Item 1. Business
WSB Holdings, Inc. (“WSB” or the “Company”) became the holding company of The Washington Savings Bank, F.S.B. (the “Bank”) as of January 3, 2008.
The Bank is a federally chartered, federally insured, stock savings bank which was organized in 1982 as a Maryland-chartered, privately insured savings and loan association. It received federal insurance in 1985 and a federal savings bank charter in 1986. The Bank is a member of the Federal Home Loan Bank (“FHLB”) system and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) to the maximum amount provided by law. We are subject to supervision and regulation by the Office of the Comptroller of the Currency (“OCC”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).
We have five savings branches in Maryland. They are located in Bowie, Waldorf, Crofton, Millersville and Odenton, all of which are adjacent to the Baltimore-Washington corridor. Also located in our corporate headquarters are our commercial lending group and our retail mortgage group. Our retail mortgage group also has offices in Northern Virginia, Catonsville and Annapolis, Maryland.
We are engaged primarily in the business of attracting deposit accounts from the general public and using such funds, together with other borrowed funds, to make first and second mortgage loans, land acquisition and development loans, commercial loans, construction loans, consumer loans, and non-residential mortgage loans, with an emphasis on residential mortgage, commercial and construction lending.
Recent Developments
On September 10, 2012, WSB and Old Line Bancshares, Inc., the parent company of Old Line Bank, entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Old Line Bancshares will acquire WSB for consideration of approximately $48.7 million in stock and cash, or $6.12 per share, subject to possible adjustment. The Merger Agreement, which has been approved by the Boards of Directors of both companies, provides that WSB will be merged with and into Old Line Bancshares. The Bank will be merged with and into Old Line Bank immediately following consummation of the merger.
Consummation of the merger is subject to certain conditions, including, among others, the approval of the Merger Agreement by the stockholders of Old Line Bancshares and WSB and the receipt of required regulatory approvals; we received Federal Reserve Board approval and OCC non-objection as of February 6, 2013, and we received the required Maryland Commissioner approval as of March 4, 2013. Therefore, all required regulatory approvals with respect to the Merger have now been received. WSB and Old Line Bancshares have each scheduled a special meeting of their stockholders on April 15, 2013, for stockholders to vote to approve the merger agreement. In addition, a lawsuit has been filed against WSB and its directors and against Old Line Bancshares that seeks to enjoin the merger. Please see “Item 3. Legal Proceedings” in Part I of this report.
The Merger Agreement includes customary representations, warranties and covenants of the parties. The Merger Agreement contains termination rights of WSB and Old Line Bancshares and
further provides that we will be required to pay Old Line Bancshares a termination fee of $1.75 million if the Merger Agreement is terminated under specified circumstances set forth therein.
We expect the merger to close on or about May 3, 2013. For additional information regarding our pending merger with Old Line Bancshares, please see as our definitive proxy statement filed with the Securities and Exchange Commission on March 5, 2013.
You should keep in mind that discussions in this report that refer to WSB’s business, operations and risks in the future refer to WSB as a stand-alone entity up to the closing of the pending merger or if the merger does not close, and that these considerations will be different with respect to the combined company after the closing of the merger.
Market Area and Target Market
We consider our current primary market area to consist of the suburban Maryland (Baltimore/Washington, D.C. suburbs) counties of Prince George’s, Anne Arundel and Charles. We generally target middle income individuals and small and middle income businesses.
Lending Activities
General. Lending by the Bank has historically focused on residential mortgage loans and construction loans on residential projects. The following table sets forth information concerning our loan portfolio net of deferred fees at the dates indicated:
(1) Includes $1.7 million, $1.9 million, $1.9 million, $1.2 million and $1.5 million of second mortgage loans at December 31, 2012, 2011, 2010, 2009 and 2008, respectively.
Contractual Maturities. The following table reflects the approximate schedule of contractual principal repayments of the held-for-investment loan portfolio at December 31, 2012. With respect to adjustable rate loans, the following table reflects the approximate schedule of contractual maturities:
Prepayment Experience. Contractual principal repayment terms do not necessarily reflect the actual repayment experience within the loan portfolio. The average lives of mortgage loans are expected to be substantially less than their contractual terms due to loan prepayments and refinancings. The following table presents estimated maturities of our loan portfolio based upon our historic prepayment experience. With respect to adjustable rate loans, the following table reflects the approximate schedule of contractual maturities:
Origination, Purchase and Sale of Loans. As a federal savings bank, the Bank has authority to originate and purchase loans secured by real estate located throughout the United States. Generally, we make loans in and around our market area, which primarily is the Baltimore-Washington corridor. Historically, we have not engaged in the purchasing of loans.
In addition to accepting loan requests from our customer base, we employ 16 mortgage loan originators compensated primarily on an incentive basis and two commercial loan originators compensated primarily on a salary basis. The loan originators and other members of our management maintain contacts with local builders, developers and realtors, which provide us with additional potential customers. The Bank also enhances its business contacts within the communities it serves by participating in local civic organizations.
The Bank originates residential loans for its portfolio and for sale in the secondary market. Our general practice has been to sell loans on an individual basis to various lenders throughout the country, without retaining loan servicing rights (commonly referred to as “servicing released”). In general, higher interest rate loans, such as commercial loans, second mortgages, construction loans, and construction/permanent loans, are held in the Bank’s portfolio, while conforming first mortgages are sold at or shortly after origination. During this period of slow demand in other areas of lending, we are focusing on increasing mortgage activity in order to reduce balance sheet risk and realize gains on the sale of loans in the secondary market. Due to
slow demand in commercial lending, our management has reduced our commercial business and commercial real estate lending department staff during the years ended December 31, 2010 and 2011. This has resulted in a decrease in the portfolios of commercial business, commercial real estate, and residential land development loans to commercial borrowers. We also use available funds to retain certain higher-yielding fixed rate residential mortgage loans in our portfolio in order to improve interest income. During the past three fiscal years, we originated 1376 loans with a principal value of approximately $413.8 million. The proceeds from loan sales are used to fund loans held for investment, mortgage-backed securities (“MBS”) and investment securities. We also have approval to sell loans to Fannie Mae (“FNMA”) and Freddie Mac (“FHLMC”), which enhances our ability to sell our mortgage loans and to convert pools of loans into marketable Ginnie Mae (“GNMA”), FNMA and FHLMC participation certificates. See “Mortgage-Backed Securities.”
Loan Underwriting Policies. Under our loan approval policy, all loans approved must comply with federal regulations. Generally, we will make residential mortgage loans in amounts up to the limits established from time to time by FNMA and FHLMC for secondary market resale purposes. This amount for single-family residential loans currently varies from $417,000 up to a maximum of $625,500 for certain high-cost designated areas. We also make residential mortgage loans up to limits established by the Federal Housing Administration (“FHA”) which currently is $729,500. The Washington, D.C. and Baltimore areas are both considered high-cost designated areas. We will, however, make loans in excess of this amount, if we believe we can sell the loans in the secondary market or that the loans should be held in our portfolio.
We obtain detailed loan applications to determine a borrower’s ability to repay and verify the more significant items on these applications through credit reports, financial statements and confirmations. We also require appraisals of collateral and title insurance on secured real estate loans. Most borrowers must establish a mortgage escrow account for items such as real estate taxes, governmental charges and hazard and private mortgage insurance premiums.
Our lending policy generally requires private mortgage insurance when the loan-to-value ratio exceeds 80%. We generally do not lend in excess of 90% of the appraised value of single-family residential dwellings even when private mortgage insurance is obtained, except for FHA, Veterans Administration (“VA”) and Farmers Home Administration (“FmHA”) loans, which permit higher loan-to-value ratios. Underwriting policies on other types of loans are described below.
Under federal law, the aggregate amount of loans that we may make to any one borrower and related entities is generally limited to 15% of the Bank’s unimpaired capital and unimpaired surplus. Our general lending limit at December 31, 2012 was approximately $8.2 million. We have not made any loans aggregated in excess of this limit.
Single-Family Residential Real Estate Lending. At December 31, 2012, we had a total of $204.2 million in loans receivable and MBS. Loans secured by first or second mortgages on single-family properties, excluding construction loans, were $71.2 million or 34.89% of total loans receivable and MBS. MBS were $24.8 million or 12.15% of total loans receivable and MBS.
Our single-family residential loans have historically consisted of fixed interest rates for terms of up to 30 years. We originate conventional mortgage loans, FHA loans, VA loans, and loans in excess of the FNMA and FHLMC ceilings both for sale in the secondary market and for
our own portfolio. We also offer adjustable-rate mortgages, with rates adjusting to external indices in one to ten years. We have also made loans which fully amortize in 15 years and, on investment properties, loans which are due and payable in five years, subject to extension in some circumstances.
Non-Residential Real Estate Lending. We make permanent mortgage loans on various non-residential properties, including office buildings and warehouses. Non-residential loans are made on properties located in or around our market area. Non-residential real estate lending may entail significant additional risks as compared to single-family residential property lending. At December 31, 2012, non-residential real estate loans represented $30.0 million, or 14.72% of total loans receivable and MBS, and lot and land loans represented $6.1 million, or 2.98%, of our total loans receivable and MBS.
Acquisition, Development and Construction Lending. We provide construction loans for single-family and multi-family residences and for non-residential properties. These loans usually include funding for the acquisition and development of unimproved properties to be used for residential or non-residential construction. We may provide permanent financing on the same projects for which we have provided the construction financing.
Acquisition, development and construction lending, while providing higher yields, may also have greater risks of loss than long-term residential mortgage loans on improved, owner-occupied properties. At December 31, 2012, acquisition, development and construction loans represented $4.3 million, or 2.12%, of our total loans receivable and MBS.
The Bank generally is not currently seeking land or land acquisition loans; however, in the past the Bank would generally make land acquisition loans with terms of up to three years and loan to value ratios of up to 65%, and land development loans with terms of up to two years and loan-to value ratios of up to 75%. The Bank is currently focusing on owner occupied residential construction loans with original terms of generally up to one year and loan to-value ratios of up to 80%.
Commercial Lending. Federal laws and regulations permit thrift institutions to lend up to 20% of total assets in commercial loans on an unsecured basis or secured by collateral other than real estate, provided that amounts in excess of 10% of total assets may be used only for small business loans. Prior to 2008, commercial lending was a minor component of our lending portfolio and operations. Since 2008, we expanded this part of our lending business and continue to promote the origination of commercial and commercial real estate lending, but due to slow demand in commercial lending, our commercial portfolio has continued to decrease as a result of loan pay-downs, including by approximately $12.0 million during the year ended December 31, 2012. We have, however, recently shifted our focus to increasing our mortgage banking activity, primarily loans sold in the secondary market, during this current period of slow demand for commercial lending. At December 31, 2012, commercial loans represented $1.8 million, or 0.90%, of total loans receivable and MBS. Commercial loans secured by real estate represented $65.4 million, or 32.04%, of total loans receivable and MBS at December 31, 2012. In addition, we have issued a limited number of standby letters of credit, generally to development loan customers in connection with development work financed by the Bank.
Consumer Lending. Federal laws and regulations permit a federally chartered thrift institution to make secured and unsecured consumer loans in an aggregate amount up to 35% of the institution’s total assets. The 35% limitation does not include home equity loans (loans
secured by the equity in the borrower’s residence, but not necessarily for the purpose of improvement), home improvement loans or loans secured by deposits. We have not actively promoted these kinds of loans. Consumer loans, including loans secured by deposits, represented $417,000, or 0.20%, of total loans receivable and MBS at December 31, 2012.
Loan Fees and Service Charges. In addition to interest earned on loans, we receive income through servicing of loans and certain loan fees in connection with loan originations, loan modifications, loan commitments, late payments, changes of property ownership inspection fees and other services related to our outstanding loans. Income from these activities varies from period to period with the volume and types of loans made and repaid. We charge loan origination fees, which are calculated as a percentage of the amount loaned. The fees received in connection with the origination of construction and mortgage loans have generally been from one to four points (one point being equivalent to 1% of the principal amount of the loan) and are dependent upon market conditions and other factors. Loan origination fees, net of certain costs, are deferred and recognized as a yield adjustment over the lives of the loans primarily utilizing the interest method.
Mortgage-Backed Securities (MBS)
In addition to short-term investments, when management believes favorable interest rate spreads are available, we may invest excess funds in MBS. GNMA participation certificates represent interests in pools of loans which are either insured by the FHA or guaranteed by the VA. FHLMC participation certificates are guaranteed by the FHLMC and FNMA participation certificates are guaranteed by the FNMA. The United States is not obligated to fund either FHLMC’s obligations or FNMA’s obligations. MBS may also be used as collateral for short-term and long-term borrowings, which we may obtain from time to time. We do not generally employ hedging strategies in connection with a MBS portfolio.
The primary risk of holding these securities is the fluctuation of principal value corresponding to changes in interest rates. Although MBS do not alter the overall maturity of our assets as compared to holding a comparable portfolio of whole loans, they are more liquid than whole mortgage loans. At December 31, 2012, we had $24.8 million MBS in our portfolio. The following table sets forth the book value and estimated market value of the MBS portfolio at the dates indicated.
We sold $53.2 million MBS classified as available-for-sale during the year ending December 31, 2012 and experienced $189,000 pre-tax gain, or approximately $115,000 after tax gain, compared to $11.0 million MBS classified as available-for-sale, experiencing a $401,000 pre-tax gain in 2011, or approximately $243,000 after tax gain for the twelve months ending December 31, 2011. We sold the majority of these MBS during 2012 after entry into the Merger Agreement because we believe, based on the manner that the merger consideration will be calculated as provided in the Merger Agreement, that these MBS may have resulted in downward adjustments in the total consideration to be paid to WSB’s stockholders in the merger had such MBS remained
in our portfolio on the effective date of the merger. The 2011 gain was due to the opportunity to sell and receive a premium on MBS then held in our portfolio. We expect to continue to reposition the investment portfolio in order to attempt to minimize any potential adjustment to the total consideration to be paid upon closing of the merger.
At December 31, 2012, we had no non-cash other-than-temporary impairment (“OTTI”) charges recognized in net earnings, related to available-for-sale investments as we sold the remaining non-agency private labeled MBS during the twelve month period ending December 31, 2012. For full explanation, please refer to Note 3 of the Notes to Consolidated Financial Statements.
Other Investment Activities
In addition to investment in MBS, excess short-term funds have over time been generally been invested in federal funds, agency callable paper, zero coupon bonds, a certificate of deposit (“CD”) and preferred trust coupon bonds. Our portfolio of investment securities provides a source of liquidity when loan demand exceeds funding capability, provides funding for unexpected savings and CD withdrawals, provides funds for CD maturities, serves as a vehicle for interest rate risk management, and provides a source of income. We are required to maintain certain liquidity ratios and generally do so by investing in securities that qualify as liquid assets under federal regulations. We are also required to hold FHLB stock in specified amounts and to maintain certain reserves with the Federal Reserve Bank of Richmond. See “Business-Supervision and Regulation”.
The following table sets forth certain information regarding our investment securities (excluding MBS), at carrying value and other interest earning assets at the dates indicated.
The following table sets forth our scheduled maturities on other investments:
Other Investments Scheduled Maturity Table as of December 31, 2012
Prepayments and calls on the U.S. Government Agencies shorten the actual maturity. FHLB and Atlantic Central Bankers Bank stock has been excluded from this table as they have no stated maturity.
Approximately $43.5 million short term investments, callable agencies, were called during the twelve month period ending December 31, 2012. Also, during the twelve month period ending December 31, 2012, we sold approximately $2.6 million in short term agencies, $5.0 million in corporate bonds and $2.3 million in municipal bonds. We sold most of these investments to reposition the investment portfolio in order to attempt to minimize any potential adjustment to the total consideration to be paid upon closing of the merger.
Sources of Funds
General. Deposits are the primary source of the Bank’s funds for use in lending and for other general business purposes. In addition to deposits, we obtain funds from loan amortizations and prepayments and sales of loans, MBS and investment securities. We maintain funding facilities with correspondent banks and the Federal Home Loan Bank of Atlanta, which are cancelable by the lender and subject to lender discretion. Management has begun investing excess cash liquidity in investment grade securities which offer a ready source of collateral for secured borrowings under existing credit facilities. Structured repurchase agreements (“repos”) are financial transactions in which an organization borrows money by selling securities and simultaneously agreeing to buy the securities back later at a higher price, and they function similarly to a secured loan with the securities serving as collateral. At December 31, 2012, we had borrowings of $68.0 million in the form of advances from the FHLB of Atlanta.
Deposits. Deposits are the primary source of our funds for use in lending and for other general business purposes. We compete with other financial institutions for deposits. Competition for deposits remains high. The receipt and disbursement of deposits are significantly influenced by economic conditions, interest rates, money market conditions and other factors. Our consumer deposits and commercial deposits are attracted from within our primary market areas through the offering of a broad selection of deposit instruments including consumer, small business and commercial demand deposit accounts, interest-bearing checking accounts, money market accounts, regular savings accounts, certificates of deposit and retirement savings plans. These accounts are a source of low-interest cost funds and provide fee income to the Bank.
Information concerning our deposits is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Consolidated Financial Condition Analysis - Deposits” and in Note 8 of the Notes to Consolidated Financial Statements.
The change in the mix of our deposits during 2012, as discussed further in the table below, reflects our emphasis to decrease our deposits by decreasing the rates offered on these products to continue our efforts to reduce interest expense. We advertise for CDs from time to time generally when we have the need for deposits of specific maturities. We have received deposits through brokers on an occasional basis in a manner consistent with federal regulations for our current funding obligations, however, we have consciously reduced our reliance on brokered deposits and have focused growth through the branches.
The following table shows the distribution of our deposits by type of deposit, including accrued interest, for the periods indicated.
Our deposits are insured by the FDIC. The Bank’s deposits have FDIC insurance coverage of $250,000 per depositor. The Dodd-Frank Wall Street Reform and Consumer Protection Act signed on July 21, 2010, made permanent the deposit insurance amount of $250,000.
The following table presents, by various interest rate categories, the amounts of time deposit accounts, excluding accrued interest payable of $7,254 at December 31, 2012, which will mature during the periods indicated.
(1)Brokered accounts consisting of individual accounts issued under master certificates in the broker’s name have been included in the total representing balance of $100,000 or less.
The following table contains information pertaining to approximately 146 certificates of deposit accounts held in excess of $100,000 as of December 31, 2012.
Borrowings. At December 31, 2012, total borrowings consisted of $68.0 million in FHLB advances. During the fiscal year ending December 31, 2012, our borrowings were reduced as a result of an $8.0 million maturity and the repayment of $8.0 million in the daily rate credit, bringing the balance of our FHLB advances to $68.0 million at December 31, 2012 as compared to $84.0 million at December 31, 2011. Borrowings for fiscal 2012 were as follows:
FHLB Borrowings
Our interest expense on our borrowings decreased approximately $85,400 and $1.4 million for the periods ending December 31, 2012 and 2011. This decrease is due to our continuing efforts to reduce our higher cost liabilities.
Subsidiaries
WSB, Inc.
The Bank established a wholly owned service corporation subsidiary, WSB, Inc., in 1985. WSB Inc. became a subsidiary of WSB in the holding company reorganization. WSB, Inc. purchases land to develop into single-family building lots that are offered for sale to third parties. It also builds homes on certain lots on a contract basis. During the years ended December 31, 2012 and 2011, WSB, Inc. did not develop any lots. See Note 5 of Notes to Consolidated Financial Statements.
WSB Realty, LLC
The Bank established a wholly-owned operating subsidiary in January 2009 for the purpose of directly or indirectly, acquiring, owning, holding, leasing, developing, managing, operating, investing in or otherwise dealing with various real and personal property. Management is authorized to take assignment of the right to acquire title to certain properties purchased at foreclosure sales. Management is authorized to take usual and customary activities toward the acquisition, rehabilitation, sale, rental and disposition of these properties. At December 31, 2012, WSB Realty, LLC had assets of approximately $3.2 million consisting primarily of cash and other real estate owned. WSB Realty, LLC reports a net loss of approximately $24,700 for year ending December 31, 2012.
WSB Realty, Inc.
The Bank established a wholly-owned operating subsidiary in September 2010 for the purpose of directly or indirectly, acquiring, owning, holding, leasing, developing, managing, operating, investing in or otherwise dealing with various real and personal property. Management is authorized to take assignment of the right to acquire title to certain properties purchased at
foreclosure sales. Management is authorized to take usual and customary activities toward the acquisition, rehabilitation, sale, rental and disposition of these properties. At December 31, 2012, WSB Realty, Inc. had assets of approximately $17,000 consisting primarily of cash. WSB Realty, Inc. reports a net loss of approximately $65 for year ending December 31, 2012.
Employees
We had 88 full-time and 22 part-time employees at December 31, 2012. We provide health and life insurance benefits and an employer matching 401(k) plan. None of the employees are represented by a collective bargaining union. We believe that we enjoy good relations with our employees.
Available Information
WSB’s internet address is www.twsb.com. There we make available, free of charge, our annual report on Form 10-K, proxy statements, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports as soon as practicable after we file or furnish them with the Securities and Exchange Commission (“SEC”), as well as copies of required Forms 3, 4, and 5 filings for insider security holdings and transactions and copies of our Code of Ethics for our officers, directors and employees as well as our committee charters. Our SEC reports can be accessed through the financial highlights information section of our website. The information on our website is not a part of this or any other report we file with or furnish to the SEC.
Supervision and Regulation
General
The following discussion summarizes certain material elements of the regulatory framework applicable to WSB and its subsidiaries. These summaries of statutes and regulations are not intended to be complete and such summaries are qualified in their entirety by reference to such statutes and regulations.
WSB is a unitary savings and loan holding company that is subject to regulation and supervision by the Federal Reserve Board. As such, WSB is required to serve as a source of financial strength to its subsidiary depository institution and to commit resources to support the depository institution as needed. The Federal Reserve Board also has the authority to require WSB to terminate any activity or to relinquish control of a nonbank subsidiary upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of the holding company or the depository institution. WSB’s status as a savings and loan holding company does not exempt it from certain federal and state laws applicable to Delaware corporations generally, including, without limitation, certain provisions of the federal securities laws.
As a federal savings bank, the Bank is subject to extensive regulation and periodic examination by the OCC. The lending activities and other investments of the Bank must comply with various federal regulatory requirements and the Bank must periodically file reports with the OCC describing its activities and financial condition. The Bank’s deposits are insured by the FDIC through its Deposit Insurance Fund (“DIF”). The Bank is also subject to regulation for certain matters by the FDIC and for certain other matters by the Federal Reserve Board. This
supervision and regulation is intended primarily for the protection of depositors. Certain of these regulatory requirements are referred to below or appear elsewhere herein.
As a savings and loan holding company, WSB is registered with the Federal Reserve Board and is subject to regulation, examinations, supervision, and reporting requirements applicable to savings and loan holding companies. In addition, the Federal Reserve Board has enforcement authority over WSB and its subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the Bank.
On June 3, 2011, WSB and the Bank entered into separate Supervisory Agreements (the “Agreements”) with the Office of Thrift Supervision (the “OTS”), their primary banking regulator on such date.
