Item 1. Business
Unless the context requires otherwise in this Annual Report on Form 10-K, the terms the “Company,” “we,” “us,” and “our” refer to Carroll Bancorp, Inc. and references to the “Bank” refer to Carroll Community Bank.
Carroll Bancorp, Inc.
Carroll Bancorp, Inc. is a one-bank holding company for Carroll Community Bank. The Company is registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended. As such, the Company is subject to supervision and regulation by the Board of Governors of the Federal Reserve System. The Company began operating in 2011.
Our executive offices are located at 1321 Liberty Road, Sykesville, Maryland 21784. Our telephone number at this address is (410)
795-1900. Our website address is www.carrollcobank.com. Information on this website should not be considered a part of this annual report.
Carroll Community Bank
Carroll Community Bank is a state-chartered commercial bank headquartered in Sykesville, Maryland. The Bank was organized in 1870 as Sykesville Perpetual Building Association. The Association was chartered in 1887 and re-chartered and reorganized in 1907 when it became Sykesville Building Association of Carroll County. In 1985 the Association was chartered as a federal mutual savings association and in 1988 the business name changed from Sykesville Building Association of Carroll County to Sykesville Federal Savings Association. In 2010, Sykesville Federal Savings Association converted from a federal savings association to a Maryland-chartered mutual savings bank and changed its name to Carroll Community Bank. Lastly, in 2011, the Bank converted from a state-chartered mutual savings bank to a state-chartered commercial bank, a stock form of organization, pursuant to its plan of conversion of which the formation of Carroll Bancorp, Inc. was a part.
Available Information
Carroll Bancorp, Inc. is a public company and files interim, quarterly, and annual reports with the SEC. These respective reports are on file and a matter of public record with the SEC and may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC (http://www.sec.gov).
General
Our business consists primarily of attracting and accepting deposits from the general public in the areas surrounding our offices and investing those deposits, together with funds generated from operations, primarily in residential mortgage and commercial real estate loans. We intend to continue our focus on commercial real estate loans and related products. In this regard we offer demand deposit accounts, remote deposit capture and business internet banking to support the business community. We are committed to meeting the credit needs of our community, consistent with safe and sound operations.
We offer a variety of deposit products, including savings accounts, certificates of deposit, money market accounts, business and retail noninterest and interest bearing checking accounts and individual retirement accounts. We have two full service branches with each providing a drive-through facility and automated teller machine, or ATM, for our customers’ convenience. In addition, we recently opened a loan production office in Bethesda, Maryland.
We have based our strategic plan on the foundation of enhancing stockholder value, growth in market share and operating profitability. Our goals include maintaining credit quality, using technology to expand market share and implementing extensions of core banking services.
Market Area
The primary market areas we serve are Carroll County, Maryland and all the contiguous counties in Maryland. We are headquartered in Sykesville, Maryland, a suburban area located 20 miles west of the city of Baltimore, Maryland and 50 miles north of Washington D.C. Sykesville is located in the southeastern portion of Carroll County, close to the border of Howard and Baltimore Counties. Carroll Community Bank maintains one other branch office in the town of Westminster, located in central Carroll County. Carroll County has historically been known as a rural area but in recent years the southern and eastern sections of the County have been transformed into a suburban market area as the population base has expanded westward from Baltimore City.
Our market area can be classified as both suburban and rural, with the original rural communities west of Baltimore City giving way over the past several decades to suburban growth in the form of housing developments and increased commercial development. Carroll and Howard Counties represent the western suburban regions of the Baltimore metropolitan area, which would include Baltimore County. Montgomery and Frederick Counties are considered part of suburban Maryland and aligned more closely with the Washington D.C. metropolitan area. Carroll and Howard Counties can be considered “bedroom” communities, as a portion of their residents commute to employment in Baltimore, Suburban Maryland or Washington, D.C.
The commercial and industrial tax base in Carroll County is among the lowest in the region and new business activity tends to lag that of the larger market. The strategic direction of the Bank is to shift towards entering growth markets. These markets are to the south in the Washington metropolitan area which includes Howard, Frederick and Montgomery counties in Maryland. We have recently hired two experienced commercial lenders to focus our lending efforts in Montgomery and Howard counties along with their contiguous counties. In addition, we opened a loan production office in Montgomery county.
Competition
We face intense competition in both originating loans and attracting deposits. We compete with other commercial banks, savings associations, credit unions, money market mutual funds and other financial entities operating in our primary market area and elsewhere. Among our competitors are much larger and more diversified financial institutions including banks with a national or regional presence, which have greater resources, name recognition and market presence and offer more products and services. From a competitive standpoint, we believe that we benefit from our status as a locally-based financial institution with longstanding customer relationships, and continued efforts to offer competitive products and services. However, competitive pressures will likely continue to build as the financial services industry continues to consolidate and as other non-bank investment options for consumers become available.
Loan Products
The Bank provides a variety of commercial and consumer lending products to small businesses and consumers for various business and personal purposes. Our loan products include owner occupied and non-owner occupied commercial real estate loans, one- to four-family investor mortgages, owner-occupied one- to four-family residential mortgages and, to a lesser extent, second mortgages which consist of home equity lines of credit and home equity loans. We also offer consumer loans and residential construction loans to compliment our core loan products. As we have since 2011, we will continue to place a greater focus on building a portfolio of commercial real estate and business loans and emphasizing relationship banking in our market area.
Commercial Real Estate and Commercial Loans. Included in this category are commercial real estate loans, commercial construction loans and other commercial loans. Owner occupied and non-owner occupied commercial real estate loans represent over 90% of our commercial loan portfolio as of December 31, 2014.
As of December 31, 2014, $40.8 million, or 45.0%, of our total loan portfolio consisted of commercial loans. Of these, $11.2 million, or 27.5% (or 12.4% of our total loan portfolio), were loans for owner occupied properties and $29.6 million, or 72.5% (or 32.6% of our total loan portfolio), were loans for non-owner occupied properties and other types of commercial loans. We intend to continue to expand this segment of lending as a percentage of the total loan portfolio. In this regard, commercial loans increased 28.4% during the year ended December 31, 2014 compared to December 31, 2013, and increased to 45.0% of our total loan portfolio at December 31, 2014 from 37.8% at December 31, 2013.
We originate a variety of fixed and adjustable rate commercial loans typically with a five year maturity and a principal amortization term of five years to 25 years. We generally seek to originate commercial loans with principal balances of up to $5.0 million with any credit exposure over our loans to one borrower limitation participated with another financial institution. Commercial loans are generally supported by personal guarantees.
Commercial real estate loans are secured by first mortgages, and loan amounts typically do not exceed 80% of the property’s appraised value for owner occupied properties and 75% for non-owner occupied properties. We require all properties securing commercial real estate loans to be appraised by a board-approved, independent, licensed or certified appraiser. A majority of our commercial real estate loans are secured by properties located in our market area.
Commercial loans generally carry higher interest rates and have shorter terms than one- to four-family residential mortgage loans. Commercial loans, however, entail greater credit risks compared to the one- to four-family residential mortgage loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions that are not in the control of the borrower or lender could affect the value of the collateral for the loan or the future cash flow of the property.
One- to Four-Family Non-Owner Occupied Residential Mortgage Loans. We also offer mortgage loans on non-owner occupied residential properties (in other words, investment properties) in our market area. These loans are generated through our existing customer base and referrals, real estate agents, real estate investors and other marketing efforts. At December 31, 2014, $9.1 million, or 10.0%, of our loan portfolio consisted of this type of mortgage loan. The maximum loan-to-value ratio on these loans is 75%, and they are typically held to a five year maturity with a 30-year payment amortization. A title insurance policy must be obtained for each loan, and we require fire and extended coverage casualty insurance. We generally obtain personal guarantees of repayment from borrowers on multifamily residential loans.
One- to Four-Family Owner-Occupied Residential Mortgage Loans. At December 31, 2014, $40.3 million, or 44.6%, of our total loan portfolio consisted of one- to four-family owner-occupied residential mortgage loans, of which $35.1 million, or 87.0% (or 38.8% of the total loan portfolio), were first lien loans. Our origination of one- to four-family mortgage loans enables borrowers to purchase or refinance existing homes located primarily in our market area.
Prior to January 2014 we offered balloon mortgages with five, ten, and 15 year maturities that we retained in our loan portfolio. However, the Consumer Financial Protection Bureau (“CFPB”) implemented a new rule effective January 10, 2014 that was designed to clarify for lenders how they can avoid legal liability under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), which would otherwise hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet the “qualified mortgage” definition set forth in the rule will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features.
The rule also establishes general underwriting criteria for qualified mortgages, including that the consumer must have a total (or “back end”) debt-to-income ratio that is less than or equal to 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages limits our ability to make residential mortgage loans that include a balloon payment, which could limit our growth or profitability.
As a result we no longer offer owner-occupied residential mortgage balloon loans. We have replaced those loan products with adjustable rate mortgages that reset at five, seven and ten years, all with a 30-year payment amortization. At December 31, 2014, $3.4 million, or 9.7%, of our one- to four-family residential first lien mortgage loans held in our portfolio were adjustable rate loans.
We still offer fixed rate residential mortgages with ten and 15 year terms with no balloon payments. We will originate fixed rate residential loans with a maturity of more than 15 years, but we will sell such loans in the secondary market instead of retaining them in our loan portfolio.
We generally limit the maximum loan to value ratio to 80% of the lower of the appraised value or the purchase price of the property securing the loan, although our policy permits us to originate loans with a loan to value ratio up to 85% of the appraised value or purchase price of the property.
We require all properties securing mortgage loans to be appraised by a board-approved, independent state-licensed appraiser, unless the loan is for $250,000 or less or in certain other limited circumstances; transactions under $250,000 require an in-house evaluation of the secured property. Appraisals are subsequently reviewed by a loan officer. Appraisals of a value of $500,000 or more must be reviewed by an independent appraisal review company. We also require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance and flood insurance is required for all properties located in flood hazard areas.
When underwriting residential real estate loans, we review and verify each loan applicant’s employment, income and credit history and, if applicable, our experience with the borrower. Our policy is to obtain credit reports and verification of employment/income on all borrowers and guarantors. We also generally obtain personal guarantees of repayment of borrowers for multi-family residential loans.
We also offer second mortgages and home equity lines of credit with a loan-to-value ratio of up to 80%. Second mortgage loans are made at fixed rates for terms of up to 15 years. Home equity lines of credit allow for the borrower to draw against a line for ten years, followed by a ten-year repayment period. Home equity lines of credit carry a variable rate of interest with monthly payments of interest due and 0.50% of the outstanding principal balance. After the initial ten-year draw period, the borrower is required to make payments of principal and interest based on a ten-year amortization period. Both of these products are underwritten with the same criteria that we use to underwrite one- to four-family residential mortgage loans including appraisals. At closing, we record the mortgage to perfect our security interest in the underlying collateral either as a first or second mortgage. We also require title insurance, hazard insurance and if applicable, flood insurance that the borrower must obtain.
Second mortgages and home equity lines of credit generally have greater risk than one- to four-family residential mortgage loans. In these cases, we face the risk that collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding
loan balance. In particular, because in most cases the loans are secured by second mortgages, decreases in real estate values could adversely affect the value of the property serving as collateral for these loans. Thus, the foreclosure of such property could be insufficient for us to recover the value of these loans.
Second mortgages and home equity lines of credit totaled $5.2 million at December 31, 2014 and represented 13.0% of one- to four-family owner occupied residential mortgage loans (or 5.8% of our total loan portfolio) at such date.
On a limited basis, we originate residential construction loans and lot loans, which are loans used to acquire unimproved land for future residential construction. At December 31, 2014, the balance of residential construction and lot loans was $1.4 million, or 1.5% of our total loan portfolio. We will make residential construction loans for one- to four-family homes located in our market area. Construction loans bear a fixed rate of interest with interest-only payments on the outstanding balance during the construction phase, which is usually six to 12 months. At the end of the term, which generally coincides with the end of the construction phase, the loan generally converts to a permanent mortgage loan. Residential construction loans can be made with a maximum loan to value ratio of 80%, based on appraised value as if complete. In addition, the borrower must have an initial investment in the project that is equal to at least 20% of the final project value. Before making a commitment to fund a residential construction loan, we require an appraisal of the property by a board-approved, independent, licensed or certified appraiser. We also require a review of the plans and specifications and of any approved changes to the original plan and an inspection of the property before disbursement of funds during the term of the loan.
We will make unimproved lot loans located in our market area. Lot loans are generally offered at a rate 2% above our residential first mortgage lien rate and at a maximum loan to value ratio of 75%. The property must be perked (i.e. have appropriate drainage) and have a water well. The term of the loan is limited to a maximum of five years. Before making a commitment to fund a lot loan, we require an appraisal of the property by a board-approved, independent, licensed or certified appraiser.
Construction and lot loan financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on such loans depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction or development cost proves to be inaccurate, we may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment. In the event we make a lot acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. Construction loans also expose us to the risks that improvements will not be completed on time in accordance with specifications and projected costs and that repayment will depend on the successful operation or sale of the properties. In addition, the ultimate sale or rental of the property may not occur as anticipated. Further, many of these borrowers have more than one loan outstanding.
We do not offer “interest only” mortgage loans (where the borrower pays only interest for an initial period, after which the loan converts to a fully amortizing loan). We also do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan. We do not offer, and have not offered, “subprime loans” (loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios), no-documentation mortgage loans or Alt-A mortgages (traditionally defined as loans having less than full documentation).
Consumer Loans. We offer consumer loans as an accommodation to our customers and do not emphasize this type of lending. We have made a variety of consumer loans, including automobile loans, loans secured by a borrower’s savings account or certificate of deposit at Carroll Community Bank, and unsecured overdraft lines of credit. The maximum term on such loans is five years with monthly principal and interest payments. For loans secured by a borrower’s savings account or certificate of deposit, the maximum loan to value ratio is 100% of the account balance and the interest rate is 2.0% above the current interest rate being paid on the account. Automobile loans may be made for up to 100% of the retail value of the vehicle. The interest rate for unsecured overdraft lines of credit is a fixed rate of 18%. At December 31, 2014, consumer loans totaled $392,000 or 0.4% of our total loan portfolio. The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan.
Loan Originations, Purchases, Sales and Participations. All loans we originate are underwritten pursuant to our policies and procedures, which incorporate standard underwriting guidelines. Our loan origination activity may be adversely affected by a rising interest rate environment which typically results in decreased loan demand. Most of our one- to four-family residential mortgage loan originations are generated by our loan officers or referred by members of our Board of Directors, while most of our commercial real estate loans are generated internally by our loan officers.
Historically, we have retained in our portfolio the vast majority of loans that we originate, although in limited cases we originate residential mortgage loans with a maturity of greater than 15 years that we sell into the secondary market and sell loan participations on commercial loans that exceed our loans-to-one borrower limitation.
Occasionally, we enter into purchase loan participations from other banks primarily for commercial real estate loans. In these circumstances, we generally follow our customary loan underwriting and approval guidelines. At December 31, 2014, we had $7.7 million in outstanding balances from purchased loan participations.
In addition, we enter into the purchase of whole loans (includes the servicing). In these circumstances, we follow our customary loan underwriting and approval guidelines. We did not purchase any whole loans during 2014. At December 31, 2014 we had $9.3 million in outstanding balances of purchased whole loans.
As of December 31, 2014, our legal lending limit for loans-to-one borrower was approximately $1.6 million. With the closing of our private placement offering, pursuant to which we sold 310,848 shares of our common stock for aggregate gross proceeds of $5.1 million, our loans-to-one borrower limit has increased to approximately $2.4 million as of the closing of the private placement offering on January 23, 2015. We will participate part of a loan relationship to another financial institution when a relationship’s total loan exposure is greater than our loans-to-one borrower limit. At December 31, 2014, we had $3.0 million in sold loan participations.
Loan Approval Procedures and Authority. We base our decision to lend primarily on the credit worthiness of the borrower and guarantors, and their capacity to repay the loan from future cash flow. In evaluating the collateral for a proposed non-owner occupied commercial real estate loan, we emphasize the ratio of the property’s projected net cash flow to the loan’s debt service requirement (generally requiring a preferred ratio of 1.20x), computed after deduction for a vacancy factor and property expenses we deem appropriate. Personal guarantees are usually obtained from commercial real estate borrowers. We require title insurance, fire and extended coverage casualty insurance, and, if appropriate, flood insurance, in order to protect our security interest in the underlying property.
Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by our Board of Directors. The loan approval process is intended to assess the borrower’s ability to repay the loan and value of the property that will secure the loan. To assess the borrower’s ability to repay, we review the borrower’s employment and credit history and information on the historical and projected income and expenses of the borrower.
Our policies and loan approval limits are approved by the Board of Directors. While our President and Chief Executive Officer has the ability to approve loans up to $500,000, as a matter of practice all loans are typically presented to the Loan Committee for approval. Any loan over $500,000 must be approved by the Loan Committee, except for deposit-secured loans which can be originated by our loan officers without Loan Committee or Board approval.
We require appraisals of all real property securing one- to four-family residential and commercial real estate loans and home equity loans and lines of credit. All appraisers are state-licensed or state-certified appraisers, and our practice is to have local appraisers approved by the Board of Directors annually.
Investment Securities
At December 31, 2014, our investment securities portfolio totaled $11.1 million, which consisted of $9.6 million in mortgage-backed securities guaranteed by U.S. Government-sponsored enterprises and $275,000 in municipal bonds classified as available for sale, along with $500,000 in municipal bonds and $756,000 in corporate bonds classified as held to maturity.
