UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005.
Commission file number: 333-87781
Bay National Corporation
(Exact name of small business issuer as specified in its charter)
Maryland 52-2176710
----------------------------------------- ----------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2328 West Joppa Road, Lutherville, MD 21093
-------------------------------------------
Address of principal executive offices
(410) 494-2580
--------------
Issuer's telephone number
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
---------- ---------
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:
At May 13, 2005, the issuer had 1,920,194 shares of Common Stock
outstanding.
Transitional Small Business Disclosure Format (Check One): Yes No X
--- ---
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
------- --------------------
BAY NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
---------------------------
As of March 31, 2005 and December 31, 2004
March 31, December 31,
2005 2004
---------------- ---------------
ASSETS (Unaudited)
Cash and due from banks $ 1,162,644 $ 1,403,424
Federal funds sold and other overnight investments 18,493,156 16,708,528
Loans held for sale 7,726,815 9,613,162
Investment securities available for sale (AFS) - at fair value 1,543,073 1,544,496
Other equity securities 654,790 556,090
Loans, net of unearned fees 142,194,796 141,413,437
Less: Allowance for credit losses (1,842,000) (1,810,000)
---------------- ---------------
Loans, net 140,352,796 139,603,437
Premises and equipment, net 627,410 593,583
Accrued interest receivable and other assets 929,730 740,754
---------------- ---------------
Total Assets $ 171,490,414 $ 170,763,474
================ ===============
LIABILITIES
Non-interest-bearing deposits $ 23,605,655 $ 20,638,596
Interest-bearing deposits 130,746,300 133,288,446
---------------- ---------------
Total deposits 154,351,955 153,927,042
Short-term borrowings 1,261,000 1,381,000
Note Payable 1,250,000 1,250,000
Accrued expenses and other liabilities 760,376 786,668
---------------- ---------------
Total Liabilities 157,623,331 157,344,710
---------------- ---------------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, authorized:
9,000,000 shares authorized, 1,920,194 and 1,917,710 issued and
outstanding as of March 31, 2005 and December 31, 2004,
respectively 19,202 19,177
Additional paid in capital 17,419,088 17,400,284
Accumulated deficit (3,571,207) (4,000,697)
---------------- ---------------
Total Stockholders' Equity 13,867,083 13,418,764
---------------- ---------------
Total Liabilities and Stockholders' Equity $ 171,490,414 $ 170,763,474
================ ===============
See accompanying notes to consolidated financial statements.
2
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
For the three-month periods ended March 31, 2005 and 2004
(Unaudited)
Three Months Ending
March 31
-----------------------------
2005 2004
------------- ------------
INTEREST INCOME:
Interest and fees on loans $ 2,463,260 $ 1,530,644
Interest on federal funds sold and other
overnight investments 66,478 25,942
Taxable interest and dividends on investment
securities 11,606 4,895
------------- ------------
Total interest income 2,541,344 1,561,481
------------- ------------
INTEREST EXPENSE:
Interest on deposits 790,469 508,437
Interest on short-term borrowings 8,116 2,908
Interest on note payable 16,996 -
------------- ------------
Total interest expense 815,581 511,345
------------- ------------
Net interest income 1,725,763 1,050,136
Provision for credit losses 32,000 109,721
------------- ------------
Net interest income after provision for
credit losses 1,693,763 940,415
------------- ------------
NON-INTEREST INCOME:
Service charges on deposit accounts 49,239 54,455
Gain on sale of mortgage loans 41,604 56,949
Other income 11,386 13,923
------------- ------------
Total non-interest income 102,229 125,327
------------- ------------
NON-INTEREST EXPENSES:
Salaries and employee benefits 748,595 594,677
Occupancy expenses 94,174 69,821
Furniture and equipment expenses 77,091 54,103
Legal and professional fees 40,000 38,748
Data processing and other outside services 208,825 130,671
Advertising and marketing related expenses 61,785 43,498
Other expenses 136,032 73,148
------------- ------------
Total non-interest expenses 1,366,502 1,004,666
------------- ------------
Income before income taxes 429,490 61,076
Income tax expense - -
------------- ------------
NET INCOME $ 429,490 $ 61,076
============= ============
Per Share Data:
Cash Dividends Paid $ - $ -
Net Income (basic) $ .22 $ .03
Net Income (diluted) $ .22 $ .03
Weighted Average shares outstanding (basic) 1,919,725 1,862,710
Effect of Dilution - Stock options and Warrants 66,573 54,705
------------- ------------
Weighted Average shares outstanding (diluted) 1,986,298 1,917,415
============= ============
See accompanying notes to consolidated financial statements.
3
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
For the three-months ended March 31, 2005 and 2004
(Unaudited)
Common Paid in Accumulated Stockholders'
Stock Capital Deficit Equity
------------- -------------- ----------------- ---------------
Balances at December 31, 2004 $ 19,177 $ 17,400,284 $ (4,000,697) $ 13,418,764
Issuance of Common Stock 25 18,804 - 18,829
Net Income - - 429,490 429,490
------------- -------------- ----------------- ---------------
Balances at March 31, 2005 $ 19,202 $ 17,419,088 $ (3,571,207) $ 13,867,083
============= ============== ================= ===============
Additional Total
Paid in Accumulated tockholders'
Common Stock Capital Deficit S Equity
------------- -------------- ----------------- ---------------
Balances at December 31, 2003 $ 18,627 $ 16,850,834 $ (4,802,961) $ 12,066,500
Net Income - - 61,076 61,076
------------- -------------- ----------------- ---------------
Balances at March 31, 2004 $ 18,627 $ 16,850,834 $ (4,741,885) $ 12,127,576
============= ============== ================= ===============
See accompanying notes to consolidated financial statements.
4
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three-months ended March 31, 2005 and 2004
(Unaudited)
2005 2004
------------- -------------
Cash Flows From Operating Activities
Net income $ 429,490 $ 61,076
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 41,113 43,158
Accretion of investment discounts (9,009) (3,415)
Provision for credit losses 32,000 109,721
Gain on sale of loans held for sale (41,604) (56,949)
Origination of loans held for sale (29,932,146) (5,449,684)
Proceeds from sale of loans 31,860,097 5,478,918
Net increase in accrued interest receivable and other assets (188,976) (49,744)
Net decrease in accrued expenses and other liabilities (26,292) (80,518)
------------- -------------
Net cash provided by operating activities 2,164,673 52,563
------------- -------------
Cash Flows From Investing Activities
Purchases of investment securities - AFS (1,539,568) (1,446,575)
Maturities of investment securities - AFS 1,550,000 1,550,000
Purchase of Federal Home Loan Bank of Atlanta stock (98,700) (51,200)
Loan disbursements in excess of principal payments (781,359) (8,202,893)
Capital expenditures (74,940) (104,361)
------------- -------------
Net cash used by investing activities (944,567) (8,255,029)
------------- -------------
Cash Flows From Financing Activities
Net increase in deposits 424,913 26,215,643
Net (decrease) increase in short-term borrowings (120,000) 228,000
Net proceeds from stock issuance 18,829 -
------------- -------------
Net cash provided by financing activities 323,742 26,443,643
------------- -------------
Net increase in cash and cash equivalents 1,543,848 18,241,177
Cash and cash equivalents at beginning of period 18,111,952 18,060,105
------------- -------------
Cash and cash equivalents at end of period $ 19,655,800 $ 36,301,282
============= =============
Cash paid for:
Interest $ 801,949 $ 491,803
Income taxes $ - $ -
See accompanying notes to consolidated financial statements.