The Agreements, which are formal enforcement actions initiated by the OTS, require WSB and the Bank to take certain measures to improve their safety and soundness and maintain ongoing compliance with applicable laws. During the course of a routine review of the Company by the OTS, examiners identified certain supervisory issues, primarily related to our classified assets. The Supervisory Agreements set forth the actions that WSB, the Bank and their Boards of Directors must undertake to address the issues. Pursuant to regulatory changes instituted by the Dodd-Frank Act, WSB is now regulated by the Federal Reserve Board and the Bank is now regulated by the OCC. As our current regulators, the Agreements will be enforced by the OCC with respect to the Bank and the Federal Reserve Board with respect to WSB. Each Agreement will remain in effect until terminated, modified or suspended by the Federal Reserve Board or OCC, as applicable.
We have adopted many of the requirements required by the Supervisory Agreements and have submitted the information to the appropriate regulators for their approval.
For additional information regarding the Agreements, please see the Company’s Current Report on Form 8-K filed with the SEC on June 6, 2011. The Agreements are also filed as Exhibits 10.12 and 10.13 to our quarterly report for the period ending June 30, 2011.
The following is a summary of certain laws and regulations that are applicable to the Bank. This summary is not a complete description of such laws and regulations, nor does it encompass all such laws and regulations. Any change in the laws and regulations governing the Bank or in the policies of the various regulatory authorities could have a material impact on the Bank, its operations and its stockholders.
Regulatory Reform Legislation. The Dodd-Frank Act, enacted in 2010, will have a broad impact on the financial services industry, imposing significant regulatory and compliance changes, including the designation of certain financial companies as systemically significant, the imposition of increased capital, leverage, and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector.
The following items provide a brief description of certain provisions of the Dodd-Frank Act.
· OTS merged with OCC. The Dodd-Frank Act eliminated the OTS. On July 21, 2011, the OTS merged into the OCC, with the OCC assuming all functions and authority from the OTS relating to federally chartered savings banks, such as the Bank, and the Federal
Reserve Board assuming all functions and authority from the OTS relating to holding companies for savings banks, such as WSB. As a result, as of July 21, 2011, the OCC became the Bank’s primary federal regulator and WSB became subject to supervision by the Federal Reserve Board.
· Source of strength. The Dodd-Frank Act extended the Federal Reserve Board’s “source of strength” doctrine to savings and loan holding companies such as WSB. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
· Mortgage loan origination and risk retention. The Dodd-Frank Act imposes new standards for mortgage loan originations on all lenders, including banks, in an effort to require steps to verify a borrower’s ability to repay. In addition, the Dodd-Frank Act generally requires lenders or securitizers to retain an economic interest in the credit risk relating to loans the lender sells or mortgage and other asset-backed securities that the securitizer issues. The risk retention requirement generally will be 5%, but could be increased or decreased by regulation.
· Consumer Financial Protection Bureau (“CFPB”). The Dodd-Frank Act created a new independent CFPB within the Federal Reserve Board. The CFPB is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The CFPB has rulemaking authority over many of the statutes governing products and services offered to bank consumers, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. For banking organizations with assets under $10 billion, like the Bank, the CFPB has exclusive rulemaking authority, but the Bank’s primary federal regulator will continue to have examination and enforcement authority under federal consumer financial law. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB. Compliance with any such new regulations would increase our cost of operations.
· Deposit insurance. The Dodd-Frank Act made permanent the general $250,000 deposit insurance limit for insured deposits. The Dodd-Frank Act also extended until January 1, 2013, federal deposit insurance coverage for the full net amount held by depositors in non-interest bearing transaction accounts. Amendments to the Federal Deposit Insurance Act also broadened the assessment base against which an insured depository institution’s deposit insurance premiums paid to DIF will be calculated. Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity. These provisions could increase the FDIC deposit insurance premiums paid by the Bank.
· Corporate governance. The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including the Company. The Dodd-Frank Act provides the SEC with authority to adopt proxy access rules that would allow stockholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company’s proxy materials and directs the SEC and national
securities exchanges to adopt rules that (1) provide stockholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) will enhance independence requirements for compensation committee members; and (3) will require companies listed on national securities exchanges to adopt incentive-based compensation clawback policies for executive officers.
Many of the requirements of the Dodd-Frank Act will be implemented over time and most will be subject to regulations implemented over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.
Liquidity Requirements. As a thrift, the Bank derives its lending and investment authority from the Home Owners’ Loan Act, as amended, and regulations of the OCC thereunder. Those laws and regulations limit the ability of the Bank to invest in certain types of assets and to make certain types of loans. For example, the OCC requires thrifts to maintain sufficient liquidity to ensure their safe and sound operation. Liquid assets are defined to include cash, deposits maintained pursuant to Federal Reserve Board reserve requirements, time deposits in certain institutions and certain savings deposits, obligations of the United States and certain of its agencies and qualifying obligations of the states and political subdivisions thereof, highly rated corporate debt, mutual funds that are restricted by their investment policies to investing only in liquid assets, certain mortgage loans and mortgage-related securities and bankers acceptances. As of December 31, 2012, the Bank had $41.4 million of cash and cash equivalents. Further, the Company had $77.6 million of unpledged investment securities. .
Internal sources of operational liquidity used by the Bank are cash, various short-term investments, mortgage-backed securities and loans and investments classified as available-for-sale. Additionally, we may borrow funds from commercial banks or from the FHLB of Atlanta or the Federal Reserve Bank “discount window” after exhausting FHLB sources. Previously, we also have utilized short term borrowings in the form of reverse repurchase agreements from a commercial bank to meet short-term liquidity needs. At December 31, 2012, we had approximately $43.8 million of availability on our FHLB line, and $12.0 million of availability on our secured line of credits with correspondent banks.
Qualified Thrift Lender Test. As a federal savings bank, the Bank must satisfy the qualified thrift lender, or “QTL,” test. To satisfy the QTL test, the Bank must either qualify as a domestic building and loan association under the Internal Revenue Code, or maintain an appropriate level of certain investments, called “Qualified Thrift Investments” (“QTIs”). QTIs include, among other things, a bank’s residential mortgages and related investments, including mortgage-backed securities, Federal Home Loan Bank stock, education loans, small business loans, and loans made through credit cards. QTIs must represent 65% or more of the Bank’s portfolio assets on a monthly average basis in 9 months out of every 12-month period. “Portfolio
assets” generally means total assets of a savings bank, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings bank’s business. Failure by the Bank to maintain its status as a QTL will result in certain restrictions under the Home Owners’ Loan Act on the Bank’s ability to engage in new activities, to establish new branches and to pay dividends. Additionally, WSB would be required to register as a bank holding company and become subject to the various restrictions applicable to the activities of bank holding companies. The Dodd-Frank Act made noncompliance with the QTL test subject to OCC enforcement action for a violation of law. At December 31, 2012, our QTL ratio was 67%, which exceeded the requirements of the QTL test.
Capital Standards. The Bank is subject to capital standards imposed by the OCC. These standards call for a minimum “leverage ratio” of core capital to adjusted total assets of 4% (3% for savings institutions receiving the highest composite CAMELS rating for safety and soundness), a minimum ratio of tangible capital to adjusted total assets of 1.5%, and a minimum ratio of risk-based capital to risk-weighted assets of 8%. For capital adequacy purposes, a bank is placed in one of the following five categories based on the bank’s capital: (1) well capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital); (2) adequately capitalized (at least 4% leverage capital (3% for savings banks receiving the highest rating on the CAMELS rating system), 4% Tier 1 risk-based capital and 8% total risk-based capital); (3) undercapitalized (less than 4% leverage capital (3% for savings banks receiving the highest rating on the CAMELS rating system), 4% Tier 1 risk-based capital or less than 8% total risk-based capital,); (4) significantly undercapitalized (less than 3% leverage capital, 3% Tier 1 risk-based capital or less than 6% total risk-based capital,); and (5) critically undercapitalized (less than 2% tangible capital). The federal banking agencies are required to take prompt corrective action with respect to insured institutions that fall below the adequately capitalized level. Any insured depository institution that falls below the adequately capitalized level must submit a capital restoration plan, and, if its capital levels further decline or do not increase, will face increased scrutiny and more stringent supervisory action. At December 31, 2012, the Bank’s ratios exceeded all regulatory capital requirements for well capitalized institutions. See Note 12 of Notes to Consolidated Financial Statements.
Proposed New Capital Rules. On June 12, 2012, the federal bank regulatory agencies adopted notices of proposed rulemaking in which they proposed to revise their risk-based and leverage capital requirements consistent with agreements reached by the Basel Committee on Banking Supervision (BCBS) in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”). If adopted, the new requirements would introduce new tier 1 common equity ratio requirements of 4.5% and 6.5%, net of regulatory deductions, for adequately capitalized and well-capitalized institutions, respectively, and would also establish more conservative standards for including an instrument in regulatory capital. The new requirements would also introduce a capital conservation buffer of an additional 2.5% of common equity to risk-weighted assets, raising the target minimum common equity ratio to 7%, the minimum tier 1 capital ratio to 8.5%, and the minimum total capital ratio to 10.5%. An institution’s failure to achieve these minimum levels including the capital conservation buffer would restrict the institution’s ability to make capital distributions, including dividends, and to make certain discretionary bonus payments to executive officers. The regulatory agencies also reserve the right to require capital ratios for individual institutions that are higher than these minimums depending on the institution’s individual circumstances. The new requirements would also assign new risk weight categories for certain assets, most notably residential mortgage loans, high volatility commercial real estate loans, and past due assets. These new risk weightings may require banks and bank holding companies to maintain additional capital against assets in those categories and
may introduce more volatility in their capital ratios. The new capital requirements would be applicable to savings and loan holding companies such as WSB.
Prompt Corrective Action. The federal banking agencies have established by regulation, for each capital measure, the levels at which an insured institution is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized. The federal banking agencies are required to take prompt corrective action with respect to insured institutions that fall below the adequately capitalized level. Any insured depository institution that falls below the adequately capitalized level must submit a capital restoration plan, and, if its capital levels further decline or do not increase, will face increased scrutiny and more stringent supervisory action. As of December 31, 2012, we were deemed to be well capitalized.
Interest Rate Risk. The OCC has issued guidelines regarding the management of interest rate risk (“IRR”). The OCC expects all federal savings associations, such as the Bank, to manage their IRR exposure using processes and systems commensurate with their earnings and capital levels; complexity; business model; risk profile; and scope of operations. Savings associations are required to have comprehensive policies and procedures that govern all aspects of their IRR management process and that address the potential impact of changing interest rates on earnings and capital from a short-term and a long-term perspective. Stress testing is an integral component of IRR management. The Bank’s IRR program incorporates a stress-testing process to identify and quantify the Bank’s IRR exposure and potential problem areas.
Deposit Insurance. Deposit accounts in the Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor. FDIC-insured depository institutions are required to pay deposit insurance assessments to the FDIC. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. Rates are based on each institution’s risk category and certain specified risk adjustments. Deposit insurance assessments fund the DIF, which is currently under-funded.
The Dodd-Frank Act changed the way an insured depository institution’s deposit insurance premiums are calculated. The assessment base is no longer the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity. The legislation also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and noninterest bearing transaction accounts had unlimited deposit insurance through December 31, 2012. The Dodd-Frank Act also made changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% percent to 1.35% of the estimated amount of total insured deposits, eliminating the upper limit for the reserve ratio designated by the FDIC each year, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds.
As mandated by the Dodd-Frank Act, in February 2011, the FDIC approved a final rule that changes the deposit insurance assessment system from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. In addition, the rule adopts a “scorecard” assessment scheme for larger banks and suspends dividend payments indefinitely if the DIF reserve ratio exceeds 1.5% percent, but provides for decreasing assessment rates when the reserve ratio reaches certain thresholds. Under the new rule, larger
insured depository institutions generally pay higher assessments than under the old system, which should offset the cost of the assessment increases for institutions with consolidated assets of less than $10 billion, such as the Bank.
In 2009, the FDIC imposed a 5 basis point special assessment on each insured depository institution’s insurance assets minus Tier 1 capital (core capital) as of June 30, 2009, not to exceed 10 basis points of the institution’s domestic deposits. This special assessment was collected on September 30, 2009. The FDIC also adopted a final rule requiring insured institutions to prepay quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. The pre-payment allowed the FDIC to strengthen the cash position of the DIF immediately without impacting earnings of the industry. We paid the prepaid assessments, along with our regular quarterly assessment, on December 30, 2009. As of December 31, 2012, $223,000 in pre-paid deposit insurance assessments is included in other assets in the accompanying consolidated balance sheet.
In addition to FDIC deposit insurance assessments, all FDIC-insured depository institutions must also pay an annual assessment to interest payments on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds (commonly referred to as “FICO bonds”) were issued to capitalize the Federal Savings and Loan Insurance Corporation. The Financing Corporation payments will continue until the bonds mature in 2017 through 2019. Our FICO expense payments totaled $632,000 in 2012 and $742,000 in 2011.
The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Our management is not aware of any existing circumstances which would result in termination of our deposit insurance.
Restrictions on Capital Distributions. OCC regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the capital account. A savings bank must file an application for approval of a capital distribution if: (1) the total capital distributions for the applicable calendar year exceed the sum of the savings bank’s net income for that year to date plus the savings bank’s retained net income for the preceding two years; (2) the bank would not be at least adequately capitalized following the distribution; (3) the distribution would violate any applicable statute, regulation, agreement or OCC-imposed condition; or (4) the savings bank is not eligible for expedited treatment of its filings. Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must file a notice with the Federal Reserve Board at least 30 days before the board of directors declares a dividend or approves a capital distribution. The OCC may disapprove a notice or application if: (1) the savings bank would be undercapitalized following the distribution; (2) the proposed capital distribution raises safety and soundness concerns; or (3) the capital distribution would violate a prohibition contained in any statute, regulation or agreement. Refer to “Market Price of WSB’s Capital Stock and Dividends” for WSB’s current dividend position.
Federal Reserve System.
Pursuant to regulations of the Federal Reserve Board, a thrift institution must maintain non-interest bearing reserves at the Federal Reserve Bank or in a pass-through account at a correspondent institution, calculated daily, equal to 3% of its “low reserve tranche,” currently the first $79.5 million of transaction accounts (less a $12.4 million exclusion). Amounts above $79.5 million require reserves of $2,013,000 plus 10 percent of the amount in excess of $79.5 million. We have consistently met the reserve requirements.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Atlanta, which is one of 12 regional Federal Home Loan Banks. FHLB banks provide a central credit facility primarily for member institutions. At December 31, 2012 and 2011, we had advances of $68.0 million and $84.0 million, respectively, from the FHLB of Atlanta. The FHLB borrowings are collateralized by a blanket collateral loan agreement under which we must maintain minimum eligible collateral for the outstanding advances.
As a member, the Bank is also required to acquire and hold shares of capital stock in the FHLB of Atlanta. We were compliant with this requirement with an investment in FHLB of Atlanta stock at December 31, 2012 of $3.6 million.
Safety and Soundness Standards. We are subject to certain standards designed to maintain the safety and soundness of individual banks and the banking system. The OCC has prescribed safety and soundness guidelines relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate exposure; (v) asset growth, concentration, and quality; (vi) earnings; and (vii) compensation and benefit standards for officers, directors, employees and principal stockholders. A federal savings institution not meeting one or more of the safety and soundness guidelines may be required to file a compliance plan with the OCC. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Community Reinvestment Act. In 1977, Congress enacted the Community Reinvestment Act to encourage depository institutions, including thrifts, to help meet the credit needs of their entire communities, including low- and moderate-income areas, consistent with safe and sound banking practices. Because the Bank meets the OCC’s definition of an “intermediate small savings association,” i.e., those with more than $296 million in assets, but less than $1.186 billion in assets as of the end of either of the two previous years, the Bank is subject to somewhat streamlined examinations and reduced data collection and regulatory reporting requirements under the Community Reinvestment Act, relative to large retail savings associations. As a result, the Bank qualifies for the intermediate small institution Community Reinvestment Act examinations, based on its present asset size. Standard Community Reinvestment Act examinations evaluate depository institutions under lending, investment and community service tests. Intermediate small institutions’ examinations, however, focus mainly on the lending activities of depository institutions, and also evaluate community development activities of the institution, such as community development loans, investments, and services.
The Bank received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.
Loans-to-One-Borrower Limitations. Generally, a federal savings bank may not make a loan or extend credit to a single borrower or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2012, we were in compliance with loans-to-one-borrower limitations.
Transactions with Related Parties. Under Sections 23A and 23B of the Federal Reserve Act, which are applicable to savings banks, extensions of credit and certain asset purchases between a savings bank and its affiliates are restricted. An affiliate of a bank is a company that controls or is under common control with the bank, except, in most instances, subsidiaries of the bank itself. In a holding company context, the parent savings and loan holding company and any companies that are controlled by such savings and loan holding company are affiliates of the subsidiary savings bank. The general purpose of these restrictions is to prevent a savings bank from subsidizing its affiliates that are not insured by the FDIC through transactions that are excessive in amount, on preferential terms, or otherwise unsafe and unsound. Under Section 23A, the Bank is not able to engage in “covered transactions” with any single affiliate if the aggregate amount of its covered transactions with that affiliate exceeds 10% of the Bank’s capital and surplus, or with all of the Bank’s affiliates collectively if the aggregate amount of our covered transactions with all affiliates exceeds 20% of our capital and surplus. A transaction with a third party is deemed to be a covered transaction to the extent that the proceeds of the transaction are used for the benefit of or transferred to an affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of guarantees and other similar transactions. In addition, loans or other extensions of credit by the Bank to an affiliate are required to be collateralized in accordance with regulatory requirements, and the Bank’s transactions with affiliates must be consistent with safe and sound banking practices and may not involve the purchase by the Bank of any low-quality asset. Section 23B applies to covered transactions as well as certain other transactions and requires that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to non-affiliates. Dividends and fees paid by us are not defined as covered transactions and are not subject to section 23A and 23B restrictions, but are subject to the capital distribution restrictions noted above.
Certain transactions with affiliates are prohibited altogether. For example, the Bank may not purchase or invest in securities issued by any of its affiliates. Other transactions are subject to full or partial exemptions. For example, purchasing an asset having a readily identifiable and publicly available market quotation and purchased at or below the asset’s current market quotation is exempt from the quantitative limits, collateral requirements and low-quality asset restrictions of Section 23A.
Section 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board govern extensions of credit made by a bank to its directors, executive officers, and principal stockholders (“insiders”). Among other things, these provisions require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features. Further, such extensions may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. Extensions of credit in excess of certain limits must be also be approved by the board of directors.
Consumer Protection Laws. The Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair and Accurate Credit Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and various state law counterparts.
In addition, federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, a financial institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Further under the “Interagency Guidelines Establishing Information Security Standards,” savings banks must implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of customer information. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Anti-Money Laundering and OFAC
Under federal law, financial institutions must maintain anti-money laundering programs that include established internal policies, procedures and controls; a designated compliance officer, an ongoing employee training program and testing of the program by an independent audit function. Financial institutions are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and customer identification in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and law enforcement authorities have been granted increased access to financial information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations, and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.
The Office of Foreign Assets Control, or OFAC, is responsible for helping to insure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC sends bank regulatory agencies lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If WSB or the Bank finds a name on any transaction, account, or wire transfer that is on an OFAC list, they must freeze such account, file a suspicious activity report and notify the appropriate authorities.
Holding Company Regulation
General. WSB is registered with the Federal Reserve Board and is subject to regulations, examinations, supervision and reporting requirements applicable to savings and loan holding companies. In addition, the Federal Reserve Board has enforcement authority over WSB and its subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the Bank. The Federal Reserve Board assumed the authority over savings and loan holding companies previously exercised by the OTS on July 21, 2011.
Permissible Activities. Under present law, the business activities of WSB are generally limited to those activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, provided certain conditions are met, and certain additional activities authorized by federal regulations.
Savings and loan holding companies, such as WSB, may not directly or indirectly, or through one or more subsidiaries, acquire more than 5% of another savings institution or savings and loan holding company, without prior regulatory approval. WSB may not, with certain exceptions, acquire more than 5% of a non-subsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquire or retain control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
Capital. Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. In addition, proposed capital rules would subject top-tier saving and loan holding companies, such as WSB, to the same general capital requirements applicable to their subsidiary savings banks. See “- Proposed New Capital Rules.”.
Source of Strength. The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
Dividends. The Bank must notify the Federal Reserve Board 30 days before declaring any dividend to WSB. The Federal Reserve Board may disapprove such dividend, in whole or in part, if it finds that the proposed dividend would, among other things, cause the Bank to be undercapitalized, raise safety or soundness concerns, or violate a prohibition contained in any statute, regulation, enforcement action, or agreement between the Bank or WSB and any Federal banking agency.
Acquisition of WSB
Under the Federal Change in Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the company’s outstanding voting stock, unless the Federal Reserve Board has found that the acquisition will not result in control of the company. A change in control definitively occurs upon the acquisition of 25% or more of the company’s outstanding voting stock. Under the Change in Bank Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.
Proposed Legislation and Regulatory Actions
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Board’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of financial institutions through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Item 1A.
Item 1A. Risk Factors
You should consider carefully the following risks, along with the other information contained in and incorporated into this annual report. The risks and uncertainties described below are not the only ones that may affect us. Additional risks and uncertainties also may adversely affect our business and operations. If any of the following events actually occur, our business and financial results could be materially adversely affected.
Risks Related to our Pending Merger with Old Line Bancshares, Inc.
We may be unable to obtain satisfaction of all conditions to complete our merger with Old Line Bancshares, including the approval of our stockholders, in the anticipated timeframe.
As discussed above, on September 10, 2012, we entered into a Merger Agreement with Old Line Bancshares pursuant to which WSB will be merged with and into Old Line Bancshares, with Old Line Bancshares being the surviving company. Completion of the Merger is contingent upon customary closing conditions, including approval of the Merger Agreement by our stockholders and approval of the Merger Agreement and the merger by Old Line Bancshares’ stockholders. If
the stockholders do not approve the merger and/or Merger Agreement at the special stockholder meetings, the Merger will not be consummated.
Completion of the Merger is also conditioned upon customary closing conditions.
Although WSB and Old Line Bancshares have agreed in the Merger Agreement to use reasonable best efforts to consummate the merger, the other conditions to the merger may fail to be satisfied. In addition, satisfying the conditions to, and completion of, the merger may take longer than, and could cost more than, we expect. Any delay in completing the merger may adversely affect the benefits that WSB and Old Line Bancshares expect to achieve from the merger and the integration of our businesses. In addition, failure to complete the merger may adversely affect Old Line Bancshares.
Failure to complete the merger could negatively impact our stock price and future businesses and financial results SB. If the merger is not completed, our ongoing business may be adversely affected we will be subject to several risks, including the following:
· As noted above we may be required, under certain circumstances, to pay Old Line Bancshares a termination fee of $1,750,000 under the merger agreement;
· We will be required to pay certain costs relating to the merger, whether or not the merger is completed, such as legal, accounting, financial advisor and printing fees;
· Under the merger agreement, we are subject to certain restrictions on the conduct of our business prior to completing the merger, which may adversely affect our ability to execute certain of our business strategies; and
· Matters relating to the merger have required and may require substantial commitments of time and resources by our management that could otherwise have been devoted to other opportunities that may have been beneficial WSB as an independent company, and WSB and The Washington Savings Bank will remain subject to the provisions of the agreements with the OCC and Federal Reserve Board, respectively, described in “Item 1. Business - Supervision and Regulation - General.”
In addition, if the merger is not completed, we may experience negative reactions from the financial markets and from our customers and employees. We also could be subject to litigation related to any failure to complete the merger or to enforcement proceedings commenced against us to perform our obligations under the Merger Agreement. If the merger is not completed, we cannot assure our stockholders that the risks described above will not materialize and will not materially affect our business, financial results and stock price.
