Item
1.
Business.
BUSINESS
General
The
Company was incorporated under the laws of Maryland on December 10, 1996 and
is
a financial holding company registered under the Bank Holding Company Act of
1956, as amended (the “BHC Act”). The Company’s sole business is acting as the
parent company to The Peoples Bank, a Maryland-chartered bank (the “Bank”), and
Fleetwood, Athey, Macbeth & McCown, Inc., a Maryland insurance agency (the
“Insurance Subsidiary”).
During
2006, we operated in only one business segment: community banking. On January
2,
2007, the Company acquired the Insurance Subsidiary and began operating in
the
insurance products and services business segment.
Location
and Service Area
We
offer
a
variety
of services to consumer and commercial customers in
our
primary service area, which encompasses all of Kent County, northern Queen
Anne’s County, and southern Cecil County, Maryland.
The
principal components making up the economy for our service area are agriculture
and light industry. Kent County is also growing as a tourist and retirement
area. The tourist business is centered primarily in Chestertown and Rock Hall.
There is a large retirement community, Heron Point, located in Chestertown.
The
seafood business, once prominent, is in decline. There are three health-care
facilities located in Chestertown. Agriculture and agricultural-related
businesses are the largest overall employers in the service area. There are
several light industry companies in Kent County.
Banking
Products and Services
Through
the Bank’s five branches located throughout Kent County, Maryland and one branch
in Queen Anne’s County, Maryland, we offer a full range of deposit services that
are typically offered by most depository institutions in our service area,
including checking accounts, NOW accounts, savings accounts and other time
deposits of various types, ranging from daily money market accounts to
longer-term certificates of deposit. The transaction accounts and time
certificates are tailored to
our
principal service area and have rates that are competitive with those offered
by
other institutions in the area. In addition, we offer certain retirement
account
services, such as Individual Retirements Accounts. All deposits are insured
by
the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum amount
allowed by law. We solicit these accounts from individuals, businesses,
associations and organizations, and governmental authorities.
We
also
offer a full range of short- to medium-term commercial and personal loans.
Commercial loans include both secured and unsecured loans for working capital
(including inventory and receivables), business expansion (including acquisition
of real estate and improvements), and purchase of equipment and machinery.
Consumer loans include secured and unsecured loans for financing automobiles,
home improvements, education, and personal investments. We also originate
mortgage loans and real estate construction and acquisition loans.
Other
services include cash management services, safe deposit boxes, travelers checks,
internet banking, direct deposit of payroll and social security checks, and
automatic drafts for various accounts. The Bank is associated with a regional
network of automated teller machines that may be used by our customers
throughout Maryland and other regions. We also offer credit card services
through a correspondent bank and non-deposit investment products, such as
insurance and securities products, through broker-dealer
relationships.
Information
about our revenues, net income and assets derived from our operations in the
community banking segment for each of the years ended December 31, 2007, 2006
and 2005 may be found in our Consolidated Financial Statements and Notes
thereto, which are included in Item 8 of Part II of this annual report.
Investment
Activities
We
maintain a portfolio of investment securities to provide liquidity and income.
The current portfolio amounts to approximately 6.90% of our total assets and
is
invested primarily in U.S. government agency and mortgage-backed
securities.
A
key
objective of the investment portfolio is to provide a balance in our asset
mix
of loans and investments consistent with our liability structure, and to assist
in management of interest rate risk. The investments augment our capital
positions, providing the necessary liquidity to meet fluctuations in credit
demand of the community and fluctuations in deposit levels. In addition, the
portfolio provides collateral for pledging against public funds and repurchase
agreements and a reasonable allowance for control of tax liabilities. Finally,
the investment portfolio is designed as a source of income. In view of the
above
objectives, management treats the portfolio conservatively and generally only
purchases securities that meet conservative investment criteria.
Insurance
Activities
The
Insurance Subsidiary is located in Chestertown, Kent County, Maryland. The
Insurance Subsidiary offers a full range of property and casualty insurance
products and services to customers in our market area.
Seasonality
Management
does not believe that our business activities are seasonal in nature. Demand
for
our products and services may vary depending on local and national economic
conditions, but management believes that any variation will not have a material
impact on our planning or policy-making strategies.
