Item 1.
Business. See "Business" at Page 63.
Item 1A.
Item 1A.
Risk Factors. No disclosure required as the Company is a smaller reporting company.
Item 1B.
Item 1B.
Unresolved Staff Comments. None.
Item 2.
Item 2.
Properties. See "Properties" at Page 66.
Item 3.
Item 3.
Legal Proceedings. See "Legal Proceedings" at Page 67.
Item 4.
Item 4.
[Removed and Reserved]
PART II
Item 5.
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. See "Market for Common Stock and Dividends" at Page 74.
Item 6.
Item 6.
Selected Financial Data. See "Five-Year Summary of Financial Information" at Page 4.
Item 7.
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" at Page 5.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk. See "Market Risk, Liquidity and Interest Rate Sensitivity" at page 10.
Item 8.
Item 8.
Financial Statements and Supplementary Data. See Consolidated Financial Statements and Notes thereto at Page 29.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.
Item 9A
Item 9A
Controls and Procedures. See "Management's Report on Internal Control over Financial Reporting" at page 27 and "Disclosure Controls and Procedures" at Page 28.
Item 9B.
Item 9B.
Other Information. None.
PART III
Item 10.
Item 10.
Directors, Executive Officers, and Corporate Governance. The information required by this Item is incorporated by reference to, the material appearing under the captions "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Proxy Statement.
The Company has adopted a code of ethics that applies to its Chief Executive Officer and Chief Financial Officer. A copy of the code of ethics will be provided to any person, without charge, upon written request directed to William R. Talley, Jr., EVP, CFO & COO, Frederick County Bancorp, Inc., P.O. Box 1100, Frederick, MD 21702-0100.
There have been no material changes in the procedures by which shareholders may recommend nominees to the Company's Board of Directors since the proxy statement for the 2010 annual meeting of shareholders.
Item 11.
Item 11.
Executive Compensation. The information required by this Item is incorporated by reference to the material appearing under the captions "Executive Compensation" and "Election of Directors-Director's Compensation" in the Proxy Statement.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. See "Securities Authorized for Issuance Under Equity Compensation Plans" under the heading "Market for Common Stock and Dividends" at Page 76. The other information required by this Item is incorporated by reference to the material appearing under the captions "Voting Securities and Principal Holders" in the Proxy Statement.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence. The information required by this Item is incorporated by reference to the material appearing under the caption "Election of Directors" and "Transactions with Related Parties" in the Proxy Statement. See also Item 10 to this Annual Report on Form 10-K.
Item 14.
Item 14.
Principal Accountant Fees and Services. The information required by this Item is incorporated by reference to the material appearing under the caption "Ratification of the Appointment of Independent Registered Public Accounting Firm" in the Proxy Statement.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules. See "Exhibits and Financial Statement Schedules" at Page 79.
Forward Looking Statements
This report contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements relating to the Company's beliefs, expectations, anticipations and plans regarding, among other things, general economic trends, interest rates, product expansions and other matters. In some cases, forward looking statements can be identified by use of words such as "may," "will," "anticipates," "believes," "expects," "plans," "estimates," "potential," "continue," "could," "should," and similar words or phrases. These statements are based upon current and anticipated economic conditions, nationally and in the Company's market, interest rates and interest rate policy, competitive factors, and other conditions which by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainties, such as federal monetary policy, inflation, employment, profitability and consumer confidence levels, both nationally and in the Company's market area, the health of the real estate and construction markets in the Company's market area, the Company's ability to develop and market new products and to enter new markets, competitive challenges in the Company's market, legislative changes and other factors, and as such, there can be no assurance that future events will develop in accordance with the forward looking statements contained herein.
FIVE-YEAR SUMMARY OF FINANCIAL INFORMATION
The following table sets forth certain selected financial data concerning the Company, and is qualified in its entirety by the detailed information and consolidated financial statements, including notes thereto, included elsewhere herein.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Frederick County Bancorp, Inc. (the "Bancorp"), the parent company for its wholly-owned subsidiary Frederick County Bank (the "Bank" and together with Bancorp, the "Company"), was organized in September 2003. The Bank was incorporated under the laws of the state of Maryland in August 2000 and commenced banking operations in October 2001. The Bank provides its customers with various banking services. The Bank offers various loan and deposit products to their customers. The Bank's customers include individuals and commercial enterprises within its principal market area consisting of Frederick County, Maryland. The Company operates out of four banking offices located in the City of Frederick and Walkersville, Maryland. The Company also has a subsidiary trust, established to issue trust preferred securities, and two subsidiaries established to hold foreclosed properties. The two subsidiaries established to hold foreclosed properties are known as FCB Holdings, Inc (a direct subsidiary of Bancorp) and FCB Hagerstown, LLC (an indirect subsidiary of Bancorp). See Note 8 to the consolidated financial statements for the year ended December 31, 2010 (the "consolidated financial statements") for additional disclosures related to the subsidiary trust.
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are based on information available as of the date of the financial statements and could differ from actual results.
Critical Accounting Policies
The accompanying consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. The estimates used in management's assessment of the adequacy of the allowance for loan losses require that management make assumptions about matters that are uncertain at the time of estimation. Differences in these assumptions and differences between the estimated and actual losses could have a material effect. For discussions related to the critical accounting policies of the Company, refer to the sections in this Management's Discussion and Analysis entitled "Income Taxes," "Allowance for Loan Losses" and "Investment Portfolio."
Overview
The following paragraphs provide an overview of the financial condition and results of operations of the Company. This discussion is intended to assist the readers in their analysis of the accompanying financial statements and notes thereto.
During 2010, the economy in Frederick County continued to remain at a low level, as was the economy for many regions in the United States and many countries throughout the world. The unemployment rate for Frederick County remained stubbornly high at 7.4%, but compared favorably to the Maryland rate of 8.2% and the national rate of 9.8%. Businesses, as well as consumers, felt the continuing effects of the downturn as the slow improvement in the economy has produced low results in activity and job production. The effects of this downturn has had an effect on the loans that the Company has made. However, it is felt the local economy may be somewhat insulated from the full impact that may be felt in other parts of the country, because of the local presence of a federal government medical research installation that has seen government funds continue to flow into Frederick County.
Net income was $1.16 million, $1.05 million and $1.04 million for the years ended December 31, 2010, 2009 and 2008, respectively. Basic and diluted earnings per share for 2010 were $0.79 and $0.78, respectively; 2009 were $0.72 and $0.71, respectively and 2008 were $0.71 and $0.69, respectively.
Return on average assets and return on average shareholders' equity are key measures of earnings performance. Return on average assets measures the ability of a bank to utilize its assets in generating income. The Company experienced returns on average assets of 0.40% for each of the years ended December 31, 2010, 2009 and 2008. Additionally, the Company experienced a return on average shareholders' equity of 5.04%, 4.92% and 5.12% for the years ended December 31, 2010, 2009 and 2008, respectively.
During the year ended December 31, 2010, the Company experienced an increase in total assets as its customers sought the safety of the banking system and increased the Company's deposit base. At December 31, 2010, assets stood at $289.04 million as compared to $258.56 million at December 31, 2009 and $254.56 million at December 31, 2008. Gross loans decreased $5.56 million, or 2.58%, in 2010 to end the period at $209.39 million compared to $214.94 million at December 31, 2009 and $211.84 million at December 31, 2008. During 2010, certificates of deposit increased approximately $7.17 million, while total deposits increased to $248.62 million at December 31, 2010, up from $219.31 million at December 31, 2009 and from $216.88 million at December 31, 2008. During 2010, the Company continued the strategy, implemented in 2009, of utilizing some of the excess liquidity to purchase investment securities, resulting in a $6.06 million increase in the investment portfolio, to $31.70 million at December 31, 2010, a $4.00 million increase, to $25.64 million, at December 31, 2009, as compared to $21.64 million at December 31, 2008.
Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential
The "Comparative Statement Analysis" on the next page shows average balances of asset and liability categories, interest income and interest paid, and average yields and rates for the periods indicated.
Net Interest Income
Net interest income is generated from the Company's lending and investment activities, and is the most significant component of the Company's earnings. Net interest income is the difference between interest and rate-related fee income on earning assets (primarily loans and investment securities) and the interest paid on the funds (primarily deposits) supporting them. The Company primarily utilizes deposits to fund loans and investments, with a small amount of additional funding from junior
subordinated debentures and short-term and long-term borrowings. In future periods it may utilize a higher level of short-term and long-term borrowings, including borrowings from the Federal Home Loan Bank, federal funds lines with correspondent banks and repurchase agreements, to fund operations, depending on economic conditions, deposit availability and pricing, interest rates and other factors.
The taxable-equivalent interest income of $14.79 million earned in 2010 was $578 thousand higher than the $14.21 million earned in 2009, which was $1.50 million lower than the amount realized in 2008. The increase in interest income in 2010 was primarily due to the increased volume of investment securities and loans, as the average yield on investment securities declined from 2009 and loan yields held steady. The decrease in interest income in 2009 was primarily due to the reduced yields earned on the loan portfolio which decreased to 6.26% in 2009 from 6.64% in 2008. The primary factor in the changes in interest income was changes in the federal funds target rate discussed below.
The interest expense decreased from $7.12 million in 2008, to $5.27 million in 2009 and $3.95 million in 2010. The primary factor in the decreased interest expense in 2009 and 2010 was the reduction of the rates paid on the interest-bearing liabilities, as a result of actions of the Federal Reserve. Average interest bearing liabilities increased 10.12% in 2010, from $201.76 million in 2009 to $222.18 million in 2010, but decreased 0.6% to $201.76 million in 2009 from $202.97 million at in 2008. The average rate paid on these liabilities decreased from 3.50% to 2.61% from 2008 to 2009, and continued to decline to 1.78% during 2010, as the percentage of liabilities represented by certificates of deposit declined, and the rates paid on such deposits declined as they renewed or were replaced at current market rates. The Company feels that the rates paid on its deposit liabilities should remain stable, subject to a slight increase as a result of competitive factors, local market conditions and customer preferences.
During 2010, the loan yields and the rates paid on interest bearing liabilities decreased due to the decrease of the federal funds rate maintained by the Federal Reserve, and the decreased reliance on higher rate funding sources, including certificates of deposits, which dropped to 54.9% of average interest-bearing liabilities in 2010 from 60.5% in 2009 and 64.2% in 2008. The Federal Reserve eased the federal funds rate down to a range of 0% to 0.25% as of December 31, 2008 and has maintained this level through December 31, 2010.
The Company's net interest margin (net interest income as a percent of average interest-earning assets) was 3.89%, 3.51% and 3.44%, and the net interest spread (the spread between yields on average interest-earning assets and rates paid on average interest-bearing liabilities) was 3.53%, 2.98% and 2.78% for the years ended December 31, 2010, 2009 and 2008, respectively.
Comparative Statement Analysis
(1)Yields on securities available-for-sale have been calculated on the basis of historical cost and do not give effect to changes in the fair value of those securities, which is reflected as a component of shareholders' equity.
(2)Presented on a taxable-equivalent basis using the statutory federal income tax rate of 34%. Taxable-equivalent adjustments of $158 thousand in 2010, $123 thousand in 2009 and $177 thousand in 2008 are included in the calculation of the tax-exempt investment securities interest income.
(3)Presented on a taxable-equivalent basis using the statutory federal income tax rate of 34%. Taxable-equivalent adjustments of $134 thousand in 2010, $86 thousand in 2009 and $57 thousand in 2008 are included in the calculation of the loan interest income. Loans placed on nonaccrual status are included in average balances. Net loan fees included in interest income totaled $90 thousand in 2010, $28 thousand in 2009 and $24 thousand in 2008.
Rate/Volume Analysis
The following table indicates the changes in interest income and interest expense that are attributable to changes in average volume and average rates, in comparison with the same period in the preceding year. The change in interest due to the combined rate-volume variance has been allocated entirely to the change in rate.
Noninterest Income
Noninterest income was $849 thousand in 2010, $775 thousand in 2009 and $576 thousand in 2008, attributable primarily to service fees on deposit accounts and ATM interchange fees. Included in the noninterest income are securities gains of $283 thousand in 2010 and $235 thousand in 2009. Also included in noninterest income for 2009 is a loss of $37 thousand on the sale of foreclosed property, whereas no gain or loss was recognized in 2010.
Noninterest Expenses
Noninterest expenses were $7.96 million in 2010, $6.79 million in 2009 and $6.53 million in 2008. See Note 12 to the consolidated financial statements for a schedule showing a detailed breakdown of the Company's noninterest expenses. The primary increase in noninterest expense in 2010 compared to 2009 relates to increases in salaries of $782 thousand, which includes $253 thousand of stock option compensation expense in 2010, as compared to no option expense in 2009, an increase in audit fees of $100 thousand which covers external audit, internal audit, loan review, and compliance audits, an increase in 401(k) matching contributions of $93 thousand, reflecting the resumption of matching contributions in 2010, and increased advertising expenses of $53 thousand. Salaries expense was also
impacted in 2010 due to promotions at the end of 2009, additional personnel for compliance, retail lending and staffing for the anticipated new branch opening in the third quarter of 2011, along with a merit increase for all employees.
Income Taxes
The Company incurred $626 thousand, $488 thousand and $441 thousand of income tax expenses in 2010, 2009 and 2008. The effective tax rates are 35.15% for 2010, 31.77% for 2009 and 29.82% for 2008. The increase in income tax rate in 2010 is primarily due to the higher pre-tax income and the impact of the $253 thousand of stock option compensation expense with the associated tax benefit of $49 thousand being recorded as additional paid in capital and not used to reduce the current period's income tax expense. The increase in the income tax rate for 2009 was due to a lower amount of tax-exempt interest income as a percentage of pre-tax income.
Market Risk, Liquidity and Interest Rate Sensitivity
Asset/liability management involves the funding and investment strategies necessary to maintain an appropriate balance between interest sensitive assets and liabilities. It also involves providing adequate liquidity while sustaining stable growth in net interest income. Regular review and analysis of deposit and loan trends, cash flows in various categories of loans, and monitoring of interest spread relationships are vital to this process.
