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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,
---------------------------------------------
2004 2003 2002
--------------- --------------- -------------
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
--------------- --------------- -------------
Total interest and dividend income $57,998 $45,968 $38,998
--------------- --------------- -------------
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
--------------- --------------- -------------
Total interest expense $16,331 $13,893 $14,128
--------------- --------------- -------------
NET INTEREST INCOME $41,667 $32,075 $24,870
Provision for loan losses 2,989 1,575 1,678
--------------- --------------- -------------
Net interest income after provision for loan losses $38,678 $30,500 $23,192
--------------- --------------- -------------
NON-INTEREST INCOME:
Service charges and other fees $ 1,749 $ 1,609 $ 1,616
Non-deposit investment services commissions 427 202 14
Fees and net gains on loans held-for-sale 3,229 5,670 3,920
Gain (loss) on sale of securities -- -- (1)
Other 354 265 44
--------------- --------------- -------------
Total non-interest income $ 5,759 $ 7,746 $ 5,593
--------------- --------------- -------------
NON-INTEREST EXPENSE:
Salaries and employee benefits $13,478 $12,562 $10,159
Occupancy expense 3,240 3,190 2,915
Data processing 1,314 1,239 1,079
Other operating expense 4,775 3,829 3,064
--------------- --------------- -------------
Total non-interest expense $22,807 $20,820 $17,217
--------------- --------------- -------------
Income before taxes on income $21,630 $17,426 $11,568
Provision for income taxes 7,401 5,880 3,892
--------------- --------------- -------------
NET INCOME $14,229 $11,546 $ 7,676
=============== =============== =============
Earnings per common share, basic $ 1.35 $ 1.18 $ 0.86
Earnings per common share, diluted $ 1.24 $ 1.08 $ 0.77
=============== =============== =============
See Notes to Consolidated Financial Statements.
25
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
Accumulated
Other Total
Preferred Common Retained Comprehensive Comprehensive Stockholders'
Stock Stock Surplus Earnings Income (Loss) Income Equity
---------- ----------- --------- ----------- --------------- ---------------- --------------
BALANCE, DECEMBER 31, 2001 $ -- $ 2,721 $13,190 $10,138 $171 $26,220
---------- ----------- --------- ----------- --------------- ---------------- --------------
Comprehensive Income:
Net Income 2002 7,676 $7,676 7,676
Other comprehensive income, net of
tax, unrealized holding gains arising
during the period (net of tax of
$263) 510 510 510
---------- ----------- --------- ----------- --------------- ---------------- --------------
Total comprehensive income $8,186
---------- ----------- --------- ----------- --------------- ---------------- --------------
Five-for-four stock split in form
of a 25% stock dividend -- 680 (680) -- -- --
Cash paid in lieu of fractional shares -- -- -- (6) -- (6)
Rights offering, net -- 291 6,666 -- -- 6,957
Stock options/warrants exercised -- 47 446 -- -- 493
========== =========== ========== -========= =============== ================ ==============
BALANCE, DECEMBER 31, 2002 $ -- $ 3,739 $19,622 $17,808 $681 $41,850
========== =========== ========== -========= =============== ================ ==============
Comprehensive Income:
Net Income 2003 11,546 $11,546 11,546
Other comprehensive income, net of
tax, unrealized holding losses
arising during the period (net of
tax of $357) (694) (694) (694)
---------- ----------- --------- ----------- --------------- ---------------- --------------
Total comprehensive income $10,852
---------- ----------- --------- ----------- --------------- ---------------- --------------
Two-for-one stock split in form of
a 100% stock dividend -- 3,893 (3,893) -- -- --
Stock options/warrants exercised -- 228 2,162 -- -- 2,390
========== =========== ========== -========= =============== ================ ==============
BALANCE, DECEMBER 31, 2003 $ -- $ 7,860 $17,891 $29,354 $(13) $55,092
========== =========== ========== -========= =============== ================ ==============
Comprehensive Income:
Net Income 2004 14,229 $14,229 14,229
Other comprehensive income, net of
tax, unrealized holding losses
arising during the period (net of
tax of $274) (506) (506) (506)
---------- ----------- --------- ----------- --------------- ---------------- --------------
Total comprehensive income $13,723
---------- ----------- --------- ----------- --------------- ---------------- --------------
Five-for-four stock split in form of
a 25% stock dividend -- 2,206 (2,206) -- -- --
Cash paid in lieu of fractional shares -- -- -- (5) -- (5)
Follow-on offering, net -- 891 20,915 -- -- 21,806
Stock options/warrants exercised -- 89 619 -- -- 708
========== =========== ========== -========= =============== ================ ==============
BALANCE, DECEMBER 31, 2004 $ -- $11,046 $37,219 $43,578 $(519) $91,324
========== =========== ========== -========= =============== ================ ==============
See Notes to Consolidated Financial Statements.
26
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
Year Ended December 31,
--------------------------------------------
2004 2003 2002
--------------- -------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest received $ 57,076 $ 45,021 $ 38,709
Other income received 5,759 7,746 5,594
Net change in loans held-for-sale (6,149) 15,435 (3,106)
Interest paid (15,800) (14,140) (14,159)
Cash paid to suppliers and employees (21,540) (25,243) (16,293)
Income tax benefit of stock options/warrants exercised (279) (1,402) (323)
Income taxes paid (7,530) (5,406) (3,538)
--------- --------- ---------
Net cash provided by operating activities $ 11,537 $ 22,011 $ 6,884
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and principal payments on
securities held-to-maturity $ 6,569 $ 10,188 $ 3,358
Proceeds from maturities and principal payments on
securities available-for-sale 53,075 70,456 44,531
Proceeds from sales of securities available-for-sale -- -- 1,350
Purchases of securities held-to-maturity (2,586) (41,143) (7,975)
Purchases of securities available-for-sale (71,636) (118,501) (58,699)
Net increase in loans made to customers (273,920) (139,526) (123,470)
Purchase of bank premises and equipment (1,589) (718) (1,303)
--------- --------- ---------
Net cash used in investing activities $(290,087) $(219,244) $(142,208)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand, NOW, money market and
savings accounts $ 20,541 $ 170,521 $ 90,127
Net increase in time deposits 176,916 35,994 69,947
Net increase (decrease) in securities sold under
agreement to repurchase and federal funds purchased 22,320 (1,194) (10,371)
Net increase (decrease) in other borrowed funds -- (400) (11,000)
Proceeds from issuance of trust preferred capital notes -- -- 18,000
Proceeds from exercise of stock options and warrants 708 2,390 493
Proceeds from issuance of capital stock 21,806 -- 6,957
Cash paid in lieu of fractional shares (5) -- (6)
--------- --------- ---------
Net cash provided by financing activities $ 242,286 $ 207,311 $ 164,147
--------- --------- ---------
Increase (decrease) in cash and cash equivalents $ (36,264) $ 10,078 $ 28,823
--------- --------- ---------
CASH AND CASH EQUIVALENTS:
Beginning 54,056 43,978 15,155
Ending $ 17,792 $ 54,056 $ 43,978
========= ========= =========
See Notes to Consolidated Financial Statements.
27
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year Ended December 31,
---------------------------------------------
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY 2004 2003 2002
OPERATING ACTIVITIES:
---------------- -------------- -------------
Net income $ 14,229 $ 11,546 $ 7,676
--------- --------- ---------
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,087 1,046 1,024
Provision for loan losses 2,989 1,575 1,678
Deferred tax benefit (1,051) (600) (609)
Amortization of security premiums and accretion of
discounts, net (189) (64) (11)
Origination of loans held-for-sale (175,873) (287,773) (207,817)
Sale of loans 169,724 303,208 204,711
(Gain) loss on sale of securities available-for-sale -- -- 1
Increase in other assets (296) (6,116) (534)
Increase in other liabilities 1,119 321 1,073
Increase in accrued interest receivable (733) (883) (278)
Increase (decrease) in accrued interest payable 531 (249) (30)
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 11,537 $ 22,011 $ 6,884
========= ========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
ACTIVITIES:
Unrealized gain (loss) on securities $ (780) $ (1,051) $ 773
See Notes to Consolidated Financial Statements.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BANKING ACTIVITIES AND ACCOUNTING POLICIES
BUSINESS
On December 22, 1999, Virginia Commerce Bancorp, Inc. (the "Company") became the
holding company for Virginia Commerce Bank (the "Bank"). The Company acquired
the Bank through a share exchange in which the stockholders of the Bank received
one share of the Company for each share of the Bank. The exchange was a tax-free
transaction for federal income tax purposes. The merger was accounted for on the
same basis as a pooling-of-interests.
The Company provides loan and deposit products to commercial and retail
customers in the Washington Metropolitan Area, with the primary emphasis on
Northern Virginia. The loan portfolio is generally collateralized by assets of
the customers and is expected to be re-paid from cash flows or proceeds from the
sale of selected assets of the borrowers.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries, the Bank, VCBI Capital Trust I, VCBI Capital
Trust II and Northeast Land and Investment Company. In consolidation, all
significant intercompany accounts and transactions have been eliminated. FASB
Interpretation No. 46 (R) requires that the Company no longer consolidate VCBI
Capital Trust I and II. The subordinated debt of the trusts is reflected as a
liability of the Company, and the common securities of the trusts as an other
asset.
RISKS AND UNCERTAINTIES
In its normal course of business, the Company encounters two significant types
of risk: economic and regulatory. There are three main components of economic
risk: interest rate risk, credit risk and market risk. The Company is subject to
interest rate risk to the degree that its interest-bearing liabilities mature or
reprice more rapidly or on a different basis than its interest-earning assets.
Credit risk is the risk of default on the Company's loan portfolio that results
from the borrowers' inability or unwillingness to make contractually required
payments. Market risk reflects changes in the value of collateral underlying
loans receivable and the valuation of real estate held by the Company.
The determination of the allowance for loan losses is based on estimates that
are particularly susceptible to significant changes in the economic environment
and market conditions. Management believes that, as of December 31, 2004, the
allowance for loan losses is adequate based on information currently available.
A worsening or protracted economic decline or substantial increase in interest
rates, would increase the likelihood of losses due to credit and market risks
and could create the need for substantial increases to the allowance for loan
losses. The Company is subject to the regulations of various regulatory
agencies, which can change significantly from year to year. In addition, the
Company undergoes periodic examinations by regulatory agencies, which may
subject it to further changes based on the regulators' judgments about
information available to them at the time of their examination.
SECURITIES
Debt securities that management has the positive intent and ability to hold to
maturity are classified as held-to-maturity and recorded at amortized cost.
Securities not classified as held-to-maturity, including equity securities with
readily determinable fair values, are classified as available-for-sale and
recorded at fair value, with unrealized gains and losses excluded from earnings
and reported in other comprehensive income.
Purchased premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair value of
held-to-maturity and available-for-sale securities below their cost that are
deemed to be other than temporary are reflected in earnings as realized losses.
Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method. In estimating
other-than-temporary impairment losses, management considers (1) the length of
time and the extent to which the fair value has been less than cost, (2) the
financial condition and near-term prospects of the issuer, and (3) the entity
and ability of the Company to retain its investment in the issuer for a period
of time sufficient to allow for any anticipated recovery in fair value.
29
LOANS HELD-FOR-SALE
Loans held-for-sale are carried at the lower of cost or market, determined in
the aggregate. Market value considers commitment agreements with investors and
prevailing market prices. All loans originated by the Company's mortgage banking
division are pre-sold and held-for-sale to outside investors, servicing
released. Gains and losses on sales of mortgage loans are recognized based on
the difference between the selling price and the carrying value of the related
mortgage loans sold.
LOANS
The Company grants mortgage, commercial and consumer loans to customers. A
substantial portion of the loan portfolio is represented by real estate loans.
The ability of the Company's debtors to honor their contracts is dependent upon
the real estate and general economic conditions of the Company's market area.
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or pay-off are reported at their outstanding unpaid
principal balances adjusted for the allowance for loan losses and any deferred
fees or costs on originated loans. Interest income is accrued on the unpaid
principal balance. Loan origination fees, net of certain origination costs, are
deferred and recognized as an adjustment of the related loan yield using the
interest method.
The accrual of interest on real estate and commercial loans is discontinued at
the time the loan is 90 days delinquent unless the credit is well-secured and in
the process of collection. Installment loans are typically charged-off no later
than 180 days past due. In all cases, loans are placed on nonaccrual or
charged-off at an earlier date if collection of principal or interest is
considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual
or charged off is reversed against interest income. The interest on these loans
is accounted for on the cash-basis or cost-recovery method, until qualifying for
return to accrual. Loans are returned to accrual status when all principal and
interest amounts contractually due are brought current and future payments are
reasonably assured.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
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 for impairment testing. 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.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured on a loan-by-loan basis for commercial and construction loans by either
the present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's obtainable market price, or the fair value
of the collateral if the loan is collateral dependent.
30
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 their 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 have occurred but have 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. See Note 4 for
information regarding the allowance for loan losses.
BANK PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Land is carried at cost. Furniture, fixtures, equipment and
computer software are depreciated over their estimated useful lives, generally
from three to seven years; leasehold improvements are amortized over the lives
of the respective leases or the estimated useful life of the leasehold
improvement, generally from five to ten years. Depreciation and amortization are
recorded on the straight-line and declining-balance methods.
Costs of maintenance and repairs are charged to expense as incurred. The costs
of replacing structural parts of major units are considered individually and are
expended or capitalized as the facts dictate.
INCOME TAXES
Deferred income tax assets and liabilities are determined using the liability
(or balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between book and tax bases of the various balance sheet assets and liabilities
and gives current recognition to changes in tax rates and laws.
ADVERTISING COST
The Company follows the policy of charging the production costs of advertising
to expense as incurred. Total advertising expense was $283 thousand, $291
thousand and $245 thousand in 2004, 2003 and 2002, respectively.
USE OF ESTIMATES
In preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the balance sheet and the reported
amounts of revenues and expenses during the reported period. Actual results
could differ from those estimates. Material estimates that are particularly
susceptible to significant change in the near term relate to the determination
of the allowance for loan losses, and the valuation of deferred tax assets.
RATE LOCK COMMITMENTS
The Company enters into commitments to originate mortgage loans whereby the
interest rate on the loans is determined prior to funding (rate lock
commitments). Rate lock commitments on mortgage loans that are intended to be
sold are considered to be derivatives. The period of time between issuances of a
loan commitment and closing and the sale of the loan generally ranges from
thirty to ninety days. The Company protects itself from changes in interest
rates through the use of best efforts forward delivery commitments, whereby the
Company commits to sell a loan at the time the borrower commits to an interest
rate with the intent that the buyer has assumed interest rate risk on the loan.
As a result, the Company is not exposed to losses nor will it realize
significant gains related to its rate lock commitments due to changes in
interest rates. The correlation between the rate lock commitments and the best
efforts contracts is very high due to their similarity. Because of this high
correlation, no gain or loss occurs on the rate lock commitments.
31
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks, and federal funds sold. Generally, federal funds
are sold and purchased for one-day periods.
EARNINGS PER SHARE
Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from the assumed issuance.
Potential common shares that may be issued by the Company relate solely to
outstanding stock options and warrants, and are determined using the treasury
method.
