U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the fiscal year ended December 31, 2005
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _________ to _________
Commission file number: 0-25923
Eagle Bancorp, Inc.
(Exact Name of Registrant as Specified in its Charter)
Maryland 52-2061461
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
7815 Woodmont Avenue, Bethesda, Maryland 20814
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including area code: (301) 986-1800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock $.01
par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Section 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act Yes [ ] No [X]
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 in pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
The aggregate market value of the outstanding Common Stock held by nonaffiliates
as of June 30, 2005 was approximately $120 million.
As of February 28, 2006, the number of outstanding shares of the Common Stock,
$.01 par value, of Eagle Bancorp, Inc. was 7,233,864.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on May 25, 2006 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
May 25, 2006, 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 48 through 60.
ITEM 1A. RISK FACTORS. See "Risk Factors" at Pages 51 through 54.
ITEM 1B. UNRESOLVED STAFF COMMENTS. NONE
ITEM 2. PROPERTIES. See "Properties" at Page 60.
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 proceedings 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 2005.
PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS. See "Market for Common Stock and Dividends" at Page
23.
ITEM 6. SELECTED FINANCIAL DATA. See "Six Year Summary of Financial
Information" 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 22.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
See "Interest Rate Risk Management - Asset/Liability
Management and Quantitative and Qualitative Disclosure About
Market Risk" at Page 19.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See
Consolidated Financial Statements and Notes thereto at Pages
24 through 47.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE. None.
ITEM 9A. CONTROLS AND PROCEDURES. See "Controls and Procedures" at
Page 61 and "Management Report on Internal Control Over
Financial Reporting" at Page 62.
ITEM 9B. OTHER INFORMATION. None.
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The
information required by this Item is incorporated by
reference to, the material appearing under the captions
"Election of Directors"; "Executive Officers who are Not
Directors"; and "Compliance with Section 16(a) of the
Securities Exchange Act of 1934" in 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 Zandra
Nichols, Corporate Secretary, Eagle Bancorp, Inc., 7815
Woodmont Avenue, Bethesda, Maryland 20814.
ITEM 11. EXECUTIVE COMPENSATION. The information required by this
Item is incorporated by reference to the material appearing
under the captions "Election of Directors - Director's
Compensation"; "- Executive Compensation" and "- Report of
the Compensation Committee" and "Stock Performance
Comparison" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information
required by this Item is incorporated by reference to the
material appearing under the caption "Voting Securities and
Principal Shareholders".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The
information required by this Item is incorporated by
reference to the material appearing under the caption
"Election of Directors - Certain Relationships and Related
Transactions" in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. The information
required by this Item is incorporated by reference to the
material appearing under the caption "Independent Registered
Public Accounting Firm - Fees Paid to Independent Accounting
Firm" in the Proxy Statement.
PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. See "Exhibits
and Financial Statements" at Page 64.
2
SIX YEAR SUMMARY OF SELECTED FINANCIAL DATA
The following table shows selected historical consolidated financial data for
Eagle Bancorp ("the Company"). It should be read in conjunction with the
Company's audited consolidated financial statements appearing elsewhere in this
report.
Year Ended December 31, 5 Year
--------------------------------------------------------------------- Compound
(dollars in thousands except per share data) 2005 2004 2003 2002 2001 2000 Growth Rate
-------------------------------------------- --------- --------- --------- --------- --------- --------- -----------
SELECTED BALANCES- PERIOD END
Total assets $ 672,252 $ 553,453 $ 442,997 $ 347,829 $ 236,833 $ 164,082 33%
Total stockholders' equity 64,964 58,534 53,012 20,028 17,132 15,522 33%
Total loans 549,212 415,509 317,533 236,860 182,256 116,576 36%
Total deposits 568,893 462,287 335,514 278,434 195,688 135,857 33%
SELECTED BALANCES - AVERAGES
Total assets $ 610,245 $ 487,853 $ 375,802 $ 292,921 $ 198,843 $ 136,756 35%
Total stockholders' equity 61,563 55,507 34,028 18,381 16,615 14,571 33%
Total loans 479,311 353,537 266,811 210,303 149,056 84,767 41%
Total deposits 512,416 397,788 292,953 237,910 166,118 110,765 36%
RESULTS OF OPERATIONS
Interest income $ 36,726 $ 24,195 $ 18,403 $ 16,661 $ 14,121 $ 10,501 28%
Interest expense 8,008 4,328 3,953 5,170 5,998 4,549 12%
Net interest income 28,718 19,867 14,450 11,491 8,123 5,952 37%
Provision for credit losses 1,843 675 1,175 843 979 581 26%
Net interest income after
provision for credit losses 26,875 19,192 13,275 10,648 7,144 5,371 38%
Noninterest income 3,998 3,753 2,850 2,107 1,324 351 63%
Noninterest expense 18,960 14,952 11,007 8,530 6,445 4,664 32%
Income before taxes 11,913 7,993 5,118 4,225 2,023 1,058 62%
Income tax expense 4,369 2,906 1,903 1,558 269 -
Net income 7,544 5,087 3,215 2,667 1,754 1,058 48%
Dividends declared 1,994 - - - - -
PER SHARE DATA (1)
Net income, basic $ 1.06 $ 0.72 $ 0.63 $ 0.71 $ 0.47 $ 0.28 31%
Net income, diluted 1.00 0.69 0.59 0.66 0.45 0.28 29%
Book value 9.04 8.29 7.61 5.32 4.55 4.14 17%
Dividends declared per share 0.28 - - - - -
Dividend payout ratio (3) 26.42% - - - - -
FINANCIAL RATIOS
Return on average assets 1.24% 1.04% 0.86% 0.91% 0.88% 0.78%
Return on average equity 12.25% 9.16% 9.45% 14.51% 10.56% 7.41%
Average equity to average assets 10.09% 11.38% 9.05% 6.28% 8.36% 10.40%
Net Interest Margin 4.99% 4.35% 4.14% 4.16% 4.31% 4.62%
Efficiency ratio (2) 57.95% 63.30% 63.62% 62.73% 68.22% 74.00%
(1) Adjusted for all years presented giving retroactive effect to a 1.3 for one
stock split in the form of a 30% stock dividend paid on February 28, 2005,
a seven for five stock split in the form of a 40% stock dividend paid on
June 15, 2001 and a five for four stock split in the form of a 25%
stock dividend paid on March 31, 2000.
(2) Computed by dividing noninterest expense by the sum of net interest income
and noninterest income.
(3) Computed by dividing dividends declared per share by net income per
share(basic).
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion provides information about the results of
operations, and financial condition, liquidity, and capital resources of Eagle
Bancorp, Inc. (the "Company") and its subsidiary, EagleBank (the "Bank"). This
discussion and analysis should be read in conjunction with the audited
Consolidated Financial Statements and Notes thereto, appearing elsewhere in this
report.
This report contains forward looking statements within the meaning of
the Securities 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 such words as
"may", "will", "anticipate", "believes", "expects", "plans", "estimates",
"potential", "continue", "should", and similar words or phases. 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 in the future
may differ materially from those indicated herein. Readers are cautioned against
placing undue reliance on any such forward looking statements.
GENERAL
The Company is a growth oriented, one-bank holding company
headquartered in Bethesda, Maryland. We provide general commercial and consumer
banking services through our wholly owned banking subsidiary EagleBank, a
Maryland chartered bank which is a member of the Federal Reserve System. We were
organized in October 1997, to be the holding company for the Bank. The Bank was
organized as an independent, community oriented, and full-service alternative to
the super regional financial institutions, which dominate our primary market
area. Our philosophy is to provide superior, personalized service to our
customers. We focus on relationship banking, providing each customer with a
number of services, becoming familiar with and addressing customer needs in a
proactive, personalized fashion. The Bank currently has five offices serving
Montgomery County and three offices in the District of Columbia. In January
2005, the Bank opened a branch in the McPherson Square area of the District of
Columbia. In February 2005, Eagle Land Title, LLC, a Bank subsidiary which
performs title and attendant services commenced operations. In February 2004,
the Company executed a lease for a new office to be opened in the second quarter
of 2006 in Chevy Chase, Montgomery County, Maryland.
The Company offers a broad range of commercial banking services to our
business and professional clients as well as full service consumer banking
services to individuals living or working in the service area. We emphasize
providing commercial banking services to sole proprietors, small and
medium-sized businesses, partnerships, corporations, non-profit organizations
and associations, and investors living and working in and near our primary
service area. A full range of retail banking services are offered to accommodate
the individual needs of both business customers as well as the community we
serve. These services include the usual deposit functions of commercial banks,
including business and personal checking accounts, "NOW" accounts and money
market and savings accounts, business, construction, and commercial loans,
equipment leasing, residential mortgages and consumer loans and cash management
services. We have developed significant expertise and commitment as an SBA
lender, have been designated a Preferred Lender by the Small Business
Administration (SBA), and are the largest community bank SBA lender in the
Washington metropolitan area.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and follow general practices within the banking industry.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the consolidated financial
statements; accordingly, as this information changes, the consolidated financial
statements could reflect different estimates, assumptions, and
4
judgments. Certain policies inherently have a greater reliance on the use of
estimates, assumptions and judgments and as such have a greater possibility of
producing results that could be materially different than originally reported.
Estimates, assumptions, and judgments are necessary when assets and liabilities
are required to be recorded at fair value, when a decline in the value of an
asset not carried on the financial statements at fair value warrants an
impairment write-down or valuation reserve to be established, or when an asset
or liability needs to be recorded contingent upon a future event. Carrying
assets and liabilities at fair value inherently results in more financial
statement volatility. The fair values and the information used to record
valuation adjustments for certain assets and liabilities are based either on
quoted market prices or are provided by other third-party sources, when
available.
The allowance for credit losses is an estimate of the losses that may
be sustained in our loan portfolio. The allowance is based on two principles of
accounting: (a) Statement on Financial Accounting Standards ("SFAS") 5,
"Accounting for Contingencies", which requires that losses be accrued when they
are probable of occurring and are estimable and (b) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued when
it is probable that the Company will not collect all principal and interest
payments according to the contractual terms of the loan. The loss, if any, can
be determined by the difference between the loan balance and the value of
collateral, the present value of expected future cash flows, or values
observable in the secondary markets.
Three components comprise our allowance for credit losses: a specific
allowance, a formula allowance and a nonspecific or environmental factors
allowance. Each component is determined based on estimates that can and do
change when the actual events occur.
The specific allowance allocates an allowance to identified loans. A
loan for which reserves are individually allocated may show deficiencies in the
borrower's overall financial condition, payment record, support available from
financial guarantors and or the fair market value of collateral. When a loan is
identified as impaired, a specific reserve is established based on the Company's
assessment of the loss that may be associated with the individual loan.
The formula allowance is used to estimate the loss on internally risk
rated loans, exclusive of those identified as requiring specific reserves. Loans
identified as special mention, substandard, doubtful and loss, are segregated
from non-classified loans. Each loan type is assigned an allowance factor based
on management's estimate of the risk, complexity and size of individual loans
within a particular category. Classified loans are assigned higher allowance
factors than non-classified loans due to management's concerns regarding
collectibility or management's knowledge of particular elements regarding the
borrower. Allowance factors relate to the level of the internal risk rating.
The nonspecific or environmental factors allowance is used to estimate
the loss of remaining loans (those not identified as either requiring specific
reserves or having classified risk ratings). The loss estimates are based on
more global factors incident to the overall portfolio, such as delinquency
trends, loss history, trends in the volume and size of individual credits,
effects of changes in lending policy, the experience and depth of management,
national and local economic trends, any concentrations of credit, the quality of
the loan review system and the effect of external factors such as competition
and regulatory requirements. The environmental factors allowance captures losses
whose impact on the portfolio may have occurred but have yet to be recognized in
either the formula or specific allowance.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses,
including, in connection with the valuation of collateral, a borrower's
prospects of repayment, and in establishing allowance factors on the formula
allowance and nonspecific allowance components of the allowance. The
establishment of allowance factors is a continuing evaluation, based on
management's ongoing assessment of the global factors discussed above and their
impact on the portfolio. The allowance factors may change from period to period,
resulting in an increase or decrease in the amount of the provision or
allowance, based upon the same volume and classification of loans. Changes in
allowance factors will have a direct impact on the amount of the provision, and
a related, after tax effect on net income. Errors in management's perception and
assessment of the global factors and their impact on the portfolio could result
in the allowance not being adequate to cover losses in the portfolio, and may
result in additional provisions or charge-offs. Alternatively, errors in
management's perception and assessment of the global factors and their impact on
the portfolio could result in the allowance being in excess of amounts necessary
to cover losses in the portfolio, and may
5
result in lower provisions in the future. For additional information regarding
the allowance for credit losses, refer to the discussion under the caption
"Allowance for Credit Losses" below.
RESULTS OF OPERATIONS
OVERVIEW
The Company reported net income of $7.5 million for the year ended
December 31, 2005, a 48% increase over net income of $5.1 million for the year
ended December 31, 2004, as compared to $3.2 million for the year ended December
31, 2003.
Earnings per basic share were $1.06 for the year ended December 31,
2005, as compared to $0.72 for the year 2004 and $0.63 for the year 2003.
Earnings per diluted share was $1.00 for the year ended December 31, 2005, as
compared to $0.69 for the year 2004 and $0.59 for the year 2003.
For the three months ended December 31, 2005, the Company reported net
income of $2.1 million as compared to $1.8 million for the same period in 2004.
Earnings per basic share was $0.29 and $.27 per diluted share for the three
months ended December 31, 2005, as compared to $0.26 per basic share and $0.25
per diluted share for the same period in 2004.
Earnings per share for the three and twelve months ended December 31,
2004 and 2003 have been adjusted to reflect a 1.3 for one stock spilt in the
form of a 30% stock dividend effected on February 28, 2005
The Company had a return on average assets of 1.24% and a return on
average equity of 12.25% for the year of 2005, as compared to returns on average
assets and average equity of 1.04% and 9.16%, respectively, for the year of 2004
and 0.86% and 9.45% respectively, for the year of 2003.
The increase in net income for the year ended December 31, 2005 as
compared to the year ended December 31, 2004 can be largely attributed to an
increase of 45% in net interest income, resulting from an increase of 26% in
average earning assets and an increase of 41 basis points in the net interest
spread and of 64 basis points in the net interest margin between the comparable
periods. Between June 2004 and December 2005, the Federal Reserve Bank has
increased the federal funds target rate by 325 basis points to 4.25% in thirteen
interest rate increases of 25 basis points each. The impact of these interest
rate increases has contributed to the improvement in the Company's net interest
margin during the year 2005. While the average rate on earning assets for the
year of 2005 has increased by 107 basis points from 5.31% to 6.38%, the cost of
interest bearing liabilities increased by only 66 basis points from 1.32% to
1.98%, resulting in a widening of the net interest spread. Additionally, the
growth in average noninterest bearing funding sources for the year ended
December 31, 2005 as compared to 2004 was $45 million or 28%. This significant
growth in noninterest bearing funding sources (noninterest bearing deposits,
other liabilities and stockholders' equity) has increased the benefit of such
sources funding earning assets from 36 basis points for the year ended December
31, 2004 to 59 basis points for the year ended December 31, 2005. This benefit
has contributed to a widening of the net interest margin mentioned above. Thus,
the Company has been able to increase its primary source of funds (core
deposits) at rates which have allowed its net interest spread and margin to
increase in the year of 2005 as compared to the year of 2004.
As a result of competitive pressures, interest rates paid on deposits,
which have not increased as much or as rapidly as interest rates on earning
assets, may result in a higher cost of funding in future periods, which may not
be offset by further increases in interest rates on earning assets. As a result
of such potential margin compression, the Company's earnings could be adversely
impacted.
Loans, which generally have higher yields than securities and other
earning assets, increased from 78% of average earning assets in the year 2004 to
83% of average earning assets for the year of 2005. Investment securities for
the year of 2005 accounted for 12% of average earning assets as compared to 15%
for the year of 2004. This decline in the proportion of average investment
securities to average earning assets was directly related to average loan growth
for the year 2005 exceeding the growth of average deposits and other funding
sources.
6
The provision for credit losses was $1.8 million for the year of 2005
as compared to $675 thousand for the year 2004. This increase was attributable
primarily to growth in the loan portfolio in the twelve months ended December
31, 2005, which was very favorable, in addition to a change in the mix of the
loan portfolio at December 31, 2005 toward more real estate-commercial and
construction credits, as compared to the loan portfolio at December 31, 2004. As
discussed in the section on Provision for Credit Losses, the Company had $98
thousand of net charge-offs in the year of 2005. This compared to net
charge-offs of $115 thousand for the year 2004. At December 31, 2005, the
allowance for credit losses was $6.0 million or 1.09% of total loans, as
compared to $4.2 million or 1.02% of total loans at December 31, 2004. The
provision for credit losses was $532 thousand for the three months ended
December 31, 2005 as compared to $218 thousand for the same period in 2004, the
increase attributable primarily to growth in the level of outstanding loans.
Total noninterest income was $4.0 million for the year of 2005 as
compared to $3.8 million for 2004, a 7% increase. These amounts include net
investment gains of $279 thousand for the year of 2005 and $453 thousand in
2004. Excluding gains on the sale of investment securities, noninterest income
was $3.7 million in 2005 versus $3.3 million for 2004, an increase of 13%. This
increase was due primarily to increased gains on the sale of SBA loans and SBA
service fees which amounted to $1.2 million for the year of 2005 versus $1.1
million for 2004. For the three months ended December 31, 2005, total
noninterest income was $833 thousand as compared to $1.1million for the same
period in 2004. These amounts include net investment losses of $2 thousand for
the three months ended December 31, 2005 as compared to net investment gains of
$260 thousand for the same quarter in 2004. Excluding gains (losses) on the sale
of investment securities, noninterest income decreased modestly to $835 thousand
for the fourth quarter of 2005, versus $889 thousand for the fourth quarter of
2004.
Noninterest expenses increased from $15.0 million for the year of 2004
to $19.0 million for the year of 2005, an increase of 27%. The increase was
attributable primarily to increases in personnel and related benefit cost
increases, higher amounts of incentive based compensation, increased premises
and equipment expenses, due in part to new banking offices, and to higher
marketing, outside data processing and professional fees associated with a
larger organization. In spite of higher amounts of noninterest expenses, the
Company's stronger growth in revenue as compared to noninterest expenses
resulted in the efficiency ratio improving in the year of 2005 to 57.95% as
compared to 63.30% for the year of 2004. For the three months ended December 31,
2005, total noninterest expenses were $4.9 million, as compared to $3.9 million
for the same period in 2004, an increase of 26%. This increase was due to the
same factors mentioned above which affected the increase for the full year 2005
over 2004.
The combination of increases in net interest income attributed to both
increased volume and favorable interest rate effects and increases in
noninterest income, offset in part by increases in the provision for credit
losses due to growth, and increases in noninterest expenses, resulted in
significant improvement in net income for the year of 2005 versus 2004 of 48%
and for the three months ended December 31, 2005 versus 2004 of 13%.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income is the difference between interest income on
earning assets and the cost of funds supporting those assets. Earning assets are
composed primarily of loans and investment securities. The cost of funds
represents interest expense on deposits, customer repurchase agreements and
other borrowings which comprise federal funds purchased and advances from the
Federal Home Loan Bank of Atlanta ("FHLB"). Noninterest bearing deposits and
capital are other components representing funding sources. Changes in the volume
and mix of assets and funding sources, along with the changes in yields earned
and rates paid, determine changes in net interest income. Net interest income in
2005 was $28.7 million compared to $19.9 million in 2004 and $14.5 million in
2003.
The following table labeled "Average Balances, Interest Yields and
Rates and Net Interest Margin" presents the average balances and rates of the
various categories of the Company's assets and liabilities. Included in the
table is a measurement of interest rate spread and margin. Interest spread is
the difference (expressed as a percentage) between the interest rate earned on
earning assets less the interest rate paid on interest bearing liabilities.
While net interest spread provides a quick comparison of earnings rates versus
cost of funds, management believes that the net interest margin provides a
better measurement of performance, since the net interest margin includes the
effect of noninterest bearing sources in its calculation, which are significant
factors in the Company's financial performance. The net interest margin is net
interest income (annualized) expressed as a percentage of average earning
assets.
