UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

 

 

 

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

 

 

For the quarterly period ended June 30, 2007.

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

 

 

For the transition period from                 to                

 

Commission file number:  0-21815

FIRST MARINER BANCORP

(Exact name of registrant as specified in its charter)

 

Maryland

 

 

 

52-1834860

(State of Incorporation)

 

 

 

(I.R.S. Employer Identification Number)

 

 

 

 

 

1501 South Clinton Street,
Baltimore, MD

 

21224

 

410-342-2600

(Address of principal executive offices)

 

(Zip Code)

 

(Telephone Number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such report, and (2) has been subject to such filing requirements for the past 90 days.   Yes  x No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer   o            Accelerated filer   x            Non-accelerated filer   o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)   Yes  o No  x

The number of shares of common stock outstanding as of August 3, 2007 is 6,437,181 shares.

 




 

FIRST MARINER BANCORP AND SUBSIDIARIES
CONTENTS

PART I -

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

 

Item 1 -

 

Financial Statements

 

 

 

 

 

 

 

 

 

Consolidated Statements of Financial Condition at June 30, 2007 (unaudited) and at December 31, 2006

 

 

 

 

 

 

 

 

 

Consolidated Statements of Operations (unaudited) for the Three and Six months Ended June 30, 2007 and 2006

 

 

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the Six months Ended June 30, 2007 and 2006

 

 

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Item 2 -

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

 

 

 

Item 3 -

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

 

 

Item 4 -

 

Controls and Procedures

 

 

 

 

 

PART II -

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1-

 

Legal Proceedings

 

 

 

 

 

 

 

Item 1a -

 

Risk Factors

 

 

 

 

 

 

 

Item 2 -

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

 

 

 

Item 3 -

 

Defaults Upon Senior Securities

 

 

 

 

 

 

 

Item 4 -

 

Submission of Matters to a Vote of Security Holders

 

 

 

 

 

 

 

Item 5 -

 

Other Information

 

 

 

 

 

 

 

Item 6 -

 

Exhibits

 

 

 

 

 

 

 

Signatures

 

2




PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

First Mariner Bancorp and Subsidiaries
Consolidated Statements of Financial Condition
(dollars in thousands, except per share data)

 

 

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Cash and due from banks

 

$

33,316

 

$

36,734

 

Federal funds sold and interest-bearing deposits

 

77,798

 

6,235

 

Trading securities, at fair value

 

38,095

 

 

Securities available for sale, at fair value

 

52,103

 

147,290

 

Loans held for sale

 

97,276

 

94,371

 

Loans receivable

 

826,325

 

866,459

 

Allowance for loan losses

 

(12,550

)

(12,399

)

Loans, net

 

813,775

 

854,060

 

Other real estate owned

 

15,388

 

2,440

 

Restricted stock investments

 

5,983

 

6,449

 

Premises and equipment, net

 

52,585

 

49,062

 

Accrued interest receivable

 

8,092

 

10,579

 

Deferred income taxes

 

8,685

 

6,806

 

Bank-owned life insurance

 

34,192

 

33,492

 

Prepaid expenses and other assets

 

14,897

 

15,772

 

 

 

 

 

 

 

Total assets

 

$

1,252,185

 

$

1,263,290

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing

 

$

170,660

 

$

186,720

 

Interest-bearing

 

733,486

 

738,218

 

Total deposits

 

904,146

 

924,938

 

Short-term borrowings

 

42,560

 

40,884

 

Long-term borrowings, at fair value

 

61,296

 

 

Long-term borrowings

 

85,982

 

132,557

 

Junior subordinated deferrable interest debentures

 

73,724

 

73,724

 

Accrued expenses and other liabilities

 

11,038

 

12,558

 

Total liabilities

 

1,178,746

 

1,184,661

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $.05 par value; 20,000,000 shares authorized; 6,437,181 and 6,427,725 shares issued and outstanding, respectively

 

322

 

321

 

Additional paid-in capital

 

57,227

 

57,123

 

Retained earnings

 

16,035

 

22,109

 

Accumulated other comprehensive loss

 

(145

)

(924

)

Total stockholders’ equity

 

73,439

 

78,629

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,252,185

 

$

1,263,290

 

 

See accompanying notes to the consolidated financial statements

3




 

First Mariner Bancorp and Subsidiaries
Consolidated Statements of Operations
(dollars in thousands except per share data)

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(unaudited)

 

(unaudited)

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans

 

$

19,901

 

$

20,668

 

$

39,636

 

$

39,696

 

Investments and other earning assets

 

2,490

 

3,520

 

4,734

 

6,807

 

Total interest income

 

22,391

 

24,188

 

44,370

 

46,503

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

6,980

 

5,585

 

13,909

 

10,632

 

Short-term borrowings

 

302

 

2,697

 

617

 

4,694

 

Long-term borrowings

 

3,651

 

3,264

 

7,179

 

6,293

 

Total interest expense

 

10,933

 

11,546

 

21,705

 

21,619

 

Net interest income

 

11,458

 

12,642

 

22,665

 

24,884

 

Provision for loan losses

 

2,515

 

623

 

3,053

 

1,045

 

Net interest income after provision for loan losses

 

8,943

 

12,019

 

19,612

 

23,839

 

Noninterest income:

 

 

 

 

 

 

 

 

 

Gain on sale of mortgage loans

 

457

 

2,263

 

2,050

 

3,706

 

Other mortgage-banking revenue

 

619

 

799

 

1,349

 

1,424

 

ATM fees

 

855

 

824

 

1,571

 

1,609

 

Service fees on deposits

 

1,642

 

1,769

 

3,113

 

3,448

 

Trading gain (loss) on securities and long-term borrowings

 

47

 

 

(64

)

 

Gain on investment securities, net

 

 

 

887

 

 

Commissions on sales of nondeposit investment products

 

243

 

122

 

550

 

216

 

Income from bank-owned life insurance

 

365

 

256

 

700

 

508

 

Commissions on sales of other insurance products

 

746

 

753

 

1,333

 

1,318

 

Other

 

435

 

601

 

869

 

1,154

 

Total noninterest income

 

5,409

 

7,387

 

12,358

 

13,383

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

8,961

 

9,006

 

18,317

 

17,438

 

Occupancy

 

2,322

 

1,932

 

4,563

 

3,635

 

Furniture, fixtures and equipment

 

907

 

750

 

1,769

 

1,550

 

Professional services

 

449

 

257

 

799

 

459

 

Advertising

 

409

 

397

 

920

 

863

 

Data processing

 

485

 

468

 

914

 

917

 

ATM servicing expenses

 

279

 

242

 

508

 

525

 

Write-downs and costs of other real estate owned

 

837

 

4

 

923

 

 

Secondary marketing valuation

 

2,319

 

 

2,352

 

 

Service and maintenance

 

559

 

528

 

1,303

 

1,066

 

Other

 

2,951

 

2,702

 

5,756

 

5,349

 

Total noninterest expense

 

20,478

 

16,286

 

38,124

 

31,802

 

Net (loss) income before income taxes

 

(6,126

)

3,120

 

(6,154

)

5,420

 

Income tax (benefit) expense

 

(2,262

)

919

 

(2,390

)

1,559

 

Net (loss) income

 

$

(3,864

)

$

2,201

 

$

(3,764

)

$

3,861

 

Net (loss) income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.60

)

$

0.35

 

$

(0.59

)

$

0.62

 

Diluted

 

$

(0.60

)

$

0.33

 

$

(0.59

)

$

0.58

 

 

See accompanying notes to the consolidated financial statements.