Employees
At
March
1, 2008, we employed 76 persons, of which 65 were employed on a full-time
basis.
COMPETITION
The
banking business, in all of its phases, is highly competitive. Within our
service area and the surrounding area, we compete with commercial banks
(including local banks and branches or affiliates of other larger banks),
savings and loan associations and credit unions for loans and deposits, with
consumer finance companies for loans, with money market mutual funds and other
investment vehicles for deposits, with insurance companies, agents and brokers
for insurance products, and with other financial institutions for various types
of financial products and services. There is also competition for commercial
and
retail banking business from banks and financial institutions located outside
of
our market area. Many of these financial institutions offer services, such
as
trust services, that we do not offer and have greater financial resources or
have substantially higher lending limits than us.
The
primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services.
To
compete with other financial services providers, we rely principally upon local
promotional activities, personal relationships established by officers,
directors and employees with our customers and specialized services tailored
to
meet our customers’ needs. In those instances in which we are unable to
accommodate a customer’s needs, we will arrange for those services to be
provided by other financial services providers with which we have a
relationship. We offer many personalized services and attract customers by
being
responsive and sensitive to the needs of the community. We rely not only on
the
goodwill and referrals of satisfied customers, as well as traditional media
advertising to attract new customers, but also on individuals who develop new
relationships to build our customer base. To enhance our image in the community,
we support and participate in many local events. Our employees, officers and
directors represent us on many boards and local civic and charitable
organizations.
The
following table sets forth deposit data for Kent County, Maryland as of June
30,
2007, the most recent date for which comparative information is available (the
Bank’s branch in Queen Anne’s County was not operational on or prior to June 30,
2007:
Institution
|
|
Offices
In
Market Area
|
|
Deposits
(in
thousands)
|
|
Market
Share
|
|
Peoples
Bank of Kent County, Maryland
|
|
|
5
|
|
|
159,916
|
|
|
33.65
|
%
|
Mercantile
Shore Bank
|
|
|
5
|
|
|
151,864
|
|
|
31.96
|
%
|
Chesapeake
Bank & Trust Co
|
|
|
2
|
|
|
65,641
|
|
|
13.81
|
%
|
Branch
Banking & Trust Co
|
|
|
2
|
|
|
40,988
|
|
|
8.63
|
%
|
Centreville
National Bank of Maryland
|
|
|
2
|
|
|
30,488
|
|
|
6.42
|
%
|
SunTrust
Bank
|
|
|
1
|
|
|
26,298
|
|
|
5.53
|
%
|
Source:
FDIC Deposit Market Share Report
SUPERVISION
AND REGULATION
The
following is a summary of the material regulations and policies applicable
to us
and is not intended to be a comprehensive discussion. Changes in applicable
laws
and regulations may have a material effect on our business, financial condition
and results of operation.
General
The
Company is a financial holding company registered with the Board of Governors
of
the Federal Reserve System (the “FRB”) under the BHC Act and, as such, is
subject to the supervision, examination and reporting requirements of the BHC
Act and the regulations of the FRB.
The
Bank
is a Maryland commercial bank subject to the banking laws of Maryland and to
regulation by the Commissioner of Financial Regulation of Maryland, who is
required by statute to make at least one examination in each calendar year
(or
at 18-month intervals if the Commissioner determines that an examination is
unnecessary in a particular calendar year).
The
Insurance Subsidiary is subject to examination by the FRB, and, as an affiliate
of the Bank, may be subject to examination by the Bank’s regulators from time to
time. In addition, the Insurance Subsidiary is subject to licensing and
regulation by the insurance authorities of the states in which it does business.
Retail sales of insurance products by the Insurance Subsidiary to customers
of
the Bank are also subject to the requirements of the Interagency Statement
on
Retail Sales of Nondeposit Investment Products promulgated in 1994, as amended,
by the federal banking regulators, including the FDIC and the FRB.
Regulation
of Financial Holding Companies
In
November 1999, the federal Gramm-Leach-Bliley Act (the “GLBA”) was signed into
law. Effective in pertinent part on March 11, 2000, GLBA revised the BHC Act
and
repealed the affiliation provisions of the Glass-Steagall Act of 1933, which,
taken together, limited the securities, insurance and other non-banking
activities of any company that controls an FDIC insured financial institution.