Our President and Chief Executive Officer has the primary responsibility for implementing our investment policy, which was developed and amended by management and approved by our Asset and Liability Committee and the Board of Directors. The investment policy is reviewed annually by the Board of Directors, and any amendments deemed necessary are made pursuant to such review. The overall objectives of our investment policy are to: (i) optimize after-tax income from funds not used to fund loans, consistent with our objectives for liquidity and asset quality standards; (ii) provide liquidity for loan demand, deposit fluctuations or other changes in the balance sheet mix; (iii) provide a source of collateral for pledging purposes; (iv) provide a means to manage interest rate risk; and (v) provide an investment medium to balance the market and credit risk of our other assets and liabilities structure. The policy dictates that investment management should emphasize: (i) the preservation of capital; (ii) strong cash-flow characteristics; (iii) readily-available credit information; (iv) appropriateness of size both as to Carroll Community Bank and as to an obligor’s outstanding debt; (v) eligibility as collateral for public-agency deposits, customer repurchase agreement accounts and pledging purposes; and (vi) broad marketability, as an indicator of quality.
Our current investment policy permits investments in U.S. Treasury securities, securities guaranteed by Ginnie Mae and collateralized mortgage obligations that are exclusively backed by Ginnie Mae, securities issued by U.S. Government agencies, mortgage-backed securities issued by Fannie Mae, Freddie Mac, Ginnie Mae or U.S. government-sponsored agencies and collateralized mortgage obligations that are exclusively backed by government-sponsored enterprises, investment-grade municipal bonds, investment-grade
corporate debt securities, certificates of deposit issued by well capitalized financial institutions, Community Reinvestment Act (“CRA”) investments that provide credit to Carroll Community Bank’s CRA rating, and other interest-earning assets, including federal funds sold, interest-bearing deposits with other banks and securities purchased under agreement to resell.
We designate a security as either available for sale or held to maturity based upon our ability and intent to hold the security. Securities available for sale are carried at an estimated fair value and securities held to maturity are reported at amortized cost. A periodic review and evaluation of the securities available for sale and securities held to maturity portfolios is conducted to determine if the fair value of any security has declined below its carrying value and whether such decline is other-than-temporary. The fair values of mortgage-backed securities are based on quoted market prices or, when quoted prices in active markets for identical assets are not available, are based on matrix pricing, which is a mathematical technique that relies on the securities’ relationship to other benchmark quoted prices.
We purchase mortgage-backed securities issued and guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac, which constitute the majority of our securities portfolio. Historically, we have invested in mortgage-backed securities to achieve positive interest rate spreads with minimal administrative expense and to lower our credit risk as a result of the guarantees provided by Ginnie Mae, Freddie Mac or Fannie Mae. However, in 2008, the Federal Housing Finance Agency placed Freddie Mac and Fannie Mae into conservatorship. The U.S. Treasury Department has established financing agreements to ensure that Freddie Mac and Fannie Mae meet their obligations to holders of mortgage-backed securities that they have issued or guaranteed. Based on our experience, these actions have not affected the markets for mortgage-backed securities issued by Freddie Mac or Fannie Mae.
Mortgage-backed securities are securities issued in the secondary market that are collateralized by pools of mortgages. Certain types of mortgage-backed securities are commonly referred to as “pass-through” certificates because the principal and interest of the underlying loans is “passed through” to investors, net of certain costs, including servicing and guarantee fees. Mortgage-backed securities typically are collateralized by pools of one- to four-family or multifamily (loans on properties with five or more units) mortgages, although we invest primarily in mortgage-backed securities backed by one- to four-family mortgages. The issuers of such securities pool and resell the participation interests in the form of securities to investors such as Carroll Community Bank. The interest rate on the security is lower than the interest rates on the underlying loans to allow for payment of servicing and guaranty fees. Ginnie Mae, a U.S. Government agency, and government sponsored enterprises, such as Fannie Mae and Freddie Mac, either guarantee the payments or guarantee the timely payment of principal and interest to investors. Based on our experience, mortgage-backed securities are more liquid than individual mortgage loans since there is an active trading market for such securities. In addition, mortgage-backed securities may be used to collateralize our borrowings. Investments in mortgage-backed securities involve a risk that actual payments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such interests, thereby affecting the net yield on our securities. Current prepayment speeds determine whether prepayment estimates require modification that could cause amortization or accretion adjustments.
All securities transactions are reviewed with the Board of Directors on a monthly basis. It is not our intention to profit in our investment account from short-term securities price movements. Accordingly, we do not currently have a trading account for investment securities.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Balance Sheet Analysis and Comparison of Financial Condition at December 31, 2014 to December 31, 2013-Investment Securities Portfolio” for further information.
Sources of Funds
General. Deposits traditionally have been our primary source of funds for our lending and investment activities. We also have access to a line of credit with the Federal Home Loan Bank of Atlanta and to short-term lines of credit with our correspondent banks to supplement cash flow needs. Additional sources of funds are scheduled loan payments, loan payoffs, sold or maturing investments and, to a limited extent, the proceeds of loan sales.
Deposits. We generate deposits primarily from within Carroll and Howard Counties in Maryland. We rely on our competitive pricing and products, convenient locations, technology and quality customer service to attract and retain deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of savings accounts, money market accounts, certificates of deposit, retail and business checking accounts and IRA accounts.
Interest rates, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements and our deposit growth goals. Pursuant to our business plan, we intend to grow the number and amount of our retail and business checking accounts.
Borrowings. At December 31, 2014, we had three advances with balances totaling $8.0 million, or 7.6%, of total liabilities under a line of credit with the Federal Home Loan Bank of Atlanta (the “FHLBA”). We have a long-term advance of $5.0 million at a fixed interest rate of 2.29%, which matures on August 12, 2018 but is callable quarterly by the FHLBA. In addition, we had a secured borrowing of $1.5 million at a fixed rate of 0.21%, which matures on March 31, 2015 and another secured borrowing of $1.5 million at a fixed rate of 0.29%, which matures on June 30, 2015. At December 31, 2014, we had access to additional FHLBA advances of up to $3.3 million. Advances from the FHLBA are secured by a blanket lien on our residential first lien mortgage loan portfolio as well as by our investment in the stock of the FHLBA.
We also have short-term lines of credit with various correspondent banks for an aggregate of $10.5 million at December 31, 2014.
Personnel
As of December 31, 2014 we had 23 full-time and two part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have a good working relationship with our employees.
SUPERVISION AND REGULATION
General
As a bank holding company, Carroll Bancorp, Inc. is required to file certain reports with, is subject to examination by, and otherwise must comply with the rules and regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), and is subject to certain regulations of the Maryland Office of the Commissioner of Financial Regulation. Carroll Bancorp, Inc. is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.
As a state chartered commercial bank, Carroll Community Bank is subject to supervision and regulation of the Maryland Office of the Commissioner of Financial Regulation, and by the Federal Deposit Insurance Corporation (the “FDIC”) as the insurer of its deposits and its primary federal regulator. As a subsidiary of Carroll Bancorp, Inc., Carroll Community Bank is also regulated to a lesser extent by the Federal Reserve Board. Carroll Community Bank’s relationship with its depositors and borrowers also is regulated by state and federal law, including in matters concerning the ownership of deposit accounts and the form and content of Carroll Community Bank’s loan documents. This system of state and federal regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the FDIC’s deposit insurance fund and depositors, and not for the protection of stockholders. Carroll Community Bank is periodically examined by the Maryland Office of the Commissioner of Financial Regulation and the FDIC to ensure that it satisfies applicable standards with respect to its capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Following examinations, the Maryland Office of the Commissioner of Financial Regulation and the FDIC prepare reports for the consideration of Carroll Community Bank’s Board of Directors on any operating deficiencies. The enforcement powers available to Carroll Community Bank’s federal and state banking regulators include, among other things the ability to: issue cease and desist or removal orders; terminate insurance of deposits; assess civil money penalties; issue directives to increase capital; place Carroll Community Bank into receivership; and initiate injunctive actions against Carroll Community Bank and institution-affiliated parties.
Any change in these laws or regulations, whether by the FDIC, the Maryland Office of the Commissioner of Financial Regulation, the Federal Reserve Board, Congress or the State of Maryland, could have a material adverse impact on Carroll Bancorp, Inc., Carroll Community Bank and our operations.
Set forth below is a brief description of the material regulatory requirements that are applicable to Carroll Bancorp, Inc. and Carroll Community Bank. The description below is limited to the material aspects of the statutes and regulations addressed, and is not intended to be a complete description of such statutes and regulations and their effects on Carroll Bancorp, Inc. and Carroll Community Bank.
Banking Regulation
Financial Institutions Article of the Maryland Annotated Code. The Financial Institutions Article of the Maryland Annotated Code (the “Banking Code”), contains detailed provisions governing the organization, operations, corporate powers, commercial and investment authority, branching rights and responsibilities of directors, officers and employees of Maryland banking institutions. The Banking Code delegates extensive rulemaking power and administrative discretion to the Maryland Office of the Commissioner of Financial Regulation in its supervision and regulation of state-chartered banking institutions. The Maryland Office of the Commissioner of Financial Regulation may order any banking institution to discontinue any violation of law or unsafe or unsound business practice.
Capital Adequacy Guidelines. Under the FDIC’s regulations, federally insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”), such as Carroll Community Bank, are required to comply with minimum
leverage capital requirements. The minimum leverage capital requirement for a bank is the ratio of Tier 1 (core) capital to total assets of not less than 3% if the FDIC determines that the institution is not anticipating or experiencing significant growth and has well-diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and in general is considered a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System (the CAMELS rating system) established by the Federal Financial Institutions Examination Council. For all other institutions, the minimum leverage capital ratio is not less than 4%. Tier 1 capital is the sum of common stockholders’ equity, noncumulative perpetual preferred stock (including any related surplus) and, in certain cases and subject to certain limitations, minority investments in certain subsidiaries, less goodwill and other non-qualifying intangible assets and certain other specified items.
In addition, FDIC regulations require state non-member banks to maintain certain ratios of regulatory capital to regulatory risk-weighted assets, or “risk-based capital ratios.” Under the capital rules, risk-based capital ratios are calculated by dividing Tier 1 and total risk-based capital, respectively, by risk-weighted assets. Under rules in effect through December 31, 2014, state non-member banks must maintain a minimum required Tier 1 risk-based capital ratio of 4% and a minimum required total risk-based capital ratio of 8%. Total capital consists of Tier 1 capital plus Tier 2 capital, less certain required deductions. Tier 2 capital generally consists of hybrid capital instruments, such as perpetual debt and mandatory convertible debt securities, cumulative perpetual preferred stock, term subordinated debt and intermediate-term preferred stock, and, subject to limitations, allowances for loan losses.
New Capital Rules. In July 2013, the Federal Deposit Insurance Corporation and the other federal bank regulatory agencies issued a final rule implementing the capital standards of the Basel Committee on Banking Supervision and the minimum capital requirements and certain other provisions of the Dodd-Frank Act. The final rule, which became effective on January 1, 2015, applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies. Among other things, the rule establishes a new minimum common equity Tier 1 risk-based capital ratio requirement of 4.5%, a minimum Tier 1 risk-based capital ratio requirement of 6%, a minimum total risk-based capital ratio requirement of 8% and a minimum leverage ratio requirement of 4%. The new capital requirements also include changes in the risk-weights of certain assets to better reflect credit risk and other risk exposures. Additionally, subject to a transition schedule, the rule limits a banking organization’s ability to make capital distributions, engage in share repurchases and pay certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.
Under the new rules, accumulated other comprehensive income (positive or negative) must be reflected in regulatory capital; however, Carroll Community Bank may make a one-time, permanent election to continue to exclude accumulated other comprehensive income from regulatory capital. If the Bank does not make this election, unrealized gains and losses, net of taxes, on certain financial instruments, including available-for-sale-securities, will be included in the calculation of the Bank’s regulatory capital. Carroll Community Bank intends to make this election.
Prompt Corrective Action Regulations. Under federal prompt corrective action regulations, the FDIC is authorized and, under certain circumstances, required to take various “prompt corrective actions” to resolve the problems of any state non-member bank that is not adequately capitalized. Under these regulations, as in effect through December 31, 2014, a bank was considered to be: (i) “well capitalized” if it had total risk-based capital of 10% or more, Tier 1 risk-based capital of 6.0% or more, Tier I leverage capital of 5% or more, and was not subject to any written capital order or directive; (ii) “adequately capitalized” if it had total risk-based capital of 8% or more, Tier I risk-based capital of 4.0% or more and Tier I leverage capital of 4% or more (3% under certain circumstances), and does not meet the definition of “well capitalized”; (iii) “undercapitalized” if it had total risk-based capital of less than 8%, Tier I risk-based capital of less than 4% or Tier I leverage capital of less than 4% (3% under certain circumstances); (iv) “significantly undercapitalized” if it had total risk-based capital of less than 6%, Tier I risk-based capital less than 3%, or Tier I leverage capital of less than 3%; and (v) “critically undercapitalized” if its ratio of tangible equity to total assets was equal to or less than 2%. Under certain circumstances, the FDIC may reclassify a well capitalized institution as adequately capitalized, and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). As of December 31, 2014, Carroll Community Bank was “well capitalized” for this purpose and its capital exceeded all applicable requirements.
Under the FDIC’s amended rules, effective January 1, 2015, a bank is considered “well capitalized” if it: (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of at least 6.5% or greater; (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. As of December 31, 2014, Carroll Community Bank remained “well capitalized” for this purpose and its capital exceeded all applicable requirements.
As an additional means to identify problems in the financial management of depository institutions, the Federal Deposit Insurance Act requires federal bank regulatory agencies to establish certain non-capital safety and soundness standards for institutions for which they are the primary federal regulator. The standards relate generally to operations and management, asset quality, interest rate exposure and executive compensation. The agencies are authorized to take action against institutions that fail to meet such standards.
Deposit Insurance. The Deposit Insurance Fund (“DIF”) of the FDIC insures deposits at FDIC insured financial institutions such as Carroll Community Bank. Deposit accounts in Carroll Community Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor. FDIC-insured depository institutions are required to pay deposit insurance assessments to the FDIC to fund the DIF, which is currently under-funded.
Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. Rates are based on each institution’s risk category and certain specified risk adjustments. Stronger institutions pay lower rates while riskier institutions pay higher rates. To determine its deposit insurance premium, Carroll Community Bank computes the base amount of its average consolidated assets less its average tangible equity (defined as the amount of Tier 1 capital) and the applicable assessment rate. Assessment rates range from 2.5 to 45 basis points.
In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs, and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of Carroll Community Bank. Management cannot predict what assessment rates will be in the future. Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Maryland Regulatory Assessment. The Maryland Office of the Commissioner of Financial Regulation annually assesses state banking institutions to cover the expense of regulating banking institutions. The Bank’s asset size determines the amount of the assessment.
Liquidity. Carroll Community Bank is subject to the reserve requirements imposed by the State of Maryland. A Maryland banking institution is required to have at all times a reserve equal to at least 15% of its demand deposits. Carroll Community Bank is also subject to the uniform reserve requirements of Federal Reserve Board Regulation D, which applies to all depository institutions with transaction accounts or non-personal time deposits. Specifically, for 2015, amounts in transaction accounts above $14.5 million and up to $103.6 million must have reserves held against them in the ratio of three percent of the amount. Amounts above $103.6 million require reserves of $2,673,000 plus 10 percent of the amount in excess of $103.6 million. Carroll Community Bank is in compliance with its reserve requirements.
Loans-to-One-Borrower Limitation. With certain limited exceptions, a Maryland banking institution may lend to a single or related group of borrowers an amount equal to 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. Carroll Community Bank is in compliance with its loans-to-one borrower limitations.
Community Reinvestment Act and Fair Lending Laws. Under the Community Reinvestment Act of 1977 (“CRA”), the FDIC is required to assess the record of all financial institutions regulated by it to determine if such institutions are meeting the credit needs of the community (including low and moderate income neighborhoods) which they serve. CRA performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory, Needs to Improve and Substantial Noncompliance. CRA performance evaluations are considered in evaluating applications for such things as mergers, acquisitions and applications to open branches. Carroll Community Bank has a CRA rating of “Outstanding.” In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, the Department of Housing and Urban Development, and the Department of Justice, and in private civil actions by borrowers.
Transactions with Related Parties. Transactions between banks and their related parties or affiliates are limited by Sections 23A and 23B of the Federal Reserve Act and federal regulations. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. In a holding company context, the parent bank holding company and any companies which are controlled by such parent holding company are affiliates of the bank.
Generally, Section 23A of the Federal Reserve Act and the Federal Reserve Board’s Regulation W limit the extent to which the bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such institution’s capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such institution’s capital stock and surplus. The term “covered transaction” includes the making of loans, purchase of assets, issuance of guarantees and other similar transactions. In addition, loans or other extensions of credit by the bank to an affiliate are required to be
collateralized in accordance with regulatory requirements, and the bank’s transactions with affiliates must be consistent with safe and sound banking practices and may not involve the purchase by the bank of any low-quality asset. Section 23B applies to covered transactions as well as certain other transactions and requires that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to non-affiliates.
Section 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board govern extensions of credit made by a bank to its directors, executive officers, and principal stockholders (“insiders”). Among other things, these provisions require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features. Further, such extensions may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Carroll Community Bank’s capital. Extensions of credit in excess of certain limits must be also be approved by the board of directors.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Federal Home Loan Bank System. Carroll Community Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the Federal Home Loan Bank of Atlanta, Carroll Community Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank. As of December 31, 2014, Carroll Community Bank was in compliance with this requirement.
Other Regulations. Interest and other charges collected or contracted for by Carroll Community Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:
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Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
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Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;
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Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit;
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Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
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Truth in Savings Act; and
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Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
The operations of Carroll Community Bank also are subject to the:
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Right to Financial Privacy Act which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
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Electronic Funds Transfer Act and Regulation E promulgated there under, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;
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Check Clearing for the 21st Century Act (“Check 21”), which gives substitute checks, such as digital check images and copies made from that image, the same legal standing as the original paper check;
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The USA PATRIOT Act, which requires savings banks to, among other things, establish broadened anti-money laundering compliance programs and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and
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The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to opt out of the sharing of certain personal financial information with unaffiliated third parties.
Further, the Dodd-Frank Act established the CFPB, which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB also has a broad mandate to prohibit unfair or deceptive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties. The FDIC will examine Carroll Community Bank for compliance with CFPB rules and will enforce CFPB rules with respect to Carroll Community Bank.
Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Board’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Bank Holding Company Regulation
General. As a bank holding company, Carroll Bancorp, Inc. is subject to regulation and examination by the Maryland Office of the Commissioner of Financial Regulation and the Federal Reserve Board. Carroll Bancorp, Inc. is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). Among other things, the BHC Act requires regulatory filings by a stockholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution. The determination whether an investor “controls” a depository institution is based on all of the facts and circumstances surrounding the investment. As a general matter, a party is deemed to control a depository institution or other company if the party owns or controls 25% or more of any class of voting stock. Subject to rebuttal, a party may be presumed to control a depository institution or other company if the investor owns or controls 10% or more of any class of voting stock. Ownership by affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party’s ownership of Carroll Bancorp were to exceed certain thresholds, the investor could be deemed to “control” Carroll Bancorp for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.
Permissible Activities. Pursuant to provisions of the BHC Act and regulations promulgated by the Federal Reserve Board thereunder, Carroll Bancorp, Inc. may only engage in or own companies that engage in activities deemed by the Federal Reserve Board to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto, and the holding company must obtain permission from the Federal Reserve Board prior to engaging in most new business activities. In addition, bank holding companies like Carroll Bancorp, Inc. must be well capitalized and well managed in order to engage in the expanded financial activities permissible only for a financial holding company.
Capital. Federal banking regulators have adopted risk-based capital guidelines for bank holding companies with consolidated assets of $500 million or more. These guidelines also apply on a consolidated basis to any bank holding company with consolidated assets of less than $500 million if such holding company (i) is engaged in significant nonbanking activities either directly or through a nonbank subsidiary; (ii) conducts significant off-balance sheet activities or (iii) has a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the SEC. As of December 31, 2014, Carroll Bancorp, Inc. had consolidated assets of less than $500 million and did not satisfy the nonbanking, off-balance sheet, or debt requirements that would make it subject to the risk-based or leverage ratio requirements discussed above. However, under the BHC Act, as amended by the Dodd-Frank Act, Carroll Bancorp, Inc. must continue to serve as a source of strength for its subsidiary bank.
The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve Board’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital requirements, asset quality and overall financial condition. The Federal Reserve Board’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Under the prompt corrective action laws, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of Carroll Bancorp, Inc. to pay dividends or otherwise engage in capital distributions.
Federal Securities Laws
The Company’s common stock is registered with the SEC under the Securities Exchange Act of 1934. The Company is subject to the information, proxy solicitation, insider trading restrictions and, other requirements under the Securities Exchange Act of 1934.
Carroll Bancorp, Inc. common stock held by persons who are affiliates (generally officers, directors and principal shareholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, the Company’s Chief Executive Officer and Chief Financial Officer are required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the SEC under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company’s internal control over financial reporting; they have made certain disclosures to the Company’s auditors and the audit committee of the Board of Directors about the Company’s internal control over financial reporting; and they have included information in the Company’s quarterly and annual reports about their evaluation and whether there have been changes in the Company’s internal control over financial reporting or in other factors that could materially affect internal control over financial reporting. The Company has prepared policies, procedures and systems designed to ensure compliance with these regulations.
Item 1A.
Item 1A. Risk Factors
Readers should carefully consider the following risks prior to making an investment decision regarding Carroll Bancorp, Inc. The following risk factors may cause future earnings to be lower or the financial condition less favorable than we expect. In addition, other risks of which we are not currently aware or which we do not believe to be material may cause earnings to be lower or may cause our financial condition to be worse than expected. Please consider all information contained within this Annual Report on Form 10-K, as well as, the documents incorporated by reference.
We may not be able to successfully manage continued growth.
We intend to seek further growth in the level of our assets and deposits both within our existing footprint and to expand our footprint in the Washington, D.C. metropolitan area. We may not be able to manage increased levels of assets and liabilities without increased expenses and higher levels of nonperforming assets. We may be required to make additional investments in equipment and personnel to manage higher asset levels and loan balances, which may adversely impact earnings, stockholder returns and our efficiency ratio. Increases in operating expenses or nonperforming assets may have an adverse impact on the value of our common stock.
Our growth strategy will increase our non-interest expenses and may not be successful.
Our long-term goals are to improve profitability and asset quality by increasing and diversifying our loan portfolio and increasing and improving our deposit mix, as well as growing our assets overall. In this regard, we intend to grow organically (i.e. through making loans and attracting deposits as opposed to growing through acquisitions) by the use of technology and opening an additional branch within the next three years, as well as potential acquisitions, although we have no specific plans or commitments to do so. As contemplated by our business plan, we intend to hire additional staff in 2015 and 2016 as part of the planned expansion of our lending and operational activities. Acquiring or building branch offices and hiring new employees to staff these offices would significantly increase our non-interest expenses. Moreover, new branch offices are generally unprofitable for a number of years until they generate sufficient levels of deposits and loans to offset their cost of operations. For these reasons, our growth strategy may have an adverse effect on our earnings.
Our ability to establish new branch offices depends on whether we can identify advantageous locations and generate new deposits and loans for those locations that will create an acceptable level of net income. If we were to acquire another financial institution or branch thereof, we may not be able to successfully integrate the institution or branch into our operations. Also, the costs to start up new branch facilities or to acquire existing financial institutions or branches thereof, and the additional costs to operate these facilities, will increase our non-interest expense. It may also be difficult to adequately and profitably manage the anticipated growth from the new branches.
If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially and adversely affect our financial condition and results of operation. Further, we may not be successful in our growth strategy, which would negatively impact our financial condition and results of operations.
Our continued growth depends on our ability to meet minimum regulatory capital levels. Growth and stockholder returns may be adversely affected if sources of capital are not available to help us meet them.
As we grow, we will have to maintain our regulatory capital levels at or above the required minimum levels, including the new capital requirements under Basel III and the Dodd-Frank Act. If earnings do not meet our current estimates, if we incur unanticipated losses or expenses, or if we grow faster than expected, we may need to obtain additional capital sooner than expected or we may be required to reduce our level of assets or reduce our rate of growth in order to maintain regulatory compliance. Under those circumstances net income and the rate of growth of net income may be adversely affected. Additional issuances of equity securities could have a dilutive effect on existing stockholders.
A worsening of economic conditions could adversely affect our results of operations and financial condition.
Although the U.S. economy has emerged from the severe recession that occurred in 2008 and 2009, economic growth has been slow and uneven and unemployment levels remain elevated. Recovery by many businesses has been impaired by lower consumer spending. A return to prolonged deteriorating economic conditions could significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in sales volumes and increases in unemployment levels may result in higher than expected loan delinquencies, increases in our nonperforming and criticized classified assets and a decline in demand for our products and services. These events may cause us to incur losses and may adversely affect our financial condition and results of operations.
A worsening of credit markets and economic conditions could adversely affect our liquidity.
We are required to maintain certain capital levels in accordance with banking regulations. We must also seek to maintain adequate funding sources in the normal course of business to support our lending and investment operations and repay our outstanding liabilities as they become due. Our liquidity may be adversely affected by the current environment of economic uncertainty reducing business activity as a result of, among other factors, disruptions in the financial system in the recent past, concerns regarding U.S. debt levels and related governmental actions, including potential tax increases and cuts in government spending, and continuing global economic problems. If adverse conditions worsen, we may be required to raise additional capital as well to maintain adequate capital levels or to otherwise finance our business. Such capital, however, may not be available when we need it or may be available only on unfavorable terms. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our liquidity, financial condition, results of operations and prospects. Further, if we raise capital by issuing stock, the holdings of our current stockholders could be diluted.
As our loans are concentrated to borrowers in our market area, we have a greater risk of loan defaults and losses if there is an economic downturn in our market area.
The majority of our loans are to individuals and businesses secured by properties located in our market area of Carroll and Howard Counties in Maryland and those counties that are contiguous to Carroll County including Baltimore, Frederick and Montgomery Counties in Maryland. As a result, we have a greater risk of loan defaults and losses in the event of an economic downturn in our market area as adverse economic changes may have a negative effect on the ability of our borrowers to make timely repayment of their loans. Sustained elevated levels of or increases in unemployment or declines in collateral values could be factors requiring us to make additional provisions to the allowance for loan losses, which would have a negative impact on net income. Additionally, if we are required to liquidate a significant amount of collateral during a period of reduced real estate values to satisfy the debt, our earnings and capital could be adversely affected.
Further, unexpected changes in the national and local economy may adversely affect our ability to attract deposits and to make loans. In particular, due to our proximity to Washington, D.C., borrowers in our market areas are more likely to be impacted than borrowers in most other areas of the country from cuts in federal spending due to measures implemented to control the national debt and limit federal government spending. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our common stock.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could be adversely affected.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of borrowers and the value of real estate and other assets serving as collateral for the repayment of most of our loans. In determining the amount of the allowance for loan losses, we review our loan portfolio and our loan loss and delinquency experience, and evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover future incurred losses in our loan portfolio and additions to the allowance could materially decrease our net income. Our allowance for loan losses was 0.80% of total loans and 150.72% of nonperforming loans at December 31, 2014. If delinquencies and defaults rise, we may be required to further increase our provision for loan losses. Further, as we continue to expand and diversify our lending activities into commercial real estate and other areas considered to have greater credit risk than one- to four-family lending, we expect that the allowance for loan losses will need to increase.
In addition, bank regulators periodically review our allowance for loan losses and may require an increase in the provision for loan losses or additional loan charge-offs to the allowance for loan losses. Any increase in the allowance for loan losses or loan charge-offs might have a material adverse effect on our financial condition and results of operations.
Future changes in interest rates could have a material adverse effect on our operations.
Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between interest income earned on assets and interest expense paid on liabilities. The majority of our loans have fixed interest rates. Additionally, many of our investment securities have fixed interest rates. Like many financial institutions, we focus on deposit accounts, which have no stated maturity date or shorter contractual maturities, as a source of funds, which results in our liabilities having a shorter duration than our earning assets. For example, as of December 31, 2014, 35.6% of our fixed rate loans had maturities of more than five years, while 45.5% of our certificates of deposit had maturities of one year or less. This imbalance can create significant earnings volatility as market interest rates change over time. In a period of rising interest rates, the interest income earned on our assets, such as loans and investments, may not increase as rapidly as the interest paid on our liabilities, such as deposits. In a period of declining interest rates, the interest income earned on our assets may decrease more rapidly
than the interest paid on our liabilities, as borrowers prepay mortgage loans, and mortgage-backed securities and callable investment securities are called or prepaid, thereby requiring us to reinvest these cash flows at lower interest rates.
At December 31, 2014, $40.7 million, or 45.0%, of our total loan portfolio, consisted of fixed-rate balloon residential mortgage loans with maturities of five, ten and 15 years. This investment in fixed-rate mortgage loans exposes us to increased levels of interest rate risk, and could result in decreased net interest income during periods of rising interest rates.
Changes in interest rates create reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Alternatively, increases in interest rates may decrease loan demand. Changes in interest rates also affect the current market value of our investment securities portfolio. Generally, the value of interest-earning investment securities moves inversely with changes in interest rates.
Our liabilities are comprised in large part of certificates of deposit, which totaled $40.2 million, or 41.5% of total deposits, at December 31, 2014. Certificates of deposit have specified terms to maturity, and generally reprice more slowly than deposit accounts without a stated maturity.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Management of Market Risk” for additional information.
Our plan to continue to diversify and expand our loan portfolio to increase commercial real estate loans will expose us to increased lending risks.
Our business plan emphasizes an expansion of our lending activities, particularly with respect to commercial real estate lending. We anticipate that a majority of the growth in our loan portfolio during the period covered by the business plan will be attributable to commercial real estate lending.
Commercial real estate loans are considered to have greater credit risk than one-to four-family residential loans because the repayment of such loans typically depends on the successful operations and income stream of the borrower’s business and/or the real estate securing the loan as collateral, which can be significantly affected by economic conditions. In addition, these loans generally carry larger balances to single borrowers or related groups of borrowers than one-to four-family owner occupied residential mortgage loans. Accordingly, an adverse development with respect to one loan or one credit relationship can expose us to greater risk of loss compared to an adverse development with respect to a single one-to four-family residential mortgage loan.
The nature of our commercial loan portfolio may expose us to increased lending risks.
Many of our commercial real estate loans are unseasoned, meaning that they were originated recently. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our expectations, which could negatively affect our performance. In addition, a portion of our commercial loan portfolio is comprised of participation interests in loans originated by other local banks. While we have underwritten each of these loans to our credit standards, our decision making authority may be limited by the terms of the participation agreement with the originating bank.
Strong competition within our market area may limit our growth and profitability.
Competition in the banking and financial services industry is intense. Among our competitors are much larger and more diversified institutions, which have greater resources, name recognition and market presence and offer more products and services than we do. Financial institution competitors in our market area include primarily commercial banks, including banks with a national and regional presence. There are also a number of smaller community-based banks that pursue similar operating strategies as us. Competitive pressures will also likely continue to build as the financial services industry continues to consolidate and as additional non-bank investment options for consumers become available.
Larger competitors may be able to price loans and deposits more aggressively than we do, which could affect our ability to grow and remain profitable on a long-term basis. Our profitability depends upon our ability to successfully compete in our market area. If we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected.
Our lending limit may limit our growth.
We are limited in the amount we can loan to a single borrower by the amount of our capital. Specifically, under current law, Carroll Community Bank may lend up to 15% of its unimpaired capital and surplus to any one borrower. Based on our current capital level, after the closing of our private placement offering on January 23, 2015, our limit on the amount we can lend to one borrower is approximately $2.4 million. This limit on the dollar amount we can lend is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our lending limit from conducting business with us.
We are dependent upon the services of our President and Chief Executive Officer, and the loss of our President and Chief Executive Officer could adversely affect our operations.
We rely heavily on our President and Chief Executive Officer, Russell J. Grimes. The loss of Mr. Grimes could have a material adverse impact on our operations because he provides valuable services to us and would be difficult to replace. As a small company, we have fewer management-level personnel that have the experience and expertise to readily replace Mr. Grimes. A change in our President and Chief Executive Officer or his responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition, and results of operations. Although we have entered into an employment agreement with Mr. Grimes, the existence of such agreement does not assure that we will retain his services.
Also, our growth and success is, and our future growth and success will be, in large part, due to the relationships maintained by our banking executives with our customers. The loss of services of one or more of these executives or other key employees could similarly have a material adverse effect on our operations and our business could suffer.
We do maintain life insurance coverage on our senior executive officers through bank-owned life insurance.
Historically low interest rates may adversely affect our net interest income and profitability.
The Federal Reserve Board has recently maintained interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As of October 31, 2014, the Federal Reserve Board ended the purchase of mortgage-backed securities. We do not know when the Federal Reserve will start to raise interest rates. As a general matter, our interest-bearing liabilities reprice or mature more quickly than its interest-earning assets. This has resulted in increases in net interest income in the short term. Our ability to lower our interest expense is limited at these interest rate levels while the average yield on our interest-earning assets may continue to decrease. The Federal Reserve Board has indicated that it intends to maintain low interest rates for an extended period, although it is free to change this policy as conditions indicate. Accordingly, our net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) may decrease, which could have an adverse affect on our profitability.
New regulations restrict our ability to originate residential real estate loans.
A CFPB rule effective January 10, 2014, is designed to clarify for lenders how they can avoid legal liability under the Dodd-Frank Act, which would otherwise hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet the “qualified mortgage” definition set forth in the rule will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features.
The rule also establishes general underwriting criteria for qualified mortgages, including that the consumer must have a total (or “back end”) debt-to-income ratio that is less than or equal to 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower on the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages limits our ability to make residential mortgage loans that include a balloon payment, which could limit our growth or profitability.
In addition, the Dodd-Frank Act requires the regulatory agencies to issue regulations that require securitizers of loans to retain “not less than 5% of the credit risk for any asset that is not a qualified residential mortgage.” The regulatory agencies issued a final rule to implement this requirement on October 21, 2014. The final rule aligns the definition of “qualified residential mortgage” with the definition of “qualified mortgage” issued by the CFPB for purposes of its regulations. The final rule is effective February 23, 2015. Compliance with the final rule is required beginning December 24, 2015 with respect to asset-backed securities collateralized by residential mortgages and beginning December 24, 2016 with respect to all other classes of asset-backed securities. The final rule could have a significant effect on the secondary market for loans and the types of loans we originate, and restrict our ability to make loans.
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses as well as damage our reputation.
The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us, including our Internet banking activities, against damage
from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, damage our reputation and inhibit current and potential customers from our Internet banking services. We rely on standard internet and other security systems to provide the security and authentication necessary to effect secure transmission of data. Each year, we add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches including firewalls and penetration testing. These precautions may not, however, protect our systems from compromises or breaches of our security measures. We continue to monitor developments in this area and consider whether additional protective measures are necessary, and have obtained cybersecurity insurance.
In addition, we outsource a majority of the data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and business, subject us to additional regulatory scrutiny, or could expose us to litigation and possible financial liability. Any of these events could have a material adverse effect on our financial condition and results of operations.
Our need to comply with extensive and complex governmental regulation could have an adverse effect on our business and our growth strategy, and we may be adversely affected by changes in laws and regulations.
Carroll Community Bank is subject to extensive regulation by the Maryland Office of the Commissioner of Financial Regulation and regulation, supervision and examination by the FDIC and Carroll Bancorp, Inc. is subject to regulation and supervision by the Federal Reserve Board and regulation by the Maryland Office of the Commissioner of Financial Regulation. Such regulation and supervision governs the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and the depositors of Carroll Community Bank rather than for holders of Carroll Bancorp, Inc.’s common stock. Regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy, ability to attract and retain personnel and many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The burden imposed by these federal and state regulations may place banks in general, and Carroll Community Bank specifically, at a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably.
Further, regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, classification of our assets and determination of the level of our allowance for loan losses. If regulators require Carroll Community Bank to charge-off loans or increase its allowance for loan losses, our earnings would suffer. Any change in such regulation and oversight, whether in the form of regulatory policy, regulation, legislation or supervisory action, may have a material impact on our operations. For a further discussion, see “Supervision and Regulation.”
