,731 16,865 - ---------------------------------------------------------------------------------------------------------------- Average common shares and equivalents, full diluted 2,319,153 1,708,166 - ---------------------------------------------------------------------------------------------------------------- Stock options outstanding that were antidilutive at December 31 35,100 6,500 - ----------------------------------------------------------------------------------------------------------------
42 ANNAPOLIS NATIONAL BANCORP, INC. Note 21. PARENT COMPANY FINANCIAL INFORMATION The balance sheet and statements of income and cash flows for Annapolis National Bancorp, Inc. (Parent Company only) follow: Balance Sheets
- --------------------------------------------------------------------------------------------------------------------------------- December 31, 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 7,391 $ 191 $ 20,765 Investment in Annapolis National Bank 11,790,853 10,713,401 6,453,665 Deferred income taxes and other assets 373,722 373,722 -- - --------------------------------------------------------------------------------------------------------------------------------- Total assets $12,090,966 $11,087,314 $6,474,430 - --------------------------------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity Due to stockholder $ -- $ -- $1,003,661 - --------------------------------------------------------------------------------------------------------------------------------- Stockholders' equity Commonstock, par value $.01 per share; authorized 10,000,000 shares; issued and outstanding 2,313,506 shares in 1998, 2,312,306 shares in 1997, 1,478,972 shares in 1996 23,135 23,123 14,789 Capital surplus 13,142,508 13,135,320 8,633,560 Retained earnings (deficit) (1,075,000) (2,077,844) (3,162,041) Accumulated other comprehensive income 323 6,715 (15,539) - --------------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 12,090,966 11,087,314 5,470,769 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $12,090,966 $11,087,314 $6,474,430 - ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- Interest revenue $ -- $ 8,257 $ -- Interest expense -- 59,575 78,759 - ---------------------------------------------------------------------------------------------------------------------- Net interest income (expense) -- (51,318) (78,759) - ---------------------------------------------------------------------------------------------------------------------- Equity in undistributed income of subsidiary 1,002,844 761,893 501,399 Expenses Other operating -- 100 100 - ---------------------------------------------------------------------------------------------------------------------- Income before income taxes 1,002,844 710,475 422,540 Income taxes -- (373,722) -- - ---------------------------------------------------------------------------------------------------------------------- Net income $1,002,844 $1,084,197 $ 422,540 - ----------------------------------------------------------------------------------------------------------------------
43 ANNAPOLIS NATIONAL BANCORP, INC. Statements of Cash Flows
- ---------------------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities - ---------------------------------------------------------------------------------------------------------------------------- Interest received $ -- $ 8,257 $ -- Interest paid -- (214,836) (19,044) Cash paid for operating expenses -- (100) (100) - ---------------------------------------------------------------------------------------------------------------------------- -- (206,679) (19,144) - ---------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities Capital contributed to Annapolis National Bank -- (3,475,589) -- - ---------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities Proceeds from stock offering -- 4,510,094 -- Proceeds from stock options exercised 7,200 -- -- Repayment of stockholder loan -- (848,400) -- - ---------------------------------------------------------------------------------------------------------------------------- 7,200 3,661,694 -- - ---------------------------------------------------------------------------------------------------------------------------- Net (decrease) in cash 7,200 (20,574) (19,144) Cash and equivalents at beginning of year 191 20,765 39,909 - ---------------------------------------------------------------------------------------------------------------------------- Cash and equivalents at end of year $ 7,391 $191 $ 20,765 - ---------------------------------------------------------------------------------------------------------------------------- Reconciliation of net income to net cash provided by operating activities Net income $1,002,844 $ 1,084,197 $422,540 Adjustments to reconcile net income to net cash used in operating activities Undistributed net income of subsidiary (1,002,844) (761,893) (501,399) Increase in deferred tax assets -- (373,722) -- Increase (decrease) in accrued interest expense -- (155,261) 59,715 - ---------------------------------------------------------------------------------------------------------------------------- $ -- (206,679) $(19,144) - ----------------------------------------------------------------------------------------------------------------------------
