United
States
Securities
and Exchange Commission
Washington,
D.C. 20549
Form
10-K
(Mark
One)
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[X]
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the fiscal year ended December 31,
2007
[
] TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period
fromto
Commission
File Number 000-51765
Bay National
Corporation
(Exact
name of registrant as specified in its charter)
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Maryland
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52-2176710
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(State
or other jurisdiction of
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(I.R.S.
Employer
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incorporation
or organization)
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Identification
No.)
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2328 West Joppa Road, Lutherville,
Maryland
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21093
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant's telephone
number, including area code: 410-494-2580
Securities
registered pursuant to Section 12(b) of the Act:
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Title
of each class
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Name
of each exchange on which registered
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Common
stock, par value $0.01 per share
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The
Nasdaq Stock Market LLC
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Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by checkmark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes__No X
Indicate
by checkmark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the
Act. Yes __ No X
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Indicate
by checkmark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
__
Indicate
by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. ____
Indicate
by checkmark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
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Large
accelerated filer ____
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Accelerated
filer ____
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Non-accelerated
filer ____ (Do not check if a smaller reporting company)
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Smaller
reporting company _X__
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act):
Yes __ No X
The aggregate market value of the
common equity held by non-affiliates was $25,637,666 as of June 29, 2007, based
on a sales price of $16.53 per share of Common Stock, which is the sales price
at which shares of Common Stock were last sold on the Nasdaq Stock Market on
June 29, 2007.
The
number of shares outstanding of the registrant's Common Stock was 2,140,933 as
of March 25, 2008.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the Proxy Statement for the 2008 Annual Meeting of Stockholders of Bay
National Corporation, to be filed with the Securities and Exchange Commission no
later than 120 days after the close of the fiscal year, are incorporated by
reference in Part III of this Annual Report on Form 10-K.
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PART
I
Item
1. Description of Business
BUSINESS
OF BAY NATIONAL CORPORATION AND BAY NATIONAL BANK
General
Bay
National Corporation was incorporated under the laws of the State of Maryland on
June 3, 1999, primarily to serve as a bank holding company for a proposed
federally chartered commercial bank to be named Bay National Bank.
Bay
National Bank commenced operations on May 12, 2000 with its main office in
Lutherville, Maryland and a branch office in Salisbury,
Maryland. Subsequently, it has added residential lending offices
located in Salisbury, Maryland and Towson, Maryland and, in December 2007, a
loan production office located in Columbia, Maryland. Bay National
Bank accepts checking and savings deposits and offers a wide range of commercial
and industrial, real estate, consumer and residential mortgage
loans.
On
December 12, 2005, Bay National Corporation consummated the sale of a trust
preferred securities offering in which it issued $8,248,000 of subordinated debt
securities due 2036 to Bay National Capital Trust I, a Delaware statutory trust
(the “Trust”) and an unconsolidated subsidiary formed by Bay National
Corporation, and the Trust simultaneously issued $8,000,000 of trust preferred
securities. The Trust also issued $248,000 of its common securities to Bay
National Corporation. No underwriting commissions were paid in connection with
the issuances. All of the securities were issued in a private placement exempt
from registration under 4(2) of the Securities Act of 1933, as amended and/or
Regulation D promulgated thereunder.
Marketing
Focus
Bay
National Bank was formed by a group of individuals active in business,
professional, banking, financial and charitable activities in the Baltimore,
Maryland metropolitan area and the Eastern Shore of Maryland. These individuals
believed that the banking needs of certain segments of these communities were
not being served adequately by existing banks. Specifically, as a
result of bank mergers in the 1990s, many banks in the Baltimore metropolitan
area and the Eastern Shore of Maryland became local branches of large regional
and national banks. Although size gave the larger banks some advantages in
competing for business from large corporations, including economies of scale and
higher lending limits, the organizers believed that these “mega banks” were
focused on a mass market approach which de-emphasized personal contact and
service. The organizers also believed that the centralization of
decision-making power at these large institutions had resulted in a lack of
customer service. At many of these institutions, determinations were made at the
"home office" by individuals who lacked personal contact with customers as well
as an understanding of the customers' needs and scope of the relationship with
the institution.
Bay
National Bank’s management believes that this trend is ongoing, and continues to
be particularly frustrating to owners of small and mid-sized businesses,
business professionals and high net worth individuals who traditionally have
been accustomed to dealing directly with a bank executive who had an
understanding of their banking needs with the ability to deliver a prompt
response.
Bay
National Bank targets its commercial banking services to small and mid-sized
businesses and targets its retail banking services to the owners of these
businesses and their employees, to business professionals and to high net worth
individuals.
Bay
National Bank seeks to distinguish itself by
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Developing
personal relationships with its
customers.
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Customizing
its products to fit the needs of its customers instead of adopting a "one
size fits all" mentality.
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Streamlining
the decision-making process.
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Offering
its customers additional complementary services, such as insurance and
investment advice, through relationships with strategic
partners.
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Bay
National Bank’s offices are not organized in the traditional retail branch
structure, which is transaction and "bank teller" oriented. Instead, Bay
National Bank emphasizes a "sit-down" model where customers can choose to be
greeted by a personal banker and taken to a private desk. Customers also have
the option to conduct their transactions using a more traditional teller
counter. Management believes that this approach makes service more
individualized and enhances the banker's understanding of the customer's needs.
Furthermore, Bay National Bank’s branch locations do not focus on capturing
every customer within the surrounding area. Instead, they are strategically
located in areas convenient to Bay National Bank’s target customer
base.
Market
Area and Facilities
Bay
National Bank’s headquarters and Baltimore branch office are located at 2328
West Joppa Road, Lutherville, Maryland 21093. Bay National Bank serves the
Baltimore metropolitan area from that location, with its primary service area
being Towson, Lutherville-Timonium, Cockeysville, Hunt Valley, Ruxton and Roland
Park. Bay National Bank’s loan production office at 8820 Columbia 100
Parkway, Columbia, Maryland 21045 primarily serves the Baltimore-Washington
corridor. Bay National Bank’s Salisbury, Maryland branch office is
located at 109 Poplar Hill Avenue, Salisbury, Maryland 21801, from which it
serves Maryland’s Eastern Shore.
Products
and Services
Loan
Portfolio.
Bay
National Bank offers a full range of loans, including commercial and industrial
loans, real estate loans, consumer loans and residential mortgage and home
equity loans. Commercial business and commercial real estate loans for
owner-occupied properties are Bay National Bank's primary loan products,
accounting for approximately 65% of the loan portfolio as of December 31,
2007.
Generally,
Bay National Bank is subject to a lending limit to any one borrower of 15% of
Bay National Bank’s unimpaired capital and surplus. However,
management is able to originate loans and to participate with other lenders with
respect to loans that exceed Bay National Bank's lending limits.
The
following is a description of the types of loans that Bay National Bank has
targeted in building its loan portfolio:
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Commercial
and industrial loans for business purposes including working capital,
equipment purchases, lines of credit and government contract
financing. Asset-based lending and accounts receivable
financing are also available. As of December 31, 2007, these loans
represented approximately 43% of Bay National Bank’s loan portfolio. In
general, Bay National Bank targets small and mid-sized businesses in its
market area with credit needs in the range of up to $5
million.
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Commercial
real estate loans, including mortgage loans on non-residential properties,
and land development and construction loan financing, primarily for
owner-occupied premises as well as
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| first and second mortgage loans on commercially owned residential investment properties. As of December 31, 2007, these loans represented approximately 22% of Bay National Bank’s loan portfolio. |
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Mortgage
loans and residential construction loans secured by residential property,
including first and second mortgage loans on owner occupied and investment
properties (1 to 4 family and multi-family) owned by individuals, and home
equity loans secured by single-family owner-occupied residences. As of
December 31, 2007, these loans represented approximately 33% of Bay
National Bank’s loan portfolio. Like its consumer loans, Bay National
Bank’s residential real estate loans are targeted to business owners and
their employees, business professionals and high net worth
individuals.
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Consumer
loans including automobile and personal loans. In addition, Bay National
Bank offers personal lines of credit. As of December 31, 2007, these loans
represented approximately 2% of Bay National Bank’s loan portfolio. Bay
National Bank’s consumer loans are targeted to business owners and their
employees, business professionals and high net worth
individuals.
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Prior to
2007, Bay National Bank originated some of its Eastern Shore residential
mortgage loans through BNB Mortgage, LLC, a Maryland limited liability company,
which is a joint venture between Bay National Bank and an Ocean City, Maryland
real estate agent. Bay National Bank was responsible for all of the
operations of BNB Mortgage, LLC. Bay National Bank’s share of net income from
this entity amounted to $2,682 for the year ended December 31, 2006. All loans
originated by BNB Mortgage, LLC were immediately sold to Bay National Bank.
These loans were then sold to third party investors in the same fashion as other
conventional first and second residential mortgage loans originated by Bay
National Bank. While recently this joint venture has not been active
due to current market conditions, it is still operational and could potentially
be a source for origination of loans in the future should real estate market
conditions in the area improve.
Bay
National Bank’s conventional first and second residential mortgage loans adhere
to standards developed by FNMA/FHLMC. Bay National Bank sells most of
its first and second residential mortgage loans in the secondary market.
Therefore, management sells those loans that have a lower degree of risk, and a
lower yield, relative to the other types of loans that Bay National Bank makes.
Since these loans are typically sold, Bay National Bank offers these loans as
well as certain residential construction loans to a broader array of individuals
than its home equity loans and other consumer loan products. As of December 31,
2007, mortgage loans held for sale totaled $11.6 million.
Deposits.
Bay
National Bank offers a wide range of interest-bearing and non-interest-bearing
accounts, including commercial and retail checking accounts, money market
accounts, individual retirement accounts, interest-bearing statement savings
accounts and certificates of deposit with fixed and variable rates and a range
of maturity date options.
Other Banking and Financial
Services.
Bay
National Bank offers cash management services such as sweep accounts, repurchase
agreements, commercial paper investments, account reconciliation, lockbox
services and wire transfers of funds to its commercial customers. Additionally,
Bay National Bank makes available telephone banking, ATM/debit cards, safe
keeping boxes, after-hours deposit services, travelers checks, direct deposit of
payroll and automatic drafts for various accounts. These services are provided
either directly by Bay National Bank or through correspondent banking
relationships. Bay National Bank does not have its own network of ATM
machines. In general, Bay National Bank waives fees on a predetermined number of
ATM transactions per month, thereby allowing its customers to use almost any ATM
machine.
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In
addition, Bay National Bank's customers are able to access information about
their accounts and view information about Bay National Bank's services and
products on Bay National Bank's website, which is located at http://www.baynational.com.
Bay National Bank’s website also permits customers to make transfers of funds
among accounts, pay bills, order checks and send e-mail to Bay National Bank
personnel.
Bay
National Bank offers, through strategic partners, investment advisory, risk
management and employee benefit services. Through these affiliations, banking
clients can receive a full range of financial services, including investment
advice, personal and business insurance products and employee benefit products
such as pension and 401(k) plan administration. To the extent permitted by
applicable regulations, the strategic partners may share fees and commissions
with Bay National Bank. As of December 31, 2007, Bay National Bank
had not entered in to any such fee arrangements. When sufficient volume is
developed in any of these lines of business, Bay National Bank may provide these
services if permitted by applicable regulations.
Competition
In both
the Baltimore metropolitan area and on Maryland's Eastern Shore, Bay National
Bank faces strong competition from large banks headquartered within and outside
of Maryland. Bay National Bank also competes with other community
banks, savings and loan associations, credit unions, mortgage companies, finance
companies and others providing financial services. In addition,
insurance companies, securities brokers and other non-bank entities or their
affiliates may provide services, which historically have been considered banking
in nature.
Many of
Bay National Bank’s competitors can finance extensive advertising campaigns,
maintain extensive branch networks and technology investments, and offer
services, which Bay National Bank cannot offer or chooses not to offer. Also,
larger institutions have substantially higher lending limits than Bay National
Bank. Some of Bay National Bank’s competitors have other advantages, such as tax
exemption in the case of credit unions, and less stringent regulation in the
case of mortgage companies and finance companies.
Employees
As of
March 25, 2008, Bay National Bank employed seventy-two
individuals. Forty people operate from Bay National Bank’s
headquarters and banking office in Lutherville, Maryland, ten people operate
from the Towson, Maryland residential lending office, nine people operate from
the Columbia, Maryland loan production office, nine people operate from the
Salisbury, Maryland banking office and four people operate from the Salisbury,
Maryland residential lending office. Bay National Corporation has no
employees.
SUPERVISION
AND REGULATION
General
Bay
National Corporation and Bay National Bank are subject to extensive regulation
under state and federal banking laws and regulations. These laws impose specific
requirements and restrictions on virtually all aspects of operations and
generally are intended to protect depositors, not stockholders. The following
discussion is only a summary and readers should refer to particular statutory
and regulatory provisions for more detailed information. In addition, management
cannot predict the nature or the extent of the effect on our business and
earnings that new federal or state legislation may have in the
future.
Bay
National Corporation
Federal Bank Holding Company
Regulation. Bay National Corporation is a bank holding company
registered under the Bank Holding Company Act of 1956, as amended, and is
subject to supervision by the Federal Reserve Board. As a bank holding company,
Bay National Corporation is required to file with the
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Federal
Reserve Board an annual report and such other additional information as the
Federal Reserve Board may require by statute. The Federal Reserve Board may also
examine Bay National Corporation and each of its subsidiaries.
The
Federal Reserve Board must approve, among other things, the acquisition by a
bank holding company of control of more than 5% of the voting shares, or
substantially all the assets, of any bank or bank holding company or the merger
or consolidation by a bank holding company with another bank holding company.
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(“Reigle-Neil Act”), the restrictions on interstate acquisitions of banks by
bank holding companies were repealed as of September 29, 1995. The effect of the
repeal of these restrictions is that, subject to certain time and deposit base
requirements, Bay National Corporation may acquire a bank located in Maryland or
any other state, and a bank holding company located outside of Maryland can
acquire any Maryland-based bank holding company or bank.
Unless it
chooses to become a financial holding company, as further described below, a
bank holding company is prohibited from acquiring control of voting shares of
any company which is not a bank or bank holding company and from engaging
directly or indirectly in any activity other than banking, or managing or
controlling banks or furnishing services for its authorized
subsidiaries. There are limited exceptions. A bank holding
company may, for example, engage in activities which the Federal Reserve Board
has determined by order or regulation to be so closely related to banking or
managing or controlling banks as to be "properly incident thereto." In making
such a determination, the Federal Reserve Board is required to consider whether
the performance of such activities can reasonably be expected to produce
benefits to the public, such as convenience, increased competition or gains in
efficiency, which outweigh possible adverse effects, such as undue concentration
of resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. The Federal Reserve Board is also empowered to differentiate
between activities commenced de novo and activities commenced by the
acquisition, in whole or in part, of a going concern. Some of the activities
that the Federal Reserve Board has determined by regulation to be closely
related to banking include servicing loans, performing certain data processing
services, acting as a fiduciary, investment or financial advisor, and making
investments in corporations or projects designed primarily to promote community
welfare.
Subsidiary
banks of a bank holding company are subject to certain restrictions imposed by
statute on any extensions of credit to the bank holding company or any of its
subsidiaries, or investments in their stock or other securities, and on taking
such stock or securities as collateral for loans to any borrower. Further, a
bank holding company and any subsidiary bank are prohibited from engaging in
certain tie-in arrangements in connection with the extension of credit. The
Federal Reserve Board adopted amendments to its Regulation Y, creating
exceptions to the Bank Holding Company Act's anti-tying prohibitions that give
bank subsidiaries of holding companies greater flexibility in packaging products
and services with their affiliates.
In
accordance with Federal Reserve Board policy, Bay National Corporation is
expected to act as a source of financial strength to Bay National Bank and to
commit resources to support Bay National Bank in circumstances in which Bay
National Corporation might not otherwise do so. The Federal Reserve Board may
require a bank holding company to terminate any activity or relinquish control
of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the
Federal Reserve's determination that such activity or control constitutes a
serious risk to the financial soundness or stability of any subsidiary
depository institution of the bank holding company. Further, federal bank
regulatory authorities have additional discretion to require a bank holding
company to divest itself of any bank or non-bank subsidiary if the agency
determines that divestiture may aid the depository institution's financial
condition.
Pursuant
to authority granted under the Gramm-Leach-Bliley Act of 1999 (“GLBA”), a bank
holding company may elect to become a financial holding company and thereby
engage in a broader range of financial and other activities than are permissible
for traditional bank holding companies. In order to qualify for the
election, all of the depository institution subsidiaries of the bank holding
company must be well
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capitalized
and well managed, as defined by regulation, and all of its depository
institution subsidiaries must have achieved a rating of satisfactory or better
with respect to meeting community credit needs.
Pursuant
to the GLBA, financial holding companies are permitted to engage in activities
that are "financial in nature" or incidental or complementary thereto and not a
substantial risk to the safety and soundness of the depository institution or
the financial system in general, as determined by the Federal Reserve
Board. The GLBA identifies several activities as "financial in
nature," including, among others, insurance underwriting and agency, investment
advisory services, merchant banking and underwriting, and dealing or making a
market in securities. Being designated a financial holding company will allow
insurance companies, securities brokers and other types of financial companies
to affiliate with and/or acquire depository institutions.
As a bank
holding company with consolidated assets of more than $150 million, Bay National
Corporation also is subject to certain risk-based capital guidelines imposed on
bank holding companies by the Federal Reserve Board to ensure the holding
company’s capital adequacy. See "Item 1. Description of Business -
Supervision and Regulation - Bay National Bank - Capital Adequacy Guidelines"
below for details.
The
status of Bay National Corporation as a registered bank holding company under
the Bank Holding Company Act does not exempt it from certain federal and state
laws and regulations applicable to corporations generally, including, without
limitation, certain provisions of the federal securities laws.
State Bank Holding Company
Regulation. Bay National Corporation is a Maryland-chartered
bank holding company and is subject to various restrictions on its activities as
set forth in Maryland law, in addition to those restrictions set forth in
federal law.
Under
Maryland law, a bank holding company that desires to acquire a Maryland
state-chartered bank or trust company, a federally chartered bank with its main
office in Maryland, or a bank holding company that has its principal place of
business in Maryland, must file an application with the Maryland Commissioner of
Financial Regulation (the "Commissioner"). In approving the application, the
Commissioner must consider whether the acquisition may be detrimental to the
safety and soundness of the entity being acquired or whether the acquisition may
result in an undue concentration of resources or a substantial reduction in
competition in Maryland. The Commissioner may not approve an acquisition if, on
consummation of the transaction, the acquiring company, together with all its
insured depository institution affiliates, would control 30% or more of the
total amount of deposits of insured depository institutions in Maryland. The
Commissioner has authority to adopt by regulation a procedure to waive this
requirement for good cause. In a transaction for which the
Commissioner's approval is not required due to an exemption under Maryland law,
or for which federal law authorizes the transaction without application to the
Commissioner, the parties to the acquisition must provide written notice to the
Commissioner at least 15 days before the effective date of the
acquisition.
Bay
National Bank
General. Bay National Bank,
as a national banking association whose accounts are insured by the Bank
Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC") up
to the maximum legal limits, is subject to regulation, supervision and regular
examinations by the Office of the Comptroller of the Currency ("OCC"). Bay
National Bank is a member of the Federal Reserve System and, as such, is subject
to certain regulations issued by the Federal Reserve Board. Bay National Bank
also is subject to applicable banking provisions of Maryland law insofar as they
do not conflict with or are not preempted by federal law. The regulations of
these various agencies govern most aspects of Bay National Bank's business,
including setting required reserves against deposits, loans, investments,
mergers and acquisitions, borrowing, dividends, and location and number of
branch offices.
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The GLBA
authorizes expanded activities for national banks, but requires (with the
exception of underwriting municipal revenue bonds and other state and local
obligations) that any expanded activities be conducted in a new entity called a
“financial subsidiary” that is a subsidiary of the bank rather than the bank
itself. A financial subsidiary may engage in any activities in which
a financial holding company or a financial holding company’s non-bank
subsidiaries can engage, except that a financial subsidiary may not underwrite
most insurance, engage in real estate development or conduct merchant banking
activities. A financial subsidiary may be established through
acquisition or de
novo.
In order
for a national bank to operate a financial subsidiary, it must be well
capitalized and well managed, have a satisfactory or better rating with respect
to meeting community credit needs and the aggregate assets of all of the bank’s
financial subsidiaries may not exceed 45% of the total assets of the bank,
subject to certain exceptions. Existing authority of the OCC and the
FDIC to review subsidiary activities is preserved.
Banking
is a business which depends on interest rate differentials. In general, the
differences between the interest paid by a bank on its deposits and its other
borrowings and the interest received by a bank on loans extended to its
customers and securities held in its investment portfolio constitute the major
portion of a bank's earnings. Thus, the earnings and growth of Bay National Bank
will be subject to the influence of economic conditions generally, both domestic
and foreign, and also on the monetary and fiscal policies of the United States
and its agencies, particularly the Federal Reserve Board, which regulates the
supply of money. We cannot predict the nature and timing of changes in such
policies and their impact on Bay National Bank.
Branching and Interstate Banking.
The federal banking agencies are authorized to approve interstate bank
merger transactions without regard to whether such a transaction is prohibited
by the law of any state, unless the home state of one of the banks has opted out
of the interstate bank merger provisions of the Riegle-Neal Act. Furthermore,
under the Riegle-Neal Act, interstate acquisitions of branches are permitted if
the law of the state in which the branch is located permits such acquisitions.
The Riegle-Neal Act also authorizes the OCC and FDIC to approve interstate
branching de novo by national and non-member banks, respectively, but only in
states which specifically allow for such branching.
The
District of Columbia, Maryland, Delaware and Pennsylvania have all enacted laws
which permit interstate acquisitions of banks and bank branches and permit
out-of-state banks to establish de novo branches.
Gramm-Leach-Bliley
Act. The GLBA altered substantially the statutory framework
for providing banking and other financial services in the United States of
America. The GLBA, among other things, eliminated many of the restrictions on
affiliations among banks and securities firms, insurance firms, and other
financial service providers. The GLBA also provides protections
against the transfer and use by financial institutions of consumers’ nonpublic
personal information. A financial institution must provide to its
customers, at the beginning of the customer relationship and annually
thereafter, the institution’s policies and procedures regarding the handling of
customers’ nonpublic personal financial information. The privacy
provisions generally prohibit a financial institution from providing a
customer’s personal financial information to unaffiliated third parties unless
the institution discloses to the customer that the information may be so
provided and the customer is given the opportunity to opt out of such
disclosure.
Capital Adequacy
Guidelines. The Federal Reserve Board, the OCC and the FDIC
have all adopted risk-based capital adequacy guidelines by which they assess the
adequacy of capital in examining and supervising banks and bank holding
companies and in analyzing bank regulatory applications. Risk-based capital
requirements determine the adequacy of capital based on the risk inherent in
various classes of assets and off-balance sheet items.
National
banks and bank holding companies are expected to meet a minimum ratio of total
qualifying capital (the sum of core capital (Tier 1) and supplementary capital
(Tier 2)) to risk-weighted assets (a "Total
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Risk-Based
Capital Ratio") of 8%. At least half of this amount (4%) should be in the form
of Tier 1 capital. These requirements apply to Bay National Bank and Bay
National Corporation.
Tier 1
capital generally consists of the sum of common stockholders' equity and
perpetual preferred stock (subject in the case of the latter to limitations on
the kind and amount of such stock which may be included as Tier 1 capital), less
goodwill, without adjustment in accordance with Statement of Financial
Accounting Standards No. 115. Tier 2 capital consists of the following: hybrid
capital instruments, perpetual preferred stock which is not otherwise eligible
to be included as Tier 1 capital, term subordinated debt and intermediate-term
preferred stock, and, subject to limitations, general allowances for credit
losses. Assets are adjusted under the risk-based guidelines to take into account
different risk characteristics, with the categories ranging from 0% (requiring
no risk-based capital) for assets such as cash, to 100% for the bulk of assets
which are typically held by a commercial bank, including certain multi-family
residential and commercial real estate loans, commercial business loans and
consumer loans. Residential first mortgage loans on one-to-four-family
residential real estate and certain seasoned multi-family residential real
estate loans, which are not 90 days or more past-due or non-performing and which
have been made in accordance with prudent underwriting standards, are assigned a
50% level in the risk-weighing system, as are certain privately issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.
In
addition to the risk-based capital requirements, the OCC and the FDIC have
established a minimum 3% Leverage Capital Ratio (Tier 1 capital to total
adjusted assets) requirement for the most highly-rated national banks, with an
additional cushion of at least 100 to 200 basis points for all other national
banks, which effectively increases the minimum Leverage Capital Ratio for such
other banks to 4% or 5% or more. Under the applicable regulations, highest-rated
banks and bank holding companies are those that the OCC and the FDIC determine
are not anticipating or experiencing significant growth and have well
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and, in general, those which are
considered a strong banking organization. A national bank or bank holding
company that has less than the minimum Leverage Capital Ratio requirement must
submit, to the applicable regulator for review and approval, a reasonable plan
describing the means and timing by which the bank will achieve its minimum
Leverage Capital Ratio requirement. A national bank or bank holding company
which fails to file such a plan is deemed to be operating in an unsafe and
unsound manner and could be subject to a cease-and-desist order.
The
OCC's and FDIC’s regulations also provide that any insured depository
institution with a Leverage Capital Ratio less than 2% is deemed to be operating
in an unsafe or unsound condition. Operating in an unsafe or unsound manner
could lead the FDIC to terminate deposit insurance. However, such an institution
will not be subject to an enforcement proceeding solely on account of its
capital ratios if it has entered into and is in compliance with a written
agreement with the OCC and FDIC to increase its Leverage Capital Ratio to such
level as the OCC or FDIC deems appropriate and to take such other action as may
be necessary for the institution to be operated in a safe and sound manner. The
capital regulations also provide, among other things, for the issuance by the
OCC or the FDIC or their respective designee(s) of a capital directive, which is
a final order issued to a bank that fails to maintain minimum capital or to
restore its capital to the minimum capital requirement within a specified time
period. Such directive is enforceable in the same manner as a final
cease-and-desist order.
Prompt Corrective
Action. Each federal banking agency is required to implement a
system of prompt corrective action for institutions which it regulates. Under
applicable regulations, a bank will be deemed to be: (i) "well capitalized" if
it has a Total Risk-Based Capital Ratio of 10% or more, a Tier 1 Risk-Based
Capital Ratio of 6% or more, a Leverage Capital Ratio of 5% or more and is not
subject to any written capital order or directive; (ii) "adequately capitalized"
if it has a Total Risk-Based Capital Ratio of 8% or more, a Tier 1 Risk-Based
Capital Ratio of 4% or more and a Leverage Capital Ratio of 4% or more (3% under
certain circumstances) and does not meet the definition of “well capitalized”;
(iii) "undercapitalized" if it has a Total Risk-Based Capital Ratio that is less
than 8%, a Tier 1 Risk-Based Capital Ratio that is less than 4% or a Leverage
Capital Ratio that is less than 4% (3.3% under certain circumstances); (iv)
"significantly
10
undercapitalized"
if it has a Total Risk-Based Capital Ratio that is less than 6%, a Tier 1
Risk-Based Capital Ratio that is less than 3% or a Leverage Capital Ratio that
is less than 3%; and (v) "critically undercapitalized" if it has a ratio of
tangible equity to total assets that is equal to or less than 2%. Bay
National Bank is "well capitalized" as of December 31, 2007.
An
institution generally must file a written capital restoration plan which meets
specified requirements with an appropriate federal banking agency within 45 days
of the date the institution receives notice or is deemed to have notice that it
is undercapitalized, significantly undercapitalized or critically
undercapitalized. The federal banking agency must provide the institution with
written notice of approval or disapproval within 60 days after receiving the
capital restoration plan, subject to extensions by the applicable
agency.
An
institution which is required to submit a capital restoration plan must
concurrently submit a performance guaranty by each company that controls the
institution. Such guaranty is limited to the lesser of (i) an amount equal to 5%
of the institution's total assets at the time the institution was notified or
deemed to have notice that it was undercapitalized or (ii) the amount necessary
at such time to restore the relevant capital measures of the institution to the
levels required for the institution to be classified as adequately capitalized.
Such a guaranty expires after the federal banking agency notifies the
institution that it has remained adequately capitalized for each of four
consecutive calendar quarters. An institution which fails to submit a written
capital restoration plan within the requisite period, including any required
performance guaranty, or fails in any material respect to implement a capital
restoration plan, is subject to the restrictions in Section 38 of the Federal
Deposit Insurance Act which are applicable to significantly undercapitalized
institutions.
Immediately
upon becoming undercapitalized, an institution becomes subject to statutory
provisions which: (i) restrict payment of capital distributions and management
fees; (ii) require that the appropriate federal banking agency monitor the
condition of the institution and its efforts to restore its capital; (iii)
require submission of a capital restoration plan; (iv) restrict the growth of
the institution's assets; and (v) require prior approval of certain expansion
proposals. The appropriate federal banking agency for an undercapitalized
institution also may take any number of discretionary supervisory actions if the
agency determines that any of these actions is necessary to resolve the problems
of the institution at the least possible long-term cost to the deposit insurance
fund, subject, in certain cases, to specified procedures. These discretionary
supervisory actions include requiring the institution to raise additional
capital, restricting transactions with affiliates, requiring divestiture of the
institution or the sale of the institution to a willing purchaser, and any other
supervisory action that the agency deems appropriate. Significantly
undercapitalized and critically undercapitalized institutions are subject to
these and additional mandatory and permissive supervisory actions.
A
critically undercapitalized institution will be placed in conservatorship or
receivership within 90 days unless the FDIC formally determines that forbearance
from such action would better protect the deposit insurance fund. Unless the
FDIC or other appropriate federal banking regulatory agency makes specific
further findings and certifies that the institution is viable and is not
expected to fail, an institution that remains critically undercapitalized on
average during the four calendar quarters after the date it becomes critically
undercapitalized must be placed in receivership. The general rule is
that the FDIC will be appointed as receiver within 90 days after a bank becomes
critically undercapitalized unless extremely good cause is shown and the federal
regulators agree to an extension. In general, good cause is defined
as capital that has been raised and is immediately available for infusion into
the bank except for certain technical requirements that may delay the infusion
for a period of time beyond the 90 day time period.
Additionally,
under Section 11(c)(5) of the FDIA, a conservator or receiver may be appointed
for an institution where: (i) an institution’s obligations exceed its assets;
(ii) there is substantial dissipation of the institution’s assets or earnings as
a result of any violation of law or any unsafe or unsound practice; (iii) the
institution is in an unsafe or unsound condition; (iv) there is a willful
violation of a cease-and-desist order; (v) the institution is unable to pay its
obligations in the ordinary course of business; (vi) losses or threatened losses
deplete all or substantially all of an institution’s capital, and there is no
reasonable prospect of
11
becoming
“adequately capitalized” without assistance; (vii) there is any violation of law
or unsafe or unsound practice or condition that is likely to cause insolvency or
substantial dissipation of assets or earnings, weaken the institution’s
condition, or otherwise seriously prejudice the interests of depositors or the
insurance fund; (viii) an institution ceases to be insured; (ix) the institution
is undercapitalized and has no reasonable prospect that it will become
adequately capitalized, fails to become adequately capitalized when required to
do so, or fails to submit or materially implement a capital restoration plan; or
(x) the institution is critically undercapitalized or otherwise has
substantially insufficient capital.
