Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________
COMMISSION FILE NUMBER 333-117385
----------
THE BANCORP, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 23-3016517
------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
405 SILVERSIDE ROAD
WILMINGTON, DE 19809
--------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (302) 385-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK
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 [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ]
No [X]
The aggregate market value of the common shares of the registrant held
by non-affiliates of the registrant, based upon the closing price of such shares
on March 23, 2005 of $14.00, was approximately $166.4 million.
As of March 23, 2005, 11,888,061 shares of common stock, par value $1.00
per share, of the registrant were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for registrant's 2005 Annual Meeting of
Shareholders are incorporated by reference in Part III of this Form 10-K.
================================================================================
PART I
ITEM 1. BUSINESS
GENERAL
We are a Delaware financial holding company with a wholly owned subsidiary, The
Bancorp Bank, which we refer to as the Bank. We were formed in 1999 and
commenced operations in July 2000. From our formation until February 2004 we
were the sole stockholder of the Bank. In February 2004, the Bank completed a
public offering of its common stock which resulted in our holding 32.7% of the
Bank's common stock. In December 2004, we completed a reorganization with the
Bank which resulted in the Bank once again becoming our wholly-owned subsidiary.
Our target market is the greater Philadelphia-Wilmington metropolitan area. We
believe that a key factor in our ability to achieve our business strategy and
financial goals and to create shareholder value is the attractiveness of this
market. This area consists of the 12 counties surrounding Philadelphia and
Wilmington and includes: Philadelphia, Delaware, Chester, Montgomery, Bucks and
Lehigh Counties in Pennsylvania, New Castle County in Delaware and Mercer,
Burlington, Camden, Ocean and Cape May Counties in New Jersey.
We believe that changes in this market have created an underserved base of small
and middle-market businesses and high net worth individuals that we can
successfully target. The Philadelphia-Wilmington market area currently is home
to 150 bank and thrift institutions and is characterized by the dominance of
large out-of-state banking organizations. Of these institutions, the five
largest banking organizations by deposits control approximately 50% of the
market by deposit share and, of the ten largest, seven are headquartered outside
of the Philadelphia-Wilmington area. 140 institutions are below $2 billion in
deposit size and control approximately 31% of the market by deposit share. We
believe that our target customers are interested in banking with a company
headquartered in, and with decision-making authority based in, the
Philadelphia-Wilmington area.
To serve our customers, we provide a full range of retail and commercial banking
services, including a variety of checking, savings and other interest-bearing
accounts. We feature accounts with no required minimum balance, no service fees,
rebates on ATM fees, free debit MasterCard, overdraft protection plans and, on
our interest-bearing accounts, competitive interest rates. Our business lending
services focus on secured loans and lines of credit, construction loans and
customized equipment and vehicle leasing programs. Our consumer lending services
focus on home equity loans, personal and home equity lines of credit, personal
installment loans and vehicle leasing.
We have a continuing program of providing banking services to the members and
employees of organizations or businesses, which we call affinity group banking.
We provide these services through a private-label website under the affinity
group's name and offer an affinity group the ability to customize the banking
services offered on the website to respond to the needs and preferences of its
members.
As part of our private-label programs, we have developed a system for processing
credit and debit card transactions for independent sales organizations and their
merchant members that is a source of fee income for us and, because the merchant
members must maintain accounts with us, a
3
source of low-cost deposits. By using our services rather than those of other
banks, independent service organizations remove potential competitors from the
relationship between the independent service organization and its merchant
customers, since we do not offer any products comparable to those of the
independent service organization. Our infrastructure allows us to process high
volume transactions that permit merchant customers to access the card
associations and debit networks at a significantly lower cost. We offer
end-to-end services, which means that we believe we have the ability to fulfill
all of our customers' needs with respect to merchant card services and funds
transfers. We market our services through a variety of sales channels that
includes affinity groups and independent sales organizations and financial
institutions.
Our customers access our banking services through our website, or the website of
their affinity group, from any personal computer with a web browser, and obtain
cash withdrawals from automated teller machines. As a result, we do not maintain
a branch bank system.
Our offices are located at 405 Silverside Road, Wilmington, Delaware 19809 and
our telephone number is (302) 385-5000. We also maintain executive offices at
1818 Market Street, Philadelphia, Pennsylvania 19103. Our web address is
www.thebancorp.com. We include on our website our Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to
those reports as soon as reasonably practicable after we file them with the SEC.
OUR STRATEGY
Our principal growth strategies are to:
Build upon the network of relationships developed by our senior management. We
seek to build upon our senior managers' network of relationships through a
division called The Philadelphia Private Bank. This division offers banking
services specifically targeted to individuals and businesses in the
Philadelphia, Pennsylvania, region with which our senior management has
developed relationships. Philadelphia Private Bank seeks to offer these
customers products and services that meet their banking and financing needs, and
to provide them with the attention of senior management which we believe is
often lacking at larger financial institutions. Philadelphia Private Bank offers
a staff of people experienced in dealing with, and solving, the banking and
financing needs of small to mid-size businesses. The website for the
Philadelphia Private Bank is www.philadelphiaprivatebank.com.
Develop relationships with affinity groups to gain sponsored access to their
membership, client or customer bases to market our banking products and
services. We seek to develop relationships with organizations with established
membership, client or customer bases. Through these relationships, we gain
access to the affinity groups' members, clients and customers through their
pre-existing relationships with the groups, and under the groups' sponsorship.
We seek to build on these relationships by offering online banking under the
name of and through the facilities of the affinity group, as described in "-The
Affinity Group Relationship," below, referred to as "privately-labeled" banking.
We believe that by marketing targeted products and services to constituencies
through their pre-existing relationships with affinity groups, we will lower our
customer acquisition costs and build close customer relationships.
Develop Relationships with Small to Mid-Size Businesses and Their Principals. We
target small to mid-size businesses and their principals. We believe that
satisfactory attention to this market requires a combination of the ability to
provide a high level of services, including customized financing to meet a
customer's needs, and the personal attention of senior management. Because
4
of the significant consolidation of banking institutions in the
Philadelphia-Wilmington area, we believe that many of the financial institutions
with which we compete may have become too large to provide those services
efficiently and cost-effectively.
Use Our Existing Infrastructure as a Platform for Growth. We have made
significant investments in our banking infrastructure in order to be able to
support our growth. We believe that this infrastructure can accommodate
significant additional growth without substantial additional expenditure. We
believe that this infrastructure enables us to maximize efficiencies through
economies of scale as we grow without adversely affecting our relationships with
our customers.
PRODUCTS AND SERVICES
Deposit Products and Services. We offer our depositors a wide range of products
and services, including:
o Checking accounts, featuring no required minimum balance, no service
fees, competitive interest rates, rebates on automated teller machine
fees, free debit MasterCard and overdraft protection plans. Premium
checking accounts have free online bill paying, an enhanced debit
MasterCard or an automated teller machine card.
o Savings accounts.
o Health savings accounts.
o Money market accounts.
o Individual retirement accounts, including Roth and education IRAs as
well as traditional IRAs.
o Commercial accounts, including general commercial checking, small
business checking, business savings and business money market accounts.
o Certificates of deposit.
o Stored value and payroll cards.
Lending Activities. At December 31, 2004, we had a loan portfolio of $427.9
million, representing 74.2% of our total assets at that date. We originate
substantially all of the loans held in our portfolio, except in certain
instances we have purchased individual lease and lease pools. Where a proposed
loan exceeds our lending limit, we typically sell a participation in the loan to
another financial institution. We generally separate our lending function into
commercial term loans, commercial mortgages, commercial lines of credit,
construction, direct lease financing and personal loans. We focus primarily on
lending to small to mid-size businesses and their principals. As a result,
commercial, construction and commercial mortgage loans have comprised a majority
of our loan portfolio since we commenced operations. At December 31, 2004,
commercial, construction and commercial mortgage loans made up $327.3 million,
or 76.5%, of our total loan portfolio. These types of loans are generally viewed
as having more risk of default than residential real estate loans or consumer
loans and are typically larger than residential real estate and consumer loans.
5
While in making our loans we rely upon our evaluation of the creditworthiness
and debt-servicing capability of a borrower, we typically require that our loans
be secured by tangible collateral, usually residential or commercial real
property. We do not engage in non-recourse lending (that is, lending as to which
the lender only looks to the asset securing the loan for repayment) and will
typically require the principals of any commercial borrower to personally
guarantee the loan. In general, we require that the ratio of the principal
amount of a loan to the value of the collateral securing it be no greater than
between 65% to 85% depending on the type of property and its use. The maturity
dates on our loans are generally short to mid-term. We typically seek to
structure our loans with variable rates of interest based upon either a stated
prime rate or the London Inter-Bank Offered Rate, although we do lend at fixed
rates when appropriate for a particular customer.
Commercial Term Lending. We make loans to businesses to finance fixed assets,
acquisitions and other long-term needs of our business customers. While the
loans are generally secured, the loans are underwritten principally upon our
evaluation of the future cash flows of the borrower. Maturities of these loans
are typically five years or less and have amortization schedules that do not
exceed the useful life of the asset to be acquired with the financing. As of
December 31, 2004, commercial term loans were 7.9% of our total loan portfolio.
Commercial Mortgage Lending. We make loans to businesses to finance the
acquisition of, or to refinance, income-producing real property. The principal
repayment source for these loans is the property and the income it produces,
which depends upon the operation of the property and its market value, although
we also evaluate the creditworthiness of the borrower and guarantors as a second
repayment source. These loans typically are secured by real estate which is
either for rent or sale. Maturities on these loans generally do not exceed 10
years, although they may have an extended amortization schedule resulting in a
balloon payment due at maturity. As of December 31, 2004, commercial mortgages
were 21.8% of our total loan portfolio.
Commercial lines of credit. Lines of credit are typically short-term facilities
intended to support seasonal cash needs. They may be secured or unsecured,
depending on the purpose, anticipated repayment source and financial condition
of the borrower. This form of financing is typically self-liquidating as
repayment comes from the conversion of the financed assets to cash. All lines of
credit are payable on demand and the availability of the line of credit is
subject to a periodic review of the borrower's financial information. Generally,
lines of credit terminate between one year and 18 months. Lines of credit that
have termination dates in excess of one year typically must be paid out at least
annually. As of December 31, 2004, commercial lines of credit were 23.9% of our
total loan portfolio.
