UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004.
Commission file number: 333-87781
Bay National Corporation
(Exact name of small business issuer as specified in its charter)
Maryland 52-2176710
------------------------------------ ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2328 West Joppa Road, Lutherville, MD 21093
-------------------------------------------
Address of principal executive offices
(410) 494-2580
-----------------------------------
Issuer's telephone number
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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
---------- ---------
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:
At August 13, 2004, the issuer had 1,866,460 shares of Common Stock
outstanding.
Transitional Small Business Disclosure Format (Check One): Yes ____ No X__
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
BAY NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
As of June 30, 2004 and December 31, 2003
June 30, December 31,
2004 2003
------------- -------------
ASSETS (Unaudited)
Cash and due from banks $ 328,397 $ 573,124
Federal funds sold and other overnight investments 6,737,768 17,486,981
Loans held for sale 15,682,918 923,825
Investment securities available for sale (AFS) - at fair value 1,547,355 1,547,798
Other equity securities 532,290 481,090
Loans, net of unearned fees 117,922,938 101,391,975
Less: Allowance for credit losses (1,474,000) (1,266,500)
------------- -------------
Loans, net 116,448,938 100,125,475
Premises and equipment, net 651,270 637,612
Accrued interest receivable and other assets 790,466 552,351
------------- -------------
Total Assets $ 142,719,402 $ 122,328,256
============= =============
LIABILITIES
Non-interest-bearing deposits $ 16,833,405 $ 14,277,909
Interest-bearing deposits 111,553,022 94,252,992
------------- -------------
Total deposits 128,386,427 108,530,901
Short-term borrowings 1,550,000 1,222,000
Accrued expenses and other liabilities 482,092 508,855
------------- -------------
Total Liabilities 130,418,519 110,261,756
------------- -------------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, authorized: 9,000,000 shares authorized,
1,862,710 issued and outstanding as of June 30, 2004 and December 31,
2003, respectively: 18,627 18,627
Surplus 16,850,834 16,850,834
Accumulated deficit (4,568,578) (4,802,961)
------------- -------------
Total Stockholders' Equity 12,300,883 12,066,500
------------- -------------
Total Liabilities and Stockholders' Equity $ 142,719,402 $ 122,328,256
------------- -------------
See accompanying notes to consolidated financial statements.
2
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
----------------------------------------------------------------
For the three and six-month periods ended June 30, 2004 and 2003
(Unaudited)
Three Months Ending Six Months Ending
June 30 June 30
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------- ------------
INTEREST INCOME:
Interest and fees on loans $ 1,708,501 $ 1,358,185 $ 3,239,145 $ 2,502,510
Interest on federal funds sold and other
overnight investments 26,557 29,782 52,499 50,829
Taxable interest and dividends on investment
securities 14,890 13,947 19,785 17,907
------------ ------------ ------------- ------------
Total interest income 1,749,948 1,401,914 3,311,429 2,571,246
------------ ------------ ------------- ------------
INTEREST EXPENSE:
Interest on deposits 567,247 494,850 1,075,684 933,785
Interest on short-term borrowings 3,532 3,989 6,440 5,825
------------ ------------ ------------- ------------
Total interest expense 570,779 498,839 1,082,124 939,610
------------ ------------ ------------- ------------
Net interest income 1,179,169 903,075 2,229,305 1,631,636
Provision for credit losses 104,000 138,000 213,721 307,500
------------ ------------ ------------- ------------
Net interest income after provision for
credit losses 1,075,169 765,075 2,015,584 1,324,136
------------ ------------ ------------- ------------
NON-INTEREST INCOME:
Service charges on deposit accounts 57,123 50,186 111,578 90,752
Gain on sale of mortgage loans 74,172 136,537 131,121 218,516
Other income 12,201 8,509 26,124 17,676
------------ ------------ ------------- ------------
Total non-interest income 143,496 195,232 268,823 326,944
------------ ------------ ------------- ------------
NON-INTEREST EXPENSES:
Salaries and employee benefits 589,209 539,124 1,183,886 1,054,292
Occupancy expenses 73,194 66,349 143,015 127,364
Furniture and equipment expenses 68,467 53,431 122,570 98,558
Legal and professional fees 34,500 43,691 73,248 79,860
Data processing and other outside services 151,989 122,213 282,660 258,457
Advertising and marketing related expenses 41,476 83,820 84,974 121,344
Other expenses 86,523 76,368 159,671 142,295
------------ ------------ ------------- ------------
Total non-interest expenses 1,045,358 984,996 2,050,024 1,882,170
------------ ------------ ------------- ------------
Income (loss) before income taxes 173,307 (24,689) 234,383 (231,090)
Income tax benefit - - -- --
------------ ------------ ------------- ------------
NET INCOME (LOSS) $ 173,307 $ (24,689) $ 234,383 $ (231,090)
============ ============ ============= ============
Per Share Data:
Cash Dividends Paid $ -- -- $ $ --
Net Income (Loss) (basic) $ .09 $ (.01) $ .13 $ (.16)
Net Income (Loss) (diluted) $ .09 $ (.01) $ .12 $ (.16)
Weighted Average shares outstanding (basic) 1,862,710 1,664,908 1,862,710 1,454,632
Effect of Dilution - Stock options and
Warrants 71,040 - 62,272 --
------------ ------------ ------------- ------------
Weighted Average shares outstanding (diluted) 1,933,750 1,664,908 1,924,982 1,454,632
============ ============ ============= ============
See accompanying notes to consolidated financial statements.