7
AVERAGE BALANCES, INTEREST YIELDS AND RATES AND NET INTEREST MARGIN
Year Ended December 31,
------------------------------------------------------------------------------------------------
2005 2004 2003
------------------------------ ------------------------------ ------------------------------
Average Average Average
Average Yield / Average Yield / Average Yield /
(dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
--------------------------- ---------- -------- ------- ---------- -------- ------- ---------- -------- -------
ASSETS:
Interest earning assets:
Interest bearing deposits
with other banks and other
short-term investments $ 12,168 $ 417 3.43% $ 6,432 $ 152 2.36% $ 7,843 $ 180 2.30%
Loans (1)(2) 479,311 33,478 6.98% 353,537 21,393 6.05% 266,811 16,354 6.13%
Investment securities
available for sale 71,438 2,424 3.39% 70,720 2,195 3.10% 69,086 1,807 2.62%
Federal funds sold 12,281 407 3.31% 25,290 455 1.80% 5,417 62 1.14%
---------- -------- ---------- -------- ---------- --------
Total interest earning
assets 575,198 36,726 6.38% 455,979 24,195 5.31% 349,157 18,403 5.27%
---------- -------- ---------- -------- ---------- --------
Noninterest earning
assets 40,073 35,810 29,687
Less: allowance for
credit losses 5,026 3,936 3,042
---------- ---------- ----------
Total noninterest
earning assets 35,047 31,874 26,645
---------- ---------- ----------
TOTAL ASSETS $ 610,245 $ 487,853 $ 375,802
========== ========== ==========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest bearing
liabilities:
Interest bearing
transaction $ 61,230 $ 122 0.20% $ 50,599 $ 72 0.14% $ 38,820 $ 79 0.20%
Savings and money
market 138,844 2,504 1.80% 121,477 1,185 0.98% 100,226 1,161 1.16%
Time deposits 171,827 4,837 2.82% 122,864 2,498 2.03% 81,788 1,859 2.27%
---------- -------- ---------- -------- ---------- --------
Total interest
bearing deposits 371,901 7,463 2.01% 294,940 3,755 1.27% 220,834 3,099 1.40%
Customer repurchase
agreements and funds
purchased 29,341 350 1.19% 20,258 105 0.52% 22,146 108 0.49%
Other short-term
borrowings 3,964 195 4.92% 5,271 171 3.24% 7,979 266 3.33%
Long term borrowings - - 7,210 297 4.12% 12,489 480 3.84%
---------- -------- ---------- -------- ---------- --------
Total interest bearing
liabilities 405,206 8,008 1.98% 327,679 4,328 1.32% 263,448 3,953 1.50%
---------- -------- ---------- -------- ---------- --------
Noninterest bearing
liabilities:
Noninterest bearing demand 140,515 102,848 72,119
Other liabilities 2,961 1,819 6,207
---------- ---------- ----------
Total noninterest bearing
liabilities 143,476 104,667 78,326
---------- ---------- ----------
Stockholders' equity 61,563 55,507 34,028
---------- ---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS EQUITY $ 610,245 $ 487,853 $ 375,802
========== ========== ==========
Net interest income $ 28,718 $ 19,867 $ 14,450
======== ======== ========
Net interest spread 4.40% 3.99% 3.77%
Net interest margin 4.99% 4.35% 4.14%
(1) Includes loans held for sale
(2) Loans placed on nonaccrual status are included in average balances. Net
loan fees and late charges in interest income on loans totaled $1.2
million, $595 thousand and $181thousand for 2005, 2004, and 2003
respectively.
8
The rate/volume table below presents the composition of the change in
net interest income for the periods indicated, as allocated between the change
in net interest income due to changes in the volume of average earning assets
and interest bearing liabilities, and the changes in net interest income due to
changes in interest rates. As the table shows, the increase in net interest
income in 2005 as compared to 2004 is due to both growth in the volume of
earning assets (77%) and an increase in the margin earned on earning assets
(23%). For 2004 over 2003, the increase in net interest income was a function
more related to increased volume of earning assets (88%) as compared to
increases in the net interest margin (12%).
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
2005 compared with 2004 2004 compared with 2003
------------------------------------ ------------------------------------
Due to Due to Total Increase Due to Due to Total Increase
(dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease)
-------- -------- -------------- -------- -------- --------------
INTEREST EARNED ON:
Loans $ 7,611 $ 4,474 $ 12,085 $ 5,316 $ (277) $ 5,039
Investment securities 22 207 229 43 345 388
Interest bearing bank deposits 136 129 265 (32) 4 (28)
Federal funds sold (234) 186 (48) 227 166 393
-------- -------- -------------- -------- -------- --------------
Total interest income 7,535 4,996 12,531 5,554 238 5,792
-------- -------- -------------- -------- -------- --------------
INTEREST PAID ON:
Interest bearing transaction 15 35 50 24 (31) (7)
Savings and money market 169 1,150 1,319 246 (222) 24
Time 995 1,344 2,339 934 (295) 639
Customer repurchase agreements 47 198 245 (9) 6 (3)
Other borrowings (339) 66 (273) (293) 15 (278)
-------- -------- -------------- -------- -------- --------------
Total interest expense 887 2,793 3,680 902 (527) 375
-------- -------- -------------- -------- -------- --------------
NET INTEREST INCOME $ 6,648 $ 2,203 $ 8,851 $ 4,652 $ 765 $ 5,417
======== ======== ============== ======== ======== ==============
PROVISION FOR CREDIT LOSSES
The provision for credit losses represents the amount of expense
charged to earnings to fund the allowance for credit losses. The amount of the
allowance for credit losses is based on many factors which reflect management's
assessment of the risk in the loan portfolio. Those factors include economic
conditions and trends, the value and adequacy of collateral, volume and mix of
the portfolio, performance of the portfolio, and internal loan processes of the
Company and Bank.
During the year of 2005, a provision for credit losses was made in the
amount of $1.8 million and the allowance for credit losses increased
$1.7million, including the impact of a modest amount of net credit losses of $98
thousand during the period. The provision for credit losses of $1.8 million for
the year 2005 compared to a provision for credit losses of $675 thousand for the
year 2004. The higher level of the provision in 2005 is attributable primarily
to significant growth in the loan portfolio and to a change in the mix of the
loan portfolio toward more real estate - commercial and construction credits
during the year. For the three months ended December 31, 2005, a provision for
credit losses was made in the amount of $532 thousand, as compared to $218
thousand for the same period in 2004, the higher provision being due to growth
in the portfolio in the three months ended December 31, 2005 and to accommodate
a higher level of net-charge offs in the fourth quarter of 2005 as compared to
net recoveries for the fourth quarter in 2004.. For the fourth quarter of 2005,
net charge-offs amounted to $45 thousand as compared to net recoveries of $76
thousand for the same period in 2004.
The provision for credit losses was $675 thousand in 2004 compared to a
provision for credit losses of $1.2 million in 2003. The lower provision for
2004, during which loans grew over 30%, maintained the allowance at a level
management believes to be adequate. As reported for the third quarter of 2004,
the Company had one loan in excess of $2 million which was impaired. This loan
was paid in full during the fourth quarter of 2004 with the
9
collection of all principal, interest and expenses associated with the credit.
The payoff of this loan resulted in releasing approximately $400 thousand of the
allowance which had been specifically allocated for this loan.
The maintenance of a high quality loan portfolio, with an adequate
allowance for credit losses will continue to be a primary objective of the
Company.
NON-INTEREST INCOME
Noninterest income consists of deposit account service charges, gains
on the sale of SBA and residential mortgage loans, investment gains and losses,
other noninterest loan fees, income from bank owned life insurance ("BOLI") and
other service fees. For the year ended December 31, 2005, noninterest income was
$4.0 million. This compared to $3.8 million of noninterest income for the year
ended December 31, 2004 and $2.8 million for the year ended December 31, 2003.
The Company is an active originator of SBA loans and its current
practice is to sell the insured portion of those loans at a premium. Income from
this source was $933 thousand for the year ended December 31, 2005 compared to
$648 thousand and $401 thousand for the years ended December 31, 2004 and 2003,
respectively, as the Company continues to emphasize this lending activity. The
Company also originates residential mortgage loans on a pre-sold basis,
servicing released. Sales of these mortgage loans yielded gains of $312 thousand
in 2005 compared to $304 thousand in 2004 and $270 thousand in 2003.
Net investment gains amounted to $279 thousand for 2005 as compared to
$453 thousand for 2004 and $311 thousand for 2003. The Company sells securities
in response to asset/liability management objectives.
Income for the year of 2005 amounted to $1.2 million from deposit
account service charges on deposits and $401 thousand from BOLI, versus $1.3
million from deposit account service charges and $385 thousand from BOLI for the
year ended December 31, 2004.
Other noninterest income which comprises other service charges, SBA
service fees, title and settlement fees, and loan prepayment and commitment
fees, amounted to $920 thousand for the year of 2005, as compared to $708
thousand for the year of 2004, the increase due in part to income from Eagle
Land Title, which commenced operations in 2005 and to increases in SBA service
fees. The decline in deposit service charges in 2005 versus 2004 was primarily
related to a decline in overdraft fees but was also attributed to lower
commercial deposit account service fees as the 2005 level of interest rates
increased the earnings credit to commercial bank clients during the year 2005 as
compared to 2004.
Noninterest income was $833 thousand for the three months ended
December 31, 2005 compared to $1.1 million for the three months ended December
31, 2004, a decrease of 28%. These amounts include a small net investment loss
of $2 thousand for the three months ended December 31, 2005 as compared to net
investment gains of $260 thousand for the same quarter in 2004. Excluding gains
(losses) on the sale of investment securities, noninterest income was $835
thousand for the fourth quarter of 2005, versus $889 thousand for the fourth
quarter of 2004, a decrease of 6%, resulting primarily from a decline in deposit
service fees for reasons discussed above relating to the year 2005 as compared
to 2004.
NON-INTEREST EXPENSE
Noninterest expense was $19.0 million for 2005, an increase of 27% as
compared to $15.0 million for 2004 and $11.0 million for 2003.
Salaries and benefits were $10.5 million for the year of 2005, a 28%
increase as compared to $8.2 million for 2004, and $5.8 million for 2003. This
increase in 2005 over 2004 was due to staff additions and related benefit costs,
including an enhanced health insurance benefit commencing July 2005, and to
increases in incentive based compensation. At December 31, 2005, the Bank had
145 full time equivalent employees as compared to 119 at December 31, 2004 and
101 at December 31, 2003.
10
Premises and equipment expenses amounted to $3.5 million for the year
of 2005 versus $2.7 million for 2004. This increase of 31% was due primarily to
a new banking office opened in January 2005, a full year of costs for a banking
office opened in the second quarter of 2004, ongoing operating expense increases
associated with the Company's facilities, all of which are leased, and increased
equipment costs. Premises and equipment expense was $2.1 million for 2003.
Marketing and advertising costs increased from $280 thousand in 2004 to
$473 thousand in 2005, an increase of 68%. This increase was associated
primarily with increased advertising for deposit products and to special
marketing efforts, including sponsorships and events highlighting the Bank's
community efforts.
Outside data processing costs were $769 thousand for 2005, as compared
to $652 thousand in 2004, or an increase of 18%. The higher costs were due to
special charges associated with the Company's conversion of certain core
processing systems to new operating platforms, to added system capabilities and
to higher processing volumes.
Other expenses, increased from $2.7 million in 2004 to $3.1 million for
2005. The major components of costs in this category include ATM expenses,
telephone, courier, printing, business development, office supplies, charitable
contributions, and dues. These costs increased by 13% in the year 2005 over
2004, and were due substantially to a companywide initiative to enhance the
Company's continued emphasis on relationship management and attendant systems.
Noninterest expenses were $4.9 million for the three months ended
December 31, 2005 compared to $3.9 million for the three months ended December
31, 2004, an increase of 26%. The same factors which contributed to increased
noninterest expense for the year of 2005 over 2004 mentioned above also
contributed to the increase in noninterest expenses for the three months ended
December 31, 2005, as compared to the same period in 2004.
INCOME TAX EXPENSE
The Company recorded income tax expense of $4.4 million in 2005
compared to $2.9 million in 2004 and $1.9 million in 2003, resulting in an
effective tax rate of 36.7%, 36.3% and 37.2% respectively.
BALANCE SHEET ANALYSIS
OVERVIEW
At December 31, 2005, the Company's total assets were $672.3 million,
loans were $549.2 million, deposits were $568.9 million and stockholders' equity
was $65.0 million. As compared to December 31, 2004, assets grew in 2005 by
$118.8 million (21%), loans by $133.7 million (32%), deposits by $106.6 million
(23%) and stockholders' equity by $6.4 million (11%).
The Company initiated a cash dividend of $0.07 per share in the first
quarter of 2005 and declared dividends per share of $0.28 during 2005.
SECURITIES
The investment securities portfolio is comprised primarily of U.S.
Agency securities with stated maturities not exceeding seven years, except
mortgage pass-through securities which have average expected lives of less than
six years but contractual maturities of up to thirty years. At December 31,
2005, the investment portfolio amounted to $68.0 million with a relatively short
average life of 2.2 years as compared to a balance of $64.1 million at December
31, 2004, an increase of 6%. The investment portfolio is managed to achieve
goals related to income, liquidity, interest rate risk management and providing
collateral for customer repurchase agreements and other borrowing relationships.
The Company also has a portfolio of short-term investments utilized for
asset liability management needs which consists of discount notes, money market
investments, other bank certificates of deposit and the like. This portfolio
amounted to $11.2 million at December 31, 2005 as compared to $9.6 million at
December 31, 2004.
11
The third element of the Company's securities portfolio is federal
funds sold which amounted to $6.1 million at December 31, 2005 as compared to
$15.0 million at December 31, 2004. These funds represent excess daily liquidity
which is invested on an unsecured basis with well capitalized banks, in amounts
limited both in the aggregate and to any one bank.
The tables below and Note 3 to the Consolidated Financial Statements
provide additional information regarding the Company's investment securities.
The Company classifies all its investment securities as available-for-sale
("AFS"). This classification requires that investment securities be recorded at
their fair value with any difference between the fair value and amortized cost
(the purchase price adjusted by any accretion or amortization) reported as a
component of stockholders' equity (accumulated other comprehensive income), net
of deferred income taxes. At December 31, 2005, the Company had a net unrealized
loss in AFS securities of $1.0 million as compared to a net unrealized gain in
AFS securities of $148 thousand at December 31, 2004. The deferred income tax
component of these unrealized gains and losses was $390 thousand and $50
thousand, respectively.
The following table provides information regarding the composition of
the Company's investment securities portfolio at the dates indicated. Amounts
are reported at estimated fair value.
December 31,
---------------------------------------------------------------------
2005 2004 2003
--------------------- --------------------- ---------------------
Percent Percent Percent
(dollars in thousands) Balance of Total Balance of Total Balance of Total
--------- --------- --------- --------- --------- ---------
U. S. Government agency securities $ 46,998 69.1% $ 34,184 53.3% $ 25,373 30.7%
Mortgage backed securities 17,240 25.3% 23,066 36.0% 51,842 62.8%
Federal Reserve and Federal Home Loan
Bank stock 2,230 3.3% 1,956 3.1% 1,670 2.0%
Other equity investments 1,582 2.3% 4,892 7.6% 3,696 4.5%
--------- --------- --------- --------- --------- --------
$ 68,050 100% $ 64,098 100% $ 82,581 100%
========= ========= ========= ========= ========= ========
The following table provides information, on an amortized cost basis,
regarding the contractual maturity and weighted average yield of the investment
portfolio at December 31, 2005. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
After One Year After Five Years
One Year or Less Through Five Years Through Ten Years After Ten Years Total
------------------- ------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average
(dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
------------------------ --------- -------- --------- -------- --------- -------- --------- -------- --------- --------
U. S.Government
agency securities $ 13,989 3.00% $ 28,316 4.23% $ 5,347 4.86% $ - - $ 47,652 3.80%
Mortgage backed
securities - - 7,634 3.85% 4,046 3.44% 6,118 4.29% 17,798 3.91%
Federal Reserve
and Federal Home Loan
Bank stock - - - - - - 2,230 5.03% 2,230 5.03%
Other equity investments - - - - - - 1,380 6.44% 1,380 6.44%
--------- -------- --------- -------- --------- -------- --------- -------- --------- --------
$ 13,989 3.00% $ 35,950 4.15% $ 9,393 4.25% $ 9,728 4.76% $ 69,060 3.92%
========= ======== ========= ======== ========= ======== ========= ======== ========= ========
At December 31, 2005, there were no issuers, other than the U.S.
Government and its agencies, whose securities owned by the Company had a book or
fair value exceeding ten percent of the Company's stockholders' equity.
12
LOAN PORTFOLIO
In its lending activities, the Company seeks to develop sound
relationships with clients whose businesses and individual banking needs will
grow with the Bank. There has been a significant effort to grow the loan
portfolio and to be responsive to the lending needs in the markets served, while
maintaining sound asset quality.
Loan growth over the past year has been favorable, with loans
outstanding reaching $549.2 million at December 31, 2005, an increase of $132.7
million or 32% as compared to $415.5 million at December 31, 2004, and were
$317.5 million at December 31, 2003, an increase of $98.0 million or 31% in 2004
over 2003
The Bank is primarily business oriented and has a very large proportion
of its loan portfolio related to real estate (68%) consisting of real
estate-commercial, real estate-residential mortgage and construction-commercial
and residential.
The following table shows the trends in the composition of the loan
portfolio over the past five years.
December 31,
-----------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---------------- ---------------- ---------------- ---------------- ----------------
(dollars in thousands) Amount % Amount % Amount % Amount % Amount %
--------- ---- --------- ---- --------- ---- --------- ---- --------- ----
Commercial $ 118,928 22% $ 101,911 25% $ 93,112 29% $ 64,869 27% $ 49,432 27%
Real estate - commercial (1) 284,667 52% 189,708 47% 142,819 45% 111,262 47% 86,553 47%
Real estate - residential mortgage 1,130 - 9,230 2% 6,964 2% 3,699 2% - 0%
Construction - commercial and
residential 90,035 16% 62,745 14% 35,644 11% 23,180 10% 15,512 9%
Home equity 50,776 9% 49,632 11% 34,092 11% 30,631 13% 26,656 15%
Other consumer 3,676 1% 2,283 1% 4,902 2% 3,219 1% 4,103 2%
--------- ---- --------- ---- --------- ---- --------- ---- --------- ----
Total loans 549,212 100% 415,509 100% 317,533 100% 236,860 100% 182,256 100%
==== ==== ==== ==== ====
Less: Allowance for Credit Losses (5,985) (4,240) (3,680) (2,766) (2,111)
--------- --------- --------- --------- ---------
Net loans $ 543,227 $ 411,269 $ 313,853 $ 234,094 $ 180,145
========= ========= ========= ========= =========
(1) includes loans for land acquisition and development
LOAN MATURITY
The following table sets forth the term to contractual maturity of the
loan portfolio as of December 31, 2005.
Due In
------------------------------------------------------------------
One Year or One to Five Over Five to Over Ten
(dollars in thousands) Total Less Years Ten Years Years
---------- ------------ ------------ ------------ ------------
Commercial $ 118,928 $ 55,715 $ 34,291 $ 24,067 $ 4,855
Real estate-commercial 284,667 44,641 76,450 143,153 20,423
Real estate-residential 1,130 533 597 - -
Construction 90,035 42,202 25,946 20,904 983
Home equity 50,776 1,014 1,070 195 48,497
Other consumer 3,676 1,242 1,481 11 942
---------- ------------ ------------ ------------ ------------
Total loans $ 549,212 $ 145,347 $ 139,835 $ 188,330 $ 75,700
========== ============ ============ ============ ============
Loans with:
Predetermined fixed interest rate $ 142,195 $ 15,015 $ 11,067 $ 104,768 $ 11,345
Floating interest rate 407,017 130,332 128,768 83,562 64,355
---------- ------------ ------------ ------------ ------------
Total loans $ 549,212 $ 145,347 $ 139,835 $ 188,330 $ 75,700
========== ============ ============ ============ ============
Loans are shown in the period based on final contractual maturity.
Demand loans, having no contractual maturity and overdrafts, are reported as due
in one year or less.
13
As noted above, a significant portion of the loan portfolio consists of
commercial, construction and commercial real estate loans, primarily made in the
Washington, D.C. metropolitan area and secured by real estate or other
collateral in that market. Although these loans are made to a diversified pool
of unrelated borrowers across numerous businesses, adverse developments in the
Washington D.C. metropolitan real estate market could have an adverse impact on
this portfolio of loans and the Company's income and financial position. While
our basic trading area is the Washington, D.C. metropolitan area, the Bank has
made loans outside that market area where the nature and quality of such loans
was consistent with the Bank's lending policies.
At December 31, 2005, 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.
ALLOWANCE FOR CREDIT LOSSES
Management has developed a comprehensive review process to monitor the
adequacy of the allowance for credit losses. The review process and guidelines
were developed utilizing guidance from federal banking regulatory agencies. The
results of this review process, in combination with conclusions of the Bank's
outside loan review consultant, support management's view as to the adequacy of
the allowance as of the balance sheet date. During 2005, a provision for credit
losses was made in the amount of $1.8 million before net charge-offs of $98
thousand. A full discussion of the accounting for allowance for credit losses is
contained in Note 1 to the Consolidated Financial Statements; activity in the
allowance for credit losses is contained in Note 4 to the Consolidated Financial
Statements. Also, please refer to the discussion under the caption, "Critical
Accounting Policies" within Management's Discussion and Analysis of Financial
Condition and Results of Operation for further discussion of the methodology
which management employs to maintain an adequate allowance for credit losses,
and the discussion under the caption "Provision for Credit Losses".