5
BAY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Three Months Ended March 31, 2005 and 2004
(Unaudited)
1. GENERAL
Organization
Bay National Corporation (the "Company") was incorporated on June 3,
1999 under the laws of the State of Maryland to operate as a bank holding
company of a national bank with the name Bay National Bank (the "Bank"). On May
12, 2000, the Company purchased all the shares of common stock issued by the
Bank. The Bank commenced operations on May 12, 2000 after successfully meeting
the conditions of the Office of the Comptroller of the Currency (the "OCC") to
receive its charter authorizing it to commence operations as a national bank,
and obtaining the approval of the Federal Deposit Insurance Corporation to
insure its deposit accounts, and meeting certain other regulatory requirements.
Basis of Presentation
The accompanying consolidated financial statements include the activity
of Bay National Corporation and its wholly owned subsidiary, Bay National Bank.
All significant intercompany transactions and balances have been eliminated in
consolidation.
The foregoing consolidated financial statements are unaudited; however,
in the opinion of management, all adjustments (comprising only normal recurring
accruals) necessary for a fair presentation of the results of the interim
periods have been included. The balances as of December 31, 2004 have been
derived from audited financial statements. These statements should be read in
conjunction with the financial statements and accompanying notes included in Bay
National Corporation's 2004 Annual Report on Form 10-KSB. There have been no
significant changes to the Company's Accounting Policies as disclosed in the
2004 Annual Report. The results shown in this interim report are not necessarily
indicative of results to be expected for the full year 2005 or any other interim
period.
The accounting and reporting policies of the Company conform to
accounting principles generally accepted in the United States of America and to
general practices in the banking industry.
Reclassifications
Certain reclassifications have been made to amounts previously reported
to conform to the current presentation. These reclassifications had no effect on
previously reported results of operations or accumulated deficit.
2. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital action, the
Bank must meet specific capital guidelines that involve quantitative measures of
the Bank's assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weighting and other factors.
6
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios. Management
believes, as of March 31, 2005, that the Bank meets all capital adequacy
requirements to which it is subject.
As of March 31, 2005, the Bank has been categorized as "Well
Capitalized" by the OCC under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, the Bank must maintain minimum
total risk-based, Tier I risk-based, and Tier I leverage ratios.
3. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the liability
method, deferred-tax assets and liabilities are determined based on differences
between the financial statement carrying amounts and the tax bases of existing
assets and liabilities (i.e., temporary differences) and are measured at the
enacted rates that will be in effect when these differences reverse. Deferred
income taxes will be recognized when it is deemed more likely than not that the
benefits of such deferred income taxes will be realized; accordingly, no
deferred income taxes or income tax benefits have been recorded by the Company.
4. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per common share is computed by dividing net income by the weighted
average number of common shares outstanding during the period, including any
potential dilutive common shares outstanding, such as options and warrants.
5. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123) and Statement of Financial Accounting Standards No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS
No. 148), and applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. No compensation
expenses related to the Company's stock option plan were recorded during the
three-month periods ended March 31, 2005 and 2004.
7
The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
SFAS No. 123 and SFAS No. 148 to stock-based employee compensation for the
three-month periods ended March 31:
Three Months Ending
March 31
------------------------------
2005 2004
------------- ------------
INTEREST INCOME:
Net income, as reported $ 429,490 $ 61,076
Less pro forma stock-based compensation
expense determined under the fair value
method (17,011) (15,609)
------------- ------------
Pro forma net income $ 412,479 $ 45,467
============= ============
Net income per share:
Basic - as reported $ .22 $ .03
Diluted - as reported $ .22 $ .03
Basic - pro forma $ .21 $ .02
Diluted - pro forma $ .21 $ .02
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion and analysis provides an overview of the financial
condition and results of operations of Bay National Corporation (the "Parent")
and its national bank subsidiary, Bay National Bank (the "Bank"), collectively
(the "Company"), as of March 31, 2005 and December 31, 2004 and for the
three-month periods ended March 31, 2005 and 2004.
General
On May 12, 2000 the Parent became a bank holding company by purchasing
all of the common stock of the Bank. The Bank opened its first office on May 12,
2000 and its second office on May 26, 2000.
The Bank serves the business communities of North Baltimore and
Salisbury, Maryland.
Overview
While the Company experienced a slow down in the growth of assets for
the three-month period ended March 31, 2005, operating results continued a
strong trend of improvement over prior year results. Key measurements for the
three-month period ended March 31, 2005 include the following:
o Total assets at March 31, 2005 increased marginally to $171.5 million
as compared to $170.8 million as of December 31, 2004.
o Net loans outstanding increased from $139.6 million as of December 31,
2004 to $140.4 million as of March 31, 2005.
o There were no nonperforming loans at March 31, 2005. Appropriate
reserves for loan losses continue to be maintained.
o Deposits at March 31, 2005 were $154.4 million, a small increase from
$153.9 million as of December 31, 2004.
o The Company realized net income of $429,490 for the three-month period
ended March 31, 2005. This is a 603.21% increase over net income of
$61,076 for the three-month period ended March 31, 2004.
o Net interest income, the Company's main source of income, was $1.7
million during the three-month period ended March 31, 2005 compared to
$1.1 million for the same period in 2004. This represents an increase
of 64.34% for the three-months ended March 31, 2005 as compared to the
same period in 2004.
o There were no charge-offs for the three-month period ended March 31,
2005. Loan charge-offs were $6,221 for the three-month period ended
March 31, 2004.
o Non-interest income declined by $23,098, or 18.43%, for the three-month
period ended March 31, 2005, as compared to the same period in 2004.
o Non-interest expenses increased by $361,836, or 36.02%, for the
three-month period ended March 31, 2005, as compared to the same period
ended March 31, 2004.
9
o The market price of common shares ended the quarter at $14.50, up 9.43%
from the closing price of $13.25 on December 31, 2004.
A detailed discussion of the factors leading to these changes can be
found in the discussion below.
Results of Operations
Overview
The Company recorded net income of $429,490 for the three-month period
ended March 31, 2005. This compares to net income of $61,076 for the same period
in 2004. This is an improvement of $368,414 or 603.21% for the three-month
period. This significant improvement in results for the period is due to the
continued year over year growth of the loan portfolio.