3
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
For the six-months ended June 30, 2004 and 2003
(Unaudited)
Additional
Paid in Accumulated
Common Stock Capital Deficit Total
------------- -------------- ----------------- -------------
Balances at December 31, 2003 $ 18,627 $ 16,850,834 $ (4,802,961) $ 12,066,500
Net Income - - 234,383 234,383
------------- -------------- --------------- -------------
Balances at June 30, 2004 $ 18,627 $ 16,850,834 $ (4,568,578) $ 12,300,883
============= ============== =============== =============
Additional
Paid in Accumulated
Common Stock Capital Deficit Total
------------- -------------- --------------- -------------
Balances at December 31, 2002 $ 12,420 $ 12,407,780 $ (4,810,542) $ 7,609,658
Issuance of Common Stock 6,207 4,443,054 - 4,449,261
Net Loss - - (231,090) (231,090)
------------- -------------- --------------- -------------
Balances at June 30, 2003 $ 18,627 $ 16,850,834 $ (5,041,632) $ 11,827,829
============= ============== =============== =============
See accompanying notes to consolidated financial statements.
4
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
For the six-months ended June 30, 2004 and 2003
(Unaudited)
2004 2003
------------- -------------
Cash Flows From Operating Activities
Net income (loss) $ 234,383 $ (231,090)
Adjustments to reconcile net income (loss) to net cash provided (used)
by operating activities:
Depreciation 94,683 89,422
Accretion of investment discounts (7,192) (7,154)
Provision for credit losses 213,721 307,500
Gain on sale of loans held for sale (131,121) (218,516)
Origination of loans held for sale (48,737,479) (20,852,051)
Proceeds from sale of loans 34,109,507 21,983,967
Net increase in accrued interest receivable and other assets (238,115) (69,469)
Net decrease in accrued expenses and other liabilities (26,763) (240,968)
------------- -------------
Net cash (used) provided by operating activities (14,488,376) 761,641
------------- -------------
Cash Flows From Investing Activities
Purchases of investment securities - AFS (2,992,365) (2,992,100)
Maturities of investment securities - AFS 3,000,000 2,400,000
Purchase of Federal Home Loan Bank of Atlanta stock (51,200) (88,500)
Loan disbursements in excess of principal payments (16,537,184) (20,017,574)
Capital expenditures (108,341) (65,619)
------------- -------------
Net cash used by investing activities (16,689,090) (20,763,793)
------------- -------------
Cash Flows From Financing Activities
Net increase in deposits 19,855,526 33,581,543
Net increase in short-term borrowings 328,000 1,007,000
Net proceeds from stock issuance - 4,449,261
------------- -------------
Net cash provided by financing activities 20,183,526 39,037,804
------------- -------------
Net (decrease) increase in cash and cash equivalents (10,993,940) 19,035,652
Cash and cash equivalents at beginning of period 18,060,105 12,115,736
------------- -------------
Cash and cash equivalents at end of period $ 7,066,165 $ 31,151,388
============= =============
Cash paid for:
Interest $ 1,054,894 $ 921,371
Income taxes $ -- $ --
See accompanying notes to consolidated financial statements.
5
BAY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
Organization
Bay National Corporation (the "Company") was incorporated on June 3,
1999 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 "Bank"). On May
12, 2000, the Company purchased all the shares of common stock issued by the
Bank. The Bank commenced operations on May 12, 2000 after successfully meeting
the conditions of the Office of the Comptroller of the Currency (the "OCC") to
receive its charter authorizing it to commence operations as a national bank,
and obtaining the approval of the Federal Deposit Insurance Corporation to
insure its deposit accounts, and meeting certain other regulatory requirements.
Basis of Presentation
The accompanying consolidated financial statements include the activity
of Bay National Corporation and its wholly owned subsidiary, Bay National Bank.
All significant intercompany transactions and balances have been eliminated in
consolidation.
The foregoing consolidated financial statements are unaudited; however,
in the opinion of management, all adjustments (comprising only normal recurring
accruals) necessary for a fair presentation of the results of the interim
periods have been included. The balances as of December 31, 2003 have been
derived from audited financial statements. These statements should be read in
conjunction with the financial statements and accompanying notes included in Bay
National Corporation's 2003 Annual Report on Form 10-KSB. There have been no
significant changes to the Company's Accounting Policies as disclosed in the
2003 Annual Report. The results shown in this interim report are not necessarily
indicative of results to be expected for the full year 2004.
The accounting and reporting policies of the Company conform to
accounting principles generally accepted in the United States of America.
Reclassifications
Certain reclassifications have been made to amounts previously reported
to conform to the current presentation. These reclassifications had no effect on
previously reported results of operations or accumulated deficit.
2. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the 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 financial statements. Under capital 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 weighting and other factors.
6
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios. Management
believes, as of June 30, 2004, that the Bank meets all capital adequacy
requirements to which it is subject.
As of June 30, 2004, 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.
3. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "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 that will be in effect when these differences reverse. Deferred
income taxes will be recognized when it is deemed more likely than not that the
benefits of such deferred income taxes will be realized; accordingly, no
deferred income taxes or income tax benefits have been recorded by the Company.
4. 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.
