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Eagle Bancorp 10-K 2007

 

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, 2006

o

 

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
incorporation or organization)

 

(I.R.S. Employer
Identification 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: Common Stock  $.01 par value

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Section 405 of the Securities Act. Yes  o     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  o     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 o

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. o

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  o

 

Accelerated filer  x

 

Non-accelerated filer  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The aggregate market value of the outstanding Common Stock held by nonaffiliates as of June 30, 2006 was approximately $152 million.

As of March 7, 2007, the number of outstanding shares of the Common Stock, $.01 par value, of Eagle Bancorp, Inc. was 9,501,172.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of  the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 15, 2007 are incorporated by reference in part III hereof.

 




Form 10-K Cross Reference Sheet

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 15, 2007, 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 58 through 61.

 

Item 1A.

Risk Factors. See “Risk Factors” at Pages 61 through 66.

 

Item 1B.

Unresolved Staff Comments. None

 

Item 2.

Properties. See “Properties” at Page 72.

 

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 2006.

PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. See “Market for Common Stock and Dividends” at Pages 28 though 29.

 

Item 6.

Selected Financial Data. See “Six Year Summary of Financial Information” at Page 4.

 

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 5 through 27.

 

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 23.

 

Item 8.

Financial Statements and Supplementary Data. See Consolidated Financial Statements and Notes thereto at Pages 30 through 57.

 

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 73 and “Management Report on Internal Control Over Financial Reporting” at Page 74.

 

Item 9B.

Other Information. None.

2




 

PART III

Item 10.

Directors, Executive Officers and Corporate Governance. 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” 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” in the Proxy Statement.

 

Item 13.

Certain Relationships and Related Transactions and Director Independence. 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 76.

 

3




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

 

 

 

2006

 

2005

 

2004

 

2003

 

2002

 

2001

 

Growth Rate

 

 

 

(dollars in thousands except per share data)

 

Selected Balances—Period End

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

773,451

 

$

672,252

 

$

553,453

 

$

442,997

 

$

347,829

 

$

236,833

 

 

27

%

 

Total stockholders’ equity

 

72,916

 

64,964

 

58,534

 

53,012

 

20,028

 

17,132

 

 

34

%

 

Total loans

 

625,773

 

549,212

 

415,509

 

317,533

 

236,860

 

182,256

 

 

28

%

 

Total deposits

 

628,515

 

568,893

 

462,287

 

335,514

 

278,434

 

195,688

 

 

26

%

 

Selected Balances—Averages

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

712,297

 

$

610,245

 

$

487,853

 

$

375,802

 

$

292,921

 

$

198,843

 

 

29

%

 

Total stockholders’ equity

 

68,973

 

61,563

 

55,507

 

34,028

 

18,381

 

16,615

 

 

33

%

 

Total loans

 

575,854

 

479,311

 

353,537

 

266,811

 

210,303

 

149,056

 

 

31

%

 

Total deposits

 

585,621

 

512,416

 

397,788

 

292,953

 

237,910

 

166,118

 

 

29

%

 

Results of Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

50,318

 

$

36,726

 

$

24,195

 

$

18,403

 

$

16,661

 

$

14,121

 

 

29

%

 

Interest expense

 

17,880

 

8,008

 

4,328

 

3,953

 

5,170

 

5,998

 

 

24

%

 

Net interest income

 

32,438

 

28,718

 

19,867

 

14,450

 

11,491

 

8,123

 

 

32

%

 

Provision for credit losses

 

1,745

 

1,843

 

675

 

1,175

 

843

 

979

 

 

12

%

 

Net interest income after provision for credit losses

 

30,693

 

26,875

 

19,192

 

13,275

 

10,648

 

7,144

 

 

34

%

 

Noninterest income

 

3,846

 

3,998

 

3,753

 

2,850

 

2,107

 

1,324

 

 

24

%

 

Noninterest expense

 

21,824

 

18,960

 

14,952

 

11,007

 

8,530

 

6,445

 

 

28

%

 

Income before taxes

 

12,715

 

11,913

 

7,993

 

5,118

 

4,225

 

2,023

 

 

44

%

 

Income tax expense

 

4,690

 

4,369

 

2,906

 

1,903

 

1,558

 

269

 

 

77

%

 

Net income

 

8,025

 

7,544

 

5,087

 

3,215

 

2,667

 

1,754

 

 

36

%

 

Dividends declared

 

2,147

 

1,994

 

 

 

 

 

 

 

 

 

Per Share Data(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income, basic

 

$

0.85

 

$

0.82

 

$

0.56

 

$

0.49

 

$

0.54

 

$

0.36

 

 

19

%

 

Net income, diluted

 

0.81

 

0.77

 

0.53

 

0.46

 

0.51

 

0.34

 

 

19

%

 

Book value

 

7.69

 

6.95

 

6.38

 

5.85

 

4.09

 

3.50

 

 

17

%

 

Dividends declared per share

 

0.23

 

0.22

 

 

 

 

 

 

 

 

 

Dividend payout ratio(3)

 

27.06

%

26.83

%

 