The Merger Agreement limits our ability to pursue alternative transactions to the merger and requires us to pay a termination fee if we do.
The Merger Agreement prohibits WSB and our directors, officers, representatives and agents, subject to narrow exceptions, from initiating, encouraging, soliciting or entering into discussions with any third party regarding alternative acquisition proposals. The prohibition limits our ability to pursue offers from other possible acquirers that may be superior to the pending merger with Old Line Bancshares from a financial point of view. If we receive an unsolicited proposal from a third party that is superior from a financial point of view to that made by Old Line Bancshares and the Merger Agreement is terminated, we would be required to pay a
termination fee of $1,750,000. This fee makes it less likely that a third party will make an alternative acquisition proposal.
If the merger is completed, Old Line Bancshares may fail to realize all of the anticipated benefits of the merger.
Because a portion of the merger consideration to be paid to our stockholders in the merger in exchange for their shares of WSB common stock consists of Old Line Bancshares common stock, realization of the anticipated benefits in the merger for those who receive Old Line Bancshares common stock in the merger will depend, in part, on the combined company’s ability to successfully integrate the businesses and operations of Old Line Bancshares and us. The combined company will be required to devote significant management attention and resources to integrating its business practices, operations and support functions.
The success of the merger will depend, in part, on Old Line Bancshares’ ability to realize the anticipated benefits and cost savings from combining the businesses of Old Line Bancshares and WSB. To realize these anticipated benefits and cost savings, however, Old Line Bancshares must successfully combine the businesses of Old Line Bancshares and WSB. If Old Line Bancshares is unable to achieve these objectives, the anticipated benefits and cost savings of the merger may not be realized fully or at all or may take longer to realize than expected.
Old Line Bancshares and WSB have operated and, until the completion of the merger, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the loss of key depositors or other bank customers, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect Old Line Bancshares’ and WSB’s ability to maintain their relationships with their respective clients, customers, depositors and employees or to achieve the anticipated benefits of the merger. Integration efforts between the two companies may, to some extent, also divert management attention and resources. These integration matters could have an adverse effect on each of Old Line Bancshares and WSB during such transition period.
If the merger is not completed, we will have incurred substantial expenses without realizing the expected benefits.
We have incurred substantial expenses in connection with the execution of the Merger Agreement and the merger. The completion of the merger depends on the satisfaction of specified conditions, including the approval of the stockholders of Old Line Bancshares and WSB. There is no guarantee that these conditions will be met. If the merger is not completed, these expenses could have a material adverse impact on our financial condition because we would not have realized the expected benefits of the merger.
Because the aggregate merger consideration is subject to adjustment, our stockholders will not know until the effective time of the merger the value of the consideration they will receive in the merger.
Upon completion of the merger, each share of WSB common stock will be converted into the right to receive merger consideration consisting of shares of Old Line Bancshares common stock and/or cash pursuant to the terms of the Merger Agreement. The value of the aggregate merger consideration to be received by WSB stockholders will be adjusted as provided in the Merger Agreement for certain operating losses, asset quality changes, changes in the value of
certain investment securities and merger-related expenses incurred by WSB. Assuming there are no adjustments to the aggregate merger consideration, the value of the per-share cash consideration would be $6.09 and the exchange ratio with respect to the per-share stock consideration, based on 8,016,607 shares of WSB common stock outstanding as of the date hereof, would be 0.5585. In addition, the per-share merger consideration will be reduced if the aggregate merger consideration is adjusted, however, and these calculations will not be completed until the closing of the merger.
Further, the exchange ratio will not be adjusted if the average price of Old Line Bancshares common stock, as determined pursuant to the Merger Agreement, decreases, although, as discussed below, WSB can terminate the merger agreement if the average price falls below $8.14 and Old Line Bancshares does not increase the merger consideration. As a result, the value of shares of Old Line Bancshares common stock that a WSB stockholder receives in the merger will decline correspondingly with declines in the average price of Old Line Bancshares common stock prior to and as of the date the merger consideration is received.
Accordingly, at the time of the special meeting of WSB stockholders to vote to approve the merger and at the time stockholders must elect what form of consideration they want in the merger, WSB stockholders will not know or be able to calculate the amount of the consideration they will receive, the exchange ratio that will be used to determine the number of shares of Old Line Bancshares common stock that they would receive upon completion of the merger, or the value of any shares of Old Line Bancshares common stock they would receive upon completion of the merger. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in the businesses, operations and prospects of Old Line Bancshares and regulatory considerations. Many of these factors are beyond Old Line Bancshares’ control. You should obtain current market quotations for shares of Old Line Bancshares common stock.
WSB has the option, but is not required, to terminate the merger agreement if the average price of the Old Line Bancshares common stock falls below $8.14, although WSB does not have this option if Old Line Bancshares, in its sole discretion, increases the aggregate merger consideration to at least $40.8 million (subject to adjustment) as set forth in the Merger Agreement. We cannot predict at this time whether or not our board of directors would exercise its right to terminate the Merger Agreement if these conditions were met. The Merger Agreement does not provide for a resolicitation of WSB stockholders in the event that the conditions are met and our board nevertheless chooses to complete the transaction. Our board of directors has made no decision as to whether it would exercise its right to terminate the Merger Agreement. In considering whether to exercise its right to terminate the Merger Agreement, the board of directors would take into account all the relevant facts and circumstances that exist at the time and would consult with our financial advisor and legal counsel.
Our stockholders may not receive the form of merger consideration that they elect.
Depending on the elections made by all our stockholders, certain stockholders who elect to receive cash consideration may instead receive shares of Old Line Bancshares common stock for all or a portion of their shares of WSB common stock, and some stockholders who elect to receive the stock consideration may instead receive cash for all or a portion of their shares of WSB common stock.
If WSB stockholders oversubscribe for the cash portion of the merger consideration, those WSB stockholders electing to receive cash will have the amount of cash they selected reduced and will receive all or a portion of their consideration in the form of shares of Old Line Bancshares common stock. Similarly, if WSB stockholders oversubscribe for the Old Line Bancshares common stock portion of the merger consideration, those WSB stockholders electing to receive shares of Old Line Bancshares common stock will have the amount of common stock they selected reduced and will receive all or a portion of their consideration in the form of cash. Accordingly, at the time WSB stockholders vote on the proposal to approve the merger agreement, they will not know the form of merger consideration that they will receive, regardless of their intended election.
Pending litigation related to the merger may delay or prevent the merger and could cause Old Line Bancshares and WSB to incur significant costs and expenses.
As discussed under “Legal Proceedings,” Rosalie Jones, both individually and on behalf of a putative class of WSB Holdings’ stockholders, filed a complaint in the Circuit Court for Prince George’s County, Maryland, against WSB and its directors as well as Old Line Bancshares. The complaint asks the Court to enjoin the merger based on allegations that, among others things, the merger consideration to be paid to stockholders of WSB is inadequate and, in approving that consideration and the other terms of the merger agreement, the directors of WSB breached their fiduciary duties to stockholders. If the merger is consummated prior to the time these claims are adjudicated, then the plaintiff has asked the Court to rescind the merger or award rescissory damages to the plaintiff and the other members of the putative class of stockholders. While the defendants have entered into a memorandum of understanding with the plaintiff that contemplates a settlement between the parties (which must be approved by the court), there can be no assurance that the parties will enter into a stipulation of settlement or, if they do, that the court will approve any proposed settlement, or that any eventual settlement will be under the same terms as those contemplated by the memorandum of understanding. If the parties do not enter into a stipulation of settlement or the court does not approve such a stipulation of settlement, then this litigation could delay or even prevent the merger and could cause WSB to incur significant legal fees and other costs to defend the claims, which could reduce the aggregate merger consideration that will be payable to stockholders of WSB if and when the merger is consummated and/or adversely impact the financial condition and results of operations of WSB and Old Line Bancshares, both before and after the merger. No assurance can be given that Old Line Bancshares, WSB or WSB’s directors would be successful in the defense of these claims.
Risks Related to Our Business
If economic conditions should further deteriorate, our results of operations and financial condition could be adversely affected as borrowers’ ability to repay loans declines and the value of the collateral securing our loans decreases.
There has been significant disruption and volatility in the financial and capital markets since 2007. The financial markets and the financial services industry in particular suffered unprecedented disruption, causing a number of institutions to fail or require government intervention to avoid failure. Our financial results may be adversely affected by changes in prevailing economic conditions, including further decreases in real estate values, changes in interest rates which may cause a decrease in interest rate spreads, sustained adverse employment
conditions, the monetary and fiscal policies of the federal government and other significant external events. Further, because a significant portion of our loan portfolio is comprised of real estate related loans, additional decreases in real estate values could adversely affect the value of property used as collateral for loans in our portfolio.
As discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this report, we have experienced increasing pressure on our margins caused by the lower Federal Reserve Board interest rates and the significant slowdown in loan demand resulting from the stresses in the economy, which included sustained declines in the housing and financial and capital markets over the past five years. For the year ended December 31, 2012, we had $3.0 million in net loan charge-offs, or 1.66% of total loans held for investment. Impaired loans, which includes loans that are 90 days past due, nonaccrual loans and troubled debt restructurings (“TDRs”) renegotiated loans, were $33.7 million or 18.8% of loans held for investment at December 31, 2012 and $31.3 million or 14.8% of loans held for investment at December 31, 2011. Impaired loans at December 31, 2012 consisted of approximately $19.7 million in non-accrual loans and approximately $22.7 million restructured loans, which included approximately $9.7 million in non accrued status. Although there continues to be evidence of improvement in the economy, it remains unclear when economic conditions will improve to an extent that will impact our borrowers’ ability to repay their loans and demand for loans overall, and therefore when these negative trends in our loan portfolio will reverse. Although signs of stability have emerged, we expect that the business environment in the State of Maryland and the entire United States will continue to present challenges for the foreseeable future. Continued declines, or even ongoing sustention of recent declines in real estate values, home sales volumes, and financial stress on borrowers as a result of the uncertain economic environment could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. A worsening of these conditions would likely exacerbate the adverse effects on the Company and others in the financial institutions industry. As a result, our future earnings continue to be susceptible to further negative or deteriorating economic conditions which may continue to negatively affect our revenues, net income and liquidity.
If U.S. credit markets and economic conditions do not significantly improve or further deteriorate, our liquidity could be adversely affected.
We are required to maintain certain capital levels in accordance with banking regulations. We must also seek to maintain adequate funding sources in the normal course of business to support our lending and investment operations and repay our outstanding liabilities as they become due. Our liquidity may be adversely affected by the current environment of economic uncertainty reducing business activity as a result of, among other factors, disruptions in the financial system in the recent past, concerns regarding U.S. debt levels and related governmental actions, including potential tax increases and cuts in government spending, and continuing economic problems in Europe including concerns over debt levels. Dramatic declines in the housing market during the past five years, with falling real estate prices and increased foreclosures and unemployment, have resulted in significant asset value write-downs by financial institutions, including government-sponsored entities and investment banks. These investment write-downs have caused financial institutions to seek additional capital. If adverse conditions continue or worsen, we may be required to raise additional capital as well to maintain adequate capital levels or to otherwise finance our business. Such capital, however, may not be available when we need it or may be available only on unfavorable terms. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance.
Accordingly, we cannot assure you of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our liquidity, financial condition, results of operations and prospects. Further, if we raise capital by issuing stock, the holdings of our current stockholders would be diluted.
Our failure to meet any applicable regulatory guideline related to our lending activities or any capital requirement otherwise imposed upon us or to satisfy any other regulatory requirement could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities of a capital directive to increase capital, and the termination of deposit insurance by the FDIC.
We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the OCC, our current chartering authority (see risk factor below), the Federal Reserve Board and by the FDIC, as insurer of our deposits. Such regulation and supervision govern the activities in which a financial institution may engage and are intended primarily for the protection of the DIF and depositors and are not intended for the protection of holders of our common stock. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution’s allowance for loan losses. Further, regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our rate of growth.
Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact our operations. In light of the performance of and government intervention in the financial sector, we fully expect there will be significant changes to the banking and financial institutions’ regulatory agencies in the foreseeable future. Any changes in regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, may have a material adverse impact on our operations, and we cannot currently predict the impact of any such potential changes. The cost of compliance with regulatory requirements could increase our costs, limit our ability to pursuant certain business opportunities, increase compliance challenges, and otherwise adversely affect our ability to operate profitably. In addition, the burden imposed by these federal and state regulations may place banks in general, and the Bank specifically, at a competitive disadvantage compared to less regulated competitors.
The Dodd-Frank Act may adversely impact our results of operations, liquidity or financial condition.
The Dodd-Frank Act, enacted in July 2010, represents a comprehensive overhaul of the U.S. financial services industry. Among other things, the Dodd-Frank Act established the new CFPB, included provisions that impact corporate governance and executive compensation disclosure by all SEC reporting companies, impose new capital requirements on bank and thrift holding companies, allow financial institutions to pay interest on business checking accounts, broaden the base for FDIC insurance assessments, impose additional duties and limitations on mortgage lending activities and restrict how mortgage brokers and loan originators may be compensated,
included additional mortgage origination provisions including risk retention, and modified many other regulations applicable to insured depository institutions. The Dodd-Frank Act also eliminated the OTS, resulting in the Bank being regulated by the OCC and WSB being regulated by the Federal Reserve Board as of July 21, 2011.
The Dodd-Frank Act requires the CFPB and other federal agencies to implement many new and significant rules and regulations to implement its various provisions. There are many regulations under the Dodd-Frank act that have not yet been proposed or adopted. We will not know the full impact of the Dodd-Frank Act on our business for years until regulations implementing the various provisions of the statute are adopted and implemented. As a result, we cannot at this time predict the extent to which the Dodd-Frank Act will impact our business, operations or financial condition. However, compliance with these new laws and regulations may require us to make changes to our business and operations, impose on us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes will also likely result in additional costs and a diversion of management’s time from other business activities and may decrease revenues by, for example, limiting the fees we can charge, any of which may adversely impact our results of operations, liquidity or financial condition. Further, if the industry responds to provisions allowing financial institutions to pay interest on business checking accounts by competing for those deposits with interest-bearing accounts, this will put some degree of downward pressure on our net interest margin. The new duties to be imposed on mortgage lenders, including a duty to determine the borrower’s ability to repay the loan and a requirement on mortgage securitizers to retain a minimum level of economic interest in securitized pools of certain mortgage types, may decrease the demand for mortgage loans as well as our ability to sell such loans into the secondary market, which would reduce both our interest and non-interest income, especially in light of our renewed focus on mortgage loans. We may also experience increased expenses as a result of having a different regulator for each of WSB and the Bank and as a result of switching regulators. Any of these consequences, as well as the failure to comply with new requirements or any future changes in laws or regulations, may adversely impact our results of operations, liquidity or financial condition. For a more detailed description of the Dodd-Frank Act, see “Supervision and Regulation-The Dodd-Frank Act.”
Our focus on commercial and real estate loans may increase the risk of credit losses.
We offer a variety of loans including commercial business loans, commercial real estate loans, construction loans, home equity loans and consumer loans. We secure many of our loans with real estate (both residential and commercial) in the Maryland suburbs of Baltimore and Washington, D.C. While we believe our credit underwriting adequately considers the underlying collateral in the evaluation process, continued or further weakness in the real estate market could adversely affect our customers, which in turn could adversely impact us. Further, commercial lending generally carries a higher degree of credit risk than do residential mortgage loans because of several factors including larger loan balances, dependence on the successful operation of a business or a project for repayment, or loan terms with a balloon payment rather than full amortization over the loan term.
We may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans.
We sell a portion of the residential mortgage loans we originate in the secondary market. In response to the financial crisis, we believe that purchasers of residential mortgage loans, such as government sponsored entities, are increasing their efforts to seek to require sellers of residential
mortgage loans to either repurchase loans previously sold or reimburse purchasers for losses related to loans previously sold when losses are incurred on a loan previously sold due to actual or alleged failure to strictly conform to the purchaser’s purchase criteria. As a result, we may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans and we may face increasing expenses to defend against such claims. If we are required in the future to repurchase loans previously sold, reimburse purchasers for losses related to loans previously sold, or if we incur increasing expenses to defend against such claims, our financial condition and results of operations would be negatively affected.
We face strong competition in our market area, which could hurt our profits and slow growth.
We face strong competition in our market area from many other banks, savings institutions, and other financial organizations, as well as many other companies now offering a broad array of financial services. Many of these competitors have greater financial resources, name recognition, market presence and operating experience than we do and are able to offer services that we cannot. If the Bank cannot attract deposits and make loans at a sufficient level, our operating results will suffer, as will our opportunities for growth.
Because the Bank serves a limited market area in Maryland, an economic downturn in our market area could more adversely affect us than it affects our larger competitors that are more geographically diverse.
Our success is largely dependent on the general economic conditions of our targeted market area of the Baltimore-Washington corridor. Broad geographic diversification is not currently part of our community bank focus. As a result, if our market area continues to suffer an economic downturn, it may more severely affect our business and financial condition than it affects our larger bank competitors. Our larger competitors serve more geographically diverse market areas, parts of which may not be affected by the same economic conditions that may exist in our market area. Further, unexpected changes in the national and local economy may adversely affect our ability to attract deposits and to make loans. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our securities.
Our operations are susceptible to adverse effects of changes in interest rates.
Our operations are substantially dependent on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities. As with most depository institutions, our earnings are affected by changes in market interest rates and other economic factors beyond our control. If our interest-earning assets have longer effective maturities than our interest-bearing liabilities, the yield on our interest-earning assets generally will adjust more slowly than the cost of our interest-bearing liabilities, and, as a result, our net interest income generally will be adversely affected by material and prolonged increases in interest rates and positively affected by comparable declines in interest rates. Conversely, if liabilities re-price more slowly than assets, net interest income would be adversely affected by declining interest rates, and positively affected by increasing interest rates. Currently our average interest rate on interest-earning assets has decreased which has impacted our results of operations. At any time, it is likely that our assets and liabilities will
reflect interest rate risk of some degree, and changes in interest rates may therefore have a material adverse affect on our results of operations.
In addition to affecting interest income and expense, changes in interest rates also can affect the value of our interest-earning assets, comprising fixed- and adjustable-rate instruments, as well as the ability to realize gains from the sale of such assets. Generally, the value of fixed-rate instruments fluctuates inversely with changes in interest rates.
Our allowance for loan losses may not be sufficient to cover loan losses and any increase in our allowance for loan losses would adversely affect earnings.
We believe we have established an allowance for loan losses to prudently cover the eventuality of losses inherent in our loan portfolio. However, even under normal economic conditions we cannot predict loan losses with certainty. Even with the improved economic stability as of late, the unprecedented volatility experienced in the financial and capital markets during the last five years makes this determination even more difficult as processes we use to estimate allowance for loan losses and reserves may no longer be reliable because they rely on complex judgments, including forecasts of economic conditions and property values, which may no longer be capable of accurate estimation. As a result, we cannot assure you that charge offs in future periods will not exceed the allowance for loan losses. In addition, regulatory agencies, as an integral part of their examination process, review our allowance for loan losses and may require additions to the allowance based on their judgment about information available to them at the time of their examination. An increase in our allowance for loan losses could reduce our earnings.
We depend on the services of key personnel. The loss of any of these personnel could disrupt our operations and hurt our business.
Our success depends, in large part, on our ability to attract and retain key people, including Phillip Bowman, our CEO and Kevin Huffman, our President. Competition for the best people in most activities engaged in by us can be intense and we may not be able to hire qualified personnel when we need to do so or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
We face limits on our ability to lend.
We are limited in the amount we can loan to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. As of December 31, 2012, we were able to lend approximately $8.2 million to any one borrower. This amount is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our legal lending limit from doing business with us. We try to accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy is not always available. We may not be able to attract or maintain customers seeking larger loans and we may not be able to sell participations in such loans on terms we consider favorable.
Future increases in our deposit insurance premiums could have a material adverse impact on our future earnings and financial condition.
The FDIC insures deposits at FDIC-insured financial institutions, including the Bank. The FDIC charges insured financial institutions premiums to maintain the DIF at a specific level. The Bank’s FDIC insurance premiums increased substantially beginning in 2009 and we paid significantly higher premiums during 2009 and 2010 although our premiums decreased in 2011 and 2012 due to the change in the assessment calculation previously discussed, they are still higher than pre-2009 levels. Current economic conditions have increased bank failures during the last few years and additional failures are expected, all of which decrease the DIF. In order to restore the DIF to its statutorily mandated minimum of 1.15 percent over a period of several years, the FDIC increased deposit insurance premium rates at the beginning of 2009 and imposed a special assessment on June 30, 2009. The FDIC may increase the assessment rates or impose additional special assessments in the future to keep the DIF at the statutory target level. Any increase in our FDIC premiums, whether as a result of an increase in the risk category for the Bank or in the general assessment rates or as a result of special assessments, could have an adverse effect on our profits and financial condition.
Our information systems may experience an interruption or breach in security, which could damage our reputation and negatively impact our financial condition.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of any failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
Our ability to compete effectively and operate profitably may depend on our ability to keep up with technological changes.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands and to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing consumers to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage
accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our business.
Severe weather and natural disasters, both of which may exacerbated by global climate change, acts of war or terrorism and other adverse external events cannot be predicted and could have a significant impact on our ability to conduct business. Such events could also affect the stability of our deposit base, impair the ability of our borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
We operate five savings branch locations in Bowie, Crofton, Millersville, Odenton, and Waldorf, Maryland. Space for three of our branches, Millersville, Odenton and Waldorf, are under long-term leases with third parties. We have exercised our five-year option to extend our Waldorf lease for 2,700 square feet and the lease now expires in April 2017. Our Millersville lease is for a 1,628 square foot parcel of land on which our Millersville office is located. We currently own the Millersville building and the land lease expires in March 2018. Our Odenton lease for 3,167 square feet expires in November 2014. The 570 square foot Crofton branch was purchased by the Bank in July 1995.
Our corporate, administrative, and accounting offices are located in a five-story building in Bowie owned by WSB. We also operate a branch of the Bank at this location. At December 31, 2012, 94% of the Bowie building’s residual space was occupied, of which 51% is tenant occupied and 43% is occupied by WSB staff. Also located in WSB’s corporate headquarters are our Commercial Lending Group and our Retail Mortgage Group.
Item 3.
Item 3. Legal Proceedings
On September 27, 2012, a complaint was filed by Rosalie Jones, both individually and on behalf of a putative class of WSB’s stockholders, in the Circuit Court for Prince George’s County, Maryland, against WSB and its Directors and Old Line Bancshares. The complaint seeks to enjoin the Merger and alleges, among other things, that the members of WSB’s Board of Directors breached their fiduciary duties by agreeing to sell WSB for inadequate and unfair consideration and pursuant to an unfair process.
On February 5, 2013, the defendants entered into a memorandum of understanding with the plaintiff regarding settlement of all claims asserted on behalf of the alleged class of WSB stockholders. In connection with the settlement contemplated by that memorandum of understanding, the litigation and all claims asserted in such litigation will be dismissed, subject to court approval. The proposed settlement terms require Old Line Bancshares and WSB to make certain additional disclosures related to the merger, which disclosures are included in this joint proxy statement/prospectus. The parties also agreed that plaintiffs may seek attorneys’ fees and costs in an as-yet undetermined amount, with the defendants to pay such fees and costs if and to the extent they are approved by the court. The memorandum of understanding further contemplates that the parties will enter into a stipulation of settlement, which will be subject to customary conditions, including confirmatory discovery and court approval following notice to WSB’s stockholders. If the parties enter into a stipulation of settlement, a hearing will be scheduled at which the court will consider the fairness, reasonableness and adequacy of the settlement. There can be no assurance that the parties will ultimately enter into a stipulation of settlement, that the court will approve any proposed settlement, or that any eventual settlement will be under the same terms as those contemplated by the memorandum of understanding.