For the three and six month periods ended June 30, 2003, the effect
of incremental shares from options and warrants of 204,156 have been excluded
from diluted weighted average shares as the effect would have been antidilutive.
5. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123) and Statement of Financial Accounting Standards No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS
No. 148), and applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. No compensation
expenses related to the Company's stock option plan were recorded during the
three-month and six-month periods ended June 30, 2004 and 2003.
7
The following table illustrates the effect on net income (loss) and
earnings (loss) per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 and SFAS No. 148 to stock-based employee compensation
for the three-month and six-month periods ended June 30:
Three Months Ending Six Months Ending
June 30 June 30
----------------------------- --------------------------------
2004 2003 2004 2003
------------ ------------ ------------- ------------
INTEREST INCOME:
Net income (loss), as reported $ 173,307 $ (24,689) $ 234,383 $ (231,090)
Less pro forma stock-based compensation
expense determined under the fair value
method (56,063) (50,527) (71,672) (67,150)
------------ ------------ ------------- ------------
Pro forma net income (loss) $ 117,244 $ (75,216) $ 162,711 $ (298,240)
============ ============ ============= ============
Net income (loss) per share:
Basic - as reported $ .09 $ (.01) $ .13 $ (.16)
Diluted - as reported $ .09 $ (.01) $ .12 $ (.16)
Basic - pro forma $ .06 $ (.05) $ .09 $ (.21)
Diluted - pro forma $ .06 $ (.05) $ .08 $ (.21)
8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This discussion and analysis provides an overview of the financial
condition and results of operations of Bay National Corporation (the "Parent")
and its national bank subsidiary, Bay National Bank (the "Bank"), collectively
(the "Company"), as of June 30, 2004 and December 31, 2003 and for the
three-month and six-month periods ended June 30, 2004 and 2003.
General
On May 12, 2000 the Parent became a bank holding company by purchasing
all of the common stock of the Bank. The Bank opened its first office on May 12,
2000 and its second office on May 26, 2000.
The Bank was formed to serve the business communities of North
Baltimore and Salisbury, Maryland.
Overview
The Company continued a pattern of strong growth during the three-month
and six-month periods ended June 30, 2004. This growth has resulted in improved
operating results as compared to prior periods. Key measurements for the
three-month and six-month periods ended June 30, 2004 include the following:
o Total assets at June 30, 2004 increased by 16.67% to $142.7 million as
compared to $122.3 million as of December 31, 2003.
o Net loans outstanding increased by 16.30% from $100.1 million as of
December 31, 2003 to $116.4 million as of June 30, 2004.
o There were no nonperforming loans at June 30, 2004; however,
appropriate reserves for loan losses continue to be maintained.
o Deposits at June 30, 2004 were $128.4 million, an increase of $19.9
million or 18.29% from December 31, 2003.
o The Company realized net income of $173,307 and $234,383 for the
three-month and six-month periods ended June 30, 2004. This compares
to losses of $24,689 and $231,090 for the three-month and six-month
periods ended June 30, 2003.
o Net interest income, the Company's main source of income, was $1.2
million and $2.2 million during the three-month and six-month periods
ended June 30, 2004 compared to $903,075 and $1.6 million for the same
periods in 2003. This represents increases of 30.57% and 36.63% for
the three-months and six-months ended June 30, 2004 as compared to the
same periods in 2003.
o Loan charge-offs were $6,221 for the six-month period ended June 30,
2004. There were no charge-offs for the same period in 2003.
o Non-interest income declined by $51,736 and $58,121, or 26.50% and
17.78%, for the three-month and six-month periods ended June 30, 2004,
as compared to the three-month and six-month periods ended June 30,
2003.
9
o Non-interest expenses increased by $60,362 or 6.13%, and $167,854 or
8.92% for the three-month and six-month periods ended June 30, 2004,
as compared to the same periods ended June 30, 2003.
o The market price of common shares ended the quarter at $12.00, up
18.81% from the closing price of $10.10 on December 31, 2003.
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 $173,307 and $234,383 for the
three-month and six-month periods ended June 30, 2004. This compares to net
losses of $24,689 and $231,090 for the same periods in 2003. This is an
improvement of $197,996 for the three-month period and $465,473 for the
six-month period. This significant improvement in results for the periods is due
to the continued strong growth of the loan portfolio, which reached the levels
necessary to generate sufficient net interest income to cover operating
expenses. The losses incurred in the first half of 2003 were expected since loan
and deposit growth initially were not expected to produce net interest income
sufficient to cover operating expenses. On average, community banks do not
achieve profitability for the first 24 to 36 months of operation. The Company
achieved marginal monthly profitability for the month of June 2003, its 37th
full month of operations. This milestone was achieved during a very challenging
economic environment in which interest margins have been compressed by
historically low interest rates.
Bay National Bank's mortgage division, based in Salisbury, Maryland,
originates conventional first and second residential mortgage loans. Bay
National Bank sells most of its first and second 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 mortgage division has been a significant
contributor to operating results. For the three-month periods ended June 30,
2004 and 2003, gains on the sale of mortgage loans totaled $74,172 and $136,537,
respectively. For the six-month period ended June 30, 2004 and 2003, gains on
the sale of mortgage loans totaled $131,121 and $218,516, respectively. The
level of gains on the sale of mortgage loans has declined in 2004 due to the
strengthening of economic conditions and the resulting increase in long-term
interest rates as compared to the rates in effect during the first half of 2003.