Regulatory Enforcement
Authority. The Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 ("FIRREA") included substantial enhancement to the
enforcement powers available to federal banking regulators. This enforcement
authority included, among other things, the ability to assess civil money
penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined in FIRREA. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with regulatory
authorities. FIRREA significantly increased the amount of and grounds for civil
money penalties and requires, except under certain circumstances, public
disclosure of final enforcement actions by the federal banking
agencies.
Deposit
Insurance. The FDIC has adopted a risk-based deposit insurance
assessment system. The FDIC assigns an institution to one of three capital
categories based on the institution's financial information, as of the reporting
period ending seven months before the assessment period, consisting of (i) well
capitalized, (ii) adequately capitalized or (iii) undercapitalized, and one of
three supervisory subcategories within each capital group. The supervisory
subgroup to which an institution is assigned is based on a supervisory
evaluation provided to the FDIC by the institution's primary federal regulator
and information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds. An
institution's assessment rate depends on the capital category and supervisory
subcategory to which it is assigned. Assessment rates for BIF insured deposits
currently range from 5 basis points to 43 basis points. Bay National Bank was
assigned to a capital and supervisory subcategory that had an annual assessment
rate ranging from 5 to 7 basis points. The FDIC is authorized to
raise the assessment rates in certain circumstances, including to maintain or
achieve a designated reserve ratio for BIF deposits. The FDIC has exercised its
authority to raise rates in the past and may raise insurance premiums in the
future. If such action is taken by the FDIC, it could have an adverse effect on
the earnings of Bay National Bank.
Under the
Federal Deposit Insurance Act, insurance of deposits may be terminated by the
FDIC upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the
FDIC.
Transactions with Affiliates and
Insiders. Bay National Bank is subject to the provisions of
Section 23A and 23B of the Federal Reserve Act and Regulation W of the Federal
Reserve Bank, which place limits on the amount of loans or extensions of credit
to affiliates (as defined in the Federal Reserve Act), investments in or certain
other transactions with affiliates and on the amount of advances to third
parties collateralized by the securities or obligations of affiliates. The law
and regulation limit the aggregate amount of transactions with any individual
affiliate to 10% of the capital and surplus of Bay National Bank and also limits
the aggregate amount of transactions with all affiliates to 20% of capital and
surplus. Loans and certain other extensions of credit to affiliates are required
to be secured by collateral in an amount and of a type described in the
regulation.
The law
and Regulation W, among other things, prohibit an institution from engaging in
certain transactions with certain affiliates (as defined in the Federal Reserve
Act) unless the transactions are on terms substantially the same, or at least as
favorable to such institution and/or its subsidiaries, as those prevailing at
the time for comparable transactions with non-affiliated entities. In the
absence of comparable transactions,
12
such
transactions may only occur under terms and circumstances, including credit
standards that in good faith would be offered to or would apply to
non-affiliated companies. In addition, under Regulation
W:
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a
bank and its subsidiaries may not purchase a low-quality asset from an
affiliate;
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covered
transactions and other specified transactions between a bank or its
subsidiaries and an affiliate must be on terms and conditions that are
consistent with safe and sound banking practices;
and
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with
some exceptions, each loan or extension of credit by a bank to an
affiliate must be secured by collateral with a market value ranging from
100% to 130%, depending on the type of collateral, of the amount of the
loan or extension of credit.
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Regulation
W generally excludes all nonbank and nonsavings association subsidiaries of
banks from treatment as affiliates, except to the extent that the Federal
Reserve Board decides to treat these subsidiaries as affiliates.
Bay
National Bank also is subject to the restrictions contained in Section 22(h) of
the Federal Reserve Act and the Federal Reserve Board's Regulation O thereunder
on loans to executive officers, directors and principal stockholders. Under
Section 22(h), loans to a director, an executive officer or a greater-than-10%
stockholder of a bank as well as certain affiliated interests of any of the
foregoing may not exceed, together with all other outstanding loans to such
person and affiliated interests, the loans-to-one-borrower limit applicable to
national banks (generally 15% of the institution's unimpaired capital and
surplus), and all loans to all such persons in the aggregate may not exceed the
institution's unimpaired capital and unimpaired surplus. Regulation O also
prohibits the making of loans in an amount greater than $25,000 or 5% of capital
and surplus but in any event not over $500,000, to directors, executive officers
and greater-than-10% stockholders of a bank, and their respective affiliates,
unless such loans are approved in advance by a majority of the Board of
Directors of the bank with any "interested" director not participating in the
voting. Further, Regulation O requires that loans to directors, executive
officers and principal stockholders be made on terms substantially the same as
those that are offered in comparable transactions to unrelated third parties
unless the loans are made pursuant to a benefit or compensation program that is
widely available to all employees of the bank and does not give preference to
insiders over other employees. Regulation O also prohibits a depository
institution from paying overdrafts over $1,000 of any of its executive officers
or directors unless they are paid pursuant to written pre-authorized extension
of credit or transfer of funds plans.
All of
Bay National Bank’s loans to its and Bay National Corporation’s executive
officers, directors and greater-than-10% stockholders, and affiliated interests
of such persons, comply with the requirements of Regulation W and 22(h) of the
Federal Reserve Act and Regulation O.
Loans to One
Borrower. As a national bank, Bay National Bank is subject to
the statutory and regulatory limits on the extension of credit to one borrower.
Generally, the maximum amount of total outstanding loans that a national bank
may have to any one borrower at any one time is 15% of the bank's unimpaired
capital and surplus. A national bank may lend an additional 10% on top of the
15% if the amount that exceeds 15% of the bank's unimpaired capital and surplus
is fully secured by readily marketable collateral.
Liquidity. Bay National Bank
is subject to the reserve requirements of Federal Reserve Board Regulation D,
which applies to all depository institutions with transaction accounts or
non-personal time deposits. Specifically, as of October 31, 2007, amounts in
transaction accounts above $9.3 million and up to $43.9 million must have
reserves held against them in the ratio of 3 percent of the
amount. Amounts above $43.9 million require reserves of $1.038
million plus 10 percent of the amount in excess of $43.9 million. Bay
National Bank is in compliance with the applicable liquidity
requirements.
Dividends. The
amount of dividends that may be paid by Bay National Bank to Bay National
Corporation depends on its earnings and capital position and is limited by
statute, regulations and policies. As a national bank, Bay National
Bank may not pay dividends from its paid-in surplus. All dividends
must
13
be paid
out of undivided profits then on hand, after deducting expenses, including
provisions for credit losses and bad debts. In addition, a national
bank is prohibited from declaring a dividend on its shares of common stock until
its surplus equals its stated capital, unless there has been transferred to
surplus no less than one-tenth of the bank’s net profits for the preceding two
consecutive half-year periods (in the case of an annual
dividend). OCC approval is required if the total of all dividends
declared by a national bank in any calendar year exceeds the total of its net
profits for that year combined with its retained net profits for the preceding
two years, less any required transfers to surplus. In addition, Bay
National Bank may not pay a dividend if, after paying the dividend, it would be
undercapitalized.
Community Reinvestment
Act. The Community Reinvestment Act ("CRA") requires that, in
connection with examinations of financial institutions within their respective
jurisdictions, the Federal Reserve Board, the FDIC, the OCC or the Office of
Thrift Supervision shall evaluate the record of the financial institutions in
meeting the credit needs of their local communities, including low and moderate
income neighborhoods, consistent with the safe and sound operation of those
institutions. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. An
institution's CRA activities are considered in, among other things, evaluating
mergers, acquisitions and applications to open a branch or facility as well as
determining whether the institution will be permitted to exercise certain of the
powers allowed by the GLBA. The CRA also requires all institutions to
make public disclosure of their CRA ratings. Bay National Bank received a
“satisfactory” rating in its latest CRA examination conducted in May
2003.
USA PATRIOT
Act. Under the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act, commonly
referred to as the “USA Patriot Act” or the “Patriot Act,” financial
institutions are subject to prohibitions against specified financial
transactions and account relationships, as well as enhanced due diligence
standards intended to detect, and prevent, the use of the United States
financial system for money laundering and terrorist financing
activities. The Patriot Act requires financial institutions,
including banks, to establish anti-money laundering programs, including employee
training and independent audit requirements, meet minimum standards specified by
the act, follow minimum standards for customer identification and maintenance of
customer identification records, and regularly compare customer lists against
lists of suspected terrorists, terrorist organizations and money
launderers.
The U.S.
Treasury Department (“Treasury”) has issued a number of implementing regulations
that apply to various requirements of the USA Patriot Act to financial
institutions such as Bay National Bank. Those regulations impose new
obligations on financial institutions to maintain appropriate policies,
procedures and controls to detect, prevent and report money laundering and
terrorist financing. Treasury is expected to issue additional
regulations that will further clarify the USA Patriot Act’s
requirements.
Failure of a financial institution to
comply with the USA Patriot Act’s requirements could have serious legal and
reputational consequences for the institution. The Company has adopted
appropriate policies, procedures and controls to address compliance with the
requirements of the USA Patriot Act under the existing regulations and will
continue to revise and update its policies, procedures and controls to reflect
changes required by the USA Patriot Act and Treasury’s
regulations.
The costs
or other effects of the compliance burdens imposed by the Patriot Act or future
anti-terrorist, homeland security or anti-money laundering legislation or
regulations cannot be predicted with certainty.
Check 21. The Check Clearing
for the 21st Century Act, also known as “Check 21,” gives “substitute
checks,” such as a digital image of a check and copies made from that image, the
same legal standing as the original paper check. Some of the major
provisions include:
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allowing
check truncation without making it
mandatory;
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14
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requiring
that every financial institution communicate to accountholders in writing
a description of its substitute check processing program and their rights
under the law;
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retaining
in place the previously mandated electronic collection and return of
checks between financial institutions only when individual agreements are
in place;
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requiring
that when accountholders request verification, financial institutions
produce the original check (or a copy that accurately represents the
original) and demonstrate that the account debit was accurate and valid;
and
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requiring
recrediting of funds to an individual’s account on the next business day
after a consumer proves that the financial institution has
erred.
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Consumer Credit
Reporting. The Fair and Accurate Credit Transactions Act
amended the federal Fair Credit Reporting Act. These amendments to
the Fair Credit Reporting Act (the “FCRA Amendments”) include, among other
things:
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requirements
for financial institutions to develop policies and procedures to identify
relevant patterns, practices, and specific forms of activity that are “red
flags” signaling potential identity theft and, upon the request of a
consumer, place a fraud alert in the consumer's credit file stating that
the consumer may be the victim of identity theft or other
fraud;
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for
entities that furnish information to consumer reporting agencies (which
would include us), requirements to implement procedures and policies
regarding the accuracy and integrity of the furnished information, and
regarding the correction of previously furnished information that is later
determined to be inaccurate; and
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a
requirement for mortgage lenders to disclose credit scores to
consumers.
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The FCRA
Amendments also prohibit a business that receives consumer information from an
affiliate from using that information for marketing purposes unless the consumer
is first provided a notice and an opportunity to direct the business not to use
the information for such marketing purposes (the “opt-out”), subject to certain
exceptions. We do not share consumer information among our affiliated
companies for marketing purposes, except as allowed under exceptions to the
notice and opt-out requirements. Because none of our affiliates is
currently sharing consumer information with any other affiliate for marketing
purposes, the limitations on sharing of information for marketing purposes do
not have a significant impact on us.
Federal Deposit Insurance
Reform. The Federal Deposit Insurance Reform Act of 2005
(“FDIRA”), among other things, changed the Federal deposit insurance system
by:
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raising
the coverage level for retirement accounts to
$250,000;
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indexing
deposit insurance coverage levels for inflation beginning in
2012;
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prohibiting
undercapitalized financial institutions from accepting employee benefit
plan deposits;
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merging
the Bank Insurance Fund and Savings Association Insurance Fund into a new
Deposit Insurance Fund (the “DIF”);
and
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providing
credits to financial institutions that capitalized the FDIC prior to 1996
to offset future assessment
premiums.
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FDIRA
also authorizes the FDIC to revise the current risk-based assessment system,
subject to notice and comment and caps the amount of the DIF at 1.50% of
domestic deposits. The FDIC must issue cash dividends, awarded on a historical
basis, for the amount of the DIF over the 1.50% ratio. Additionally,
if the DIF exceeds 1.35% of domestic deposits at year-end, the FDIC must issue
cash dividends, awarded on a historical basis, for half of the amount of the
excess.
Other
Regulations. Interest and other charges we collect or contract
for are subject to state usury laws and federal laws concerning interest
rates. For example, under the Service Members Civil Relief Act,
15
which
amended the Soldiers’ and Sailors’ Civil Relief Act of 1940, a lender is
generally prohibited from charging an annual interest rate in excess of 6% on
any obligation of a borrower who is on active duty with the United States
military.
Our loan
operations are also subject to federal laws applicable to credit transactions,
such as the following:
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The
Federal Truth-In-Lending Act, governing disclosures of credit terms to
consumer borrowers;
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The
Home Mortgage Disclosure Act of 1975, requiring financial institutions to
provide information to enable the public and public officials to determine
whether a financial institution is fulfilling its obligation to help meet
the housing needs of the community it
serves;
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The
Equal Credit Opportunity Act, prohibiting discrimination on the basis of
race, creed or other prohibited factors in extending
credit;
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The
Fair Debt Collection Act, governing the manner in which consumer debts may
be collected by collection agencies;
and
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The
rules and regulations of the various federal agencies charged with the
responsibility of implementing these federal
laws.
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Our
deposit operations are subject to the following:
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The
Right to Financial Privacy Act, which imposes a duty to maintain
confidentiality of consumer financial records and prescribes procedures
for complying with administrative subpoenas of financial records;
and
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The
Electronic Funds Transfer Act and Regulation E issued by the Federal
Reserve Board to implement that Act, which govern automatic deposits to
and withdrawals from deposit accounts and customers' rights and
liabilities arising from the use of automated teller machines and other
electronic banking services.
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Proposed Legislation and Regulatory
Actions. New regulations and statutes are regularly proposed
that contain wide-ranging proposals for altering the structures, regulations,
and competitive relationships of the nation’s financial
institutions. We cannot predict whether or in what form any proposed
regulation or statute will be adopted or the extent to which our business may be
affected by any new regulation or statute.
Effect Of Governmental Monetary
Policies. Our earnings are affected by domestic economic conditions and
the monetary and fiscal policies of the United States government and its
agencies. The Federal Reserve Board’s monetary policies have had, and
are likely to continue to have, an important impact on the operating results of
commercial banks through its power to implement national monetary policy in
order, among other things, to curb inflation or combat a
recession. The monetary policies of the Federal Reserve Board affect
the levels of bank loans, investments and deposits through its control over the
issuance of United States government securities, its regulation of the discount
rate applicable to member banks and its influence over reserve requirements to
which member banks are subject. We cannot predict the nature or impact of future
changes in monetary and fiscal policies.
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FORWARD
LOOKING STATEMENTS
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Some of
the matters discussed in this annual report including under the captions
“Business of Bay National Corporation and Bay National Bank,” and “Management’s
Discussion And Analysis Of Financial
16
Condition
And Results Of Operations” include forward-looking statements. These
forward-looking statements include statements regarding, among other things, the
Company’s expectations with respect to profitability, liquidity,
earnings and asset growth, allowance for credit losses, interest rate
sensitivity, market risk, hiring intentions, increasing non-interest income,
competing for large certificates of deposit and expansion, financial and other
goals. Forward-looking statements often use words such as “believe,”
“expect,” “plan,” “may,” “will,” “should,” “project,” “contemplate,”
“anticipate,” “forecast,” “intend”, or other words of similar
meaning. You can also identify them by the fact that they do not
relate strictly to historical or current facts. When you read a
forward-looking statement, you should keep in mind the risk factors described
below and any other information contained in this annual report which identifies
a risk or uncertainty. Bay National Corporation’s actual results and
the actual outcome of Bay National Corporation’s expectations and strategies
could be different from that described in this annual report because of these
risks and uncertainties and you should not put undue reliance on any
forward-looking statements. All forward-looking statements speak only
as of the date of this filing, and Bay National Corporation undertakes no
obligation to make any revisions to the forward-looking statements to reflect
events or circumstances after the date of this filing or to reflect the
occurrence of unanticipated events.
Item
1A. Risk Factors
You
should carefully consider the following risks, along with the other information
contained in this annual report. The risks and uncertainties
described below are not the only ones that may affect Bay National
Corporation. Additional risks and uncertainties may also adversely
affect our business and operations including those discussed in Item 7 –
Management’s Discussion and Analysis of Financial Condition and Results of
Operations. If any of the following events actually occur, our business and
financial results could be materially adversely affected.
Bay National Corporation and
Bay National Bank depend heavily on one key employee, Mr. Hugh W. Mohler, and
business would suffer if something were to happen to Mr. Mohler. Mr. Mohler
is the Chairman, President and Chief Executive Officer of Bay National Bank. If
he were to leave for any reason, Bay National Corporation’s and Bay National
Bank’s business would suffer because he has banking experience and relationships
with clients and potential clients that would not be easy to replace. In
addition, because Bay National Bank’s business is relationship-driven, the loss
of an employee who has primary contact with one or more of Bay National Bank’s
clients could cause Bay National Bank to lose those clients' business, possibly
resulting in a decline in revenues.
If our allowance for credit
losses is not sufficient to cover actual loan losses, our earnings could
decrease. We make various assumptions and judgments about the
collectibility of our loan portfolio, including the creditworthiness of our
borrowers and the value of collateral for the repayment of many of our
loans. In determining the amount of the allowance for credit losses,
we review and evaluate, among other things, our loans and our loss and
delinquency experience and current economic conditions. If our
assumptions are incorrect, our allowance for credit losses may not be sufficient
to cover losses inherent in our loan portfolio, resulting in additions to our
allowance.
We are
particularly susceptible to this risk because we have experienced significant
growth in our residential real estate loan portfolio over the past few
years. In general, loans do not begin to show signs of credit
deterioration or default until they have been outstanding for some period of
time, a process referred to as “seasoning.” As a result, a portfolio
of older loans will usually behave more predictably than a newer
portfolio. Because our residential real estate loan portfolio is not
significantly seasoned and there has been a downturn in the residential real
estate market, the current level of delinquencies and defaults may not be
representative of the level that will prevail when the portfolio becomes more
seasoned or if the condition of the residential real estate market does not
improve. If delinquencies and defaults continue to increase, we may
be required to further increase our provision for credit losses.
Material
additions to our allowance would materially decrease our net
income. In addition, bank regulators periodically review our
allowance for credit losses and may require us to increase our provision for
17
loan
losses or recognize further loan charge-offs. Any increase in our
allowance for credit losses or loan charge-offs may have a material adverse
effect on our results of operations and financial condition.
Bay National Bank’s lending
strategy involves risks resulting from the choice of loan
portfolio. Bay National Bank's loan strategy emphasizes
commercial business loans and commercial real estate loans. At December 31,
2007, such loans accounted for approximately 65% of the loan portfolio.
Commercial business and commercial real estate loans generally carry a higher
degree of credit risk than do residential mortgage loans because of several
factors including larger loan balances, dependence on the successful operation
of a business or a project for repayment, or loan terms with a balloon payment
rather than full amortization over the loan term.
Bay National Bank’s lending
limit may limit its growth and the growth of Bay National
Corporation. Bay National Bank is limited in the amount it can
loan to a single borrower by the amount of its capital. Specifically, under
current law, Bay National Bank may lend up to 15% of its unimpaired capital and
surplus to any one borrower. Bay National Bank’s lending limit is significantly
less than that of many of its competitors and may discourage potential borrowers
who have credit needs in excess of Bay National Bank’s lending limit from
conducting business with Bay National Bank.
Bay National Bank faces
substantial competition which could adversely affect its ability to attract
depositors and borrowers. Bay National Bank operates in a
competitive market for financial services and faces intense competition from
other institutions both in making loans and in attracting deposits. Many of
these institutions have been in business for many years, are significantly
larger, have established customer bases, have greater financial resources and
lending limits than Bay National Bank, and are able to offer certain services
that Bay National Bank is not able to offer. If Bay National Bank cannot attract
deposits and make loans at a sufficient level, its operating results will
suffer, as will its opportunities for growth.
Government regulation could
restrict Bay National Corporation’s or Bay National Bank’s growth or cause Bay
National Corporation or Bay National Bank to incur higher
costs. Bay National Corporation and Bay National Bank operate
in a highly regulated environment and are subject to examination, supervision
and comprehensive regulation by several federal and state regulatory agencies.
Banking regulations, designed primarily for the safety of depositors, may limit
the growth of Bay National Bank and the return to investors by restricting
activities such as the payment of dividends; mergers with, or acquisitions by,
other institutions; investments; loans and interest rates; interest rates paid
on deposits; and the creation of branch offices. Laws and regulations could
change at any time, and changes could adversely affect Bay National
Corporation’s and Bay National Bank’s business. In addition, the cost of
compliance with regulatory requirements could adversely affect Bay National
Corporation’s and Bay National Bank’s ability to operate
profitably.
Bay National Bank's ability
to compete may suffer if it cannot take advantage of technology to provide
banking services or if its customers fail to embrace that
technology. Bay National Bank’s business strategy relies less
on customers' access to a large branch network and more on access to technology
and personal relationships. Further, the market for financial services is
increasingly affected by advances in technology, including developments in
telecommunications, data processing, computers, automation, Internet-based
banking and tele-banking. Bay National Bank’s ability to compete
successfully may depend on the extent to which Bay National Bank can take
advantage of technological changes and the extent to which Bay National Bank’s
customers embrace technology to complete their banking
transactions.
Because we currently serve
limited market areas, we could be more adversely affected by an economic
downturn in our market areas than our larger competitors who are more
geographically diverse. Currently, our primary market
area is limited to the Baltimore metropolitan area, the Baltimore-Washington
corridor and Maryland’s Eastern Shore. If either of these areas
suffer an economic downturn, our business and financial condition may be
severely affected. Our larger competitors serve a more geographically
diverse market area, parts of which may not be affected by the same economic
conditions that exist in our primary market areas.
18
If economic conditions
deteriorate, our results of operations and financial condition could be
adversely affected as borrowers’ ability to repay loans declines and the value
of the collateral securing our loans decreases. Our financial
results may be adversely affected by changes in prevailing economic conditions,
including decreases in real estate values, changes in interest rates which may
cause a decrease in interest rate spreads, adverse employment conditions, the
monetary and fiscal policies of the federal government and other significant
external events. Because a significant portion of our loan portfolio
is comprised of real estate related loans, decreases in real estate values could
adversely affect the value of property used as collateral. Adverse
changes in the economy also may have a negative effect on the ability of our
borrowers to make timely repayments of their loans, which would have an adverse
impact on our earnings.
Our profitability depends on
interest rates and changes in monetary policy may impact
us. Our results of operations depend to a large extent on our
“net interest income,” which is the difference between the interest expense
incurred in connection with our interest-bearing liabilities, such as interest
on deposit accounts, and the interest income received from our interest-earning
assets, such as loans. Interest rates, because they are influenced
by, among other things, expectations about future events, including the level of
economic activity, federal monetary and fiscal policy and geo-political
stability, are not predictable or controllable. In addition,
competitive factors heavily influence the interest rates we can earn on our loan
and investment portfolios and the interest rates we pay on our
deposits. Community banks are often at a competitive disadvantage in
managing their cost of funds compared to the large regional, super-regional or
national banks that have access to the national and international capital
markets. These factors influence our ability to maintain a stable
interest margin.
The costs of being a public
company are proportionately higher for small companies like us due to the
requirements of the Sarbanes-Oxley Act. The Sarbanes-Oxley Act
of 2002 and the related rules and regulations promulgated by the Securities and
Exchange Commission have increased the scope, complexity, and cost of corporate
governance, reporting, and disclosure practices. These regulations
are applicable to our company. We expect to experience increasing
compliance costs, including costs related to internal controls, as a result of
the Sarbanes-Oxley Act. These necessary costs are proportionately
higher for a company of our size and will affect our profitability more than
that of some of our larger competitors.
Item
1B. Unresolved Staff Comments
Not
applicable as the Company is not an accelerated filer or large accelerated
filer.
19
Item
2. Properties
Baltimore
Our
Baltimore branch and administrative offices are located at 2328 West Joppa Road,
Lutherville, Maryland 21093. Currently, we lease space in the
basement (1,429 square feet), the first floor (4,067 square feet) and the third
floor (6,206 square feet) of this building. The basement space is
currently used for training and storage purposes of which approximately 400
square feet is sublet, 1,712 square feet of the first floor space is currently
used for administrative office space, 2,355 square feet of the first floor space
is used for the Lutherville branch office and the third floor space is used for
Bay National Corporation and Bay National Bank’s administrative
offices. The current lease expires on February 28, 2010, and we have
the right to extend the lease for one five-year term to February 28,
2015.
As of
December 31, 2007, Bay National Corporation was paying rent of $359,746 per
year, or $29,979 per month for all of the leased space in the
building. For the March 2008 to February 2009 lease year, Bay
National Corporation will pay annual rent of $370,539, or $30,878 per
month. For each lease year thereafter, including any lease years
during any renewal term, the yearly base rent will increase by
3%. The rent includes Bay National Corporation’s share of taxes and
building operating costs.
The
Landlord, Joppa Green II Limited Partnership, LLLP, is beneficially owned by the
MacKenzie Companies. Gary T. Gill, who has been a director of Bay
National Corporation and Bay National Bank since January 2003, is the president
and chief executive officer of the MacKenzie Companies. See “Item 13
– Certain Relationships and Related Transactions, and Director
Independence.”
Towson
Bay
National Bank began leasing 4,317 square feet of space on the first floor of a
building located at 1122 Kenilworth Drive, Towson, Maryland 21204 for its
Baltimore residential mortgage operation on October 1, 2006. Pursuant to the
lease agreement, the Bank agreed to an initial lease term of five years and two
months, terminating on November 30, 2011. The Bank was also provided the right
to renew the lease
for one additional five-year term. As part of this agreement, the
aggregate rent due under the lease is $8,708 monthly from December 2007 through
November 2008. For each lease year thereafter, including any lease
years during any renewal term, the yearly base rent will increase by
3%.
Columbia
On
October 3, 2007, Bay National Bank agreed to lease 3,181 square feet of space on
the third floor of a building located at 8820 Columbia 100 Parkway, Suite 301,
Columbia, Maryland 21045. This space is currently used for its
Baltimore-Washington corridor loan production office. Pursuant to the
lease agreement, the Bank agreed to an initial lease term of five
years. The Bank was also provided the right to renew the lease for
two additional five-year terms. As part of this agreement, the
aggregate rent due under the lease is $6,720 monthly from commencement for a
term of 12 months. For each lease year thereafter, including any
lease years during any renewal term, the yearly base rent will increase by
3%.
Salisbury
Bay
National Bank's Salisbury, Maryland branch office is located at 109 Poplar Hill
Avenue, Salisbury Maryland 21801 in a two-story building containing
approximately 2,500 square feet of office space. The current lease
terminates on August 31, 2009, and we have the right to extend the lease for two
additional five-year terms. During the current lease term, Bay National
Corporation is paying monthly rent of approximately $2,292, plus all real estate
taxes and utilities. Pursuant to this lease, Bay National Corporation has a
right of first refusal to purchase the building in the event the landlord
receives a bona fide offer to sell. This property is owned by John R. Lerch, who
has been a director of Bay National Corporation and Bay
20
National
Bank since their formation. See “Item 13 – Certain Relationships and
Related Transactions, and Director Independence.”
Bay
National Bank's Salisbury, Maryland mortgage division office is located at 318
East Main Street, Salisbury Maryland 21801. The leased space consists of two
office suites totaling approximately 420 square feet. The original
lease for this space expired on December 31, 2004 and Bay National Corporation
currently rents the space on a month-to-month basis at a cost of $700 per month.
The landlord is responsible for all real estate taxes and
utilities. The Company had leased an additional 200 square feet in
this building from January 1, 2005 through November 2005 at an additional cost
of $300 per month.
Item
3. Legal Proceedings
The
Company is party to legal actions that are routine and incidental to our
business. In management’s opinion, the outcome of these matters,
individually or in the aggregate, will not have a material effect on our results
of operations or financial position. There are no proceedings known to Bay
National Corporation to be contemplated by any governmental
authority. There are no material proceedings known to Bay National
Corporation, pending or contemplated, in which any director, officer or
affiliate or any principal security holder of Bay National Corporation is a
party adverse to Bay National Corporation or Bay National Bank or has a material
interest adverse to Bay National Corporation or Bay National Bank.
Item
4. Submission of Matters to a Vote of Security Holders
No matter
was submitted during the fourth quarter of the year ended December 31, 2007 to a
vote of security holders of Bay National Corporation.
21
PART
II
Item
5. Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
As of
March 25, 2008, the number of holders of record of Bay National Corporation’s
common stock was approximately 353. Bay National Corporation’s common stock is
currently traded on the NASDAQ Capital Market under the symbol
"BAYN."
Bay
National Corporation completed an initial public offering (“IPO”) of its common
stock on April 30, 2000. Stock prices subsequent to the IPO are based upon
limited trading on the Over the Counter Bulletin Board (“OTCBB”) prior to May
15, 2006 and on the NASDAQ Capital Market subsequent to that date. The following
table reflects the high and low sales information for the periods presented.
Quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commission and may not represent actual transactions. Amounts
previously reported have been adjusted to reflect a 1.1 to 1 stock split in the
form of a stock dividend recorded on June 29, 2007.
|
2007
Sales
Price Range
|
2006
Bid
or Sales Price Range
|
|||||||||||
|
Quarter
|
Low
|
High
|
Low
|
High
|
||||||||
|
1st
|
$
|
15.50
|
$
|
17.55
|
$
|
16.27
|
$
|
20.91
|
||||
|
2nd
|
14.77
|
16.83
|
16.27
|
17.73
|
||||||||
|
3rd
|
14.50
|
16.75
|
16.82
|
17.77
|
||||||||
|
4th
|
9.70
|
18.00
|
16.84
|
18.67
|
||||||||
Bay
National Corporation declared a 10% stock dividend in April 2007 payable on June
29, 2007 to stockholders of record on June 18, 2007. Management
anticipates that Bay National Corporation will retain all earnings, if any, in
order to provide more funds to operate and expand Bay National Corporation’s
business and, therefore, Bay National Corporation has no plans to pay any cash
dividends at least until its profitability exceeds the level necessary to
support capital growth in excess of regulatory capital needs. If Bay
National Corporation decides to pay dividends in the future, its ability to do
so will depend on the ability of Bay National Bank to pay dividends to Bay
National Corporation. In addition, management would consider a number of other
factors before deciding to pay dividends, including Bay National Corporation’s
earnings prospects, financial condition and cash needs.
The
amount of dividends that may be paid by Bay National Bank to Bay National
Corporation depends on Bay National Bank's earnings and capital position and is
limited by statute, regulations and regulatory policies. As a
national bank, Bay National Bank may not pay dividends from its permanent
capital. All cash dividends must be paid out of undivided profits then on hand,
after deducting expenses, including provisions for credit losses and bad debts.
