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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2004
Commission file number: 000-28635
Virginia Commerce Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Virginia 54-1964895
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
5350 Lee Highway, Arlington, Virginia 22207
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: 703.534.0700
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, $1.00 par value
Indicate by check mark whether the registrant; (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained in this form,
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.
Yes \X\ No \ \
The registrant's Common Stock is traded on the Nasdaq National Market under the
symbol VCBI. The aggregate market value of the approximately 7,677,638 shares of
Common Stock of the registrant issued and outstanding held by nonaffiliates on
June 30, 2004 was approximately $181.3 million, based on the closing sales price
of $23.62 per share on that date. For purposes of this calculation the term
"affiliate" refers to all directors, executive officers and 10% shareholders of
the registrant.
As of the close of business on March 1, 2005, 11,188,716 shares of the
registrant's Common Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual Meeting
of Shareholders, to be held on April 27, 2005, are incorporated by reference in
part III hereof.
FORM 10-K CROSS REFERENCE OF MATERIAL INCORPORATED BY REFERENCE
The following shows the location in this Annual Report on Form 10-K or the
Company's Proxy Statement for the Annual Meeting of Stockholders to be held on
April 27, 2005, of the information required to be disclosed by the United States
Securities and Exchange Commission Form 10-K. References to pages only are to
pages in this report.
PART I ITEM 1. BUSINESS. See "Business" at Pages 50 through 59.
ITEM 2. PROPERTIES. See "Properties" at Page 59.
ITEM 3. LEGAL PROCEEDINGS. From time to time the Company is a
participant in various legal proceedings incidental to its
business. In the opinion of management, the liabilities (if
any) resulting from such legal proceeding will not have a
material effect on the financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No
matter was submitted to a vote of the security holders of
the Company during the fourth quarter of 2004.
PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES. See
"Market Price of Stock and Dividends" at Page 20.
ITEM 6. SELECTED FINANCIAL DATA. See "Five Year Financial Summary"
at Page 3.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation"
at Pages 4 through 20.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
See "Asset/Liability Management and Quantitative and
Qualitative Disclosures About Market Risk" at Page 9.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See
Consolidated Financial Statements at Pages 22 through 49.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE. None.
ITEM 9A. CONTROLS AND PROCEDURES. See "Controls and Procedures" and
"Management Report on Internal Control Over Financial
Reporting" at page 60.
ITEM 9B. OTHER INFORMATION. None
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The
information required by Item 10 is incorporated by
reference from the material under the caption "Election of
Directors" contained at pages 4 through 7, and under the
caption "Compliance with Section 16(a) of the Securities
Exchange Act of 1934" at page 13, of the Proxy Statement.
The Company has adopted a code of ethics that applies to
its Chief Executive Officer and Chief Financial Officer. A
copy of the code of ethics will be provided to any person,
without charge, upon written request directed to Lynda
Cornell, Assistant to the Chief Executive Officer, Virginia
Commerce Bancorp, Inc., 5350 Lee Highway, Arlington,
Virginia 22207.
ITEM 11. EXECUTIVE COMPENSATION. The information required by Item 11
is incorporated by reference from the material under the
caption "Executive Officer Compensation and Certain
Transactions," contained at pages 8 through 13 of the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information
required by Item 12 is incorporated by reference from the
material under the captions "Voting Securities and
Principal Holders Thereof" contained at Page 3 of the Proxy
Statement, and included under the caption "Securities
Authorized for Issuance Under Equity Compensation Plans" at
page 21 hereof.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The
information required by Item 13 is incorporated by
reference from the material under the caption "Transactions
with Management and Others" contained at page 11 of the
Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. The information
required by Item 14 is incorporated by reference from the
material under the caption "Independent Registered Public
Accounting Firm" contained at page 14 of the Proxy
Statement.
PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. See "Financial
Statements and Exhibits" at Page 61.
2
FIVE YEAR FINANCIAL SUMMARY
Year Ended December 31,
----------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ---------- ------------
(Dollars in thousand, except per share amounts)
SELECTED YEAR-END BALANCES
Total assets $ 1,139,353 $ 881,694 $ 663,457 $ 489,511 $ 371,182
Total stockholders' equity 91,324 55,092 41,850 26,220 21,166
Total loans (net) 925,782 654,851 516,900 395,108 300,799
Total deposits 970,968 773,511 566,996 406,922 310,934
SUMMARY RESULTS OF OPERATIONS
Interest income $ 57,998 $ 45,968 $ 38,998 $ 33,897 $ 26,776
Interest expense 16,331 13,893 14,128 15,991 12,861
Net interest income $ 41,667 $ 32,075 $ 24,870 $ 17,906 $ 13,915
Provision for loan losses 2,989 1,575 1,678 1,572 947
Net interest income after
provision for loan losses $ 38,678 $ 30,500 $ 23,192 $ 16,334 $ 12,968
Non-interest income 5,759 7,746 5,593 4,704 2,599
Non-interest expense 22,807 20,820 17,217 13,982 10,636
Income before taxes $ 21,630 $ 17,426 $ 11,568 $ 7,056 $ 4,931
Income tax expense 7,401 5,880 3,892 2,391 1,681
Net income $ 14,229 $ 11,546 $ 7,676 $ 4,665 $ 3,250
PER SHARE DATA (1)
Net income, basic $ 1.35 $ 1.18 $ 0.86 $ 0.55 $ 0.38
Net income, diluted $ 1.24 $ 1.08 $ 0.77 $ 0.50 $ 0.36
Book value $ 8.27 $ 5.61 $ 4.48 $ 3.09 $ 2.50
Average number of shares outstanding 10,570,097 9,733,444 8,899,393 8,472,972 8,458,495
GROWTH AND SIGNIFICANT RATIOS
% Change in net income 23.24% 50.42% 64.54% 43.54% 50.06%
% Change in assets 29.22% 32.89% 35.53% 31.88% 31.36%
% Change in loans 41.37% 26.69% 30.82% 31.35% 46.61%
% Change in deposits 25.53% 36.42% 39.34% 30.87% 27.93%
% Change in equity 65.77% 31.64% 59.61% 23.88% 21.02%
Equity to asset ratio 8.02% 6.25% 6.31% 5.36% 5.70%
Return on average assets 1.39% 1.47% 1.32% 1.05% 1.00%
Return on average equity 19.28% 23.71% 23.06% 19.37% 17.04%
Average equity to average assets 7.22% 6.21% 5.71% 5.44% 5.87%
Efficiency ratio (2) 48.01% 52.17% 56.52% 61.84% 64.41%
(1) Adjusted for all years presented giving retroactive effect to a 10% stock
dividend in 2000, five-for-four stock splits in the form of 25% stock
dividends in 2001 and 2002, a two-for-one split in the form of a 100%
stock dividend in 2003, and a five-for-four stock split in the form of a
25% stock dividend in 2004.
(2) Computed by dividing non-interest expense by the sum of net interest
income on a tax equivalent basis and non-interest income, net of
securities gains or losses. This is a non-GAAP financial measure, which
we believe provides investors with important information regarding our
operational efficiency. Comparison of our efficiency ratio with those of
other companies may not be possible, because other companies may
calculate the efficiency ratio differently.
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING STATEMENTS
This management's discussion and analysis and other portions of this report,
contain forward-looking statements within the meaning of the Securities and
Exchange Act of 1934, as amended, including statements of goals, intentions, and
expectations as to future trends, plans, events or results of Company operations
and policies and regarding general economic conditions. In some cases,
forward-looking statements can be identified by use of words such as "may,"
"will," "anticipates," "believes," "expects," "plans," "estimates," "potential,"
"continue," "should," and similar words or phrases. These statements are based
upon current and anticipated economic conditions, nationally and in the
Company's market, interest rates and interest rate policy, competitive factors,
and other conditions which by their nature, are not susceptible to accurate
forecast, and are subject to significant uncertainty. Because of these
uncertainties and the assumptions on which this discussion and the
forward-looking statements are based, actual future operations and results may
differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward-looking statements. The Company's
past results are not necessarily indicative of future performance.
NON-GAAP PRESENTATIONS
This management's discussion and analysis refers to the efficiency ratio, which
is computed by dividing non-interest expense by the sum of net interest income
on a tax equivalent basis and non-interest income. This is a non-GAAP financial
measure that we believe provides investors with important information regarding
our operational efficiency. Comparison of our efficiency ratio with those of
other companies may not be possible because other companies may calculate the
efficiency ratio differently. The Company, in referring to its net income, is
referring to income under accounting principles generally accepted in the United
States, or "GAAP".
GENERAL
The following presents management's discussion and analysis of the consolidated
financial condition and results of operations of Virginia Commerce Bancorp, Inc.
and subsidiaries (the "Company") as of the dates and for the periods indicated.
This discussion should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto, and other financial data appearing
elsewhere in this report. The Company is the parent bank holding company for
Virginia Commerce Bank (the "Bank"), a Virginia state-chartered bank that
commenced operations in May 1988. The Bank pursues a traditional community
banking strategy, offering a full range of business and consumer banking
services through sixteen branch offices, two residential mortgage offices and
one investment services office.
Headquartered in Arlington, Virginia, Virginia Commerce serves the Northern
Virginia suburbs of Washington, D.C., including Arlington, Fairfax, Fauquier,
Loudoun and Prince William Counties and the cities of Alexandria, Fairfax, Falls
Church, Manassas and Manassas Park. Its service area also covers, to a lesser
extent, Washington, D.C. and the nearby Maryland counties of Montgomery and
Prince Georges. The Bank's customer base includes small-to-medium sized
businesses including firms that have contracts with the U.S. government,
associations, retailers and industrial businesses, professionals and their
firms, business executives, investors and consumers. Additionally, the Bank has
strong market niches in commercial real estate, and construction lending and
operates its residential mortgage lending division as its only business segment.
CRITICAL ACCOUNTING POLICIES
During the year ended December 31, 2004 there were no changes in the Company's
critical accounting policies as reflected in the last report.