Construction Loans. The majority of our construction loans are made to
residential developers for acquisition of land, site improvements and
construction of single and multi-family residential units for sale. Terms of the
loans are generally for no longer than two years. Repayment of these loans is
typically dependent on the sale of the residential units to consumers or sale of
the property to another developer. Loans to finance the construction of
commercial or industrial properties require permanent financing upon completion
of the construction. As of December 31, 2004, construction loans were 22.7% of
our total loan portfolio.
Direct Lease Financing. Substantially all of our leases are for financing small
commercial automobile fleets. The term of our leases is typically 48 months or
less and they are open ended, meaning that potential residual risk, or the
difference between the fair market value of the automobile and the amount owed
to us, lies with the customer. As of December 31, 2004, direct lease financing
made up 10.5% of our total loan portfolio.
6
Consumer Loans. We provide loans to consumers to finance personal residences,
automobiles, home improvements and other personal wants. The majority of our
consumer loans are secured by the borrower's residence in either a first or
second lien position. The ratio of loan amount to the value of the collateral
securing the loan is typically less than 85%; however, based on a borrower's
financial strength, we may increase the ratio. As of December 31, 2004, consumer
loans were 13.2% of total loan portfolio.
OTHER OPERATIONS
Account Activity. Account holders may access our products and services through
the websites of their affinity groups, or through our website, from any personal
computer with a secure web browser, regardless of its location. This access
allows account holders to apply for loans, review account activity, enter
transactions into an on-line account register, pay bills electronically, receive
statements by mail and print bank statement reports. To open a new account, a
customer must complete a simple on-line enrollment form. Customers can make
deposits into an open account via direct deposit programs, by transferring funds
between existing accounts, by wire transfer, by mail, at any deposit-taking
automated teller machine, at any of the more than 3,400 UPS Stores throughout
the United States, or in person at our Delaware offices (although we do not
maintain a teller line and do not currently intend to establish a physical
branch system). Customers may also make withdrawals and have access to their
accounts at automated teller machines.
Call Center. We have a call center as a customer support service as well as for
outbound telemarketing efforts. The call center provides account holders or
potential account holders with assistance in opening accounts, applying for
loans or otherwise accessing the Bank's products and services, and in resolving
any problems that may arise in the servicing of accounts, loans or other banking
products. The call center operates from 8:00 a.m. to 8:00 p.m., Delaware time,
on weekdays. Outside these hours, and on weekends, we outsource call center
operations to a third-party service provider. We currently employ eight persons
in our call center, including one supervisor.
Third-Party Service Providers. To reduce operating costs and to capitalize on
the technical capabilities of selected vendors, we arrange for the outsourcing
of specific bank operations and systems to third-party service providers,
principally the following:
o fulfillment functions and similar operating services, including check
processing, check imaging, electronic bill payment and statement
rendering;
o issuance and servicing of debit cards;
o compliance and internal audit;
o access to automated teller machine networks;
o processing and temporarily funding residential mortgage loans where we
will not hold the loans in our portfolio;
o bank accounting and general ledger system; and
o data warehousing services.
7
Because we outsource these operational functions to experienced third-party
service providers that have the capacity to process a high volume of
transactions, we believe it allows us to more readily and cost-effectively
respond to growth than if we sought to develop these capabilities internally.
Should any of our current relationships terminate, we believe we could secure
the required services from an alternative source without material interruption
of our operations.
THE AFFINITY GROUP RELATIONSHIP
We seek to create a unique banking website for each affinity group, enabling the
affinity group to provide its members with the full banking services and
products we offer or just those banking services and products it believes will
be of interest to its members. We design each website to carry the brand of the
affinity group and carry the "look and feel" of the affinity group's own
website. Each such website, however, indicates that we provide all banking
services. To facilitate the creation of these individualized banking websites,
we have packaged our products and services into a series of modules, with each
module providing a specific service, such as basic banking, electronic payment
systems and loan and mortgage centers. Each affinity group selects from our menu
of service modules those services that it wants to offer its members or
customers. We and the affinity group also may create products and services, or
modify products and services already on our menu, that specifically relate to
the needs and interests of the affinity group's members or customers. We pay
fees to the affinity group based upon deposits and loans it generates through
our program with it. The fees typically range from between 25 to 100 basis
points (0.25% to 1.00%) of average deposits and loans generated by the
relationship and outstanding in the period, with the lower fees being charged on
interest-bearing deposits and loans with lower interest rates. We include these
fees as a component of expense in calculating our net interest margin. In the
year ended December31, 2004, these fees aggregated $356,000.
As a result of our initial investment in developing private-label banking
software, we have reduced the time, personnel and expense in establishing a
privately-labeled banking website providing core banking products and services
to an affinity group to approximately two weeks of dedicated time of one of our
technical staff members, at a cost of approximately $9,000.
We currently have 91 affinity group relationships, as follows:
o Forty-nine affinity group relationships are with independent service
organizations. These organizations provide operating and settlement
accounts to their merchant members, enabling the merchants to service
their client base from the point at which a credit or debit card
transaction occurs through settlement of that transaction. For
independent service organizations, we have created banking products that
enable those organizations to more easily process electronic payments
and maintain reserve accounts as protection against chargebacks and
losses from the parties with which they deal. Our services also enable
independent service organizations to provide their members with access
to their account balances through the Internet. By using our services
rather than those of other banks, independent service organizations
remove potential competitors from the relationship between the
independent service organization and its merchant customers, since we do
not offer any products comparable to those of the independent service
organization. In addition to the customary banking fees generated by
these relationships (which we share with the independent service
organizations), these relationships are a source of low-cost deposits
for us because of the settlement and reserve checking accounts that
merchants affiliated with the independent service organization must
maintain with us.
8
o Twenty-seven affinity group relationships are with businesses and a
twenty-eighth relationship is with a university. We offer these
organizations, and other institutions with which we may develop
relationships, privately-labeled full service retail banking or, at the
organization's option, a selection of banking services and products
targeted to the needs or preferences of its members. In addition, we
separately market a treasury program to these organizations,
particularly university endowment funds, that provides transaction
processing and maintenance services to managers of the organization.
o Fourteen affinity group relationships are with employers providing their
employees health savings accounts. Our health savings account program
provides qualified entities a turnkey, low-cost way to provide this
benefit to their employees. Under this program, we open all of the
accounts offered by an employer in a privately-labeled banking
environment, and enable their employees to access account information
and process payments to health care providers through the Internet.
SALES AND MARKETING
Philadelphia Private Bank. Our marketing program for the Philadelphia Private
Bank targets a customer base of successful individuals and business owners in
the Philadelphia area and uses a personal contact/targeted media advertising
approach. This program consists of:
o direct e-mail and letter introductions of the Philadelphia Private Bank
to senior management's contacts;
o invitation-only, private receptions with prominent business leaders in
the Philadelphia community;
o advertisements in local media outlets, principally newspapers and radio
stations; and
o charitable sponsorships.
Affinity Group Marketing. We pursue affinity group relationships through the
contacts of our senior management. We seek to attract customers from an affinity
group's community not only by our presence on the affinity group's website and
through targeted marketing programs to the affinity group's members, but also
through the quality of our products and services.
Loan Production Offices. We maintain two loan production offices in the
Philadelphia metropolitan area. We established these offices to serve suburban
areas south (our Exton, Pennsylvania office) and north (our Warminster,
Pennsylvania office) of center city Philadelphia. In addition, we maintain three
offices to market and administer our automobile leasing programs, one in
Maryland, one in Alabama in connection with a portfolio of automobile leases we
acquired in 2003 and one in Florida in connection with our acquisition of
Mears Motor Livery in 2005.
Marketing Staff. We have a marketing department, currently consisting of eight
people that focus on developing marketing campaigns to particular affinity group
communities and the targeted audience of the Philadelphia Private Bank.
TECHNOLOGY
Core and Internet Banking Systems. We obtain a significant portion of our core
and internet banking systems and operations under non-exclusive licenses between
us and Metavante
9
(previously M&I Data Services). These systems include, principally, those for
general ledger, deposit and loan processing, Internet banking and processing
checks and other items.
Software. Our proprietary data assets also support our online and traditional
banking products and services. We have developed a series of financial services
modules that are easy to deploy and that we can readily adopt to serve its
customers' needs. We developed these modules using an open architecture and
object-oriented technologies. We use the modules to extend the functionality of
our core and internet banking systems and to personalize financial services to
the constituencies we serve.
System Architecture. We provide financial products and services through a
highly-secured four-tiered architecture using the Microsoft Windows 2000
operating system, Microsoft Internet Information Server web server software,
Microsoft SQL 2000, Macromedia JRun, CheckPoint Systems and Cisco Systems
firewalls, and our licensed and proprietary financial services software. User
activity is distributed and load-balanced across multiple servers on each tier
through our proprietary software and third-party equipment, which maintain
replicated, local storage of underlying software and data, resulting in minimal
interdependencies among servers. Each server has its own local storage, and all
data and software are replicated across all servers. The system's flexible
architecture is designed to have the capacity, or to be easily expanded to add
capacity, to meet future demand. In addition to built-in redundancies, we
continuously operate automated internal monitoring tools and independent third
parties continuously monitor our websites.
Our primary website hosting facility is in Wilmington, Delaware and connects to
the Internet by Cisco routers through Internap's New York and FastNet's
Philadelphia, Pennsylvania network operating centers. We also maintain a
completely redundant standby hosting facility at our Philadelphia offices.
Internap's Philadelphia network operating center provides Internet connectivity
to the Philadelphia offices.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
Since a significant portion of the core and internet banking systems and
operations we use come from third-party providers, our primary proprietary
intellectual property is the software for creating affinity group bank websites.
We rely principally upon trade secret and trademark law to protect our
intellectual property. We do not typically enter into confidentiality agreements
with our employees or our affinity group customers because we maintain control
over the software used to create the sites and their banking functions rather
than licensing them for customers to use. Moreover, we believe that factors such
as the relationships we develop with our affinity group and banking customers,
the quality of our banking products, the level and reliability of the service we
provide, and the customization of our products and services to meet the need of
our affinity group and other customers are substantially more significant to our
ability to succeed.
