Notes To Consolidated Financial Statements
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The accounting and reporting policies of Columbia Bancorp and subsidiary (the "Company") conform to generally accepted accounting principles.The following is a description of the more significant of these policies:
Organization
The Company was formed November 16, 1987 and is a Maryland corporation chartered as a bank
holding company. The Company holds all the issued and outstanding shares of common stock of The
Columbia Bank (the "Bank").The Bank is a Maryland trust company which engages in general commercial
banking operations. Deposits in the Bank are insured by the Federal Deposit Insurance Corporation.
The Bank provides comprehensive and service-intensive commercial and retail banking services to indi-viduals and small and medium-sized businesses. Services offered by the Bank include a variety of loans and a broad spectrum of commercial and consumer financial services.
Basis of presentation
The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported amounts of assets and lia-bilities
and disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.
Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for credit losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for credit losses and other real estate owned, management prepares fair value analyses and obtains independent appraisals as necessary. Management believes that the allowance for credit losses is sufficient to address the risks in the current loan portfolio. While management uses available information to recognize losses on loans and other real estate owned, future additions to the allowances may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowances for credit losses and other real estate owned. Such agen-cies may require the Bank to recognize additions to the allowances based on their judgments about infor-mation available to them at the time of their examinations.
All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.
Certain amounts for 1996 and 1995 have been reclassified to conform to the presentation for 1997.
Investment securities
The Company classifies its debt securities as trading securities, investment securities or securities avail-able-
for-sale. The Company has no trading securities. Investment securities are securities which the
Company has the intent and ability to hold until maturity. All other securities are classified as securities
available-for-sale. Investment securities are recorded at cost, adjusted for amortization of premium and
accretion of discount. Securities available-for-sale are recorded at their fair value and unrealized holding
gains or losses, net of the related tax effect, are excluded from earnings and reported as a separate compo-nent
of stockholders'equity until realized.Transfers of securities between categories are recorded at fair
value on the date of the transfer. The unrealized holding gains or losses included as a separate component of
stockholders'equity at the time of a transfer of securities from securities available-for-sale to investment
securities are amortized into earnings over the remaining life of the security as an adjustment to yield.
A decline in the market value of any security which is deemed other than temporary is charged to earnings, resulting in a new cost basis for the security. Gains and losses on sales of securities are determined on a specific identification basis; purchases and sales of securities are recognized on a trade-date basis.
Federal funds sold
Federal funds sold are carried at cost which approximates market and are generally sold for one-day
periods.
Residential mortgage loans originated for sale
Residential mortgage loans originated for sale are carried at the lower of cost or the committed sale
price, determined on an individual basis.
Loans receivable
Loans are stated at the amount of unpaid principal reduced by unearned income and the allowance for
credit losses. Unearned income consists of commitment and origination fees, net of origination costs. Loans
are placed in 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 principal and interest is in doubt. Management may grant a
waiver from nonaccrual status for a 90-day past-due loan which is both well secured and in the process of
collection. A loan remains in 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 determined to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is not considered impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest past-due. The Company generally considers a period of delay in payment to include delinquency up to 90 days.
In accordance with SFAS No. 114,"Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114") and SFAS No. 118,"Accounting by Creditors for Impairment of a LoanÑIncome Recognition and Disclosures" ("SFAS No. 118"), the Company measures impairment (i) at the present value of expected cash flows discounted at the loan's effective interest rate; (ii) at the observable market price; or (iii) at the fair value of the collateral if the loan is collateral dependent. If the measure of the impaired loan is less than the recorded investment in the loan, an impairment is recognized through a valuation allowance and corre-sponding provision for credit losses. SFAS No. 114 does not apply to larger groups of smaller-balance homogeneous loans such as consumer installment, residential first and second mortgage loans and credit card loans.These loans are collectively evaluated for impairment.The Company's impaired loans are there-fore comprised primarily of commercial loans, including commercial mortgage loans, and real estate devel-opment and construction loans. In addition, impaired loans are generally loans which management has placed in nonaccrual status.
The allocated valuation allowance, if any, is included in the Company's allowance for credit losses. An impaired loan is charged-off when the loan, or a portion thereof, is considered uncollectible.
The Company recognizes interest income for impaired loans consistent with its method for nonaccrual loans. Specifically, interest payments received are recognized as interest income or, if the ultimate collectibil-ity of principal is in doubt, are applied to principal.
