UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2002
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ______
Commission File Number 0-18279
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TRI-COUNTY FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Maryland 52-1652138
- ------------------------------- -------------------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3035 Leonardtown Road, Waldorf, Maryland 20601
- -------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(301) 843-0854
--------------
(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
As of November 6, 2002 registrant had outstanding 760,934 shares of Common
Stock.
1
TRI-COUNTY FINANCIAL CORPORATION
FORM 10-Q INDEX
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PART I - FINANCIAL INFORMATION PAGE
Item 1 - Financial Statements (Unaudited)
Consolidated Balance Sheets - September 30, 2002
and December 31, 2001 3
Consolidated Statements of Income and Comprehensive Income -
Three And Nine Months Ended September 30, 2002 and 2001 4
Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 2002 and 2001 5 - 6
Notes to Consolidated Financial Statements 7
Item 2- Management's Discussion and Analysis of Financial Condition
and Results of Operations 8 - 14
Item 3 - Quantitative and Qualitative Disclosure about Market Risk 15
Item 4 - Controls and Procedures 15
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K 16
SIGNATURES AND CERTIFICATIONS 17
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS (UNAUDITED)
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
ASSETS
September 30, 2002 December 31, 2001
Cash and due from banks $ 4,308,293 $ 693,439
Interest-bearing deposits with banks 3,058,193 7,678,158
Investment securities available for sale - at fair value 48,250,010 41,673,742
Investment securities held to maturity - at amortized cost 2,288,620 2,289,354
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 3,035,550 3,035,550
Loans held for sale -- 2,354,315
Loans receivable - net of allowance for loan losses
of $2,295,188 and $2,281,581, respectively 198,302,353 193,450,011
Premises and equipment, net 6,162,097 5,432,848
Foreclosed real estate 770,014 1,800,569
Accrued interest receivable 1,131,893 1,049,401
Other assets 3,919,903 2,499,903
------------- -------------
Total assets $ 271,226,926 $ 261,957,290
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits $ 24,355,516 $ 17,738,165
Interest-bearing deposits 168,023,713 165,378,369
------------- -------------
Total deposits 192,379,229 183,116,534
Short-term borrowings 734,748 1,813,317
Long-term debt 47,250,000 48,650,000
Accrued expenses and other liabilities 4,647,126 2,790,981
------------- -------------
Total liabilities 245,011,103 236,370,832
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued - 762,411 and 756,805 shares, respectively 7,624 7,568
Surplus 7,697,825 7,545,590
Retained earnings 18,150,962 17,678,367
Accumulated other comprehensive income 522,457 555,513
Unearned ESOP shares (163,045) (200,580)
------------- -------------
Total stockholders' equity 26,215,823 25,586,458
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 271,226,926 $ 261,957,290
============= =============
See notes to consolidated financial statements
3
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2002 2001 2002 2001
INTEREST INCOME:
Interest and fees on loans $ 3,604,299 $ 3,863,424 $ 10,671,659 $ 11,493,494
Taxable interest and dividends on
investment securites 662,707 746,375 1,921,272 2,629,682
Interest on bank deposits 14,928 20,561 63,748 64,691
------------ ------------ ------------ ------------
Total interest income 4,281,934 4,630,360 12,656,679 14,187,867
------------ ------------ ------------ ------------
INTEREST EXPENSE:
Interest on deposits 865,583 1,484,060 2,640,487 4,782,318
Interest on long term debt 618,793 646,736 1,889,676 1,897,052
Interest on other borrowings -- 2,008 -- 257,354
------------ ------------ ------------ ------------
Total interest expense 1,484,376 2,132,804 4,530,163 6,936,724
------------ ------------ ------------ ------------
NET INTEREST INCOME 2,797,558 2,497,556 8,126,516 7,251,143
PROVISION FOR LOAN LOSSES 30,000 90,000 130,000 270,000
------------ ------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 2,767,558 2,407,556 7,996,516 6,981,143
------------ ------------ ------------ ------------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 57,921 64,193 146,269 161,092
Net gain on sale of loans held for sale 81,557 43,158 289,539 127,893
Service charges 242,534 230,495 727,903 727,188
Other income 4,901 6,560 18,610 29,619
------------ ------------ ------------ ------------
Total noninterest income 386,913 344,406 1,182,321 1,045,792
------------ ------------ ------------ ------------
NONINTEREST EXPENSE:
Salary and employee benefits 1,031,744 1,001,742 3,129,922 2,841,474
Occupancy expense 200,914 232,963 592,582 537,769