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States (GAAP). The financial
information contained within our statements is, to a significant extent,
financial information that is based on measures of the financial effects of
transactions and events that have already occurred. A variety of factors could
affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one factor in determining the inherent loss that may
be present in our loan portfolio. Actual losses could differ significantly from
the historical factors that we use. In addition, GAAP itself may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
4
The allowance for loan losses is an estimate of the losses that are inherent in
our loan portfolio. The allowance is based on two basic principles of
accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses
be accrued when they are probable of occurring and estimatable and (ii) SFAS
114, Accounting by Creditors for Impairment of a Loan, which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
Our allowance for loan losses has three basic components: the specific
allowance, the formula allowance and the unallocated allowance. Each of these
components is determined based upon estimates that can and do change when the
actual events occur. The specific allowance is used to individually allocate an
allowance for loans identified as impaired. Impairment testing includes
consideration of the borrower's overall financial condition, resources and
payment record, support available from financial guarantors and the fair market
value of collateral. These factors are combined to estimate the probability and
severity of inherent losses. When impairment is identified, then a specific
reserve is established based on the Company's calculation of the loss embedded
in the individual loan. Large groups of smaller balance, homogeneous loans are
collectively evaluated for impairment. Accordingly, the Company does not
separately identify individual consumer and residential loans for impairment.
The formula allowance is used for estimating the loss on internally risk rated
loans exclusive of those identified as impaired. The loans meeting the criteria
for special mention, substandard, doubtful and loss, as well as impaired loans,
are segregated from performing loans within the portfolio. Internally classified
loans are then grouped by loan type (commercial, commercial real estate,
commercial construction, residential real estate, residential construction or
installment). Each loan type is assigned an allowance factor based on
management's estimate of the associated risk, complexity and size of the
individual loans within the particular loan category. Classified loans are
assigned a higher allowance factor than non-rated loans due to management's
concerns regarding collectibility or management's knowledge of particular
elements surrounding the borrower. Allowance factors grow with the worsening of
the internal risk rating. The unallocated formula is used to estimate the loss
of non-classified loans and loans identified for impairment testing for which no
impairment was identified. These un-criticized loans are also segregated by loan
type and allowance factors are assigned by management based on delinquencies,
loss history, trends in volume and terms of loans, effects of changes in lending
policy, the experience and depth of management, national and local economic
trends, concentrations of credit, quality of the loan review system and the
effect of external factors (i.e. competition and regulatory requirements). The
factors assigned differ by loan type. The unallocated allowance captures losses
whose impact on the portfolio has occurred but has yet to be recognized in
either the formula or specific allowance. Allowance factors and the overall size
of the allowance may change from period to period based on management's
assessment of the factors described above and the relative weights given to each
factor. For further information regarding the allowance for loan losses see
Notes 1 and 4 to the Consolidated Financial Statements and the discussion under
the caption "Asset Quality - Provision and Allowance for Loan Losses" at page
12.
OVERVIEW
Over the past five years the Company has experienced significant growth in
assets, loans, deposits and net income. In 2004, total assets increased $257.7
million, or 29.2%, from $881.7 million at December 31, 2003, to $1.139 billion
at December 31, 2004, with loans, net of the allowance for loan losses,
increasing $270.9 million, or 41.4%, from $654.9 million at December 31, 2003,
to $925.8 million at December 31, 2004. The majority of the growth was provided
by an increase in total deposits of $197.5 million, or 25.5%, from $773.5
million at December 31, 2003, to $971.0 million and $21.8 million in net
proceeds from a follow-on public offering in May 2004. For the year net income
was up $2.7 million, or 23.2%, from $11.5 million for the fiscal year ended
December 31, 2003, to $14.2 million in 2004. In 2003, total assets increased
32.9% from $663.5 million at December 31, 2002, to $881.7 million at December
31, 2003, loans increased 26.7% from $516.9 million to $654.9 million and
deposits grew 36.4% from $567.0 million at December 31, 2002, to $773.5 million.
Net income in 2003 was up $3.8 million, or 50.4%, from $7.7 million in 2002 to
$11.5 million.
5
As noted, the Company achieved significant growth in loans in 2004. The majority
of loan growth occurred in real estate mortgage loans, which rose $161.0
million, or 36.2%, from $444.4 million at December 31, 2003, to $605.4 million
at December 31, 2004. Real estate construction loans represented the second
largest dollar increase rising $87.1 million, or 56.8%, from $153.4 million at
December 31, 2003, to $240.5 million, while a greater emphasis by the Company on
commercial lending contributed to a record level increase in commercial loans
with total commercial loans increasing $27.5 million, or 45.0%, from $61.2
million at December 31, 2003, to $88.7 million at December 31, 2004. In 2003,
loans, net of the allowance for loan losses, increased $138.0 million, or 26.7%,
from $516.9 million at December 31, 2002, to $654.9 million at December 31,
2003. Growth by category was similar to what was achieved in 2004, with real
estate mortgage loans increasing $82.4 million, real estate construction loans
representing the second largest increase at $42.1 million, and commercial loans
rising $16.6 million.
In 2004, deposits increased by $197.5 million, or 25.5%, from $773.5 million at
December 31, 2003, to $971.0 million with non-interest-bearing demand deposits
increasing $28.3 million, or 23.6%, to $148.1 million, savings and
interest-bearing demand deposits decreasing $7.7 million, or 2.3%, from $340.1
million at December 31, 2003, to $332.4 million at December 31, 2004, and time
deposits growing $176.9 million, or 56.4%, from $313.6 million at December 31,
2003, to $490.5 million. For the year ended December 31, 2003, deposit growth
included a $21.2 million increase in non-interest-bearing demand deposits, a
$149.3 million increase in savings and interest-bearing demand deposits, and a
$36.0 million increase in time deposits. The majority of the Bank's deposits are
attracted from individuals and businesses in the Northern Virginia and the
Metropolitan, Washington D.C. area, and the interest rates the Bank pays are
generally near the top of the local market. In 2003, due to historically low
interest rates, many depositors held funds in savings and interest-bearing
demand deposits rather than in time deposits. As interest rates started to climb
in the second half of 2004, that trend changed and large sums transferred into
time deposits with terms less than 24 months as rates on those instruments
became more attractive.
In addition to the strong growth in deposits, repurchase agreements which
represent funds of numerous demand deposit customers of the Bank, increased
$22.3 million, or 72.3%, from $30.9 million at December 31, 2003, to $53.2
million at December 31, 2004. In 2003, repurchase agreements fell $1.2 million,
or 3.7%, from $32.1 million at December 31, 2002, to $30.9 million at December
31, 2003. The Company had no other borrowed funds outstanding at December 31,
2003, and 2004.
Although loan growth utilized most of the Company's funding sources in 2004,
investment securities, which are generally maintained as additional liquidity
sources and for various collateral needs, managed to increase by $14.0 million,
or 9.4%, from $149.2 million at December 31, 2003, to $163.2 million at December
31, 2004, with the growth concentrated in short-term U.S. Government Agency and
Treasury obligations. In 2003, investment securities rose by $78.0 million, or
109.5%, from $71.2 million at December 31, 2002, to $149.2 million, with growth
generally in short-term U.S. Government Agency and variable rate domestic
corporate debt obligations in the available-for-sale portfolio. However, at
times during 2003, increases in long-term interest rates and higher levels of
liquidity provided the Company with some opportunity for higher yields, and as a
result approximately $30 million in seven to fifteen year U.S. Government Agency
obligations were added to the held-to-maturity portfolio. The Company has
generally avoided long-term investments over the past two years due to
historically low interest rates and a desire to maintain a low level of interest
rate risk to provide greater flexibility and opportunities when interest rates
rise. In May 2003, the Bank also purchased $6.0 million in single premium
bank-owned life insurance policies through three highly rated carriers in order
to help offset the rising cost of employee health care benefits. These policies
were recorded on the balance sheet under other assets and have contributed
non-taxable income of $178 thousand, and $282 thousand in 2003, and 2004.
For the year ended December 31, 2004, the Company achieved record earnings of
$14.2 million, an increase of 23.2% compared to earnings of $11.5 million for
the prior fiscal year as net interest income increased $9.6 million, or 29.9%,
from $32.1 million in 2003, to $41.7 million in 2004, non-interest income
declined $1.9 million, or 25.7%, from $7.7 million in 2003, to $5.8 million,
loan loss provisions were up $1.4 million, while non-interest expense rose only
9.5% from $20.8 million in 2003, to $22.8 million. As a result, the Company's
efficiency ratio, as defined, improved from 52.2% for the year ended December
31, 2003, to 48.0% in 2004. In 2003, earnings of $11.5 million increased $3.8
million, or 50.4%, compared to earnings of $7.7 million in 2002 as net interest
income increased $7.2 million, or 29.0%, non-interest income rose $2.1 million
and non-interest expense increased $3.6 million, or 20.9%. In 2002 the Company
achieved earnings of $7.7 million, an increase of 64.5% compared to earnings of
$4.7 million in 2001. On a diluted per share basis earnings were $1.24, $1.08,
and $0.77 in 2004, 2003, and 2002, respectively. The Company's return on average
assets was 1.39% for 2004, as compared to 1.47% in 2003 and 1.32% in 2002.
Return on average equity was 19.28% in 2004, as compared to 23.71% in 2003, and
23.06% in 2002 due to the follow-on public offering in May 2004.
