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CRRB > SEC Filings for CRRB > Form 10-Q on 14-Nov-2011All Recent SEC Filings

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Form 10-Q for CARROLLTON BANCORP


14-Nov-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

THE COMPANY

Carrollton Bancorp was formed on January 11, 1990 and is a Maryland chartered bank holding company. The Company holds all of the outstanding shares of common stock of Carrollton Bank. The Bank, formed on April 10, 1900, is a commercial bank that provides a full range of financial services to individuals, businesses and organizations through its branch and loan origination offices and its automated teller machines. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation. The Bank considers its core market area to be the Baltimore Metropolitan Area.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Statements that include the use of terminology such as "anticipates," "expects," "intends," "plans," "believes," "estimates," and similar expressions also identify forward-looking statements. The statements in this report with respect to, among other things, our plans, strategies, objectives and intentions and the anticipated results thereof, opportunities emerging as the business environment clarifies and improves, reinstatement of dividends, improving earnings and operating results, increased loan demand in the future, the recovery of fair value of available-for sale securities, the allowance for loan losses, anticipated increases in the value of trust preferred securities held in our investment portfolio as the economy improves, the impact of new accounting guidance, liquidity sources, future capital ratios/levels and the impact of the outcome of pending legal proceedings, are forward-looking. These forward-looking statements are based on our current intentions, beliefs, and expectations.

These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Actual results may differ materially from these forward-looking statements because of, among other things, interest rate fluctuations, changes in monetary policy, a further deterioration of economic conditions in the Baltimore Metropolitan area, a deterioration in our local real estate market and the economy generally or a slowing recovery, higher than anticipated loan losses or the insufficiency of the allowance for loan losses, changes in federal and state bank laws and regulations, including as a result of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), and changes in accounting standards that may adversely affect us or the banking industry as a whole, our ability to implement our business strategy, and other risks described in this report, in the Company's 2010 Form 10-K, and in our other filings with the SEC. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-Q. We undertake no obligation to update or revise the information contained in this report whether as a result of new information, future events or circumstances, or otherwise. Past results of operations may not be indicative of future results. Readers should carefully review the risk factors described in other documents that we file from time to time with the SEC.

BUSINESS AND OVERVIEW

The Company is a bank holding company headquartered in Columbia, Maryland, with one wholly-owned subsidiary, Carrollton Bank. The Bank has four subsidiaries, CMSI, CFS, and MSLLC that are wholly owned, and CCDC, which is 96.4% owned.

The Bank is engaged in general commercial and retail banking business, with ten branch locations. The Bank attracts deposit customers from the general public and uses such funds, together with other borrowed funds, to make loans. Our results of operations are primarily determined by the difference between interest income earned on interest-earning assets, primarily interest and fee income on loans, and interest paid on our interest-bearing liabilities, including deposits and borrowings.

During 2004, the Bank opened a mortgage subsidiary, Carrollton Mortgage Services, Inc. ("CMSI"). CMSI is in the business of originating residential mortgage loans to be sold and has one location from which it conducts operations. The mortgage-banking business is structured to provide a source of fee income largely from the process of originating residential mortgage loans for sale on the secondary market, as well as the origination of loans to be held in our loan portfolio. Mortgage-banking products include Federal Housing Administration and Federal Veterans Administration loans, conventional and nonconforming first and second mortgages, and construction and permanent financing. Loans originated by CMSI are generally sold into the secondary market but may be considered for retention by the Bank as part of our balance sheet strategy.

CFS provides brokerage services and a variety of financial planning and investment options to customers through INVEST Financial Corp. pursuant to a service agreement with INVEST and recognizes commission income as these services are provided. The investment options CFS offers through this arrangement include mutual funds, U.S. government bonds, tax-free municipals, individual retirement account rollovers, long-term care, and health care insurance services. INVEST is a full-service broker/dealer, registered with the Financial Industry Regulatory Authority ("FINRA") and the SEC, a member of Securities Investor Protection Corporation ("SIPC"), and licensed with state insurance agencies in all 50 states. CFS refers clients to an INVEST representative for investment counseling prior to purchase of securities.

MSLLC manages and disposes of real estate acquired through foreclosure.


CCDC promotes, develops, and improves the housing and economic conditions of people in Maryland. We coordinate our efforts to identify opportunities with a local non-profit ministry whose mission and vision is to eliminate poverty housing in the region by building decent houses for affordable homeownership throughout Anne Arundel County and the Baltimore metropolitan region. CCDC generates revenue through the origination of loans for the purchase of these homes.