Under GLBA, a bank holding company can elect, subject to certain qualifications,
to become a “financial holding company.” GLBA provides that a financial holding
company may engage in a full range of financial activities, including insurance
and securities sales and underwriting activities, and real estate development,
with new expedited notice procedures.
Under
FRB
policy, the Company is expected to act as a source of strength to its subsidiary
banks, and the FRB may charge the Company with engaging in unsafe and unsound
practices for failure to commit resources to a subsidiary bank when required.
In
addition, under the Financial Institutions Reform, Recovery and Enforcement
Act
of 1989 (“FIRREA”), depository institutions insured by the FDIC can be held
liable for any losses incurred by, or reasonably anticipated to be incurred
by,
the FDIC in connection with (i) the default of a commonly controlled
FDIC-insured depository institution or (ii) any assistance provided by the
FDIC
to a commonly controlled FDIC-insured depository institution in danger of
default. Accordingly, in the event that any insured subsidiary of the Company
causes a loss to the FDIC, other insured subsidiaries of the Company could
be
required to compensate the FDIC by reimbursing it for the estimated amount
of
such loss. Such cross guaranty liabilities generally are superior in priority
to
obligations of a financial institution to its stockholders and obligations
to
other affiliates.
Regulation
of the Bank
Federal
and state banking regulators may prohibit the institutions over which they
have
supervisory authority from engaging in activities or investments that the
agencies believes are unsafe or unsound banking practices. These banking
regulators have extensive enforcement authority over the institutions they
regulate to prohibit or correct activities that violate law, regulation or
a
regulatory agreement or which are deemed to be unsafe or unsound practices.
Enforcement actions may include the appointment of a conservator or receiver,
the issuance of a cease and desist order, the termination of deposit insurance,
the imposition of civil money penalties on the institution, its directors,
officers, employees and institution-affiliated parties, the issuance of
directives to increase capital, the issuance of formal and informal agreements,
the removal of or restrictions on directors, officers, employees and
institution-affiliated parties, and the enforcement of any such mechanisms
through restraining orders or other court actions.
The
Company and its affiliates are subject to the provisions of Section 23A and
Section 23B of the Federal Reserve Act. Section 23A limits the amount of loans
or extensions of credit to, and investments in, the Company and its nonbank
affiliates by the Bank. Section 23B requires that transactions between any
of
the Bank and the Company and its nonbank affiliates be on terms and under
circumstances that are substantially the same as with non-affiliates.
The
Bank
is also subject to certain restrictions on extensions of credit to executive
officers, directors, and principal stockholders or any related interest of
such
persons, which generally require that such credit extensions be made on
substantially the same terms as are available to third parties dealing with
the
Bank and not involve more than the normal risk of repayment. Other laws tie
the
maximum amount that may be loaned to any one customer and its related interests
to capital levels.
As
part
of the Federal Deposit Insurance Company Improvement Act of 1991 (“FDICIA”),
each federal banking regulator adopted non-capital safety and soundness
standards for institutions under its authority. These standards include internal
controls, information systems and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. An institution that fails to meet those standards may be
required by the agency to develop a plan acceptable to meet the standards.
Failure to submit or implement such a plan may subject the institution to
regulatory sanctions. We believe that the Bank meets substantially all standards
that have been adopted. FDICIA also imposes new capital standards on insured
depository institutions.
The
Community Reinvestment Act (“CRA”) requires that, in connection with the
examination of financial institutions within their jurisdictions, the federal
banking regulators evaluate the record of the financial institution in meeting
the credit needs of their communities including low and moderate income
neighborhoods, consistent with the safe and sound operation of those banks.
These factors are also considered by all regulatory agencies in evaluating
mergers, acquisitions and applications to open a branch or facility. As of
the
date of its most recent examination report, the Bank had a CRA rating of
“Outstanding.”
GLBA
permits certain qualified national banks to form “financial subsidiaries”, which
have broad authority to engage in all financial activities except insurance
underwriting, insurance investments, real estate investment or development,
and
merchant banking, and expands the potential financial activities of subsidiaries
of state banks, subject to applicable state law. Maryland law generally permits
Maryland state-chartered banks, including the Bank, to engage those activities,
directly or through an affiliate, in which a national bank may
engage.