An increase in rates traditionally has a negative impact on mortgage loan
production due to a reduction in the incentive for borrowers to refinance
existing mortgages or purchase new homes.
During the second quarter of 2004, the Company introduced a new loan
program for conventional first and second 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 that 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. The Company earns interest on these loans at a
rate indexed to the prime rate. The primary risk to the Company 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 declined to purchase the loan, the Company could
attempt to sell the
10
loan to other investors or could hold the loan in its loan portfolio. As of June
30, 2004 the Company held $14.7 million of these loans which were classified as
held for sale. The Company earned $70,633 of interest on this program for the
three-month period ended June 30, 2004.
Management expects continued improvement in operating results over the
remainder of 2004; however, actual results will be subject to the volatility of
the provision for credit losses, which is related to loan growth, and the
volatility of mortgage loan production, which is sensitive to economic and
interest rate fluctuations.
Net Interest Income
Net interest income is the difference between income on 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
short-term 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.
As previously stated, net interest income was $1.2 million and $2.2
million during the three-month and six-month periods ended June 30, 2004
compared to $903,075 and $1.6 million for the same periods in 2003. This
represents increases of 30.57% and 36.63% for the three-month and six-months
ended June 30, 2004 as compared to the same periods in 2003.
Interest income from loans and investments for the three-month and
six-month periods ended June 30, 2004 was $1,749,948 and $3,311,429,
respectively, compared to $1,401,914 and $2,571,246 for the three-month and
six-month periods ended June 30, 2003. The 24.83% and 28.79% increase over the
same periods in 2003 is directly related to the 34.36% increase in average
interest-earning assets for the six-months ended June 30, 2004 as compared to
the same period in 2003. The increase in average earning assets was somewhat
offset by declines in average yields due to a declining interest rate
environment. The yields on these assets declined from 5.27% for the six months
ended June 30, 2003 to 5.05% for the six months ended June 30, 2004.
The percentage of average interest-earning assets represented by loans
was 86.87% and 85.26% for the six-month periods ended June 30, 2004 and 2003,
respectively. Stability in the percentage of interest-earning assets represented
by the loan portfolio would normally be expected to result in stability in
average yields on interest-earning assets. However, loan yields have declined as
a result of actions taken by the Federal Reserve to reduce its target for the
federal funds rate from 1.25% at December 31, 2002 to 1.00% effective June 25,
2003. For the six-month period ended June 30, 2004, the average yield on the
loan portfolio decreased to 5.69% from 6.02% for the six-month period ended June
30, 2003. This decrease is primarily due to the difference in the target federal
funds rate in effect for the periods. The Federal Reserve increased its target
for the federal funds rate to 1.25% effective June 30, 2004 and then increased
the target to 1.50% effective August 10, 2004. These increases had no effect on
the Company's results for the three-month and six-month periods ended June 30,
2004.
The average yield on the investment portfolio, including overnight
investments, was .84% for the six-month period ended June 30, 2004 as compared
to .96% for the same period in 2003. The decline in the average yields was a
direct result of the Federal Reserve actions discussed above, which was somewhat
offset by an increase in the holdings of Federal Reserve and Federal Home Loan
bank stocks, which pay dividend yields that are higher than the prevailing
federal funds rates. The percentage of average interest-earning assets
represented by investments was 13.13% and 14.74% for the six-month periods ended
June 30, 2004 and 2003, respectively.
11
Interest expense from deposits and short-term borrowings for the
three-month and six-month periods ended June 30, 2004 was $570,779 and
$1,082,124, respectively. This compares to $498,839 and $939,610 for the
comparable periods in 2003. The 14.42% and 15.17% increases over the three and
six month periods in 2003 are a result of the 33.68% increase in average
interest-bearing liabilities for the six-month period ended June 30, 2004 as
compared to the same period in 2003. The increase in average interest-bearing
liabilities was significantly offset by declines in average rates paid due to
the declining interest rate environment. The average rates paid on these
liabilities declined from 2.41% for the six-month period ended June 30, 2003 to
2.08% for the six-month period ended June 30, 2004.
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.