 

 

 

 

 

 

 

Financial Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

1.13

%

1.24

%

1.04

%

0.86

%

0.91

%

0.88

%

 

 

 

 

Return on average equity

 

11.63

%

12.25

%

9.16

%

9.45

%

14.51

%

10.56

%

 

 

 

 

Average equity to average assets

 

9.68

%

10.09

%

11.38

%

9.05

%

6.28

%

8.36

%

 

 

 

 

Net interest margin

 

4.81

%

4.99

%

4.35

%

4.14

%

4.16

%

4.31

%

 

 

 

 

Efficiency ratio(2)

 

60.15

%

57.95

%

63.30

%

63.62

%

62.73

%

68.22

%

 

 

 

 


(1)             Adjusted for all years presented giving retroactive effect to stock splits in the form of 30% stock dividends paid on July 5, 2006 and February 28, 2005 and a seven for five stock split in the form of a 40% stock dividend paid on June 15, 2001.

(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.

4




MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the results of operations, 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 six offices serving Montgomery County and three offices in the District of Columbia. In May 2006, the Bank opened its newest branch in Chevy Chase, Montgomery County, Maryland. In July 2006, the Company formed Eagle Commercial Ventures, LLC as a direct subsidiary to provide subordinate financing for the acquisition, development and construction of real estate projects, where the  primary financing would be provided by EagleBank.

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. In 2006, the Bank developed and began offering a remote deposit service which allows clients to facilitate and expedite deposit transactions through the use of electronic scanning devices.

5




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 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 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 substandard, doubtful and loss, which are segregated from non-classified loans. Classified loans are assigned specific reserves based on an impairment analysis. Allowance factors relate to the level of the internal risk rating with non-classified loans exhibiting higher risk ratings receiving a higher allowance factor.

The nonspecific or environmental factors allowance is an estimate of potential loss associated with the remaining loans (those not identified as either requiring specific reserves or having classified risk ratings). The loss estimates are based on more global factors, 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 risk, 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 the other allowance factors.

6




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 or environmental 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 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 result in lower provisioning in the future. For additional information regarding the allowance for credit losses, refer to the discussion under the caption “Allowance for Credit Losses” below.

Beginning in January 2006, the Company adopted the provisions of SFAS No. 123R, which requires the expense recognition for the fair value of share based compensation awards, such as stock options, restricted stock, performance based shares and the like. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates which directly impact estimated fair value. The accounting standard also allows for the use of alternative option pricing models which may impact fair value as determined. The Company’s practice is to utilize reasonable and supportable assumptions, which are reviewed with the appropriate Board Committee(s).

RESULTS OF OPERATIONS

Overview

The Company reported net income of $8.0 million for the year ended December 31, 2006, a 6% increase over net income of $7.5 million for the year ended December 31, 2005, as compared to $5.1 million for the year ended December 31, 2004.

Earnings per basic share were $0.85 for the year ended December 31, 2006, as compared to $0.82 for the year 2005 and $0.56 for the year 2004. Earnings per diluted share was $0.81 for the year ended December 31, 2006, as compared to $0.77 for the year 2005 and $0.53 for the year 2004.

For the three months ended December 31, 2006, the Company reported net income of $2.2 million as compared to $2.1 million for the same period in 2005. Earnings per basic share was $0.23 and $0.22 per diluted share for the three months ended December 31, 2006, as compared to $0.22 per basic share and $0.21 per diluted share for the same period in 2005.

Earnings per share for the three and twelve months ended December 31, 2005 and 2004 have been adjusted to reflect 1.3 for one stock splits in the form of 30% stock dividends effected on July 5, 2006 and February 26, 2005.

The Company had a return on average assets of 1.13% and a return on average equity of 11.63% for the year of 2006, as compared to returns on average assets and average equity of 1.24% and 12.25%, respectively, for the year of 2005 and 1.04% and 9.16% respectively, for the year of 2004.

The increase in net income for the twelve months ended December 31, 2006 as compared to the same period in 2005 can be attributed substantially to an increase of 13% in net interest income, resulting from an increase of 17% in average earning assets and a decline in the net interest margin of 18 basis points. Since June 2004, the Federal Reserve Bank increased the federal funds target rate by 425 basis points to 5.25% in seventeen interest rate increases of 25 basis points each. Through the year ended December 2005,

7




the impact of these interest rate increases was to contribute to gains in the Company’s net interest margin as the higher interest rates impacted asset yields more than the higher interest rates impacted funding costs. For the twelve months ended December 31, 2006, the Company has experienced a decline in its net interest margin as the funding mix has shifted to more interest bearing deposits and borrowed funds and as the costs of those funds increased. For the twelve months ended December 31, 2006, average interest bearing liabilities funding average earning assets increased to 73% as compared to 70% for the twelve months of 2005. Additionally, while the average rate on earning assets for the twelve month period ended December 31, 2006 as compared to 2005 has risen by 108 basis points from 6.38% to 7.46%, the cost of interest bearing liabilities has increased by 164 basis points from 1.98% to 3.62%, resulting in a decline in the net interest spread from 4.40% for the twelve months ended December 31, 2005 to 3.84% for the twelve months ended December 31, 2006. The 18 basis point decline in the net interest margin during the same period has been less than the decline in the net interest spread as the Company continues to benefit from a significant amount of average noninterest bearing funding sources. For the twelve months ended December 31, 2006, average noninterest sources funding earning assets was $183 million as compared to $170 million for the same period in 2005. The combination of higher levels of market interest rates and the increase in noninterest funding sources has resulted in an increase in the value of noninterest sources funding earning assets from 59 basis points for the twelve months in 2005 to 98 basis points for the twelve months ended December 31, 2006.

