UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2003
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-18279
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TRI-COUNTY FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Maryland 52-1652138
- ------------------------------- ----------------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 Leonardtown Road, Waldorf, Maryland 20601
- ------------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(301) 843-0854
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(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes No x --- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
As of October 10, 2003 registrant had outstanding 756,460 shares of Common
Stock.
TRI-COUNTY FINANCIAL CORPORATION
FORM 10-Q
INDEX
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PART I - FINANCIAL INFORMATION PAGE
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Item 1 - Financial Statements
Consolidated Balance Sheets - September 30, 2003
(Unaudited) and December 31, 2002 3
Consolidated Statements of Income and Comprehensive Income -
Three and Nine Months Ended September 30, 2003
(Unaudited) and 2002 4-5
Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 2003
(Unaudited) and 2002 (Unaudited) 6-7
Notes to Consolidated Financial Statements 8-10
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 10-17
Item 3 - Quantitative and Qualitative Disclosure about Market Risk 18
Item 4 - Controls and Procedures 18
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 19
Item 2 - Change in Securities and Use of Proceeds 19
Item 3 - Default upon Senior Securities 19
Item 4 - Submission of Matters to a Vote of Security Holders 19
Item 5 - Other Information 19
Item 6 - Exhibits and Reports on Form 8-K 19
SIGNATURES 20
2
ITEM I. FINANCIAL STATEMENTS
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2003 (UNAUDITED) AND DECEMBER 31, 2002
ASSETS
September 30, 2003 December 31, 2002
Cash and due from banks $ 11,213,506 $ 10,356,932
Interest-bearing deposits with banks 6,646,826 15,179,851
Investment securities available for sale - at fair value 45,420,912 41,826,113
Investment securities held to maturity - at amortized cost 45,929,159 2,841,807
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 4,602,250 2,736,750
Loans held for sale 616,250 1,262,667
Loans receivable - net of allowance for loan losses
of $2,408,910 and $2,314,074, respectively 206,123,174 197,449,282
Premises and equipment, net 5,498,501 5,736,395
Foreclosed real estate 706,764 716,014
Accrued interest receivable 1,325,120 1,042,453
Bank owned life insurance 5,847,696 --
Other assets 9,074,507 3,025,431
--------------- -------------
Total assets $ 337,156,969 $ 282,173,695
=============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 29,754,430 $ 33,045,310
Interest-bearing deposits 187,427,155 169,979,802
--------------- -------------
Total deposits 217,181,585 203,025,112
Short-term borrowings 27,671,430 752,298
Long-term debt 63,058,996 48,170,000
Accrued expenses and other liabilities 2,162,065 3,353,520
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Total liabilities 310,074,076 255,300,930
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STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued - 752,240 and 759,778 shares, respectively 7,522 7,598
Additional paid in capital 7,810,776 7,716,906
Retained earnings 19,604,356 18,817,615
Accumulated other comprehensive (loss) income (229,618) 493,691
Unearned ESOP shares (110,143) (163,045)
--------------- -------------
Total stockholders' equity 27,082,893 26,872,765
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 337,156,969 $ 282,173,695
=============== =============
See notes to consolidated financial statements
3
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ----------------------
2003 2002 2003 2002
INTEREST INCOME:
Interest and fees on loans $3,361,521 $3,604,299 $10,016,346 $10,671,659
Taxable interest and dividends on
investment securities 843,200 662,707 1,978,374 1,921,272
Interest on bank deposits 5,903 14,928 58,084 63,748
---------- ---------- ----------- -----------
Total interest income 4,210,624 4,281,934 12,052,804 12,656,679
---------- ---------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits 696,914 865,583 2,167,049 2,640,487
Interest on long term debt 725,273 617,390 1,993,929 1,884,127
Interest on short term debt and
other borrowings 9,637 1,403 10,884 5,549
---------- ---------- ----------- -----------
Total interest expense 1,431,824 1,484,376 4,171,862 4,530,163
---------- ---------- ----------- -----------
NET INTEREST INCOME 2,778,800 2,797,558 7,880,942 8,126,516
PROVISION FOR LOAN LOSSES 31,013 30,000 145,340 130,000
---------- ---------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 2,747,787 2,767,558 7,735,602 7,996,516
---------- ---------- ----------- -----------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 76,151 57,921 206,130 146,269
Net gain on sale of loans held for sale 135,036 81,557 499,726 289,539
Service charges 120,756 242,534 459,580 727,903
Other income 819 4,901 9,073 18,610
---------- ---------- ----------- -----------
Total noninterest income 332,762 386,913 1,174,509 1,182,321
---------- ---------- ----------- -----------
NONINTEREST EXPENSE:
Salary and employee benefits 1,305,584 1,031,744 3,530,637 3,129,922
Occupancy expense 175,459 200,914 547,306 592,582
Advertising 89,140 91,675 224,066 254,641
Loss on disposal of obsolete equipment -- -- -- 65,104