6
Stockholders' equity increased by $36.2 million in 2004, or 65.8%, from $55.1
million at December 31, 2003, to $91.3 million at the end of 2004, on earnings
of $14.2 million, $21.8 million in net proceeds from the issuance of 1,114,062
shares of common stock (adjusted for a 5-for-4 stock split on July 15, 2004)
through a follow-on public offering in May 2004, $708 thousand in proceeds and
tax benefits from the exercise of stock options and warrants by Company
directors and officers and the purchase of stock by Company employees under an
Employee Stock Purchase Plan, and a decline in other comprehensive income of
$506 thousand, net of tax. In 2003, stockholders' equity increased $13.2
million, or 31.6%, from $41.8 million at December 31, 2002, to $55.1 million at
December 31, 2003, on earnings of $11.5 million, $2.4 million in proceeds and
tax benefits from the exercise of stock options and warrants by Company
directors and officers and the purchase of stock by Company employees under an
Employee Stock Purchase Plan, and a $694 thousand decline in other comprehensive
income, net of tax. The total number of common shares outstanding increased in
2004 by 3,186,131 with 891,250 shares (pre-split) issued in the follow-on public
offering in May 2004, 2,205,935 shares issued due to a five-for-four stock split
in the form of a twenty-five percent stock dividend in July 2004, 82,888 shares
issued as a result of the exercise of stock options and warrants by Company
directors and officers and 6,058 shares issued to employees under the Company's
Employee Stock Purchase Plan.
NET INTEREST INCOME
Net interest income is the excess of interest earned on loans and investments
over the interest paid on deposits and borrowings and is the Company's primary
revenue source. In 2004, net interest income increased $9.6 million, or 29.9%,
from $32.1 million in 2003, to $41.7 million with $10.9 million in additional
interest income due to growth, generally in loans, and $1.3 million in less
income due to a decline in the net interest margin from 4.30% in 2003, to 4.23%.
In 2003, net interest income increased $7.2 million, or 29.0%, from $24.9
million in 2002, to $32.1 million with most of the increase again attributable
to growth as the net interest margin declined from 4.48% in 2002, to 4.30%. In
2002, net interest income increased $7.0 million, or 38.9%, from $17.9 million
in 2001, to $24.9 million.
In January 2001, the Federal Reserve began reducing the fed funds target rate by
over five hundred basis points with its last reduction in June 2003 to a
historically low level of 1.00%. Along with these reductions came a similar
decline in the prime lending rate, to which the majority of the Company's
interest rates on loans are tied, and significantly lower rates on treasuries,
affecting the Company's investment securities portfolio. As a result, the
Company's average yield on loans has steadily declined from 8.50% in 2001, to
6.49% in 2004, and its yield on investment securities has fallen from 6.07% in
2001, to 3.71% in 2004. Consequently the Company's yield on interest earning
assets has fallen two hundred and twelve basis points over the past three years
from 8.01% in 2001, to 5.89% in 2004. On the other side, the cost of liabilities
also fell during this period, from 4.48% in 2001 to 2.03% by the end of 2004.
Overall the Company's net interest margin was unchanged at 4.23% in 2001 and
2004. On June 30, 2004, the Federal Reserve began increasing the fed funds
target rate and by the end of the year had increased it to 2.25% and as a result
the Company's net interest margin increased, from 4.05% during the second
quarter of 2004, to 4.30% in the fourth. With expectations that increases will
continue in 2005, the Company expects its net interest margin will also continue
to improve.
7
TABLE 1: AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
The following table shows the average balance sheets for each of the years ended
December 31, 2004, 2003, and 2002. In addition, the amounts of interest earned
on earning assets, with related yields, and interest expense on interest-bearing
liabilities, with related rates, are shown. Loans placed on a non-accrual status
are included in the average balances. Net loan fees and late charges included in
interest income on loans totaled $2.8 million, $2.1 million and $1.6 million for
2004, 2003, and 2002, respectively.
2004 2003 2002
------------------------------ ------------------------------ -------------------------------
Interest Average Interest Average Interest Average
Average Income- Yields Average Income- Yields Average Income- Yields
(Dollars in thousands) Balance Exppense /Rates Balance Exppense /Rates Balance Exppens /Rates
------------------------------ ------------------------------ -------------------------------
ASSETS
Securities (1) $ 159,833 $ 5,853 3.71% $115,995 $ 4,526 3.98% $ 61,986 $ 3,152 5.16%
Loans, net of unearned income 798,195 51,814 6.49% 595,816 41,065 6.89% 471,924 35,491 7.52%
Interest-bearing deposits in other
banks 447 10 2.23% -- -- -- -- -- --
Federal funds sold 27,748 321 1.16% 36,018 377 1.05% 22,165 355 1.60%
------------------------------ ------------------------------ -------------------------------
TOTAL INTEREST-EARNING ASSETS $ 986,223 $57,998 5.89% $747,829 $45,968 6.16% $556,075 $38,998 7.02%
------------------------------ ------------------------------ -------------------------------
Other assets 36,455 35,754 27,235
------------------------------ ------------------------------ -------------------------------
TOTAL ASSETS $1,022,678 $783,583 $583,310
============================== ============================== ==============================
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing deposits
NOW accounts $209,617 $ 2,789 1.33% $157,958 $ 2,415 1.53% $ 89,756 $ 1,847 2.06%
Money market accounts 119,963 1,667 1.39% 85,418 1,354 1.59% 54,144 1,213 2.24%
Savings accounts 20,255 111 0.55% 22,136 180 0.81% 16,131 220 1.36%
Time deposits 395,718 10,533 2.66% 299,752 8,965 2.99% 255,875 10,061 3.93%
------------------------------ ------------------------------ -------------------------------
Total interest-bearing deposits $ 745,553 $15,100 2.03% $565,264 $12,914 2.28% $415,906 $13,341 3.21%
------------------------------ ------------------------------ -------------------------------
Securities sold under agreement to
repurchase and federal funds
purchased 39,962 325 0.81% 32,963 123 0.37% 33,791 245 0.73%
------------------------------ ------------------------------ -------------------------------
Other borrowed funds 733 15 2.00% 351 21 5.98% 10,109 497 4.91%
------------------------------ ------------------------------ -------------------------------
Trust preferred capital notes 18,000 891 4.95% 18,000 835 4.64% 929 45 4.78%
------------------------------ ------------------------------ -------------------------------
TOTAL INTEREST-BEARING LIABILITIES $ 804,248 $16,331 2.03% $616,578 $13,893 2.25% $460,735 $14,128 3.07%
------------------------------ ------------------------------ -------------------------------
Demand deposits and other liabilities 144,617 118,313 89,293
------------------------------ ------------------------------ -------------------------------
TOTAL LIABILITIES $ 948,865 $734,891 $550,028
------------------------------ ------------------------------ -------------------------------
Stockholders' equity 73,813 48,692 33,282
------------------------------ ------------------------------ -------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $1,022,678 $783,583 $583,310
============================== ============================== ==============================
Interest rate spread 3.86% 3.91% 3.95%
NET INTEREST INCOME AND MARGIN $41,667 4.23% $32,075 4.30% $24,870 4.48%
============================== ============================== ==============================
(1) Yields on securities available-for-sale have been calculated on the basis of
historical cost and do not give effect to changes in the fair value of those
securities, which are reflected as a component of stockholders' equity. Average
yields on securities are stated on a tax equivalent basis, using a 35% rate for
2004 and 34% for 2003 and 2002.
8
TABLE 2: RATE-VOLUME VARIANCE ANALYSIS
Interest income and expense are affected by changes in interest rates, by
changes in the volumes of earning assets and interest-bearing liabilities, and
by changes in the mix of these assets and liabilities. The following analysis
shows the year-to-year changes in the components of net interest income.
2004 COMPARED TO 2003 2003 COMPARED TO 2002
--------------------------------- -------------------------------------
Total
Increase/(Decrease) Increase/(Decrease) Increase/
Due to Total Due to (Decrease)
---------------------- Increase/ ----------------------- -------------
(Dollars in thousands) Volume Rate (Decrease) Volume Rate
---------- ----------- ---------- ----------- ----------- -------------
INTEREST INCOME
Loans $ 13,137 $(2,388) $ 10,749 $ 8,539 $(2,965) $ 5,574
Securities 1,638 (311) 1,327 2,108 (734) 1,374
Interest bearing deposits in other banks 10 -- 10 -- -- --
Federal funds sold (96) 40 (56) 145 (123) 22
---------- ----------- ---------- ----------- ----------- -------------
Total interest income $14,689 $(2,659) $ 12,030 $10,792 $(3,822) $ 6,970
========== =========== ========== =========== =========== =============
INTEREST EXPENSE
Interest-bearing deposits:
NOW accounts $ 687 $ (313) $ 374 $ 1,043 $ (475) $ 568
Money market accounts 480 (167) 313 496 (355) 141
Savings accounts (10) (59) (69) 49 (89) (40)
Time deposits 2,533 (965) 1,568 1,328 (2,424) (1,096)
---------- ----------- ---------- ----------- ----------- -------------
Total interest-bearing deposits $3,690 $(1,504) $ 2,186 $ 2,916 $(3,343) $ (427)
Securities sold under agreement to
repurchase and federal funds purchased 57 145 202 (3) (119) (122)
Other borrowed funds 8 (14) (6) (579) 103 (476)
Trust preferred capital notes -- 56 56 791 (1) 790
---------- ----------- ---------- ----------- ----------- -------------
Total interest expense $3,755 $(1,317) $2,438 $ 3,125 $(3,360) $(235)
---------- ----------- ---------- ----------- ----------- -------------
CHANGE IN NET INTEREST INCOME $10,934 $(1,342) $9,592 $ 7,667 $ (462) $7,205
========== =========== ========== =========== =========== =============
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
In the normal course of business, the Company is exposed to market risk, or
interest rate risk, as its net income is largely dependent on its net interest
income. Market risk is managed by the Company's Asset/Liability Management
Committee that formulates and monitors the performance of the Company based on
established levels of market risk as dictated by policy. In setting tolerance
levels, or limits on market risk, the Committee considers the impact on earnings
and capital, the level and general direction of interest rates, liquidity, local
economic conditions and other factors. Interest rate risk, or interest
sensitivity, can be defined as the amount of forecasted net interest income that
may be gained or lost due to favorable or unfavorable movements in interest
rates. Interest rate risk, or sensitivity, arises when the maturity or repricing
of interest-bearing assets differs from the maturing or repricing of
interest-bearing liabilities and as a result of the difference between total
interest-bearing assets and interest-bearing liabilities. The Company seeks to
manage interest rate sensitivity while enhancing net interest income by
periodically adjusting this asset/liability position; however in general the
Company has maintained a fairly balanced sensitivity to changes in interest
rates.