Data processing expense 94,102 63,967 432,558 240,574
Loss on disposal of obsolete equipment -- -- 65,104 --
Advertising 91,675 110,758 254,641 223,638
Equipment depreciation 58,380 53,301 279,576 169,987
Telephone communications 74,794 37,643 268,174 98,040
Valuation allowance on foreclosed real estate -- -- 1,044,070 --
Other 482,137 362,530 1,353,475 1,042,275
------------ ------------ ------------ ------------
Total noninterest expense 2,033,746 1,862,904 7,420,102 5,153,757
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 1,120,725 889,058 1,758,735 2,873,178
INCOME TAXES 391,000 322,000 621,000 1,005,700
------------ ------------ ------------ ------------
NET INCOME 729,725 567,058 1,137,735 1,867,478
OTHER COMPREHENSIVE INCOME, NET OF TAX
Net unrealized holding gains (losses) arising
during the period (10,628) 451,325 (33,056) 860,372
------------ ------------ ------------ ------------
COMPREHENSIVE INCOME $ 719,097 $ 1,018,383 $ 1,104,679 $ 2,727,850
============ ============ ============ ============
EARNINGS PER SHARE
Basic $ .96 $ .71 $ 1.49 $ 2.42
Diluted .91 .68 1.41 2.33
See notes to consolidated financial statements
4
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,137,735 $ 1,867,478
Adjustments to reconcile net income to net
cash (used) provided by operating activities:
Valuation allowance on foreclosed real estate 1,044,070 --
Provision for loan losses 130,000 270,000
Depreciation and amortization 339,392 242,650
Loss on disposal of obsolete equipment 65,104 --
Net amortization of premium/discount on investment securities 21,869 51,054
Deferred income tax benefit (477,000) (110,000)
(Increase) decrease in accrued interest receivable (82,492) 176,186
(Decrease) Increase in deferred loan fees (41,248) 9,586
Increase in accounts payable, accrued expenses,
and other liabilities 1,856,145 614,473
Increase in other assets (1,220,565) (864,271)
Gain on disposal of premises and equipment (4,458) (8,386)
Origination of loans held for sale (13,860,196) (7,812,412)
Gain on sales of loans held for sale (289,540) (127,893)
Proceeds from sale of loans held for sale 12,518,971 8,036,305
----------- -----------
Net cash provided by operating activities 1,137,787 2,344,770
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in interest-bearing deposits with banks 4,619,965 291,389
Purchase of investment securities available for sale (43,041,197) (20,961,399)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 36,394,570 36,538,900
Purchase of investment securities held to maturity (1,201,212) (100,000)
Proceeds from maturities or principal payments
of investment securities held to maturity 1,201,946 606,497
Loans originated or acquired (67,672,186) (69,123,620)
Principal collected on loans 66,716,172 50,579,419
Proceeds from disposal of premises and equipment 13,000 8,963
Purchase of foreclosed real estate (29,562) -
Purchase of premises and equipment (1,142,287) (853,200)
Proceeds from foreclosed real estate 309,046 (5,697)
----------- -----------
Net cash used in investing activities (3,831,745) (3,018,748)
----------- -----------
5
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (CONTINUED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2002 2001
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 9,262,695 $ 9,709,542
Proceeds from long-term borrowings -- 10,250,000
Payments of long-term borrowings (1,400,000) (5,000,000)
Net decrease in other borrowed funds (1,078,569) (12,913,074)
Exercise of stock options 141,906 31,817
Net change in unearned ESOP shares 47,999 (47,998)
Dividends paid (385,129) (309,204)
Redemption of common stock (280,090) (673,956)
----------- -----------
Net cash provided by financing activities 6,308,812 1,047,127
----------- -----------
INCREASE IN CASH AND CASH EQUIVALENTS 3,614,854 373,148
CASH AND CASH EQUIVALENTS - JANUARY 1 693,439 645,817
CASH AND CASH EQUIVALENTS - SEPTEMBER 30 $ 4,308,293 $ 1,018,965
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the nine months for:
Interest $ 4,773,641 $ 6,959,887
=========== ===========
Income taxes $ 1,130,000 $ 1,017,000
=========== ===========
Noncash transfers from loans to other assets $ 1,040,000 $ 1,273,320
=========== ===========
See notes to consolidated financial statements
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
1. BASIS OF PRESENTATION
General - The consolidated financial statements of Tri-County Financial
Corporation (the "Company") and its wholly owned subsidiary, Community Bank
of Tri-County (the "Bank") included herein are unaudited; however, they
reflect all adjustments consisting only of normal recurring accruals that,
in the opinion of Management, are necessary to present fairly the results
for the periods presented. Certain information and note disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The Company believes that the
disclosures are adequate to make the information presented not misleading.