Data processing expense 103,042 94,102 297,075 432,558
Depreciation of furniture, fixtures, and equipment 132,022 58,380 361,761 279,576
Telephone communications 33,407 74,794 136,139 268,174
ATM expenses 71,153 51,686 197,622 123,638
Office supplies 28,582 32,572 104,420 136,292
Valuation allowance on foreclosed real estate -- -- -- 1,044,070
Office equipment expense 29,629 34,537 109,602 114,510
Other expenses 222,146 363,342 755,577 979,035
---------- ---------- ----------- -----------
Total noninterest expense 2,190,164 2,033,746 6,264,205 7,420,102
---------- ---------- ----------- -----------
4
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (CONTINUED)
INCOME BEFORE INCOME TAXES 890,385 1,120,725 2,645,906 1,758,735
INCOME TAX EXPENSE 293,550 391,000 898,765 621,000
---------- ---------- ---------- -----------
NET INCOME 596,835 729,725 1,747,141 1,137,735
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
Net unrealized holding gains (losses) arising
during the period (475,055) (10,628) (723,309) (33,056)
---------- ---------- ---------- -----------
COMPREHENSIVE INCOME $ 121,780 $ 719,097 $1,023,832 $ 1,104,679
========== ========== ========== ===========
EARNINGS PER SHARE
Basic $ 0.79 $ 0.96 $ 2.32 $ 1.49
Diluted 0.75 0.91 2.20 1.41
See notes to consolidated financial statements
5
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------------
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1,747,141 $ 1,137,735
Adjustments to reconcile net income to net
cash (used) provided by operating activities:
Valuation allowance on foreclosed real estate -- 1,044,070
Provision for loan losses 145,340 130,000
Depreciation and amortization 474,900 339,392
Loss on disposal of obsolete equipment -- 65,104
Net amortization of premium/discount on investment securities 367,646 21,869
Deferred income tax benefit (29,000) (477,000)
Increase in accrued interest receivable (282,667) (82,492)
Increase in deferred loan fees (43,588) (41,248)
Increase in accounts payable, accrued expenses, and other
liabilities (1,191,455) 1,856,145
Decrease (Increase) in other assets 213,052 (1,220,565)
Gain on disposal of premises and equipment -- (4,458)
Origination of loans held for sale (16,246,950) (13,860,196)
Gain on sales of loans held for sale (499,725) (289,540)
Proceeds from sale of loans held for sale 17,393,092 12,518,971
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Net cash provided by operating activities 2,047,786 1,137,787
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CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in interest-bearing deposits with banks 8,533,025 4,619,965
Purchase of investment securities available for sale (63,963,745) (43,041,197)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 58,892,560 36,394,570
Purchase of investment securities held to maturity (45,833,440) (1,201,212)
Proceeds from maturities or principal payments
of investment securities held to maturity 2,746,088 1,201,946
Net purchase of FHLB and FRB stock (1,865,500) --
Loans originated or acquired (132,967,284) (67,672,186)
Principal collected on loans 124,191,640 66,716,172
Proceeds from disposal of premises and equipment -- 13,000
Purchase of bank owned life insurance policies (5,847,696) --
Purchase of foreclosed real estate -- (29,562)
Purchase of premises and equipment (237,006) (1,142,287)
Proceeds from foreclosed real estate 9,250 309,046
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Net cash used in investing activities (56,342,108) (3,831,745)
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6
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(CONTINUED)
NINE MONTHS ENDED
SEPTEMBER
30,
---------------------------------------
2003 2002
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $14,156,473 $9,262,695
Proceeds from long-term borrowings 15,000,000 --
Payments of long-term borrowings (111,004) (1,400,000)
Net increase (decrease) in other borrowed funds 26,919,132 (1,078,569)
Exercise of stock options 54,375 141,906
Net change in unearned ESOP shares 92,459 47,999
Dividends paid (422,361) (385,129)
Redemption of common stock (538,178) (280,090)
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Net cash provided by financing activities 55,150,896 6,308,812
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INCREASE IN CASH AND CASH EQUIVALENTS 856,574 3,614,854
CASH AND CASH EQUIVALENTS - JANUARY 1 10,356,932 693,439
CASH AND CASH EQUIVALENTS - SEPTEMBER 30 $11,213,506 $4,308,293
=========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the nine months for:
Interest $ 2,697,029 $4,773,641
=========== ==========
Income taxes $ 1,422,869 $1,130,000
=========== ==========
Noncash transfers from loans to other assets $ -- $1,040,000
=========== ==========
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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1. BASIS OF PRESENTATION
General - The consolidated financial statements of Tri-County Financial
Corporation (the "Company") and its wholly owned subsidiary, Community Bank
of Tri-County (the "Bank") included herein are unaudited; however, they
reflect all adjustments consisting only of normal recurring accruals that,
in the opinion of Management, are necessary to present fairly the results
for the periods presented. Certain information and note disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The Company believes that the
disclosures are adequate to make the information presented not misleading.