Bay National Bank's mortgage origination operations, located in
Lutherville and Salisbury, Maryland, originate conventional first and second
lien residential mortgage loans. Bay National Bank sells most of its first and
second lien residential mortgage loans in the secondary market and typically
recognizes a gain on the sale of these loans after the payment of commissions to
the loan origination officer. Since its inception in February 2001, the
Salisbury mortgage division has been a significant contributor to operating
results. The Lutherville mortgage operation was initiated in February 2005 and
is expected to contribute to the Company's overall profitability by the second
half of 2005. For the three-month periods ended March 31, 2005 and 2004, gains
on the sale of mortgage loans totaled $41,604 and $56,949, respectively.
The level of gains on the sale of mortgage loans has declined from 2004
due to the strengthening of economic conditions and the resulting increase in
long-term interest rates as compared to the rates in effect during the same
period of 2004. An increase in rates traditionally has a negative impact on
mortgage loan production due to a reduction in the incentive for borrowers to
refinance existing mortgages or purchase new homes. The addition of the
Lutherville origination operation is expected to offset this trend by focusing
on construction and rehabilitation loans that will be modified to permanent
financing upon completion of the project. This type of residential lending is
expected to be less sensitive to the fluctuation of interest rates.
During the second quarter of 2004, the Company introduced a new loan
program for conventional first and second lien residential mortgage loans. Under
this program the Company purchases a 100% participation in mortgage loans
originated by a mortgage company in the Baltimore metropolitan area. These
participations are for loans which a secondary market investor has committed to
purchase. The participations are typically held for a period of three to four
weeks before being sold to the secondary market investor. This holding period
represents the amount of time taken by the secondary market investor to review
the loan files for completeness and accuracy. During this holding period, the
Company earns interest on these loans at a rate indexed to the prime rate.
The primary risk to the Company is that the secondary market investor
may decline to purchase the loans due to documentary deficiencies or errors. The
Company attempts to manage this risk by conducting a thorough review of the
documentation prior to purchasing the participation. If the secondary market
investor declines to purchase the loan, the Company could attempt to sell the
loan to other investors or hold the loan in its loan portfolio. As of March 31,
2005, the Company held $7.2 million of these loans which were classified as held
for sale. The Company earned $104,558 of interest on this program for the
three-month period ended March 31, 2005.
10
Management expects continued improvement in operating results over the
remainder of 2005; however, actual results will be subject to the volatility of
the provision for credit losses, which is related to loan growth, the success of
the new Lutherville mortgage lending programs, and the volatility of existing
mortgage loan production, which is sensitive to economic and interest rate
fluctuations.
Net Interest Income
Net interest income is the difference between income on assets and the
cost of funds supporting those assets. Earning assets are composed primarily of
loans, investments, and federal funds sold. Interest-bearing deposits and other
short-term borrowings make up the cost of funds. Non-interest bearing deposits
and capital are also funding sources. Changes in the volume and mix of earning
assets and funding sources along with changes in associated interest rates
determine changes in net interest income.
As previously stated, net interest income was $1.7 million during the
three-month period ended March 31, 2005 as compared to $1.1 million for the same
period in 2004. This represents an increase of 64.34% for the three-months ended
March 31, 2005 as compared to the same period in 2004.
Interest income from loans and investments for the three-month period
ended March 31, 2005 was $2.5 million, compared to $1.6 million for the
three-month period ended March 31, 2004. The 62.75% increase is directly related
to the 35.31% increase in average interest-earning assets for the three-months
ended March 31, 2005 as compared to the same period in 2004. The increase in
average interest-earning assets was also aided by a significant increase in
average yields due to seven .25% increases in the target federal funds rate
since June 30, 2004. The yields on these assets increased from 5.03% for the
three-months ended March 31, 2004 to 6.05% for the three-months ended March 31,
2005.
The percentage of average interest-earning assets represented by loans
was 89.63% and 85.98% for the three-month periods ended March 31, 2005 and 2004,
respectively. An increase in the percentage of interest-earning assets
represented by the loan portfolio would normally result in an increase in
average yields on interest-earning assets. For the three-month period ended
March 31, 2005, the average yield on the loan portfolio increased to 6.54% from
5.73% for the three-month period ended March 31, 2004. This increase is
primarily due to the difference in the target federal funds rate in effect for
the periods. The Federal Reserve has increased its target for the federal funds
rate from 1.00% as of March 31, 2004 to 2.75% as of March 31, 2005 and most
recently to its current target rate of 3.00%, which became effective on May 3,
2005. As can be seen by the yields discussed above, these increases have begun
to have a significant effect on the Company's operating results. Yields on
earning assets in future periods should continue to improve following any future
actions by the Federal Reserve.
The average yield on the investment portfolio and other earning assets
such as federal funds sold, was 1.79% for the three-month period ended March 31,
2005 as compared to .71% for the same period in 2004. The improvement in the
average yield was a direct result of the Federal Reserve actions discussed
above, as well as an increase in the holdings of Federal Reserve and Federal
Home Loan bank stocks, which pay dividend yields greater than the prevailing
federal funds rates. The percentage of average interest-earning assets
represented by investments was 10.37% and 14.02% for the three-month periods
ended March 31, 2005 and 2004, respectively.
Interest expense from deposits and borrowings for the three-month
period ended March 31, 2005 was $815,581. This compares to $511,345 for the
comparable period in 2004. The 59.50% increase is a result of a 34.30% increase
in average interest-bearing liabilities for the
11
three-month period ended March 31, 2005 as compared to the same period in 2004.
The increase in interest expense was also related to the increase in average
rates paid. Average rates paid on these liabilities increased from 2.08% for the
three-month period ended March 31, 2004 to 2.47% for the three-month period
ended March 31, 2005. The increase in rates paid is directly attributable to the
Federal Reserve actions discussed above. Even though market rates of interest
have increased significantly since June 30, 2004, management has been able to
minimize deposit rate increases, which has allowed for significantly improved
margins. Management expects that pressure to increase rates paid on deposits
will increase as the target for the federal funds rate continues to rise. In
fact, upward pressure began to appear on shorter term rates in the fourth
quarter of 2004 and continued during the first quarter of 2005.
12
The following tables set forth, for the periods indicated, information
regarding the average balances of interest-earning assets and interest-bearing
liabilities, the amount of interest income and interest expense and the
resulting yields on average interest-earning assets and rates paid on average
interest-bearing liabilities. Average balances are also provided for
non-interest-earning assets and non-interest-bearing liabilities.
No tax equivalent adjustments were made and no income was exempt from
federal income taxes. All average balances are monthly average balances. We do
not believe that the monthly averages differ materially from what the daily
averages would have been. The amortization of loan fees is included in computing
interest income; however, such fees are not material.