Deposit
Insurance
The
Bank’s deposits are insured through the Deposit Insurance Fund, which is
administered by the FDIC, and the Bank is required to pay semi-annual deposit
insurance premium assessments to the FDIC. The Bank paid a total of $19,851
in
FDIC premiums during 2007. The Deposit Insurance Fund was created pursuant
to
the Federal Deposit Insurance Reform Act of 2005, which was signed into law
on
February 8, 2006. Under this new law, (i) the current $100,000 deposit insurance
coverage will be indexed for inflation (with adjustments every five years,
commencing January 1, 2011), and (ii) deposit insurance coverage for retirement
accounts was increased to $250,000 per participant subject to adjustment for
inflation. In addition, the FDIC will be given greater latitude in setting
the
assessment rates for insured depository institutions which could be used to
impose minimum assessments. The law also allows “eligible insured depository
institutions” to share in a one-time assessment credit pool. The Bank’s portion
of the one time credit assessment was $132,329.
Capital
Requirements
Under
Maryland law, the Bank must meet certain minimum capital stock and surplus
requirements before it may establish a new branch office. With each new branch
located outside the municipal area of the Bank’s principal banking office, these
minimal levels are subject to upward adjustment based on the population size
of
the municipal area in which the branch will be located. Prior to establishment
of the branch, the Bank must obtain Maryland Commissioner and FDIC approval.
If
establishment of the branch involves the purchase of a bank building or
furnishings, the total investment in bank buildings and furnishings cannot
exceed, with certain exceptions, 50% of the Bank’s unimpaired capital and
surplus.
FDICIA
established a system of prompt corrective action to resolve the problems of
undercapitalized institutions. Under this system, federal banking regulators
are
required to rate supervised institutions on the basis of five capital
categories: “well -capitalized,” “adequately capitalized,” “undercapitalized,”
“significantly undercapitalized,” and “critically undercapitalized;” and to take
certain mandatory actions, and are authorized to take other discretionary
actions, with respect to institutions in the three undercapitalized categories.
The severity of the actions will depend upon the category in which the
institution is placed. A depository institution is “well capitalized” if it has
a total risk based capital ratio of 10% or greater, a Tier 1 risk based capital
ratio of 6% or greater, and a leverage ratio of 5% or greater and is not subject
to any order, regulatory agreement, or written directive to meet and maintain
a
specific capital level for any capital measure. An “adequately capitalized”
institution is defined as one that has a total risk based capital ratio of
8% or
greater, a Tier 1 risk based capital ratio of 4% or greater and a leverage
ratio
of 4% or greater (or 3% or greater in the case of an institution with a
composite CAMEL rating of 1).
Tier
1
capital consists of common stockholders’ equity, qualifying perpetual preferred
stock, and minority interests in equity accounts of consolidated subsidiaries,
less certain intangibles.
FDICIA
generally prohibits a depository institution from making any capital
distribution, including the payment of cash dividends, or paying a management
fee to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to growth
limitations and are required to submit capital restoration plans. For a capital
restoration plan to be acceptable, the depository institution’s parent holding
company must guarantee (subject to certain limitations) that the institution
will comply with such capital restoration plan.
Significantly
undercapitalized depository institutions may be subject to a number of other
requirements and restrictions, including orders to sell sufficient voting stock
to become adequately capitalized and requirements to reduce total assets and
stop accepting deposits from correspondent banks. Critically undercapitalized
depository institutions are subject to the appointment of a receiver or
conservator, generally within 90 days of the date such institution is determined
to be critically undercapitalized.
As
of
December 31, 2007, the Company and the Bank were deemed to be “well
capitalized”. For more information regarding the capital condition of the
Company and the Bank, see Item 7 of Part II of this annual report under the
caption “Capital”.
Limitations
on Dividends
Holders
of shares of the Company’s common stock are entitled to dividends if, when, and
as declared by the Company’s Board of Directors out of funds legally available
for that purpose, and the Board’s ability to declare dividends is subject to
certain restrictions imposed under federal banking law and state banking and
corporate law. These restrictions are discussed in more detail below in Item
1A
of Part I of this report under the caption “The Company’s ability to pay
dividends is limited”.