There have been no significant changes to the Company's Accounting Policies
as disclosed in the 2002 Annual Report. The results of operations for the
nine months ended September 30, 2003 are not necessarily indicative of the
results of operations to be expected for the remainder of the year. Certain
previously reported amounts have been restated to conform to the 2003
presentation.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes included
in the Company's Annual Report for the year ended December 31, 2002.
2. NATURE OF BUSINESS
The Company, through its bank subsidiary, provides domestic financial
services primarily in southern Maryland. The primary financial services
include real estate, commercial and consumer lending, as well as
traditional demand deposits and savings products.
3. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred-tax assets and liabilities are determined based
on differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities (i.e., temporary differences) and
are measured at the enacted rates that will be in effect when these
differences reverse.
4. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period.
Diluted net income per common share is computed by dividing net income by
the weighted average number of common shares outstanding during the period,
including any potential dilutive common shares outstanding, such as options
and warrants. As of September 30, 2003, 7,916 shares were excluded from the
diluted net income per share computation because the option price exceeded
the average market price and therefore, their effect would be
anti-dilutive. Basic and diluted earnings per share, have been computed
based on weighted-average common and common equivalent shares outstanding
as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ------------------------
2003 2002 2003 2002
Basic 751,633 763,084 752,334 761,563
Diluted 793,649 806,291 794,556 804,971
8
5. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure", but applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting
for its Plan. No compensation expense related to the Plan was recorded
during the nine months ended September 30, 2003 and 2002. If the Company
had elected to recognize compensation cost based on fair value at the grant
dates for awards under the Plan consistent with the method prescribed by
SFAS No. 123, net income and earnings per share would have been changed to
the pro forma amounts as follows for the nine months ended September 30.
2003 2002
---- ----
Net Income as reported $1,747,141 $1,137,735
Less pro forma stock based compensation
expense determined under the
fair value method, net of tax effects.
173,261 109,390
---------- ----------
Pro forma net income $1,573,880 $1,028,345
========== ==========
Net income per share
Basic - as reported $ 2.32 $ 1.49
Basic - pro forma $ 2.09 $ 1.35
Diluted - as reported $ 2.20 $ 1.41
Diluted - pro forma $ 1.98 $ 1.28
6. NEW ACCOUNTING STANDARDS
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS No. 146"). The requirements of SFAS No. 146 are effective
prospectively for qualifying activities initiated after December 31, 2002.
SFAS No. 146 applies to costs associated with an exit activity, including
restructuring, or with a disposal of long-lived assets. The Statement has
had no effect on the Company's financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("Interpretation No. 45"). Beginning
in 2003, Interpretation No. 45 requires recognition of liabilities as their
fair value for newly issued guarantees. The adoption of Interpretation No.
45 did not have a material effect on the Company's financial statements.
9
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (SFAS No. 148"). SFAS No. 148
amends SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No.
148 provides alternative methods of transition for a voluntary change to
the fair value-based method of accounting for stock-based compensation and
required disclosure in both annual and interim financial statements about
the method of accounting for stock-based compensation and the effect of the
method used on reported results. The Company has adopted the disclosure
provisions of SFAS No. 148. The Company has not changed to the fair
value-based method of accounting for stock-based compensation.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("Interpretation No. 46"), which explains
identification of variable interest entities and the assessment of whether
to consolidate those entities. Interpretation No. 46 requires existing
unconsolidated variable interest entities to be consolidated by their
primary beneficiaries if the entities do not effectively disperse risks
among the involved parties. The provisions of Interpretation No. 46 are
effective for all financial statements issued after January 1, 2003. The
Company holds no significant variable interest entities that would require
disclosure or consolidation.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" (SFAS No. 149"). SFAS No.
149 amends and clarifies accounting for derivative instruments, including
certain derivative instruments imbedded in other contracts, and for hedging
activities under Statement 133. SFAS No. 149 is effective for contracts
entered into or modified after June 30, 2003, with some exceptions. The
Company does not believe that SFAS No. 149 will have a material impact on
its financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS No. 150"), effective for financial instruments entered into or
modified after May 31, 2003. This statement established standards for
classifying and measuring certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within the scope of the statement
as a liability rather than as an equity, such as obligations that a
reporting entity can or must settle by issuing its own equity shares. SFAS
No. 150 did not have an impact on the Company's earnings, financial
condition or equity.
10
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
This document contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, including discussions of
Tri-County Financial Corporation's (the "Company's") goals, strategies and
expected outcomes; estimates of risks and future costs; and reports of the
Company's ability to achieve its financial and other goals. These
forward-looking statements are subject to significant known and unknown risks
and uncertainties because they are based upon future economic conditions,
particularly interest rates, competition within and without the banking
industry, changes in laws and regulations applicable to the Company and various
other matters. Because of these uncertainties, there can be no assurance that
actual results, performance or achievements of the Company will not differ
materially from any future results, performance or achievements expressed or
implied by these forward-looking statements.