There have been no significant changes to the Company's Accounting Policies
as disclosed in 2001 Annual Report. The results of operations for the three
and nine months ended September 30, 2002 are not necessarily indicative of
the results of operations to be expected for the remainder of the year.
Certain previously reported amounts have been restated to conform to the
2002 presentation.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes included
in the Company's Annual Report for the year ended December 31, 2001.
2. EARNINGS PER SHARE
Basic and diluted earnings per share, have been computed based on
weighted-average common and common equivalent shares outstanding as
follows:
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------
2002 2001 2002 2001
Basic 761,563 770,519 763,084 761,895
Diluted 804,971 803,099 806,291 796,601
7
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
This document contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, including discussions of
Tri-County Financial Corporation's (the "Company's") goals, strategies and
expected outcomes; estimates of risks and future costs; and reports of the
Company's ability to achieve its financial and other goals. These
forward-looking statements are subject to significant known and unknown risks
and uncertainties because they are based upon future economic conditions,
particularly interest rates, competition within and without the banking
industry, changes in laws and regulations applicable to the Company and various
other matters. Because of these uncertainties, there can be no assurance that
actual results, performance or achievements of the Company will not differ
materially from any future results, performance or achievements expressed or
implied by these forward-looking statements.
GENERAL
The Company is a bank holding company organized in 1989 under the laws of the
State of Maryland. It presently owns all the outstanding shares of capital stock
of the Community Bank of Tri-County (the "Bank"), a Maryland-chartered
commercial bank. The Company engages in no significant activity other than
holding the stock of the Bank and operating the business of the Bank.
Accordingly, the information set forth in this report, including financial
statements and related data, relates primarily to the Bank and its subsidiaries.
The Bank serves the southern Maryland area through its main office and eight
branches located in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata,
Charlotte Hall, and California, Maryland. The Bank is engaged in the commercial
and retail banking business as authorized by the banking statutes of the State
of Maryland and applicable Federal regulations. The Bank accepts demand and time
deposits, and originates loans to individuals, associations, partnerships and
corporations. The Bank makes real estate loans including residential first and
second mortgage loans, home equity lines of credit and commercial mortgage
loans. The Bank makes commercial loans including secured and unsecured loans.
The Bank is a member of the Federal Reserve and Federal Home Loan Bank ("FHLB")
Systems. The Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance Corporation ("FDIC") provides deposit insurance coverage up to
applicable limits.
Since its conversion to a state chartered commercial bank in 1997, the Bank has
sought to increase its commercial, commercial real estate, construction, second
mortgage, home equity, and consumer lending business as well as the level of
transactional deposits to levels consistent with similarly sized commercial
banks. As a result of this emphasis, the Bank's percentage of assets invested in
residential first mortgage lending and investment securities has declined since
1997. Conversely, targeted loan types have increased. The Bank has also seen an
increase in transactional deposit accounts while the percentage of total
liabilities represented by certificates of deposits has also declined.
Management believes that these changes will enhance the Bank's overall long-term
financial performance.
Management recognizes that the shift in composition of the Bank's loan portfolio
will tend to increase its exposure to credit losses. The Bank has continued to
evaluate its allowance for loan losses and the associated provision to
compensate for the increased risk. Any evaluation of the allowance for loan
losses is inherently inexact and reflects management's expectations as to future
economic conditions in the Southern Maryland area as well as individual
borrower's circumstances. Management believes that its allowance for loan losses
is adequate. For further information on the Bank's allowance for loan losses see
the discussion in the financial condition section of this form, as well as the
relevant discussions in the Form 10-K and annual report for the year ended
December 31, 2001.
In the last several quarters, the national economy has recovered slowly from a
mild recession while our local economy has remained strong in relation to the
national and statewide economy. Prospects for growth appear to be steady, and
local employment remains strong. The Bank remains exposed to asset deterioration
should the local economy experience a prolonged period of economic decline. In
addition, any Federal Reserve action on interest rates may affect the Bank's
financial performance.
In the second quarter, the Bank established a valuation allowance on certain
foreclosed real estate based on indications that the market value was below
carrying value. The establishment of valuation allowances decreased earnings by
approximately $1.0 million pretax and $675 thousand after taxes. The effect of
these write downs was to decrease basic and diluted earnings per share for the
nine months ending September 30, 2002 by $.89 and $.84, respectively. For a
discussion of the Bank's accounting policies regarding the accounting for
foreclosed real estate, see Note 1 to the Company's Consolidated Financial
Statements for the year ended December 31, 2001. For a discussion of the
specific events leading to the establishment of the valuation allowances and
other relevant facts regarding these properties, see the discussion of the
Company's financial condition.