In addition, a national bank is prohibited from declaring a cash dividend on its
shares of common stock until its surplus equals its stated capital, unless there
has been transferred to surplus no less than one-tenth of the bank's net profits
for the preceding two consecutive half-year periods (in the case of an annual
dividend). OCC approval is required if the total of all cash dividends declared
by a national bank in any calendar year exceeds the total of its net profits for
that year combined with its retained net profits for the preceding two years,
less any required transfers to surplus. In addition, Bay National Bank may not
pay a dividend if, after paying the dividend, it would be “undercapitalized” as
defined in the applicable regulations.
22
Item
6. Selected Financial Data
SELECTED
FINANCIAL DATA
AS OF
DECEMBER 31, 2007, 2006, 2005, 2004 and 2003
(dollars
in thousands, except per share data)
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Total
assets
|
$
|
256,536
|
$
|
254,805
|
$
|
209,966
|
$
|
170,763
|
$
|
122,328
|
|||||
|
Cash
and due from banks
|
2,314
|
2,348
|
1,461
|
1,403
|
573
|
||||||||||
|
Federal
funds sold and other overnight investments
|
4,859
|
31,550
|
6,033
|
16,709
|
17,487
|
||||||||||
|
Investment
securities available for sale
|
400
|
698
|
1,540
|
1,544
|
1,548
|
||||||||||
|
Federal
Reserve Bank stock
|
607
|
607
|
452
|
313
|
313
|
||||||||||
|
Federal
Home Loan Bank stock
|
1,108
|
510
|
342
|
243
|
168
|
||||||||||
|
Loans,
net
|
235,956
|
214,841
|
196,590
|
149,217
|
101,049
|
||||||||||
|
Deposits
|
201,981
|
224,149
|
182,573
|
153,927
|
108,531
|
||||||||||
|
Short-term
borrowings
|
25,372
|
1,545
|
1,444
|
1,381
|
1,222
|
||||||||||
|
Note
payable
|
-
|
-
|
-
|
1,250
|
-
|
||||||||||
|
Subordinated
debt
|
8,000
|
8,000
|
8,000
|
-
|
-
|
||||||||||
|
Stockholders’
equity
|
19,921
|
18,842
|
16,214
|
13,419
|
12,067
|
||||||||||
|
Common
shares outstanding*
|
2,137,633
|
2,128,867
|
2,116,841
|
2,109,442
|
2,048,608
|
||||||||||
|
Book
value per share
|
$
|
9.32
|
$
|
8.85
|
$
|
7.66
|
$
|
6.36
|
$
|
5.89
|
|||||
|
Ratio
of interest earning assets to interest bearing liabilities
|
121.35
|
%
|
126.40
|
%
|
126.38
|
%
|
124.95
|
%
|
127.61
|
%
|
|||||
|
Stockholders’
equity as a percentage of assets
|
7.77
|
%
|
7.39
|
%
|
7.72
|
%
|
7.86
|
%
|
9.86
|
%
|
SELECTED
FINANCIAL RATIOS
FOR THE
YEARS ENDED DECEMBER 31, 2007, 2006, 2005, 2004 and 2003
|
Weighted
average yield/rate on:
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||
|
Loans
and loans held for sale
|
8.79
|
%
|
9.12
|
%
|
7.46
|
%
|
5.89
|
%
|
5.98
|
%
|
||||
|
Investments
and interest bearing cash balances
|
3.90
|
%
|
3.79
|
%
|
2.27
|
%
|
1.11
|
%
|
.80
|
%
|
||||
|
Deposits
and borrowings
|
4.45
|
%
|
4.31
|
%
|
2.96
|
%
|
2.17
|
%
|
2.26
|
%
|
||||
|
Net
interest spread
|
3.95
|
%
|
4.40
|
%
|
4.12
|
%
|
3.14
|
%
|
2.81
|
%
|
||||
|
Net
interest margin
|
4.82
|
%
|
5.27
|
%
|
4.74
|
%
|
3.60
|
%
|
3.29
|
%
|
SELECTED
OPERATIONAL DATA
FOR THE
YEARS ENDED DECEMBER 31, 2007, 2006, 2005, 2004 and 2003
(dollars
in thousands, except per share data)
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||
|
Interest
income
|
$
|
20,588
|
$
|
19,781
|
$
|
12,983
|
$
|
7,624
|
$
|
5,520
|
||||
|
Interest
expense
|
8,765
|
7,823
|
4,294
|
2,464
|
1,937
|
|||||||||
|
Net
interest income
|
11,823
|
11,958
|
8,689
|
5,160
|
3,583
|
|||||||||
|
Provision
for credit losses
|
2,126
|
203
|
1,179
|
560
|
415
|
|||||||||
|
Net
interest income after provision for credit losses
|
9,697
|
11,755
|
7,510
|
4,600
|
3,168
|
|||||||||
|
Non-interest
income
|
725
|
777
|
750
|
539
|
626
|
|||||||||
|
Non-interest
expenses
|
8,993
|
8,424
|
6,171
|
4,337
|
3,786
|
|||||||||
|
Income
before income taxes
|
1,429
|
4,108
|
2,089
|
802
|
8
|
|||||||||
|
Income
tax (expense) benefit
|
(492
|
)
|
(1,678)
|
655
|
-
|
-
|
||||||||
|
Net
income
|
$
|
937
|
$
|
2,430
|
$
|
2,744
|
$
|
802
|
$
|
8
|
||||
|
PER
COMMON SHARE
|
||||||||||||||
|
Basic
net income per share*
|
$
|
.44
|
$
|
1.14
|
$
|
1.30
|
$
|
.39
|
$
|
.00
|
||||
|
Diluted
net income per share*
|
$
|
.42
|
$
|
1.09
|
$
|
1.24
|
$
|
.37
|
$
|
.00
|
||||
|
Average
shares outstanding (Basic)*
|
2,133,174
|
2,131,882
|
2,114,809
|
2,065,693
|
1,826,357
|
|||||||||
|
Average
shares outstanding (Diluted)*
|
2,210,151
|
2,219.989
|
2,202,417
|
2,130,333
|
1,851,170
|
*All periods have been adjusted to
reflect a 1.1 to 1 stock split in the form of a 10% dividend recorded on June
29, 2007.
23
Item
7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
The
following discussion of Bay National Corporation’s financial condition and
results of operations should be read in conjunction with Bay National
Corporation’s consolidated financial statements, the notes thereto and the other
information included in this annual report.
This
discussion and analysis provides an overview of the financial condition and
results of operations of Bay National Corporation ("Parent") and its national
bank subsidiary, Bay National Bank ("Bank"), (collectively
the "Company"), as of December 31, 2007 and 2006 and for the years
ended December 31, 2007, 2006 and 2005.
Certain
reclassifications have been made to amounts previously reported to conform to
the classifications made in 2007.
General
The
Parent was incorporated on June 3, 1999 under the laws of the State of Maryland
to operate as a bank holding company of the Bank. The Bank commenced operations
on May 12, 2000.
The
principal business of the Company is to make loans and other investments and to
accept time and demand deposits. The Company’s primary market areas are in the
Baltimore Metropolitan area, Baltimore-Washington corridor and on Maryland’s
Eastern Shore, although the Company’s business development efforts generate
business outside of these areas. The Company offers a broad range of banking
products, including a full line of business and personal savings and checking
accounts, money market demand accounts, certificates of deposit, and other
banking services. The Company funds a variety of loan types including commercial
and residential real estate loans, commercial term loans and lines of credit,
consumer loans, and letters of credit with an emphasis on meeting the borrowing
needs of small businesses. The Company’s target customers are small and
mid-sized businesses, business owners, professionals and high net worth
individuals.
Overview
The
Company’s growth moderated in 2007 and operating results declined due to
deterioration of the economic environment and industry-wide problems in
residential real estate lending. As such, management continues to emphasize
prudent asset/liability management and it has significantly tightened its
underwriting standards for residential real estate loans. Key
measurements for the year ended December 31, 2007 include the
following:
|
·
|
Total
assets at December 31, 2007 increased by 0.7% to $256.5 million as
compared to $254.8 million as of December 31,
2006.
|
|
·
|
Net
loans outstanding increased by 9.8% from $ 214.8 million as of December
31, 2006 to $235.9 million as of December 31,
2007.
|
|
·
|
There
was approximately $9.4 million in non-accrual loans as of December 31,
2007. In addition, the Company foreclosed on three pieces of
investor-owned residential real estate during the third quarter of 2007.
These properties were placed into other real estate owned at estimated net
realizable value of approximately $1.06 million. There were no
other non-performing assets as of December 31,
2007.
|
|
·
|
Deposits
at December 31, 2007 were $202.0 million, a decrease of $22.2 million or
9.9% from December 31, 2006.
|
24
|
·
|
The
Company realized net income of $937,369 for the year ended December 31,
2007. This compares to net income of $2.4 million and $2.7 million for the
years ended December 31, 2006 and 2005, respectively. Included in the
results of the year ended December 31, 2007 was income tax expense of
$491,395 compared to $1.7 million recorded in 2006. Net income for the
year ended December 31, 2005 included an income tax benefit of
$655,000.
|
|
·
|
Net
interest income, the Company’s main source of income, was $11.8 million
for the year ended December 31, 2007 compared to $12.0 million and $8.7
million for the years ended December 31, 2006 and 2005, respectively. This
represents a decrease of 1.1% over 2006 and an increase of 36.1% over
2005.
|
|
·
|
Net
loan charge-offs were $300,680 for the year ended December 31, 2007. The
Company added $1.8 million to the allowance for credit losses during the
fourth quarter of 2007 primarily due to weaknesses in its portfolio of
investor-owned residential construction and reconstruction loans resulting
from problems in the housing market in its target markets. Net
loan charge-offs were $27,931 for the year ended December 31, 2006 and
there were no charge-offs for the year ended December 31,
2005.
|
|
·
|
Non-interest
income for the year ended December 31, 2007 decreased by $52,536, or 6.8%,
as compared to the year ended December 31, 2006 and by $25,796, or 3.4%,
as compared to the year ended December 31,
2005.
|
|
·
|
Non-interest
expense increased by $568,802, or 6.8%, and $2.8 million, or 45.7%, for
the year ended December 31, 2007, as compared to the years ended December
31, 2006 and 2005, respectively.
|
|
·
|
The
market price of our common stock ended the year at $9.75, down 44.1% from
the closing price of $17.45 on December 31,
2006.
|
|
·
|
During
the third and fourth quarter of 2007, the Company added four seasoned
commercial bankers, a cash management specialist and a commercial account
manager to lead its expansion into the Baltimore-Washington
corridor. The Company will continue to pursue expansion into
this and other markets; however, this strategy may have a short-term
impact on operating results.
|
A
detailed discussion of the factors leading to these changes can be found in the
discussion below.
Results
of Operations
OVERVIEW
The
Company recorded net income of $937,369 for the year ended December 31, 2007.
This compares to $2.4 million reported for the year ended December 31, 2006, a
decrease of $1.5 million. The Company reported net income of $2.7
million for the year ended December 31, 2005. The decrease in year-over-year
results is primarily due to a highly competitive market that has made revenue
growth difficult, a $1.8 million provision for credit losses during the fourth
quarter of 2007 primarily due to the slowdown in the residential real estate
market, and an increase in non-interest expenses.
Bay
National Bank’s mortgage origination operations, located in Towson and
Salisbury, Maryland, originate conventional first and second lien residential
mortgage loans and construction and rehabilitation loans. Bay National Bank
sells most of its first and second lien residential mortgage loans in the
secondary market and typically recognizes a gain on the sale of these loans
after the payment of commissions to the loan origination officer. Since its
inception in February 2001, the Salisbury mortgage division has been a
25
significant
contributor to operating results. The Towson mortgage operation was initiated in
February 2005 and began to contribute to the Company’s overall profitability
during the second half of 2005. For the years ended December 31, 2007, 2006 and
2005, gains on the sale of mortgage loans totaled $450,184, $573,387 and
$512,047, respectively. Gains on the sale of mortgage loans decreased
for the year ended December 31, 2007 as compared to the same period in 2006 due
to a slowdown in the real estate markets in the Company’s primary market
areas.
The
level of gains on the sale of mortgage loans increased in 2006 as compared to
2005 due to the addition of the Towson origination operation, which focuses on
construction and rehabilitation loans that will be modified to permanent
financing upon completion of the project. The permanent financing is then sold
in the secondary market.
In 2004,
the Company introduced a new loan program for conventional first lien and second
lien residential mortgage loans. Under this program, the Company purchases a
100% participation in mortgage loans originated by a mortgage company in the
Baltimore metropolitan area. These participations are for loans which a
secondary market investor has committed to purchase. The participations are
typically held for a period of three to four weeks before being sold to the
secondary market investor. This holding period represents the amount of time
taken by the secondary market investor to review the loan files for completeness
and accuracy. During this holding period, the Company earns interest on these
loans at a rate indexed to the prime rate.
The
primary risk to the Company from this program is that the secondary market
investor may decline to purchase the loans due to documentary deficiencies or
errors. The Company attempts to manage this risk by conducting a thorough review
of the documentation prior to purchasing the participation. If the secondary
market investor declines to purchase the loan, the Company could attempt to sell
the loan to other investors or hold the loan in its loan portfolio. As of
December 31, 2007, the Company had $8.2 million of loans outstanding under this
program, which are classified as held for sale. The Company earned $416,851 of
interest on this program during 2007, $264,299 during 2006 and $751,803 during
2005. The activity in this program declined significantly in 2006 as the
originating mortgage company utilized other available funding
sources.
Earnings
and asset growth were a challenge in 2007 as a result of the slowing economy and
the Company’s need to continue to invest in personnel to support its long-term
growth. Management also expects to face this challenge in
2008. Actual results will be subject to the volatility of the
provision for credit losses, which is related to loan growth, the volatility of
volume in the mortgage participations purchasing program, the volatility of
mortgage loan production, which is sensitive to economic and interest rate
fluctuations and other competitive pressures that arise in a slowing
economy.
NET
INTEREST INCOME / MARGINS
Net
interest income is the difference between income on earning assets and the cost
of funds supporting those assets. Earning assets are composed primarily of
loans, investments, and federal funds sold. Interest-bearing deposits and other
borrowings make up the cost of funds. Non-interest bearing deposits and capital
are also funding sources. Changes in the volume and mix of earning assets and
funding sources along with changes in associated interest rates determine
changes in net interest income.
Interest
income from loans and investments for the year ended December 31, 2007 was $20.6
million compared to $19.8 million and $13.0 million for
the years ended December 31, 2006 and 2005, respectively. The 4.1% increase over
2006, and the 58.6% increase over 2005, is directly related to the 7.9% increase
in average interest earning assets from 2006 and the 33.6% increase in average
interest earning assets from 2005. The change in interest income was also
impacted by changes in average yields due to a rising interest rate environment
in 2006 and 2005 and a declining interest rate environment in 2007. The yields
on these assets rose from 7.08% for the year ended December 31, 2005 to 8.71%
for the year ended December 31, 2006 and declined to 8.40% for the year ended
December 31, 2007.
26
The
percentage of average interest-earning assets represented by loans was 92.0%,
92.3% and 92.5% for the years ended December 31, 2007, 2006, and 2005,
respectively. For the year ended December 31, 2007, the average yield on the
loan portfolio was 8.79%, as compared to 9.12% for the year ended December 31,
2006 and 7.46% for the year ended December 31, 2005. Loan yields declined from
2006 primarily due to three reductions in the target federal funds rate during
2007, from 5.25% effective June 29, 2006 to 4.25% at December 11,
2007. Loan yields increased from 2005 to 2006 primarily as a result
of twelve 0.25% increases in the target federal funds rate, from 2.25% at
December 14, 2004 to 5.25% effective June 29, 2006. As can be seen by the yields
discussed above, these fluctuations had a significant impact on the Company’s
operating results. The timing and amount of the impact on loan yields of changes
to the federal funds rates varies from period to period as a result of
differences in the mix of fixed rate loans to variable rate loans at any point
in time.
The
average yield on the investment portfolio and other earning assets such as
federal funds sold was 3.90% for the year ended December 31, 2007 as
compared to 3.79% and 2.27% for the years ended December 31, 2006 and 2005,
respectively. The fluctuations in the average yields were a direct result of the
Federal Reserve actions discussed above as well as an increase in the holdings
of Federal Reserve and Federal Home Loan Bank of Atlanta stocks, which pay
dividend yields greater than the prevailing federal funds rate. The percentage
of average interest-earning assets represented by investments was 8.0%, 7.7% and
7.5% for the years ended December 31, 2007, 2006 and 2005,
respectively.
Interest
expense from deposits and borrowings for the year ended December 31, 2007 was
$8.8
million compared to $7.8 million and $4.3 million for the years ended December
31, 2006 and 2005, respectively. The 12.0% increase over 2006 and the 104.1%
increase over 2005 are directly related to the 8.5% increase in average
interest-bearing liabilities from 2006 and the 35.7% increase in average
interest-bearing liabilities from 2005. Interest expense was also impacted by
changes in average rates paid due to Federal Reserve actions discussed above.
The average rates paid on these liabilities changed from 2.96% for the year
ended December 31, 2005 to 4.31% for the year ended December 31, 2006 to 4.45%
for the year ended December 31, 2007. During the fourth quarter of
2007, management observed ongoing pressure to pay higher rates on deposits as
the market for funds has become more competitive. In addition, the
market is very competitive for loans, which, as is typical, has created downward
pressure on loan pricing.
The
following tables set forth, for the periods indicated, information regarding the
average balances of interest-earning assets and interest-bearing liabilities,
the amount of interest income and interest expense, and the resulting yields on
average interest-earning assets and rates paid on average interest-bearing
liabilities. Average balances are also provided for non-interest-earning assets
and non-interest-bearing liabilities.
No tax
equivalent adjustments were made and no interest income was exempt from federal
income taxes. All average balances are daily average
balances. The average balances of non-accrual loans are included in
the average loan balances for the periods indicated. The amortization
of loan fees is included in computing interest income; however, such fees are
not material.
27
|
Year
Ended December 31, 2007
|
||||||||||||
|
Average
Balance
|
Interest
and fees
|
Yield/
Rate
|
||||||||||
|
ASSETS
|
||||||||||||
|
Loans
and loans held for sale
|
$ | 225,627,420 | $ | 19,823,408 | 8.79 | % | ||||||
|
Investment
securities
|
1,659,751 | 93,630 | 5.64 | |||||||||
|
Federal
funds sold and other overnight investments
|
17,924,113 | 670,971 | 3.74 | |||||||||
|
Total
Earning Assets
|
245,211,284 | 20,588,009 | 8.40 | % | ||||||||
|
Less:
Allowance for credit losses
|
(3,221,583 | ) | ||||||||||
|
Cash
and due from banks
|
2,467,696 | |||||||||||
|
Other
real estate owned, net
|
273,588 | |||||||||||
|
Premises
and equipment, net
|
1,122,160 | |||||||||||
|
Investment
in bank owned life insurance
|
1,044,092 | |||||||||||
|
Accrued
interest receivable and other assets
|
2,904,620 | |||||||||||
|
Total
Assets
|
$ | 249,801,857 | ||||||||||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||||||
|
Interest-bearing
demand deposits
|
$ | 75,969,362 | 2,670,374 | 3.52 | % | |||||||
|
Regular
savings deposits
|
3,858,771 | 75,207 | 1.95 | |||||||||
|
Time
deposits
|
103,139,490 | 5,163,572 | 5.01 | |||||||||
|
Short-term
borrowings
|
5,997,193 | 253,956 | 4.23 | |||||||||
|
Subordinated
debt
|
8,000,000 | 602,096 | 7.53 | |||||||||
|
Total
interest-bearing liabilities
|
196,964,816 | 8,765,205 | 4.45 | % | ||||||||
|
Net
interest income and spread
|
$ | 11,822,804 | 3.95 | % | ||||||||
|
Non-interest-bearing
demand deposits
|
31,164,810 | |||||||||||
|
Accrued
expenses and other liabilities
|
1,576,342 | |||||||||||
|
Stockholders’
equity
|
20,095,889 | |||||||||||
|
Total
Liabilities and Stockholders’ Equity
|
$ | 249,801,857 | ||||||||||
|
Interest
and fee income/earning assets
|
8.40 | % | ||||||||||
|
Interest
expense/earning assets
|
3.58 | |||||||||||
|
Net
interest margin
|
4.82 | % | ||||||||||
|
Return
on Average Assets
|
.38 | % | ||||||||||
|
Return
on Average Equity
|
4.66 | % | ||||||||||
|
Average
Equity to Average Assets
|
8.04 | % | ||||||||||
28
|
Year
Ended December 31, 2006
|
||||||||||||
|
Average
Balance
|
Interest and fees
|
Yield/
Rate
|
||||||||||
|
ASSETS
|
||||||||||||
|
Loans
and loans held for sale
|
$ | 209,637,043 | $ | 19,117,244 | 9.12 | % | ||||||
|
Investment
securities
|
2,151,124 | 105,625 | 4.91 | |||||||||
|
Federal
funds sold and other overnight investments
|
15,366,594 | 557,970 | 3.63 | |||||||||
|
Total
Earning Assets
|
227,154,761 | 19,780,839 | 8.71 | % | ||||||||
|
Less:
Allowance for credit losses
|
(3,029,070 | ) | ||||||||||
|
Cash
and due from banks
|
2,089,474 | |||||||||||
|
Premises
and equipment, net
|
952,629 | |||||||||||
|
Accrued
interest receivable and other assets
|
2,761,444 | |||||||||||
|
Total
Assets
|
$ | 229,929,238 | ||||||||||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||||||
|
Interest-bearing
demand deposits
|
$ | 61,312,209 | 2,208,830 | 3.60 | % | |||||||
|
Regular
savings deposits
|
6,327,802 | 67,402 | 1.07 | |||||||||
|
Time
deposits
|
103,935,678 | 4,856,379 | 4.67 | |||||||||
|
Short-term
borrowings
|
1,935,743 | 86,522 | 4.47 | |||||||||
|
Subordinated
debt
|
8,000,000 | 603,567 | 7.55 | |||||||||
|
Total
interest-bearing liabilities
|
181,511,432 | 7,822,700 | 4.31 | % | ||||||||
|
Net
interest income and spread
|
$ | 11,958,139 | 4.40 | % | ||||||||
|
Non-interest-bearing
demand deposits
|
29,145,397 | |||||||||||
|
Accrued
expenses and other liabilities
|
1,701,423 | |||||||||||
|
Stockholders’
equity
|
17,570,986 | |||||||||||
|
Total
Liabilities and Stockholders’ Equity
|
$ | 229,929,238 | ||||||||||
|
Interest
and fee income/earning assets
|
8.71 | % | ||||||||||
|
Interest
expense/earning assets
|
3.44 | |||||||||||
|
Net
interest margin
|
5.27 | % | ||||||||||
|
Return
on Average Assets
|
1.06 | % | ||||||||||
|
Return
on Average Equity
|
13.83 | % | ||||||||||
|
Average
Equity to Average Assets
|
7.64 | % | ||||||||||
29
|
Year
Ended December 31, 2005
|
||||||||||||
|
Average
Balance
|
Interest
and fees
|
Yield/
Rate
|
||||||||||
|
ASSETS
|
||||||||||||
|
Loans
and loans held for sale
|
$ | 169,811,066 | $ | 12,671,707 | 7.46 | % | ||||||
|
Investment
securities
|
2,343,007 | 86,267 | 3.68 | |||||||||
|
Federal
funds sold and other overnight investments
|
11,340,021 | 224,732 | 1.98 | |||||||||
|
Total
Earning Assets
|
183,494,094 | 12,982,706 | 7.08 | % | ||||||||
|
Less:
Allowance for credit losses
|
(2,064,604 | ) | ||||||||||
|
Cash
and due from banks
|
1,328,632 | |||||||||||
|
Premises
and equipment, net
|
708,549 | |||||||||||
|
Accrued
interest receivable and other assets
|
900,832 | |||||||||||
|
Total
Assets
|
$ | 184,367,233 | ||||||||||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||||||
|
Interest-bearing
demand deposits
|
$ | 56,170,562 | 1,064,126 | 1.89 | % | |||||||
|
Regular
savings deposits
|
5,643,798 | 36,572 | .65 | |||||||||
|
Time
deposits
|
77,785,133 | 2,957,821 | 3.80 | |||||||||
|
Short-term
borrowings
|
3,630,729 | 115,810 | 3.19 | |||||||||
|
Note
payable
|
1,426,027 | 91,709 | 6.43 | |||||||||
|
Subordinated
debt
|
438,356 | 28,108 | 7.20 | |||||||||
|
Total
interest-bearing liabilities
|
145,094,605 | 4,294,146 | 2.96 | % | ||||||||
|
Net
interest income and spread
|
$ | 8,688,560 | 4.12 | % | ||||||||
|
Non-interest-bearing
demand deposits
|
24,032,958 | |||||||||||
|
Accrued
expenses and other liabilities
|
884,689 | |||||||||||
|
Stockholders’
equity
|
14,354,981 | |||||||||||
|
Total
Liabilities and Stockholders’ Equity
|
$ | 184,367,233 | ||||||||||
|
Interest
and fee income/earning assets
|
7.08 | % | ||||||||||
|
Interest
expense/earning assets
|
2.34 | |||||||||||
|
Net
interest margin
|
4.74 | % | ||||||||||
|
Return
on Average Assets
|
1.49 | % | ||||||||||
|
Return
on Average Equity
|
19.12 | % | ||||||||||
|
Average
Equity to Average Assets
|
7.79 | % | ||||||||||
30
RATE/VOLUME
ANALYSIS
A
rate/volume analysis, which demonstrates changes in taxable-equivalent interest
income and expense for significant assets and liabilities, appears below. The
calculation of rate, volume and rate/volume variances is based on a procedure
established for bank holding companies by the Securities and Exchange
Commission. Rate, volume and rate/volume variances presented for each component
may not total to the variances presented on totals of interest income and
interest expense because of shifts from year to year in the relative mix of
interest-earning assets and interest-bearing liabilities.
|
Year
ended December 31,
|
||||||||||||
|
2007
vs. 2006
Due
to variances in
|
||||||||||||
|
Total
|
Rates
|
Volumes
|
Rate/
Volume
|
|||||||||
|
Interest
income on:
|
||||||||||||
|
Loans
and loans held for sale
|
$
|
706,164
|
$
|
(698,735
|
)
|
$
|
1,458,196
|
$
|
(53,297
|
)
|
||
|
Investment
securities
|
(11,995
|
)
|
15,724
|
(24,127
|
)
|
(3,592
|
)
|
|||||
|
Federal
funds sold and other overnight investments
|
113,001
|
17,263
|
92,865
|
2,873
|
||||||||
|
Total
interest income
|
807,170
|
(665,748
|
)
|
1,526,934
|
(54,016
|
)
|
||||||
|
Interest
expense on:
|
||||||||||||
|
Interest-bearing
demand deposits
|
461,544
|
(53,665
|
)
|
528,038
|
(12,829
|
)
|
||||||
|
Regular
savings deposits
|
7,805
|
55,926
|
(26,299
|
)
|
(21,822
|
)
|
||||||
|
Time
deposits
|
307,193
|
347,054
|
(37,202
|
)
|
(2,659
|
)
|
||||||
|
Short-term
borrowings
|
167,434
|
(4,552
|
)
|
181,535
|
(9,549
|
)
|
||||||
|
Subordinated
debt
|
(1,471
|
)
|
(1,471
|
)
|
-
|
-
|
||||||
|
Total
interest expense
|
942,505
|
343,292
|
646,072
|
(46,859
|
)
|
|||||||
|
Net
interest income
|
$
|
(135,335
|
)
|
$
|
(1,009,040
|
)
|
$
|
880,862
|
$
|
(7,157
|
)
|
|
|
Year
ended December 31,
|
||||||||||||
|
2006
vs. 2005
Due
to variances in
|
||||||||||||
|
Total
|
Rates
|
Volumes
|
Rate/
Volume
|
|||||||||
|
Interest
income on:
|
||||||||||||
|
Loans
and loans held for sale
|
$
|
6,445,537
|
$
|
2,813,722
|
$
|
2,971,909
|
$
|
659,906
|
||||
|
Investment
securities
|
19,358
|
28,780
|
(7,065
|
)
|
(2,357
|
)
|
||||||
|
Federal
funds sold and other overnight investments
|
333,238
|
187,031
|
79,797
|
66,410
|
||||||||
|
Total
interest income
|
6,798,133
|
3,029,533
|
3,044,641
|
723,959
|
||||||||
|
Interest
expense on:
|
||||||||||||
|
Interest-bearing
demand deposits
|
1,144,704
|
959,471
|
97,406
|
87,827
|
||||||||
|
Regular
savings deposits
|
30,830
|
23,544
|
4,433
|
2,853
|
||||||||
|
Time
deposits
|
1,898,558
|
676,678
|
994,388
|
227,492
|
||||||||
|
Short-term
borrowings
|
(29,288
|
)
|
46,473
|
(54,065
|
)
|
(21,696
|
)
|
|||||
|
Note
payable
|
(91,709
|
)
|
(91,709
|
)
|
(91,709
|
)
|
91,709
|
|||||
|
Subordinated
Debt
|
575,459
|
4,964
|
484,863
|
85,632
|
||||||||
|
Total
interest expense
|
3,528,554
|
1,619,421
|
1,435,316
|
473,817
|
||||||||
|
Net
interest income
|
$
|
3,269,579
|
$
|
1,410,112
|
$
|
1,609,325
|
$
|
250,142
|
||||
PROVISION
FOR CREDIT LOSSES
The
provision for credit losses was $2.1 million for the year ended December 31,
2007, as compared to $202,931 for the year ended December 31, 2006, and $1.2
million for the year ended December 31, 2005. The provision in 2007 was higher
than the same period in the prior year due to an increase in the level of risk
in the Company’s residential real estate portfolio resulting from a slowdown in
the real estate market in the Company’s markets. This slowdown
resulted in an increase in loan extensions and delinquencies due to the
inability of investors to resell properties as quickly as
anticipated. More specifically, the Company
31
experienced
weaknesses in its portfolio of investor-owned residential construction and
reconstruction loans, which totaled approximately $27.5 million of which $9.4
million was classified as non-accrual as of December 31, 2007. In
addition, the Company foreclosed on three pieces of investor-owned residential
real estate during the third quarter of 2007. For additional
information on nonperforming loans, see the Management Discussion and Analysis
section entitled “Nonperforming Loans and Other Delinquent Assets.”
Management
is aggressively addressing the problems in this portfolio; however, resolving
these issues will take time as the residential real estate market works through
its downturn and housing inventories return to normal levels. As
such, there can be no assurance that management’s actions will result in
decreases in the rate of non-accrual and past due loans.
The
provision for 2005 was higher than 2006 due to the fact that an additional
$500,000 provision was established in the fourth quarter of 2005 as a result of
the downgrading of one credit. For additional information regarding the
methodology used to determine the provision for credit losses see the Management
Discussion and Analysis section entitled “Allowance for Credit Losses and Credit
Risk Management.”
NON-INTEREST
INCOME
Non-interest
income consists primarily of gains on the sale of mortgage loans, deposit
account service charges and cash management fees. For the year ended December
31, 2007, the Company realized non-interest income in the amount of $724,797 as
compared to $777,333 and $750,593 for the years ended December 31, 2006 and
2005, respectively.