At December 31, 2005, the Company had $491 thousand of loans classified
as nonperforming. Please refer to Note 1 of the notes to the Consolidated
Financial Statements under the caption "Loans" for a discussion of the Company's
policy regarding impairment of loans.
As the loan portfolio and allowance for credit losses review process
continues to evolve, there may be changes to elements of the allowance and this
may have an effect on the overall level of the allowance maintained. To date,
the Bank has enjoyed a high quality loan portfolio with minimal net charge-offs
and low delinquency rates. The maintenance of a high quality portfolio will
continue to be a high priority for both management and the Board of Directors.
Management, being aware of the significant loan growth experienced by
the Company and the problems which could develop in an unmonitored environment,
is intent on maintaining a strong credit review system and risk rating process.
The Company established its Credit Department in 2003 to provide independent
analysis of credit requests and to manage problem credits. The Credit Department
has developed and implemented additional analytical procedures for evaluating
credit requests, has further refined the Company's risk rating system, and has
adopted enhanced monitoring of the portfolio. The loan portfolio analysis
process is ongoing and proactive in order to maintain a portfolio of quality
credits and to quickly identify any weaknesses before they become more severe.
The following table sets forth activity in the allowance for credit
losses for the past five years.
14
Year Ended December 31,
----------------------------------------------------
(dollars in thousands) 2005 2004 2003 2002 2001
-------- -------- -------- -------- --------
Balance at beginning of year $ 4,240 $ 3,680 $ 2,766 $ 2,111 $ 1,142
Charge-offs:
Commercial (122) (257) (319) (192) -
Other consumer (17) (35) (14) (40) (23)
-------- -------- -------- -------- --------
Total charge-offs (139) (292) (333) (232) (23)
-------- -------- -------- -------- --------
Recoveries:
Commercial 41 175 68 26 -
Other consumer - 2 4 18 13
-------- -------- -------- -------- --------
Total recoveries 41 177 72 44 13
-------- -------- -------- -------- --------
Net (charge-offs) recoveries (98) (115) (261) (188) (10)
-------- -------- -------- -------- --------
Additions charged to operations 1,843 675 1,175 843 979
-------- -------- -------- -------- --------
Balance at end of year $ 5,985 $ 4,240 $ 3,680 $ 2,766 $ 2,111
======== ======== ======== ======== ========
Ratio of net charge-offs during the
year to average loans outstanding
during the year 0.02% 0.03% 0.10% 0.09% 0.01%
The following table presents the allocation of the allowance by loan
category and the percent of loans each category bears to total loans. The
allocation of the allowance to each category is not necessarily indicative of
future losses or charge-offs and does not restrict the usage of the allowance
for any specific loan or category.
Year Ended December 31,
--------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---------------- ---------------- ---------------- ---------------- ----------------
% of % of % of % of % of
(dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial $ 2,594 22% $ 1,963 25% $ 1,689 29% $ 1,134 27% $ 743 27%
Real estate - commercial 2,395 52% 1,426 47% 850 45% 835 47% 701 49%
Real estate - residential mortgage 48 - 105 2% 38 2% 27 2% - -
Construction - commercial and
residential 602 16% 431 14% 613 11% 231 10% 218 10%
Home equity 176 9% 223 11% 171 11% 253 13% 212 12%
Other consumer 84 1% 58 1% 72 2% 83 1% 100 2%
Unallocated 86 34 247 203 137
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total $ 5,985 100% $ 4,240 100% $ 3,680 100% $ 2,766 100% $ 2,111 100%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
NONPERFORMING ASSETS
The Company's nonperforming assets, which are comprised of loans
delinquent 90 days or more, nonaccrual loans, restructured loans and other real
estate owned, totaled $491 thousand at December 31, 2005 compared to $156
thousand at December 31, 2004. The percentage of nonperforming assets to total
assets was 0.07% at December 31, 2005 compared to 0.03% at December 31, 2004.
Non-accrual loans constituted 100% of the nonperforming assets at December 31,
2005 and December 31, 2004.
15
The following table shows the amounts of nonperforming assets for the
past five years.
Year End December 31,
--------------------------------------
(dollars in thousands) 2005 2004 2003 2002 2001
------ ------ ------ ------ ------
Nonaccrual Loans
Commercial $ 362 $ 156 $ 554 $ 147 -
Consumer $ 129 - 100 - -
Loans Past Due - 90 days or more
Commercial - - - 818 $ 19
------ ------ ------ ------ ------
Total nonperforming assets $ 491 $ 156 $ 654 $ 965 $ 19
====== ====== ====== ====== ======
At December 31, 2005, there were $2.9 million of performing loans
considered potential problem loans, defined as loans which are not included in
the 90 day past due, nonaccrual or restructured categories, but for which known
information about possible credit problems causes management to be uncertain as
to the ability of the borrowers to comply with the present loan repayment terms
which may in the future result in disclosure in the past due, non-accrual or
restructured loan categories. Additionally, in February 2006, management
identified a deterioration in a specific watch listed secured credit amounting
to $3.5 million. This credit became past due in excess of 90 days in February
2006. While the specific credit is likely to be classified as a non-accrual loan
at the end of the first quarter of 2006, based on available information,
management does not anticipate any charge-off or loss of principal balance.
During 2005, no interest was included in interest income in respect of
nonperforming loans. If the $491 thousand in nonaccrual loans had been
performing in accordance with their terms, $16 thousand in gross interest income
would have been recorded in 2005.
OTHER EARNING ASSETS
Residential mortgage loans held for sale increased to $2.9 million at
December 31, 2005 from $2.2 million at December 31, 2004. Origination and sales
of these loans during 2005 was emphasized in the Company in order to enhance
non-interest income, which emphasis is expected to continue in 2006.
Bank owned life insurance is utilized in the Company in accordance with
tax regulations as part of the Company's financing of its benefit programs. At
December 31, 2005 this asset amounted to $11.1 million as compared to $10.7
million at December 31, 2004, which reflected an increase in cash surrender
value, as compared to new investments.
INTANGIBLE ASSETS
In 2005, the Company began recognizing a servicing asset for the
computed value of servicing fees on the sale of the guaranteed portion of SBA
loans, which is in excess of a normal servicing fee. Assumptions related to loan
term and amortization are made to arrive at the initial recorded value, which is
included in other assets. For 2005, excess servicing fees of $188 thousand were
recorded, of which $19 thousand was amortized as a reduction of actual service
fees collected, which is a component of other income. At December 31, 2005, the
balance of excess servicing fees was $168 thousand. Prior to 2005, this asset
was deemed to be not material. This asset is subject to impairment testing
annually.
DEPOSITS AND OTHER BORROWINGS
The principal sources of funds for the Bank are core deposits,
consisting of noninterest bearing demand, interest bearing transaction, money
market and savings accounts and time deposits from the local market areas
surrounding the Bank's offices. The deposit base includes transaction accounts,
time and savings accounts and accounts which customers use for cash management
and which provide the Bank with a source of fee income and cross-marketing
opportunities as well as an attractive source of lower cost funds. Time and
savings accounts, including money market deposit accounts, also provide a
relatively stable and low-cost source of funding.
16
For the year ending December 31, 2005 deposits grew $106.5 million,
from $462.3 million to $568.9 million or 23%. Approximately 33% of the Bank's
deposits are made up of time deposits, which are generally the most expensive
form of deposit because of their fixed rate and term. These deposits had
significant increases in the year ended December 31, 2005 as the Bank has seen
more growth in these funding sources. Time deposits in denominations of $100
thousand or more can be more volatile and more expensive than time deposits of
less than $100 thousand. However, because the Bank focuses on relationship
banking, its historical experience has been that large time deposits have not
been more volatile or significantly more expensive than smaller denomination
certificates. It has been the practice of the Bank to pay posted rates on its
time deposit whether under or over $100 thousand. From time to time, when
appropriate in order to fund strong loan demand, the Bank accepts time deposits,
generally in denominations of less than $100 thousand from bank and credit union
subscribers to a wholesale deposit rate line and may also accept brokered
deposits. Wholesale deposits amounted to approximately $11million or 2% of total
deposits at December 31, 2005, as compared to approximately $25 million or 5% of
total deposits at December 31, 2004. During the year of 2005, the Bank reduced
its wholesale deposits in favor of its core sources, which provided adequate
funding and liquidity and was in accordance with planned amounts.
At December 31, 2005, the Company had approximately $165.1 million in
noninterest bearing demand deposits, representing 29% of total deposits. This
compared to approximately $130.3 million of these deposits at December 31, 2004
or 28% of total deposits. These are primarily business checking accounts on
which the payment of interest is prohibited by regulations of the Federal
Reserve. Proposed legislation has been introduced in each of the last several
sessions of Congress which would permit banks to pay interest on checking and
demand deposit accounts established by businesses. If 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 noninterest bearing deposits in order to compete
with other banks. Payment of interest on these deposits could have a significant
negative impact on our net interest income and net interest margin, net income,
and the return on assets and equity.
As an enhancement to the basic noninterest bearing demand deposit
account, the Company offers a sweep account, or "customer repurchase agreement",
allowing qualifying businesses to earn interest on short-term excess funds which
are not suited for either a certificate of deposit or a money market account.
The balances in these accounts were $32 million at December 31, 2005 compared to
$24 million at December 31, 2004. Customer repurchase agreements are not
deposits and are not insured but are collateralized by U.S. government agency
securities. These accounts are particularly suitable to businesses with
significant fluctuation in the levels of cash flows. Attorney and title company
escrow accounts are an example of accounts which can benefit from this product,
as are customers who may require collateral for deposits in excess of $100
thousand but do not qualify for other pledging arrangements. This program
requires the Company to maintain a sufficient investment securities level to
accommodate the fluctuations in balances which may occur in these accounts.
At December 31, 2005, the Company had no outstanding balances under its
lines of credit provided by correspondent banks. Also, the Bank had no
borrowings outstanding under its credit facility from the FHLB, as compared to
$6.3 million at December 31, 2004. Outstanding advances are secured by
collateral consisting of U.S. government agency securities and a blanket lien on
qualifying loans in the Bank's commercial mortgage loan portfolio.
CONTRACTUAL OBLIGATIONS
The Company has various financial obligations, including contractual
obligations and commitments that may require future cash payments. Except for
its loan commitments, as shown in Note 13 to Notes to Consolidated Financial
Statements - Financial Instruments with Off-Balance Sheet Risk, the following
table shows details on these fixed and determinable obligations in the time
period indicated.
17
Within One One to Three to Over Five
(dollars in thousands) Year Three Years Five Years Years Total
-------------------------------------- ----------- ----------- ----------- ----------- -----------
Deposits without a stated maturity (1) $ 381,648 $ - $ - $ - $ 381,648
Time deposits (1) 161,574 24,801 870 - 187,245
Short-term borrowings 32,139 - - - 32,139
Operating lease obligations 1,680 3,672 3,257 4,414 13,023
Leasehold improvements & equipment
purchases (2) 568 - - - 568
Outside data processing (3) 892 1,935 - - 2,827
----------- ----------- ----------- ----------- -----------
Total $ 578,501 $ 30,408 $ 4,127 $ 4,414 $ 617,450
=========== =========== =========== =========== ===========
(1) Includes accrued interest payable through December 31, 2005
(2) At December 31, 2005, the Company had commitments to vendors for
leasehold improvements and equipment purchases associated with the Bank's new
Chevy Chase office. The estimated amount of these commitments at December 31,
2005 was $568 thousand.
(3) The Bank had outstanding obligations under its current data processing
contract that expires in September 2008. Based on an assumed growth rate of 16%
per annum, this contractual obligation is estimated to be approximately $2.8
million at December 31, 2005.
OFF BALANCE SHEET ARRANGEMENTS
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 and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit and standby
letters of credit. They involve, to varying degrees, elements of credit risk in
excess of the amount recognized in the balance sheets. 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 is represented by the contractual 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. See Note 13
of the Notes to Consolidated Financial Statements for a summary list of loan
commitments at December 31, 2005 and 2004.
Loan commitments represent agreements to lend to a customer as long as
there is no violation of any condition established in the contract and which
have been accepted in writing by the borrower. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since some of the commitments may 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 is based on management's credit evaluation of the
borrower. Collateral obtained varies, and may include certificates of deposit,
accounts receivable, inventory, property and equipment, residential and
commercial real estate.
Standby letters of credit are conditional commitments issued by the
Company which 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.
Collateral held varies as specified above and is required in instances which the
Company deems necessary. At December 31, 2005, approximately 88% percent of the
dollar amount of standby letters of credit was collateralized.
18
With the exception of these off-balance sheet arrangements, 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, capital
expenditures or capital resources, that is material to investors.
LIQUIDITY MANAGEMENT
Liquidity is a measure of the Bank's ability to meet loan demand and to
satisfy depositor withdrawal requirements in an orderly manner. The Bank's
primary sources of liquidity consist of cash and cash balances due from
correspondent banks, loan repayments, federal funds sold and other short-term
investments, maturities and sales of investment securities and income from
operations. The Bank's entire investment securities portfolio is in an
available-for-sale status which allows it flexibility to generate cash from
sales as needed to meet ongoing loan demand. These sources of liquidity are
primary and are supplemented by the ability of the Company and Bank to borrow
funds, which are termed secondary sources. The Company maintains secondary
sources of liquidity, which includes a $10 million line of credit with a
correspondent bank, against which there were no amounts outstanding at December
31, 2005. Additionally, the Bank can purchase up to $37 million in federal funds
on an unsecured basis and $5.5 million on a secured basis from its
correspondents, against which there were no borrowings outstanding at December
31, 2005. At December 31, 2005, the Bank was also eligible to take advances from
the FHLB up to $63 million based on collateral at the FHLB, of which it had no
advances outstanding at December 31, 2005. Also, the Bank may enter into
repurchase agreements as well as obtaining additional borrowing capabilities
from the FHLB provided adequate collateral exists to secure these lending
relationships.
The loss of deposits, through disintermediation, is one of the greater
risks to liquidity. Disintermediation occurs most commonly when rates rise and
depositors withdraw deposits seeking higher rates in alternative savings and
investment sources than the Bank may offer. The Bank was founded under a
philosophy of relationship banking and, therefore, believes that it has less of
an exposure to disintermediation and resultant liquidity concerns than do many
banks. There is, however, a risk that some deposits would be lost if rates were
to increase and the Bank elected not to remain competitive with its deposit
rates. Under those conditions, the Bank believes that it is well positioned to
use other sources of funds such as FHLB borrowings, customer repurchase
agreements and Bank lines of credit to offset a decline in deposits in the short
run. Over the long-term, an adjustment in assets and change in business emphasis
could compensate for a potential loss of deposits. The Bank also maintains a
marketable investment portfolio to provide flexibility in the event of
significant liquidity needs. The Bank Board's Asset Liability Board Committee
has adopted policy guidelines which emphasize the importance of core deposits
and their continued growth.
At December 31, 2005, under the Bank's liquidity formula, it had $202
million of primary and secondary liquidity sources, which was deemed adequate to
meet current and projected funding needs.
INTEREST RATE RISK MANAGEMENT
ASSET/LIABILITY MANAGEMENT AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK
A fundamental risk in banking is exposure to market risk, or interest
rate risk, since a bank's net income is largely dependent on net interest
income. The Bank's Asset Liability Committee ("ALCO") of the Board of Directors
formulates and monitors the management of interest rate risk through policies
and guidelines established by it and the full Board of Directors. In its
consideration of risk limits, the ALCO considers the impact on earnings and
capital, the level and direction of interest rates, liquidity, local economic
conditions, outside threats and other factors. Banking is generally a business
of managing the maturity and re-pricing mismatch inherent in its asset and
liability cash flows and to provide net interest income growth consistent with
the Company's profit objectives.
The Company, through its ALCO, monitors the interest rate environment
in which it operates and adjusts the rates and maturities of its assets and
liabilities to remain competitive and to achieve its overall financial
objectives subject to established risk limits. In the current interest rate
environment, the Company is managing its assets to be either variably priced or
with relatively short maturities, so as to mitigate the risk to earnings and
capital
19
should interest rates increase from current levels. At the same time, the Bank
seeks to acquire longer-term core deposits to lock in relatively lower cost
funds. In the current market, due to competitive factors and customer
preferences, the effort to attract longer-term fixed priced liabilities has not
been as successful as the Company's best case asset liability mix would prefer.
There can be no assurance that the Company will be able to successfully achieve
its optimal asset liability mix, as a result of competitive pressures, customer
preferences and the inability to perfectly forecast future interest rates.
One of the tools used by the Company to manage its interest rate risk
is a static GAP analysis presented below. The Company also uses an earnings
simulation model (simulation analysis) on a quarterly basis to monitor its
interest rate sensitivity and risk and to model its balance sheet cash flows and
its income statement effects in different interest rate scenarios. The model
utilizes current balance sheet data and attributes and is adjusted for
assumptions as to investment maturities (calls), loan prepayments, interest
rates, the level of noninterest income and noninterest expense. The data is then
subjected to a "shock test", which assumes a simultaneous change in interest
rate up 100 and 200 basis points or down 100 and 200 basis points, along the
entire yield curve, but not below zero. The results are analyzed as to the
impact on net interest income, and net income over the next twelve and twenty
four month periods and to the market value of equity impact. The Company
analysis at December 31, 2005 shows a positive effect on income when interest
rates are shocked up 100 and 200 basis points, due to the significant level of
variable rate loans. A negative impact occurs if rates were to decline based on
the Company's asset sensitive position. Interest rate declines would reduce
income on earning assets more than the benefit of reductions in the cost of
funds, potentially resulting in net interest margin contraction. The Company
concluded in the second quarter of 2005, based on market factors and its recent
experience, that larger increases in its retail deposit rate assumptions would
likely occur in a rising interest rate environment and modified its model
assumptions to reflect more rate sensitivity within the core deposit base. While
the impact of higher interest rates continues to be viewed as positive to future
net interest income and market values of equity, this assumption change
moderated the benefits of such higher interest rates assumptions, as compared to
earlier analysis.
The following table reflects the result of simulation analysis on the
December 31, 2005 asset and liabilities balances.
Percentage change in
Change in interest Percentage change in net Percentage change in Market Value of
rates (basis points) interest income net income Portfolio Equity
-------------------- ------------------------ -------------------- --------------------
+200 +2.9% +7.2% +3.1%
+100 +1.6% +4.0% +2.4%
0 - - -
-100 -3.0% -7.5% -4.6%
-200 -7.0% -17.3% -10.1%
These results of simulation are within policy limits recently adopted
by the Company. For net interest income, the Company has adopted a policy limit
of 15% for a 100 basis point change and 20% for a 200 basis point change. For
the market value of equity, the Company has adopted a policy limit of 20% for a
100 basis point change and 25% for a 200 basis point change.
Certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or repricing periods, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable rate mortgage
loans, have features that restrict changes in interest rates on a short-term
basis and over the life of the loan. Further, in the event of a change in
interest rates, prepayment and early withdrawal levels could deviate
significantly from those assumed in calculating the tables. Finally, the ability
of many borrowers to service their debt may decrease in the event of a
significant interest rate increase.
GAP ANALYSIS
Banks and other financial institutions earnings are significantly
dependent upon net interest income, which is the difference between interest
earned on earning assets and interest expense on interest bearing liabilities.
20
In falling interest rate environments, net interest income is maximized
with longer term, higher yielding assets being funded by lower yielding
short-term funds, or what is referred to as a negative mismatch or GAP.
Conversely, in a rising interest rate environment, net interest income is
maximized with shorter term, higher yielding assets being funded by longer-term
liabilities or what is referred to as a positive mismatch or GAP.
The current interest rate environment is signaling higher interest
rates. Management has been emphasizing the acquisition of variable rate and
shorter term assets and has been attempting to secure longer-term core deposits.
While management believes that this overall position creates a good balance in
managing its interest rate risk and maximizing its net interest margin within
plan objectives, there can be no assurance as to actual results.
The GAP position, which is a measure of the difference in maturity and
re-pricing volume between assets and liabilities, is a means of monitoring the
sensitivity of a financial institution to changes in interest rates. The chart
below provides an indication of the rate sensitivity of the Company. A negative
GAP indicates the degree to which the volume of repriceable liabilities exceeds
repriceable assets in given time periods. At December 31, 2005, the Company had
a positive cumulative GAP position of approximately 10% out to three months and
3% out to twelve months, as compared to a three month positive GAP of 38% and a
cumulative twelve month positive GAP of 8% at December 31, 2004. The change in
the GAP position at December 31, 2005 as compared to December 31, 2004 relates
primarily to a change in the re-pricing assumption for money market deposits to
a shorter time-frame, adopted in the second quarter of 2005. This change was
made to recognize the Company's actual practices and experience over the first
six months of 2005.