GENERAL
The Company is a bank holding company organized in 1989 under the laws of the
State of Maryland. It presently owns all the outstanding shares of capital stock
of the Community Bank of Tri-County (the "Bank"), a Maryland-chartered
commercial bank. The Company engages in no significant activity other than
holding the stock of the Bank and operating the business of the Bank.
Accordingly, the information set forth in this report, including financial
statements and related data, relates primarily to the Bank and its subsidiaries.
The Bank serves the southern Maryland area through its main office and eight
branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata,
Charlotte Hall, and California, Maryland. The Bank expects to open an additional
branch in Calvert County in 2004. The Bank is engaged in the commercial and
retail banking business as authorized by the banking statutes of the State of
Maryland and applicable Federal regulations. The Bank accepts demand and time
deposits, and originates loans to individuals, associations, partnerships and
corporations. The Bank makes real estate loans including residential first and
second mortgage loans, home equity lines of credit and commercial mortgage
loans. The Bank makes commercial loans including secured and unsecured loans.
The Bank is a member of the Federal Reserve and Federal Home Loan Bank ("FHLB")
Systems. The Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance Corporation ("FDIC") provides deposit insurance coverage up to
applicable limits. In the fourth quarter of 2003, the Bank expects to offer
Internet banking to its commercial and consumer customers. Management believes
that the introduction of an internet banking capability will enable it to
compete for a larger share of customers in its market area.
Since its conversion to a state chartered commercial bank in 1997, the Bank has
sought to increase its commercial, commercial real estate, construction, second
mortgage, home equity, and consumer lending business as well as the level of
transactional deposits to levels consistent with similarly sized commercial
banks. As a result of this emphasis, the Bank's percentage of assets invested in
residential first mortgage lending has declined since 1997. Conversely, targeted
loan types have increased. The Bank has also seen an increase in transactional
deposit accounts while the percentage of total liabilities represented by
certificates of deposits has also declined. Management believes that these
changes will enhance the Bank's overall long-term financial performance.
Management recognizes that the shift in composition of the Bank's loan portfolio
will tend to increase its exposure to credit losses. The Bank has continued to
evaluate its allowance for loan losses and the associated provision to
compensate for the increased risk. Any evaluation of the allowance for loan
losses is inherently inexact and reflects management's assessment of economic
conditions in the Southern Maryland area as well as individual borrower's
circumstances. Management believes that its allowance for loan losses reflects
the losses inherent in the loan portfolio as of the balance sheet date. For
further information on the Bank's allowance for loan losses see the discussion
in the financial condition section of this form and in the section titled
"Critical Accounting Policies," as well as the relevant discussions in the Form
10-K and annual report for the year ended December 31, 2002.
During the second quarter of 2002, the Bank recorded a valuation allowance on
certain foreclosed real estate. In addition the Bank incurred certain expenses
related to its core data system conversion during the same period. These
expenses did not recur in 2003, which had the effect of decreasing noninterest
expense in the current year to date period, when compared to the same period in
2002.
In the last several quarters, the national economy has recovered fitfully from a
mild recession while our local economy has remained strong in relation to the
national and statewide economy. Prospects for growth appear to be steady, and
local employment remains strong. The Bank remains exposed to asset deterioration
should the local economy experience a prolonged period of economic decline. In
addition, any Federal Reserve action on interest rates may affect the Bank's
financial performance.
11
Residential first mortgage loan customers have reacted to lower interest rates
by continuing to refinance higher rate loans. Because the Bank does not wish to
keep low rate, long term, fixed rate residential first mortgages in its
portfolio, these loans are then sold to third parties with the Bank retaining
servicing. These transactions have led to a reduction in residential first
mortgage loan balances. The Bank continues to generate a high level of
noninterest income from these transactions. Other types of loans particularly
commercial real estate and commercial lines of credit have increased. The Bank
continues to generate a high level of non-interest income from the sale of
loans.
Although the Bank's net interest income had grown for several quarters due to
increased assets and an increase in net interest margin, in the past quarter the
Bank's net interest margin narrowed. This was caused by continuing decreases in
short term interest rates. These decreases in short term rates were reflected in
the Bank's interest rates on loans, however, because cost of funds has already
approached a historical low point, the Bank was unable to reduce its cost of
funds by an equal amount resulting in a lower net interest income. Income tax
rates were comparable to the prior year.
In order to offset the effects of the narrowing interest rate spread, the Bank
increased its assets in the third quarter of 2003 by increasing its holdings of
certain held to maturity investments. This increase was primarily funded by
increases in short and long term borrowings in 2003. The effect of these
transactions was to increase the size of the Bank's assets, as well as
increasing its net interest income. The transactions decreased the Bank's
capital ratios. The Bank remains well capitalized under all applicable
regulations.
It is anticipated that any further reductions in interest rates will have a
significant adverse effect on earnings as rates paid on interest bearing
liabilities, which are as low as 0.10% on NOW accounts, cannot continue to
decline at the same rate as yields on loans and investments.