Gains on
the sale of mortgage loans of $450,184 represented 62.1% of non-interest income
for the year ended December 31, 2007. This compares to gains on the
sale of mortgage loans of $573,387, or 73.8%, of total non-interest income for
the year ended December 31, 2006 and $512,047, or 68.2%, of total non-interest
income for the year ended December 31, 2005. The decrease for the year ended
December 31, 2007 as compared to the prior year was due to a general decline in
home purchase and refinance activity in the Company’s markets. The
level of gains on the sale of mortgage loans increased from 2005 to 2006 because
the Company added additional residential construction and mortgage capabilities
with the opening of the Towson mortgage operation in February 2005. This was
achieved through the hiring of a team of eight individuals, including
originators, processors and servicers who have extensive experience in the
industry and the Company’s market area.
Service
charges on deposit accounts totaled $153,813 for the year ended December 31,
2007, as compared to $148,042 and $188,276 for the years ended December 31, 2006
and 2005, respectively. This represents an increase of 3.9% over 2006 and a
decrease of 18.3% compared to 2005. The increase over 2006 was primarily due to
an increase in the level of analysis fees charged on transaction accounts. The
decrease from 2005 can be primarily attributed to a decline in the level of
overdraft fees charged on transaction accounts.
Other
income totaled $120,800 for the year ended December 31, 2007 as compared to
$55,904 and $50,270 for the years ended December 31, 2006 and 2005,
respectively. These represent increases of 116.1% and 140.3% over
2006 and 2005, respectively. These increases were primarily driven by
the Company’s investment in bank owned life insurance (“BOLI”) which was
purchased during the fourth quarter of 2007. The initial investment
totaled $5.0 million and the Company recognized income of $41,662 related to
increases in this investment during the year ended December 31,
2007.
The
Company will continue to seek ways to expand its sources of non-interest income.
In the future, the Company may enter into fee arrangements with strategic
partners that offer investment advisory services, risk management and employee
benefit services. No assurance can be given that such fee arrangements will be
obtained or maintained.
32
NON-INTEREST
EXPENSE
The components of non-interest expense
were as follows:
|
Years Ended December
31,
|
|||||||
|
2007
|
2006
|
2005
|
|||||
|
Salaries
and employee benefits
|
$
|
5,460,772
|
$
|
5,431,989
|
$
|
3,627,630
|
|
|
Occupancy
expenses
|
653,227
|
506,323
|
420,866
|
||||
|
Furniture
and equipment expenses
|
351,599
|
342,261
|
304,132
|
||||
|
Legal
and professional fees
|
285,434
|
245,412
|
154,476
|
||||
|
Data
processing and other outside services
|
870,404
|
701,422
|
655,726
|
||||
|
Advertising
and marketing related expenses
|
486,204
|
512,709
|
445,482
|
||||
|
Other
expenses
|
885,517
|
684,239
|
562,645
|
||||
|
Total
non-interest expenses
|
$
|
8,993,157
|
$
|
8,424,355
|
$
|
6,170,957
|
|
2007 compared to
2006
Non-interest
expense for the year ended December 31, 2007 totaled $9.0 million compared to
$8.4 million for the year ended December 31, 2006. The increase of $568,802, or
6.8%, was primarily due to increases in other expenses, data processing and
other outside services and occupancy expenses.
Salaries
and employee benefit expenses represented 60.7% and 64.5% of non-interest
expenses for the years ended December 31, 2007 and 2006,
respectively. Salaries and benefits marginally increased by $28,783
or 0.5%. The Bank experienced staffing growth during 2007 in
commercial account portfolio managers, commercial lenders and other operations
support. In addition, the Company added four commercial bankers, a
cash management specialist and a commercial account manager during the second
half of the year to lead expansion into the Baltimore-Washington
corridor. These additions were made to continue to expand its market
presence, as well as to manage the growth of the loan and deposit portfolios and
support increased operational volume. The Company’s strategy to
continue to pursue additional markets may have a short-term impact on operating
results. The increased expense related to this staffing growth was
offset by a decrease in accrued bonuses based on the Company’s financial
performance and a decrease in commissions based on the industry-wide slow down
in residential real estate lending.
Occupancy
expenses increased by $146,904, or 29.0%, due in part to scheduled rent
increases, the acquisition of new space obtained during the fourth quarter of
2006 for the Company’s Towson residential lending operation and assumption of
first floor space that had previously been sublet at the Bank’s Baltimore
location.
Legal and
professional fees increased $40,022, or 16.3%, during 2007. The
increase was related to legal fees incurred in connection with the drafting of a
Stock Incentive Plan, increased costs associated with drafting the Annual Report
and Proxy materials, and increased legal fees incurred to help manage and
workout loans in the Company’s residential real estate portfolio. There was also
an increase in internal and external audit and other accounting fees related to
Company growth and implementation of provisions of the Sarbanes-Oxley Act of
2002 related to the documentation and testing of internal control over financial
reporting.
The
$168,982, or 24.1%, increase in data processing and other outside services
resulted from increased costs paid during 2007 for the cost of supporting a
computer infrastructure at an additional location, the costs associated with
enhanced security and preventive maintenance programs and an increase in
outsourced data and item processing costs that are a function of the growth of
the Bank and the number of customer accounts.
The
$9,338, or 2.7%, increase in furniture and equipment expenses during 2007 is
related to increased costs associated with expanded staffing and facilities.
Advertising and marketing related expenses
33
decreased
$26,505 or 5.2%, which was related to a decline in charitable contributions
offset by increased advertising for the Towson residential lending and Howard
County loan production offices. The increase of $201,278, or 29.4%,
in all other expenses relates to various costs associated with the increased
size and complexity of the Company and a provision for other real estate owned
losses of $111,700 recorded during the fourth quarter of 2007. In
addition, the Company experienced an increase of $108,978 in FDIC insurance
expense as the FDIC revised its fee structure.
The
banking industry utilizes the “efficiency ratio” as a key measure of expense
management and overall operating efficiency. This ratio is computed by dividing
non-interest expense by the sum of net interest income before the loan loss
provision and non-interest income. The Company’s efficiency ratio was 71.7%
for the year ended December 31, 2007 compared to 66.1% for the year ending
December 31, 2006. The increase in the efficiency ratio from the prior year is a
result of management’s decision to continue to invest in personnel to support
the long-term growth of the Company.
Approximately
73% of the occupancy costs in 2007 were paid to directors of Bay National
Corporation or entities controlled by directors of Bay National
Corporation. Management believes that the terms of these leases are
at least as favorable as could be obtained from independent third
parties. However, management has not conducted a recent market
analysis to confirm this. For a discussion of the terms of the leases with these
persons, see “Item 13 – Certain Relationships and Related Transactions, and
Director Independence.”
2006 compared to
2005
Non-interest
expense for the year ended December 31, 2006 totaled $8.4 million compared to
$6.2 million for the year ended December 31, 2005. The increase of $2.2 million,
or 36.5%, was primarily due to increases in salaries and employee benefit
expenses, which represented 64.5% and 58.8% of non-interest expenses for the
years ended December 31, 2006 and 2005, respectively.
Salaries
and benefits increased by $1.8 million, or 49.7%, which was related to staffing
growth, including the addition of a Senior Credit Officer in January 2006 and a
Senior Business Development Officer in June 2006, as well as staffing growth in
residential real estate lending, private banking, commercial account portfolio
managers and other operational support. These additions were made to continue to
expand the Bank’s market presence, as well as to manage the growth of the loan
and deposit portfolios and support increased operational volume. Occupancy
expenses increased by $85,457, or 20.3%, due in part to scheduled rent increases
and increased rental expenses associated with new space obtained to accommodate
a larger Baltimore banking office and the Towson mortgage
operation.
Legal and
professional fees increased $90,936, or 58.9%, resulting from legal fees
incurred in connection with the drafting of executive employment agreements and
legal assistance with the development of a commercial paper program, as well as
an increase in internal and external audit fees related to Company growth and
management’s desire to more frequently assess more complex functions such as
information technology controls and residential lending compliance.
The
$45,696, or 7.0%, increase in data processing and other outside services
resulted from increased costs paid during 2006 for enhancements to the Company’s
information technology maintenance and security infrastructure, human resource
consulting, and higher printing expenses related to increased regulatory
filings. The increased regulatory filings were required when the Company
registered its securities under Section 12 of the Securities Exchange Act of
1934, as amended (the “Exchange Act”) in connection with listing its common
stock on the NASDAQ Capital Market during the first quarter of
2006.
The
$38,129, or 12.5%, increase in furniture and equipment expenses is related to
increased costs associated with expanded staffing and facilities. Advertising
and marketing related expenses increased $67,227, or 15.1%, which was related to
an increase in the number of marketing events conducted and the
34
number of
business development professionals. The increase of $121,594, or 21.6%, in all
other expenses relates to various costs associated with the increased size and
complexity of the Company.
The
Company’s efficiency ratio was 66.1% for the year ended December 31, 2006
compared to 65.4% for the year ending December 31, 2005. The increase from the
prior year was driven by increased expenses not matching up to revenue
growth.
INCOME
TAXES
For the
year ended December 31, 2007, the Company recorded income tax expense of
$491,395 compared to $1,678,358 recorded for the year ended December 31,
2006. The decrease is primarily a result of a decrease in taxable
income for the 2007 period.
For
financial reporting purposes, taxable income for the year ended December 31,
2005 was offset by the Company’s net operating loss carryforwards available in
that year. The 2005 liability was offset by the recognition of a deferred tax
asset of $1,083,000, resulting in the net tax benefit of $655,000 for the year
ended December 31, 2005.
At
December 31, 2007, the Company continues to have approximately $2.3 million of
Maryland net operating loss carryforwards (a possible net tax benefit of
$192,000) for the unconsolidated state tax return for Bay National
Corporation. Unless Bay National Corporation generates income from
its own operations (i.e., unrelated to Bay National Bank), these operating loss
carryforwards will expire in 2019 and 2021.
35
Financial
Condition
COMPOSITION
OF THE BALANCE SHEET
Total
assets of the Company were $256.5 million as of December 31, 2007, compared to
total assets of $254.8 million as of December 31, 2006. This represents marginal
growth of approximately $1.7 million, or 0.68%, since December 31,
2006. Deposits at December 31, 2007 were $202.0 million as compared
to deposits of $224.1 million at December 31, 2006. The decline in deposits was
primarily attributed to an $18.4 million decrease in interest-bearing deposits
which was offset by a $3.1 million increase in national market certificates of
deposit. As of December 31, 2007, loans including loans held for sale
(net of a $5.0 million allowance for credit losses), totaled $235.9
million. This represents an increase of $21.1 million, or 9.8%,
from December 31, 2006. This growth is a result of expansion into the
Baltimore-Washington corridor and an increase in activity under the program
where the Company purchases 100% participations in mortgage loans originated by
a mortgage company in the Baltimore metropolitan area. A total of
approximately $56.8 million in loans that were outstanding as of December 31,
2006 were paid off during 2007. This activity, combined with normal fluctuations
in revolving credit balances and installment payments on amortizing loans,
offset most of the approximately $58.6 million in new loans, excluding loans
held for sale, funded during that same period. During 2007, the
Company funded approximately $162 million in mortgage loans held for sale of
which approximately $152 million were subsequently sold in the secondary
market.
The
composition of the loan portfolio as of December 31, 2007 was approximately
$102.7 million of commercial loans (excluding real estate loans), $4.1 million
of consumer loans and $122.6 million of real estate loans excluding $11.6
million of mortgage loans held for sale. The composition of the loan portfolio
as of December 31, 2006 was approximately $88.5 million of commercial loans
(excluding real estate loans), $3.3 million of consumer loans and $124.8 million
of real estate loans excluding $1.4 million of mortgage loans held for sale. The
overall growth in the loan portfolio and specifically the increased
concentration in commercial loans are a direct result of the expansion into the
Baltimore-Washington corridor as well as the marketing efforts of bank
employees, members of the Board of Directors and the Baltimore and Salisbury
Advisory Boards.
The
Company has experienced weakness in its portfolio of investor-owned residential
construction and reconstruction loans. This total portfolio as of December 31,
2007 was approximately $27.5 million of which $9.4 million was classified as
non-accrual. Management is proactively and aggressively addressing the problems
in this portfolio by reviewing the specific credits more frequently, consulting
with legal counsel when necessary, working with borrowers for potential
restructure or working with potential investors to facilitate the sale of the
property. In addition, the Company has significantly tightened
underwriting standards for these types of loans and is currently originating
very little of this business. Resolving these issues will take time
as the residential real estate market works through its downturn and housing
inventories return to normal levels, and there can be no assurance that
management’s actions will result in decreases in the rate of non-accrual and
past due loans.
During
the third quarter of 2007, the Company foreclosed on three pieces of
investor-owned residential real estate. These properties were placed into other
real estate owned at estimated net realizable value of approximately $1.05
million. The difference between the related loan balances totaling approximately
$1.38 million and the net realizable value was charged off to the allowance for
credit losses during that period. Prior to these foreclosures, the Company had
no other real estate owned. Based on review of estimates of current
market values for these properties, the Company recorded a provision of $111,700
in December 2007.
The
Company will continue to emphasize prudent growth through the hiring of
experienced commercial lenders and the development and use of referral sources
including accountants, lawyers and existing customers, as well as members of the
Board of Directors and the Baltimore and Salisbury Advisory Boards.
36
Funds not
extended in loans are held in cash and due from banks, and various investments
including federal funds sold and other overnight investments, United States
Treasury securities, Federal Reserve Bank stock and Federal Home Loan Bank
stock. These investments totaled $9.3 million as of December 31, 2007 compared
to $35.7 million as of December 31, 2006. Other than the investments in Federal
Reserve Bank stock and Federal Home Loan Bank stock, totaling $1.7 million and
$1.1 million at December 31, 2007 and 2006, respectively, all investments have
maturities of 90 days or less. The Treasury securities are used to collateralize
municipal deposits and repurchase agreements which are classified as short-term
borrowings under which $300,000 was outstanding as of December 31, 2006. There
were no outstanding repurchase agreements as of December 31,
2007. Management has made a decision to maintain liquidity in the
investment portfolio in order to ensure that funds are readily available to fund
the growth of the loan portfolio or to fund the maturity of higher cost national
time deposits.
Total capital at December 31, 2007 was
$19.9 million as compared to $18.8 million at December 31, 2006. The increase in
capital is primarily a result of the positive operating results for the year
ended December 31, 2007.
COMPOSITION
OF LOAN PORTFOLIO
Because
yields on loans typically exceed the yields on investments, the Company’s
business strategy is to continue to increase the overall level of loans, as well
as maintain a relatively high percentage of loans to total earning
assets. Increasing loans and loans as a percentage of total earning
assets will maximize the net interest margin. As of December 31, 2007
and 2006, loans represented 97.2% and 86.73% of total earning assets,
respectively.
The
following table sets forth the composition of the principal balances of the
Company’s loan portfolio as of December 31, 2007, 2006, 2005, 2004, and 2003,
respectively.
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||||||||
|
Real
Estate – Home Equity Line of Credit
|
$ | 18,585,641 | $ | 19,963,116 | $ | 21,067,964 | $ | 24,548,506 | $ | 16,078,166 | ||||||||||
|
Real
Estate – Construction
|
67,775,883 | 76,889,997 | 47,933,768 | 12,968,251 | 8,101,017 | |||||||||||||||
|
Real
Estate – Mortgage
|
36,210,905 | 27,903,399 | 34,542,931 | 27,854,130 | 13,687,709 | |||||||||||||||
|
Loans
Held for Sale
|
11,601,070 | 1,444,303 | 17,509,064 | 9,613,162 | 923,825 | |||||||||||||||
|
Commercial
|
102,728,342 | 88,491,722 | 75,626,825 | 73,836,994 | 61,868,002 | |||||||||||||||
|
Consumer
|
4,054,400 | 3,323,141 | 2,909,409 | 2,205,556 | 1,657,081 | |||||||||||||||
|
Total
Loans
|
$ | 240,956,241 | $ | 218,015,678 | $ | 199,589,961 | $ | 151,026,599 | $ | 102,315,800 | ||||||||||
The
following table sets forth the percentages of loans in each category for the
Company’s loan portfolio as of December 31, 2007, 2006, 2005, 2004 and 2003,
respectively.
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||||||||
|
Real
Estate – Home Equity Line of Credit
|
7.71 | % | 9.16 | % | 10.55 | % | 16.25 | % | 15.71 | % | ||||||||||
|
Real
Estate – Construction
|
28.13 | 35.27 | 24.02 | 8.59 | 7.92 | |||||||||||||||
|
Real
Estate – Mortgage
|
15.03 | 12.80 | 17.31 | 18.44 | 13.38 | |||||||||||||||
|
Loans
Held for Sale
|
4.82 | 0.66 | 8.77 | 6.37 | .90 | |||||||||||||||
|
Commercial
|
42.63 | 40.59 | 37.89 | 48.89 | 60.47 | |||||||||||||||
|
Consumer
|
1.68 | 1.52 | 1.46 | 1.46 | 1.62 | |||||||||||||||
|
Total
Loans
|
100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % | ||||||||||
37
The
following table sets forth the maturity distribution for the Company’s loan
portfolio at December 31, 2007. Some of the loans may be renewed or repaid prior
to maturity. Therefore, the following table should not be used as a forecast of
future cash flows.
|
Within
one
year
|
One
to
three years
|
Three
to
five years
|
Over
five
years
|
|||||||||||||
|
Real
Estate – Home Equity Line of Credit
|
$ | 18,585,641 | $ | - | $ | - | $ | - | ||||||||
|
Real
Estate – Construction
|
67,216,437 | 323,799 | 235,647 | - | ||||||||||||
|
Real
Estate – Mortgage
|
17,708,242 | 7,225,520 | 7,658,945 | 3,618,198 | ||||||||||||
|
Loans
Held for Sale
|
11,601,070 | - | - | - | ||||||||||||
|
Commercial
|
70,193,949 | 17,065,667 | 11,568,208 | 3,900,518 | ||||||||||||
|
Consumer
|
3,745,142 | 169,892 | 116,173 | 23,193 | ||||||||||||
|
Total
|
$ | 189,050,481 | $ | 24,784,878 | $ | 19,578,973 | $ | 7,541,909 | ||||||||
|
Fixed
interest rate
|
$ | 60,003,268 | $ | 24,784,878 | $ | 19,578,973 | $ | 7,541,909 | ||||||||
|
Variable
interest rate
|
117,446,143 | - | - | - | ||||||||||||
|
Loans
Held for Sale
|
11,601,070 | - | - | - | ||||||||||||
|
Total
|
$ | 189,050,481 | $ | 24,784,878 | $ | 19,578,973 | $ | 7,541,909 | ||||||||
The
scheduled repayments as shown above are reported in the maturity category in
which the payment is due, except for the adjustable rate loans, which are
reported in the period of repricing.
The
Company’s loan portfolio composition as of December 31, 2007 reflects a 53.6%
concentration in variable rate loans. Loans held for sale represented 4.8% of
the Company’s loan portfolio. Fixed rate loans totaled $111.9 million, or 46.4%,
of the Company’s loan portfolio. Interest rates on variable rate loans adjust to
the current interest rate environment, whereas fixed rates do not allow this
flexibility. Loans held for sale are expected to be sold in three months or less
and as a result are not materially impacted by interest rate fluctuations. If
interest rates were to increase in the future, the interest earned on the
variable rate loans would improve, and, if rates were to fall, the interest
earned would decline. See “Liquidity and Interest Rate
Sensitivity.”
The
officers and directors of the Company, including their related companies, had
outstanding loans from the Bank of $13.5 million at December 31, 2007 and $11.2
million at December 31, 2006. All loans made to officers and directors,
including their related companies, are made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with unaffiliated third parties and do not involve more
than the normal risk of repayment or present other unfavorable
features.
ALLOWANCE
FOR CREDIT LOSSES AND CREDIT RISK MANAGEMENT
Originating
loans involves a degree of risk that credit losses will occur in varying amounts
according to, among other factors, the type of loans being made, the
credit-worthiness of the borrowers over the term of the loans, the quality of
the collateral for the loan, if any, as well as general economic
conditions. The Company charges the provision for credit losses to
earnings to maintain the total allowance for credit losses at a level considered
by management to represent its best estimate of the losses known and inherent in
the portfolio that are both probable and reasonable to estimate, based on, among
other factors, prior loss experience, volume and type of lending conducted,
estimated value of any underlying collateral, economic conditions (particularly
as such conditions relate to the Company’s market area), regulatory guidance,
peer statistics, management’s judgment, past due loans in the loan portfolio,
loan charge off experience and concentrations of risk (if any). The
Company charges losses on loans against the allowance when it is
38
believed
that collection of loan principal is unlikely. Recoveries on loans
previously charged off are added back to the allowance.
Management
uses a loan grading system where all loans are graded based on management’s
evaluation of the risk associated with each loan. A factor, based on the loan
grading, is applied to the loan balance to reserve for potential losses. In
addition, management judgmentally establishes an additional nonspecific reserve.
The nonspecific portion of the allowance reflects management’s estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower’s financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates and risk factors that have not yet manifested themselves in loss
allocation factors.
The
reserve factors used are based on management’s judgment as to appropriate
reserve percentages for various categories of loans, and management adjusts
those values based on the following: historical losses in each category,
historical and current delinquency in each category, underwriting standards in
each category, comparison of losses and delinquencies to peer group performance
and an assessment of the likely impact of economic and other external conditions
on the performance of each category.
A test of
the adequacy of the allowance for credit losses is performed and reported to the
Board of Directors on a monthly basis. Management uses the
information available to make a determination with respect to the allowance for
credit losses, recognizing that the determination is inherently subjective and
that future adjustments may be necessary depending upon, among other factors, a
change in economic conditions of specific borrowers or generally in the economy
and new information that becomes available. However, there are no
assurances that the allowance for credit losses will be sufficient to absorb
losses on nonperforming assets or that the allowance will be sufficient to cover
losses on nonperforming assets in the future.
The
allowance for credit losses as of December 31, 2007 and December 31, 2006 was
$5.0 million and $3.2 million, respectively. The amount equates to 2.18%
and 1.47% of outstanding loans, including loans held for sale, as of December
31, 2007 and 2006, respectively. The increased percentage was due to a provision
of $1.8 million recorded in the fourth quarter of 2007 from weaknesses in the
Company’s portfolio of investor-owned residential construction and
reconstruction loans. This is a direct result of weaknesses in the
housing markets in its target markets. Bay National Corporation has
no exposure to foreign countries or foreign borrowers. Management believes that
the allowance for loan losses is adequate for each period
presented.
The
following table represents an analysis of the activity in the allowance for
credit losses for the periods presented:
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||||||||
|
Balance
at beginning of year
|
$ | 3,175,000 | $ | 3,000,000 | $ | 1,810,000 | $ | 1,266,500 | $ | 851,500 | ||||||||||
|
Provision
for credit losses
|
2,125,680 | 202,931 | 1,178,866 | 559,596 | 415,000 | |||||||||||||||
|
Loan
charge-offs
|
||||||||||||||||||||
|
Commercial
|
- | (37,931 | ) | - | (15,222 | ) | - | |||||||||||||
|
Real
Estate – Construction
|
(343,919 | ) | - | - | - | - | ||||||||||||||
|
Consumer
|
- | - | - | (2,134 | ) | - | ||||||||||||||
|
Loan
recoveries
|
||||||||||||||||||||
|
Commercial
|
27,931 | 10,000 | 11,134 | 1,260 | - | |||||||||||||||
|
Real
Estate – Construction
|
15,308 | - | - | - | - | |||||||||||||||
|
Net
recoveries (charge-offs)
|
(300,680 | ) | (27,931 | ) | 11,134 | (16,096 | ) | - | ||||||||||||
|
Balance
at end of year
|
$ | 5,000,000 | $ | 3,175,000 | $ | 3,000,000 | $ | 1,810,000 | $ | 1,266,500 | ||||||||||
39
The
following table presents the allocation of the allowance for credit losses,
reflecting use of the methodology presented above for the periods
presented:
|
Amount
|
|||||||||||||||
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Real
Estate – Home Equity Line of Credit
|
$
|
92,935
|
$
|
100,811
|
$
|
106,986
|
$
|
122,918
|
$
|
80,370
|
|||||
|
Real
Estate – Construction
|
3,435,204
|
1,482,349
|
469,580
|
150,346
|
86,252
|
||||||||||
|
Real
Estate – Mortgage
|
186,545
|
177,116
|
214,601
|
179,798
|
133,109
|
||||||||||
|
Loans
Held for Sale
|
58,005
|
7,222
|
87,545
|
48,066
|
-
|
||||||||||
|
Commercial
|
1,206,946
|
1,281,491
|
2,046,219
|
1,279,472
|
954,623
|
||||||||||
|
Consumer
|
19,562
|
16,693
|
10,275
|
11,032
|
10,324
|
||||||||||
|
Unallocated
|
803
|
109,318
|
64,794
|
18,368
|
1,822
|
||||||||||
|
Total
Allowance
|
$
|
5,000,000
|
$
|
3,175,000
|
$
|
3,000,000
|
$
|
1,810,000
|
$
|
1,266,500
|
|||||
The
unallocated portion of the allowance for credit losses decreased in 2007. This
occurred because the Company calculates an overall reserve level while the
underlying portfolio experienced a moderate shift in the mix of loans by risk
grade and the real estate market softened in the Company’s primary market areas.
The shift in the mix of loans by risk grade is a normal result of the addition
of new loans, the decrease in balances of more mature loans and the ongoing
reassessment of all loans.
The
following table sets forth the percentages of loans in each category for the
Company's loan portfolio as of December 31, 2007, 2006, 2005, 2004, and 2003,
respectively.
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Real
Estate – Home Equity Line of Credit
|
7.71
|
%
|
9.16
|
%
|
10.55
|
%
|
16.25
|
%
|
15.71
|
%
|
|||||
|
Real
Estate – Construction
|
28.13
|
35.27
|
24.02
|
8.59
|
7.92
|
||||||||||
|
Real
Estate – Mortgage
|
15.03
|
12.80
|
17.31
|
18.44
|
13.38
|
||||||||||
|
Loans
Held for Sale
|
4.82
|
0.66
|
8.77
|
6.37
|
.90
|
||||||||||
|
Commercial
|
42.63
|
40.59
|
37.89
|
48.89
|
60.47
|
||||||||||
|
Consumer
|
1.68
|
1.52
|
1.46
|
1.46
|
1.62
|
||||||||||
|
Total
Loans
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
NONPERFORMING
LOANS AND OTHER DELINQUENT ASSETS
Management
performs reviews of all delinquent loans. Management will generally classify
loans as non-accrual when collection of full principal and interest under the
original terms of the loan is not expected or payment of principal or interest
has become 90 days past due. Classifying a loan as non-accrual results in the
Company no longer accruing interest on such loan and reversing any interest
previously accrued but not collected. A non-accrual loan may be restored to
accrual status when delinquent principal and interest payments are brought
current and future monthly principal and interest payments are expected to be
collected. The Company will recognize interest on non-accrual loans only when
received. As of December 31, 2007, the Company had $9.4 million of non-accrual
loans. The Company did not have any non-accrual loans outstanding as
of December 31, 2006.
Any
property acquired by the Company as a result of foreclosure on a mortgage loan
will be classified as "real estate owned" and will be recorded at the lower of
the unpaid principal balance or fair value at the date of acquisition and
subsequently carried at the lower of cost or net realizable value. Any required
write-down of the loan to its net realizable value will be charged against the
allowance for credit losses. Upon foreclosure, the Company generally will
require an appraisal of the property and, thereafter, appraisals of the property
on at least an annual basis with external inspections on at least a quarterly
basis. As of December 31, 2007 the Company held $946,431 of real estate
acquired as a result of foreclosure, which is net of a provision of $111,700 for
estimated losses in market value.
40
The
Company applies the provisions of Statements of Financial Accounting Standards
No. 114 ("SFAS No. 114"), "Accounting by Creditors for Impairment of a Loan," as
amended by Statements of Financial Accounting Standards No. 118 ("SFAS No.
118"), "Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosure." SFAS No. 114 and SFAS No. 118 require that impaired loans, which
consist of all modified loans and other loans for which collection of all
contractual principal and interest is not probable, be measured based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, or at the loan's observable market price or 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 corresponding provision for credit
losses. The Company considers consumer loans as homogenous loans and thus does
not apply the SFAS No. 114 impairment test to these loans. Impaired loans will
be written off when collection of the loan is doubtful.
As of
December 31, 2007, the Company had impaired loans totaling $9.4 million,
all of which were included in its investor-owned residential real estate
construction loan portfolio, were classified as non-accrual loans and were over
90 days past due. This is a direct result of the slowdown in the real estate
market, which has resulted in an increase in loan extensions and delinquencies
due to the inability of investors to resell properties as quickly as
anticipated. These nonperforming loans represented 3.9% of total
outstanding loans, including loans held for sale, as of December 31,
2007. All of these loans are at least partially collateralized by
real estate. As of December 31, 2006 the Company had one non-accrual loan with a
fully paid principal balance and unpaid fees of approximately
$13,000. Management will continue to closely monitor these loans and
the overall level of delinquencies; however, management believes that the
allowance for credit losses is adequate for these loans.
The
respective allowance for credit losses on impaired loans was approximately $1.9
million and $13,000 as of December 31, 2007 and 2006,
respectively. The average recorded investment in impaired loans was
approximately $2.5 million, $508,000 and $5,000 for the years ended December 31,
2007, 2006 and 2005, respectively, and no income had been accrued or collected
on these loans while they had been classified as impaired. If these
impaired loans had been current in accordance with their original terms, the
Company would have recognized interest income of approximately $506,000 and
$26,000 for the periods ended December 31, 2007 and 2006,
respectively. The Company recognized interest income on impaired
loans as of December 31, 2005 as the respective loans were not classified as
non-accrual as of that date. Any losses on these loans will be
charged off as soon as the amount of loss is determinable.
INVESTMENT
PORTFOLIO
The
Company has chosen to invest its available funds primarily in federal funds sold
and other overnight investments. As a result, investment securities as of
December 31, 2007, consisted of $607,300 of Federal Reserve Bank stock,
$1,107,700 of Federal Home Loan Bank stock and $399,529 of U.S. Treasury
securities which mature within three months. Investment securities for the year
ended December 31, 2006, consisted of $607,300 of Federal Reserve Bank stock,
$509,800 of Federal Home Loan Bank stock and $697,526 of U.S. Treasury
securities which mature within three months.
The
Company had no investments that were obligations of the issuer, or payable from
or secured by a source of revenue or taxing authority of the issuer, whose
aggregate book value exceeded 10% of stockholders' equity at December 31,
2007.
41
The
following table reflects the amortized cost, estimated fair value and weighted
average yield of the investment portfolio as of December 31:
|
2007
|
|||||||||
|
Amortized
Cost
|
Estimated
Fair Value
|
Weighted
Average Yield
|
|||||||
|
U.S.
Treasury securities
|
|||||||||
|
Due
within one year
|
$
|
399,529
|
$
|
399,529
|
3.91%
|
||||
|
Other
equity securities
|
1,715,000
|
1,715,000
|
6.00%
|
||||||
|
Total
investments
|
$
|
2,114,529
|
$
|
2,114,529
|
5.61%
|
||||
|
2006
|
|||||||||
|
Amortized
Cost
|
Estimated
Fair Value
|
Weighted
Average Yield
|
|||||||
|
U.S.