One of the tools used by the Company to assess interest sensitivity on a monthly
basis is the static gap analysis that measures the cumulative differences
between the amounts of assets and liabilities maturing or repricing within
various time periods. It is the Company's goal to limit the one-year cumulative
difference to plus or minus 10% of total interest-earning assets in an attempt
to limit changes in future net interest income from sudden changes in market
interest rates. A gap analysis is shown in Table 3 below, and reflects the
earlier of the maturity or repricing dates for various assets and liabilities as
of December 31, 2004. At that point in time, the Company had a cumulative net
liability sensitive twelve-month gap position of $5.5 million, or a negative
0.50% of total interest-earning assets.
This position would generally indicate that over a period of one-year net
interest earnings should decline slightly in a rising interest rate environment
as more liabilities would reprice than assets and should rise slightly in a
falling interest rate environment. However, this measurement of interest rate
risk sensitivity represents a static position as of a single day and is not
necessarily indicative of the Company's position at any other point in time,
does not take into account the sensitivity of yields and costs of specific
assets and liabilities to changes in market rates, and it does not take into
account the specific timing of when changes to a specific asset or liability
will occur. More accurate measures of interest sensitivity are provided to the
Company using earnings simulation models.
9
TABLE 3: INTEREST SENSITIVITY-GAP ANALYSIS
At December 31, 2003 INTEREST SENSITIVITY PERIODS
-----------------------------------------------------------
(Dollars in thousands) Within 91 to 365 Over 1 to Over 5
90 Days Days 5 Years Years Total
---------- ------------ ----------- ----------- -----------
INTEREST EARNING ASSETS
Securities, at amortized cost $63,467 $ 50,469 $24,474 $25,621 $ 164,031
Interest bearing deposits in other banks -- 1,009 -- -- 1,009
Loans, net of unearned income 425,018 99,920 383,720 37,188 945,846
---------- ------------ ----------- ----------- -----------
Total interest earning assets $488,485 $151,398 $408,194 $62,809 $1,110,886
---------- ------------ ----------- ----------- -----------
INTEREST-BEARING LIABILITIES
NOW accounts $ 85,160 $75,123 $ 41,632 $ -- $201,915
Money market accounts 47,932 45,926 15,752 -- 109,610
Savings accounts 1,669 5,215 13,976 -- 20,860
Time deposits 66,330 246,257 177,345 588 490,520
Securities sold under agreements to
repurchase 53,207 -- -- -- 53,207
Trust preferred capital notes -- 18,570 -- -- 18,570
---------- ------------ ----------- ----------- -----------
Total interest-bearing liabilities $254,298 $391,091 $248,705 $ 588 $894,682
---------- ------------ ----------- ----------- -----------
CUMULATIVE MATURITY / INTEREST SENSITIVITY $234,187 $(5,506) $153,983 $216,204 $216,204
GAP
As % of total earnings assets 21.08% (0.50)% 13.86% 19.46%
========== ============ =========== =========== ==========
In order to more closely measure interest sensitivity, the Company uses earnings
simulation models on a quarterly basis. These models utilize the Company's
financial data and various management assumptions as to growth and earnings to
forecast a base level of net interest income and earnings over a one-year
period. This base level of earnings is then shocked assuming a sudden 200 basis
points increase or decrease in interest rates. The most recent earnings
simulation model was run based on data as December 31, 2004, and even though the
Company's GAP analysis reflected a slightly liability sensitive position within
twelve months, the model projected that forecasted net income would decrease by
4.04% if interest rates would immediately fall by 200 basis points, and if rates
were to immediately rise by 200 basis points, the model projected a slight
increase in net income of 0.14%. The Company considers these results to be its
worst case scenario should these immediate increases or decreases in interest
rates be equally applied to both interest earning assets and interest bearing
liabilities; however, given changes in rates are first applied to loans and then
to NOW, money market and savings accounts on a lagging basis, the Company
expects net interest earnings will increase in a rising rate environment.
Management believes the modeled results are consistent with the short duration
of its balance sheet and given the many variables that effect the actual timing
of when assets and liabilities will reprice. The Company has set a limit on this
measurement of interest sensitivity to a maximum decline in earnings of 20%.
Since the earnings model uses numerous assumptions regarding the effect of
changes in interest rates on the timing and extent of repricing characteristics,
future cash flows and customer behavior, the model cannot precisely estimate net
income and the effect on net income from sudden changes in interest rates.
Actual results will differ from simulated results due to the timing, magnitude
and frequency of interest rate changes and changes in market conditions and
management strategies, among other factors.
NON-INTEREST INCOME
The Company's non-interest income sources include service charges and other fees
on deposit accounts, fee and net gains from loans originated and sold through
its mortgage lending division, commissions from non-deposit investment sales and
increases in the cash surrender value of Bank owned life insurance policies. In
2004, non-interest income declined by $1.9 million, or 25.7%, from $7.7 million
in 2003, to $5.8 million in 2004, and increased $2.1 million, or 38.5%, from
$5.6 million in 2002, to $7.7 million in 2003. In 2002, non-interest income
increased $889 thousand, or 18.9%, from $4.7 million in 2001 to $5.6 million.
Fees and net gains on mortgage loans held-for-sale have accounted for the
majority of the increase/decrease in non-interest income over the past three
years as lower interest rates and a strong local housing market pushed
production levels to new highs in 2002 and 2003, while in 2004 refinancing
activity slowed considerably, and consequently fees and net gains on mortgage
loans held-for-sale decreased $2.4 million, or 43.1%, from $5.7 million in 2003,
to $3.2 million. In 2003 fees and net gains increased $1.8 million, or 44.6%,
from $3.9 million in 2002, to $5.7 million and in 2002, they increased $541
thousand, or 16.0%, from $3.4 million in 2001, to $3.9 million in 2002.
10
The Company's mortgage lending division began operations in 1999 and in that
first year of operation originated $73.7 million in mortgages for sale. In 2000,
results were similar with $79.8 million in originations. In 2001, 2002 and 2003,
as mortgage rates began to fall, refinancing and home purchases increased
significantly with refinancing activity hitting record levels. As a result,
mortgages originated for sale increased to $180.7 million in 2001, $207.8
million in 2002 and to a record level of $287.8 million in 2003. In 2004, due to
lower levels of refinancing activity, originations were $175.9 million. Adverse
changes in the local real estate market, consumer confidence, and interest rates
could adversely impact the level of loans originated for sale, and the resulting
fees and earnings thereon. The Company anticipates that due to a slow down in
refinancing activity and the possibility of higher interest rates in 2005, its
fees and net gains on mortgage loans originated for sale could be lower in 2005,
as compared to 2004; however, the Company is attempting to hire additional
commissioned based loan officers to help offset these factors.
Service charges and other fees, which include monthly deposit account
maintenance charges, overdraft fees, ATM fees and charges, debit card income,
safe deposit box rents, merchant discount fee income, and lock box service fees,
increased $140 thousand, or 8.7%, from slightly over $1.6 million in 2003, to
over $1.7 million in 2004. In 2003, service charges and other fees were mostly
unchanged at $1.6 million, while in 2002 they increased $345 thousand, or 27.1%,
from slightly under $1.3 million in 2001. The increase in 2002 was the result of
lower interest rates that pushed down earnings credits on customer demand
deposit accounts and consequently increased the level of service charges
actually charged. As this decline in the earnings credit stabilized in 2003
there was little improvement in service charge levels, while in 2004 service
charges increased by $140 thousand due to higher lock box service fees, debit
card income and ATM fees and charges.
The Company continues to seek to improve non-interest income having added
non-deposit investment services, through a third party arrangement, in 2002.
These activities provided $14 thousand in income in 2002, $202 thousand in 2003,
and increased by $225 thousand in 2004, or 111.4%, to $427 thousand. It is
expected that the amount of commissions will continue to increase as additional
sales representatives are added, although there can be no assurance.
Other non-interest income increased by $89 thousand, or 33.6%, from $265
thousand in 2003, to $354 thousand in 2004, and from $44 thousand in 2002 to
$265 thousand in 2003 due to the purchase of $6 million in Bank owned life
insurance policies in May 2003. These polices which are recorded on the
Company's balance sheet under other assets, accounted for $282 thousand of the
$354 thousand in other income in 2004, and $178 thousand of the $265 thousand in
other income in 2003. The Company does not anticipate additional purchases of
this insurance in 2005. Income from Bank owned life insurance is non taxable.
NON-INTEREST EXPENSE
In 2004, non-interest expense increased $2.0 million, or 9.5%, from $20.8
million in 2003, to $22.8 million, and increased $3.6 million, or 20.9%, from
$17.2 million in 2002 to $20.8 million in 2003. In 2002, non-interest expense
was up $3.2 million, or 23.1%, from $14.0 million in 2001 to $17.2 million.
Salaries and benefits accounted for $916 thousand, or 46.1%, of the total
increase in non-interest expense in 2004, $2.4 million, or 66.7%, in 2003, and
$2.0 million, or 62.7% in 2002. Commissions and incentive compensation
associated with the significant increases in total loans and loans originated
for sale were the main reason for these increases in salaries and benefits
expense over the past three years; however, also contributing to the increased
compensation expenses were other staff increases due to overall growth and
branch expansion. The Company anticipates that salaries and benefits expense
will continue to be the largest single factor in increased non-interest
expenses.