Real estate properties acquired in satisfaction of loans
Real estate properties acquired in satisfaction of loans are reported in other real estate owned and are
recorded at the lower of cost or estimated fair value on their acquisition dates and at the lower of such ini-tial
amount or estimated fair value less selling costs thereafter. Subsequent write-downs are included in
noninterest expense, along with operating income net of related expenses of such properties and gains or
losses realized upon disposition.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation
and amortization are charged to operating expenses. Depreciation generally is computed on the straight-line
basis over the estimated useful lives of the assets. Leasehold improvements are generally amortized over the lesser of the terms of the related leases or the lives of the assets. Maintenance and repairs are expensed
as incurred.
Depreciation and amortization amounts are adjusted, if appropriate, at the time an asset is retired. Any gain or loss on the sale of an asset is treated as an adjustment to the basis of its replacement, if traded in, or as an income or expense item if sold. Leases are accounted for as operating leases since none meet the cri-teria for capitalization.
Income taxes The Company and its subsidiary file a consolidated federal income tax return. Deferred income taxes are recognized for the tax consequences of temporary differences between financial statement carrying amounts and the tax bases of assets and liabilities. Deferred income taxes are provided on income and expense items when they are reported for financial statement purposes in periods different from the periods in which these items are recognized in the income tax returns. Deferred tax assets are recognized only to the extent that it is more likely than not that such amounts will be realized based upon consideration of available evi-dence, including tax planning strategies and other factors.
Net income per common share The Company adopted SFAS No. 128,"Earnings per Share" ("SFAS No. 128") in 1997 and, as required by the Statement, earnings per share ("EPS") data presented for prior periods have been restated to con-form to the new standard.
In accordance with the provisions of SFAS No. 128, basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding. Diluted EPS is computed after adjusting the numerator and denominator of the basic EPS computation for the effects of all potentially dilutive common shares outstanding during the period.The dilutive effects of options and warrants, discussed in notes 12 and 13, and their equivalents are computed using the "treasury stock" method.
Information relating to the calculations of earnings per common share is summarized as follows:
Stock-based compensation
The Company uses the intrinsic value method to account for stock-based employee compensation
plans. Under this method, compensation cost is recognized for awards of shares of common stock to
employees only if the quoted market price of the stock at the grant date (or other measurement date, if
later) is greater than the amount the employee must pay to acquire the stock. Information concerning the
pro forma effects of using an optional fair value-based method to account for stock-based employee com-pensation
plans is provided in note 11.
Statements of cash flows
For purposes of the Consolidated Statements of Cash Flows, cash and cash equivalents include cash and
due from banks and federal funds sold.
The Bank is required by the Federal Reserve System to maintain certain cash reserve balances based principally on deposit liabilities. At December 31, 1997 and 1996, the required reserve balances were $3,310,000 and $3,669,000, respectively.
The Bank is also required to maintain a compensating balance with the servicer of its credit card opera-tion. The balance is calculated periodically based upon activity. At December 31, 1997 and 1996, the required compensating balances were $110,440 and $85,680, respectively.
The amortized cost and estimated fair values of investment securities and securities available-for-sale at December 31, 1997 were as follows:
The amortized cost and estimated fair values of investment securities and securities available-for-sale at December 31, 1996 were as follows:
The amortized cost and estimated fair values of nonequity investment securities and securities available-for- sale at December 31, 1997 and 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
There were no sales of investment securities or securities available-for-sale during 1997 or 1996. At December 31, 1997, investment securities and securities available-for-sale with an aggregate book value and fair value of $11,649,553 and $11,680,711, respectively, were pledged as collateral, primarily for short term borrowings.
Nonperforming assets and loans past-due 90 days or more but not in nonaccrual status were as follows at December 31:
An analysis of the allowance for credit losses is summarized as follows for the years ended December 31:
The Bank has made loans to certain of its executive officers and directors. These loans were made on substantially the same terms, including interest rate and collateral requirements, as those prevailing at the time for comparable transactions with unrelated customers. The following schedule summarizes changes in amounts of loans outstanding to current executive officers and directors during 1997:
| Balance at January 1, 1997 | $2,258,648 |
| Additions | 2,749,842 |
| Repayments | (1,593,254) |
| Balance at December 31, 1997 | $3,415,236 |
The Bank has issued letters of credit totalling $5,845 at December 31, 1997 and 1996 on behalf of par-ties related to directors of the Company. At December 31, 1997 and 1996, all of the letters of credit were collateralized by deposits with the Bank.
During 1996 and 1995, the Bank paid $9,000 and $149,870, respectively, to companies controlled by two directors for assistance with the disposition of other real estate owned, primarily residential building lots. The payments represented sales commissions, reimbursement of marketing expenses, and management fees, exclusive of costs to build.