The conduct of our banking business requires that we maintain adequate liquidity to meet changes in the composition and volume of assets and liabilities due to seasonal, cyclical or other reasons. Liquidity describes the ability of the Company to meet financial obligations that arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the customers of the Company, as well as for meeting current and future planned expenditures. This liquidity is typically provided by the funds received through customer deposits, investment maturities, loan repayments, borrowings, and income. Management considers the current liquidity position to be adequate to meet the needs of the Company and its customers.
The Company seeks to limit the risks associated with interest rate fluctuations by managing the balance between interest sensitive assets and liabilities. Managing to mitigate interest rate risk is, however, not an exact science. Not only does the interval until repricing of interest rates on assets and liabilities change from day to day as the assets and liabilities change, but for some assets and liabilities, contractual maturity and the actual maturity experienced are not the same. Similarly, NOW and money market accounts, by contract, may be withdrawn in their entirety upon demand and savings deposits may be withdrawn on seven days notice. While these contracts are extremely short, it is the Company's belief that these accounts turn over at the rate of five percent (5%) per year. The Company therefore treats them as having maturities ratably over all periods. If all of the Company's NOW, money market, and savings accounts were treated as repricing in one year or less, the Company would have a cumulative negative gap at one year or less of $(42.99) million.
Interest rate sensitivity is an important factor in the management of the composition and maturity configurations of the Company's earning assets and funding sources. An Asset/Liability Committee manages the interest rate sensitivity position in order to maintain an appropriate balance between the maturity and repricing characteristics of assets and liabilities that is consistent with the Company's liquidity analysis, growth, and capital adequacy goals. It is the objective of the Asset/Liability Committee to maximize net interest margins during periods of both volatile and stable interest rates, to attain earnings growth, and to maintain sufficient liquidity to satisfy depositors' requirements and meet the funding needs of the Company's loan production.
The following table, "Interest Rate Sensitivity Gap Analysis," summarizes, as of December 31, 2010, the anticipated maturities or repricing of the Company's interest-earning assets and interest-
bearing liabilities, the Company's interest rate sensitivity gap (interest-earning assets less interest-bearing liabilities), the Company's cumulative interest rate sensitivity gap, and the Company's cumulative interest sensitivity gap ratio (cumulative interest rate sensitivity gap divided by total assets). A negative gap for any time period means that more interest-bearing liabilities will reprice or mature during that time period than interest-earning assets. During periods of rising interest rates, a negative gap position would generally decrease earnings, and during periods of declining interest rates, a negative gap position would generally increase earnings. The converse would be true for a positive gap position. Therefore, a positive gap for any time period means that more interest-earning assets will reprice or mature during that time period than interest-bearing liabilities. During periods of rising interest rates, a positive gap position would generally increase earnings, and during periods of declining interest rates, a positive gap position would generally decrease earnings.
It is important to note that the following table represents the static gap position for interest sensitive assets and liabilities at December 31, 2010. The table does not give effect to prepayments or extensions of loans as a result of changes in general market interest rates. Moreover, it does not account for timing differences that occur during periods of repricing. For example, changes to deposit rates traditionally tend to lag in a rising rate environment and lead in a falling rate environment, although this will not always be the case. Nor does it account for the effects of competition on pricing of deposits and loans. For example, under current market conditions, market rates paid on deposits may not be able to adjust by the full amount of downward adjustments in the federal funds target rate, while rates on loans will tend to adjust by the full amount, subject to certain limitations. During 2009, the Company began to place interest rate floors on its commercial floating rate loans.
Interest Rate Sensitivity Gap Analysis
December 31, 2010
(1)Excludes equity securities.
In addition to the Interest Rate Sensitivity Gap Analysis, the Company also uses an earnings simulation model on a quarterly basis to closely monitor interest sensitivity and to expose its balance sheet and income statement to different scenarios. The model is based on period end Company data and adjusted by assumptions as to growth patterns, noninterest income and noninterest expense and interest rate sensitivity, based on historical data, for both assets and liabilities projected for a one-year period. The model is then subjected to a "shock test" assuming a sudden interest rate increase of 200 basis points or a decrease of 200 basis points, but not below zero. The results show that with a 200 basis point rise in interest rates, the Company's net interest income would decline by 0.96%. However, a decrease in interest rates of 200 basis points was not considered to be feasible since this would imply that the federal funds rate would fall below zero.
Certain shortcomings are inherent in this method of analysis. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase.
Investment Portfolio
The investment portfolio is used as a source of interest income, credit risk diversification and liquidity, as well as to manage rate sensitivity and provide collateral for secured public funds, repurchase agreements and other short-term borrowings. Management has historically emphasized investments with a weighted-average life of seven years or less to provide greater flexibility in managing the balance sheet in changing interest rate environments. At December 31, 2010, the mortgage-backed debt securities had a weighted-average life of 6.50 years, and the municipal securities had a weighted-average life of 8.17 years, giving the total investment portfolio a weighted-average life of 5.89 years. The average tax-equivalent yield earned on the investment portfolio for 2010, 2009 and 2008 was 3.37%, 4.66% and 5.29%, respectively. The mortgage-backed securities portfolio does not include any private label, subprime or Alt-A type investments, which would carry a higher degree of risk.
The Company had $13.65 million in bonds in an unrealized loss position amounting to $271 thousand at December 31, 2010 that were temporarily impaired due to the current interest rate environment and not increased credit risk. In estimating other-than-temporary impairment losses, the Company considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near term prospects of the issuer, and (iii) the intent and the ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost. The Company had no investments that were obligations of the issuer, or payable from or secured by a source of revenue or taxing authority of the issuer, whose aggregate book value exceeded 10% of shareholders' equity at December 31, 2010.
The following tables set forth certain information regarding the Company's investment portfolio at the dates indicated.
Available-for-Sale Portfolio
Loan Portfolio
The Company makes real estate construction and land development, real estate mortgage, commercial and industrial, and consumer loans. The real estate mortgage loans are generally secured by the property and have a maximum loan to value ratio at origination of 75% and generally a term of one to five years. The Company does not make it a practice of establishing an interest reserve account as part of the loan funding amount. The commercial and industrial loans consist of secured and unsecured loans. The unsecured commercial loans are made based on the financial strength of the borrower and usually require personal guarantees from the principals of the business. The collateral for the secured commercial loans may be equipment, accounts receivable, marketable securities or deposits in the Bank. These loans typically have a maximum loan to value ratio at origination of 75% and a term of one to five years. The consumer loan category consists of secured and unsecured loans. The unsecured consumer loans are made based on the financial strength of the individual borrower. The collateral for secured consumer loans may be marketable securities, automobiles, recreational vehicles or deposits in the Bank. The usual term for these loans is three to five years.
The following table sets forth the distribution of the Company's loan portfolio at the dates indicated by category of loan and the percentage of loans in each category to total loans.
As of December 31, 2010, the real estate loan portfolio constituted 87% of the total loan portfolio. While this exceeds the 10% threshold for determining a concentration of credit risk within an industry, we do not consider this to be a concentration with adverse risk characteristics given the diversity of borrowers within the real estate portfolio and other sources of repayment. An industry for this purpose is defined as a group of counterparties that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The loan portfolio does not include concentrations of credit risk in loan products that permit the deferral of principal payments or payments that are smaller than normal interest accruals (negative amortization); loans with high loan-to-value ratios; and loans, such as option adjustable-rate mortgages, that may expose the borrower to future increases in repayments that are in excess of increases that would result solely from increases in market interest rates. The Company has $9.57 million and $8.66 million in outstanding balances of interest-only home equity lines of credit at December 31, 2010 and 2009, respectively.
During 2010, the balance of loans in the construction and land development category has remained constant. However, over the past three years, the Company intentionally limited the origination of real estate construction and land development loans, raising credit standards, as management believed the market for projects being financed was becoming overheated.
Under guidance by the federal banking regulators, banks which have concentrations in construction, land development or commercial real estate loans (other than loans for majority owner occupied properties) would be expected to maintain higher levels of risk management and, potentially, higher levels of capital. It is possible that we may be required to maintain higher levels of capital than we would otherwise be expected to maintain as a result of our levels of construction, development and commercial real estate loans, which may require us to obtain additional capital. The Company monitors the level of construction and land development, and non-owner occupied commercial real estate loans in relation to its total risk-weighted capital on at least a quarterly basis. The banking regulators have established guidance limits of 100% and 300% of total risk-weighted capital for construction and land development, and non-owner occupied commercial real estate loans, respectively. These ratios as of December 31, 2010 were 48.97% for construction and land development loans and 180.13% for non-owner occupied commercial real estate loans. While our level of loans in these areas is below the percentages established in the regulatory guidance, there can be no assurance that we will not be required to maintain higher levels of capital as a result of our concentration of loans.
Maturity and Interest Rate Sensitivity of Loans
The following table presents the maturities or repricing periods of loans outstanding at December 31, 2010.
Allowance for Loan Losses
The Company makes provisions for loan losses in amounts deemed necessary to maintain the allowance for loan losses at an appropriate level. The provision for loan losses is determined based upon management's estimate of the amount required to maintain an adequate allowance for loan losses reflective of the risks in the Company's loan portfolio. The Company's provision for loan losses in 2010, 2009 and 2008 were $1.66 million, $1.18 million and $935 thousand, respectively. The increase in the provision for loan losses in 2010 compared to 2009 and 2008 is primarily due to the an increase in the amount of substandard loans, which require higher levels of reserves, along with an increase in gross charge-offs incurred in 2010 of $1.28 million as compared to $1.17 million in 2009 and $465 thousand in 2008. At December 31, 2010, the allowance for loan losses was $3.72 million or 1.78% of total loans.
The Company prepares a quarterly analysis of the allowance for loan losses, with the objective of quantifying portfolio risk into a dollar amount of inherent losses. The determination of the allowance for loan losses is based on eight qualitative factors and one quantitative factor for each category and type of loan along with any specific allowance for adversely classified loans within each category. Each factor is assigned a percentage weight and that total weight is applied to each loan category. Factors are different for each category. Qualitative factors include: levels and trends in delinquencies and nonaccrual loans; trends in volumes and terms of loans; effects of any changes in lending policies, the experience, ability and depth of management; national and local economic trends and conditions; concentrations of credit; quality of the Company's loan review system; and regulatory requirements. The total allowance required thus changes as the percentage weight assigned to each factor is increased or decreased due to the particular circumstances, as the various types and categories of loans change as a percentage of total loans and as specific allowances are required due to increases in adversely classified loans. See Note 1 to the consolidated financial statements for additional information regarding the determination of the provision and allowance for loan losses.
The Company follows the guidance of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 450 Contingencies and ASC Topic 310 Receivables. This guidance requires that losses be accrued when they are probable of occurring and estimable and requires that impaired loans, within its scope, be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. This guidance excludes smaller balance and homogeneous loans, which are collectively evaluated for impairment, from impairment reporting. Therefore, the Company has designated consumer and residential mortgage loans to be excluded for this purpose. From the remaining loan portfolio, loans rated as doubtful or worse, classified as nonaccrual, and troubled debt restructurings may be evaluated for impairment. Slow payment on a loan is considered, by the Company, to only be a minimum delay.
Loans are evaluated for nonaccrual status when principal or interest is delinquent for 90 days or more and are placed on nonaccrual status when a loan is specifically determined to be impaired. Any unpaid interest previously accrued on those loans is reversed from income. Any interest payments subsequently received are recognized as income unless, in management's opinion, a potential for loss remains. Interest payments received on loans, where management believes a potential for loss remains, are applied as a reduction of the loan principal balance.
Management believes that the allowance for loan losses is adequate. There can be no assurance, however, that adjustments to the provision for loan losses will not be required in the future. Changes in the economic assumptions underlying management's estimates and judgments; adverse developments in the economy, on a national basis or in the Company's market area; or changes in the circumstances of particular borrowers are criteria that could change and make adjustments to the provision for loan losses necessary.
The following table reflects activity in the allowance for loan losses for the periods indicated.
Problem Assets
The following table reflects the Company's problem assets at the dates indicated. Except as reflected in the tables, there were no other interest-bearing assets at December 31, 2010 classifiable as nonaccrual, 90 days past due or problem assets.
Information concerning the Company's recorded investment in impaired loans is as follows:
At December 31, 2010, there were $14.96 million of impaired loans with no specific reserves that consisted of two (2) construction loans in the aggregate amount to $2.04 million, fourteen (14) commercial real estate loans in the aggregate amount of $8.36 million, one (1) residential mortgage loan for $364 thousand and ten (10) commercial and industrial loans totaling $4.18 million. By comparison at December 31, 2009 there were $7.97 million of impaired loans which required no specific reserves consisting of six (6) commercial real estate loans in the aggregate amount of $2.56 million, five (5) commercial and industrial loans totaling $3.28 million and three (3) construction loans for an aggregate of $2.13 million at December 31, 2009. In addition at December 31, 2010, there were $6.03 million of impaired loans, which required specific reserves totaling $1.24 million, that consisted of one (1) construction loan for $365 thousand, eleven (11) commercial real estate loans in the aggregate amount of $4.73 million, one (1) residential mortgage loan for $517 thousand and three (3) commercial and industrial loans totaling $414 thousand compared to $4.98 million of impaired loans, which required specific reserves totaling $600 thousand, that consisted of one (1) construction
loan for $365 thousand, seven (7) commercial real estate loans in the aggregate amount of $3.85 million, two (2) commercial and industrial loans totaling $239 thousand and one (1) residential mortgage loan for $525 thousand at December 31, 2009.
The increase in impaired loans is primarily related to two (2) commercial real estate loan relationships, aggregating $6.39 million, with no missed payments as of December 31, 2010 and one (1) commercial and industrial loan relationship totaling $790 thousand, with missed payment history, which required specific reserves of $213 thousand at December 31, 2010. These credits have been experiencing some cash flow problems, which causes the Company to have concerns about the ability of the borrowers to continue to perform in accordance with the current terms of the loan.
There are no loans that had a specific allowance as of December 31, 2009 that are still in the Company's loan portfolio as of December 31, 2010 where the specific allowance has been reduced or eliminated.
Loans are placed into a nonaccruing status and classified as nonperforming when the principal or interest has been in default for a period of 90 days or more unless the obligation is well secured and in the process of collection. A debt is "well secured" if it is secured by (i) pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt, (including accrued interest), in full, or (ii) the guarantee of a financially responsible party. A debt is "in the process of collection" if collection on the debt is proceeding in due course either through legal action, including judgment enforcement procedure, or, in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to a current status.