4




First Mariner Bancorp and Subsidiaries
Consolidated Statements of Cash Flows

(dollars in thousands)

 

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

 

 

(unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) income

 

$

(3,764

)

$

3,861

 

Adjustments to reconcile net (loss) income to net cash from operating activities:

 

 

 

 

 

Stock-based compensation

 

29

 

51

 

Excess tax benefit on share-based compensation

 

 

(7

)

Depreciation and amortization

 

2,503

 

2,200

 

Amortization of unearned loan fees and costs, net

 

(305

)

(612

)

Amortization of premiums and discounts on loans, net

 

(472

)

(368

)

Amortization of premiums and discounts on mortgage-backed securities, net

 

7

 

115

 

Loss on trading securities

 

64

 

 

Gain on sale of securities available for sale

 

(887

)

 

Gain on sale of mortgage loans

 

(2,050

)

(3,706

)

Decrease (increase) in accrued interest receivable

 

2,487

 

(713

)

Provision for loan losses

 

3,053

 

1,045

 

Write-downs and losses on sale of other real estate owned

 

1,030

 

(9

)

Secondary marketing reserve

 

2,352

 

 

Loss on disposal of premises and equipment

 

 

2

 

Increase in cash surrender value of bank-owned life insurance

 

(700

)

(508

)

Originations of mortgage loans held for sale

 

(495,550

)

(615,874

)

Proceeds from mortgage loans held for sale

 

493,694

 

592,526

 

Net (decrease) increase in accrued expenses and other liabilities

 

(5,013

)

4,198

 

Net decrease (increase) in prepaids and other assets

 

809

 

(1,360

)

Net cash used in operating activities

 

(2,713

)

(19,159

)

Cash flows from investing activities:

 

 

 

 

 

Loan principal repayments, net of (disbursements)

 

52,222

 

(9,858

)

Repurchase of loans previously sold

 

(29,851

)

 

Purchases of premises and equipment

 

(6,047

)

(6,030

)

Proceeds from disposals of premises and equipment

 

21

 

15

 

Redemptions of restricted stock investments

 

466

 

201

 

Maturities/calls/repayments of trading securities

 

2,050

 

 

Activity in securities available for sale:

 

 

 

 

 

Sales of securities available for sale

 

1,301

 

 

Maturities/calls/repayments of securities available for sale

 

54,656

 

12,402

 

Purchase of securities available for sale

 

(999

)

(5,250

)

Proceeds from sales of other real estate owned

 

2,662

 

875

 

Net cash provided by (used in) investing activities

 

76,481

 

(7,645

)

Cash flows from financing activities:

 

 

 

 

 

Net (decrease) increase in deposits

 

(20,792

)

6,759

 

Net increase in other borrowed funds

 

15,102

 

20,795

 

Excess tax benefit on share-based compensation

 

 

7

 

Proceeds from stock issuance

 

207

 

347

 

Repurchase of common stock, net of costs

 

(140

)

 

Net cash (used in) provided by financing activities

 

(5,623

)

27,908

 

Increase in cash and cash equivalents

 

68,145

 

1,104

 

Cash and cash equivalents at beginning of period

 

42,969

 

45,835

 

Cash and cash equivalents at end of period

 

$

111,114

 

$

46,939

 

Supplemental information:

 

 

 

 

 

Interest paid on deposits and borrowed funds

 

$

21,633

 

$

21,308

 

Income taxes paid

 

$

 

$

1,616

 

Real estate acquired in satisfaction of loans

 

$

16,640

 

$

1,000

 

Transfer of loans held for sale to loan portfolio

 

$

1,001

 

$

 

 

See accompanying notes to the consolidated financial statements.

5




 

First Mariner Bancorp and Subsidiaries
Notes to Consolidated Financial Statements

(Information as of and for the three and six months
ended June 30, 2007 and 2006 is unaudited)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis Of Presentation

The accompanying consolidated financial statements for First Mariner Bancorp (the “Company”) have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a full presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements should be read in conjunction with the audited financial statements included in our 2006 Annual Report on Form 10-K.

The consolidated financial statements include the accounts of the Company’s subsidiaries, First Mariner Bank (the “Bank”), Mariner Finance, LLC (“Mariner Finance”) (which changed its name from Finance Maryland, LLC, effective August 1, 2007), and FM Appraisals, LLC (“FM Appraisals”).  All significant intercompany balances and transactions have been eliminated.

The consolidated financial statements as of June 30, 2007 and for the three and six months ended June 30, 2007 and 2006 are unaudited but include all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of financial position and results of operations for those periods. The results of operations for the three and six months ended June 30, 2007 are not necessarily indicative of the results that will be achieved for the entire year.

The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for credit losses (the “allowance”), the valuation allowance on repurchased loans, other than temporary impairment of investment securities, accounting for gain on sale of mortgage loans, determination of changes in fair value for the derivative loan commitments, use of derivatives to manage interest rate risk, and deferred tax assets.

Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2007.

Investment Securities

We designate securities into one of the three categories at the time of purchase. Debt securities that we have the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Debt and equity securities are classified as trading securities if bought and held principally for the purpose of selling them in the near term. Trading securities are reported at estimated fair value, with unrealized gains and losses included in earnings. Debt securities not classified as held to maturity and debt and equity securities not classified as trading securities are considered available for sale and are reported at estimated fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity, net of tax effects, in accumulated other comprehensive income.  Effective January 1, 2007, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115, and designated $42.000 million in securities as trading securities which were previously designated as available for sale.  In accordance with SFAS No. 159, we recorded a cumulative effect of accounting change reduction to retained earnings related to the investments in the amount of $993,000 (net of deferred tax impact) as of January 1, 2007.