Treasury securities
|
|||||||||
|
Due
within one year
|
$
|
697,526
|
$
|
697,526
|
5.00%
|
||||
|
Other
equity securities
|
1,117,100
|
1,117,100
|
5.28%
|
||||||
|
Total
investments
|
$
|
1,814,626
|
$
|
1,814,626
|
5.17%
|
||||
Management
has made the decision to maintain its available funds in highly liquid assets
because it wishes to ensure that funds are readily available to fund the growth
of the loan portfolio. Management believes that this strategy will allow the
Company to maximize interest margins while maintaining appropriate levels of
liquidity.
SOURCES
OF FUNDS
General
Deposits,
short-term borrowings in the form of repurchase agreements, short-term
borrowings under an overnight commercial paper program, short-term borrowings
under secured and unsecured lines of credit, borrowings under the subordinated
debt, scheduled amortization and prepayment of loans, funds provided by
operations and capital are the current sources of funds utilized by the Company
for lending and investment activities, and other general business
purposes.
Deposits
The
Company offers a variety of deposit products having a range of interest rates
and terms. The Company's deposits consist of checking accounts, savings
accounts, money market accounts and certificates of deposit.
The
following table sets forth the composition of the Company's deposits as of
December 31, 2007 and December 31, 2006:
|
2007
|
2006
|
|||||||||||||||
|
Demand
Deposits
|
$ | 58,912,584 | 29.17 | % | $ | 58,118,270 | 25.93 | % | ||||||||
|
Savings
|
1,905,072 | 0.94 | 7,456,143 | 3.33 | ||||||||||||
|
Money
Market and sweep
|
41,277,267 | 20.44 | 43,428,638 | 19.37 | ||||||||||||
|
Certificates
of deposit
|
99,886,542 | 49.45 | 115,145,901 | 51.37 | ||||||||||||
|
Total
deposits
|
$ | 201,981,465 | 100.00 | % | $ | 224,148,952 | 100.00 | % | ||||||||
The mix
of deposits shifted to a higher concentration of demand deposits and money
market and sweep accounts and a decreased concentration in savings and
certificates of deposit in 2007 compared to 2006. The increased concentration in
demand deposits was primarily a function of a decline in total deposits. Savings
accounts decreased approximately $5.5 million from 2006 due to one customer’s
decision to move money to a money market account. The approximate
$2.2 million decline in money market and sweep
42
accounts
was primarily driven by the shift to the Company’s newly created overnight
commercial paper program. Certificates of deposit accounts declined
by approximately $15.3 million due to scheduled maturities and management’s
decision not to aggressively compete for deposits during 2007 as adequate
liquidity was available to fund loan growth.
Of the
total deposits at December 31, 2007, $6.2 million, or 3.08%, was related to one
customer as compared to $8.2 million, or 3.66%, at December 31, 2006 for this
same customer. The deposits for this large customer tend to fluctuate
significantly; as a result, management monitors these deposits on a daily basis
to ensure that liquidity levels are adequate to compensate for these
fluctuations.
The
following table sets forth the maturity distribution for the Company's deposits
at December 31, 2007. Some of the deposits may be renewed or withdrawn prior to
maturity. Therefore, the following table should not be used as a forecast of
future cash flows.
|
Within
one
year
|
One
to
three years
|
Three
to
five years
|
Over
five
years
|
|||||||||
|
Demand
deposits
|
$
|
58,912,584
|
$
|
-
|
$
|
-
|
$
|
-
|
||||
|
Savings
|
1,905,072
|
-
|
-
|
-
|
||||||||
|
Money
Market and sweep
|
41,277,267
|
-
|
-
|
-
|
||||||||
|
Certificates
of deposit
|
75,496,132
|
20,794,446
|
3,595,964
|
-
|
||||||||
|
Total
|
$
|
177,591,055
|
$
|
20,794,446
|
$
|
3,595,964
|
$
|
-
|
Certificates
of deposit in amounts of $100,000 or more, and their remaining maturities at
December 31, 2007, are as follows:
|
Three
months or less
|
$
|
19,303,042
|
|
|
Over
three months through six months
|
10,401,598
|
||
|
Over
six months through twelve months
|
5,838,645
|
||
|
Over
twelve months
|
11,639,910
|
||
|
Total
|
$
|
47,183,195
|
The
market in which the Company operates is very competitive and the rates of
interest paid on deposits are affected by rates paid by other depository
institutions. Management closely monitors rates offered by other institutions
and seeks to be competitive within the market. The Company has chosen to
selectively compete for large certificates of deposits. The Company will choose
to pursue such deposits when expected loan growth provides for adequate spreads
to support the cost of those funds. As of December 31, 2007, the Company had
outstanding certificates of deposit of approximately $31.6 million that were
either obtained through the listing of certificate of deposit rates on two
Internet-based listing services (such deposits are sometimes referred to herein
as national market certificates of deposit) or acquired through Promontory
Financial Network’s certificate of deposit account registry service (CDARS)
program. The national market certificates of deposit were issued with an average
yield of 4.58% and an average term of 46 months. Included in the $31.6 million
are national market certificates of deposit totaling $199,000 that have been
classified as “Brokered Deposits” for bank regulatory purposes. These “Brokered
Deposits” were issued with an average yield of 5.60% and an average term of 30
months. As of December 31, 2006, the total certificates of deposit
obtained through the listing of certificate of deposit rates on the
Internet-based listing services were approximately $29.1 million, and included
$1.4 million of “Brokered Deposits.” The Company has never paid
broker fees for deposits.
In the
first quarter of 2006, the Company began using brokered certificates of deposit
through Promontory Financial Network. Through this deposit matching network and
its CDARS program, the Company has the ability to offer its customers access to
FDIC-insured deposit products in aggregate amounts exceeding current insurance
limits. When the Company places funds through CDARS on behalf of a
43
customer,
it receives matching deposits through the network. The Company also has the
ability to raise deposits directly through the network. These
deposits are also considered “Brokered Deposits” for bank regulatory purposes.
As of December 31, 2007, the Company had approximately $27.0 million of CDARS
deposits outstanding of which $988,995 was placed on behalf of customers and
$26.0 million was raised by the Company. These deposits were issued
with an average yield of 4.17% and an average term of 1 month.
Below is
a reconciliation of total deposits to core deposits as of December 31, 2007 and
2006, respectively:
|
December
31,
2007
|
December
31,
2006
|
|||||||
|
Total
deposits
|
$
|
201,981,465
|
$
|
224,148,952
|
||||
|
National
market certificates of deposit
|
(32,661,081
|
)
|
(29,586,997
|
)
|
||||
|
Variable
balance accounts (1 customer in 2007 and 2006)
|
(6,230,689
|
)
|
(8,197,951
|
)
|
||||
|
Portion
of variable balance accounts considered to be core
|
3,000,000
|
3,000,000
|
||||||
|
Core
deposits
|
$
|
166,089,695
|
$
|
189,364,004
|
Core
deposits, which management categorizes as all deposits other than national
market certificates of deposit, CDARS deposits and $3.2 million of the $6.2
million deposits from the large customer described above, stood at $166.1
million as of December 31, 2007, down 12.3% from $189.4 million as of December
31, 2006. Overall, the Company did not aggressively compete for new deposits
during 2007 as adequate liquidity was available to fund loan growth, which
primarily accounts for the decrease in core deposits over 2006. In addition, the
Company experienced a decline in money market and sweep accounts as customers
shifted to its newly created overnight commercial paper program, which is
classified as short-term borrowings. Core deposits are closely monitored by
management because they consider such deposits not only a relatively stable
source of funding but also reflective of the growth of commercial and consumer
depository relationships.
Borrowings.
Short-term
borrowings as of December 31, 2006 included repurchase agreements collateralized
by pledges of U.S. Government Treasury Securities, based upon their market
values, equal to 100% of the principal and accrued interest of the repurchase
agreements. The outstanding balance of repurchase agreements decreased from
$300,000 at December 31, 2006 to no borrowings at December 31, 2007, due to one
customer’s decision to invest available overnight funds in the Bank’s newly
created overnight commercial paper program. This decision is advantageous for
the Bank because it eliminates the Bank’s need to tie up securities as
collateral for deposits.
Included
in short-term borrowings as of December 31, 2007 is $7.3 million of borrowings
under the previously-mentioned overnight commercial paper program and $3.6
million borrowed under Federal Funds lines of credit. These borrowings are
unsecured and are subordinated to all deposits. In addition, the Company
borrowed $14.4 million under its secured Federal Home Loan Bank credit
facility. Short-term borrowings as of December 31, 2006 included $1.2
million borrowed under commercial paper.
Subordinated
debt consists of $8 million of fixed interest rate trust preferred securities
(the “Trust Preferred Securities”), issued on December 12, 2005 through a
Delaware trust subsidiary, Bay National Capital Trust I (the “Trust”). The Trust
was formed for the purpose of issuing the Trust Preferred Securities and all of
its common securities are owned by the Company. The Company purchased the common
securities from the Trust for $248,000. In accordance with provisions of FIN46,
the financial position and results of operations are not included in the
Company’s consolidated financial position and results of
operations.
The Trust
used the proceeds of the sale of the Trust Preferred Securities and common
securities to purchase from the Company the aggregate principal amount of
$8,248,000 of the Company’s Fixed Rate Junior Subordinated Debt Securities Due
2036 (the “Debt Securities”). Like the Trust Preferred Securities,
44
the Debt
Securities bear interest at the fixed annual rate of 7.20% until maturity. The
interest expense on Trust Preferred Securities, which include amortization of
issuance costs, was $602,096, $603,567 and $28,108 in 2007, 2006 and 2005,
respectively. The Debt Securities mature on February 23, 2036, but may be
redeemed at the Company’s option at any time on any February 23, May 23, August
23 or November 23 on or after February 23, 2011, or at any time upon certain
events, such as a change in the regulatory capital treatment of Debt Securities,
the Trust being deemed to be an “investment company” under the Investment
Company Act of 1940, as amended, or the occurrence of certain adverse tax
events. Except upon the occurrence of the events described above,
which require a redemption premium for redemptions prior to February 23, 2011,
the Company may redeem the Debt Securities at their aggregate principal amount,
plus accrued interest, if any.
The
Parent is required to retain $1,000,000 of the proceeds from the Debt Securities
for general corporate purposes (which may include making interest payments on
the Debt Securities) until the earlier of (i) the date on which the retained
funds are reduced to zero, or (ii) the date on which the Bank (or any successor)
meets the statutory requirements to pay dividends of at least $148,464 for each
of two consecutive quarters with positive retained earnings remaining after any
such dividend payment. As of December 31, 2007, the Bank met the
retained earnings requirement.
The Debt
Securities are subordinated to the prior payment of other indebtedness of the
Company that, by its terms, is not similarly subordinated. Although
the Debt Securities are recorded as a liability on the Company’s balance sheet,
the trust preferred securities qualify as Tier 1 capital, subject to regulatory
guidelines that limit the amount included to an aggregate of 25% of Tier 1
capital.
As of
December 31, 2007, the Company had unused commitments for a total of $5.4
million of borrowing availability under unsecured Federal Funds lines of credit
with three separate financial institutions. The Company also had
approximately $11.7 million of borrowing capacity with the Federal Home Loan
Bank of Atlanta as of December 31, 2007.
For
additional information with respect to borrowings, please see Note 6 to the
Company’s audited financial statements, “Borrowings.”
INTEREST
RATE SENSITIVITY
The
primary objective of asset/liability management is to ensure the steady growth
of the Company’s primary earnings component, net interest income. Net interest
income can fluctuate with significant interest rate movements. To minimize the
risk associated with these rate swings, management works to structure the
Company’s balance sheet so that the ability exists to adjust pricing on
interest-earning assets and interest-bearing liabilities in roughly equivalent
amounts at approximately the same time intervals. Imbalances in these repricing
opportunities at any point in time constitute interest rate
sensitivity.
The
measurement of the Company’s interest rate sensitivity, or "gap," is one of the
principal techniques used in asset/liability management. The interest sensitive
gap is the dollar difference between assets and liabilities which are subject to
interest rate pricing within a given time period, including both floating rate
or adjustable rate instruments, and instruments which are approaching
maturity.
45
The
following table sets forth the amount of the Company's interest-earning assets
and interest-bearing liabilities as of December 31, 2007, which are expected to
mature or reprice in each of the time periods shown:
|
Maturity
or repricing within
|
||||||||||||||||||||||||
|
Amount
|
Percent
of Total
|
0
to 3 Months
|
4
to 12 Months
|
1
to 5 Years
|
Over
5 Years
|
|||||||||||||||||||
|
Interest-earning
assets
|
||||||||||||||||||||||||
|
Federal
funds sold and other overnight investments
|
$ | 4,859,248 | 1.96 | % | $ | 4,859,248 | $ | - | $ | - | $ | - | ||||||||||||
|
Loans
held for sale
|
11,601,070 | 4.68 | 11,601,070 | - | - | - | ||||||||||||||||||
|
Investment
securities available for sale
|
399,529 | 0.16 | 399,529 | - | - | - | ||||||||||||||||||
|
Loans
– Variable rate
|
117,446,143 | 47.37 | 117,446,143 | - | - | - | ||||||||||||||||||
|
Loans
– Fixed rate
|
111,909,028 | 45.14 | 39,173,690 | 20,829,578 | 44,363,851 | 7,541,909 | ||||||||||||||||||
|
Other
earning assets
|
1,715,000 | 0.69 | - | - | - | 1,715,000 | ||||||||||||||||||
|
Total
interest-earning assets
|
$ | 247,930,018 | 100.00 | % | $ | 173,479,680 | $ | 20,829,578 | $ | 44,363,851 | $ | 9,256,909 | ||||||||||||
|
Interest-bearing
liabilities
|
||||||||||||||||||||||||
|
Deposits
– Variable rate
|
$ | 71,050,751 | 34.78 | % | $ | 71,050,751 | $ | - | $ | - | $ | - | ||||||||||||
|
Deposits
– Fixed rate
|
99,886,542 | 48.89 | 51,451,352 | 24,044,779 | 24,390,411 | - | ||||||||||||||||||
|
Short-term
borrowings – variable rate
|
25,371,508 | 12.42 | 25,371,508 | - | - | - | ||||||||||||||||||
|
Subordinated
debt
|
8,000,000 | 3.91 | - | - | - | 8,000,000 | ||||||||||||||||||
|
Total
interest-bearing liabilities
|
$ | 204,308,801 | 100.00 | % | $ | 147,873,611 | $ | 24,044,779 | $ | 24,390,411 | $ | 8,000,000 | ||||||||||||
|
Periodic
repricing differences
|
||||||||||||||||||||||||
|
Periodic
gap
|
$ | 25,606,069 | $ |
(3,215,201
|
) | $ | 19,973,440 | $ | 1,256,909 | |||||||||||||||
|
Cumulative
gap
|
$ | 25,606,069 | $ | 22,390,868 | $ | 42,364,308 | $ | 43,621,217 | ||||||||||||||||
|
Ratio
of rate sensitive assets to rate sensitive liabilities
|
117.32 | % | 86.63 | % | 181.89 | % | 115.71 | % | ||||||||||||||||
The
Company has 54.01% of its interest-earning assets and 47.20% of its
interest-bearing liabilities in variable rate balances. The excess of
interest-earning assets over interest-bearing liabilities of $42.4
million in the categories of items maturing or repricing within 5 years
comprises the majority of the overall gap. This gap is generally reflective of
the Company’s emphasis on investing in short-term investments and originating
variable rate loans and the demand in the market for higher yielding fixed rate
deposits. This analysis indicates that the Company generally will benefit from
rising market rates of interest. However, since all interest rates and yields do
not adjust at the same pace, the gap is only a general indicator of interest
rate sensitivity. The analysis of the Company's interest-earning assets and
interest-bearing liabilities presents only a static view of the timing of
maturities and repricing opportunities, without taking into consideration the
fact that changes in interest rates do not affect all assets and liabilities
equally. Net interest income may be affected by other significant factors in a
given interest rate environment, including changes in the volume and mix of
interest-earning assets and interest-bearing liabilities.
Management
constantly monitors and manages the structure of the Company's balance sheet,
seeks to control interest rate exposure and evaluate pricing strategies.
Strategies to better match maturities of interest-earning assets and
interest-bearing liabilities include structuring loans with rate floors and
ceilings on variable rate notes and by providing for repricing opportunities on
fixed rate notes. Management believes that a lending strategy focusing on
variable rate loans and short-term fixed rate loans will best facilitate the
goal of minimizing interest rate risk. However, management will
opportunistically enter into longer term fixed rate loans and/or investments
when, in management’s judgment, rates adequately compensate the Company
46
for the
interest rate risk. The Company's current investment concentration in federal
funds sold and other overnight investments provides the most flexibility and
control over rate sensitivity since it generally can be restructured more
quickly than the loan portfolio. On the liability side, deposit products can be
restructured so as to offer incentives to attain the maturity distribution
desired; although, competitive factors sometimes make control over deposit
maturity difficult.
In
theory, maintaining a nominal level of interest rate sensitivity can diminish
interest rate risk. In practice, this is made difficult by a number of factors,
including cyclical variation in loan demand, different impacts on interest
sensitive assets and liabilities when interest rates change and the availability
of funding sources. Management generally attempts to maintain a balance between
rate-sensitive assets and liabilities as the exposure period is lengthened to
minimize the overall interest rate risk to the Company.
LIQUIDITY
The
Company’s overall asset/liability strategy takes into account the need to
maintain adequate liquidity to fund asset growth and deposit
runoff. Management monitors the liquidity position
daily.
The
Company’s primary sources of funds are deposits, short-term borrowings in the
form of repurchase agreements, commercial paper, borrowings under the Federal
funds and Federal Home Loan Bank credit facilities, scheduled amortization and
prepayment of loans, funds provided by operations and capital. While
scheduled principal repayments on loans are a relatively predictable source of
funds, deposit flows and loan prepayments are greatly influenced by market
interest rates, economic conditions, and rates offered by our
competition.
The
Company's most liquid assets are cash and assets that can be readily converted
into cash, including investment securities maturing within one year. As of
December 31, 2007, the Company had $2.3 million in cash and due from banks, $4.9
million in federal funds sold and other overnight investments and $399,529 in
three-month U.S. Treasury Securities. As of December 31, 2006, the Company had
$2.3 million in cash and due from banks, $31.5 million in federal funds sold and
other overnight investments and $697,526 in three-month U.S. Treasury
Securities.
The
decrease in the overall level of liquid assets, other than loans expected to be
sold within 60 days, is the result of management’s decision to maintain margins
by using available liquidity to fund loan growth and allow non-core time
deposits to mature.
As of
December 31, 2007, the Company had unused commitments for a total of $5.4
million of borrowing availability under unsecured Federal Funds lines of credit
with three separate financial institutions. The Company also has approximately
$11.7 million of borrowing capacity with the Federal Home Loan Bank of Atlanta.
These credit facilities can be used in conjunction with the normal deposit
strategies, which include pricing changes to increase deposits as
necessary. From time to time, the Company may sell or participate out
loans to create additional liquidity as required.
The
Company has sufficient liquidity to meet its loan commitments as well as
fluctuations in deposits. The Company will seek to retain maturing
certificates of deposit, when necessary, by offering competitive
rates.
Management
is not aware of any known trends, events or uncertainties that will have or are
reasonably likely to have a material effect on our liquidity, capital or
operations, nor are we aware of any current recommendation by regulatory
authorities, which if implemented, would have a material effect on liquidity,
capital or operations.
47
CONTRACTUAL
OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES, AND OFF-BALANCE SHEET
ARRANGEMENTS
The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business. These financial instruments primarily
include commitments to extend credit, lines of credit and standby letters of
credit. The Company uses these financial instruments to meet the
financing needs of its customers. These financial instruments
involve, to varying degrees, elements of credit, interest rate and liquidity
risk. In addition, the Company also has operating lease obligations
and purchase commitments.
Outstanding
loan commitments and lines and letters of credit at December 31, 2007 and 2006
are as follows:
|
2007
|
2006
|
||||
|
Loan
commitments
|
$
|
35,114,676
|
$
|
33,782,891
|
|
|
Unused
lines of credit
|
85,999,686
|
66,660,250
|
|||
|
Letters
of credit
|
3,564,927
|
2,188,659
|
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments
generally have interest rates fixed at current market amounts, fixed expiration
dates or other termination clauses and may require payment of a
fee. Unused lines of credit represent the unused portion of lines of
credit previously extended and available to the customer as long as there is no
violation of any contractual condition. These lines generally have variable
interest rates. Since many of the commitments are expected to expire without
being drawn upon, and since it is unlikely that customers will draw upon their
line of credit in full at any time, the total commitment amount or line of
credit amount does not necessarily represent future cash
requirements. The Company is not aware of any loss it would incur by
funding its commitments or lines of credit.
Standby
letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The Company’s exposure to
credit loss in the event of nonperformance by the customer is the contract
amount of the commitment.
In
general, loan commitments, lines of credit and letters of credit are made on the
same terms, including with respect to collateral, as outstanding loans. Each
customer’s credit-worthiness and the collateral required are evaluated on a
case-by-case basis.
The
increase in the overall level of loan commitments and unused lines of credit as
of December 31, 2007 as compared to loan commitments and unused lines of credit
as of December 31, 2006, is reflective of the level of business development
activity undertaken during the year primarily a result of the expansion into the
Baltimore-Washington corridor.
The
Company has various financial obligations, including contractual obligations and
commitments that may require future cash payments.
48
The
following table presents, as of December 31, 2007, significant fixed and
determinable contractual obligations to third parties by payment
date:
|
Within
one
year
|
One
to
three years
|
Three
to
five years
|
Over
five
years
|
Total
|
||||||||||||||||
|
Deposits
without a
stated
maturity(a)
|
$ | 102,095,603 | $ | - | $ | - | $ | - | $ | 102,095,603 | ||||||||||
|
Certificates
of deposit(a)
|
76,067,356 | 20,794,446 | 3,595,964 | - | 100,457,766 | |||||||||||||||
|
Other
borrowings(a)
|
25,430,292 | - | - | 8,000,000 | 33,430,292 | |||||||||||||||
|
Operating
leases
|
578,535 | 849,382 | 283,542 | 7,790 | 1,719,249 | |||||||||||||||
|
Purchase
obligations
|
412,217 | 472,092 | - | - | 884,309 | |||||||||||||||
|
Total
|
$ | 204,584,003 | $ | 22,115,920 | $ | 3,879,506 | $ | 8,007,790 | $ | 238,587,219 | ||||||||||
|
(a)
|
Includes
accrued interest payable.
|
The
Company's operating lease obligations represent short and long-term lease and
rental payments for facilities. Purchase obligations represent estimated
obligations under agreements to purchase goods or services that are enforceable
and legally binding on the Company. The purchase obligation amounts presented
above primarily relate to estimated obligations under data and item processing
contracts and accounts payable for goods and services received through December
31, 2007.
CAPITAL
RESOURCES
The
Company had stockholders’ equity at December 31, 2007 of $19.9 million as
compared to $18.8 million at December 31, 2006. The increase in capital is the
result of positive operating results. The Company has declared no cash dividends
since its inception.
Banking
regulatory authorities have implemented strict capital guidelines directly
related to the credit risk associated with an institution’s assets. Banks and
bank holding companies are required to maintain capital levels based on their
"risk adjusted” assets so that categories of assets with higher "defined” credit
risks will require more capital support than assets with lower risks. The Bank
has exceeded its capital adequacy requirements to date.
Banking
regulations also limit the amount of dividends that may be paid without prior
approval of the Bank's regulatory agencies. Regulatory approval is
required to pay dividends that exceed the Bank’s net profits for the current
year plus its retained net profits for the preceding two years. The
Bank could have paid dividends to the Company without approval from bank
regulatory agencies at December 31, 2007; however, such payments are not
currently planned.
49
The
tables below present the Bank's capital position relative to its various minimum
regulatory capital requirements as of December 31, 2007 and 2006. For a
discussion of these capital requirements, see "Item 1. Description of Business -
Supervision and Regulation - Bay National Bank - Capital Adequacy
Guidelines."
|
December
31, 2007
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
27,392,869
|
10.41
|
%
|
$
|
21,047,000
|
8.00
|
%
|
$
|
26,309,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
24,083,165
|
9.15
|
%
|
10,523,000
|
4.00
|
%
|
15,785,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
24,083,165
|
9.63
|
%
|
7,504,000
|
3.00
|
%
|
12,506,000
|
5.00
|
%
|
||||||
|
December
31, 2006
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
25,951,690
|
10.34
|
%
|
$
|
20,074,000
|
8.00
|
%
|
$
|
25,093,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
22,814,690
|
9.09
|
%
|
10,037,000
|
4.00
|
%
|
15,056,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
22,814,690
|
9.29
|
%
|
7,370,000
|
3.00
|
%
|
12,284,000
|
5.00
|
%
|
||||||
The
tables below present Bay National Corporation’s capital position relative to its
various minimum regulatory capital requirements as of December 31, 2007 and
2006.
|
December
31, 2007
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
31,230,256
|
11.87
|
%
|
$
|
21,054,000
|
8.00
|
%
|
$
|
26,317,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
27,728,115
|
10.54
|
%
|
10,527,000
|
4.00
|
%
|
15,790,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
27,728,115
|
11.09
|
%
|
7,504,000
|
3.00
|
%
|
12,506,000
|
5.00
|
%
|
||||||
|
December
31, 2006
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
29,979,493
|
11.94
|
%
|
$
|
20,084,000
|
8.00
|
%
|
$
|
25,104,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
26,337,366
|
10.49
|
%
|
10,042,000
|
4.00
|
%
|
15,063,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
26,337,366
|
10.72
|
%
|
7,370,000
|
3.00
|
%
|
12,284,000
|
5.00
|
%
|
||||||
50
Impact
of Inflation and Changing Prices
The
consolidated financial statements and notes thereto presented herein have been
prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollars without considering the
change in the relative purchasing power of money over time and due to inflation.
The impact of inflation is reflected in the increased cost of the Company's
operations. Unlike most industrial companies, nearly all the assets of the
Company are monetary in nature. As a result, interest rates have a greater
impact on the Company's performance than do the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or to
the same extent as the price of goods and services.
Application
of Critical Accounting Policies
The
Company’s consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the industries in which it operates. Application
of these principles requires management to make estimates, assumptions and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, the financial statements could reflect different
estimates, assumptions and judgments. Certain policies inherently have a greater
reliance on the use of estimates, assumptions and judgments and as such, have a
greater possibility of producing results that could be materially different than
originally reported. Estimates, assumptions and judgments are necessary when
assets and liabilities are required to be recorded at fair value, when a decline
in the value of an asset not carried on the financial statements at fair value
warrants an impairment write-down or valuation reserve to be established or when
an asset or liability must be recorded contingent upon a future event. Carrying
assets and liabilities at fair value inherently results in more financial
statement volatility. The fair values and the information used to record
valuation adjustments for certain assets and liabilities are based either on
quoted market prices or are provided by other third-party sources, when
available.
The most
significant accounting policies followed by the Company are presented in Note 1
to the consolidated financial statements. These policies, along with the
disclosures presented in the other financial statement notes and in this
financial review, provide information on how significant assets and liabilities
are valued in the financial statements and how those values are determined.
Based on the valuation techniques used and the sensitivity of financial
statement amounts to the methods, assumptions and estimates underlying those
amounts, management has identified the determination of the allowance for credit
losses as a critical accounting policy that requires the most subjective or
complex judgments, and, as such, could be most subject to revision as new
information becomes available.
The
allowance for credit losses represents management's best estimate of losses
known and inherent in the loan portfolio that are both probable and reasonable
to estimate, based on, among other factors: prior loss experience of the Company
and peer institutions; current economic conditions; review of the ongoing
financial conditions of borrowers; and the views of the Company’s regulators and
the firm that conducts an annual independent loan review. Determining the amount
of the allowance for credit losses is considered a critical accounting estimate
because it requires significant estimates, assumptions and judgments. The loan
portfolio also represents the largest asset type on the consolidated balance
sheets.
The
Company uses a loan grading system where loans are graded based on management's
evaluation of the risk associated with each loan. A factor, based on the loan
grading, is applied to the loan balance to reserve for losses. In addition,
management judgmentally establishes an additional nonspecific reserve. The
nonspecific portion of the allowance reflects management's estimate of probable
inherent but undetected losses within the portfolio due to uncertainties in
economic conditions, delays in obtaining information, including unfavorable
information about a borrower's financial condition, the difficulty in
identifying triggering events that correlate perfectly to subsequent loss rates
and risk factors that have not yet manifested themselves in loss allocation
factors.
51
Management
has significant discretion in making the judgments inherent in the determination
of the provision and allowance for credit losses, including the valuation of
collateral and the assessment of the financial condition of the borrower, and in
establishing allowance percentages and risk ratings. The
establishment of allowance factors is a continuing exercise and allowance
factors may change over time, resulting in an increase or decrease in the amount
of the provision or allowance based upon the same volume and classification of
loans.
Changes
in allowance factors or in management’s interpretation of those factors will
have a direct impact on the amount of the provision and a corresponding effect
on income and assets. Also, errors in management’s perception and
assessment of the allowance factors could result in the allowance not being
adequate to cover losses in the portfolio and may result in additional
provisions or charge-offs, which would adversely affect income and
capital. For additional information regarding the allowance for loan
and lease losses, see the “Provision for Credit Losses and Credit Risk
Management” section of this financial review.
Recent
Accounting Pronouncements And Developments
Note 1 to
the consolidated financial statements discusses new accounting policies adopted
by the Company during 2007 and the expected impact of accounting policies,
recently issued or proposed, but not yet required to be adopted. To the extent
the adoption of new accounting standards materially affects the Company's
financial condition, results of operations or liquidity, the impacts are
discussed in the applicable section(s) of this financial review and notes to the
consolidated financial statements.
Risk
Management
The Board
of Directors is the foundation for effective corporate governance and risk
management. The Board demands accountability of management, keeps stockholders'
and other constituencies' interests in focus and fosters a strong internal
control environment. Through its Executive, Asset/Liability and Audit
Committees, the Board actively reviews critical risk positions, including
market, credit, liquidity and operational risk. The Company's goal in managing
risk is to reduce earnings volatility, control exposure to unnecessary risk and
ensure appropriate returns for risk assumed. Senior management actively manages
risk at the line of business level, supplemented with corporate-level oversight
through the Asset/Liability Committee, the internal audit process and quality
control functions and other risk management groups within the Company. This risk
management structure is designed to uncover risk issues through a systematic
process, enabling timely and appropriate action to avoid and mitigate risk. The
risk management process establishes risk limits and other measurement systems,
with a focus on risk reduction strategies and capital allocation
practices.
Item
7A. Quantitative and Qualitative Disclosures About Market
Risk.
Not
applicable
52
Item
8. Financial Statements and Supplementary Data
The
following consolidated financial statements are filed with this
report:
53
Management’s
Report On Internal Control Over Financial Reporting
The
management of Bay National Corporation (“the Company”) is responsible for
establishing and maintaining adequate internal control over financial reporting.
The internal control over financial reporting has been designed under our
supervision to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of the Company’s consolidated financial
statements for external reporting purposes in accordance with accounting
principles generally accepted in the United States of America.
Management
has conducted an assessment of the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2007, utilizing the
framework established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this assessment, management has determined that
the Company’s internal control over financial reporting as of December 31,
2007 is effective.
Our
internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
the Company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Company’s assets that could have a
material effect on the financial statements.
Any
internal control system, no matter how well designed, will have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.