Loans classified as substandard or worse are considered for impairment testing. A substandard loan shows signs of continuing negative financial trends and unprofitability and therefore, is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. The borrower on such loans typically exhibit one or more of the following characteristics: financial ratios and profitability margins are well below industry average; a negative cash flow position exists; debt service capacity is insufficient to the service debt and an improvement in the cash flow position is unlikely within the next twelve months; secondary and tertiary means of debt repayment are weak. Loans classified as substandard are characterized by the probability that the Bank will not collect amounts due according to the contractual terms or sustain some loss if the deficiencies are not corrected.
Loss potential, while existing with respect to the aggregate amount of substandard (or worse) loans, does not have to exist in any individual assets classified as substandard. Such credits are also evaluated for nonaccrual status.
Impaired loans include loans that have been classified as substandard or worse. However, certain of such loans have been paying as agreed and have remained current, with some financial issues related to cash flow that has caused some concern as to the ability of the borrower to perform in accordance with the current loan terms, but it has not been extreme enough to require the loan be put into a nonaccruing status. At December 31, 2010, there were $18.79 million of such loans.
The Company does not have a formal modification program such as the Making Home Affordable Program, but instead uses a system whereby loans are modified on a case-by-case basis, based upon an analysis of the individual borrower's situation and the causes of the weakness in the individual loan. To date, loan modifications have primarily involved commercial real estate mortgages and commercial and industrial loans and have included reducing the interest rate on the loan to a level that is in line with current market rates for similar type loans, converting to an interest only period, usually six to twelve months, or re-amortizing the loan. During 2010, the Company has made concessions on only a few residential mortgage loans which included reducing the interest rate on two (2) residential mortgage
loans in the amount $841 thousand and an interest only period of six to twelve months for a $473 thousand residential loan.
Troubled debt restructured loans, which are included in the total of impaired loans, amounted to $10.44 million as of December 31, 2010: loans converted to interest only periods for six to twelve months in the amount of $6.18 million, reduced interest rates on loans in the amount of $629 thousand, and loans that have been re-amortized in the amount of $3.63 million. These loans have specific reserves of $1.08 million based on the collateral value.
As noted above the Company does not have a formal modification program; however, it had four (4) loan relationships as of December 31, 2010 that had been modified and then subsequently re-defaulted. The first of these loan relationships involves a $760 thousand commercial real estate loan, the second involves a $612 thousand commercial real estate loan, the third is a commercial and industrial loan in the amount of $178 thousand and the last is a $70 thousand commercial real estate loan.
Loans classified as non-performing are nonaccrual loans and loans 90 days or more past due. The Company does not have any loans 90 days or more past due that are still in an accruing status. If a loan has been modified and it is current as to principal and interest for a period of at least six months then it is classified as a performing loan, otherwise it is considered to be a non-performing loan.
The Company's charge-off policy states after all collection efforts have been exhausted and the loan is deemed to be a loss, it will be charged to the Company's established allowance for loan losses. Consumer loans subject to the Uniform Retail Credit Classification are charged-off as follows: (a) closed end loans are charged-off no later than 120 days after becoming delinquent, (b) consumer loans to borrowers who subsequently declare bankruptcy, where the Company is an unsecured creditor, are charged-off within 60 days of receipt of the notification from the bankruptcy court, (c) fraudulent loans are charged-off within 90 days of discovery and (d) death of a borrower will cause a charge-off to be incurred at such time an actual loss is determined. All other types of loans are generally evaluated for loss potential at the 90th day past due threshold, and any loss is recognized no later than the 120th day past due threshold; each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
The Company does not normally engage in partial charge-offs and has only incurred one (1) in the amount of $70,000 for a residential real estate loan for the year ended December 31, 2010.
The allocation of the allowance, presented in the following table, is based primarily on the factors discussed above in evaluating the adequacy of the allowance as a whole. Since all of those factors are subject to change, the allocation is not necessarily indicative of the category of future loan losses, and does not restrict the use of the allowance to absorb losses in any category.
Allocation of Allowance for Loan Losses
Deposits
The principal sources of funds for the Company are core deposits (demand deposits, interest-bearing transaction accounts, money market accounts, savings deposits and certificates of deposit) from the Company's market area. The Company's deposit base includes transaction accounts, time and savings accounts and other accounts that customers use for cash management purposes and which provide the Company with a source of fee income and cross-marketing opportunities as well as a low-cost source of funds. Time and savings accounts, including money market deposit accounts, also provide a relatively stable low-cost source of funding.
Approximately 56.0% and 49.7% of the Company's deposits at December 31, 2010 and 2009 are made up of time deposits, which are generally the most expensive form of deposit because of their fixed rate and term. Time deposits in denominations of $100,000 or more can be more volatile and more expensive than time deposits of less than $100,000. However, because the Bank focuses on relationship banking, and most of these deposits are obtained from the local community, historical experience has been that large time deposits have not been more volatile or significantly more volatile or expensive than smaller denomination certificates. The Company does not have any brokered deposits as of December 31, 2010, 2009 or 2008.
The following tables provide a summary of the Company's deposit base at the dates indicated and the maturity distribution of certificates of deposit of $100,000 or more as of December 31, 2010, 2009, and 2008.
Average Deposits and Average Rate
Maturities of Certificates of Deposit-$100,000 or More
Borrowings
For liquidity purposes and for customer convenience, the Company also utilizes short-term borrowings, which includes federal funds lines of credit to purchase overnight funds from correspondent banks and an unsecured line of credit for Bancorp. The Company also offers retail repurchase agreements, which are securities sold under an agreement to repurchase, which is considered to be a short-term borrowing. There were no retail repurchase agreements outstanding at December 31, 2010, 2009 or 2008. The following table set forth certain information regarding the Company's short-term borrowings at the dates indicated.
Short-Term Borrowings
The short-term borrowings at December 31, 2010 consist of an unsecured revolving line of credit borrowing arrangement from an unaffiliated financial institution in the amount of $300 thousand at a floating interest rate equal to the Wall Street Journal prime rate plus 0.50%, subject to a minimum rate of 4.25%, that matures on July 22, 2011. The Company's unused lines of credit for short-term borrowings totaled $7.70 million and $7.50 million at December 31, 2010 and 2009, respectively. These include an unsecured line of credit from an unaffiliated financial institution for Bancorp in the amounts of $3.70 million and $3.50 million as of December 31, 2010 and 2009, respectively, and an unsecured federal funds line of credit from an unaffiliated financial institution for the Bank in the amount of $4.00 million at December 31, 2010 and 2009.
Long-Term Borrowings
At December 31, 2010 and 2009, the Company had $10.00 million in borrowings under its credit facility from the Federal Home Loan Bank of Atlanta ("FHLB"). There are two advances in the amounts of $5.00 million each, which bear interest rates of 3.29% and 3.05%, and each of which matures on November 19, 2015. Outstanding advances are secured by collateral consisting of a blanket lien on qualifying loans in the Bank's residential mortgage loan portfolio.
Trust Preferred Securities/Junior Subordinated Debentures
In December 2006, Bancorp completed the private placement of an aggregate of $6.00 million of trust preferred securities through FCBI Statutory Trust I (the "Trust"), a newly formed trust subsidiary organized under Connecticut law, of which Bancorp owns all $186 thousand of the common securities. The principal asset of the Trust is $6.186 million of Bancorp's junior subordinated debentures. The junior subordinated debentures bear interest at a fixed rate of 6.5375% until December 15, 2011, at which time the interest rate becomes a variable rate, adjusted quarterly, equal to 163 basis points over three-month LIBOR. The junior subordinated debentures mature on December 15, 2036, and may be redeemed at par, at Bancorp's option, on any interest payment date commencing December 15, 2011. The securities are redeemable prior to December 15, 2011, at a premium ranging up to 103.525% of the principal amount thereof, upon the occurrence of certain regulatory or legal events. The obligations of Bancorp with respect to the Trust's preferred securities constitute a full and unconditional guarantee by Bancorp of Trust's obligations with respect to the trust preferred securities to the extent set forth in the related guarantee. Subject to certain exceptions and limitations, Bancorp may elect from time to time to defer interest payments on the junior subordinated debentures, resulting in a deferral of distribution payments on the related trust securities. The proceeds from this issuance were used to repay a $450 thousand short-term debt obligation that matured in January 2007, capital injections of $4.50 million into the Bank, and the remaining proceeds were used to supplement the Company's capital for continued growth and other general corporate purposes. The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy purposes up to 25% of Tier 1 capital, net of goodwill, after its inclusion. The portion of the trust preferred securities not qualifying as Tier 1 capital may be included as part of total qualifying capital in Tier 2 capital, subject to limitation. At December 31, 2010, all of the trust preferred securities qualified as Tier 1 capital.
Capital Resources
The ability of the Company to grow is dependent on the availability of capital with which to meet regulatory capital requirements, discussed below. To the extent the Company is successful it may need to acquire additional capital through the sale of additional common stock, other qualifying equity instruments, subordinated debt or other qualifying capital instruments. There can be no assurance that additional capital will be available to the Company on a timely basis or on attractive terms. On December 15, 2006, the Company completed the issuance of $6.00 million of trust preferred securities, as discussed above that can be recognized as capital for regulatory purposes. The Company has an unsecured revolving line of credit borrowing arrangement with an unaffiliated financial institution in
the amount of $4.00 million with outstanding balances of $300 thousand and $500 thousand as of December 31, 2010 and 2009, respectively. This facility matures on July 22, 2011, has a floating interest rate equal to the Wall Street Journal prime rate plus 0.50%, subject to a minimum rate of 4.25%, and requires monthly interest payments only. The purpose of this facility is to provide capital to the Bank, as needed. The Company does not anticipate any issues with the renewal of this credit facility.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. The Company will be subject to additional requirements when its assets exceed $500 million, it has publicly issued debt or it engages in certain highly leveraged activities. 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 consolidated 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 the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification 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 of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined). Management believes that the Bank met all capital adequacy requirements to which it is subject as of December 31, 2010 and that the Company would meet such requirements if applicable. See Note 13 to the consolidated financial statements for a table depicting compliance with regulatory capital requirements.
As of December 31, 2010, the most recent notification from the regulatory agency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table in Note 13 to the consolidated financial statements. There are no conditions or events since that notification which management believes have changed the Bank's category.
On June 26, 2007, the Company authorized the repurchase of up to 146,000 shares of its common stock, for an aggregate expenditure of not more than $4.50 million, through June 30, 2012, or earlier termination of the program by the Board of Directors. Repurchases, if any, by the Company pursuant to this authorization are expected to enable the Company to repurchase its shares at an attractive price, and to provide a source of liquidity for the Company's shares. As of December 31, 2010, 5,118 shares have been repurchased by the Company.
The Bank's capital ratios significantly exceed the regulatory requirements for well capitalized banks, with its ratios of 13.81% and 12.56% for Total Risk-Based Capital and Tier 1 Capital, respectively, compared to the regulatory minimums to be well capitalized of 10.00% and 6.00%, and compared to ratios of 12.80% and 11.55% at December 31, 2009. The increase in the Bank's capital ratios over the course of 2010 resulted primarily from retained earnings of $1.44 million and the shifting of risk-weighted assets to lower weighted categories. Management of the Company believes that its level of existing capital is adequate to support continued successful implementation of the Company's business plan without the need for government capital assistance. In light of regulatory pressures on substantially all banks, and the Company's desire, to maintain capital levels in excess of the minimum requirements for well capitalized status, the Company has relatively little room for asset growth without an additional capital infusion, through borrowing or through the issuance of additional capital stock.
Inflation
The effect of changing prices on financial institutions is typically different than on non-banking companies since virtually all of a bank's assets and liabilities are monetary in nature. In particular, interest rates are significantly affected by inflation, but neither the timing nor magnitude of the changes are directly related to price level indices; therefore, the Company can best counter inflation over the long term by managing net interest income and controlling net increases in noninterest income and expenses.
Off-Balance Sheet Arrangements
With the exception of the Company's obligations in connection with its trust preferred securities and in connection with its irrevocable letters of credit and loan commitments, the Company has no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors. For additional information on off-balance sheet arrangements, please see "Note 1-Nature of Operations and Significant Accounting Policies-Recent Accounting Pronouncements," "Note 9-Leasing Arrangements," "Note 16-Transactions with Related Parties-Lease Agreement" and "Note 17-Commitment and Contingencies" to the consolidated financial statements.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Frederick County Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records, that in reasonable detail, accurately and fairly reflect the transactions and disposition of the Company's assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of the financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with the authorizations of Company's management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material impact on the financial statements. The internal control system contains monitoring mechanisms, and appropriate actions taken to correct identified deficiencies. The Audit Committee of the Board of Directors (the "Committee"), is comprised entirely of outside directors who are independent of management. The Committee is responsible for the appointment and compensation of the independent auditors and makes decisions regarding the appointment or removal of members of the internal audit function. The Committee meets periodically with management, the independent registered public accounting firm, and the internal auditors to ensure that they are carrying out their responsibilities. The Committee is also responsible for performing an oversight role by reviewing and monitoring the financial, accounting, and auditing procedures of the Company in addition to reviewing the Company's financial reports. The independent registered public accounting firm and the internal auditors have full and unlimited access to the Audit Committee, with or without the presence of management, to discuss the adequacy of internal control over financial reporting, and any other matters which they believe should be brought to the attention of the Audit Committee.
There are inherent limitations in the effectiveness of any internal control system, including the possibility of human error and the circumvention or overriding of internal controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. In addition, because of changes in conditions and circumstances, the effectiveness of internal control over financial reporting may vary over time and controls may become inadequate, and the degree of compliance with the policies and procedures may deteriorate, over time.
Under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, the Company conducted an evaluation of the effectiveness of the internal control over financial reporting based on the framework in "Internal Control-Integrated Framework" promulgated by the Committee of Sponsoring Organizations of the Treadway Commission, commonly referred to as the "COSO" criteria. Based on this evaluation under the "COSO" criteria, management concluded that the Company's internal control over financial reporting was effective as of December 31, 2010. Management's assessment concluded that there were no material weaknesses within the Company's internal control over financial reporting.