Borrowings

In conjunction with our adoption of SFAS No. 159 as of January 1, 2007, we began recording certain of our long-term borrowings at fair value, with corresponding changes in fair values recorded in income.  On January 1, 2007, we recorded a cumulative effect of accounting change reduction to retained earnings in the amount of $1.251 million (net of deferred tax impact) related to $60.000 million in borrowings that we began recording at fair value.

6




NOTE 2 — COMPREHENSIVE INCOME

The following table shows the Company’s comprehensive income for the three and six months ended June 30, 2007 and 2006:

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(dollars in thousands)

 

Net income

 

$

(3,864

)

$

2,201

 

$

(3,764

)

$

3,861

 

Other comprehensive income items:

 

 

 

 

 

 

 

 

 

Cumulative effect of accounting change for certain investments, net of tax expense of $0, $0, $625 and $0, respectively

 

 

 

993

 

 

Unrealized holding gains (losses) arising during the period (net of tax expense (benefit) of $(92), $(426), $208, and $(1,172), respectively)

 

(147

)

(677

)

330

 

(1,862

)

Less: reclassification adjustment for gains (net of taxes of $0, $0, $343, and $0, respectively) included in net (loss) income

 

 

 

(544

)

 

Total other comprehensive (loss) income

 

(147

)

(677

)

779

 

(1,862

)

Total comprehensive (loss) income

 

$

(4,011

)

$

1,524

 

$

(2,985

)

$

1,999

 

 

NOTE 3 — PER SHARE DATA

Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding.  Diluted earnings per share is computed after adjusting the denominator of the basic earnings per share computation for the effects of all dilutive potential common shares outstanding during the period. The dilutive effects of options, warrants and their equivalents are computed using the “treasury stock” method.  For the three and six month periods ended June 30, 2007, all options were antidilutive and excluded from the computations.  For both the three and six month periods ended June 30, 2006, there were 8,600 shares which were antidilutive and excluded from the computations.

Information relating to the calculation of earnings per common share is summarized as follows:

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(dollars in thousands, except for per share data)

 

Net (loss) income - basic and diluted

 

$

(3,864

)

$

2,201

 

$

(3,764

)

$

3,861

 

Weighted-average share outstanding - basic

 

6,430,015

 

6,276,362

 

6,425,439

 

6,270,629

 

Dilutive securities - options and warrants

 

 

352,783

 

 

342,364

 

Adjusted weighted-average shares outstanding - dilutive

 

6,430,015

 

6,629,145

 

6,425,439

 

6,612,993

 

(Loss) earnings per share - basic

 

$

(0.60

)

$

0.35

 

$

(0.59

)

$

0.62

 

(Loss) earnings per share - diluted

 

$

(0.60

)

$

0.33

 

$

(0.59

)

$

0.58

 

 

NOTE 4 — STOCK BASED COMPENSATION

We have stock option award arrangements, which provide for the granting of options to acquire common stock to our directors and key employees. Option prices are equal to or greater than the estimated fair market value of the common stock at the date of the grant. As of June 30, 2007, 793,539 of the outstanding options are fully vested and 5,933 of the outstanding options vest over a three year period.  All options expire ten years after the date of grant.  There have been no modifications to the existing plan.  We recognized stock compensation expense, net of taxes, of $13,000, $51,000, $29,000 and $51,000, for the three and six months ended June 30, 2007 and 2006 respectively.  We anticipate incurring an additional $21,000 in compensation expense, net of taxes, over the next three years related to the unvested options.

7




Information with respect to stock options is as follows for the six months ended June 30, 2007:

 

Number
of Shares

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contractual
Term

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

(in years)

 

(in thousands)

 

Outstanding at beginning of period

 

793,022

 

$

12.84

 

 

 

 

 

Granted

 

11,450

 

14.58

 

 

 

 

 

Exercised

 

(2,500

)

11.20

 

 

 

 

 

Forfeited/Cancelled

 

(2,500

)

17.76

 

 

 

 

 

Outstanding at end of period

 

799,472

 

$

12.85

 

5.8

 

$

15,704

 

Exercisable at end of period

 

793,539

 

$

12.85

 

5.7

 

$

12,974

 

 

The weighted average fair values of our option grants for the six months ended June 30, 2007 and 2006 were $6.28 and $5.71, respectively, on the dates of grants. The fair values of our options granted were calculated using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions for the six months ended June 30, 2007 and 2006:

 

2007

 

2006

 

Dividend yield

 

0.00%

 

0.00%

 

Expected volatility

 

28.38%

 

15.61%

 

Risk-free interest rate

 

4.63%

 

5.12%

 

Expected lives

 

8 years

 

8 years

 

 

The total intrinsic value of options exercised and the related tax benefit during the six months ended June 30, 2007 and 2006 amounted to $11,320, $81,288, $0, and $31,393, respectively, and proceeds from exercises of stock options amounted to $28,005 and $163,692 for the six months ended June 30, 2007 and 2006, respectively.

While our employee stock purchase plan provides for a 10% discount from market value at issuance, we do not recognize compensation expense on the discount because substantially all employees that meet limited employment qualifications may participate in the plan on an equitable basis; the plan incorporates no option features, the purchase price is based solely on the market price of the shares at the date of purchase, and employees are permitted to cancel participation before the purchase date and obtain a refund of amounts previously paid and;  the discount from the market price does not exceed the per-share amount of share issuance costs that would have been incurred to raise a significant amount of capital by a public offering.

NOTE 5 — COMMITMENTS AND CONTINGENT LIABILITIES

We are party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of customers.  These financial instruments include commitments to extend credit, available lines of credit and standby letters of credit.  Our exposure to credit risk is represented by the contractual amounts of those financial instruments.  We apply the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.  A summary of the financial instruments at June 30, 2007 whose contract amounts represent potential credit risk is as follows:

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

(dollars in thousands)

 

Commitments to extend credit (includes unused lines of credit)

 

$

232,513

 

$

294,227

 

Standby letters of credit

 

4,548

 

4,677

 

 

We have established a reserve for potential loan repurchases in the amount of $1.705 million as of June 30, 2007.  This reserve is included in other liabilities and is based on projections made by management on the volume of future loans repurchases.  These projections contain assumptions that are continually updated as circumstances and experiences change.