If interest rates continue to rise, as many forecasters are predicting,
the Bank's interest income and margin are expected to be stable because of the
present positive mismatch position combined with a more competitive business
environment for both deposits and loans. Because competitive market behavior
does not necessarily track the trend of interest rates but at times moves ahead
of financial market influences, the rise in the cost of liabilities may be
greater than anticipated by the GAP model. If this were to occur, the benefits
of a rising interest rate environment may not be in accordance with management's
expectations. Management has carefully considered its strategy to maximize
interest income by reviewing interest rate levels, economic indicators and call
features within its investment portfolio. These factors have been discussed with
the ALCO and management believes that current strategies are appropriate to
current economic and interest rate trends.
GAP TABLE
(dollars in thousands)
0-3 4-12 13-36 37-60 over 60 Total Rate Non- Total
Repriceable in: months months months months months Sensitive Sensitive Assets
--------- ---------- --------- ---------- --------- ----------- ---------- ----------
RATE SENSITIVE ASSETS:
Investments and bank deposits $ 7,410 $ 15,603 $ 27,277 $ 13,625 $ 2,553 $ 66,468
Loans (1) 304,379 69,878 108,949 60,505 8,425 552,136
Fed funds and other short-term
investments 12,356 - - - - 12,356
Other earning assets 1,582 11,122 - - - 12,704
--------- ---------- --------- ---------- --------- -----------
Total $ 325,727 $ 96,603 $ 136,226 $ 74,130 $ 10,978 $ 643,664 $ 28,588 $ 672,252
--------- ---------- --------- ---------- --------- -----------
RATE SENSITIVE LIABILITIES:
Noninterest bearing demand $ 28,290 $ 19,340 $ 34,861 $ 29,607 $ 53,006 $ 165,104
Interest bearing transaction 22,100 - 14,734 14,732 22,100 73,666
Savings and money market 139,826 - 654 436 1,963 142,879
Time deposits 41,203 122,496 22,676 870 - 187,245
Customer repurchase agreements 32,139 - - - - 32,139
Other short-term borrowings - - - - - -
--------- ---------- --------- ---------- --------- -----------
Total $ 263,558 $ 141,836 $ 72,925 $ 45,645 $ 77,069 $ 601,033 $ 6,255 $ 607,288
--------- ---------- --------- ---------- --------- -----------
GAP $ 62,169 $ (45,233) $ 63,301 $ 28,485 $ (66,091) $ 42,631
Cumulative GAP $ 62,169 $ 16,936 $ 80,237 $ 108,722 $ 42,631
Cumulative gap as percent of total
assets 9.25% 2.52% 11.94% 16.17% 6.34%
21
Although, interest bearing transaction accounts and money market
accounts (which are administered rates) are subject to re-pricing as a whole
category of deposits, the Bank's GAP model has incorporated a re-pricing
schedule to account for the historical lag in effecting rate changes and the
amount of those rate changes relative to the amount of rate change in assets.
CAPITAL RESOURCES AND ADEQUACY
The assessment of capital adequacy depends on a number of factors such
as asset quality, liquidity, earnings performance, changing competitive
conditions and economic forces, as well as the overall level of growth. The
adequacy of the Company's current and future capital needs is 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.
The capital position of the Company's wholly-owned subsidiary, the
Bank, continues to meet regulatory requirements as a well-capitalized
institution. 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 and other intangibles of which the
Bank has none. Total risk-based capital consists of Tier 1 capital, qualifying
subordinated debt, and the qualifying portion of the allowance for credit
losses, 100% of which qualifies at December 31, 2005 and 2004. Risk-based
capital ratios are calculated with reference to risk-weighted assets, which are
prescribed by regulation. The Tier 1 capital to average assets ratio is often
referred to as the leverage ratio.
The Company's capital ratios were all in excess of guidelines
established by the Federal Reserve and the Bank's capital ratios as earlier
mentioned were in excess of those required to be classified as a "well
capitalized" institution under the prompt corrective action rule of the Federal
Deposit Insurance Act. The Company and Bank's capital ratios at December 31,
2005 and 2004 are shown in Note 15 to the Consolidated Financial Statements.
The ability of the Company to continue to grow is dependent on its
earnings and those of the Bank, the ability to obtain additional funds for
contribution to the Bank's capital, through additional borrowings, through the
sale of additional common stock or preferred stock, or through the issuance of
additional qualifying equity equivalents, such as subordinated debt or trust
preferred securities.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto have been
prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollars without considering the
changes in the relative purchasing power of money over time due to inflation.
The impact of inflation is reflected in the increased cost of operations. Unlike
most industrial companies, nearly all of our assets and liabilities are monetary
in nature. As a result, interest rates have a greater impact on our performance
than do the effects of general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the price of
goods or services.
NEW ACCOUNTING STANDARDS
Refer to Note 1 of the Notes to Consolidated Financial Statements for
statements on New Accounting Standards.
22
MARKET FOR COMMON STOCK AND DIVIDENDS
Market for Common Stock. The Company's common stock is listed for
trading on the NASDAQ Capital Market under the symbol "EGBN". Trading in the
common stock has been relatively light. Over the twelve month period ended
December 31, 2005, the average daily trading amounted to approximately 5,400
shares. No assurance can be given that an active trading market will develop in
the foreseeable future or can be maintained. The following table sets forth the
high and low bid prices for the common stock during each calendar quarter during
the last three fiscal years, as adjusted for the stock split paid in the form of
a 30% stock dividend on February 28, 2005. These quotations reflect inter-dealer
prices, without retail markup, markdown or commission, and may not represent
actual transactions. As of February 28, 2006, there were 7,233,864 shares of
common stock outstanding, held by approximately 1,500 beneficial shareholders,
plus approximately 800 shareholders of record.
2005 2004 2003
------------------- ------------------- -------------------
Quarter High Bid Low Bid High Bid Low Bid High Bid Low Bid
------- -------- -------- -------- -------- -------- --------
First $ 25.80 $ 18.65 $ 15.38 $ 13.23 $ 11.77 $ 10.32
Second $ 21.75 $ 17.50 $ 15.33 $ 12.88 $ 13.08 $ 11.06
Third $ 24.34 $ 19.55 $ 15.38 $ 13.86 $ 11.98 $ 9.51
Fourth $ 23.89 $ 22.25 $ 16.36 $ 13.62 $ 13.62 $ 11.69
Dividends. Through December 31, 2004, the Company had not paid any cash
dividends. In January 2005, the Company declared its initial quarterly cash
dividend of $0.07 per share of common stock for the first quarter of 2005. For
the full year 2005, the Company declared regular quarterly cash dividends which
totaled $0.28 per share. While the Company has adequate liquidity at present,
the payment of future cash dividends may depend upon the ability of the Bank,
its sole operating business, to declare and pay dividends to the Company. 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
In February 2005, the Company declared a 1.3 for 1 stock split in the
form of a 30% stock dividend which was paid on February 28, 2005.
Regulations of the Federal Reserve Board and Maryland law place limits
on the amount of dividends the Bank may pay to the Company without prior
approval. Prior regulatory approval is required to pay dividends which exceed
the Bank's net profits for the current year plus its retained net profits for
the preceding two calendar years, less required transfers to surplus. State and
federal bank regulatory agencies also have authority to prohibit a bank from
paying dividends if such payment is deemed to be an unsafe or unsound practice,
and the Federal Reserve Board has the same authority over bank holding
companies.
The Federal Reserve Board has established guidelines with respect to
the maintenance of appropriate levels of capital by registered bank holding
companies. Compliance with such standards, as presently in effect, or as they
may be amended from time to time, could possibly limit the amount of dividends
that the Company may pay in the future. In 1985, the Federal Reserve Board
issued a policy statement on the payment of cash dividends by bank holding
companies. In the statement, the Federal Reserve Board expressed its view that a
holding company experiencing earnings weaknesses should not pay cash dividends
exceeding its net income, or which could only be funded in ways that weaken the
holding company's financial health, such as by borrowing. As a depository
institution, the deposits of which are insured by the FDIC, the Bank may not pay
dividends or distribute any of its capital assets while it remains in default on
any assessment due the FDIC. The Bank currently is not in default under any of
its obligations to the FDIC.
Issuer Repurchase of Common Stock. No shares of the Company's Common
Stock were repurchased by or on behalf of the Company during 2005.
Internet Access To Company Documents. The Company provides access to
its SEC filings through the Bank's web site at www.eaglebankmd.com by linking to
the SEC's web site. After accessing the web site, the filings are available upon
selecting "Investor Relations SEC Filings." 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.
23
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and
Stockholders of Eagle Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Eagle Bancorp,
Inc. (the "Company") and subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the three years in the period ended December 31,
2005. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements 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 audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Eagle Bancorp Inc.
as of December 31, 2005 and 2004, and the results of its operations and cash
flows for each of the three years in the period ended December 31, 2005, in
conformity with accounting principles generally accepted in the United States of
America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005, based on the
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated February 28, 2006 expressed an unqualified opinion on management's
assessment of, and the effective operation of, internal control over financial
reporting.
/s/ Stegman & Company
Stegman & Company
Baltimore, Maryland
February 28, 2006
24
EAGLE BANCORP, INC.
Consolidated Balance Sheets
(dollars in thousands)
December 31, December 31,
2005 2004
------------ ------------
ASSETS
Cash and due from banks $ 16,662 $ 31,100
Interest bearing deposits with banks and other short term
investments 11,231 9,594
Federal funds sold 6,103 15,035
Investment securities available for sale, at fair value 68,050 64,098
Loans held for sale 2,924 2,208
Loans 549,212 415,509
Less allowance for credit losses (5,985) (4,240)
------------ ------------
Loans, net 543,227 411,269
Premises and equipment, net 5,774 5,726
Deferred income taxes 2,854 1,102
Accrued interest, taxes and other assets 15,427 13,321
------------ ------------
TOTAL ASSETS $ 672,252 $ 553,453
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest bearing demand $ 165,103 $ 130,309
Interest bearing transaction 73,666 57,063
Savings and money market 142,879 126,299
Time, $100,000 or more 122,571 99,882
Other time 64,674 48,734
------------ ------------
Total deposits 568,893 462,287
Customer repurchase agreements
and federal funds purchased 32,139 23,983
Other short-term borrowings - 6,333
Other liabilities 6,256 2,316
------------ ------------
Total liabilities 607,288 494,919
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; shares authorized 20,000,000, shares
issued and outstanding 7,184,891 (2005) and 5,421,730 (2004) 72 54
Additional paid in capital 48,594 47,014
Retained earnings 16,918 11,368
Accumulated other comprehensive (loss) gain (620) 98
------------ ------------
Total stockholders' equity 64,964 58,534
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 672,252 $ 553,453
============ ============
See notes to consolidated financial statements.
25
EAGLE BANCORP, INC.
Consolidated Statements of Operations
Years Ended December 31,
(dollars in thousands, except per share data)
2005 2004 2003
---------- ---------- ----------
INTEREST INCOME
Interest and fees on loans $ 33,478 $ 21,393 16,354
Taxable interest and dividends on investment securities 2,424 2,195 1,807
Interest on balances with other banks and short term investments 417 152 180
Interest on federal funds sold 407 455 62
---------- ---------- ----------
Total interest income 36,726 24,195 18,403
---------- ---------- ----------
INTEREST EXPENSE
Interest on deposits 7,463 3,755 3,099
Interest on customer repurchase agreements
and federal funds purchased 350 105 108
Interest on short-term borrowings 195 171 266
Interest on long-term borrowings - 297 480
---------- ---------- ----------
Total interest expense 8,008 4,328 3,953
---------- ---------- ----------
NET INTEREST INCOME 28,718 19,867 14,450
PROVISION FOR CREDIT LOSSES 1,843 675 1,175
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 26,875 19,192 13,275
---------- ---------- ----------
NONINTEREST INCOME
Service charges on deposits 1,153 1,255 1,216
Gain on sale of loans 1,245 952 671
Gain on sale of investment securities 279 453 311
Increase in the cash surrender value of bank owned life insurance 401 385 250
Other income 920 708 402
---------- ---------- ----------
Total noninterest income 3,998 3,753 2,850
---------- ---------- ----------
NONINTEREST EXPENSE
Salaries and employee benefits 10,503 8,204 5,847
Premises and equipment expenses 3,470 2,655 2,111
Marketing and advertising 473 280 244
Outside data processing 769 652 555
Legal and consulting fees 674 434 160
Other expenses 3,071 2,727 2,090
---------- ---------- ----------
Total noninterest expense 18,960 14,952 11,007
---------- ---------- ----------
INCOME BEFORE INCOME TAX EXPENSE 11,913 7,993 5,118
INCOME TAX EXPENSE 4,369 2,906 1,903
---------- ---------- ----------
NET INCOME $ 7,544 $ 5,087 $ 3,215
========== ========== ==========
NET INCOME PER SHARE
Basic $ 1.06 $ 0.72 $ 0.63
Diluted $ 1.00 $ 0.69 $ 0.59
DIVIDENDS DECLARED PER SHARE $ 0.28 $ - $ -
See notes to consolidated financial statements
26
EAGLE BANCORP, INC.
Consolidated Statements of Changes in Stockholders' Equity
(dollars in thousands)
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Stockholders'
Stock Capital Earnings Income (Loss) Equity
------------ ------------ ------------ ------------- -------------
Balance, January 1, 2003 $ 29 $ 16,541 $ 3,066 $ 392 $ 20,028
Comprehensive Income
Net Income 3,215 3,215
Other comprehensive income:
Unrealized gain on securities available for
sale (net of taxes) 70 70
Less: reclassification adjustment for gains net
of taxes of $120 included in net income (191) (191)
------------- -------------
Total Comprehensive Income 271 3,094
Exercise of options for 12,620 shares of common
stock 123 123
Issuance of 2,448,979 shares of common stock 25 29,742 29,767
------------ ------------ ------------ ------------- -------------
Balance, December 31, 2003 54 46,406 6,281 271 53,012
Comprehensive Income
Net Income 5,087 5,087
Other comprehensive income:
Unrealized gain on securities available for
sale (net of taxes) 105 105
Less: reclassification adjustment for gains net
of taxes of $175 included in net income (278) (278)
------------- -------------
Total Comprehensive Income (173) 5,192
Exercise of options for 62,427 shares of common
stock 510 510
Tax benefit on non-qualified options exercise 98 98
------------ ------------ ------------ ------------- -------------
Balance, December 31, 2004 54 47,014 11,368 98 58,534
Comprehensive Income
Net Income 7,544 7,544
Other comprehensive income:
Unrealized loss on securities available for
sale (net of taxes) (549) (549)
Less: reclassification adjustment for gains net
of taxes of $110 included in net income (169) (169)
------------- -------------
Total Comprehensive Income (718) 6,826
Cash Dividend ($ .28 per share) (1,994) (1,994)
1.3 to one stock split in the form of a 30%
stock dividend 17 (17) -
Cash paid in lieu of fractional shares (4) (4)
Exercise of options for 136,841 shares of common
stock 1 1,133 1,134
Tax benefit on non-qualified options exercise 468 468
------------ ------------ ------------ ------------- -------------
Balance, December 31, 2005 $ 72 $ 48,594 $ 16,918 $ (620) $ 64,964
============ ============ ============ ============= =============
See notes to consolidated financial statements.
27
EAGLE BANCORP, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 2005, 2004 and 2003
(dollars in thousands)
2005 2004 2003
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,544 $ 5,087 $ 3,215
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Decrease in deferred income taxes (1,312) (151) (319)
Provision for credit losses 1,843 675 1,175
Depreciation and amortization 1,122 984 714
Gains on sale of loans (1,245) (952) (671)
Origination of loans held for sale (29,083) (29,592) (24,726)
Proceeds from sale of loans held for sale 29,612 31,985 27,294
Gain on sale of investment securities (279) (453) (311)
Net increase in surrender value of BOLI (402) (385) (250)
Tax benefit on non-qualified options exercise 468 98 -
Increase in other assets (1,704) (528) (458)
Decrease (increase) in other liabilities 3,940 834 (126)
---------- ---------- ----------
Net cash provided by operating activities 10,504 7,602 5,537
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase (decrease) in interest bearing deposits - other banks (1,637) (5,262) 1,787
Purchases of available for sale investment securities (48,336) (204,254) (443,296)
Proceeds from maturities of available for sale securities 31,230 166,962 382,186
Proceeds from sale / call of available for sale securities 12,275 55,969 49,328
Net increase in loans (133,801) (98,091) (80,673)
Bank premises and equipment acquired (1,170) (2,451) (1,372)
Purchase of BOLI - (4,000) (2,000)
---------- ---------- ----------
Net cash used in investing activities (141,439) (91,127) (94,040)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits 106,606 126,773 57,080
Increase (decrease) in customer repurchase agreements 8,156 (14,471) 13,400
Decrease in other short-term borrowings (6,333) (4,000) (8,600)
Increase (decrease) in long-term borrowings - (4,255) 255
Issuance of common stock 1,130 510 29,890
Payment of dividends (1,994) - -
---------- ---------- ----------
Net cash provided by financing activities 107,565 104,557 92,025
---------- ---------- ----------
NET (DECREASE) INCREASE IN CASH
(23,370) 21,032 3,522
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 46,135 25,103 21,581
---------- ---------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 22,765 $ 46,135 $ 25,103
========== ========== ==========
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid $ 4,805 $ 3,818 $ 4,024
========== ========== ==========
Income taxes paid $ 5,083 $ 2,462 $ 1,887
========== ========== ==========
NON-CASH FINANCING ACTIVITIES
Reclassification of borrowings from long-term to short-term $ - $ 6,333 $ 4,000
See notes to consolidated financial statements.
28
EAGLE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31,2005,
2004 AND 2003:
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Eagle Bancorp,
Inc. (the "Company") and its subsidiaries, EagleBank (the "Bank") and Bethesda
Leasing, LLC ("Bethesda Leasing") with all significant intercompany transactions
eliminated. The investment in subsidiaries is recorded on the Company's books
(Parent Only) on the basis of its equity in the net assets of the subsidiary.
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices in the banking industry. Certain reclassifications have been made to
amounts previously reported to conform to the classification made in 2005. The
following is a summary of the more significant accounting policies.
NATURE OF OPERATIONS
The Company, through its bank subsidiary, conducts a full service community
banking business, primarily in Montgomery County, Maryland and Washington, D.C.
The primary financial services include real estate, commercial and consumer
lending, as well as traditional deposit and repurchase agreement products. The
Bank is also active in the origination and sale of residential mortgage loans
and the origination of small business loans. The guaranteed portion of small
business loans is typically sold thru the Small Business Administration, in a
transaction apart from the loan's origination. The Bank offers its products and
services thru eight banking offices and various electronic capabilities. The
Bank commenced operation of a limited liability corporation, Eagle Land Title,
LLC, early in 2005, to provide noninterest income through title and attendant
services.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Actual results could differ from those estimates.
CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, and federal funds sold (items with an original maturity of three
months or less).
LOANS HELD FOR SALE
The Company engages in sales of residential mortgage loans and the guaranteed
portion of Small Business Administration ("SBA") loans originated by the Bank.
Loans held for sale are carried at the lower of aggregate cost or fair value.
Fair value is derived from secondary market quotations for similar instruments.
Gains and losses on sales of these loans are recorded as a component of
noninterest income in the Consolidated Statements of Income.
The Company's current practice is to sell residential mortgage loans on a
servicing released basis, and, therefore, it has no intangible asset recorded
for the value of such servicing as of December 31, 2005 or 2004. The sale of the
guaranteed portion of SBA loans on a servicing retained basis gives rise to an
Excess Servicing Asset, which is computed on a loan by loan basis and which
unamortized amount is included in other assets. This asset is being amortized on
a straight line basis as an offset of servicing fees collected which is included
in other noninterest income.
The Company enters into commitments to originate residential mortgage loans
whereby the interest rate on the loan is determined prior to funding (i.e. rate
lock commitments). Such rate lock commitments on mortgage loans to be sold in
the secondary market are considered to be derivatives. The period of time
between issuance of a loan commitment and closing and sale of the loan generally
ranges from 15 to 60 days. The Company protects itself from changes in interest
rates through the use of best efforts forward delivery commitments, whereby the
Company
29
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 gains related
to its rate lock commitments due to changes in interest rates.
The market values of rate lock commitments and best efforts contracts are not
readily ascertainable with precision because rate lock commitments and best
efforts contracts are not actively traded. Because of the high correlation
between rate lock commitments and best efforts contracts, no gain or loss occurs
on the rate lock commitments.
INVESTMENT SECURITIES
The Company and Bank have no securities classified as trading nor are any
investment securities classified as held- to- maturity.
Marketable equity securities and debt securities not classified as
held-to-maturity or trading are classified as available-for-sale. Securities
available-for-sale are acquired as part of the Company's asset/liability
management strategy and may be sold in response to changes in interest rates,
loan demand, changes in prepayment risk and other factors. Securities
available-for-sale are carried at fair value, with unrealized gains or losses
being reported as accumulated other comprehensive income, a separate component
of stockholders' equity, net of deferred tax. Realized gains and losses, using
the specific identification method, are included as a separate component of
noninterest income. Related interest and dividends are included in interest
income. Declines in the fair value of individual available-for-sale securities
below their cost that are other than temporary result in write-downs of the
individual securities to their fair value. Factors affecting the determination
of whether other-than-temporary impairment has occurred include a downgrading of
the security by a rating agency, a significant deterioration in the financial
condition of the issuer, or a change in managements' intents and ability to hold
a security for a period of time sufficient to allow for any anticipated recovery
in fair value.