As a result of competitive pressures, rates paid on deposits, which have been increasing to meet funding needs, may continue to have increases 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 to 85% of average earning assets in the year 2006 from 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 11% for the year of 2006. This decline in the proportion of average investment securities to average earning assets was directly related to average loan growth for the year 2006 exceeding the growth of average deposits and other funding sources.

The provision for credit losses was $1.7 million for the year of 2006 as compared to $1.8 million for the same period in 2005. This decline was largely attributable to a lesser amount of loan growth in the loan portfolio in 2006 as compared to 2005, offset by specific reserves being provided on a significant problem commercial loan relationship identified in August 2006. As discussed in the section on Allowance for Credit Losses, the Company had $357 thousand of net charge-offs in the year of 2006. This compared to net charge-offs of $98 thousand for the year of 2005. At December 31, 2006, the allowance for credit losses was $7.4 million or 1.18% of total loans, as compared to $6.0 million or 1.09% of total loans at  December 31, 2005. The provision for credit losses was $327 thousand for the three months ended December 31, 2006 as compared to $532 thousand for the same period in 2005, the decrease being attributable to a lesser amount of loan growth in the fourth quarter of 2006 as compared to 2005. For the fourth quarter of 2006, the Company had no net charge-offs or recoveries as compared to net charge-offs of $45 thousand for the same period in 2005.

Total noninterest income was $3.8 million for the year 2006 as compared to $4.0 million for 2005, a 4% decline. These amounts include net investment gains of $124 thousand for the year of 2006 and $279 thousand in 2005. Excluding gains on the sale of investment securities, noninterest income was $3.7 million in both 2006 and 2005. This result was due primarily to increased revenue on deposit service charges being effectively offset by lesser amounts of gains on the sale of SBA loans and SBA service fees. For the three months ended December 31, 2006, total noninterest income was $945 thousand as compared to $833 thousand for the same period in 2005. These amounts include net investment gains of $39 thousand for the three months ended December 31, 2006 as compared to net investment losses of

8




$2 thousand for the same quarter in 2005. Excluding gains on the sale of investment securities, noninterest income increased to $906 thousand for the fourth quarter of 2006, versus $835 thousand for the fourth quarter of 2005.

Noninterest expenses increased from $19.0 million for the year of 2005 to $21.8 million for the year of 2006, an increase of 15%. The increase was attributable primarily to increases in personnel and related benefit cost increases, the cost of share based compensation under new accounting rules effective January 1, 2006 ($345 thousand pre-tax), increased premises and equipment expenses, due in part to a new banking office and the relocation of another banking office, and to higher marketing and advertising costs, outside data processing costs and professional fees associated with a larger organization. For the year 2006, the efficiency ratio, which measures the ratio of noninterest expenses to the sum of net interest income and noninterest income (total revenue) was 60.15% as compared to 57.95% for the year of 2005. For the three months ended December 31, 2006, total noninterest expenses were $5.7 million, as compared to $4.9 million for the same period in 2005, an increase of 18%. This increase was due substantially to the same factors mentioned above which affected the increase for the full year 2006 over 2005.

The combination of increases in net interest income attributed to increases in the average volume of earning assets offset partially by a decline in the net interest margin, similar amounts of total noninterest income, lesser amounts of  provision for credit losses due to lesser growth, and increases in noninterest expenses, resulted in an  improvement in net income for the year of 2006 versus 2005 of 6% and for the three months ended December 31, 2006 versus 2005 of 4%.

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 (“FHLBA”). 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 2006 was $32.4 million compared to $28.7 million in 2005 and $19.9 million in 2004.

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.

9




Average Balances, Interest Yields and Rates and Net Interest Margin

 

Year Ended December 31,

 

 

 

2006

 

2005

 

2004

 

 

 

Average
Balance

 

Interest

 

Average
Yield/
Rate

 

Average
Balance

 

Interest

 

Average
Yield/
Rate

 

Average
Balance

 

Interest

 

Average
Yield/
Rate

 

 

 

(dollars in thousands)

 

ASSETS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits with other banks and other short-term investments

 

$

3,379

 

 

$

212

 

 

 

6.27

%

 

$

12,168

 

 

$

417

 

 

 

3.43

%

 

$

6,432

 

 

$

152

 

 

 

2.36

%

 

Loans(1)(2)

 

575,854

 

 

45,814

 

 

 

7.96

%

 

479,311

 

 