NOTE 6 — SEGMENT INFORMATION

We are in the business of providing financial services, and we operate in three business segments—commercial and consumer banking, consumer finance, and mortgage-banking.  Commercial and consumer banking is conducted through First Mariner Bank (the “Bank”) and involves delivering a broad range of financial services, including lending and deposit taking, to individuals and commercial enterprises.  This segment also includes our treasury and administrative functions.  Consumer finance is conducted through Mariner Finance, and involves originating small direct consumer loans and the purchase of retail installment sales contracts.  Mortgage-banking is conducted through First Mariner Mortgage, a division of the Bank, and involves originating first- and second-

8




lien residential mortgages for sale in the secondary market and to the Bank.  The results of our subsidiary, FM Appraisals, are included in the mortgage-banking segment.

The following table presents certain information regarding our business segments:

For the six month period ended June 30, 2007:

 

 

Commercial and

 

Consumer

 

Mortgage-

 

 

 

 

 

Consumer Banking

 

Finance

 

Banking

 

Total

 

 

 

(dollars in thousands)

 

Interest income

 

$

33,625

 

$

7,892

 

$

2,853

 

$

44,370

 

Interest expense

 

17,910

 

1,945

 

1,850

 

21,705

 

Net interest income

 

15,715

 

5,947

 

1,003

 

22,665

 

(Recovery of) provision for loan losses

 

(2,141

)

903

 

4,291

 

3,053

 

Net interest income (loss) after provision for loan losses

 

17,856

 

5,044

 

(3,288

)

19,612

 

Noninterest income

 

7,924

 

1,561

 

2,873

 

12,358

 

Noninterest expense

 

24,512

 

5,177

 

8,435

 

38,124

 

Net intersegment income

 

83

 

 

(83

)

 

Net income (loss) before income taxes

 

$

1,351

 

$

1,428

 

$

(8,933

)

$

(6,154

)

Total assets

 

$

1,082,037

 

$

72,872

 

$

97,276

 

$

1,252,185

 

 

For the six month period ended June 30, 2006:

 

 

Commercial and

 

Consumer

 

Mortgage-

 

 

 

 

 

Consumer Banking

 

Finance

 

Banking

 

Total

 

 

 

(dollars in thousands)

 

Interest income

 

$

36,272

 

$

6,569

 

$

3,662

 

$

46,503

 

Interest expense

 

17,687

 

1,461

 

2,471

 

21,619

 

Net interest income

 

18,585

 

5,108

 

1,191

 

24,884

 

Provision for loan losses

 

100

 

945

 

 

1,045

 

Net interest income after provision for loan losses

 

18,485

 

4,163

 

1,191

 

23,839

 

Noninterest income

 

6,868

 

1,575

 

4,940

 

13,383

 

Noninterest expense

 

21,623

 

4,665

 

5,514

 

31,802

 

Net intersegment income

 

(119

)

 

119

 

 

Net income before income taxes

 

$

3,611

 

$

1,073

 

$

736

 

$

5,420

 

Total assets

 

$

1,219,742

 

$

57,485

 

$

119,405

 

$

1,396,632

 

 

NOTE 7 — RECENT ACCOUNTING PRONOUNCEMENTS

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.  This statement amends SFAS No. 133 and SFAS No. 140 by: permitting fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifying which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; establishing a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifying that concentrations of credit risk in the form of subordination are not embedded derivatives and; amending 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.  The statement is effective for fiscal years beginning after September 15, 2006.  The adoption of this standard did not have a material impact on our financial condition, results of operations or liquidity.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140.  This statement amends SFAS No. 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities.  It requires an entity to recognize a servicing asset or servicing liability each time an obligation is undertaken to service a financial asset by entering into a servicing contract in certain situations and requires all separately recognized servicing assets and liabilities to be initially measured at fair value, if practicable.  The statement permits the choice between the “amortization method” and the “fair value measurement method” for the subsequent measurement of the servicing assets or liabilities and allows for a one-time reclassification of available-for-sale securities to trading securities at initial adoption.   The statement also requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.   The statement is effective for fiscal years

9




beginning after September 15, 2006.  The adoption of this standard did not have a material impact on our financial condition, results of operations or liquidity.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.  The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes.  The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.  In May 2007, the FASB issued FASB Interpretation No. 48-1, Definition of Settlement in FASB Interpretation No. 48, which provides guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits.  These interpretations are effective for fiscal years beginning after December 15, 2006.  The adoption of these interpretations did not have a material impact on our financial condition, results of operations or liquidity.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007.  We adopted this standard effective January 1, 2007, with no material impact on our financial condition, results of operations or liquidity.

In September 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.  EITF 06-4 requires the recognition of a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods as defined in SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions.  The EITF reached a consensus that Bank Owned Life Insurance policies purchased for this purpose do not effectively settle the entity’s obligation to the employee in this regard and, thus, the entity must record compensation costs and a related liability.  Entities should recognize the effects of applying this Issue through either, (a) a change in accounting principle through a cumulative-effective adjustment to retained earnings or to other components of equity or net assets in the balance sheet as of the beginning of the year of adoption, or (b) a change in accounting principle through retrospective application to all prior periods.  This Issue is effective for fiscal years beginning after December 15, 2007.  The adoption of this interpretation is not anticipated to have a material impact on our financial condition, results of operations or liquidity.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115, which generally permits the measurement of selected eligible financial instruments, including investment securities, at fair value as of specified election dates and the reporting of unrealized gains or losses on those instruments in earnings at each subsequent reporting date. Generally, the fair value option may be applied on an instrument by instrument basis but, once applied, the election is irrevocable and is applied to the entire instrument.  The statement is effective for fiscal years beginning after November 15, 2007, with early adoption permitted as of the beginning of a fiscal year that begins on or before November 15, 2007.

We adopted SFAS No. 159 on January 1, 2007.  The effect of adopting this statement on existing eligible items at the time of adoption is recorded as a cumulative effect of accounting change through retained earnings in the financial statements and is detailed as follows:

 

 

Balance Sheet
January 1, 2007
Prior to Adoption

 

Net Loss
Upon Adoption

 

Balance Sheet
January 1, 2007
After Adoption
of Fair Value Option

 

 

 

(dollars in thousands)

 

Investment trading securities

 

$

42,569

 

$

(1,618

)

$

40,951

 

Long-term debt

 

60,000

 

(2,038

)

62,038

 

Pre-tax cumulative effect of adoption of the fair value option

 

 

 

(3,656

)

 

 

Increase in deferred tax assets

 

 

 

1,412

 

 

 

Cumulative effect of adoption of the fair value option (charge to retained earnings)

 

 

 

$

(2,244

)

 

 

 

10




Management believes the adoption was appropriate in order to more closely align the impact of interest rate movements within stockholders’ equity.  Prior to adoption, the securities were marked to market through the Company’s stockholders’ equity, with no offsetting impact of any borrowings or other interest-bearing liabilities, which may act as a natural interest rate risk hedge.  By treating certain assets and liabilities with similar characteristics as fair value instruments, both positions will be subject to fair value adjustments through earnings and ultimately stockholders’ equity.  Management believes the adoption will minimize the volatility in reported stockholders’ equity as the borrowing position will also be subject to fair value treatment.