COMPETITION
We believe that our principal competition is mid-Atlantic regional banks such as
Citizens Bank, Sovereign Bank, Commerce Bank, Royal Bank and Republic First
Bank. While we also believe that we face competition from Internet-based banks
or bank divisions such as Net.Bank and E-Trade Bank, we compete more directly
with National Interbanc and Virtual Bank, Internet-based banks that provide
private labeled financial services to affinity groups and communities. We also
compete more generally with numerous other banks and thrift institutions,
mortgage brokers and other financial institutions such as finance companies,
credit unions, insurance companies, money
10
market funds, investment firms and private lenders, as well as on-line
computerized services and other non-traditional competitors. We believe that our
ability to compete successfully depends on a number of factors, including:
o our ability to build upon the customer relationships developed by our
senior management;
o our ability to expand our affinity group banking program;
o competitors' interest rates and service fees;
o the scope of our products and services;
o the relevance of our products and services to customer needs and demands
and the rate at which we and our competitors introduce them;
o satisfaction of our customers with our customer service;
o ease of use of our banking website;
o the capacity, reliability and security of our network infrastructure;
and
o industry and general economic trends.
If we experience difficulty in any of these areas, our competitive position
could be materially adversely affected, which will affect our consolidated
growth, our profitability and, possibly, our ability to continue operations.
While the banking industry is highly competitive, we believe we can compete
effectively as a result of our focus on small to mid-size businesses and their
principals, a market segment we believe is under-served in our region. However,
many of our competitors have larger customer bases, greater name recognition and
brand awareness, greater financial and other resources and longer operating
histories which may make it difficult for it to compete effectively. Our future
success will depend on our ability to compete effectively in a highly
competitive market and geographic area.
EMPLOYEES
As of March 1, 2005, we had 139 employees and believe our relationships
with our employees to be good. Our employees are not represented by a collective
bargaining agreement.
RISKS RELATING TO THE BUSINESS AND OPERATIONS OF THE COMPANY
We have a limited operating history, which makes it difficult to predict our
future prospects and financial performance following the reorganization.
We were formed in 1999 and began banking operations in July 2000. Because of our
limited operating history, it may be difficult to evaluate our business
prospects or performance. Our prospects are subject to the risks and
uncertainties frequently encountered by companies in their early stages of
development, including the risk that we will not be able to implement our
business strategies. Accordingly, our financial performance to date may not be
representative of our long-term future performance or indicative of whether our
business strategies will be successful.
11
We may have difficulty managing our growth which may divert resources and limit
our ability to successfully expand our operations.
We expect to continue to experience significant growth in the amount of our
assets, the level of our deposits and the scale of our operations. Our future
profitability will depend in part on our continued ability to grow; however, we
may not be able to sustain our historical growth rate or even be able to grow at
all.
In our first years of operation, we incurred substantial expenses to build our
management team and personnel, develop our delivery systems and establish our
infrastructure to support our future growth. Our future success will depend on
the ability of our officers and key employees to continue to implement and
improve our operational, financial and management controls, reporting systems
and procedures, and manage a growing number of customer relationships. We may
not implement improvements to our management information and control systems in
an efficient or timely manner and may discover deficiencies in existing systems
and controls. Consequently, our continued growth may place a strain on our
administrative and operational infrastructure. Any such strain could increase
our costs, reduce or eliminate our profitability and reduce the price at which
our common shares trade.
Changes in interest rates could reduce our income, cash flows and asset values.
Our consolidated income and cash flows and the value of our consolidated assets
will depend to a great extent on the difference between the interest rates we
earn on interest-earning assets, such as loans and investment securities, and
the interest rates we pay on interest-bearing liabilities such as deposits and
borrowings. We discuss the effects of interest rate changes on the market value
of our portfolio equity and net interest income in "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Asset and Liability
Management." Interest rates are highly sensitive to many factors which are
beyond our control, including general economic conditions and policies of
various governmental and regulatory agencies and, in particular, the Federal
Reserve. Changes in monetary policy, including changes in interest rates, will
influence not only the interest we receive on our loans and investment
securities and the amount of interest we pay on deposits, it will also affect
our ability to originate loans and obtain deposits and our costs in doing so. If
the rate of interest we pay on our deposits and other borrowings increases more
than the rate of interest we earn on its loans and other investments, our
consolidated net interest income, and therefore our consolidated earnings, could
be adversely affected. These earnings could also be adversely affected if the
rates on our loans and other investments fall more quickly than those on our
deposits and other borrowings.
We are subject to lending risks.
There are risks inherent in making all loans. These risks include interest rate
changes over the time period in which loans may be repaid and changes in the
national economy or the economy of our regional market that impact the ability
of our borrowers to repay their loans or the value of the collateral securing
those loans. Our loan portfolio contains a high percentage of commercial,
construction and commercial mortgage loans in relation to its total loans and
total assets. At December 30, 2004, commercial loans were 20.9% of total loans,
construction loans were 22.7% of total loans and commercial mortgage loans were
32.9% of total loans. These types of loans are generally viewed as having more
risk of default than residential real estate loans or consumer loans. These
types of loans are also typically larger than residential real estate loans and
consumer loans. Because our loan portfolio contains a significant number of
commercial,
12
construction and commercial mortgage loans with relatively large balances, the
deterioration of one or a few of these loans would cause a significant increase
in nonperforming loans. On a consolidated basis, an increase in nonperforming
loans could result in an increase in our provision for loan losses or in loan
charge-offs and a consequent reduction of our earnings.
Lack of seasoning of our loan portfolio may increase the risk of credit defaults
in the future.
All of the loans in our loan portfolio were originated within the past four
years. In general, loans do not begin to show signs of credit deterioration or
default until they have been outstanding for some period of time, a process
referred to as "seasoning." As a result, a portfolio of older loans will usually
behave more predictably than a portfolio of recently originated loans. Because
our loan portfolio is relatively unseasoned, the current level of delinquencies
and defaults may be below the level that will prevail when the portfolio becomes
more seasoned.
Until Our Portfolio Becomes More Seasoned, We Must Rely In Part On The
Historical Loan Loss Experience Of Other Financial Institutions And Our
Management's Past Experience In Determining The Allowance For Loan And Lease
Losses, Which May Result In Our Having Inadequate Reserves.
Because most of our loans were originated relatively recently, our loan
portfolio does not provide an adequate history of loan losses for management to
rely upon in establishing its allowance for loan and lease losses. We therefore
rely to a significant extent upon other financial institutions' histories of
loan losses and their allowance for loan and lease losses, as well as
management's estimates based on their experience in the banking industry, when
determining our loss allowance. The history of loan and lease losses, the
reserving policies of other financial institutions and management's judgment may
not result in reserving policies that will be adequate for our consolidated
business and operations.
Our operations are concentrated in the Philadelphia-Wilmington metropolitan
area.
Our loan activities are largely based in the Philadelphia-Wilmington
metropolitan area. To a lesser extent, our deposit base is also generated from
this area. As a result, our consolidated financial performance depends largely
upon economic conditions in this area. Adverse local economic conditions could
cause us to experience an increase in loan delinquencies, a reduction in
deposits, an increase in the number of borrowers who default on their loans and
a reduction in the value of the collateral securing their loans, all of which
would adversely affect our consolidated profitability.
We depend to a significant extent upon wholesale and brokered deposits to
satisfy funding needs.
We have relied to a significant extent on funds provided by wholesale and
brokered deposits to support the growth of our loan portfolio. These funding
sources amounted to 41.4% of our total deposits at December 31, 2004. If we are
not successful in obtaining wholesale funding or increasing our current deposit
base to a level commensurate with our funding needs, we may be unable to
continue our growth, or could experience contraction in our total assets.
Moreover, to the extent that we are unable to match the maturities of the
interest rates we pay for wholesale and brokered funds to the maturities of the
loans we make using those funds, increases in the interest rates we pay for such
funds could decrease our consolidated net interest income.
13
Our future success will depend on our ability to compete effectively in a highly
competitive market and geographic area.
We will face substantial competition in all phases of our operations from a
variety of different competitors, including commercial banks and their holding
companies, savings and loan associations, mutual savings banks, credit unions,
consumer finance companies, factoring companies, insurance companies and money
market mutual funds. Competition for financial services in the
Philadelphia-Wilmington metropolitan area, which is our principal service area,
is very strong. This geographic area includes offices of many of the largest
financial institutions in the nation. Most of those competing institutions have
much greater financial and marketing resources than we have and, because we are
relatively newly-formed entities, far greater name recognition. Due to their
size, many of our competitors can achieve economies of scale and, as a result,
may offer a broader range of products and services as well as better pricing
structures for those products and services. Moreover, because we are smaller and
less well-established, we may have to pay higher rates on our deposits or offer
more free or reduced-cost services in order to attract and retain customers.
Some of the financial services organizations with which we compete are not
subject to the same degree of regulation as federally-insured and regulated
financial institutions such as ours. As a result, those competitors may be able
to access funding and provide various services more easily or at less cost than
we can.
Our affinity group marketing strategy has been adopted by other institutions
with which we compete.
As a result of the high costs encountered by Internet banks in acquiring
customers through traditional marketing and advertising or for other reasons,
several online banking operations as well as the online banking programs of
conventional banks have instituted affinity group marketing strategies similar
to ours. As a consequence, we have encountered competition in this area and
anticipate that we will continue to do so in the future. This competition may,
on a consolidated basis, increase our costs, reduce our revenues or revenue
growth or, because we are a relatively new banking operation without the name
recognition of other, more established banking operations, make it difficult for
us to compete effectively in obtaining affinity group relationships.
Our lending limit may adversely affect our competitiveness.
Our regulatory lending limit as of December 31, 2004 to any one customer or
related group of customers was $17.6 million. Our lending limit is substantially
smaller than those of most financial institutions with which we compete. While
we believe that our lending limit is sufficient for our targeted market of small
to mid-size businesses, individuals and affinity group members, it may affect
our ability to attract or maintain customers or to compete with other financial
institutions. Moreover, to the extent that we incur losses and do not obtain
additional capital, our lending limit, which depends upon the amount of our
capital, will decrease.