Occupancy expenses, which include rents, depreciation, maintenance on buildings,
leaseholds and equipment, increased $50 thousand, or 1.6%, from just under $3.2
million in 2003, to slightly over $3.2 million in 2004, and increased $275
thousand, or 9.4%, from $2.9 million in 2002 to $3.2 million in 2003. In 2002,
occupancy expense was up $578 thousand, or 24.7%. The increases in 2002 and 2003
were due to the opening of the Bank's twelfth and thirteenth branch locations
along with additional facilities for the Company's operations department due to
growth, while in 2004, occupancy expense was mostly unchanged as two new branch
locations were opened in the later part of the year while depreciation levels
associated with older branch locations were reduced. Occupancy is expected to
increase in 2005 due to the two new branches opened in the late 2004, the Bank's
most recent branch opening in January 2005, and three additional locations
scheduled to open between March and October 2005.
11
Data processing expense increased by $75 thousand, or 6.1%, in 2004, increased
by $160 thousand, or 14.8%, in 2003, and was up $177 thousand, or 19.6%, in
2002. Increases were due to growth in total loans and deposits along with added
services, such as Internet banking; however, the amount of increase has
continued to decline each year as the Bank realizes some economies of scale on
various systems.
Other operating expenses, which include advertising and public relations
expenses, bank franchise taxes, legal and professional fees, supplies and
postage, increased by $946 thousand, or 24.7%, from $3.8 million in 2003, to
$4.8 million in 2004, and increased $765 thousand, or 25.0%, from $3.1 million
in 2002 to $3.8 million in 2003. In 2002, other operating expenses increased
$451 thousand, or 17.3%. The increase over the years is due to overall growth,
expanded amounts of advertising and public relations expenses, and in 2004, $239
thousand in additional professional fees associated with Sarbanes/Oxley Section
404 compliance efforts. Other non-interest expenses to which the Company is not
currently subject, such as deposit insurance premiums, which may be incurred in
the future, could have an adverse affect on earnings and results of operations
in future periods. The Company expects costs associated with Sarbanes/Oxley
Section 404 to be lower in 2005.
INCOME TAXES
The Company's income tax provisions are adjusted for non-deductible expenses and
non-taxable interest after applying the U.S. federal income tax rate of 35% in
2004 and 34% in 2003 and 2002. The provision for income taxes totaled $7.4
million, $5.9 million and $3.9 million, for the years ended December 31, 2004,
2003 and 2002, respectively. The effects of non-deductible expenses and
non-taxable interest on the Company's income tax provisions are minimal.
ASSET QUALITY - PROVISION AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is based upon management's estimate of the amount
required to maintain an adequate allowance for loan losses reflective of the
risks in the loan portfolio. In 2004, net charge-offs totaled $44 thousand
compared to $42 thousand and $110 thousand in 2003 and 2002, respectively. The
provision for loan loss expense in 2004 was $3.0 million compared to $1.6
million in 2003 and $1.7 million in 2002. The total allowance for loan losses of
$10.4 million at December 31, 2004, increased 39.5% from $7.5 million at
December 31, 2003, and increased 25.9% from $5.9 million at December 31, 2002,
to $7.5 million at December 31, 2003. Higher provisions in 2004 were the result
of an increase in total loans of 41.4% while slightly lower provisions in 2003
were reflective of a lower level of net charge-offs and a decrease in
non-performing assets from $2.4 million at December 31, 2002, to $1.4 million at
December 31, 2003. The allowance for loan losses was equal to 1.11% of total
loans at December 31, 2004, as compared to 1.13% at the end of 2003.
Management feels that the allowance for loan losses is adequate at December 31,
2004. However, there can be no assurance that additional provisions for loan
losses will not be required in the future, including as a result of possible
changes in the economic assumptions underlying management's estimates and
judgments, adverse developments in the economy, on a national basis or in the
Company's market area, or changes in the circumstances of particular borrowers.
The Company generates a quarterly analysis of the allowance for loan losses,
with the objective of quantifying portfolio risk into a dollar figure of
inherent losses, thereby translating the subjective risk value into an objective
number. Emphasis is placed on semi-annual independent external loan reviews and
monthly internal reviews. The determination of the allowance for loan losses is
based on applying and summing the results of eight qualitative factors and one
quantitative factor to each category of loans along with any specific allowance
for impaired and adversely classified loans within the particular category. Each
factor is assigned a percentage weight and that total weight is applied to each
loan category. The resulting sum from each loan category is then combined to
arrive at a total allowance for all categories. Factors are different for each
loan category. Qualitative factors include: levels and trends in delinquencies
and non-accruals, trends in volumes and terms of loans, effects of any changes
in lending policies, the experience, ability and depth of management, national
and local economic trends and conditions, concentrations of credit, quality of
the Company's loan review system, and regulatory requirements. The total
allowance required thus changes as the percentage weight assigned to each factor
is increased or decreased due to its particular circumstance, as the various
types and categories of loans change as a percentage of total loans and as
specific allowances are required due to an increase in impaired and adversely
classified loans. For further information regarding the allowance for loan
losses see Notes 1 and 4 to the Consolidated Financial Statements.
12
TABLE 4: PROVISION AND ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands) 2004 2003 2002 2001 2000
----------- ------------- ----------- ------------ ------------
Allowance, beginning of period $ 7,457 $ 5,924 $ 4,356 $ 2,803 $ 1,889
----------- ------------- ----------- ------------ ------------
CHARGE-OFFS
Real estate loans $ -- $ -- $ -- $ -- $ --
Commercial loans -- 30 87 -- --
Consumer loans 62 26 68 23 36
----------- ------------- ----------- ------------ ------------
Total charge-offs $ 62 $ 56 $ 155 $ 23 $ 36
----------- ------------- ----------- ------------ ------------
RECOVERIES
Real estate loans $ -- $ -- $ -- $ -- $ --
Commercial loans 12 2 5 2 1
Consumer loans 6 12 40 2 2
----------- ------------- ----------- ------------ ------------
Total recoveries $ 18 $ 14 $ 45 $ 4 $ 3
----------- ------------- ----------- ------------ ------------
Net charge-offs $ 44 $ 42 $ 110 $ 19 $ 33
----------- ------------- ----------- ------------ ------------
PROVISIONS FOR LOAN LOSSES 2,989 1,575 1,678 1,572 947
----------- ------------- ----------- ------------ ------------
Allowance, end of period $ 10,402 $ 7,457 $ 5,924 $ 4,356 $ 2,803
=========== ============= =========== ============ ============
Ratio of net charges-offs to average total
loans outstanding during period 0.01% 0.01% 0.02% 0.01% 0.01%
TABLE 5: ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is a general allowance applicable to all loan
categories; however, management has allocated the allowance to provide an
indication of the relative risk characteristics of the loan portfolio. The
allocation is an estimate and should not be interpreted as an indication that
charge-offs will occur in these amounts, or that the allocation indicates future
trends. The allocation of the allowance at December 31 for the years indicated
and the ratio of related outstanding loan balances to total loans are as
follows:
(Dollars in thousands) 2004 2003 2002 2001 2000
----------- ----------- ---------- --------- ----------
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES:
Real estate - mortgage $5,584 $4,188 $3,159 $1,957 $1,571
Real estate - construction 2,328 1,789 1,239 863 518
Commercial 2,422 1,434 1,469 1,482 628
Consumer 68 46 57 54 86
----------- ----------- ---------- --------- ----------
Balance, December 31, $10,402 $7,457 $5,924 $4,356 $2,803
========== =========== ========== ========= ==========
RATIO OF LOANS TO TOTAL YEAR-END LOANS:
Real estate - mortgage 65% 67% 70% 66% 64%
Real estate - construction 25% 23% 21% 23% 21%
Commercial 9% 9% 8% 9% 12%
Consumer 1% 1% 1% 2% 3%
----------- ----------- ---------- --------- ----------
100% 100% 100% 100% 100%
========== =========== ========== ========= ==========
See Notes 1 and 4 to the Consolidated Financial Statements for additional
information regarding the provision and allowance for loan losses.
13
RISK ELEMENTS AND NON-PERFORMING ASSETS
Non-performing assets consist of non-accrual loans, impaired loans, restructured
loans, and other real estate owned (foreclosed properties). The total
non-performing assets and loans that are 90 days or more past due and still
accruing interest decreased by $211 thousand, or 14.8%, from $1.4 million at
year-end 2003 to $1.2 million at year-end 2004, and decreased by $966 thousand,
or 40.5%, from $2.4 million at year-end 2002, to $1.4 million at December 31,
2003. The decline of $966 thousand in 2003 was attributable to the payoff of a
residential single-family property mortgage for $1.0 million while the decrease
in 2004 was due to the payoff of another residential single-family mortgage for
$875 thousand and the payoff of several other impaired loans totaling $401
thousand, offset somewhat by the addition of $1.2 million in commercial loans to
a single borrower for which impairment was identified and a specific allowance
of $400 thousand was applied. Those loans are currently performing in accordance
with their terms.
Loans are placed in non-accrual status when in the opinion of management the
collection of additional interest is unlikely or a specific loan meets the
criteria for non-accrual status established by regulatory authorities. No
interest is taken into income on non-accrual loans. A loan remains on
non-accrual status until the loan is current as to both principal and interest
or the borrower demonstrates the ability to pay and remain current, or both.
The ratio of non-performing assets and past due loans to total loans decreased
from .21% at December 31, 2003, to .13% at December 31, 2004, and decreased from
..44% at December 31, 2002, to .21% at December 31, 2003. As noted above, the
decreases in the ratio in 2003, and 2004, were due to two loans on single-family
residential properties that were paid off in full. The Company expects its ratio
of non-performing assets to remain low relative to its peers, however, the ratio
could increase due to an aggregate of $1.7 million in other identified potential
problem loans, to four borrowers, as of December 31, 2004, for which management
has identified risk factors that may result in them not being repaid in
accordance with their terms although the loans are generally well secured and
are currently performing. At December 31, 2003, other identified potential
problem loans were $2.2 million and they were $1.9 million at December 31, 2002.