We reported net income of $504,240 for the three months ended September 30, 2011 and a net loss of $21,823 for the nine months ended September 30, 2011, compared to net income of $153,274 and $243,262 for the comparable periods in 2010. Net income available to common stockholders of $367,162 ($0.14 per diluted share) for the three months ended September 30, 2011 and a net loss attributable to common stockholders was $433,058 ($0.17 loss per diluted share) for the nine months ended September 30, 2011, compared to net income available to common stockholders of $17,790 ($0.01 per diluted share) and a net loss attributable to common stockholders of $163,190 ($0.06 loss per diluted share) for the prior year periods.

Return on average assets and return on average equity are key measures of our performance. Return on average assets, the quotient of net (loss) income divided by total average assets, measures how effectively the Company utilizes its assets to produce income. The Company's return on average assets for the three and nine month periods ended September 30, 2011 was 0.54% and (0.01)% compared to return on average assets of 0.15% and 0.08% for the three and nine month periods ended September 30, 2010. Return on average equity, the quotient of net (loss) income divided by average equity, measures how effectively the Company invests its capital to produce income. Return on average equity for the three and nine month periods ended September 30, 2011 was 6.01% and (0.09) % compared to return on average equity of 1.69% and 0.90% for the corresponding periods in 2010.

Net interest income decreased $148,578, or 4.04%, for the three month period ended September 30, 2011, and increased $45,400, or 0.43%, for the nine month period ended September 30, 2011 compared to the same periods in 2010, while our net interest margin increased to 4.00% for the nine months ended September 30, 2011 from 3.63% for the comparable period in 2010. Net interest margin, a profitability measure, is the dollar difference between interest income from earning assets, including loans and investments, and interest expense paid on deposits and other borrowings, expressed as a percentage of average earning assets. The year to date improvement in net interest margin while asset yields are declining is a result of our strategy focused on reducing excess balance sheet liquidity and reducing the cost of our interest-bearing liabilities. The decline in net interest income in the quarter is a result of the decline in average interest earning assets offsetting the improvement in the net interest margin.

The improvement in operating results for the quarter ended September 30, 2011, as compared to the same period in 2010, is a result of a $445,000 decline in the provision for loan losses, as well as an increase in noninterest income and a decline in noninterest expenses. The decline in operating results for the nine month period ended September 30, 2011, compared to the same period in 2010, is a result of the ongoing losses associated with the loan portfolio and foreclosed real estate. During the nine month period ended September 30, 2011, the Company recorded a provision for loan losses of $2.0 million compared to $1.6 million during the same period in 2010. Expenses and losses associated with foreclosed real estate were $1.1 million for the nine month period ended September 30, 2011 as compared to $210,813 for the same period in 2010.

No dividends were declared or paid to common stockholders during the first nine months of 2011 as we continue the suspension of dividends in recognition of our limited earnings during recent periods. It is our intention to reinstate the payment of dividends when earnings improve and capital preservation efforts boost our capital ratios. During the first nine months of 2010, we declared dividends of $0.10 per share to stockholders.

CURRENT STRATEGY

Our Board of Directors and senior management continue to employ a strategy designed to strengthen the balance sheet and improve operating results by improving asset quality, reducing higher cost funding sources, and pursuing operating efficiencies through the use of technology and strategic partners. The objective is to strengthen our overall foundation during these difficult and uncertain economic times in order to take advantage of opportunities that we expect will emerge as the business environment clarifies and improves.

The financial regulatory reform measures enacted and to be enacted pursuant to the Dodd-Frank Act, along with the ongoing instability in the residential and commercial real estate markets, have created a great deal of uncertainty within the community banking industry. In addition, uncertainty about future tax policy and the cost of employment associated with healthcare reform add uncertainty to planning for operational costs. We have chosen to carefully evaluate all growth opportunities with this uncertainty in mind, carefully limiting decisions that could be impacted by circumstances beyond our control.

We have narrowed our focus for targeted growth on the following customer groups:

Small and mid-sized businesses, including service firms, manufacturing companies and distributors;

Executives and professionals, including attorneys, accountants, medical professionals, consultants, corporate executives and their firms;

Non-profit associations, including charities, foundations, professional/trade associations, homeowner/condo associations, and faith based organizations; and


High net worth individuals and affluent families.

The Bank will serve its customers by utilizing its existing branch network as well as by providing internet based services, remote deposit capture, courier service, and loan production business offices.

Going forward, our business strategy will include:

Increasing awareness and consideration in the business marketplace through directed marketing and direct sales efforts;

Leading with deposit and cash management products;

Retaining and growing existing customer relationships;

Growing our Small Business Administration loan portfolio; and

Increasing adoption and usage of online products.