Six Months Ended June 30, 2004
Average Interest Yield/
Balance and fees Rate
---------------- ------------ ------------
ASSETS
Loans $ 113,905,280 $ 3,239,145 5.69%
Investment Securities 1,991,440 19,785 1.99
Federal funds sold and other overnight investments 15,227,504 52,499 .69
---------------- ------------
Total Earning Assets 131,124,224 3,311,429 5.05%
------------
Less: Allowance for credit losses (1,354,026)
Cash and due from banks 804,855
Premises and equipment, net 654,798
Accrued interest receivable and other assets 518,384
----------------
Total Assets $ 131,748,235
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 42,164,785 218,923 1.04%
Regular savings deposits 3,700,434 11,984 .65
Time deposits 56,924,186 844,777 2.97
Short-term borrowings 1,340,357 6,440 .96
---------------- ------------
Total interest-bearing liabilities 104,129,762 1,082,124 2.08%
------------
Non-interest-bearing demand deposits 15,018,908
Accrued expenses and other liabilities 435,452
Stockholders' equity 12,164,113
----------------
Total Liabilities and Stockholders' Equity $ 131,748,235
================
Net interest income and spread $ 2,229,305 2.97%
============
Interest and fee income/earning assets 5.05 %
Interest expense/earning assets 1.65
----------------
Net interest margin 3.40 %
================
12
Six Months Ended June 30, 2003
Average Interest Yield/
Balance and fees Rate
---------------- ------------ ------------
ASSETS
Loans $ 83,200,358 $ 2,502,510 6.02%
Investment Securities 1,650,873 17,907 2.17
Federal funds sold and other overnight investments 12,738,004 50,829 .80
------------- ------------
Total Earning Assets 97,589,235 2,571,246 5.27%
------------
Less: Allowance for credit losses (983,751)
Cash and due from banks 824,963
Premises and equipment, net 699,558
Accrued interest receivable and other assets 416,012
-------------
Total Assets $ 98,546,017
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 30,479,387 189,404 1.24%
Regular savings deposits 2,406,317 8,819 .73
Time deposits 43,969,773 735,562 3.35
Short-term borrowings 1,039,536 5,825 1.12
------------- ------------
Total interest-bearing liabilities 77,895,013 939,610 2.41%
------------
Non-interest-bearing demand deposits 10,626,935
Accrued expenses and other liabilities 321,354
Stockholders' equity 9,702,715
-------------
Total Liabilities and Stockholders' Equity $ 98,546,017
=============
Net interest income and spread $ 1,631,636 2.86%
============
Interest and fee income/earning assets 5.27 %
Interest expense/earning assets 1.93
-------------
Net interest margin 3.34 %
=============
Provision for Credit Losses
The provision for credit losses was $104,000 and $213,721 for the
three-month and six-month periods ended June 30, 2004, as compared to $138,000
and $307,500 for the three-month and six-month periods ended June 30, 2003. The
provisions for each period were the direct result of growth in loan balances
outstanding in all segments of the portfolio. The provisions for the three-month
and six-month periods ended June 30, 2004 were lower than the same periods in
the prior year due to fact that gross loans outstanding increased by
approximately $16.5 million during the six months ended June 30, 2004 as
compared to an increase of approximately $20.0 million for the same period in
2003. The fluctuations are reflective of the high concentration of revolving
credit facilities in the loan portfolio and the unpredictable nature of customer
needs to draw on these facilities. 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
three-month period ended June 30, 2004, the Company realized non-interest income
in the amount of $143,496 as compared to $195,232 for the three-month period
ended June 30, 2003. Gains on the sale of mortgage loans of $74,172 comprise
51.69% of the total for the three-month period ended June 30, 2004. This
13
compares to gains on the sale of mortgage loans of $136,537, or 69.94% of total
non-interest income, for the three-month period ended June 30, 2003.
For the six-month period ended June 30, 2004, the Company realized
non-interest income in the amount of $268,823 as compared to $326,944 for the
six-month period ended June 30, 2003. Gains on the sale of mortgage loans of
$131,121 comprised 48.78% of the total for the six-month period ended June 30,
2004. This compares to gains on the sale of mortgage loans of $218,516, or
66.84% of total non-interest income, for the six-month period ended June 30,
2003.
The level of gains on the sale of mortgage loans has declined due to
recent increases in long-term interest rates driven by stronger economic
conditions. Additional increases in interest rates, or a slow down in the
housing market, could further impact the Company's ability to maintain the same
level of income associated with mortgage loan production.
Service charges on deposit accounts totaled $57,123 and $111,578 for
the three-month and six-month periods ended June 30, 2004, as compared to
$50,186 and $90,752 for the three-month and six-month periods ended June 30,
2003. The increases of 13.82% and 22.95% for the three and six-month periods as
compared to the same periods in 2003 can be directly attributed to the ongoing
growth in the Company's deposit portfolio.
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.
Non-Interest Expense
Non-interest expense for the three-month and six-month periods ended
June 30, 2004, totaled $1,045,358 and $2,050,024, respectively. This compares to
non-interest expense for the comparable periods in 2003 of $984,996 and
$1,882,170, respectively. The increase of $167,854, or 8.92%, for the six-month
period resulted from an increase in salaries and benefits of $129,594 related to
staffing growth to increase marketing efforts, manage the growth of the loan and
deposit portfolios, and support increased operational volume. Occupancy expenses
increased by $15,651, or 12.29%, for the six-months ended June 30, 2004 as
compared to the same period in 2003. This increase was due to scheduled rent
increases as well as a reduction in sublease income of approximately $3,500 due
to expansion of the Company's corporate office into previously sublet space and
$8,200 of rental expense associated with new space obtained to facilitate the
expansion of the Company's corporate offices. The $24,203, or 9.36%, increase in
data processing and other outside services for the six-months ended June 30,
2004 as compared to the same period in 2003 is the result of increased data and
item processing costs paid to external service providers. These costs are
volume-driven based upon the number of customer accounts and related transaction
volume. As a result, these costs increase with the growth of the Company. The
$36,370, or 29.97%, decrease in advertising and marketing-related expenses for
the six-months ended June 30, 2004 as compared to the same period in 2003 is
related to a reduction in the number of events and marketing campaigns
conducted. This reduction was made possible through the use of less costly
marketing methods and through the success of prior campaigns which increased the
visibility of the Bank in its markets. The increase of $34,776, or 10.84%, in
all other expenses relates to various costs associated with the increased size
and complexity of the Company.
Non-interest expense for the three-month period ended June 30, 2004
increased by $60,362, or 6.13%, as compared to the same period for the prior
year. The increase is directly attributable to the same factors that resulted in
the increase for the comparable six-month periods.
