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SVBI > SEC Filings for SVBI > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for SEVERN BANCORP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SEVERN BANCORP INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The Company

Bancorp is a savings and loan holding company chartered as a corporation in the state of Maryland in 1990. It conducts business primarily through two subsidiaries, Severn Savings Bank, FSB ("Bank") and SBI Mortgage Company ("SBI"). The Bank's principal subsidiary Louis Hyatt, Inc. ("Hyatt Commercial"), conducts business as Hyatt Commercial, a commercial real estate brokerage and property management company. SBI holds mortgages that do not meet the underwriting criteria of the Bank, and is the parent company of Crownsville Development Corporation ("Crownsville"), which is doing business as Annapolis Equity Group, which acquires real estate for syndication and investment purposes. The Bank has four branches in Anne Arundel County, Maryland, which offer a full range of deposit products, and originate mortgages in its primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware and Virginia.

Bank Competition

The Annapolis, Maryland area has a high density of financial institutions, many of which are significantly larger and have greater financial resources than the Bank, and all of which are competitors of the Bank to varying degrees. The Bank's competition for loans comes primarily from savings and loan associations, savings banks, mortgage banking companies, insurance companies and commercial banks. Its most direct competition for deposits has historically come from savings and loan associations, savings banks, commercial banks and credit unions. The Bank faces additional competition for deposits from money market mutual funds and corporate and government securities funds and investments. The Bank also faces increased competition for deposits from other financial institutions such as brokerage firms and insurance companies. The Bank is a community-oriented financial institution serving its market area with a wide selection of mortgage loan products. Management considers the Bank's reputation and customer service to be a major competitive advantage in attracting and retaining customers in its market area. The Bank also believes it benefits from its community orientation.


Forward Looking Statements

In addition to the historical information contained herein, the discussion in this report contains forward-looking statements that involve risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. The forward-looking statements contained herein include, but are not limited to, those with respect to the Bank's strategy; management's determination of the amount of the loan loss allowance; the effect of changes in interest rates; changes in deposit insurance premiums; ability to meet obligations; and legal proceedings. The words "anticipate," "believe," "estimate," "expect," "intend," "may," "plan," "will," "would," "could," "should," "guidance," "potential," "continue," "project," "forecast," "confident," and similar expressions are typically used to identify forward-looking statements. Bancorp's operations and actual results could differ significantly from those discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences include, but are not limited to: changes in general economic conditions and political conditions and by governmental monetary and fiscal policies; changes in the economic conditions of the geographic areas in which Bancorp conducts business; changes in interest rates; a downturn in the real estate markets in which Bancorp conducts business; the high degree of risk exhibited by Bancorp's loan portfolio; environmental liabilities with respect to properties Bancorp has title; changes in federal and state regulation; the effects of the supervisory agreements entered into by each of Bancorp and the Bank; Bancorp's ability to estimate loan losses; competition; breaches in security or interruptions in Bancorp's information systems; Bancorp's ability to timely develop and implement technology; Bancorp's ability to retain its management team; perception of Bancorp in the market place; Bancorp's ability to maintain effective internal controls over financial reporting and disclosure controls and procedures; and terrorist attacks and threat of actual war; and other factors detailed from time to time in Bancorp's filings with the Securities and Exchange Commission (the "SEC"), including "Item 1A. Risk Factors" contained in Bancorp's Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Critical Accounting Policies

Bancorp's significant accounting policies are set forth in Note 1 of the audited consolidated financial statements as of December 31, 2011 which were included in Bancorp's Annual Report on Form 10-K. Of these significant accounting policies, Bancorp considers its policies regarding the allowance for loan losses and the fair value of foreclosed real estate to be its most critical, because they require management's most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and the fair value of foreclosed real estate and therefore on the provision for loan losses and the provision for losses on foreclosed real estate and, ultimately, on results of operations. Bancorp has developed policies and procedures for assessing the adequacy of the allowance for loan losses and the fair value of foreclosed real estate, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio and estimated value of foreclosed real estate. Bancorp's assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements.

Overview

Bancorp provides a wide range of personal and commercial banking services. Personal services include various lending services as well as checking, individual retirement accounts, money market, savings and time deposit accounts. Commercial services include commercial secured and unsecured lending services as well as business internet banking, corporate cash management services and deposit services. Bancorp also provides ATMs, debit cards, internet banking including on-line bill pay, mortgage lending, safe deposit boxes, and telephone banking, among other products and services.