There was no change in the Company's internal control over financial reporting that occurred during the fourth quarter of 2010 that has materially affected or is likely to materially affect, the Company's internal control over financial reporting.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. As the Company is a smaller reporting company, management's report is not required to be attested to by the Company's registered public accounting firm.
DISCLOSURE CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated, as of the last day of the period covered by this report, the effectiveness of the design and operation of the Company's disclosure controls and procedures, as defined in Rule 13a-15 under the Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective.
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Frederick County Bancorp, Inc.
Frederick, Maryland
We have audited the accompanying consolidated balance sheets of Frederick County Bancorp, Inc. and Subsidiaries (the "Company") as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the years then ended. 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 audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 audit 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Frederick County Bancorp, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
Baltimore, Maryland
February 15, 2011
Frederick County Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
See Notes to Consolidated Financial Statements.
Frederick County Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income
See Notes to Consolidated Financial Statements.
Frederick County Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
See Notes to Consolidated Financial Statements.
Frederick County Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
See Notes to Consolidated Financial Statements.
FREDERICK COUNTY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1. Nature of Operations and Significant Accounting Policies:
Frederick County Bancorp, Inc. (the "Bancorp"), the parent company for its wholly-owned subsidiary Frederick County Bank (the "Bank" and together with Bancorp, the "Company"), was organized in September 2003. The Bank was incorporated under the laws of the State of Maryland in August 2000 and commenced banking operations in October 2001. The Bank provides its customers with various banking services. The Bank offers various loan and deposit products to their customers. The Bank's customers include individuals and commercial enterprises within its principal market area consisting of Frederick County, Maryland. The Company also has a subsidiary trust, established to issue trust preferred securities, and two subsidiaries established to hold foreclosed properties. The two subsidiaries established to hold foreclosed properties are known as FCB Holdings, Inc (a direct subsidiary of Bancorp) and FCB Hagerstown, LLC (an indirect subsidiary of Bancorp). See Note 8 for additional disclosures for the subsidiary trust.
Additionally, the Bank maintains correspondent banking relationships and transacts daily federal funds sales on an unsecured basis with regional correspondent banks. Note 3 discusses the types of securities the Bank invests in. Note 4 discusses the types of lending that the Bank engages in. The Bank does not have any significant concentrations to any one industry or customer.
The accounting and reporting policies and practices of the Company conform with accounting principles generally accepted in the United States of America. The following is a summary of the Company's significant accounting policies:
Principles of consolidation:
The accompanying consolidated financial statements include the accounts of the Company and the Bank.
In consolidation, all significant intercompany balances and transactions have been eliminated.
The Company also has an investment in FCBI Statutory Trust I, a statutory trust that is not consolidated in accordance with Accounting Standards Codification ("ASC") Topic 810 Consolidation. See Note 8.
Use of estimates:
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Comprehensive income:
Accounting principles generally require 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 available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.
Presentation of cash flows:
For purposes of reporting cash flows, cash and cash equivalents includes cash on hand, amounts due from banks (including cash items in process of clearing) and interest-bearing deposits in banks with
an original maturity of 90 days or less, and federal funds sold. Generally, federal funds are sold for one-day periods.
Investment securities:
Securities classified as held-to-maturity are those debt securities the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost, adjusted for amortization of premium and accretion of discount, computed using the interest method, over their contractual lives.
Securities classified as available-for-sale are equity securities with readily determinable fair values and those debt securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movement in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. These securities are carried at estimated fair value based on information provided by a third party pricing service with any unrealized gains or losses excluded from net income and reported in accumulated other comprehensive income (loss), which is reported as a separate component of shareholders' equity, net of the related deferred tax effect.
Dividend and interest income, including amortization of premium and accretion of discount arising at acquisition, from all categories of investment securities are included in interest income in the consolidated statements of income.
Gains and losses realized on sales of investment securities, determined using the adjusted cost basis of the specific securities sold, are included in noninterest income in the consolidated statements of income. Additionally, declines in the estimated fair value of individual investment securities below their cost that are other-than-temporary are reflected as realized losses in the statements of income. Factors affecting the determination of whether an other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or that management would not have the intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value.
Restricted stock is stock from the Federal Home Loan Bank ("FHLB") of Atlanta, the Federal Reserve Bank and the Atlantic Central Banker's Bank, which are restricted as to their marketability. Because no ready market exists for these investments and they have no quoted market value, the Bank's investment in these stocks are carried at cost.
Loans and allowance for loan losses:
Loans are carried at the amount of unpaid principal, adjusted for deferred loan fees and origination costs. Interest on loans is accrued based on the principal amounts outstanding. Nonrefundable loan fees and related direct costs are deferred and the net amount is amortized to income as a yield adjustment over the life of the loan using the interest method. When principal or interest is delinquent for ninety days or more, the Company evaluates the loan for nonaccrual status. After a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Subsequent collections of interest payments on nonaccrual loans are recognized as interest income unless ultimate collectability of the loan is in doubt. Cash collections on loans where ultimate collectability remains in doubt are applied as reductions of the loan principal balance and no interest income is recognized until the principal balance has been collected.
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any,
are credited to the allowance. The allowance is based on two basic principles of accounting: (i) ASC Topic 450 Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) ASC Topic 310 Receivables, which requires that losses be accrued based on the differences between the loan balance and either the value of collateral, if such loans are considered to be collateral dependent and in the process of collection, or the present value of future cash flows, or the loan's value as observable in the secondary market. A loan is considered impaired when, based on current information and events, the Company has concerns about the ability 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 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.
The Company's allowance for loan losses has three basic components: the specific allowance, the formula allowance and the pooled allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. As a result of the uncertainties inherent in the estimation process, management's estimate of loan losses and the related allowance could change in the near term.
The specific allowance component is used to individually establish an allowance for loans identified for impairment testing. When impairment is identified, a specific reserve may be established based on the Company's calculation of the estimated loss embedded in the individual loan. Impairment testing includes consideration of the borrower's overall financial condition, resources and payment record, support available from financial guarantors and the fair market value of collateral. These factors are combined to estimate the probability and severity of inherent losses. Large groups of smaller balance, homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately evaluate individual consumer and residential loans for impairment.
The formula allowance component is used for estimating the loss on internally risk rated loans exclusive of those identified as impaired. The loans meeting the Company's internal criteria for classification, such as special mention, substandard, doubtful and loss, as well as impaired loans, are segregated from performing loans within the portfolio. These internally classified loans are then grouped by loan type (commercial, commercial real estate, commercial construction, residential real estate, residential construction or installment). Each loan type is assigned an allowance factor based on management's estimate of the associated risk, complexity and size of the individual loans within the particular loan category. Classified loans are assigned a higher allowance factor than non-classified loans due to management's concerns regarding collectability or management's knowledge of particular elements surrounding the borrower. Allowance factors increase with the worsening of the internal risk rating.
The pooled formula component is used to estimate the losses inherent in the pools of non-classified loans. These loans are then also segregated by loan type and allowance factors are assigned by management based on delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of management, national and local economic trends, concentrations of credit, results of the loan review system and the effect of external factors (i.e. competition and regulatory requirements). The allowance factors assigned differ by loan type.
Allowance factors and overall size of the allowance may change from period to period based on management's assessment of the above-described factors and the relative weights given to each factor.
In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require the Bank to make additions to the allowance for loan losses based on their judgments of collectibility based on information available to them at the time of their examination.
Loans are placed into a nonaccruing status and classified as nonperforming when the principal or interest has been in default for a period of 90 days or more unless the obligation is well secured and in the process of collection. A debt is "well secured" if it is secured by (i) pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt, (including accrued interest), in full, or (ii) the guarantee of a financially responsible party. A debt is "in the process of collection" if collection on the debt is proceeding in due course either through legal action, including judgment enforcement procedure, or, in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to a current status.
Loans classified as substandard or worse are considered for impairment testing. A substandard loan shows signs of continuing negative financial trends and unprofitability and therefore, is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. The borrower on such loans typically exhibit one or more of the following characteristics: financial ratios and profitability margins are well below industry average; a negative cash flow position exists; debt service capacity is insufficient to the service debt and an improvement in the cash flow position is unlikely within the next twelve months; secondary and tertiary means of debt repayment are weak. Loans classified as substandard are characterized by the probability that the Bank will not collect amounts due according to the contractual terms or sustain some loss if the deficiencies are not corrected.
Loss potential, while existing with respect to the aggregate amount of substandard (or worse) loans, does not have to exist in any individual assets classified as substandard. Such credits are also evaluated for nonaccrual status.
Impaired loans include loans that have been classified as substandard or worse. However, certain of such loans have been paying as agreed and have remained current, with some financial issues related to cash flow that has caused some concern as to the ability of the borrower to perform in accordance with the current loan terms, but it has not been extreme enough to require the loan be put into a nonaccruing status.
The Company's charge-off policy states after all collection efforts have been exhausted and the loan is deemed to be a loss, it will be charged to the Company's established allowance for loan losses. Consumer loans subject to the Uniform Retail Credit Classification are charged-off as follows (a) closed end loans are charged-off no later than 120 days after becoming delinquent, (b) consumer loans to borrowers who subsequently declare bankruptcy, where the Company is an unsecured creditor, are charged-off within 60 days of receipt of the notification from the bankruptcy court, (c) fraudulent loans are charged-off within 90 days of discovery and (d) death of a borrower will cause a charge-off to be incurred at such time an actual loss is determined. All other types of loans are generally evaluated for loss potential at the 90th day past due threshold, and any loss is recognized no later than the 120th day past due threshold; each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
Bank premises and equipment:
Bank premises and equipment are stated at cost less accumulated depreciation and amortization. The provision for depreciation is computed using straight-line and accelerated methods based on the estimated useful lives of the assets, which range from 5 to 10 years for bank equipment and 39 years for bank buildings. Leasehold improvements are amortized over the lesser of the terms of the leases or their estimated useful lives. Expenditures for improvements, which extend the life of an asset, are
capitalized and depreciated over the asset's remaining useful life. Gains or losses realized on the disposition of properties and equipment are reflected in the statements of income. Expenditures for repairs and maintenance are charged to operating expenses as incurred.
Foreclosed properties:
Foreclosed properties include properties that have been acquired in complete or partial satisfaction of a debt. These properties are initially recorded at fair value on the date of acquisition. Any write-downs at the time of acquisition are charged to the allowance for loan losses. Subsequent to acquisition, a valuation allowance is established, if necessary, to report these assets at the lower of (a) fair value minus estimated costs to sell or (b) cost. Gains and losses realized on the sale, and any adjustments resulting from periodic re-evaluation of this property are included in noninterest income or expense, as appropriate. Net costs of maintaining and operating the properties are expensed as incurred.
Stock-based compensation plan:
The Company maintains an Employee Stock Option Plan, which is described more fully in Note 10, and provides for grants of incentive and non-incentive stock options. This plan has been presented to and approved by the Company's shareholders.
Compensation cost for all stock-based awards is measured at fair value on date of grant and recognized over the service period for awards expected to vest. Such value is recognized as expense over the service period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience.
Income taxes:
Provisions for income taxes are based on taxes payable or refundable for the current year and deferred taxes on temporary differences between the amount of taxable income and pretax financial income and between the tax bases of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. In addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We recognize interest and penalties related to income tax matters in income tax expense.
Fair value measurements:
The Company follows the guidance of ASC Topic 825 Financial Instruments and ASC Topic 820 Fair Value Measurements and Disclosures. 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. This guidance clarifies that fair value is an exit price, representing the amount that would be received to sell and asset or paid to transfer a liability in an orderly transaction between market participants. Under this guidance, fair value measurements are not adjusted for transaction costs. This guidance 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).
Per share amounts:
Earnings per share ("EPS") are disclosed as basic and diluted. Basic EPS is generally computed by dividing net income by the weighted-average number of common shares outstanding for the period, whereas diluted EPS essentially reflects the potential dilution in basic EPS, determined using the treasury stock method, that could occur if other contracts to issue common stock were exercised.
Transfers of financial assets:
The Company accounts for transfers and servicing of financial assets in accordance with ASC Topic 860 Transfers and Servicing. Transfers of financial assets are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Valuation of long-lived assets:
The Company accounts for the valuation of long-lived assets under ASC Topic 360 Property, Plant and Equipment. This guidance requires that long-lived assets and certain identifiable intangible assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the long-lived asset is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Assets to be disposed of are reportable at the lower of the carrying amount or fair value, less costs to sell.
Segment reporting:
ASC Topic 280 Segment Reporting, requires that an enterprise report selected information about operating segments in its financial reports issued to its shareholders. Based on the analysis performed by the Company, management has determined that the Company only has one operating segment, which is commercial banking. The chief operating decision-makers use consolidated results to make
operating and strategic decisions, and therefore, are not required to disclose any additional segment information.
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board ("FASB") issued new guidance under ASC Topic 860 Transfers and Servicing, also known as Accounting Standards Update ("ASU") 2009-16, for guidance on the transfer and servicing of financial assets. This guidance eliminates the concept of a "qualifying special-purpose entity" from the original accounting guidance and removes the exception from applying FASB guidance on consolidation of variable interest entities, to qualifying special-purpose entities. This guidance is effective at the beginning of a reporting entity's first fiscal year that begins after November 15, 2009. The Company adopted this guidance on January 1, 2010 and it did not have a material impact on the Company's consolidated financial condition or results of operations.
In June 2009, the FASB issued new guidance under ASC Topic 810 Consolidation, also known as ASU 2009-17, for guidance on the consolidation of variable interest entities. This amends the original guidance, to require an enterprise to perform an analysis to determine whether the enterprise's variable interest or interests give it a controlling financial interest in a variable interest entity (VIE). This analysis identifies the primary beneficiary of a VIE as the enterprise that has both (a) the power to direct the activities of a VIE that most significantly impact the entity's economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE. Additionally, this new guidance requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining it has the power to direct the activities of the VIE that most significantly impact the entity's economic performance. It is effective at the beginning of a company's first fiscal year that begins after November 15, 2009. The Company adopted this guidance on January 1, 2010 and it did not have a material impact on the Company's consolidated financial condition or results of operations.