COMPREHENSIVE INCOME
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
STOCK COMPENSATION PLAN
At December 31, 2004, the Company has a stock-based compensation plan, which is
described more fully in Note 11. The Company accounts for the plan under the
recognition and measurement principles of APB Opinion 25, Accounting for Stock
Issued to Employees, and related interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under the
plan had an exercise price equal to the market value of the underlying common
stock on the date of the grant. The following table illustrates the effect on
net income and earnings per share for the Company had the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
been adopted.
- -------------------------------------------------------- --------------------- ------------------- ---------------------
(Dollars in thousands except per share amounts) 2004 2003 2002
- -------------------------------------------------------- --------------------- ------------------- ---------------------
NET INCOME, AS REPORTED $14,229 $11,546 $7,676
Deduct: total stock-based employee compensation
expense determined based on fair value
method of awards, net of tax (593) (368) (419)
---- ---- ----
PRO FORMA NET INCOME $13,636 $11,178 $7,257
BASIC EARNINGS PER SHARE:
As reported $1.35 $1.18 $0.86
Pro Forma $1.29 $1.15 $0.82
DILUTED EARNING PER SHARE:
As reported $1.24 $1.08 $0.77
Pro Forma $1.19 $1.05 $0.73
- -------------------------------------------------------- --------------------- ------------------- ---------------------
The fair value of each grant is estimated at the grant date using the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 2004, 2003, and 2002, respectively: price volatility
of 29.61%, 28.63% and 21.48%, risk-free interest rates of 4.37%, 4.02% and
5.43%, dividend rate of .03%, .02% and .02% and expected lives of 10 years. See
Note 12 to the Consolidated Financial Statements for further information
regarding the Company's stock-based compensation plan.
32
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46").
This Interpretation provides guidance with respect to the identification of
variable interest entities when the assets, liabilities, non-controlling
interests, and results of operations of a variable interest entity need to be
included in a Company's consolidated financial statements. An entity is deemed a
variable interest entity, subject to the interpretation, if the equity
investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties,
or in cases in which the equity investors lack one or more of the essential
characteristics of a controlling financial interest, which include the ability
to make decisions about the entity's activities through voting rights, the
obligations to absorb the expected losses of the entity if they occur, or the
right to receive the expected residual returns of the entity if they occur. Due
to significant implementation issues, the FASB modified the wording of FIN 46
and issued FIN 46R in December of 2003. FIN46R deferred the effective date for
the provisions of FIN 46 to entities other than Special Purpose Entities
("SPEs") until financial statements issued for periods ending after March 15,
2004. SPEs were subject to the provisions of either FIN 46 or FIN 46R as of
December 15, 2003. Management has evaluated the Company's investments in
variable interest entities and potential variable interest entities or
transactions, particularly in trust preferred securities structures because
these transactions constitute the Company's primary FIN 46 and FIN 46R exposure.
The adoption of FIN 46 and FIN 46R did not have a material effect on the
Company's consolidated financial position or consolidated results of operations.
In December 2003, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants issued Statement of Position
("SOP") 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a
Transfer." The SOP is effective for loans acquired in fiscal years beginning
after December 15, 2004. The scope of the SOP applies to unhealthy "problem"
loans that have been acquired, either individually in a portfolio, or in a
business acquisition. The SOP addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities (loans) acquired in a
transfer if those differences are attributable, at least in part, to credit
quality. The SOP does not apply to loans originated by the Company. The Company
intends to adopt the provisions of SOP 03-3 effective January 1, 2005, and does
not expect the initial implementation to have a significant effect on the
Company's consolidated financial position or consolidated results of operations.
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105,
"Application of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105
clarifies existing accounting practices relating to the valuation of issued loan
commitments, including interest rate lock commitments ("IRLC"), subject to SFAS
No. 149 and Derivative Implementation Group Issue C13, "Scope Exceptions: When a
Loan Commitment is included in the Scope of Statement 133." Furthermore, SAB 105
disallows the inclusion of the values of a servicing component and other
internally developed intangible assets in the initial and subsequent IRLC
valuation. The provisions of SAB 105 were effective for loan commitments entered
into after March 31, 2004. The Company has adopted the provisions of SAB 105.
Since the provisions of SAB 105 affect only the timing of the recognition of
mortgage banking income, management does not anticipate that this guidance will
have a material adverse effect on either the Company's consolidated financial
position or consolidated results of operations.
Emerging Issues Task Force Issue No. ("EITF") 03-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments" was
issued and is effective March 31, 2004. The EITF 03-1 provides guidance for
determining the meaning of "other-than-temporarily impaired" and its application
to certain debt and equity securities within the scope of Statement of Financial
Accounting Standards No. 115 "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS No. 115") and investments accounted for under the cost
method. The guidance requires that investments which have declined in value due
to credit concerns or solely due to changes in interest rates must be recorded
as other-than-temporarily impaired unless the Company can assert and demonstrate
its intention to hold the security for a period of time sufficient to allow for
a recovery of fair value up to or beyond the cost of the investment which might
mean maturity. This issue also requires disclosures assessing the ability and
intent to hold investments in instances in which an investor determines that an
investment with a fair value less than cost is not other-than-temporarily
impaired. On September 30, 2004, the Financial Accounting Standards Board
decided to delay the effective date for the measurement and recognition guidance
contained in Issue 03-1. This delay does not suspend the requirement to
recognize other-than-temporary impairments as required by existing authoritative
literature. The disclosure guidance in Issue 03-1 was not delayed.
33
EITF No. 03-16, "Accounting for Investments in Limited Liability Companies" was
ratified by the FASB and is effective for reporting periods beginning after June
15, 2004. APB Opinion No. 18, "The Equity Method of Accounting Investments in
Common Stock," prescribes the accounting for investments in common stock of
corporations that are not consolidated. AICPA Accounting Interpretation 2,
"Investments in Partnerships Ventures," of Opinion 18, indicates that "many of
the provisions of the Opinion would be appropriate in accounting" for
partnerships. In EITF Abstracts, Topic No. D-46, "Accounting for Limited
Partnership Investments," the SEC staff clarified its view that investments of
more than 3 to 5 percent are considered to be more than minor and, therefore,
should be accounted for using the equity method. Limited liability companies
(LLCs) have characteristics of both corporations and partnerships, but are
dissimilar from both in certain respects. Due to those similarities and
differences, diversity in practice exists with respect to accounting for
non-controlling investments in LLCs. The consensus reached was that an LLC
should be viewed as similar to a corporation or similar to a partnership for
purposes of determining whether a non-controlling investment should be accounted
for using the cost method or the equity method of accounting.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), "Share-Based Payment." This Statement establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. It also addresses transactions in
which an entity incurs liabilities in exchange for goods or services that are
based on the fair value of the entity's equity instruments or that may be
settled by the issuance of those equity instruments. The Statement focuses
primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. The Statement requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award
(with limited exceptions). That cost will be recognized over the period during
which an employee is required to provide service in exchange for the award - the
requisite service period (usually the vesting period). The entity will initially
measure the cost of employee services received in exchange for an award of
liability instruments based on its current fair value; the fair value of that
award will be re-measured subsequently at each reporting date through the
settlement date. Changes in fair value during the requisite service period will
be recognized as compensation cost over that period. The grant-date fair value
of employee share options and similar instruments will be estimated using
option-pricing models adjusted for the unique characteristics of those
instruments (unless observable market prices for the same or similar instruments
are available). If an equity award is modified after the grant date, incremental
compensation cost will be recognized in an amount equal to the excess of the
fair value of the modified award over the fair value of the original award
immediately before the modification. This Statement is effective for public
entities that do not file as small business issuers--as of the beginning of the
first interim or annual reporting period that begins after June 15, 2005. For
public companies that file as small business issuers, as of the beginning of the
first interim or annual reporting period that begins after December 15, 2005.
Under the transition method, compensation cost is recognized on or after the
required effective date for the portion of outstanding awards for which the
requisite service has not yet been rendered, based on the grant-date fair value
of those awards calculated under Statement 123 for either recognition or pro
forma disclosures. For periods before the required effective date, entities may
elect to apply a modified version of retrospective application under which
financial statements for prior periods are adjusted on a basis consistent with
the pro forma disclosures required for those periods by Statement 123.
STOCKHOLDERS' EQUITY
A five-for-four stock split in the form of a 25% stock dividend was declared on
June 3, 2004. This transaction was recorded by increasing common stock by $2.2
million and decreasing surplus by $2.2 million.
A two-for-one stock split in the form of a 100% stock dividend was declared on
April 22, 2003. This transaction was recorded by increasing common stock by $3.9
million and decreasing surplus by $3.9 million.
A five-for-four stock split in the form of a 25% stock dividend was declared on
February 28, 2002. This transaction was recorded by increasing common stock by
$680 thousand and decreasing surplus by $680 thousand.
NOTE 2. SECURITIES
Amortized cost and fair value of the securities available-for-sale and
held-to-maturity as of December 31, 2004 and 2003, are as follows (dollars in
thousands):
34
- -------------------------------------------------- -------------- ----------------- -------------- -------------------
DECEMBER 31, 2004 GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS (LOSSES) FAIR VALUE
- -------------------------------------------------- -------------- ----------------- -------------- -------------------
AVAILABLE-FOR-SALE:
U.S. Government Agency obligations $ 100,955 $ 207 $ (1,069) $ 100,093
U.S. Treasuries 9,962 -- (32) 9,930
Domestic corporate debt obligations 6,000 20 -- 6,020
Obligations of states and political subdivisions 1,263 75 -- 1,338
Restricted stock:
Federal Reserve Bank 1,442 -- -- 1,442
Federal Home Loan Bank 1,761 -- -- 1,761
Community Bankers' Bank 55 -- -- 55
--------- --------- --------- ---------
$ 121,438 $ 302 $ (1,101) $ 120,639
HELD-TO-MATURITY:
U.S. Government Agency obligations $ 33,667 $ 226 $ (23) $ 33,870
Obligations of state and political subdivisions 8,433 141 (124) 8,450
Domestic corporate debt obligations 493 25 -- 518
- -------------------------------------------------- --------- --------- --------- ---------
$ 42,593 $ 392 $ (147) $ 42,838
- -------------------------------------------------- --------- --------- --------- ---------
- -------------------------------------------------- -------------- ------------------ -------------- ------------------
DECEMBER 31, 2003 GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS (LOSSES) FAIR VALUE
- -------------------------------------------------- -------------- ------------------ -------------- ------------------
AVAILABLE-FOR-SALE:
U.S. Government Agency obligations $ 93,363 $ 466 $ (555) $ 93,274
Domestic corporate debt obligations 6,000 -- (5) 5,995
Obligations of states and political subdivisions 1,220 75 -- 1,295
Restricted stock:
Federal Reserve Bank 758 -- -- 758
Federal Home Loan Bank 1,355 -- -- 1,355
Community Bankers' Bank 55 -- -- 55
--------- --------- --------- ---------
$ 102,751 $ 541 $ (560) $ 102,732
HELD-TO-MATURITY:
U.S. Government Agency obligations $ 38,490 $ 476 $-- $ 38,996
Obligations of state and political subdivisions 7,535 155 (38) 7,652
Domestic corporate debt obligations 488 56 -- 544
- -------------------------------------------------- --------- --------- --------- ---------
$ 46,513 $ 687 $ (38) $ 47,162
- -------------------------------------------------- --------- --------- --------- ---------
The amortized cost and fair value of the securities, including restricted stock,
as of December 31, 2004 by contractual maturity, are shown below (dollars in
thousands):
- -------------------------------------------------- -------------------------------- -----------------------------------
DECEMBER 31, 2004 AMORTIZED COST FAIR VALUE
- -------------------------------------------------- -------------------------------- -----------------------------------
AVAILABLE-FOR-SALE:
Due within one year $ 15,021 $ 14,944
Due after one year through five years 72,111 71,184
Due after five years through ten years 15,007 15,005
Due after ten years 19,299 19,506
- -------------------------------------------------- -------------------------------- -----------------------------------
$ 121,438 $ 120,639
- -------------------------------------------------- -------------------------------- -----------------------------------
HELD-TO-MATURITY:
Due after one year through five years $ 3,480 $ 3,562
Due after five years through ten years 33,496 33,652
Due after ten years 5,617 5,624
- -------------------------------------------------- -------------------------------- -----------------------------------
$42,593 $ 42,838
- -------------------------------------------------- -------------------------------- -----------------------------------
35
The amortized cost of securities pledged as collateral for repurchase
agreements, certain public deposits, and other purposes were $66.4 million and
$56.5 million at December 31, 2004 and 2003, respectively.
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (1) the length of time and the extent
to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the entity and ability of the Company
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value.
Provided below is a summary of securities which were in an unrealized loss
position at December 31, 2004, and 2003. Of the total securities in an
unrealized loss position for less than twelve months at December 31, 2004,
96.5%, or thirty six positions, were U.S. Government Agency and Treasury
securities with maturities ranging from six months to fourteen years. As the
Company has the ability and intent to hold these securities until maturity, or
until such time as the value recovers, no declines are deemed to be
other-than-temporary.
- --------------------------------------- ------------------------- ------------------------- -------------------------
At December 31, 2004 LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
- --------------------------------------- ------------ ------------ ----------- ------------- ------------ ------------
Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) Value Losses Value Losses Value Losses
- --------------------------------------- ------------ ------------ ----------- ------------- ------------ ------------
AVAILABLE-FOR-SALE:
U.S. Government Agency obligations $81,350 $(1,069) -- -- $81,350 $(1,069)
U.S. Treasuries 9,930 (32) -- -- 9,930 (32)
- --------------------------------------- ------------ ------------ ----------- ------------- ------------ ------------
$91,280 $(1,101) -- -- $91,280 $(1,101)
- --------------------------------------- ------------ ------------ ----------- ------------- ------------ ------------
HELD-TO-MATURITY:
U.S. Government Agency obligations $4,977 $ (23) -- -- $4,977 $ (23)
Obligations of states/political
subdivisions 3,457 (124) -- -- 3,457 (124)
- --------------------------------------- ------------ ------------ ----------- ------------- ------------ ------------
$8,434 $ (147) -- -- $8,434 $(147)
- --------------------------------------- ------------ ------------ ----------- ------------- ------------ ------------
- --------------------------------------- ------------------------- ------------------------- -------------------------
At December 31, 2003 LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
- --------------------------------------- ------------------------- ------------------------- -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) Value Losses Value Losses Value Losses
- --------------------------------------- ----------- ------------- ----------- ------------- ------------ ------------
AVAILABLE-FOR-SALE:
U.S. Government Agency obligations $46,444 $(555) -- -- $46,444 $(555)
Domestic corporate debt obligations 1,995 (5) -- -- 1,995 (5)
- --------------------------------------- ----------- ------------- ----------- ------------- ------------ ------------
$48,439 $(560) -- -- $48,439 $(560)
- --------------------------------------- ----------- ------------- ----------- ------------- ------------ ------------
HELD-TO-MATURITY:
- --------------------------------------- ----------- ------------- ----------- ------------- ------------ ------------
Obligations of states/political
subdivisions $ 953 $(38) -- -- $ 953 $(38)
- --------------------------------------- ----------- ------------- ----------- ------------- ------------ ------------
36
NOTE 3. LOANS
Major classifications of loans, excluding loans held-for-sale, are summarized as
follows (dollars in thousands):
- -------------------------------------------------------------------- ------------------------ ------------------------
2004 2003
- -------------------------------------------------------------------- ------------------------ ------------------------
Commercial $88,725 $61,178
Real estate - 1-4 family residential 125,089 88,789
Real estate - multifamily residential 43,798 29,954
Real estate - nonfarm, nonresidential 436,533 325,668
Real estate - construction 240,469 153,400
Consumer 5,879 6,061
- -------------------------------------------------------------------- ------------------------ ------------------------
TOTAL LOANS $ 940,493 $ 665,050
- -------------------------------------------------------------------- ------------------------ ------------------------
Less unearned income 4,309 2,742
Less allowance for loan losses 10,402 7,457
- -------------------------------------------------------------------- ------------------------ ------------------------
LOANS, NET $ 925,782 $ 654,851
- -------------------------------------------------------------------- ------------------------ ------------------------
As of December 31, 2004 and 2003, there were $246 thousand and $275 thousand,
respectively, in checking account overdrafts that were reclassified on the
balance sheet as loans.