Three Months Ended March 31, 2005
Average Interest Yield/
Balance and fees Rate
------- -------- ----
ASSETS
Loans and loans held for sale $ 150,681,459 $ 2,463,260 6.54%
Investment securities 2,104,452 11,606 2.21
Federal funds sold and other overnight investments 15,320,999 66,478 1.74
---------------- ------------
Total earning assets 168,106,910 2,541,344 6.05%
------------
Less: Allowance for credit losses (1,821,378)
Cash and due from banks 1,173,244
Premises and equipment, net 608,415
Accrued interest receivable and other assets 667,893
----------------
Total assets $ 168,735,084
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 55,952,233 202,465 1.45%
Regular savings deposits 5,335,595 8,538 .64
Time deposits 67,856,868 579,466 3.42
Short-term borrowings 1,460,756 8,116 2.22
Note payable 1,250,000 16,996 5.44
---------------- ------------
Total interest-bearing liabilities 131,855,452 815,581 2.47%
------------ ------------
Net interest income and spread $ 1,725,763 3.58%
============ ============
Non-interest-bearing demand deposits 22,758,094
Accrued expenses and other liabilities 614,716
Stockholders' equity 13,506,822
----------------
Total liabilities and stockholders' equity $ 168,735,084
================
Interest income/earning assets 6.05%
Interest expense/earning assets 1.94
----------------
Net interest margin 4.11%
================
Return on Average Assets (Annualized) 1.02%
================
Return on Average Equity (Annualized) 12.72%
================
Average Equity to Average Assets 8.00%
================
13
Three Months Ended March 31, 2004
---------------------------------
Average Interest Yield/
Balance and fees Rate
------- -------- ----
ASSETS
Loans and loans held for sale $ 106,823,760 $ 1,530,644 5.73%
Investment securities 1,938,267 4,895 1.01
Federal funds sold and other overnight investments 15,477,632 25,942 .67
---------------- ------------
Total earning assets 124,239,659 1,561,481 5.03%
------------
Less: Allowance for credit losses (1,307,128)
Cash and due from banks 737,346
Premises and equipment, net 627,785
Accrued interest receivable and other assets 460,430
----------------
Total assets $ 124,758,092
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 39,595,098 101,222 1.02%
Regular savings deposits 3,413,533 5,529 .65
Time deposits 53,853,033 401,686 2.98
Short-term borrowings 1,321,406 2,908 .88
---------------- ------------
Total interest-bearing liabilities 98,183,070 511,345 2.08%
------------ ------------
Net interest income and spread $ 1,050,136 2.95%
============ ============
Non-interest-bearing demand deposits 14,020,473
Accrued expenses and other liabilities 409,827
Stockholders' equity 12,144,722
----------------
Total liabilities and stockholders' equity $ 124,758,092
================
Interest income/earning assets 5.03%
Interest expense/earning assets 1.65
----------------
Net interest margin 3.38%
================
Return on Average Assets (Annualized) .20%
================
Return on Average Equity (Annualized) 2.01%
================
Average Equity to Average Assets 9.74%
================
Provision for Credit Losses
The provision for credit losses was $32,000 for the three-month period
ended March 31, 2005, as compared to $109,721 for the three-month period ended
March 31, 2004. The provisions for each period were reflective of the growth in
loan balances outstanding in all segments of the portfolio. The provision for
the three-month period ended March 31, 2005 was substantially lower than the
same period in the prior year due to fact that gross loans outstanding increased
by $781,359 during that period as compared to an increase of approximately $8.2
million for the same period in 2004. For additional information regarding the
methodology used to determine the provision for credit losses, see the
Management Discussion and Analysis section entitled "Allowance for Credit Losses
and Credit Risk Management."
Non-Interest Income
Non-interest income consists primarily of gains on the sale of mortgage
loans, deposit account service charges, and cash management fees. For the
three-month period ended March 31, 2005, the Company realized non-interest
income in the amount of $102,229 as compared to $125,327 for the three-month
period ended March 31, 2004. Gains on the sale of mortgage loans of $41,604
comprise 40.70% of the total for the three-month period ended March 31, 2005.
14
This compares to gains on the sale of mortgage loans of $56,949, or 45.44% of
total non-interest income, for the three-month period ended March 31, 2004.
The level of gains on the sale of mortgage loans has declined due to
recent increases in long-term interest rates driven by stronger economic
conditions. Additional increases in interest rates, or a slow down in the
housing market, could further impact the Company's ability to maintain the same
level of non-interest income associated with mortgage loan production.
In February 2005, the Company added additional residential construction
and mortgage capabilities in the Baltimore market area. It is expected that
these additional capabilities will increase future levels of gains on the sale
of mortgage loans, while also providing interest income on construction loans.
This capability was added through the hiring of a team of eight individuals,
including originators, processors and servicers from another financial
institution. These individuals have extensive experience in the industry and the
Company's market area.
Service charges on deposit accounts totaled $49,239 for the three-month
period ended March 31, 2005, as compared to $54,455 for the three-month period
ended March 31, 2004. The decrease of 9.58% for the period, as compared to the
same period in 2004, can be directly attributed to a decline in analysis fees
charged on commercial deposit accounts. This decline occurred as the rate used
for the calculation of analysis credits increased in conjunction with the
increase in the target federal funds rate discussed earlier. Analysis credits
are fee reductions provided based upon the analysis credit rate and the average
balance of the account subject to analysis fees.
The Company will continue to seek ways to expand its sources of
non-interest income. In the future, the Company may enter into fee arrangements
with strategic partners that offer investment advisory services, risk management
and employee benefit services. No assurance can be given that such fee
arrangements will be obtained or maintained.
Non-Interest Expense
Non-interest expense for the three-month period ended March 31, 2005,
totaled $1,366,502. This compares to non-interest expense for the comparable
period in 2004 of $1,004,666. The increase of $361,836, or 36.02%, for the
three-month period resulted from an increase in salaries and benefits of
$153,918 related to staffing growth, including the addition of an eight person
mortgage lending operation in February 2005, as well as the addition of four
commercial account portfolio managers and other operational support personnel.
These additions were made to continue to expand the marketing efforts of the
Bank, as well as to manage the growth of the loan and deposit portfolios and
support increased operational volume.
Occupancy expenses increased by $24,353, or 34.88%, for the three-month
period as compared to the same period in 2004. This increase was due in part to
scheduled rent increases as well as a reduction in sublease income due to
expansion of the Company's corporate office into previously sublet space, and
the acquisition of new space obtained to facilitate the expansion of the
Company's corporate offices and accommodate the new mortgage lending group.
The $78,154, or 59.82%, increase in data processing and other outside
services for the three-months ended March 31, 2005 as compared to the same
period in 2004 is the result of increased data and item processing costs and
other costs paid to external service providers. The costs include one time
expenses of approximately $45,000 incurred in conjunction with the Bank's
planned change of core processors scheduled for May 2005, $13,000 of recruiting
fees paid to hire an additional corporate finance and compliance staff person,
and approximately $8,000 of systems support costs incurred to facilitate network
infrastructure changes required for a bank processing system upgrade. The
remaining increase is due to the fact that systems and
15
item processing costs are volume-driven based upon the number of customer
accounts and related transaction volume. As a result, these costs increase with
the growth of the Company.
The $18,287, or 42.04%, increase in advertising and marketing-related
expenses for the three-months ended March 31, 2005 as compared to the same
period in 2004 is related to an increase in the number of marketing events
conducted and the number of business development professionals on staff. The
increase of $62,884, or 85.97%, in other expenses includes director fees of
approximately $21,000, related to the director compensation plan adopted in the
second half of 2004 and an increase of approximately $6,000 in regulatory fees
related to the growth of the Bank. The remaining increase in non-interest
expense relates to various costs associated with the increased size and
complexity of the Company.