8
In the second quarter, the Bank also incurred significant costs related to its
conversion to a new provider of data processing services. These costs included
payments made to the previous vendor for conversion related work including
facilitating the transfer of customer data to the new system, costs for the
production of certain reports and other items. Other conversion related expenses
included employee training, system installation, and the write off of certain
incompatible equipment. Total costs related to the data conversion in the
quarter were approximately $805 thousand. Of this amount, approximately $415
thousand was expensed in the first nine months of 2002. These additional costs
reduced earnings per share by $.35 and $.33 per share on a basic and diluted
basis respectively. For a summary of costs incurred and results affected by the
establishment of the allowance and other additional expenses see the table
below:
Effect of
establishing
Income Effect an allowance Income from
as reported of systems on foreclosed continuing
under GAAP conversion real estate operations
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES $7,996,516 $ -- $ -- $7,996,516
NONINTEREST INCOME: 1,182,321 -- -- 1,182,321
NONINTEREST EXPENSE:
Salary and employee benefits 3,129,922 -- -- 3,129,922
Occupancy expense 592,582 -- -- 592,582
Data processing expense 432,558 142,553 -- 290,005
Loss on disposal of obsolete equipment 65,104 65,104 -- --
Advertising 254,641 -- -- 254,641
Equipment depreciation 279,576 60,000 -- 219,576
Telephone communications 268,174 101,365 -- 166,809
Valuation allowance on foreclosed real estate 1,044,070 -- 1,044,070 --
Other 1,353,475 46,034 -- 1,307,441
----------- --------- ----------- ----------
Total noninterest expenses 7,420,102 415,056 1,044,070 5,960,976
INCOME (LOSS) BEFORE INCOME TAXES 1,758,735 (415,056) (1,044,070) 3,217,861
INCOME TAX EXPENSE (BENEFIT) 621,000 (146,554) (368,656) 1,136,210
NET INCOME (LOSS) 1,137,735 (268,502) (675,414) 2,081,651
EARNINGS (LOSS) PER SHARE
Basic $ 1.49 $ (0.35) $ (0.89) $ 2.73
Diluted $ 1.41 $ (0.33) $ (0.84) $ 2.58
Equipment and software acquired -- 310,519 -- --
On April 28, 2002, a tornado caused damages to property in our market area. The
Company's facilities suffered no damage, and we are not aware of any customer
who suffered material losses which would affect their ability to meet
obligations to repay loans. We do not believe that the storm will cause material
long term economic damage to our market area.
In the last several years, the Bank has increased its sources of noninterest
income through fees gathered on transactional accounts, the sale of non-deposit
products including investments, and continued operation of our residential
mortgage operation. These fees have continued to grow over the last several
quarters, while the Bank's fee income from the residential mortgage lending
business has decreased due to the Bank's shift in lending emphasis. Management
believes that the Bank's strong local focus and responsiveness to customers will
enable it to increase its fee income over time.
9
SELECTED FINANCIAL DATA
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2002 2001
Condensed Income Statement
Interest Income $12,656,679 $14,187,867
Interest Expense 4,530,163 6,936,724
Net Interest Income 8,126,516 7,251,143
Provision for Loan Loss 130,000 270,000
Noninterest Income 1,182,321 1,045,792
Noninterest Expense 7,420,102 5,153,757
Income Before Income Taxes 1,758,735 2,873,178
Income Taxes 621,000 1,005,700
Net Income 1,137,735 1,867,478
Per Common Share
Basic Earnings $ 1.49 $ 2.42
Diluted Earnings 1.41 2.33
Book Value 34.39 33.30
RESULTS OF OPERATIONS
Net income for the nine month period ended September 30, 2002 totaled $1,137,735
($1.49 basic and $1.41 diluted earnings per share) compared with a total of
$1,867,478 ($2.42 basic and $2.33 diluted earnings per share) for the same
period in the prior year. This decrease of $730 thousand or 39.1% was caused
primarily by additional expenses incurred by the Company in the current period
relating to the systems conversion and the valuation allowance established for
certain foreclosed real estate as noted previously. The combined effect of these
events was to decrease pretax income in the current period by $1.5 million and
after tax income by approximately $1 million.
For the nine month period ended September 30, 2002, interest income declined by
$1.5 million or 10.8% to $12.7 million. This decline was caused by the continued
decline in interest rates particularly the declines in the Prime, and one,
three, and five year treasury rates. Many loan products are priced based on
these rates. This decline in interest rates was partially offset by higher
average asset balances.