In addition, from time to time we may be involved in ordinary routine litigation incidental to our business. We are not, however, involved in any legal proceedings the outcome of which, in management’s opinion, would be material to our financial condition or results operations.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
WSB’s common stock is traded on the NASDAQ Global Market under the symbol “WSB.” The following table reflects the high and low sale prices for, as well as dividends declared during, the periods presented. Quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not represent actual transactions.
As of February 15, 2013, WSB had 163 record holders of our common stock.
We did not pay dividends on our common stock during the years ended December 31, 2012 and 2011. Cash dividends are subject to determination and declaration by the Board of Directors, which takes into account our financial condition, results of operations, tax considerations, industry standards, economic conditions, and other factors, including regulatory restrictions. Cash dividends are declared and paid in the same calendar quarter. For a discussion of the regulatory
restrictions on the declaration and payment of dividends, see “Business-Supervision and Regulation-Restrictions on Capital Distributions.” In 2010 the Board, after a careful review our capital management plan, determined to suspend dividends for the foreseeable future in order to preserve funds to ensure the continuation of a strong balance sheet. No assurance can be given that dividends will be declared in the future, or if declared, what the amount of dividends will be, or whether such dividends will continue. The Board will continue to review WSB’s dividend practice on a quarterly basis.
Unregistered Sales of Equity Securities and Use of Proceeds
In April 2008, the Board of Directors gave the authority to management to repurchase up to $1.0 million of the outstanding shares of the Company’s stock. There is no stated expiration date for the plan. We did not repurchase any of our securities during the year ending December 31, 2012.
Item 6.
Item 6. Selected Financial Data
Not applicable
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We operate a general commercial banking business, attracting deposit customers from the general public and using such funds, together with other borrowed funds, to make loans, with an emphasis on residential mortgage, commercial and construction lending. Our results of operations are primarily determined by the difference between the interest income and fees earned on loans, investments and other interest-earning assets and the interest expense paid on deposits and other interest-bearing liabilities. The difference between the average yield earned on interest-earning assets and the average cost of interest-bearing liabilities is known as net interest-rate spread. The principal expense to WSB is the interest it pays on deposits and other borrowings. Our results of operations are primarily determined by the difference between the interest income and fees earned on loans, investments and other interest-earning assets, and the interest expense paid on deposits, borrowings and other interest-bearing liabilities, which is referred to as “net interest income”. Net interest income is significantly affected by general economic conditions and by policies of state and federal regulatory authorities and the monetary policies of the Federal Reserve Board. WSB’s net income is also affected by the level of its non-interest income, including loan-related fees, deposit-based fees, rental income, operations of its service corporation subsidiary, gain on sale of real estate acquired in settlement of loans, and gain on sale of loans, as well as its non-interest and tax expenses.
Our principal expense is the interest we pay on deposits and borrowings. Net interest income is significantly affected by general economic conditions and by policies of state and federal regulatory authorities and the monetary policies of the Federal Reserve Board. Our net income is also affected by the level of our other income, including loan related fees, gain on sale of loans, deposit-based fees, rental income, operations of the Bank’s service corporation subsidiary, gains on sales of other real estate owned (“OREO”), gains on sales of loans and investment securities as well as operating and tax expenses.
During this period of continued economic slowdown, the effects of which, including declining real estate values resulting in asset impairment and tightening liquidity, has particularly impacted the banking industry in general, management continues to stress credit quality within both our loan and investment portfolios. The Bank originates residential loans for its portfolio and for sale in the secondary market. In this past, we had focused on diversifying our loan portfolio by broadening our lending emphasis to include commercial real estate and commercial and industrial loans. Since 2008, however, demand for these and other areas of lending have slowed, and we again are focusing on increasing mortgage activity in order to reduce balance sheet risk as well as realizing gains on the sale of loans in the secondary market. As a result, our portfolios of commercial business, commercial real estate, and residential land development loans to commercial borrowers have decreased. We also use available funds to retain certain higher-yielding fixed rate residential mortgage loans in our portfolio in order to improve interest income. Although we intend to again focus on diversifying our loan portfolio when demand for these other areas of loans picks up, we believe that our continued efforts to expand our residential mortgage lending department are important to ensure future profitability based on the current slow demand for commercial lending. Management believes that interest rates and general economic conditions nationally and in our market area are most likely to have a significant impact on our results of operations. We carefully evaluate all loan applications in an attempt to minimize our credit risk exposure by obtaining a thorough application with enhanced approval procedures; however, there is no assurance that this process can reduce lending risks.
Management reviews models and has established benchmark rates and assures that we remain within the limits. If the limits exceed the established benchmark rate, management develops a plan to bring interest rate risk back within the limits.
Our management considers return on average assets and equity as a measure of our earnings performance. Return on average assets measures the ability to utilize our assets to generate income. However, current economic conditions such as unemployment or declining real estate values may have a significant impact on our ability to utilize those assets. Return on average assets and equity. Key measures of earnings performance for periods ending December 31, 2012, 2011 and 2010, respectively, are as follows:
We continue to advertise our lower-cost NOW accounts, no fee checking incentives, overdraft protection program and variable money market savings account priced to current interest rates, as well as the advantages of customer access to ATM networks. During 2012, our interest rates on money market and checking accounts were slightly lower than many of our competitors. Lower CD rates than in the past negatively affected renewals for CDs as management has focused on lowering deposit costs through lower CD rates and reduced brokered deposits. Our money market and checking accounts decreased approximately $745,000 and our CDs decreased $12.9 million during 2012, which decreased our overall total deposits to $231.4 million at December 31, 2012, a 5.6% decrease in total deposits as compared to $245.0 million at December 31, 2011. The decrease of approximately $12.9 million in our CDs is primarily the result of a lower interest rate environment and our paying a lower interest rate on CDs during than
our competitors during 2012. This resulted in a decrease in our interest expense on deposits by approximately $1.2 million for 2012 compared to 2011. Our borrowings decreased by $16.0 million as a result of an $8.0 million maturity and the repayment of $8.0 million in daily rate credit with the FHLB. Our interest expense on our borrowings decreased approximately $85,000 and $1.4 million for the periods ending December 31, 2012 and 2011, respectively, compared to the prior year periods. This decrease for the period ending December 31, 2012 is due to our continuing efforts to reduce higher cost liabilities. The decrease for the period December 31, 2011 is the result of restructuring some of our borrowings during the previous fiscal year.
Both basic and diluted earnings per share amounts are shown on the Consolidated Statements of Earnings. Per-share references in this report are to “basic earnings per share” unless otherwise stated.
Forward Looking Statements
This report contains forward-looking statements within the meaning of and pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. A forward-looking statement encompasses any estimate, prediction, opinion or statement of belief contained in this report and the underlying management assumptions, including those identified by terminology such as “may,” “will,” “believe,” “expect,” “estimate,” “anticipate,” “continue,” or similar expressions. The statements presented herein with respect to, among other things, our pending merger with Old Line Bancshares, Inc. and the anticipated closing thereof, our intensions with respect to our investment portfolio, our expectations regarding diversifying our loan portfolio as demand for commercial and other non-residential real estate lending improves, the impact of potential future economic changes and conditions, the allowance for loan losses and the adequacy thereof, settlement of loans committed to be purchased and the potential for losses in connection therewith, increased professional services fees going forward , use of brokered deposits going forward, the impact or expected outcome of pending legal proceedings, the Bank’s continuing to meet its capital requirements, future sources of liquidity, strengthening the balance sheet and future profitability are forward-looking.
Forward-looking statements are based on the Company’s current expectations and assessments of potential developments affecting market conditions, interest rates and other economic conditions and assumptions and results may ultimately vary from the statements made in this report. Our future results and prospects may be dependent upon a number of factors that could cause our performance to differ from the performance anticipated or projected in these forward-looking statements or to compare unfavorably to prior periods. Among these factors are: (a) the pending lawsuit regarding the merger could delay or preclude the merger; (b) the inability to receive required stockholder approval of the pending merger; (c) ongoing review of our business and operations; (d) implementation of changes in lending practices and lending operations; (e) the Board of Directors ongoing review of our capital management plan; (f) changes in accounting principles; (g) government legislation and regulation, including regulations implemented pursuant to the Dodd-Frank Act; (h) changes in interests rates; (i) further deterioration of economic conditions; (j) credit or other risks of lending activity, such as changes in real estate values and changes in the quality or composition of our loan portfolio; and (k) other expectations, assessments and risks that are specifically mentioned in this report and in such other reports we have filed with the Securities and Exchange Commission. We wish to caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including those described above, could affect our financial performance and could cause our actual results or circumstances for future periods to
differ materially from those anticipated or projected. Unless required by law, we do not undertake, and specifically disclaim any obligations, to publicly update or revise any forward- looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. 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. We use historical loss factors as one factor in determining an inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Allowance for Loan Losses. The allowance for loan and lease losses has two basic components: a general reserve reflecting historical losses by loan category, as adjusted by several factors, the effects of which are not reflected in historical loss ratios, and specific allowances for separately identified loans. Each of these components, and the systematic allowance methodology used to establish them, are described in detail in Note 1 of the Notes to the Consolidated Financial Statements included in this report. The amount of the allowance is reviewed monthly by the Executive Committee of the Board of Directors and formally approved quarterly by the full Board of Directors.
The general reserve portion of the allowance that is based upon historical loss factors, as adjusted, establishes allowances for the major loan categories based upon adjusted historical loss experience over the prior four quarters. The use of these historical loss factors is intended to reduce the differences between estimated losses inherent in the loan portfolio and actual losses. The challenges caused by the recent recession and continuing high unemployment levels and uncertain real estate valuations, have resulted in the Bank currently applying a loss history look back period for the allowance for loan losses of 12 months, which is shorter that the period the Bank had used historically. The factors used to adjust the historical loss ratios address changes in the risk characteristics of our loan portfolio that are related to (1) trends in delinquencies and other non-performing loans, (2) changes in the risk level of the loan portfolio related to large loans, (3) changes in the categories of loans comprising the loan portfolio, (4) concentrations of loans to specific industry segments, (5) changes in economic conditions on both a local and national level, (6) changes in our credit administration and loan and lease portfolio management processes, and (7) quality of our credit risk identification processes. This general reserve component comprised 61.5% of the total allowance at December 31, 2012 and 52.1% at December 31, 2011.
The specific allowance is used primarily to establish allowances for risk-rated credits on an individual basis, primarily our impaired loans, and accounted for 38.5% of the total allowance at December 31, 2012 and 47.9% December 31, 2011. The actual occurrence and severity of losses involving risk-rated credits can differ substantially from estimates, and some risk-rated credits may not be identified. Our policy is to charge off all or that portion of our investment in an impaired loan upon a determination that it is probable the full amount will not be collected. Our prior primary regulator allowed a specific reserve to be established on our impaired loans, which reduced our reportable principle balances on collateral dependent loans; as a result of the change in the Bank’s primary regulator from the OTS to the OCC, however, the impaired loan balances were reduced in periods ending December 31, 2012 and December 31, 2011 to reflect partial charge offs in order to be compliant with OCC guidance now applicable to the Bank, resulting in a reduction of our specific reserves.
Other-Than-Temporary Impairment of Securities. We review all investment securities with significant declines in fair value for potential other-than-temporary impairment on a periodic basis. We record an impairment charge when we believe an investment has experienced a decline in value that is other than temporary. Generally changes in market interest rates that result in a decline in value of an investment security are considered to be temporary, since the value of such investment can recover in the foreseeable future as market interest rates return to their original levels. However, such declines in value that are due to the underlying credit quality of the issuer or other adverse conditions that cannot be expected to improve in the foreseeable future, may be considered to be other than temporary. Management believes this is a critical accounting policy because this evaluation of the underlying credit or analysis of other conditions contributing to the decline in the value involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters. The valuation process and OTTI determination, assumptions related to prepayment, default and severity on the collateral supporting the non-agency MBSs are input into an industry standard valuation model.
Voluntary Prepayment Rate
This is based primarily on historical activity. As most of these instruments move toward a voluntary baseline prepayment (VPR) stream from the previous year, recent history gives a good and conservative estimate of future voluntary prepayment results.
Current Default Rates
This is based primarily on the performance of the collateral historical data when considering the performance of both the collateral pool and the entire MBS collateral pool. Estimates for the current default rate (CDR) vectors are based on the status of the loans at the valuation date - current, 30-59 days delinquent, 60-89 days delinquent, 90+ days delinquent, foreclosure or OREO.
Default assumptions are benchmarked to the recent results experienced by major servicers of non-Agency MBS for securities with similar attributes and forecasts from other industry experts and industry research.
Loss Severity Rate
Management obtains the individual security’s historical data. The data will recognize most recent monthly realized loss severity rates (SEV) by issuer and origination year, which are surveyed, then using the most recent severity result to build an assumption.
Management reviews this current information to see if there are any underlying trends with the assumption that the current performance is believed to be the best indicator of future collateral performance. The collateral performance obtained from these Bloomberg screens for each tranche within the security is reviewed to determine the likelihood there will be a credit loss based on the collateral performance. If there were no loans in default for a period of time and there are no serious delinquencies, we determine that there is no current OTTI. If however, there is some stress in the underlying collateral (evidenced by losses in the most recent periods and some level of current delinquencies), and considering management’s general knowledge of the trends in the residential mortgage markets, which takes into account current economic conditions and negative credit trends, management determines projected future CDR, SEV and VPR figures, which we then provide to our third party brokerage firm for input into their model. Using these new assumptions, the model determines the future credit loss and the projected loss is then discounted back to the present value based on the current book yield of the investment. We concurred that no OTTI existed during the period ending December 31, 2012. All our remaining private-labeled non agency MBS were sold during fiscal year 2012.
We account for income taxes under the asset/liability method. Deferred tax assets are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period indicated by the enactment date. A valuation allowance is established for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred tax assets could change in the near term.
Results of Operations
General. Net earnings for the year ended December 31, 2012 was $1.0 million, or $0.13 per basic share, compared to net earnings of $1.2 million, or $0.16 per basic share, for the year ended December 31, 2011.
The decrease in net earnings for the twelve month period ending December 31, 2012, is primarily the result of a reduction in our interest income of approximately $2.8 million as compared to the corresponding 2011 period partially offset by a decrease of approximately $1.3 million in interest expense, as a result of continued efforts to reduce higher cost liabilities, compared to the same corresponding 2011 period. This resulted in a decrease of net interest income of $1.5 million compared to the same period of 2011. As we continue to experience low loan demand, there has been a decrease in our loans held-for-investment portfolio which has contributed to our decrease in interest income. Non-interest income increased $828,000, or 22%, primarily as a result of increases in our rental income, gain on the sale of loans sold in the secondary market and gain on the sale of real estate acquired in settlement of loans. Non-interest expense increased $68,000, or 0.50%, for the twelve month period primarily as a result of increase in salaries and benefits, provisions for losses on real estate acquired in settlement of
loans and service bureau charges, partially offset by lower FDIC premiums compared to the same twelve month period of the prior year.
Average Balances, Interest and Yields. The following table sets forth, for the periods indicated, information regarding: (i) the total dollar amounts of interest income from interest- earning assets and the resulting average yields; (ii) the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs; (iii) net interest income; (v) interest rate spread; (v) average interest-earning assets and the total yield earned on average interest-earning assets; (vi) average interest-bearing liabilities, the amount of interest paid on such liabilities and the average interest rate paid on interest-bearing liabilities; and (vii) the ratio of total interest-earning assets to total interest-bearing liabilities. Average balances, yields, and costs are calculated on the basis of month-end averages (except deposits, which are on the basis of daily averages) for all periods through December 31, 2012.
Weighted average yields and costs at December 31, 2012 are also indicated. Non-accrual loans are included in total loan balances, lowering the effective yield for the loan portfolio in the aggregate.
(1) There are no tax equivalency adjustments.
(2) This is a weighted average yield.
(3) Interest-rate spread is the arithmetic difference between the average yield on interest-earning assets (expressed as a percentage) and the average cost of interest-bearing liabilities (expressed as a percentage).
(4) Net yield on interest-earning assets is the ratio of net interest income to average interest-earning assets.
Rate/Volume Analysis. The following table shows, for the periods indicated, the changes in interest income and interest expense attributable to: (i) changes in volume (change in volume multiplied by prior period rate); and (ii) changes in rate (change in rate multiplied by current period volume).
(1) Includes approximately $155,000, $138,000, and $159,000 of loan fees earned for calendar 2012, 2011 and 2010 respectively.
Net Interest Income. During 2012, net interest income before the provision for loan losses decreased $1.5 million or 11.9%, to $10.8 million from $12.3 million for 2011. The decrease in interest income of $2.8 million was offset by a decrease of $1.3 million in interest expense during the year ending December 31, 2012.
The decrease in interest income during 2012 is due to a decrease in the average balance and, to a slightly lesser extent, average rates paid on our interest-earning assets during 2012 as compared to 2011. For the year ended December 31, 2012, the average balance of our total interest-earnings assets decreased to $336.6 million from $358.8 million for the year ended December 31, 2011 while the average yield on our interest-earning assets decreased to 4.60% from 5.08% for the year ended December 31, 2011. These decreases are primarily the result of a decrease in the average balance of our loan portfolio and investment securities offsetting the increase in our MBS as compared to the prior year. The decrease in our investment securities is primarily the result of callable agencies that were called and the sale of approximately $2.8 million of our callable agencies, $5.0 million in corporate bonds and $2.3 million in municipal bonds. Our loan portfolio average also decreased as a result of a reduction in our commercial real estate loans, as a result of loan pay-downs. The increase in the average MBS during 2012 was due to the purchase of approximately $27.0 million during the year offset by the sale of $53.0 million during the year, approximately $41.4 million of which were sold during the fourth quarter of 2012. This resulted in a higher yearly average even as the balance of MBS was lower at December 31, 2012 compared to December 31, 2011. This is the result of WSB repositioning the investment portfolio in accordance with the merger agreement as discussed in “Item 1. Business - Mortgage-Backed Securities (MBS)”. The sold securities were primarily sold at a premium and we used the proceeds to purchase additional investment securities with Old Line Bancshares’ consent. The decrease in the average yield is primarily the result of lower interest rates on our loan portfolio, MBS portfolio and investment portfolio compared to the prior year due to a lower interest rate environment. In addition, we experienced an increase in our restructured loans compared to the same period last year, which also negatively impacted the yield on our interest-earning assets.
The interest expense decrease during 2012 is attributable to a decrease in the average interest rate on our deposits and, to a lesser extent, the average volume of our interest-bearing liabilities. The decrease in the average balance and average rate paid on deposits was primarily due to the reduction of interest rates on our CDs. The average cost of deposits decreased to 1.12% during 2012 from 1.55% during 2011 while the average cost of our borrowings increased to 2.88% during 2012 from 2.66% during 2011 resulting in our overall average cost of our interest-bearing liabilities decreasing to 1.53% for the year ended December 31, 2012 from 1.82% for the year ended December 31, 2011. In addition, the average balance of interest-bearing liabilities decreased to $304.6 million for the year ended December 31, 2012 as compared to $329.5 million for the year ended December 31, 2011. Average borrowings decreased $9.1 million as the result of the repayment of $16.0 million in FHLB advances.
For the year ending December 31, 2012, as compared to the year ending December 31, 2011, total deposits decreased $13.7 million primarily due to a decrease in our CDs. The decrease in time deposits was a result of not retaining CDs that matured during 2012 due to our offering lower rates on these products compared to our competitors and the lower overall interest rate environment. At December 31, 2012 and December 31, 2011, our time deposits were $90.6 million and $103.5 million, respectively, and the corresponding interest expense on these deposits during 2012 and 2011 was approximately $1.7 million and $2.7 million, respectively. Time deposits at December 31, 2012, included 5 accounts totaling approximately $18.0 million received through brokers. These funds were primarily used to fund loan originations and purchase investments. These brokered accounts consist of individual accounts issued under master certificates in the broker’s name. These types of accounts are covered by FDIC insurance. We did not retain additional brokered deposits to replace all of the runoff during 2012 as we didn’t need to replenish the lost deposits at that time as a result of having access to other funding sources. The interest rates on these brokered deposits are similar to our posted rates or less than the borrowed fund rates for similar terms. As a result, we anticipate we may increase brokered deposits as a source of funding as needed in the future.
Allowance for Loan Losses. Our loan portfolio is subject to varying degrees of credit risk. We seek to mitigate this risk through portfolio diversification and limiting exposure to any single customer or industry. We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The amount of the allowance is based on careful, continuous review and evaluation of the loan portfolio, along with monthly and quarterly assessments of the probable losses inherent in that portfolio. The amount of the allowance is reviewed monthly by the Loan Committee and reviewed and approved monthly by the Bank’s Board of Directors. The methodology for determining the appropriate amount of the allowance includes: (1) a formula allowance reflecting historical losses by credit category, (2) the specific allowance for risk rated credits on an individual or portfolio basis, and (3) a non-specific allowance which considers risk factors not evaluated by the other two components of the methodology. Additions to the allowance are made through periodic charges to income (provision for loan losses), and actual loan losses are charged against the allowance, while recoveries are added to the allowance.
Each of the components of the allowance for loan losses is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for loans identified for impairment testing. 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. When an
impairment is identified, a specific reserve is established based on our calculation of the loss embedded in the individual loan. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment. The formula allowance is used for estimating the loss on those loans internally classified as high risk exclusive of those identified for impairment testing. The Bank categorizes its classified assets within four categories: Special Mention, Substandard, Doubtful and Loss. Special Mention loans have potential weaknesses that deserve management’s attention. These loans are not adversely classified and do not expose an institution to sufficient risk to currently warrant adverse classification. Substandard loans are loans that have a well-defined weakness. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. The Doubtful category consists of loans where we expect a loss, but not a total loss. Various subjective factors are considered with the most important consideration being the estimated underlying value of the collateral in determining the loss reserve for these loans. Loans that are classified as “Loss” are fully reserved for on our financial statements, while we establish a prudent allowance for loan losses for loans classified as “Substandard” or “Doubtful” and “Special Mention”. The loans meeting the criteria for classification as special mention, substandard, doubtful and loss, as well as impaired loans are segregated from performing loans within the portfolio. 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 part of the formula allowance and 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 grow with the worsening of the internal risk rating. The non-specific formula is used to estimate the loss of non-classified loans and loans identified for impairment testing for which no impairment was identified. These loans are 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, quality of loan review system and the effect of external factors (i.e. competition and regulatory requirements). The factors assigned differ by loan type.
We have significant discretion in making the judgments inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral, a borrower’s prospects of repayment, and in establishing allowance factors on the formula allowance and nonspecific allowance components. The establishment of allowance factors is a continuing exercise, based on management’s continuing assessment of the global factors discussed above and their impact on the portfolio, and allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based upon the same volume and classification of loans. Changes in allowance factors will have a direct impact on the amount of the provision, and a corresponding effect on net earnings. Errors in management’s perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs.