In January 2010, the FASB issued new guidance under ASC Topic 820 Fair Value Measurements and Disclosures, also known as ASU 2010-06, to improve disclosures about fair value measurements. The guidance requires entities to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the same. It also requires Level 3 reconciliation to be presented on a gross basis disclosing purchases, sales, issuances and settlements separately. The guidance is effective for interim and annual financial periods beginning after December 15, 2009 except for gross basis presentation for Level 3 reconciliation, which is effective for interim and annual periods beginning after December 15, 2010. The disclosure requirements effective for interim and annual financial periods beginning after December 15, 2009 have been adopted for the interim period ended March 31, 2010.
In July 2010, the FASB issued new guidance under ASC Topic 310 Receivables-Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses" also known as ASU 2010-20. The guidance requires entities to provide disclosures designed to facilitate financial statement users' evaluation of (i) the nature of credit risk inherent in the entity's portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segment. The required disclosures include, among other things, a roll forward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 will be effective for the Company's financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period will be required for the Company's financial statements that include periods beginning on or after January 1, 2011.
Note 2. Compensating Balances:
Compensating balance arrangements exist with various correspondent banks. These noninterest-bearing deposits are maintained in lieu of cash payments for standard bank services. The required balances amounted to $750 thousand at each of December 31, 2010 and 2009. In addition, for the reserve maintenance period in effect at December 31, 2010 and 2009, the Company was required to maintain balances of $350 thousand with the Federal Reserve Bank.
Note 3. Investments:
The amortized cost and estimated fair value of securities classified as available-for-sale at December 31, 2010 and 2009 are as follows:
Available-for-sale
Information pertaining to securities with gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:
The bonds in an unrealized loss position at December 31, 2010 were temporarily impaired due to the current interest rate environment and not increased credit risk. In estimating other-than-temporary impairment losses, the Company considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near term prospects of the issuer, and (iii) the intent and the ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost. All securities owned by the Company are payable at par at maturity. Of the temporarily impaired securities, eight (8) are government sponsored enterprise issued bonds (Federal National Mortgage Association, Government National Mortgage Association and Federal Home Loan Mortgage Corporation) rated AAA by Standard and Poor's, and nine (9) municipal bonds rated by Standard and Poor's or Moody's are as follows: four (4) rated AA+, one (1) rated AA-, one (1) rated A+, one (1) rated A2 and two (2) rated Aa2.
Included in the investment portfolio at December 31, 2010 and 2009 are securities carried at $5.89 million and $939 thousand, respectively, which are pledged for public fund deposits, to secure repurchase agreements and for other purposes as required and permitted by law.
Gross gains of $283 thousand and $235 thousand in 2010 and 2009, respectively, were realized from sales of investment securities available-for-sale.
Restricted Stock
The following table shows the amounts of restricted stock as of December 31, 2010 and 2009:
Note 4. Loans and Allowance for Loan Losses:
Loans consist of the following at December 31, 2010 and 2009:
Allowance for loan losses and recorded investment in loans for the years ended December 31, 2010 is summarized as follows:
Credit quality indicators as of December 31, 2010 are as follows:
Internally assigned grade:
Pass-loans in this category have strong asset quality and liquidity along with a multi-year track record of profitability.
Special mention-loans in this category are currently protected but are potentially weak. The credit risk may be relatively minor, yet constitute an increased risk in light of the circumstances surrounding a specific loan.
Substandard-loans in this category show signs of continuing negative financial trends and unprofitability and therefore, is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.
Commercial credit exposure-Credit risk profile by internally assigned grade
Consumer credit exposure-Credit risk profile by internally assigned grade
Information on impaired loans for the year ended December 31, 2010 is as follows:
At December 31, 2010 and 2009, nonaccrual loans are $2.20 million and $943 thousand, respectively.
An age analysis of past due loans as of December 31, 2010 is as follows:
Note 5. Bank Premises and Equipment:
Bank premises and equipment consisted of the following at December 31, 2010 and 2009:
Depreciation and amortization charged to operations amounted to $294 thousand in 2010 and $320 thousand in 2009.
Note 6. Deposits:
Certificates of deposit and other time deposits issued in denominations of $100 thousand or more totaled $47.57 million and $42.75 million at December 31, 2010 and 2009, respectively, and are included in interest-bearing deposits in the consolidated balance sheet.
At December 31, 2010, the maturity distribution of certificates of deposit are as follows:
Interest on deposits for the years ended December 31, 2010 and 2009 consists of the following:
Note 7. Borrowings:
During 2010 and 2009, the Company had no sales of securities under agreements to repurchase the same securities.
Short-term borrowings:
The Company's unused lines of credit for short-term borrowings totaled $7.70 million and $7.50 million at December 31, 2010 and 2009, respectively. These include an unsecured line of credit from an unaffiliated financial institution for Bancorp in the amounts of $3.70 million and $3.50 million as of December 31, 2010 and 2009, respectively, and an unsecured federal funds line of credit from an unaffiliated financial institution for the Bank in the amount of $4.00 million at December 31, 2010 and 2009.
Long-Term Borrowings
The Company has a secured line of credit with the Federal Home Loan Bank of Atlanta ("FHLB") in the amount of $19.48 million, which is secured by a blanket lien on its 1-4 family residential mortgage loan portfolio and certain commercial real estate loans. At December 31, 2010 and 2009, the Company had $10.00 million in borrowings under this credit facility from the FHLB. As of December 31, 2009, there were two convertible advances in the amounts of $5.00 million each, which are both at a rate of 4.56%, with maturity dates of April 27, 2012 and September 4, 2012, unless called earlier on September 4, 2010, by the FHLB. During 2010, these advances were converted to fixed rates of 3.29% and 3.05%, with a maturity of November 19, 2015.
Note 8. Trust preferred securities/junior subordinated debentures:
In December 2006, Bancorp completed the private placement of an aggregate of $6.00 million of trust preferred securities through FCBI Statutory Trust I (the "Trust"), a newly formed trust subsidiary organized under Connecticut law, of which Bancorp owns all of the common securities of $186 thousand. The principal asset of the Trust is a similar amount of Bancorp's junior subordinated debentures. The junior subordinated debentures bear interest at a fixed rate of 6.5375% until December 15, 2011, at which time the interest rate becomes a variable rate, adjusted quarterly, equal to 163 basis points over three-month LIBOR. The junior subordinated debentures mature on December 15, 2036, and may be redeemed at par, at Bancorp's option, on any interest payment date commencing December 15, 2011. The securities are redeemable prior to December 15, 2011, at a premium ranging up to 103.525% of the principal amount thereof, upon the occurrence of certain regulatory or legal events. The obligations of Bancorp with respect to the Trust's preferred securities constitute a full and unconditional guarantee by Bancorp of Trust's obligations with respect to the trust preferred securities to the extent set forth in the related guarantee. Subject to certain exceptions and limitations, Bancorp may elect from time to time to defer interest payments on the junior subordinated debentures, resulting in a deferral of distribution payments on the related trust preferred securities. If the Company defers interest payments on the junior subordinated debentures, or otherwise is in default of the obligations, the Company would be prohibited from making dividend payments to its shareholders.
The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy purposes up to 25% of Tier 1 capital, net of goodwill after its inclusion. The portion of the trust preferred securities not qualifying as Tier 1 capital may be included as part of total qualifying capital in Tier 2 capital, subject to limitation.
Note 9. Leasing Arrangements:
The Company leases branch and administrative office facilities under noncancellable operating lease arrangements whose maturity dates extend to July 2016. These leases contain options, which enable the Company to renew the leases at fair rental value for periods of 5 to 10 years. In addition to minimum rentals, certain leases have escalation clauses based upon various price indices and include provisions for additional payments to cover taxes, insurance and maintenance. See Note 16 for a discussion of the terms of a lease agreement with related parties. The total minimum rental commitment, including renewal periods under these leases at December 31, 2010 is outlined below:
Rent expense included in occupancy and equipment expenses amounted to $390 thousand in 2010 and $387 thousand in 2009.
Note 10. Employee Benefit Plans:
401(k) profit sharing plan:
The Company has a Section 401(k) profit sharing plan covering employees meeting certain eligibility requirements as to minimum age and years of service. Employees may make voluntary contributions to the Plan through payroll deductions on a pre-tax basis. The Company has the discretion to make matching contributions of 100% of the employee's contributions up to 4% of the employee's salary. In 2010 and 2009, the Company made matching contributions of 100%. In April 2009, the Company suspended the matching contribution for the remainder of 2009. A participant's account under the Plan, together with investment earnings thereon, is normally distributable, following retirement, death, disability or other termination of employment, in a single lump-sum payment.
The Company expensed contributions to the Plan in the amounts of $123 thousand in 2010 and $30 thousand in 2009.
Deferred compensation plan:
On January 28, 2002, the Board of Directors of the Bank approved the Frederick County Bank Executive and Director Deferred Compensation Plan (the "Plan"). The Plan was effective January 1, 2002 for certain executive employees and directors of the Bank. The purpose of the Plan is to (1) allow participants an opportunity to elect to defer the receipt of compensation ("Participant Compensation Deferral"), and (2) provide a vehicle for the Bank to credit amounts on a tax deferred basis for employee participants ("Employer Contribution Credit"). The Employer Contribution Credits are subject to various vesting restrictions and are available solely to Plan participants who are employees of the Bank. The Plan is intended to be a "top hat" plan under various provisions of the Employee Retirement Income Security Act of 1974, as amended.
Each Plan participant's account will be adjusted for credited interest or increases or decreases in the realizable net asset value, as applicable, of the designated deemed Plan investments. Benefit payments under the Plan, which in the aggregate equal the participant's vested account balance, will be paid in a lump sum or in five or ten substantially equal, annual installments, commencing on the date or dates selected by the Plan's participants.
No amounts have been deferred or were expensed under this Plan in the accompanying consolidated statements of income for 2010 or 2009.
Stock-based compensation plan:
The Company's 2001 Stock Option Plan ("2001 Plan") provides that 260,000 shares of the Company's common stock will be reserved for the granting of both incentive stock options ("ISO") and non-incentive stock options ("NQSO") to purchase these shares. At December 31, 2010, there are 5,240 shares remaining that are reserved for future grants under this plan. The exercise price per share shall not be less than the fair market value of a share of common stock on the date on which such options were granted, subject to adjustments for the effects of any stock splits or stock dividends, and may be exercised not later than ten years after the grant date.
The following is a summary of transactions in the 2001 Plan during the years ended December 31, 2010 and 2009.
As noted in the table above, there were 118,700 and 3,000 options granted in 2010 and 2009, respectively. The Company recognizes the cost of employee services received in exchange for an award of equity investment based on the grant-date fair value of the award. That cost will be recognized over the vesting period of the award. Stock-based compensation expense related to stock options for the years ended December 31, 2010 and 2009 was $253 thousand and $3 thousand. As of December 31, 2010, there was $130 thousand of total unrecognized compensation cost related to non-vested stock options, respectively, that will be expensed over the next two years.
The weighted-average fair value of options granted in the year ended December 31, 2010 and 2009 was $3.17 and $2.97, respectively, and was estimated at the date of grant using the Black-Scholes Option Pricing Model with the following weighted-average assumptions.
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected lives are based on the "simplified" method allowed by ASC Topic 718 Compensation, whereby the expected term is equal to the midpoint between the vesting date and the end of the contractual term of the award. The expected volatility is based on the Company's estimated level of volatility. The dividend yield assumption is based on the Company's expectation of dividend payouts.
The 235,430 and 129,810 options outstanding as of December 31, 2010 and 2009, respectively, have an aggregate intrinsic value, which is the amount that the market value of the underlying stock exceeds the exercise price of the option, of $269 thousand and $97 thousand, respectively. The aggregate intrinsic value of the options exercised in 2010 and 2009 amounted to $16 thousand and $1 thousand, respectively.
At December 31, 2010 and 2009, the 235,430 and 129,810 options issued and outstanding, respectively, had exercise prices and weighted-average remaining contractual lives as follows:
Note 11. Income Taxes:
Significant components of the Company's deferred tax assets and liabilities at December 31, 2010 and 2009 were as follows:
A reconciliation of the statutory income tax to the provision for income taxes included in the consolidated statements of income for the years ended December 31, 2010 and 2009 is as follows:
Significant components of the provision for income taxes for the years ended December 31, 2010 and 2009 are as follows:
Note 12. Noninterest Expenses:
Noninterest expenses included in the consolidated statements of income for the years ended December 31, 2010 and 2009 include the following:
Note 13. Shareholders' Equity:
Restrictions on dividends:
The amount of dividends that the Bank can pay to Bancorp without approval from the Federal Reserve Board is limited to its net profits for the current year plus its retained net profits for the preceding two years. Under Maryland law, dividends may be paid without approval from the Department of Financial Regulation only out of undivided profits. At December 31, 2010, the Bank was limited from paying dividends to Bancorp in excess of $4.10 million, and by the requirement to meet certain capital ratios. The Bank did not pay any dividends to Bancorp in 2010 or 2009.
Restrictions on lending from subsidiary to parent:
Federal law imposes certain restrictions limiting the ability of the Bank to transfer funds to Bancorp in the forms of loans or advances. Section 23A of the Federal Reserve Act prohibits the Bank from making loans or advances to Bancorp in excess of 10 percent of its capital stock and surplus, as defined therein. There were no loans or advances outstanding at December 31, 2010 and 2009.
Capital:
The Bank is, and when the Company's assets exceed $500 million, it has public debt or it engages in certain highly leverage activities, the Company will be, subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined). Management believes that the Company and the Bank met all capital adequacy requirements to which they are subject as of December 31, 2010 and 2009.
As of December 31, 2010, the most recent notification from the regulatory agencies categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification which management believes have changed the Bank's category.
The Company's and the Bank's actual capital amounts and ratios at December 31, 2010 and 2009 are presented in the following tables:
Note 14. Fair Value Measurements:
The FASB issued new guidance under ASC Topic 825 Financial Instruments. This Statement 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 Company commitment. Subsequent changes must be recorded in earnings.
Simultaneously with the adoption of ASC Topic 825, the Company adopted ASC Topic 820 Fair Value Measurements and Disclosures, effective January 1, 2008. This guidance 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 this guidance, fair value measurements are not adjusted for transaction costs. This guidance 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 this guidance 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 this guidance, the Company 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 at a 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.
The following table sets forth the Company's financial assets and liabilities that were accounted for or disclosed at fair value on a recurring basis as of December 31, 2010.