NOTE 4. ALLOWANCE FOR LOAN LOSSES
An analysis of the allowance for loan losses for the years ended December 31,
2004, 2003 and 2002 is shown below (dollars in thousands):
- ------------------------------------------------- ------------------------- ---------------------- -------------------
2004 2003 2002
- ------------------------------------------------- ------------------------- ---------------------- -------------------
Allowance, at beginning of period $ 7,457 $ 5,924 $ 4,356
Provision charged against income 2,989 1,575 1,678
Recoveries added to reserve 18 14 45
Losses charged to reserve (62) (56) (155)
- ------------------------------------------------- ------------------------- ---------------------- -------------------
ALLOWANCE, AT END OF PERIOD $10,402 $ 7,457 $ 5,924
- ------------------------------------------------- ------------------------- ---------------------- -------------------
Information about impaired loans as of and for the years ended December 31,
2004, 2003 and 2002, is as follows (dollars in thousands):
- ---------------------------------------------------------------------------- -------------- ------------ -------------
2004 2003 2002
- ---------------------------------------------------------------------------- -------------- ------------ -------------
Impaired loans for which an allowance has been provided $ 1,177 $ 416 $ 444
Impaired loans for which no allowance has been provided 15 -- --
- ---------------------------------------------------------------------------- -------------- ------------ -------------
TOTAL IMPAIRED LOANS $ 1,192 $ 416 $ 444
- ---------------------------------------------------------------------------- -------------- ------------ -------------
Allowance provided for impaired loans, included in the allowance for loan 400 61 59
losses
Average balance in impaired loans $ 1,782 $ 216 $ 281
- ---------------------------------------------------------------------------- -------------- ------------ -------------
Interest income recognized -- -- --
- ---------------------------------------------------------------------------- -------------- ------------ -------------
Non-accrual loans excluded from impaired loan disclosure under FASB 114 amounted
to $18 thousand, $46 thousand, and $1.9 million at December 31, 2004, 2003 and
2002, respectively. If interest on these loans had been accrued as interest
income, such income would have approximated $1 thousand, $5 thousand and $33
thousand for the years ended December 31, 2004, 2003 and 2002, respectively.
Loan past due 90 days or more, and still accruing interest totaled $84 thousand
at December 31, 2003. There were no loans past due 90 days or more, and still
accruing interest at December 31, 2004, and December 31, 2002.
37
NOTE 5. BANK PREMISES AND EQUIPMENT, NET
Premises and equipment are stated at cost less accumulated depreciation at
December 31, 2004 and 2003, as follows (dollars in thousands):
- ------------------------------------------------------------------ --------------------------- -----------------------
2004 2003
- ------------------------------------------------------------------ --------------------------- -----------------------
Land $1,839 $1,839
Buildings 2,259 2,193
Furniture, fixtures and equipment 7,057 6,081
Leasehold improvements 2,324 2,050
Construction in progress 301 29
- ------------------------------------------------------------------ --------------------------- -----------------------
Total Cost $13,780 $12,192
Less accumulated depreciation and amortization 7,088 6,003
- ------------------------------------------------------------------ --------------------------- -----------------------
Net premises and equipment $6,692 $6,189
- ------------------------------------------------------------------ --------------------------- -----------------------
Depreciation and amortization expense on premises and equipment amounted to $1.1
million, $1.1 million and $1.0 million in 2004, 2003 and 2002,respectively.
NOTE 6. TIME DEPOSITS
The aggregate amount of time deposits with a minimum denomination of $100
thousand each, was approximately $253.2 million and $140.7 million at December
31, 2004 and 2003, respectively. Scheduled maturities of all time deposits at
December 31, 2004, are as follows (dollars in thousands):
- ------------------------------------------------------------- ---------------------------------------------------------
2005 $312,587
2006 77,499
2007 27,048
2008 43,792
2009 29,006
2010 and thereafter 588
- ------------------------------------------------------------- ---------------------------------------------------------
$490,520
- ------------------------------------------------------------- ---------------------------------------------------------
NOTE 7. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase, which are classified as secured
borrowings, represent funds of numerous demand deposit customers, and mature one
day from the transaction date. Securities sold under agreements to repurchase
are reflected at the amount of cash received and are collateralized by
securities in the Company's investment securities portfolio.
NOTE 8. INCOME TAXES
Net deferred tax assets consist of the following components at December 31, 2004
and 2003 (dollars in thousands):
- --------------------------------------------------------------- --------------------------- ---------------------------
2004 2003
- --------------------------------------------------------------- --------------------------- ---------------------------
DEFERRED TAX ASSETS:
Allowance for loan losses $3,641 $2,536
Non-accrual loans 27 33
Organization costs -- 2
Deferred loan fees -- 83
Securities available-for-sale 279 6
Bank premises and equipment 300 229
- --------------------------------------------------------------- --------------------------- ---------------------------
$4,247 $2,889
- --------------------------------------------------------------- --------------------------- ---------------------------
DEFERRED TAX LIABILITIES:
Federal Home Loan Bank stock 2 2
- --------------------------------------------------------------- --------------------------- ---------------------------
NET DEFERRED TAX ASSETS $4,245 $2,887
- --------------------------------------------------------------- --------------------------- ---------------------------
38
The provision for income tax and its components for the years ending December
31, 2004, 2003, and 2002 are as follows (dollars in thousands):
- ------------------------------- -------------------------------------------- --------------------- --------------------
DECEMBER 31, 2004 2003 2002
- ------------------------------- -------------------------------------------- --------------------- --------------------
Current tax expense $8,452 $ 6,480 $ 4,501
Deferred tax benefit (1,051) (600) (609)
- ------------------------------- -------------------------------------------- --------------------- --------------------
$7,401 $ 5,880 $ 3,892
- ------------------------------- -------------------------------------------- --------------------- --------------------
The income tax provision differs from the amount of income tax determined by
applying the U.S. federal income tax rate to pretax income from continuing
operations for the years ended December 31, 2004, 2003, and 2002, due to the
following (dollars in thousands):
- ----------------------------------------------------- ---------------------- --------------------- --------------------
DECEMBER 31, 2004 2003 2002
- ----------------------------------------------------- ---------------------- --------------------- --------------------
Computed "expected" tax expense at 35% in 2004 and $ 7,571 $ 5,925 $ 3,917
34% in 2003 and 2002
Increase (decrease) in income taxes resulting from:
Income at higher statutory rate (35%) -- 74 16
Nondeductible expense 16 40 8
Nontaxable income (186) (159) (49)
- ----------------------------------------------------- ---------------------- --------------------- --------------------
$ 7,401 $ 5,880 $ 3,892
- ----------------------------------------------------- ---------------------- --------------------- --------------------
NOTE 9. EARNINGS PER SHARE
The following shows the weighted average number of shares used in computing
earnings per share and the effect on the weighted average number of shares of
diluted potential common stock. For the years reported, the weighted average
number of shares have been adjusted to give effect to stock dividends and
splits. Potential dilutive common stock had no effect on income available to
common stockholders.
- -------------------------------- ---------------------------- ---------------------------- -----------------------------
2004 2003 2002
- -------------------------------- ------------- -------------- -------------- ------------- --------------- -------------
Per Share Per Share Per Share
Shares Amount Shares Amount Shares Amount
- -------------------------------- ------------- -------------- -------------- ------------- --------------- -------------
BASIC EARNINGS PER SHARE 10,570,097 $1.35 9,733,444 $1.18 8,899,393 $0.86
Effect of dilutive securities:
Stock options 848,063 864,471 700,765
Warrants 45,975 42,655 392,142
- -------------------------------- ------------- -------------- -------------- ------------- --------------- -------------
DILUTED EARNINGS PER SHARE 11,464,135 $1.24 10,640,570 $1.08 9,992,300 $0.77
- -------------------------------- ------------- -------------- -------------- ------------- --------------- -------------
Stock options for 1,250 shares of common stock were not included in computing
diluted earnings per share in 2003, because their effects were anti-dilutive.
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company leases office space for twelve of its branch locations, its
operations, mortgage lending, and construction lending departments and has
entered into leases for four additional branch locations in 2005. These
non-cancellable agreements, which expire through April 2017, in some instances
require payment of certain operating charges. Generally, all leases contain
renewal options of one to two additional five-year terms. The total minimum
lease commitment, adjusted for the effect of annual fixed increases or the
Consumer Price Index, at December 31, 2004, is $10.1 million, due as follows
(dollars in thousands):
39
- ------------------------------------------- ------------------------------- -----------------------------------------
Due in the year ending December 31, 2005 $1,463
2006 1,177
2007 1,192
2008 1,111
2009 892
Thereafter 4,216
- ------------------------------------------- ------------------------------- -----------------------------------------
The total lease expense was $1.3 million, $1.2 million and $1.2 million in 2004,
2003, and 2002, respectively. In the normal course of business, the Company
makes various commitments and incurs certain contingent liabilities that are not
presented in the accompanying financial statements. The Company does not
anticipate any material losses as a result of the commitments and contingent
liabilities.
NOTE 11: LOANS TO OFFICERS AND DIRECTORS
Officers, directors and/or their related business interests are loan customers
in the ordinary course of business. In management's opinion, these loans are
made on substantially the same terms as those prevailing at the time for
comparable loans with other persons and do not involve more than normal risk of
collectibility or present other unfavorable features. The aggregate amount
outstanding on such loans at December 31, 2004 and 2003, was $20.6 million and
$5.9 million, respectively. During 2004, new loans and advances amounted to
$15.1 million and repayments of $442 thousand were made.
NOTE 12. STOCK OPTIONS OUTSTANDING
The current plan, adopted May 29, 1998, and amended in May 2001, is a qualified
Incentive Stock Option Plan which provides for the granting of options to
purchase up to 1,238,280 shares of common stock at a price to be determined by
the Board of Directors at the date of grant, but in any event no less than 100%
of the fair market value. Options outstanding prior to May 29, 1998, were
granted under the Company's plan adopted in 1988 which was replaced by the
current plan. As of December 31, 2004, 950,969 options had been granted under
the current plan. Options are awarded to employees and the Board of Directors of
the Company at the discretion of the Board of Directors. All options expire ten
years from the grant date. Options granted under the current plan, through
December 31, 2002, vest over three years, while options granted since December
31, 2002, vest over five years. In January 2005, 104,750 options were granted to
forty-three officers and seven outside directors of the Company at an exercise
price of $28.86 per share.
A summary of the status of the plan at December 31, 2004, 2003 and 2002, and
changes during the years ended on those dates is as follows:
- -------------------------------------- --------------------------- -------------------------- ------------------------
2004 2003 2002
- -------------------------------------- --------------------------- -------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number of Exercise
of Shares Price of Shares Price Shares Price
- -------------------------------------- -------------- ------------ ------------ ------------- ----------- ------------
Outstanding at beginning of year 1,094,279 $ 4.26 1,037,191 $ 3.41 895,031 $ 2.85
Granted 139,182 $ 24.34 138,550 $10.33 142,660 $ 6.97
Exercised 82,888 $ 3.56 80,378 $ 3.70 -- --
Forfeited 3,489 $ 16.04 1,084 $16.26 500 $ 7.22
Outstanding at end of year 1,147,084 $ 6.71 1,094,279 $ 4.26 1,037,191 $ 3.41
Exercisable at end of year 855,601 822,606 744,860
Pro forma weighted-average fair
value per option of options granted
during the year $12.14 $4.92 $3.25
- -------------------------------------- -------------- ------------ ------------ ------------- ----------- ------------
A further summary about the options outstanding and exercisable at December 31,
2004 is provided in the following table:
40
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ----------------------- --------------------- ---------------- ------------------ -------------------- ------------------
Number Outstanding Remaining Weighted Number Exercisable Weighted
Range of Exercise at December 31, Contractual Average at December 31, Average
Prices 2004 Life Exercise Price 2004 Exercise Price
- ----------------------- --------------------- ---------------- ------------------ -------------------- ------------------
$ 1.16 to $ 1.56 205,696 1.2 years $1.37 205,696 $ 1.37
$ 2.89 to $ 3.28 174,214 3.6 years 3.02 174,214 3.02
$ 3.33 to $ 3.50 358,847 5.4 years 3.39 358,847 3.39
$ 5.92 to $ 8.91 263,519 7.5 years 8.27 115,469 7.51
$15.50 to $26.44 144,808 9.1 years 24.08 1,375 18.86
- ----------------------- --------------------- ---------------- ------------------ -------------------- ------------------
$ 1.16 TO $26.44 1,147,084 5.3 YEARS $6.71 855,601 $ 3.41
All options granted, available under the current Plan, and exercisable have been
adjusted for all three years giving retroactive effect to the five-for-four
stock splits in the form of 25% stock dividends in 2002 and 2004, and the
two-for-one stock split in the form of a 100% stock dividend in 2003.
In September 2003, the Company adopted an Employee Stock Purchase Plan. Under
the plan a total of 187,500 shares of common stock, as adjusted for the
five-for-four stock split in July 2004, were reserved for issuance to eligible
employees at a price equal to at least 85% of the fair market value of the
shares of common stock on the date of grant. Grants each year expire at the end
of that fiscal year if not exercised by the employee. On September 24, 2003,
eligible employees were granted the right to purchase 19,026 shares at a price
of $23.18 per share, which was equal to 100% of the fair market value of the
shares at that time. Of the total grant, 8,433 shares were purchased, and the
rights to purchase the remaining 10,593 shares expired on December 31, 2003. On
January 10, 2004, rights to purchase 21,380, as adjusted, shares of common stock
were granted at a price of $26.72 which was equal to 85% of the fair market
value of the shares at that time. Of that total grant 6,058 were purchased and
the remaining 15,322 expired on December 31, 2004. On January 18, 2005, rights
to purchase 23,703 shares of common stock were granted at a price of $24.65
which was equal to 85% of the fair market value of the shares at that time.
Those grants must be exercised by December 31, 2005 or they will expire.