Interest expense also decreased to $4.5 million in the nine month period ending
September 30, 2002 as compared to $6.9 million in the same period in the prior
year a decrease of $2.4 million or 34.7%. This decrease was a reflection of the
declining interest rate environment experienced during the last year. Interest
expense also declined as a result of the Bank's increase in noninterest bearing
deposit accounts. The Bank's interest expense declined faster than its interest
income because the Bank was able to aggressively cut funding costs by repricing
certain of its deposit products. Further declines in interest rates would
probably not lead to similar results as the Bank has decreased interest rates on
certain products to extremely low levels. The Bank is attempting to protect its
interest rate position in the event of increases in interest rates by
lengthening, to the extent possible, average maturities on liabilities and
adding interest rate sensitive loans.
Provision for loan losses declined from prior year levels to $130 thousand from
$270 thousand for the nine month periods ending September 30, 2002 and 2001,
respectively. Management will continue to periodically review its allowance for
loan losses and the related provision and adjust as deemed necessary. This
review will include a review of economic conditions nationally and locally, as
well as a review of the performance of significant major loans and the overall
portfolio.
Noninterest income increased to $1.2 million for the nine month period ending
September 30, 2002, an increase of $136 thousand or 13.1% over the prior year
total of $1.0 million. Increased income was primarily the result of a large
increase in gains on selling mortgage loans, which increased by $162 thousand or
126.4% to $290 thousand in the current period. This large gain offset small
declines in other areas of noninterest income.
Noninterest expense for the nine month period increased by $2.3 million or 44.0%
to $7.4 million from $5.2 million in the same period for the prior year. Salary
and employee benefits increased by 10.2% to $3.1 million from $2.8 for the same
period in the prior year. The increase was attributable to an increase in
employees and to increases in average salary costs per
10
employee. Occupancy expense increased from $538 thousand to $592 thousand, an
increase of 10.2%. This increase was caused by larger amounts of repairs and
maintenance at the Bank's branch locations as well as the opening of the Bank's
permanent facility at Charlotte Hall. Data processing expense increased by $192
thousand to $433 thousand or an increase of 79.8%. This increase was the result
of fees paid to the former data processing provider for conversion related
services, fees paid to the new provider for system installation, configuration,
and training, and for payments to both providers for a short period (about 6
weeks) where both providers provided basic monthly services. In 2001, the Bank
did not incur these same data processing costs. In 2002, the Bank also disposed
of certain computer equipment which was incompatible with the new data
processing system. Advertising expense increased by $31 thousand or 13.9%
primarily due to increased marketing efforts related to various transaction
based accounts. Depreciation increased to $280 thousand an increase of 64.5%
over the prior year level of $170 thousand. The increase was primarily due to
the obsolescence of computer and other equipment incompatible with the new data
processing system. Expenses related to telephone communications also increased
to $268 thousand for the nine months ended September 30, 2002 from $98 thousand
in the same period in the prior year, an increase of 174%. This increase was
primarily related to the data conversion. As noted above, for the nine months
ended September 30, 2002, the Bank established a valuation allowance on
foreclosed assets in the amount of $1.0 million. In 2001, there were no expenses
in this category. Other expenses increased by $311 thousand to $1.4 million from
the prior year total of $1.0 million, an increase of 29.9%.
Income taxes decreased to $621 thousand or 35.3% of pretax income in the current
year compared to $1 million or 35.0% of pretax income in the prior year. The
increase in the tax rate was primarily attributable to an increase in the state
income tax burden. In the prior period, taxes were substantially reduced because
income earned on investment securities held by the Bank's investment corporation
subsidiary, Tri-County Investment Corporation ("TCIC") which was not subject to
the state income tax. In the current year, reductions in the assets invested in
TCIC and a reduction in the overall yield on invested assets have reduced the
amount of income sheltered from state income tax, increasing the effective tax
rate.
RESULTS OF OPERATIONS -- THIRD QUARTER
The Company recorded net income for the third quarter of 2002 of $730 thousand
($.96 and $.91 basic and diluted earnings per share), compared to net income of
$567 thousand ($.71 and $.68 basic and diluted earnings per share) for the same
period in 2001. This increase was the result of the increase in net interest
income noted above, combined with strong noninterest income growth, partially
offset by increases in noninterest expense. Increases in net interest income and
noninterest income were affected by the declines in interest rates as mentioned
in the general and year to date discussions above.
Net interest income increased by $300 thousand or 12.0%. Noninterest income
increased by $43 thousand or 12.3% in the third quarter of 2002, compared to the
third quarter of 2001. This increase was the result of increases in income from
service charges, increased gains on selling residential mortgage loans and was
offset by declines in loan service charges. Total non-interest expense increased
by $171 thousand or 9.2% for the third quarter compared to the same period last
year primarily due to increased personnel, data processing and other costs.