Bancorp experienced net income for the three months ended September 30, 2012, in part due to management's decision to not add to the loan loss reserves during the third quarter. While non-performing assets continued to decrease, and loan delinquencies improved, management elected not to add additional reserves. Bancorp continues to experience challenges it and many other financial institutions face as a result of the weak economic recovery. Some of those challenges, including increased loan delinquencies and a decrease in loan demand have improved from 2008 and 2009, but others, such as declines in the real estate values and financial stress on borrowers as a result of the recession continue. The interest rate spread between Bancorp's cost of funds and what it earns on loans has remained relatively constant from 2010 and 2011 levels.

If interest rates increase, demand for borrowing may decrease and Bancorp's interest rate spread could decrease. Bancorp will continue to manage loan and deposit pricing against the risks of rising costs of its deposits and borrowings. Interest rates are outside the control of Bancorp, so it must attempt to balance its pricing and duration of its loan portfolio against the risks of rising costs of its deposits and borrowings.

The continued success and attraction of Anne Arundel County, Maryland, and vicinity, will also be important to Bancorp's ability to originate and grow mortgage loans and deposits, as will Bancorp's continued focus on maintaining a low overhead.

If the volatility in the market and the economy continues or worsens, our business, financial condition, results of operations, access to funds and the price of our stock could be materially and adversely impacted.

Results of Operations

Net income increased by $7,000 to net income of $558,000 for the third quarter of 2012, compared to a net income of $551,000 for the third quarter of 2011. Basic and diluted earnings per share were $.02 for the third quarter of 2012 compared to $0.01 for the third quarter of 2011. The increase in net income and basic and diluted earnings per share over last year was primarily the result of management's decision to add approximately $850,000 to the loan loss reserve during the third quarter of 2011, while no loan loss reserve provision was added during the third quarter of 2012. Net income increased by $1,975,000 to net income of $2,127,000 for the nine months ended September 30, 2012, compared to a net income of $152,000 for the nine months ended September 30, 2011. Basic and diluted earnings (loss) per share increased by $.21, to $.10 for the nine months ended September 30, 2012 compared to $(.11) for the nine months ended September 30, 2011. The increase in net income and basic and diluted earnings per share over last year was primarily the result of management's decision to add approximately $4,471,000 to the loan loss reserve during the nine months ended September 30, 2011 compared to $465,000 in loan loss reserve provision added during the nine months ended September 30, 2012.

Net interest income, which is interest earned net of interest expense, decreased by $1,058,000, or 14.8%, to $6,077,000 for the third quarter of 2012, compared to $7,135,000 for the third quarter of 2011. The primary reason for the decrease in net interest income was a decrease in Bancorp's loan portfolio and a decrease in yield on the loan portfolio, partially offset by a lower cost of funds. Net interest income decreased $2,285,000, or 10.4%, to $19,730,000 for the nine months ended September 30, 2012, compared to $22,015,000 for the nine months ended September 30, 2011. The primary reason for the decrease in net interest income was a decrease in Bancorp's loan portfolio and a decrease in yield on the loan portfolio, partially offset by a lower cost of funds.

Bancorp's loan portfolio is subject to varying degrees of credit risk and an allowance for loan losses is maintained to absorb losses inherent in its loan portfolio. Credit risk includes, but is not limited to, the potential for borrower default and the failure of collateral to be worth what Bancorp determined it was worth at the time of the granting of the loan. Bancorp monitors its loan delinquencies at least monthly. All loans that are delinquent and all loans within the various categories of Bancorp's portfolio as a group are evaluated. Bancorp's Board, with the advice and recommendation of Bancorp's loss mitigation committee, estimates an allowance to be set aside for loan losses. Included in determining the calculation are such factors as historical losses for each loan portfolio, current market value of the loan's underlying collateral, inherent risk contained within the portfolio after considering the state of the general economy, economic trends, consideration of particular risks inherent in different kinds of lending and consideration of known information that may affect loan collectability.


The provision for loan losses decreased by $850,000, or 100.0%, to zero for the third quarter of 2012, compared to $850,000 for the third quarter of 2011. This decrease was a result of management's decision not to add to the provision for loan losses during the quarter ended September 30, 2012, compared to the quarter ended September 30, 2011. The provision for loan losses decreased by $4,006,000, or 89.6%, to $465,000 for the nine months ended September 30, 2012, compared to $4,471,000 for the same period in 2011. Bancorp's total loan portfolio has decreased from 2011.