NOTE 13. DIRECTOR COMPENSATION PLAN
In April 1996, the Company granted 185,286 warrants at an exercise price of
$3.56 to six outside Directors. In January 1998, the Company granted 51,990
warrants at an exercise price of $2.89 to an additional outside Director. All
warrants have been restated giving retroactive effect to the 10% stock
restructurings in 1998 and 1999, the 10% stock dividend in 2000, and the
five-for-four stock splits in the form of 25% stock dividends in 2001 and 2002,
while the warrants granted in January 1998 were also restated giving retroactive
effect to the two-for-one stock split in the form of a 100% stock dividend in
2003, and the five-for-four stock split in the form of a 100% stock dividend in
July 2004. Of the total warrants granted in April 1996, 46,321 were exercised in
2002, and 138,965 were exercised in 2003. The 51,990 warrants granted in January
1998 were exercised in January 2005.
In addition to the warrants, the seven outside Directors have been awarded a
total of 133,189, 49,998, 20,834, 34,000 and 21,875 options under the Company's
Incentive Option Plan in 2000, 2001, 2002, 2003 and 2004 respectively and as
adjusted for the 10% stock dividend in 2000, the five-for-four stock splits in
the form of 25% stock dividends in 2001, 2002 and 2004, and the two-for-one
stock split in the form of a 100% stock dividend in 2003. In January 2005 each
of the seven outside Directors were awarded an additional 2,000 options. All
director options are included in the tables under Note 12.
NOTE 14. OTHER BORROWED MONEY AND LINES OF CREDIT
The Bank maintains a $170.8 million line of credit with the Federal Home Loan
Bank of Atlanta. The interest rate and term of each advance from the line is
dependent upon the advance and commitment type. Advances on the line are secured
by all of the Bank's qualifying first liens, second liens and home equity
lines-of-credit on one-to-four unit single-family dwellings. As of December 31,
2004, the book value of these qualifying loans totaled approximately $92.1
million and the amount of available credit using this collateral was $55.8
million. Advances on the line of credit, in excess of this amount, require
pledging of additional assets including other types of loans and investment
securities. As of December 31, 2004 and 2003, the Bank had no advances
outstanding. The Bank has additional short-term lines of credit totaling $22
million with nonaffiliated banks at December 31, 2004, on which no amount was
outstanding at that date.
41
NOTE 15. TRUST PREFERRED CAPITAL NOTES
On November 13, 2002, the Company completed a private placement issuance of $3.0
million of trust preferred securities through a newly formed, wholly-owned,
subsidiary trust (VCBI Capital Trust I) which issued $100,000 in common equity
to the Company. The securities bear a floating rate of interest, adjusted
semi-annually, of 340 basis points over six month Libor, currently 5.89%, with a
maximum rate of 12.0% until November 15, 2007. The securities have a thirty year
term and are callable at par beginning November 15, 2007. On December 19, 2002,
the Company completed a separate private placement issuance of $15.0 million of
trust preferred securities through another newly formed, wholly-owned,
subsidiary trust (VCBI Capital Trust II) which issued $470,000 in common equity
to the Company. These securities bear a floating rate of interest, adjusted
semi-annually, of 330 basis points over six month Libor, currently 6.07%, with a
maximum rate of 11.9% until December 30, 2007. These securities also have a
thirty year term and are callable at par beginning December 30, 2007. The
principal asset of each trust is a similar amount of the Company's junior
subordinated debt securities with like maturities and interest rates to the
trust preferred securities. The obligations of the Company with respect to the
issuance of the trust preferred securities constitute a full and unconditional
guarantee by the Company of each Trust's obligations with respect to the trust
preferred securities to the extent set forth in the related guarantees. Subject
to certain exceptions and limitations, the Company may elect from time to time
to defer interest payments on the junior subordinated debt securities, resulting
in a deferral of distribution payments on the related trust preferred
securities.
The Trust Preferred Securities may be included in Tier 1 capital for regulatory
capital adequacy purposes up to 25.0% of Tier 1 capital after its inclusion. The
portion of the trust preferred securities not qualifying as Tier 1 capital may
be included as part of total qualifying capital in Tier 2 capital.
NOTE 16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, standby letters of
credit and financial guarantees. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the balance sheet. The contract or notional amounts of those instruments reflect
the extent of involvement the Company has in particular classes of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit and financial guarantees written is represented by the
contractual or notional amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
A summary of the contract or notional amount of the Company's exposure to
off-balance-sheet risk as of December 31, 2004 and 2003, is as follows:
-------------------------------------------------------- ----------------------------- --------------------------
(Dollars in thousands) 2004 2003
-------------------------------------------------------- ----------------------------- --------------------------
Financial instruments whose contract amounts represent
credit risk:
Commitments to extend credit $ 34,853 $ 26,944
Standby letters of credit and financial guarantees $ 18,277 $ 14,732
written
Unfunded lines of credit $326,430 $182,761
-------------------------------------------------------- ----------------------------- --------------------------
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 fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation of the customer. Collateral held varies but may
include cash, marketable securities, accounts receivable, inventory, property
and equipment, residential real estate, and income-producing commercial
properties.
42
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Company to guarantee the performance of a customer to
a third party. Those guarantees are primarily issued to support public and
private borrowing arrangements, including commercial paper, bond financing, and
similar transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Company holds certificates of deposit, marketable securities, and business
assets as collateral supporting those commitments for which collateral is deemed
necessary.
The Company originates loans for sale to secondary market investors subject to
contractually specified and limited recourse provisions. In 2004, the Company
originated $175.9 million and sold $169.7 million to investors, compared to
$287.8 million originated and $303.2 million sold in 2003. Most contracts with
investors contain certain recourse language that may vary from 90 days up to one
year. In general, the company may be required to repurchase a previously sold
mortgage loan or indemnify the investor if there is major non-compliance with
defined loan origination or documentation standards, including fraud, negligence
or material misstatement in the loan documents. Repurchase may also be required
if necessary governmental loan guarantees are canceled or never issued, or if an
investor is forced to buy back a loan after it has been re-sold as part of a
loan pool. In addition, the Company may have an obligation to repurchase a loan
if the mortgagor has defaulted early in the loan term. The potential default
period is approximately twelve months after sale of the loan to the investor.
Mortgages subject to recourse are collateralized by single-family residential
properties, have loan-to-value ratios of 80% or less, or have private mortgage
insurance or are insured or guaranteed by an agency of the United States
government.
At December 31, 2004, the Bank had rate lock commitments to originate and sell
mortgage loans amounting to $5.2 million and loans held-for-sale of $9.7
million. Risks arise from the possible inability of counterparties to meet the
terms of their contracts. The Bank does not expect any counterparty to fail to
meet its obligation.
NOTE 17. CONCENTRATIONS OF CREDIT RISK
The Bank does a general banking business, serving the commercial and personal
banking needs of its customers. The Bank's market area consists of the Northern
Virginia suburbs of Washington, D.C., including Arlington Fairfax, Fauquier,
Loudoun and Prince William Counties, the cities of Alexandria, Fairfax, Falls
Church, Manassas and Manassas Park, and to some extent the Maryland suburbs and
the city of Washington D.C.. Substantially all of the Company's loans are made
within its market area.
The ultimate collectibility of the Bank's loan portfolio and the ability to
realize the value of any underlying collateral, if needed, are influenced by the
economic conditions of the market area. The Company's operating results are
therefore closely related to the economic conditions and trends in the
Metropolitan Washington, D.C. area.
At December 31, 2004 and 2003, there were $720.8 million and $509.2 million, or
76.7% and 76.6%, respectively of total loans concentrated in commercial real
estate. Commercial real estate for purposes of this note includes all
construction loans, loans secured by 5+ family residential properties and loans
secured by non-farm, non-residential properties. At December 31, 2004, and 2003
construction loans represented 25.6% and 23.1% of total loans, loans secured by
5+ family residential properties represented 4.7% and 4.5%, and loans secured by
non-farm, non-residential properties represented 46.4% and 49.0%, respectively.
Construction loans at December 31, 2004 and 2003 included $163.3 million and
$110.5 million in loans to commercial builders of single family housing in the
Northern Virginia market, representing 17.2% and 16.6% of total loans,
respectively.
The Bank has established formal policies relating to the credit and collateral
requirements in loan originations including policies that establish limits on
various loan types as a percentage of total loans and total capital. Loans to
purchase real property are generally collateralized by the related property with
limitations based on the property's appraised value. Credit approval is
primarily a function of collateral and the evaluation of the creditworthiness of
the individual borrower, guarantors and or the individual project. Management
considers the concentration of credit risk to be minimal due to the
diversification of borrowers over numerous business and industries.
NOTE 18. FUND RESTRICTIONS AND RESERVE BALANCE
The transfer of funds from the Bank to the Company in the form of loans,
advances, and cash dividends are restricted by Federal and State regulatory
authorities. As of December 31, 2004, the aggregate amount of unrestricted funds
that could be transferred totaled approximately $29.9 million, or 32.75%, of the
consolidated net assets of the Company.
43
As members of the Federal Reserve System, the Company is required to maintain
certain average reserve balances. For the final weekly reporting period in the
years ended December 31, 2004 and 2003, the aggregate amounts of daily average
required balances were approximately $2.5 million and $2.2 million,
respectively.
NOTE 19. EMPLOYEE BENEFITS
The Company has a 401(k) defined contribution plan covering substantially all
full-time employees and provides that an employee becomes eligible to
participate at the date he or she has reached the age of 21 and has completed
three months of service, whichever occurs last. Under the plan, a participant
may contribute up to 15% of his or her covered compensation for the year,
subject to certain limitations. The Company may also make, but is not required
to make, a discretionary contribution for each participant out of its current or
accumulated net profits. The amount of contribution, if any, is determined on an
annual basis by the Board of Directors. Contributions made by the Company
totaled $234 thousand, $212 thousand and $182 thousand for the years ended
December 31, 2004, 2003 and 2002, respectively.
NOTE 20. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS AND
INTEREST RATE RISK
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
CASH AND SHORT-TERM INVESTMENTS
For those short-term instruments, the carrying amount is a reasonable estimate
of fair value.
SECURITIES
For securities held for investment purposes, fair values are based on quoted
market prices or dealer quotes. The carrying value of restricted stock
approximates fair value based on the redemption provisions of the issuers.
LOANS HELD-FOR-SALE
Fair value is based on selling price arranged by arms-length contracts with
third parties.
LOAN RECEIVABLES
For certain homogeneous categories of loans, such as some residential mortgages,
and other consumer loans, fair value is estimated using the quoted market prices
for securities backed by similar loans, adjusted for differences in loan
characteristics. The fair value of other types of loans is estimated by
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities.
DEPOSITS AND BORROWINGS
The fair value of demand deposits, savings accounts, and certain money market
deposits is the amount payable on demand at the reporting date. For all other
deposits and borrowings, the fair value is determined using the discounted cash
flow method. The discount rate was equal to the rate currently offered on
similar products.
ACCRUED INTEREST
The carrying amounts of accrued interest approximate fair value.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The fair value of commitments to extend credit is estimated using the fees
currently charged to enter similar agreements, taking into account the remaining
terms of the agreements and the present creditworthiness of the counterparties.
For fixed-rate loan commitments, fair value also considers the difference
between current levels of interest rates and the committed rates. The fair value
of stand-by letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties at the reporting date.
44
At December 31, 2004 and 2003, the fair value of loan commitments and stand-by
letters of credit were deemed immaterial.
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows:
- ----------------------------------------- ---------------------------------- ------------------------------------
2004 2003
- ----------------------------------------- ---------------------------------- ------------------------------------
(Dollars in thousands) Carrying Estimated Fair Carrying Amount Estimated Fair
Amount Value Value
- ----------------------------------------- -------------- ------------------- ----------------- ------------------
FINANCIAL ASSETS:
Cash and short-term investments $ 17,792 $ 17,792 $54,056 $ 54,056
Securities 163,232 163,477 149,245 149,894
Loans held-for-sale 9,662 9,662 3,513 3,513
Loans 925,782 952,752 654,851 682,969
Accrued interest receivable 4,105 4,105 3,372 3,372
- ----------------------------------------- -------------- ------------------- ----------------- ------------------
Total Financial assets $ 1,120,573 $ 1,147,788 $ 865,037 $ 893,804
- ----------------------------------------- -------------- ------------------- ----------------- ------------------
2004 2003
- ----------------------------------------- ---------------------------------- ------------------------------------
(Dollars in thousands) Carrying Estimated Fair Carrying Amount Estimated Fair
Amount Value Value
- ----------------------------------------- -------------- ------------------- ----------------- ------------------
FINANCIAL LIABILITIES:
Deposits $ 970,968 $ 969,861 $ 773,511 $ 776,672
Securities sold under agreements to 53,207 53,197 30,887 30,882
repurchase
Trust preferred capital notes 18,570 18,761 18,570 18,656
Accrued interest payable 1,555 1,555 1,024 1,024
- ----------------------------------------- -------------- ------------------- ----------------- ------------------
Total Financial liabilities $ 1,044,300 $ 1,043,374 $ 823,992 $ 827,234
- ----------------------------------------- -------------- ------------------- ----------------- ------------------
In the normal course of business, the Company is subject to market risk which
includes interest rate risk (the risk that general interest rate levels will
change). As a result, the fair values of the Company's financial instruments
will change when interest rate levels change and that change may be either
favorable or unfavorable to the Company. Management attempts to match maturities
of assets and liabilities to the extent believed necessary to minimize this
risk.
NOTE 21. CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, possibly additional discretionary,
actions by regulators that, if undertaken, could have a direct material effect
on the Company's and Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors. Prompt
corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of Total Capital, Tier 1 Capital and Tier 1 Leverage
Capital. Total Capital and Tier 1 Capital ratios are in reference to
risk-weighted assets (as defined), and the Tier 1 Leverage Capital ratio is in
reference to average assets. Management believes, as of December 31, 2004 and
2003, that the Bank met all capital adequacy requirements to which it is
subject.
As of December 31, 2004, the Bank is categorized as "well-capitalized" under the
regulatory framework for prompt corrective action. To be categorized as
"well-capitalized", the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. There are no
conditions or events since December 31, 2004, that management believes changed
the Bank's category. The Company's and the Bank's actual capital amounts and
ratios are also presented in the table.
45
- ------------------------------- --------------------------- ------------------------ ----------------------------
Minimum To Be
Well-Capitalized Under
Actual Capital Minimum Capital Prompt Corrective Action
Requirement* Provisions
- ------------------------------- --------------------------- ------------------------ ----------------------------
AS OF DECEMBER 31, 2004: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------- ------------- ------------- ----------- ------------ ------------ ---------------
TOTAL CAPITAL:
Company $120,244 11.92% $80,693 8.00% $ N/A N/A
Bank 119,232 11.82% 80,667 8.00% 100,834 10.00%
TIER 1 CAPITAL:
Company $109,842 10.89% $40,346 4.00% $ N/A N/A
Bank 90,830 9.01% 40,333 4.00% 60,500 6.00%
TIER 1 LEVERAGE CAPITAL:
Company $109,842 9.76% $45,017 4.00% $ N/A N/A
Bank 90,830 8.09% 44,910 4.00% 56,137 5.00%
- ------------------------------- ------------- ------------- ----------- ------------ ------------ ---------------
AS OF DECEMBER 31, 2003: AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------- ------------- ------------- ----------- ------------ ------------ ---------------
TOTAL CAPITAL:
Company $80,558 11.13% $57,911 8.00% $ N/A N/A
Bank 79,781 11.03% 57,877 8.00% 72,346 10.00%
TIER 1 CAPITAL:
Company $73,101 10.10% $28,956 4.00% $ N/A N/A
Bank 54,323 7.51% 28,938 4.00% 43,408 6.00%
TIER 1 LEVERAGE CAPITAL
Company $73,101 8.49% $34,441 4.00% $ N/A N/A
Bank 54,324 6.33% 34,327 4.00% 42,909 5.00%
- ------------------------------- ------------- ------------- ----------- ------------ ------------ ---------------
* The minimum capital requirement for the Company is a guideline.