33,478

 

 

 

6.98

%

 

353,537

 

 

21,393

 

 

 

6.05

%

 

Investment securities available for sale

 

75,181

 

 

3,277

 

 

 

4.36

%

 

71,438

 

 

2,424

 

 

 

3.39

%

 

70,720

 

 

2,195

 

 

 

3.10

%

 

Federal funds sold

 

20,271

 

 

1,015

 

 

 

5.01

%

 

12,281

 

 

407

 

 

 

3.31

%

 

25,290

 

 

455

 

 

 

1.80

%

 

Total interest earning
assets

 

674,685

 

 

50,318

 

 

 

7.46

%

 

575,198

 

 

36,726

 

 

 

6.38

%

 

455,979

 

 

24,195

 

 

 

5.31

%

 

Noninterest earning assets

 

44,090

 

 

 

 

 

 

 

 

 

40,073

 

 

 

 

 

 

 

 

 

35,810

 

 

 

 

 

 

 

 

 

Less: allowance for credit
losses

 

6,478

 

 

 

 

 

 

 

 

 

5,026

 

 

 

 

 

 

 

 

 

3,936

 

 

 

 

 

 

 

 

 

Total noninterest earning assets

 

37,612

 

 

 

 

 

 

 

 

 

35,047

 

 

 

 

 

 

 

 

 

31,874

 

 

 

 

 

 

 

 

 

TOTAL ASSETS

 

$

712,297

 

 

 

 

 

 

 

 

 

$

610,245

 

 

 

 

 

 

 

 

 

$

487,853

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing transaction

 

$

58,675

 

 

$

204

 

 

 

0.35

%

 

$

61,230

 

 

$

122

 

 

 

0.20

%

 

$

50,599

 

 

$

72

 

 

 

0.14

%

 

Savings and money market

 

152,162

 

 

5,174

 

 

 

3.40

%

 

138,844

 

 

2,504

 

 

 

1.80

%

 

121,477

 

 

1,185

 

 

 

0.98

%

 

Time deposits

 

229,719

 

 

10,225

 

 

 

4.45

%

 

171,827

 

 

4,837

 

 

 

2.82

%

 

122,864

 

 

2,498

 

 

 

2.03

%

 

Total interest bearing deposits

 

440,556

 

 

15,603

 

 

 

3.54

%

 

371,901

 

 

7,463

 

 

 

2.01

%

 

294,940

 

 

3,755

 

 

 

1.27

%

 

Customer repurchase agreements and federal funds purchased

 

32,968

 

 

1,199

 

 

 

3.64

%

 

29,341

 

 

350

 

 

 

1.19

%

 

20,258

 

 

105

 

 

 

0.52

%

 

Other short-term borrowings

 

12,596

 

 

639

 

 

 

5.07

%

 

3,964

 

 

195

 

 

 

4.92

%

 

5,271

 

 

171

 

 

 

3.24

%

 

Long term borrowings

 

7,888

 

 

439

 

 

 

5.57

%

 

 

 

 

 

 

 

 

7,210

 

 

297

 

 

 

4.12

%

 

Total interest bearing liabilities

 

494,008

 

 

17,880

 

 

 

3.62

%

 

405,206

 

 

8,008

 

 

 

1.98

%

 

327,679

 

 

4,328

 

 

 

1.32

%

 

Noninterest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest bearing demand

 

145,065

 

 

 

 

 

 

 

 

 

140,515

 

 

 

 

 

 

 

 

 

102,848

 

 

 

 

 

 

 

 

 

Other liabilities

 

4,251

 

 

 

 

 

 

 

 

 

2,961

 

 

 

 

 

 

 

 

 

1,819

 

 

 

 

 

 

 

 

 

Total noninterest bearing liabilities

 

149,316

 

 

 

 

 

 

 

 

 

143,476

 

 

 

 

 

 

 

 

 

104,667

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

68,973

 

 

 

 

 

 

 

 

 

61,563

 

 

 

 

 

 

 

 

 

55,507

 

 

 

 

 

 

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

712,297

 

 

 

 

 

 

 

 

 

$

610,245

 

 

 

 

 

 

 

 

 

$

487,853

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

$

32,438

 

 

 

 

 

 

 

 

 

$

28,718

 

 

 

 

 

 

 

 

 

$

19,867

 

 

 

 

 

 

Net interest spread

 

 

 

 

 

 

 

 

3.84

%

 

 

 

 

 

 

 

 

4.40

%

 

 

 

 

 

 

 

 

3.99

%

 

Net interest margin

 

 

 

 

 

 

 

 

4.81

%

 

 

 

 

 

 

 

 

4.99

%

 

 

 

 

 

 

 

 

4.35

%

 


(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 $2 million, $1.2 million and $595 thousand for 2006, 2005, and 2004 respectively.

10




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 2006 as compared to 2005 is due to growth in the volume of earning assets and a decrease in the margin earned on earning assets. For 2005 over 2004, the increase in net interest income was a function of both increased volume of earning assets and increases in the net interest margin.