14
The rate of increase in non-interest expenses is substantially less than
the 33.69% increase in average assets for the six-month period ended June 30,
2004 as compared to average assets for the six-month period ended June 30, 2003.
Management believes this indicates that the Company is continuing to effectively
leverage its cost structure to generate profitable growth. While management
expects that the ongoing growth of the Company's customer base will continue to
require additional staffing in order to service customers and manage the
business properly, management believes that additional growth in the customer
base can continue to be accomplished without proportionate increases in these
costs.
Financial Condition
Composition of the Balance Sheet
As of June 30, 2004, total assets were $142,719,402. This represents
growth of $20,391,146 or 16.67% since December 31, 2003. The growth in total
assets included increases of $14,759,093 in loans held for sale, $51,200 in
other equity securities, $16,323,463 in loans net of the allowance for credit
losses and $251,773 in other non-earning assets. These increases were offset by
decreases of $244,727 in cash and due from banks, $10,749,213 in federal funds
sold and other overnight investments and $443 in investment securities available
for sale.
During the second quarter of 2004, the Company introduced a new loan
program for conventional first and second 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 that 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. The Company earns interest on these
loans at a rate indexed to the prime rate. As of June 30, 2004, the Company held
$14.7 million of these loans which were classified as held for sale.
As of June 30, 2004, loans, excluding loans held for sale (net of a
$1,474,000 allowance for credit losses), totaled $116,448,938. The increase of
16.30%, from a balance of $100,125,475 as of December 31, 2003, is a
continuation of the growth trend established in prior periods. The Company
continues 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.
The composition of the loan portfolio as of June 30, 2004 was
approximately $70.0 million of commercial loans, $3.9 million of consumer loans,
and $44.0 million of real estate loans (excluding mortgage loans held for sale).
The composition of the loan portfolio as of December 31, 2003 was approximately
$61.9 million of commercial loans, $1.7 million of consumer loans, and $37.8
million of real estate loans (excluding mortgage loans held for sale). There
were $15.7 million and $923,825 of mortgage loans held for sale as of June 30,
2004 and December 31, 2003, respectively.
Funds not extended in loans are invested in cash and due from banks,
federal funds sold and other overnight investments, and short-term U.S. Treasury
securities. At June 30, 2004, the Company had federal funds sold and other
overnight investments totaling $6,737,768 as compared to $17,486,981 as of
December 31, 2003. The decline in investments is related to the allocation of
liquid funds to the new first and second residential mortgage loan program
discussed above. These loans are highly liquid but provide a significantly
higher yield than federal funds sold and other overnight investments. Management
has made a decision to maintain an appropriate level of liquidity in the
investment portfolio in order to ensure that funds are readily available to fund
the growth of the loan portfolio and to meet the needs of deposit customers.
15
The Company held $312,690 of Federal Reserve Bank stock at June 30,
2004 and December 31, 2003, respectively. The Company also held Federal Home
Loan Bank of Atlanta stock of $219,600 and $168,400 as of June 30, 2004 and
December 31, 2003, respectively, and United States Treasury bills with a
maturity value of $1,550,000 as of both June 30, 2004 and December 31, 2003. The
Treasury securities are used to collateralize repurchase agreements which are
classified as short-term borrowings under which $1,550,000 and $1,222,000 were
outstanding as of June 30, 2004 and December 31, 2003, respectively. The growth
in assets was funded by deposit growth of $19,855,526, or 18.29%, and an
increase in short-term borrowings of $328,000.
Deposits at June 30, 2004 were $128,386,427, of which $7,414,461, or
5.78% are related to two customers in one industry. Deposits at December 31,
2003 were $108,530,901, of which deposits for these same customers stood at
$7,749,590 or 7.14% of total deposits. The deposits for these customers 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 deposit growth resulted from the continued marketing efforts
of officers and directors, direct mail campaigns and the listing of money market
and certificate of deposit rates in print publications and on the Internet.
Management has set the interest rates paid on deposits to be competitive in the
market and will continue its marketing activities to generate growth in
deposits.
The market in which the Company operates is very competitive;
therefore, 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 June 30, 2004,
the Company had outstanding certificates of deposit of approximately $30.1
million that were 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). These certificates of
deposit were issued with an average yield of 2.70% and an average term of 27.4
months. Included in the $30.1 million of Internet-originated certificates of
deposit is $593,374 that has been classified as "Brokered Deposits" for bank
regulatory purposes. These "Brokered Deposits" were issued in average amounts of
approximately $98,896 with an average yield of 3.79% and an average term of
33.05 months. As of December 31, 2003, the total certificates of deposit
obtained through the listing of certificate of deposit rates on the
Internet-based listing services were approximately $25 million, of which
$790,157 were classified as "Brokered Deposits." The Company has never paid
broker fees for deposits. Additionally, the Company has not accepted any new
"Brokered Deposits" since August 2002.
Core deposits, which management categorizes as all deposits other than
national market certificates of deposit and all but $2.0 million of deposits
from the two large customers described above (which management considers to be a
stable deposit amount from these customers based upon historical trends), stood
at $92,852,213 as of June 30, 2004, up 19.44% from $77,742,030 as of December
31, 2003. 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.
Short-term borrowings consist of 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 its short-term
borrowings. The outstanding balance of short-term borrowings increased from
$1,222,000 at December 31, 2003 to $1,550,000 at June 30, 2004, due to increases
in the balance of available funds of the customers participating in this
program.