Other real estate owned was $4,621,873 and $447,550 at December 31, 1997 and 1996, respectively. Net expense on other real estate owned for the years ended December 31 was:
Property and equipment consisted of the following at December 31:
Prepaid expenses and other assets consisted of the following at December 31:
The Company occupies office space under lease agreements which are recorded as operating leases. A summary of the noncancellable long-term commitment is as follows at December 31, 1997:
The lease amounts represent minimum rentals, excluding property taxes, operating expenses or percent-age rent which the Company may be obligated to pay. Rental expense was $843,967, $621,782 and $350,798 in 1997, 1996, and 1995, respectively.
The Company utilizes a third party servicer to provide data processing services under terms of an agree-ment which expires in October 2004. Data processing costs are based upon account and transaction volume and currently approximate $50,000 monthly.
The Company is also party to legal actions which are routine and incidental to its business. In manage-ment's opinion, the outcome of these matters will not have a material effect on the financial statements of the Company.
The Company is party to financial instruments with off-balance-sheet risk in the normal course of busi-ness in order to meet the financing needs of customers. These financial instruments include commitments to extend credit, available credit lines and standby letters of credit.
Credit risk is the possibility of sustaining a loss in the event of nonperformance by the other party to commitments to extend credit and standby letters of credit.The Company's exposure to credit risk is repre-sented by the contractual amounts of those financial instruments.The Company applies the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. A summary of the financial instruments with off-balance-sheet credit risk at December 31 is as follows:
The Company evaluates the creditworthiness of each customer on an individual basis.The amount of collateral obtained, if deemed necessary, upon the extension of credit is based on management's evaluation of the counterparty. Collateral obtained varies but may include: accounts receivable; inventory; property, plant and equipment; deposits held in financial institutions; other marketable securities; residential real estate; and, income producing commercial properties.
Commitments to extend credit are agreements to extend credit to a customer so long as there is no vio-lation of any contractual condition. Commitments generally have fixed expiration dates or other termina-tion clauses and may require payment of a fee. Historically, many of the commercial and retail commit-ments expire without being fully drawn, and the total commitment amounts therefore do not necessarily represent future cash requirements. Real estate development and construction commitments represent advances to be made based on established draw schedules. Due to the short-term nature and rapid turnover of the real estate development and construction portfolio, cash requirements are generally satisfied by prin-cipal repayments from sales of properties being financed.
Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. Credit lines generally have fixed expiration dates or other termination clauses. Since many of the credit lines are expected to expire without being fully drawn, the available amounts do not necessarily represent future cash requirements. Available commercial and residential construction credit lines generally do not extend for more than 18 months. Second mortgages and home equity credit lines generally extend for a period of 15 years and are reviewed annually.
Standby letters of credit are conditional commitments issued by the Company to guarantee the perfor-mance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. It is not likely that the letters of credit will be called because they principally guarantee the completion of development and construction work to be funded, subsequent to inspection, by scheduled loan advances issued by the Company on related loans. Limited recourse on mortgage loans sold relates to contractual provisions under which the Company may be required to repurchase such loans sold in the normal course of business which fail to perform in accor-dance with the provisions of the related mortgages during a specified period (generally the first six months or less). Management believes these arrangements represent insignificant exposure to the Company.
A concentration of credit risk exists with borrowers whose principal occupation is residential real estate development and/or construction. Loans, unused credit lines, and letters of credit to such borrowers totalled approximately $94.9 million, $55.2 million, and $13.8 million, respectively at December 31, 1997. Generally, these extensions of credit are secured by the real estate under development and/or construction. Management believes that its underwriting practices, specifically collateral requirements, mitigate exposure to the Company.
Profit Sharing Plan
Retirement benefits are provided to employees meeting certain age and service eligibility requirements
through a profit sharing plan with a cash or deferral arrangement qualifying under Section 401(k).
Matching contributions made by the Company totalled $151,073 in 1997, $130,192 in 1996 and $101,020
in 1995.
Deferred Compensation Plan
The Company has a nonqualified deferred compensation arrangement for selected senior officers.
Amounts paid under this plan will be partially or fully recovered through single premium life insurance
policies purchased on the lives of the participants.The Company's matching contribution and interest cred-ited
to participant accounts totalled $83,379 in 1997 and $31,796 in 1996.
Stock Option Plans
The Company has stock option award arrangements which provide for the granting of options to
acquire common stock to founders, directors and key employees. Option prices are equal to or greater than
the market price of the common stock at the date of the grant. Employee options generally are not exercis-able
prior to one year from the date of grant.Thereafter, employee options are generally exercisable to the
extent of 25%, 50%, 75% and 100% after one, two, three and four years, respectively, from the date of grant.