Environmental liability associated with lending activities could result in
losses.
In the course of our business, we may foreclose on and take title to properties
securing our loans. If hazardous substances were discovered on any of these
properties, we may be liable to governmental entities or third parties for the
costs of remediation of the hazard, as well as for personal injury and property
damage. Many environmental laws can impose liability regardless of whether we
knew of, or were responsible for, the contamination. In addition, if we arrange
for the
14
disposal of hazardous or toxic substances at another site, we may be liable for
the costs of cleaning up and removing those substances from the site, even if we
neither own nor operate the disposal site. Environmental laws may require us to
incur substantial expenses and may materially limit use of properties we acquire
through foreclosure, reduce their value or limit our ability to sell them in the
event of a default on the loans they secure. In addition, future laws or more
stringent interpretations or enforcement policies with respect to existing laws
may increase our exposure to environmental liability.
As a financial institution whose principal medium for delivery of banking
services is the internet, we are subject to risks particular to that medium.
We operate an independent Internet bank, as distinguished from the Internet
banking service of an established conventional bank. Independent Internet banks
often have found it difficult to achieve profitability and revenue growth.
Several factors contribute to the unique problems that Internet banks face.
These include concerns for the security of personal information, the absence of
personal relationships between bankers and customers, the absence of loyalty to
a conventional hometown bank, the customer's difficulty in understanding and
assessing the substance and financial strength of an Internet bank, a lack of
confidence in the likelihood of success and permanence of Internet banks and
many individuals' unwillingness to trust their personal assets to a relatively
new technological medium such as the Internet. As a result, many potential
customers may be unwilling to establish a relationship with us.
Conventional financial institutions, in growing numbers, are offering the option
of Internet banking and financial services to their existing and prospective
customers. The public may perceive conventional financial institutions as being
safer, more responsive, more comfortable to deal with and more accountable as
providers of their banking and financial services, including their Internet
banking services. We may not be able to offer Internet banking and financial
services and personal relationship characteristics that have sufficient
advantages over the Internet banking and financial services and other
characteristics of established conventional financial institutions to enable us
to compete successfully.
Moreover, both the Internet and the financial services industry are undergoing
rapid technological changes, with frequent introductions of new
technology-driven products and services. In addition to improving the ability to
serve customers, the effective use of technology increases efficiency and
enables financial institutions to reduce costs. Our future success will depend,
in part, upon our ability to address the needs of our customers by using
technology to provide products and services that will satisfy customer demands,
as well as to create additional efficiencies in our operations. Many of our
competitors have substantially greater resources to invest in technological
improvements. We may not be able to implement effectively new technology-driven
products and services or be successful in marketing these products and services
to our customers.
Our operations may be interrupted if our network or computer systems, or those
of our providers, fail.
Because we deliver our products and services over the Internet and outsource
several critical functions to third parties, our operations depend on our
ability, as well as that of our service providers, to protect computer systems
and network infrastructure against interruptions in service due to damage from
fire, power loss, telecommunications failure, physical break-ins, computer
hacking or similar catastrophic events. Our operations also depend upon our
ability to replace a
15
third-party provider if it experiences difficulties that interrupt our
operations or if an operationally essential third-party service terminates.
Service interruptions to customers may adversely affect our ability to obtain or
retain customers and could result in regulatory sanctions. Moreover, if a
customer were unable to access his or her account or complete a financial
transaction due to a service interruption, we could be subject to a claim by the
customer for his or her loss. While our accounts and other agreements contain
disclaimers of liability for these kinds of losses, we cannot predict the
outcome of litigation if a customer were to make a claim against us.
Security concerns may adversely affect internet banking.
A significant barrier to on-line financial transactions is the secure
transmission of confidential information over public networks. The systems we
use rely on encryption and authentication technology to provide secure
transmission of confidential information. Advances in computer capabilities, new
discoveries in the field of cryptography or other developments could result in a
compromise or breach of the algorithms used to protect customer transaction
data. If we, or another provider of financial services through the Internet,
were to suffer damage from a security breach, public acceptance and use of the
Internet as a medium for financial transactions could suffer. Any security
breach could deter potential customers or cause existing customers to leave,
thereby materially adversely affecting our ability to grow and maintain
profitability and, possibly, our ability to continue delivering our products and
services through the Internet. Although we, with the help of third-party service
providers, intend to continue to implement security technology and establish
operational procedures to prevent security breaches, these measures may not be
successful.
We outsource many essential services to third-party providers who may terminate
their agreements with us, resulting in interruptions to our banking operations.
We obtain essential technological and customer services support for the systems
used by the Company from third-party providers. We outsource our check
processing, check imaging, electronic bill payment, statement rendering,
internal audit and other services to third party vendors. For a description of
these services, you should read "-Other Operations -Third Party Service
Providers." Our agreements with each service provider are generally cancelable
without cause by either party upon specified notice periods. If one of our
third-party service providers terminates its agreement with us and we are unable
to replace it with another service provider, our operations may be interrupted.
If an interruption were to continue for a significant period of time, our
consolidated operations, revenues and profitability could be materially
adversely affected.
We may be adversely affected by government regulation.
We are subject to extensive federal and state banking regulation and
supervision. The regulations are intended primarily to protect our depositors'
funds, the federal deposit insurance funds and the safety and soundness of the
Bank, not our shareholders. Regulatory requirements affect lending practices,
capital structure, investment practices, dividend policy and growth. A failure
by either the Bank or us to meet minimum capital requirements will result in the
imposition of limitations on our operations that would adversely impact our
operations and could, if capital levels drop significantly, result in our being
required to cease operations. Changes in governing law, regulations or
regulatory practices could impose additional costs on us or adversely affect our
ability to obtain deposits or make loans and, as a consequence, our consolidated
revenues and profitability.
16
As a Delaware-chartered bank whose depositors and financial services customers
are located in several states, the Bank may be subject to additional licensure
requirements or other regulation of its activities by state regulatory
authorities and laws outside of Delaware. If the Bank's compliance with
licensure requirements or other regulation becomes overly burdensome, we may
seek to convert its state charter to a federal charter in order to gain the
benefits of federal preemption of some of those laws and regulations. Conversion
of the Bank to a federal charter will require the prior approval of the relevant
federal bank regulatory authorities, which we may not be able to obtain.
Moreover, even if we obtain approval, there could be a significant period of
time between our application and receipt of the approval, and/or any approval we
do obtain may be subject to burdensome conditions or restrictions.
Our success will depend on our ability to retain Betsy Z. Cohen, our Chief
Executive Officer.
We believe that the future success of the Company will depend upon the expertise
of, and customer relationships established by Betsy Z. Cohen, our chief
executive officer. If Mrs. Cohen were to become unavailable for any reason, or
if we are unable to hire highly qualified and experienced personnel with similar
relationships to replace her, our ability to attract deposits or loan customers
may be materially adversely affected. We do not have an employment agreement
with, nor do we have key man life insurance on Mrs. Cohen.
REGULATION UNDER BANKING LAW
We are extensively regulated under both federal and state banking
law. We are a Delaware corporation and a registered bank holding company that is
also a registered financial holding company. We are subject to supervision and
regulation by the Federal Reserve and the Delaware State Bank Commissioner.
The Bank, as a state-chartered depository institution, is supervised by the
Delaware State Bank Commissioner, as well as the Federal Deposit Insurance
Company, or FDIC. The Bank is subject to requirements and restrictions under
federal and state law, including requirements to maintain reserves against
deposits, restrictions on the types and amount of loans that may be made and the
interest that may be charged, and limitations on the types of investments that
may be made and the types of services that may be offered. Various consumer laws
and regulations also affect the Bank's operations.
Federal Regulation
As a bank holding company, we must file annual reports with the Federal Reserve,
provide any additional information that the Federal Reserve may request, and are
subject to regular examination by it.
Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act, or GLBA, made extensive
changes in the rules governing the financial services industry, particularly
banking. It eliminated many of the restrictions placed upon the activities of
bank holding companies and established a new type of bank holding company called
a financial holding company. We were registered as a financial holding company
in 2004. Financial holding companies are granted the authority to engage in
"financial activities" that are beyond those of conventional bank holding
companies and to affiliate with entities engaged in financial activities. While
the Federal Reserve (together with the Treasury Secretary) is authorized to
determine what a financial activity is, the GLBA provides that financial
activities include:
17
o lending, investing for others or safeguarding money or securities;
o Underwriting insurance and annuities as principal, agent or broker;
o providing financial, investment or economic advisory services;
o issuing or selling interests in pools of assets permissible for a bank
to hold directly;
o engaging in any activity that the Federal Reserve found before the act
to be a proper incident to banking; and
o insurance portfolio investing.
The GLBA directs the Federal Reserve to define the following activities as
financial in nature and the extent to which they are financial in nature:
o lending, exchanging, transferring, investing for others or safeguarding
financial assets other than money or securities; and
o arranging financial transactions for the account of third parties.
The banking and nonfinancial subsidiaries of a financial holding company may not
cross sell each other's products and services where the financial holding
company owns the non-financial subsidiary through the financial holding
company's merchant banking authority or through its insurance subsidiary under
its investment portfolio authority. However, insurance products or services may
be marketed by Internet websites or statement inserts with Federal Reserve
approval if there is no illegal tying arrangement. A bank also may not engage in
a "covered transaction" with a controlled affiliate of a financial holding
company. A "covered transaction" includes loans to, investments in, purchases of
assets from or guaranteeing loans of the affiliate, or accepting securities of
the affiliate as collateral for a loan.
Transactions with Affiliates. There are various legal restrictions on the extent
to which a bank holding company and certain of its nonbank subsidiaries can
borrow or otherwise obtain credit from banking subsidiaries or engage in certain
other transactions with or involving those banking subsidiaries. In general,
these restrictions require that any such transactions must be on terms that
would ordinarily be offered to unaffiliated entities and secured by designated
amounts of specified collateral. Transactions between a banking subsidiary and
its holding company or any nonbank subsidiary are limited to 10% of the banking
subsidiary's capital stock and surplus and, as to the holding company and all
such nonbank subsidiaries in the aggregate, up to 20% of the bank's capital
stock and surplus.