The allowance is increased by provisions for loan losses, which are charged to expense. Charge-offs of loan amounts determined by management to be uncollectible or impaired decrease the allowance, while recoveries of loans previously charged-off are added back to the allowance. We make provisions for loan losses in amounts considered by management necessary to maintain
the allowance at an appropriate level to cover its estimate of losses inherent and probable in the loan portfolio, as established by use of the allowance methodology. Under the methodology, we consider trends in credit risk against broad categories of homogenous loans, as well as a loan by loan review of loans criticized or classified by the Bank. There was no provision for loan losses in 2012 compared to $200,000 in 2011. The challenges caused by the recent recession and continuing high unemployment levels and uncertain real estate valuations have resulted in the Bank currently applying a loss history look back period for the allowance for loan losses of 12 months, which is shorter than the period the Bank had used historically. During 2012, management determined no provision was necessary. During 2011, management determined that based on updated appraisals on some of our loans, an additional provision was needed of $200,000. As of December 31, 2012, the allowance decreased by $3.0 million, or 49%, to $3.2 million or 1.76% of the loan portfolio from $6.1 million or 2.90% of the loan portfolio at December 31, 2011. The change in the allowance was primarily due to the fact that the risk profile of our loan portfolio has improved as well as the reduction of our loan portfolio balance classified as held-for-investment, particularly our commercial secured by real estate loans. This balance also continues to be reduced in 2012 as compared to 2011 based on the OCC guidance to eliminate specific reserves on collateral dependent loans and charge off these loans by the specific reserve amount.
During the year ended December 31, 2012, charge-offs were approximately $3.1 million and approximately $104,000 was recorded as recoveries for a net charge-off of $3.0 million, compared to charge-offs of approximately $4.4 million and approximately $46,000 recorded as recoveries for a net charge-off of $4.3 million for the year ending December 31, 2011.
We are intent on maintaining a strong credit review system and risk rating process. Management believes its evaluation as to the adequacy of the allowance as of December 31, 2012 are appropriate, however, provisions for 2012 are not necessarily indicative of future provisioning. Subjective judgment is significant in the determination of the provision and allowance for loan losses, manifested in the valuation of collateral, a borrower’s prospects of repayment, and in establishing allowance factors and components for the formula allowance for homogeneous loans. A time lag between the recognition of loss exposure in the evaluation of the adequacy of the allowance and a loan’s ultimate resolution and/or charge-off is normal and to be expected. Future additions to the allowance may be necessary based on changes in the credits comprising the portfolio and changes in the financial condition of borrowers, which may result from changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the loan portfolio and the allowance. Such review may result in additional provisions based upon the agencies’ judgments of information available at the time of each examination.
We have developed a comprehensive review process to monitor the adequacy of the allowance for loan losses. The review process and guidelines were developed using guidance from federal banking regulatory agencies and rely on relevant observable data. The observable data considered in the determination of the allowance is modified if other more relevant data becomes available. The results of this review process support management’s view as to the adequacy of the allowance as of the balance sheet date.
Changes in estimation methods may take place based upon the status of the economy, and the estimate of the value of the property securing loans and as a result, the allowance may increase or decrease. Future adjustments could substantially affect the amount of the allowance.
The current economic environment continues to be a factor increasing our internally criticized loans, the devaluation of real estate collateral used to secure some of these loans and restructuring of these loans; however, these types of loans have remained stable since December 31, 2010. The allowance for loans losses is very subjective in nature, relying significantly on historical loss experience, collateral valuations available to management on specific loans, and economic conditions. We continue to be mindful of the continued problems within the economy and its impact on our loan portfolio as well as the inherent risk within the portfolio, and management will make adjustments to the allowance and loan loss provision as necessary.
The $17.8 million loans held-for-sale portfolio has already been committed to be purchased by investors at December 31, 2012 and subsequent to December 31, 2012, and will be settled subsequent to that date. Analysis of our history of sold loans indicates that minimal credit losses have been realized after the sale of loans, and therefore management does not consider these loans in determining the amount of the allowance.
The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2012, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. Management’s analysis of our impaired loans represents a level of reserves of approximately $1.2 million for the period ending December 31, 2012 compared to approximately $2.9 million at December 31, 2011. This balance continues to be reduced in 2012 as compared to 2011 based on the OCC guidance to eliminate specific reserves on collateral dependent loans and charge off these loans by the specific reserve amount.
The following table sets forth certain information as to the allowance for loan losses:
Our loans held-for-investment portfolio decreased $32.1 million, or 15.2% as of December 31, 2012, compared to December 31, 2011. Our average loans held-for-investment also decreased by 13.6% for 2012 compared to 2011. This decrease is primarily the result of a decrease in our commercial real estate mortgage loans secured by other properties due to slow demand in commercial lending and loan payoffs, which has resulted in a decrease in the portfolios of commercial business, commercial real estate, and residential land development loans to commercial borrowers.
The following table sets forth the allocation of the allowance for loan losses to each loan category as of the dates indicated. The allowance established for each category is not necessarily indicative of future losses or charge offs for that category and does not restrict the use of the allowance to absorb losses in any category:
(1) Excludes loans held-for-sale
Non-Performing Assets.
The following table sets forth information as to non-accrual and past due loans. We generally discontinue the accrual of interest on loans after a delinquency of more than four monthly payments, or when, in the opinion of management, the complete recovery of principal and interest is unlikely, at which time all previously accrued but uncollected interest is reversed from income.
Total non-accrual loans increased by $6.9 million, or 53.7%, to $19.7 million at December 31, 2012, compared to $12.8 million at December 31, 2011. This increase is primarily the result of one of our commercial non-residential loans that has an outstanding principal balance of $5.9 million becoming non-accrual during 2012. We are currently working with the borrower to resolve the technical deficiency that caused the status change. However the ability to resolve this technical deficiency has been hampered because one lending institution that is a participant in this transaction has been slow to respond. We believe that the deficiency will be corrected by the end of the first quarter.
The allowance for loan losses is approximately 15.8% of non-accrual loans as of December 31, 2012, versus 47.7% at December 31, 2011. Significant variation in this ratio may occur from period to period because the amount of non-performing loans depends largely on the
condition of a small number of individual credits and borrowers relative to the total loan and lease portfolio.
At December 31, 2012, total impaired loans were $33.7 million, or 18.82% of total loans held for investment, compared to $31.3 million, or 14.82% of total loans held-for-investment, at December 31, 2011. Non-performing loans consisted of $19.7 million that were non-accrual loans at December 31, 2012 and approximately $22.7 million of troubled debt restructured loans, which included $8.7 million in non accrued status. Significant variation in this ratio may occur from period to period because the amount of non-performing loans depends largely on the condition of a small number of individual credits and borrowers relative to the total loan and lease portfolio.
The following table sets forth information as to loans defined as delinquent (three payments past due, less than the four months past due as presented on the previous schedule) on which we continued to accrue interest.
Real estate acquired at or in lieu of foreclosure is classified as OREO until such time as it is sold. Acquired property is recorded at the lower of net acquisition cost or fair value, less estimated costs to sell subsequent to acquisition. Operating expenses of OREO are reflected in non-interest expenses. Any write-down of the property at the acquisition date is charged against the allowance for loan losses with any subsequent additional write-downs reflected in non-interest expenses.
For the year ending December 31, 2012, there was a $331,000 provision for OREO losses compared to a $266,000 provision for OREO losses for the year ended December 31, 2011. This provision is primarily the result of a reduction of the values of our OREO properties. The provision for OREO losses was expensed during the respective period for OREO property as is our practice when information is obtained that indicates the fair value is less than its carrying value. The value of OREO property held due to foreclosures at December 31, 2012 and 2011 were $5.1 million and $4.8 million, respectively. At December 31, 2012, OREO properties consist of $913,000 in residential construction properties, $1.4 million in lot properties, $622,000 in 1 - 4 residential properties and $2.2 million in commercial real estate properties. Management is actively seeking buyers for these properties.
Non-Interest Income. Total non-interest income for the year ending December 31, 2012 was $4.5 million compared to $3.7 million for the year ending December 31, 2011, an increase of $828,000, or 22.3%. The increase in non-interest income for the current twelve month period is
primarily attributable to increases of $224,000 in rental income, $204,000 on the gain on sale of loans, $155,000 on the sale of real estate acquired in settlement of loans, $126,000 in loan related fees and $73,000 on the gain on the sale of MBS and investment securities.
Net gain on the sale of mortgage-backed securities and investment securities for the period ending December 31, 2012 included approximately $635,000 pre-tax, $385,000 net of tax, compared to $562,000 pre-tax, $341,000 net of tax, for the same twelve month period of 2011. Gain on the sale of investments is the result of the Bank selling approximately $53.2 million of our MBS, $2.6 million of our callable agencies, $5.0 million corporate bonds and $2.3 million municipal bonds. Also, $43.5 million of callable investments were called prior to maturity. The net gain during the 2011 period resulted from the sale of approximately $11.0 million of our MBS and $42.0 million of our callable agencies, of which included $32.0 million of investments being called prior to maturity.
In accordance with the merger agreement, WSB repositioned a portion of the investment portfolio by selling existing securities and purchasing new securities with Old Line Bancshares’ consent. This consisted of selling the five remaining non-agency MBS that were rated less that investment grade by at least one rating agency. We expect to continue to reposition the investment portfolio in order to attempt to minimize any potential adjustment to the total consideration upon closing of the merger.
The $224,000 increase in rental income is due to rent received from available rental space located in the corporate office building in Bowie, MD that had been previously vacant.
The $155,000 increase on the gain on sale of real estate acquired in settlement of loans during 2012 is due to the gain on the sale of eleven properties resulting in a net gain of $191,000 compared to the sale of ten properties resulting in a net gain of $36,000 during 2011.
Gain on the sale of loans increased $204,000 for the year ending December 31, 2012, compared to last year. Gain on sale of loans includes servicing release fees and discount points earned on loans sold. The increase in the gain on sale of loans compared to the same period of 2011 is primarily due to an increase in the number of new originations, overall higher premiums and increased collection of up-front fees associated with those loans. Our ability to realize gains in future periods will depend largely on interest rates and the demand for mortgage loans.
While production of loans held-for-sale has been negatively impacted nationally by the current market constriction as to non-conforming and non-traditional mortgage offerings, and overall credit tightening, the Bank continues to offer traditional mortgage financing through its mortgage banking operations. Because loans we sell in the secondary market are with recourse, and we could be required to repurchase such loans if the purchasers turn out to be not creditworthy, we continue to monitor the anticipated negative impact and/or exposure of many of the larger secondary market investors, and as such have further reduced or eliminated the selling of loans to investors where liquidity or financial capacity is in question.
Loan-related fees, which consist primarily of late fees, document preparation fees, tax service fees and construction inspection fees, increased $126,000 during the year ended December 31, 2012, due primarily to the increase of upfront loan fees. We originated approximately 423 loans that were sold in the secondary market totaling $130.1 million during fiscal 2012, compared to 388 loans totaling $109.3 million during fiscal 2011.
Other income includes primarily fees from our deposit-based operations. The $28,000 increase in other income during 2012 is primarily the result of an increase in miscellaneous and other fee income.
Non-Interest Expenses. Non-interest expenses were $13.9 million and $13.8 million for the years ended December 31, 2012 and 2011, respectively.
The $68,000 increase in non-interest expenses during the year ended December 31, 2012 as compared to the year ended December 31, 2011 was primarily due to an increase of $71,000 in salaries and benefits, $65,000 in provision for loss on real estate acquired in settlement of loans and $148,000 in other expenses, partially offset by decreases of $110,000 in deposit insurance premiums and assessments, $55,000 in service contracts and $31,000 in advertising.
The increase in salaries and benefits is primarily the result of increased employee benefits expense, annual increases and commission paid to our loan originators. Benefit costs increased due to higher medical and life insurance premiums. We have reduced the number of paid commission loan personnel, however, these commissions are based on production and our production level increased compared to 2011. Salaries and benefit costs fluctuate based on the number of loan originators needed to meet the current loan demand. As of December 31, 2012, we have 16 mortgage loan originators. We cannot anticipate what impact this may have on future earnings.
The increase in the provision for OREO losses was due to OREO properties with a fair value less than the original carrying value. These increases are the result of obtaining updated appraisal and/or evaluations on the properties that have been classified as real estate owned, which resulted in additional write downs of certain properties. Continuing declines in real estate prices may affect the carrying OREO balances.
The decrease in deposit insurance premiums is the result of an overall decrease in FDIC assessment rates for smaller institutions. During the third quarter of 2011, FDIC changed the calculation formula to charge assessments on average assets, which resulted in lower premiums for WSB.
The decrease in service contracts is the result of a reduction of less service calls as compared to the previous year. The decrease in advertising is the result of a reduction of our advertising campaign for our mortgage departments as a result of the pending merger.
Professional services fees increased $20,000 during the year ended December 31, 2012. This increase is a result of additional legal and investment banker fees associated with the Merger Agreement and pending merger with Old Line Bancshares, partially offset by reduced legal expenses during the first nine months of 2012 associated with litigation during 2011 on two of our loans that was resolved in June 2012. We expect that professional services fees will remain elevated as we work toward stockholder approval and closing of the merger, which we expect to be completed in the second quarter of 2013.
Other expense increased primarily as a result of $42,000 in expenses related to our status as an SEC reporting company and $34,000 in director fees. The increase for both of these expenses is primarily the result of additional expenses associated with the pending merger. The additional expenses related to our status as an SEC reporting company was the result of fees and charges associated with the preparation of the required approval applications and fees associated
with announcements of the merger. Director fees increased as a result of additional meetings held during the year in connection with the pending merger.
Income Taxes. Although we generally provide for income taxes at substantially equivalent statutory rates, the tax effects of certain operations have caused variances in our overall effective tax rates from year to year. As a result, a tax expense of $429,000 was recognized for the year ended December 31, 2012 compared to a tax expense of $712,000 for the year ended December 31, 2011. The tax expense was the result of pre-tax earnings of $1.4 million, which included the exclusion of income for the bank owned life insurance and a state tax benefit attributable to our investments portfolio which consists of U.S. Agencies. The tax expense for 2011 was the result of pre-tax earnings of $2.0 million, which included the exclusion of income for the bank owned life insurance and a state tax benefit attributable to our investment portfolio which consists of U.S. Agencies. The effective tax rates were 29.5% and 36.3% for years ended December 31, 2012 and 2011, respectively.
The determination of current and deferred income taxes is a critical accounting estimate which is based on complex analyses of many factors including interpretation of income tax laws, the evaluation of uncertain tax positions, differences between the tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed such as the timing of reversal of temporary differences and current financial accounting standards. Additionally, there can be no assurance that estimates and interpretations used in determining income tax liabilities may not be challenged by taxing authorities. Actual results could differ significantly from the estimates and tax law interpretations used in determining the current and deferred income tax liabilities.
In addition, under generally accepted accounting principles, deferred income tax assets and liabilities are recorded at the income tax rates expected to apply to taxable income in the periods in which the deferred income tax assets or liabilities are expected to be realized. If such rates change, deferred income tax assets and liabilities must be adjusted in the period of change through a charge or credit to the Consolidated Statements of Operations. Also, if current period income tax rates change, the impact on the annual effective income tax rate is applied year-to-date in the period of enactment.
Financial Condition and Liquidity.
General.
Total assets were $356.5 million at December 31, 2012 as compared to $385.0 million at December 31, 2011. The $28.5 million, or 7.4%, decrease in assets at December 31, 2012 was principally attributable to a decrease of $32.1 million in loans held for investment and $56.0 million in MBS, offsetting the increase of $37.0 million in cash and cash equivalents and $14.2 million in investment securities available-for-sale. As our loan portfolio decreased due to loan payoffs and principle pay-downs, we reinvested into agency callable securities. In accordance with the merger agreement announced on September 10, 2012, WSB has been repositioning a portion of the investment portfolio by selling existing securities and purchasing new securities with Old Line Bancshares’ consent. We expect to continue to reposition the investment portfolio in order to attempt to minimize any potential adjustment to the total consideration upon closing of the merger.
Liabilities decreased by $29.5 million, or 8.9%, to $301.2 million at December 31, 2012 as compared to $330.7 million at December 31, 2011, as a result of a decrease of $16.0 million in our borrowings and $13.6 in our total deposits. The decrease in deposits is the result of a decrease in our time deposits as a result of reductions of $12.9 million in CDs and $745,000 in our savings and NOW accounts. Management directed its focus to decrease its core savings and NOW accounts by decreasing the rates we offer on these products so that our rate is slightly lower than the rate offered by our competitors. Previously, we had generally sought to lengthen our deposit maturities and decrease the effect of short-term interest rate swings through the pricing of our CDs.
Liquidity. We must meet requirements for liquid assets and for liquidity described in “Part I, Item 1, Business¾Supervision and Regulation¾Liquidity Requirements.” As of December 31, 2012, we had $41.4 million of cash and cash equivalents. Further, we had $77.6 million of unpledged investment securities. At December 31, 2012, we had approximately $43.8 million of availability on our FHLB line and $12.0 million of availability on our secured lines of credit with correspondent banks.
Funding requirements are impacted by loan originations and maturities of CDs and borrowings. We comply with regulatory guidelines regarding required liquidity levels and monitor our liquidity position. In an effort to reduce exposure to liquidity risk, the Board’s Asset and Liability Committee monitors our sources of funds and our assets and liabilities, which may result in a change of our asset, liability, and off-balance sheet positions. Long-term liquidity is generated through growth in our deposits and long-term debt, while short-term liquidity is generated though federal funds and securities sold under agreement to repurchase.
Credit Commitments. The following table lists our credit commitments as of December 31, 2012. Off-balance sheet financial instruments include commitments to extend credit, standby letters of credit, operating lease obligations and financial guarantees. See Note 16 in our notes to consolidated financial statements contained elsewhere in this report for a complete description of off-balance sheet financial instruments.
Capital. Current statutory provisions and OCC regulations establish standards for capital, require subsidiaries of a federally-chartered thrift institution to be separately capitalized, and require investments in and extension of credit to any subsidiary engaged in activities not permissible for a national bank to be deducted in the computation of an institution’s regulatory capital. The Bank’s regulatory risk-based capital reflects a decrease of $861,000, while its regulatory assets reflect a decrease of $1.4 million, both of which represent unrealized gains (after-tax for capital deductions and pre-tax for asset deductions, respectively) on MBS and investment securities classified as available-for-sale. See “Part I, Item 1, Business- Supervision and Regulation”, “Part I, Item 1, Business¾Subsidiaries” and Note 12 of Notes to Consolidated Financial Statements contained in “Part II, Item 8” of this report. The minimum regulatory capital and ratios required, the Bank’s actual regulatory capital and ratios, and the amount by
which the Bank’s ratios exceed the minimum regulatory requirements, as of December 31, 2012, are as follows:
Our management believes that, under current regulations, and eliminating the assets of WSB, the Bank remains well capitalized and will continue to meet its minimum capital requirements in the foreseeable future. However, events beyond the control of the Bank, such as a shift in interest rates or a further downturn in the economy in areas where we extend credit, could adversely affect future earnings and, consequently, the ability of the Bank to meet its future minimum capital requirements.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements of WSB and related notes presented elsewhere herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Unlike those of many industries, most of the assets and liabilities of financial institutions such as this Company are monetary in nature. Monetary items, which are those assets and liabilities that are convertible into a fixed number of dollars regardless of changes in prices, include cash, investments, loans and other receivables, savings accounts, short-term and long-term debt and, as in our case, most of its other liabilities. Virtually all of our assets and liabilities are monetary in nature. Inflation has had an immaterial effect on our operations in the two most recent fiscal years.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
Item 8.
Item 8. Financial Statements and Supplementary Data
Contents
Page
CONSOLIDATED FINANCIAL STATEMENTS:
Management’s report on internal control over financial reporting
Report of independent registered public accounting firm
Consolidated statements of financial condition
Consolidated statements of operations and Comprehensive income
Consolidated statements of changes in stockholders’ equity
Consolidated statements of cash flows
Notes to consolidated financial statements
Management’s Report on Internal Control Over Financial Reporting
The management of WSB Holdings, Inc. (“the Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012, utilizing the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2012, is effective.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s financial statements are prevented or timely detected.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of result of a provision of the Dodd-Frank Act, which, among other things, permanently exempted non-accelerated filers, such as the Company, from complying with the requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002, which requires an issuer to include an attestation report from an issuer’s independent registered public accounting firm on the issuer’s internal control over financial reporting, this annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report is not subject to attestation by the Company’s independent registered accounting firm.
[Stegman & Company Letterhead]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
WSB Holdings, Inc.
Bowie, Maryland
We have audited the accompanying consolidated statements of financial condition of WSB Holdings, Inc. (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2012. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2012 and 2011 and the results of their operations and their cash flows for the years in the two-year period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
/s/ Stegman & Company
Baltimore, Maryland
March 14, 2013
WSB HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF DECEMBER 31, 2012 AND DECEMBER 31, 2011
See notes to consolidated financial statements.
WSB HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
See notes to consolidated financial statements.
WSB HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2012 AND DECEMBER 31, 2011
See notes to consolidated financial statements.
WSB HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
WSB HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012 and DECEMBER 31, 2011
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The consolidated financial statements include WSB Holdings, Inc. (“WSB” or “we”) and its wholly owned subsidiaries, The Washington Savings Bank FSB (“the Bank”), WSB, Inc., WSB Realty, LLC and WSB Realty, Inc. (collectively referred to herein, as the “Company”). All significant intercompany balances and transactions between entities have been eliminated.
Nature of Operations - We are primarily engaged in the business of obtaining funds in the form of savings deposits and investing such funds in mortgage loans on residential, construction, and commercial real estate, and various types of consumer and other loans, mortgage-backed securities, and investment and money market securities. We grant loans throughout the Washington DC, Baltimore, Northern Virginia and surrounding metropolitan areas. Borrowers’ ability to repay is dependent upon the economy of these respective areas. WSB, Inc. is primarily engaged in the business of developing single family residential lots. WSB Realty, LLC and WSB Realty, Inc. are both primarily engaged to take assignment of the right to acquire title to certain properties purchased at foreclosure sales. Management is authorized to take usual and customary activities toward the acquisition, rehabilitation, sale, rental and disposition of these properties.
Management Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for loan losses, the valuation of real estate held for development, and the valuation of real estate acquired in settlement of loans.
Cash and Cash Equivalents - Cash and cash equivalents include demand deposits at other financial institutions, interest bearing deposits at other financial institutions and federal funds sold. All cash equivalents have original maturities of three months or less.
Investment Securities and Mortgage-Backed Securities - Investment Securities and Mortgage-Backed Securities are required to be segregated into the following three categories: trading, held-to-maturity, and available-for-sale. Trading securities are purchased and held principally for the purpose of reselling them within a short period of time with unrealized gains and losses included in earnings. Debt securities classified as held-to-maturity are accounted for at amortized cost and require the Company to have both the positive intent and ability to hold those securities to maturity. Securities not classified as either trading or held-to-maturity are considered to be available-for-sale. The premium or discount associated with these securities are amortized on a level yield to the full term of the securities. Unrealized gains and losses for available-for-sale securities are excluded from earnings and reported, net of income taxes, as other comprehensive income, a separate component of stockholders’ equity, until realized. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) the structure of the security. An impairment loss is
recognized in earnings only when: (1) we intend to sell the debt security; (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or (3) we do not expect to recover the entire amortized cost basis of the security. In situations where we intend to sell or when it is more likely than not that we will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in stockholders’ equity as a component of other comprehensive income, net of deferred taxes. Credit loss is determined by calculating the present value of future cash flows of the security compared to the amortized cost of the security. Realized gains or losses on the sale of investment and mortgage-backed securities are reported in earnings and determined using the amortized cost of the specific security sold.