NOTE 22. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
- ----------------------------------------------------- ---------------------------- ------------------------------
BALANCE SHEETS (in thousands) DECEMBER 31, 2004 DECEMBER 31, 2003
---------------------------- ------------------------------
Assets:
Cash and due from banks $ 686 $ 349
Investment in Subsidiaries 90,882 54,884
Subordinated Debt in Subsidiary 18,000 18,000
Other Assets 351 430
- ----------------------------------------------------- ---------------------------- ------------------------------
TOTAL ASSETS $ 109,919 $ 73,663
- ----------------------------------------------------- ---------------------------- ------------------------------
Liabilities and Stockholders' Equity:
Junior subordinated capital notes $ 18,570 $ 18,570
Other Liabilities 25 1
- ----------------------------------------------------- ---------------------------- ------------------------------
Total Liabilities $ 18,595 $ 18,571
- ----------------------------------------------------- ---------------------------- ------------------------------
Stockholders' Equity 91,324 55,092
- ----------------------------------------------------- ---------------------------- ------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 109,919 $ 73,663
- ----------------------------------------------------- ---------------------------- ------------------------------
46
- ----------------------------------------------------- -----------------------------------------------------------
STATEMENTS OF INCOME (in thousands) YEAR ENDED DECEMBER 31,
--------------------- ------------------- -----------------
2004 2003 2002
--------------------- ------------------- -----------------
Income:
Interest on subordinated debt $ 888 $ 879 $ 615
Dividend from subsidiary -- -- 4,017
- ----------------------------------------------------- --------------------- ------------------- -----------------
Total Income 888 879 4,632
- ----------------------------------------------------- --------------------- ------------------- -----------------
Expenses:
Interest on trust preferred capital notes $ 892 $ 835 $ 44
Interest on long term debt -- -- 472
Other operating expense 419 352 94
- ----------------------------------------------------- --------------------- ------------------- -----------------
Total Expenses 1,311 1,187 610
- ----------------------------------------------------- --------------------- ------------------- -----------------
Gain (loss) before income taxes (benefit) and
equity in undistributed earnings of subsidiary $ (423) $ (308) $4,022
Income tax (benefit) (148) (108) 2
- ----------------------------------------------------- --------------------- ------------------- -----------------
(275) (200) 4,020
Equity in undistributed net income of
Virginia Commerce Bank 14,504 11,746 3,656
- ----------------------------------------------------- --------------------- ------------------- -----------------
Net Income $ 14,229 $ 11,546 $7,676
- ----------------------------------------------------- --------------------- ------------------- -----------------
- --------------------------------------------------------- -------------------------------------------------------
STATEMENTS OF CASH FLOWS (in thousands) YEAR ENDED DECEMBER 31,
-------------------------------------------------------
2004 2003 2002
-------------------- ------------------ ---------------
Cash Flows from Operating Activities:
Net Income $ 14,229 $ 11,546 $ 7,676
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Equity in undistributed net income of Virginia
Commerce Bank (14,504) (11,746) (3,656)
Decrease (increase) in other assets 79 112 (511)
Increase (decrease) in other liabilities 24 (43) 36
- --------------------------------------------------------- -------------------- ------------------ ---------------
Net cash provided by (used in) operating activities $ (172) $ (131) $ 3,545
- --------------------------------------------------------- -------------------- ------------------ ---------------
Cash Flows from Investing Activities:
- --------------------------------------------------------- -------------------- ------------------ ---------------
Purchase additional stock in subsidiary (22,000) (6,000) (7,570)
Purchase of debt securities -- (4,000) (2,900)
- --------------------------------------------------------- -------------------- ------------------ ---------------
Net cash (used in) investing activities $ (22,000) $(10,000) $(10,470)
- --------------------------------------------------------- -------------------- ------------------ ---------------
Cash Flows from Financing Activities:
Net (decrease) increase in long term debt -- -- (11,000)
Net increase in junior subordinated capital notes -- -- 18,570
Common stock issued 22,514 2,390 7,450
Cash paid in lieu of fractional shares (5) -- (6)
- --------------------------------------------------------- -------------------- ------------------ ---------------
Net cash provided by financing activities $ 22,509 $ 2,390 $ 15,014
- --------------------------------------------------------- -------------------- ------------------ ---------------
Change in cash and cash equivalents $ 337 $(7,741) $ 8,089
Beginning 349 8,090 1
Ending $ 686 $ 349 $ 8,090
- --------------------------------------------------------- -------------------- ------------------ ---------------
47
NOTE 23. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected financial information for the quarterly periods of 2004 and 2003 is
presented below (dollars in thousands except per share data):
2004 QUARTERS
-------------------------------------------------------
FIRST SECOND THIRD FOURTH
-------------- ------------- ------------ -------------
Interest income $12,533 $13,573 $15,152 $16,740
Interest expense 3,534 3,853 4,262 4,682
- --------------------------------- -------------- ------------- ------------ -------------
Net interest income $ 8,999 $ 9,720 $10,890 $12,058
Provision for loan losses 487 820 698 984
Net interest income after
provision for loan losses $ 8,512 $ 8,900 $10,192 $11,074
Non-interest income 1,209 1,602 1,518 1,430
Non-interest expense 5,047 5,279 5,907 6,574
- --------------------------------- -------------- ------------- ------------ -------------
Income before taxes $ 4,674 $ 5,223 $ 5,803 $ 5,930
Income tax expense 1,588 1,785 1,992 2,036
- --------------------------------- -------------- ------------- ------------ -------------
Net income $ 3,086 $ 3,438 $ 3,811 $ 3,894
- --------------------------------- -------------- ------------- ------------ -------------
Net income per common share:
Basic $ 0.32 $ 0.33 $ 0.35 $ 0.35
Diluted $ 0.29 $ 0.30 $ 0.32 $ 0.33
2003 QUARTERS
-------------------------------------------------------
FIRST SECOND THIRD FOURTH
-------------- ------------- ------------ -------------
Interest income $10,588 $11,293 $11,758 $12,329
Interest expense 3,387 3,584 3,496 3,426
- --------------------------------- -------------- ------------- ------------ -------------
Net interest income $ 7,201 $ 7,709 $ 8,262 $ 8,903
Provision for loan losses 356 408 323 488
Net interest income after
provision for loan losses $ 6,845 $ 7,301 $ 7,939 $ 8,415
Non-interest income 1,743 1,989 2,457 1,557
Non-interest expense 4,918 5,032 5,481 5,389
- --------------------------------- -------------- ------------- ------------ -------------
Income before taxes $ 3,670 $ 4,258 $ 4,915 $ 4,583
Income tax expense 1,252 1,421 1,651 1,556
- --------------------------------- -------------- ------------- ------------ -------------
Net income $ 2,418 $ 2,837 $ 3,264 $ 3,027
- --------------------------------- -------------- ------------- ------------ -------------
Net income per common share:
Basic $ 0.25 $ 0.29 $ 0.33 $ 0.31
Diluted $ 0.23 $ 0.26 $ 0.30 $ 0.29
NOTE 24: SEGMENT REPORTING
In accordance with SFAS No. 131, "Disclosures About Segments of an Enterprise
and Related Information" the Company has two reportable segments, its community
banking operations and its mortgage banking division. Community banking
operations, the major segment, involves making loans and gathering deposits from
individuals and businesses in the Bank's market area, while the mortgage banking
division originates and sells mortgage loans serving released, on one-to-four
family residential properties. Revenues from mortgage lending consist of
interest earned on mortgage loans held-for-sale, loan origination fees, and net
gains on the sale of loans in the secondary market. The Bank provides the
mortgage division with short term funds to originate loans and charges it
interest on the funds based on what the Bank earns on overnight funds. Expenses
include both fixed overhead and variable costs on originated loans such as loan
officer commissions, document preparation and courier fees. The following table
presents segment information for the years ended December 31, 2004, 2003 and
2002. Eliminations consist of overhead and interest charges by the Bank to the
mortgage lending division.
48
- ------------------------------------------------- -------------------------------------------------------------------
2004
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Community Mortgage
(In thousands) Banking Lending Eliminations Total
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Interest income $ 57,591 $ 407 $ -- $ 57,998
Non-interest income 2,530 3,229 -- 5,759
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Total operating income $ 60,121 $ 3,636 $ -- $ 63,757
Interest expense $ 16,331 $ 85 $ (85) $ 16,331
Provision for loan losses 2,989 -- -- 2,989
Non-interest expense 20,326 2,529 (48) 22,807
Total operating expense $ 39,646 $ 2,614 $(133) $ 42,127
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Income before taxes on income $ 20,475 $ 1,022 $ 133 $ 21,630
Provision for income taxes 7,043 358 -- 7,401
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Net Income $ 13,432 $ 664 $ 133 $ 14,229
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Total Assets $1,129,587 $ 9,766 $ -- $1,139,353
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
- ------------------------------------------------- -------------------------------------------------------------------
2003
- ------------------------------------------------- -------------------------------------------------------------------
Community Mortgage
(In thousands) Banking Lending Eliminations Total
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Interest income $ 45,216 $ 752 $ -- $ 45,968
Non-interest income 2,076 5,670 -- 7,746
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Total operating income $ 47,292 $ 6,422 $ -- $ 53,714
Interest expense $ 13,893 $ 120 $(120) $ 13,893
Provision for loan losses 1,575 -- -- 1,575
Non-interest expense 17,185 3,676 (41) 20,820
Total operating expense $ 32,653 $ 3,796 $(161) $ 36,288
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Income before taxes on income $ 14,639 $ 2,626 $ 161 $ 17,426
Provision for income taxes 4,987 893 -- 5,880
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Net Income $ 9,652 $ 1,733 $ 161 $ 11,546
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Total Assets $ 878,032 $ 3,662 $ -- $ 881,694
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
- ------------------------------------------------- -------------------------------------------------------------------
2002
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Community Mortgage
(In thousands) Banking Lending Eliminations Total
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Interest income $ 38,430 $ 568 $ -- $ 38,998
Non-interest income 1,673 3,920 -- 5,593
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Total operating income $ 40,103 $ 4,488 $ -- $ 44,591
Interest expense $ 14,128 $ 121 $(121) $ 14,128
Provision for loan losses 1,678 -- -- 1,678
Non-interest expense 14,594 2,662 (39) 17,217
Total operating expense $ 30,400 $ 2,783 $(160) $ 33,023
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Income before taxes on income $ 9,703 $ 1,705 $ 160 $ 11,568
Provision for income taxes 3,314 578 -- 3,892
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Net Income $ 6,389 $ 1,127 $ 160 $ 7,676
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
Total Assets $644,313 $ 19,144 $ -- $663,457
- ------------------------------------------------- --------------- ------------------ --------------- ----------------
49
BUSINESS
GENERAL
Virginia Commerce Bancorp, Inc. (the "Company") was organized under Virginia law
on November 5, 1999 to become the holding company for Virginia Commerce Bank
(the "Bank"). The Company acquired all of the outstanding shares of the Bank on
December 22, 1999, upon the effectiveness of the Agreement and Plan of Share
Exchange dated September 22, 1999 between the Company and the Bank. As a result
of the Agreement and Plan of Share Exchange, each shares of the Bank's common
stock was automatically exchanged for and converted into one share of the
Company's common stock.
The Bank was organized as a national banking association and commenced
operations on May 16, 1988. On June 1, 1995, the Bank converted from a national
banking association to a Virginia chartered bank which is a member of the
Federal Reserve System.
The Company's and the Bank's executive offices, a branch with a drive-in
facility, and an investments services office are located at 5350 Lee Highway,
Arlington, Virginia. The Bank currently has fifteen additional full service
branch offices, located at: 2930 Wilson Boulevard and 6500 Williamsburg
Boulevard, both in Arlington, Virginia; 1414 Prince Street, 5140 Duke Street and
506 King Street in Alexandria, Virginia, 1356 Chain Bridge Road in McLean,
Virginia, 4230 John Marr Drive in Annandale, Virginia, 10777 Main Street in
Fairfax, Virginia, 374 Maple Avenue East in Vienna, Virginia, 13881 G Metrotech
Drive in Chantilly, Virginia, 2030 Old Bridge Road in Lake Ridge, Virginia,
11820 Spectrum Center in Reston, Virginia, 7901 Richmond Highway, Alexandria,
Virginia, 4221 Walney Road, Chantilly, Virginia, and 2401 Mount Vernon Avenue,
Alexandria, Virginia (opened in January 2005). Additionally, the Bank maintains
residential mortgage lending offices, located in Vienna and Warrenton, Virginia,
and has entered into lease agreements for three additional branch office
locations to be opened in 2005.
The Company engages in a general commercial banking business through the Bank,
its sole direct operating subsidiary. 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 business executives and consumers. The economic base of the
Bank's service area includes Arlington, Fairfax, Fauquier, Loudoun and Prince
William Counties and the City of Alexandria in Northern Virginia, and the
metropolitan Washington, D.C. area generally. Northern Virginia has experienced
significant population and economic growth during the past decade. The Bank
participated in this growth through its commercial and retail banking
activities.
The Bank's primary service area consists of 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. This area's banking business is dominated by a small number
of large commercial banks with extensive branch networks. Most are branches of
national, state-wide or regional banks. The Bank's primary service area is also
served by a large number of other financial institutions, including savings
banks, credit unions and non-bank financial institutions such as securities
brokerage firms, insurance companies and mutual funds. The Bank's primary
service area is oriented toward independently owned small-to-medium-sized
businesses, light industry and firms specializing in government contracting. An
increasing number of new community banking organizations have been opened in the
Bank's market area, potentially representing an increased competitive threat to
the Bank.
50
The banking business in Virginia generally, and in the Bank's primary service
area specifically, is highly competitive with respect to both loans and
deposits, and is dominated by a relatively small number of major banks with many
offices operating over a wide geographic area. Among the advantages such major
banks have over the Bank are their ability to finance wide-ranging advertising
campaigns and to allocate their investment assets to regions of highest yield
and demand. Such banks offer certain services such as international banking,
which are not offered directly by the Bank (but are offered indirectly through
correspondent institutions) and, by virtue of their greater total
capitalization, such banks have substantially higher lending limits than the
Bank. The Bank competes for deposits and lendable funds with other commercial
banks, savings banks, credit unions and other governmental and corporate
entities which raise operating capital through the issuance of debt and equity
securities. The Bank also competes for available investment dollars with
non-bank financial institutions, such as brokerage firms, insurance companies
and mutual funds. With respect to loans, the Bank competes with other commercial
banks, savings banks, consumer finance companies, mortgage companies, credit
unions and other lending institutions. Additionally, as a result of enactment of
federal and Virginia interstate banking legislation, additional competitors
which are not currently operating in Virginia may enter the Bank's markets and
compete directly with the Bank. Recent legislation expanding the array of firms
that can own banks may also result in increased competition for the Company and
the Bank.