Rate/Volume Analysis of Net Interest Income

 

 

2006 compared with 2005

 

2005 compared with 2004

 

 

 

Change
Due to
Volume

 

Change
Due to
Rate

 

Total
Increase
(Decrease)

 

Change
Due to
Volume

 

Change
Due to
Rate

 

Total
Increase
(Decrease)

 

 

 

(dollars in thousands)

 

Interest earned on:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

6,743

 

$

5,593

 

 

$

12,336

 

 

$

7,611

 

$

4,474

 

 

$

12,085

 

 

Investment securities

 

127

 

726

 

 

853

 

 

22

 

207

 

 

229

 

 

Interest bearing bank deposits

 

(301

)

96

 

 

(205

)

 

136

 

129

 

 

265

 

 

Federal funds sold

 

265

 

343

 

 

608

 

 

(234

)

186

 

 

(48

)

 

Total interest income

 

6,834

 

6,758

 

 

13,592

 

 

7,535

 

4,996

 

 

12,531

 

 

Interest paid on:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing transaction

 

(5

)

87

 

 

82

 

 

15

 

35

 

 

50

 

 

Savings and money market

 

240

 

2,430

 

 

2,670

 

 

169

 

1,150

 

 

1,319

 

 

Time

 

1,630

 

3,758

 

 

5,388

 

 

995

 

1,344

 

 

2,339

 

 

Customer repurchase agreements

 

43

 

806

 

 

849

 

 

47

 

198

 

 

245

 

 

Other borrowings

 

864

 

19

 

 

883

 

 

(339

)

66

 

 

(273

)

 

Total interest expense

 

2,772

 

7,100

 

 

9,872

 

 

887

 

2,793

 

 

3,680

 

 

Net interest income

 

$

4,062

 

$

(342

)

 

$

3,720

 

 

$

6,648

 

$

2,203

 

 

$

8,851

 

 

 

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 2006, a provision for credit losses was made in the amount of $1.7 million and the allowance for credit losses increased $1.4 million, including the impact of net charge-offs of $357 thousand during the period. The provision for credit losses of $1.7 million for the year 2006 compared to a provision for credit losses of $1.8 million for the year 2005 and $675 thousand for the year 2004. The lower provision in 2006 is attributable primarily to three factors: a lower amount of net loan growth in 2006 as compared to 2005 offset in part by a specific loan provision in the third quarter of 2006 associated with a large commercial lending relationship, and a slight change in the mix of the loan portfolio toward more real estate—commercial and construction credits during the year (70% versus 68%). For the three months ended December 31, 2006, a provision for credit losses was made in the amount of $327 thousand, as compared to $532 thousand for the same period in 2005, the lower provision being due to lesser growth in the portfolio in the three months ended December 31, 2006 as compared to the same period in 2005, and to accommodate a higher level of net-charge offs in the fourth quarter of 2005. For the fourth quarter of 2005, net charge-offs amounted to $45 thousand as compared to no net charge-offs for the same period in 2006.

The provision for credit losses was $1.8 million in 2005 compared to $675 thousand in 2004. The higher provision for 2005, was due substantially to a 32% growth rate in the loan portfolio during the year.

11




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, 2006, noninterest income was $3.8 million. This compared to $4.0 million of noninterest income for the year ended December 31, 2005 and $3.8 million for the year ended December 31, 2004.

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 $813 thousand for the year ended December 31, 2006 compared to $933 thousand and $648 thousand for the years ended December 31, 2005 and 2004, respectively, as the Company continues to emphasize this lending activity. The decline in income in 2006 as compared to 2005 was due substantially to more competitive sales pricing while the increase in 2005 over 2004 primarily reflected an increased volume of loans sold. The Company also originates residential mortgage loans on a pre-sold basis, servicing released. Sales of these mortgage loans yielded gains of $301 thousand in 2006 compared to $312 thousand in 2005 and $304 thousand in 2004.

Net investment gains amounted to $124 thousand for 2006 as compared to $279 thousand for 2005 and $453 thousand for 2004. The Company sells securities in response to asset/liability management objectives.

Income for the year 2006 amounted to $1.4 million from deposit account service charges and $406 thousand from BOLI, versus $1.2 million from deposit account service charges and $401 thousand from BOLI for the year ended December 31, 2005 and $1.3 million from deposit account service charges and $385 thousand from BOLI for the year ended December 31, 2004. The increase in deposit service charges in 2006 over 2005 was due to additional volume and modifications of earnings credit rates. 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.

Other noninterest income which comprises other service charges, SBA service fees, title and settlement fees, and loan prepayment and commitment fees, amounted to $816 thousand for the year of 2006, $920 thousand for the year of 2005, and $708 thousand for the year of 2004, the decrease in 2006 as compared to 2005 due in part to lower amounts of commitment and prepayment fees.