Salary and benefits expense increased by 3.0% due to an increased number of
employees and higher benefits costs. Occupancy expense declined as certain
maintenance and other costs were incurred in the second quarter. Data processing
expense increased to $94 thousand, an increase of $30 thousand or 47.1%. This
increase was due to the switch to the new data processing system. Advertising
expenses decreased slightly to $92 thousand due to a slightly decreased level of
advertising activity in the third quarter. Depreciation increased due to the
purchases of new equipment for the conversion and new branches. Other expenses
increased primarily due to increases in the overall level of financial activity
in the Bank including higher assets and new branches.
FINANCIAL CONDITION
Assets
Total assets as of September 30, 2002 increased by $9.3 million to $271.3
million from the December 31, 2001 level of $262 million. Cash and due from
banks increased by $3.6 million, or 521% from December 31, 2001's total.
Interest-bearing deposits with banks declined by $4.6 million or 60.2% during
the period to $3.1 million at September 30, 2002. Investment securities,
including both the available for sale and held to maturity portfolios, increased
from $44.0 million to $50.5 million an increase of $6.6 million or 15.0%.
Increases were primarily the result of additional purchases of investments using
the proceeds of loan prepayments and the conversion of certain interest bearing
deposits to investments.
The Bank's loan portfolio increased by $4.9 million or 2.5% during the nine
month period ending September 30, 2002 to $198 million from December 2001's
total of $193 million. The increase was primarily the result of increases in the
Commercial, Commercial Real Estate, and Consumer portfolios which offset
declines in the Residential First Mortgage portfolio. At September 30, 2002 the
Bank's allowance for loan losses totals $2.3 million or 1.14% of loan balances
as
11
compared to $2.3 million or 1.18% of loan balances at December 31, 2001.
Management's determination of the adequacy of the allowance is based on a
periodic evaluation of the portfolio with consideration given to the overall
loss experience; current economic conditions; volume, growth and composition of
the loan portfolio; financial condition of the borrowers; and other relevant
factors that, in management's judgment, warrant recognition in providing an
adequate allowance. Management believes that the allowance is adequate. Loans
held for sale declined to $0 from $2.3 million at December 31, 2001. Certain
loan information is presented below (amounts in 000's). Additional loan
information for prior years is presented in the Form 10-K for the year ended
December 31, 2001:
LOAN PORTFOLIO September 30, December 31,
2002 2001
---------------------- -----------------------
Amount % Amount %
------ ----- ------ -----
Real Estate Loans
Residential first mortgage $ 58,070 28.85% $ 61,430 31.26%
Commercial 72,615 36.07% 65,617 33.39%
Construction and land development 12,014 5.97% 18,136 9.23%
Home equity and second mortgage 19,253 9.56% 18,580 9.46%
Commercial loans 25,783 12.81% 18,539 9.44%
Consumer loans 13,577 6.74% 14,187 7.22%
--------- ------ --------- ------
Total loans 201,312 100.00% 196,489 100.00%
Less: Deferred loan fees 717 ====== 757 ======
Loan loss reserve 2,295 2,282
--------- ---------
Loans receivable net $ 198,300 $ 193,450
--------- ---------
LOAN LOSS ALLOWANCE
9 Months Ended 9 Months Ended
September 30, 2002 September 30, 2001
------------------ ------------------
Beginning Balance $ 2,282 $ 1,930
Charge Offs (119) --
Recoveries 3 26
Net Charge Offs (116) 26
Additions charged to operations 130 270
------- -------
Balance at end of period $ 2,296 $ 2,226
======= =======
Ratio of net charge-offs during the period to
average loans 0.01% 0.01%
==== ====
NON-PERFORMING LOANS
Balances as of Balances as of
September 30, 2002 December 31, 2001
Restructured Loans $ -- $ --
-------- --------
Accruing loans which are contractually
past due 90 days or more: $ 232 $ 25
-------- --------
Loans accounted for on a nonaccrual basis $ -- $ 204
-------- --------
Total non-performing loans $ 232 $ 229
======== ========
Non-performing loans to total loans 0.12% 0.12%
==== ====
Allowance for loan losses to non-performing loans 989.22% 996.07%
====== ======
There were no loans as of September 30, 2002 not reflected in the above table
where known information about possible credit problems of borrowers caused
management to have serious doubts as to the ability of those borrowers to comply
with present loan repayment terms.
12
Premises and equipment increased due to equipment replacement needed for the
data processing conversion as well as construction costs related to the
permanent Charlotte Hall facility.