In addition, because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact our operations. Changes in regulation and oversight, including in the form of changes to statutes, regulations or regulatory policies or changes in interpretation or implementation of statutes, regulations or policies, could affect the service and products we offer, increase our operating expenses, increase compliance challenges and otherwise adversely impact our financial performance and condition. In addition, the burden imposed by these federal and state regulations may place banks in general, and Carroll Community Bank specifically, at a competitive disadvantage compared to less regulated competitors.
Regulations pursuant to the Dodd-Frank Act may adversely impact our results of operations, liquidity or financial condition.
The Dodd-Frank Act represents a comprehensive overhaul of the U.S. financial services industry. The Dodd-Frank Act requires the CFPB and other federal agencies to implement many new and significant rules and regulations to implement its various provisions. There are a number of regulations under the Dodd-Frank act that have not yet been proposed or adopted, and we will not know the full impact of the Dodd-Frank Act on our business until regulations implementing the statute are adopted and implemented, which could be years. As a result, we cannot predict the full extent to which the Dodd-Frank Act will impact our business, operations or financial condition. However, compliance with these new laws and regulations may require us to make changes to our business and operations and will likely result in additional costs and a diversion of management’s time from other business activities, any of which may adversely impact our results of operations, liquidity or financial condition.
Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses.
Our risk management framework is designed to minimize risk and loss. We seek to identify, measure, monitor, report and control exposure to risk, including, but not limited to, strategic, market, liquidity, compliance and operational risks. While we use a broad and diversified set of risk monitoring and mitigation techniques, these techniques are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Recent economic conditions and heightened legislative and regulatory scrutiny of the financial services industry, among other developments, have increased our level of risk. Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks.
Our operations rely on certain external vendors.
Our business is dependent on the use of outside service providers that support our day-to-day operations including data processing and electronic communications. Our operations are exposed to the risk that a service provider may not perform in accordance with established performance standards required in our agreements for any number of reasons including equipment or network failure, a change in their senior management, their financial condition, their product line or mix and how they support existing customers, or a simple change in their strategic focus. While we have comprehensive policies and procedures in place to mitigate risk at all phases of service provider management from selection, to performance monitoring and renewals, the failure of a service provider to perform in accordance with contractual agreements could be disruptive to our business, which could have a material adverse effect on our financial conditions and results of our operations.
Our share-based benefit plans will increase expenses and reduce income and may dilute stockholders’ ownership interest.
We maintain the Carroll Bancorp, Inc. 2011 Stock Option Plan and 2011 Recognition and Retention Plan and Trust Agreement. During 2013 we repurchased 10,783 shares of stock to fund the shares available for the 2011 Recognition and Retention plan. The total cost to purchase the shares was $134,000, which is being amortized over a five-year vesting period. All of the 10,783 shares of common stock available under the 2011 Recognition and Retention Plan were awarded as restricted shares to senior management and directors in October 2013 and March 2014. Pursuant to our rights offering in March 2014, the 2011 Recognition and Retention Plan purchased 3,749 units at a cost of $60,000. A unit is comprised of a share of common stock and a warrant to buy one-half of one share of common stock at the stock price of $16.00 per whole share. With the warrants, the 2011 Recognition and Retention Plan has the right to purchase 1,874 additional shares at a cost of approximately $30,000.
Any shares issued under the 2011 Stock Option Plan will be newly issued shares and therefore any such issuances will dilute stockholders’ interests in Carroll Bancorp, Inc. As of December 31, 2014, no options for any of the 35,945 shares of our common stock available for issuance under this plan had been granted. Furthermore, once options are issued under this plan, we will incur expenses as the options are granted to plan participants.
The Bank’s Employee Stock Ownership Plan, using proceeds from a loan made by Carroll Bancorp, Inc., purchased 7,498 units in the rights offering and as a result has an additional 7,498 shares of common stock and the option to purchase an additional 3,749 shares of common stock pursuant to warrants, which are or would be available for issuance. We have filed a Prohibited Transaction Exemption request with the U.S. Department of Labor in connection with the making of the loan, and the contribution, holding and exercise of the rights issued, to our employee stock ownership plan.
In a letter dated January 29, 2015, the Department of Labor stated that it had tentatively decided not to grant the requested exemption. As part of the exemption process, the Department has asked our counsel to submit additional information. Our counsel has submitted the requested information in accordance with the deadline established by the Department, but we have not yet received a response from the Department regarding the additional information. A failure to receive the exemption could result in excise taxes, however, we expect to be indemnified for any such excise taxes and as a result, we do not expect the outcome of this matter to have an impact on our financial condition, results of operations or liquidity.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results, may be materially adversely affected.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing consumers to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in
brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
If our stock of the Federal Home Loan Bank of Atlanta is classified as other-than-temporarily impaired or as permanently impaired, our earnings and stockholders’ equity could decrease.
We own stock of the FHLBA. We hold this stock to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBA’s advance program. The aggregate cost and fair value of our FHLBA stock as of December 31, 2014 was $457,000 based on its par value. There is no market for our FHLBA stock.
Although the FHLBA is not reporting current operating difficulties, it is possible that the capital of the Federal Home Loan Bank system, including the FHLBA, could be substantially diminished. This could occur with respect to an individual Federal Home Loan Bank due to the requirement that each Federal Home Loan Bank is jointly and severally liable along with the other Federal Home Loan Banks for the consolidated obligations issued through the Office of Finance, a joint office of the Federal Home Loan Banks, or due to the merger of a Federal Home Loan Bank experiencing operating difficulties into a stronger Federal Home Loan Bank. Consequently, there continues to be a risk that our investment in FHLBA common stock could be deemed other-than-temporarily impaired at some time in the future, and if this occurs, it would cause our earnings and stockholders’ equity to decrease by the impairment charge.
We continue to originate and retain in our portfolio some residential mortgage loans. A continued downturn in the local real estate market and economy could adversely affect earnings.
We have continued to originate and retain in our portfolio certain residential mortgage loans. Although the local real estate market and economy have performed better than many other markets, a downturn could cause higher unemployment, more delinquencies, and could adversely affect the value of properties securing these loans. In addition, the real estate market may take longer to recover or not recover to previous levels. These risks increase the probability of an adverse impact on our financial results as fewer borrowers would be eligible to borrow and property values could be below necessary levels required for adequate coverage on the requested loan.
We may not be able to continue to generate profits.
Although we have generated net income for the twelve months ended December 31, 2014 and 2013, we had a net loss for 2012 and generated a loss from operations in 2011. Our recent profitability may not be sustained. Our ability to generate a profit in the future requires successful growth in revenues from loans and management of expenses, among other factors. We expect to hire additional talented staff to support our continued growth in loans and deposits. While we expect the productivity of the staffing additions to exceed their incremental expenses over time, our operating results will be adversely impacted if it does not happen promptly or at all. In addition, our non-interest expenses will continue to include the expenses of operating as a public company and will continue to increase due to the stock-based incentive plans that we implemented in 2013. Many factors could adversely affect our short and long term operating performance, including the failure to fully implement our business plan, unfavorable economic conditions, increased competition, loss of key personnel and government regulation.
Changes in accounting standards could impact reported earnings.
From time to time there are changes in the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some instances, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.
Risks Related to an Investment in our Common Stock
We do not intend to pay cash dividends in the near future, and, consequently, stockholders’ ability to achieve a return on their investment in our common stock will depend on appreciation in the price of our common stock.
We expect that we will retain all earnings, if any, for operating capital, and we do not expect to pay any dividends in the near future. In addition, the payment of cash dividends may be made only if we are in compliance with certain applicable regulatory requirements governing the payment of cash dividends. Our ability to declare and pay cash dividends is dependent upon, among other things, restrictions imposed by the reserve and capital requirements of Maryland and federal law and regulations, our income and financial condition, tax considerations and general business conditions. Even if we have earnings in an amount sufficient to pay cash dividends, the board of directors may decide to retain earnings for the purpose of financing growth. We cannot assure you that cash dividends on our common stock will ever be paid. See “Market for Common Stock, Dividend Policy and Related Stockholder Matters.”
We can sell additional shares of common stock without consulting stockholders and without offering shares to existing stockholders, which would result in dilution of stockholders’ interests in Carroll Bancorp and could depress our stock price.
Our articles of incorporation currently authorize an aggregate of 9,000,000 shares of common stock, 799,257 of which are outstanding as of the date of this report, 35,945 of which are reserved for issuance pursuant to our 2011 Stock Option Plan and 1,000,000 shares of preferred stock. Our board of directors has the authority to amend our articles of incorporation, without stockholder approval, to increase or decrease the aggregate number of shares of stock or the number of shares of any class of stock that we have the authority to issue. The board of directors is further authorized to issue additional shares of common stock and preferred stock, at such times and for such consideration as it may determine, without stockholder action. The ability of the board of directors to increase our authorized shares of capital stock, and the existence of authorized but unissued shares of common stock and preferred stock, could have the effect of rendering more difficult or discouraging hostile takeover attempts, or of facilitating a negotiated acquisition and could affect the market for and price of our common stock. Because our common stockholders do not have preemptive rights to purchase shares of our capital stock (that is, the right to purchase a stockholder’s pro rata share of any securities issued by Carroll Bancorp), any future offering of capital stock could have a dilutive effect on holders of our common stock. See “Description of Securities.”
There is a limited trading market in our common stock, which will hinder our stockholders’ ability to sell our common stock and may adversely affect our stock price.
Our common stock is sporadically traded. As a result, stockholders may not be able to sell their shares when they desire or sell them at a price equal to or above the price they paid for such shares even if a liquid trading market does develop. This limited trading market for our common stock also may reduce the market value of our common stock. In addition, our public float (which is the total number of our outstanding shares less the shares held by our employee stock ownership plan and our directors and senior officers) which is used as a measurement of shares available for trading, is quite limited. This could make it more difficult to sell a large number of shares at one time and could mean a sale of a large number of shares at one time could depress the market price.
Further, while our stock is quoted on the OTCQB marketplace of the OTC Markets Group, the OTCQB is a market with less liquidity and fewer buyers and sellers than the Over-the-Counter (OTC) Bulletin Board or securities exchanges such as The NASDAQ Stock Market or the New York Stock Exchange. The limited trading market could also result in a wider spread between the “bid” and “ask” prices for the stock. When there is a wide spread between the bid and asked price, the price at which you may be able to sell our common stock may be significantly lower than the price at which you could buy it at that time.
Our stock value may be negatively affected by federal regulations and provisions in our articles and bylaws that restrict takeovers.
Our articles of incorporation and bylaws, and Maryland law, contain provisions that may make it more difficult and expensive to pursue a takeover attempt that management opposes, even if the takeover is favored by a majority of our stockholders. These restrictions may have a negative impact on the market price of our common stock.
Our share price may fluctuate, which may make it difficult for you to sell your common stock.
The market price of our common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding our operations or business prospects. As a result, the market price of our common stock may be below the price you want to sell it at if and when you decide to sell your shares of common stock. Factors that may affect market sentiment include:
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operating results that vary from the expectations of our management or of securities analysts and investors;
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developments in our business or in the financial service sector generally;
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regulatory or legislative changes affecting our industry generally or our business and operations;
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operating and securities price performance of companies that investors consider to be comparable to us;
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changes in estimates or recommendations by securities analysts;
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announcements of strategic developments, acquisitions, dispositions, financings and other material events by us or our competitors; and
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changes in financial markets and national and local economies and general market conditions, such as interest rates and stock, commodity, credit or asset valuations or volatility.
The business environment for financial services firms continues to be challenging. During the period from 2008 through to the present many publicly traded financial services companies have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance or prospects of such companies. We may experience market fluctuations that are not directly related to our operating performance but are influenced by the market’s perception of the state of the financial services industry in general and, in particular, the market’s assessment of general credit quality conditions, including default and foreclosure rates in the industry.
While the U.S. and other governments continue efforts to restore confidence in financial markets and promote economic growth, further market and economic turmoil could still occur in the near- or long-term, negatively affecting our business, financial condition and results of operations, as well as the price, trading volume and volatility of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable
Item 2.
Item 2. Properties
We operate from our main office in Sykesville, Maryland and our full service branch office in Westminster, Maryland, both of which are in Carroll County.
Sykesville - We own the property and use the building for our headquarters and Eldersburg branch. The property is located at 1321 Liberty Road in Sykesville, Maryland. The property consists of a 3,600 square foot one-story building plus a basement and includes a drive-through facility and ATM.
Westminster - We opened our Westminster branch in 2005 and it moved to its current location in October 2010. The branch consists of approximately 1,537 square feet in the Westminster Shopping Center located at the corner of Route 140 and Englar Road in Westminster, Maryland. The branch includes an attached drive through facility and a standalone ATM. The shopping center is located at the corner of a four-way intersection for maximum exposure. The lease has a five-year term terminating on August 31, 2015, with one five-year renewal option.
Item 3.
Item 3. Legal Proceedings
We are not involved in any legal proceedings the outcome of which we believe would be material to our financial condition or results of operations.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Carroll Bancorp, Inc.’s common stock is quoted on the OTCQB marketplace of the OTC Markets Group quotation system under the symbol “CROL”. As of March 6, 2015, there were 799,257 shares of common stock outstanding. At that date, the Company had approximately 180 holders of record of its common stock. The number of stockholders of record does not reflect the number of persons whose shares are held in nominee or “street” name accounts through brokers.
The high and low sales prices of Carroll Bancorp, Inc.’s common stock during the last two years as shown below are based on information posted on the OTC Markets Group quotation system by broker-dealers. These prices may include dealer mark-up, mark-down and/or commission and may not necessarily represent actual transactions.
Our Board of Directors has the authority to declare dividends on our shares of common stock, subject to statutory and regulatory requirements. We currently do not expect to pay dividends in the foreseeable future. In determining whether to pay a cash dividend and the amount of such cash dividend in future periods, we expect that our Board of Directors would take into account a number of factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. We cannot assure you that any dividends will be paid or that, if paid, will not be reduced or eliminated thereafter. We may pay special cash dividends, stock dividends or returns of capital, to the extent permitted by applicable law and regulations, in addition to, or in lieu of, regular cash dividends. We will file a consolidated tax return with Carroll Community Bank. Accordingly, we anticipate that any cash distributions we make to our stockholders would be treated as cash dividends and not as a non-taxable return of capital for federal and state tax purposes.
Carroll Bancorp, Inc. is organized under the Maryland General Corporation Law, which prohibits the payment of a dividend if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business or the corporation’s total assets would be less than the sum of its total liabilities plus, unless the charter permits otherwise, the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution. In addition, because Carroll Bancorp, Inc. is a bank holding company the Federal Reserve Board may impose requirements on its payment of dividends. Among other things, the Federal Reserve Board has issued guidance that states, in general, that an entity experiencing financial difficulties should not pay or continue to pay dividends unless (i) the entity’s net income over the prior year is sufficient to fund all dividends and (ii) the earnings retained by the entity is consistent with the entity’s capital needs, asset quality and overall financial condition. There are additional restrictions under Maryland Financial Institutions Law with respect to Carroll Community Bank’s payment of dividends, as discussed below, which is Carroll Bancorp, Inc.’s only source of funds from which dividends to stockholders could be paid.
Under Maryland law, Carroll Community Bank may declare a cash dividend, after providing for due or accrued expenses, losses, interest and taxes, from its undivided profits or, with the prior approval of the Maryland Office of the Commissioner of Financial Regulation, from its surplus in excess of 100% of its capital stock. Also, if Carroll Community Bank’s surplus is less than 100% of its capital stock, then, until the surplus is 100 percent of the capital stock, Carroll Community Bank must transfer to its surplus annually at least ten percent of its net earnings and may not declare or pay any cash dividends that exceed 90 percent of its net earnings. In addition to these specific restrictions, the bank regulatory agencies have the ability to prohibit or limit proposed dividends if such
regulatory agencies determine the payment of such dividends would result Carroll Community Bank being in an unsafe and unsound condition. Any payment of dividends by Carroll Community Bank to us that would be deemed to be drawn out of Carroll Community Bank’s bad debt reserves, if any, would require a payment of taxes at the then-current tax rate by Carroll Community Bank on the amount of earnings deemed to be removed from the reserves for such distribution. Carroll Community Bank does not intend to make any distribution to us that would create such a federal tax liability.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial and other data has been derived, in part, from the consolidated financial statements and notes appearing elsewhere in this annual report.
(1) The interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities for the year.
(2) The net interest margin represents net interest income as a percent of average interest-earning assets for the year.
(3) The efficiency ratio represents non-interest expense divided by the sum of net interest income and non-interest income.
(4) Nonperforming consist of nonperforming loans and other real estate owned (“OREO”). Nonperforming loans consist of nonaccrual loans and accruing loans 90 days or more overdue, while OREO consists of real estate acquired through, or in lieu of, foreclosure
(5) Calculated in accordance with FDIC regulations.
(6) Book value per share is calculated using the number of common stock shares outstanding of 488,409 and 359,456 as of December 31, 2014 and 2013, respectively.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section is intended to help potential investors understand our financial performance through a discussion of the factors affecting our financial condition at December 31, 2014 and 2013. This section should be read in conjunction with the financial statements and notes to the financial statements that appear elsewhere in this annual report.
Overview
Historically, we operated as a traditional community savings association. As such, our business consisted primarily of originating one-to four-family real estate loans secured by property in our market area and investing in mortgage-backed and U.S. Agency securities. Typically, one-to four-family loans involve a lower degree of risk and carry a lower yield than commercial real estate and business loans. Our loans are primarily funded by savings accounts and certificates of deposit. This resulted in our being particularly vulnerable to increases in interest rates, as our interest-bearing liabilities mature or reprice more quickly than our interest-earning assets. Although we plan to continue to originate one- to four-family residential mortgage loans going forward, we have been and intend to continue to increase our focus on the origination of commercial real estate loans, which generally provide higher returns and have shorter durations than one- to four-family residential mortgage loans.