The rate of increase in non-interest expenses, including non-recurring
expenses, is substantially less than the 64.34% increase in net interest income
for the three-month period ended March 31, 2005 as compared to the three-month
period ended March 31, 2004. Management believes this indicates that the Company
is continuing to effectively leverage its cost structure to generate profitable
growth. While management expects that the ongoing growth of the Company's
customer base will continue to require additional staffing in order to
appropriately service customers and manage the business effectively, management
believes that additional growth in the customer base can continue to be
accomplished without proportionate increases in these costs.
Income Taxes
When the realization of deferred income taxes is deemed to be more
likely than not, the recordation of previously unrecorded net deferred income
tax assets will have a positive effect on the earnings in the period when such
determination is made. As of December 31, 2004, the Company had net deferred tax
assets of approximately $1.4 million that were eliminated through a valuation
allowance. Subsequent to the recordation of deferred taxes, the Company will
begin to record income tax expense at the statutory rate. Since inception, the
Company has not recorded any income tax expense or benefit. Recognizing income
tax expense in future periods will have a detrimental effect on reported
earnings.
Financial Condition
Composition of the Balance Sheet
As of March 31, 2005, total assets were $171,490,414. This represents
growth of $726,940 or .43% since December 31, 2004. The growth in total assets
included increases of $1,784,628 in federal funds sold and other overnight
investments, $98,700 in other equity securities, $749,359 in loans net of the
allowance for credit losses and $222,803 in other non-earning assets. These
increases were offset by decreases of $240,780 in cash and due from banks,
$1,886,347 in loans held for sale and $1,423 in investment securities available
for sale.
During the second quarter of 2004, the Company introduced a new loan
program for conventional first and second residential mortgage loans. Under this
program the Company purchases a 100% participation in mortgage loans originated
by a mortgage company in the Baltimore metropolitan area. These participations
are for loans that a secondary market investor has committed to purchase. The
participations are typically held for a period of three to four weeks before
being sold to the secondary market investor. The Company earns interest on these
loans at a rate indexed to the prime rate. As of March 31, 2005, the Company
held $7.2 million of these loans which were classified as held for sale, a
decline from the $8.0 million held as of December 31, 2004.
16
As of March 31, 2005, loans, excluding loans held for sale (net of a
$1,842,000 allowance for credit losses), totaled $140,352,796. The increase of
$749,359, or .54%, from a balance of $139,603,437 as of December 31, 2004, is a
slow down from the growth trend established in prior periods. This modest growth
is the result of significant pay downs and payoffs in the first quarter of 2005.
A total of approximately $11.8 million in loans that were outstanding as of
December 31, 2004 were paid off during the first quarter of 2005. This activity
combined with normal fluctuations in revolving credit balances and installment
payments on amortizing loans offset most of the approximately $14.8 million in
new loans funded during the quarter. Management does not believe that the first
quarter loan growth is an indicator of any ongoing trend that will result in
further moderation of growth. The Company continues to emphasize prudent growth
through the hiring of experienced commercial lenders, and the development and
use of referral sources including accountants, lawyers and existing customers,
as well as members of the Board of Directors and the Baltimore and Salisbury
Advisory Boards.
The composition of the loan portfolio as of March 31, 2005 was
approximately $72.9 million of commercial loans, $2.2 million of consumer loans,
and $67.1 million of real estate loans (excluding mortgage loans held for sale).
The composition of the loan portfolio as of December 31, 2004 was approximately
$73.8 million of commercial loans, $2.2 million of consumer loans, and $65.4
million of real estate loans (excluding mortgage loans held for sale). Mortgage
loans held for sale were $7.7 million and $9.6 million as of March 31, 2005 and
December 31, 2004, respectively.
Funds not extended in loans are invested in cash and due from banks,
and various investments including federal funds sold and other overnight
investments, U.S. Treasury securities, Federal Reserve Bank stock and Federal
Home Loan Bank stock. These investments totaled approximately $21.9 million as
of March 31, 2005 compared to approximately $20.2 million as of December 31,
2004. At March 31, 2005, the Company had federal funds sold and other overnight
investments totaling $18,493,156 as compared to $16,708,528 as of December 31,
2004. The Company held $312,690 of Federal Reserve Bank stock as of both March
31, 2005 and December 31, 2004. The Company also held Federal Home Loan Bank of
Atlanta stock of $342,100 and $243,400 as of March 31, 2005 and December 31,
2004, respectively, and United States Treasury bills with a maturity value of
$1,550,000 as of both March 31, 2005 and December 31, 2004. The Treasury
securities are used to collateralize repurchase agreements, which are classified
as short-term borrowings under which $1,261,000 and $1,381,000 were outstanding
as of March 31, 2005 and December 31, 2004, respectively.
The increase in total assets was funded with operating earnings and an
increase in deposits of $424,913, or .28% since December 31, 2004. Short-term
borrowings decreased by $120,000. Management has made a decision to maintain an
appropriate level of liquidity in the investment portfolio in order to ensure
that funds are readily available to fund the growth of the loan portfolio and to
meet the needs of deposit customers.
Deposits at March 31, 2005 were $154,351,955, of which approximately
$15.0 million, or 9.69% were related to two customers in one industry and a
third customer in another industry. Deposits at December 31, 2004 were
$153,927,042, of which deposits for these same customers stood at approximately
$16.6 million, or 10.79%, of total deposits. The deposits for these customers
tend to fluctuate significantly; as a result, management monitors these deposits
on a daily basis to ensure that liquidity levels are adequate to compensate for
these fluctuations. Management was able to manage the rate of deposit growth, to
closely match loan growth, by allowing maturing certificates of deposit obtained
by listing rates on the internet, to run off without making any significant
effort to retain these deposits.
The market in which the Company operates is very competitive;
therefore, the rates of interest paid on deposits are affected by rates paid by
other depository institutions. Management
17
closely monitors rates offered by other institutions and seeks to be competitive
within the market. The Company has chosen to selectively compete for large
certificates of deposits. The Company will choose to pursue such deposits when
expected loan growth provides for adequate spreads to support the cost of those
funds. As of March 31, 2005, the Company had outstanding certificates of deposit
of approximately $22.6 million that were obtained through the listing of
certificate of deposit rates on two Internet-based listing services (such
deposits are sometimes referred to herein as national market certificates of
deposit). These certificates of deposit were issued with an average yield of
3.15% and an average term of 36 months. Included in the $22.6 million of
Internet-originated certificates of deposit is $195,322 that has been classified
as "Brokered Deposits" for bank regulatory purposes. These "Brokered Deposits"
were issued in average amounts of approximately $97,661 with an average yield of
2.79% and an average term of 45 months. As of December 31, 2004, the total
certificates of deposit obtained through the listing of certificate of deposit
rates on the Internet-based listing services were approximately $29 million, of
which $394,666 were classified as "Brokered Deposits." The Company has never
paid broker fees for deposits. Additionally, the Company has not accepted any
new "Brokered Deposits" since August 2002.