Restricted Stock Investments - The Bank, as a member of the Federal Home Loan Bank System, is required to maintain an investment in capital stock of the FHLB in varying amounts based on balances of outstanding home loans and on amounts borrowed from the FHLB. Because no ready market exists for this stock and it has no quoted market value, our investment in this stock is carried at cost.
Loan Origination Fees, Discounts, and Premiums on Loans - Loan origination fees and direct loan origination costs are deferred and recognized as an adjustment to yield over the lives of the related loans utilizing the interest method. The amortization of such deferred fees and costs is adjusted for the prepayment experience on a loan-by-loan basis. Commitment fees to originate or purchase loans are deferred, and if the commitment is exercised, they are recognized over the life of the loan as an adjustment of yield. If the commitment expires unexercised, commitment fees are recognized in income upon expiration of the commitment.
Loans Receivable - We originate mortgage, commercial and consumer loans for portfolio investment and mortgage loans for sale in the secondary market. During the period of origination, mortgage loans are designated as either held-for-sale or held-for-investment purposes. Mortgage loans held-for-sale are carried at the lower of cost or fair value, determined on an individual loan basis. There was no valuation allowance required as of December 31, 2012 or December 31, 2011 on loans held-for-sale. The loans sold basis include any deferred loan fees and costs. Loans held-for-investment is stated at their principal balance outstanding net of related deferred fees and cost. Transfers of loans held-for-investment to the held-for-sale portfolio are recorded at the lower of cost or market value on the transfer date with any reduction in a loan’s value reflected as a write-down of the recorded investment resulting in a new cost basis with a corresponding charge to the allowance for loan losses.
We enter into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 60 days. We protect our self from changes in interest rates through the use of best efforts forward delivery commitments, whereby, we commit to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, we are not exposed to losses nor will we realize gains related to our rate lock commitments due to changes in interest rates.
The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively
traded. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.
Income Recognition on Loans Receivable - Interest on loans receivable is credited to income as earned on the principal amount outstanding. For those loans that are carried on non-accrual status, interest income is recognized on the cash basis or cost recovery method. Loans are generally placed on non-accrual status when the collection of principal or interest is four payments or more past due, or earlier, if collection is deemed uncertain. Previously accrued but uncollected interest on these loans is charged against interest income. Loans may be reinstated to accrual status when such loans have been brought current, as to both principal and interest, and the borrower demonstrates the ability to pay and remain current.
Allowance for Loan Losses - The allowance for loan losses represents an amount which, in management’s judgment, reflects probable losses on existing loans and other extensions of credit that may become uncollectible as of the balance sheet date. The allowance for loan losses consists of an allocated component, consisting of both formula and specific allowances, and a non-specific component. The adequacy of the allowance for loan losses is determined through review and evaluation of the loan portfolio along with ongoing monthly assessments of the probable losses inherent in that portfolio, and, to a lesser extent, in unused commitments to provide financing. Loans deemed uncollectible are charged against, while recoveries are credited to, the allowance. Management adjusts the level of the allowance through the provision for loan losses, which is recorded as a current period operating expense. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowances and the non-specific allowance. The amount of the allowance is reviewed monthly by the Loan Committee, and reviewed and approved by the Board of Directors.
The formula allowance is calculated by applying loss factors to corresponding categories of outstanding loans. Loss factors consider our historical loss experience in the various portfolio categories over the prior twelve months. The use of these loss factors is intended to reduce the differences between estimated losses inherent in the portfolio and observed losses.
Specific allowances are established in cases where management has identified significant conditions or circumstances related to a loan that management believes indicate the probability that a loss has been be incurred in an amount different from the amount determined by application of the formula allowance. For other problem-graded credits, allowances are established according to the application of loan risk factors. These factors are set by management to reflect its assessment of the relative level of risk inherent in each grade.
The non-specific allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. Such conditions include general economic and business conditions affecting key lending areas, loan quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examinations results and management’s judgment with respect to various other conditions including credit administration and management and the quality of risk identification systems. Executive management reviews these conditions monthly.
Management believes that the allowance for loan losses reflects its best estimate of the probable losses in the held-for-investment loan portfolio as of the respective balance sheet date. However, the determination of the allowance requires significant judgment, and estimates of probable losses
inherent in the loan portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future additions to the allowance may be necessary based on changes in the credits comprising the loan portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our loan portfolio and allowance for loan losses. Such review may result in recognition of additions to the allowance for loan losses based on the examiners’ judgments of information available to them at the time of their examination.
Impairment of Loans - We consider a loan impaired when it is probable that we will be unable to collect all interest and principal payments as scheduled in the loan agreement. A loan is tested for impairment once it becomes four payments past due. A loan is not considered impaired during a period of “insignificant delay” in payment if the ultimate collectability of all amounts due is expected. We define an “insignificant delay” in payment as past due less than four payments. A valuation allowance is maintained to the extent that the measure of the impaired loan is less than the recorded investment. Our residential mortgage and consumer loan portfolios are collectively evaluated for impairment. The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, our impairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis.
Real Estate Acquired in Settlement of Loans - Real estate acquired in settlement of loans is carried at the lower of our recorded investment or fair value at the date of acquisition. Write-downs to fair value at the date of acquisition are charged to the allowance for loan losses. Subsequent write downs are included in non-interest expense. Costs relating to the development and improvement of a property are capitalized, whereas those relating to holding the property are charged to expense when incurred. The real estate is carried at the lower of acquisition or fair value net of estimated costs to sell subsequent to acquisition. Operating expenses of real estate owned are reflected in other non-interest expenses.
The amounts we could ultimately recover from real estate acquired in settlement of loans could differ materially from the amounts used in arriving at the net carrying value of the assets because of future market factors beyond our control or changes in our strategy for recovering our investment.
Premises and Equipment - Depreciation on buildings, furniture, and equipment is computed using the straight-line method over each asset’s estimated useful life. Leasehold improvements are amortized using the straight-line method over the lesser of the estimated useful life or the lease term. Such estimated useful lives are as follows:
Mortgage Banking Activities - It is our current practice to sell mortgage loans without retaining loan servicing rights (commonly referred to as “servicing released”). We have not purchased mortgage loans with servicing rights subsequent to 1994. Prior to 1995, we originated and sold some mortgage
loans with servicing retained. The accounting treatment in effect at that time prohibited the capitalization of mortgage rights on internally originated loans that were subsequently sold. Accordingly, there are no capitalized mortgage servicing assets at December 31, 2012 and December 31, 2011.
Advertising Costs - We expense advertising costs as they are incurred.
Income Taxes - We file a consolidated federal income tax return with our subsidiaries. Deferred income tax assets and liabilities are recognized for the future income tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Any deferred tax asset is reduced by the amount of any tax benefit that more likely than not will not be realized.
A tax position is recognized in the financial statements only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
We recognize interest and penalties related to income tax matters in income tax expense.
The tax years before 2009 are no longer subject to U.S. Federal tax examinations.
Earnings Per Share - Basic earnings per share (EPS) is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if options to issue common stock were exercised. Potentially dilutive common shares include incremental shares issuable upon exercise or outstanding stock options using the Treasury Stock Method.
Stock-Based Compensation - We have incentive compensation plans that permit the granting of incentive and non-qualified awards in the form of stock options. Generally, the terms of these plans stipulate that the exercise price of options may not be less than the fair market value of our common stock on the date the options are granted. Options predominantly vest over a two year period from the date of grant, and expire not later than ten years from date of grant.
Stock-based compensation is measured based on the grant-date fair value of the awards and the costs are recognized over the period during which an employee is required to provide service in exchange for the award. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.
Reclassifications - Certain reclassifications have been made to the prior years’ consolidated financial statements to conform to the 2012 presentation.
Recent Accounting Pronouncements
In April 2011, the FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” ASU No. 2011-03 affects all entities that enter into agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity. The amendments in ASU No. 2011-03 remove from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. ASU No. 2011-03 also
eliminates the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The guidance is effective for the Company’s reporting period ended March 31, 2012. The provisions of this guidance , which were adopted effective for the Company’s quarter ended March 31, 2012, did not have a material impact on the Company’s consolidated results of operations, financial condition or disclosure.
In December 2011, the FASB issued an accounting standards update to increase the disclosure requirements surrounding derivative instruments that are offset within the balance sheet pursuant to the provisions of current GAAP. The objective of the update is to provide greater comparability between issuers reporting under U.S. GAAP versus IFRS and provide users the ability to evaluate the effect of netting arrangements on a company’s financial statements. The provisions of the update are effective for annual and interim periods beginning on or after January 1, 2013 and are not expected to add to the Company’s current level of disclosures.
In February 2013 FASB issued ASU 2013-02, “Comprehensive Income (Topic 220) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. The objective of the new guidance is to improve the transparency of reporting reclassifications out of accumulated other comprehensive income (“OCI”) by requiring entities to present in one place information about significant amounts reclassified and, in some cases, to provide cross references to related footnote disclosures. The amendments do not change the current requirements for reporting net income or OCI, nor do they require new information to be disclosed. The amendments should be applied prospectively and are effective for public entities in both interim and annual reporting periods beginning after December 15, 2012.
2. LOANS RECEIVABLE
Loans receivable held-for-investment consists of the following:
We originate adjustable and fixed interest rate loans. The adjustable rate loans have interest rate adjustment limitations and are generally indexed to the 1- or 3-year U.S. Treasury index. Future market factors may affect the correlation of the interest rate adjustment with the rates we pay on the short-term deposits that have been primarily utilized to fund these loans. Adjustable interest rate loans at December 31, 2012 and December 31, 2011 were $2.5 million and $6.7 million, respectively.
Allowance for Loan Losses -
Allowance for loan losses and recorded investment in loans for the years ended December 31, 2012 and 2011 is summarized as follows:
The risks associated with each portfolio class are as follows:
First mortgage loans secured by single family residences, secured by 5 or more residential, secured by other properties and second mortgage loans - The primary risks related to this type of lending include; unemployment, deterioration in real estate values, our ability to access the creditworthiness of the customer, deterioration in the borrower’s financial condition (whether the result of personal issues or general economic downturn), the inability of the borrower to maintain occupancy for investment properties, and an appraisal on a property is not reflective of the true property value. Portfolio risk includes condition of the economy, changing demand for these types of loans, large concentration of these types of loans and geographic concentration of these types of loans.
Construction loans - Since this portfolio is substantially owner occupied residential construction loans, the loan specific risks and portfolio risks are the same as described above as first mortgage loans secured by single family residences. However these loans carry the additional risk associated with the builder and the potential for builder cost overruns and/or the builder being unable to complete the construction.
Land development loans and land acquisition loans - The primary loan-specific risk in land and land development are: unemployment, deterioration of the business and/or collateral values, deterioration of the financial condition of the borrowers and/or guarantors creates a risk of default, and that an appraisal on the collateral is not reflective of the true property value. These loans usually include funding for the acquisition and development of unimproved properties to be used for residential or non-residential construction. We may provide permanent financing on the same projects for which we have provided the development and construction financing. Portfolio risk includes condition of the economy, changing demand for these types of loans, large concentration of these types of loans, and geographic concentrations of these types of loans.
Commercial and Commercial secured by real estate - The primary loan-specific risks in these types of loans are: unemployment, general deterioration in the economy, deterioration of the business and/or business cash flows, financial condition of the guarantors, deterioration of collateral values, and that an appraisal on any real estate collateral is not reflective of the true property value. Portfolio risk includes condition of the economy, changing demand for these types of loans, large concentration of these types of loans, and geographic concentration of these types of loans.
Loans secured by savings accounts and consumer installment loans- The primary risks of these loans are: unemployment, and deterioration of the borrower’s financial condition, whether the result of person issues or a general economic downturn. The portfolio risks for these types of loans is the same as for first mortgage loans secured by single family residences as described above.
Credit quality indicators as of December 31, 2012 are as follows:
Pass: Loans classified as pass generally meet or exceed normal credit standards. Factors include repayment source, collateral, borrower cash flows, and performance history.
Special Mention: Loans classified Special Mention loans have potential weaknesses that deserve management’s attention. These loans are not adversely classified and do not expose an institution to sufficient risk to currently warrant adverse classification.
Substandard: Loans classified as substandard are loans that have a well-defined weakness. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. These loans are inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged as security for the asset.
Doubtful: Loans classified as doubtful consists of loans where we expect a loss, but not a total loss. These loans have all the weaknesses inherent in a substandard asset, in addition, these weaknesses make collection highly questionable or improbable based on the existing circumstances.
Loss: Loans classified as loss are considered uncollectible. A loan classified as a loss does not mean that an asset has no recovery value, but that it is not practical to defer writing off or reserving all or a portion of the asset, even though partial recovery may be collected in the future. Loans that are classified as “Loss” are fully reserved for on our financial statements.
The credit risk profile by internally assigned grade under the Allowance for Loan Losses for the years ended December 31, 2012 and 2011 are as follows:
Information on impaired loans for the years ended December 31, 2012 and 2011 is as follows:
At December 31, 2012 and 2011, nonaccrual loans are $19.7 million and $12.8 million, respectively.
An age analysis of past due loans as of December 31, 2012 and 2011 are as follows:
Loans on which the recognition of interest has been discontinued amounted to approximately $19.7 million and $12.8 million at December 31, 2012 and 2011, respectively. If interest income had been recognized on those loans at their stated rates during the years ending December 31, 2012 and 2011, interest income would have been increased by approximately $2.0 million and $1.1 million, respectively. The total allowance for loan losses on these impaired loans was approximately $512,000 and $2.9 million at December 31, 2012 and 2011, respectively.
The impaired loans included in the table above were comprised of collateral dependent 1-4 residential real estate, lot loans, commercial real estate loans and consumer loans. The average recorded investment in impaired loans was $36.1 million and $32.7 million at December 31, 2012 and 2011, respectively, which included an average recorded balance in non-performing loans of $13.7 million and $19.3 million at December 31, 2012 and 2011, respectively.
A troubled debt restructure (“TDR”) is when we grant a concession to borrowers that the Bank would not otherwise have considered due to a borrower’s financial difficulties. All TDRs are considered “impaired”. The substantial majority of our residential real estate TDRs involved reducing the interest rate for a specified period. We also have restructured loans involving the restructure of loan terms such as a reduction in the payment requiring interest only payments and/or extending the maturity date of these loans.
We had approximately $22.7 million in TDRs, with approximately $2.5 million added during the twelve month period ending December 31, 2012, the majority of which were on accrual status.
We consider an impaired loan to be performing to its modified terms if the loan is not past due 30 day or more as of the report date.
The following presents, by class, information related to loans modified in a TDR during the twelve months ending December 31, 2012 and 2011.
The following reflects a summary of TDR loan modifications outstanding and respective performance under the modified terms as of December 31, 2012.
The following presents loans modified in a TDR that defaulted during the twelve month periods ending December 30, 2012 and 2011, and within twelve months of their modification date. A TDR is considered to be in default once it becomes 30 days or more past due following a modification.
Non-residential real estate loans had an outstanding balance of $30.1 million and $35.4 million at December 31, 2012 and 2011, respectively. These loans are considered by management to have somewhat greater risk of collectability due to the dependence on income production. Additionally, all of our non-residential real estate loans were collateralized by real estate (primarily warehouse and office space) in the Washington, D.C. metropolitan area.
We originate and participate in land and land development loans, real estate construction loans and commercial real estate loans, the proceeds of which are used by the borrower for acquisition, development, and construction purposes. Often the loan arrangements require us to provide, from the loan proceeds, amounts sufficient for payment of loan fees and anticipated costs during acquisition, development, or construction, including interest. This type of lending is considered by management to have higher risks. At December 31, 2012 and 2011, the undisbursed portion of such loans totaled $10.2 million and $11.0 million, respectively.
We have made loans to certain of the Bank’s executive officers and directors. These loans were made on substantially the same terms, including interest rate and collateral requirements, as those prevailing at the time for comparable transactions with unrelated customers. The risk of loss on these loans is considered to be no greater than for loans made to unrelated customers.
The following schedule summarizes changes in amounts of loans outstanding to executive officers and directors:
3. MORTGAGE-BACKED SECURITIES
Mortgage-backed securities consisted of the following:
The portfolio classified as “Available for Sale” is consistent with management’s assessment and intention as to the portfolio. While we have the intent to hold and do not expect to be required to sell the securities until maturity, from time to time or with changing conditions, it may be advantageous to sell certain securities either to take advantage of favorable interest rate changes or to increase liquidity. Securities classified as “Held to Maturity” are not subject to fair value adjustment due to temporary changes in value due to interest rate; while securities classified as “Available for Sale” are subject to adjustment in carrying value through the accumulated comprehensive income line item in stockholders’ equity section of the statement of financial condition.
Gross unrealized losses and fair value by length of time that the individual available-for-sale MBS have been in a continuous unrealized loss position is as follows:
At December 31, 2012, we had no securities in an unrealized loss position. At December 31, 2011, there were four securities that were in an unrealized loss related to our private labeled mortgage backed securities portfolio. These securities were sold during the year ending December 31, 2012.
At December 31, 2012 and December 31, 2011, we had no other-than-temporary impairment losses recognized in net earnings, related to available-for-sale investments.
In evaluating whether a security was other than temporarily impaired, we considered the severity and length of time impaired for each security in a loss position. Other qualitative data was also considered including recent developments specific to the organization issuing the security, market liquidity, extension risk, credit rating downgrades as well as analysis of performance of the underlying collateral.
Prior to the sale of our non-agency MBSs, the valuation process and OTTI determination, assumptions related to prepayment, default and severity on the collateral supporting the non-agency MBSs were input into an industry standard valuation model. The valuation is “Level Three” pursuant to FASB ASC - Topic 820- Fair Value Measurements and Disclosures. As of December 31, 2012, we currently have no non-agency private-labeled MBS. At December 31, 2012, we had no securities classified as held-to-maturity.
We recognized a gain of $189,264 on the sale of mortgage-backed securities during year ending December 31, 2012 compared to a gain of $401,052 for the previous fiscal year. Proceeds from sale of mortgage-backed securities were as follows as of December 31, 2012 and 2011:
4. INVESTMENT SECURITIES
Investment securities consist of the following:
Proceeds from the sales and calls of investment securities available-for-sale were as follows for the respective twelve month periods ending December 31, 2012 and 2011:
Approximately $43.5 million short term callable agency investments were called during the year ending December 31, 2012. Also, during the year ending December 31, 2012, we sold approximately $2.6 million in short term callable agencies, $5.0 million in corporate bonds and $2.3 million in municipal bonds.
In evaluating whether a security was other than temporarily impaired, we considered the severity and length of time impaired for each security in a loss position. Other qualitative data was also considered including recent developments specific to the organization issuing the security and the overall environment of the financial markets.
Gross unrealized losses and fair value by length of time that the individual available-for-sale investment securities have been in a continuous unrealized loss position are as follows:
All of our temporarily impaired securities are defined as impaired due to declines in fair values resulting from increases in interest rates compared to the time they were purchased. None of these
securities have exhibited a decline in value due to changes in credit risk. Furthermore, we have the ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value and do not expect to realize losses on any of these holdings. As such, management does not consider the impairments to be other than temporary.
Maturities for the investment securities are as follows:
5. LAND HELD FOR DEVELOPMENT
WSB’s wholly owned subsidiary, WSB, Inc., previously was established to purchase land in Maryland to develop into single family building lots that were offered for sale to third parties. The subsidiary also built homes on lots on a contract basis. However, due to the current economy, the subsidiary has not purchased or participated in developing homes for the past fiscal years ending December 31, 2012 and 2011.
6. REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS
Real estate acquired in settlement of loans consists of the following:
7. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
Depreciation expense totaled $444,237 and $446,770 for the years ending December 31, 2012, and 2011, respectively. Loss on disposal of assets totaled $9,198 and $2,005 for the years ending December 31, 2012 and 2011, respectively.
The Company has entered into long-term operating leases for certain premises. Some of these leases require payment of real estate taxes and other related expenses, and some contain escalation clauses that provide for increased rental payments under certain circumstances. Certain leases also contain renewal options. Rental expense under leases for the years ended December 31, 2012 and December 31, 2011 was $296,374 and $287,862, respectively.
At December 31, 2012, the minimum rental commitment for the non-cancelable leases is as follows:
8. DEPOSITS
Deposits consist of the following:
Time deposits at December 31, 2012 mature as follows:
Our deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”). The Dodd-Frank Wall Street Reform and Consumer Protection Act signed on July 21, 2010, made permanent the standard maximum deposit insurance amount of $250,000.
As of December 31, 2012, we have approximately 146 time deposits with a balance in excess of $100,000 for a total of $20,116,000, compared to approximately 176 for a total of $24,241,000 at December 31, 2011. These funds were primarily used to fund our loan originations. We currently have 5 accounts totaling approximately $18.0 million that are funds received through brokers. These brokered accounts consist of individual accounts that are not in excess of $100,000 but issued under master certificates in the broker’s name for a combined total exceeding $100,000. These types of accounts meet the FDIC requirements and are federally insured.
The following is a summary of interest expense on deposits:
9. BORROWINGS
Borrowings are as follows:
The fixed rate advances mature as follows:
At December 31, 2011, total borrowings consisted of $84.0 million in FHLB advances. During the fiscal year ending December 31, 2012, our borrowings were reduced as a result of an $8.0 million maturity and the repayment of $8.0 million in the daily rate credit, bringing the balance of our FHLB advances to $68.0 million at December 31, 2012. Borrowings for fiscal 2012 were as follows:
FHLB Borrowings
We are required to maintain collateral against FHLB advances. This collateral consisted of a blanket lien on our 1-to-4 family residential loan portfolio, commercial real estate loan portfolio and multi-family first trust mortgage portfolio, which had a net collateral value of $62,746,609 and $61,699,987 at December 31, 2012 and 2011, respectively.
During the years ended December 31, 2012 and 2011, the maximum month end balance of total borrowings was $76.0 million and $86.0 million, respectively. We currently have an unused secured line of credit of $7.0 million with M & T Bank as well as a $5.0 million unused line of credit with Atlantic Central Bankers Bank which includes $3.0 million unsecured and $2.0 million secured lines of credit.
10. BENEFIT PLANS
Profit Sharing/401(k) Retirement Plan - The Bank has a 401(k) Retirement Plan (“401(k)”). The 401(k) offers a corporate match program of 100% of the first 3% of employee directed contributions and a 50% match up to an additional 2% of employee directed contributions. For the calendar year ending December 31, 2012 and 2011, we recognized expenses of $188,861 and $139,825, respectively.
Stock Option Plans - We have incentive compensation plans that permit the granting of incentive and non-qualified awards in the form of stock options. Generally, the terms of these plans stipulate that the exercise price of options may not be less than the fair market value of WSB’s common stock on the date the options are granted. Options predominantly vest over a two year period from the date of grant, and expire not later than ten years from the date of grant.
All outstanding options are vested and there is currently no unrealized compensation cost related to non-vested share based compensation arrangements.