USA
PATRIOT Act
Congress
adopted the USA PATRIOT Act (the “Patriot Act”) on October 26, 2001 in response
to the terrorist attacks that occurred on September 11, 2001. Under the Patriot
Act, certain financial institutions, including banks, are required to maintain
and prepare additional records and reports that are designed to assist the
government’s efforts to combat terrorism. The Patriot Act includes sweeping
anti-money laundering and financial transparency laws and required additional
regulations, including, among other things, standards for verifying client
identification when opening an account and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
Federal
Securities Laws
The
shares of the Company’s common stock are registered with the Securities and
Exchange Commission (the
“SEC”) under Section 12(g) of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Company is
subject to information reporting requirements, proxy solicitation requirements,
insider trading restrictions and other requirements of the Exchange Act,
including the requirements imposed under the federal Sarbanes-Oxley Act of
2002.
Among other things, loans to and other transactions with insiders are subject
to
restrictions and heightened disclosure, directors and certain committees
of the
Board must satisfy certain independence requirements, and the Company is
required to comply with certain corporate governance
requirements.
Governmental
Monetary and Credit Policies and Economic Controls
The
earnings and growth of the banking industry and ultimately of the Bank are
affected by the monetary and credit policies of governmental authorities,
including the FRB. An important function of the FRB is to regulate the national
supply of bank credit in order to control recessionary and inflationary
pressures. Among the instruments of monetary policy used by the FRB to implement
these objectives are open market operations in U.S. Government securities,
changes in the federal funds rate, changes in the discount rate of member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth of
bank
loans, investments and deposits and may also affect interest rates charged
on
loans or paid for deposits. The monetary policies of the FRB authorities have
had a significant effect on the operating results of commercial banks in the
past and are expected to continue to have such an effect in the future. In
view
of changing conditions in the national economy and in the money markets, as
well
as the effect of actions by monetary and fiscal authorities, including the
FRB,
no prediction can be made as to possible future changes in interest rates,
deposit levels, loan demand or their effect on the business and earnings of
the
Company and its subsidiaries.
Item
1A.
Risk
Factors.
The
following factors should be considered carefully in evaluating an investment
in
shares of common stock of the Company.
Risks
Relating to the Business of the Company and its Affiliates
The
Company’s future depends on the successful growth of its
Affiliates
The
Company’s primary business activity for the foreseeable future will be to act as
the holding company of the Bank and the Insurance Subsidiary. Therefore, the
Company’s future profitability will depend on the success and growth of these
subsidiaries. In the future, part of the Company’s growth may come from buying
other banks and buying or establishing other companies. Such entities may not
be
profitable after they are purchased or established, and they may lose money,
particularly at first. A new bank or company may bring with it unexpected
liabilities, bad loans, or bad employee relations, or the new bank or company
may lose customers.
The
majority of our business is concentrated in Maryland; a significant amount
of
our business is concentrated in real estate lending.
Because
most of our loans are made to customers who reside on Maryland’s upper Eastern
Shore, a decline in local economic conditions may have a greater effect on
our
earnings and capital than on the earnings and capital of larger financial
institutions whose loan portfolios are geographically diverse. Further, we
make
many real estate secured loans, including construction and land development
loans, all of which are in greater demand when interest rates are low and
economic conditions are good. There can be no guarantee that good economic
conditions or low interest rates will continue to exist. Moreover, the market
values of the real estate securing our loans may deteriorate due to a number
of
unpredictable factors, which could cause us to lose money in the event a
borrower failed to repay a loan and we were forced to foreclose on the property.
Additionally, the FRB and the FDIC, along with the other federal banking
regulators, issued final guidance on December 6, 2006 entitled “Concentrations
in Commercial Real Estate Lending, Sound Risk Management Practices” directed at
institutions that have particularly high concentrations of commercial real
estate loans within their lending portfolios. This guidance suggests that
institutions whose commercial real estate loans exceed certain percentages
of
capital should implement heightened risk management practices appropriate to
their concentration
risk and may be required to
maintain
higher capital ratios than institutions with lower concentrations in commercial
real estate lending. Based on our commercial real estate concentration as
of
December 31, 2007, we may be subject to further supervisory analysis during
future examinations. Although we continuously evaluate our concentration
and
risk management strategies, we cannot guarantee that any risk management
practices we implement will be effective to prevent losses relating to our
commercial real estate portfolio. Management cannot predict the extent to
which
this guidance will impact our operations or capital
requirements.