Noninterest income was $945 thousand for the three months ended December 31, 2006 as compared to $833 thousand for the three months ended December 31, 2005 an increase of 13%. These amounts include a net investment gain of $39 thousand for the three months ended December 31, 2006 and a net investment loss of $2 thousand for the three months ended December 31, 2005. Excluding gains on the sale of investment securities, noninterest income was $906 thousand for the fourth quarter of 2006, versus $835 thousand for the fourth quarter of 2005, an increase of 9%, resulting primarily from an increase in deposit service fees for reasons discussed above relating to the year 2006 as compared to 2005.

Non-Interest Expense

Noninterest expense was $21.8 million for 2006, an increase of 15% as compared to $19.0 million for   2005 and $15.0 million for 2004.

Salaries and benefits were $12.2 million for the year of 2006, a 16% increase as compared to $10.5 million for 2005, and $8.2 million for 2004. This increase in 2006 over 2005 was due to additions to staff and related benefit costs, the cost of share based compensation under new accounting rules effective January 1, 2006 ($345 thousand pre-tax), partially offset by lower amounts of incentive based

12




compensation. At December 31, 2006, the Bank had 171 full time equivalent employees as compared to 145 at December 31, 2005 and 119 at December 31, 2004.

Premises and equipment expenses amounted to $3.8 million for the year of 2006 versus $3.5 million for 2005. This increase of 11% was due primarily to a new banking office opened in May 2006, to the relocation of another office, and to ongoing operating expense increases associated with the Company’s facilities, all of which are leased, and increased equipment costs. Premises and equipment expense was $2.7 million for 2004.

Marketing and advertising costs increased from $473 thousand in 2005 to $587 thousand in 2006, an increase of 24%. This increase was associated primarily with increased advertising for deposit products and to special marketing efforts, including sponsorships, customer appreciation events and amounts expended to enhance the Bank’s web-site. Marketing and advertising cost was $280 thousand in 2004.

Outside data processing costs were $881 thousand for 2006, as compared to $769 thousand in 2005, or an increase of 14%. The higher costs were due primarily to added system capabilities and to higher processing volumes. Outside data processing costs were $652 thousand for 2004.

Legal and consulting expenses were $448 thousand for 2006 as compared to $674 thousand in 2005 and $434 thousand in 2004. The lower cost in 2006 as compared to 2005 related to a significant consulting arrangement in 2005 related to a companywide initiative on relationship management and attendant systems.

Other expenses, increased to $3.8 million in 2006 from $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. Other expenses were $2.7 million for 2004.

Noninterest expenses were $5.7 million for the three months ended December 31, 2006 compared to $4.9 million for the three months ended December 31, 2005, an increase of 18%. The same factors which contributed to increased noninterest expense for the year of 2006 over 2005 mentioned above also contributed substantially to the increase in noninterest expenses for the three months ended December 31, 2006, as compared to the same period in 2005.

Commencing in 2007, the Bank will be required to pay, along with all other depository institutions insured by the FDIC, deposit insurance premiums. The Bank has never paid deposit insurance premiums before. The premium is expected to be in the range of 5-7 basis points on the Bank’s assessable deposit base. While the Bank may seek to adjust interest rates paid on deposits to reflect the payment of premiums, competitive pressures may limit its ability to do so. Institutions which are older and larger than the Bank may have substantial premium credits which may temporarily offset all or part of those institutions premium payments, which may enable them to more aggressively price deposits. If the Bank is unable to price the deposit premium into deposit rates, the payment of premiums is likely to have an adverse affect on earnings.

Income Tax Expense

The Company recorded income tax expense of $4.7 million in 2006 compared to $4.4 million in 2005, and $2.9 million in 2004, resulting in an effective tax rate of 36.9%, 36.7% and 36.3% respectively.

BALANCE SHEET ANALYSIS

Overview

At December 31, 2006, the Company’s total assets were $773.5 million, loans were $625.8 million, deposits were $628.5 million and stockholders’ equity was $72.9 million. As compared to December 31, 2005, assets grew in 2006 by $101.2 million (15%), loans by $76.6 million (14%), deposits by $59.6 million (10%) and stockholders’ equity by $8.0 million (12%).

13




The Company declared cash dividends of $0.23 per share for the year 2006 and $0.22 per share for the year 2005.

Securities

The investment securities portfolio is comprised primarily of U.S. Agency debt securities (64%) with final maturities to seven years and an average life of 3.1 years. This portfolio includes $4.3 million of structured notes. The remaining debt securities portfolio consists primarily of seasoned mortgage pass-through securities which have average expected lives of 3.4 years with contractual maturities of the underlying mortgages of up to thirty years. The remaining securities portfolio consists of equity investments, some of which are required by regulatory mandates (Federal Reserve and Federal Home Loan Bank stocks) and the remaining equities of a few community based banking companies.

At December 31, 2006, the investment portfolio amounted to $91.1 million as compared to a balance of $68.1 million at December 31, 2005, an increase of 34%. 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 similar instruments. This portfolio amounted to $4.9 million at December 31, 2006 as compared to $11.2 million at December 31, 2005.