Total other income increased by $411,000, or 65.4%, to $1,039,000 for the third quarter of 2012, compared to $628,000 for the third quarter of 2011. The primary reason for the increase in other income was an increase in mortgage banking activities. Total other income increased by $1,128,000, or 68.9%, to $2,765,000 for the nine months ended September 30, 2012, compared to $1,637,000 for the same period in 2011. Real estate commissions decreased $59,000, or 31.6%, to $128,000 for the third quarter of 2012, compared to $187,000 for the third quarter of 2011. This decrease was due to lower sales and leasing activity in the third quarter of 2012 compared to the comparable quarter in 2011. Real estate commissions increased $67,000, or 15.9%, to $488,000 for the nine months ended September 30, 2012, compared to $421,000 for the same period in 2011. Real estate management fees decreased $21,000, or 12.5%, to $147,000 for the third quarter of 2012, compared to $168,000 for the third quarter of 2011. Real estate management fees decreased $2,000, or 0.4%, to $467,000 for the nine months ended September 30, 2012, compared to $469,000 for the same period in 2011. Mortgage banking activities increased $403,000, or 341.5%, to $521,000 for the third quarter of 2012, compared to $118,000 for the third quarter of 2011. This increase was due to an increase of loans sold on the secondary market, primarily from the E-Home finance department, in the third quarter of 2012 compared to the third quarter of 2011. Mortgage banking activities increased by $932,000, or 310.7%, to $1,232,000 for the nine months ended September 30, 2012, compared to $300,000 for the same period in 2011.

Total non-interest expenses increased $193,000, or 3.2%, to $6,152,000 for the third quarter of 2012, compared to $5,959,000 for the third quarter of 2011. Total non-interest expenses decreased $470,000, or 2.5%, to $18,369,000 for the nine months ended September 30, 2012, compared to $18,839,000 for the same period in 2011. Compensation and related expenses increased by $320,000, or 12.6%, to $2,863,000 for the third quarter of 2012, compared to $2,543,000 for the third quarter of 2011. Compensation and related expenses increased by $1,185,000, or 15.5%, to $8,853,000 for the nine months ended September 30, 2012, compared to $7,668,000 for the same period in 2011. This increase was primarily because of vacated and additional positions being filled by newly hired employees during the first nine months of 2012. Net occupancy costs decreased by $127,000, or 40.2%, to $189,000 for the third quarter of 2012, compared to $316,000 for the third quarter of 2011. Net occupancy costs decreased by $339,000, or 38.9%, to $533,000 for the nine months ended September 30, 2012, compared to $872,000 for the same period in 2011. This decrease was the result of increased rents collected on previously unoccupied space which helped offset occupancy costs. Foreclosed real estate expenses, net decreased by $347,000, or 27.9%, to $895,000 for the third quarter of 2012, compared to $1,242,000 for the third quarter of 2011. Foreclosed real estate expenses, net decreased by $1,883,000, or 40.3%, to $2,793,000 for the nine months ended September 30, 2012, compared to $4,676,000 for the same period in 2011. These differences were the result of lower write downs and higher foreclosed real estate sale gains during the nine months of 2012. Legal fees decreased by $78,000, or 32.6%, to $161,000 for the third quarter of 2012, compared to $239,000 for the third quarter of 2011. Legal fees decreased $165,000, or 24.4%, to $511,000 for the nine months ended September 30, 2012, compared to $676,000 for the same period in 2011. These decreases were the result of Bancorp's ability during 2012 to utilize employees for certain services previously provided by outside legal firms. FDIC assessments and regulatory expense increased by $153,000, or 27.7% to $706,000 for the third quarter of 2012, compared to $553,000 for the third quarter of 2011. FDIC assessments and regulatory expense decreased by $69,000, or 4.1% to $1,626,000 for the nine months ended September 30, 2012, compared to $1,695,000 for the same period in 2011. Other non-interest expenses increased by $272,000, or 25.5%, to $1,338,000 for the third quarter of 2012 compared to $1,066,000 for the third quarter of 2011. Other non-interest expenses increased by $801,000, or 24.6%, to $4,053,000 for the nine months ended September 30, 2012 compared to $3,252,000 for the same period in 2011.


Income Taxes

Income tax expense increased by $3,000 to an income tax provision of $406,000 for the third quarter of 2012 compared to an income tax provision of $403,000 for the third quarter of 2011. The increase was consistent with the increase in pretax income compared to pretax income for the third quarter of 2011. The effective tax rate for the third quarter of 2011 was 42.1% compared to 42.2% for the third quarter of 2011. Income tax expense increased by $1,344,000 to an income tax provision of $1,534,000 for the nine months ended September 30, 2012 compared to an income tax provision of $190,000 for the same period in 2011. The effective tax rate for the nine months ended September 30, 2012 was 41.9% compared to 55.6% for the same period in 2011. The change in the effective tax rates was primarily due to a valuation allowance placed on a portion of the deferred tax asset resulting from current state operating loss carryforwards.