54
Report of Independent Registered Public Accounting
Firm
Board of
Directors and Stockholders
Bay
National Corporation
We have audited the accompanying
consolidated balance sheets of Bay National Corporation and subsidiary (the
“Company”) as of December 31, 2007 and 2006, and the related consolidated
statements of operations, changes in stockholders’ equity, and cash flows for
each of the three years in the period ended December 31, 2007. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. The Company is not required to have, nor
were we engaged to perform, an audit of its internal control over financial
reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects,
the financial position of Bay National Corporation and subsidiary as of December
31, 2007 and 2006, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2007, in conformity
with accounting principles generally accepted in the United States of
America.
/s/
Stegman & Company
Baltimore,
Maryland
March 20,
2008
55
BAY
NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December
31, 2007 and 2006
|
2007
|
2006
|
|||||||
|
ASSETS
|
||||||||
|
Cash and due from
banks
|
$ | 2,314,423 | $ | 2,348,304 | ||||
|
Federal funds sold and other
overnight investments
|
4,859,248 | 31,549,900 | ||||||
|
Investment securities available
for sale (AFS) - at fair value
|
399,529 | 697,526 | ||||||
|
Other
equity securities
|
1,715,000 | 1,117,100 | ||||||
|
Loans
held for sale
|
11,601,070 | 1,444,303 | ||||||
|
Loans, net of unearned
fees
|
229,355,171 | 216,571,375 | ||||||
|
Total
Loans
|
240,956,241 | 218,015,678 | ||||||
|
Less: Allowance for credit
losses
|
(5,000,000 | ) | (3,175,000 | ) | ||||
|
Loans, net
|
235,956,241 | 214,840,678 | ||||||
|
Other
real estate owned, net
|
946,431 | - | ||||||
|
Premises and equipment,
net
|
1,210,787 | 1,100,220 | ||||||
|
Investment
in bank owned life insurance
|
5,041,662 | - | ||||||
|
Accrued
interest receivable and other assets
|
4,092,538 | 3,151,119 | ||||||
|
Total Assets
|
$ | 256,535,859 | $ | 254,804,847 | ||||
|
LIABILITIES
|
||||||||
|
Non-interest-bearing
deposits
|
$ | 31,044,172 | $ | 34,808,624 | ||||
|
Interest-bearing
deposits
|
170,937,293 | 189,340,328 | ||||||
|
Total deposits
|
201,981,465 | 224,148,952 | ||||||
|
Short-term
borrowings
|
25,371,508 | 1,545,000 | ||||||
|
Subordinated
debt
|
8,000,000 | 8,000,000 | ||||||
|
Accrued expenses and other
liabilities
|
1,262,334 | 2,268,402 | ||||||
|
Total
Liabilities
|
236,615,307 | 235,962,354 | ||||||
|
STOCKHOLDERS'
EQUITY
|
||||||||
|
Common stock - $.01 par value,
authorized:
|
||||||||
|
9,000,000 shares authorized,
2,137,633 and 1,935,369 issued and outstanding as of December 31, 2007 and
2006, respectively:
|
21,376 | 19,354 | ||||||
|
Additional paid in
capital
|
17,788,833 | 17,649,678 | ||||||
|
Retained
earnings
|
2,110,343 | 1,173,461 | ||||||
|
Total Stockholders'
Equity
|
19,920,552 | 18,842,493 | ||||||
|
Total Liabilities and
Stockholders' Equity
|
$ | 256,535,859 | $ | 254,804,847 | ||||
See
accompanying notes to consolidated financial statements.
56
BAY
NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
For the
years ended December 31, 2007, 2006 and 2005
|
2007
|
2006
|
2005
|
||||||||||
|
INTEREST
INCOME:
|
||||||||||||
|
Interest and fees on
loans
|
$ | 19,823,408 | $ | 19,117,244 | $ | 12,671,707 | ||||||
|
Interest on federal funds sold
and other overnight
investments
|
670,971 | 557,970 | 224,732 | |||||||||
|
Taxable interest and dividends
on investment securities
|
93,630 | 105,625 | 86,267 | |||||||||
|
Total interest
income
|
20,588,009 | 19,780,839 | 12,982,706 | |||||||||
|
INTEREST
EXPENSE:
|
||||||||||||
|
Interest
on deposits
|
7,909,153 | 7,132,611 | 4,058,519 | |||||||||
|
Interest
on short-term borrowings
|
253,956 | 86,522 | 115,810 | |||||||||
|
Interest
on note payable
|
- | - | 91,709 | |||||||||
|
Interest
on subordinated debt
|
602,096 | 603,567 | 28,108 | |||||||||
|
Total
interest expense
|
8,765,205 | 7,822,700 | 4,294,146 | |||||||||
|
Net
interest income
|
11,822,804 | 11,958,139 | 8,688,560 | |||||||||
|
Provision
for credit losses
|
2,125,680 | 202,931 | 1,178,866 | |||||||||
|
Net
interest income after provision for credit losses
|
9,697,124 | 11,755,208 | 7,509,694 | |||||||||
|
NON-INTEREST
INCOME:
|
||||||||||||
|
Service charges on deposit
accounts
|
153,813 | 148,042 | 188,276 | |||||||||
|
Gain
on sale of mortgage loans
|
450,184 | 573,387 | 512,047 | |||||||||
|
Other income
|
120,800 | 55,904 | 50,270 | |||||||||
|
Total non-interest
income
|
724,797 | 777,333 | 750,593 | |||||||||
|
NON-INTEREST
EXPENSE:
|
||||||||||||
|
Salaries and employee
benefits
|
5,460,772 | 5,431,989 | 3,627,630 | |||||||||
|
Occupancy
expenses
|
653,227 | 506,323 | 420,866 | |||||||||
|
Furniture and equipment
expenses
|
351,599 | 342,261 | 304,132 | |||||||||
|
Legal and professional
fees
|
285,434 | 245,412 | 154,476 | |||||||||
|
Data processing and other outside
services
|
870,404 | 701,422 | 655,726 | |||||||||
|
Advertising
and marketing related expenses
|
486,204 | 512,709 | 445,482 | |||||||||
|
Other expenses
|
885,517 | 684,239 | 562,645 | |||||||||
|
Total non-interest
expenses
|
8,993,157 | 8,424,355 | 6,170,957 | |||||||||
|
Income
before income taxes
|
1,428,764 | 4,108,186 | 2,089,330 | |||||||||
|
Income
tax expense (benefit)
|
491,395 | 1,678,358 | (655,000 | ) | ||||||||
|
Net
Income
|
$ | 937,369 | $ | 2,429,828 | $ | 2,744,330 | ||||||
|
Per
Share Data:
|
||||||||||||
|
Net Income
(Basic)
|
$ | .44 | $ | 1.25 | $ | 1.43 | ||||||
|
Net
Income (Diluted)
|
$ | .42 | $ | 1.20 | $ | 1.37 | ||||||
|
Average
Shares Outstanding (Basic)
|
2,133,174 | 1,938,110 | 1,922,580 | |||||||||
|
Effect
of dilution – Stock options and warrants
|
76,977 | 80,099 | 79,645 | |||||||||
|
Average
Shares Outstanding (Diluted)
|
2,210,151 | 2,018,209 | 2,002,225 | |||||||||
See
accompanying notes to consolidated financial statements.
57
BAY
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the
years ended December 31, 2007, 2006 and 2005
|
Common
Stock
|
Additional
Paid in Capital
|
Retained
Earnings
(Accumulated
Deficit)
|
Total
|
|||||||||||||
|
Balances
at January 1, 2005
|
$ | 19,177 | $ | 17,400,284 | $ | (4,000,697 | ) | $ | 13,418,764 | |||||||
|
Issuance
of Common Stock
|
67 | 50,917 | - | 50,984 | ||||||||||||
|
Net
Income
|
2,744,330 | 2,744,330 | ||||||||||||||
|
Balances
at December 31, 2005
|
19,244 | 17,451,201 | (1,256,367 | ) | 16,214,078 | |||||||||||
|
Stock-based
compensation expense
|
- | 115,714 | - | 115,714 | ||||||||||||
|
Issuance
of Common Stock
|
110 | 82,763 | - | 82,873 | ||||||||||||
|
Net
Income
|
- | - | 2,429,828 | 2,429,828 | ||||||||||||
|
Balances
at December 31, 2006
|
19,354 | 17,649,678 | 1,173,461 | 18,842,493 | ||||||||||||
|
Stock-based
compensation expense
|
- | 122,539 | - | 122,539 | ||||||||||||
|
Stock
options exercised
|
27 | 18,611 | - | 18,638 | ||||||||||||
|
Issuance
of stock awards
|
60 | (60 | ) | - | - | |||||||||||
|
1.1
to one stock split in the form of a stock dividend
|
1,935 | (1,935 | ) | - | - | |||||||||||
|
Cash
paid in lieu of fractional shares on stock dividend
|
- | - | (487 | ) | (487 | ) | ||||||||||
|
Net
Income
|
- | - | 937,369 | 937,369 | ||||||||||||
|
Balances
at December 31, 2007
|
$ | 21,376 | $ | 17,788,833 | $ | 2,110,343 | $ | 19,920,552 | ||||||||
See
accompanying notes to consolidated financial statements.
58
BAY
NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the
years ended December 31, 2007, 2006 and 2005
|
2007
|
2006
|
2005
|
||||||||||
|
Cash
Flows From Operating Activities:
|
||||||||||||
|
Net Income
|
$ | 937,369 | $ | 2,429,828 | $ | 2,744,330 | ||||||
|
Adjustments to reconcile net
income to net cash provided (used) by operating
activities:
|
||||||||||||
|
Depreciation
|
291,025 | 250,494 | 193,196 | |||||||||
|
Loss
on disposal of equipment
|
- | 19,798 | 203 | |||||||||
|
Accretion
of investment discounts
|
(24,364 | ) | (50,556 | ) | (46,539 | ) | ||||||
|
Provision for credit
losses
|
2,125,680 | 202,931 | 1,178,866 | |||||||||
|
Provision
for losses on other real estate owned
|
111,700 | - | - | |||||||||
|
Stock-based
compensation
|
122,539 | 115,714 | - | |||||||||
|
Increase
in cash surrender of bank owned life insurance
|
(41,662 | ) | - | - | ||||||||
|
Deferred
income taxes
|
(804,000 | ) | (55,000 | ) | (1,083,000 | ) | ||||||
|
Gain
on sale of loans held for sale
|
(450,184 | ) | (573,387 | ) | (512,047 | ) | ||||||
|
Origination
of loans held for sale
|
(162,566,200 | ) | (110,309,174 | ) | (217,744,320 | ) | ||||||
|
Proceeds
from sale of loans
|
152,859,617 | 126,947,322 | 210,360,465 | |||||||||
|
Net
increase in accrued interest receivable and other assets
|
(137,419 | ) | (295,018 | ) | (977,347 | ) | ||||||
|
Net
(decrease) increase in accrued expenses and other
liabilities
|
(1,006,068 | ) | 533,389 | 948,345 | ||||||||
|
Net
cash (used in) provided by operating activities
|
(8,581,967 | ) | 19,216,341 | (4,937,848 | ) | |||||||
|
Cash
Flows From Investing Activities:
|
||||||||||||
|
Purchases of investment
securities available for sale
|
(1,877,639 | ) | (5,106,584 | ) | (6,149,351 | ) | ||||||
|
Maturities of investment
securities available for sale
|
2,200,000 | 6,000,000 | 6,200,000 | |||||||||
|
Purchase
of Federal Reserve Bank stock
|
- | (154,960 | ) | (139,650 | ) | |||||||
|
Purchase
of Federal Home Loan Bank of Atlanta
|
||||||||||||
|
stock
|
(597,900 | ) | (167,700 | ) | (98,700 | ) | ||||||
|
Loan
disbursements in excess of principal payments
|
(14,142,607 | ) | (34,518,409 | ) | (40,656,326 | ) | ||||||
|
Purchase
of bank owned life insurance
|
(5,000,000 | ) | - | - | ||||||||
|
Expenditures
for premises and equipment
|
(401,592 | ) | (623,686 | ) | (346,642 | ) | ||||||
|
Net cash used by investing
activities
|
(19,819,738 | ) | (34,571,339 | ) | (41,190,669 | ) | ||||||
|
Cash
Flows From Financing Activities:
|
||||||||||||
|
Net (decrease) increase in
deposits
|
(22,167,487 | ) | 41,575,866 | 28,646,044 | ||||||||
|
Net
increase in short-term borrowings
|
23,826,508 | 100,842 | 63,158 | |||||||||
|
Net
payoff of notes payable
|
- | - | (1,250,000 | ) | ||||||||
|
Proceeds
from subordinated debt
|
- | - | 8,000,000 | |||||||||
|
Net proceeds from issuance of
common stock
|
18,638 | 82,873 | 50,984 | |||||||||
|
Cash
dividends paid in lieu of fractional shares
|
(487 | ) | - | - | ||||||||
|
Net cash provided by financing
activities
|
1,677,172 | 41,759,581 | 35,510,186 | |||||||||
|
Net
(decrease) increase in cash and cash equivalents
|
(26,724,533 | ) | 26,404,583 | 10,618,331 | ||||||||
|
Cash
and cash equivalents at beginning of year
|
33,898,204 | 7,493,621 | 18,111,952 | |||||||||
|
Cash
and cash equivalents at end of year
|
$ | 7,173,671 | $ | 33,898,204 | $ | 7,493,621 | ||||||
See
accompanying notes to consolidated financial statements.
59
BAY
NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF
CASH FLOWS (CONT.)
For the
years ended December 31, 2007, 2006 and 2005
|
2007
|
2006
|
2005
|
||||||||||
|
Supplemental
information:
|
||||||||||||
|
Interest
paid
|
$ | 8,858,813 | $ | 7,399,278 | $ | 4,128,414 | ||||||
|
Income
taxes paid
|
$ | 1,675,168 | $ | 2,002,466 | $ | - | ||||||
|
Amount
transferred from loans to other real estate owned
|
$ | 1,058,131 | $ | - | $ | - | ||||||
See
accompanying notes to consolidated financial statements.
60
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
1.
SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
The
consolidated financial statements include the accounts of Bay National
Corporation and its subsidiary, Bay National Bank (the “Bank”), collectively
(the “Company”). All significant intercompany balances and transactions have
been eliminated in consolidation. The investment in subsidiary is recorded on
the parent's books on the basis of its equity in the net assets. The
accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices in the banking industry.
Certain
reclassifications have been made to amounts previously reported to conform to
the classifications made in 2007.
Nature of
Business
Bay
National Corporation is incorporated under the laws of the State of Maryland to
operate as a bank holding company of a national bank with the name Bay National
Bank. The Company owns all the shares of common stock issued by the Bank. The
Bank is chartered by the Office of the Comptroller of the Currency (the "OCC")
to operate as a national bank. The Bank’s deposit accounts are eligible to be
insured by the Federal Deposit Insurance Corporation.
The
principal business of the Company is to make loans and other investments and to
accept time and demand deposits. The Company’s primary market areas are
Baltimore, the Baltimore-Washington corridor and Salisbury, Maryland, although
the Company’s business development efforts generate business outside of these
areas. The Company offers a broad range of banking products, including a full
line of business and personal savings and checking accounts, money market demand
accounts, certificates of deposit and other banking services. The Company funds
a variety of loan types including commercial and residential real estate loans,
commercial term loans and lines of credit, consumer loans and letters of credit.
The Company’s customers are primarily individuals and small
businesses.
Use of
Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Cash and Cash
Equivalents
The
Company has included cash and due from banks, and federal funds sold and other
overnight investments as cash and cash equivalents for the purpose of reporting
cash flows.
Investments
Available-for-Sale and Other Equity Securities
Marketable
equity securities and debt securities, not classified as held-to-maturity or
trading, are classified as available-for-sale. Securities available-for-sale are
acquired as part of the Company's
61
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
asset/liability
management strategy and may be sold in response to changes in interest rates,
loan demand, changes in prepayment risk and other factors. Securities
available-for-sale are carried at fair value, with unrealized gains or losses
based on the difference between amortized cost and fair value reported as
accumulated other comprehensive income, a separate component of stockholders'
equity, net of deferred tax. Realized gains and losses, using the specific
identification method, are included as a separate component of non-interest
income. Related interest and dividends are included in interest
income. Declines in the fair value of individual available-for-sale
securities below their cost, that are other than temporary, result in
write-downs of the individual securities to their fair value. Factors
affecting the determination of whether an other-than-temporary impairment has
occurred include a downgrading of the security by a rating agency, a significant
deterioration in the financial condition of the issuer, or the fact that
management would not have the intent and ability to hold a security for a period
of time sufficient to allow for any anticipated recovery in fair
value.
Other
equity securities represented by Federal Reserve Bank and Federal Home Loan Bank
of Atlanta stock are considered restricted as to marketability. The
Bank’s investment in these securities is carried at cost.
Loans Held for Sale
The
Company engages in sales of residential mortgage loans originated by the Bank
and by a third party. Loans held for sale are carried at the lower of aggregate
cost or fair value. Fair value is derived from secondary market quotations for
similar instruments. Gains and losses on the sale of loans originated by the
Bank are recorded as a component of non-interest income in the accompanying
consolidated statements of operations. No gains or losses are realized on the
sale of loans originated by third parties. The Company's current practice is to
sell loans on a servicing released basis, and, therefore, it has no intangible
asset recorded for the value of such servicing at either December 31, 2007 or
December 31, 2006. The Company earns interest on the outstanding balances of all
loans that are held for sale.
Loans
Loans are
stated at the principal amount outstanding net of any deferred fees and costs.
Interest income on loans is accrued at the contractual rate on the principal
amount outstanding. It is the Company's policy to discontinue the
accrual of interest when circumstances indicate that collection is
doubtful. Fees charged and costs capitalized for originating certain
loans are amortized on the interest method over the term of the
loan.
Loans are
considered impaired when, based on current information, it is improbable that
the Company will collect all principal and interest payments according to
contractual terms. Generally, loans are considered impaired once principal and
interest payments are 90 days past due and they are placed on non-accrual.
Management also considers the financial condition of the borrower, cash flows of
the loan and the value of the related collateral. Impaired loans do not include
large groups of smaller balance homogeneous credits such as residential real
estate, consumer installment loans and commercial leases, which are evaluated
collectively for impairment. Loans specifically reviewed for impairment are not
considered impaired during periods of "minimal delay" in payment (usually ninety
days or less) provided eventual collection of all amounts due is expected.
Impaired loans are measured based on the present value of expected future cash
flows discounted at the loan’s effective interest rate, except that as a
practical expedient, the Company may
62
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
measure
impairment based on a loan’s observable market price or the fair value of the
collateral, if the loan is collateral dependent. The Company
recognizes interest income on impaired loans on a cash basis if the borrower
demonstrates the ability to meet the contractual obligation and collateral is
sufficient. If there is doubt regarding the borrower’s ability to
make payments, or if the collateral is not sufficient, payments received are
accounted for as a reduction in principal.
Allowance for Credit
Losses
The
allowance for credit losses is established through a provision for credit losses
charged to expense. Loans are charged against the allowance for
credit losses when management believes that the collectibility of the principal
is unlikely. The allowance, based on evaluations of the
collectibility of loans, is an amount that management believes will be adequate
to absorb possible losses on existing loans that may become
uncollectible. The evaluations take into consideration such factors
as changes in the nature and volume of the loan portfolio, overall portfolio
quality, review of specific problem loans and current economic conditions and
trends that may affect the borrowers' ability to pay.
The
allowance for credit losses represents an estimation done pursuant to Statement
of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies”
and SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” The
Company uses a loan grading system where loans are graded based on management's
evaluation of the risk associated with each loan. A factor, based on the loan
grading, is applied to the loan balance to reserve for losses. In addition,
management judgmentally establishes an additional nonspecific reserve. The
nonspecific portion of the allowance reflects management's estimate of probable
inherent, but undetected, losses within the portfolio due to uncertainties in
economic conditions, delays in obtaining information, including unfavorable
information about a borrower's financial condition, the difficulty in
identifying triggering events that correlate perfectly to subsequent loss rates
and risk factors that have not yet manifested themselves in loss allocation
factors. The adequacy of the allowance is determined through careful and
continuous evaluation of the credit portfolio and involves consideration of a
number of factors to establish a prudent level. Determination of the
allowance is inherently subjective and requires significant estimates, including
estimated losses on pools of homogeneous loans based on historical loss
experience and consideration of current economic trends, which may be
susceptible to significant change.
While
management believes it has established the allowance for credit losses in
accordance with generally accepted accounting principles and has taken into
account the views of its regulators and the current economic environment, there
can be no assurance that in the future the Company's regulators or the economic
environment will not require further increases in the allowance.
Real Estate Acquired Through
Foreclosure
The
Company records foreclosed real estate assets at the lower of cost or estimated
fair value on their acquisition dates and at the lower of such initial amount or
estimated fair value less selling costs thereafter. Subsequent
write-downs are included in our noninterest expenses, along with operating
income, net of related expenses of such properties and gains or losses realized
upon disposition.
Rate Lock
Commitments
The
Company enters into commitments to originate residential mortgage loans with
interest rates
63
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
determined
prior to funding. Such rate lock commitments on mortgage loans to be
sold in the secondary market are considered to be derivatives. The
period of time between issuance of a loan commitment and closing and sale of the
loan generally range from 15 to 90 days. The Company protects itself
from changes in interest rates through the use of best efforts forward delivery
commitments, whereby the Company commits to sell a loan at the time the borrower
commits to an interest rate with the intent that the buyer has assumed interest
rate risk on the loan. As a result, the Company is not exposed to
losses nor will it realize gains related to its rate lock commitments due to
changes in interest rates.
Premises and
Equipment
Premises
and equipment are stated at cost less accumulated depreciation and amortization
computed using the straight-line method. Premises and equipment are
depreciated over the useful lives of the assets, except for leasehold
improvements which are amortized over the terms of the respective leases or the
estimated useful lives of the improvements, whichever is
shorter. Useful lives range from: five to ten years for furniture,
fixtures and equipment; and three to five years for software, hardware and data
handling equipment. Leasehold improvements are amortized over the term of the
respective lease plus the first optional renewal period, if applicable.
Maintenance and repairs are charged to expense as incurred, while improvements,
which extend the useful life, are capitalized and depreciated over the estimated
remaining life of the asset.
Long-lived
depreciable assets are evaluated periodically for impairment when events or
changes in circumstances indicate the carrying amount may not be recoverable.
Impairment exists when the expected undiscounted future cash flows of a
long-lived asset are less than its carrying value. In that event, the Company
recognizes a loss for the difference between the carrying amount and the
estimated fair value of the asset based on a quoted market price, if applicable,
or a discounted cash flow analysis.
Bank Owned Life
Insurance
Bank
owned life insurance is carried at the aggregate cash surrender value of life
insurance policies owned where the Company or its subsidiaries are named
beneficiaries. Increases in cash surrender value derived from
crediting rates for underlying insurance policies are credited to noninterest
income.
Transfers of Financial
Assets
Transfers
of financial assets are accounted for as sales, when control over the assets has
been surrendered. Control over transferred assets is deemed to be
surrendered when: (1) the assets have been isolated from the Company; (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets; and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
Stock-Based Compensation
Effective
January 1, 2006, the Company adopted SFAS No. 123 (R), “Share-based Payment,”
for its equity awards vesting after the effective date. SFAS No. 123
(R) was also adopted for shares available for issuance under the Bay National
Corporation 2007 Stock Incentive Plan (the “Incentive Plan”), which was
presented to and approved by the Company’s shareholders and is described in more
detail under Note 7.
64
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
SFAS No.
123 (R) requires an entity to recognize compensation expense based on an
estimate of the number of awards expected to actually vest, exclusive of awards
expected to be forfeited. Prior to January 1, 2006, the Company
applied the intrinsic value method to account for stock-based employee
compensation whereby stock-based employee compensation cost is recognized only
if the quoted market price of the stock at the grant date is greater than the
exercise price of the options.
Advertising
Costs
Advertising
costs are generally expensed as incurred.
Income
Taxes
The
Company uses the liability method of accounting for income
taxes. Under the liability method, deferred-tax assets and
liabilities are determined based on differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities (i.e.,
temporary differences) and are measured at the enacted rates in effect when
these differences reverse.
The
Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN 48”), as of January 1, 2007. A tax position is
recognized as a benefit only if it is “more likely than not” that the tax
position would be sustained in a tax examination presuming that a tax
examination will occur. The amount recognized is the largest amount
of tax benefit that is greater than 50% likely to be realized on
examination. For tax positions not meeting the “more likely than not”
test, no tax benefit is recorded. The adoption had no effect on the
Company’s financial statements. The Company recognizes interest and
/or penalties related to income tax matters in income tax expense.
Earnings Per
Share
Earnings
per common share are computed by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted net income per
common share is computed by dividing net income by the weighted average number
of common shares outstanding during the period, including any potential dilutive
common shares outstanding such as options and warrants. Per share
data previously reported has been adjusted to reflect a 1.1 to 1 stock split in
the form of a stock dividend recorded on June 29, 2007.
New Accounting
Standards
Adoption
of New Accounting Standards:
SFAS No. 155, “Accounting for
Certain Hybrid Financial Instruments — an amendment of the Financial Accounting Standards
Board (“FASB”) Statements No. 133 and 140.”
SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities” and SFAS No. 140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”
SFAS No. 155 (i) permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation, (ii) clarifies which interest-only strips and
principal-only strips are not subject to the requirements of SFAS No. 133,
(iii) establishes a requirement to evaluate interests in securitized
financial assets to identify interests that are freestanding derivatives or
65
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
that are
hybrid financial instruments that contain an embedded derivative requiring
bifurcation, (iv) clarifies that concentrations of credit risk in the form
of subordination are not embedded derivatives, and (v) amends SFAS No.
140 to eliminate the prohibition on a qualifying special purpose entity from
holding a derivative financial instrument that pertains to a beneficial interest
other than another derivative financial instrument. SFAS No. 155 was
effective for the Company on January 1, 2007 and did not have a significant
impact on the Company’s financial statements.
SFAS No. 156, “Accounting
for Servicing of Financial Assets — an amendment of FASB Statement
No. 140.” SFAS No. 156 amends SFAS No. 140, “Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities — a replacement of FASB Statement No. 125,” by requiring,
in certain situations, an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a financial asset by
entering into a servicing contract. All separately recognized servicing assets
and servicing liabilities are required to be initially measured at fair value.
Subsequent measurement methods include the amortization method, whereby
servicing assets or servicing liabilities are amortized in proportion to and
over the period of estimated net servicing income or net servicing loss or the
fair value method, whereby servicing assets or servicing liabilities are
measured at fair value at each reporting date and changes in fair value are
reported in earnings in the period in which they occur. If the amortization
method is used, an entity must assess servicing assets or servicing liabilities
for impairment or increased obligation based on the fair value at each reporting
date. SFAS No. 156 was effective for the Company on January 1, 2007
and did not have a significant impact on the Company’s financial
statements.
FIN No. 48, “Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement 109.”
FIN No. 48 prescribes a recognition threshold and a measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. Benefits from tax positions should be
recognized in the financial statements only when it is more likely than not that
the tax position will be sustained upon examination by the appropriate taxing
authority that would have full knowledge of all relevant information. A tax
position that meets the more-likely-than-not recognition threshold is measured
at the largest amount of benefit that is greater than fifty percent likely of
being realized upon ultimate settlement. Tax positions that previously failed to
meet the more-likely-than-not recognition threshold should be recognized in the
first subsequent financial reporting period in which that threshold is met.
Previously recognized tax positions that no longer meet the more-likely-than-not
recognition threshold should be derecognized in the first subsequent financial
reporting period in which that threshold is no longer met. FIN No. 48 also
provides guidance on the accounting for and disclosure of unrecognized tax
benefits, interest and penalties. FIN No. 48 was effective for the Company on
January 1, 2007 and did not have a significant impact on the Company’s
financial statements.
Emerging Issues Task Force (“EITF”)
Issue No. 06-5, “Accounting for Purchases of Life Insurance –Determining
the Amount That Could Be Realized in Accordance with FASB Technical Bulletin
No. 85-4, Accounting for Purchases of Life Insurance.” This Issue
clarifies how a company should determine “the amount that could be realized”
from a life insurance contract, which is the measurement amount for the asset in
accordance with Technical Bulletin 85-4, and requires policyholders to determine
the amount that could be realized under a life insurance contract assuming
individual policies are surrendered, unless all policies are required to be
surrendered as a group. This Issue became
66
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
effective
for the Company on January 1, 2007 and the adoption did not have a
significant impact on the Company’s financial statements.
Newly
Issued But Not Yet Effective Accounting Standards:
SFAS No. 157, “Fair Value
Measurements.” SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. SFAS No. 157 is
effective for the Company on January 1, 2008 and is not expected to have a
significant impact on the Company’s financial statements.
SFAS No. 159, “The Fair Value
Option for Financial Assets and Financial Liabilities.” SFAS
No. 159 permits companies to elect on an instrument-by-instrument basis to
fair value certain financial assets and financial liabilities with changes in
fair value recognized in earnings as they occur. The election to fair value is
generally irrevocable. SFAS No. 157 and SFAS No. 159 are effective
January 1, 2008 for calendar year companies with the option to early adopt
as of January 1, 2007. The Company did not elect to adopt the provisions of
SFAS No. 157 and SFAS No. 159 effective January 1, 2007.
SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements.” SFAS No.
160’s objective is to improve the relevance, comparability, and transparency of
the financial information that a reporting entity provides in its consolidated
financial statements by establishing accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 shall be effective for fiscal years and interim
periods within those fiscal years, beginning on or after December 15,
2008. The Company does not expect the implementation of SFAS No. 160
to have a material impact on its consolidated financial
statements.
Staff Accounting Bulletin (“SAB”)
No. 109, “Written Loan Commitments Recorded at Fair Value through
Earnings.” Previously, SAB No. 105, “Application of Accounting
Principles to Loan Commitments,” stated that in measuring fair value of a
derivative loan commitment, a company should not incorporate the expected net
future cash flows related to the associated servicing of the
loan. SAB No. 109 supersedes SAB No. 105 and indicates that the
expected net future cash flows related to the associated servicing of the loan
should be included in measuring fair value of all written loan commitments that
are accounted for at fair value through earnings. SAB No. 105 also
indicated that internally-developed intangible assets should not be recorded as
part of the fair value of a derivative loan commitment, and SAB No. 109 retains
that view. SAB No. 109 is effective for derivative loan commitments
issued or modified in fiscal quarters beginning after December 15,
2007. The Company has no such investments, so the impact of adoption
in 2008 would not have a material impact on the Company’s consolidated financial
position or results of operation.
SFAS No. 141R, “Business
Combinations.” This revises SFAS No. 141 and changes
multiple aspects of the accounting for business combinations. Under the guidance
in SFAS No. 141R, the acquisition method must be used, which requires the
acquirer to recognize most identifiable assets acquired, liabilities assumed,
and noncontrolling interests in the acquiree at their full fair value on the
acquisition date. Goodwill is to be recognized as the excess of the
consideration transferred plus the fair value of the noncontrolling interest
over the fair values of the identifiable net assets acquired. Subsequent changes
in the fair value of contingent consideration classified as a liability are to
be recognized in earnings, while contingent consideration classified as equity
is not to be remeasured. Costs such as
67
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
transaction
costs are to be excluded from acquisition accounting, generally leading to
recognizing expense and additionally, restructuring costs that do not meet
certain criteria at acquisition date are to be subsequently recognized as
post-acquisition costs. SFAS No. 141R is effective for business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15,
2008.