Equity Incentive Plans - On April 27, 2011, the stockholders of WSB Holdings, Inc. approved the adoption of the WSB Holdings, Inc. 2011 Equity Incentive Plan, which reserve shares of common stock for issuance to certain key employees and non-employee directors. The maximum number of shares of our common stock that be issued with respect to awards granted under the plan is 500,000 plus (i) any shares of common stock that are available under the Washington Savings Bank 2001 Stock Option and Incentive Plan (the “2001 Plan”) as of its termination date (which was April 27, 2011) and (ii) shares of common stock subject to options granted under the 2001 Plan that expire or terminate without having been fully exercised. In no event, however, may the number of shares issuable pursuant to incentive stock options exceed 500,000. The period during which an option granted under the Plan will be exercisable, as determined by the Administrator, will be set forth in the
agreement evidencing the option award. However, an incentive stock option may not be exercisable for more than ten years from its date of grant.
Information with respect to stock options is as follows:
A summary of options outstanding and exercisable at December 31, 2012 is as follows:
There were no options granted during 2012 or 2011. The total intrinsic value of options exercised during the years ended December 31, 2012 and 2011 was $12,184 and $6,213 respectively. The aggregate intrinsic value of all options outstanding and exercisable was $0 at December 31, 2012. There was no pre-tax stock-based compensation recognized in the Statements of Operations for the years ended December 31, 2012 and December 31, 2011. All outstanding options are vested and there is currently no unrealized compensation cost related to non-vested share based compensation arrangements.
11. CONTINGENCIES
On September 10, 2012, WSB and Old Line Bancshares, Inc., the parent company of Old Line Bank, entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Old Line Bancshares will acquire WSB for consideration of approximately $48.7 million in stock and cash, or $6.12 per share, subject to possible adjustment. The Merger Agreement, which has been approved by the Boards of Directors of both companies, provides that WSB will be merged with and into Old Line Bancshares. The Bank will be merged with and into Old Line Bank immediately following consummation of the merger.
Consummation of the merger is subject to certain conditions, including, among others, the approval of the Merger Agreement by the stockholders of Old Line Bancshares and WSB and the receipt of required regulatory approvals; we received the required Federal Reserve Board approval and OCC non-objection as of February 6, 2013, and we received the required Maryland Commissioner approval as of March 4, 2013. Therefore, all required regulatory approvals with respect to the Merger have now been received. WSB and Old Line Bancshares have each scheduled a special meeting of their stockholders on April 15, 2013, for stockholders to vote to approve the merger agreement. In addition, a lawsuit has been filed against WSB and its directors and against Old Line Bancshares that seeks to enjoin the merger.
On September 27, 2012, a complaint was filed by Rosalie Jones, both individually and on behalf of a putative class of WSB’s stockholders, in the Circuit Court for Prince George’s County, Maryland, against WSB and its Directors and Old Line Bancshares. The complaint seeks to enjoin the Merger and alleges, among other things, that the members of WSB’s Board of Directors breached their fiduciary duties by agreeing to sell WSB for inadequate and unfair consideration and pursuant to an unfair process.
On February 5, 2013, the defendants entered into a memorandum of understanding with the plaintiff regarding settlement of all claims asserted on behalf of the alleged class of WSB stockholders. In connection with the settlement contemplated by that memorandum of understanding, the litigation and all claims asserted in such litigation will be dismissed, subject to court approval. The proposed settlement terms require Old Line Bancshares and WSB to make certain additional disclosures related to the merger, which disclosures are included in this joint proxy statement/prospectus. The parties also agreed that plaintiffs may seek attorneys’ fees and costs in an as-yet undetermined amount, with the defendants to pay such fees and costs if and to the extent they are approved by the court. The memorandum of understanding further contemplates that the parties will enter into a stipulation of settlement, which will be subject to customary conditions, including confirmatory discovery and court approval following notice to WSB’s stockholders. If the parties enter into a stipulation of settlement, a hearing will be scheduled at which the court will consider the fairness, reasonableness and adequacy of the settlement. There can be no assurance that the parties will ultimately enter into a stipulation of settlement, that the court will approve any proposed settlement, or that any eventual settlement will be under the same terms as those contemplated by the memorandum of understanding.
The Merger Agreement includes customary representations, warranties and covenants of the parties. The Merger Agreement contains termination rights of WSB and Old Line Bancshares and further provides that we will be required to pay Old Line Bancshares a termination fee of $1.75 million if the Merger Agreement is terminated under specified circumstances set forth therein.
We expect the merger to close on or about May 3, 2013. For additional information regarding our pending merger with Old Line Bancshares, please see as our definitive proxy statement filed with the Securities and Exchange Commission on March 5, 2013.
You should keep in mind that discussions in this report that refer to WSB’s business, operations and risks in the future refer to WSB as a stand-alone entity up to the closing of the pending merger or if the merger does not close, and that these considerations will be different with respect to the combined company after the closing of the merger.
12. STOCKHOLDERS’ EQUITY AND REGULATORY MATTERS
We are insured by the FDIC through its Deposit Insurance Fund (DIF) and regulated by the Office of the Comptroller of the Currency (“OCC”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As a condition of maintaining the insurance of accounts, we are required to maintain certain minimum regulatory capital in accordance with a formula provided in FDIC regulations. We may not pay dividends on our stock unless all such capital requirements are met. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our 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 (set forth in the table below) of tangible and core capital (as defined in the regulations) to total adjusted assets (as defined), and of total capital (as defined) to risk-weighted assets (as defined). Management believes, as of December 31, 2012, that the Bank meets all capital adequacy requirements to which it is subject.
Our management believes that, under current regulations, and eliminating the assets of WSB, the Bank remains well capitalized and will continue to meet its minimum capital requirements in the foreseeable future. However, events beyond the our control, such as a shift in interest rates or a further, unexpected downturn in the economy in areas where we extend credit, could adversely affect future earnings and, consequently, our ability to meet our future minimum capital requirements.
As of December 31, 2012, the Bank remains well capitalized under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” the Bank must maintain minimum core, tier 1 risk-based and total risk-based ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s category. The Bank’s actual capital amounts and ratios as of December 31, 2012 and 2011 are presented in the following tables:
The following table summarizes the reconciliation of stockholders’ equity of the Bank to regulatory capital.
At December 31, 2012 and December 31, 2011, tangible assets used in computing regulatory capital were $348,882,700 and $375,560,600, respectively, and total risk-weighted assets used in the computation were $200,995,655 and $221,953,097, respectively.
13. EARNINGS PER SHARE
Options to purchase 5,000 shares of common stock were not included in the computation of diluted EPA for the period ended December 31, 2012 because their effect would have been anti-dilutive.
Options to purchase 33,875 shares of common stock were not included in the computation of diluted EPS for the period ended December 31, 2011 because their effect would have been anti-dilutive.
Average common and common equivalent shares used in the determination of earnings per share were:
14. INCOME TAXES
The provision for income taxes consists of the following:
The provision for income taxes differs from that computed at the statutory corporate tax rate as follows:
Deferred income tax assets and liabilities reflect the net tax effects of temporary differences between the financial reporting and the tax bases of assets and liabilities.
The components of net deferred tax assets as of December 31, 2012 and December 31, 2011 are as follows:
15. FAIR VALUE MEASUREMENTS
The Company applies guidance issued by FASB regarding fair value measurements which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. This guidance requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).
The guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
Under the guidance, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:
Level 1 inputs - Unadjusted quoted process in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.
Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
Investment Securities Available-for-Sale
Investment securities available-for-sale is recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Loans
We do not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principle will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the FASB’s Accounting Standards Codification Receivables Topic. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2012, a majority of all of the totally impaired loans were evaluated based upon the fair value of the collateral. In accordance with guidance regarding fair value measurements, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the loan as nonrecurring Level 3.
Loans Held for Sale- Loans held for sale are value based quotations from the secondary market for similar instruments and are classified as level 2 of the fair value hierarchy.
Real Estate Acquired in Settlement of Loans- We record foreclosed real estate assets at the lower cost or estimated fair value on their acquisition dates and at the lower of such initial amount or estimated fair value less estimated selling costs thereafter. Estimated fair value is generally based
upon independent appraisal of the collateral. We consider these collateral values to be estimated using Level 2 inputs.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 and 2011.
Loans held-for-sale, which are carried at the lower of cost or market, did not have any impairment charge at December 31, 2012.
Assets included in Level 3 at December 31, 2011 included our private-labeled mortgage-backed securities (“MBS”) due to lack of observable market data due to decreases in market activity for these securities. Our policy is to recognize transfers in and out as of the actual date of the event or change in circumstances that caused the transfer. No assets were transferred to Level 3 during the period ending December 31, 2012. The private-labeled MBS were sold during the current fiscal year ending December 31, 2012. The level 3 balance at December 31, 2011 was due to principal repayments and the change in unrealized gains/losses for the twelve month period ending December 31, 2011. The following assumptions were used for the Level 3 valuations on the five remaining private-labeled MBS for the period ending December 31, 2011:
· Estimated future defaults are derived by an analysis of the performance of the underlying collateral as well as obtaining models from a third party. The model addresses each component of the net present value calculation, which includes loss severity rate, current default rate and current voluntary prepayment rate.
· Each individual security is reviewed and an analysis is prepared for specific credit characteristics of the underlying collateral including recent developments specific to each organization issuing the security, market liquidity, extension risks and credit rating downgrades and an estimate of future defaults is derived.
The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended December 31, 2012 and December 31, 2011.
In accordance with the merger agreement, the Company has been repositioning a portion of the investment portfolio by selling existing securities and purchasing new securities with Old Line Bancshares’ consent. As a result, the remaining five non-agency private labeled MBS were sold in 2012, resulting in a net loss of approximately $648,000 pretax and approximately $392,000 net of tax.
Assets and Liabilities measured at Fair Value on a Nonrecurring Basis
The Company may be required from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the tables below:
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $33.7 million, with a related valuation allowance of $1.2 million as of December 31, 2012.
Real estate acquired in settlement of loans is carried at the lower of our recorded investment or fair value at the date of acquisition. Write-downs to fair value at the date of acquisition are charged to the allowance for loan losses. Subsequent write downs are included in non-interest expense. Costs relating to the development and improvement of a property are capitalized, whereas those relating to holding the property are charged to expense when incurred. The real estate is carried at the lower of acquisition or fair value net of estimated costs to sell subsequent to acquisition. Operating expenses of real estate owned are reflected in other non-interest expenses. The value of OREO properties held due to foreclosures at December 31, 2012 was $5.2 million, which included a valuation allowance of $316,138.
The following disclosures of the estimated fair value of financial instruments are made in accordance with the requirements of ASC 825, “Disclosures about Fair Value of Financial Instruments”. We have determined the fair value amounts by using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Cash and Cash Equivalents - For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
Loans Receivable, Net - Loans not having quoted market prices are priced using the discounted cash flow method. The discount rate used is the rate currently offered on similar products. The estimated fair value of loans held-for-sale is based on the terms of the related sale commitments.
Mortgage-Backed Securities - Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Investment Securities - Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair values are estimated using quoted market prices for similar securities.
Investment in Federal Home Loan Bank Stock - The carrying amount of Federal Home Loan Bank (FHLB) Stock is a reasonable estimate of fair value as FHLB stock does not have a readily available market and can only be sold back to the FHLB at its par value of $100 per share.
Bank Owned Life Insurance - The carrying amount of bank owned life insurance (“BOLI”) purchased on a group of officers is a reasonable estimate of fair value. BOLI is an insurance product that provides an effective way to offset current employee benefit costs.
Deposits - The fair value of non-interest bearing accounts is the amount payable on demand at the reporting date. The fair value of interest-bearing deposits is determined using the discounted cash flow method. The discount rate used is the rate currently offered on similar products.
Borrowings - The fair value of borrowings is determined using the discounted cash flow method. The discount rate used is the rate currently offered on similar products.
Commitments to Grant Loans and Standby Letters of Credit and Financial Guarantees Written - The majority of our commitments to grant loans and standby letters of credit and financial guarantees written carry current market interest rates if converted to loans. Because commitments to extend credit and letters of credit are generally un-assignable by either us or the borrower, they only have value to us and the borrower and therefore it is impractical to assign any value to these commitments.
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2012 and December 31, 2011. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively reevaluated for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
We are party to financial instruments with off-balance-sheet risk in the normal course of our business to meet the financing needs of our customers and to reduce our own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, and financial guarantees.
These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position. The contract or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.
Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. We use the same credit
policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.
Unless noted otherwise, we do not require collateral or other security to support financial instruments with credit risk.
Commitments to grant mortgage and commercial loans, which include pending applications, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon or pending applications will be denied, the total commitment amounts do not necessarily represent future cash requirements. Historically, approximately seventy-five percent of the agreements and pending applications are drawn upon. We evaluate each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. Most equity line commitments for the unfunded portion of equity lines are for a term of 12 months and commercial lines of credit are generally renewable on an annual basis.
Standby letters of credit and financial guarantees written are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support construction borrowing. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold cash as collateral supporting those commitments for which collateral is deemed necessary.
17. CONDENSED FINANCIAL STATEMENTS- PARENT COMPANY ONLY
WSB HOLDINGS, INC.
CONDENSED STATEMENTS OF FINANCIAL CONDITION - PARENT COMPANY ONLY
AS OF DECEMBER 31, 2012 AND DECEMBER 31, 2011
WSB HOLDINGS, INC.
CONDENSED STATEMENTS - PARENT COMPANY ONLY
As of December 31, 2012 and 2011
Condensed Statement of Operations
Condensed Statement of Cash Flows
18. QUARTERLY DATA (Unaudited)
Summarized quarterly financial information is as follows (amounts in thousands except per share information):
* * * *
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of December 31, 2012.
There were no changes in our internal control over financial reporting in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Directors and Executive Officers
The following table sets for the name and age of each of our directors and executive officers, as well as their position(s) with WSB and the Bank. None of our officers or directors are related to each other.
Our Management Directors
Phillip C. Bowman
Mr. Bowman has served as Chief Executive Officer and as a Director of the Bank since March 2005 and as Chief Executive Officer and a Director of WSB since its formation in January 2008. He was a Director, President and Chief Executive Officer of American Bank, a federally chartered savings bank located in Silver Spring, Maryland, from August 1994 until March 2005. In addition, Mr. Bowman was also the President and Chief Executive Officer and a Director of American Bank Holdings, Inc., the holding company for American Bank from November 2002 until December 2004. Mr. Bowman’s qualifications for serving as a director at this time include his many years of banking experience, including with WSB and the Bank, and his in-depth knowledge of the Bank and its business and operations as a result of his many years within the banking industry as both an executive officer and a director. As a result of his extensive experience within the banking industry, Mr. Bowman brings sound administration guidance, effective communication of the Board’s strategic plans to the Bank’s officers, extensive knowledge of regulatory and compliance issues and had effectively implemented the Bank’s strategic plans. We believe it is beneficial to have executive
officers, who are familiar with the day-to-day operations of WSB and the Bank, serving on the Board of Directors.
William J. Harnett
Mr. Harnett has been a Director of the Bank since its inception, serving as Chairman of the Board since 1988 and as Chief Executive Officer from 1988 until he retired as Chief Executive Officer in February 2005. He has also served as a Director of WSB since its formation in January 2008. He also was founder, Chairman and Chief Executive Officer of the former Bank parent company, Washington Homes, Inc., which was listed on the New York Stock Exchange before being sold in 1988. Mr. Harnett’s qualifications to serve on the Board at this time include his extensive knowledge of the Bank’s history, business and operations, as well as the risks facing the industry, as a result of his long tenure with the Bank both as a director and as former CEO.
Kevin P. Huffman
Mr. Huffman has been President and a Director of the Bank since January 2004, Chief Operating Officer of the Bank since May 2003, and a Director of WSB since its formation in January 2008. He joined the Bank in November 2001 as Senior Vice President. From 2000 to 2001, he served as Vice President, Director and Secretary of Pen Mar Bancshares. Prior to that, Mr. Huffman was the Executive Vice President, COO and Director of both Patapsco Valley Bancshares, Inc. and Commercial and Farmers Bank from 1996 to March 2000. Mr. Huffman’s qualifications to serve as a director at this time include his extensive banking experience, particularly with WSB and the Bank, and his in-depth knowledge of the Bank and its business and operations as a result of his many years with the Bank as both an executive officer and a director. We believe it is beneficial to have executive officers, who are familiar with the day-to-day operations of WSB and the Bank, serving on the Board of Directors, which provides the Board with a management perspective that helps the Board successfully oversee WSB.
Our Independent Directors
George Q. Conover
Mr. Conover has served as a Director of the Bank since August 1989, and previously served as a founding Director from the inception of the Bank in 1982 until October 1985. He has also served as a Director of WSB since its formation in January 2008. Since March 2000, he has served as Product Development Manager for Financial Freedom, a reverse mortgage lender, which is a subsidiary of IndyMac. Prior to that, Mr. Conover was the CEO of International Mortgage Company for 25 years. He is a member of the Board’s Audit Committee. Mr. Conover’s qualifications to serve as a director at this time include his in-depth knowledge of the Bank’s business and operations resulting from his service on the Bank’s Board of Directors since inception of the Bank along with his years of experience in lending. Based on Mr. Conover’s experience in the mortgage lending market, he provides perspective to the Board on issues affecting the lending market community. This experience and tenure has given Mr. Conover the necessary understanding and ability to assist in Board oversight and as an audit committee member.
Charles A. Dukes, Jr.
Mr. Dukes has served as a Director of WSB and the Bank since February 2008. Mr. Dukes, known for his leadership in commercial real estate, is actively involved in economic development and
planning for Prince George’s County as well as the suburban metro area. He has served on several boards and committees including: Chairman, Board of Directors - Prince George’s County Economic Development Corporation; Board of Directors, Executive Committee; Chair, Transportation Committee - Greater Washington Board of Trade; President, Life Director - Prince George’s Chamber of Commerce; President, Life Director - Maryland National Capital Building Industry Association; Chairman - Doctors Community Hospital Foundation; Chairman - Maryland National Capital Park & Planning Commission. He is also a member of the Board’s Audit Committee. Mr. Dukes’ qualifications to serve as a director at this time include his experience on several boards of directors and executive committees. This experience has allowed Mr. Dukes to provide a unique customer and community perspective to the Board.
Eric S. Lodge
Mr. Lodge has served as a Director of the Bank since November 2003 and a Director of WSB since its formation in January 2008. Mr. Lodge is a Managing Director with High Street Partners, Inc., an international business consulting firm headquartered in Annapolis, Maryland. Prior to joining High Street Partners in August 2004, he worked in the corporate finance departments of CIENA Corporation from June 2000 to August 2004 and at Northrop Grumman - Electronic Sensors and Systems Sector (ESSS) from January 1997 to June 2000. He also served as an internal auditor of WSB during 1996. In December 1996, he received his Bachelor of Science Degree in Finance and Economics from the University of Maryland. He is a member of the Board’s Audit committee. Mr. Lodge’s qualifications to serve as a director at this time include his knowledge of the Bank’s business and operations as a result of his years of service as a director of the Bank, his education and his experience in business and finance. His education, business skills, and his experience in corporate financial departments of major corporations, provide the understanding necessary to serve on the Board of Directors and as a member of audit committee.
Charles W. McPherson
Mr. McPherson has served as a Director of WSB and the Bank since October 2008. He has 28 collective years of accounting experience, and since 1997 has served as the Chief Operating Officer of the Facchina Group of Companies and CEO of Facchina Global Services, LLC, which are headquartered in LaPlata, Md. He has over 20 years experience in financial and development matters. He is a Certified Public Accountant and is a past and present member on many prominent boards, including: Board of Trustees, Greater Washington Initiative, Washington, D.C.; Board Member and executive committee member, Greater Washington Board of Trade; Former Chairperson, Civista Health Foundation; Member and former Chairman, Metro Washington Chapter, Associated Builders and Contractors, Inc., Board of Trustees, Greenville College, Greenville, Illinois; Former Member, Charles County Economic Development Council; Former Member, Charles County Planning Commission; Former Member, La Plata Design Review Board. He is a member of the Board’s Audit Committee. Mr. McPherson’s qualifications to serve on the Board at this time include his experience on many prominent boards as well as his financial expertise. Mr. McPherson is an audit committee financial expert as defined in Item 407(d)(5) of SEC Regulation S-K. Mr. McPherson’s extensive experience in accounting as well as his knowledge in development matters enables him to provide the Board with useful insight in evaluating the business conditions in which WSB operates. Mr. McPherson has experience with public company and governance and financial matters, having served on several committees and board of directors, which provides valuable knowledge and experience to the Board regarding our obligations as a public company.
Michael J. Sullivan
Mr. Sullivan has been a Director of the Bank since its inception and a Director of WSB since its formation in January 2008. He has served as a Principal of Cherrywood Development, LLC, a residential development company doing business in the suburban area of Washington, D.C., since 1991. He serves as the Chair of the Board’s Audit Committee. Mr. Sullivan’s qualifications to serve as a director at this time include his in-depth knowledge of the Bank’s business and operations resulting from his service on the Bank’s board of directors since inception in October 1982, his experience in managing a business and his knowledge of real estate development. This background enables Mr. Sullivan to provide valuable insights to the Board, particularly with respect to the real estate markets in which we operate. Mr. Sullivan’s extensive experience and background enables him to provide useful insight in evaluating the business conditions in markets in which WSB operates. This experience and tenure with WSB has given Mr. Sullivan the necessary understanding and the ability for Board oversight and to serve as an audit committee member.
Executive Officers Who Do Not Serve as Directors
Susan L. Grant
Ms. Grant has been Senior Vice President in charge of the Mortgage Banking Division of the Bank since December 2005. Prior to joining the Bank, Ms. Grant was the Regional Vice President of nBank, of Atlanta, Georgia, from December 2001 to December 2005. Prior to this Ms. Grant was the Regional Vice President of Wholesale Lending for the Royal Bank of Canada from December 1997 thru December of 2001. Prior to this Ms. Grant was the Regional Vice President in charge of Wholesale Lending for New America Financial from December of 1993 thru December of 1997. Ms. Grant began her early career with Chase Manhattan, opening the Mid-Atlantic region for Chase in April of 1985 and until December of 1993.
Gary A. Hobert
Mr. Hobert has been Senior Vice President in charge of Commercial Lending since May 2010. Prior to joining the Bank, Mr. Hobert was Senior Vice President of Greater Atlantic Bank from 2001 to 2009. He was the manager of the Commercial Loan Department and Credit Department. Prior to that Mr. Hobert has served as a Senior Vice President and Manager of Commercial Lending for several community banks. He has also been the President of a community bank in Virginia where he served for several years. Mr. Hobert has 40 years of banking experience.
Carol A. Ramey
Mrs. Ramey has been Senior Vice President and Chief Financial Officer of WSB and the Bank since December 2008. She has held various positions since joining the Bank in March 1989, previously serving as Vice President and Controller since 2001.
Gerald J. Whittaker
Mr. Whittaker has been Senior Vice President and Corporate Secretary of WSB since its formation in January 2008. He has been Senior Vice President and Corporate Secretary of the Bank since November 2000. He previously served as Vice President of the Bank since 1986. Prior to that time, he served as Vice President of Bay State Savings and Loan Association after joining the company in 1983. He is a member of the Maryland State Bar Association, and has been admitted to practice law in Maryland since 1981.
Code of Ethics
WSB has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, as well as all of our executive officers and directors and to all associates of WSB and its subsidiaries, including the Bank. WSB has adopted this Code of Ethics to promote the highest standards of ethical conduct by its directors, executive officers and employees. A copy of the Code of Ethics can be found on WSB’s internet web site (www.twsb.com).