Regulatory Restrictions on Dividends. It is the policy of the Federal Reserve
that bank holding companies should pay cash dividends on common stock only out
of income available over the past year and only if prospective earnings
retention is consistent with the organization's expected future needs and
financial condition. The policy provides that bank holding companies should not
maintain a level of cash dividends that undermines the bank holding company's
ability to serve as a source of strength to its banking subsidiaries. See "--
Holding Company Liability," below. Federal Reserve policies also affect the
ability of a bank holding company to pay in kind dividends.
18
Various federal and state statutory provisions limit the amount of dividends
that subsidiary banks can pay to their holding companies without regulatory
approval. The Bank is also subject to limitations under state law regarding the
payment of dividends, including the requirement that dividends may be paid only
out of net profits. See "-- Delaware Regulation." In addition to these explicit
limitations, federal and state regulatory agencies are authorized to prohibit a
banking subsidiary or bank holding company from engaging in an unsafe or unsound
banking practice. Depending upon the circumstances, the agencies could take the
position that paying a dividend would constitute an unsafe or unsound banking
practice.
Because we are a legal entity separate and distinct from the Bank, our right to
participate in the distribution of assets of the Bank, or any other subsidiary,
upon the Bank's or the subsidiary's liquidation or reorganization will be
subject to the prior claims of the Bank's or subsidiary's creditors. In the
event of a liquidation or other resolution of an insured depository institution,
the claims of depositors and other general or subordinated creditors have
priority of payment over the claims of holders of any obligation of the
institution's holding company or any of its shareholders or creditors.
Holding Company Liability. Under Federal Reserve policy, a bank holding company
is expected to act as a source of financial strength to each of its banking
subsidiaries and commit resources to their support. Such support may be required
at times when, absent this Federal Reserve policy, a holding company may not be
inclined to provide it. As discussed below under "-- Prompt Corrective Action,"
a bank holding company in certain circumstances could be required to guarantee
the capital plan of an undercapitalized banking subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of the U.S.
Bankruptcy Code, the trustee will be deemed to have assumed, and is required to
cure immediately, any deficit under any commitment by the debtor holding company
to any of the federal banking agencies to maintain the capital of an insured
depository institution, and any claim for breach of such obligation will
generally have priority over most other unsecured claims.
Capital Adequacy. The Federal Reserve and FDIC have issued standards for
measuring capital adequacy for bank holding companies and banks. These standards
are designed to provide risk-based capital guidelines and to incorporate a
consistent framework. The risk-based guidelines are used by the agencies in
their examination and supervisory process, as well as in the analysis of any
applications to them to obtain approvals, including our applications for
approval of the reorganization and for registration as a financial holding
company. As discussed under "-- Prompt Corrective Action," a failure to meet
minimum capital requirements could subject us or the Bank to a variety of
enforcement remedies available to federal regulatory authorities, including, in
the most severe cases, termination of deposit insurance by the FDIC and placing
the Bank into conservatorship or receivership.
In general, the risk-related standards require banks and bank holding companies
to maintain capital based on "risk-adjusted" assets so that the categories of
assets with potentially higher credit risk will require more capital backing
than categories with lower credit risk. In addition, banks and bank holding
companies are required to maintain capital to support off-balance sheet
activities such as loan commitments.
The standards classify total capital for this risk-based measure into two tiers,
referred to as Tier 1 and Tier 2. Tier 1 capital consists of common
stockholders' equity, certain non-cumulative perpetual preferred stock, and
minority interests in equity accounts of consolidated subsidiaries,
19
less certain adjustments. Tier 2 capital consists of the allowance for loan and
lease losses (within certain limits), perpetual preferred stock not included in
Tier 1, hybrid capital instruments, term subordinate debt, and intermediate-term
preferred stock, less certain adjustments. Together, these two categories of
capital comprise a bank's or bank holding company's "qualifying total capital."
However, capital that qualifies as Tier 2 capital is limited in amount to 100%
of Tier 1 capital in testing compliance with the total risk-based capital
minimum standards. Banks and bank holding companies must have a minimum ratio of
8% of qualifying total capital to risk-weighted assets, and a minimum ratio of
4% of qualifying Tier 1 capital to risk-weighted assets. At December 31, 2004,
we and the Bank had a total capital to risk-adjusted assets ratios of 27.04% and
24.49%, respectively, and Tier 1 capital to risk-adjusted assets ratios of
26.29% and 23.74%, respectively.
In addition, the Federal Reserve and the FDIC have established minimum leverage
ratio guidelines. The principal objective of these guidelines is to constrain
the maximum degree to which a financial institution can leverage its equity
capital base. It is intended to be used as a supplement to the risk-based
capital guidelines. These guidelines provide for a minimum ratio of Tier 1
capital to adjusted average total assets of 3% for bank holding companies that
meet certain specified criteria, including those having the highest regulatory
rating. Other financial institutions generally must maintain a leverage ratio of
at least 3% plus 100 to 200 basis points. The guidelines also provide that
financial institutions experiencing internal growth or making acquisitions will
be expected to maintain strong capital positions substantially above minimum
supervisory levels, without significant reliance on intangible assets.
Furthermore, the banking agencies have indicated that they may consider other
indicia of capital strength in evaluating proposals for expansion or new
activities. At December 31, 2004, we and the Bank had leverage ratios of 22.88%
and 20.54%, respectively.
The federal banking agencies' standards provide that concentration of credit
risk and certain risks arising from nontraditional activities, as well as an
institution's ability to manage these risks, are important factors to be taken
into account by them in assessing a financial institution's overall capital
adequacy. The risk-based capital standards also provide for the consideration of
interest rate risk in the agency's determination of a financial institution's
capital adequacy. The standards require financial institutions to effectively
measure and monitor their interest rate risk and to maintain capital adequate
for that risk.
These standards can be expected to be amended from time to time.
Prompt Corrective Action. Under the Federal Deposit Insurance Corporation
Improvement Act of 1991, federal banking agencies must take prompt supervisory
and regulatory actions against undercapitalized depository institutions.
Depository institutions are assigned one of five capital categories -- "well
capitalized ," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized" -- and subjected to
differential regulation corresponding to the capital category within which the
institution falls. Under certain circumstances, a well capitalized, adequately
capitalized or undercapitalized institution may be treated as if the institution
were in the next lower capital category. As we describe in "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources," an institution is deemed to be well
capitalized if it has a total risk-based capital ratio of at least 10.0%, a Tier
1 risk-based capital ratio of at least 6.0% and a leverage ratio of at least
5.0%. An institution is adequately capitalized if it has a total risk-based
capital ratio of at least 8.0%, a Tier 1 risk-based capital ratio of at least
4.0% and a leverage ratio of at least 4.0%. At December 31, 2004, our total
risk-based capital ratio was 27.04%, our Tier 1 risk-based capital ratio was
26.29% and our leverage ratio was 22.88%, while the Bank's ratios
20
were 24.49%, 23.74% and 20.54%, respectively. A depository institution is
generally prohibited from making capital distributions (including paying
dividends) or paying management fees to a holding company if the institution
would thereafter be undercapitalized. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew, or roll over
brokered deposits. As of December 31, 2004, both we and the Bank were "well
capitalized" within the meaning of the regulatory categories.
Banking regulatory agencies are permitted or, in certain cases, required to take
action with respect to institutions falling within one of the three
undercapitalized categories. Depending on the level of an institution's capital,
the agency's corrective powers include, among other things:
o prohibiting the payment of principal and interest on subordinated debt;
o prohibiting the holding company from making distributions without prior
regulatory approval;
o placing limits on asset growth and restrictions on activities;
o placing additional restrictions on transactions with affiliates;
o restricting the interest rate the institution may pay on deposits;
o prohibiting the institution from accepting deposits from correspondent
banks; and
o in the most severe cases, appointing a conservator or receiver for the
institution.
A banking institution that is undercapitalized must submit a capital restoration
plan. This plan will not be accepted unless, among other things, the banking
institution's holding company guarantees the plan up to an agreed-upon amount.
Any guarantee by a depository institution's holding company is entitled to a
priority of payment in bankruptcy. Failure to implement a capital plan, or
failure to have a capital restoration plan accepted, may result in a
conservatorship or receivership.
Community Reinvestment Act. Under the Community Reinvestment Act of 1977, which
we refer to as the CRA, a federally-insured institution has a continuing and
affirmative obligation to help meet the credit needs of its community, including
low-and moderate-income neighborhoods, consistent with the safe and sound
operation of the institution. The CRA requires the board of directors of
federally-insured institutions, such as the Bank, to adopt a CRA statement for
its assessment area that, among other things, describes its efforts to help meet
community credit needs and the specific types of credit that the institution is
willing to extend. The CRA further requires that a record be kept of whether a
financial institution meets its community's credit needs, which record will be
taken into account when evaluating applications for, among other things,
domestic branches and mergers and acquisitions. The regulations promulgated
pursuant to the CRA contain three evaluation tests:
o a lending test which compares the institution's market share of loans in
low- and moderate- income areas to its market share of loans in its
entire service area and the percentage of the institution's outstanding
loans to low- and moderate-income areas or individuals;
21
o a services test, which evaluates the provision of services that promote
the availability of credit to low- and moderate-income areas; and
o an investment test, which evaluates an institution's record of
investments in organizations designed to foster community development,
small- and minority-owned businesses and affordable housing lending,
including state and local government housing or revenue bonds.
The Bank was examined for CRA compliance in 2002 and received a "satisfactory"
rating.
Control Acquisitions. The Change in Bank Control Act, which we refer to as the
CBCA, prohibits a person or group of persons from acquiring "control" of a bank
holding company unless the Federal Reserve has been notified and has not
objected to the transaction. Under a rebuttable presumption established by the
Federal Reserve, the acquisition of 10% or more of any class of voting
securities of a bank holding company is presumed to be an acquisition of control
of the holding company if:
o the bank holding company has a class of securities registered under
Section 12 of the Securities Exchange Act of 1934 or
o no other person will own or control a greater percentage of that class
of voting securities immediately after the transaction.
An acquisition of 25% or more of the outstanding shares of any class of voting
securities of a bank holding company is conclusively deemed to be the
acquisition of control. In determining percentage ownership for a person,
Federal Reserve policy is to count securities obtainable by that person through
option or warrant exercise, even if the options or warrants have not then
vested.