The results of our operations depend mainly on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios and the interest expense we pay on deposits and borrowings. Results of operations are also affected by provisions for loan losses, non-interest income and non-interest expense. Our non-interest expense consists primarily of compensation and employee benefits, as well as office occupancy, deposit insurance and general administrative and data processing expenses.
Our operations are significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially affect our financial condition and results of operations. See “Risk Factors” beginning on page 16.
The economic crisis that began in 2008 negatively affected the real estate market in our market area. The number of housing units sold has declined from the pre-2008 levels. These declines negatively affected our ability to make loans in the residential real estate markets, both with respect to the number of loans and the amount of such loans. Similar declines in the commercial real estate market also affected our ability to make loans in the commercial real estate context, although to a lesser extent. Beginning in 2011 and continuing through 2014, we have seen signs of an improving residential and commercial real estate market and we anticipate that as market conditions slowly return to a more normal level, there will be increased lending opportunities.
Summary of Recent Performance
The following highlights certain financial data that occurred during 2014:
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Total loans grew during the twelve months ended December 31, 2014 by $6.5 million, or 7.8%, to $90.5 million.
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Total non-interest and interest bearing checking accounts (less funds held in escrow for the private placement offering that closed on January 23, 2015) grew during the twelve months ended December 31, 2014 by $1.9 million, or 18.3%, to $12.0 million.
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Our net interest margin rose to 3.67% for the twelve months ended December 31, 2014 compared to 3.60% for the twelve months ended December 31, 2013.
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We completed a rights offering in March 2014 pursuant to which we sold units consisting of one share of our common stock and a warrant to purchase one-half of a share of our common stock. We raised $2.0 million in gross proceeds before expenses and stock purchased by the Company’s shared-based compensation plans.
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We initiated a private placement offering for our common stock in November 2014 that closed on January 23, 2015. We received gross proceeds exceeding $5.1 million as a result of the offering. The offering was open to certain institutional and other accredited investors.
Our Business Strategy
Highlights of our business strategy are as follows:
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Improve Our Earnings and Diversify Our Loan Portfolio. We continue to seek ways to increase our net interest income and net interest margin while controlling our non-interest expenses.
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Emphasizing Origination of Commercial Real Estate Loans. Commercial real estate loans are attractive because they generally provide us with higher yields and less interest rate risk because they typically have adjustable rates of interest and/or shorter terms to maturity in comparison to traditional single-family residential mortgage loans. We intend to continue to emphasize growth in our commercial real estate lending in a manner consistent with our loan underwriting policies and procedures while recognizing the increased risk inherent in commercial real estate loans.
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Expanding Commercial Banking Operations. We currently have three commercial loan officers and one commercial loan administrator. We intend to hire additional commercial lending staff positions in the next two to three years to facilitate our loan origination efforts and to further penetrate the markets we serve. As a community-based bank, we believe that we offer high quality customer service by combining locally-based management for fast decisions on loan applications and approvals with customized deposit services that are attractive to small and medium sized businesses.
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Controlling Non-interest Expense. We monitor our expense ratios closely and strive to improve our efficiency ratio through expense control. Our largest non-interest expense is compensation. We work to limit growth of compensation expense by controlling increases in the number of employees to those needed to support our growth and by maximizing the use of technology to increase efficiency.
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Offering Additional Products and Services. We intend to utilize technology to increase productivity and provide additional products and services. In this regard, during 2012 we began offering merchant services, online bill payment, ACH originations, remote deposit capture and relationship pricing. In 2013 we began offering mobile check capture and in 2014 we implemented online account opening. We continue to enhance the Internet banking services platform we currently offer to our business and retail customers. We expect that these new products and services will help to maintain and increase our deposit base and will attract business and retail customers. We analyze the need of products and services and allocate our resources to those areas we believe offer the greatest future potential.
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Continuing Residential Mortgage Lending. As a community bank we continue our mission of supporting the communities we serve by offering a strong line of traditional single-family residential mortgage products. We offer first and second mortgages of various terms using fixed or adjustable rate products. In order to manage our interest rate risk, it is our policy to sell all loans with terms of more than 15 years, which improves our interest rate risk position and non-interest income. In addition, we offer home equity loans and lines of credit to support short term financing needs.
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Improve our Funding Mix and Increase Core Deposits. We are continuing our efforts to increase our core deposits in order to help reduce and control our cost of funds. We value core deposits because they represent longer-term customer relationships and lower costs of funds. As part of our strategy to expand our commercial real estate portfolio, we expect to attract lower cost core deposits as part of these borrower relationships. We offer competitive rates on a wide variety of deposit products to meet the individual needs of our customers. We also promote longer term deposits where possible, consistent with our asset liability management goals.
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Maintain capital at “well capitalized” levels. Our policy has always been and will continue to be to protect the safety and soundness of Carroll Community Bank through conservative credit and operational risk management, balance sheet strength, and safe and sound operations. As a result, our capital ratios are in excess of the “well capitalized” standards set by the FDIC. We have maintained and seek to maintain “well capitalized” levels of regulatory capital through balance sheet management and additions to capital from profits.
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Maintain a Quality Loan Portfolio While Exercising Prudent Underwriting Standards. While our asset quality ratios continue to outperform our state and national peer groups, we continue to emphasize maintaining strong asset quality by following conservative underwriting criteria, diligently applying our collection efforts, and originating loans
secured primarily by real estate. We will continue to focus on asset quality as we seek to expand our commercial lending activities. Finally, we annually engage an outside loan review firm to perform a thorough review of our loan portfolio. This review involves analyzing all large borrowing relationships, delinquency trends and loan collateral valuation in order to identify impaired loans.
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Expand Our Market Presence into the Washington Metropolitan Area. The strategic direction of the Bank is to shift towards entering growth markets. These markets are to the south in the Washington metropolitan area which includes Howard, Frederick and Montgomery counties in Maryland. We recently hired two new commercial lenders with extensive experience in Montgomery and adjacent counties to support our growth strategy in the Washington Metropolitan area.
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Expand Our Market Presence and Geographic Reach Through Technology and De Novo Branching or Branch Acquisitions. We continue to seek ways to increase our market penetration to grow our business and expand our geographic reach. Through the use of technology we offer Internet banking, remote deposit capture, online bill payment, mobile banking with mobile check capture and on-line account opening, all of which helps us to expand our potential market reach beyond the immediate geographic area of our physical locations. While our business plan indicates our intention to open a new de novo branch office in the next two to three years, any such openings will be subject to, among other factors, market conditions, the economic environment, regulatory approval and the identification of sites that are acceptable to us being available within our targeted expense range. However, we currently have no specific agreements or understandings with respect to any acquisitions or de novo openings.
Critical Accounting Policies and Estimates
Note 1 to the Consolidated Financial Statements contains a summary of our significant accounting policies, including a discussion of recently issued accounting pronouncements. These policies, as well as estimates made by management, are integral to the presentation of our operations and financial condition. These accounting policies require that management make highly difficult, complex, or subjective judgments and estimates at times regarding matters that are inherently uncertain or susceptible to change. Management has discussed these significant accounting policies, the related estimates, and its judgments with the Audit Committee of the Board of Directors. Additional information regarding these policies can be found in Note 1 to the Consolidated Financial Statements.
Our accounting and financial reporting policies conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the financial statements require management to exercise significant judgment or discretion or make significant assumptions based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. In reviewing and understanding financial information for us, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements. We consider the allowance for loan losses to be our most significant accounting policy, which is further described in Note 1 to the Consolidated Financial Statements.
The allowance for loan losses is established through a provision for loan losses charged against income. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent losses in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on impacted loans, value of collateral, and estimated losses on our loan portfolios as well as consideration of general loss experience. Based on our estimate of the level of allowance for loan losses required, we record a provision for loan losses to maintain the allowance for loan losses at an appropriate level.
We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with respect to the allowance for loan losses. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review our allowance for loan losses. Such agencies may require that we recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for loan losses may be required that would adversely impact earnings in future periods.
Balance Sheet Analysis and Comparison of Financial Condition at December 31, 2014 to December 31,
General. Our total assets increased by $8.2 million, or 7.6%, to $115.9 million at December 31, 2014 from $107.7 million at December 31, 2013. The increase was due primarily to growth in net loans of $6.5 million, or 7.8%. On the funding side of the balance sheet, deposits increased by $5.1 million, or 5.6%, and FHLBA borrowings increased by $635,000, or 8.6%, at December 31, 2014 compared to December 31, 2013.
Loans. At December 31, 2014, net loans were $90.0 million, or 77.6% of total assets, an increase of $6.5 million or 7.8% from $83.5 million at December 31, 2013. This increase was primarily due to the growth in commercial real estate loans of $9.0 million, consistent with our business strategy.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio at December 31, 2014 and 2013:
We had no loans held for sale at December 31, 2014 and 2013.
Loan Portfolio Maturities. The following table summarizes the scheduled repayments of the loan portfolio at December 31, 2014. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.
Fixed and Adjustable Rate Loans. The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans in our portfolio at December 31, 2014 that are contractually due after December 31, 2015:
Investment Securities Portfolio. The following table sets forth the composition of our investment securities portfolio at December 31, 2014 and 2013:
Total securities decreased by $746,000, or 6.3%, to $11.1 million, or 9.6%, of total assets at December 31, 2014 from $11.9 million, or 11.0% of total assets, at December 31, 2013. The investment portfolio consisted of both securities available for sale and held to maturity at December 31, 2014 and only available for sale at December 31, 2013. The net unrealized gains or losses on individual securities as of December 31, 2014 and 2013 were the result of changes to current market interest rates as compared to the original purchase yield of the security. We had four and 14 investment securities with unrealized losses at December 31, 2014 and 2013, respectively. All of our mortgage-backed securities were issued by U.S. government agencies or government-sponsored enterprises.
During the twelve months ended December 31, 2014 and 2013, gains on sales of securities available for sale were $11,000 and $23,000, respectively.
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2014 are summarized in the following table. Maturities are based on the final contractual payment dates and do not reflect the impact of prepayments or early redemptions that may occur.
Bank-Owned Life Insurance. We invested in bank-owned life insurance in 2009 and again in 2012 to help us offset the costs of our benefit plan obligations. Bank-owned life insurance also generally provides us non-interest income that is non-taxable. Federal regulations generally limit our investment in bank-owned life insurance to 25% of our Tier 1 capital. This investment is accounted for using the cash surrender value method and is recorded at the amount that can be realized under the insurance policies at the balance sheet date. At December 31, 2014, the aggregate cash surrender value of these policies was $2.1 million.
Premises and Equipment. Premises and equipment decreased during 2014 due to depreciation expense accumulated for the year partially offset by various purchases of new equipment.
Deposits. We accept deposits primarily from the areas in which our offices are located. We have consistently focused on building broader customer relationships and targeting small business customers to increase our core deposits. We also rely on our customer service to attract and retain deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of savings accounts, certificates of deposit, money market accounts, commercial and retail checking accounts and individual retirement accounts. Our Board of Directors has approved the use of brokered deposits as a funding source for the Bank.
Interest rates, maturity terms, service fees and withdrawal penalties are reviewed and updated on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements and our deposit growth goals.
Our deposits increased by $5.1 million, or 5.6%, to $96.9 million at December 31, 2014 from $91.8 million at December 31, 2013. The growth resulted from a $4.7 million increase in checking and demand deposit account balances (of which $2.9 million represented funds held in escrow for the private placement capital offering) and a $2.4 million increase in brokered certificates of deposit. These items were partially offset by a decrease of $1.9 million in non-certificate IRA savings and premium savings accounts. Growth in the number and balances of interest and noninterest bearing checking accounts continues to be one of our key business strategies.
At December 31, 2014, we had a total of $40.2 million in certificates of deposit, of which $18.3 million had remaining maturities of one year or less. Of the $40.2 million, $4.9 million were brokered certificates of deposit. Based on historical experience and current market interest rates, we believe we will retain upon maturity a large portion of our certificates of deposit with maturities of one year or less as of December 31, 2014.
The following table sets forth the distribution of total deposit accounts, by product type, at December 31, 2014 and 2013:
The following table sets forth the maturities of certificates of deposit in amounts greater than or equal to $100,000 as of December 31, 2014:
The following table sets forth, by interest rate ranges, the maturity periods of our certificates of deposit at December 31, 2014:
Borrowings. Our borrowing portfolio consists of advances from the FHLBA. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances at the dates indicated.
(1) callable quarterly by the FHLB.
Stockholders’ Equity. Stockholders’ equity increased by $2.3 million to $10.8 million at December 31, 2014 compared to $8.4 million at December 31, 2013. The increase was mainly attributable to the rights offering that closed in March 2014 that raised net proceeds of $1.7 million and the accumulation of net income during 2014.
Average Balances and Yields
The following tables set forth average balance sheets, average yields and rates, and certain other information for the years indicated. No tax-equivalent yield adjustments were made, as we held insignificant balances of tax-advantaged interest-earning assets during the years indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of net deferred costs, discounts and premiums that are amortized or accreted to interest income.
(1) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(2) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(3) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table presents the impact of the change in volumes and rates on our net interest income for the years indicated. The volume column shows the impact attributable to changes in volume (change in volume multiplied by prior rate), the rate column shows the impact attributable to changes in rate (change in rate multiplied by prior volume) and the rate/volume column shows the impact attributable to changes in rate and volume (change in rate multiplied by change in volume).
(1) The volume, rate and rate/volume variances presented for each component will not add to the variances presented for total interest income and total interest expense due to shifts from period-to-period in the relative mix of interest-earning assets and interest-bearing liabilities.
Comparison of Results of Operations for the Years Ended December 31, 2014 and 2013
General. For the year ended December 31, 2014, we realized net income of $390,000, or $0.90, per diluted common share, compared to net income of $222,000, or $0.66, per diluted common share for the year ended December 31, 2013 for an increase of $168,000. This increase was attributable to an increase in net interest income and a decrease in the provision for loan losses during 2014, partially offset by higher non-interest expenses.
Net Interest Income. Net interest income increased by $244,000, or 6.8%, to $3.8 million for the year ended December 31, 2014 from $3.6 million for the year ended December 31, 2013. The increase in net interest income was a result of an increase in interest income due mainly to the growth in the volume of loans, the rise in investment securities yields and a decrease in interest expense due to the continued low interest rate environment. These items were partially offset by the decline in the loan yield due to the competitive market for loan growth putting downward pressure on loan rates. Our net interest rate spread and net interest rate margin were 3.60% and 3.67%, respectively, for the year ended December 31, 2014 compared to 3.54% and 3.60%, respectively, for the year ended December 31, 2013.
Interest Income. Total interest income increased by $79,000, or 1.8%, to $4.5 million for the year ended December 31, 2014 compared to $4.4 million for the year ended December 31, 2013 due to increases in average balances partially offset by the decline in the overall yield of interest-earning assets. Average interest-earning assets increased by $4.9 million, or 4.9%, to $104.4 million for the year ended December 31, 2014 from $99.5 million for the year ended December 31, 2013. The average yield on interest-earning assets decreased to 4.30% for the year ended December 31, 2014 from 4.43% for 2013 mainly due to the yield decline on the loan portfolio.
Please see “-Average Balances and Yields” and “-Rate/Volume Analysis” for more detailed information regarding the impact of changes in average balances and yield on net interest income and margin.
Interest income on loans increased slightly remaining at $4.2 million for the year ended December 31, 2014 and 2013. This increase is a result of higher average loan balances during the year ended December 31, 2014, mostly offset by a 25 basis point decrease in the average yield on loans. Average loans increased $4.8 million, or 5.8%, to $87.3 million during 2014 from $82.6 million during 2013. This increase was primarily attributable to our increasing emphasis on commercial real estate loan originations. The average yield on loans declined to 4.83% for the year ended December 31, 2014 from 5.08% for the year ended December 31, 2013. The decrease in the average yield on loans was primarily attributable to the origination of new loans in a lower interest rate environment, the repayment or refinance of higher rate loans and the high demand for loans putting significant downward pressure on loan interest rates.
Interest income on investment securities increased by $63,000, or 42.0%, to $213,000 for the year ended December 31, 2014 from $150,000 for the year ended December 31, 2013. This increase was due to the portfolio yield rising as a result of the purchase of new higher-yielding securities during late 2013 and early 2014 and lower rate investment securities being sold. The portfolio yield increased to 1.96% for the year ended December 31, 2014 from 1.34% for the year ended December 31, 2013.
Interest income on certificates of deposit decreased by $9,000, or 24.3%, to $28,000 for the year ended December 31, 2014 compared to $37,000 for the year ended December 31, 2013 due mainly to the decrease in yield for 2014 as a result of most of the portfolio being sold in late 2013. The portfolio was replaced with lower yielding investments. The average balance of certificates of deposit decreased by $77,000, or 3.1%, to $2.4 million for the year ended December 31, 2014 from $2.5 million for the year ended December 31, 2013.
Interest income on interest-earning deposits increased by $6,000, or 31.6%, to $25,000 for the year ended December 31, 2014 compared to $19,000 for the year ended December 31, 2013, as a result of increases in both yield on and average balances of interest-earning deposits. The yield on interest-earning deposits increased by 9 basis points to 0.67% for the year ended December 31, 2014 from 0.58% for the year ended December 31, 2013 due to the higher dividends received on our FHLB stock portfolio. The average balance on interest-earning deposits increased by $474,000, or 14.5%, to $3.7 million during the year ended December 31, 2014 from $3.3 million during the year ended December 31, 2013.
Interest Expense. Total interest expense decreased by $165,000, or 20.1%, to $655,000 for the year ended December 31, 2014 from $820,000 for the year ended December 31, 2013. This decrease in interest expense was primarily due to a decline in the average cost of funds for interest-bearing liabilities, which dropped to 0.70% during the year ended December 31, 2014 from 0.89% during the year ended December 31, 2013.