SELECTED FINANCIAL DATA
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
2003 2002
--------------- ------------
Condensed Income Statement
Interest Income $12,052,804 $12,656,679
Interest Expense 4,171,862 4,530,163
Net Interest Income 7,880,942 8,126,516
Provision for Loan Loss 145,340 130,000
Noninterest Income 1,174,509 1,182,321
Noninterest Expense 6,264,205 7,420,102
Income Before Income Taxes 2,645,906 1,758,735
Income Taxes 898,765 621,000
Net Income $ 1,747,141 $ 1,137,735
Per Common Share
Basic Earnings $ 2.32 $ 1.49
Diluted Earnings 2.20 1.41
Book Value $ 36.00 $ 33.62
12
RESULTS OF OPERATIONS
Net income for the nine month period ended September 30, 2003 totaled $1,747,141
($2.32 basic and $2.20 diluted earnings per share) compared with a total of
$1,137,735 ($1.49 basic and $1.41 diluted earnings per share) for the same
period in the prior year. This increase of $609,406 or 53.6% was caused
primarily by the reduction in noninterest expense, this reduction was partially
offset by the decrease in net interest and noninterest income and an increase in
provision for loan losses.
For the nine month period ended September 30, 2003, interest income declined by
$603,875 or 4.8% to $12,052,804. This decline was caused by the continued
decline in interest rates particularly the declines in the Prime Rate, and one,
three, and five year U.S. Treasury rates. Many loan products are priced based on
these rates. This decline in interest rates was partially offset by higher
average asset balances, including the increase in investments noted above.
Interest expense also decreased to $4,171,862 in the nine month period ending
September 30, 2003 as compared to $4,530,163 in the same period in the prior
year a decrease of $358,301 or 7.9%. This decrease was a reflection of the
declining interest rate environment experienced during the last year. These
lower interest rates more than offset the increases in liabilities including the
increased borrowing noted above. Interest expense also declined as a result of
the Bank's increase in the average balances of noninterest bearing deposit
accounts in the current period compared to the prior year. Net interest income
declined due to the Bank's inability to cut interest expense due to the
historically low rates paid on deposits prior to the current quarter. As
interest rates have continued to fall on loans and investments, the Bank was
unable to reduce interest expense by the same amount as interest income fell.
Provision for loan losses increased from prior year levels to $145,340 from
$130,000 for the nine month period ending September 30, 2003 and 2002,
respectively. The increase in provision expense was caused by a continuing
concentration of the Bank's loan portfolio in commercial loan categories that
have higher levels of risk than residential mortgages. Management will continue
to periodically review its allowance for loan losses and the related provision
and adjust as deemed necessary. This review will include a review of economic
conditions nationally and locally, as well as a review of the performance of
significant major loans and the overall portfolio.
Noninterest income decreased to $1,174,509 for the nine month period ending
September 30, 2003, a decrease of $7,812 or .7% over the prior year total of
$1,182,321. Loan appraisal, credit, and miscellaneous charges increased by
$59,861 to $206,130. Net gain on sale of loans also increased to $499,726 from
the prior year total of $289,539, an increase of $210,187 or 72.6%. These
increases were caused by the high volume of loan originations, caused by lower
mortgage interest rates. Income from service charges declined from the prior
year to $459,580 from the prior year total of $727,903 a decline of $268,323 or
36.9%. This decline was caused by a write off of certain originated mortgage
servicing rights ("OMSR") and by an increased rate of amortization of these
OMSR's in the current year. The write off and higher rate of amortization were
the result of the effect of lower mortgage loan interest rates on our OMSR
balances. The lower rates had the effect of shortening the projected lives of
the servicing assets, reducing their fair value. This reduction in fair value
was recognized through $195,000 in reductions in OMSR balances and a
corresponding reduction in mortgage servicing income. In addition average lives
for all OMSR's were shortened resulting in higher amortization expense related
to these rights. The higher amortization is reflected in a lower servicing
income. Other noninterest income decreased due to reductions in rental and other
noninterest income.
Noninterest expense for the six month period decreased by $1,155,897 or 15.6% to
$6,264,205 from $7,420,102 in the same period for the prior year. Salary and
employee benefits expense increased by 12.8% or 400,715, to $3,530,637 from
$3,129,922 for the same period in the prior year. The increase was attributable
to an increase in employees and to increases in average salary costs per
employee. Occupancy expense decreased slightly from $592,582, to $547,306, a
decrease of 7.6% attributable to certain nonrecurring expenses in 2002.
Advertising declined to $224,066 from $254,641, a decline of $30,575 or 12.0%.