See Notes 1 and 4 to the Consolidated Financial Statements for additional
information regarding the Company's non-performing assets.
Foreclosed real properties include properties that have been substantively
repossessed or acquired in complete or partial satisfaction of debt. Such
properties, which are held for resale, are carried at the lower of cost or fair
value, including a reduction for the estimated selling expenses, or principal
balance of the related loan. The Company held no foreclosed real properties for
any of the years presented.
TABLE 6: NON-PERFORMING ASSETS
DECEMBER 31,
------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
----------- ------------ ----------- ----------- -----------
Non-accrual loans $ 18 $ 46 $1,943 $106 $117
Impaired loans 1,192 416 444 119 107
Restructured loans -- 875 -- -- --
Foreclosed properties -- -- -- -- --
----------- ------------ ----------- ----------- -----------
Total non-performing assets $1,210 $1,337 $2,387 $225 $224
----------- ------------ ----------- ----------- -----------
Loans past due 90 days and still accruing -- 84 -- 329 318
----------- ------------ ----------- ----------- -----------
TOTAL NON-PERFORMING ASSETS AND PAST DUE LOANS $1,210 $1,421 $2,387 $554 $542
=========== ============ =========== =========== ===========
Allowance for loan losses to total loans 1.11% 1.13% 1.09% 1.05% .91%
Allowance for loan losses to non-performing loans 859.7% 524.8% 248.2% 1,936.0% 1,251.3%
Non-performing assets and past due loans to total loans 0.13% 0.21% 0.44% 0.13% 0.18%
NON-PERFORMING ASSETS AND PAST DUE LOANS TO
TOTAL ASSETS 0.11% 0.16% 0.36% 0.11% 0.15%
=========== ============ =========== =========== ===========
14
LOAN PORTFOLIO
The Bank's lending activities are its principal source of income. Real estate
loans, including residential permanents and construction, and commercial
permanents, represent the major portion of the Bank's loan portfolio. Loans, net
of unearned income and the allowance for loan losses, increased $270.9 million,
or 41.4%, from $654.9 million at December 31, 2003, to $925.8 million at
December 31, 2004, and increased $138.0 million, or 26.7%, from $516.9 million
at December 31, 2002, to $654.9 million at year-end 2003. The increase in loans
in 2004 included an increase in real estate mortgage loans of $161.0 million, or
36.2%, an increase in real estate construction loans of $87.1 million, or 56.8%,
and an increase in commercial loans of $27.5 million, or 45.0%. In 2003 growth
in loans by category was similar with real estate mortgage loans increasing
$82.4 million, or 22.8%, real estate construction loans increasing $42.1
million, or 37.8%, and commercial loans increasing $16.6 million, or 37.3%. The
majority of the increase in real estate mortgage loans is concentrated in
non-farm non-residential properties for which the Bank has had a primary focus
for years, while the increases in real estate construction loans over the past
two years are the direct result of an increased focus in this area and the
hiring of loan officers specializing in residential construction lending. At
December 31, 2004, $163.3 million of real estate construction loans were to
commercial builders of single-family homes, $14.2 million were to individuals on
single-family properties and $63.0 million were related to commercial
properties. In 2003, $110.5 million of real estate construction loans were to
commercial builders of single-family homes, $13.1 million were to individuals
and $29.8 million were related to commercial properties. The Bank expects that
real estate construction loans will continue to grow, but not at the pace
experienced in 2003 and 2004, although there can be no assurance. The Bank has
also increased its focus on commercial lending over the past two years with the
hiring of several loan officers devoted to developing that lending area. In
addition, consumer lending, through home equity lines of credit, which are
included in total real estate mortgage loans, have increased from $24.4 million
at December 31, 2002, to $42.2 million at December 31, 2003, and increased $19.0
million, or 45.0%, to $61.2 million at December 31, 2004.
As noted above, the majority of the Bank's loan portfolio consists of
construction and commercial real estate loans. At December 31, 2004, the Bank
had $163.3 million of construction loans to commercial builders of single family
housing in the Northern Virginia market, representing 17.6% of total loans.
These loans are made to a number of unrelated entities and generally have a term
of twelve to eighteen months. Adverse developments in the Northern Virginia real
estate market or economy could have an adverse impact on this portfolio of loans
and the Company's income and financial position. In addition, the Bank had
$436.5 million, or 46.6% of the loan portfolio at December 31, 2004, secured by
non-farm non-residential properties. These loans represent obligations of a
diversified pool of borrowers across numerous businesses and industries in the
Northern Virginia market and include some loans that, although secured by
commercial real estate, are commercial purpose loans made based on the financial
condition of the underlying business. At December 31, 2004, the Company had no
other concentrations of loans in any one industry exceeding 10% of its total
loan portfolio. An industry for this purpose is defined as a group of
counterparties that are engaged in similar activities and have similar economic
characteristics that would cause their ability to meet contractual obligations
to be similarly affected by changes in economic or other conditions. The Bank
seeks to manage its concentrations of loans through the establishment of limits
on the level of its various loan types to total loans and to total capital. For
further information regarding concentrations of loans see Note 17 to the
Consolidated Financial Statements.
Tables 7 and 8 present information pertaining to the composition of the loan
portfolio including unearned income, the allowance for loan losses, and the
maturity/repricing of selected loans.
TABLE 7: SUMMARY OF TOTAL LOANS
DECEMBER 31,
---------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
------------- ------------- -------------- ------------ -------------
Real estate - mortgage $ 605,420 $ 444,411 $ 362,024 $ 259,299 $ 193,624
Real estate - construction 240,469 153,400 111,333 94,452 65,460
Commercial 88,725 61,178 44,559 39,153 37,406
Consumer 5,879 6,061 6,941 8,004 7,995
------------- ------------- -------------- ------------ -------------
Total loans $ 940,493 $ 665,050 $ 524,857 $ 400,908 $ 304,485
Less unearned income 4,309 2,742 2,033 1,444 883
Less allowance for loan losses 10,402 7,457 5,924 4,356 2,803
------------- ------------- -------------- ------------ -------------
LOANS, NET $ 925,782 $ 654,851 $ 516,900 $ 395,108 $ 300,799
============= ============= ============== ============ =============
15
TABLE 8: MATURITY/REPRICING SCHEDULE OF TOTAL LOANS
At December 31, 2004 REAL ESTATE- REAL ESTATE-
(Dollars in thousands) MORTGAGE CONSTRUCTION COMMERCIAL CONSUMER TOTAL
---------------- ---------------- --------------- --------------- ---------------
VARIABLE:
Within 1 year $111,982 $182,998 $ 60,988 $ 2,794 $358,762
1-to-5 years 186,610 5,813 1,157 -- 193,580
After 5 years 15,828 262 686 -- 16,776
-------- -------- -------- -------- --------
Total $314,420 $189,073 $ 62,831 $ 2,794 $569,118
-------- -------- -------- -------- --------
FIXED RATE:
Within 1 year 16,853 $ 21,802 $ 2,270 $ 577 $ 41,502
1-to-5 years 63,899 16,467 20,767 2,356 103,489
After 5 years 210,248 13,127 2,857 152 226,384
-------- -------- -------- -------- --------
Total $291,000 $ 51,396 $ 25,894 $ 3,085 $371,375
======== ======== ======== ======== ========
TOTAL LOANS $605,420 $240,469 $ 88,725 $ 5,879 $940,493
======== ======== ======== ======== ========
INVESTMENT SECURITIES
The securities portfolio plays a primary role in the management of the interest
rate sensitivity of the Company, provides additional interest income, serves as
a source of liquidity, and is used as needed to meet certain collateral
requirements.
The securities portfolio consists of two components, securities held-to-maturity
and securities available-for-sale. Securities are classified as held-to-maturity
based on management's intent and the Company's ability, at the time of purchase,
to hold such securities to maturity. These securities are carried at amortized
cost. Securities which may be sold in response to changes in market interest
rates, changes in the securities' prepayment risk, increased loan demand,
general liquidity needs, and other similar factors are classified as
available-for-sale and are carried at estimated fair value.
Total securities increased $14.0 million, or 9.4%, from $149.2 million at
December 31, 2003, to $163.2 million at December 31, 2004, and increased $78.0
million, or 109.5%, from $71.2 million at December 31, 2002, to $149.2 million
at December 31, 2003. Securities of U.S. Government Agencies represent the
majority of the portfolio while obligations of states and or political
subdivisions, and domestic corporate debt obligations have increased over the
past two years. Table 9 provides information regarding the composition of the
securities portfolio and Table 10 details the maturities and weighted average
yields (on a tax equivalent basis) at the dates indicated. See Note 2 to the
Consolidated Financial Statements for additional information regarding the
securities portfolio.
At December 31, 2004, there were no single issuers, other than issuers who are
U.S. government agencies, whose securities owned by the Company had an aggregate
book value of more than 10% of total stockholder's equity of the Company.