The third element of the Company’s securities portfolio is federal funds sold which amounted to $9.7 million at December 31, 2006 as compared to $6.1 million at December 31, 2005. These funds represent excess daily liquidity which is invested on an unsecured basis with well capitalized banks, in amounts generally 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, 2006, the Company had a net unrealized loss in AFS securities of $420 thousand as compared to a net unrealized loss in AFS securities of $1.0 million at December 31, 2005. The deferred income tax benefit of these unrealized gains and losses was $167 thousand and $390 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,

 

 

 

2006

 

2005

 

2004

 

 

 

Balance

 

Percent
of Total

 

Balance

 

Percent
of Total

 

Balance

 

Percent
of Total

 

 

 

(dollars in thousands)

 

U. S. Government agency securities

 

$

58,584

 

 

64.3

%

 

$

46,998

 

 

69.1

%

 

$

34,184

 

 

53.3

%

 

Mortgage backed securities

 

27,333

 

 

30.0

%

 

17,240

 

 

25.3

%

 

23,066

 

 

36.0

%

 

Federal Reserve and Federal Home Loan Bank stock

 

3,829

 

 

4.2

%

 

2,230

 

 

3.3

%

 

1,956

 

 

3.1

%

 

Other equity investments

 

1,394

 

 

1.5

%

 

1,582

 

 

2.3

%

 

4,892

 

 

7.6

%

 

 

 

$

91,140

 

 

100

%

 

$

68,050

 

 

100

%

 

$

64,098

 

 

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, 2006. 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.

14




At December 31, 2006, 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.

 

One Year or Less

 

After One Year
Through Five Years

 

After Five Years
Through Ten Years

 

After Ten Years

 

Total

 

 

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

 

 

(dollars in thousands)

 

U. S. Government agency securities

 

 

$ 6,305

 

 

 

4.83

%

 

 

$ 33,484

 

 

 

4.82

%

 

 

$ 19,014

 

 

 

5.29

%

 

 

$          0

 

 

 

 

 

 

$ 58,803

 

 

 

4.97

%

 

Mortgage backed securities

 

 

 

 

 

 

 

 

6,263

 

 

 

3.91

%

 

 

4,981

 

 

 

4.33

%

 

 

16,406

 

 

 

5.16

%

 

 

27,650

 

 

 

4.72

%

 

Federal Reserve and Federal Home Loan Bank stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,829

 

 

 

5.84

%

 

 

3,829

 

 

 

5.84

%

 

Other equity investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,278

 

 

 

5.52

%

 

 

1,278

 

 

 

5.52

%

 

 

 

 

$ 6,305

 

 

 

4.83

%

 

 

$ 39,747

 

 

 

4.68

%

 

 

$ 23,995

 

 

 

5.09

%

 

 

$ 21,513

 

 

 

3.94

%

 

 

$ 91,560

 

 

 

4.62

%

 

 

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 $625.8 million at December 31, 2006, an increase of $76.6 million or 14% as compared to $549.2 million at December 31, 2005, and were $415.5 million at December 31, 2004, an increase of  $98.0 million or 31% in 2005 over 2004. For the fourth quarter of 2006, the loan portfolio increased $34.6 million over $591.2 million at September 30, 2006

The Bank is primarily business oriented and as can be seen in the chart below, has a large proportion of its loan portfolio related to real estate (70%) consisting of real estate-commercial, real estate-residential mortgage and construction-commercial and residential. Real estate also serves as collateral for loans made for other purposes, resulting in 79% of our loans being secured by real estate.

The following table shows the trends in the composition of the loan portfolio over the past five years.

 

 

December 31,

 

 

 

2006

 

2005

 

2004

 

2003

 

2002

 

 

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

 

 

(dollars in thousands)

 

Commercial

 

$ 132,981

 

21

%

$ 118,928

 

22

%

$ 101,911

 

25

%

$ 93,112

 

29

%

$ 64,869

 

27

%

Real estate—commercial(1)

 

349,044

 

56

%

284,667

 

52

%

189,708

 

47

%

142,819

 

45

%

111,262

 

47

%

Real estate—residential mortgage

 

1,523

 

 

1,130

 

 

9,230

 

2

%

6,964

 

2

%

3,699

 

2

%

Construction—commercial and residential

 

86,524

 

14

%

90,035

 

16

%

62,745

 

14

%

35,644

 

11

%

23,180

 

10

%

Home equity

 

50,572

 

8

%

50,776

 

9

%

49,632

 

11

%

34,092

 

11

%

30,631

 

13

%

Other consumer

 

5,129

 

1

%

3,676

 

1

%

2,283

 

1

%

4,902

 

2

%

3,219

 

1

%

Total loans

 

625,773

 

100

%

549,212

 

100

%

415,509

 

100

%

317,533

 

100

%

236,860

 

100

%

Less: Allowance for Credit Losses

 

(7,373

)

 

 

(5,985

)

 

 

(4,240

)

 

 

(3,680

)

 

 

(2,766

)

 

 

Net loans

 

$ 618,400

 

 

 

$ 543,227

 

 

 

$ 411,269

 

 

 

$ 313,853

 

 

 

$ 234,094

 

 

 


(1)          Includes loans for land acquisition and owner occupied properties.