Our effort to improve net interest margin by reducing balance sheet liquidity and high cost funding sources has dramatically improved net interest margins from 3.63% for the nine months ended September 30, 2010 to 4.00% for the same period in 2011. The 37 basis point improvement is primarily a result of reducing the cost of interest-bearing liabilities by 40 basis points through the reduction of borrowed funds and renewal of certificates of deposit at significantly lower rates. The annualized benefit of a 37 basis point improvement in net interest margin is approximately $1.3 million on the Bank's average earning assets of $353.2 million for the nine months ended September 30, 2011.

Our efforts to reduce non-performing assets and improve operating efficiencies will take longer to appear in operating results. The reduction of non-performing assets is subject to the market conditions associated with the commercial real estate market, while operating efficiencies will be geared towards prudently reducing operating expenses while growing the business within the constraints of our capital base.

We believe that we will ultimately need to raise additional capital to redeem our outstanding preferred stock issued to the U.S. Treasury under the Capital Purchase Program and support balance sheet growth. Fortunately, we remain "well capitalized" for regulatory purposes, which allow us to carefully assess various capital alternatives and determine which alternative is best for the Company and our existing stockholders. Management and a committee of the Board of Directors are constantly evaluating market conditions and opportunities so that we are in a position to act quickly if the right opportunity arises.

CRITICAL ACCOUNTING POLICIES

The Company's financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets. One of the most critical accounting policies applied is related to the valuation of the loan portfolio.

A variety of estimates impact the carrying value of the loan portfolio including the calculation of the allowance for loan losses, valuation of underlying collateral and the timing of loan charge-offs. The allowance for loan losses is one of the most difficult and subjective judgments that we make. The allowance is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payments on loans. Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio. Current trends in delinquencies and charge-offs, the views of bank regulators, changes in the size and composition of the loan portfolio and peer comparisons are also factors. The analysis also requires consideration of the economic climate and direction, and change in the interest rate environment, which may affect a borrower's ability to pay, legislation influencing the banking industry, and economic conditions specific to the Bank's service areas. Because the calculation of the allowance for loan losses relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates.

Another critical accounting policy is related to the securities we own. Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term "other than temporary" is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of an investment. Management reviews other criteria such as magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

FINANCIAL CONDITION

Investment Securities

The investment portfolio consists primarily of securities available for sale. Securities available for sale are those securities that we intend to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors. Investment securities we anticipate holding until the investment's maturity date are recorded at amortized cost.


The investment portfolio consists primarily of U.S. Government agency securities, mortgage-backed securities, corporate bonds, state and municipal obligations, and equity securities. The income from state and municipal obligations is exempt from federal income tax. Certain agency securities are exempt from state income taxes. We use the investment portfolio as a source of both liquidity and earnings.

Investment securities decreased $3.2 million, or 9.86%, to $29.2 million at September 30, 2011, from $32.4 million at December 31, 2010. The decrease is primarily the result of $4.4 million of principal paydowns on debt securities, partially offset by the purchase of a $1.1 million mortgage-backed security with an estimated maturity date of May 2019 and a yield of 4.02%. Management's continuing investment strategy is to use liquidity from maturing investments to fund our liquidity needs so we can reduce our use of high cost certificates of deposit and borrowed funds. Management continues to investigate investment options that will produce the most efficient use of excess funds.

Loans Held for Sale

Loans held for sale decreased $232,390 from $32.8 million at December 31, 2010, to $32.5 million at September 30, 2011. Generally, loans originated with the intention of being sold to a third party remain on our balance sheet for approximately 45 days. During September 2011, loans originated with the intention of being sold totaled $31.1 million compared to $34.0 million during December 2010. Loans held for sale are carried at the lower of cost or the committed sale price, determined on an individual loan basis.

Loans

Gross loans, excluding loans held for sale, decreased 5.33% to $273.8 million at September 30, 2011 compared to $289.2 million at December 31, 2010, resulting from tempered loan demand as businesses continue to limit borrowing to expand their operations during the continued sluggish and uncertain economy.

Loans are placed on nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of all interest and/or principal is in doubt. Placing a loan on nonaccrual status means that we no longer accrue interest on such loan and reverse any interest previously accrued but not collected. Management may grant a waiver from nonaccrual status for a 90-day past-due loan that is both well secured and in the process of collection. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current.

A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the fair value of the collateral for collateral dependent loans and at the present value of expected future cash flows using the loans' effective interest rates for loans that are not collateral dependent.

At September 30, 2011, we had 11 impaired loans totaling approximately $5.7 million, seven of which have been classified as nonaccrual. The valuation allowance for impaired loans was $1.0 million as of September 30, 2011.