The following table sets forth the Company's financial assets and liabilities that were accounted for or disclosed at fair value on a nonrecurring basis as of December 31, 2010.
The following table provides a reconciliation of all assets measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2010.
Note 15. Fair Value of Financial Instruments:
In accordance with the disclosure requirements of ASC Topic 825 Financial Instruments, the estimated fair values of the Company's financial instruments are as follows:
The following methods and assumptions were used to estimate the fair value disclosures for financial instruments as of December 31, 2010 and 2009:
Cash and cash equivalents:
The fair value of cash and cash equivalents is estimated to approximate the carrying amounts.
Investment securities and restricted stock:
Fair values are based on quoted market prices, except for certain restricted stocks where fair value equals par value because of certain redemption restrictions.
Loans:
Fair values are estimated for portfolios of loans with similar financial characteristics. Each portfolio is further segmented into fixed and adjustable rate interest terms by performing and non-performing categories.
The fair value of performing loans is calculated by discounting estimated cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The estimated cash flows do not anticipate prepayments.
Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented for loans would be indicative of the value negotiated in an actual sale.
Deposits:
The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW accounts and money market accounts, is equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently
offered for deposits of similar remaining maturities. The fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.
Short-term borrowings:
The fair value of short-term borrowings is determined using rates currently available to the Company for debt with similar terms and remaining maturities.
Long-term borrowings:
The fair value of the long-term borrowings is determined using rates currently available to the Company for debt with similar terms and remaining maturities.
Junior subordinated debentures:
The junior subordinated debentures are unsecured obligations of the Company and are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. The Company has entered into a guarantee, which together with its obligations under the junior subordinated debentures and the declaration of trust governing the Trust provides a full and unconditional guarantee of the Trust's preferred securities. The fair value of junior subordinated debentures is determined using rates currently available to the Company for debt with similar terms and remaining maturities. See Note 8 for additional disclosures.
Accrued Interest:
The carrying amounts of accrued interest approximate fair value.
Note 16. Transactions with Related Parties:
Loans:
In the normal course of banking business, loans are made to officers and directors of the Company, as well as to their affiliates. Such loans are made in the ordinary course of business with substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons. They do not involve more than normal risk of collectability or present other unfavorable features. An analysis of the activity during 2010 and 2009 is as follows:
Lease agreement:
The Company entered into a lease in July 2003 for approximately 3,800 square feet of office space owned by a limited liability company consisting of three shareholders/directors. The lease term
commenced on July 10, 2003 and will expire on July 10, 2011. Under this lease, monthly payments for the period July 10, 2010 to July 9, 2011 are $5,227.
The Company entered into a lease in February 2005 for approximately 2,418 square feet of office space with the same limited liability company mentioned above. The lease term commenced on February 1, 2005 and will expire on January 31, 2015. Under this lease, monthly payments for the period February 1, 2010 to January 31, 2011 are $3,329. Subsequent twelve-month periods are subject to a five percent increase.
The Company also entered into a lease in August 2008 for approximately 2,972 square feet of office space with the same limited liability company mentioned above. The lease term commenced on August 1, 2008 and will expire on July 31, 2013. Under this lease, monthly payments through July 2011 are $3,839 with subsequent twelve-month periods subject to a three percent increase.
Note 17. Commitments and Contingencies:
Financial instruments:
In the normal course of business, there are outstanding commitments, contingent liabilities and other financial instruments that are not reflected in the accompanying consolidated financial statements. These include commitments to extend credit and standby letters of credit, which are some of the instruments used by the Company to meet the financing needs of its customers. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet.
The Company's exposure to credit loss in the event of nonperformance by the other parties to the financial instrument for these commitments is represented by the contractual amounts of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. These commitments as of December 31, 2009 and 2008 were 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. Certain commitments have fixed expiration dates, or other termination clauses, and may require payment of a fee. Many of the commitments are expected to expire without being drawn upon; accordingly, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral or other security obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include deposits held in financial institutions; U.S. Treasury securities; other marketable securities; accounts receivable; inventory; property and equipment; personal residences; income-producing commercial properties and land under development. Personal guarantees are also obtained to provide added security for certain commitments.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to guarantee the
installation of real property improvements and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral and obtains personal guarantees supporting those commitments for which collateral or other security is deemed necessary.
Note 18. Frederick County Bancorp, Inc. (Parent Company) Condensed Financial Information:
Balance Sheets
Statements of Income
Statements of Cash Flows
BUSINESS
General
Frederick County Bancorp, Inc. (the "Bancorp"), the parent company for its wholly-owned subsidiary Frederick County Bank (the "Bank" and together with Bancorp, the "Company"), was organized in September 2003. The Bank was incorporated under the laws of the State of Maryland in August 2000 and commenced banking operations in October 2001. The Bank, headquartered in Frederick, Maryland, currently operates out of its main office and three branch offices, two in Frederick, Maryland and one in Walkersville, Maryland. The Bank was organized by successful members of the business community in Frederick, Maryland and an experienced senior management team to operate as a local business bank alternative to the superregional financial institutions, which dominate its primary market area. The primary service area of the Bank is Frederick County, Maryland, with a secondary market area in the surrounding counties of Carroll, Howard, Montgomery and Washington. The Bank's mission is to serve the needs of the business and professional community of Frederick County by building long-term relationships. The Bank seeks to focus on relationship banking, providing each customer with a number of services, familiarizing itself with, and addressing itself to, customer needs. The Bank also seeks to become an integral part of the community, a responsible citizen and make decisions based on what is good for the community. A fourth branch office, to be located at 103 Monocacy Boulevard, Frederick, Maryland, is expected to open in the second half of 2011.
Bancorp also has a direct subsidiary called FCBI Statutory Trust I. In addition, Bancorp has a direct subsidiary called FCB Holdings, Inc. and an indirect subsidiary called FCB Hagerstown, LLC, both of which are for the purpose of holding and managing problem loans and foreclosed real estate. See Note 8 to the consolidated financial statements for additional disclosures for FCBI Statutory Trust I.
Description of Services
The Bank offers full commercial banking services to its business and professional clients. The Bank primarily emphasizes providing commercial banking services to corporations, partnerships, small and medium-sized businesses and sole proprietorships, as well as to non-profit organizations and associations and investors living or working in Frederick County. The Bank also provides residential mortgage loans and a full line of retail services to accommodate the individual needs of corporate customers and residents of the community served by the Bank.
The Bank's commercial loan portfolio consists of term loans, lines of credit and owner occupied commercial real estate loans provided to primarily locally based borrowers. Traditional installment loans and personal lines of credit are available on a selective basis.
Services offered to our customers include, but are not limited to, the following:
•Commercial loans for business purposes to business owners and investors for plant and equipment, personal lines of credit, working capital, real estate renovation, and other sound business purposes;
•Commercial real estate loans on income producing properties with an emphasis on adequate debt service coverage and liquidity. Other criteria include satisfactory loan to value ratios as determined by valuations from recognized appraisers. Loans will be made primarily at variable rates, with fixed rates in the one to five year range, with maturities normally no longer than five to ten years;
•SBA guaranteed loans;
•Cash management services, including sweep accounts, repurchase agreements, account reconciliation, credit card depository, Automated Clearing House origination, wire transfers, night depository;
•Merchant credit card services for the deposit and immediate credit of sales drafts from retail merchants and professionals such as doctors and attorneys;
•Commercial depository services including interest bearing sweep accounts;
•Business checking accounts, and payroll service through outside payroll processors;
•Other commercial services based on the individual needs of the customer including direct data services, reconciliation of accounts, night depository, safe deposit boxes, and business services;
•On-line data communication with Bank customers;
•ATM services;
•Equity loans on real estate, home improvement loans, and overdraft checking privileges against preauthorized lines of credit;
•Residential mortgage loans; and
•Retail depository services including personal checking accounts, NOW accounts, regular savings accounts, money market savings accounts, certificates of deposit, and IRA accounts.
The Bank also provides courier services for deposits and other banking services, to better serve customers who are not conveniently located near the Bank's offices.
The direct lending activities in which the Bank engages each carries the risk that the borrowers will be unable to perform on their obligations. As such, interest rate policies of the Federal Reserve Board and general economic conditions, nationally and in the Bank's primary market area have a significant impact on the Bank and the Bank's results of operations. To the extent that economic conditions deteriorate, business and individual borrowers may be less able to meet their obligations to the Bank in full, in a timely manner, resulting in decreased earnings or losses to the Bank. To the extent that loans are secured by real estate, adverse conditions in the real estate market may reduce the borrower's ability to generate the necessary cash flow for repayment of the loan, and reduce the Bank's ability to collect the full amount of the loan upon a default. To the extent the Bank makes fixed rate loans, general increases in interest rates will tend to reduce the Bank's spread as the interest rates the Bank must pay for deposits increase while interest income is flat. Economic conditions and interest rates may also adversely affect the value of property pledged as security for loans.
Whenever appropriate and available, the Bank seeks Federal and State loan guarantees, such as the Small Business Administration's "7A" and "504" loan programs to reduce risks. The Bank generally requires personal guarantees on all loans; approval of exceptions to this policy is documented. All borrowers are required to forward annual corporate, partnership and personal financial statements to comply with bank policy and enforced through the loan covenants documentation for each transaction. Interest rate risks to the Bank are mitigated by using either floating interest rates or by fixing rates for a short period of time.
Consistent with the objective of the Bank to serve the needs of the business community, the Bank seeks to concentrate its assets in commercial loans and commercial real estate loans. To be consistent with the requirements of prudent banking practices, adequate assets will be invested in high-grade securities to provide liquidity and safety.
The risk of nonpayment (or deferred payment) of loans is inherent in commercial banking. The Bank's marketing focus on small to medium-sized businesses may result in the assumption by the Bank of certain lending risks that are different from those attendant to loans to larger companies.
Management of the Bank carefully evaluates all loan applications and attempts to minimize its credit risk exposure by use of thorough loan application, approval and monitoring procedures; however, there can be no assurance that such procedures can significantly reduce such lending risks.
Source of Business. Management believes that the market segments targeted, small to medium sized businesses and professionals in the Bank's market area, demand the convenience and personal service that a smaller, independent financial institution can offer. It is these themes of convenience and personal service that form the basis of the Bank's business development strategies. The Bank provides services from its centrally located main office in Frederick, Maryland, one branch on both the north and south sides of Frederick, Maryland, along with its branch in Walkersville, Maryland, which it believes complement the needs of the Bank's existing and potential customers, and provide prospects for additional growth and expansion. The Bank has implemented a courier service to better serve local customers who are not conveniently located near one of the Bank's offices. The Bank is continuously looking for opportunities to establish additional branches in different parts of its market area, which would enhance customer service for existing customers, enable the Bank to obtain additional customers, expand the Bank's market area, and which could be operated on a profitable basis. Although the Bank is open to additional branches, there can be no assurance that the Bank will establish any additional branches in any given timeframe, or that they will be profitable.
The Bank seeks to capitalize upon the extensive business and personal contacts and relationships of its Directors and Executive Officers to develop the Bank's customer base, as well as relying on Director referrals, officer-originated calling programs and customer and shareholder referrals.
Market Area and Competition
Location and Market Area. The headquarters for Bancorp and the Bank is located at 9 North Market Street, Frederick, Maryland 21701, in downtown Frederick. The Bank's main banking office is located at 30 West Patrick Street, Frederick, Maryland and has two branches located in Frederick, Maryland, one at 198 Thomas Johnson Drive, and the second at 6910 Crestwood Boulevard. The third branch is located in Walkersville, Maryland at 200 Commerce Drive. The primary service area of the Bank is Frederick County, Maryland, with a secondary market area in the surrounding counties of Carroll, Howard, Montgomery and Washington. Frederick County and the City of Frederick have experienced significant consolidation in the banking market over the past ten years. The Bank is one of two commercial banks based in Frederick County that have been organized since 1989, both of which have their headquarters in the City of Frederick. The Bank believes that market and banking trends provide an opportunity for the Bank to execute a focused strategy of offering personal and customized services and attract underserved and dissatisfied small business clients.
Frederick County, located in central Maryland, had a 2010 population of approximately 237,000. The population of Frederick County is anticipated to continue to grow, to approximately 260,000 in 2015 and 288,000 in 2020. The City of Frederick has experienced similar population growth, resulting in a 2009 population of approximately 60,000.
The County currently has approximately 125,000 jobs. Raw employment figures in Frederick County do not reflect the significant intercounty commuter traffic between Frederick and surrounding counties. A significant portion of Frederick residents work in other jurisdictions, and a substantial number of Frederick County jobs are held by nonresidents. The economy of Frederick County is highly diversified.
Employment is currently distributed among the following categories:
Competition. Deregulation of financial institutions and holding company acquisitions of banks across state lines has resulted in widespread, fundamental changes in the financial services industry. This transformation, although occurring nationwide, is particularly intense in Frederick County, and the nearby Washington, DC and Baltimore metropolitan areas, because of the changes in the area's economic base in recent years and changing federal and state laws authorizing interstate mergers and acquisitions of banks, and the interstate establishment or acquisition of branches.
In Frederick County, Maryland, competition is exceptionally keen from large banking institutions headquartered outside of Maryland. In addition, the Bank competes with other community banks, savings and loan associations, credit unions, mortgage companies, finance companies, the online divisions of out of market institutions, and others providing financial services. Among the advantages that many of these institutions have over the Bank are their abilities to finance extensive advertising campaigns, maintain extensive branch networks and technology investments, and to directly offer certain services, such as international banking and trust services, which will not be offered directly by the Bank. Further, the greater capitalization of the larger institutions allows for substantially higher lending limits than the Bank. Certain of these competitors have other advantages, such as tax exemption in the case of credit unions, and lesser regulation in the case of mortgage companies and finance companies.
The Gramm-Leach-Bliley Act (the "GLB Act") created a new type of regulated entity, the financial holding company that can offer a broad range of financial products. These new financial holding companies are able to affiliate with and engage in banking, securities, insurance and other financial activities not permitted under prior law. The GLB Act also permits banks with or without holding companies to establish and operate financial subsidiaries that may engage in most financial activities in which financial holding companies may engage. Large bank holding companies and other large financial service companies in particular will be able to take advantage of the new activities and provide a wider array of products than may be possible for smaller institutions such as the Bank.