As discussed under the caption “Business” and “Risk Factors”, the Company has directly made and expects to continue making higher risk loans that entail higher risks than loans made following normal underwriting practices (“higher risk loan transactions”). These higher risk loan transactions may also be made through the Company’s newly formed subsidiary, Eagle Commercial Ventures (“ECV”), which was

15




formed in July 2006. The transactions are structured to provide the Company or ECV with returns commensurate to the risk through the requirement of additional interest following payoff of all loans:

·       At December 31, 2006, the Company and the Bank have continuing additional interest rights in a higher risk loan transaction where the underlying loans are fully paid and substantial additional interest/revenue is currently expected in 2007 from the sale of remaining units. This residual revenue is considered additional interest under the loan agreements and will be recognized as noninterest revenue when realized. Such amounts may be material to 2007 net income.

·       At December 31, 2006, ECV has a $2.0 million loan outstanding relating to a higher risk loan transaction on a real estate project located outside the Company’s primary market area which is currently in a construction phase. The loan is expected to be outstanding throughout 2007, with sales completed in 2008.

Although the Company carefully underwrites each higher risk loan transaction and expects these transactions to provide additional revenues, there can be no assurance that any higher risk loan transaction, or the related loans made by the Bank, will prove profitable for the Company and Bank, that the Company and Bank will be able to receive any additional interest payments in respect of these loans, that any additional interest payments will be significant, or that the Company and Bank will not incur losses in respect of these transactions.

Loan Maturity

The following table sets forth the term to contractual maturity of the loan portfolio as of December 31, 2006.

 

 

Due In

 

 

 

Total

 

One Year
or Less

 

Over One to
Five Years

 

Over Five to
Ten Years

 

Over Ten
Years

 

 

 

(dollars in thousands)

 

Commercial

 

$ 132,981

 

$ 51,821

 

 

$ 45,362

 

 

 

$ 28,228

 

 

$ 7,570

 

Real estate-commercial

 

349,044

 

52,596

 

 

100,541

 

 

 

175,946

 

 

19,961

 

Real estate-residential

 

1,523

 

514

 

 

1,009

 

 

 

 

 

 

Construction

 

86,524

 

56,066

 

 

18,277

 

 

 

9,004

 

 

3,177

 

Home equity

 

50,572

 

326

 

 

459

 

 

 

418

 

 

49,369

 

Other consumer

 

5,129

 

1,578

 

 

2,410

 

 

 

168

 

 

973

 

Total loans

 

$ 625,773

 

$ 162,901

 

 

$ 168,058

 

 

 

$ 213,764

 

 

$ 81,050

 

Loans with:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Predetermined fixed interest rate

 

$ 198,735

 

$ 14,220

 

 

$ 107,086

 

 

 

$ 65,930

 

 

$ 11,499

 

Floating interest rate

 

427,038

 

148,681

 

 

60,972

 

 

 

147,834

 

 

69,551

 

Total loans

 

$ 625,773

 

$ 162,901

 

 

$ 168,058

 

 

 

$ 213,764

 

 

$ 81,050

 

 

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.

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.

16




At December 31, 2006, 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 2006, a provision for credit losses was made in the amount of $1.7 million before net charge-offs of $357 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”.

The allowance for loan losses represented 1.19% of total loans at December 31, 2006 as compared to 1.09% at December 31, 2005. This increase in the ratio of the allowance was due to two factors as follows: additional reserves provided in the third quarter of 2006 for a large problem commercial loan relationship identified in August 2006 and to a slight increase in the environmental factors of the non-specific reserve component related to various factors including potential impacts of higher interest rates on debt service capacity and on real estate values.

At December 31, 2006, the Company had $2.0 million of loans classified as nonperforming, and $4.3 million of potential problem loans, as compared to $491 thousand of nonperforming assets and $2.9 million of potential problem loans at December 31, 2005. Please refer to Note 1 to the Consolidated Financial Statements under the caption “Loans” for a discussion of the Company’s policy regarding impairment of loans. Please refer to “Nonperforming Assets” below for a discussion of problem and potential problem assets.

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 relatively low levels of 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 a 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.

17




The following table sets forth activity in the allowance for credit losses for the past five years.

 

Year Ended December 31,

 

 

 

2006

 

2005

 

2004

 

2003

 

2002

 

 

 

(dollars in thousands)

 

Balance at beginning of year

 

$ 5,985

 

$ 4,240

 

$ 3,680

 

$ 2,766

 

$ 2,111

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

(369

)

(122

)

(257

)

(319

)

(192

)

Home equity

 

(15

)

 

 

 

 

Other consumer

 

(5

)

(17

)

(35

)

(14

)

(40

)

Total charge-offs

 

(389

)

(139

)

(292

)

(333

)

(232

)

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

27

 

41

 

175

 

68

 

26

 

Other consumer

 

5

 

 

2

 

4

 

18

 

Total recoveries

 

32

 

41

 

177

 

72

 

44

 

Net charge-offs

 

(357

)

(98

)

(115

)

(261

)

(188

)

Additions charged to operations

 

1,745

 

1,843

 

675