16
TABLE 9: SECURITIES PORTFOLIO
DECEMBER 31,
-----------------------------------------------------------------------
2004 2003 2002
-----------------------------------------------------------------------
(Dollars in thousands) Percent Percent Percent
Book Value of total Book Value of total Book Value of total
---------- ------- ---------- ------- ---------- -------
AVAILABLE-FOR-SALE:
U.S. Government Agency obligations $ 100,093 61.32% $ 93,274 62.48% $ 52,661 73.92%
U.S. Treasuries 9,930 6.08% -- -- -- --
Domestic corporate debt obligations 6,020 3.69% 5,995 4.02% -- --
Obligations of states/political
subdivisions 1,338 0.82% 1,295 0.87% 1,229 1.73%
Federal Reserve Bank stock 1,442 0.88% 758 0.51% 542 0.76%
Federal Home Loan Bank stock 1,761 1.08% 1,355 0.91% 1,194 1.68%
Community Bankers' Bank stock 55 0.03% 55 0.04% 55 0.08%
--------- ------ -------- ------ -------- ------
$120,639 73.90% $102,732 68.83% $ 55,681 78.17%
--------- ------ -------- ------ -------- ------
HELD-TO-MATURITY:
U.S. Government Agency obligations $33,667 20.63% $38,490 25.79% $ 8,534 11.98%
Obligations of states/political
subdivisions 8,433 5.17% 7,535 5.05% 6,534 9.17%
Domestic corporate debt obligations 493 0.30% 488 0.33% 482 0.68%
--------- ------ -------- ------ -------- ------
$42,593 26.10% $ 46,513 31.17% $ 15,550 21.83%
========= ====== ======== ====== ======== ======
$163,232 100.00% $ 149,245 100.00% $ 71,231 100.00%
========= ====== ======== ====== ======== ======
TABLE 10: MATURITY OF SECURITIES
At December 31, 2004 2003 2002
------------------------ -------------------------- -------------------------
(Dollars in thousands) Weighted Weighted Weighted
Average Average Average
Book Value Yield Book Value Yield Book Value Yield
------------ ----------- ------------ ------------- ----------- -------------
Maturing within one year $ 14,944 1.91% $ 2,025 3.74% $ -- --
Maturing after one through five years 74,664 2.88% 62,640 2.79% 38,549 3.77%
Maturing after five through ten years 48,501 4.41% 54,670 4.34% 12,966 4.87%
Maturing after ten years 25,123 4.85% 29,910 4.82% 19,716 5.96%
============ =========== ============ ============= =========== =============
$163,232 3.55% $149,245 3.78% $ 71,231 4.58%
============ =========== ============ ============= =========== =============
DEPOSITS
The Company's principal source of funds is deposit accounts comprised of demand
deposits, savings and money market accounts, and time deposits. Substantially
all deposits are provided by individuals and businesses located within the
communities served.
Total deposits increased $197.5 million, or 25.5%, from $773.5 million at
December 31, 2003, to $971.0 million at December 31, 2004, and increased $206.5
million, or 36.4%, from $567.0 million at December 31, 2002, to $773.5 million
at December 31, 2003. In 2004, growth by deposit category included a 23.6%
increase in demand deposits, a 2.3% decline in savings accounts and
interest-bearing demand deposits and a 56.4% increase in time deposits. In 2003,
growth included a 21.5% increase in demand deposits, a 78.3% increase in savings
accounts and interest-bearing demand deposits and a 13.0% increase in time
deposits. The Company attributes its growth in deposits to a strong and affluent
local economy, the payment of interest rates at or near the highest in its
market, and bank consolidation. The average rate paid on interest-bearing
deposits fell twenty five basis points in 2004, from 2.28% in 2003, to 2.03%,
and it fell ninety-three basis points from 3.21% for the year ended December 31,
2002, to 2.28% in 2003. From early 2001, up until July 2004, interest rates have
declined in all deposit account categories and in some cases reached near floor
levels. However, with interest rates expected to continue to climb in 2005, the
Bank expects that trend to reverse. Table 11 details maturities of time deposits
with balances of $100,000 or more, which represent 51.6% of total time deposits
as of December 31, 2004, compared to 44.9% at December 31, 2003. Total time
deposits represent 50.5% of total deposits as of December 31, 2004, compared to
40.5% at December 31, 2003. See Note 6 to the Consolidated Financial Statements
and Table 3 to this Management's Discussion and Analysis for additional
information regarding the maturities of time deposits.
17
TABLE 11: MATURITIES OF TIME DEPOSITS WITH BALANCES $100,000 OR MORE
DECEMBER 31,
--------------------------------------
(Dollars in thousands) 2004 2003 2002
------------ ------------ ------------
3 months or less $29,899 $26,580 $18,477
3-6 months 23,399 20,008 10,831
6-12 months 123,054 40,431 44,289
Over 12 months 76,829 53,662 37,104
------------ ------------ ------------
TOTAL $ 253,181 $ 140,681 $ 110,701
============ ============ ============
SHORT-TERM BORROWINGS
Short-term borrowings consist of securities sold under agreements to repurchase
that are secured transactions with customers and generally mature the business
day following the date sold. These transactions are provided to several of the
Bank's demand deposit customers and are considered a core-funding source of the
Bank. Table 12 provides information on the balances and interest rates on
short-term borrowings for the years ended December 31, 2004, 2003 and 2002
(dollars in thousands):
TABLE 12: SHORT-TERM BORROWINGS
At December 31, 2004 2003 2002
----------- ------------ -----------
Securities sold under agreement to repurchase $53,207 $30,887 $32,081
Weighted interest rate at year end 1.72% 0.36% 0.37%
Averages for the year ended December 31,
Outstanding $39,962 $32,963 $33,791
Interest rate 0.81% 0.37% 0.73%
Maximum month-end outstanding $53,207 $36,657 $40,251
=========== ============ ===========
LIQUIDITY
The Company's principal sources of liquidity and funding are its deposit base.
The level of deposits necessary to support the Company's lending activities is
determined through monitoring loan demand. Considerations in managing the
Company's liquidity position include, but are not limited to, scheduled cash
flows from existing loans and investment securities, anticipated deposit
activity including the maturity of time deposits, and projected needs from
anticipated extensions of credit. The Company's liquidity position is monitored
daily by management to maintain a level of liquidity conducive to efficiently
meet current needs and is evaluated for both current and longer term needs as
part of the asset/liability management process.
The Company measures total liquidity through cash and cash equivalents,
securities available-for-sale, mortgage loans held-for-sale, other loans and
investment securities maturing within one year, less securities pledged as
collateral for repurchase agreements, public deposits and other purposes, and
less any outstanding federal funds purchased. These liquidity sources increased
$49.3 million, or 18.2%, from $271.5 million at December 31, 2003, to $320.8
million at December 31, 2003, and increased $52.7 million, or 24.1%, from $218.8
million at December 31, 2002, to $271.5 million at December 31, 2003. The
increase in 2004 was due to a $75.2 million increase in loans maturing within
one-year as cash and cash equivalents declined by $36.3 million. Additional
sources of liquidity available to the Bank include the capacity to borrow funds
through established short-term lines of credit with various correspondent banks
and the Federal Home Loan Bank of Atlanta. See Note 14 to the Consolidated
Financial Statements for further information regarding these additional
liquidity sources.
CAPITAL
The assessment of capital adequacy depends on a number of factors such as asset
quality, liquidity, earnings performance, changing competitive conditions and
economic forces, and the overall level of growth. The Company's current and
future capital needs are monitored by management on an ongoing basis. Management
seeks to maintain a capital structure that will assure an adequate level of
capital to support anticipated asset growth and to absorb potential losses.
Both the Company's and the Bank's capital levels continue to meet regulatory
requirements. The primary indicators relied on by bank regulators in measuring
the capital position are the Tier 1 risk-based capital, total risk-based
capital, and leverage ratios. Tier 1 capital consists of common and qualifying
preferred stockholders' equity less goodwill. Total risk-based capital consists
of Tier 1 capital, qualifying subordinated debt, and a portion of the allowance
for loan losses. Risk-based capital ratios are calculated with reference to
risk-weighted assets. The leverage ratio compares Tier 1 capital to total
average assets. The Bank's Tier 1 risk-based capital ratio was 9.01% at December
31, 2004, compared to 7.51% at December 31, 2003, and its total risk-based
capital ratio was 11.82% at December 31, 2004, compared to 11.03% at December
31, 2003. These ratios are in excess of the mandated minimum requirement of
4.00% and 8.00%, respectively. The Bank's leverage ratio was 8.09% at December
31, 2004, compared to 6.33% at December 31, 2003. The Company's Tier 1
risk-based capital ratio, total risk-based capital ratio, and leverage ratio was
10.89%, 11.92% and 9.76%, respectively, at December 31, 2004, compared to
10.10%, 11.13%, and 8.49% at December 31, 2003. The increases in both the
Company and Bank's capital ratios in 2004 was due to the issuance of additional
common shares in a follow-on public offering in May 2004, earnings of $14.2
million and $708 thousand in proceeds and tax benefits from the exercise of
stock options and warrants by company directors, officers and employees. Both
the Company's and Bank's capital positions include $18 million in proceeds from
the Company's issuance of trust preferred capital notes in the fourth quarter of
2002.
18
The ability of the Company to continue to grow is dependent on its earnings and
the ability to obtain additional funds for contribution to the Bank's capital,
through borrowing, the sale of additional common stock, or through the issuance
of additional trust preferred securities. In the event that the Company is
unable to obtain additional capital for the Bank on a timely basis, the growth
of the Company and the Bank may be curtailed, and the Company and the Bank may
be required to reduce their level of assets in order to maintain compliance with
regulatory capital requirements. Under those circumstances net income and the
rate of growth of net income may be adversely affected. The Company believes
that its current capital and access to sources of additional capital is
sufficient to meet anticipated growth, although there can be no assurance.
The Federal Reserve has revised the capital treatment of trust preferred
securities in light of recent accounting pronouncements and interpretations
regarding variable interest entities, which have been read to encompass the
subsidiary trusts established to issue trust preferred securities, and to which
the Company issued subordinated debentures. As a result, the capital treatment
of trust preferred securities has been revised to provide that in the future,
such securities can be counted as Tier 1 capital at the holding company level,
together with certain other restricted core capital elements, up to 25% of total
capital (net of goodwill), and any excess as Tier 2 capital up to 50% of Tier 1
capital. At December 31, trust preferred securities represented 16.4% of the
Company's tier one capital and 15.0% of its total capital. Future trust
preferred issuances to increase holding company capital levels may not be
available to the same extent as currently. The Company may be required to raise
additional equity capital, through the sale of common stock or otherwise, sooner
than it would otherwise do so.
CONTRACTUAL OBLIGATIONS
The Company has entered into certain contractual obligations including long term
debt, operating leases and obligations under service contracts. The following
table summarizes the Company's contractual cash obligations as of December 31,
2004.