16
Total stockholders' equity at June 30, 2004 was $12,300,883 as compared
to $12,066,500 at December 31, 2003. The increase in stockholders' equity is a
result of the positive operating results for the six months ended June 30, 2004.
Management believes that this level of capital is adequate to support expected
asset growth for at least the next 12 months.
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 Bay National Corporation's market area), regulatory
guidance, peer statistics, management's judgment, past due loans in the loan
portfolio and concentrations of risk (if any). The Company charges losses on
loans against the allowance when it is 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
upon 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 adjusting
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 June 30, 2004 and December 31,
2003 was $1,474,000 and $1,266,500, respectively. The amount equates to 1.25% of
outstanding loans, net of loans held for sale, as of June 30, 2004 and December
31, 2003. This percentage has remained consistent because no additional
information has indicated that the overall level of reserves is inappropriate.
Bay National Corporation has no exposure to foreign countries or foreign
17
borrowers. Management believes that the allowance for credit losses is adequate
for each period presented.
As of June 30, 2004 the Company had no loans that were more than 90
days past due. The Company has no loans that are classified as non-accrual loans
as of June 30, 2004. The Company had loan charge-offs of $6,221 during the
six-months ended June 30, 2004 with no charge-offs occurring during the
three-months ended June 30, 2004. These charge-offs were the first losses
incurred since the Company's inception in 2000.
Liquidity and Interest Rate Sensitivity
The Company's principal sources of liquidity are cash and assets that
can be readily converted into cash, including investment securities, and loans
held for sale which can be liquidated in a timeframe which is usually less than
30 days. The Company also has commitments for a total of $4.0 million of
borrowing availability under unsecured Federal funds lines of credit with two
separate financial institutions, and approximately $9.0 million of borrowing
capacity with the Federal Home Loan Bank of Atlanta. The credit facilities can
be used in conjunction with the normal deposit strategies, which include pricing
changes to increase deposits as necessary.
As of June 30, 2004, the Company had $328,397 in cash and due from
banks, and $6,737,768 in federal funds sold and other overnight investments.
This represents a decrease in liquid assets of $10,993,940, or 60.87%, since
December 31, 2003, at which time liquid assets consisted of $573,124 in cash and
due from banks, and $17,486,981 in federal funds sold and other overnight
investments. The decrease in the overall level of liquid assets is the result of
the funding of the previously discussed loan program for conventional first and
second residential mortgage loans, and the availability of the previously
discussed borrowing facilities which have allowed management to carry lower
levels of cash and overnight investments.
The Company has sufficient liquidity to meet its loan commitments as
well as fluctuations in deposits. The Company will choose to retain maturing
certificates of deposit, when necessary, by offering competitive rates.
Management is not aware of any demands, trends, commitments, or events that
would result in the Company's inability to meet anticipated or unexpected
liquidity needs.
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
subject to interest rate pricing within a given time period, including both
floating rate or adjustable rate instruments and instruments which are
approaching maturity.
18
The following table sets forth the amount of the Company's
interest-earning assets and interest-bearing liabilities as of June 30, 2004,
which are expected to mature or reprice in each of the time periods shown:
Maturity or repricing within
Percent 0 to 3 4 to 12 1 to 5 Over 5
Amount of Total Months Months Years Years
------ -------- ------ ------ ----- -----
Interest-earning assets
Federal funds sold and other
overnight investments $ 6,737,768 4.73% $ 6,737,768 $ - $ - $ -
Loans held for sale 15,682,918 11.01 15,682,918
Loans - Variable rate 82,567,589 57.97 82,567,589 - - -
Loans - Fixed rate 35,355,349 24.83 2,819,666 6,752,018 24,570,004 1,213,661
Other earning assets 2,079,645 1.46 1,547,355 - - 532,290
----------- ----------- ----------- ----------- ----------- ----------
Total interest-earning
assets $142,423,269 100.00% $109,355,296 $ 6,752,018 $24,570,004 $1,745,951
============ =========== =========== =========== =========== ==========
Interest-bearing liabilities
Deposits - Variable rate $50,969,488 45.06% $50,969,488 $ - $ - $ -
Deposits - Fixed rate 60,583,534 53.57 8,572,330 25,025,621 26,985,583 -
Short-term borrowings -
Variable rate 1,550,000 1.37 1,550,000 - - -
------------ ----------- ----------- ----------- ----------- ----------
Total interest-bearing
liabilities $113,103,022 100.00% $61,091,818 $25,025,621 $26,985,583 $ -
============ =========== =========== =========== =========== ==========
Periodic repricing differences
Periodic gap $48,263,478 $(18,273,603) $(2,415,579) $1,745,951
=========== =========== =========== ==========
Cumulative gap $48,263,478 $ 29,989,875 $27,574,296 $29,320,247
=========== =========== =========== ==========
Ratio of rate sensitive assets
to rate sensitive liabilities 179.00% 26.98% 91.05% N/A
The Company has 73.71% of its interest-earning assets and 46.43% of its
interest-bearing liabilities in variable rate balances. Interest-earning assets
exceed interest-bearing liabilities by $29,320,247. The majority of this gap is
concentrated in items maturing or repricing within 12 months. This gap is
generally reflective of the Company's emphasis on 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 increasing
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 for the
interest rate risk. The Company's current investment concentration in federal
funds sold and other overnight
19
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.