Employees
At February 1, 2011, the Company employed sixty-three (63) persons on a full-time basis, two (2) of which are executive officers, and eight (8) persons on a part time basis. None of the Company's employees are represented by any collective bargaining group, and the Company believes that its employee relations are good. The Company provides a benefit program, which includes health and dental insurance, a 401k plan, life and long-term disability insurance for substantially all full time employees and an incentive stock option plan for key employees and directors of the Company.
Properties
The main office of the Bank is located at 30 West Patrick Street, Frederick, in 3,575 square feet on the ground floor of a seven (7)-story office building, comprised of 65,477 square feet. The Company leases the space under a five (5)-year lease, which expires in July 2016, at a current annual rent of
$97,489; subject to annual increases of 3% per year, plus additional rent relating to common area fees and taxes.
The Antietam branch is located at 198 Thomas Johnson Drive, Frederick, Maryland and consists of 3,168 square feet in a 75,000 square foot building. The property is occupied under a five (5)-year lease, which expires in May 2012, at a current annual rent of $60,192; plus additional rent relating to common area fees and taxes. The Company has two 5-year renewal options.
The Company leases approximately 3,800 square feet of office space located at 7 North Market Street, 2nd floor, Frederick, Maryland, used for the Company's operations center, in a building owned by a limited liability company owned by three shareholders/directors. The lease term will expire in July 2011. Pursuant to this lease, the current annual payments are $62,724 and are subject to annual increases of 5% per year.
The Company leases approximately 2,418 square feet of office space at 9 North Market Street, Frederick, Maryland, which it uses as the headquarters location for the Bancorp and the Bank, with the same limited liability company mentioned above. The lease will expire in January 2015. Pursuant to this lease, the current annual payments are $39,945 and are subject to annual increases of 3% per year. The Company has one 5-year renewal option.
The Company also leases approximately 2,972 square feet of office space at 7 North Market Street, 3rd Floor, Frederick, Maryland, used for administrative offices, with the same limited liability company mentioned above. The lease will expire in July 2013. Pursuant to this lease, the current annual payments are $46,066 and are subject to annual increases of 3% per year. The Company has two 5-year renewal options.
The Company owns the premises for its branches located at 6910 Crestwood Boulevard, Frederick Maryland and 200 Commerce Drive, Walkersville, Maryland.
The Company also own 0.99 acres of vacant land at 103 Monocacy Boulevard, Frederick, Maryland, the site of its fourth branch. All of the regulatory approvals have been received and the Company is in the process of obtaining bids for the construction of the new facility, which is anticipated to open during the second half of 2011.
The Company also owns 1.775 acres of vacant land at 8401 Progress Court in Frederick, Maryland which may be used for future expansion.
The Company believes that its existing facilities outlined above are adequate to conduct the Company's business.
Legal Proceedings
On July 30, 2010, the Bank was served with a lawsuit, Pionteck, v. Frederick County Bank, filed in the United States District Court for the District of Maryland, Greenbelt Division, alleging noncompliance the ATM notice requirements of the Electronic Funds Transfer Act. The complaint, which purports to be a class action, was filed on July 15, 2010. If the class action proceeds and the Bank is ultimately found to be liable, statutory damages from the noncompliance could be up to 1% of the Bank's net worth, approximately $270 thousand at December 31, 2010. The Bank has entered into a settlement agreement with the plaintiff for an amount, inclusive of plaintiff legal fees and costs, below the maximum statutory damages. The settlement agreement is subject to approval by the court. The Company's December 31, 2010 financial statements reflect a reserve for litigation and settlement costs that the Company believes to cover substantially all remaining expense to be incurred in connection with this matter. If the settlement agreement is approved by the court, the Company believes that it would not have a material adverse affect on the Company's financial position. There can be no
assurance that the settlement agreement will be approved by the court on the proposed terms, or that final settlement will not result in greater expense than that anticipated.
Supervision and Regulation
Bancorp is registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the "Holding Company Act") and, as such, is subject to supervision and regulation by the Federal Reserve. As a bank holding company, Bancorp is required to furnish to the Federal Reserve annual and semi-annual reports of its operations and additional information and reports. Bancorp is also subject to regular examination by the Federal Reserve.
Under the Holding Company Act, a bank holding company must obtain the prior approval of the Federal Reserve before (1) acquiring direct or indirect ownership or control of any class of voting securities of any bank or bank holding company if, after the acquisition, the bank holding company would directly or indirectly own or control more than 5% of the class; (2) acquiring all or substantially all of the assets of another bank or bank holding company; or (3) merging or consolidating with another bank holding company.
Under the Holding Company Act, any company must obtain approval of the Federal Reserve prior to acquiring control of Bancorp or the Bank. For purposes of the Holding Company Act, "control" is defined as ownership of 25% or more of any class of voting securities of Bancorp or the Bank, the ability to control the election of a majority of the directors, or the exercise of a controlling influence over management or policies of Bancorp or the Bank.
The Change in Bank Control Act and the related regulations of the Federal Reserve require any person or persons acting in concert (except for companies required to make application under the Holding Company Act), to file a written notice with the Federal Reserve before the person or persons acquire control of Bancorp or the Bank. The Change in Bank Control Act defines "control" as the direct or indirect power to vote 25% or more of any class of voting securities or to direct the management or policies of a bank holding company or an insured bank. A presumption of control arises under the Change in Bank Control Act where a person controls 10% or more of a class of the voting stock of a company or insured bank which is a reporting company under the Securities Exchange Act of 1934, such as the Company.
The Holding Company Act also limits the investments and activities of bank holding companies. In general, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, providing services for its subsidiaries, non-bank activities that are closely related to banking, and other financially related activities. The activities of Bancorp are subject to these legal and regulatory limitations under the Holding Company Act and Federal Reserve regulations.
In addition to being a bank holding company, Bancorp has also been designated a financial holding company, and as such, under federal banking law, may engage in an expanded list of non-bank activities. Non-bank and financially related activities of bank holding companies and financial holding companies, also may be subject to regulation and oversight by regulators other than the Federal Reserve. As of December 31, 2010, the Company was not conducting any activity for which the financial holding company designation is a prerequisite.
The Federal Reserve has the power to order a holding company or its subsidiaries to terminate any activity, or to terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that the continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness, or stability of any bank subsidiary of that holding company.
The Federal Reserve has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve has issued a policy statement and supervisory guidance on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company's capital needs, asset quality, and overall financial condition.
The Bank, as a Maryland chartered commercial bank which is a member of the Federal Reserve System (a "state member bank") and whose accounts are insured by the Deposit Insurance Fund of the FDIC up to the maximum legal limits of the FDIC, is subject to regulation, supervision and regular examination by the Maryland Department of Financial Regulation and the Federal Reserve Board. The regulations of these various agencies govern most aspects of the Bank's business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices. The laws and regulations governing the Bank generally have been promulgated to protect depositors and the Deposit Insurance Fund, and not for the purpose of protecting shareholders.
Competition among commercial banks, savings and loan associations, and credit unions has increased following enactment of legislation, which greatly expanded the ability of banks and bank holding companies to engage in interstate banking or acquisition activities. As a result of federal and state legislation, banks in the Washington, DC/Maryland/Virginia area can, subject to limited restrictions, acquire or merge with a bank in another of the jurisdictions, and can branch de novo in any of the jurisdictions. The GLB Act allows a wider array of companies to own banks, which could result in companies with resources substantially in excess of the Bank's entering into competition with the Bank.
Banking is a business which depends on interest rate differentials. In general, the differences between the interest paid by a bank on its deposits and its other borrowings and the interest received by a bank on loans extended to its customers and securities held in its investment portfolio constitute the major portion of the Bank's earnings. Thus, the earnings and growth of the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly, as it relates to monetary policy, the Federal Reserve Board, which regulates the supply of money through various means including open market dealings in United States government securities. The nature and timing of changes in such policies and their impact on the Bank cannot be predicted.
Branching and Interstate Banking. The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act") by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches are permitted only if the law of the state in which the branch is located permits such acquisitions. Such interstate bank mergers and branch acquisitions are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act. The District of Columbia, Maryland and Virginia have each enacted laws which permit interstate acquisitions of banks and bank branches.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in July 2010 ("Dodd-Frank"), authorizes national and state banks to establish de novo branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Although the District of Columbia, Maryland and Virginia had all enacted laws which permitted banks in these jurisdictions to branch freely, the branching provisions of Dodd-Frank could result in banks from a wider variety of states establishing de novo branches in the Bank's market area.
USA Patriot Act. Under the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act, commonly referred to as the "USA Patriot Act" or the "Patriot Act", financial institutions are subject to prohibitions against specified financial transactions and account relationships, as well as enhanced due diligence standards intended to detect, and prevent, the use of the United States financial system for money laundering and terrorist financing activities. The Patriot Act requires financial institutions, including banks, to establish anti-money laundering programs, including employee training and independent audit requirements, meet minimum standards specified by the act, follow minimum standards for customer identification and maintenance of customer identification records, and regularly compare customer lists against lists of suspected terrorists, terrorist organizations and money launderers. The costs or other effects of the compliance burdens imposed by the Patriot Act or future anti-terrorist, homeland security or anti-money laundering legislation or regulations cannot be predicted with certainty.
Capital Adequacy Guidelines. The Federal Reserve Board and the FDIC have adopted risk based capital adequacy guidelines pursuant to which they assess the adequacy of capital in examining and supervising banks and bank holding companies and in analyzing bank regulatory applications. Risk-based capital requirements determine the adequacy of capital based on the risk inherent in various classes of assets and off-balance sheet items. The risk based capital guidelines will not be applicable to the Company until it has in excess of $500 million in assets, it has public debt or it engages in certain highly leveraged activities. Under Dodd-Frank, the Federal Reserve Board is required to apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, subject to limited exceptions, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. Dodd-Frank additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.
State member banks are expected to meet a minimum ratio of total qualifying capital (the sum of core capital (Tier 1) and supplementary capital (Tier 2)) to risk weighted assets of 8%. At least half of this amount (4%) should be in the form of core capital. Tier 1 Capital generally consists of the sum of common shareholders' equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stock which may be included as Tier 1 Capital), less goodwill, without adjustment for changes in the market value of securities classified as "available-for-sale" in accordance with FAS 115. Tier 2 Capital consists of the following: hybrid capital instruments; perpetual preferred stock which is not otherwise eligible to be included as Tier 1 Capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no risk-based capital) for assets such as cash and certain U.S. government and agency securities, to 100% for the bulk of assets which are typically held by a bank, including certain multi-family residential and commercial real estate loans, commercial business loans and consumer loans. Residential first mortgage loans on one to four family residential real estate and certain seasoned multi-family residential real estate loans, which are not
90 days or more past-due or non-performing and which have been made in accordance with prudent underwriting standards are assigned a 50% level in the risk-weighing system, as are certain privately-issued mortgage-backed securities representing indirect ownership of such loans. Off-balance sheet items also are adjusted to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the Federal Reserve Board has established a minimum 3.0% Leverage Capital Ratio (Tier 1 Capital to total adjusted assets) requirement for the most highly-rated banks, with an additional cushion of at least 100 to 200 basis points for all other banks, which effectively increases the minimum Leverage Capital Ratio for such other banks to 4.0%-5.0% or more. The highest-rated banks are those that are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, those which are considered a strong banking organization. A bank having less than the minimum Leverage Capital Ratio requirement shall, within 60 days of the date as of which it fails to comply with such requirement, submit a reasonable plan describing the means and timing by which the bank shall achieve its minimum Leverage Capital Ratio requirement. A bank which fails to file such plan is deemed to be operating in an unsafe and unsound manner, and could subject the bank to a cease-and-desist order. Any insured depository institution with a Leverage Capital Ratio that is less than 2.0% is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act (the "FDIA") and is subject to potential termination of deposit insurance. The capital regulations also provide, among other things, for the issuance of a capital directive, which is a final order issued to a bank that fails to maintain minimum capital or to restore its capital to the minimum capital requirement within a specified time period. Such a directive is enforceable in the same manner as a final cease-and-desist order.
The forgoing capital requirements represent minimum requirements. Our state and federal regulators have the discretion to require us to maintain higher capital levels based upon our concentrations of loans, the risk of our lending or other activities, the performance of our loan and investment portfolios and other factors. Failure to maintain such higher capital expectations could result in a lower composite regulatory rating, which would impact our deposit insurance premiums and could affect our ability to borrow and costs of borrowing, and could result in additional or more severe enforcement actions.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions, which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. Under the regulations, a bank shall be deemed to be: (i) "well capitalized" if it has a Total Risk Based Capital Ratio of 10.0% or more, a Tier 1 Risk Based Capital Ratio of 6.0% or more, a Leverage Capital Ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) "adequately capitalized" if it has a Total Risk Based Capital Ratio of 8.0% or more, a Tier 1 Risk Based Capital Ratio of 4.0% or more and a Tier 1 Leverage Capital Ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized;" (iii) "undercapitalized" if it has a Total Risk Based Capital Ratio that is less than 8.0%, a Tier 1 Risk based Capital Ratio that is less than 4.0% or a Leverage Capital Ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a Total Risk Based Capital Ratio that is less than 6.0%, a Tier 1 Risk Based Capital Ratio that is less than 3.0% or a Leverage Capital Ratio that is less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate federal banking agency within 45 days of the date the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of
approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the applicable agency.
An institution, which is required to submit a capital restoration plan, must concurrently submit a performance guaranty by each company that controls the institution. Such guaranty shall be limited to the lesser of (i) an amount equal to 5.0% of the institution's total assets at the time the institution was notified or deemed to have notice that it was undercapitalized or (ii) the amount necessary at such time to restore the relevant capital measures of the institution to the levels required for the institution to be classified as adequately capitalized. Such a guaranty shall expire after the federal banking agency notifies the institution that it has remained adequately capitalized for each of four consecutive calendar quarters. An institution which fails to submit a written capital restoration plan within the requisite period, including any required performance guaranty, or fails in any material respect to implement a capital restoration plan, shall be subject to the restrictions in Section 38 of the FDIA which are applicable to significantly undercapitalized institutions.