The
Bank may experience loan losses in excess of its
allowance.
The
risk
of credit losses on loans varies with, among other things, general economic
conditions, the type of loan being made, the creditworthiness of the borrower
over the term of the loan and, in the case of a collateralized loan, the value
and marketability of the collateral for the loan. Management maintains an
allowance for loan losses based upon, among other things, historical experience,
an evaluation of economic conditions and regular reviews of delinquencies and
loan portfolio quality. Based upon such factors, management makes various
assumptions and judgments about the ultimate collectability of the loan
portfolio and provides an allowance for loan losses based upon a percentage
of
the outstanding balances and for specific loans when their ultimate
collectability is considered questionable. If management's assumptions and
judgments prove to be incorrect and the allowance for loan losses is inadequate
to absorb future losses, or if the bank regulatory authorities require us to
increase the allowance for loan losses as a part of its examination process,
our
earnings and capital could be significantly and adversely affected. Although
management uses the best information available to make determinations with
respect to the allowance for loan losses, future adjustments may be necessary
if
economic conditions differ substantially from the assumptions used or adverse
developments arise with respect to our non-performing or performing loans.
Material additions to the allowance for loan losses would result in a decrease
in our net income and capital, and could have a material adverse effect on
our
financial condition.
Interest
rates and other economic conditions will impact our results of
operations.
Our
results of operations may be materially and adversely affected by changes in
prevailing economic conditions, including declines in real estate values, rapid
changes in interest rates and the monetary and fiscal policies of the federal
government. Our profitability is in part a function of the spread between the
interest rates earned on assets and the interest rates paid on deposits and
other interest-bearing liabilities (
i.e.
,
net
interest income), including advances from the Federal Home Loan Bank. Interest
rate risk arises from mismatches (
i.e.
,
the
interest sensitivity gap) between the dollar amount of repricing or maturing
assets and liabilities and is measured in terms of the ratio of the interest
rate sensitivity gap to total assets. More assets repricing or maturing than
liabilities over a given time period is considered asset-sensitive and is
reflected as a positive gap, and more liabilities repricing or maturing than
assets over a given time period is considered liability-sensitive and is
reflected as negative gap. An asset-sensitive position (
i.e.
,
a
positive gap) could enhance earnings in a rising interest rate environment
and
could negatively impact earnings in a falling interest rate environment, while
a
liability-sensitive position (
i.e.
,
a
negative gap) could enhance earnings in a falling interest rate environment
and
negatively impact earnings in a rising interest rate environment. Fluctuations
in interest rates are not predictable or controllable. We have attempted to
structure our asset and liability management strategies to mitigate the impact
on net interest income of changes in market interest rates, but there can be
no
assurance that these attempts will be successful in the event of such
changes.
The
market value of our investments could decline.
As
of
December 31, 2007, we had classified 27.89% of our investment securities as
available-for-sale pursuant to Statement of Financial Accounting Standards
No.
115 (“SFAS 115”) relating to accounting for investments. SFAS 115 requires that
the available-for-sale portfolio be “marked to market” and that unrealized gains
and losses be reflected as a separate item in stockholders’ equity (net of tax)
as accumulated other comprehensive income. The remaining investment securities
are classified as held-to-maturity in accordance with SFAS 115, and are stated
at amortized cost.
In
the
past, gains on sales of investment securities have not been a significant source
of income for us. There can be no assurance that future market performance
of
our investment portfolio will enable us to realize income from sales of
securities. Stockholders’ equity will continue to reflect the unrealized gains
and losses (net of tax) of these investments. There can be no assurance that
the
market value of our investment portfolio will not decline, causing a
corresponding decline in stockholders’ equity.
Management
believes that several factors will affect the market values of our investment
portfolio. These include, but are not limited to, changes in interest rates
or
expectations of changes, the degree of volatility in the securities markets,
inflation rates or expectations of inflation and the slope of the interest
rate
yield curve (the yield curve refers to the differences between shorter-term
and
longer-term interest rates; a positively sloped yield curve means shorter-term
rates are lower than longer-term rates). Also, the passage of time will affect
the market values of our investment securities, in that the closer they are
to
maturing, the closer the market price should be to par value. These and other
factors may impact specific categories of the portfolio differently, and
management cannot predict the effect these factors may have on any specific
category.