2.
INVESTMENT
SECURITIES
Investments
available-for-sale
The amortized cost and estimated fair values of
investments available-for-sale at December 31, 2007 were as follows:
|
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Estimated
Fair Value
|
|||||||||||||
|
U.S.
Treasury securities
|
$ | 399,529 | $ | - | $ | - | $ | 399,529 | ||||||||
|
Total
investments available-for-sale
|
$ | 399,529 | $ | - | $ | - | $ | 399,529 | ||||||||
The
amortized cost and estimated fair values of investments available-for-sale at
December 31, 2007 by contractual maturity are shown below.
|
Amortized
Cost
|
Estimated
Fair Value
|
|||||||
|
Due
in one year or less
|
$ | 399,529 | $ | 399,529 | ||||
|
Total
investments available-for-sale
|
$ | 399,529 | $ | 399,529 | ||||
The
amortized cost and estimated fair values of investments available-for-sale at
December 31, 2006 were as follows:
|
Amortized
Cost
|
Gross
Unrealized Gains
|
Gross
Unrealized Losses
|
Estimated
Fair Value
|
|||||||||||||
|
U.S.
Treasury securities
|
$ | 697,526 | $ | - | $ | - | $ | 697,526 | ||||||||
|
Total
investments available-for-sale
|
$ | 697,526 | $ | - | $ | - | $ | 697,526 | ||||||||
There
were no sales of investments available-for-sale during 2007, 2006 or
2005.
At
December 31, 2006, investments available-for-sale with a carrying value of
$300,000 were pledged as collateral for certain short-term
borrowings. No investments were pledged as collateral as of December
31, 2007.
68
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
Other
equity securities
At
December 31, the Company’s investment in other equity securities was carried at
cost and consisted of:
|
2007
|
2006
|
|||||||
|
Federal
Reserve Bank stock
|
$ | 607,300 | $ | 607,300 | ||||
|
Federal
Home Loan Bank stock
|
1,107,700 | 509,800 | ||||||
|
Total
investments in other equity securities
|
$ | 1,715,000 | $ | 1,117,100 | ||||
3.
LOANS AND ALLOWANCE FOR CREDIT LOSSES
Major
loan categories at December 31 are presented below:
|
2007
|
2006
|
|||||||
|
Real
Estate – Home Equity Line of Credit
|
$ | 18,585,641 | $ | 19,963,116 | ||||
|
Real
Estate – Construction
|
67,775,883 | 76,889,997 | ||||||
|
Real
Estate – Mortgage
|
36,210,905 | 27,903,399 | ||||||
|
Loans
Held for Sale
|
11,601,070 | 1,444,303 | ||||||
|
Commercial
|
102,728,342 | 88,491,722 | ||||||
|
Consumer
|
4,054,400 | 3,323,141 | ||||||
|
Total
Loans
|
240,956,241 | 218,015,678 | ||||||
|
Less:
Allowance for credit losses
|
(5,000,000 | ) | (3,175,000 | ) | ||||
|
Net
Loans
|
$ | 235,956,241 | $ | 214,840,678 | ||||
Activity
in the allowance for credit losses for the year ended December
31, 2007, 2006 and 2005 is shown below:
|
2007
|
2006
|
2005
|
||||||||||
|
Balance
at beginning of year
|
$ | 3,175,000 | $ | 3,000,000 | $ | 1,810,000 | ||||||
|
Provision
for credit losses
|
2,125,680 | 202,931 | 1,178,866 | |||||||||
|
Loan
charge-offs
|
||||||||||||
|
Commercial
|
- | (37,931 | ) | - | ||||||||
|
Real
Estate - Construction
|
(343,919 | ) | - | - | ||||||||
|
Loan
recoveries
|
||||||||||||
|
Commercial
|
27,931 | 10,000 | 11,134 | |||||||||
|
Real
Estate - Construction
|
15,308 | - | - | |||||||||
|
Net
recoveries (charge-offs)
|
(300,680 | ) | (27,931 | ) | 11,134 | |||||||
|
Balance
at end of year
|
$ | 5,000,000 | $ | 3,175,000 | $ | 3,000,000 | ||||||
As of
December 31, 2006, the Company had unpaid fees of approximately $13,000 related
to one loan and a specific credit reserve was established for these
fees. As of December 31, 2007, the Company had impaired loans
totaling $9.4 million, all of which were included in its investor owned
residential real estate construction loan portfolio, were classified as
non-accrual loans and were over 90 days past due. This is a direct result
of the slowdown in the real estate market, which has resulted in an increase in
loan extensions and delinquencies due to the inability of investors to resell
properties as quickly as anticipated.
69
BAY
NATIONAL CORPORATION
Notes
to Consolidated Financial Statements
For
the years ended December 31, 2007, 2006, and 2005
The
following table sets forth information with respect to impaired loans and the
related valuation allowance as of December 31:
|
2007
|
2006
|
2005
|
||||||||||
|
Impaired
loans with valuation allowance
|
$ | 9,426,202 | $ | - | $ | 1,708,874 | ||||||
|
Impaired
loans with no valuation allowance
|
- | - | - | |||||||||
|
Total
impaired loans
|
$ | 9,426,202 | $ | - | $ | 1,708,874 | ||||||
|
Allowance
for credit losses related to impaired loans
|
$ | 1,862,984 | $ | 12,874 | $ | 512,817 | ||||||
|
Allowance
for credit losses related to other than impaired loans
|
3,137,016 | 3,162,126 | 2,487,183 | |||||||||
|
Total
allowance for credit losses
|
$ | 5,000,000 | $ | 3,175,000 | $ | 3,000,000 | ||||||
|
Interest
income on impaired loans recorded on the cash basis
|
$ | - | $ | - | $ | 276 | ||||||
|
Average
recorded investment in impaired loans
|
$ | 2,537,535 | $ | 507,640 | $ | 4,682 | ||||||
4.
PREMISES AND EQUIPMENT
Premises
and equipment at December 31 include the following:
|
2007
|
2006
|
|||||||
|
Furniture
and equipment
|
$ | 814,022 | $ | 694,244 | ||||
|
Computer
hardware and software
|
684,147 | 472,590 | ||||||
|
Leasehold
improvements
|
793,299 | 721,969 | ||||||
| 2,291,468 | 1,888,803 | |||||||
|
Less
accumulated depreciation
|
(1,080,681 | ) | (788,583 | ) | ||||
|
Net
premises and equipment
|
$ | 1,210,787 | $ | 1,100,220 | ||||
The
Company rents office space in five locations under four non-cancelable lease
arrangements and one monthly rental agreement accounted for as operating
leases. The initial lease periods are five years and provide for one
or more five-year renewal options. The lease for the Salisbury
location provides for percentage rent escalations upon renewal. The
leases for the remaining locations provide for percentage annual rent
escalations. The lease for the Salisbury location requires that the
lessee pay certain operating expenses applicable to the leased
space.
Rent
expense applicable to operating leases, for the periods ended December 31, was
as follows:
|
2007
|
2006
|
2005
|
||||||||||
|
Minimum
rentals
|
$ | 498,832 | $ | 391,927 | $ | 330,406 | ||||||
|
Less:
Sublease rentals
|
(1,197 | ) | (23,568 | ) | (23,657 | ) | ||||||
|
Net
rent expense
|
$ | 497,635 | $ | 368,359 | $ | 306,749 | ||||||
70
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
At
December 31, 2007, future minimum lease payments under non-cancelable operating
leases having an initial term in excess of one year are as follows:
|
Years
ending December 31:
|
|||
|
2008
|
$
|
578,535
|
|
|
2009
|
589,090
|
||
|
2010
|
260,292
|
||
|
2011
|
192,783
|
||
|
2012
and beyond
|
98,549
|
||
|
Total
minimum lease payments
|
$
|
1,719,249
|
5.
DEPOSITS
The
following table sets forth the composition of the Company's deposits as of
December 31, 2007 and December 31, 2006:
|
2007
|
2006
|
|||||||||||
|
Demand
deposits
|
$
|
58,912,584
|
29.17
|
%
|
$
|
58,118,270
|
25.93
|
%
|
||||
|
Savings
|
1,905,072
|
0.94
|
7,456,143
|
3.33
|
||||||||
|
Money
market and sweep
|
41,277,267
|
20.44
|
43,428,638
|
19.37
|
||||||||
|
Certificates
of deposit
|
99,886,542
|
49.45
|
115,145,901
|
51.37
|
||||||||
|
Total
deposits
|
$
|
201,981,465
|
100.00
|
%
|
$
|
224,148,952
|
100.00
|
%
|
||||
The
following table sets forth the maturity distribution for the Company's deposits
at December 31, 2007. Some of the deposits may be renewed or withdrawn prior to
maturity. Therefore, the following table should not be used as a forecast of
future cash flows.
|
Within
one year
|
One
to three years
|
Three
to
five years
|
Over
five years
|
|||||||||
|
Demand
deposits
|
$
|
58,912,584
|
$
|
-
|
$
|
-
|
$
|
-
|
||||
|
Savings
|
1,905,072
|
-
|
-
|
-
|
||||||||
|
Money
market and sweep
|
41,277,267
|
-
|
-
|
-
|
||||||||
|
Certificates
of deposit
|
75,496,132
|
20,794,446
|
3,595,964
|
-
|
||||||||
|
Total
|
$
|
177,591,055
|
$
|
20,794,446
|
$
|
3,595,964
|
$
|
-
|
Certificates
of deposit in amounts of $100,000 or more and their remaining maturities at
December 31 are as follows:
|
2007
|
2006
|
|||
|
Three
months or less
|
$
|
19,303,042
|
$
|
17,995,943
|
|
Over
three months through six months
|
10,401,598
|
19,591,959
|
||
|
Over
six months through twelve months
|
5,838,645
|
10,346,026
|
||
|
Over
twelve months
|
11,639,910
|
12,844,155
|
||
|
Total
|
$
|
47,183,195
|
$
|
60,778,083
|
71
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
Interest
expense on deposits, for the years ended December 31, is as
follows:
|
2007
|
2006
|
2005
|
|||||
|
Interest-bearing
transaction
|
$
|
889,635
|
$
|
873,622
|
$
|
525,691
|
|
|
Savings
and money market
|
1,855,946
|
1,402,610
|
575,007
|
||||
|
Time,
$100,000 or more
|
2,697,860
|
2,097,542
|
980,590
|
||||
|
Other
time
|
2,465,712
|
2,758,837
|
1,977,231
|
||||
|
Total
interest on deposits
|
$
|
7,909,153
|
$
|
7,132,611
|
$
|
4,058,519
|
6.
BORROWINGS
Information relating to short-term
borrowings, as of December 31, 2007 and 2006, is as follows:
|
Securities
under agreement to repurchase
|
||||||||||||
|
2007
|
2006
|
|||||||||||
|
Amount
|
Rate
|
Amount
|
Rate
|
|||||||||
|
As
of year-end
|
$
|
-
|
-
|
%
|
$
|
300,000
|
4.00
|
%
|
||||
|
Average
for the year
|
$
|
36,011
|
4.52
|
%
|
$
|
494,913
|
3.59
|
%
|
||||
|
Maximum
month-end balance
|
$
|
300,000
|
$
|
1,277,000
|
||||||||
|
Federal
funds purchased
|
||||||||||||
|
2007
|
2006
|
|||||||||||
|
Amount
|
Rate
|
Amount
|
Rate
|
|||||||||
|
As
of year-end
|
$
|
3,637,000
|
4.25
|
%
|
$
|
-
|
-
|
%
|
||||
|
Average
for the year
|
$
|
174,068
|
3.73
|
%
|
$
|
266,351
|
5.11
|
%
|
||||
|
Maximum
month-end balance
|
$
|
3,637,000
|
$
|
3,243,000
|
||||||||
|
Commercial
paper
|
||||||||||||
|
2007
|
2006
|
|||||||||||
|
Amount
|
Rate
|
Amount
|
Rate
|
|||||||||
|
As
of year-end
|
$
|
7,309,508
|
3.25
|
%
|
$
|
1,245,000
|
4.50
|
%
|
||||
|
Average
for the year
|
$
|
4,576,086
|
4.15
|
%
|
$
|
670,370
|
4.33
|
%
|
||||
|
Maximum
month-end balance
|
$
|
9,015,951
|
$
|
1,389,000
|
||||||||
72
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
|
Federal
Home Loan Bank Borrowings
|
||||||||||||
|
2007
|
2006
|
|||||||||||
|
Amount
|
Rate
|
Amount
|
Rate
|
|||||||||
|
As
of year-end
|
$
|
14,425,000
|
4.40
|
%
|
$
|
-
|
-
|
%
|
||||
|
|
||||||||||||
|
Average
for the year
|
$
|
1,211,027
|
4.63
|
%
|
$
|
504,110
|
5.17
|
%
|
||||
|
Maximum
month-end balance
|
$
|
16,000,000
|
$
|
-
|
||||||||
The
Company pledges U.S. Government Treasury Securities, based upon their market
values, as collateral for 100% of the principal and accrued interest of its
securities under agreement to repurchase.
The
Company maintained unused commitments for a total of $5.4 million of borrowing
availability under unsecured federal funds lines of credit with three separate
financial institutions as of December 31, 2007. The Company also has
approximately $11.7 million of additional borrowing capacity with the Federal
Home Loan Bank of Atlanta as of December 31, 2007. These borrowing facilities
will be used, as necessary, to supplement short-term liquidity
needs.
Information
relating to subordinated debt as of December 31, 2007 and 2006 is as
follows:
|
2007
|
2006
|
|||||||||||
|
Amount
|
Rate
|
Amount
|
Rate
|
|||||||||
|
As
of year-end
|
$
|
8,000,000
|
7.20
|
%
|
$
|
8,000,000
|
7.20
|
%
|
||||
|
Average
for the year
|
$
|
8,000,000
|
7.53
|
%
|
$
|
8,000,000
|
7.54
|
%
|
||||
|
Maximum
month-end balance
|
$
|
8,000,000
|
$
|
8,000,000
|
||||||||
On
December 12, 2005, the Company participated in a private placement of $8 million
of fixed interest rate trust preferred securities (the “Trust Preferred
Securities”), through a newly formed Delaware trust subsidiary, Bay National
Capital Trust I (the “Trust”). The Trust was formed for the purpose of issuing
the Trust Preferred Securities and all of its common securities are owned by the
Company. The Company purchased the common securities from the Trust for
$248,000. In accordance with provisions of FIN46, the financial position and
results of operations are not included in the Company’s consolidated financial
position and results of operations.
The Trust
used the proceeds of the sale of the Trust Preferred Securities and common
securities to purchase from the Company the aggregate principal amount of
$8,248,000 of the Company’s Fixed Rate Junior Subordinated Debt Securities Due
2036 (the “Debt Securities”). Like the Trust Preferred Securities, the Debt
Securities bear interest at the fixed annual rate of 7.20% until maturity. The
interest expense on Trust Preferred Securities was $602,096, $603,567 and
$28,108 in 2007, 2006 and 2005, respectively. The Debt Securities mature on
February 23, 2036, but may be redeemed at the Company’s option at any time on
any February 23, May 23, August 23 or November 23 on or after February 23, 2011,
or at any time upon certain events, such as a change in the regulatory capital
treatment of Debt Securities, the Trust being deemed to be an “investment
company” under the Investment Company Act of 1940, as amended, or the occurrence
73
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
of
certain adverse tax events. Except upon the occurrence of the events
described above, which require a redemption premium for redemptions prior to
February 23, 2011, the Company may redeem the Debt Securities at their aggregate
principal amount, plus accrued interest, if any.
The
parent was required to retain $1,000,000 of the proceeds from the Debt
Securities for general corporate purposes (which may include making interest
payments on the Debt Securities) until the earlier of (i) the date on which the
retained funds are reduced to zero, or (ii) the date on which Bay National Bank
(or any successor) meets the statutory requirements to pay dividends of at least
$148,464 for each of two consecutive quarters with positive retained earnings
remaining after any such dividend payment. As of December 31, 2007, the Bank has
the ability to pay the required dividends.
The Debt
Securities are subordinated to the prior payment of other indebtedness of the
Company that, by its terms, is not similarly subordinated. Although
the Debt Securities are recorded as a liability on the Company’s balance sheet,
for regulatory purposes, the Debt Securities are being treated as Tier 1 or Tier
2 capital under regulatory capital guidelines issued by the Federal Reserve
Board.
7.
STOCK-BASED COMPENSATION PLANS
Stock
Options
The Bay
National Corporation 2007 Stock Incentive Plan (the “Incentive Plan”) was
established effective May 22, 2007 and provides for the granting of incentive
stock options intended to comply with the requirements of Section 422 of the
Internal Revenue Code (“incentive stock options”), non-qualified stock options,
stock appreciation rights (“SARs”), restricted or unrestricted stock awards,
awards of phantom stock, performance awards, other stock-based awards, or any
combination of the foregoing (collectively “Awards”). Awards will be
available for grant to officers, employees and directors of the Company and its
affiliates, including the Bank, except that non-employee directors will not be
eligible to receive awards of incentive stock options.
The
Incentive Plan authorizes the issuance of up to 200,000 shares of common stock
plus any shares that were available under the Company’s 2001 Stock Option Plan
(“Option Plan”) that terminated as of May 22, 2007 and shares subject to options
granted under the Option Plan that expire or terminate without having been fully
exercised. The Incentive Plan has a term of ten years, and is
administered by the Compensation Committee of the Board of Directors. The
Compensation Committee consists of at least three non-employee directors
appointed by the Board of Directors. In general, the options have an exercise
price equal to 100% of the fair market value of the common stock on the date of
the grant. As of December 31, 2007, nine Awards had been granted
under the Incentive Plan. Five of these Awards included an
unrestricted stock grant of 550 shares to five employees in August 2007 based on
their 2006 performance. The Awards vested immediately upon issuance
and the closing stock price on the grant date was $14.64. The
remaining four Awards represent restricted stock awards and are discussed in
more detail below in the section entitled “Restricted Stock Units.”
Effective
January 1, 2006 the Company adopted SFAS No. 123(R) and has included the
stock-based employee compensation cost in its income statements for the years
ended December 31, 2007 and 2006. Prior periods have not been
restated. Amounts recognized in the financial statements with respect
to stock-based compensation are as follows:
74
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
|
2007
|
2006
|
||||
|
Amounts
charged against income, before tax benefit
|
$
|
122,539
|
$
|
115,714
|
|
|
Amount
of related income tax benefit recognized in income
|
$
|
31,130
|
$
|
12,444
|
|
Prior to
January 1, 2006, the Company applied the intrinsic value method to account for
stock-based compensation and accordingly, did not record compensation expense
related to options as the exercise price was equal to the market value of the
underlying common stock at the grant date. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123(R) and SFAS No.
148 to stock-based employee compensation for the period ended December 31,
2005:
|
2005
|
|||||||
|
Net
income as reported
|
$
|
2,744,330
|
|||||
|
Less
pro forma stock-based compensation expense determined under the fair value
method, net of related tax effects
|
(102,382
|
)
|
|||||
|
Pro
forma net income (loss)
|
$
|
2,641,948
|
|||||
|
Net
income (loss) per share:
|
|||||||
|
Basic
- as reported
|
$
|
1.30
|
|||||
|
Diluted
- as reported
|
$
|
1.24
|
|||||
|
Basic
- pro forma
|
$
|
1.25
|
|||||
|
Diluted
- pro forma
|
$
|
1.20
|
75
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants during the year ended December 31:
|
2002
|
||||
|
Dividend
yield
|
-
|
|||
|
Expected
volatility
|
20.00
|
%
|
||
|
Risk-free
interest rate
|
4.17
|
%
|
||
|
Expected
lives (in years)
|
8
|
The
following is a summary of changes in shares under options for the years ended
December 31, 2007, 2006 and 2005 (amounts previously reported have been adjusted
to reflect a 1.1 to 1 stock split in the form of a stock dividend recorded on
June 29, 2007):
|
Number
of Shares
|
Weighted
Average Exercise Price
|
|||
|
Balance,
January 1, 2005
|
162,235
|
$ 6.97
|
||
|
Granted
|
-
|
-
|
||
|
Cancelled
|
-
|
-
|
||
|
Exercised
|
(7,398
|
)
|
$ 6.89
|
|
|
Balance,
December 31, 2005
|
154,837
|
$ 6.97
|
||
|
Granted
|
-
|
|
-
|
|
|
Cancelled
|
(1,366
|
)
|
$ 6.89
|
|
|
Exercised
|
(12,025
|
)
|
$ 6.89
|
|
|
Balance,
December 31, 2006
|
141,446
|
$ 6.98
|
||
|
Granted
|
-
|
-
|
||
|
Cancelled
|
-
|
-
|
||
|
Exercised
|
(2,705
|
)
|
$ 6.89
|
|
|
Balance,
December 31, 2007
|
138,741
|
$ 6.99
|
||
|
Weighted
average fair value of options granted during 2002
|
$
|
2.77
|
||
76
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
The
following table summarizes information about options outstanding at December 31,
2007:
|
Options
Outstanding
|
Options
Exercisable
|
|||||||||||
|
Range
of Exercise Price
|
Number
|
Weighted
Average Remaining Contractual Life
(in
years)
|
Weighted
Average Exercise Price
|
Number
|
Weighted
Average Exercise Price
|
|||||||
|
$6.89
|
120,245
|
2
|
$6.89
|
120,245
|
$6.89
|
|||||||
|
$7.61
|
18,496
|
3
|
$7.61
|
13,872
|
$7.61
|
|||||||
|
138,741
|
$6.99
|
134,117
|
$6.97
|
|||||||||
The
aggregate intrinsic value of options outstanding and exercisable as of December
31, 2007 was $382,925
and $372,845 respectively, based upon a closing price of $9.75 per share. The
unrecognized compensation cost related to unvested stock option awards was
$12,808 at December 31, 2007 based upon a weighted average fair value of
$2.77.
The
following table summarizes the changes in unvested option shares during the year
ended December 31, 2007 (amounts previously reported have been adjusted to
reflect a 1.1 to 1 stock split in the form of a stock dividend recorded on June
29, 2007):
|
Number
of Shares
|
Weighted
Average Grant Date Fair Value
|
|||
|
Unvested
options at January 1, 2007
|
11,440
|
$2.77
|
||
|
Granted
|
-
|
-
|
||
|
Vested
|
(6,816)
|
|
-
|
|
|
Cancelled
|
-
|
-
|
||
|
Unvested
options at December 31, 2007
|
4,624
|
$2.77
|
||
Restricted Stock
Units
Pursuant
to an employment agreement (“Agreement”) dated June 1, 2006, a grant of 13,200
shares of the Company’s common stock was awarded to a member of senior
management. This Agreement terminated effective July 20, 2007 upon
resignation of this member of senior management. The stock grant vested as
follows: 25% (3,300 shares) on the first anniversary of the Agreement; 25%
(3,300 shares) on the second anniversary of the Agreement; 25% (3,300 shares) on
the third anniversary of the Agreement; and 25% (3,300 shares) on the fourth
anniversary of the Agreement. This vesting was subject to the
individual being employed under this Agreement at each vesting
date. As such, 3,300 shares had vested under this grant as of
December 31, 2007.
As of
July 20, 2007, the unvested grants, totaling 9,900 shares, were
forfeited. As such, the Company no longer recognizes compensation
cost related to this restricted stock award.
77
BAY
NATIONAL CORPORATION
Notes
to Consolidated Financial Statements
For
the years ended December 31, 2007, 2006, and 2005
During
the third quarter of 2007, a grant of 24,000 shares of the Company’s common
stock was awarded to four new employees. Three of these awards vest
20% on each anniversary of the employee’s hiring date over 5 years and the
remaining grant vests 25% on each anniversary of the employee’s hiring date over
4 years.
The
Company incurred compensation expense of $62,589 and $33,163 associated with
restricted stock for the years ended December 31, 2007 and 2006,
respectively. The unrecognized compensation cost related to
restricted stock was $342,938 at December 31, 2007 based upon a weighted average
fair value of $15.91.
The
following table summarizes the changes in outstanding shares under restricted
stock grants for the year ended December 31, 2007. Amounts have been
adjusted to reflect a 1.1 to 1 stock split in the form of a dividend recorded on
June 29, 2007.
|
Number
of Shares
|
Weighted
Average Fair Value at Grant Date
|
|||
|
Unvested
grants at January 1, 2007
|
13,200
|
$
|
17.23
|
|
|
Granted
|
24,000
|
15.91
|
||
|
Vested
|
(3,300
|
)
|
17.23
|
|
|
Cancelled
|
(9,900
|
)
|
17.23
|
|
|
Unvested
grants at December 31, 2007
|
24,000
|
$
|
15.91
|
|
8.
RETIREMENT PLAN
The
Company has a 401(k) profit sharing plan covering substantially all full-time
employees. The plan requires the Company to match 25% of employee contributions
of up to 3% of compensation as defined under the plan. The Company has also
elected to make a safe harbor contribution to the plan on behalf of all eligible
employees, as defined under the plan. The safe harbor contribution is equal to
3% of compensation as defined under the plan. The plan permits additional
contributions at the discretion of management. Expenses under this
plan totaled $179,626, $171,224 and $120,368 for the years ended
December 31, 2007, 2006 and 2005, respectively.
78
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
9.
INCOME TAXES
Federal
and state income tax expense (benefit) consists of the following for the periods
ended December 31:
|
2007
|
2006
|
2005
|
|||||
|
Current
federal income tax
|
$
|
1,160,434
|
$
|
1,391,380
|
$
|
307,000
|
|
|
Current
state income tax
|
134,961
|
341,978
|
121,000
|
||||
|
Deferred
federal income tax expense (benefit)
|
(707,000
|
)
|
(50,000
|
)
|
(887,000
|
)
|
|
|
Deferred
state income tax expense (benefit)
|
(97,000
|
)
|
(5,000
|
)
|
(196,000
|
)
|
|
|
Total
income tax expense (benefit)
|
$
|
491,395
|
$
|
1,678,358
|
$
|
(655,000
|
)
|
The
following table is a summary of the tax effect of temporary differences that
give rise to a significant portion of deferred tax assets:
|
Deferred
tax assets:
|
2007
|
2006
|
||||
|
Net
operating loss carryforwards (state)
|
$
|
192,000
|
$
|
115,000
|
||
|
Contributions
|
-
|
-
|
||||
|
Deferred
loan fees, net
|
-
|
67,000
|
||||
|
Stock
based compensation
|
21,000
|
27,000
|
||||
|
Allowance
for other real estate owned
|
44,000
|
-
|
||||
|
Allowance
for credit losses
|
1,919,000
|
1,058,000
|
||||
|
Total
deferred tax assets
|
2,176,000
|
1,267,000
|
||||
|
Less
valuation allowance
|
(192,000
|
)
|
(115,000
|
)
|
||
|
Deferred
tax assets, net of valuation allowance
|
1,984,000
|
1,152,000
|
||||
|
Deferred
tax liabilities:
|
||||||
|
Depreciation
and amortization
|
(13,000
|
)
|
(14,000
|
)
|
||
|
Deferred
loan costs, net
|
(29,000
|
)
|
-
|
|||
|
Net
deferred tax assets
|
$
|
1,942,000
|
$
|
1,138,000
|
For the
year ended December 31, 2007, the Company recorded a current income tax
liability of $1,295,395 compared to $1,733,358 for the year ended December 31,
2006. The 2007 liability was offset by the recognition of a deferred
tax asset of $804,000, resulting in net tax expense of $491,395 for the year
ended December 31, 2007. The 2006 liability was offset by the
recognition of a deferred tax asset of $55,000, resulting in a net tax expense
of $1,678,358 for the year ended December 31, 2006. At December 31, 2007, the
Company had a net operating loss carryforward of approximately $2.3 million for
the unconsolidated state tax return of Bay National Corporation.
79
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
Reported
income tax expense (benefit) differed from the amounts computed by applying the
U.S. federal statutory income tax rate of 34% to income before income taxes as
follows:
|
2007
|
2006
|
2005
|
|||||||||||||
|
Amount
|
Percentage
of Pretax Income
|
Amount
|
Percentage
of Pretax Income
|
Amount
|
Percentage
of Pretax Income
|
||||||||||
|
Federal
income tax expense computed at the statutory rate
|
$
|
485,780
|
34.00
|
%
|
$
|
1,396,783
|
34.00
|
%
|
$
|
710,372
|
34.00
|
%
|
|||
|
State
income tax expense (benefit), net
|
64,888
|
4.54
|
222,405
|
5.41
|
(49,500
|
)
|
(2.37
|
)
|
|||||||
|
Nondeductible
expenses
|
14,199
|
0.99
|
18,281
|
0.45
|
13,536
|
0.65
|
|||||||||
|
Non-taxable
income
|
(14,165
|
)
|
(0.99
|
)
|
(12,111
|
)
|
(0.30
|
)
|
-
|
-
|
|||||
|
Deferred
tax benefit resulting from change in state income tax rate
|
(90,743
|
)
|
(6.35
|
)
|
-
|
-
|
-
|
-
|
|||||||
|
Other
|
(45,564
|
)
|
(3.19
|
)
|
-
|
-
|
-
|
-
|
|||||||
|
Adjustment
to valuation allowance
|
77,000
|
5.39
|
53,000
|
1.29
|
(1,329,408
|
)
|
(63.63
|
)
|
|||||||
|
Income
tax expense (benefit), as reported
|
$
|
491,395
|
34.39
|
%
|
$
|
1,678,358
|
40.85
|
%
|
$
|
(655,000
|
)
|
(31.35
|
)%
|
||
10.
RELATED PARTY TRANSACTIONS
Certain
directors and executive officers have loan transactions with the Company. Such
loans were made in the ordinary course of business on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with outsiders. The following schedule summarizes
changes in amounts of loans outstanding, both direct and indirect, to these
persons during 2007 and 2006.
|
2007
|
2006
|
||||
|
Balance
at beginning of period
|
$
|
11,245,284
|
$
|
8,059,647
|
|
|
Additions
|
24,904,727
|
16,914,183
|
|||
|
Repayments
|
(22,629,968
|
)
|
(13,728,546
|
)
|
|
|
Balance
at December 31
|
$
|
13,520,043
|
$
|
11,245,284
|
An
individual, who became a director of the Company in 2003, is an executive
officer of the company which owns an office building in which the Company had
leased space under two separate operating leases. The leases were
effectively combined during 2004 and extended to February 28,
2010. Bay National Corporation has the right to extend the leases for
one additional five year term, to February 28, 2015. Rent expense under this
lease was $358,000, $347,573, and $286,406 for the periods ended December 31,
2007, 2006 and 2005, respectively. Management believes that the terms of the
foregoing leases are no more and no less favorable to the Company than those
which could have been received from unaffiliated parties.
11.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business. These financial instruments may include
commitments to extend credit, standby letters of credit and purchase
commitments. The Company uses these financial instruments to meet the
financing needs of its
80
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
customers. Financial
instruments involve, to varying degrees, elements of credit, interest rate and
liquidity risk. These do not represent unusual risks and management
does not anticipate any losses which would have a material effect on the
accompanying financial statements.