Core deposits, which management categorizes as all deposits other than
national market certificates of deposit and all but $5.0 million of deposits
from the three large customers described above (which management considers to be
a stable deposit amount from these customers based upon historical trends),
stood at $121,826,504 as of March 31, 2005, up 7.42% from $113,412,507 as of
December 31, 2004. Core deposits are closely monitored by management because
they consider such deposits not only a relatively stable source of funding but
also reflective of the growth of commercial and consumer depository
relationships.
Short-term borrowings consist of repurchase agreements collateralized
by pledges of U.S. Government Treasury Securities, based upon their market
values, equal to 100% of the principal and accrued interest of its short-term
borrowings. The outstanding balance of short-term borrowings decreased from
$1,381,000 at December 31, 2004 to $1,261,000 at March 31, 2005, due to
decreases in the balance of available funds for customers participating in this
program.
Note payable consists of $1,250,000 borrowed under a $5 million,
three-year unsecured non-revolving credit facility executed on September 28,
2004 with another financial institution. Borrowings under the credit facility
are used to provide regulatory capital to the Bank. The loan bears interest at
the prime rate.
Total stockholders' equity at March 31, 2005 was $13,867,083 as
compared to $13,418,764 at December 31, 2004. The increase in stockholders'
equity is a result of the positive operating results for the three-months ended
March 31, 2005, and $18,829 received upon the issuance of 2,484 shares of common
stock upon the exercise of options.
Management believes that the Company will need additional capital, in
excess of the $3.75 million still available under the credit facility, to
support projected asset growth over the next 12 months. Management and the
Capital Committee of the Board of Directors are currently evaluating available
alternatives. Any additional capital, if available at all, may be on terms which
are not as favorable to the Company as that desired by management and may result
in dilution to the Company's shareholders. If adequate capital is not available,
the Company may be required to curtail significantly its expected growth
strategy.
18
Allowance for Credit Losses and Credit Risk Management
Originating loans involves a degree of risk that credit losses will
occur in varying amounts according to, among other factors, the type of loans
being made, the credit-worthiness of the borrowers over the term of the loans,
the quality of the collateral for the loan, if any, as well as general economic
conditions. The Company charges the provision for credit losses to earnings to
maintain the total allowance for credit losses at a level considered by
management to represent its best estimate of the losses known and inherent in
the portfolio that are both probable and reasonable to estimate, based on, among
other factors, prior loss experience, volume and type of lending conducted,
estimated value of any underlying collateral, economic conditions (particularly
as such conditions relate to the Company's market area), regulatory guidance,
peer statistics, management's judgment, past due loans in the loan portfolio and
concentrations of risk (if any). The Company charges losses on loans against the
allowance when it is believed that collection of loan principal is unlikely.
Recoveries on loans previously charged off are added back to the allowance.
Management uses a loan grading system where all loans are graded based
upon management's evaluation of the risk associated with each loan. A factor,
based on the loan grading, is applied to the loan balance to reserve for
potential losses. In addition, management judgmentally establishes an additional
nonspecific reserve. The nonspecific portion of the allowance reflects
management's estimate of probable inherent, but undetected losses, within the
portfolio due to uncertainties in economic conditions, delays in obtaining
information, including unfavorable information about a borrower's financial
condition, the difficulty in identifying triggering events that correlate
perfectly to subsequent loss rates and risk factors that have not yet manifested
themselves in loss allocation factors.
The reserve factors used are based on management's judgment as to
appropriate reserve percentages for various categories of loans, and adjusting
those values based on the following: historical losses in each category;
historical and current delinquency in each category; underwriting standards in
each category; comparison of losses and delinquencies to peer group performance;
and an assessment of the likely impact of economic and other external conditions
on the performance of each category.
A test of the adequacy of the allowance for credit losses is performed
and reported to the Board of Directors on a monthly basis. Management uses the
information available to make a determination with respect to the allowance for
credit losses, recognizing that the determination is inherently subjective and
that future adjustments may be necessary depending upon, among other factors, a
change in economic conditions of specific borrowers, or generally in the
economy, and new information that becomes available. However, there are no
assurances that the allowance for credit losses will be sufficient to absorb
losses on nonperforming assets, or that the allowance will be sufficient to
cover losses on nonperforming assets in the future.
The allowance for credit losses as of March 31, 2005 and December 31,
2004 was $1,842,000 and $1,810,000, respectively. The amount equates to 1.30%
and 1.28% of outstanding loans, net of loans held for sale, as of March 31, 2005
and December 31, 2004, respectively. This percentage has remained fairly
consistent because no additional information has indicated that the overall
level of reserves is inappropriate. The Company has no exposure to foreign
countries or foreign borrowers. Management believes that the allowance for
credit losses is adequate for each period presented.
As of March 31, 2005 the Company had no loans more than 90 days past
due and no loans classified as non-accrual loans. The Company had no loan
charge-offs during the three-months ended March 31, 2005. The Company had loan
charge-offs of $6,221 during the three-months ended March 31, 2004.
19
Liquidity
The Company's overall asset/liability strategy takes into account the
need to maintain adequate liquidity to fund asset growth and deposit runoff.
Management monitors the liquidity position daily.
The Company's primary sources of funds are deposits, short-term
borrowings in the form of repurchase agreements, borrowings under the credit
facility, scheduled amortization and prepayment of loans, funds provided by
operations and capital. While scheduled principal repayments on loans are a
relatively predictable source of funds, deposit flows and loan prepayments are
greatly influenced by market interest rates, economic conditions, and rates
offered by our competition.
The Company's most liquid assets are cash and assets that can be
readily converted into cash, including investment securities maturing within one
year. As of March 31, 2005, the Company had $1,162,644 in cash and due from
banks, $18,493,156 in federal funds sold and other overnight investments and
$1,543,073 in three-month U.S. Treasury Securities. As of December 31, 2004, the
Company had $1,403,424 in cash and due from banks, $16,708,528 in federal funds
sold and other overnight investments and $1,544,496 in three-month U.S. Treasury
Securities.
The stability in the overall level of liquid assets is the result of an
ongoing effort by management to maintain adequate liquidity to fund loan growth
and declines in deposit levels. Growth in the Company's loan portfolio, without
corresponding growth in deposits, would reduce liquidity, as would reductions in
the level of customer deposits.
The Company has commitments for a total of $7.0 million of borrowing
availability under unsecured Federal funds lines of credit with three separate
financial institutions. The Company also has approximately $17 million of
borrowing capacity with the Federal Home Loan Bank of Atlanta as of March 31,
2005 and $3,750,000 of borrowing capacity under its three-year note payable.
These credit facilities can be used in conjunction with the normal deposit
strategies, which include pricing changes to increase deposits as necessary.
From time to time, the Company may sell or participate out loans to create
additional liquidity as required.
The Company has sufficient liquidity to meet its loan commitments as
well as fluctuations in deposits. The Company will choose to retain maturing
certificates of deposit, when necessary, by offering competitive rates.