Advertising declined due to a reduction in certain sales efforts in anticipation
of being increased in the fourth quarter. In 2002, the Bank recorded a
nonrecurring loss on certain obsolete equipment of $65,104. Data processing
expense also declined to $297,075 from a prior year total of $432,558 a decline
of $135,483 or 31.3%. In 2002, additional expenses were incurred related to the
systems conversion in May 2002. Depreciation of furniture fixtures and equipment
increased to $361,761 from the prior year total of $279,576 an increase of
$82,185 or 29.4%. This increase was due to large investments in equipment added
during the prior year, mostly related to the addition of new branches and new
equipment added for the 2002 system conversion. Telephone communications expense
declined to $136,139 from $268,174 in the prior year, a decline of $132,035 or
49.2%. In 2002, extensive testing of the systems for conversion required the use
of phone lines increasing costs. Also in 2003 cost control and efficiency
13
efforts by the Bank helped to reduce costs. ATM expenses increased to $197,622
from $123,638, an increase of $73,984 or 59.8%. This increase was the result of
additional branches and ATM activity in 2003. Office supplies expense decreased
to $104,420 from the prior year amount of $136,292, a decline of $31,872 or
23.4%. This decline was caused by additional supplies expenses incurred in 2002
related to the systems conversion. The provision for valuation allowances on
foreclosed real estate declined from $1,044,070 as of September 30, 2003 to zero
in 2003 as no further increases to the valuation allowance were necessary.
Office equipment expenses decreased to $109,602 from 2002's level of $114,510, a
decrease of $4,908 or 4.3%. This decrease was caused by the retirement of
certain equipment due to the systems conversion in 2002. Other expenses declined
to $755,577 from $979,035 a decline of $223,458 or 22.8%. These expenses were
lower based on certain cost control measures in 2003. Income taxes increased to
$898,765 or 34.0% of pretax income in the current year compared to $621,000 or
35.3% of pretax income in the prior year. The decrease in the tax rate was
primarily attributable to an increase in certain tax exempt interest.
RESULTS OF OPERATIONS - THIRD QUARTER
The Company recorded net income for the third quarter of 2003 of $596,835
compared to $729,725 for the same period in 2002. The decrease was the result of
a decline in net interest and noninterest income combined with an increase in
noninterest expense compared to the same period in 2002.
Net interest income declined by 0.7% to $2,778,800 in 2003 from $2,797,558 as a
result of the continued decline in interest rates noted above. The provision for
loan losses increased by 3.4% to $31,013 in 2003 from $30,000 in 2002 primarily
because of the continued concentration of lending in higher credit risk
products. Loan appraisal, credit and miscellaneous charges and net gain on sale
of loans held for sale increased by 31.5% and 65.6%, to 76,151 and $53,479
respectively as a result of the lower interest rate environment noted earlier.
Service charges declined to $120,756 from $242,534, a decline of $121,778 or
50.2%, as a result of the write off and higher amortization related to the lower
interest rates and shorter lives of the servicing assets as discussed earlier.
Other income amounts declined due to a decline in rental income.
Salary and employee expense increased to $1,305,584 from $1,031,744, an increase
of $273,840 or 26.5% due to an increased average salary per employee and a
slightly higher number of employees. Occupancy expense declined by $25,455 to
$175,459 from the prior year's total of $200,914 a decline of 12.7% due to the
nonrecurring costs of 2002 noted above. Advertising expenses also declined by
$2,535 or 2.8% to $89,140, this decline was the result of delaying certain
advertising expenses in 2003. Data processing expense increased to $103,042, an
increase of $8,940 or 9.5% over the prior year total of $94,102. The increase
reflects the addition of certain capabilities such as internet banking in the
current quarter. Depreciation of furniture, fixtures and equipment also
increased due to the large amounts of equipment purchased in the prior year.
These expenses increased by $73,642 or 126.1%. Telephone communications also
decreased to $33,407 or by 55.3% under the prior year total of $74,794 due to
expenses in testing and installing the core data system in 2002. ATM expenses
increased by $19,467 or 37.7% to $71,153 in the current year due to changes in
ATM operations. Office supplies expense decreased to $28,582 from $32,572 a
decrease of $3,990 or 12.3% as prior year expenses were increased by the need to
change some supplies prior to conversion. Office equipment and other expense was
similarly reduced by the absence of conversion related items in 2003.
FINANCIAL CONDITION
Assets
Total assets as of September 30, 2003 increased by $54,983,274 to $337,156,969
from the December 31, 2002 level of $282,173,695. Cash and due from banks
increased by $856,574, or 8.3% from December 31, 2002's total. Interest-bearing
deposits with banks decreased by $8,533,025 or 56.2% during the period to
$6,646,826 at September 30, 2003. Investment securities, including both the
available for sale and held to maturity portfolios, increased from $44,667,920
to $91,350,071 an increase of $46,682,151 or 104.5%. Increases were primarily
the result of additional purchases of investments using the proceeds of loan
prepayments, additional short and long term borrowings, and the conversion of
interest bearing deposits to investments. Stock in the Federal Home Loan and
Federal Reserve Banks increased due to additional borrowings related to the
leverage strategy mentioned above.
Loans held for sale decreased to $616,250 from $1,262,667 at December 31, 2002.