LOANS
Loans are stated at the principal amount outstanding, net of unamortized
deferred costs and fees. Interest income on loans is accrued at the contractual
rate on the principal amount outstanding. It is the Company's policy to
discontinue the accrual of interest when circumstances indicate that collection
is doubtful. Deferred fees and costs on loans originated thru October 2005 are
being amortized on the straight line method over the term of the loan. Deferred
fees and costs on loans originated subsequent to October 2005 are being
amortized on the interest method over the term of the loan. The difference
between the straight line method and the interest method was considered
immaterial.
Management considers loans impaired when, based on current information, it is
probable that the Company will not collect all principal and interest payments
according to contractual terms. Loans are tested for impairment once principal
or interest payments become ninety days or more past due and they are placed on
nonaccrual. Management also considers the financial condition of the borrower,
cash flows of the loan and the value of the related collateral. Impaired loans
do not include large groups of smaller balance homogeneous loans such as
residential real estate and consumer type loans which are evaluated collectively
for impairment. Loans specifically reviewed for impairment are not considered
impaired during periods of "minimal delay" in payment (ninety days or less)
provided eventual collection of all amounts due is expected. The impairment of a
loan is measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate, or the fair value of the
collateral if repayment is expected to be provided by the collateral. Generally,
the Company's impairment on such loans is measured by reference to the fair
value of the collateral. Interest income on impaired loans is recognized on the
cash basis.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses represents an amount which, in management's
judgment, is adequate to absorb probable losses on existing loans and other
extensions of credit that may become uncollectible. The adequacy of the
allowance for credit losses is determined through careful and continuous review
and evaluation of the loan portfolio and involves the balancing of a number of
factors to establish a prudent level of allowance. Among the factors considered
in evaluating the adequacy of the allowance for credit losses are lending risks
associated with growth and
30
entry into new markets, loss allocations for specific nonperforming credits, the
level of the allowance to nonperforming loans, historical loss experience,
economic conditions, portfolio trends and credit concentrations, changes in the
size and character of the loan portfolio, and management's judgment with respect
to current and expected economic conditions and their impact on the existing
loan portfolio. Allowances for impaired loans are generally determined based on
collateral values. Loans deemed uncollectible are charged against the allowance,
while recoveries are credited to the allowance. Management adjusts the level of
the allowance through the provision for credit losses, which is recorded as a
current period operating expense. The allowance for credit losses consists of
allocated and unallocated components.
The components of the allowance for credit losses represent an estimation done
pursuant to either Statement of Financial Accounting Standards ("SFAS") No. 5,
"Accounting for Contingencies," or SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan." Specific allowances are established in cases where
management has identified significant conditions or circumstances related to a
specific credit that management believes indicate the probability that a loss
may be incurred in an amount different from an amount determined by application
of the formula allowance. For problem credits for which specific allowance
amounts have not been determined, the Company establishes allowances according
to the application of credit risk factors. These factors are set by management
to reflect its assessment of the relative level of risk inherent in each grade.
A third component of the allowance computation, termed a nonspecific allowance,
is based upon management's evaluation of various environmental conditions that
are not directly measured in the determination of either the specific allowance
or formula allowance. Such conditions include general economic and business
conditions affecting key lending areas, credit quality trends (including trends
in delinquencies and nonperforming loans expected to result from existing
conditions), loan volumes and concentrations, specific industry conditions
within portfolio categories, recent loss experience in particular loan
categories, duration of the current business cycle, bank regulatory examination
results, findings of outside review consultants, and management's judgment with
respect to various other conditions including credit administration and
management and the quality of risk identification systems. Executive management
reviews these environmental conditions quarterly, and documents the rationale
for all changes.
Management believes that the allowance for credit losses is adequate; however,
determination of the allowance is inherently subjective and requires significant
estimates. While management uses available information to recognize losses on
loans, future additions to the allowance may be necessary based on changes in
economic conditions. Evaluation of the potential effects of these factors on
estimated losses involves a high degree of uncertainty, including the strength
and timing of economic cycles and concerns over the effects of a prolonged
economic downturn in the current cycle. In addition, various regulatory
agencies, as an integral part of their examination process, and independent
consultants engaged by the Bank periodically review the Bank's loan portfolio
and allowance for credit losses. Such review may result in recognition of
additions to the allowance based on their judgments of information available to
them at the time of their examination.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization computed using the straight-line method. Premises and equipment are
depreciated over the useful lives of the assets, which generally range from
seven years for furniture, fixtures and equipment, three to five years for
computer software and hardware, and ten to forty years for buildings and
building improvements. Leasehold improvements are amortized over the terms of
the respective leases, which may include renewal options where management has
the positive intent to exercise such options, or the estimated useful lives of
the improvements, whichever is shorter. The costs of major renewals and
betterments are capitalized, while the costs of ordinary maintenance and repairs
are expensed as incurred. These costs are included as a component of premises
and equipment expenses on the Consolidated Statement of Income.
ADVERTISING
Advertising costs are generally expensed as incurred.
31
INCOME TAXES
Income tax expense on the Statements of Operations is based on the results of
operations, adjusted for the permanent differences between items of income and
deduction recognized for financial reporting purposes differently than for
income tax accounting purposes. The Company has adopted the liability method of
accounting for income taxes and has recorded deferred tax assets and liabilities
determined based on differences between the financial statement carrying amounts
and the tax bases of existing assets and liabilities (i.e., temporary
differences). Such temporary differences are measured at the enacted rates that
are expected to be in effect when these differences reverse.
TRANSFER OF FINANCIAL ASSETS
Transfers of financial assets are accounted for as sales, when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtain the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity. In certain cases,
the recourse to the Bank to repurchase assets may exist but be deemed immaterial
based on the specific facts and circumstances.
NET INCOME PER COMMON SHARE
Basic net income per common share is derived by dividing net income available to
common stockholders by the weighted-average number of common shares outstanding
during the period measured. Diluted net income per common share is computed by
dividing net income available to common stockholders by the weighted-average
number of common shares outstanding during the period measured including the
potential dilutive effects of stock options. Net income per common share has
been adjusted to give retroactive reflect to all stock splits.
STOCK-BASED COMPENSATION
Through December 31, 2005, the Company has adopted the disclosure-only
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS
148 "Accounting for Stock-Based Compensation-Transition and Disclosure", but
applies Accounting Principles Board Opinion No. 25 and related interpretations
in accounting for its Plan. No compensation expense related to the Plan was
recorded during the three years ended December 31, 2005. If the Company had
elected to recognize compensation cost based on fair value at the grant dates
for awards under the Plan consistent with the method prescribed by SFAS No. 123,
net income and earnings per share would have been changed to the pro forma
amounts as follows for the years ended December 31:
(dollars in thousands) 2005 2004 2003
---------- ---------- ----------
Net income, as reported $ 7,544 $ 5,087 $ 3,215
Less pro forma stock-based compensation expenses
determined under the fair value
method, net of related tax effects (793) (867) (224)
---------- ---------- ----------
Pro forma net income $ 6,751 $ 4,220 $ 2,991
========== ========== ==========
Net income per share:
Basic - as reported $ 1.06 $ 0.72 $ 0.63
Basic - pro forma $ 0.95 $ 0.60 $ 0.58
Diluted - as reported $ 1.00 $ 0.69 $ 0.59
Diluted - proforma $ 0.89 $ 0.57 $ 0.55
The pro forma amounts are not representative of the effects on reported net
income for future years.
32
Refer below under New Accounting Pronouncements for a discussion of changes
subsequent to December 31, 2005 in accounting for stock based compensation.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123R (revised 2004), "Share-Based Payment", which is a revision of SFAS No.
123, "Accounting for Stock-Based Compensation". SFAS No. 123(R) supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees" and amends SFAS No.
95, "Statement of Cash Flows". This statement establishes standards for the
accounting for transactions in which an entity (i) exchanges its equity
instruments for goods or services, or (ii) 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 the equity instruments.
SFAS 123R eliminates the ability to account for stock-based compensation using
APB 25 and requires that such transactions be recognized as a compensation cost
in the income statement based on their fair values on the date of the grant.
SFAS 123R permits entities to use any option pricing model that meets the fair
value objective of the Statement.
Pro forma disclosure of compensation cost, which is contained under the heading
Stock-Based Compensation thru December 31, 2005 will no longer be permitted
subsequent to December 31, 2005. The new standard ("SFAS 123R") is effective for
the Company in the first annual reporting period beginning after June 15, 2005
(i.e. calendar year 2006). Therefore, the impact of this Statement on the
Company's Statement of Operations will be in periods subsequent to December 31,
2005.
In accordance with the new accounting standard, for periods beginning in
calendar year 2006, the Company will record as compensation expense an amount
equal to the amortization (over the remaining service period) of the fair value
(computed at the date of option grant) of any outstanding stock option grants
which vest subsequent to December 31, 2005. Additionally, the Company has a
Share Purchase Plan (the Employee Stock Purchase Plan), whereby the Company
grants all employees options to purchase shares at discount up to 15% from the
average of the high and low stock price on the date of grant. Under SFAS 123R,
the Employee Stock Purchase Plan requires fair value accounting which recognizes
compensation expense over the service period (usually the vesting period).
Beyond the effects of stock options which vest in periods subsequent to December
31, 2005 being recognized as compensation expense and the effects of recognizing
as compensation expense shares granted and vested under the Employee Stock
Purchase Plan, the impact of SFAS 123R on the Company in periods subsequent to
December 31, 2005 depends on a number of factors, including future compensation
practices, new awards, modifications and cancellations of existing awards, and
the application of alternative option pricing assumptions.
Based on the stock-based compensation awards outstanding as of December 31, 2005
for which the requisite service period has not been rendered prior to January 1,
2006, the Company expects to recognize total pre-tax annual compensation cost of
approximately $128 thousand for 2006 related to outstanding stock option awards,
in accordance with SFAS 123R.
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections" (Statement 154), which replaces APB Opinion No. 20 "Accounting
Changes" and SFAS No. 3 "Reporting Accounting Changes in Interim Financial
Statements". This Statement changes the requirements for and reporting of a
change in accounting principle, and all voluntary changes in accounting
principles, as well as changes required by an accounting pronouncement in the
unusual instance it does not include specific transition provisions.
Specifically, this Statement requires retrospective application to prior
periods' financial statements, unless it is impracticable to determine the
period-specific effects or the cumulative effect of the change. When it is
impractical to determine the effects of the change, the new accounting principle
must be applied to the balances of assets and liabilities as of the beginning of
the earliest period for which retrospective application is practicable and a
correspondent adjustment must be made to the opening balance of retained
earnings for that period rather than being reported in an income statement. When
it is impracticable to determine the cumulative effect of the change, the new
principle must be applied as if it were adopted prospectively from the earliest
date practicable. This statement is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 31, 2005.
This statement does not change the transition provisions of any existing
pronouncements. The Company does not believe that the adoption of Statement No.
154 will have a significant impact on its consolidated statement of income or
financial condition.
NOTE 2 - CASH AND DUE FROM BANKS
Regulation D of the Federal Reserve Act requires that banks maintain reserve
balances with the Federal Reserve Bank based principally on the type and amount
of their deposits. During 2005, the Bank maintained balances at the Federal
Reserve (in addition to vault cash) to meet the reserve requirements as well as
balances to partially
33
compensate for services. Additionally, the Bank maintained balances with the
Federal Home Loan Bank and four domestic correspondents as compensation for
services they provide to the Bank.
NOTE 3 - INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated fair values of investments available for sale
at December 31, 2005 and 2004 are as follows:
(dollars in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2005 Cost Gains Losses Value
------------------------------------------------ ---------- ---------- ---------- ----------
U. S. Government agency securities $ 47,652 $ - $ 654 $ 46,998
Mortgage backed securities 17,798 - 558 17,240
Federal Reserve and Federal Home Loan Bank stock 2,230 - - 2,230
Other equity investments 1,380 214 12 1,582
---------- ---------- ---------- ----------
$ 69,060 $ 214 $ 1,224 $ 68,050
========== ========== ========== ==========
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
------------------------------------------------ ---------- ---------- ---------- ----------
U. S. Government agency securities $ 34,478 $ - $ 294 $ 34,184
Mortgage backed securities 23,177 77 188 23,066
Federal Reserve and Federal Home Loan Bank stock 1,956 - - 1,956
Other equity investments 4,339 555 2 4,892
---------- ---------- ---------- ----------
$ 63,950 $ 632 $ 484 $ 64,098
========== ========== ========== ==========
Gross unrealized losses and fair value by length of time that the individual
available-for-sale securities have been in a continuous unrealized loss position
as of December 31, 2005 are as follows:
Estimated Gross
Fair Less than More than Unrealized
December 31, 2005 (dollars in thousands) Value 12 months 12 months Losses
------------------------------------------------ ---------- ---------- ---------- ----------
U. S. Government agency securities $ 46,998 $ 218 $ 436 $ 654
Mortgage backed securities 17,240 - 558 558
Federal Reserve and Federal Home Loan Bank stock 2,230 - - -
Other equity investments 1,582 - - 12
---------- ---------- ---------- ----------
$ 68,050 $ 218 $ 994 $ 1,224
========== ========== ========== ==========
All of the bonds above (the debt instruments) are rated AAA. The debt
instruments comprise 99% of the unrealized losses and have a weighted average
duration of just 1.96 years, low credit risk, and modest loss (approximately
1.8%) when compared to book value. The remaining portion of the unrealized loss
(about 1%) represents an unrealized loss on a bank stock owned in the holding
company and which is not traded on an exchange. The estimated fair value is
determined by broker quotes. The unrealized losses that exist on the debt
securities available-for-sale are the result of market changes in interest rates
since the original purchase. These factors coupled with the fact that the
Company has both the intent and ability to hold these investments for the period
of time sufficient to allow for any anticipated recovery in fair value
substantiates that the unrealized losses in the available-for-sale portfolio are
temporary. In addition to U.S. government agency bonds and mortgage backed
securities, the Company, at December 31, 2005, held $3.8 million in equity
securities, $1.6 million which were marketable stocks and mutual
34
funds and $2.2 million which were investments in Federal Reserve Bank ("FRB")
and Federal Home Loan Bank ("FHLB") stocks which are held for regulatory
purposes and are not marketable.
The amortized cost and estimated fair values of investments available-for-sale
at December 31, 2005 and 2004 by contractual maturity are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
2005 2004
------------------------------ ------------------------------
Amortized Estimated Amortized Estimated
(dollars in thousands) Cost Fair Value Cost Fair Value
-------------- ------------- -------------- -------------
Amounts maturing:
One year or less $ 13,989 $ 13,825 $ 5,995 $ 5,964
After one year through five years 28,316 27,908 28,483 28,220
After five years through ten years 5,347 5,265 - -
Mortgage backed securities 17,798 17,240 23,177 23,066
FRB, FHLB and other equity securities 3,610 3,812 6,295 6,848
-------------- ------------- --------------- -------------
$ 69,060 $ 68,050 $ 63,950 $ 64,098
============== ============= ============== =============
Realized gains on sales of investment securities were $344 thousand and realized
losses on sales of investment securities were $65 thousand in 2005, the realized
gains on sales of investment securities were $577 thousand and realized losses
on sales of investment securities were $124 thousand in 2004 and the realized
gains on sales of investment securities were $334 thousand and realized losses
on sales of investment securities were $23 thousand in 2003.
Proceeds from sales and calls of investment securities in 2005 were
$12.3million, in 2004 were $56.0 million, and in 2003 were $49.3 million.
At December 31, 2005, $33.7 million (fair value) of securities were pledged as
collateral for certain government deposits, and securities sold under agreement
to repurchase. The outstanding balance of no single issuer, except for U.S.
Government and U.S. Government agency securities, exceeded ten percent of
stockholders' equity at December 31, 2005 or 2004.
NOTE 4 - LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Bank makes loans to customers primarily in Montgomery County, Maryland and
surrounding communities. A substantial portion of the Bank's loan portfolio
consists of loans to businesses secured by real estate and other business
assets.
Loans, net of unamortized net deferred fees, at December 31, 2005 and 2004 are
summarized by type as follows:
(dollars in thousands) 2005 2004
----------- -----------
Commercial $ 118,928 $ 101,911
Real estate - commercial (1) 284,667 189,708
Real estate - residential mortgage 1,130 9,230
Construction - commercial and residential 90,035 62,745
Home equity 50,776 49,632
Other consumer 3,676 2,283
----------- -----------
Total loans 549,212 415,509
Less: Allowance for Credit Losses (5,985) (4,240)
----------- -----------
Loans net $ 543,227 $ 411,269
=========== ===========
(1) Includes loans for land acquisition and development.
35
Unamortized net deferred fees amounted to $1.2 million and $0.6 million at
December 31, 2005 and 2004, respectively of which $195 thousand and $226
thousand respectively at December 31, 2005 and 2004 represented net deferred
costs on home equity loans.
As of December 31, 2005 and 2004, the Bank serviced $23.0 million and $16.4
million, respectively, of SBA loans participations which are not reflected as
loan balances on the on the Consolidated Balance Sheet.
Activity in the allowance for credit losses for the past three years is shown
below.
(dollars in thousands) 2005 2004 2003
-------- -------- --------
Balance at beginning of year $ 4,240 $ 3,680 $ 2,766
Provision for credit losses 1,843 675 1,175
Loan charge-offs (139) (292) (333)
Loan recoveries 41 177 72
-------- -------- --------
Balance at end of year $ 5,985 $ 4,240 $ 3,680
======== ======== ========
Information regarding impaired loans at December 31, 2005 and 2004 is as
follows:
(dollars in thousands) 2005 2004
-------- --------
Impaired loans with a valuation allowance $ 491 $ 58
Impaired loans without a valuation allowance - 98
-------- --------
Total impaired loans $ 491 $ 156
======== ========
Allowance for credit losses related to impaired loans $ 200 $ 31
Allowance for credit losses related to other than impaired loans 5,785 4,209
-------- --------
Total allowance for credit losses $ 5,985 $ 4,240
======== ========
Average impaired loans for the year $ 171 $ 879
Interest income on impaired loans recognized on a cash basis $ - $ -
NOTE 5 - PREMISES AND EQUIPMENT
Premises and equipment include the following at December 31:
(dollars in thousands) 2005 2004
-------- --------
Leasehold improvements $ 4,167 $ 3,680
Furniture and equipment 5,903 5,268
Less accumulated depreciation and amortization (4,296) (3,222)
-------- --------
Total premises and equipment, net $ 5,774 $ 5,726
======== ========
The Company occupies banking and office space in eleven locations under
non-cancelable lease arrangements accounted for as operating leases. The initial
lease periods range from 5 to 10 years and provide for one or more 5-year
renewal options. The leases in some cases provide for scheduled annual rent
escalations and require that the Bank (lessee) pay certain operating expenses
applicable to the leased space. Rent expense applicable to operating leases
amounted to $1,654 thousand in 2005, $1,185 thousand in 2004, and $838 thousand
in 2003. At December 31, 2005, future minimum lease payments under
non-cancelable operating leases having an initial term in excess of one year are
as follows:
36
(dollars in thousands)
Years ending December 31:
2006 $ 1,680
2007 1,924
2008 1,748
2009 1,602
2010 1,655
Thereafter 4,414
--------------
Total minimum lease payments $ 13,023
==============
In February 2004, the Company executed a lease for a new office expected to open
in the second quarter of 2006 in Chevy Chase, Montgomery County, Maryland. These
amounts are included in the above schedule.
NOTE 6 - DEPOSITS
The following table provides information regarding the Bank's deposit
composition at the dates indicated and shows the average rate being paid on the
interest bearing deposits in December of each year.
2005 2004 2003
---------------------------- ---------------------- ----------------------
Average Average Average
(dollars in thousands) Balance Rate Balance Rate Balance Rate
------------- ----------- ----------- -------- ---------- ---------
Noninterest bearing demand $ 165,103 - $ 130,309 - $ 90,468 -
Interest bearing transaction 73,666 0.26% 57,063 0.17% 44,093 0.14%
Savings and money market 142,879 2.88% 126,299 0.99% 104,429 0.94%
Time, $100,000 or more 122,571 3.36% 99,882 2.05% 54,992 1.74%
Other time 64,674 3.38% 48,734 2.17% 41,532 2.25%
------------- ----------- ----------
Total $ 568,893 $ 462,287 $ 335,514
============= =========== ==========
The remaining maturity of time deposit of $100,000 or more at December 31, 2005
and 2004 are as follows:
(dollars in thousands) 2005 2004
------------ -----------
Three months or less $ 25,943 $ 15,754
More than three months through six months 33,109 14,715
More than six months through twelve months 53,217 60,915
Over twelve months 10,302 8,498
------------ -----------
Total $ 122,571 $ 99,882
============ ===========
Interest expense on deposits for the three years ended December 31, 2005,
2004 and 2003 is as follows:
(dollars in thousands) 2005 2004 2003
------------ ----------- -----------
Interest bearing transaction $ 122 $ 72 $ 79
Savings and money market 2,504 1,185 1,161
Time, $100,000 or more 3,259 1,408 953
Other time 1,578 1,090 906
------------ ----------- -----------
Total $ 7,463 $ 3,755 $ 3,099
============ =========== ===========
37
NOTE 7 - BORROWINGS
Information relating to short-term borrowings is as follows for the years ended
December 31. The Company had no long-term borrowings at the dates indicated.