Foreclosed real estate declined to $770,000 at September 30, 2002 from $1.8
million at December 31, 2001 primarily due to the establishment of valuation
allowances on two properties. The larger property was a 54-acre parcel of
undeveloped land in Charles County which the Bank acquired by deed in lieu of
foreclosure in July 2001 and which had a carrying value of $1.3 million at
December 31, 2001. The original borrower had planned to develop this property
into 150 single-family lots and had received preliminary approval for the
project's first phase (consisting of 41 lots) in July 1999. Subsequently,
however, the county sought to retroactively impose more restrictive requirements
for preliminary approvals and took the position that the preliminary approval of
the first phase was no longer in force. While the borrower sought to secure
preliminary approval under the new rules, another lender threatened foreclosure
on another of the borrower's Charles County projects (which had not received any
preliminary approvals) and the borrower offered to deed the property over to the
Bank.
At the time of acquiring the property, the Bank was advised by counsel that the
prior grant of preliminary approval was binding on the county. In addition, the
county had announced that it would adopt a fee-based permitting scheme in 2003,
which was expected to facilitate the development of phase 2 of the project. In
light of these circumstances, an independent appraisal obtained prior to
December 31, 2001 determined that the property's market value exceeded its
carrying value. Accordingly, no valuation allowances were established with
respect to the property at the time of acquisition or at December 31, 2001.
After obtaining title, the Bank challenged the county's position that its
preliminary approval of the first phase was no longer in force and secured a
change in the rules that accepted the validity of the preliminary approval in
June 2002. The Bank thereupon put the entire parcel out for bid but the bids
received were substantially below the Bank's price target. Bidders advised the
Bank that they were concerned that the county would change the rules again
before phase 2 could be completed and were therefore unwilling to assign
significant value to that part of the parcel. Based on the results of the
bidding, the Bank determined that a valuation allowance of $776,000 was required
to adjust the carrying value of the property to the value indicated by the bids.
Subsequently, the Bank sought other bidders and is now negotiating a possible
sale at a price that would not indicate any further write-downs are required.
The other property has been previously acquired by the Bank and originally had a
carrying value of $275,000. In evaluating the property for sale during the
second quarter, it was discovered that there was a "vernal pool" on the property
causing it to be treated as wetland under state and federal law. Since the
property could no longer be developed as planned, the Bank established a
$250,000 valuation allowance to bring its carrying value down to a nominal
$25,000. Although the Bank will continue to explore alternative uses for the
property, there are no current developments which would justify a higher value.
Liabilities
Deposit balances increased by $9.3 million or 5.1% for the nine months ended
September 30, 2002. This increase was primarily in noninterest bearing deposits.
Management believes that the recent stock market volatility may make bank
deposits more attractive to the general public, and the low interest rate
environment makes noninterest accounts relatively less unattractive to
consumers. Short term borrowings remain at very low levels, $734 thousand. Long
term debt declined slightly to $47.2 million at September 30, 2002 from $48.7
million at December 31, 2001. Other liabilities increased to $4.6 million at
September 30, 2002 from $2.8 million at December 31, 2001, an increase of 66.5%.
Stockholders' Equity
Stockholders' equity increased $629 thousand or 2.5% to $26.2 million at
September 30, 2002 compared to $25.6 million at December 31, 2001. This reflects
the net income of $1.1 million for the nine month period partially offset by the
$385,129 in cash dividends. Accumulated other comprehensive income decreased by
$33,056. Other changes in equity occurred as a result of using $280,090 to
purchase shares in the open market and retire them, the exercise of stock
options of $141,905, and a change in unearned ESOP shares of $47,999. Book value
on a per share basis, $34.39 at September 30, 2002, as compared to $33.80 at
December 31, 2001, reflects a 1.7% increase, with a slight increase in
outstanding shares, partially offsetting the gains noted previously.
As reported on Form 8-K filed on July 28, 2002 the Board has approved of the
purchase of up to 38,000 shares of the Company's stock, for retirement. For the
nine months ended September 30, 2002, the Company purchased 8,755 shares for
$282,990.
13
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank and does not
currently have any material funding commitments. The Company's principal sources
of liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of dividends.
The Bank's principal sources of funds for investments and operations are net
income, deposits from its primary market area, principal and interest payments
on loans, interest received on investment securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered a primary source of funds supporting the Bank's lending and
investment activities.
The Bank's most liquid assets are cash and cash equivalents, which are cash on
hand, amounts due from financial institutions, federal funds sold, and money
market mutual funds. The levels of such assets are dependent on the Bank's
operating financing and investment activities at any given time. The variations
in levels of cash and cash equivalents are influenced by deposit flows and
anticipated future deposit flows.