The Bank's loan portfolio increased by $8,673,892 or 4.4% during the nine month
period ending September 30, 2003 to $206,123,174 from December 2002's total of
$197,449,282. The increase was primarily the result of increases in the Bank's
portfolio of commercial real estate loans in the nine month period ending
September 30, 2003, these increases were partially offset by decreases in other
parts of the loan portfolio. At September 30, 2003 the Bank's allowance for loan
losses totals $2,408,910 or 1.15% of loan balances as compared to $2,314,074 or
1.15% of loan balances at December 31, 2002.
14
Management's determination of the adequacy of the allowance is based on a
periodic evaluation of the portfolio with consideration given to the overall
loss experience; current economic conditions; volume, growth and composition of
the loan portfolio; financial condition of the borrowers; and other relevant
factors that, in management's judgment, warrant recognition in providing an
adequate allowance. Management believes that the allowance is adequate. Loan
information for the current quarter is presented below. Additional loan
information for prior years is presented in the Form 10-K for the year ended
December 31, 2002.
LOAN PORTFOLIO September 30, December 31,
2003 2002
-------------------------------------- -------------------------------
Amount % Amount %
------ - ------ -
Real Estate Loans
Commercial $ 86,562,279 41.39% $ 74,291,593 37.07%
Residential first mortgage 41,854,081 20.01% 48,975,989 24.44%
Construction and land development 15,474,655 7.40% 14,578,702 7.27%
Home equity and second mortgage 18,520,426 8.85% 19,007,265 9.48%
Commercial loans 42,195,561 20.17% 38,953,965 19.44%
Consumer loans 4,549,099 2.17% 4,623,447 2.31%
------------ ------ ------------ ------
Total loans 209,156,101 100.00% 200,430,961 100.00%
Less: Deferred loan fees 624,017 0.30% 667,605 0.33%
Allowance for loan losses 2,408,910 1.15% 2,314,074 1.15%
------------ ------ ------------ ------
Loans receivable net 206,123,174 197,449,282
------------ ------------
Loan Loss Allowance
9 Months Ended 9 Months Ended
September 30, 2003 September 30, 2002
------------------ ------------------
Beginning Balance $ 2,314,074 $ 2,281,581
Charge Offs (51,233) (119,188)
Recoveries 729 2,795
----------- -----------
Net Charge offs (50,504) (116,393)
Additions charged to operations 145,340 130,000
----------- -----------
Balance at end of period $ 2,408,910 $ 2,295,188
=========== ===========
Ratio of net charge-offs during
the period to loans 0.02% 0.05%
===== =====
15
Balances as of Balances as of
September 30, 2003 December 31, 2002
--------------------- ------------------
Restructured Loans $ -- $ --
--------------------- ------------------
Accruing loans which are contracturally
past due 90 days or more: $ -- $ 596,579
--------------------- ------------------
Loans accounted for on a nonaccrual basis $ 479,559 $ --
--------------------- ------------------
Total non- performing loans $ 479,559 $ 596,579
Non -performing loans to total loans 0.23% 0.30%
======= =======
Allowance for loan losses to non performing
loans 502.32% 381.91%
======= =======
Premises and equipment decreased due to depreciation in the current period.
Foreclosed real estate declined to $706,014 at September 30, 2003 from $706,764
at December 31, 2002 due to partial settlement of one property. Other assets
increased to $3,226,811 from $3,025,431 at December 31, 2002. This increase was
primarily in deferred tax benefits relating to the investment portfolio. The
Bank invested $5,700,000 in certain life insurance instruments which will
provide supplemental benefits to certain key executives and provide additional
noninterest income to the Bank.
Liabilities
Deposit balances increased by $14,156,473 or 7.0% compared to December 31, 2002
balances of $203,025,112. This increase was primarily in interest bearing
deposits. The increase in interest bearing deposit accounts offset a decline in
noninterest bearing deposits. Management believes that ongoing stock market
volatility has made bank deposits more attractive to the general public. Short
term borrowings increased to $27,671,430, an increase of $26,919,132, while long
term borrowings increased by $14,888,996. Proceeds of these borrowings were used
to purchase investment securities.
Stockholders' Equity
Stockholders' equity increased $210,128 or .8% to $27,082,893 at September 30,
2003 compared to $26,872,765 at December 31, 2002. This reflects the net income
of $1,747,141 for the nine month period partially offset by the $723,309 decline
in accumulated other comprehensive income, and $422,361 in cash dividends. Other
changes in equity occurred as a result of using $538,178 for the purchase and
retirement of shares, the exercise of stock options of $54,375, and activity
related to the ESOP shares of $92,459. Book value on a per share basis, $36.00
at September 30, 2003, as compared to $35.37 at December 31, 2002, reflects a
1.8% increase, with a decrease in outstanding shares combined with the gains
noted previously.
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank and does not
currently have any material funding commitments. The Company's principal sources
of liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of dividends.