2005 2004 2003
--------------------- --------------------- ---------------------
(dollars in thousands) Amount Rate Amount Rate Amount Rate
--------- --------- --------- --------- --------- ---------
Short-term:
At Year-End:
Federal funds purchased and securities sold under
agreement to repurchase $ 32,139 2.43% $ 23,983 0.50% $ 38,454 0.78%
Federal Home Loan Bank - current portion - - 6,333 3.73% 4,000 2.79%
--------- --------- ---------
Total $ 32,139 $ 30,316 $ 42,454
--------- --------- ---------
Average for the Year:
Federal funds purchased and securities sold under
agreement to repurchase $ 29,341 1.19% $ 20,258 0.52% $ 22,146 0.49%
Federal Home Loan Bank - current portion 3,964 4.92% 5,271 3.24% 7,979 3.33%
Maximum Month-end Balance:
Federal funds purchased and securities sold under
agreement to repurchase $ 43,485 1.75% $ 34,727 0.44% $ 38,454 0.69%
Federal Home Loan Bank - current portion 6,000 3.74% 11,000 3.87% 13,570 3.64%
The Company offers its business customers a repurchase agreement sweep account
in which it collateralizes these funds with U. S. Government agency securities
segregated in its investment portfolio for this purpose. By entering into the
agreement the customer agrees to have the Bank repurchase the designated
securities on the business day following the initial transaction in
consideration of the payment of interest at the rate prevailing on the day of
the transaction.
The Bank has commitments from correspondent banks under which it can purchase up
to $42.5 million in federal funds on a combination of unsecured and secured
basis. Additionally, the Bank can make collateralized advances from the Federal
Home Loan Bank of Atlanta ("FHLB"). Based on collateral at the FHLB at December
31, 2005, the Bank had available borrowings of $63 million against which it had
$0 million outstanding. The Company has a line of credit approved for $10
million secured by stock of EagleBank against which it had no borrowings
outstanding as of December 31, 2005 and 2004.
NOTE 8 - INCOME TAXES
Federal and state income tax expense consists of the following for the periods
ended December 31:
(dollars in thousands) 2005 2004 2003
-------- -------- --------
Current federal income tax $ 4,748 $ 2,569 $ 1,877
Current state income tax 933 488 345
-------- -------- --------
Total current 5,681 3,057 2,222
-------- -------- --------
Deferred federal income tax expense (benefit) (1,075) (123) (260)
Deferred state income tax expense (benefit) (237) (28) (59)
-------- -------- --------
Total deferred (1,312) (151) (319)
-------- -------- --------
Total income tax expense $ 4,369 $ 2,906 $ 1,903
======== ======== ========
38
Temporary differences between the amounts reported in the financial statements
and the tax bases of assets and liabilities result in deferred taxes. Deferred
tax assets and liabilities, shown as the sum of the appropriate tax effect for
each significant type of temporary difference, is presented below for the years
ended December 31:
2005 2004
-------- --------
Deferred tax assets:
Allowance for credit losses $ 2,127 $ 1,273
Deferred loan fees and costs 504 255
Unrealized loss on securities available for sale 390 -
Deferred rent 108 -
-------- --------
Total deferred tax assets 3,129 1,528
-------- --------
Deferred tax liabilities:
Unrealized gain on securities available for sale - (50)
Excess servicing (65) -
Premises and equipment (210) (376)
-------- --------
Total deferred tax liabilities (275) (426)
-------- --------
Net deferred income tax account $ 2,854 $ 1,102
======== ========
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate for the years ended December 31 follows:
2005 2004 2003
-------- -------- --------
Statutory federal income tax rate 35.00% 34.00% 34.00%
Increase (decrease) due to:
State income taxes, net of federal income tax benefit 3.80 3.83 4.70
Tax exempt interest and dividend income (2.10) (1.79) (1.70)
Other (0.03) 0.26 0.20
-------- -------- --------
Effective tax rates 36.67% 36.30% 37.20%
======== ======== ========
NOTE 9 - NET INCOME PER COMMON SHARE
The calculation of net income per common share for the years ended December 31
was as follows:
(dollars and shares in thousands, except per share data) 2005 2004 2003
-------- -------- --------
Basic:
Net income allocable to common stockholders $ 7,544 $ 5,087 $ 3,215
-------- -------- --------
Average common shares outstanding 7,117 7,025 5,112
-------- -------- --------
Basic net income per share $ 1.06 $ 0.72 $ 0.63
-------- -------- --------
Diluted:
Net income allocable to common stockholders $ 7,544 $ 5,087 $ 3,215
-------- -------- --------
Average common shares outstanding 7,117 7,025 5,112
Adjustment for stock options 441 336 304
-------- -------- --------
Average common shares outstanding-diluted 7,558 7,361 5,416
-------- -------- --------
Diluted net income per share $ 1.00 $ 0.69 $ 0.59
-------- -------- --------
As of December 31, 2005 and 2004, there were no shares and as of December 31,
2003, there were 1,075 shares excluded from the diluted net income per share
computation because their effects were anti-dilutive.
39
NOTE 10 - RELATED PARTY TRANSACTIONS
Certain directors and executive officers have had loan transactions with the
Company. Such loans were made in the ordinary course of business on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with outsiders. The following
table summarizes changes in amounts of loans outstanding, both direct and
indirect, to those persons during 2005 and 2004.
(dollars in thousands) 2005 2004
-------- --------
Balance at January 1 $ 4,182 $ 3,891
Additions 7,531 1,903
Repayments (1,883) (1,612)
-------- --------
Balance at December 31 $ 9,830 $ 4,182
======== ========
NOTE 11 - STOCK OPTION PLAN
The Company maintains the 1998 Stock Option Plan (the "1998 Plan"). The 1998
Plan provides for the periodic granting of incentive and non-qualifying options
to selected key employees and members of the Board. Options for not more than
1,142,732, as adjusted for the 1.3 for 1 split paid in February 2005, shares of
common stock may be granted under the Plan and the term of such options shall
not exceed ten years.
The Company also maintains the 2004 Employee Stock Purchase Plan (the "ESPP").
Under the ESPP, a total of 195,000 shares of common stock, as adjusted for the
1.3 for 1 stock split in February 2005, 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 no later
than the last business day of January in the calendar year following the year in
which the grant is made.
Following is a summary of changes in shares under option (split adjusted) for
the years indicated:
Year Ended December 31,
-------------------------------------------------------------------
2005 2004 2003
--------------------- --------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
(shares in thousands) of Shares Price of Shares Price of Shares Price
--------- ---------- --------- ---------- --------- ----------
Outstanding at beginning of year 690 $ 7.63 632 $ 6.14 569 $ 5.29
Granted 208 17.42 142 13.88 83 12.09
Exercised (137) (8.41) (81) (6.30) (15) (7.52)
Cancelled (8) (12.98) (3) (14.73) (5) (4.39)
--------- --------- ---------
Outstanding at end of year 753 $ 10.13 690 $ 7.63 632 $ 6.14
========= ========= =========
Shares exercisable as of 12/31/2005 661 $ 9.06
Weighted average fair value of options
granted during the year $ 4.94 $ 8.85 $ 4.76
---------- ---------- ----------
Weighted average remaining contract life 5.5 years
----------
Weighted Average Weighted
Remaining Average
Contract Life Exercise
Range of Exercise Price Number (in years) Price
------------------------------ ------------ ------------------ -----------
$ 4.26-$8.75 396,485 3.9 $ 5.19
$8.76-$13.26 63,003 4.5 11.49
$13.27-$17.77 234,242 8.5 14.78
$17.78-$23.28 59,482 5.0 23.27
------------ -----------
753,212 $ 10.13
============ ===========
40
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants during the years ended December 31, 2005, 2004
and 2003.
2005 2004 2003
--------- ---------- ---------
Dividend yield 1.63% 0.00% 0.00%
Expected volatility 22.94% 35.85% 21.88%
Risk free interest 4.27% 4.23% 4.23%
Expected lives (in years) 6.5 10 10
NOTE 12 - EMPLOYEE BENEFIT PLANS
The Company has a qualified 401(k) Plan which covers all employees who have
reached the age of 21 and have completed at least one month of service as
defined by the Plan. The Company makes contributions to the Plan based on a
matching formula. For years 2005, 2004 and 2003, respectively, the Company
recognized $160 thousand, $133 thousand, and $98 thousand, in expense. These
amounts are included in salaries and employee benefits in the accompanying
Consolidated Statements of Income.
NOTE 13 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Various commitments to extend credit are made in the normal course of banking
business. Letters of credit are also issued for the benefit of customers. These
commitments are subject to loan underwriting standards and geographic boundaries
consistent with the Company's loans outstanding.
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.
Loan commitments outstanding and lines and letters of credit at December 31,
2005 and 2004 are as follows:
(dollars in thousands) 2005 2004
------------ ------------
Loan commitments $ 59,248 $ 57,617
Unused lines of credit 146,433 105,590
Letters of credit 4,463 3,370
Because most of the Company's business activity is with customers located in the
Washington, D.C., metropolitan area, a geographic concentration of credit risk
exists within the loan portfolio, and, as such, its performance will be
influenced by the economy of the region.
The Bank maintains a reserve for unfunded commitments which amounted to $33
thousand at December 31, 2005 and $12 thousand at December 31, 2004. These
amounts are included in other liabilities. Increases and decreases to the
reserve are a component of other expenses.
NOTE 14 - LITIGATION
In the normal course of its business, the Company is involved in litigation
arising from banking, financial, and other activities it conducts. Management,
after consultation with legal counsel, does not anticipate that the ultimate
liability, if any, arising out of these matters will have a material effect on
the Company's financial condition, operating results or liquidity.
NOTE 15 - REGULATORY MATTERS
The Company and Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and Bank must meet specific capital guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance sheet items as
calculated under regulatory accounting practices. The capital amounts and
41
classification are also subject to qualitative judgments by the regulators about
components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank and Company to maintain amounts and ratios (set forth in the
table below) of total Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2005 and 2004, that
the Company and Bank met all capital adequacy requirements to which they are
subject.
The actual capital amounts and ratios for the Company and Bank as of December
31, 2005 and 2004 are presented in the table below:
To Be Well
Capitalized
For Under Prompt
Company Bank Capital Corrective
----------------------- ----------------------- Purposes Action
Actual Actual Adequacy Provisions*
(dollars in thousands) Amount Ratio Amount Ratio Ratio Ratio
---------- ---------- ---------- ---------- ---------- --------------
As of December 31, 2005
Total capital (to risk weighted assets) $ 71,569 12.05% $ 62,583 10.66% 8.0% 10.0%
Tier 1 capital (to risk weighted assets) 65,584 11.04% 56,617 9.64% 4.0% 6.0%
Tier 1 capital (to average assets) 65,584 9.94% 56,617 8.71% 3.0% 5.0%
As of December 31, 2004
Total capital (to risk weighted assets) $ 62,774 13.45% $ 48,588 10.69% 8.0% 10.0%
Tier 1 capital (to risk weighted assets) 58,436 12.52% 44,364 9.76% 4.0% 6.0%
Tier 1 capital (to average assets) 58,436 11.98% 44,364 8.45% 3.0% 5.0%
* Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Bank, as well as restrict extensions of
credit and transfers of assets between the Bank and the Company. At December 31,
2005, the Bank was limited from paying dividends to its parent company by the
positive amount of retained earnings it held and the requirement to meet certain
capital ratios. The Bank did not pay any dividends in 2004 or 2003.
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company discloses fair value information about financial instruments for
which it is practicable to estimate the value, whether or not such financial
instruments are recognized on the balance sheet. Fair value is the amount at
which a financial instrument could be exchanged in a current transaction between
willing parties, other than in a forced sale or liquidation, and is best
evidenced by quoted market price, if one exists.
Quoted market prices, if available, where available, are shown as estimates of
fair value. Because no quoted market prices exist for a portion of the Company's
financial instruments, the fair value of such instruments has been derived based
on management's assumptions with respect to future economic conditions, the
amount and timing of future cash flows and estimated discount rates. Different
assumptions could significantly affect these estimates. Accordingly, the net
realizable value could be materially different from the estimates presented
below. In addition, the estimates are only indicative of individual financial
instrument values and should not be considered an indication of the fair value
of the Company taken as a whole.
The following methods and assumptions were used to estimate the fair value of
each category of financial instrument for which it is practicable to estimate
value:
Cash and federal funds sold: For cash and due from banks, and federal funds sold
the carrying amount approximates fair value.
Interest bearing deposits with banks: Values are estimated by discounting the
future cash flows using the current rates at which similar deposits would be
earning.
42
Investment securities: For these instruments, fair values are based on published
market or dealer quotes. Loans held for sale: Values are at the carrying value
since such loans are short-term and are carried on a pre-sold basis.
Loans net of unearned interest: For variable rate loans that reprice on a
scheduled basis, fair values are based on carrying values. The fair value of the
remaining loans are estimated by discounting the estimated future cash flows
using the current interest rate at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining term.
Other earning assets represent the carrying value of bank owned life insurance,
whose fair value is assumed to be the current cash surrender value.
Noninterest bearing deposits: The fair value of these deposits is the amount
payable on demand at the reporting date, since generally accepted accounting
standards does not permit an assumption of core deposit value.
Interest bearing deposits: The fair value of interest bearing transaction,
savings, and money market deposits with no defined maturity is the amount
payable on demand at the reporting date, since generally accepted accounting
standards does not permit an assumption of core deposit value.
The fair value of certificates of deposit is estimated by discounting the
future cash flows using the current rates at which similar deposits would be
accepted.
Customer repurchase agreements and other borrowings: The carrying amount for
variable rate borrowings approximate the fair values at the reporting date. The
fair value of Federal Home Loan Bank advances is estimated by computing the
discounted value of contractual cash flows payable at current interest rates for
obligations with similar remaining terms.
Off-balance sheet items: Management has reviewed the unfunded portion of
commitments to extend credit, as well as standby and other letters of credit,
and has determined that the fair value of such instruments is equal to the fee,
if any, collected and unamortized for the commitment made.
The estimated fair values of the Company's financial instruments at December 31,
2005 and 2004 are as follows:
2005 2004
------------------------ ------------------------
Carrying Fair Carrying Fair
(dollars in thousands) Value Value Value Value
------------------------------------------ ---------- ---------- ---------- ----------
ASSETS:
Cash and due from banks $ 16,662 $ 16,662 $ 31,100 $ 31,100
Interest bearing deposits with other banks 11,231 11,231 9,594 9,594
Federal funds sold 6,103 6,103 15,035 15,035
Investment securities 68,050 68,050 63,950 64,098
Loans held for sale 2,924 2,924 2,208 2,208
Loans 549,212 520,273 415,509 415,547
Other earning assets 11,122 11,122 10,721 10,720
LIABILITIES:
Noninterest bearing deposits 165,103 165,103 130,309 130,309
Interest bearing deposits 403,790 402,385 331,978 331,387
Borrowings 32,139 32,139 30,316 30,354
43
NOTE 17 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table reports the unaudited results of operations for each quarter
during 2005, 2004 and 2003:
2005
---------------------------------------------------------------------
(dollars in thousands except per share data) Fourth Quarter Third Quarter Second Quarter First Quarter
--------------- --------------- --------------- ---------------
Total interest income $ 10,606 $ 9,758 $ 8,652 $ 7,710
Total interest expense 2,824 2,242 1,707 1,235
Net interest income 7,782 7,516 6,945 6,475
Provision for credit losses 532 424 470 417
Net interest income after provision for
credit losses 7,250 7,092 6,475 6,058
Noninterest income 833 1,239 887 1,039
Noninterest expense 4,855 4,729 4,901 4,475
Net income before income tax expenses 3,228 3,602 2,461 2,622
Income tax expense 1,163 1,332 905 969
--------------- --------------- --------------- ---------------
Net income $ 2,065 $ 2,270 $ 1,556 $ 1,653
=============== =============== =============== ===============
Income per share
Basic $ 0.29 $ 0.32 $ 0.22 $ 0.23
Diluted 0.27 0.30 0.21 0.22
Dividends declared per share 0.07 0.07 0.07 0.07
2004
---------------------------------------------------------------------
Fourth Quarter Third Quarter Second Quarter First Quarter
--------------- --------------- --------------- ---------------
Total interest income $ 7,057 $ 6,146 $ 5,616 $ 5,376
Total interest expense 1,197 1,115 1,047 969
Net interest income 5,860 5,031 4,569 4,407
Provision for credit losses 218 227 76 154
Net interest income after provision for
credit losses 5,642 4,804 4,493 4,253
Noninterest income 1,149 697 825 1,082
Noninterest expense 3,866 3,962 3,631 3,493
Net income before income tax expenses 2,925 1,539 1,687 1,842
Income tax expense 1,090 539 614 663
--------------- --------------- --------------- ---------------
Net income $ 1,835 $ 1,000 $ 1,073 $ 1,179
=============== =============== =============== ===============
Income per share
Basic $ 0.26 $ 0.14 $ 0.15 $ 0.17
Diluted 0.24 0.14 0.15 0.16
2003
---------------------------------------------------------------------
Fourth Quarter Third Quarter Second Quarter First Quarter
--------------- --------------- --------------- ---------------
Total interest income $ 5,044 $ 4,541 $ 4,353 $ 4,466
Total interest expense 905 906 1,067 1,075
Net interest income 4,139 3,635 3,286 3,391
Provision for credit losses 445 305 201 224
Net interest income after provision for
credit losses 3,694 3,330 3,085 3,167
Noninterest income 803 687 573 873
Noninterest expense 3,174 2,804 2,651 2,465
Net income before income tax expenses 1,323 1,213 1,007 1,575
Income tax expense 508 435 368 592
--------------- --------------- --------------- ---------------
Net income $ 815 $ 778 $ 639 $ 983
=============== =============== =============== ===============
Income per share
Basic $ 0.11 $ 0.10 $ 0.16 $ 0.26
Diluted 0.11 0.10 0.14 0.24
Note: Earnings per share are calculated on a quarterly basis and may not be
additive to the year-to-date amount. Income per share has been adjusted for a
1.3 for 1 stock split in the form of a 30% stock dividend paid in February 2005.