Audit Committee
The Board of Directors has established an Audit Committee in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The Audit Committee currently consists of Messrs. Sullivan (Chairman), Conover, Dukes, Lodge and McPherson, all of whom meet the independence and experience requirements of the NASDAQ Stock Market LLC. The primary functions of the Audit Committee are to assist in Board oversight of (i) the integrity of WSB’s financial statements, (ii) the adequacy of WSB’s system of internal controls, (iii) WSB’s compliance with legal and regulatory requirements, (iv) the independent auditors’ qualifications and independence, and (v) the performance of WSB’s independent auditors. The Audit Committee meets with WSB’s independent registered public accounting firm and with WSB’s independent auditors, which reports on the results of WSB’s quality control reviews, outsourced compliance and independent audit reports. The Audit Committee’s responsibilities are as described in a written Charter. A copy WSB’s Audit Committee Charter can be found on WSB’s internet web site (www.twsb.com).
The Board of Directors has determined that Mr. McPherson is an “audit committee financial expert” as that term is defined by the rules and regulations of the Securities and Exchange Commission.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The federal securities laws require that WSB’s directors and executive officers and persons holding more than ten percent of its outstanding shares of common stock report their ownership and changes in such ownership to the Securities and Exchange Commission and WSB. Based solely on its review of the copies of such reports, we believe that, for the year ended December 31, 2012, all Section 16(a) filing requirements applicable to WSB’s officers, directors and greater than ten percent stockholders were complied with on a timely basis, with the exception of two Form 4 filings for Michael J. Sullivan each reporting 1 transaction, which reports have since been filed.
Item 11.
Item 11. Executive Compensation and Director Compensation
Executive Compensation
The following table sets forth the compensation paid to our Chief Executive Officer as well as the two other most highly compensated executive officers who were serving as executive officers on December 31, 2012 (the “Named Executive Officers”) and who received total compensation exceeding $100,000 during the year ended December 31, 2012. Our executive officers are paid as employees of the Bank and are not separately paid for their services to WSB.
(1) “All Other Compensation” for 2012 includes employer contributions of $9,989, $7,632 and $5,726 to the 401(k) plan and $2,067, $444 and $478 paid for Life Insurance coverage for Mr. Bowman, Mr. Huffman and Mr. Whittaker.
General Compensation Philosophy
WSB’s executive compensation program is designed to attract, retain and motivate key executives, and to encourage a long-term commitment to WSB. To achieve this, the Compensation Committee of the Board of Directors uses a variety of compensation elements, including (1) base salary, (2) annual cash incentive awards, and (3) other compensation and benefits. Except for the one-time action with respect to Mr. Bowman’s salary discussed below, the Compensation Committee considers appropriate executive compensation at competitive levels compared to our size and growth level. On an annual basis or at the time of promotion or other changes in responsibilities, the Compensation Committee determines and approves the total compensation paid to the executive employees considering each executive’s level of experience, unique skills and abilities critical to WSB, tenure, performance, position and responsibility with WSB. The Compensation Committee considers the overall business outlook and business goals in determining the base salaries. The Compensation Committee also considers recommendations submitted by the CEO regarding levels of salary and incentive awards for each executive officer. The CEO provides to the Compensation Committee a three year historical chart of the total direct compensation for each executive officer. The committee reviews these recommendations and where appropriate, modifies the compensation, awards or grants prior to making its recommendations to the full Board of Directors. Annual cash incentive awards are designed to attract, retain and motivate our executive officers. Cash incentives are awarded based on performance consistent with our strategic plan. Cash incentive awards have varied from year to year. We believe our compensation program is aligned with the interests of our stockholders and sound corporate governance.
Employment Arrangement with Phillip C. Bowman
In 2011 the Bank’s board of directors elected not to renew Mr. Bowman’s employment agreement, which expired by its terms on April 30, 2011, and to waive the non-solicitation provisions thereof. The board of directors offered Mr. Bowman the opportunity to serve as our Chief Executive Officer for a term of indefinite duration as an employee at will at the pleasure and discretion of the board of directors at a rate of compensation comparable to his current rate. Mr. Bowman accepted and remained as Chief Executive Officer on these terms. Mr. Bowman agreed and signed the formal offer letter specifying the terms of his continuing employment.
Under the terms of his employment as set forth in the offer letter, Mr. Bowman’s annual salary was $282,000 and he was eligible to participate in all employee benefit plans, insurance plans and other fringe benefits maintained by the Bank for the benefit of its executives. Effective June 1, 2012 and primarily to positively impact earnings, the Board of Directors and Mr. Bowman mutually agreed to a $60,000 reduction in Mr. Bowman’s salary. The other provisions in the offer letter remain in effect. If Mr. Bowman’s employment
is terminated by the Bank for any reason other than cause or Mr. Bowman’s death or disability, he will receive a payment equal to one week’s base salary for every year he has been employed at the Bank.
Other Post-Employment Severance and Change-in-Control Benefits
Pursuant to a resolution adopted by the Bank’s Board of Directors approving a lump sum severance payment for the Bank’s officers with the title at the time of Vice President and above in the event of a change in control as defined by the OCC, the eligible officers are entitled to a lump sum severance payment if their employment is involuntarily terminated, or if their level of compensation does not remain substantially the same (including bonuses) and they voluntarily terminate their employment, within 18 months following a change in control. Pursuant to the Board resolution, Mr. Huffman would be entitled to a lump sum severance payment in the amount of $150,000 if within 18 months following a change in control (i) his employment is involuntarily terminated or (ii) his level of compensation does not remain substantially the same (including bonuses) and he voluntarily terminates his employment.
Other than Mr. Bowman, none of the Named Executive Officers are currently entitled to receive post-employment severance payments in the absence of a change-in-control.
Long-Term Incentive Awards
We believe that the granting of stock options, restricted share unit awards, and other stock awards are an appropriate means to compensate our Named Executive Officers by aligning their interests with those of our stockholders. WSB maintains an Equity Incentive Plan, which was approved on April 27, 2011, by the stockholders of WSB, that reserves shares of common stock for issuance to certain key employees and non-employee directors. The maximum number of shares of our common stock that may be issued with respect to awards granted under the plan is 500,000 plus (i) any shares of common stock that are available under the Washington Savings Bank 2001 Stock Option and Incentive Plan (the “2001 Plan”) as of its termination date (which was April 27, 2011) and (ii) shares of common stock subject to options granted under the 2001 Plan that expire or terminate without having been fully exercised. In no event, however, may the number of shares issuable pursuant to incentive stock options awarded under the equity incentive plan exceed 500,000.
Our stock award program is used for offering long-term incentives, rewarding our executive officers and key employees, as a retention tool, and as a means of aligning Named Executive Officer performance with company objectives. These objectives determine the type of award granted and the number of shares underlying an award. Our Board of Directors and the Compensation Committee have not established specific criteria to be used for granting future stock awards, electing to evaluate the appropriateness of individual grants on a case by case basis, in their subjective, reasoned business judgment and experience. The Board of Directors and the Independent Directors (as defined below)/Compensation Committee have elected not to issue of stock options in the past three years, in the belief that the Named Executive Officers’ interests were appropriately aligned with our stockholders’ long-term interests.
Under the terms of all our equity compensation plan, the exercise price of options granted is equal to the closing price of our common stock on the date of grant. While historically, our CEO has made option grant recommendations to the Independent Directors or Compensation Committee, as applicable, and the Board for the other Named Executive Officers and employees, the authority to grant options is vested solely with the Board, which considers the recommendations of the Independent Directors or Compensation Committee serving as an awards committee.
Retirement and Welfare Benefits
We maintain a 401(k) plan that provides an employer matching contribution of 100% of the first 3% of an executive’s compensation, with a contribution equal to $0.50 on the dollar up to the next 2% of an executive’s compensation or the maximum amount allowable by law. This benefit is available to all eligible employees. Our Named Executive Officers participate in our 401(k) plan on the same basis as our other employees. We also offer health and welfare benefits to our employees, including the Named Executive Officers who also receive these benefits on a basis consistent with our other employees. During 2012, in
addition to contributions under the 401(k) plan, we offered the following benefits to our Named Executive Offices: life, group health and dental insurance.
Bank Owned Life Insurance
The Bank has invested in BOLI to finance employee benefit programs. The current cash surrender value of the policies included in other assets was $12.8 million as of December 31, 2012. The Bank recorded income from the insurance policies for the twelve-month period ended December 31, 2012 of $455,794. Under the BOLI insurance agreement, while employed, the beneficiaries of the Named Executive Officers would receive life insurance benefits of two times their annual salary. Life insurance coverage under the plan is solely during the active employment of the Named Executive Officer and does not continue past retirement. The outside independent directors have determined that these insurance policies and death benefit endorsement are a desirable and appropriate investment for the Bank.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth, on an award by award basis, information about unexercised stock options held by the Named Executive Officers as of December 31, 2012. All options were granted with an exercise or base price of 100% of market value as determined in accordance with the applicable plan. The number of shares subject to each award and the exercise or base price have been adjusted to reflect all stock splits effected after the date of such award, but have not otherwise been modified.
(1) Mr. Bowman’s options for 5,000 shares of stock were granted on April 18, 2007 at $8.65 per share to be vested 50% on April 18, 2008 and the remaining 50% on April 18, 2009.
Compensation of Directors
The following table summarizes the compensation paid to WSB’s non-employee directors during fiscal year 2012. Beyond these and other standard arrangements described below, no other compensation was paid to any such director.
Director Compensation
(1) Messrs. Bowman and Huffman are executive officers and are not compensated for their services as Directors.
(2) Represents annual salary of $150,000 paid to Mr. Harnett as a non-executive employee.
Director/Committee Fees
Our non-employee directors are paid board fees and committee fees based on attendance. Directors are paid $1,000 for each board meeting attended and $500 for each committee meeting attended, except that committee fees are only paid for meetings not occurring on board meeting dates. Chairman Harnett has been retained as a non-executive employee to serve as our Board Chairman and as an advisor to the CEO and Board. In lieu of Board and committee fees paid to our non-employee directors, Mr. Harnett receives an annual salary of $150,000 and the use of a company-paid automobile, and is eligible to a receive a bonus as determined in the Board’s discretion. Mr. Harnett is also entitled to certain other benefits in his capacity as a non-executive employee, including participation in the Bank’s 401(k) plan and life, group health and dental insurance plans on the same basis as other employees. Mr. Harnett is also entitled to a change in control lump sum severance payment in the amount of $500,000 in the event his employment is involuntarily terminated, or if his level of compensation does not remain substantially the same (including bonus) and he voluntarily terminates his employment within 18 months following a change in control as defined by the OCC.
Director compensation and benefits are reviewed annually by the compensation committee, who review outside, publicly-available independent compensation reviews from SNL Financial and America’s Community Bankers Association in analyzing board compensation and benefits. The peer group information used for consideration is based on peer groups as defined and set by the outside service provider based on asset size, geographic location, type of financial institution, and operating performance. Accordingly, consistent with our objectives, the compensation of our directors is set with regard to the increased demands of serving as a director and local market practice. We do not, however, specifically benchmark the director compensation or any individual element of compensation to our peer companies, but generally review the information for competitive purposes.
Incentive Stock Awards
Our non-employee directors are eligible, and have received in the past, stock option grants as part of their compensation; however, no grants were awarded to non-employee directors in 2012. Option grants for non-employee directors are subject to Board approval. The Board believes that stock option grants further align the interest of the Directors with our stockholders.
Health and Welfare
Non-employee directors were previously allowed to participate in the Bank’s medical insurance plan on a basis consistent with employee participants; of the non-employee directors, only Mr. Sullivan elected to participate.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Securities Authorized For Issuance Under Equity Compensation Plans
The following table sets forth certain information as of December 31, 2012, with respect to compensation plans under which equity securities of WSB are authorized for issuance:
(1) Includes the 1997 Omnibus Stock Plan, the 2001 Stock Option and Incentive Plan, and the 2011 Equity Incentive Plan. The 2011 Equity Incentive Plan was approved by the stockholders of WSB and the other Plans were approved by security holders of the Bank. Effective January 3, 2008, all of the then stockholders of the Bank became stockholders of WSB.
Beneficial Ownership of Securities
The following table sets forth information as of February 15, 2013 indicating the amount and percentage of WSB’s common stock beneficially owned by each director, each Named Executive Officer, and all directors and executive officers as a group, and by all persons, to the knowledge of WSB, beneficially owning more than five percent of WSB common stock.
* Constitutes less than 1% of the outstanding shares of WSB common stock.
(1) Beneficial ownership is direct except as otherwise indicated by footnote. In accordance with Rule 13d-3 of the Securities Exchange Act of 1934, as amended, a person is deemed to be the beneficial owner of a security if he or she has or shares voting power or investment power with respect to such security or has the right to acquire such ownership within 60 days. Unless otherwise indicated, all persons have sole voting and dispositive powers as to all shares reported.
(2) Beneficial ownership of Mr. Bowman includes 5,000 shares subject to options granted and exercisable under WSB’s option plans.
(3) Does not include 260,886 shares owned by Mr. Harnett’s adult children, of which he disclaims beneficial ownership. Mr. Harnett’s address is c/o 4201 Mitchellville Road, Suite 200, Bowie, Maryland 20716.
(4) With respect to Mr. Lodge includes 150 shares which are jointly owned with his wife. The 4,050 shares for Mr. McPherson are also jointly owned with his wife. Mr. Duke’s shares include 1,250 shares indirectly owned as trustee for his grandchildren.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships and Related Person Transactions
From time to time, WSB has had, and expects to have in the future, banking transactions in the ordinary course of business with its directors and officers, and other related parties. WSB maintains written policies and procedures to strictly control all loans to insiders in accordance with Federal law (Regulation O). Insiders include any executive officer, director, or principal stockholder and entities which such persons control. These transactions have been made on substantially the same terms, including interest rates, collateral, and repayment terms, as those prevailing at the same time for comparable transactions with unaffiliated parties. The extensions of credit to these persons have not and do not currently involve more than the normal risk of collectability or present other unfavorable features. None of these loans or other extensions of credit are disclosed as nonaccrual, past due, restructured or potential problem loans.
WSB’s Board of Directors is required to review all related party transactions, excluding insider loans, which are approved by the full Board of Directors, and with any interested director not participating in the approval process, for potential conflicts of interest. All related party transactions and relationships must be on terms not materially less favorable than what would be usual and customary in similar transactions between unrelated persons dealing at arms length. To the extent such transactions are ongoing business relationships with WSB, such transactions are reviewed annually. Related party transactions are those involving WSB and the Bank, which are required to be disclosed pursuant to SEC Regulation S-K, Item 404.
Independence of the Board of Directors
The Board of Directors has determined that Messrs. Sullivan, Conover, Dukes, Lodge and McPherson are independent as defined under the applicable rules and listing standards of the NASDAQ Stock Market LLC (the “Independent Directors”). In making this determination, the Board considered any transactions and relationships between each director or his or her immediate family and WSB and its subsidiaries, as reported under “Certain Relationships and Related Person Transactions” below. Mr. Harnett is not independent because he was previously an executive officer of WSB, and remains a non-executive employee. Messrs. Bowman and Huffman are not independent because they are executive officers of WSB.
Item 14.
Item 14. Principal Accounting Fees and Services
Independent Registered Public Accounting Firm
The Audit Committee has appointed Stegman & Company as WSB’s independent registered public accounting firm to audit the books and accounts of WSB and its subsidiaries for the year ending December 31, 2012. Stegman & Company has served as independent auditors for the subsidiaries of WSB for the last thirteen years and as auditors for WSB since 2008. The following is
a summary of the fees billed to WSB by Stegman & Company for professional services rendered for the years ended December 31, 2012 and 2011:
Audit Fees consist of fees billed for professional services rendered for the audit of the WSB’s annual financial statements and review of the interim consolidated financial statements included in quarterly reports, and services that are normally provided by Stegman & Company in connection with statutory and regulatory filings or engagements.
Audit-Related Fees consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of WSB’s consolidated financial statements and are not reported under “Audit Fees”. The fees shown above were for auditing the Bank’s employee benefit plan.
Tax Fees. Consist of fees billed for professional services for tax compliance and advice, tax planning and preparation of tax returns.
All Other Fees. There were no fees billed for other professional services in fiscal years 2012 and 2011 that were not included in one of the above categories.
Policy on Audit Committee Pre-Approval of Audit Services and Permissible Non-Audit Services of Independent Registered Public Accounting Firm
The Audit Committee’s policy is to pre-approve all audit and permissible non-audit services performed by its independent registered public accounting firm. These services may include audit services, audit-related services, tax services and other services. For audit services, the independent registered public accounting firm provides an engagement letter in advance of the Audit Committee meeting, outlining the scope of the audit and related audit fees. If agreed to by the Audit Committee, this engagement letter is formally accepted by the Audit Committee at the Audit Committee meeting. For non-audit services, WSB’s senior management will submit from time to time to the Audit Committee for approval non-audit services that they recommend the Audit Committee engage the independent registered public accounting firm to provide for the year. WSB’s senior management and the independent registered public accounting firm will each confirm to the Audit Committee that each non-audit service is permissible under all applicable legal requirements. A budget, estimating non-audit service spending for the year, will be provided to the Audit Committee along with the request. The Audit Committee must approve both permissible non-audit services and the budget for such services. The Audit Committee will be informed routinely as to the non-audit services actually provided by the independent registered public accounting firm pursuant to this pre-approval process. The Audit Committee may delegate pre-approval authority to its Chairman. The Chairman must report any decisions to the Audit Committee at the next scheduled meeting.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)(1)
The following consolidated financial statements of WSB and its subsidiaries are included in Item 8:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition-as of December 31, 2012 and 2011
Consolidated Statements of Operations-Years ended December 31, 2012 and 2011
Consolidated Statements of Changes in Stockholders’ Equity-Years ended December 31, 2012 and 2011
Consolidated Statements of Cash Flows-Years ended December 31, 2012 and 2011
Notes to Consolidated Financial Statements
(a)(2)
Financial statements schedules-none applicable or required
(a)(3)
The following is an index of the exhibits included in this report:
Exhibit No.
Item
2.1
- Plan of Merger and Reorganization by and among The Washington Savings Bank, F.S.B., Washington Interim Savings Bank and WSB Holdings, Inc. (Incorporated by reference from Amendment No. 1 to WSB’s Registration Statement on Form S-4, filed October 26, 2007, file no. 333-146877).
2.2
Agreement and Plan of Merger, dated as of September 10, 2012, by and between Old Line Bancshares, Inc. and WSB Holdings, Inc. (Incorporated by reference from WSB’s Current Report on Form 8-K filed on September 11, 2012).
3.1
- Amended and Restated Certificate of Incorporation of WSB Holdings, Inc. (Incorporated by reference from Amendment No. 1 to WSB’s Registration Statement on Form S-4, filed October 26, 2007, file no. 333-146877).
3.2
- Amended and Restated By-Laws of WSB Holdings, Inc. (Incorporated by reference from Amendment No. 1 to WSB’s Registration Statement on Form S-4, filed October 26, 2007, file no. 333-146877).
10.2
- 1997 Omnibus Stock Plan of WSB. (Incorporated by reference from WSB’s Registration Statement on Form S-4, filed October 23, 2007, file no.333-14687) .
10.3
- Amendment No. 1 to the 1997 Omnibus Stock Plan (Incorporated by reference from WSB’s Registration Statement on Form S-8, filed January 18, 2008, file no. 333-148753) .
10.4
- 2001 Stock Option and Incentive Plan. (Incorporated by reference from WSB’s Registration Statement on Form S-4, filed October 23, 2007, file no. 333-14687).
10.4.1
- Amendment No. 1 to the 2001 Stock Option and Incentive Plan (Incorporated by reference from WSB’s Registration Statement on Form S-8, filed January 18, 2008, file no. 333-148753) .
10.5
- Form of Stock Award Agreement for executive officers pursuant to 2001 Stock Option and Incentive Plan. (Incorporated by reference from WSB’s Registration Statement on Form S-4, filed October 23, 2007, file no. 333-14687) .
10.6
- Amended and Restated Employment Agreement dated June 11, 2010 by and among The Washington Savings Bank, F.S.B. and Phillip C. Bowman. (Incorporated by reference from WSB’s Form 10-Q, filed for the quarter ended June 30, 2010) .
10.7
- Form of Stock Option Agreement pursuant to the 1999 Stock Option and Incentive Plan (Incorporated by reference from WSB’s Registration Statement on Form S-4, filed October 23, 2007, file no. 333-14687) .
10.8
- Description of payments due certain officers upon a change-in-control (Incorporated by reference from WSB’s Form 10-K for the year ended December 31, 2008) .
10.9
- Description of compensation arrangement for William J. Harnett for service as Chairman of the Board (Incorporated by reference from WSB’s Form 10-K for the year ended December 31, 2008).
10.10
- WSB Holdings 2011 Equity Incentive Plan (Incorporated by reference from Appendix A to WSB’s Definitive Proxy Statement on Schedule A filed March 22, 2011) .
10.11
- Form of Restricted Stock Agreement under 2011 Equity Incentive Plan (Incorporated by reference to Exhibit 4.2 of the Registrant’s Current Report on Form 8-K filed with the Commission on June 16, 2011) .
10.12
- Form of Qualified Stock Option Agreement under 2011 Equity Incentive Plan (Incorporated by reference from WSB’s Form 8-K filed April 27, 2011) 
10.13
- Form of Non-Qualified Stock Option Agreement under 2011 Equity Incentive Plan (Incorporated by reference from WSB’s Form 8-K filed April 27, 2011) .
10.14
- Supervisory Agreement for WSB Holdings, Inc. dated June 3, 2011 (Incorporated by reference from WSB’s Form 10-Q for the quarter ended June 30, 2011).
10.15
- Supervisory Agreement for The Washington Savings Bank dated June 3, 3011 (Incorporated by reference from WSB’s Form 10-Q for the quarter ended June 30, 2011).
10.16
- Letter to Phillip C. Bowman outlining offer of at-will employment dated April 27, 2011 (Incorporated by reference from WSB’s Form 10-Q for the quarter ended March 31, 2011) .
- Subsidiaries of WSB Holdings, Inc. (filed herewith)
- Consent of Independent Registered Public Accounting Firm (filed herewith).
31.1
- Rule 13a-14(a)/15d - 14(a) Certifications of Chief Executive Officer (filedherewith).
31.2
- Rule 13a-14(a)/15d -14(a) Certifications of Chief Financial Officer (filed herewith).
32.1
- Section 1350 Certifications (furnished herewith).
The following materials from WSB Holdings, Inc.’s Quarterly Report on Form 10-K for the year ended December 31, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Cash Flows and (iv) the Notes to the Consolidated Financial Statements, tagged as blocks of text - (Furnished herewith).*
*Pursuant to Rule 406T of Regulation S-T, the interactive data files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
Management compensatory arrangement.
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 capacity and on the dates indicated.
March 14, 2013
/s/ Phillip C. Bowman
Phillip C. Bowman, Director
March 14, 2013
/s/ George Q. Conover
George Q. Conover, Director
March 14, 2013
/s/ Charles A. Dukes
Charles A. Dukes, Director
March 14, 2013
/s/ William J. Harnett
William J. Harnett, Director
March 14, 2013
/s/ Kevin P. Huffman
Kevin P. Huffman, Director
March 14, 2013
/s/ Eric S. Lodge
Eric S. Lodge, Director
March 14, 2013
/s/ Charles W. McPherson
Charles W. McPherson, Director
March 14, 2013
/s/ Michael J. Sullivan
Michael J. Sullivan, Director