Insurance of Deposit Accounts. The Bank's deposits are insured to the maximum
extent permitted by the Bank Insurance Fund, or BIF. As the insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious threat
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against banks. The FDIC has implemented a risk-based assessment system under
which FDIC-insured depository institutions pay annual premiums at rates based on
their risk classification. A bank's risk classification is based on its capital
levels and the level of supervisory concern the bank poses to the regulators.
Institutions assigned to higher risk classifications (that is, institutions that
pose a greater risk of loss to the BIF) pay assessments at higher rates than
institutions that pose a lower risk. A decrease in a bank's capital ratios or
the occurrence of events that have an adverse effect on a bank's asset quality,
management, earnings or liquidity could result in a substantial increase in
deposit insurance premiums paid by a bank, which would adversely affect
earnings. In addition, the FDIC can impose special assessments in certain
instances. The range of assessments in the risk-based system is a function of
the reserve ratio in the BIF. The current range of BIF assessments is between 0%
and 0.27% of deposits because the BIF reserve ratio was greater than 1.25% when
the ratios were set. In 2002, the BIF reserve ratio fell below 1.25%, creating
the possibility that the FDIC would raise assessment rates, but in 2003 the
ratio was slightly above 1.25%. At December 31, 2003 and December 31, 2004, the
Bank's BIF assessment rate was 0%. If the BIF reserve ratio were to fall below
1.25% again, the FDIC would consider whether to levy higher assessments.
Congress has also recently
22
considered proposals that would increase assessments on certain types of rapidly
growing institutions.
Loans-to-One Borrower. Generally, a bank may not make a loan or extend credit to
a single or related group of borrowers in excess of 15% of its unimpaired
capital and surplus. An additional amount may be lent, equal to 10% of
unimpaired capital and surplus, if such loan is secured by specified collateral,
generally readily marketable collateral (which is defined to include certain
financial instruments and bullion) and real estate. At December 31, 2004, the
Bank's limit on loans-to-one borrower was $17.6 million ($29.3 million for
secured loans). At December 31, 2004, the Bank's largest aggregate outstanding
balance of loans-to-one borrower was $19.5 million, which was secured. As a
general policy, the Bank seeks to limit secured loans-to-one borrower to a
maximum of $10.0 million.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (that is, any company that
controls or is under common control with an institution, including us and our
non-bank subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve
Act and Regulation W promulgated thereunder. Section 23A restricts the aggregate
amount of covered transactions with any individual affiliate to 10% of the
Bank's capital and surplus. At December 31, 2004, we owed the Bank $-0-. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the Bank's capital and surplus. Certain transactions with affiliates are
required to be secured by collateral in an amount and of a type described in
Section 23A and the purchase of low quality assets from affiliates is generally
prohibited. Section 23B generally provides that certain transactions with
affiliates, including loans and asset purchases, must be on terms and under
circumstances, including credit standards, that are substantially the same or at
least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies.
Enforcement. Under the Federal Deposit Insurance Act, the FDIC has the authority
to bring actions against a bank and all affiliated parties, including
stockholders, attorneys, appraisers and accountants, who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on the bank.
Formal enforcement action may range from the issuance of a capital directive or
cease and desist order to removal of officers and/or directors to institution of
receivership, conservatorship or termination of deposit insurance. Civil
penalties cover a wide range of violations and can amount to $25,000 per day, or
even $1 million per day in especially egregious cases. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The Federal Deposit Insurance Act requires
each federal banking agency to prescribe for all insured depository institutions
standards relating to, among other things, internal controls, information and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees, benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Prescribing Standards for Safety and Soundness to implement these
safety and soundness standards. The guidelines set forth the safety and
soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard.
23
Federal Reserve System. Federal Reserve regulations require banks to maintain
non-interest bearing reserves against their transaction accounts (primarily NOW
and regular checking accounts). Federal Reserve regulations generally required
for 2004 that reserves be maintained against aggregate transaction accounts as
follows: for accounts aggregating $45.4 million or less (subject to adjustment
by the Federal Reserve), the reserve requirement is 3%; and, for accounts
aggregating greater than $45.4 million, the reserve requirement is $1.164
million plus 10% (subject to adjustment by the Federal Reserve between 8% and
14%) of that portion of total transaction accounts in excess of $45.4 million.
The first $6.6 million of otherwise reservable balances (subject to adjustments
by the Federal Reserve) are exempt from the reserve requirements. At December
31, 2004, the Bank met these requirements.
USA Patriot Act. The Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act was intended to detect,
and prevent, the use of the United States' financial system for money laundering
and terrorist financing activities. The Act requests financial institutions,
such as banks, to prohibit correspondent accounts with foreign shell banks, to
establish an anti-money laundering program that includes employee training and
an independent audit, to follow minimum standards for identifying customers and
maintaining records of the identification information, and to make regular
comparisons of customers against agency lists of suspected terrorists, terrorist
organizations and money launderers.
DELAWARE REGULATION
General. As a Delaware bank holding company, we are subject to the supervision
of and periodic examination by the Delaware State Bank Commissioner and must
comply with the reporting requirements of the Delaware State Bank Commissioner.
The Bank, as a banking corporation chartered under Delaware law, is subject to
comprehensive regulation by the Delaware State Bank Commissioner, including
regulation of the conduct of its internal affairs, the extent and exercise of
its banking powers, the issuance of capital notes or debentures, any mergers,
consolidations or conversions, its lending and investment practices and its
revolving and closed-end credit practices. The Bank also is subject to periodic
examination by the Delaware State Bank Commissioner and must comply with the
reporting requirements of the Delaware State Bank Commissioner. The Delaware
State Bank Commissioner has the power to issue cease and desist orders
prohibiting unsafe and unsound practices in the conduct of a banking business.
Limitation on Dividends. Under Delaware banking law, the Bank's directors may
declare dividends on common or preferred stock of so much of its net profits as
they judge expedient, but the Bank must, before the declaration of a dividend on
common stock from net profits, carry 50% of its net profits of the preceding
period for which the dividend is paid to its surplus fund until its surplus fund
amounts to 50% of its capital stock and thereafter must carry 25% of its net
profits for the preceding period for which the dividend is paid to its surplus
fund until its surplus fund amounts to 100% of its capital stock.
PENDING LEGISLATION
Deposit Insurance Reform. On April 2, 2003, the U.S. House of Representatives
passed H.R. 522, the Federal Deposit Insurance Reform Act of 2003. This proposed
legislation would reform the deposit insurance system by:
o merging the BIF and the Savings Association Insurance Fund;
24
o ending the 23 basis point premium "rate cliff" that occurs when the
reserve ratio of deposits insured to premiums held falls beneath 1.25%
for more than one year;
o creating a reserve range within which a bank's reserve ratio can float;
o increasing insurance coverage limits for municipal deposits;
o increasing insurance coverage limits for individual accounts to $130,000
and indexing future coverage limits to inflation; and
o doubling insurance coverage limits for certain types of IRAs and 401(k)
plans.
ITEM 2. PROPERTIES
We are the lessor of eight premises. Our banking and operations facilities
occupy 20,236 square feet in Wilmington, Delaware under a lease expiring in
2010. The rent is currently $36,062 per month and escalates yearly based upon
scheduled increases in base rent and actual increases in taxes and premises
operating costs over specified base rates. We provided a letter of credit,
$106,000 in outstanding principal amount as of December 31, 2004, as security
under the lease. The letter of credit reduces $65,000 per year. We also hold a
lease on 24,531 square feet of space in Philadelphia, Pennsylvania expiring in
2014. The rent is currently $49,922 per month and escalates yearly based upon
scheduled increases in base rent and actual increases in taxes and premises
operating costs over specified base rates. We provided a letter of credit,
$391,000 in outstanding principal amount as of December 31, 2004, as security
under the lease which reduces $80,000 per year. We sublease portions of our
Philadelphia space to affiliated entities. We use the Philadelphia space for our
executive offices. We pay aggregate rent of $9,845 per month for our two
Philadelphia-area loan production offices, and an aggregate of $10,961 per month
for our Maryland, Alabama and Florida automobile leasing offices. We also pay
rent of $603 per month for a customer service space, principally an ATM and
computer interfaces. We believe these facilities are adequate for our current
needs and for the reasonably foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
25
PART II
ITEM 5. MARKET FOR OUR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Our common stock trades on the NASDAQ National Market under the symbol "TBBK."
Prior to our reorganization, which became effective on December 22, 2004, there
had been no public market for our common stock. The following table sets forth
the range of high and low sales prices for the indicated periods for our common
stock after the reorganization.
2004 HIGH LOW
- ------------------------- -------- --------
Fourth quarter (beginning
December 23, 2004) $ 16.38 $ 14.50
As of March 23, 2005 there were 11,888,061 shares of common stock outstanding
held of record by 183 persons.
We have not paid cash dividends on our common stock since our inception, and do
not plan to pay cash dividends on our common stock for the foreseeable future.
We intend to retain earnings, if any, to fund the development and growth of our
operations. Our board of directors will determine any changes in our dividend
policy based upon its analysis of factors it deems relevant. We expect that
these factors will include our earnings, financial condition, cash requirements
and available investment opportunities.
Our payment of dividends is subject to restrictions which we disclose in
"Regulations under Banking Law." In addition, before we may pay a cash dividend
on our common stock in any quarter, we must pay that quarters dividend on our
Series A preferred stock.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data as of and for the years
ended December 31, 2004, 2003, 2002 and 2001, and for the period July 28, 2000
(date of inception of operations) through December 31, 2000. We derived the
selected financial data for the years ended December 31, 2004, 2003, 2002 and
2001 and for the period July 28, 2000 (date of inception of operations) through
December 31, 2000 from our financial statements for those periods, which have
been audited by Grant Thornton LLP, independent registered public accounting
firm. You should read the selected financial data in this table together with,
and such selected financial data is qualified by reference to our financial
statements, the notes to those financial statements and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in Item 7 of this
report.