The Bank's principal sources of funds for investments and operations are net
income, deposits from its primary market area, principal and interest payments
on loans, interest received on investment securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered a primary source of funds supporting the Bank's lending and
investment activities.
The Bank's most liquid assets are cash and cash equivalents, which are cash on
16
hand, amounts due from financial institutions, federal funds sold, and money
market mutual funds. The levels of such assets are dependent on the Bank's
operating financing and investment activities at any given time. The variations
in levels of cash and cash equivalents are influenced by deposit flows and
anticipated future deposit flows.
The Bank may borrow up to 35% of consolidated Bank assets on a line of credit
available from the FHLB. As of September 30, 2003, the maximum available under
this line would be $118 million, while current outstanding advances totaled $91
million. In order to draw on this line the Bank must have sufficient collateral.
Qualifying collateral includes residential 1-4 family first mortgage loans,
certain second mortgage loans, certain commercial real estate loans, and various
investment securities.
REGULATORY MATTERS
The Bank is subject to Federal Reserve Board capital requirements as well as
statutory capital requirements imposed under Maryland law. At September 30,
2003, the Bank's tangible, leverage and risk-based capital ratios were 7.70%,
7.69% and 11.85%, respectively. These levels are well in excess of the required
4.0%, 4.0% and 8.0% ratios required by the Federal Reserve Board.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP). The
financial information contained within the financial statements is, to a
significant extent, financial information that is based on measures of financial
effects of transactions and events that have already occurred. A variety of
factors could affect the ultimate value that is obtained when earning of income,
recognizing an expense, recovering an asset or relieving a liability. The
Company uses historical loss factors as one in determining the inherent loss
that may be present in its loan portfolio. Actual losses could differ
significantly from the historical factors used. In addition GAAP itself may
change from one previously acceptable method to another method. Although the
economics of the Company's transactions would be the same, the timing of events
that would impact the Company's transactions could change.
The Company considers the allowance for loan losses to be a critical accounting
policy. The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting : (1) SFAS 5, "Accounting for Contingencies", which requires that
losses be accrued when they are probable of occurring and estimable and (2) SFAS
114, "Accounting by Creditors for Impairment of a Loan", which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
Management has significant discretion in making the judgments inherent in the
determination of the provision and allowance for loan losses, including in
connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance. The
establishment of allowance factors is a continuing exercise, based on
management's continuing assessment of the global factors such as delinquencies,
loss history, trends in the volume and term of loans, national and local
economic trends, concentration of credit, loan classification, and other
factors. Changes in allowance factors will have a direct impact on the amount of
the provision and a corresponding effect on net income. Errors in management's
perception and assessment of the global factors and their impact on the
portfolio could result in the allowance not being adequate to cover losses in
the portfolio, and may result in additional provisions or chargeoffs.
17
ITEM 3 Quantitative and qualitative Disclosure about Market Risk
Not applicable.
ITEM 4 CONTROLS AND PROCEDURES
Controls and Procedures.
As of the end of the period covered by this report, management of the Company
carried out an evaluation, under the supervision and with the participation of
the Company's principal executive officer and principal financial officer, of
the effectiveness of the Company's disclosure controls and procedures. Based on
this evaluation, the Company's principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required to be disclosed
by the Company in reports that it files or submits under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported, within
the time periods specified in the Securities and Exchange Commission's rules and
forms. It should be noted that the design of the Company's disclosure controls
and procedures is based in part upon certain reasonable assumptions about the
likelihood of future events, and there can be no reasonable assurance that any
design of disclosure controls and procedures will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote,
but the Company's principal executive and financial officers have concluded that
the Company's disclosure controls and procedures are, in fact, effective at a
reasonable assurance level.
In addition, there have been no changes in the Company's internal control over
financial reporting (to the extent that elements of internal control over
financial reporting are subsumed within disclosure controls and procedures)
identified in connection with the evaluation described in the above paragraph
that occurred during the Company's last fiscal quarter, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
18
TRI-COUNTY FINANCIAL CORPORATION
--------------------------------
PART II - OTHER INFORMATION
---------------------------
Item 1 - Legal Proceedings -- None
Item 2 - Change in Securities and Use of Proceeds -- None
Item 3 - Default Upon Senior Securities -- None
Item 4 - Submission of Matters to a Vote of Security Holders -- None
Item 5 - Other Information -- None
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits - The following exhibits are being filed with this Form 10-Q:
Exhibit 31 - Rule 13a-14(a) Certifications
Exhibit 32 - Section 1350 Certifications
(b) During the quarter for which this Form 10-Q is being filed, the
registrant did not file any reports on Form 8-K.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Tri-County Financial Corporation:
Date: November 12, 2003 By:/s/ Michael L. Middleton
-------------------------------------
Michael L. Middleton, President
and Chairman of the Board
Date: November 12, 2003 By:/s/ William J. Pasenelli
-------------------------------------
William J. Pasenelli, Executive
Vice President and Chief
Financial Officer