Founder and director options may be exercised at any time after the date of grant. Options expire ten years
after the date of grant.
Information with respect to stock options is as follows for the years ended December 31:
A summary of information about stock options outstanding at December 31, 1997 is as follows:
At December 31, 1997 and 1996, options to purchase 80,200 and 144,809 shares, respectively, were exercisable at weighted average prices of $9.77 and $9.48, respectively. The per share weighted average fair value of options granted during 1997 was $13.51.This value was estimated using the Black-Scholes option pricing model and the following assumptions:
The option price was equal to the market price of the common stock at the date of grant for all options granted in 1997 and, accordingly, no compensation expense related to options was recognized. If the Company had applied a fair value-based method to recognize compensation cost for the options granted, net income and net income per share would have been changed to the following pro forma amounts for the year ended December 31, 1997:
Warrants to acquire 68,000 shares and 75,900 shares of common stock at $9.09 per share were outstand-ing and exercisable at December 31, 1997 and 1996, respectively.
The provision for income taxes was composed of the following for the years ended December 31:
The types of temporary differences that give rise to significant portions of the net deferred tax asset were as follows at December 31:
A reconciliation between the provision for income taxes and the amount computed by multiplying income before income taxes by the federal income tax rate of 34% is as follows for the years ended December 31:
Short-term borrowings consist of short-term promissory notes issued to certain qualified investors and borrowings from the FHLB. The short-term promissory notes are in the form of commercial paper, which reprice daily and have maturities of 270 days or less. Borrowings from the FHLB reprice daily, have maturi-ties of one year or less and may be prepaid without penalty. Information with respect to short-term bor-rowings is as follows at December 31:
Net occupancy expense is comprised of the following for the years ended December 31:
Other expense is comprised of the following for the years ended December 31:
(a) No single item included in this category exceeded one percent of total income.
As a depository institution whose deposits are insured by the FDIC, the Bank may not pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Bank currently is not in default under any of its obligations to the FDIC. As a commercial bank under the Maryland Financial Institution Law, the Bank may declare cash dividends from undivided profits or, with the prior approval of the Commissioner of Financial Regulation, out of surplus in excess of 100% of its required capital stock, and after providing for due or accrued expenses, losses, interest and taxes.
The Company and the Bank, in declaring and paying dividends, are also limited insofar as minimum capital requirements of regulatory authorities must be maintained.The Company and the Bank comply with such capital requirements.
Dividends declared per share on the Company's common stock were $.50, $.42 and $.25 for the years ended December 31, 1997, 1996 and 1995, respectively. Dividends declared per share on the Company's Series A preferred stock were $1.30 for the year ended December 31, 1995.
On December 18, 1997, the Board of Directors of the Bank authorized a cash dividend of $308,000 to be paid to the Company on January 16, 1998. In addition, on December 18, 1997, the Board of Directors of the Company declared a $.14 per share cash dividend to shareholders of common stock of record on January 5, 1998, payable January 16, 1998.
The Company and Bank are subject to various regulatory capital requirements administered by the fed-eral banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting procedures. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 1997, that the Bank meets all capital adequacy require-ments to which it is subject. As of December 31, 1997, the most recent notification from the FDIC catego-rized the Bank as "well capitalized" under the regulatory framework for prompt corrective action.There are no conditions or events since that notification that management believes would change the Bank's category.
Regulatory capital amounts and ratios for the Company and the Bank at December 31 were:
The following methods and assumptions were used to estimate the fair value of each class of financial instrument.
Cash and due from banks
The carrying amount of cash and due from banks is a reasonable estimate of fair value.
Federal funds sold
The carrying amount of federal funds sold is a reasonable estimate of fair value.
Investment securities and securities available-for-sale
The fair value of securities held as investment and securities available-for-sale is based upon quoted mar-ket
prices or dealer quotes.
Residential mortgage loans originated for sale
The carrying amounts of residential mortgage loans originated for sale are reasonable estimates of fair
value.
Loans receivable
The fair value of loans receivable is estimated by discounting future cash flows using current rates for
which similar loans would be made to borrowers with similar credit history and remaining maturities.
Deposit liabilities
The fair value of demand deposits and savings accounts is the amount payable on demand at December
31, 1997.The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered
for deposits of similar remaining maturities.
Short-term borrowings
The carrying amount of short-term borrowings is a reasonable estimate of fair value.
Commitments to extend credit, standby letters of credit, and financial guarantees written The Company charges fees for commitments to extend credit. Interest rates on commitments to extend credit are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments. The estimated fair values of the Company's financial instruments at December 31 were as follows:
The following is financial information of Columbia Bancorp at and for the years ended December 31 (parent company only):