We
operate in a competitive environment.
We
operate in a competitive environment, competing for loans, deposits, insurance
products and customers with commercial banks, savings associations and other
financial entities. Competition for deposits comes primarily from other
commercial banks, savings associations, credit unions, money market and mutual
funds and other investment alternatives. Competition for loans comes primarily
from other commercial banks, savings associations, mortgage banking firms,
credit unions and other financial intermediaries. Competition for other
products, such as insurance and securities products, comes from other banks,
securities and brokerage companies, insurance companies, insurance agents and
brokers, and other nonbank financial service providers in our market areas.
Many
of these competitors are much larger in terms of total assets and
capitalization, have greater access to capital markets, and/or offer a broader
range of financial services than those offered by us. In addition, banks with
a
larger capitalization and financial intermediaries not subject to bank
regulatory restrictions have larger lending limits and are thereby able to
serve
the needs of larger customers. Our growth and profitability will depend upon
our
ability to attract and retain skilled managerial, marketing and technical
personnel. Competition for qualified personnel in the financial services
industry is intense, and there can be no assurance that we will be successful
in
attracting and retaining such personnel.
In
addition, current banking laws facilitate interstate branching, merger activity
among banks, and expanded activities. Since September 1995, certain bank holding
companies have been authorized to acquire banks throughout the United States.
Since June 1, 1997, certain banks have been permitted to merge with banks
organized under the laws of different states. As a result, interstate banking
is
now an accepted element of competition in the banking industry and the
Corporation may be brought into competition with institutions with which it
does
not presently compete. Moreover, as discussed above, the GLBA revised the BHC
Act in 2000 and repealed the affiliation provisions of the Glass-Steagall Act
of
1933, which, taken together, limited the securities, insurance and other
non-banking activities of any company that controls an FDIC-insured financial
institution. These laws may increase the competition we face in our market
areas
in the future, although management cannot predict the degree to which such
competition will impact our financial condition or results of
operations.
The
banking industry is heavily regulated; significant regulatory changes could
adversely affect our operations.
Our
operations will be impacted by current and future legislation and by the
policies established from time to time by various federal and state regulatory
authorities. The Company is subject to supervision by the FRB and the Bank
is
subject to supervision and periodic examination by the Maryland Commissioner
and
the FDIC. Banking regulations, designed primarily for the safety of depositors,
may limit a financial institution's growth and the return to its investors
by
restricting such activities as the payment of dividends, mergers with or
acquisitions by other institutions, investments, loans and interest rates,
interest rates paid on deposits, expansion of branch offices, and the offering
of securities or trust services. The Company and the Bank are also subject
to
capitalization guidelines established by federal law and could be subject to
enforcement actions to the extent that either is found by regulatory examiners
to be undercapitalized. It is not
possible to predict what changes,
if
any, will be made to existing federal and state legislation and regulations
or
the effect that such changes may have on our future business and earnings
prospects. Management also cannot predict the nature or the extent of the
effect
on our business and earnings of future fiscal or monetary policies, economic
controls, or new federal or state legislation. Further, the cost of compliance
with regulatory requirements may adversely affect our ability to operate
profitably.
The
loss of key personnel could disrupt our operations and result in reduced
earnings.
Our
growth and profitability will depend upon our ability to attract and retain
skilled managerial, marketing and technical personnel. Competition for qualified
personnel in the financial services industry is intense, and there can be no
assurance that we will be successful in attracting and retaining such personnel.
Our current executive officers provide valuable services based on their many
years of experience and in-depth knowledge of the banking industry and our
market area. Due to the intense competition for financial professionals, these
key personnel would be difficult to replace and an unexpected loss of their
services could result in a disruption to the continuity of operations and a
possible reduction in earnings.
We
may be adversely affected by recent legislation.