As a result of our early adoption of SFAS No. 159, we elected to transfer $42.000 million of investment securities previously held as available for sale to trading securities.  These securities were selected based upon their yield (under 5%) and quality of available pricing data.  The average life of the bonds selected was 5.22 years.  In addition, we elected to record $60.000 million of our long-term borrowings at fair value.  The borrowings selected were fixed rate (6.07%) with an average remaining life of 3.24 years and have a consistent and reliable pricing source.  Retained earnings as of January 1, 2007 was reduced by $2.244 million, net of tax, as a result of the election. This is a permanent adjustment to retained earnings; however, there is no impact to total stockholders’ equity from the investment reclassification because the market value adjustment of the available for sale securities was already recorded in accumulated other comprehensive loss. This one-time charge will not be recognized in current earnings based upon application of SFAS No. 159. In addition, a pre-tax loss of approximately $64,000 was recognized in the first six months of 2007 due to a net decrease in the fair value of these financial instruments since January 1, 2007.

Interest income on trading securities and interest expense on long-term borrowings at fair value is accrued at the contractual rate based on the principal outstanding.  Premiums and discounts related to trading securities are expensed at time of purchase.  The interest from trading securities is included in the Statements of Operations in “Interest income from investments and other earning assets” and the interest on borrowings at fair value is included in the Statements of Operations in “Interest expense from long-term borrowings.”

The following table shows details of the financial instruments as of June 30, 2007 for which we elected to apply the fair value option:

 

 

Carrying
Value
(Fair
Value)

 

Quoted
Prices
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Trading
Gains and
(Losses)

 

Total Changes
In Fair Values
Included In 
Period Earnings

 

 

 

(dollars in thousands)

 

Trading securities

 

$

38,095

 

$

38,095

 

$

 

$

(806

)

$

(806

)

Long-term debt at fair value

 

61,296

 

 

61,296

 

742

 

742

 

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read and reviewed in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in our Annual Report on Form 10-K for the year ended December 31, 2006.

Forward-Looking Statements

This quarterly report on Form 10-Q may contain forward-looking language within the meaning of The Private Securities Litigation Reform Act of 1995.  Statements may include expressions about our confidence, policies, and strategies, provisions and allowance for loan losses, adequacy of capital levels, and liquidity.  All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Statements that include the use of terminology such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “estimates” and similar expressions also identify forward-looking statements. The forward-looking statements are based on our current intent, belief and expectations. Forward-looking statements in this Quarterly Report on Form 10-Q include, but are not limited to, statements of our plans, strategies, objectives, intentions, including, among other statements, statements involving our projected loan and deposit growth, loan collateral values, collectibility of loans, anticipated changes in other operating income, payroll and branching expenses, branch, office and product expansion of the Company and its subsidiaries, and liquidity and capital levels.  Such forward-looking statements involve certain risks and uncertainties, including general economic conditions, competition in the geographic and business areas in which we operate, inflation, fluctuations in interest rates, legislation and government regulation.  These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. For a more complete discussion of risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements, see “Risk Factors” filed as Item 1A of Part I in our Form 10-K for the year ended December 31, 2006.  Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

11




The Company

The Company is a bank holding company incorporated under the laws of Maryland and registered under the federal Bank Holding Company Act of 1956, as amended.  The Company was organized in 1994 and changed its name to First Mariner Bancorp in May 1995. Since 1995, the Company’s strategy has involved building a network of banking branches, ATMs and other financial services outlets to capture market share and build a community franchise for stockholders, customers and employees.  The Company is currently focused on growing assets and earnings by capitalizing on the broad network of bank branches, mortgage offices, consumer finance offices, and ATMs established during its infrastructure expansion phase.

The Company’s business is conducted primarily through its wholly owned subsidiaries, First Mariner Bank (the “Bank”), Mariner Finance, LLC (“Mariner Finance”), and FM Appraisals, LLC (“FM Appraisals”).  The Bank is the largest operating subsidiary of the Company with assets exceeding $1.1 billion as of June 30, 2007. The Bank was formed in 1995 through the merger of several small financial institutions. The Bank’s primary market area for its core banking operations, which consist of traditional commercial and consumer lending, as well as retail and commercial deposit operations, is central Maryland as well as portions of Maryland’s eastern shore.   The Bank opened its first branch in Pennsylvania during the first quarter of 2007.  The Bank is an independent community bank, and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”).

The Bank is engaged in the general commercial banking business, with particular attention and emphasis on the needs of individuals and small to mid-sized businesses, and delivers a wide range of financial products and services that are offered by many larger competitors. Products and services include traditional deposit products, a variety of consumer and commercial loans, residential and commercial mortgage and construction loans, wire transfer services, non-deposit investment products, and internet banking and similar services.  Most importantly, the Bank provides customers with access to local Bank officers who are empowered to act with flexibility to meet customers’ needs in an effort to foster and develop long-term loan and deposit relationships.

First Mariner Mortgage, a division of the Bank, engages in mortgage-banking activities, providing mortgages and associated products to customers and selling most of those mortgages into the secondary market.  During 2006, First Mariner Mortgage expanded its secondary marketing activities significantly and began hedging the interest rate risk associated with mortgage-banking activities.  During 2007, such activity decreased significantly due to decreased loan demand resulting in a decline in originations, a reduction in the types of products that we offer, and tightening of our underwriting standards.  During the second quarter of 2007, we closed the wholesale lending division of First Mariner Mortgage.

Mariner Finance (formerly Finance Maryland) engages in traditional consumer finance activities, making small direct cash loans to individuals, the purchase of installment loan sales contracts from local merchants and retail dealers of consumer goods, and loans to individuals via direct mail solicitations. Mariner Finance currently operates 18 branches, including a central approval office, in the State of Maryland and four branches in the state of Delaware.  Mariner Finance had total assets of $72.9 million as of June 30, 2007.

FM Appraisals is a residential real estate appraisal preparation and management company that is headquartered in Baltimore City. FM Appraisals offers appraisal services for residential real estate lenders, including appraisal preparation, the compliance oversight of sub-contracted appraisers, appraisal ordering and administration, and appraisal review services. FM Appraisals provides these services to First Mariner Mortgage.