44 ANNAPOLIS NATIONAL BANCORP, INC. Officers and Directors [PHOTO of Officers and Directors HERE] Seated Ronald E. Gardner, John W. Marhefka Jr., Standing (left to right) Lawrence W. Schwartz, Stanley H. Katsef, Richard M. Lerner, Stanley J. Klos Jr., Dimitri P. Mallios, Albert Phillips and Lawrence E. Lerner. Board of Directors Executive Officers of Annapolis National of Annapolis National Bancorp, Inc. and Bancorp, Inc. Annapolis National Bank Russell J. Grimes Jr. Chief Financial Officer & Treasurer Ronald E. Gardner John W. Marhefka Jr. Stanley H. Katsef Chief Executive Officer & Vice Chairman of the Board Vice President Stanley J. Klos Jr. Lori J. Mueller Lawrence E. Lerner Secretary Richard M. Lerner Albert Phillips Dimitri P. Mallios President John W. Marhefka Jr. Chief Executive Officer Albert Phillips Officers of Annapolis National Bank Chairman of the Board Executive Officers Lawrence W. Schwartz Kevin J. Barron Senior Vice President, Real Estate Lending Russell J. Grimes Jr. Senior Vice President, Chief Financial Officer & Treasurer Michael L. Irwin, CPA Senior Vice President, Credit Administration Robert E. Mann Senior Vice President, Business Banking John W. Marhefka Jr. President & Chief Executive Officer Lori J. Mueller Senior Vice President, Administration & Marketing Vice Presidents Tianne Baker Real Estate Lending Tamara S. Cleaver Loan Servicing Jo Ann Pyles Mortgage Banking Michele Stachura Real Estate Lending Assistant Vice presidents Judith A. Atkins Construction Loan Administration Deborah L. Cobb Relationship Manager Cherylann C. Conte Real Estate Portfolio Manager Mary A. Fitzpatrick Mortgage Loan Officer Linda W. Friday Relationship Manager Janice A. Korvin Accounting Manager Michelle L. Lechowicz Relationship Manager Matthew B. Pipken Commercial Lending Mary L. Queen Operations Manager Susan F. Smith Relationship Manager Sharon M. Sturm Loan Processing 45 ANNAPOLIS NATIONAL BANCORP, INC. Corporate Information Executive Offices 180 Admiral Cochrane Drive Suite 300 Annapolis, Maryland 21401 410-224-4455 Community Offices Annapolis 900 Bestgate Road Suite 100 Annapolis, Maryland 21401 410-224-4483 Cape St. Claire 1372-B Cape St. Claire Road Annapolis, Maryland 21401 410-974-1515 Edgewater 120 Central Avenue Edgewater, Maryland 21037 410-956-2900 Kent Island Route 50 and 18 Kent Island Shopping Center Stevensville, Maryland 21666 410-643-4191 Severna Park 50 West McKinsey Road Severna Park, Maryland 21146 410-518-6885 Address of Principal Office Annapolis National Bancorp, Inc. 180 Admiral Cochrane Dr., Suite 300 Annapolis, Maryland 21401 Transfer Agent Registrar and Transfer Company 10 Commerce Drive Cranford, New Jersey 07016 Independent Audit Firm Rowles & Company, L.L.P. 101 East Chesapeake Avenue Baltimore, Maryland 21286 Securities Counsel Patton Boggs, L.L.P. 2550 MStreet, N.W. Washington, D.C. 20037 Annual Meeting The Annual Meeting of the stockholders of Annapolis National Bancorp, Inc. will be held at the Annapolis Holiday Inn, 210 Holiday Ct., Annapolis, MD 21401 at 6:00 PM on Thursday, April 29, 1999. Investor Information Analysts, stockholders and others seeking information about Annapolis National Bancorp, Inc. are invited to contact: John W. Marhefka Jr. Chief Executive Officer or Russell J. Grimes Jr. Chief Financial Officer & Treasurer Annapolis National Bancorp, Inc. 180 Admiral Cochrane Drive Suite 300 Annapolis, Maryland 21401 (410) 224-4455 Securities Listing The Company's shares are listed on The NASDAQ Stock Market(R). Ticker Symbol: ANNB Member Federal Deposit Insurance Corporation Member Federal Reserve System 46 EX-27 4 FDS
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 1998 ANNUAL REPORT AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1 US$ YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1 3,854,793 0 10,284,419 0 15,190,949 15,190,949 15,190,949 86,924,416 1,177,437 120,456,915 100,742,243 7,143,980 449,726 0 0 0 23,135 12,067,508 120,456,915 7,655,050 963,154 1,194,758 9,812,962 3,520,981 3,889,590 5,923,372 300,000 0 4,965,903 1,524,773 1,524,773 0 0 1,002,844 0.43 0.43 9.91 505,576 717,169 0 3,922,751 1,177,437 363,427 44,853 1,158,863 1,158,863 0 979,646
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