44
NOTE 18- PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Eagle Bancorp, Inc. (Parent Company only) is
as follows:
CONDENSED BALANCE SHEETS
December 31, 2005 and 2004
(dollars in thousands)
2005 2004
---------- ----------
ASSETS:
Cash $ 139 $ 28
Cash equivalents 4,978 6,843
Investment securities available for sale 1,582 4,891
Investment in subsidiary 56,086 44,190
Loans 1,716 2,743
Less: allowance for credit losses (19) (14)
---------- ----------
1,697 2,729
Other assets 579 33
---------- ----------
TOTAL ASSETS $ 65,061 $ 58,714
========== ==========
LIABILITIES:
Accounts payable $ 19 $ 5
Other liabilities 78 175
---------- ----------
Total liabilities 97 180
---------- ----------
STOCKHOLDERS' EQUITY:
Common stock 72 54
Additional paid in capital 48,594 47,014
Retained earnings 16,918 11,368
Accumulated other comprehensive (loss) income (620) 98
---------- ----------
Total stockholders' equity 64,964 58,534
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 65,061 $ 58,714
========== ==========
45
CONDENSED STATEMENTS OF INCOME
For the Years Ended December 31, 2005, 2004, and 2003
(dollars in thousands)
2005 2004 2003
-------- -------- --------
INCOME:
Other interest and dividends $ 475 $ 669 $ 384
Gain on sale of investment securities 332 421 -
-------- -------- --------
Total income 807 1,090 384
-------- -------- --------
EXPENSES:
Salaries and employee benefits - 39 39
Interest expense - 13 180
Legal and professional 89 62 39
Directors' fees 38 35 18
Other 264 167 183
-------- -------- --------
Total expenses 391 316 459
-------- -------- --------
Provision for Credit Losses 5 - 14
-------- -------- --------
INCOME (LOSS) BEFORE INCOME TAX (EXPENSE) BENEFIT
AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 411 774 (89)
INCOME TAX (EXPENSE) BENEFIT (123) (263) 30
-------- -------- --------
INCOME (LOSS) BEFORE EQUITY IN UNDISTRIBUTED
INCOME OF SUBSIDIARIES 288 511 (59)
EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 7,256 4,576 3,274
-------- -------- --------
NET INCOME $ 7,544 $ 5,087 $ 3,215
======== ======== ========
46
CONDENSED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003
(dollars in thousands)
2005 2004 2003
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 7,544 $ 5,087 $ 3,215
ADJUSTMENTS TO RECONCILE NET INCOME TO NET
CASH (USED) PROVIDED BY OPERATING ACTIVITIES:
Provision for credit losses 5 - 14
Gain on sale of investment securities (332) (421) -
Equity in undistributed income of subsidiary (7,256) (4,576) (3,274)
Tax Benefit on non-qualified options exercise 468 - -
Decrease (increase) in other assets (546) 135 (135)
(Decrease) increase in other liabilities 38 (522) 15
--------- --------- ---------
Net cash (used in) provided by operating activities (79) (297) (165)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in loans 1,027 (1,583) (1,150)
Purchase of available for sale investment securities (178) (43,632) (229,374)
Proceeds from maturity and sales of available for sale investment securities 3,340 70,347 199,580
Investment in subsidiary (net) (5,000) (5,682) (7,020)
--------- --------- ---------
Net cash (used in) provided by investing activities (811) 19,450 (37,964)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 1,130 510 29,890
Dividends paid (1,994) - -
(Repayment of) proceeds from short term borrowings - (14,363) 9,763
--------- --------- ---------
Net cash (used in) provided by financing activities (864) (13,853) 39,653
--------- --------- ---------
NET (DECREASE) INCREASE IN CASH: (1,754) 5,300 1,524
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 6,871 1,571 47
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 5,117 $ 6,871 $ 1,571
========= ========= =========
47
BUSINESS
Eagle Bancorp, Inc. (the "Company") was incorporated under the laws of
the State of Maryland on October 28, 1997, to serve as the bank holding company
for a newly formed Maryland chartered commercial bank. The Company was formed by
a group of local businessmen and professionals with significant prior experience
in community banking in the Company's market area, together with an experienced
community bank senior management team. EagleBank, a Maryland chartered
commercial bank which is a member of the Federal Reserve System, the Company's
principal operating subsidiary, was chartered as a bank and commenced banking
operations on July 20, 1998. The Bank operates from five Montgomery County
offices located in Gaithersburg, Rockville, Bethesda and Silver Spring, Maryland
and three locations in the District of Columbia, at 20th and K Streets, NW,
south of Dupont Circle and near McPherson Square. In February 2004, the Company
executed a lease for a new office to be opened in the second quarter of 2006 in
Chevy Chase, Montgomery County, Maryland on the District of Columbia line.
The Bank operates as a community bank alternative to the super-regional
financial institutions which dominate EagleBank's primary market area. The
cornerstone of the Bank's philosophy is to provide superior, personalized
service to its customers. The Bank focuses on relationship banking, providing
each customer with a number of services, familiarizing itself with, and
addressing itself to, customer needs in a proactive, personalized fashion.
Description of Services. The Bank offers full commercial banking
services to its business and professional clients as well as complete consumer
banking services to individuals living and/or working in the service area. The
Bank emphasizes providing commercial banking services to sole proprietorships,
small and medium-sized businesses, partnerships, corporations, non-profit
organizations and associations, and investors living and working in and near the
Bank's primary service area. A full range of retail banking services are offered
to accommodate the individual needs of both corporate customers as well as the
community the Bank serves.
The Bank has developed a loan portfolio consisting primarily of
traditional business and real estate secured loans with variable rates and or
short maturities, where the cash flow of the borrower/borrower's business is the
principal source of debt service with a secondary emphasis on collateral. Real
estate loans are made generally for commercial purposes and are structured using
both variable rates and fixed rates which adjust in three to five years, with
maturities of five to ten years. Consumer loans are made on the traditional
installment basis for a variety of purposes. The Bank has developed significant
expertise and commitment as a Small Business Administration ("SBA") lender and
is one of the largest SBA lenders, in dollar volume, in the Washington
metropolitan area. A new noninterest income business was organized in the first
quarter of 2005, which provides title and attendant services.
All new business customers are screened to determine, in advance, their
credit qualifications and history. This practice permits the Bank to respond
quickly to credit requests as they arise.
In general, the Bank offers the following credit services:
1) Commercial loans for business purposes including working capital,
equipment purchases, real estate, lines of credit, and government
contract financing. Asset based lending and accounts receivable
financing are available on a selective basis.
2) Real estate loans, including construction loan financing, for
business and investment purposes.
3) Lease financing for business equipment.
4) Traditional general purpose consumer installment loans including
automobile and personal loans. In addition, the Bank offers
personal lines of credit.
5) Credit card services are offered through an outside vendor.
The direct lending activities in which the Bank engages each carries
the risk that the 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 the Bank's primary market area have a significant
impact on the Bank's and the Company's results of operations. To the extent that
economic conditions deteriorate, business and individual borrowers may be less
able to meet their obligations to the Bank in full, in a timely manner,
resulting in decreased earnings or losses to the Bank. To the extent the Bank
makes fixed rate loans, general increases in interest rates will tend to reduce
the Bank's
48
spread as the interest rates the Bank must pay for deposits may increase while
interest income may be unchanged. Economic conditions and interest rates may
also adversely affect the value of property pledged as security for loans.
The Bank's goals are to mitigate risks in the event of unforeseen
threats to the loan portfolio as a result of 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
business plan during the underwriting process and throughout the loan term,
identifying and monitoring primary and alternative sources for repayment, and
obtaining collateral to mitigate economic loss in the event of liquidation.
Specific loan reserves are established based upon increased credit and/or
collateral risks on an individual loan basis. A risk rating system is employed
to proactively estimate loss exposure and provide a measuring system for setting
general and specific reserve allocations.
Under certain circumstances, the Bank attempts to further mitigate
commercial term loan losses by using loan guarantee programs offered by the SBA.
The Bank has been approved for the SBA's preferred lender program ("PLP"). SBA
loans made using PLP by the Bank are not subject to SBA pre-approval.
The composition of the Bank's loan portfolio is heavily commercial real
estate, both owner occupied and investment real estate. At December 31, 2005,
real estate - commercial, real estate - residential and real estate-
construction combined represented 68% of the loan portfolio. These loans are
underwritten to mitigate lending risks typical of this type of loan such as
drops in real estate values, changes in cash flow and general economic
conditions. The Bank typically requires a loan to value of 85% or less and
minimum cash flow debt service coverage of 1.15x to 1.0. In making real estate -
commercial mortgage loans, the Bank generally requires that interest rates
adjust not less frequently than five years and generally seeks more frequent
adjustments.
The Bank is also an active traditional commercial lender providing
loans for a variety of purposes, including cash flow, equipment and account
receivable financing. This loan category represents approximately 22% of the
loan portfolio at December 31, 2005 and is generally variable or adjustable
rate. Commercial loans meet reasonable underwriting standards, including
appropriate collateral, and cash flow necessary to support debt service.
Personal guarantees are generally required, although, may be limited. SBA loans
represent 10% of the commercial loan category of loans. In originating SBA
loans, the Company assumes the risk of nonpayment on the uninsured portion of
the credit. The Company generally sells the insured portion of the loan;
generating noninterest income from the gains on sale, as well as servicing
income on the portion participated. SBA loans are subject to the same cash flow
analyses as other commercial loans. SBA loans, and the Section 7A lending
program in particular, are subject to maximum loan size which may receive SBA
guarantees.
Approximately 10% of the loan portfolio at December 31, 2005 consists
of home equity loans and lines of credit and other consumer loans. These
credits, while making up a smaller portion of the loan portfolio, demand the
same emphasis on underwriting and credit evaluation as other types of loans
advanced by the Bank.
At January 31, 2006, the Bank had a legal lending limit of $9.4
million. Due to legal lending limitations, the Bank has participated portions of
credits to other area banks. The Bank has also participated loans to the Company
until such time as the Bank could accommodate the participation within its legal
limit or the loan could be participated to another lender. The ability of the
Company to assist the Bank with these credits has expanded the flexibility and
service the Bank can offer its customers. From time to time the Company may make
loans for its own portfolio. Such loans, which may be made to accommodate
borrowers at the Bank level, may have higher risk characteristics than loans
made by the Bank, such as lower priority security interests and or higher loan
to value ratios. The Company will generally make such loans only to borrowers in
industries where the Company's directors or lending officers have significant
expertise, such as real estate development lending. The Company seeks interest
rates and overall financial compensation commensurate with the risks involved in
the particular loan.
The Bank originates residential mortgage loans, as a correspondent
lender. The loans are registered with one of the designated investors at the
time of application with intentions of immediate sale to that investor on a
servicing released basis. This activity is managed by utilizing the available
pricing, programs and lock periods which produce market gains on the sale of the
loan. Activity in the residential mortgage loan market is highly sensitive to
changes in interest rates and product availability. The Bank does not have
residential mortgage underwriting abilities on staff and
49
employs the services of contract underwriters approved by the designated
investor. Because the loans are originated with investor guidelines, designated
automated underwriting and product specific requirements as part of the loan
application, the loans sold have a limited recourse provision. 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. 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 repurchase 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. In certain instances,
the Bank may provide equity loans (second position financing) in combination
with residential first mortgage lending for purchase money and refinancing
purposes.
Deposit services include business and personal checking accounts, NOW
accounts, tiered savings and money market account and time deposits with varying
maturity structures and customer options. A complete individual retirement
account ("IRA") program is available. In cooperation with Goldman Sachs Asset
Management, the bank has introduced Eagle Asset Management Account, a check
writing cash management account that sweeps funds to one of several off-balance
sheet investment accounts managed by Goldman Sachs.
Other services include cash management services such as electronic
banking, business sweep accounts, lock box, and account reconciliation services,
credit card depository, professional settlement services, including title
insurance placement, safety deposit boxes and Automated Clearing House ("ACH")
origination. After-hours depositories and ATM service are also available.
The Bank and Company maintain portfolios of short term investments and
investment securities consisting primarily of U.S. Agency bonds and mortgage
backed securities, but which also contains equity investments related to Bank
regulatory rules. The Company's securities portfolio also consists of equity
investments in the form of preferred and common stocks and mutual fund issues.
These portfolios provide the following objectives: liquidity management,
additional income to the Company and Bank in the form of interest and gain on
sale opportunities, collateral to facilitate borrowing arrangements and
assistance with meeting interest rate risk management objectives.
The Company and Bank have formalized an asset and liability management
process and have a standing Committee ("ALCO") consisting primarily of outside
directors. The ALCO operates under established policies and practices, which are
updated and re-approved annually. A typical Committee meeting includes
discussion of current economic conditions and strategies, including interest
rate trends and volumes positions, the current balance sheet and earnings
position, cash flow estimates, liquidity positions, interest rate risk position
(quarterly), review of the investment portfolio of the Bank and the Company, and
the approval of investment transactions. The current Investment Policy limits
the Bank to investments of high quality, U.S. Treasury securities, U.S.
Government agency securities and high grade municipal securities. High risk
investments, derivatives and non traditional investments are prohibited,
although the Bank does have investments in structured notes, which are
permissible. Investment maturities are limited to seven years, except as
specifically approved by the ALCO, and mortgage backed pass through securities
with average lives of generally seven years or less.
Management believes that the market segments which the Bank targets,
small to medium sized for profit and not for profit businesses and the consumer
base of the Bank's market area demand the convenience and personal service that
a smaller, independent financial institution such as the Bank can offer. It is
these themes of convenience and personal service that form the basis for the
Bank's business development strategies. The Bank provides services from its main
office in Bethesda, Maryland, and branches in Gaithersburg, Rockville and Silver
Spring. The Bank opened its initial branch in Washington, D.C. in 2001, opened a
second branch in May 2004 and a third branch in January 2005. A sixth Montgomery
County, Maryland branch in Chevy Chase, Maryland, is expected to open in the
second quarter of 2006. The Bank actively seeks additional banking offices
consistent with its strategic plan, although there can be no assurance that the
Bank will establish any additional offices, or that any branch office will prove
to be profitable.
50
The Bank's customer base has benefited from the extensive business and
personal contacts of its Directors and Executive Officers. To introduce new
customers to the Bank, enhanced reliance is expected on proactively designed
officer calling programs, newly created advisory board structures and enhanced
referral programs.
The risk of nonpayment (or deferred payment) of loans is inherent in
commercial banking. The Bank's marketing focus on small to medium-sized
businesses may result in the assumption by the Bank of certain lending risks
that are different from those attendant to loans to larger companies. The
management and director committees of the Bank carefully evaluate all loan
applications and attempts to minimize credit risk exposure by use of extensive
loan application data, and approval and monitoring procedures; however, there
can be no assurance that such procedures can significantly reduce such lending
risks.
RISK FACTORS
An investment in our common stock involves various risks. The following
is a summary of certain risks identified by us as affecting our business. You
should carefully consider the risk factors listed below, as well as other
cautionary statements made in this Annual Report on Form 10K, and risks and
uncertainties which we may identify in our other reports and documents filed
with the Securities and Exchange Commission or other public announcements. These
risk factors may cause our future earnings to be lower or our financial
condition to be less favorable than we expect. In addition, other risks of which
we are not aware, which relate to the banking and financial services industries
in general, or which we do not believe are material, may cause earnings to be
lower, or hurt our future financial condition. You should read this section
together with the other information in this Annual Report on Form 10K.
OUR RESULTS OF OPERATIONS, FINANCIAL CONDITION AND THE VALUE OF OUR
SHARES MAY BE ADVERSELY AFFECTED IF WE ARE NOT ABLE TO MAINTAIN OUR HISTORICAL
GROWTH RATE.
Since opening for business in 1998, our asset level has increased
rapidly, including 21% increase in 2005. Since 2000, the first full year for
which we achieved profitability, our earnings have increased at an average
annual rate of 48%, including a 48% increase in 2005 over 2004. We cannot assure
you that we will continue to achieve comparable results in future years. As our
asset size and earnings increase, it may become more difficult to achieve high
rates of increase in assets and earnings. Additionally, it may become more
difficult to achieve continued improvements in our expense levels and efficiency
ratio. We may not be able to maintain the relatively low levels of nonperforming
assets that we have experienced. Declines in the rate of growth of income or
assets or deposits, and increases in operating expenses or nonperforming assets
may have an adverse impact on the value of the common stock.
WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE CONTINUED GROWTH.
We intend to seek further growth in the level of our assets and
deposits and the number of our branches, both within our existing footprint and
possibly to expand our footprint in the Maryland suburbs of Washington D.C., and
in the District of Columbia. We cannot be certain as to our ability to manage
increased levels of assets and liabilities, and an expanded branch system,
without increased expenses and higher levels of nonperforming assets. We may be
required to make additional investments in equipment and personnel to manage
higher asset levels and loan balances and a larger branch network, which may
adversely impact earnings, shareholder returns and our efficiency ratio.
Increases in operating expenses or nonperforming assets may have an adverse
impact on the value of our common stock.
OUR CONCENTRATIONS OF LOANS MAY CREATE A GREATER RISK OF LOAN DEFAULTS
AND LOSSES.
A substantial portion of our loans are secured by real estate in the
Washington, D.C. metropolitan area, and substantially all of our loans are to
borrowers in that area. We also have a significant amount of real estate
construction loans and land related loans for residential and commercial
developments. At December 31, 2005, 79% of our portfolio loans were secured by
real estate, primarily commercial real estate. Of these loans, $140 million, or
25% of loans, were construction and land development loans. An additional 19% of
portfolio loans were commercial and industrial loans which are not secured by
real estate. These categories of loans generally have a higher risk of default
than other types of
51
loans, such as single family residential mortgage loans. The repayment of these
loans often depends on the successful operation of a business or the sale or
development of the underlying property, and as a result, are more likely to be
adversely affected by adverse conditions in the real estate market or the
economy in general. While we believe that our loan portfolio is well diversified
in terms of borrowers and industries, these concentrations expose us to the risk
that adverse developments in the real estate market, or in the general economic
conditions in the Washington, D.C. metropolitan area, could increase the levels
of nonperforming loans and charge-offs, and reduce loan demand. In that event,
we would likely experience lower earnings or losses. Additionally, if, for any
reason, economic conditions in our market area deteriorate, or there is
significant volatility or weakness in the economy or any significant sector of
the area's economy, our ability to develop our business relationships may be
diminished, the quality and collectibility of our loans may be adversely
affected, the value of collateral may decline and loan demand may be reduced.
Commercial and commercial real estate and construction loans tend to
have larger balances than single family mortgages loans and other consumer
loans. Because the loan portfolio contains a significant number of commercial
and commercial real estate and construction loans with relatively large
balances, the deterioration of one or a few of these loans may cause a
significant increase in nonperforming assets. An increase in nonperforming loans
could result in: a loss of earnings from these loans, an increase in the
provision for loan losses, or an increase in loan charge-offs, which could have
an adverse impact on our results of operations and financial condition.
OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS WOULD BE ADVERSELY
AFFECTED IF OUR ALLOWANCE FOR LOAN LOSSES IS NOT SUFFICIENT TO ABSORB ACTUAL
LOSSES OR IF WE ARE REQUIRED TO INCREASE OUR ALLOWANCE FOR LOAN LOSSES.
Historically, we have enjoyed a relatively low level of nonperforming
assets and net charge-offs, both in absolute dollars, as a percentage of loans
and as compared to many of our peer institutions. As a result of this historical
experience, we have incurred relatively lower loan loss provision expenses,
which has positively impacted our earnings. However, experience in the banking
industry indicates that a portion of our loans will become delinquent, that some
of our loans may only be partially repaid or may never be repaid and we may
experience other losses for reasons beyond our control. Despite our underwriting
criteria and historical experience, we may be particularly susceptible to losses
due to: (1) the geographic concentration of our loans, (2) the concentration of
higher risk loans, such as commercial real estate, construction and commercial
and industrial loans, and (3) the relative lack of seasoning of certain of our
loans. As a result, there can be no assurance that we will be able to maintain
our low levels of nonperforming assets and charge-offs. Although we believe that
our allowance for loan losses is maintained at a level adequate to absorb any
inherent losses in our loan portfolio, these estimates of loan losses are
necessarily subjective and their accuracy depends on the outcome of future
events. If we need to make significant and unanticipated increases in our loss
allowance in the future, our results of operations and financial condition would
be materially adversely affected at that time.
While we strive to carefully monitor credit quality and to identify
loans that may become nonperforming, at any time there are loans included in the
portfolio that will result in losses, but that have not been identified as
nonperforming or potential problem loans. We cannot be sure that we will be able
to identify deteriorating loans before they become nonperforming assets, or that
we will be able to limit losses on those loans that are identified. As a result,
future additions to the allowance may be necessary.
LACK OF SEASONING OF OUR LOAN PORTFOLIO MAY INCREASE THE RISK OF CREDIT
DEFAULTS IN THE FUTURE.
Due to our rapid growth, a substantial amount of the loans in our
portfolio and of our lending relationships are of relatively recent origin. In
general, loans do not begin to show signs of credit deterioration or default
until they have been outstanding for some period of time, a process referred to
as "seasoning." A portfolio of older loans will usually behave more predictably
than a newer portfolio. As a result, because a large portion of our loan
portfolio is relatively new, the current level of delinquencies and defaults may
not be representative of the level that will prevail when the portfolio becomes
more seasoned, which may be higher than current levels. If delinquencies and
defaults increase, we may be required to increase our provision for loan losses,
which would adversely affect our results of operations and financial condition.
52
OUR CONTINUED GROWTH DEPENDS ON OUR ABILITY TO MEET MINIMUM REGULATORY
CAPITAL LEVELS. GROWTH AND SHAREHOLDER RETURNS MAY BE ADVERSELY AFFECTED IF
SOURCES OF CAPITAL ARE NOT AVAILABLE TO HELP US MEET THEM.
As we grow, we will have to maintain our regulatory capital levels at
or above the required minimum levels. If earnings do not meet our current
estimates, if we incur unanticipated losses or expenses, or if we grow faster
than expected, we may need to obtain additional capital sooner than expected,
through borrowing, additional issuances of debt or equity securities, or
otherwise. If we do not have continued access to sufficient capital, we may be
required to reduce or eliminate the dividend paid on our common stock, reduce
our level of assets or reduce our rate of growth in order to maintain regulatory
compliance. Under those circumstances net income and the rate of growth of net
income may be adversely affected. Additional issuances of equity securities
could have a dilutive effect on existing shareholders.
THERE IS NO ASSURANCE THAT WE WILL BE ABLE TO SUCCESSFULLY COMPETE WITH
OTHERS FOR BUSINESS.
The Suburban Maryland/Washington, D.C. metropolitan area in which we
operate is considered highly attractive from an economic and demographic
viewpoint, and is a highly competitive banking market. We compete for loans,
deposits, and investment dollars with numerous regional and national banks,
online divisions of out-of-market banks, and other community banking
institutions, as well as other kinds of financial institutions and enterprises,
such as securities firms, insurance companies, savings associations, credit
unions, mortgage brokers, and private lenders. Many competitors have
substantially greater resources than us, and operate under less stringent
regulatory environments. The differences in resources and regulations may make
it harder for us to compete profitably, reduce the rates that we can earn on
loans and investments, increase the rates we must offer on deposits and other
funds, and adversely affect our overall financial condition and earnings.