As
discussed above, the GLBA repealed restrictions on banks affiliating with
securities firms and permits bank holding companies that become financial
holding companies to engage in additional financial activities, including
insurance and securities underwriting and agency activities, merchant banking,
and insurance company portfolio investment activities that are currently not
permitted for bank holding companies. Although the Company is a financial
holding company, this law may increase the competition we face from larger
banks
and other companies. It is not possible to predict the full effect that this
law
will have on us.
The
Sarbanes-Oxley Act of 2002 requires management of publicly-traded companies
to
perform an annual assessment of their internal control over financial reporting
and to report on whether the system is effective as of the end of the Company’s
fiscal year. Disclosure of significant deficiencies or material weaknesses
in
internal controls could cause an unfavorable impact to stockholder value by
affecting the market value of our stock.
The
Patriot Act reinforced the importance of implementing and following procedures
required by the Bank Secrecy Act and money laundering issues. Non-compliance
with this act or failure to file timely and accurate documentation could expose
the Company to adverse publicity as well as fines and penalties assessed by
regulatory agencies.
Periodically,
the federal and state legislatures consider bills with respect to the regulation
of financial institutions. Some of these proposals could significantly change
the regulation of banks and the financial services industry. We cannot predict
whether such proposals will be adopted or the impact on our business, earnings
or operations of such future legislation.
We
may be subject to claims and the costs of defensive
actions.
Our
customers may sue us for losses due to alleged breaches of fiduciary duties,
errors and omissions of employees, officers and agents, incomplete
documentation, our failure to comply with applicable laws and regulations,
or
many other reasons. Also, our employees may knowingly or unknowingly violate
laws and regulations. Management may not be aware of any violations until after
their occurrence. This lack of knowledge may not insulate us from liability.
Claims and legal actions may result in legal expenses and liabilities that
may
reduce our profitability and hurt our financial condition.
We
may not be able to keep pace with developments in
technology.
We
use
various technologies in conducting our businesses, including telecommunication,
data processing, computers, automation, internet-based banking, and debit cards.
Technology changes rapidly. Our ability to compete successfully with other
financial institutions may depend on whether we can exploit technological
changes. We may not be able to exploit technological changes, and any investment
we do make may not make us more profitable.
Risks
Related to the Company’s Common Stock
The
Company’s ability to pay dividends is limited.
The
Company’s stockholders are entitled to dividends on their shares of common stock
if, when, and as declared by the Company’s Board of Directors out of funds
legally available for that purpose. The Company’s ability to pay dividends to
stockholders is largely dependent upon the receipt of dividends from the Bank.
Both federal and state laws impose restrictions on the ability of the Bank
to
pay dividends. Federal law prohibits the payment of a dividend by an insured
depository institution if the depository institution is considered
“undercapitalized” or if the payment of the dividend would make the institution
“undercapitalized”. For a Maryland state-chartered bank, dividends may be paid
out of undivided profits or, with the prior approval of the Maryland
Commissioner, from surplus in excess of 100% of required capital stock. If,
however, the surplus of a Maryland bank is less than 100% of its required
capital stock, then cash dividends may not be paid in excess of 90% of net
earnings. In addition to these specific restrictions, bank regulatory agencies
also have the ability to prohibit proposed dividends by a financial institution
that would otherwise be permitted under applicable regulations if the regulatory
body determines that such distribution would constitute an unsafe or unsound
practice. Because of these limitations, there can be no guarantee that the
Company’s Board will declare dividends in any fiscal quarter.
Shares
of the Company’s common stock are not insured
Investments
in shares of the Company’s common stock are not deposits and are not insured
against loss by the government.
Shares
of the Company’s common stock are not heavily traded
There
is
no established trading market for the shares of common stock of the Company,
and
transactions are infrequent and privately negotiated by the buyer and seller
in
each case. Management cannot predict the extent to which an active public market
for these securities will develop or be sustained in the future. Securities
that
are not heavily traded can be more volatile than stock trading in an active
public market. Factors such as our financial results, the introduction of new
products and services by us or our competitors, and various factors affecting
the banking industry generally may have a significant impact on the market
price
of our common stock. In recent years, the stock market has experienced a high
level of price and volume volatility, and market prices for the securities
of
many companies have experienced wide price fluctuations that have not
necessarily been related to their operating performance. Accordingly, the
Company’s stockholders may not be able to sell their shares at the volumes,
prices, or times that they desire.