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.
Outstanding loan commitments and lines and letters of credit as of June
30, 2004 and December 31, 2003 are as follows:
June 30 December 31
2004 2003
------------- -------------
Loan commitments $ 7,031,595 $ 11,458,333
Unused lines of credit 39,874,839 32,234,145
Letters of credit 2,038,001 2,167,501
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 is
evaluated on a case-by-case basis.
The increase in the overall level of loan commitments and unused lines
of credit as of June 30, 2004 as compared to loan commitments and unused lines
of credit as of December 31, 2003, is a direct result of the same marketing
activities that resulted in the 16.30% increase in outstanding loans.
20
Capital Resources
The Company had stockholders' equity at June 30, 2004 of $12,300,883 as
compared to $12,066,500 at December 31, 2003. The increase in capital is a
result of the positive operating results for the six-month period ended June 30,
2004. 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
not have paid dividends to the Company without approval from bank regulatory
agencies at June 30, 2004.
Reconciliation of Non-GAAP Measures
Below is a reconciliation of total deposits to core deposits as of June
30, 2004 and December 31, 2003, respectively:
June 30 December 31
2004 2003
------------- --------------
Total deposits $ 128,386,427 $ 108,530,901
National market certificates of deposit (30,119,753) (25,039,281)
Variable balance accounts (2 customers) (5,414,461) (5,749,590)
------------- --------------
Core deposits $ 92,852,213 $ 77,742,030
============= ==============
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.
Based on the valuation techniques used and the sensitivity of financial
statement amounts
21
to the methods, assumptions and estimates underlying those amounts, management
has identified the determination of the allowance for credit losses as the
accounting area that requires the most subjective or complex judgments, and as
such could be most subject to revision as new information becomes available.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses. 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 "Allowance for Credit Losses and Credit Risk Management" section
of this financial review.
Item 3. Controls and Procedures
As of the end of the period covered by this quarterly report on Form
10-QSB, 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. 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 Securities Exchange Act of 1934,
as amended, 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 controls over financial reporting (as defined in Rule 13a-15 or Rule
15d-15 under the Securities Act of 1934, as amended) during the quarter ended
June 30, 2004, that have materially affected, or are reasonably likely to
materially affect, Bay National Corporation's internal control over financial
reporting.
Information Regarding Forward-Looking Statements
In addition to the historical information contained in Part I of this
Quarterly Report on Form 10-QSB, the discussion in Part I of this Quarterly
Report on Form 10-QSB contains certain forward-looking statements.
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. Our actual
results and the actual outcome of our expectations and strategies could be
different from those anticipated or estimated.
The statements presented herein with respect to, among other things,
Bay National Corporation's plans, objectives, expectations and intentions,
including statements regarding profitability, liquidity, allowance for loan
losses, interest rate sensitivity, market risk and financial and other goals are
forward looking. These statements are based on Bay National Corporation's
beliefs and assumptions, and on information available to Bay National
Corporation as of the date of this filing, and involve risks and uncertainties.
These risks and uncertainties include, among others, those discussed in this
Quarterly Report on Form 10-QSB; Bay National Corporation's limited operating
history; dependence on key personnel; risks related to Bay National Bank's
22
choice of loan portfolio; risks related to Bay National Bank's lending limit;
risks of a competitive market; impact of government regulation on operating
results; and effect of developments in technology. For a more complete
discussion of these risks and uncertainties see the discussion under the caption
"Factors Affecting Future Results" in Bay National Corporation's Form 10-KSB.
Bay National Corporation's actual results could differ materially from
those discussed herein 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.
23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None
Item 2. Changes in Securities.
None
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Securities Holders.
At the Company's Annual Meeting of Stockholders held May 25,
2004, the following directors were elected to serve a three-year term expiring
upon the date of the Company's 2007 Annual Meeting or until their respective
successors are duly elected and qualified.
Votes Cast
For Withheld Total
---- -------- -----
William B. Rinnier 1,433,590 5,000 1,438,590
Edwin A. Rommel III 1,433,590 5,000 1,438,590
Henry H. Stansbury 1,438,590 - 1,438,590
Kenneth H. Trout 1,438,590 - 1,438,590
Eugene M. Waldron, Jr. 1,429,590 9,000 1,438,590
Names of other directors continuing in office:
Carroll A. Bodie
Charles E. Bounds
Gary T. Gill
John R. Lerch
Donald G. McClure, Jr.
Hugh W. Mohler
Robert L. Moore
H. Victor Rieger, Jr.
Margaret K. Riehl
Carl A.J. Wright
At the Company's Annual Meeting of Stockholders held May 25, 2004,
the selection of Stegman & Company to serve as independent auditors for the 2004
fiscal year was ratified by the following vote:
Votes Cast
For Against Abstain Total
--- ------- ------- -----
1,411,390 20,700 6,500 1,438,590
There were no broker nonvotes on these matters.
24
Item 5. Other Information.
None
25
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
Form 8-K filed, dated April 27, 2004, Items 7, 9 and 12.
26
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Bay National Corporation
Date: August 13, 2004 By: /s/ Hugh W. Mohler
-------------------------------------
Hugh W. Mohler, President
(Principal Executive Officer)
Date: August 13, 2004 By: /s/ Mark A. Semanie
-------------------------------------
Mark A. Semanie, Treasurer
(Principal Accounting and Financial
Officer)
27