The majority of the Bank's deposits are attracted from individuals and business
in the Metropolitan Washington D.C. area., and as such, no material portion of
the Bank's deposits have been obtained from any single person, single entity, or
area outside the Metropolitan Washington D.C. area. The loss of any one or more
of the Bank's depositors would not have a materially adverse effect on the
business of the Bank. Although the Bank's loans are concentrated in its Northern
Virginia Market area, and a significant portion are secured by real property in
that market, the Bank's loans are not concentrated within a single industry or
group of related industries. See Note 17 to the Consolidated Financial
Statements for more information on concentrations of credit risk.
The Bank provides businesses with a full range of deposit accounts, merchant
bankcard services, electronic funds transfer services, lock-box services,
on-line banking, lines of credit for working capital, term loans and commercial
real estate loans, and provides consumers with a wide array of deposit products,
home equity and revolving lines of credit, installment loans and internet
banking services. The Bank also offers insurance and investment services and
provides safe deposit boxes as well as other customary banking services. The
Bank is not authorized to offer trust services nor does it offer international
services but makes these services available to its customers through financial
institutions with which the Bank has correspondent banking relationships.
The Bank also offers a wide variety of residential mortgage loans through its
mortgage lending division which are originated on a pre-sold, servicing released
basis to numerous investors. Offered types include conventional single family
first trusts, FHA and VA mortgages for both purchase and refinance purposes. In
addition, the Bank offers construction loans to both individuals and commercial
builders on single family residential properties which are generally for terms
of twelve to eighteen months. Changes in the local real estate market and
interest rates could adversely impact the level of loans originated for sale and
the level of construction loans originated and outstanding, and the resulting
fees and earnings thereon.
The Bank does not depend upon seasonal business. The Bank relies substantially
on local promotional activity, personal contact by its officers, directors,
employees and stockholders, personalized service and its reputation in the
communities served to compete effectively.
The Bank has one wholly owned subsidiary, Northeast Land and Investment Company,
a Virginia corporation, organized to hold and market foreclosed real estate.
On December 31, 2004, the Company had 189 full-time equivalent employees,
including six executive officers. None of the Company's employees presently is
represented by a union or covered under a collective bargaining agreement.
Management of the Company believes that its employee relations are satisfactory.
Other than its President, the Company does not have any employees that are not
also employees of the Bank.
Banking is dependent upon interest rate differentials. In general, the
difference between the interest rate paid by the Bank on its deposits and its
other borrowings and the interest rate earned by the Bank on loans, securities
and other interest-earning assets comprises the major source of the Bank's
earnings, while increasing fees and net gains on mortgage loans originated for
sale have made a significant contribution to the Bank's non-interest earnings.
Thus, the earnings and growth of the Bank are subject to the influence of
economic conditions generally, both domestic and foreign, and also of the
monetary and fiscal policies of the United States and its agencies, particularly
the Federal Reserve Board. The Federal Reserve Board implements national
monetary policy, such as seeking to curb inflation and combat recession, by its
open-market activities in United States government securities, by adjusting the
required level of reserves for financial institutions subject to reserve
requirements and through adjustments to the discount rate applicable to
borrowings by banks which are members of the Federal Reserve System. The actions
of the Federal Reserve Board in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates. The nature and timing
of any future changes in such policies and their impact on the Bank cannot be
predicted. In addition, adverse economic conditions could make a higher
provision for loan losses a prudent course and could cause higher loan loss
charge-offs, thus adversely affecting the Bank's net income.
51
From time to time, new legislation or regulations are adopted which increase the
cost of doing business, limit or expand permissible activities, or otherwise
affect the competitive balance between banks and other financial institutions.
Bills have been introduced in each of the last several Congresses which would
permit banks to pay interest on checking and demand deposit accounts established
by businesses, a practice which is currently prohibited by regulation. If the
legislation effectively permitting the payment of interest on business demand
deposits is enacted, of which there can be no assurance, it is likely that we
may be required to pay interest on some portion of our demand deposits in order
to compete against other banks. As a significant portion of our deposits are
demand deposits established by businesses, payment of interest on these deposits
could have a significant negative impact on our net income, net interest income,
interest margin, return on assets and equity, and other indices of financial
performance. We expect that other banks would be faced with similar negative
impacts. We also expect that the primary focus of competition would continue to
be based on other factors, such as quality of service. Additionally, various
proposals are under consideration and study for the reform or revision of
deposit insurance premium assessment system. Currently, we are not subject to
payment of deposit insurance premiums and generally have not been over the past
several years. If we are required to pay deposit insurance premiums, our
earnings will be adversely affected.
Banks or bank holding companies which are undercapitalized and either have not
timely approved a capital plan or have failed to implement the plan become
subject to extraordinary powers pursuant to which the bank regulatory agencies
may close the bank, restrict its growth, force its sale, restrict interest rates
paid on deposits, and dismiss directors or senior executive officers. Each
agency has prescribed standards relating to internal controls and systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
compensation, fees and benefits, and other operational and managerial standards.
The agencies have also adopted standards relating to asset quality, earnings,
valuation and compensation. Banks or bank holding companies which do not meet
such standards may be subject to restrictions and consequences comparable to
those which apply to undercapitalized banks and bank holding companies. Bank
regulatory authority to appoint a conservator or receiver for a bank is broad,
including grounds such as substantial dissipation of assets or earnings due to
violations of law or regulation or due to any unsafe or unsound practices, an
unsafe or unsound condition, and certain violations of law or regulation likely
to weaken the institution's condition.
Regulations promulgated by the Federal Reserve Board prohibit state member banks
such as the Bank from paying any dividend on common stock out of capital.
Dividends can be paid only to the extent of net profits then on hand, less
losses and bad debts. Without the prior approval of the Federal Reserve Board, a
state member bank cannot pay dividends in any calendar year in excess of the
retained net profits for the prior two years and the profits of the current
year, less any required transfers to surplus.
LENDING ACTIVITIES
The Bank offers a wide array of lending services to its customers, including
commercial loans, commercial real estate loans, lines of credit, equipment
financing, construction loans, letters of credit, residential mortgages,
personal loans, auto loans and home equity loans and lines of credit. Loan
terms, including interest rates, loan-to-value ratios, and maturities, are
tailored as much as possible to meet the needs of the borrower within prudent
lending guidelines in terms of interest rate risk and credit risk.
When considering loan requests, the primary factors taken into consideration are
the purpose, the cash flow and financial condition of the borrower, primary and
secondary repayment sources, the value of the underlying collateral, if
applicable, and the character and integrity of the borrower. These factors are
evaluated in a number of ways including an analysis of financial statements,
credit history, trade references and visits to the borrower's place of business.
The Bank has adopted a comprehensive loan policy manual to provide its loan
officers with underwriting, term, collateral, loan-to-value and pricing
guidelines.
52
The Bank's goal is to build and maintain a commercial loan portfolio consisting
of term loans, lines of credit, commercial real estate and construction loans
provided primarily to locally-based borrowers. Additionally, installment loans
and personal lines of credit, as well as residential mortgages, are made
available to consumer customers. Commercial loans are generally considered to
have a higher degree of risk of default or loss than other types of loans, such
as residential real estate loans, because repayment may be affected by general
economic conditions, interest rates, the quality of management of the business,
and other factors which may cause a borrower to be unable to repay its
obligations. General economic conditions can directly or indirectly affect the
quality of a small and mid-sized business loan portfolio. The Bank manages the
loan portfolio to avoid high concentrations of similar industry loan types
and/or property types in relation to total capital. Commercial construction
loans will make up 50-100% of total capital, residential construction loans
125-250%, non-farm non-residential real estate loans 400-600%, residential
mortgages and home equity loans 100-200%, commercial loans 100-200% and consumer
installment and personal loans 50-100%. Overall, real estate loans will not
exceed 1,150% of total capital. There can however, be no assurance that the Bank
will be able to achieve or maintain this distribution of loans. At December 31,
2004 the loan portfolio's actual composition compared to qualified capital
consisted of approximately 53% commercial construction loans, 148% residential
construction loans, 403% non-farm non-residential real estate loans, 105%
residential mortgages and home equity loans, 74% commercial loans and 5%
consumer installment and personal loans. Total real estate loans were 709%.
The lending activities in which we engage carry the risk that borrowers will be
unable to perform on their obligations. As such, interest rate policies of the
Federal Reserve Board and general economic conditions, nationally and in our
primary market area will have a significant impact on our results of operations.
To the extent that economic conditions deteriorate, business and individual
borrowers may be less able to meet their obligations in a timely manner,
resulting in decreased earnings or losses to the Bank. To the extent that loans
are secured by real estate, adverse conditions in the real estate market may
reduce the ability of the borrower to generate the necessary cash flow for
repayment of the loan and reduce our ability to collect the full amount of the
loan upon a default. These same external factors could also negatively impact
collateral values. To the extent that the Bank makes fixed rate loans, general
increases in interest rates will tend to reduce our spread as the interest rates
we must pay for deposits increase. Interest rates may also adversely affect the
value of property pledged as security for loans.
We constantly strive to mitigate risks in the event of unforeseen threats to the
loan portfolio as a result of an economic downturn or other negative influences.
Plans for mitigating inherent risks in managing loan assets include carefully
enforcing loan policies and procedures, evaluating each borrower's industry and
business plan during the underwriting process, identifying and monitoring
primary and alternative sources for repayment, obtaining collateral that is
margined to minimize loss in the event of liquidation, ongoing tests of borrower
credit worthiness and cash flow, ongoing collateral evaluations and site
inspections and monitoring of economic and market trends
Loan business is generated primarily through referrals and direct-calling
efforts. Referrals of loan business comes from directors, shareholders, current
customers and professionals such as lawyers, accountants and financial
intermediaries.
At December 31, 2004, the Banks statutory lending limit to any single borrower
was $17,884,825 subject to certain exceptions provided under applicable law. As
of December 31, 2004, the Bank's credit exposure to its largest borrower did not
exceed $7,500,000.
Commercial Loans: Commercial loans are written for any legitimate business
purpose including the financing of plant and equipment, interim working capital
pending collection of accounts receivable, permanent working capital for growth
and the acquisition and construction of real estate projects. There is a focus
in the Bank's loan portfolio on commercial real estate investment which
represents a predominant activity in the Bank's market area. The Bank's
commercial loan portfolio reflects a diverse group of borrowers with no
significant concentration in any borrower, or group of borrowers.
Commercial construction loans, residential construction loans to builders and
land acquisition and development loans are made to builders with established
track records of quality construction. Land loans are discouraged unless
underwritten in conjunction with a related construction loan or out-sale
contract. Typical advance rates are not greater than 65% of the lesser of cost
or appraisal for raw land, 75% of the value of finished lots for land
acquisition, and 80% of land cost and 100% of construction costs for
construction loans. In all cases, a minimum 10% equity contribution of total
project costs is required. Financing terms generally do not exceed 24 months.
Construction loans are subject to progress inspections and controlled advances.
Speculative construction loans are maintained to a minimum with a majority of
loans requiring pre-sale contracts or specified lease-up thresholds prior to
construction commencement. Personal guarantees by principals of borrowing
entities is a standard requirement and loans are typically priced to float at a
factor at or above the prime lending rate.
53
Commercial real estate loans will generally represent borrower occupied
transactions with a principal reliance on the borrowing businesses' ability to
repay or investor transactions focused on tenant quality, occupancy and expense
controls, as well as prudent guidelines for assessing real estate values. Risks
inherent in managing a commercial real estate portfolio relate to either sudden
or gradual drops in property values as a result of a general or local economic
downturn. A decline in real estate values can cause loan to value margins to
increase and diminish the Bank's equity cushion on both an individual and
portfolio basis. The Bank attempts to mitigate commercial real estate lending
risks by carefully underwriting each loan of this type to address the perceived
risks in the individual transaction. Generally, the Bank requires a
loan-to-value ratio of 80% of the lesser of cost or appraisal for owner occupied
transactions and 75% for investor transactions. A borrower's ability to repay is
carefully analyzed and policy calls for a minimum ongoing cash flow to debt
service requirement of 1.10 to 1 although most loans exceed this minimum. An
approved list of commercial real estate appraisers selected on the basis of a
reputation for quality and accuracy has been established. Each appraisal is
scrutinized in an effort to insure compliance with established appraisal
guidelines and conformity with current comparable market values. The Bank
generally requires personal guarantees on all loans to closely-held entities as
a matter of policy. Borrowers are required to provide, at a minimum, annual
corporate, partnership and personal financial statements to comply with Bank
policy. Interest rate risk to the Bank is mitigated by using either floating
interest rates or by fixing rates for an intermediate period of time, generally
less than five years. While loan amortizations may be approved for up to 360
months, loans generally have a call provision (maturity date) of 10 years or
less.
Commercial term loans are used to provide funds for equipment and general
corporate needs. This loan category is designed to support borrowers who have a
proven ability to service debt over a term generally not to exceed 84 months.
The Bank typically requires a first lien position on the collateral financed and
other business assets and guarantees from owners having at least a 20% interest
in the business. Interest rates on commercial term loans generally float or are
fixed for a term not to exceed five years. Management carefully monitors
industry and collateral concentrations to avoid loan exposures to a large group
of similar industries and/or similar collateral. Commercial loans are evaluated
for historical and projected cash flow, balance sheet strength and primary and
secondary repayment sources. Commercial term loan documents include certain
financial and performance covenants and require borrowers to forward regular
financial information on both the business and on personal guarantors at least
annually. In certain cases, this information is required more frequently,
depending on the degree to which lenders desire information to monitor a
borrower's financial condition and compliance with loan covenants. Key person
life insurance is required as appropriate and as necessary to mitigate the risk
associated with the loss of a primary owner or manager.
Commercial lines of credit are used to finance a business borrower's short-term
or seasonal credit needs and advances are often based on a percentage of
eligible receivables and inventory. In addition to the risks inherent in term
loan facilities, line of credit borrowers typically require additional
monitoring to protect the lender against diminishing collateral values.
Commercial lines of credit are generally revolving in nature and payable on
demand. The Bank generally requires at least an annual rest period (for seasonal
borrowers) and regular financial information (monthly or quarterly financial
statements, monthly accounts receivable agings, borrowing base certificates,
etc.) for borrowers with rapid growth and permanent working capital financing
needs. Advances against collateral are generally margined, limiting advances on
eligible receivables to 75-80% of current accounts. Lines of credit and term
loans to the same borrowers are generally cross-defaulted and
cross-collateralized. Industry and collateral concentration disciplines are the
same as those used in managing the commercial term loan portfolio. Interest rate
charges on this group of loans generally float at a factor at or above the prime
lending rate. Generally, personal guarantees are also required on these loans.
Consumer Loans. Loans are considered for any worthwhile personal purpose on a
case-by-case basis, such as financing of tuition, household expenditures, home
and automobile financing. Consumer credit facilities are underwritten to focus
on the borrower's credit record, length and stability of employment, income to
service debt and quality of collateral. Residential real estate loans held in
portfolio are limited to advances of 90% of loan to appraised value. Maximum
debt to income ratio established by loan policy is 40% and maximum unsecured
revolving debt will not exceed 10% of net worth. Installment loan terms range
out to 72 months and are priced at fixed interest rate. Home equity loans
amortize over 5-15 years and are fixed rate while home equity lines are
revolving with 10-year maturities and have floating rates tied to the prime
rate.