Management is not aware of any known trends, events or uncertainties
that will have or are reasonably likely to have a material effect on liquidity,
capital or operations, nor is management aware of any current recommendation by
regulatory authorities, which if implemented, would have a material effect on
liquidity, capital or operations.
Interest Rate Sensitivity
The primary objective of asset/liability management is to ensure the
steady growth of the Company's primary earnings component, net interest income.
Net interest income can fluctuate with significant interest rate movements. To
minimize the risk associated with these rate swings, management works to
structure the Company's balance sheet so that the ability exists to adjust
pricing on interest-earning assets and interest-bearing liabilities in roughly
equivalent amounts at approximately the same time intervals. Imbalances in these
repricing opportunities at any point in time constitute interest rate
sensitivity.
20
The measurement of the Company's interest rate sensitivity, or "gap,"
is one of the principal techniques used in asset/liability management. The
interest sensitive gap is the dollar difference between assets and liabilities
subject to interest rate pricing within a given time period, including both
floating rate or adjustable rate instruments and instruments which are
approaching maturity.
The following table sets forth the amount of the Company's
interest-earning assets and interest-bearing liabilities as of March 31, 2005,
which are expected to mature or reprice in each of the time periods shown:
Maturity or repricing within
Percent 0 to 3 4 to 12 1 to 5 Over 5
Amount of Total Months Months Years Years
Interest-earning assets
Federal funds sold and
other overnight investments $ 18,493,156 10.84% $ 18,493,156 $ - $ - $ -
Loans held for sale 7,726,815 4.53 7,726,815
Loans - Variable rate 104,213,168 61.08 104,213,168 - - -
Loans - Fixed rate 37,981,628 22.26 3,317,415 5,847,542 28,252,664 564,007
Other earning assets 2,197,863 1.29 1,543,073 - - 654,790
------------ ---------- ------------ ----------- ----------- -----------
Total interest-earning
assets $170,612,630 100.00% $135,293,627 $ 5,847,542 $28,252,664 $ 1,218,797
============ ========== ============ =========== =========== ===========
Interest-bearing liabilities
Deposits - Variable rate $ 63,988,131 48.02% $ 63,988,131 $ - $ - $ -
Deposits - Fixed rate 66,758,169 50.10 8,547,100 19,171,929 39,039,140 -
Short-term borrowings -
Variable rate 1,261,000 .94 1,261,000 - - -
Note Payable 1,250,000 .94 1,250,000 - - -
------------ ---------- ------------ ----------- ----------- -----------
Total interest-bearing
liabilities $133,257,300 100.00% $ 75,046,231 $19,171,929 $39,039,140 $ -
============ ========== ============ =========== =========== ===========
Periodic repricing differences
Periodic gap $ 60,247,396 $(13,324,38) $(10,786,47) $ 1,218,797
============ =========== =========== ===========
Cumulative gap $ 60,247,396 $46,923,009 $36,136,533 $37,355,330
============ =========== =========== ===========
Ratio of rate sensitive
assets to rate sensitive
liabilities 180.28% 30.50% 72.37% N/A
The Company has 77.74% of its interest-earning assets and 49.90% of its
interest-bearing liabilities in variable rate balances. Interest-earning assets
exceed interest-bearing liabilities by $37,355,330. The majority of this gap is
concentrated in items maturing or repricing within 12 months. This gap is
generally reflective of the Company's emphasis on originating variable rate
loans and the demand in the market for higher yielding fixed rate deposits. This
analysis indicates that the Company generally will benefit from increasing
market rates of interest. However, since all interest rates and yields do not
adjust at the same pace, the gap is only a general indicator of interest rate
sensitivity. The analysis of the Company's interest-earning assets and
interest-bearing liabilities presents only a static view of the timing of
maturities and repricing opportunities, without taking into consideration the
fact that changes in interest rates do not affect all assets and liabilities
equally. Net interest income may be affected by other significant factors in a
given interest rate environment, including changes in the volume and mix of
interest-earning assets and interest-bearing liabilities.
Management constantly monitors and manages the structure of the
Company's balance sheet, seeks to control interest rate exposure, and evaluate
pricing strategies. Strategies to better match maturities of interest-earning
assets and interest-bearing liabilities include structuring loans with rate
21
floors and ceilings on variable-rate notes and providing for repricing
opportunities on fixed rate notes. Management believes that a lending strategy
focusing on variable-rate loans and short-term fixed rate loans will best
facilitate the goal of minimizing interest rate risk. However, management will
opportunistically enter into longer term fixed-rate loans and/or investments
when, in management's judgment, rates adequately compensate the Company for the
interest rate risk. The Company's current investment concentration in federal
funds sold and other overnight investments provides the most flexibility and
control over rate sensitivity since it generally can be restructured more
quickly than the loan portfolio. On the liability side, deposit products can be
restructured so as to offer incentives to attain the maturity distribution
desired although competitive factors sometimes make control over deposit
maturity difficult.
In theory, maintaining a nominal level of interest rate sensitivity can
diminish interest rate risk. In practice, this is made difficult by a number of
factors, including cyclical variation in loan demand, different impacts on
interest sensitive assets and liabilities when interest rates change, and the
availability of funding sources. Management generally attempts to maintain a
balance between rate-sensitive assets and liabilities as the exposure period is
lengthened to minimize the overall interest rate risk to the Company.
Off-Balance Sheet Arrangements
In the normal course of business the Company is a party to financial
instruments with off-balance sheet risk. These financial instruments primarily
include commitments to extend credit, lines of credit and standby letters of
credit. The Company uses these financial instruments to meet the financing needs
of its customers. These financial instruments involve, to varying degrees,
elements of credit, interest rate, and liquidity risk.
Outstanding loan commitments and lines and letters of credit as of
March 31, 2005 and December 31, 2004 are as follows:
March 31, 2005 December 31, 2004
----------------- -------------------
Loan commitments $ 8,511,575 $ 9,867,893
Unused lines of credit 44,900,594 40,423,986
Letters of credit 1,363,521 1,578,379
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have interest rates fixed at current market amounts, fixed
expiration dates or other termination clauses and may require payment of a fee.
Unused lines of credit represent the unused portion of lines of credit
previously extended and available to the customer as long as there is no
violation of any contractual condition. These lines generally have variable
interest rates. Since many of the commitments are expected to expire without
being drawn upon, and since it is unlikely that customers will draw upon their
line of credit in full at any time, the total commitment amount or line of
credit amount does not necessarily represent future cash requirements. The
Company is not aware of any loss it would incur by funding its commitments or
lines of credit.
Standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. The Company's exposure
to credit loss in the event of nonperformance by the customer is the contract
amount of the commitment.
In general, loan commitments, lines of credit and letters of credit are
made on the same terms, including with respect to collateral, as outstanding
loans. Each customer's credit-worthiness and collateral requirement is evaluated
on a case-by-case basis.
22
The modest increase in the overall level of loan commitments and unused
lines of credit as of March 31, 2005 as compared to loan commitments and unused
lines of credit as of December 31, 2004, is consistent with the overall increase
in outstanding loans.