Analysis of Financial Condition

Total assets decreased $38,862,000 to $861,766,000 at September 30, 2012, compared to $900,628,000 at December 31, 2011. Cash and cash equivalents increased by $946,000, or 1.1%, to $88,336,000 at September 30, 2012, compared to $87,390,000 at December 31, 2011. This increase was primarily in cash and due from bank balances. The loan portfolio decreased, as net loans receivable decreased $28,078,000, or 4.0%, to $665,225,000 at September 30, 2012, compared to $693,303,000 at December 31, 2011. This decrease was the result of the continued general slowdown in loan demand during the first nine months of 2012 and the transfer of $10,938,000 of net loans to foreclosed real estate. Loans held for sale increased $2,666,000, or 64.6%, to $6,794,000 at September 30, 2012, compared to $4,128,000 at December 31, 2011. This increase was primarily due to the timing of loans pending sale as of September 30, 2012. Foreclosed real estate decreased $6,131,000, or 30.8%, to $13,801,000 at September 30, 2012 compared to $19,932,000 at December 31, 2011. This decrease was the result of an increase in foreclosed property sales during the first nine months of 2012 compared to the first nine months of 2011. Total deposits decreased $42,985,000, or 6.6%, to $609,772,000 at September 30, 2012 compared to $652,757,000 at December 31, 2011. These changes were primarily the result of Bancorp's continued monitoring of the deposit portfolio and allowing higher rate deposits to leave. Long-term borrowings remained at $115,000,000 at September 30, 2012 and December 31, 2011. These borrowings do not mature until 2016 or later and would incur prepayment penalties if paid earlier.

Stockholders' Equity

Total stockholders' equity increased $1,212,000 to $107,142,000 at September 30, 2012 compared to $105,930,000 as of December 31, 2011. This increase was primarily a result of the decrease in dividends paid to Bancorp's preferred stockholders and net income for the first nine months of 2012.


Liquidity

Bancorp's liquidity is determined by its ability to raise funds through several sources including borrowed funds, capital, deposits, loan repayments, maturing investments and the sale of loans.

In assessing its liquidity, the management of Bancorp considers operating requirements, anticipated deposit flows, expected funding of loans, deposit maturities and borrowing availability, so that sufficient funds may be available on short notice to meet obligations as they arise or to permit Bancorp to take advantage of business opportunities.

Management believes Bancorp has sufficient cash flow and liquidity to meet its current commitments through the next 12 months. Certificates of deposit, which are scheduled to mature in less than one year, totaled $203,538,000 at September 30, 2012. Based on past experience, management believes that a significant portion of such deposits will remain with Bancorp. At September 30, 2012, Bancorp had commitments to originate mortgage loans of $7,909,000, unadvanced home equity lines of credit of $14,026,000, unadvanced construction commitments of $11,946,000, unused lines of credit of $32,389,000 and commitments under standby letters of credit of $16,365,000. Bancorp has the ability to reduce its commitments for new loan originations, adjust other cash outflows, and borrow from FHLB Atlanta should the need arise. As of September 30, 2012, outstanding FHLB Atlanta borrowings totaled $115,000,000, and Bancorp had available to it an additional $63,290,000 in borrowing availability from FHLB Atlanta.

Net cash provided by operating activities decreased $19,000 to $8,283,000 for the nine months ended September 30, 2012, compared to $8,302,000 for the same period in 2011. This decrease was primarily the result of a net decrease in loans originated and sold in 2012 and a decrease in accrued interest receivable and other assets, partially offset by a gain on loans sold and net income generated in the current period. Net cash provided by investing activities decreased $13,082,000 to $36,595,000 for the nine months ended September 30, 2012, compared to $49,677,000 provided by investing activities for the same period in 2011. This decrease was primarily due to a decrease in loans in 2012 compared to the same period in 2011. Net cash used in financing activities was $43,932,000 for the nine months ended September 30, 2012, compared to $37,146,000 for the same period in 2011. This decrease was primarily due to a larger decrease in deposits in 2012 compared to the same period in 2011.