54
Mortgage Lending. The Company originates residential mortgage loans, on a
pre-sold basis, for sale to secondary market purchasers, on a servicing released
basis. This produces benefits primarily in the form of gains on the sale of the
loans at a premium. Activity in the residential mortgage loan market is highly
sensitive to changes in interest rates. The loans are sold on a limited recourse
basis. Most contracts with investors contain recourse periods that may vary from
90 days up to one year. In general, the Company may be required to repurchase a
previously sold mortgage loan or indemnify the investor if there is major
non-compliance with defined loan origination or documentation standards,
including fraud, negligence or material misstatement in the loan documents.
Repurchase may also be required if necessary governmental loan guarantees are
canceled or never issued, or if an investor is forced to buy back a loan after
it has been re-sold as part of a loan pool. In addition, the Company may have an
obligation to repurchase a loan if the mortgagor has defaulted early in the loan
term. The potential default period is approximately twelve months after sale of
the loan to the investor. Mortgages subject to recourse are collateralized by
single-family residential properties, have loan-to-value ratios of 80% or less,
or have private mortgage insurance or are insured or guaranteed by an agency of
the United States government.
Loan Administration. As part of its internal loan administration process, the
Bank's Directors Loan Committee, comprised of directors, reviews all loans
30-days delinquent, loans on the watch list, loans rated special mention,
substandard, or doubtful and other loans of concern at least quarterly. The
Committee also reviews new loan production, credit concentrations, loan loss
reserves, declined loans, documentation exceptions, loan policy exceptions, new
products and pricing. The Committee commissions periodic documentation and
internal control reviews by outside vendors to complement internal audit and
credit administration oversight.
REGULATION, SUPERVISION, AND GOVERNMENTAL POLICY
The Company. The Company is a bank holding company registered under Bank Holding
Company Act of 1956, as amended, (the "BHCA") and is subject to supervision by
the Federal Reserve Board. As a bank holding company, the Company is required to
file with the Federal Reserve Board an annual report and such other additional
information as the Federal Reserve Board may require pursuant to the BHCA. The
Federal Reserve Board may also make examinations of the Company and each of its
subsidiaries.
BHCA - Activities and other Limitations. The BHCA requires approval of the
Federal Reserve Board for, among other things, the acquisition by a proposed
bank holding company of control of more than five percent (5%) of the voting
shares, or substantially all the assets, of any bank or the merger or
consolidation by a bank holding company with another bank holding company. The
BHCA also generally permits the acquisition by a bank holding company of control
or substantially all the assets of any bank located in a state other than the
home state of the bank holding company, except where the bank has not been in
existence for the minimum period of time required by state law, but if the bank
is at least 5 years old, the Federal Reserve Board may approve the acquisition.
Under current law, with certain limited exceptions, a bank holding company is
prohibited from acquiring control of any voting shares of any company which is
not a bank or bank holding company and from engaging directly or indirectly in
any activity other than banking or managing or controlling banks or furnishing
services to or performing service for its authorized subsidiaries. A bank
holding company may, however, engage in or acquire an interest in, a company
that engages in activities which the Federal Reserve Board has determined by
order or regulation to be so closely related to banking or managing or
controlling banks as to be properly incident thereto. In making such a
determination, the Federal Reserve Board is required to consider whether the
performance of such activities can reasonably be expected to produce benefits to
the public, such as convenience, increased competition or gains in efficiency,
which outweigh possible adverse effects, such as undue concentration of
resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. The Federal Reserve Board is also empowered to differentiate
between activities commenced de novo and activities commenced by the
acquisition, in whole or in part, of a going concern. Some of the activities
that the Federal Reserve Board has determined by regulation to be closely
related to banking include making or servicing loans, performing certain data
processing services, acting as a fiduciary or investment or financial advisor,
and making investments in corporations or projects designed primarily to promote
community welfare.
Effective on March 11, 2000, the Gramm Leach Bliley Act of 1999 (the "GLB Act")
allows a bank holding company or other company to certify status as a financial
holding company, which allows such company to engage in activities that are
financial in nature, that are incidental to such activities, or are
complementary to such activities. The GLB Act enumerates certain activities that
are deemed financial in nature, such as underwriting insurance or acting as an
insurance principal, agent or broker, underwriting, dealing in or making markets
in securities, and engaging in merchant banking under certain restrictions. It
also authorizes the Federal Reserve Board to determine by regulation what other
activities are financial in nature, or incidental or complementary thereto.
55
Subsidiary banks of a bank holding company are subject to certain restrictions
imposed by the Federal Reserve Act on any extensions of credit to the bank
company or any of its subsidiaries, or investments in the stock or other
securities thereof, and on the taking of such stock or securities as collateral
for loans to any borrower. Further, a holding company and any subsidiary bank
are prohibited from engaging in certain tie-in arrangements in connection with
the extension of credit. A subsidiary bank may not extend credit, lease or sell
property, or furnish any services, or fix or vary the consideration for any of
the foregoing on the condition that: (i) the customer obtain or provide some
additional credit, property or services from or to such bank other than a loan,
discount, deposit or trust service; (ii) the customer obtain or provide some
additional credit, property or service from or to company or any other
subsidiary of the company; or (iii) the customer not obtain some other credit,
property or service from competitors, except for reasonable requirements to
assure the soundness of credit extended.
Commitments to Subsidiary Banks. Under Federal Reserve policy, the Company is
expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances when it might not do so absent
such policy.
Limitations of Acquisitions of Common Stock. The federal Change in Bank Control
Act prohibits a person or group from acquiring "control" of a bank holding
company unless the Federal Reserve has been given 60 days' prior written notice
of such proposed acquisition and within that time period the Federal Reserve
Board has not issued a notice disapproving the proposed acquisition or extending
for up to another 30 days the period during which such a disapproval may be
issued. An acquisition may be made prior to expiration of the disapproval period
if the Federal Reserve issues written notice of its intent not to disapprove the
action. Under a rebuttable presumption established by the Federal Reserve, the
acquisition of 10% or more of a class of voting stock of a bank holding company
with a class of securities registered under Section 12 of the Exchange Act or
which would represent the single largest interest in the voting stock would,
under the circumstances set forth in the presumption, constitute the acquisition
of control.
In addition, with limited exceptions, any "company" would be required to obtain
the approval of the Federal Reserve under the BHCA before acquiring 25% (5% in
the case of an acquirer that is a bank holding company) or more of the
outstanding Common Stock of, or such lesser number of shares as constitute
control over, the Company. Such approval would be contingent upon, among other
things, the acquirer registering as a bank holding company, divesting all
impermissible holdings and ceasing any activities not permissible for a bank
holding company.
The Federal Reserve has adopted capital adequacy guidelines pursuant to which it
assesses the adequacy of an institution's capital. These guidelines are
substantially similar to those which are applicable to the Bank, discussed
below.
The Bank. The Bank, as a Virginia chartered commercial bank which is a member of
the Federal Reserve System (a "state member bank") and whose accounts are
insured by the Bank Insurance Fund of the FDIC up to the maximum legal limits of
the FDIC, is subject to regulation, supervision and regular examination by the
Bureau of Financial Institutions and the Federal Reserve Board. The regulations
of these various agencies govern most aspects of the Bank's business, including
required reserves against deposits, loans, investments, mergers and
acquisitions, borrowing, dividends and location and number of branch offices.
The laws and regulations governing the Bank generally have been promulgated to
protect depositors and the deposit insurance funds, and not for the purpose of
protecting stockholders.
Competition among commercial banks, savings banks, and credit unions has
increased following enactment of legislation which greatly expanded the ability
of banks and bank holding companies to engage in interstate banking or
acquisition activities. As a result of federal and state legislation, banks in
the Washington D.C./Maryland/Virginia area can, subject to limited restrictions,
acquire or merge with a bank in another of the jurisdictions, and can branch de
novo in any of the jurisdictions. The GLB Act allows a wider array of companies
to own banks, which could result in companies with resources substantially in
excess of the Company's entering into competition with the Company and the Bank.
Branching and Interstate Banking. The federal banking agencies are authorized to
approve interstate bank merger transactions without regard to whether such
transaction is prohibited by the law of any state, unless the home state of one
of the banks has opted out of the interstate bank merger provisions of the
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Riegle-Neal Act") by adopting a law after the date of enactment of the
Riegle-Neal Act and prior to June 1, 1997 which applies equally to all
out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. Interstate acquisitions of branches are permitted only if
the law of the state in which the branch is located permits such acquisitions.
Such interstate bank mergers and branch acquisitions are also subject to the
nationwide and statewide insured deposit concentration limitations described in
the Riegle-Neal Act.
56
The Riegle-Neal Act authorizes the federal banking agencies to approve
interstate branching de novo by national and state banks in states which
specifically allow for such branching. The District of Columbia, Maryland and
Virginia have all enacted laws which permit interstate acquisitions of banks and
bank branches and permit out-of-state banks to establish de novo branches.
USA Patriot Act. Under the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act, commonly
referred to as the "USA Patriot Act" or the "Patriot Act", financial
institutions are subject to prohibitions against specified financial
transactions and account relationships, as well as enhanced due diligence
standards intended to detect, and prevent, the use of the United States
financial system for money laundering and terrorist financing activities. The
Patriot Act requires financial institutions, including banks, to establish
anti-money laundering programs, including employee training and independent
audit requirements, meet minimum standards specified by the act, follow minimum
standards for customer identification and maintenance of customer identification
records, and regularly compare customer lists against lists of suspected
terrorists, terrorist organizations and money launderers. The costs or other
effects of the compliance burdens imposed by the Patriot Act or future
anti-terrorist, homeland security or anti-money laundering legislation or
regulations cannot be predicted with certainty.
Capital Adequacy Guidelines. The Federal Reserve Board and the FDIC have adopted
risk based capital adequacy guidelines pursuant to which they assess the
adequacy of capital in examining and supervising banks and bank holding
companies and in analyzing bank regulatory applications. Risk-based capital
requirements determine the adequacy of capital based on the risk inherent in
various classes of assets and off-balance sheet items.
State member banks are expected to meet a minimum ratio of total qualifying
capital (the sum of core capital (Tier 1) and supplementary capital (Tier 2)) to
risk weighted assets of 8%. At least half of this amount (4%) should be in the
form of core capital. Tier 1 Capital generally consists of the sum of common
stockholders' equity and perpetual preferred stock (subject in the case of the
latter to limitations on the kind and amount of such stock which may be included
as Tier 1 Capital), less goodwill, without adjustment for changes in the market
value of securities classified as "available for sale" in accordance with FAS
115. Tier 2 Capital consists of the following: hybrid capital instruments;
perpetual preferred stock which is not otherwise eligible to be included as Tier
1 Capital; term subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan losses. Assets are adjusted
under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no risk-based
capital) for assets such as cash and certain U.S. government and agency
securities, to 100% for the bulk of assets which are typically held by a bank
holding company, including commercial real estate loans, commercial business
loans and consumer loans. Residential first mortgage loans on one to four family
residential real estate and certain seasoned multi-family residential real
estate loans, which are not 90 days or more past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
In addition to the risk-based capital requirements, the Federal Reserve Board
has established a minimum 3.0% Leverage Capital Ratio (Tier 1 Capital to total
adjusted assets) requirement for the most highly-rated banks, with an additional
cushion of at least 100 to 200 basis points for all other banks, which
effectively increases the minimum Leverage Capital Ratio for such other banks to
4.0% - 5.0% or more. The highest-rated banks are those that are not anticipating
or experiencing significant growth and have well diversified risk, including no
undue interest rate risk exposure, excellent asset quality, high liquidity, good
earnings and, in general, those which are considered a strong banking
organization. A bank having less than the minimum Leverage Capital Ratio
requirement shall, within 60 days of the date as of which it fails to comply
with such requirement, submit a reasonable plan describing the means and timing
by which the bank shall achieve its minimum Leverage Capital Ratio requirement.
A bank which fails to file such plan is deemed to be operating in an unsafe and
unsound manner, and could subject a bank to a cease-and-desist order. Any
insured depository institution with a Leverage Capital Ratio that is less than
2.0% is deemed to be operating in an unsafe or unsound condition pursuant to
Section 8(a) of the Federal Deposit Insurance Act (the "FDIA") and is subject to
potential termination of deposit insurance. However, such an institution will
not be subject to an enforcement proceeding solely on account of its capital
ratios, if it has entered into and is in compliance with a written agreement to
increase its Leverage Capital Ratio and to take such other action as may be
necessary for the institution to be operated in a safe and sound manner. The
capital regulations also provide, among other things, for the issuance of a
capital directive, which is a final order issued to a bank that fails to
maintain minimum capital or to restore its capital to the minimum capital
requirement within a specified time period. Such directive is enforceable in the
same manner as a final cease-and-desist order.
57
At December 31, 2004, the Bank's Tier 1 risk based capital ratio was 9.01%, its
Total risk based capital ratio was 11.82% and its Leverage Capital ratio was
8.09%. At December 31, 2004, the Company's Tier 1 Capital was 10.89%, its Total
Capital was 11.92% and its Leverage Capital ratio was 9.76%.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking
agency is required to implement a system of prompt corrective action for
institutions which it regulates. The federal banking agencies have promulgated
substantially similar regulations to implement the system of prompt corrective
action established by Section 38 of the FDIA. Under the regulations, a bank
shall be deemed to be: (i) "well capitalized" if it has a Total Risk Based
Capital Ratio of 10.0% or more, a Tier 1 Risk Based Capital Ratio of 6.0% or
more, a Leverage Capital Ratio of 5.0% or more and is not subject to any written
capital order or directive; (ii) "adequately capitalized" if it has a Total Risk
Based Capital Ratio of 8.0% or more, a Tier 1 Risk Based Capital Ratio of 4.0%
or more and a Tier 1 Leverage Capital Ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized;" (iii)
"undercapitalized" if it has a Total Risk Based Capital Ratio that is less than
8.0%, a Tier 1 Risk based Capital Ratio that is less than 4.0% or a Leverage
Capital Ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a Total Risk Based Capital Ratio that
is less than 6.0%, a Tier 1 Risk Based Capital Ratio that is less than 3.0% or a
Leverage Capital Ratio that is less than 3.0%; and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%.
An institution generally must file a written capital restoration plan which
meets specified requirements with an appropriate federal banking agency within
45 days of the date the institution receives notice or is deemed to have notice
that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. A federal banking agency must provide the institution with
written notice of approval or disapproval within 60 days after receiving a
capital restoration plan, subject to extensions by the applicable agency. An
institution which is required to submit a capital restoration plan must
concurrently submit a performance guaranty by each company that controls the
institution. Such guaranty shall be limited to the lesser of (i) an amount equal
to 5.0% of the institution's total assets at the time the institution was
notified or deemed to have notice that it was undercapitalized or (ii) the
amount necessary at such time to restore the relevant capital measures of the
institution to the levels required for the institution to be classified as
adequately capitalized. Such a guaranty shall expire after the federal banking
agency notifies the institution that it has remained adequately capitalized for
each of four consecutive calendar quarters. An institution which fails to submit
a written capital restoration plan within the requisite period, including any
required performance guaranty, or fails in any material respect to implement a
capital restoration plan, shall be subject to the restrictions in Section 38 of
the FDIA which are applicable to significantly undercapitalized institutions. At
December 31, 2004, the Bank was considered to be a "well capitalized"
institution for purposes of Section 38 of the FDIA.