The following table provides information concerning non-performing assets and past due loans at the dates indicated:

                                                      September 30,       December 31,       September 30,
                                                           2011               2010                2010

Nonaccrual loans                                     $      5,714,626     $   5,021,777     $    12,838,113
Restructured loans                                          8,370,810         7,795,668           4,788,998
Foreclosed real estate                                      5,342,488         4,509,551           3,001,457
Total non-performing assets                          $     19,427,924     $  17,326,996     $    20,628,568

Accruing loans past-due 90 days or more              $              -     $           -     $       148,000

Two restructured notes totaling $493,607 are more than 90 days past due and are included in nonaccrual loans. All other restructured notes are paying in accordance with the terms of the agreement, and remain on accrual status.

The level of non-performing assets continues to have a negative impact on earnings as the economy is showing little improvement and real estate values continue to decline. Management has worked diligently to identify borrowers that may be facing difficulties in order to restructure terms where appropriate, secure additional collateral or pursue foreclosure and other secondary sources of repayment. The successful reduction of non-performing assets will ultimately be dependent on continued management diligence and improvement in the economy and the real estate market.


Allowance for Loan Losses

The allowance for loan losses represents management's best estimate of probable losses in the existing loan portfolio. We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term and is established through a provision for loan losses.

We base the evaluation of the adequacy of the allowance for loan losses upon loan categories. We categorize loans as commercial loans or consumer loans. We further divide commercial and consumer loans by collateral type and whether the loan is an installment loan or a revolving credit facility. We apply historic loss ratios to each subcategory of loans within the commercial and consumer loan categories. Loss ratios are determined based upon the most recent three years of history for each loan subcategory.

We further divide commercial loans by risk rating and apply loss ratios by risk rating to determine estimated loss amounts. We evaluate delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with loan collateral separately and assign loss amounts based upon the evaluation.

With respect to commercial loans, management assigns a risk rating of one through nine to each loan at inception, with a risk rating of one having the least amount of risk and a risk rating of nine having the greatest amount of risk. The risk rating is reviewed at least annually based on, among other things, the borrower's financial condition, cash flow and ongoing financial viability; the collateral securing the loan; the borrower's industry; and payment history. We evaluate loans with a risk rating of five or greater separately and allocate a portion of the allowance for loan losses based upon the evaluation, if necessary.

We consider delinquency rates and other qualitative or environmental factors that may cause estimated credit losses associated with our existing portfolio to differ from historical loss experience. These factors include, but are not limited to, changes in lending policies and procedures, changes in the nature and volume of the loan portfolio, changes in the experience, ability and depth of lending management and the effect of other external factors such as economic factors, competition and legal and regulatory requirements on the level of estimated credit losses in our existing portfolio.

Our policies require an independent review of assets on a regular basis and we believe that we appropriately reclassify loans as warranted. We believe that we use the best information available to make a determination with respect to the allowance for loan losses, recognizing that the determination is inherently subjective and that future adjustments may be necessary depending upon, among other factors, a change in economic conditions of specific borrowers or generally in the economy and new information that becomes available to us. However, there are no assurances that the allowance for loan losses will be sufficient to absorb losses on non-performing assets, or that the allowance will be sufficient to cover losses on non-performing assets in the future.

The allowance for loan losses was $4.7 million at September 30, 2011, which was 1.73% of loans compared to $4.5 million at December 31, 2010, which was 1.55% of loans. During the first nine months of 2011, we experienced net chargeoffs of $1.8 million compared to net chargeoffs of $920,710 during the same period of 2010. The annualized ratio of net loan losses to average loans outstanding was 0.63% for the nine months ended September 30, 2011 compared to the net loan loss ratio of 0.31% for the first nine months of 2010. The ratio of nonperforming assets, including accruing loans past-due 90 days or more but excluding renegotiated loans, as a percentage of period-end loans, excluding loans held for sale, and foreclosed real estate increased to 3.96% at September 30, 2011, compared to 3.24% at December 31, 2010. The increase in the allowance for loan losses was necessary to recognize the increase in historical loss rates used to calculate the allowance as well as the completion of new appraisals that indicated that collateral values have continued to decline during 2011. These declines result from the extended economic stagnation and the limited market activity in commercial and residential real estate.

The following table shows the activity in the allowance for loan losses:

                                                          Nine Months Ended            Year Ended
                                                            September 30,             December 31,
                                                         2011            2010             2010

Allowance for loan losses - beginning of period      $  4,481,236     $ 4,322,604     $   4,322,604
Provision for loan losses                               2,036,828       1,644,362         4,106,353
Charge-offs                                            (1,877,173 )      (987,063 )      (4,026,093 )
. . .
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