Federal Home Loan Bank of Atlanta Line of Credit

The Bank has an available line of credit, secured by various loans in its portfolio, in the amount of twenty percent of its total assets, with the FHLB Atlanta. As of September 30, 2012, the total available line of credit with the FHLB Atlanta was approximately $178,290,000, of which $115,000,000 was outstanding in the form of long-tem borrowings. The Bank, from time to time, utilizes the line of credit when interest rates are more favorable than obtaining deposits from the public.

During the third quarter 2012, the Bank restructured a portion of its FHLB Atlanta borrowings by repaying $65 million of existing advances and replacing them with $65 million of lower cost advances. The transaction resulted in $5.3 million in prepayment penalties that were deferred and will be recognized in interest expense through yield adjustments on the new borrowings in future periods. The existing borrowings had an average cost of 3.87%. The new borrowings had an average cost of 2.72% including the deferred adjustment. The relevant accounting treatment for this transaction was provided in ASC 470-50. This transaction was executed as an earnings strategy.


The following table sets forth information concerning the interest rates and maturity dates of the advances from the FHLB Atlanta as of September 30, 2012 (dollars in thousands):

                  Principal Amount         Rate          Maturity
                  $               -             -%             2012
                                  -             -%             2013
                                  -             -%             2014
                                  -             -%             2015
                             15,000   1.81% to 1.83%           2016
                            100,000   2.43% to 4.05%    Thereafter
                  $         115,000

Subordinated Debentures

As of September 30, 2012, Bancorp had outstanding $20,619,000 principal amount of Junior Subordinated Debt Securities Due 2035 (the "2035 Debentures"). The 2035 Debentures were issued pursuant to an Indenture dated as of December 17, 2004 (the "2035 Indenture") between Bancorp and Wells Fargo Bank, National Association, as Trustee. The 2035 Debentures pay interest quarterly at a floating rate of interest of LIBOR (0.45510% as of September 30, 2012) plus 200 basis points, and mature on January 7, 2035. Payments of principal, interest, premium and other amounts under the 2035 Debentures are subordinated and junior in right of payment to the prior payment in full of all senior indebtedness of Bancorp, as defined in the 2035 Indenture. The 2035 Debentures became redeemable, in whole or in part, by Bancorp on January 7, 2010.

The 2035 Debentures were issued and sold to Severn Capital Trust I (the "Trust"), of which 100% of the common equity is owned by Bancorp. The Trust was formed for the purpose of issuing corporation-obligated mandatorily redeemable Capital Securities ("Capital Securities") to third-party investors and using the proceeds from the sale of such Capital Securities to purchase the 2035 Debentures. The 2035 Debentures held by the Trust are the sole assets of the Trust. Distributions on the Capital Securities issued by the Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Trust on the 2035 Debentures. The Capital Securities are subject to mandatory redemption, in whole or in part, upon repayment of the 2035 Debentures. Bancorp has entered into an agreement which, taken collectively, fully and unconditionally guarantees the Capital Securities subject to the terms of the guarantee.

On November 15, 2008, Bancorp completed a private placement offering consisting of a total of 70 units, at an offering price of $100,000 per unit, for gross proceeds of $7.0 million. Each unit consists of 6,250 shares of Bancorp's Series A 8.0% Non-Cumulative Convertible Preferred Stock and Bancorp's Subordinated Note in the original principal amount of $50,000.

The aggregate principal amount of Subordinated Notes outstanding at September 30, 2012 was $3,500,000. The Subordinated Notes earn interest at an annual rate of 8.0%, payable quarterly in arrears on the last day of March, June, September and December commencing December 31, 2008. The Subordinated Notes are redeemable in whole or in part at the option of Bancorp at any time beginning on December 31, 2009 until maturity, which is December 31, 2018. Debt issuance costs totaled $245,000 and are being amortized over 10 years.

Preferred Stock

Bancorp issued a total of 437,500 shares of its Series A 8.0% Non-Cumulative Convertible Preferred Stock ("Series A Preferred Stock") as part of the private placement offering completed on November 15, 2008. The liquidation preference is $8.00 per share. Each share of Series A Preferred Stock is convertible at the option of the holder into one share of Bancorp's common stock, subject to adjustment upon certain corporate events. The initial conversion rate is equivalent to an initial conversion price of $8.00 per share of Bancorp's common stock. At the option of Bancorp, on and after December 31, 2013, at any time and from time to time, some or all of the Series A Preferred Stock may be converted into shares of Bancorp's common stock at the then-applicable conversion rate. Costs related to the issuance of the preferred stock totaled $247,000 and were netted against the proceeds.

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