Interest expense on deposits decreased by $164,000, or 23.5%, to $535,000 for the year ended December 31, 2014 from $699,000 for the year ended December 31, 2013. This was primarily the result of a decline in the average interest rates on interest-bearing deposits during 2014 compared to 2013. The average interest rates on interest-bearing deposits dropped to 0.61% during the year ended December 31, 2014 from 0.82% during the year ended December 31, 2013. This decrease is primarily attributable to reductions in the average interest rates on certificates of deposit, savings and money market accounts. The average rate on certificates of deposit decreased to 1.05% from 1.42%, the average rate on our savings accounts decreased to 0.24% from 0.35% and the average rate on our money market accounts decreased to 0.40% from 0.57% during the year ended December 31, 2014 compared to the year ended December 31, 2013. The continued historically low level of market interest rates enabled us to renew maturing certificates of deposits at significantly lower interest rates and to lower the rates on our non-maturing interest bearing deposits during 2014.
Provision for Loan Losses. We establish a provision for loan losses, which is charged to operations, in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of nonperforming loans. The amount of the allowance is based on estimates and actual losses may vary from such estimates as more information becomes available or economic conditions change. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as circumstances change as more information becomes available. The allowance for loan losses is assessed on a quarterly basis and provisions are made for loan losses as required in order to maintain the allowance. Management analyzes the allowance for loan losses as described in the section entitled “Allowance for Loan Losses.” The provision that is recorded is sufficient, in management’s judgment, to bring the allowance for loan losses to a level that reflects the losses inherent in our loan portfolio relative to loan mix, economic conditions and historical loss experience. Management believes, to the best of their knowledge, that all known losses as of the balance sheet dates have been recorded. See “Nonperforming and Problem Assets” beginning on page 41.
Based on management’s evaluation of the above factors, the provision for loan losses decreased by $71,000 to $15,000 for the year ended December 31, 2014 from $87,000 for the year ended December 31, 2013. The drop in the provision for loan losses was due an increase in recoveries collected during 2014, the reduction in our historical loss and qualitative factors due to improved asset quality during 2014 and to a charge-off provided for during 2013. During the year ended December 31, 2014 we had no loan charge-offs and loan loss recoveries of $25,000 and during the year ended December 31, 2013, we had loan charge-offs of $268,000 and loan loss recoveries of $4,000.
Non-interest Income. The following table summarizes changes in non-interest income for the years ended December 31, 2014 and 2013:
Non-interest income increased by $6,000, or 3.1%, to $197,000 during the year ended December 31, 2014 from $191,000 for the year ended December 31, 2013. The increase was a result of several offsetting items. Loss and/or write downs on OREO properties declined significantly, increasing non-interest income by $61,000 as the Bank worked through most of its OREO portfolio. This was partially offset by decreases in loan fee income of $26,000 and in gains on the sale of investment securities and certificates of deposits of $26,000. The decrease in loan fee income was due to lower late fee and loan processing fee collections.
Non-interest Expenses. The following table summarizes changes in non-interest expenses for the years ended December 31, 2014 and 2013:
Non-interest expenses increased slightly by $26,000, or 0.8%, remaining at $3.4 million for the years ended December 31, 2014 and 2013.
Salaries and employee benefits increased by $98,000, or 6.2%, to $1.7 million for the year ended December 31, 2014 from $1.6 million for the year ended December 31, 2013. The increase was primarily attributable to the implementation of a management incentive program in 2014 and higher share-based benefit costs for the ESOP and restricted stock grant plans.
Premises and equipment increased by $35,000, or 11.3%, to $345,000 for the year ended December 31, 2014 from $310,000 for the year ended December 31, 2013. The increase was the result of higher depreciation expense from the significant purchase of security equipment in 2013 and higher costs for equipment service contracts.
Data processing expenses increased by $20,000, or 4.8%, to $440,000 for the year ended December 31, 2014 from $420,000 for the year ended December 31, 2013 due to higher volume of accounts and transactions along with increased costs associated with our internal network and core processing post-conversion support.
Professional fees decreased by $17,000, or 5.4%, to $299,000 during the year ended December 31, 2014 from $316,000 during the year ended December 31, 2013 due to lower costs related to internal audit, general legal matters and public company reporting and filing. These items were partially offset by higher consulting costs for compliance administration due to hiring of a new compliance officer.
FDIC insurance decreased by $20,000, or 22.2%, to $70,000 for the year ended December 31, 2014 from $90,000 for the year ended December 31, 2013 due to lower assessment rates in 2014 as a result of our improved financial ratios.
Directors’ fees increased by $22,000, or 15.8%, to $161,000 for the year ended December 31, 2014 from $139,000 for the year ended December 31, 2013 as a result of increasing the annual retainer for all directors and the addition of a new director in late 2014.
Printing and supplies decreased by $16,000, or 34.0%, to $31,000 for the year ended December 31, 2014 from $47,000 for the year ended December 31, 2013 due to the reduction in the cost for electronic forms on the new core processing system and 2013 including a few special printing projects.
Loan and OREO expense decreased by $57,000, or 75.0%, to $19,000 for the year ended December 31, 2014 from $76,000 for the year ended December 31, 2013. The decrease was due to the decline in loan workouts and foreclosed properties held by the Bank along with the costs incurred to fix-up and repair such properties during 2014 compared to 2013.
Other operating expenses decreased by $43,000, or 12.6%, to $298,000 during the year ended December 31, 2014 from $341,000 during the year ended December 31, 2013. The decrease was mostly attributable to lower advertising and marketing costs in 2014 and 2013 including post-robbery police support and a loss taken for fraudulent checks.
We expect our non-interest expense will continue to increase in the immediate future as a result of increased compensation expense associated with the addition of staff and the continued implementation of stockholder approved stock-based benefit plans.
Income Tax Expense. Income tax expense for the year ended December 31, 2014 was $236,000 compared to $109,000 in 2013. The increased tax expense is primarily the result of higher income before income taxes during 2014 compared to 2013. The effective income tax rates were 37.7% and 32.9% for the years ending December 31, 2014 and 2013, respectively.
Nonperforming and Problem Assets
Management performs reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a timely manner. Customers are sent a reminder notice ten or 15 days after they miss their payment due date. Customers who are delinquent appear on our delinquency report, which is updated and reviewed weekly. Once on the delinquency report, our loan officers attempt to contact customers and secure payment. For loans secured by a residential dwelling, on the 45th day of delinquency our attorney sends the customers a letter informing them of our intent to foreclose. Such residential borrowers are also sent a HAMP (Making Home Affordable) application to ascertain if there are reasons that have prohibited them from making a payment and if it has been resolved. On the 120th day of delinquency, our attorney files to become our substitute trustee. After such filing (dependent on courts and judges) the applicable borrower or borrowers are served with a foreclosure notice. Once served, a sale date is set for 45 days later.
When in the best interests of Carroll Community Bank and the customer, we will do a troubled debt restructure with respect to a particular loan. When not possible, we are aggressively moving loans through the legal and foreclosure process within applicable legal constraints.
Non-Performing Assets. Loans are placed on non-accrual status when payment of principal or interest is 90 days or more past due, although management may take action to place loans on non-accrual status earlier than 90 days past due based on the borrower’s particular circumstances. Loans are also placed on non-accrual status if management has serious doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are placed on a non-accrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received. The loan may be returned to accrual status if the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time and ultimate collectability of the total contractual principal and interest is no longer in doubt.
Nonperforming loans are evaluated and valued at the time the loan is identified as impaired on a case by case basis, at the lower of cost or market value. Market value is measured based on the value of the collateral securing the loan. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by us. Appraised values may be discounted based on management’s historical experience, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. The difference between the appraised value and the principle balance of the loan will determine the specific allowance valuation required for the loan, if any. Nonperforming loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.
The deterioration in the real estate market since the 2008 recession has resulted in a decrease in the collateral value for many of the properties securing our classified loans. For some classified loans this has required a specific reserve when such loans become nonperforming or substandard. For other classified loans, while the value of some of the properties securing the loans has decreased, their values still exceed the carrying value of the corresponding loan requiring no specific valuation allowance. It is our practice to obtain updated appraisals if there is a material change in market conditions or if we become aware of new or additional facts that indicate a potential material reduction in the value of any individual property collateral.
We evaluate the loan portfolio on at least a quarterly basis, more frequently if conditions warrant, and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Maryland Office of the Commissioner of Financial Regulation and the FDIC will periodically review the allowance for loan losses. The Maryland Office of the Commissioner of Financial Regulation and the FDIC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.
The table below sets forth the amounts and categories of our nonperforming assets, which consist of nonaccrual loans, accruing loans 90 days or more delinquent and OREO (which includes real estate acquired through or in lieu of foreclosure) at December 31, 2014 and 2013:
As of December 31, 2014, none of our nonperforming loans had specific reserves as the collateral was sufficient to cover, at a minimum, the principle balance.
During the fourth quarter of 2013 a commercial loan that was secured by equipment, other business assets and personal guarantees was classified as substandard and placed on nonaccrual status. The balance of the loan at December 31, 2013 was $733,000, which impacted our asset quality ratios at December 31, 2013. Based on its analysis and assessment, management believed that the collateral coverage on this loan was sufficient and therefore there was no impairment charge taken. On February 14, 2014, the loan was repaid in full including all interest and fees with no loss to the Bank.
Delinquent Loans. The following table sets forth certain information with respect to our loan portfolio delinquencies at December 31, 2014 and 2013:
There were no loans contractually past due 90 days or more and still accruing interest at December 31, 2014 or 2013.
Trouble Debt Restructurings. For the twelve months ended December 31, 2014, there were no loans modified as a troubled debt restructure (“TDR”).
For the twelve months ended December 31, 2013, two loans were modified with aggregate balances of $210,000 that were classified as TDRs. One loan was nonperforming at the time of restructure to a below market interest rate. The loan has been performing since the restructure based on the new contractual terms and will be reported as a performing impaired loan. The second loan was restructured as part of a bankruptcy. At the time of the restructure the loan was classified as nonperforming. After six months of current payments and the customer’s demonstrated ability to maintain the loan current, the loan was then classified as performing as of December 31, 2013.
TDRs that are classified as nonaccrual loans remain in nonaccrual status until the borrower has made at least six consecutive payments based on the contractual terms of their modified loan. At that time, the loan may revert to accrual status based on management’s evaluation and determination. Interest collected during the nonaccrual period is recognized as interest income on a cash basis.
A performing TDR will no longer be reported as a TDR in calendar years after the year of the restructuring if the effective interest rate is equal or greater than the market rate for credits with comparable risk.
Foreclosed Real Estate. Real estate we acquire as a result of foreclosure is classified as other real estate owned. When property is acquired it is recorded at the lower of cost, which is the unpaid balance of the loan plus estimated foreclosure costs, or fair value at the date of foreclosure. If there is a subsequent decline in the value of real estate owned, we provide an additional allowance to reduce real estate acquired through foreclosure to its fair value less estimated disposal costs. Costs relating to holding such real estate like property taxes are charged against income in the current period while costs relating to improving such real estate are capitalized up to the property’s net realizable value, then such costs would be charged against income in the current period. We had foreclosed real estate of $53,000 and $462,000 at December 31, 2014 and 2013, respectively.
Classification of Loans. Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as substandard, doubtful, or loss assets. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the
weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets (or portions of assets) classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as special mention.
We maintain an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Our determination as to the classification of our assets is subject to review by the Maryland Commissioner of Financial Regulation and the FDIC. We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations.
The following table sets forth our amounts of criticized loans (classified loans and loans designated as special mention) as of December 31, 2014 and 2013:
For a discussion of these criticized loans as they relate to the allowance for loan losses as well as a discussion as to how we calculate the allowance, see Note 4 to the Consolidated Financial Statements, “Credit Quality of Loans and Allowance for Loan Losses”.
The following table sets forth activity in our allowance for loan losses for the periods indicated.
For additional information with respect to the portions of the allowance for loan losses attributable to our loan classifications, see “-Allocation of Allowance for Loan Losses.” For additional information with respect to nonperforming loans and delinquent loans, see “-Nonperforming and Problem Assets-Nonperforming Assets” and “-Nonperforming and Problem Assets-Delinquent Loans.”
Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
Management of Market Risk
General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. Our Board of Directors has established an Asset Liability Committee, which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.
Historically, we operated as a traditional savings association. Therefore, the majority of our assets consist of longer-term, fixed rate residential mortgage loans, which we funded primarily with savings accounts and certificates of deposit. In an effort to improve our earnings and to decrease our exposure to interest rate risk, we have shifted our focus to originating more commercial real estate loans, which generally have shorter maturities than one- to four-family residential mortgage loans.
In addition to the above strategies with respect to our lending activities, we have used the following strategies to reduce our interest rate risk:
•
increasing our personal and business checking accounts, which are less rate-sensitive than certificates of deposit and which provide us with a stable, low-cost source of funds;
•
limiting short-term borrowings; and
•
maintaining a well capitalized bank.
We have not conducted hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage-backed securities. In addition, changes in interest rates can affect the fair values of our financial instruments.
Net Portfolio Value. An institution’s net portfolio value or “NPV” is the difference between the present value of its assets and liabilities, and would change in the event of a range of assumed changes in market interest rates. The simulation model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. Historically, the model estimated the economic value of each type of asset, liability and off-balance sheet contract using the current interest rate yield curve with instantaneous increases of 100 to 400 basis points in 100 basis point increments and a decrease of 100 basis points. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3.0% to 4.0% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. Given the current relatively low level of market interest rates, an NPV calculation for an interest rate decrease of greater than 100 basis points has not been prepared.
Quantitative Analysis. The table below sets forth, as of December 31, 2014, the estimated changes in our NPV that would result from the designated instantaneous changes in the interest rate yield curve.
(1) Assume interest rate changes (up and down) in increments of 100 basis points.
(2) NPV is the discounted present value of expected cash flows from assets and liabilities.
(3) Present value of assets represents the discounted present value of incoming cash flows on interest-bearing assets.
(4) NPA Ratio represents NPV divided by the present value of assets.
Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in net portfolio value. Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs, or loan repayments and deposit decay, respond to changes in market interest rates. In this regard, the net portfolio value table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the net portfolio value tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, short-term lines of credit with correspondent banks, advances from the FHLBA, principal repayments and the sale of securities available-for-sale. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset and Liability Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists to fund asset growth and deposit runoff as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of December 31, 2014.
Liquidity management is both a daily and long-term function of business management. We regularly monitor and adjust our investments in liquid assets based upon our assessment of:
(i) expected loan demand;
(ii) expected deposit flows and borrowing maturities;
(iii) yields available on interest-earning deposits and securities; and
(iv) the objectives of our asset and liability management program.
Excess liquid assets are invested generally in interest-earning deposits and short-term securities.
Our most liquid assets are cash and cash equivalents. The level of these assets is dependent on our operating, investing and financing activities during any given period from which our cash flows are derived. At December 31, 2014, cash and cash equivalents totaled $6.9 million.
At December 31, 2014, we had $5.3 million in loan commitments outstanding, a majority of which were for commercial real estate loans. In addition, we had $6.2 million in unused lines of credit to borrowers, including $4.3 million with respect to consumer loans and $1.9 million for commercial real estate loans. Certificates of deposit due within one year of December 31, 2014 totaled $18.3 million, or 18.9% of total deposits. If these deposits do not remain with us, we may be required to seek other sources of funds, including loan and securities sales, draws on our short-term lines of credit with correspondent banks and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on our certificates of deposit. We believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of our certificates of deposit with maturities of one year or less as of December 31, 2014.
Our primary investing activity is loan originations. During the years ended December 31, 2014 and 2013, we originated $19.4 million and $22.0 million of loans, respectively.
Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances. We experienced a net increase in deposits of $5.1 million during the year ended December 31, 2014. Deposit flows are affected by the overall market level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.
If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLBA, which provide an additional source of funds. Federal Home Loan Bank advances and borrowings were $8.0 million and $7.4 million at December 31, 2014 and 2013, respectively. At December 31, 2014, we had the ability to borrow up to an additional $10.5 million from our correspondent banks under short-term lines of credit and $3.3 million from the FHLBA.
Carroll Community Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2014, Carroll Community Bank exceeded all regulatory capital requirements. Carroll Community Bank is considered “well capitalized” under regulatory guidelines. See “Supervision and Regulation-Banking Regulation-Capital Requirements” and Note 17 of the Notes to the Financial Statements.
Off-Balance Sheet Arrangements, Commitments and Aggregate Contractual Obligations
Commitments. We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These financial instruments are limited to commitments to originate mortgage loans and home equity loans, and involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks and management does not anticipate any losses which would have a material effect on us.
Outstanding loan commitments and lines of credit at December 31, 2014 and 2013 are as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counter party. Commitments generally have interest rates fixed at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that customers will draw upon their lines of credit in full at any time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer’s credit-worthiness on a case-by-case basis. Because we conservatively underwrite these facilities at inception, we have not had to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit.
The credit risks involved in these financial instruments are essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in the statement of financial condition at December 31, 2014 or 2013 as a liability for credit loss related to these commitments.
Impact of Inflation and Changing Prices
Our consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on our performance than the effects of inflation.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF
CARROLL BANCORP, INC. AND SUBSIDIARY
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Carroll Bancorp, Inc.
Sykesville, Maryland
We have audited the accompanying consolidated statements of financial condition of Carroll Bancorp, Inc. and Subsidiary (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Carroll Bancorp, Inc. and Subsidiary as of December 31, 2014 and 2013, and the results of their consolidated operations and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ Stegman & Company
Baltimore, Maryland
March 10, 2015
Carroll Bancorp, Inc. and Subsidiary
Consolidated Statements of Financial Condition
The notes to the consolidated financial statements are an integral part of these statements.
Carroll Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations
The notes to the consolidated financial statements are an integral part of these statements.
Carroll Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
The notes to the consolidated financial statements are an integral part of these statements.
Carroll Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders’ Equity
For the Years Ended December 31, 2014 and 2013
The notes to the consolidated financial statements are an integral part of these statements.
Carroll Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
The notes to the consolidated financial statements are an integral part of these statements.