A "critically undercapitalized institution" is to be placed in conservatorship
or receivership within 90 days unless the FDIC formally determines that
forbearance from such action would better protect the deposit insurance fund.
Unless the FDIC or other appropriate federal banking regulatory agency makes
specific further findings and certifies that the institution is viable and is
not expected to fail, an institution that remains critically undercapitalized on
average during the fourth calendar quarter after the date it becomes critically
undercapitalized must be placed in receivership. The general rule is that the
FDIC will be appointed as receiver within 90 days after a bank becomes
critically undercapitalized unless extremely good cause is shown and an
extension is agreed to by the federal regulators. In general, good cause is
defined as capital which has been raised and is imminently available for
infusion into the bank except for certain technical requirements which may delay
the infusion for a period of time beyond the 90 day time period.
Immediately upon becoming undercapitalized, an institution shall become subject
to the provisions of Section 38 of the FDIA, which (i) restrict payment of
capital distributions and management fees; (ii) require that the appropriate
federal banking agency monitor the condition of the institution and its efforts
to restore its capital; (iii) require submission of a capital restoration plan;
(iv) restrict the growth of the institution's assets; and (v) require prior
approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any number of discretionary
supervisory actions if the agency determines that any of these actions is
necessary to resolve the problems of the institution at the least possible
long-term cost to the deposit insurance fund, subject in certain cases to
specified procedures. These discretionary supervisory actions include: requiring
the institution to raise additional capital; restricting transactions with
affiliates; requiring divestiture of the institution or the sale of the
institution to a willing purchaser; and any other supervisory action that the
agency deems appropriate. These and additional mandatory and permissive
supervisory actions may be taken with respect to significantly undercapitalized
and critically undercapitalized institutions.
58
Additionally, under Section 11(c)(5) of the FDIA, a conservator or receiver may
be appointed for an institution where: (i) an institution's obligations exceed
its assets; (ii) there is substantial dissipation of the institution's assets or
earnings as a result of any violation of law or any unsafe or unsound practice;
(iii) the institution is in an unsafe or unsound condition; (iv) there is a
willful violation of a cease-and-desist order; (v) the institution is unable to
pay its obligations in the ordinary course of business; (vi) losses or
threatened losses deplete all or substantially all of an institution's capital,
and there is no reasonable prospect of becoming "adequately capitalized" without
assistance; (vii) there is any violation of law or unsafe or unsound practice or
condition that is likely to cause insolvency or substantial dissipation of
assets or earnings, weaken the institution's condition, or otherwise seriously
prejudice the interests of depositors or the insurance fund; (viii) an
institution ceases to be insured; (ix) the institution is undercapitalized and
has no reasonable prospect that it will become adequately capitalized, fails to
become adequately capitalized when required to do so, or fails to submit or
materially implement a capital restoration plan; or (x) the institution is
critically undercapitalized or otherwise has substantially insufficient capital.
Regulatory Enforcement Authority. Federal banking law grants substantial
enforcement powers to federal banking regulators. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease-and-desist or removal orders and to initiate injunctive actions
against banking organizations and institution-affiliated parties. In general,
these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with regulatory authorities.
Deposit Insurance Premiums. The FDIA establishes a risk based deposit insurance
assessment system. Under applicable regulations, deposit premium assessments are
determined based upon a matrix formed utilizing capital categories - well
capitalized, adequately capitalized and undercapitalized - defined in the same
manner as those categories are defined for purposes of Section 38 of the FDIA.
Each of these groups is then divided into three subgroups which reflect varying
levels of supervisory concern, from those which are considered healthy to those
which are considered to be of substantial supervisory concern. The matrix so
created results in nine assessment risk classifications, with rates ranging from
0.04% of insured deposits for well capitalized institutions having the lowest
level of supervisory concern, to 0.31% of insured deposits for undercapitalized
institutions having the highest level of supervisory concern. In general, while
the Bank Insurance Fund of the FDIC ("BIF") maintains a reserve ratio of 1.25%
or greater, no deposit insurance premiums are required. When the BIF reserve
ratio falls below that level, all insured banks would be required to pay
premiums.
PROPERTIES
The Bank offers its services from its main office, located at 5350 Lee Highway
in Arlington, Virginia, and fifteen additional banking offices, two mortgage
lending offices and its bank operations center. The main office consists of two
connected red brick buildings, contains an aggregate of approximately 18,000
square feet of space on three levels. The Bank utilizes one of the buildings,
containing approximately 10,000 square feet, as the executive offices and a
branch facility. In August 1995, the Bank sold the connected building which it
had previously leased out. The Bank operates a branch located at 2930 Wilson
Boulevard, Arlington, Virginia. That property, which consists of a stand alone
brick building containing approximately 2,400 square feet on a parcel of
approximately 18,087 square feet, was purchased by the Bank in April 1997. The
Bank also operates a branch location at 5140 Duke Street, Alexandria, Virginia.
That property, which consists of a two story brick building containing
approximately 4,800 square feet on a parcel of approximately 16,800 square feet,
was also purchased by the Bank in April 1997.
The Bank leases thirteen locations: the Alexandria Office, located at 1414
Prince Street, Alexandria, Virginia, consists of 2,500 square feet; the McLean
Office, located at 1356 Chain Bridge Road, McLean, Virginia, consists of 1,625
square feet; the Williamsburg Boulevard Office, located at 6500 Williamsburg
Road, Arlington, Virginia, consists of 1,781 square feet; the Annandale Office,
located at 4230 John Marr Drive, Annandale, Virginia, consists of 2,400 square
feet; the Fairfax Office, located at 10777 Main Street, Fairfax Virginia,
consists of 2,038 square feet; the Vienna Office, located at 374 Maple Avenue,
Vienna, Virginia, consists of 5,831 square feet; the King Street Office, located
at 506 King Street, Alexandria Virginia, consists of 1,484 square feet; the
Chantilly Office, located at 13881 G Metrotech Drive, Chantilly Virginia,
consists of 1,950 square feet; the Lake Ridge office, located at 2030 Old Bridge
Road, Lake Ridge, Virginia consists of 2,492 square feet; the Reston Office,
located at 11820 Spectrum Center, Reston Virginia consists of 3,700 square feet,
the Mount Vernon office, located at 7901 Richmond Highway, Alexandria Virginia,
consists of 2,831 square feet; the Walney Road office, located at 4221Walney
Road, Chantilly Virginia, consists of 2,661 square feet; the Del Ray office
(opened in January 2005), located at 2401 Mount Vernon Avenue, Alexandria
Virginia, consists of 1,750 square feet; and the Bank's operations center,
located at 14201 Sullyfield Circle, Chantilly, Virginia consists of 14,756
square feet. Generally the leases contain renewal option clauses for one or two
additional five-year terms, and in some instances require payment of certain
operating charges. In addition, the Bank has entered into lease agreements for
three additional offices to be opened in 2005. The total rental expense under
the leases was $1.3 million in 2004. The total minimum rental commitment under
the leases, including the three offices to be opened in 2005, as of December 31,
2004 is as follows: $1.5 million for 2005; $1.2 million for 2006, $1.2 million
for 2007, $1.1 million for 2008, $892 thousand for 2009 and $4.2 million for
2010 and beyond.
59
CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the participation of
the Chief Executive Officer and Chief Financial Officer, evaluated, as of the
last day of he period covered by this report, the effectiveness of the design
and operation of the Company's disclosure controls and procedures, as defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were adequate. There were
no changes in the Company's internal control over financial reporting (as
defined in Rule 13a-15 under the Securities Act of 1934) during the quarter
ended December 31, 2004 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Virginia Commerce Bancorp, Inc. (the "Company") is responsible
for the preparation, integrity and fair presentation of the financial statements
included in this Annual Report.. The financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America and reflect management's judgments and estimates concerning the effects
of events and transactions that are accounted for or disclosed.
Management is also responsible for establishing and maintaining an effective
internal control over financial reporting. The Company's internal control over
financial reporting includes those policies and procedures that pertain to the
Company's ability to record, process, summarize and report reliable financial
data. The internal control system contains monitoring mechanisms, and
appropriate actions are taken to correct identified deficiencies. Management
believes that internal controls over financial reporting, which are subject to
scrutiny by management and the Company's internal auditors, support the
integrity and reliability of the financial statements. Management recognizes
that there are inherent limitations in the effectiveness of any internal control
system, including the possibility of human error and the circumvention or
overriding of internal controls. Accordingly, even effective internal control
over financial reporting can provide only reasonable assurance with respect to
financial statement preparation. In addition, because of changes in conditions
and circumstances, the effectiveness of internal control over financial
reporting may vary over time.
Management assessed the Company's system of internal control over financial
reporting as of December 31, 2004. This assessment was conducted based on the
Committee of Sponsoring Organizations ("COSO") of the Treadway Commission
"Internal Control - Integrated Framework". Based on this assessment, management
believes that the Company maintained effective internal control over financial
reporting as of December 31, 2004. Management's assessment concluded that there
were no material weaknesses within the Company's internal control structure.
The 2004 end of year financial statements have been audited by the independent
accounting firm of Yount, Hyde & Barbour, P.C. ("YHB"). Personnel from YHB were
given unrestricted access to all financial records and related data, including
minutes of all meetings of the Board of Directors and Committees thereof.
Management believes that all representations made to the independent auditors
were valid and appropriate. The resulting report from YHB accompanies the
financial statements. YHB has also issued an attestation report on management's
assessment of the effectiveness of internal controls over financial reporting.
That report has also been made a part of this Annual Report.
60
The Board of Directors of the Company, acting through its Audit Committee (the
"Committee"), is responsible for the oversight of the Company's accounting
policies, financial reporting and internal control. The Audit Committee of the
Board of Directors is comprised entirely of outside directors who are
independent of management. The Audit Committee is responsible for the
appointment and compensation of the independent auditors and approves decisions
regarding the appointment or removal of members of the internal audit function.
The Committee meets periodically with management, the independent auditors, and
the internal auditors to insure that they are carrying out their
responsibilities. The Committee is also responsible for performing an oversight
role by reviewing and monitoring the financial, accounting, and auditing
procedures of the Company in addition to reviewing the Company's financial
reports. The independent auditors and the internal auditors have full and
unlimited access to the Audit Committee, with or without the presence of the
management of the Company, to discuss the adequacy of internal control over
financial reporting, and any other matters which they believe should be brought
to the attention of the Audit Committee.
/s/ Peter A. Converse /s/ William K. Beauchesne
Chief Executive Officer Chief Financial Officer
FINANCIAL STATEMENTS AND EXHIBITS
The following financial statements are included in this report:
Consolidated Balance Sheets at December 31, 2003 and 2004
Consolidated Statements of Income for the years ended December 31, 2002,
2003 and 2004
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2003 and 2004
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 2002, 2003 and 2004
Notes to the Consolidated Financial Statements
Report of Independent Auditors
All financial statement schedules have been omitted as the required information
is either inapplicable or included in the consolidated financial statements or
related notes.
Exhibits
Exhibit No. Description
----------- -----------
3.1 Articles of Incorporation of Virginia Commerce Bancorp,
Inc. (1)
3.2 Bylaws of Virginia Commerce Bancorp, Inc. (1)
4.1 Junior Subordinated Indenture, dated as of November 15, 2002
between Virginia Commerce Bancorp, Inc. and The Bank of New
York, as Trustee (2)
4.2 Amended and Restated Declaration of Trust, dated as of
November 15, 2002 among Virginia Commerce Bancorp, Inc., The
Bank of New York, as Property Trustee, The Bank of New York
(Delaware), as Delaware Trustee, and Peter A. Converse,
William K. Beauchesne and Marcia J. Hopkins as
Administrative Trustees (2)
4.3 Guarantee Agreement dated as of November 15, 2002, between
Virginia Commerce Bancorp, Inc. and The Bank of New York, as
Guarantee Trustee (2)
4.4 Junior Subordinated Indenture, dated as of December 19, 2002
between Virginia Commerce Bancorp, Inc. and The Bank of New
York, as Indenture Trustee (2)
4.5 Amended and Restated Declaration of Trust, dated as of
December 19, 2002 among Virginia Commerce Bancorp, Inc., The
Bank of New York, as Property Trustee, The Bank of New York
(Delaware), as Delaware Trustee, and Peter A. Converse,
William K. Beauchesne and Marcia J. Hopkins as
Administrative Trustees (2)
4.6 Guarantee Agreement dated as of December 19, 2002, between
Virginia Commerce Bancorp, Inc. and The Bank of New York, as
Guarantee Trustee (2)
10.1 1998 Stock Option Plan (1)
10.2 2003 Employee Stock Purchase Plan (3)
11 Statement Regarding Computation of Per Share Earnings
See Note 8 to the Consolidated Financial Statements
21 Subsidiaries of the Registrant
23 Consent of Yount, Hyde & Barbour, PC, Independent Registered
Public Accounting Firm
31.1 Certification of Peter A. Converse, President and Chief
Executive Officer
61
Exhibit No. Description
----------- -----------
31.2 Certification of William K. Beauchesne, Treasurer and Chief
Financial Officer
32.1 Certification of Peter A. Converse, President and Chief
Executive Officer
32.2 Certification of William K. Beauchesne, Treasurer and Chief
Financial Officer
(1) Incorporated by reference to the same numbered exhibit to the Company's
Annual Report on Form 10-KSB for the year ended December 31,1999.
(2) Not filed in accordance with the provisions of Item 601(b)(4)(iii) of
Regulation S-K. Virginia Commerce Bancorp, Inc. agrees to provide a copy of
these documents to the Commission upon request.
(3) Incorporated by reference to exhibit 4 to the Company's Registration
Statement on Form S-8 (No. 333-109079).
62
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
VIRGINIA COMMERCE BANCORP, INC.
By: /s/ Peter A. Converse
-------------------------------------------
Peter A. Converse, Chief Executive Officer
Dated: March 9, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
NAME CAPACITY DATE
/s/ Leonard Adler Director March 9, 2005
- ------------------------------------
Leonard Adler
/s/ Michael G. Anzilotti Director, President March 9, 2005
- ------------------------------------
Michael G. Anzilotti
/s/ Peter A. Converse Director, Chief Executive Officer March 9, 2005
- ------------------------------------
Peter A. Converse (Principal Executive Officer)
/s/Frank L. Cowles, Jr. Director March 9, 2005
- ------------------------------------
Frank L. Cowles, Jr.
/s/ W. Douglas Fisher Chairman of the Board of Directors March 9, 2005
- ------------------------------------
W. Douglas Fisher
/s/ David M. Guernsey Vice Chairman of the Board of Directors March 9, 2005
- ------------------------------------
David M. Guernsey
/s/ Robert H. L'Hommedieu Director March 9, 2005
- ------------------------------------
Robert H. L'Hommedieu
/s/ Norris E. Mitchell Director March 9, 2005
- ------------------------------------
Norris E. Mitchell
/s/ Arthur L. Walters Vice Chairman of the Board of Directors March 9, 2005
- ------------------------------------
Arthur L. Walters
/s/ William K. Beauchesne Treasurer and Chief Financial Officer March 9, 2005
- ------------------------------------
William K. Beauchesne (Principal Financial and Accounting Officer)
63