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America and follow general practices within the industry 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 needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. When applying accounting policies in such areas that are subjective in nature, management must use its best judgment to arrive at the carrying value of certain assets and liabilities.   Below is a discussion of our critical accounting policies.

Allowance for loan losses

A variety of estimates impact the carrying value of the loan portfolio including the calculation of the allowance for loan losses, valuation of underlying collateral and the timing of loan charge-offs.

12




The allowance is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payments on loans.  Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio.  Current trends in delinquencies and charge-offs, the views of Bank regulators, changes in the size and composition of the loan portfolio and peer comparisons are also factors.  The analysis also requires consideration of the economic climate and direction and change in the interest rate environment, which may impact a borrower’s ability to pay, legislation impacting the banking industry, and environmental and economic conditions specific to the Bank’s service areas.  Because the calculation of the allowance for loan losses relies on estimates and judgments relating to inherently uncertain events, results may differ from our estimates.

Investment securities

Securities are evaluated periodically to determine whether a decline in their value is other than temporary. The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Management reviews criteria such as the magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Deferred income taxes

Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not.

Loan income recognition

Interest income on loans is accrued at the contractual rate based on the principal outstanding. Loan origination fees and certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual loan terms. Accrual of interest is discontinued when its receipt is in doubt, which typically occurs when a loan becomes 90 days past due as to principal or interest. Any interest accrued to income in the year when interest accruals are discontinued is generally reversed. Management may elect to continue the accrual of interest when a loan is in the process of collection and the estimated fair value of the collateral is sufficient to satisfy the principal balance and accrued interest. Loans are returned to accrual status once the doubt concerning collectibility has been removed and the borrower has demonstrated the ability to pay and remain current. Payments on nonaccrual loans are generally applied to principal.

Derivative Loan Commitments and Hedging Activities

In connection with our mortgage-banking activities, we enter into commitments to fund residential mortgage loans at specified times in the future. We enter into these commitments through retail and broker channels and also purchase loan commitments from correspondent lenders. A mortgage loan commitment binds the Company to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 90 days after inception of the rate lock commitment. Such a commitment is referred to as a derivative loan commitment if the loan that will result from exercise of the commitment will be held for sale upon funding under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. As such, loan commitments that are derivatives must be recognized at fair value on the consolidated balance sheets with changes in their fair values recorded as part of income from mortgage-banking operations. For accounting purposes, we value this commitment to zero at inception. Subsequent to inception, we estimate the fair value of the commitment, taking into consideration the probability of funding of the loan, and compare it to the fair value calculated at inception to measure the change in value, which is recorded through current period earnings with a corresponding asset for an increase in value or a liability for a decrease in value.

Loan Repurchases

Our sales agreements with investors who buy our loans generally contain covenants which may require us to repurchase loans under certain provisions, including delinquencies, or return premiums paid by those investors should the loan be paid off early.  These covenants are usual and customary within the mortgage-banking industry and generally apply for the first 30 to 90 days after the loan has been purchased by the investor.  We maintain a reserve (included in other liabilities) for potential losses relating to these sales covenants and also provide a valuation allowance for the devaluation of repurchased loans as a result of their delinquency status.

Loans repurchased are accounted for under AICPA Statement of Position (“SOP”) 3-03, Accounting for Purchases of Impaired Loans.  Under the SOP, loans repurchased must be recorded at market value at the time of repurchase with any deficiency for recording the loan compared to proceeds paid recorded as a valuation allowance and charged to noninterest expense.  Repurchased

13




loans are carried on the balance sheet in the loan portfolio.  Any further change in the underlying risk profile or further impairment is recorded as a specific reserve in the Company’s allowance for loan losses through the provision for loan losses.

Repurchased loans which are foreclosed upon are transferred to Other Real Estate Owned at the time of ratification of foreclosure and recorded at estimated fair value.  Any difference between the carrying amount of the loan and its estimated fair value upon foreclosure is charged to the valuation allowance set up for repurchased loans that is separate from the allowance for loan losses.  These assets remain in Other Real Estate Owned until their disposition.  Any declines in value during this time reduce the carrying amounts through a charge to noninterest expense.

Cumulative Effect of Accounting Change

We adopted SFAS No. 159 effective January 1, 2007.  The effect of adopting this statement on existing eligible items at the time of adoption is recorded as a cumulative effect of accounting change in the financial statements through retained earnings and is detailed as follows:

 

 

Balance Sheet
January 1, 2007
Prior to Adoption

 

Net Loss
Upon Adoption

 

Balance Sheet
January 1, 2007
After Adoption
of Fair Value Option

 

 

 

(dollars in thousands)

 

Investment trading securities

 

$

42,569

 

$

(1,618

)

$

40,951

 

Long-term debt

 

60,000

 

(2,038

)

62,038

 

Pre-tax cumulative effect of adoption of the fair value option

 

 

 

(3,656

)

 

 

Increase in deferred tax assets

 

 

 

1,412

 

 

 

Cumulative effect of adoption of the fair value option (charge to retained earnings)

 

 

 

$

(2,244

)

 

 

 

See Note 7 to the Consolidated Financial Statements above for additional information about our adoption of SFAS No. 159.

Financial Condition

The Company’s total assets were $1.252 billion at June 30, 2007, compared to $1.263 billion at December 31, 2006, decreasing $11.105 million for the first six months of 2007.  Earning assets decreased $23.224 million or 2.1% to $1.098 billion at June 30, 2007 from $1.121 billion at December 31, 2006.  The decrease in assets was due to decreases in cash and due from banks (-$3.418 million), investment securities, both trading and available for sale (-$57.092 million), and net loans outstanding (-$40.285 million), partially offset by increases in loans held for sale (+$2.905 million) and short-term investments (+$71.563 million).  We also experienced decreases in deposits (-$20.792 million), partially offset by increases in short-term (+$1.676 million) and long-term (+$14.721 million) borrowings.

Investment securities available for sale

We utilize the investment portfolio as part of our overall asset/liability management practices to enhance interest revenue while providing necessary liquidity for the funding of loan growth or deposit withdrawals.  Investment securities available for sale declined $95.187 million due to the transfer of securities available for sale to the trading securities portfolio, security sales of $1.301 million, and normal principal payments on mortgage-backed securities and scheduled maturities of other investments ($54.656 million).  These decreases were offset by additional purchases of securities of $999,000. At June 30, 2007, our unrealized loss on securities classified as available for sale totaled $232,000, compared to a loss of $1.505 million at December 31, 2006.  The improvement resulted from the transfer of certain securities to the trading portfolio.