26
For the
period
July 28,
As of or for the 2000
Year Ended through
--------------------------------------------------------- ------------
December 31, December 31, December 31, December 31, December 31,
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Income Statement Data:
Interest income $ 24,673 $ 14,797 $ 12,060 $ 7,474 $ 2,458
Interest expense 7,077 5,423 4,590 3,566 1,295
------------ ------------ ------------ ------------ ------------
Net interest income 17,596 9,374 7,470 3,908 1,163
Provision for loan and lease
losses 1,632 685 600 435 350
------------ ------------ ------------ ------------ ------------
Net interest income after
provision for loan and
lease losses 15,964 8,689 6,870 3,473 813
Non-interest income 8,904 10,487 4,342 1,719 518
Non-interest expense 22,193 18,355 11,703 8,706 5,673
------------ ------------ ------------ ------------ ------------
Net income (loss) from
continuing operations 2,675 821 (491) (3,514) (4,342)
Income tax benefit (1,043) (250) (500)
Discontinued operations - - - (104) (1,877)
------------ ------------ ------------ ------------ ------------
Net income (loss) 3,718 1,071 9 (3,618) (6,219)
Less preferred stock dividends
and accretion (817) (881) (750) (278) -
Income allocated to Series A
preferred shareholders (323) (61) - - -
------------ ------------ ------------ ------------ ------------
Net income (loss) available
to common stock $ 2,578 $ 129 $ (741) $ (3,896) $ (6,219)
============ ============ ============ ============ ============
Balance Sheet Data:
Total assets $ 576,279 $ 304,161 $ 233,424 $ 155,006 $ 84,823
Total loans, net of unearned
costs (fees) 427,881 232,397 163,337 106,208 27,926
Allowance for loan and lease
losses 3,593 1,991 1,379 780 350
Total cash and cash equivalents 19,503 42,183 30,148 5,866 51,542
Deposits 388,081 276,765 209,443 137,517 72,516
Federal Home Loan Bank advances 55,000 - - - -
Shareholders' equity 121,402 21,673 16,969 14,239 10,963
Selected Operating Ratios:
Return on average assets 0.79% 0.41% nm nm nm
Return on average common equity 3.94% 4.93% nm nm nm
Net interest margin 3.86% 3.77% 4.05% 3.73% 3.13%
Selected Capital and Asset Quality
Ratios:
Equity/assets 21.07% 7.13% 7.27% 9.19% 12.92%
Tier 1 capital to average
assets 22.88% 8.46% 9.76% 10.19% 14.86%
Tier 1 capital to total
risk-weighted assets 26.29% 10.26% 11.60% 11.65% 23.29%
Total capital to total
risk-weighted assets 27.04% 11.05% 12.33% 12.23% 24.10%
Allowance for loan and lease
losses to total loans 0.84% 0.86% 0.84% 0.73% 1.25%
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In the following discussion we provide information about our results of
operations, financial condition, liquidity and asset quality. We intend that
this information facilitate your understanding and assessment of significant
changes and trends related to our financial condition and results of operations.
OVERVIEW
We are a registered financial holding company whose principal asset is our
wholly owned subsidiary bank. Since July 2000, when the Bank began banking
operations, we have grown to $576.3 million in consolidated assets as of
December 31, 2004. To sustain this growth, we raised additional capital in 2001,
2002 and 2003 and invested substantially all of the net proceeds in the Bank. In
February 2004, the Bank completed its own offering of its common stock that
resulted in its obtaining $82.9 million of additional capital, after
underwriting discounts and commissions and expenses of the offering. After the
offering, we owned approximately 32.7% of the Bank. In December 2004 we
completed our reorganization at which time the Bank again became a wholly-owned
subsidiary.
We focus on two markets: small to mid-size businesses and their principals and
affinity groups with their established membership, client or customer bases. We
concentrate our lending activities in the Philadelphia-Wilmington area, while we
draw our deposits from that area and from out of area, principally through our
merchant card processing operation. To a lesser extent, we obtain deposits from
the open market as required to meet our loan funding needs. Our lending
activities emphasize commercial, industrial and construction loans secured by
real estate and commercial real estate loans.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our accounting and reporting policies conform with accounting principles
generally accepted in the United States and general practices within the
financial services industry. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and the accompanying notes. Actual results
could differ from those estimates.
We believe that the determination of our allowance for loan and lease losses
involves a higher degree of judgment and complexity than our other significant
accounting policies. We determine our allowance for loan and lease losses with
the objective of maintaining a reserve level we believe to be sufficient to
absorb our estimated probable credit losses. We base our determination of the
adequacy of the allowance on periodic evaluations of our loan portfolio and
other relevant factors. However, this evaluation is inherently subjective as it
requires material estimates, including, among others, expected default
probabilities, the amount of loss we may incur on a defaulted loan, expected
commitment usage, the amounts and timing of expected future cash flows on
impaired loans, value of collateral, estimated losses on consumer loans and
residential mortgages, and general amounts for historical loss experience. We
also evaluate economic conditions and uncertainties in estimating losses and
inherent risks in our loan portfolio. All of these factors may be susceptible to
significant change. To the extent actual outcomes differ from
28
our estimates, we may need additional provisions for loan losses. Any such
additional provision for loan losses will be a direct charge to our earnings.
We capitalize costs associated with internally developed and purchased software
systems for new products and enhancements to existing products that have reached
the application stage and meet recoverability tests. Capitalized costs include
external direct costs of materials and services used in developing or obtaining
internal-use software, payroll and payroll related expenses for employees who
are directly associated with and devote time to the internal-use software
project and interest costs incurred, if material, while developing internal-use
software. Capitalization of these costs begins when we complete the preliminary
project stage, and ceases no later than the point at which the project is
substantially complete and ready for its intended purpose.
We account for income taxes under the liability method whereby we determine
deferred tax assets and liabilities based on the difference between the carrying
values on our financial statements and the tax basis of assets and liabilities
as measured by the enacted tax rates which will be in effect when these
differences reverse. Deferred tax expense (benefit) is the result of changes in
deferred tax assets and liabilities.
RESULTS OF OPERATIONS
Net Income: fiscal 2004 compared to fiscal 2003. Net income for fiscal 2004 was
$3.7 million, compared to net income of $1.1 million for fiscal 2003. Preferred
stock dividends and accretion for fiscal 2004 were $818,000, compared to
$881,000 for fiscal 2003, which resulted in a net income available to common
stock of $2.6 million for fiscal 2004 as compared to net income of $129,000 for
fiscal 2003. Diluted earnings per share were $0.24 for fiscal 2004 as compared
to $0.06 for fiscal 2003. Return on average assets was .79% and return on
average equity was 3.94% for fiscal 2004.
Net Interest Income: fiscal 2004 compared to fiscal 2003. Our interest income
for fiscal 2004 increased to $19.5 million from $12.5 million for fiscal 2003,
while our net interest income increased to $17.6 million from $9.4 million. Our
average loans increased to $315.1 million for fiscal 2004 from $192.2 million
for the prior year period. The primary reason for the increases in our interest
income and net interest income was our ability to increase our earning assets
through continued organic growth of our loan portfolio as well as through
purchases of investment securities with the proceeds from the Bank's public
offering. We expect that the new capital obtained from the offering will enable
us to continue growth in our loan portfolio for the foreseeable future.
Our net interest margin (representing the spread between our cost of funds and
the rates we receive on our interest-earning assets) for fiscal 2004 increased
to 3.86% from 3.77% for 2003, an increase of 9 basis points (.09%). For fiscal
2004 the average yield on our interest-earning assets decreased to 5.42% from
5.94% for fiscal 2003, a decrease of 52 basis points (.52%). The decrease in
yield was the result of declines in the overall interest rate environment as
well as a change in the mix of our earning assets as average investment
securities increased as a percentage of earning assets to 22.6% for fiscal 2004
from 11.5% for fiscal 2003. The change in mix of earning assets resulted from
the deployment of the proceeds from our initial public offering into investment
securities. It is our intention to shift the mix in the future as we leverage
our capital through growth in the loan portfolio. Cost of interest-bearing
deposits decreased to 2.14% for fiscal 2004 from 2.47% for fiscal 2003, a
decrease of 33 basis points (.33%) due to declines in the overall interest rate
environment. Average interest-bearing deposits increased to $279.3 million from
$197.0 million, an increase of $82.3 million or 41.8%.
29
Net Interest Income: fiscal 2003 compared to fiscal 2002. Our interest income
for fiscal 2003 increased to $14.8 million from $12.1 million in the prior year,
while our net interest income increased to $9.4 million from $7.5 million. Our
average loans increased to $192.2 million for fiscal 2003 from $137.3 million
for fiscal 2002. The primary reason for the increases in our interest income and
net interest income was our ability to increase our earning assets, primarily
net loans, as we increased our deposit base and deployed an additional $4.0
million of capital we obtained in 2003.
Net interest income for 2003 was reduced by $551,000 of interest expense related
to the trust preferred securities of The Bancorp Capital Trust I and the related
debenture issued by us, as discussed in Note B. 13. in the Notes to Consolidated
Financial Statements, as compared to $305,000 of such expense for fiscal 2002.
The trust preferred securities and the related debenture were issued in June
2002 resulting in only a partial-year interest expense for 2002.
Our net interest margin for fiscal 2003 decreased to 3.77% from 4.05% for fiscal
2002, a decrease of 28 basis points (.28%). The decrease in fiscal 2003 resulted
from a timing difference between the rates we obtained on our loans and rates on
our deposits that we had determined to lock in on a longer-term basis.
For fiscal 2003, the average yield on our interest-earning assets decreased to
5.94% from 6.55% for fiscal 2002, a decrease of 61 basis points (.61%). The
decrease was the result of decreases in the discount rate by the Federal
Reserve, which resulted in decreases in both our prime rate and the rates we
received on federal funds sold. While the low interest rate environment in
fiscal 2003 primarily resulted from rate reductions that occurred in fiscal
2001, there were a total of 50 basis points (.50%) of reductions in 2002 and an
additional 25 basis points (.25%) of reductions in 2003.
The rate decreases by the Federal Reserve also had an impact on the costs of our
interest-bearing deposits, which decreased to 2.47% in fiscal 2003 from 2.86% in
fiscal 2002. Except for immaterial amounts of securities sold under agreements
to repurchase and overnight federal funds for liquidity management purposes, we
did not borrow funds during fiscal 2003.