CARROLL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Organization and Nature of Operations
Carroll Bancorp, Inc. a Maryland corporation (the “Company”) was incorporated on February 18, 2011, to serve as the holding company for Carroll Community Bank (the “Bank”), a state chartered commercial bank. On October 12, 2011, in accordance with a Plan of conversion adopted by its Board of Directors and approved by its members, the Bank converted from a Maryland chartered mutual savings bank to a state chartered commercial bank. The conversion was accomplished through formation of the Company to serve as the holding company of the Bank. The Company’s common stock began trading on the Over the Counter Bulletin Board under the symbol “CROL” on October 12, 2011.
In accordance with applicable regulations at the time of the conversion from a mutual holding company to a stock holding company, the Bank substantially restricted its retained earnings by establishing a liquidation account. The liquidation account is maintained for the benefit of eligible account holders who keep their accounts at the Bank after conversion. The liquidation account is reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder’s interest in the liquidation account. In the event of a complete liquidation of the Bank, and only in such event, each account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the adjusted qualifying account balances then held. The Bank may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount.
The Bank (formerly Sykesville Federal Savings Association) is headquartered in Sykesville, Maryland. The Bank is a community-oriented financial institution providing financial services to individuals, families and businesses through two banking offices located in Sykesville and Westminster, Maryland. The Bank is subject to the regulation, examination and supervision by the State of Maryland Department of Licensing and Regulation and the Federal Deposit Insurance Corporation (“FDIC”), our deposit insurer. Its primary deposits are certificate of deposit, savings and demand accounts and its primary lending products are residential and commercial real estate loans.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, the Bank. All significant intercompany balances and transactions between the Company and the Bank have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosure or in satisfaction of loans. In connection with the determination of the allowance for losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year method of presentation. Such reclassifications have no effect on net income.
Cash and Cash Equivalents
For the purposes of the statements of cash flows, cash and cash equivalents include cash on hand, balances due from banks, interest-bearing deposits in other banks and federal funds sold.
Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Securities that the Bank has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost (including amortization of premium or accretion of discount).
Securities classified as available for sale are those securities that the Bank intends to hold for an indefinite time period but not necessarily to maturity. Securities available for sale are reported at fair value. Net unrealized gains and losses on securities available for sale are recognized as increases or decreases in other comprehensive income, net of taxes, and are excluded from the determination of net income.
Interest and dividend income is recognized as earned. Realized gains and losses on the sale of securities are included in earnings based on trade date and are determined using the specific identification method. Purchase premiums and discounts are recognized as part of interest income using the interest method over the terms of the securities.
Declines in the fair value of individual available for sale securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. In estimating other-than-temporary impairment (“OTTI”) losses for debt securities, management considers whether the Bank (1) has the intent to sell the security, or (2) will more likely than not be required to sell the security before its anticipated recovery, or (3) will suffer a credit loss as the present value of the cash flows is expected to be collected from the security are less than its amortized cost basis.
The Bank does not engage in securities trading.
Loans Held For Sale
The Bank may from time to time carry loans held for sale. Loans held for sale are carried at lower of aggregate cost or fair value. Market value is derived from secondary market quotations for similar instruments. Net unrealized losses are recognized through a valuation allowance by charges to income.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as a yield adjustment of the related loans using the interest method over the contractual term.
The accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status, if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest is reversed. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current and future payments are reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is maintained at a level to provide for losses that are probable and can be reasonably estimated. Management’s periodic evaluation of the adequacy of the allowance is based on the Bank’s past loan loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.
The allowance consists of specific, general and unallocated components. The specific reserve component relates to loans that are classified as substandard or doubtful. For such loans that are also classified as impaired, an allowance is established when the collateral value of the impaired loan is lower than the carrying amount of that loan. Impaired loans for which the estimated fair value of the loan exceeds the carrying value of the loan do not require a specific allowance.
General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired. The portfolio is grouped into similar risk characteristics, primarily loan type. The Company applies an estimated loss rate to each loan group. The loss rates applied are based upon its loss experience adjusted, as appropriate, for qualitative factors.
The unallocated component represents the margin of imprecision inherent in the underlying assumptions used in estimating specific and general allowances.
A loan is considered past due or delinquent when a contractual payment is not paid by its due date. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for all loans secured by real estate by either the present value of expected cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer loans for impairment disclosures.
The Bank’s charge-off policy states after all collection efforts have been exhausted, the loan is deemed to be a loss and the loss amount has been determined, the loss amount will be charged against the allowance for loan losses. Loans secured by real estate, either residential or commercial, are evaluated for loss potential at the 60 day past due threshold. At 90 days past due the loan is placed on nonaccrual status and a specific reserve is established if the net realizable value in less than the principal value of the loan balance(s). Once the actual loss value has been determined a charge-off for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss. Consumer real estate loans are typically charged-off no later than 180 days past due and unsecured consumer loans are charged-off at the 90 day past due threshold or when an actual loss has been determined whichever is earlier.
Other Equity Securities
Federal law requires a member institution of the Federal Home Loan Bank (“FHLB”) to hold stock of its district FHLB according to a predefined formula. FHLB stock represents the required investment in the common stock of the FHLB of Atlanta and is carried at cost. FHLB stock ownership is restricted and the stock can be sold only to the FHLB or to another member institution at its par value per share.
The Company evaluates the FHLB stock for impairment. The Company’s determination of whether this investment is impaired is based on an assessment of the ultimate recoverability of its cost rather than by recognizing temporary declines in value. The determination of whether a decline in value affects the ultimate recoverability of its cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB.
The Bank also maintains an investment in capital stock of Atlantic Central Bankers Bank, Community Bankers Bank and Maryland Financial Bank. Because no ready market exists for Atlantic Central Bankers Bank, Community Bankers Bank and Maryland Financial Bank stock, the Bank’s investment in these stocks is carried at cost.
Bank Owned Life Insurance
The Bank purchased single-premium life insurance policies on certain employees of the Bank. Appreciation in the value of the insurance policies is classified in non-interest income.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation. Land is carried at cost. Depreciation of premises and equipment is computed on the straight-line method over the estimated useful lives of the assets. Additions and improvements are capitalized and amortized over the shorter of their estimated useful life or the term of the lease. Estimated useful lives are 20 to 40 years for buildings, 5 to 10 years for leasehold improvements and 5 years for equipment. Charges for repairs and maintenance are expensed when incurred.
Foreclosed Real Estate
Real estate acquired through foreclosure is recorded at the lower of cost or fair value less estimated selling costs at the date of the foreclosure. Management periodically evaluates the recoverability of the carrying value of the real estate acquired through foreclosure. In the event of a subsequent decline, management provides an additional allowance to reduce real estate acquired through foreclosure to its fair value less estimated disposal cost. Costs related to holding such real estate are included in expenses for the current period while costs relating to improving the fair value of such real estate are capitalized.
Income Taxes
Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities based on enacted tax rates expected to be in effect when such amounts are realized or settled. Deferred tax assets are recognized only to the extent that it is more likely than not those amounts will be realized based on consideration of available evidence. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company has entered into a tax sharing agreement with the Bank. The agreement provides that the Company will file a consolidated federal tax return and that the tax liability shall be apportioned among the entities as would be computed if each entity had filed a separate return. According to Maryland tax law, the Company and the Bank file separate Maryland state tax returns.
Advertising Costs
All advertising costs are expensed as incurred. Advertising expense was $41,747 in 2014 and $75,222 in 2013.
Comprehensive Income
GAAP requires that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale, are reported as a separate component of equity, such items, along with net income, are components of comprehensive income.
The element of “other comprehensive income” includes unrealized gains or losses on securities available for sale and reclassification adjustments for gains on security sales.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit. Such financial instruments are recorded in the statement of financial condition when they are funded.
Credit Risk Concentrations
Most of the Bank’s activities are with customers within Carroll County, Maryland and all contiguous counties in Maryland and Pennsylvania. The Bank does not have any significant concentrations to any one industry or customer but does have a concentration in real estate lending.
Recent Accounting Pronouncements
In January 2014, the FASB issued ASU 2014-04, Receivables - Troubled Debt Restructurings By Creditors (Subtopic 310-40) - Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure. This amendment clarifies the circumstances under which an in substance repossession or foreclosure is deemed to occur determining when all or a portion of the loan should be derecognized and the real estate property received should be recognized. The amendment is effective for annual and interim periods beginning after December 15, 2014 and is not expected to have a material impact to the financial statements. Early adoption is permitted.
In May 2014, the FASB and the international Accounting Standards Board (the “IASB”) jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards (“IFRS”). Previous revenue recognition guidance in GAAP
comprised broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes resulted in different accounting for economically similar transactions. In contrast, IFRS provided limited revenue recognition guidance and, consequently, could be difficult to apply to complex transactions. Accordingly, the FASB and IASB initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS that would : (1) Remove inconsistencies and weaknesses in revenue requirements; (2) Provide a more robust framework for addressing revenue issues; (3) Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets: (4) Provide more useful information to users of financial statements through improved disclosure requirements; and (5) Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. To meet those objectives, The FASB issued ASU No. 2014-09 Revenue from Contracts with Customers. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies generally will be required to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard is effective for public entities for interim and annual periods beginning after December 15, 2016; early adoption is not permitted. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company is currently evaluating the provisions of ASU No. 2014-09 and will be closely monitoring developments and additional guidance to determine the potential impact the new standard will have on the Company’s financial statements.
In August 2014, the FASB issued ASU No. 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. The objective of this guidance is to reduce diversity in practice related to how creditors classify government-guaranteed mortgage loans, including FHA and VA guaranteed loans, upon foreclosure. Some creditors reclassify those loans to real estate consistent with other foreclosed loans that do not have guarantees; others reclassify the loans to other receivables. The amendments in this guidance require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) The loan has a government guarantee that is not separable from the loan before foreclosure; (2) At the time of foreclosure, the creditor has the intent to convey the real property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measure based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. ASU No. 2014-14 is effective for the interim and annual reporting periods beginning after December 15, 2014. The adoption of ASU No. 2014-14 is not expected to have a material impact on the Company’s financial statements.
Other than the disclosures contained within these statements, the Company has determined that all other recently issued accounting pronouncements will not have a material impact on its consolidated financial statements or do not apply to its operations.
Note 2. Securities
The amortized cost and fair value of securities available for sale at December 31, 2014 and 2013 are as follows:
The Bank had no private label residential mortgage-backed securities at December 31, 2014 or December 31, 2013, or during the years then ended. In addition, the Bank had no held to maturity securities at December 31, 2013.
At December 31, 2014 and 2013, the carrying amount of securities pledged as collateral for uninsured public fund deposits was $1.8 million and $1.4 million, respectively.
The amortized cost and fair value of securities at December 31, 2014 and December 31, 2013, by contractual maturity, are shown below. Expected maturities for residential mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Bank sold $4.1 million and $3.0 million in securities available for sale during the years ended December 31, 2014 and 2013, respectively. From those sale transactions, the Bank recognized net realized gains of $11,374 and $22,774 for the years ended December 31, 2014 and 2013, respectively.
The Bank also sold $2.3 million in CD investments in 2013 for net realized gains of $14,012.
Securities with gross unrealized losses at December 31, 2014 and December 31, 2013, aggregated by investment category and the length of time individual securities have been in a continual loss position, are as follows:
There were no unrealized losses for securities held to maturity. All of the securities with unrealized losses in the portfolio have modest duration risk, low credit risk, and minimal losses when compared to the total fair value. The unrealized losses that exist are the result of market changes in interest rates since the original purchase. Because the Bank does not intend to sell these securities and it is not more likely than not that the Bank will be required to sell these securities before recovery of their amortized cost basis, which may be at maturity, the Bank considers the unrealized losses to be temporary.
Note 3. Loans
Loans at December 31, 2014 and 2013 are summarized as follows:
Our residential one- to four-family first lien mortgage loan portfolio is pledged as collateral for our advances with FHLB.
Note 4. Credit Quality of Loans and Allowance for Loan Losses
Company policies, consistent with regulatory guidelines, provide for the classification of loans that are considered to be of lesser quality as substandard, doubtful, or loss. A loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans include those loans characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans (or portions of loans) classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Loans that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as special mention.
The Company maintains an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Our determination as to the classification of our assets is subject to review by the Maryland Commissioner of Financial Regulation and the FDIC. We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations.
The Company provides for loan losses based upon the consistent application of our documented allowance for loan loss methodology. All loan losses are charged to the allowance for loan losses and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio and make provisions for loan losses in order to maintain the allowance for loan losses in accordance with GAAP. The allowance for loan losses consists primarily of two components:
1) specific allowances are established for loans classified as substandard or doubtful. For loans classified as impaired, the allowance is established when the net realizable value (collateral value less costs to sell) of the loan is lower than the carrying amount of the loan. The amount of impairment provided for as a specific allowance is represented by the deficiency, if any, between the underlying collateral value and the carrying value of the loan. Impaired loans for which the estimated fair value of the loan, or the loan’s observable market price or the fair value of the underlying collateral, if the loan is collateral dependent, exceeds the carrying value of the loan are not considered in establishing specific allowances for loan losses; and
2) general allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired loans. The portfolio is grouped into similar risk characteristics, primarily loan type and regulatory classification. We apply an estimated loss rate to each loan group. The loss rates applied are based upon our loss experience adjusted, as appropriate, for the qualitative factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions.
The allowance for loan losses is maintained at a level to provide for losses that are probable and can be reasonably estimated. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.
The adjustments to historical loss experience are based on our evaluation of several qualitative factors, including:
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changes in the types of loans in the loan portfolio and the size of the overall portfolio;
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changes in the levels of concentration of credit;
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changes in the number and amount of non-accrual loans, classified loans, past due loans and troubled debt restructurings and other loan modifications;
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changes in the experience, ability and depth of lending personnel;
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changes in the quality of the loan review system and the degree of Board oversight;
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changes in lending policies and procedures;
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changes in national, state and local economic trends and business conditions; and
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changes in external factors such as competition and legal and regulatory oversight.
A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for all loans secured by real estate by the fair value of the collateral if the loan is collateral dependent.
The Bank’s charge-off policy states after all collection efforts have been exhausted, the loan is deemed to be a loss and the loss amount has been determined, the loss amount will be charged to the established allowance for loan losses. Loans secured by real estate, either residential or commercial, are evaluated for loss potential at the 60 day past due threshold. At no later than 90 days past due the loan is placed on nonaccrual status and a specific reserve is established if the net realizable value in less than the principal value of the loan balance(s). Once the actual loss value has been determined, a charge-off to the allowance for loan losses for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss. Unsecured loans are charged-off to the allowance for loan losses at the 90 day past due threshold or when an actual loss has been determined whichever is earlier.
We evaluate the allowance for loan losses based upon the combined total of the specific and general components. Generally when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally when the loan portfolio decreases, absent other factors, the allowance for loan loss methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease.
Commercial real estate loans generally have greater credit risks compared to one- to four-family residential mortgage loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Therefore, we expect that the percentage of the allowance for loan losses as a percentage of the loan portfolio will increase going forward as we increase our focus on the origination of commercial real estate loans.
The following tables summarize the activity in the allowance for loan losses by portfolio segment for the twelve months ended December 31, 2014 and 2013.
The following tables set forth the balance of the allowance for loan losses by portfolio segment, disaggregated by impairment methodology, which is then further segregated by amounts evaluated for impairment collectively and individually at December 31, 2014 and 2013.
The allowance for loan losses allocated to each portfolio segment is not necessarily indicative of future losses in any particular portfolio segment and does not restrict the use of the allowance to absorb losses in other portfolio segments.
The following tables are a summary of the loan portfolio quality indicators by portfolio segment at December 31, 2014 and 2013:
Management uses a ten point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized and are aggregated as a “Pass” rating.
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Pass (risk ratings 1-6) - risk ratings one to four are deemed “acceptable”. Risk rating five is “acceptable with care” and risk rating six is a “watch credit”.
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Special mention (risk rating 7) - a special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.
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Substandard (risk rating 8) - substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
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Doubtful (risk rating 9) - loans classified as doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
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Loss (risk rating 10) - loans classified as loss are considered uncollectible and of such little value that their continuance as assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may occur in the future.
Loans classified special mention, substandard, doubtful or loss are reviewed at least quarterly to determine their appropriate classification. Non-classified commercial loan relationships greater than $50,000 are reviewed annually. Non-classified residential mortgage loans and consumer loans are not evaluated unless a specific event occurs to raise the awareness of possible credit deterioration.
The following tables set forth certain information with respect to our loan delinquencies by portfolio segment at December 31, 2014 and 2013:
The following tables are a summary of impaired loans by portfolio segment at December 31, 2014 and 2013:
The following tables present by portfolio segment, information related to the average recorded investment and the interest income foregone and recognized on impaired loans for the twelve months ended December 31, 2014 and 2013:
The following table is a summary of performing and nonperforming impaired loans by portfolio segment at December 31, 2014 and 2013:
Troubled debt restructurings. Loans may be periodically modified in a troubled debt restructuring (“TDR”) to make concessions to help a borrower remain current on the loan and/or to avoid foreclosure. Generally we do not forgive principal or interest on a loan or modify the interest rate to below market rates. When we modify loans in a TDR, we evaluate any possible impairment similar to any other impaired loans. If we determine that the value of the restructured loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance estimate or a charge-off to the allowance.
If a restructured loan was nonperforming prior to the restructuring, the restructured loan will remain a nonperforming loan. After a period of six months and if the restructured loan is in compliance with its modified terms, the loan will become a performing loan. If a restructured loan was performing prior to the restructuring, the restructured loan will remain a performing loan. A performing TDR will no longer be reported as a TDR in calendar years after the year of the restructuring if the effective interest rate is equal or greater than the market rate for credits with comparable risk.
The Company has no commitments to loan additional funds to borrowers whose loans have been restructured.
The following table is a summary of impaired loans that were modified pursuant to a TDR during the twelve months ended December 31, 2014 and 2013:
There were no defaults on any TDRs that were restructured in 2014 or 2013.
Note 5. Premises and Equipment
A summary of premises and equipment at December 31, 2014 and 2013 is as follows:
In April 2010, the Bank entered into a five-year lease agreement for its Westminster branch. The lease included an option for an additional five-year lease term. The Bank exercised that option in February 2015. The Bank pays its own operating expenses, including real estate taxes, insurance, utilities, maintenance and repairs. Rent expense for the years ended December 31, 2014 and 2013 totaled $53,204 and $50,550, respectively.