14




The investment securities available for sale portfolio composition is as follows:

 

 

June 30,
2007

 

December 31,
2006

 

 

 

Balance

 

Percent
of Total

 

Balance

 

Percent
of Total

 

 

 

(dollars in thousands)

 

Investment securities available for sale:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

$

18,581

 

35.7

%

$

62,281

 

42.3

%

Trust preferred securities

 

24,433

 

46.9

%

33,028

 

22.4

%

US government agency notes

 

 

 

39,894

 

27.1

%

US Treasury securities

 

999

 

1.9

%

998

 

0.7

%

Obligations of state and municipal subdivisions

 

2,960

 

5.7

%

2,965

 

2.0

%

Corporate obligations

 

1,979

 

3.8

%

1,988

 

1.3

%

Equity securities

 

652

 

1.2

%

1,395

 

1.0

%

Foreign government bonds

 

1,500

 

2.9

%

1,750

 

1.2

%

Other investment securities

 

999

 

1.9

%

2,991

 

2.0

%

Total investment securities available for sale

 

$

52,103

 

100.0

%

$

147,290

 

100.0

%

 

Loans

Total loans decreased $40.134 million during the first six months of 2007.  Higher balances occurred in our residential mortgage loan portfolio (+$6.120 million) primarily due to repurchases of loans previously sold on the secondary market.  Our loans secured by second mortgages, consumer loans, and our loans secured by deposits and other increased by $7.307 million, $824,000, and $411,000, respectively.  The growth in these loan types was offset by decreases in our commercial real estate portfolio (-$36.873 million), commercial construction portfolio (-$5.932 million), consumer residential construction portfolio (-$4.204 million), and our commercial portfolio (-$8.437 million).  The total loan portfolio was comprised of the following:

 

 

June 30,
2007

 

December 31,
2006

 

 

 

Balance

 

Percent
of Total

 

Balance

 

Percent
of Total

 

 

 

(dollars in thousands)

 

Loans secured by first mortgages on real estate:

 

 

 

 

 

 

 

 

 

Residential

 

$

62,844

 

7.6

%

$

56,724

 

6.5

%

Commercial

 

281,363

 

34.0

%

318,236

 

36.7

%

Consumer residential construction

 

93,802

 

11.3

%

98,006

 

11.3

%

Commercial/residential construction

 

131,837

 

16.0

%

137,769

 

15.9

%

 

 

569,846

 

68.9

%

610,735

 

70.4

%

Commercial

 

70,564

 

8.5

%

79,001

 

9.1

%

Loans secured by second mortgages on real estate

 

109,674

 

13.3

%

102,367

 

11.8

%

Consumer loans

 

74,014

 

9.0

%

73,190

 

8.5

%

Loans secured by deposits and other

 

2,368

 

0.3

%

1,957

 

0.2

%

Total loans

 

826,466

 

100.0

%

867,250

 

100.0

%

Unamortized loan discounts

 

(322

)

 

 

(220

)

 

 

Unearned loan fees, net

 

181

 

 

 

(571

)

 

 

 

 

$

826,325

 

 

 

$

866,459

 

 

 

 

Credit Risk Management

Credit risk is the risk of loss arising from the inability of a borrower to meet its obligations.  We manage credit risk by evaluating the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions and expectations.  We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies and evaluation processes are designed to minimize our risk, management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions.

 We provide for loan losses through the establishment of an allowance for loan losses (the “allowance”) by provisions charged against earnings. Our allowance for loan losses represents an estimated reserve for existing losses in the loan portfolio. We deploy a systematic methodology for determining our allowance for loan losses that includes a quarterly review process, risk rating,

15




and adjustment to our allowance.  We classify our portfolios as either consumer or commercial and monitor credit risk separately as discussed below.  We evaluate the adequacy of our allowance for loan losses continually based on a review of all significant loans, with a particular emphasis on nonaccruing, past due, and other loans that we believe require special attention.

The allowance for loan losses consists of three elements: (1) specific reserves and valuation allowances for individual credits; (2) general reserves for types or portfolios of loans based on historical loan loss experience, judgmentally adjusted for current conditions and credit risk concentrations; and (3) unallocated reserves. Combined specific reserves and general reserves by loan type are considered allocated reserves. All outstanding loans are considered in evaluating the adequacy of the allowance.

Commercial

Our commercial portfolio includes all secured and unsecured loans to borrowers for commercial purposes, including commercial lines of credit and commercial real estate.  Our process for evaluating commercial loans includes performing updates on all loans that we have rated for risk. Our commercial loans are generally reviewed individually, in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, to determine impairment, accrual status and the need for specific reserves.  Our methodology incorporates a variety of risk considerations, both qualitative and quantitative. Quantitative factors include our historical loss experience by loan type, collateral values, financial condition of borrowers, and other factors. Qualitative factors include judgments concerning general economic conditions that may affect credit quality, credit concentrations, the pace of portfolio growth, and delinquency levels; these qualitative factors are evaluated in connection with our unallocated portion of our allowance for loan losses. We periodically engage outside firms and experts to independently assess our methodology, and perform various loan review functions.

The process of establishing the allowance with respect to our commercial loan portfolio begins when a loan officer initially assigns each loan a risk grade, using established credit criteria. Risk grades are subject to review and validation annually by an independent consulting firm, as well as periodically by our internal credit review function.  Our methodology employs management’s judgment as to the level of future losses on existing loans based on our internal review of the loan portfolio, including an analysis of the borrowers’ current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers and or lines of business. In determining our ability to collect certain loans, we also consider the fair value of any underlying collateral. We also evaluate credit risk concentrations, including trends in large dollar exposures to related borrowers, industry and geographic concentrations, and economic and environmental factors.

A commercial loan is determined to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Such a loan is not considered impaired during a period of delay in payment if we expect to collect all amounts due, including past-due interest. We generally consider a period of delay in payment to include delinquency up to 90 days.  During the first six months of 2007, management considered eleven commercial construction loans and nine commercial mortgage loans to be impaired under this criteria. As of June 30, 2007, we had impaired loans of $16.224 million, $13,334 million of which has been classified as nonaccrual.  The valuation allowance for impaired loans was $1.100 million as of June 30, 2007.

We place impaired loans on nonaccrual status when it is probable that we will be unable to collect any accrued and unpaid interest.  Once a loan is placed on nonaccrual, it remains in nonaccrual status until the loan is current as to payment of both principal and interest and the borrower demonstrates the ability to pay and remain current. As a result of our ongoing review of the loan portfolio, we may classify loans as nonaccrual even though the presence of collateral or the borrowers financial strength may be sufficient to provide for ultimate repayment. All payments made on nonaccrual loans are applied to the principal balance of the loan.