Capital Resources
The Company had stockholders' equity at March 31, 2005 of $13,867,083
as compared to $13,418,764 at December 31, 2004. The increase in capital is a
result of the positive operating results for the three-months ended March 31,
2005, and $18,829 received upon the issuance of 2,484 shares of common stock
upon the exercise of options. Management believes that the Company will need
additional capital, in excess of the $3.75 million still available under the
credit facility, to support projected asset growth over the next 12 months.
Management and the Capital Committee of the Board of Directors are currently
evaluating available alternatives. Any additional capital, if available at all,
may be on terms which are not as favorable to the Company as that desired by
management and may result in dilution to the Company's shareholders. If adequate
capital is not available, the Company may be required to curtail significantly
its expected growth strategy.
Banking regulatory authorities have implemented strict capital
guidelines directly related to the credit risk associated with an institution's
assets. Banks and bank holding companies are required to maintain capital levels
based on their "risk adjusted" assets so that categories of assets with higher
"defined" credit risks will require more capital support than assets with lower
risks. The Bank has exceeded its capital adequacy requirements to date.
Banking regulations also limit the amount of dividends that may be paid
without prior approval of the Bank's regulatory agencies. Regulatory approval is
required to pay dividends that exceed the Bank's net profits for the current
year plus its retained net profits for the preceding two years. The Bank could
not have paid dividends to the Company without approval from bank regulatory
agencies at March 31, 2005.
Reconciliation of Non-GAAP Measures
Below is a reconciliation of total deposits to core deposits as of
March 31, 2005 and December 31, 2004, respectively:
March 31, December 31
2005 2004
---------------- ----------------
Total deposits $ 154,351,955 $ 153,927,042
National market certificates of deposit (22,568,884) (28,908,592)
Variable balance accounts (3 customers) (14,956,567) (16,605,943)
Portion of variable balance accounts
considered to be core 5,000,000 5,000,000
---------------- ----------------
Core deposits $ 121,826,504 $ 113,412,507
================ ================
Application of Critical Accounting Policies
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America and follow general practices within the industries in which it operates.
Application of these principles requires management to make estimates,
assumptions and judgments that affect the amounts reported in the consolidated
financial statements and accompanying notes. These estimates, assumptions and
judgments are based on information available as of the date of the financial
statements; accordingly, as this information changes, the financial statements
could reflect different estimates, assumptions and judgments. Certain policies
inherently have a greater reliance on the use of estimates, assumptions and
judgments and as such have a greater possibility of producing
23
results that could be materially different than originally reported. Estimates,
assumptions and judgments are necessary when assets and liabilities are required
to be recorded at fair value, when a decline in the value of an asset not
carried on the financial statements at fair value warrants an impairment
write-down or valuation reserve to be established, or when an asset or liability
must be recorded contingent upon a future event. Carrying assets and liabilities
at fair value inherently results in more financial statement volatility. The
fair values and the information used to record valuation adjustments for certain
assets and liabilities are based either on quoted market prices or are provided
by other third-party sources, when available.
Based on the valuation techniques used and the sensitivity of financial
statement amounts to the methods, assumptions and estimates underlying those
amounts, management has identified the determination of the allowance for credit
losses as the accounting area that requires the most subjective or complex
judgments, and as such could be most subject to revision as new information
becomes available.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses. The
establishment of allowance factors is a continuing exercise and allowance
factors may change over time, resulting in an increase or decrease in the amount
of the provision or allowance based upon the same volume and classification of
loans. Changes in allowance factors or in management's interpretation of those
factors will have a direct impact on the amount of the provision and a
corresponding effect on income and assets. Also, errors in management's
perception and assessment of the allowance factors could result in the allowance
not being adequate to cover losses in the portfolio, and may result in
additional provisions or charge-offs, which would adversely affect income and
capital.
For additional information regarding the allowance for loan and lease
losses, see the "Allowance for Credit Losses and Credit Risk Management" section
of this financial review.
Item 3. Controls and Procedures
As of the end of the period covered by this quarterly report on Form
10-QSB, Bay National Corporation's Chief Executive Officer and Chief Financial
Officer evaluated the effectiveness of Bay National Corporation's disclosure
controls and procedures. Based upon that evaluation, Bay National Corporation's
Chief Executive Officer and Chief Financial Officer concluded that Bay National
Corporation's disclosure controls and procedures are effective. Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed by Bay National Corporation in
the reports that it files or submits under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
In addition, there were no changes in Bay National Corporation's
internal controls over financial reporting (as defined in Rule 13a-15 or Rule
15d-15 under the Securities Act of 1934, as amended) during the quarter ended
March 31, 2005, that have materially affected, or are reasonably likely to
materially affect, Bay National Corporation's internal control over financial
reporting.
Information Regarding Forward-Looking Statements
In addition to the historical information contained in Part I of this
Quarterly Report on Form 10-QSB, the discussion in Part I of this Quarterly
Report on Form 10-QSB contains certain forward-looking statements.
Forward-looking statements often use words such as "believe," "expect," "plan,"
"may," "will," "should," "project," "contemplate," "anticipate," "forecast,"
"intend" or other words of similar meaning. You can also identify them by the
fact that they do
24
not relate strictly to historical or current facts. Our actual results and the
actual outcome of our expectations and strategies could be different from those
anticipated or estimated.
The statements presented herein with respect to, among other things,
Bay National Corporation's plans, objectives, expectations and intentions,
including statements regarding profitability, liquidity, allowance for loan
losses, interest rate sensitivity, market risk and financial and other goals are
forward looking. These statements are based on Bay National Corporation's
beliefs and assumptions, and on information available to Bay National
Corporation as of the date of this filing, and involve risks and uncertainties.
These risks and uncertainties include, among others, those discussed in this
Quarterly Report on Form 10-QSB; Bay National Corporation's limited operating
history; dependence on key personnel; risks related to Bay National Bank's
choice of loan portfolio; risks related to Bay National Bank's lending limit;
risks of a competitive market; impact of government regulation on operating
results; and effect of developments in technology. For a more complete
discussion of these risks and uncertainties see the discussion under the caption
"Factors Affecting Future Results" in Bay National Corporation's Form 10-KSB.
Bay National Corporation's actual results could differ materially from
those discussed herein and you should not put undue reliance on any
forward-looking statements. All forward-looking statements speak only as of the
date of this filing, and Bay National Corporation undertakes no obligation to
make any revisions to the forward-looking statements to reflect events or
circumstances after the date of this filing or to reflect the occurrence of
unanticipated events.
25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) None
(b) None
(c) None
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Securities Holders.
None
Item 5. Other Information.
None
26
Item 6. Exhibits.
(a) Exhibits.
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
27
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Bay National Corporation
Date: May 13, 2005 By: /s/ Hugh W. Mohler
-----------------------------------------------
Hugh W. Mohler, President
(Principal Executive Officer)
Date: May 13, 2005 By: /s/ Mark A. Semanie
-----------------------------------------------
Mark A. Semanie, Treasurer
(Principal Accounting and Financial Officer)
28