TABLE 13: CONTRACTUAL OBLIGATIONS
Payments Due-By Period
One To
Less Than Three Four To After
(Dollars in thousands) Total One Year Years Five Years Five Years
- ------------------------------------------------------ ------------- ------------- ----------- ----------- -----------
Securities sold under agreements to repurchase $ 53,207 $ 53,207 $ -- $ -- $ --
Trust preferred capital notes 18,000 -- -- -- 18,000
Operating leases 10,051 1,463 2,369 2,003 4,216
Data processing services 839 839 -- -- --
- ------------------------------------------------------ ------------- ------------- ----------- ----------- -----------
Total contractual cash obligations $ 82,097 $ 55,509 $2,369 $2,003 $22,216
- ------------------------------------------------------ ------------- ------------- ----------- ----------- -----------
The obligation for data processing services represents estimates of early
termination charges. The table does not reflect deposit liabilities entered into
in the ordinary course of the Company's banking business. At December 31, 2004,
the Company had approximately $480.4 million of demand and savings deposits,
exclusive of interest, which have no stated maturity or payment date. The
Company also had approximately $490.5 million of time deposits, exclusive of
interest, the maturity distribution of which is set forth in Note 6 to the
Consolidated Financial Statements. For additional information about the
Company's deposit obligations, see "Net Interest Income" and "Deposits" above.
The trust preferred capital notes exclude $570 thousand of capital notes that
relate to the common securities of the issuing trusts, all of which are owned by
the Company. See Note 15 to the Consolidated Financial Statements for additional
information regarding the trust preferred securities and related capital notes.
19
OFF-BALANCE SHEET ARRANGEMENTS
The Company enters into certain off-balance sheet arrangements in the normal
course of business to meet the financing needs of its customers. These
off-balance sheet arrangements include commitments to extend credit, standby
letters of credit and financial guarantees which would impact the Company's
liquidity and capital resources to the extent customer's accept and or use these
commitments. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the balance sheet.
See Note 16 to the Consolidated Financial Statements for further discussion of
the nature, business purpose and elements of risk involved with these
off-balance sheet arrangements. With the exception of these off-balance sheet
arrangements, and the Company's obligations in connection with its trust
preferred securities, the Company has no off-balance sheet arrangements that
have or are reasonably likely to have a current or future effect on the
Company's financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures, or capital
resources, that is material to investors. For further information, see Notes 15
and 16 to the Consolidated Financial Statements.
MARKET PRICE OF STOCK AND DIVIDENDS
The Company's stock is traded on the Nasdaq National Market under the symbol
"VCBI". Table 14 sets forth the range of high and low sales prices (adjusted for
stock dividends and splits) known to the Company for each full quarterly period
within the two most recent fiscal years.
The Company has not paid cash dividends since 1995, electing to retain earnings
for funding the growth of the Company and its business. The Company currently
anticipates continuing the policy of retaining earnings to fund growth. The
ability of the Company to pay dividends, should it elect to do so, depends
largely upon the ability of the Bank to declare and pay dividends to the
Company, as the principal source of the Company's revenue is dividends paid by
the Bank. Future dividends will depend primarily upon the Bank's earnings,
financial condition, and need for funds, as well as governmental policies and
regulations applicable to the Company and the Bank, which limit the amount that
may be paid as dividends without prior approval.
TABLE 14: MARKET PRICE OF STOCK
2004 2003
-------------------- -----------------------
Quarter High Low High Low
- ------------------------- ---------- --------- ---------- ------------
First $25.60 $23.51 $14.10 $9.46
Second 25.12 20.00 16.60 13.44
Third 27.82 22.85 19.80 14.86
Fourth 30.00 26.44 26.64 18.32
At December 31, 2004, the Company had 578 stockholders of record, and
representing an aggregate of approximately 2,124 beneficial owners. Information
regarding stock dividends and splits in 2004, 2003, and 2002 is as follows:
1. A five-for-four stock split in the form of a 25% stock dividend was
declared on June 3, 2004, for stockholders of record on June 15, 2004,
and was paid on July 15, 2004.
2. A two-for-one stock split in the form of a 100% stock dividend was
declared on April 22, 2003, for stockholders of record on May 5, 2003,
and was paid on May 30, 2003.
3. A five-for-four stock split in the form of a 25% stock dividend was
declared on February 28, 2002, for stockholders of record on March 15,
2002, and was paid on April 12, 2002.
20
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS. The
following table sets forth information regarding outstanding options and other
rights to purchase common stock granted under the Company's compensation plans
as of December 31, 2004:
Equity Compensation Plan Information
Number of securities remaining
available for future
issuance under equity
Number of securities to be issued Weighted average exercise compensation plans
upon exercise of outstanding price of outstanding options, (excluding securities
Plan category options, warrants and rights warrants and rights reflected in column (a)
- ---------------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders (1) 1,199,074 $6.54 472,246
Equity compensation plans not
approved by security holders 0 0 0
--------- ----- -------
Total 1,199,074 $6.54 472,246
(1) Consists of the Company's 1989 and 1998 Stock Option Plans, the 2003
Employee Stock Option Plan and director warrants granted in 1998. For
additional information, see Notes 12 and 13 to the Consolidated Financial
Statements.
ISSUER REPURCHASES OF COMMON STOCK. No shares of the Company's common stock were
repurchased by or on behalf of the Company during the fourth quarter of 2004.
ANNUAL MEETING OF STOCKHOLDERS
The annual meeting of stockholders of Virginia Commerce Bancorp, Inc. (the
"Company") will be held at 4:00 pm on Wednesday, April 27, 2005 at "The Tower
Club", 8000 Towers Crescent Drive, Suite 1700, Vienna, Virginia.
ANNUAL REPORT ON FORM 10-K
A COPY OF FORM 10-K AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS
AVAILABLE WITHOUT CHARGE TO STOCKHOLDERS UPON WRITTEN REQUEST TO:
LYNDA S. CORNELL
ASSISTANT TO THE CHIEF EXECUTIVE OFFICER
VIRGINIA COMMERCE BANCORP, INC.
5350 LEE HIGHWAY
ARLINGTON, VA 22207
INTERNET ACCESS TO COMPANY DOCUMENTS
The Company provides access to its SEC filings through the Bank's web site at
www.vcbonline.com. After accessing the web site, the filings are available upon
selecting "about us/stock information/financial information." Reports available
include the annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports as soon as reasonably
practicable after the reports are electronically filed or furnished to the SEC.
21
[GRAPHIC]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Virginia Commerce Bancorp, Inc.
Arlington, Virginia
We have audited the accompanying consolidated balance sheets of Virginia
Commerce Bancorp, Inc. and subsidiaries as of December 31, 2004 and 2003, and
the related consolidated statements of income, changes in stockholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
2004. We also have audited management's assessment, included in the accompanying
Management Report on Internal Control Over Financial Reporting appearing under
Item 9A, that Virginia Commerce Bancorp, Inc. and subsidiaries maintained
effective internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control-- Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Virginia Commerce Bancorp, Inc. and subsidiaries' management is responsible for
these financial statements, for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
these financial statements, an opinion on management's assessment, and an
opinion on the effectiveness of Virginia Commerce Bancorp, Inc. and
subsidiaries' internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our
audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
22
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Virginia Commerce
Bancorp, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2004 in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion,
management's assessment that Virginia Commerce Bancorp, Inc. and subsidiaries
maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our
opinion, Virginia Commerce Bancorp, Inc. and subsidiaries maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
February 23, 2005
23
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
December 31,
---------------------------------
2004 2003
----------------- ---------------
ASSETS
Cash and due from banks $ 16,783 $ 22,434
Interest-bearing deposits with other banks 1,009 --
Securities (fair value: 2004, $163,477; 2003, $149,894) 163,232 149,245
Federal funds sold -- 31,622
Loans held-for-sale 9,662 3,513
Loans, net of allowance for loan losses of $10,402 in 2004 and
$7,457 in 2003 925,782 654,851
Bank premises and equipment, net 6,692 6,189
Accrued interest receivable 4,105 3,372
Other assets 12,088 10,468
----------------- ---------------
Total assets $ 1,139,353 $881,694
================= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS
Demand deposits $ 148,063 $119,785
Savings and interest-bearing demand deposits 332,385 340,122
Time deposits 490,520 313,604
----------------- ---------------
Total deposits $ 970,968 $773,511
Securities sold under agreement to repurchase 53,207 30,887
Trust preferred capital notes 18,570 18,570
Accrued interest payable 1,555 1,024
Other liabilities 3,729 2,610
Commitments and contingent liabilities -- --
----------------- ---------------
Total liabilities $ 1,048,029 $826,602
================= ===============
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par, 1,000,000 shares authorized and
unissued $ -- $ --
Common stock, $1.00 par, 20,000,000 shares authorized, issued and
outstanding 2004, 11,046,422; 2003, 7,860,291 11,046 7,860
Surplus 37,219 17,891
Retained earnings 43,578 29,354
Accumulated other comprehensive income (loss), net (519) (13)
----------------- ---------------
Total stockholders' equity $ 91,324 $ 55,092
----------------- ---------------
Total liabilities and stockholders' equity $ 1,139,353 $ 881,694
================= ===============
See Notes to Consolidated Financial Statements.
24
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
Year Ended December 31,
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2004 2003 2002
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INTEREST AND DIVIDEND INCOME:
Interest and fees on loans $51,814 $41,065 $35,491
Interest and dividends on investment securities:
Taxable 5,479 4,154 2,905
Tax-exempt 250 277 162
Dividends 124 95 85
Interest on deposits with other banks 10 -- --
Interest on federal funds sold 321 377 355
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Total interest and dividend income $57,998 $45,968 $38,998
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INTEREST EXPENSE:
Deposits $15,100 $12,914 $13,341
Securities sold under agreement to repurchase and federal
funds purchased 325 123 245
Other borrowed funds 15 21 497
Trust preferred capital notes 891 835 45