The total rental commitment under this lease is as follows:
Note 6. Foreclosed Assets
The following table is a summary of the activity in other real estate owned for the years ended December 31, 2014 and 2013:
Note 7. Deposits
Deposits were comprised of the following at December 31, 2014 and 2013:
Certificates of deposit scheduled maturities are as follows:
Deposit accounts in the Bank are insured by the FDIC, generally up to a maximum of $250,000 per separately insured depositor.
Note 8. Borrowings
The Company has a credit line with the FHLBA, with a maximum borrowing limit of 10% of the Bank’s total assets, as determined on a quarterly basis. The maximum borrowing availability is also limited to approximately 74% of the unpaid principal balance of qualifying residential mortgage loans. The FHLBA has a blanket floating lien on the Company’s residential mortgage portfolio and FHLBA stock as collateral for the outstanding advances.
(1) callable quarterly by the FHLBA.
At December 31, 2014, the scheduled maturities of the FHLBA advances are as follows:
At December 31, 2014, the Company had availability of $10.5 million with various correspondent banks for short term liquidity needs, if necessary. There were no borrowings outstanding at December 31, 2014 and 2013 under these facilities.
Note 9. Income Taxes
Income tax expense consisted of the following components:
A reconciliation of the statutory income tax rate of 34% to the income tax expense included in the statements of operations is as follows:
The components of the net deferred tax assets are as follows:
The Bank was allowed a special bad debt deduction at various percentages of otherwise taxable income for years through December 31, 1987. If the amounts which qualified as deductions for income tax purposes prior to December 31, 1987 are later used for purposes other than to absorb loan losses, including distributions in liquidations, they will be subject to income tax at the then current corporate rate. Retained earnings at December 31, 2014 and 2013 include $655,000 of such bad debt deductions for which no provision for income tax has been provided.
In assessing whether the Company will be able to realize the deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, the Company believes it is more likely than not the benefits of these deductible differences will be realized. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced. There was no valuation allowance for deferred tax assets as of December 31, 2014 and 2013.
As of December 31, 2014, the Company did not have any uncertain tax positions. Interest and penalties associated with tax liabilities would be classified as additional income taxes in the statement of operations. As of December 31, 2014, tax years ended
December 31, 2011 through December 31, 2014 remain open and are subject to Federal and State taxing authority examination.
Note 10. Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These financial instruments are limited to commitments to originate mortgage loans and home equity loans, and involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks and management does not anticipate any losses which would have a material effect on us.
Outstanding loan commitments and lines of credit at December 31, 2014 and 2013 are as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counter party. Commitments generally have interest rates fixed at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that customers will draw upon their lines of credit in full at any time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer’s credit-worthiness on a case-by-case basis. Because we conservatively underwrite these facilities at inception, we have not had to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit.
The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in the statement of financial condition at December 31, 2014 or 2013 as a liability for credit loss related to these commitments.
Note 11. Defined Contribution Benefit Plan
The Company has a 401(k) profit sharing plan in which a majority of employees participate. Employees of the Bank, who are 21 years of age or older, are eligible to participate in the plan (“Participants”). Participants may contribute up to 100% of their annual compensation to the plan on a pre-tax basis, subject to limits prescribed by federal tax law. Carroll Community Bank may make a discretionary 401(k) match (as approved by the Board of Directors) equal to a percentage of eligible compensation as to Participants who have completed at least one year of service and worked at least 1,000 hours during the plan year. Employer contributions vest 100% after three years of credited service and are 0% vested prior to such time. Participants are always 100% vested in their salary deferrals. Participants will also become 100% vested in the employer contributions allocated to their accounts upon attainment of normal retirement age or in the event of the Participant’s death or disability. Participants may invest their accounts in the investment options provided under the 401(k) plan. Participants may borrow up to 50% of their vested interest (subject to a minimum of $1,000 and a maximum during any 12-month period of $50,000). The loan must be repaid within five years. Participants may request a withdrawal from their accounts in the event they incur a financial hardship. A Participant will become eligible for distribution of his or her plan benefit upon termination of employment and a Participant that satisfies certain eligibility requirements may request distributions of certain portions of their account balance while employed. Participants may elect to receive payments of their benefits in a lump sum or, provided that their account balance equals or exceeds $1,000, that the amount in their accounts be rolled over into another qualified retirement plan. During the year ended December 31, 2014, the Bank matched 50% up to 3% of an employee’s eligible earnings for a total of $14,789. The Bank matched $14,496 during the year ended December 31, 2013.
Effective January 1, 2015 the 401(k) plan was amended to be a “safe harbor” plan in order to satisfy certain IRS non-discrimination testing requirements. Starting in 2015 the employer match will be calculated on the participants contribution based on 100% of the first 3% of a participants annual salary and 50% on the next 2% of a participants annual salary.
Note 12. Employee Stock Ownership Plan.
In connection with the conversion to stock form on October 12, 2011, the Company established an employee stock ownership plan (“ESOP”) for eligible employees. The ESOP borrowed $215,670 from the Company and used those funds to acquire 21,567 shares or 6% of the total number of shares issued and sold in its initial public offering. The shares were acquired at a price of $10.00 per share.
The loan is secured by the shares purchased with the loan proceeds and will be repaid by the ESOP over the 20-year term of the loan with funds from the Bank’s contributions to the ESOP and dividends payable on stock, if any. The interest rate on the ESOP loan is an adjustable rate equal to the lowest Prime rate, as published in The Wall Street Journal. The interest rate will adjust monthly and will be the Prime rate on the first business day of the calendar month. The interest rate on the loan is 3.25% as of December 31, 2014.
In March 2014, the ESOP purchased additional shares in conjunction with the Company’s rights offering. The ESOP purchased 7,498 Units, which consists of a share of common stock and a warrant to purchase a half share of common stock, with the proceeds from a loan from the Company. The loan will be repaid over the 17-year term of the loan from the Bank’s contribution to the ESOP and has the same interest rate parameters as the original loan.
Shares purchased by the ESOP are held by a trustee in an unallocated suspense account, and shares will be released annually from the suspense account on a pro-rata basis as principal and interest payments are made by the ESOP to the Company. The trustee will allocate the shares released among participants on the basis of each participant’s proportional share of compensation relative to all participants. As shares are committed to be released from the suspense account, the Bank reports compensation expense based on the average fair value of shares committed to be released with a corresponding credit to stockholders’ equity.
Participants will vest in their accounts 20% after each year of service and become 100% vested upon the completion of five years of service. Participants who were employed by the Bank immediately prior to the offering will receive credit for vesting purposes for years of service prior to adoption of the employee stock ownership plan. Participants also will become fully vested automatically upon normal retirement, death or disability, a change in control, or termination of the employee stock ownership plan. Generally, participants will receive distributions from the ESOP upon separation from service. Forfeitures will be reallocated to remaining plan participants.
The debt of the ESOP, in accordance with generally accepted accounting principles, is eliminated in consolidation and the shares pledged as collateral are reported as unearned ESOP shares in the consolidated balance sheet. Contributions to the ESOP shall be sufficient to pay principal and interest currently due under the loan agreement. As shares are committed to be released from collateral, the Company reports compensation expense equal to the average market price of the shares for the respective period, and shares become outstanding for earnings per share computations. ESOP compensation expense for the year ended December 31, 2014 and 2013 was $25,055 and $15,968, respectively.
Shares held by the ESOP trust at December 31, 2014 and 2013 are as follows:
Note 13. Share-Based Compensation
In April 2012, our stockholders approved the Carroll Bancorp, Inc. 2011 Stock Option Plan and 2011 Recognition and Retention Plan and Trust Agreement (“Plan”), which provides for awards of restricted stock and stock options to key officers and outside directors.
During 2013, the Company repurchased 10,783 shares in the open market for the 2011 Recognition and Retention Plan and Trust agreement at an average cost of $12.42 per share for a total of $134,000. In October 2013, the Compensation Committee granted all of the shares to key management and outside directors. No stock options had been granted as of December 31, 2014.
In March 2014, the Company purchased for the Plan additional shares in conjunction with the Company’s rights offering. The Plan purchased 3,749 Units, which consists of a share of common stock and a warrant to purchase a half share of common stock. As of December 31, 2014, those shares have not been granted.
The fair value of these restricted stock awards is based on the closing price of the Company’s stock on the grant date. Non-vested restricted stock awards may not be disposed of or transferred during the vesting period. The restricted stock vests at a rate of 20% over a five year period on the anniversary date of the grant.
The table below presents the restricted stock award activity for the periods shown:
At December 31, 2014, the Company had $170,000 of unrecognized compensation cost related to the restricted stock awards. The cost of the restricted stock awards will be amortized in equal installments over a five-year vesting period. Restricted stock expense was $31,876 and $8,788 for the twelve months ended December 31, 2014 and 2013, respectively.
Note 14. Earnings per Share
Basic earnings per share are computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Unallocated ESOP and unearned Recognition and Retention Plan shares are excluded from this calculation.
Note 15. Related Party Transactions
In the ordinary course of business, the Bank has granted loans to executive officers and directors and their affiliates. The activity for related party loans for the years ended December 31, 2014 and 2013 are as follows:
Note 16. Fair Value Measurements
The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Topic 825 “Financial Instruments” which provides guidance on the fair value option for financial assets and liabilities. This guidance permits entities to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The election to use the fair value option is available when an entity first recognizes a financial asset or financial liability or upon entering into a commitment. Subsequent changes must be recorded in earnings.
Simultaneously with the adoption of ASC 825, the Company adopted ASC 820, Fair Value Measurements, effective January 1, 2008. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Under ASC 820, fair value measurements are not adjusted for transaction costs. ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are described below.
Level 1 Valuations for assets and liabilities traded in active exchange markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within Level 1 or Level 2 of the fair value hierarchy. As required by ASC 820, the Bank does not adjust the quoted price for such instruments.
The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high-yield corporate bonds, less liquid mortgage products, less liquid equities, state, municipal and provincial obligations, and certain physical commodities. Such instruments are generally classified within Level 2 of the fair value hierarchy.
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans and is classified within Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisal by qualified licensed appraisers hired by the Company. The value of business equipment, inventory and accounts receivable collateral is based on the net book value on the business’ financial statements and, if necessary, discounted based on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
Foreclosed assets are adjusted for fair value upon transfer of loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value and fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market prices, the Bank records the foreclosed asset as nonrecurring Level 3.
The following table presents a summary of financial assets measured at fair value on a recurring basis at December 31, 2014 and 2013:
The following table presents a summary of financial assets measured at fair value on a non-recurring basis at December 31, 2014 and 2013:
The following table shows a reconciliation of the beginning and ending balances for Level 3 assets:
The methods and assumptions used to estimate the fair values, including items in the above tables, are included in the disclosures that follow.
Certificates of Deposit with Depository Institutions (Carried at Cost). The carrying amounts of the certificates of deposit approximate fair value.
Securities Available for Sale (Carried at Fair Value). Where quoted prices are available in an active market, securities available for sale are classified within Level 1 of the valuation hierarchy. Level 1 would include highly liquid government bonds, mortgage products and exchange-traded equities. If quoted market prices are not available, securities available for sale are classified within level 2 and fair value values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 would include U.S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities available for sale are classified within Level 3 of the valuation hierarchy.
Securities Held to Maturity (Carried at Amortized Cost). Where quoted prices are available in an active market, securities held to maturity are classified within Level 1 of the valuation hierarchy. Level 1 would include highly liquid government bonds, mortgage products and exchange-traded equities. If quoted market prices are not available, securities held to maturity are classified within level 2 and fair value values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 would include U.S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities held to maturity are classified within Level 3 of the valuation hierarchy.
Loans, Net of Allowance for Loan Losses (Carried at Cost). The fair values of loans are estimated using discounted cash flow analyses, using market rates at the statement of condition date that reflect the credit and interest rate risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. Impaired loans are measured at an observable market price (if available), or at fair value of the loan’s collateral (if the loan is collateral dependent). When the loan is dependent on collateral, fair value of collateral is determined by appraisal or independent valuation, which is then adjusted for the related cost to sell. Impaired loans allocated to the allowance for loan losses are measured at the lower of cost or fair value on a nonrecurring basis.
Foreclosed Assets (Carried at Lower of Cost or Fair Value Less Estimated Selling Costs). Fair values of foreclosed assets are measured at fair value less cost to sell. The valuation of the fair value measurement follows GAAP. Foreclosed assets are measured on a nonrecurring basis.
Bank-Owned Life Insurance (Carried at Surrender Value). The carrying amount of the life insurance policies is based on the accumulated cash surrender value of each policy.
Other Equity Securities (Carried at Cost). The carrying amount of Federal Home Loan Bank and correspondent bank stock approximates fair value, and considers the limited marketability of such securities.
Deposit Liabilities (Carried at Cost). The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities.
Federal Home Loan Bank Advances (Carried at Cost). Fair values of FHLB advances are estimated using discounted cash flows analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
Off- Balance Sheet Credit-Related Instruments (Disclosures at Cost). Fair values for off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of these instruments is not material.
The estimated fair values of the Company’s financial instruments were as follows:
Note 17. Regulatory Matters and Capital Requirements
Federal and state banking regulations place certain restrictions on dividends paid to the Company by the Bank, and loans or advances made by the Bank to the Company. For a Maryland chartered bank, dividends may be paid out of undivided profits or, with the prior approval of the Commissioner, from surplus in excess of 100% of capital stock. If, however, the surplus of a Maryland bank is less than 100% of its capital stock, then, until the surplus is 100 percent of the capital stock, Carroll Community Bank must transfer to its surplus annually at least ten percent of its net earnings and may not declare or pay any cash dividends that exceed 90 percent of its net earnings. Loans and advances are limited to 10% of the Bank’s capital and surplus on a secured basis. In addition, the payment of dividends by the Bank would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below minimum capital requirements.
The Company’s ability to pay dividends is dependent on the Bank’s ability to pay dividends to the Company.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk weighted assets, core capital to adjusted tangible assets and tangible capital to tangible assets. Management believes, as of December 31, 2014, the Bank met all capital adequacy requirements to which it is subject.
As of October 2012, the most recent notification from the Bank’s regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category.
The Bank’s actual capital amounts and ratios as of December 31, 2014 and 2013 are presented in the table below:
The following table presents a reconciliation of the Company’s consolidated equity as determined using U.S. GAAP and the Bank’s regulatory capital amounts:
Note 18 Other Comprehensive Income
Comprehensive income is defined as net income plus transactions and other occurrences that are the result of non-owner changes in equity. For the financial statements presented, non-equity changes are comprised of the unrealized gains or losses on available-for-sale securities. Unrealized gain or losses do not have an impact on the Company’s net income. The following table presents the components of other comprehensive income (loss) for the years ended December 31, 2014 and 2013:
The following table presents the changes in accumulated comprehensive income (loss), net of tax, for the years ended December 31, 2014 and 2013:
The following table presents the amount reclassified out of accumulated other comprehensive income (loss) for the years ended December 31, 2014 and 2013:
Note 19. Parent Company Only Financial Statements
Presented below are the condensed balance sheet, statement of operations and statement of cash flows for Carroll Bancorp, Inc. at and for the twelve months ended December 31, 2014 and 2013:
Condensed Balance Sheets
Condensed Statements of Operations
Condensed Statements of Cash Flows
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Our management, under the supervision and with the participation of our President and Chief Executive Officer and our Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934) as of December 31, 2014. Based on that evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective.
During the quarter ended December 31, 2014, there have been no changes in Carroll Bancorp, Inc.’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Carroll Bancorp, Inc.’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may be inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of the Carroll Bancorp, Inc.’s Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014 based on the framework in Internal Control-Integrated Framework (1992 version) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2014.
ITEM 9B.
ITEM 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Code of Conduct and Ethics. We have adopted a Code of Conduct and Ethics that applies to all of our directors and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. The Code of Conduct and Ethics can be accessed on our website at www.carrollcobank.com.
The remaining information required by this Item 10 is incorporated herein by reference from our definitive Proxy Statement for our 2015 Annual Meeting of Stockholders (the “Proxy Statement”), specifically the sections captioned “Proposal I-Election of Directors” and “Beneficial Ownership Of Common Stock By Certain Beneficial Owners And Executive Officers-Section 16(a) Beneficial Ownership Reporting Compliance.”
Item 11.
Item 11. Executive Compensation
The information required by this Item 11 is incorporated herein by reference from the Proxy Statement, specifically the sections captioned “Proposal I-Election of Directors-Directors Compensation” and “Proposal I-Election of Directors-Executive Compensation.”
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item 12 is incorporated herein by reference from the Proxy Statement, specifically the section captioned “Beneficial Ownership Of Common Stock By Certain Beneficial Owners And Executive Officers” and “Securities Authorized For Issuance Under Equity Compensation Plans.”
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item 13 is incorporated herein by reference from the Proxy Statement, specifically the sections captioned “Proposal I-Election of Directors” and “Transactions with Certain Related Persons.”
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item 14 is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned “Proposal II-Ratification of Appointment of Independent Registered Public Accounting Firm.”
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
+ Management compensatory plan, contract or arrangement
* Incorporated by reference from Carroll Bancorp, Inc.’s Registration Statement on Form S-1, as amended, File No. 333-172770, originally filed with the U.S. Securities and Exchange Commission on March 11, 2011.
^ Incorporated by reference from Carroll Bancorp, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011, File No. 000-54422, filed with the U.S. Securities and Exchange Commission on March 9, 2012.
# Incorporated by reference from Carroll Bancorp, Inc.’s Registration Statement on Form S-8, File No. 333-186267, filed with the U.S. Securities and Exchange Commission on January 29, 2013.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CARROLL BANCORP, INC.
By:
/s/ Russell J. Grimes
Russell J. Grimes
President, Chief Executive Officer and Director (Principal Executive Officer)
Date: March 10, 2015
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.