Outstanding
loan commitments and lines and letters of credit at December 31 are as
follows:
|
2007
|
2006
|
||||
|
Loan
commitments
|
$
|
35,114,676
|
$
|
33,782,891
|
|
|
Unused
lines of credit
|
85,999,686
|
66,660,250
|
|||
|
Standby
letters of credit
|
3,564,927
|
2,188,659
|
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. The Company
generally requires collateral to support financial instruments with credit risk
on the same basis as it does for on-balance sheet instruments. The collateral is
based on management's credit evaluation of the counter party. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. Each customer's
credit-worthiness is evaluated on a case-by-case basis.
Standby
letters of credit are conditional commitments issued to guarantee the
performance 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.
12.
REGULATORY MATTERS
As of
December 31, 2007, the Company was required to maintain a weekly average of $1.9
million of non-interest-bearing deposits with the Federal Reserve Bank. As of
December 31, 2006, the Company was required to maintain a weekly average of $1.8
million of non-interest-bearing deposits with the Federal Reserve
Bank. The average weekly balance maintained with the Federal Reserve
Bank for the weekly period including December 31, 2007 was $2.0 million. The
average weekly balance maintained with the Federal Reserve Bank for the weekly
period including December 31, 2006 was $1.9 million. The actual balances
maintained with the Federal Reserve Bank at December 31, 2007 and December 31,
2006 was $1.8 million and $1.9 million, respectively.
The
Company and the Bank are subject to various regulatory capital requirements
administered by federal 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 and the Bank'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 the Bank's assets, liabilities
and certain off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain amounts and ratios (set forth in the table below) of total and Tier
I capital (as defined in the regulations) to risk-weighted assets (as defined)
and Tier I capital (as defined) to average assets (as
defined).
81
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
Management
believes, as of December 31, 2007, that the Bank met all capital adequacy
requirements to which it is subject.
The Bank
has been categorized as “well capitalized” by the OCC under the regulatory
framework for prompt corrective action. To be categorized as well capitalized,
the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I
leverage ratios. There are no conditions or events that management believes
would prevent the Bank from continuing to be categorized as well
capitalized.
The
Bank’s actual capital amounts and ratios as of December 31, 2007 and 2006 are
presented in the following tables:
|
December
31, 2007
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
27,392,869
|
10.41
|
%
|
$
|
21,047,000
|
8.00
|
%
|
$
|
26,309,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
24,083,165
|
9.15
|
%
|
10,523,000
|
4.00
|
%
|
15,785,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
24,083,165
|
9.63
|
%
|
7,504,000
|
3.00
|
%
|
12,506,000
|
5.00
|
%
|
||||||
|
December
31, 2006
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
25,951,690
|
10.34
|
%
|
$
|
20,074,000
|
8.00
|
%
|
$
|
25,093,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
22,814,690
|
9.09
|
%
|
10,037,000
|
4.00
|
%
|
15,056,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
22,814,690
|
9.29
|
%
|
7,370,000
|
3.00
|
%
|
12,284,000
|
5.00
|
%
|
||||||
Bay
National Corporation’s actual capital amounts and ratios as of December 31, 2007
and 2006 are presented in the following tables:
|
December
31, 2007
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
31,230,256
|
11.87
|
%
|
$
|
21,054,000
|
8.00
|
%
|
$
|
26,317,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
27,728,115
|
10.54
|
%
|
10,527,000
|
4.00
|
%
|
15,790,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
27,728,115
|
11.09
|
%
|
7,504,000
|
3.00
|
%
|
12,506,000
|
5.00
|
%
|
||||||
82
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
|
December
31, 2006
|
|||||||||||||||
|
Actual
|
For
Capital
Adequacy
Purpose
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||
|
Total
Capital (to Risk Weighted Assets):
|
$
|
29,979,493
|
11.94
|
%
|
$
|
20,084,000
|
8.00
|
%
|
$
|
25,104,000
|
10.00
|
%
|
|||
|
Tier
I Capital (to Risk Weighted Assets):
|
26,337,366
|
10.49
|
%
|
10,042,000
|
4.00
|
%
|
15,063,000
|
6.00
|
%
|
||||||
|
Tier
I Capital (to Average Assets):
|
26,337,366
|
10.72
|
%
|
7,370,000
|
3.00
|
%
|
12,284,000
|
5.00
|
%
|
||||||
Banking
regulations also limit the amount of dividends that may be paid without prior
approval of the Bank's regulatory agencies. Regulatory approval is
required to pay dividends which exceed the Bank’s net profits for the current
year, plus its retained net profits for the preceding two years.
13.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The
Company discloses fair value information about financial instruments, for which
it is practicable to estimate the value, whether or not such financial
instruments are recognized on the balance sheet. Financial
instruments have been defined broadly to encompass 99.2% of the Company's assets
and 100% of its liabilities. Fair value is the amount at which a financial
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation, and is best evidenced by a quoted
market price, if one exists.
Quoted
market prices, where available, are shown as estimates of fair market values.
Because no quoted market prices are available for a significant part of the
Company's financial instruments, the fair values of such instruments have been
derived based on the amount and timing of future cash flows and estimated
discount rates.
Present
value techniques used in estimating the fair value of many of the Company's
financial instruments are significantly affected by the assumptions used. In
that regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in
immediate cash settlement of the instrument. Additionally, the accompanying
estimates of fair values are only representative of the fair values of the
individual financial assets and liabilities and should not be considered an
indication of the fair value of the Company.
83
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
The
estimated fair values of the Company's financial instruments at December 31 are
as follows:
|
2007
|
2006
|
|||||||||||
|
Estimated
|
Estimated
|
|||||||||||
|
Carrying
|
Fair
|
Carrying
|
Fair
|
|||||||||
|
Amount
|
Value
|
Amount
|
Value
|
|||||||||
|
Financial
Assets
|
||||||||||||
|
Cash
and temporary investments (1)
|
$
|
7,173,671
|
$
|
7,173,671
|
$
|
33,898,204
|
$
|
33,898,204
|
||||
|
Investments
available-for-sale
|
399,529
|
399,529
|
697,526
|
697,526
|
||||||||
|
Other
equity securities
|
1,715,000
|
1,715,000
|
1,117,100
|
1,117,100
|
||||||||
|
Bank
owned life insurance
|
5,041,662
|
5,041,662
|
-
|
-
|
||||||||
|
Loans,
net of allowances (2)
|
235,956,241
|
236,780,874
|
214,840,678
|
213,777,628
|
||||||||
|
Accrued
interest receivable and other assets (3)
|
4,092,538
|
4,092,538
|
1,654,381
|
1,654,381
|
||||||||
|
Financial
Liabilities
|
||||||||||||
|
Deposits
|
$
|
201,981,465
|
$
|
202,210,573
|
$
|
224,148,952
|
$
|
224,405,800
|
||||
|
Short-term
borrowings
|
25,371,508
|
25,371,508
|
1,545,000
|
1,545,000
|
||||||||
|
Subordinated
debt
|
8,000,000
|
7,258,433
|
8,000,000
|
7,993,481
|
||||||||
|
Accrued
interest payable and other liabilities (3)
|
1,262,334
|
1,262,334
|
811,755
|
811,755
|
||||||||
|
|
(1)
|
Temporary
investments include federal funds sold and overnight
investments.
|
|
|
(2)
|
Loans,
net of allowances, include loans held for
sale.
|
|
|
(3)
|
Only
financial instruments as defined in Statement of Financial Accounting
Standards No. 107, “Disclosure about Fair Value of Financial Instruments,”
are included in other assets and other
liabilities.
|
The
following methods and assumptions were used to estimate the fair value of each
category of financial instruments for which it is practicable to estimate that
value:
Cash and due from banks, federal
funds sold and overnight investments. The carrying amount approximated
the fair value.
Loans held for sale. The fair
value of residential mortgage loans held for sale was derived from secondary
market quotations for similar instruments.
Investment Securities. The
fair value for U.S. Treasury securities was based upon quoted market
bids.
Other equity securities. The
fair value of Federal Reserve Bank and Federal Home Loan Bank of Atlanta stock
is not readily determinable since these stocks are restricted as to
marketability.
Loans. The fair value was
estimated by computing the discounted value of estimated cash flows, adjusted
for potential credit losses, for pools of loans having similar characteristics.
The discount rate was based upon the current loan origination rate for a similar
loan. Non-performing loans have an assumed interest rate of 0%.
84
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial
Statements
For the years ended December 31, 2007, 2006, and
2005
Bank owned life
insurance. The carrying amount approximated the fair value due
to the variable interest rate.
Accrued interest receivable.
The carrying amount approximated the fair value of accrued interest, considering
the short-term nature of the receivable and its expected
collection.
Other assets. The carrying
amount approximated the fair value.
Deposit liabilities. The fair
value of demand, money market savings and regular savings deposits, which have
no stated maturity, were considered equal to their carrying amount, representing
the amount payable on demand. These estimated fair values do not
include the intangible value of core deposit relationships, which comprise a
significant portion of the Bank’s deposit base. Management believes
that the Bank’s core deposit relationships provide a relatively stable, low-cost
funding source that has a substantial intangible value separate from the value
of the deposit balances.
The fair
value of time deposits was based upon the discounted value of contractual cash
flows at current rates for deposits of similar remaining maturity.
Short-term borrowings. The
carrying amount approximated the fair value due to their variable interest
rates.
Subordinated Debt. Carrying values were
discounted using a cash flow approach based on market rates as of
December 31, 2007.
Other liabilities. The
carrying amount approximated the fair value of accrued interest payable, accrued
dividends and premiums payable, considering their short-term nature and expected
payment.
Off-balance sheet instruments.
The Company charges fees for commitments to extend credit. Interest rates on
loans, for which these commitments are extended, 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.
85
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
14.
PARENT COMPANY FINANCIAL INFORMATION
Condensed
financial information for Bay National Corporation (Parent Only) is as
follows:
CONDENSED BALANCE
SHEETS
December
31, 2007 and 2006
|
2007
|
2006
|
||||||||
|
ASSETS
|
|||||||||
|
Cash and cash
equivalents
|
$
|
5,714
|
$
|
5,450
|
|||||
|
Due
from subsidiary
|
3,807,670
|
4,019,503
|
|||||||
|
Investment in
subsidiary
|
24,331,166
|
23,062,691
|
|||||||
|
Other
assets
|
82,786
|
108,883
|
|||||||
|
Total Assets
|
$
|
28,227,336
|
$
|
27,196,527
|
|||||
|
LIABILITIES
|
|||||||||
|
Accrued expenses and other
liabilities
|
$
|
58,784
|
$
|
106,034
|
|||||
|
Subordinated
debt
|
8,248,000
|
8,248,000
|
|||||||
|
Total
Liabilities
|
8,306,784
|
8,354,034
|
|||||||
|
STOCKHOLDERS'
EQUITY
|
|||||||||
|
Common stock - $.01 par value,
authorized:
|
|||||||||
|
9,000,000 shares authorized,
2,137,633 and 1,935,369 issued and outstanding as of December 31, 2007 and
2006, respectively:
|
21,376
|
19,354
|
|||||||
|
Additional paid in
capital
|
17,788,833
|
17,649,678
|
|||||||
|
Retained
earnings
|
2,110,343
|
1,173,461
|
|||||||
|
Total Stockholders'
Equity
|
19,920,552
|
18,842,493
|
|||||||
|
Total Liabilities and
Stockholders' Equity
|
$
|
28,227,336
|
$
|
27,196,527
|
|||||
86
BAY
NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2007, 2006, and
2005
CONDENSED STATEMENTS OF
OPERATIONS
For the
years ended December 31, 2007, 2006 and 2005
|
2007
|
2006
|
2005
|
||||||||||
|
Interest
and dividends on investment securities
|
$ | 264 | $ | 238 | $ | 1,376 | ||||||
|
Interest
expense
|
602,096 | 603,567 | 119,817 | |||||||||
|
Net
interest expense
|
(601,832 | ) | (603,329 | ) | (118,441 | ) | ||||||
|
Non-interest
expense
|
75,274 | 162,966 | - | |||||||||
|
Loss
before income taxes and equity in undistributed losses of
subsidiary
|
(677,106 | ) | (766,295 | ) | (118,441 | ) | ||||||
|
Income
tax expense (benefit)
|
(576,000 | ) | - | (257,000 | ) | |||||||
|
Income
(loss) before equity in undistributed income (losses) of
subsidiary
|
(101,106 | ) | (766,295 | ) | 138,559 | |||||||
|
Equity
in undistributed income of subsidiary
|
1,038,475 | 3,196,123 | 2,605,771 | |||||||||
|
Net
Income
|
$ | 937,369 | $ | 2,429,828 | $ | 2,744,330 | ||||||
CONDENSED STATEMENTS OF CASH
FLOWS
For the
years ended December 31, 2007, 2006 and 2005
|
2007
|
2006
|
2005
|
||||||||||
|
Cash
Flows From Operating Activities
|
||||||||||||
|
Net Income
|
$ | 937,369 | $ | 2,429,828 | $ | 2,744,330 | ||||||
|
Adjustments to reconcile net
income to net cash
|
||||||||||||
|
(used) provided by operating
activities:
|
||||||||||||
|
Equity in undistributed income
of subsidiary
|
(1,038,475 | ) | (3,196,123 | ) | (2,605,771 | ) | ||||||
|
Stock
based compensation expense
|
122,539 | 115,714 | - | |||||||||
|
Net decrease (increase) in
other assets
|
237,930 | 1,438,739 | (5,429,625 | ) | ||||||||
|
Net (decrease) increase in
other liabilities
|
(47,250 | ) | 79,207 | 20,525 | ||||||||
|
Net cash provided by (used in)
operating activities
|
212,113 | 867,365 | (5,270,541 | ) | ||||||||
|
Cash
Flows From Investing Activities
|
||||||||||||
|
Investment in
subsidiary
|
(230,000 | ) | (950,000 | ) | (1,878,000 | ) | ||||||
|
Net cash used in investing
activities
|
(230,000 | ) | (950,000 | ) | (1,878,000 | ) | ||||||
|
Cash
Flows From Financing Activities
|
||||||||||||
|
Net
payoff of note payable
|
- | - | (1,250,000 | ) | ||||||||
|
Proceeds
from issuance of preferred stock
|
- | - | 8,248,000 | |||||||||
|
Net proceeds from issuance of
common stock
|
18,638 | 82,873 | 50,984 | |||||||||
|
Cash
dividends paid in lieu of fractional shares
|
(487 | ) | - | - | ||||||||
|
Net cash provided by financing
activities
|
18,151 | 82,873 | 7,048,984 | |||||||||
|
Net
increase (decrease) in cash and cash equivalents
|
264 | 238 | (99,557 | ) | ||||||||
|
Cash
and cash equivalents at beginning of year
|
5,450 | 5,212 | 104,769 | |||||||||
|
Cash
and cash equivalents at end of year
|
$ | 5,714 | $ | 5,450 | $ | 5,212 | ||||||
87
Item
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There has
been no occurrence requiring a response to this Item.
Item
9A. Controls and Procedures
As of the
end of the period covered by this annual report on Form 10-K, Bay National
Corporation’s Chief Executive Officer and Chief Financial Officer evaluated the
effectiveness of Bay National Corporation’s disclosure controls and
procedures. Based upon that evaluation, Bay National Corporation’s
Chief Executive Officer and Chief Financial Officer concluded that Bay National
Corporation’s disclosure controls and procedures are effective as of December
31, 2007. Disclosure controls and procedures are controls and other
procedures that are designed to ensure that information required to be disclosed
by Bay National Corporation in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission’s rules and
forms.
In
addition, there were no changes in Bay National Corporation’s internal control
over financial reporting (as defined in Rule 13a-15 under the Exchange Act)
during the quarter ended December 31, 2007, that have materially affected, or
are reasonably likely to materially affect, Bay National Corporation’s internal
control over financial reporting.
88
Item
9B. Other Information
On
January 22, 2008, the Compensation Committee of the Board of Directors of Bay
National Bank increased, effective January 1, 2008, Hugh Mohler’s annual base
compensation from $240,000 to $255,000, Richard Oppitz’s annual base
compensation from $154,000 to $175,000, and Mark Semanie’s annual base
compensation from $185,000 to $200,000.
89
PART
III
Item
10. Directors, Executive Officers and Corporate
Governance
Code
of Ethics
Bay
National Corporation’s Board of Directors has adopted a code of conduct that
applies to all of its directors, officers and employees, including it principal
executive officer, principal financial officer, principal accounting officer or
controller and persons performing similar functions. That Code of Conduct is
posted on Bay National Bank’s internet website at
www.baynational.com.
The
remaining information required by this Item 10 is incorporated by reference
to the information appearing under the captions “Proposal 1. Election of
Director,” “Board Meetings and Committees” and “Section 16(a) Beneficial
Ownership Reporting Compliance” in the Proxy Statement for the 2008 Annual
Meeting of Stockholders of Bay National Corporation.
Item
11. Executive Compensation
The
information required by this Item 11 is incorporated by reference to the
information appearing under the captions “Director Compensation” and “Executive
Compensation” in the Proxy Statement for the 2008 Annual Meeting of Stockholders
of Bay National Corporation.
90
Item
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
Securities
Authorized For Issuance Under Equity Compensation Plans
The
following table sets forth certain information as of December 31, 2007,
with respect to compensation plans under which equity securities of Bay National
Corporation are authorized for issuance.
|
Equity
Compensation Plan Information
|
|||||||||
|
Plan
category
|
Number
of securities to be issued(1)
(a)
|
Weighted-average
exercise price of outstanding options and warrants(2)
(b)
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a)
(c)
|
||||||
|
Equity
compensation plans approved by security holders
|
162,741
|
$6.99
|
229,750
|
||||||
|
Equity
compensation plans not approved by security holders
|
-
|
-
|
-
|
||||||
|
Total
|
162,741
|
$6.99
|
229,750
|
||||||
|
(1)
|
Includes
unvested restricted stock units
|
|
(2)
|
Excludes
unvested restricted stock units
|
The
remaining information required by this Item 12 is incorporated by reference
to the information appearing under the caption “Security Ownership of Management
and Certain Securityholders” in the Proxy Statement for the 2008 Annual Meeting
of Stockholders of Bay National Corporation.
Item
13. Certain Relationships and Related Transactions, and Director
Independence
The
information required by this Item 13 is incorporated by reference to the
information appearing under the captions “Proposal 1. Election of
Directors” and “Certain Relationships and Related Transactions” in the Proxy
Statement for the 2008 Annual Meeting of Stockholders of Bay National
Corporation.
Item
14. Principal Accountant Fees and Services.
The
information required by this Item 14 is incorporated by reference to the
information appearing under the captions “Audit Committee Report – Audit and
Non-Audit Fees” and “Audit Committee Report – Policy on Audit Committee
Pre-Approval of Audit and Non-Audit Services of Independent Registered Public
Accounting Firm” in the Proxy Statement for the 2008 Annual Meeting of
Stockholders of Bay National Corporation.
91
Item
15. Exhibits
The
following exhibits are filed with or incorporated by reference into this
report.
|
No.
|
Description
of Exhibit
|
|
3.1*
|
Articles
of Incorporation of Bay National Corporation
|
|
3.2%
|
Amended
and Restated Bylaws of Bay National Corporation
|
|
4.1*
|
Rights
of Holders of Common Stock (as contained in Exhibit
3.1)
|
|
4.2*
|
Form
of Common Stock Certificate
|
|
4.3@
|
Indenture
dated as of December 12, 2005 between Bay National Corporation and
Wilmington Trust Company, as Trustee.
|
|
4.4@
|
Amended
and Restated Declaration of Trust dated as of December 12, 2005 between
Wilmington Trust Company, as the Trustees of Bay National Capital Trust I,
Bay National Corporation, as Sponsor, and Hugh W. Mohler, Mark A. Semanie
and Warren F. Boutilier, as the Administrators.
|
|
4.5@
|
Guarantee
Agreement dated as of December 12, 2005 between Bay National Corporation
and Wilmington Trust Company.
|
|
10.1+
|
Amended
and Restated Employment Agreement, dated as of June 1, 2006, between Bay
National Bank and Hugh W. Mohler.
|
|
10.1.1
|
Terms
of December 2008 Amendment to Employment Agreement between Bay National
Bank and Hugh W. Mohler.
|
|
10.2+
|
Employment
Agreement, dated as of June 1, 2006, between Bay National Bank and Richard
C. Springer.
|
|
10.3
|
Terms
of Employment Arrangement between Bay National Bank and Richard J.
Oppitz
|
|
10.4
|
Terms
of Employment Arrangement between Bay National Bank and Mark A.
Semanie
|
|
10.5**
|
Bay
National Corporation Stock Option Plan
|
|
10.6**
|
Form
of Incentive Stock Option Agreement for Stock Option
Plan
|
|
10.7#
|
Bay
National Corporation and Bay National Bank Director Compensation
Policy
|
|
10.8*
|
Office
Lease Agreement dated July 16, 1999 between Bay National Corporation and
Joppa Green II Limited Partnership
|
|
10.9*
|
Office
Lease Agreement dated July 16, 1999 between Bay National Corporation and
Joppa Green II Limited Partnership
|
|
10.10##
|
Amendment
to Lease Agreement dated February 12, 2004 between Bay National
Corporation and Joppa Green II Limited Partnership
|
|
10.11##
|
Amendment
to Lease Agreement dated October 5, 2004 between Bay National Corporation
and Joppa Green II Limited Partnership
|
|
10.12##
|
Amendment
to Lease Agreement dated January 3, 2005 between Bay National Corporation
and Joppa Green II Limited Partnership
|
|
10.13##
|
Amendment
to Lease Agreement dated March 7, 2005 between Bay National Corporation
and Joppa Green II Limited Partnership
|
|
10.14*
|
Lease
Agreement dated September 16, 1999 between Bay National Corporation and
John R. Lerch and Thomas C. Thompson
|
|
10.15@@
|
Lease
Agreement dated July 19, 2006 between Bay National Bank and Riderwood
Limited Partnership
|
|
10.16^
|
Lease
Agreement dated October 3, 2007 between Bay National Corporation and
Columbia 100, LLC
|
|
10.17++
|
Bay
National Corporation 2007 Stock Incentive Plan and Forms of
Agreement
|
92
|
10.18^^
|
Confidential
Separation Agreement and General Release by and between Bay National Bank
and Richard C. Springer, dated July 3, 2007
|
|
21.1
|
|
|
23.1
|
|
|
31.1
|
|
|
31.2
|
|
|
32
|
The
exhibits which are denominated with an asterisk (*) were previously filed by Bay
National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Registration Statement on Form SB-2, as
amended, under the Securities Act of 1933, Registration Number
333-87781.
The
exhibit which is denominated with a percentage sign (%) was previously filed by
Bay National Corporation as a part of, and is hereby incorporated by reference
from, Bay National Corporation’s Current Report on Form 8-K filed on September
26, 2007.
The
exhibits which are denominated with an @ sign were previously filed by Bay
National Corporation as part of, and are hereby incorporated by reference from,
Bay National Corporation’s Annual Report on Form 10-K for the year ended
December 31, 2005, filed with the Commission on March 30, 2006.
The
exhibits which are denominated by the plus sign (+) were previously filed by Bay
National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Current Report on Form 8-K filed on June 6,
2006.
The
exhibits which are denominated by two asterisks (**) were previously filed by
Bay National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Registration Statement on Form S-8, as amended,
under the Securities Act of 1933, Registration Number 333-69428.
The
exhibit which is denominated by the number sign (#) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Current Report on Form 8-K filed on January 26,
2005.
The
exhibits which are denominated by two number signs (##) were previously filed by
Bay National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Current Report on Form 8-K filed on March 11,
2005.
The
exhibit which is denominated by two @ signs (@@) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2006, filed on August 14, 2006.
The
exhibit which is denominated by a carrot sign (^) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Current Report on Form 8-K filed on October 9,
2007.
93
The
exhibit which is denominated by two plus signs (++) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Registration Statement on Form S-8 under the
Securities Act of 1933, Registration Number 333-143544.
The
exhibit which is denominated by two carrot signs (^^) was previously filed by
Bay National Corporation as a part of, and is hereby incorporated by reference
from, Bay National Corporation’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2007, filed on August 14, 2007.
Note:
Exhibits 10.1 through 10.7 and 10.17 through 10.18 relate to management
contracts or compensatory plans or arrangements.
94
SIGNATURES
In accordance with Section 13 or 15(d)
of the Securities Exchange Act of 1934, the registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
|
|
BAY
NATIONAL CORPORATION
|
||
| Date: March 25, 2008 | By: /s/ Hugh W. Mohler | Hugh W. Mohler, President | |
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
|
Name
|
Position
|
Date
|
|
/s/ Hugh W.
Mohler
Hugh
W. Mohler
|
Director
and President (Principal Executive Officer)
|
March
25, 2008
|
|
/s/ Mark A. Semanie
Mark
A. Semanie
|
Executive
Vice President and CFO
(Principal
Accounting and Financial Officer)
|
March
25, 2008
|
|
Gary
T. Gill
|
Director
|
|
|
/s/ R. Michael Gill
R.
Michael Gill
|
Director
|
March
25, 2008
|
|
/s/ John R. Lerch
John
R. Lerch
|
Director
|
March
20, 2008
|
|
/s/ Donald G. McClure,
Jr.
Donald
G. McClure, Jr.
|
Director
|
March 27,
2008
|
|
/s/ Robert L. Moore
Robert
L. Moore
|
Director
|
March
26, 2008
|
|
/s/ James P. O’Conor
James
P. O’Conor
|
Director
|
March
25, 2008
|
|
H.
Victor Rieger, Jr.
|
Director
|
|
|
/s/ William B. Rinnier
William
B. Rinnier
|
Director
|
March
25, 2008
|
95
|
/s/ Edwin A. Rommel
Edwin
A. Rommel, III
|
Director
|
March
25, 2008
|
|
/s/ Henry H. Stansbury
Henry
H. Stansbury
|
Director
|
March
25, 2008
|
|
/s/ Kenneth H. Trout
Kenneth
H. Trout
|
Director
|
March
25, 2008
|
|
/s/ Eugene M. Waldron, Jr.
Eugene
M. Waldron, Jr.
|
Director
|
March
25, 2008
|
|
/s/ Carl A. J. Wright
Carl
A.J. Wright
|
Director
|
March 25,
2008
|
96
EXHIBIT INDEX
|
No.
|
Description
of Exhibit
|
|
3.1*
|
Articles
of Incorporation of Bay National Corporation
|
|
3.2%
|
Amended
and Restated Bylaws of Bay National Corporation
|
|
4.1*
|
Rights
of Holders of Common Stock (as contained in Exhibit
3.1)
|
|
4.2*
|
Form
of Common Stock Certificate
|
|
4.3@
|
Indenture
dated as of December 12, 2005 between Bay National Corporation and
Wilmington Trust Company, as Trustee.
|
|
4.4@
|
Amended
and Restated Declaration of Trust dated as of December 12, 2005 between
Wilmington Trust Company, as the Trustees of Bay National Capital Trust I,
Bay National Corporation, as Sponsor, and Hugh W. Mohler, Mark A. Semanie
and Warren F. Boutilier, as the Administrators.
|
|
4.5@
|
Guarantee
Agreement dated as of December 12, 2005 between Bay National Corporation
and Wilmington Trust Company.
|
|
10.1+
|
Amended
and Restated Employment Agreement, dated as of June 1, 2006, between Bay
National Bank and Hugh W. Mohler.
|
|
10.1.1
|
|
|
10.2+
|
Employment
Agreement, dated as of June 1, 2006, between Bay National Bank and Richard
C. Springer.
|
|
10.3
|
|
|
10.4
|
|
|
10.5**
|
Bay
National Corporation Stock Option Plan
|
|
10.6**
|
Form
of Incentive Stock Option Agreement for Stock Option
Plan
|
|
10.7#
|
Bay
National Corporation and Bay National Bank Director Compensation
Policy
|
|
10.8*
|
Office
Lease Agreement dated July 16, 1999 between Bay National Corporation and
Joppa Green II Limited Partnership
|
|
10.9*
|
Office
Lease Agreement dated July 16, 1999 between Bay National Corporation and
Joppa Green II Limited Partnership
|
|
10.10##
|
Amendment
to Lease Agreement dated February 12, 2004 between Bay National
Corporation and Joppa Green II Limited Partnership
|
|
10.11##
|
Amendment
to Lease Agreement dated October 5, 2004 between Bay National Corporation
and Joppa Green II Limited Partnership
|
|
10.12##
|
Amendment
to Lease Agreement dated January 3, 2005 between Bay National Corporation
and Joppa Green II Limited Partnership
|
|
10.13##
|
Amendment
to Lease Agreement dated March 7, 2005 between Bay National Corporation
and Joppa Green II Limited Partnership
|
|
10.14*
|
Lease
Agreement dated September 16, 1999 between Bay National Corporation and
John R. Lerch and Thomas C. Thompson
|
|
10.15@@
|
Lease
Agreement dated July 19, 2006 between Bay National Bank and Riderwood
Limited Partnership
|
|
10.16^
|
Lease
Agreement dated October 3, 2007 between Bay National Corporation and
Columbia 100, LLC
|
|
10.17++
|
Bay
National Corporation 2007 Stock Incentive Plan and Forms of
Agreement
|
|
10.18^^
|
Confidential
Separation Agreement and General Release by and between Bay National Bank
and Richard C. Springer, dated July 3, 2007
|
|
21.1
|
|
|
23.1
|
97
|
31.1
|
|
|
31.2
|
|
|
32
|
The
exhibits which are denominated with an asterisk (*) were previously filed by Bay
National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Registration Statement on Form SB-2, as
amended, under the Securities Act of 1933, Registration Number
333-87781.
The
exhibit which is denominated with a percentage sign (%) was previously filed by
Bay National Corporation as a part of, and is hereby incorporated by reference
from, Bay National Corporation’s Current Report on Form 8-K filed on September
26, 2007.
The
exhibits which are denominated with an @ sign were previously filed by Bay
National Corporation as part of, and are hereby incorporated by reference from,
Bay National Corporation’s Annual Report on Form 10-K for the year ended
December 31, 2005, filed with the Commission on March 30, 2006.
The
exhibits which are denominated by the plus sign (+) were previously filed by Bay
National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Current Report on Form 8-K filed on June 6,
2006.
The
exhibits which are denominated by two asterisks (**) were previously filed by
Bay National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Registration Statement on Form S-8, as amended,
under the Securities Act of 1933, Registration Number 333-69428.
The
exhibit which is denominated by the number sign (#) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Current Report on Form 8-K filed on January 26,
2005.
The
exhibits which are denominated by two number signs (##) were previously filed by
Bay National Corporation as a part of, and are hereby incorporated by reference
from, Bay National Corporation’s Current Report on Form 8-K filed on March 11,
2005.
The
exhibit which is denominated by two @ signs (@@) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2006, filed on August 14, 2006.
The
exhibit which is denominated by a carrot sign (^) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Current Report on Form 8-K filed on October 9,
2007.
The
exhibit which is denominated by two plus signs (++) was previously filed by Bay
National Corporation as a part of, and is hereby incorporated by reference from,
Bay National Corporation’s Registration Statement on Form S-8 under the
Securities Act of 1933, Registration Number 333-143544.
The
exhibit which is denominated by two carrot signs (^^) was previously filed by
Bay National Corporation as a part of, and is hereby incorporated by reference
from, Bay National Corporation’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2007, filed on August 14, 2007.
Note:
Exhibits 10.1 through 10.7 and 10.17 through 10.18 relate to management
contracts or compensatory plans or arrangements.
98