The Bank may borrow up to 35% of consolidated Bank assets on a line available
from the FHLB. As of September 30, 2002, the maximum available under this line
would be $91 million, while current outstanding advances totaled $48.7 million.
In order to draw on this line the Bank must have sufficient collateral.
Qualifying collateral includes residential 1-4 family first mortgage loans,
certain second mortgage loans, certain commercial real estate loans, and various
investment securities.
REGULATORY MATTERS
The Bank is subject to Federal Reserve Board capital requirements as well as
statutory capital requirements imposed under Maryland law. At September 30,
2002, the Bank's tangible, leverage and risk-based capital ratios were 9.47%,
9.48% and 13.82%, respectively. These levels are well in excess of the required
4.0%, 4.0% and 8.0% ratios required by the Federal Reserve Board.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States (GAAP). The financial
information contained within the financial statements is, to a significant
extent, financial information that is based on measures of financial effects of
transactions and events that have already occurred. A variety of factors could
affect the ultimate value that is obtained when earning of income, recognizing
an expense, recovering an asset or relieving a liability. We use historical loss
factors as one in determining the inherent loss that may be present in our loan
portfolio. Actual losses could differ significantly from the historical factors
that we use. In addition GAAP itself may change from one previously acceptable
method to another method. Although the economics of our transactions would be
the same, the timing of events that would impact our transactions could change.
The Company considers the allowance for loan losses to be a critical accounting
policy. The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting: (1) SFAS 5, "Accounting for Contingencies", which requires that
losses be accrued when they are probable of occurring and estimable and (2) SFAS
114, "Accounting by Creditors for Impairment of a Loan", which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that rae observable in the
secondary market and the loan balance.
Management has significant discretion in making the judgments inherent in the
determination of the provision and allowance for loan losses, including in
connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the formula allowance. The
establishment of allowance factors is a continuing exercise, based on
management's continuing assessment of the global factors such as delinquencies,
loss history, trends in the volume and term of loans, national and local
economic trends, concentration of credit, loan classification, and other
factors. Changes in allowance factors will have a direct impact on the amount of
the provision and a corresponding effect on net income. Errors in management's
perception and assessment of the global factor sand their impact on the
portfolio could result in the allowance not being adequate to cover losses in
the portfolio could result in the allowance not being adequate to cover losses
in the portfolio, and may result in additional provisions or chargeoffs.
14
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
ITEM 4 CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have
evaluated the Company's disclosure controls and procedures (as such term is
defined in Rule 13a-14(c) under the Exchange Act) as of a date within 90 days of
the date of filing of this Form 10-Q. Based upon such evaluation, the Company's
Chief Executive Officer and Chief Financial Officer have concluded that such
controls and procedures are effective to ensure that the information required to
be disclosed by the Company in the reports it files under the Exchange Act is
gathered, analyzed and disclosed with adequate timeliness.
There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of the evaluation described above.
15
TRI-COUNTY FINANCIAL CORPORATION
--------------------------------
PART II - OTHER INFORMATION
---------------------------
Item 6 - Exhibits and reports on Form 8-K
A. Exhibits- The following exhibits are being filed with this Form
10-Q
99.1 Certification pursuant to Section 906 of the Sarbanes -
Oxley Act of 2002
B. Reports on Form 8-K. A report on form 8-K was filed on July 28,
2002. In this Form 8-K, the Company reported under Item 5 that it
intended to repurchase up to 38,000 shares of its common stock.
No financial statements were filed with this report.
16
SIGNATURES
Pursuant to the requirements 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.
TRI-COUNTY FINANCIAL CORPORATION:
Date: November 14, 2002 By:/s/ Michael L. Middleton
-------------------------------------
Michael L. Middleton, President
and Chairman of the Board
Date: November 14, 2002 By:/s/ William J. Pasenelli
-------------------------------------
William J. Pasenelli, Executive
Vice President and Chief
Financial Officer
17
CERTIFICATION
I, Michael L. Middleton, President and Chief Executive Officer of Tri-County
Financial Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tri-County Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board or directors (or persons fulfilling the equivalent
functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Michael L. Middleton
---------------------------------------
Michael L. Middleton
President and Chief Executive Officer
18
CERTIFICATION
I, William J. Pasenelli, Executive Vice President, Treasurer and Chief Financial
Officer of Tri-County Financial Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tri-County Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board or directors (or persons fulfilling the equivalent
functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/s/ William J. Pasenelli
----------------------------------------------------
William J. Pasenelli
Executive Vice President and Chief Financial Officer
19