Average Daily Balances. The following table presents the average daily balances
of assets, liabilities and stockholders' equity and the respective interest
earned or paid on interest-earning assets and interest-bearing liabilities, as
well as average rates for the periods indicated:
Year Ended December 31,
---------------------------------------------------------------------------
2004 2003
------------------------------------- -----------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- --------- ----------- --------- --------- -----------
(dollars in thousands)
ASSETS:
Interest-earning assets:
Loans net of unearned discount $ 315,088 $ 19,472 6.18% $ 192,206 $ 12,508 6.51%
Investment securities 102,967 4,710 4.57% 28,612 1,984 6.93%
Interest bearing deposits 827 11 1.33% 1,025 8 0.78%
Federal funds sold 36,532 480 1.31% 27,119 297 1.10%
--------- --------- --------- ---------
Net interest-earning assets 455,414 24,673 5.42% 248,962 14,797 5.94%
Allowance for loan and lease losses (2,530) (1,640)
Other assets 16,747 16,167
--------- ---------
$ 469,631 $ 263,489
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Demand (non-interest bearing
deposits) $ 57,669 $ 40,687
Interest checking 22,070 $ 262 1.19% 14,605 $ 219 1.50%
Savings and money market 126,166 2,576 2.04% 81,158 2,082 2.57%
Time 131,023 3,145 2.40% 101,211 2,556 2.53%
--------- --------- --------- ---------
Total interest-bearing deposits 279,259 5,983 2.14% 196,974 4,857 2.47%
Subordinated debt 5,250 551 10.50% 5,250 551 10.50%
FHLB advances 29,057 516 1.78%
Other borrowed funds 1,507 27 1.79% 660 15 2.27%
--------- --------- --------- ---------
Net interest-bearing liabilities 315,073 7,077 2.25% 202,884 5,423 2.67%
Other liabilities 2,415 597
Shareholders' equity 94,474 19,321
--------- ---------
$ 469,631 $ 263,489
========= =========
Net yield on average interest
earning assets $ 17,596 3.86% $ 9,374 3.77%
========= =========== ========= ===========
Year Ended December 31,
-----------------------------------
2002
-----------------------------------
Average Average
Balance Interest Rate
--------- --------- -----------
(dollars in thousands)
ASSETS:
Interest-earning assets:
Loans net of unearned discount $ 137,278 $ 9,469 6.90%
Investment securities 34,994 2,403 6.87%
Interest bearing deposits 1,103 7 0.63%
Federal funds sold 10,887 181 1.66%
--------- ---------
Net interest-earning assets 184,262 12,060 6.55%
Allowance for loan and lease losses (1,054)
Other assets 13,921
---------
$ 197,129
=========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Demand (non-interest bearing
deposits) 26,882
Interest checking $ 7,872 $ 150 1.91%
Savings and money market 74,917 2,141 2.86%
Time 65,433 1,950 2.98%
--------- ---------
Total interest-bearing deposits 148,222 4,241 2.86%
Subordinated debt 2,905 305 10.50%
FHLB advances
Other borrowed funds 1,556 44 2.83%
--------- ---------
Net interest-bearing liabilities 152,683 4,590 3.01%
Other liabilities 1,857
Shareholders' equity 15,707
---------
$ 197,129
=========
Net yield on average interest
earning assets $ 7,470 4.05%
========= ===========
30
In fiscal 2004, average interest-earning assets increased to $455.4 million, an
increase of $206.4 million, or 82.9%, from fiscal 2003. During the same period,
average loan balances increased $122.9 million, or 63.9%. In fiscal 2003,
average interest-earning assets increased to $249.0 million, an increase of
$64.6 million, or 35.1%, from fiscal 2002. During the same period, average loan
balances increased $54.9 million, or 40.0%. Average interest-bearing deposits
increased to $279.3 million in fiscal 2004 from $197.0 million for fiscal 2003
and $148.2 million for fiscal 2002, an increase of $82.3 million or 41.8% in
2004 and $48.8 million or 32.9% in 2003.
Volume and Rate Analysis. The following table sets forth the changes in net
interest income attributable to either changes in volume (average balances) or
to changes in average rates from 2002 through 2004. The changes attributable to
the combined impact of volume and rate have been allocated proportionately to
the changes due to volume and the changes due to rate.
2004 versus 2003 2003 versus 2002
-------------------------------- --------------------------------
Due to change in: Due to change in:
-------------------- --------------------
Volume Rate Total Volume Rate Total
-------- -------- -------- -------- -------- --------
INTEREST INCOME:
Loans net of unearned
discount $ 7,559 $ (595) $ 6,964 $ 3,539 $ (500) $ 3,039
Investment securities 3,137 (411) 2,726 (443) 24 (419)
Interest bearing deposits (1) 4 3 - 1 1
Federal funds sold 116 67 183 150 (34) 116
-------- -------- -------- -------- -------- --------
Total interest earning
assets 10,811 (935) 9,876 3,246 (509) 2,737
INTEREST EXPENSE:
Interest checking $ 73 $ (30) 43 $ 92 $ (23) 69
Savings and money market 763 (269) 494 258 (317) (59)
Time 708 (119) 589 841 (235) 606
-------- -------- -------- -------- -------- --------
Total deposit interest
expense 1,544 (418) 1,126 1,191 (575) 616
Subordinated debt - - - 246 - 246
FHLB advances 516 - 516 - - -
Other borrowed funds 14 (2) 12 (22) (7) (29)
-------- -------- -------- -------- -------- --------
Total interest expense 2,074 (420) 1,654 1,415 (582) 833
-------- -------- -------- -------- -------- --------
Net interest income $ 8,737 $ (515) $ 8,222 $ 1,831 $ 73 $ 1,904
======== ======== ======== ======== ======== ========
31
Provision for Loan and Lease Losses. Our provision for loan and lease losses was
$1.6 million for fiscal 2004, $685,000 for 2003 and $600,000 for 2002. At
December 31, 2004, our allowance for loan and lease losses amounted to $3.6
million or .84% of total loans. We believe that our allowance is adequate to
cover expected losses. For more information about our provisions and allowance
for loan and lease losses and our loss experience see " -- Allowance for Loan
and Lease Losses" and " -- Summary of Loan and Lease Loss Experience," below.
Non-Interest Income. Non-interest income, exclusive of gains on sales of
investment securities, was $8.4 million for fiscal 2004 as compared to $9.7
million for fiscal 2003, a decrease of $1.3 million or 15.2%. The gains on sales
of investment securities totaled $481,000 for fiscal 2004 compared to a $787,000
gain on sale investment securities for fiscal 2003. Gains (or losses) on sales
of investment securities vary from transaction to transaction, and the timing of
these transactions also may vary. As a result, there may be significant
variation in the amount of our gains (or losses) from period to period. The
principal reasons for the decrease of non-interest income, exclusive of gains on
sales of investment securities, were a decrease in service fees on deposit
accounts and a decrease in merchant credit card fees. Service fees on deposit
accounts for fiscal 2004 decreased $183,000 to $695,000 as compared to fiscal
2003. The decrease was the result of a discontinuation of a deposit program,
which created fee income. Management's review of the program led it to the
conclusion that the fee income did not mitigate the potential risk involved. Our
merchant credit card income was $6.8 million for fiscal 2004, a decrease of $1.2
million, or 14.9% as compared to fiscal 2003 which resulted from the termination
of a high-volume, thin-spread relationship. This decrease was substantially
offset by a similar decrease in related expenses, as discussed in " --
Non-Interest Expense," below. The net fees generated from the merchant credit
card processing support the infrastructure associated with the merchant
division. We believe that our merchant card program generally will expand as we
grow and that fee income from this source will likewise expand.
Total non-interest income for fiscal 2003 was $10.5 million, an increase of $6.1
million or 141.5% over fiscal 2002. The principal reasons for the increase were
an increase in merchant credit card deposit fees to $8.0 million from $3.3
million, gains from sales of investment securities, which amounted to $787,000
for fiscal 2003 as compared to $20,000 in fiscal 2002, and an increase in our
service fees on deposit accounts to $878,000 from $431,000. The increase in
merchant credit card fees resulted from increased transactional volume arising
out of the relationship that we discussed above where there was high volume and
a thin spread, together with a growth in existing relationships. These fees were
substantially offset by related expenses, as discussed in " -- Non-Interest
Expense," below. The increase in service fees on deposit accounts resulted from
an overall increase in account relationships, in particular from the deposit
program discussed above that was discontinued in fiscal 2004.
Non-Interest Expense. Total non-interest expense was $22.2 million for fiscal
2004, as compared to $18.3 million for fiscal 2003, an increase of $3.8 or
20.9%. Salaries and employee benefits amounted to $7.9 million for fiscal 2004
as compared to $5.0 million for fiscal 2003. The increase reflects additional
staff required for the commercial lending, call center and merchant processing
areas as we increased in size from $304.2 million in total assets at December
31, 2003 to $576.3 million in total assets at December 31, 2004. It also
reflects annual salary increases of 3% to 5% to our employees and our payment of
compensation to executives who had not received
32
salaries and/or bonuses in the second quarter of 2003, principally our chief
executive officer. We expect salaries and employee benefits expense to increase
in future periods as we increase our staff to accommodate our expected growth in
assets. Merchant credit card deposit expense amounted to $6.1 million for fiscal
2004, a decrease of $1.3 million, or 17.6% over fiscal 2003. As discussed above,
the decrease resulted from the termination of a high-volume, thin-spread
relationship. Advertising costs increased to $442,000 for fiscal 2004, as
compared to $242,000 for fiscal 2003, an increase of $200,000 or 82.6%. The
increase was the result of targeted events for the Philadelphia Private Bank
customers. Other expense was $4.0 million for fiscal 2004 as compared to $3.1
million for fiscal 2003, an increase of $509,000 or 30.6%. Of this increase,
insurance costs increased by $448,000 primarily due to the premium increase for
directors' and officers' insurance after our initial public offering. We expect
that other expenses will increase over at least the next 12 months as a result
of compliance measures required by recent legislative and regulatory initiatives
such as the Sarbanes-Oxley Act of 2002.
Total non-interest expense was $18.4 million for fiscal 2003, as compared to
$11.7 million in fiscal 2002, an increase of $6.7 million