A "critically undercapitalized institution" is required to be placed in conservatorship or receivership within 90 days unless the appropriate federal regulator, with the concurrence of the FDIC, formally determines that forbearance from such action would better protect the deposit insurance fund. Unless the FDIC or other appropriate federal banking regulatory agency makes specific further findings and certifies that the institution is viable and is not expected to fail, an institution that remains critically undercapitalized on average during the fourth calendar quarter after the date it becomes critically undercapitalized must be placed in receivership. The general rule is that the FDIC will be appointed as receiver within 90 days after a bank becomes critically undercapitalized unless extremely good cause is shown and an extension is agreed to by the federal regulators. In general, good cause is defined as capital, which has been raised and is imminently available for infusion into the bank except for certain technical requirements, which may delay the infusion for a period of time beyond the 90 day time period.
Immediately upon becoming undercapitalized, an institution shall become subject to the provisions of Section 38 of the FDIA, which (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution's assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: requiring the institution to raise additional capital; restricting transactions with affiliates; requiring divestiture of the institution or the sale of the institution to a willing purchaser; and any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.
Additionally, under Section 11(c)(5) of the FDIA, a conservator or receiver may be appointed for an institution where: (i) an institution's obligations exceed its assets; (ii) there is substantial dissipation of the institution's assets or earnings as a result of any violation of law or any unsafe or unsound practice; (iii) the institution is in an unsafe or unsound condition; (iv) there is a willful violation of a cease-and-desist order; (v) the institution is unable to pay its obligations in the ordinary course of business; (vi) losses or threatened losses deplete all or substantially all of an institution's capital, and there is no reasonable prospect of becoming "adequately capitalized" without assistance; (vii) there is any violation of law or unsafe or unsound practice or condition that is likely to cause insolvency or substantial dissipation of assets or earnings, weaken the institution's condition, or otherwise seriously prejudice the interests of depositors or the insurance fund; (viii) an institution ceases to be insured;
(ix) the institution is undercapitalized and has no reasonable prospect that it will become adequately capitalized, fails to become adequately capitalized when required to do so, or fails to submit or materially implement a capital restoration plan; or (x) the institution is critically undercapitalized or otherwise has substantially insufficient capital.
Regulatory Enforcement Authority. Federal banking law grants substantial enforcement powers to federal banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
A result of the volatility and instability in the financial system during 2008 and 2009, the Congress, the bank regulatory authorities and other government agencies have called for or proposed additional regulation and restrictions on the activities, practices and operations of banks and their holding companies. While many of these proposals relate to institutions that have accepted investments from, or sold troubled assets to, the Department of the Treasury or other government agencies, or otherwise participate in government programs intended to promote financial stabilization, the Congress and the federal banking agencies have broad authority to require all banks and holding companies to adhere to more rigorous or costly operating procedures, corporate governance procedures, or to engage in activities or practices which they would not otherwise elect. Any such requirement could adversely affect the Company's business and results of operations. The Company did not accept an investment by the Treasury Department in its preferred stock or warrants to purchase common stock, and except for the temporary increases in deposit insurance for customer accounts, has not participated in any of the programs adopted by the Treasury Department, FDIC or Federal Reserve.
FDIC Insurance Premiums. The FDIC maintains a risk-based assessment system for determining deposit insurance premiums. Four risk categories (I-IV), each subject to different premium rates, are established, based upon an institution's status as well capitalized, adequately capitalized or undercapitalized, and the institution's supervisory rating. The levels of rates are subject to periodic adjustment by the FDIC. Depository institutions will also pay premiums for the increased coverage provided by the FDIC.
Commencing in 2009, the premium rates increased by 7 basis points in each category for the first quarter of 2009. For the second quarter of 2009 and beyond, the FDIC established further changes in rates, and introduced three adjustments that can be made to an institution's initial base assessment rate: (1) a potential decrease for long-term unsecured debt, including senior and subordinated debt and, for small institutions, a portion of Tier 1 capital; (2) a potential increase for secured liabilities above a threshold amount; and (3) for non-Risk Category I institutions, a potential increase for brokered deposits above a threshold amount. The schedule for base assessment rates and potential adjustment is set forth in the following table.
The FDIC also imposed a special FDIC insurance assessment of 5 basis points of each insured depository institution's assets minus Tier 1 capital as of June 30, 2009, but no more than 10 basis points
times the institution's assessment base for the second quarter of 2009, which was collected on September 30, 2009. Additional special assessments may be imposed by the FDIC in the future.
Additionally, the Bank has elected to participate in the FDIC program whereby noninterest bearing transaction account deposits will be insured without limitation through June 30, 2010. Until December 31, 2009, the Bank was required to pay an additional premium to the FDIC of 10 basis points on the amount of balances in noninterest bearing transaction accounts that exceed the existing deposit insurance limit of $250 thousand. During 2010, the fee ranged between 15 to 25 basis points, depending on the institution's risk category.
Dodd-Frank permanently increases the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor, and extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. Dodd-Frank also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. Dodd-Frank requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. Effective one year from the date of enactment, Dodd-Frank eliminates the federal statutory prohibition against the payment of interest on business checking accounts.
Consumer Financial Protection Bureau. Dodd-Frank creates a new, independent federal agency called the Consumer Financial Protection Bureau ("CFPB") which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act., Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower's ability to repay. In addition, Dodd-Frank will allow borrowers to raise certain defenses to foreclosure if they receive any loan, other than a "qualified mortgage" as defined by the CFPB. Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
It is difficult to predict at this time what specific impact Dodd-Frank and the yet to be written implementing rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.
Market for Common Stock and Dividends
Market for Common Stock. Our common stock is not traded on any organized exchange, including The NASDAQ Stock Market. As of December 31, 2010, two market makers offered to make a market in the common stock in the over the counter "bulletin board" market under the symbol "FCBI". The common stock has traded only sporadically and in limited volume. No assurance can be given that an active or established trading market will develop in the foreseeable future. The following table sets forth the high and low bid prices for the common stock during each calendar quarter for 2010 and 2009. These quotations reflect inter-dealer prices, without retail markup, markdown or commission, and
may not represent actual transactions. These quotations do not necessarily reflect the intrinsic or market values of the common stock. As of December 31, 2010, there were 1,461,802 shares of common stock outstanding, held by approximately 650 shareholders of record.
Dividends. Neither Bancorp nor the Bank has paid any cash dividends to date. Regulations of the Federal Reserve Board and Maryland law place limits on the amount of dividends the Bank may pay without prior approval. Prior approval of the Federal Reserve is required to pay dividends which exceed the Bank's net profits for the current year plus its retained net profits for the preceding two calendar years, less required transfers to surplus. Under Maryland law, cash dividends may be paid without approval from the Department of Financial Institutions only out of undivided profits.
State and federal bank regulatory agencies also have authority to prohibit a bank from paying dividends if such payment is deemed to be an unsafe or unsound practice. Compliance with minimum capital requirements, as presently in effect, or as they may be amended from time to time, could limit the amount of dividends that the Bank may pay. As a depository institution, the deposits of which are insured by the FDIC, the Bank may not pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Bank currently is not in default under any of its obligations to the FDIC. Even if the Bank has earnings in an amount sufficient to pay cash dividends, the Board of Directors may determine to retain earnings for the purpose of funding the growth of the Bank. Please refer to Note 13 to the consolidated financial statements included in this report for additional information.
Issuer Repurchases of Securities During the Fourth Quarter of 2010. The following table provides information on the Company's purchase of its common stock during the quarter ended December 31, 2010.
(1)On June 26, 2007, the Company's Board of Directors approved a share repurchase program that authorizes the repurchase of up to 146,000 shares of the Company's outstanding common stock, subject to a maximum expenditure of $4.5 million. Repurchases under the program may be made on the open market and in privately negotiated transactions from time to time until June 30, 2012, or earlier termination of the program by the Board.
(2)Subject to a maximum expenditure of $4.5 million. Number of shares indicated is the remaining number of shares authorized for repurchase as of the end of the indicated period. To date the Company has expended $62 thousand for share repurchases. Recent Sales of Unregistered Shares. None.
Use of Proceeds. Not Applicable.
Securities Authorized for Issuance Under Equity Compensation Plans. The following table sets forth information regarding outstanding options and other rights to purchase common stock granted under the Company's compensation plans.
(1)Consists of the 2001 Stock Option Plan. Certain employment arrangements entered into by the Company, which have not been specifically approved by stockholders provide for the issuance under the 2001 Stock Option Plan of options to purchase common stock to certain officers. All of such options have been issued and are fully vested. For additional information, see the discussion of employment agreements in response to Item 10 and Note 10 to the consolidated financial statements.
Annual Meeting of Shareholders
Tuesday, April 12, 2011-7:00 p.m.
Dutch's Daughter
581 Himes Avenue
Frederick, MD 21703
Transfer Agent
Registrar & Transfer Company
10 Commerce Drive
Cranford, NJ 07016
1-800-368-5948
Market Makers
RBC Wealth Management
365 W. Patrick Street
Frederick, MD 21701
301-662-6488
Koonce Securities, Inc.
6550 Rock Spring Drive, Suite 600
Bethesda, MD 20817
1-800-368-2806
Availability of 10-K Report
The annual report on Form 10-K filed with the Securities and Exchange Commission is available without charge upon written request to:
William R. Talley, Jr.
Executive Vice President, Chief Financial Officer and Chief Operating Officer
Frederick County Bancorp, Inc.
P.O. Box 1100
Frederick, Maryland 21702-0100
Internet Access to Company Documents
The Company provides access to its filings with the Securities and Exchange Commission at www.fcbmd.com. After accessing the web site, the filings are available upon selecting "About FCB" and then "Investor Relations." Reports available include the annual report on Form 10-K or 10-KSB, quarterly reports on Form 10-Q or 10-QSB, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed or furnished to the SEC.
Principal Affiliate
Balance Sheet
Exhibits and Financial Statement Schedules.
The following financial statements are included in this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2010 and 2009
Consolidated Statements of Income for the years ended December 31, 2010 and 2009
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2010 and 2009
Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009
Notes to Consolidated Financial Statements
All financial statement schedules have been omitted as the required information is either inapplicable or included in the consolidated financial statements or related notes.
Exhibit No.
Description of Exhibits
3(a)
Articles of Incorporation of the Company, as amended(1)
3(b)
Bylaws of the Company(2)
4(a)
Indenture, dated as of December 15, 2006 between Frederick County Bancorp, Inc. and U.S. Bank National Association, as trustee(3)
4(b)
Amended and Restated Declaration of Trust, dated as December 15, 2006 between Frederick County Bancorp, Inc. and U.S. Bank National Association, as trustee, and Martin S. Lapera and William R. Talley, Jr. as Administrators(3)
4(c)
Guarantee Agreement dated as of dated as December 15, 2006 between Frederick County Bancorp, Inc. and U.S. Bank National Association, as Guarantee Trustee(3)
10(a)
2001 Stock Option Plan(4)
10(b)
Employment Agreement between the Bank and Martin S. Lapera(5)
10(c)
Employment Agreement between the Bank and William R. Talley, Jr.(6)
10(f)
2002 Executive and Director Deferred Compensation Plan, as amended(7)
10(g)
Amendment No. 1 to the 2002 Executive and Director Deferred Compensation Plan(7)
10(h)
Promissory Note with Atlantic Central Bankers Bank(8)
10(i)
Amendment to Loan Documents(9)
Statement Regarding Computation of Per Share Income-Please refer to Note 1 to the consolidated financial statements for the year ended December 31, 2010.
Subsidiaries of the Registrant
23(a)
Consent of Stegman & Company
31(a)
Certification of Martin S. Lapera, President and Chief Executive Officer
31(b)
Certification of William R. Talley, Jr., Executive Vice President and Chief Financial Officer
32(a)
Certification of Martin S. Lapera, President and Chief Executive Officer
32(b)
Certification of William R. Talley, Jr., Executive Vice President and Chief Financial Officer
(1)Incorporated by reference to Exhibit of the same number to the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004, as filed with the Securities and Exchange Commission.
(2)Incorporated by reference to Exhibit of the same number to the Company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 2003, as filed with the Securities and Exchange Commission.
(3)Not filed in accordance with the provision of Item 601(b)(4)(v) of Regulation SK. The Company agrees to provide a copy of these documents to the Commission upon request.
(4)Incorporated by reference to Exhibit 4 to the Company's Registration Statement on Form S-8 (no. 333-111761).
(5)Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on September 29, 2009.
(6)Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed on September 29, 2009.
(7)Incorporated by reference to Exhibit of the same number to the Company's Annual Report on Form 10-KSB for the year ended December 31, 2004, as filed with the Securities and Exchange Commission.
(8)Incorporated by reference to Exhibit of the same number to the Company's Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission.
(9)Incorporated by reference to Exhibit of the same number to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, as filed with the Securities and Exchange Commission.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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 indicated on February 18, 2011.
Name
Position
Signature
Emil D. Bennett
Director
/s/ EMIL D. BENNETT
John N. Burdette
Chairman of the Board of Directors
/s/ JOHN N. BURDETTE
J. Denham Crum
Director
/s/ J. DENHAM CRUM
William S. Fout
Director
/s/ WILLIAM S. FOUT
Helen G. Hahn
Director
/s/ HELEN G. HAHN
William J. Kissner
Director
/s/ WILLIAM J. KISSNER
Martin S. Lapera
President, Chief Executive Officer and Director (Principal Executive Officer)
/s/ MARTIN S. LAPERA
Kenneth G. McCombs
Director
/s/ KENNETH G. MCCOMBS
Farhad Memarsadeghi
Director
/s/ FARHAD MEMARSADEGHI
Raymond Raedy
Vice Chairman of the Board of Directors
/s/ RAYMOND RAEDY
William R. Talley, Jr.
Executive Vice President, Chief Financial Officer and Chief Operating Officer (Principal Financial and Accounting Officer)
/s/ WILLIAM R. TALLEY, JR.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
DISCLOSURE CONTROLS AND PROCEDURES
Frederick County Bancorp, Inc. and Subsidiaries Consolidated Balance Sheets
Frederick County Bancorp, Inc. and Subsidiaries Consolidated Statements of Income
Frederick County Bancorp, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity
Frederick County Bancorp, Inc. and Subsidiaries Consolidated Statements of Cash Flows
FREDERICK COUNTY BANCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
BUSINESS
SIGNATURES