TRADING IN THE COMMON STOCK HAS BEEN LIGHT. AS A RESULT, SHAREHOLDERS
MAY NOT BE ABLE TO QUICKLY AND EASILY SELL THEIR COMMON STOCK.
Although our common stock is listed for trading on the NASDAQ Capital
Market (formerly known as the NASDAQ Small Cap Market), and a number of brokers
offer to make a market in the common stock on a regular basis, trading volume to
date has been limited, averaging only approximately 5400 shares per day over the
year ended December 31, 2005, and there can be no assurance that a more active
and liquid market for the common stock will develop or can be maintained. As a
result, shareholders may find it difficult to sell a significant number of
shares at the prevailing market price.
DIRECTORS AND OFFICERS OF EAGLE BANCORP OWN APPROXIMATELY 14% OF THE
OUTSTANDING COMMON STOCK. DIRECTORS OF EAGLEBANK WHO ARE NOT DIRECTORS OF EAGLE
BANCORP OWN ADDITIONAL SHARES. AS A RESULT OF THEIR COMBINED OWNERSHIP, THEY
COULD MAKE IT MORE DIFFICULT TO OBTAIN APPROVAL FOR SOME MATTERS SUBMITTED TO
SHAREHOLDER VOTE, INCLUDING ACQUISITIONS OF THE COMPANY. THE RESULTS OF THE VOTE
MAY BE CONTRARY TO THE DESIRES OR INTERESTS OF THE PUBLIC SHAREHOLDERS.
Directors and executive officers and their affiliates and directors of
EagleBank are believed to own approximately 22% of the currently outstanding
common stock, excluding shares which may be acquired upon the exercise of
options. By voting against a proposal submitted to shareholders, the directors
and officers, as a group, may be able to make approval more difficult for
proposals requiring the vote of shareholders, such as some mergers, share
exchanges, asset sales, and amendments to the Articles of Incorporation.
CHANGES IN INTEREST RATES AND OTHER FACTORS BEYOND OUR CONTROL COULD
HAVE AN ADVERSE IMPACT ON OUR FINANCIAL PERFORMANCE AND RESULTS.
Our operating income and net income depend to a great extent on our net
interest margin, i.e., the difference between the interest yields we receive on
loans, securities and other interest bearing assets and the interest rates we
pay on interest bearing deposits and other liabilities. Net interest margin is
affected by changes in market interest rates, because different types of assets
and liabilities may react differently, and at different times, to market
interest
53
rate changes. When interest bearing liabilities mature or reprice more quickly
than interest earning assets in a period, an increase in market rates of
interest could reduce net interest income. Similarly, when interest earning
assets mature or reprice more quickly than interest bearing liabilities, falling
interest rates could reduce net interest income These rates are highly sensitive
to many factors beyond our control, including competition, general economic
conditions and monetary and fiscal policies of various governmental and
regulatory authorities, including the Board of Governors of the Federal Reserve
System.
We attempt to manage our risk from changes in market interest rates by
adjusting the rates, maturity, repricing, and balances of the different types of
interest earning assets and interest bearing liabilities, but interest rate risk
management techniques are not exact. As a result, a rapid increase or decrease
in interest rates could have an adverse effect on our net interest margin and
results of operations. At December 31, 2005, we would expect that a sudden
decrease of 100 basis points in market interest rates could reduce projected net
income over a twelve month period by approximately 8%. At December 31, 2005, our
cumulative net asset sensitive twelve month gap position was 3% of total assets
and as such we expect that the decline in projected net income over a twelve
month period resulting from a 100 basis point decrease in rates would be
approximately 7%. The results of our interest rate sensitivity simulation model
depend upon a number of assumptions which may not prove to be accurate. There
can be no assurance that we will be able to successfully manage our interest
rate risk. Increases in market rates and adverse changes in the local
residential real estate market, the general economy or consumer confidence would
likely have a significant adverse impact on our noninterest income, as a result
of reduced demand for residential mortgage loans, which we make on a pre-sold
basis.
Adverse changes in the real estate market in our market area could also
have an adverse affect on our cost of funds and net interest margin, as we have
a large amount of noninterest bearing deposits related to real estate sales and
development. While we expect that we would be able to replace the liquidity
provided by these deposits, the replacement funds would likely be more costly,
negatively impacting earnings.
Additionally, changes in applicable law, if enacted, including those
that would permit banks to pay interest on checking and demand deposit accounts
established by businesses, could have a significant negative effect on net
interest income, net income, net interest margin, return on assets and return on
equity. At December 31, 2005, 29% of our deposits were noninterest bearing
demand deposits.
Government policy relating to the deposit insurance funds may also
adversely affect our results of operations. Under current law and regulation, if
the reserve ratio of the Bank Insurance Fund falls below 1.25%, all insured
banks will be required to pay deposit insurance premiums. We do not currently
pay any deposit insurance premiums. Payment of deposit insurance premiums will
have an adverse effect on our earnings. These changes or other legislative or
regulatory developments could have a significant negative effect on our net
interest income, net income, net interest margin, return on assets and return on
equity.
SUBSTANTIAL REGULATORY LIMITATIONS ON CHANGES OF CONTROL AND
ANTI-TAKEOVER PROVISIONS OF MARYLAND LAW MAY MAKE IT MORE DIFFICULT FOR YOU TO
RECEIVE A CHANGE IN CONTROL PREMIUM.
With certain limited exceptions, federal regulations prohibit a person
or company or a group of persons deemed to be "acting in concert" from, directly
or indirectly, acquiring more than 10% (5% if the acquiror is a bank holding
company) of any class of our voting stock or obtaining the ability to control in
any manner the election of a majority of our directors or otherwise direct the
management or policies of our company without prior notice or application to and
the approval of the Federal Reserve. There are comparable prior approval
requirements for changes in control under Maryland law. Also, Maryland corporate
law contains several provisions that may make it more difficult for a third
party to acquire control of us without the approval of our Board of Directors,
and may make it more difficult or expensive for a third party to acquire a
majority of our outstanding common stock.
54
EMPLOYEES
At December 31, 2005 the Bank employed 145 persons on a full time
basis, six of which are executive officers of the Bank. Except for the President
of the Company, the Company does not have any employees or officers who are not
employees or officers of the Bank. None of the Bank's employees are represented
by any collective bargaining group, and the Bank believes that its employee
relations are good. The Bank provides a benefit program which includes health
and dental insurance, a 401k plan, life and long term disability insurance, and
a stock purchase plan for substantially all full time employees. Additionally,
the Company maintains an incentive stock option plan for certain employees of
the Company and Bank.
MARKET AREA AND COMPETITION
The Bank's main office and the headquarters of the Company and the
Bank is located at 7815 Woodmont Avenue, Bethesda, Maryland 20814. The Bank has
four additional Maryland offices, located at 110 North Washington Street,
Rockville, 8677 Georgia Avenue, Silver Spring, 11921 Rockville Pike, Rockville,
and 9600 Blackwood Road, Gaithersburg. There are three offices in Washington DC,
located at 20th and K Streets, NW, 1228 Connecticut Ave, NW and 1425 K Street,
NW.
The primary service areas of the Bank are Montgomery County, Maryland,
and Washington D.C., with a secondary market area of, Prince George's County in
Maryland, and Arlington and Fairfax Counties in Virginia. The Washington, D.C.
metropolitan area attracts a substantial federal workforce as well as supporting
a variety of support industries such as attorneys, lobbyists, government
contractors, real estate developers and investors, non-profit organizations,
tourism and consultants.
Montgomery County, Maryland with a total population of approximately
922,000 (2004), is a diverse and healthy segment of Maryland's economics. While
the State of Maryland boosts a demographic profile superior to the U.S. economy
at large, the economy in and around Montgomery County is among the very best in
Maryland. According to data from the Maryland Department of Labor, Licensing and
Regulation, the number of jobs in the County have increased about 1% per year in
the recent past to approximately 450,000 (2004), with an unemployment rate among
the lowest in the state at 3.1% (May 2005). A very educated population has
contributed to favorable average earnings per worker in Montgomery County of
about $51,000 (2004) and average single family home sales prices of $385,000
(2004). According to the 2000 census, approximately 52% of the County's
residents hold college or advanced degrees, placing Montgomery County among the
most educated in the nation. The area boosts a diverse business climate with
strong growth in federal contracting, housing construction and renovation, legal
services and financial services. The market for commercial space improved in
2005, with office vacancy rates at about 8% at mid-year. The county is also an
incubator for firms engaged in bio-technology and the area is attracting
significant venture capital. Transportation congestion remains the biggest
threat to future economic development and the quality of life in the area.
The Washington region has experienced the most rapid growth of any
major metropolitan area in the nation over the past three years, aided by
increases in the federal budget and federal contracting, according to an October
2005 report by the Montgomery County Department of Economic Development.
Montgomery County is home to many major federal and private sector
research and development and regulatory agencies, including the National
Institute of Standards and Technology, the National Institutes of Health,
National Oceanic and Atmospheric Administration, Naval Research and Development
Center, Naval Surface Warfare Center, Nuclear Regulatory Commission, the Food
and Drug Administration and the National Naval Medical Center in Bethesda..
Deregulation of financial institutions and holding company acquisitions
of banks across state lines has resulted in widespread, fundamental changes in
the financial services industry. This transformation, although occurring
nationwide, is particularly intense in the greater Washington, D.C. metropolitan
area because of the changes in the area's economic base in recent years and
changing state laws authorizing interstate mergers and acquisitions of banks,
and the interstate establishment or acquisition of branches.
55
In Montgomery County, Maryland, competition is exceptionally keen from
large banking institutions headquartered outside of Maryland. In addition, the
Bank competes with other community banks, savings and loan associations, credit
unions, mortgage companies, finance companies and others providing financial
services. Among the advantages that many of these institutions have over the
Bank are their abilities to finance extensive advertising campaigns, maintain
extensive branch networks and technology investments, and to directly offer
certain services, such as international banking and trust services, which are
not offered directly by the Bank. Further, the greater capitalization of the
larger institutions allows for substantially higher lending limits than the
Bank. Certain of these competitors have other advantages, such as tax exemption
in the case of credit unions, and lesser regulation in the case of mortgage
companies and finance companies.
REGULATION
The following summaries of statutes and regulations affecting bank
holding companies do not purport to be complete discussions of all aspects of
such statutes and regulations and are qualified in their entirety by reference
to the full text thereof.
The Company. The Company is a bank holding company registered under the
Bank Holding Company Act of 1956, as amended, (the "Act") 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 Act. The Federal Reserve Board may also make examinations of the Company
and each of its subsidiaries.
The Act 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 Act 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.
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.
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 holding 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 the
Company or any other subsidiary
56
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.
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. 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.
The Bank. The Bank, as a Maryland chartered commercial bank which is a
member of the Federal Reserve System (a "state member bank") and whose accounts
will be insured by the Bank Insurance Fund of the Federal Deposit Insurance
Corporation (the "FDIC") up to the maximum legal limits of the FDIC, is subject
to regulation, supervision and regular examination by the Maryland Department 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 and loan associations, 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. Additionally, legislation has
been proposed which may result in non-banking companies being authorized 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.
Banking is a business which depends on interest rate differentials. In
general, the differences between the interest paid by a bank on its deposits and
its other borrowings and the interest received by a bank on loans extended to
its customers and securities held in its investment portfolio constitute the
major portion of the bank's earnings. Thus, the earnings and growth of the Bank
will be subject to the influence of economic conditions generally, both domestic
and foreign, and also to the monetary and fiscal policies of the United States
and its agencies, particularly the Federal Reserve Board, which regulates the
supply of money through various means including open market dealings in United
States government securities. The nature and timing of changes in such policies
and their impact on the Bank cannot be predicted.
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.
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.
57
The GLB Act made substantial changes in the historic restrictions on
non-bank activities of bank holding companies, and allows affiliations between
types of companies that were previously prohibited. The GLB Act also allows
banks to engage in a wider array of non banking activities through "financial
subsidiaries."
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
regulation 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, to 100% for the bulk of assets which are
typically held by a bank holding company, including certain multi-family
residential and 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 nonperforming 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 the 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
58
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.
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.
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
59
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.
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 formula which 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 assessment. 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 under the BIF fund,
although the Bank and other banks are required to pay a premium associated with
bonds issued in connection with resolution of the savings and loan crises. When
the BIF reserve ratio falls below 1.25% of insured deposits, all insured banks
may be required to pay additional premiums under the BIF reserve. The payment of
deposit insurance premiums would have an adverse effect on earnings. While
changes in the deposit insurance premium have been proposed, which may require
the Bank to pay deposit premiums at some level, there can be no assurance as to
the final form or timing of such changes, if any, or the impact of any such
changes on the Bank.
PROPERTIES
The main banking office and the executive offices for the Bank and the
Company are located at 7815 Woodmont Avenue, Bethesda, Maryland, in a 12,000
square foot, two story masonry structure (plus lower level), with parking. The
Company leases the building under a ten year lease plus options which commenced
in April 1998. The Silver Spring office of the Bank is located at 8677 Georgia
Avenue, Silver Spring, Maryland and consists of 2,794 square feet. The property
is currently occupied under a lease option, which expires in June 2008. The
Rockville office is located at 110 North Washington Street, Rockville, Maryland,
and consists of 2,000 square feet. The property is currently occupied under a
five year lease option which expires in April 2008. The K Street branch of the
Bank is located at 2001 K Street NW, Washington, D.C. and consists of 4,154
square feet. The property is currently occupied under a ten year lease, which
expires in December 2010. The Shady Grove office is located at 9600 Blackwood
Road, Rockville, Maryland, and consists of 2,326 square feet. The property is
currently occupied under a ten year lease, which expires in January 2012. The
Rockville Pike office is located at 11921 Rockville Pike, Rockville, Maryland
and consists of 2,183 square feet. The property is currently occupied under a
five year lease, which expires in October 2008.The
60
Dupont Circle office is located at 1228 Connecticut Avenue, NW, Washington, D.C.
and consists of 1,738 square feet. The property is currently occupied under a
ten year lease, which expires in May 2014. The McPherson Square office is
located at 1425 K Street, NW, Washington, D.C. and consists of 5,199 square
feet. The property is currently occupied under a ten year lease, which expires
in July 2014.
In January 2002, the Company occupied an office facility in Bethesda at
7758 Woodmont Avenue under a ten year lease with options which expires in
October 2016. Additional contiguous space at this location has been leased and
was incorporated into the existing lease. The current space consists of 7,906
square feet.
In June 2004, the Company occupied an additional office facility in
Bethesda at 7819 Norfolk Avenue, consisting of 2,820 square feet under a ten
year lease with options which expires in May 2018.
In April 2004, the Company occupied an operations center at 11961 Tech
Road, Silver Spring, Maryland, consisting of 9,172 square feet. The property is
currently occupied under a seven year lease with options which expires in
December 2020.
In February 2004, the Company entered into a lease for a facility at 11
Wisconsin Circle, Chevy Chase, Maryland, with a planned ninth banking office
expected to open in the second quarter of 2006. The facility consists of 4,276
square feet and will be occupied under a ten year lease which expires in May
2016.
In November 2005, the Company entered into a lease for a facility at
8655 Georgia Avenue, Silver Spring, Maryland, with intention to move its
existing Silver Spring office in the third quarter of 2006. The facility
consists of approximately 3,635 square feet and will be occupied under a ten
year lease which expires in February 2016.
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 the 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 effective. 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, 2005 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
61
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Eagle 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
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 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. The Audit Committee of the Board of Directors (the
"Committee"), is comprised entirely of outside directors who are independent of
management. The Committee is responsible for the appointment and compensation of
the independent auditors and makes 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 ensure 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 management, 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.
Management assessed the Company's system of internal control over
financial reporting as of December 31, 2005. 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, 2005. Management's assessment concluded that there
were no material weaknesses within the Company's internal control structure.
The 2005 financial statements have been audited by the independent
registered public accounting firm of Stegman & Company ("Stegman"). Personnel
from Stegman 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 Stegman
accompanies the financial statements. Stegman has also issued an attestation
report on management's assessment of the effectiveness of internal control over
financial reporting. That report has also been made a part of this Annual
Report.
/s/ Ronald D. Paul /s/ Michael T. Flynn /s/ Wilmer Tinley /s/ James H. Langmead
President and Chief Executive Vice President of Senior Vice President and Executive Vice President and
Executive Officer of the the Company and President Chief Financial Officer of Chief Financial Officer of
Company and CEO of EagleBank the Company EagleBank
62
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
of Eagle Bancorp, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Eagle
Bancorp, Inc. (the "Company") maintained effective internal control over
financial reporting as of December 31, 2005, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible 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 management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit 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 audit provides a reasonable basis for our
opinion.
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.
In our opinion, management's assessment that Eagle Bancorp, Inc.
maintained effective internal control over financial reporting as of December
31, 2005 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). Also, in our
opinion, Eagle Bancorp, Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2005, based in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets as of December 31, 2005, and 2004 and the related consolidated statements
of operations, changes in stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 2005 of Eagle Bancorp, Inc. and our
report dated February 28, 2006 expressed an unqualified opinion on those
consolidated financial statements.
/s/ Stegman & Company
Baltimore, Maryland
February 28, 2006
63
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following financial statements are included in this report
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2005 and 2004
Consolidated Statements of Income for the years ended
December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended
December 31, 2005, 2004 and 2003
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2005, 2004 and 2003
Notes to the Consolidated Financial Statements
All financial statement schedules have been omitted as the required information
is either inapplicable or included in the consolidated financial statements or
related notes.
Exhibit No. Description of Exhibit
----------- --------------------------------------------------------------
3.1 Certificate of Incorporation of the Company, as amended (1)
3.2 Bylaws of the Company (2)
10.1 1998 Stock Option Plan (3)
10.2 Employment Agreement between Michael Flynn and the
Company, (4)
10.3 Employment Agreement between Thomas D. Murphy and the
Bank, (4)
10.4 Employment Agreement between Ronald D. Paul and the
Company, (4)
10.5 Director Fee Agreement between Leonard L. Abel and the
Company, (4)
10.6 Employment Agreement between Susan G. Riel and the Bank, (4)
10.7 Employment Agreement between Martha F. Tonat and the Bank, (4)
10.8 Employment Agreement between Wilmer L. Tinley and the
Bank, (4)
10.9 Employment Agreement between James H. Langmead and the Bank,
filed herewith
10.10 Employee Stock Purchase Plan (5)
11 Statement Regarding Computation of Per Share Income
Please refer to Note 9 to the consolidated financial
statements for the year ended December 31, 2005.
21 Subsidiaries of the Registrant
23 Consent of Stegman & Company
31.1 Certification of Ronald D. Paul
31.2 Certification of Wilmer L. Tinley
31.3 Certification of Michael T. Flynn
31.4 Certification of James H. Langmead
32.1 Certification of Ronald D. Paul
32.2 Certification of Wilmer L. Tinley
32.3 Certification of Michael T. Flynn
32.4 Certification of James H. Langmead
----------
(1) Incorporated by reference to the exhibit of the same number to the
Company's Quarterly Report on Form 10-Q for the period ended September 30,
2005.
(2) Incorporated by reference to Exhibit 3(b) to the Company's Registration
Statement on Form SB-2, dated December 12, 1997.
(3) Incorporated by reference to Exhibit 10.1 to the Company's Annual Report
on Form 10-KSB for the year ended December 31, 1998.
(4) Incorporated by reference to exhibit of the same number to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003.
(5) Incorporated by reference to Exhibit 4 the Company's Registration
Statement on Form S-8 (No. 333-116352).
64
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.
EAGLE BANCORP, INC.
March 13, 2006 By: /s/ Ronald D. Paul
---------------------------------------
Ronald D. Paul, President and CEO
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 POSITION DATE
------------------------- ---------------------------------- -------------
/s/ Leonard L. Abel Chairman of the Board of Directors March 8, 2006
-------------------------
Leonard L. Abel
/s/ Leslie M. Alperstein Director March 8, 2006
-------------------------
Leslie M. Alperstein
/s/ Dudley C. Dworken Director March 8, 2006
-------------------------
Dudley C. Dworken
/s/ Michael T. Flynn Executive Vice President and March 8, 2006
------------------------- Director of the Company and
Michael T. Flynn President of the Bank
Director March _, 2006
-------------------------
Eugene F. Ford, Sr.
Director March _, 2006
-------------------------
Philip N. Margolius
/s/ Ronald D. Paul President, Director and Principal March 13, 2006
------------------------- Executive Officer of the Company
Ronald D. Paul
Director March _, 2006
-------------------------
Leland M. Weinstein
/s/ Wilmer L. Tinley Senior Vice President and Chief March 8, 2006
------------------------- Financial Officer of the Company
Wilmer L. Tinley Principal Financial and Accounting
Officer
65