Consumer

Our consumer portfolio includes residential mortgage loans and other loans to individuals.  Consumer and residential mortgage loans, excluding repurchased residential first- and second-lien loans, are segregated into homogeneous pools with similar risk characteristics. Trends and current conditions in consumer and residential mortgage pools are analyzed and historical loss experience is adjusted accordingly.  Adjustment factors for the consumer and residential mortgage portfolios are consistent with those for the commercial portfolios.  Certain loans in the consumer portfolio identified as having the potential for further deterioration are analyzed individually to confirm the appropriate risk grading and accrual status, and to determine the need for a specific reserve.  We follow the same guidelines with regard to consumer nonaccrual loans as we do for commercial nonaccrual loans.  Consumer loans, being pools of smaller-balance homogeneous loans are collectively evaluated for impairment.  See discussion below under “Valuation Reserves on Repurchased Loans” for detailed discussion on determining reserves on repurchased loans.

Unallocated

The unallocated portion of the allowance is intended to provide for losses that are not identified when establishing the specific and general portions of the allowance and is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss

16




experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of external loan review examiners, and management’s judgment with respect to various other conditions including loan administration and management and the quality of risk identification systems.  Executive management reviews these conditions quarterly.  We have risk management practices designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may exist inherently within the loan portfolios. The judgmental aspects involved in applying the risk grading criteria, analyzing the quality of individual loans, and assessing collateral values can also contribute to undetected, but probable, losses.

Valuation Reserves on Repurchased Loans

In accordance with AICPA Statement of Position (“SOP”) 3-03, Accounting for Purchases of Impaired Loans, we establish valuation reserves for repurchased loans originated for sale or transfer of loans from loans held for sale to the loan portfolio.  These reserves are in addition to and separate from the allowance for loan losses, and represent the difference between the principal and accrued interest on the repurchased loan, and the loan’s estimated fair value at the time of repurchase.  The valuation reserves ($3.084 million as of June 30, 2007) are not part of our allowance for loan losses of $12.550 million, but are in addition to it.

In establishing the valuation reserves, management needed to make significant assumptions concerning the ultimate collectibility of loans currently delinquent and their ultimate realizable value.  Additionally, a portion of these reserves are based upon projected volume of repurchases.  While these projections were made with the most current data available to management, actual realized losses could differ due to the changes in the borrowers’ willingness or ability to resolve the delinquency status, changes in the actual volume of future repurchases, or changes in market values of those loans which are liquidated.  Management will update these assumptions continually as greater experience becomes available.

As of June 30, 2007, we maintained $20.098 million in loans that we have repurchased from investors in accordance with certain covenants in our sales agreements, net of a valuation allowance for these loans in the amount of $2.989 million that is in addition to and separate from the allowance for loan losses.  The following table shows the total portfolio of repurchased loans and their status as of June 30, 2007.

 

 

Principal
Balance

 

Valuation
Allowance

 

Carrying
Value

 

Additional
Specific
Reserves
(1)

 

 

 

(dollars in thousands)

 

Nonaccrual loans

 

$

4,001

 

$

2,080

 

$

1,921

 

$

1,921

 

Delinquent 1st mortgages

 

9,868

 

500

 

9,368

 

197

 

Modifications

 

7,930

 

409

 

7,521

 

406

 

Current loans

 

1,288

 

 

1,288

 

26

 

 

 

$

23,087

 

$

2,989

 

$

20,098

 

$

2,550

 


(1)             Additional specific reserves are included in the allowance for loan losses

The nonaccrual, delinquent and modified loans are currently in the process of collection and the resolution of many of these loans may be through foreclosure of the property.  The purchased and accrued interest receivable relating to the delinquent and accruing first-lien mortgage loans is $625,000.  The modifications in the table represent repurchased loans we have renegotiated at below market rates in order to improve the borrower’s ability to pay.  All of these loans are less than 60 days past due as of June 30, 2007.

We also maintain $707,000, net of a valuation allowance of $96,000, in second-lien mortgage loans that we transferred from loans held for sale to our consumer loan portfolio.  These are loans similar to those that have been repurchased, but they were never sold.  Of the $707,000, $62,000 have been placed on nonaccrual, net of a valuation allowance of $78,000.  A substantial amount of these loans are on properties located in Northern Virginia, where the housing market has declined dramatically.

17




Our total allowance at June 30, 2007 is considered by management to be sufficient to address the credit losses inherent in the current loan portfolio.  However, our determination of the appropriate allowance level is based upon a number of assumptions we make about future events, which we believe are reasonable, but which may or may not prove valid. Thus, there can be no assurance that our charge-offs in future periods will not exceed our allowance for loan losses or that we will not need to make additional increases in our allowance for loan losses.  The changes in the allowance are presented in the following table:

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(dollars in thousands)

 

Allowance for loan losses, beginning of year

 

$

12,399

 

$

11,743

 

Loans charged off:

 

 

 

 

 

Commercial

 

(67

)

 

Commercial/residential construction

 

 

 

Commercial mortgages

 

(340

)

 

Residential construction—consumer

 

 

(9

)

Residential mortgages

 

(262

)

 

Consumer

 

(2,481

)

(895

)

Total loans charged off

 

(3,150

)

(904

)

Recoveries:

 

 

 

 

 

Commercial

 

 

 

Commercial/residential construction

 

 

 

Commercial mortgages

 

 

 

Residential construction—consumer

 

 

22

 

Residential mortgages

 

29

 

 

Consumer

 

219

 

206

 

Total recoveries

 

248

 

228

 

Net charge-offs

 

(2,902

)

(676

)

Provision for loan losses

 

3,053

 

1,045

 

Allowance for loan losses, end of period

 

$

12,550

 

$

12,112

 

Loans (net of premiums and discounts):

 

 

 

 

 

Period-end balance

 

$

826,325

 

$

860,748

 

Average balance during period

 

851,855

 

854,757

 

Allowance as a percentage of period-end loan balance

 

1.52

%

1.41

%

Percent of average loans:

 

 

 

 

 

Provision for loan losses (annualized)

 

0.72

%

0.25

%

Net charge-offs (annualized)

 

0.69

%

0.16

%

 

The following table summarizes our allocation of allowance by loan type:

 

 

June 30, 2007

 

December 31, 2006

 

 

 

Amount

 

Percent
of Total

 

Percent
of Loans
to Total
Loans

 

Amount

 

Percent
of Total

 

Percent
of Loans
to Total
Loans

 

 

 

(dollars in thousands)

 

Commercial

 

$

515

 

4.1

%

8.5

%

$

926

 

7.5

%

9.1

%

Commercial/residential construction

 

2,005

 

16.0

%

15.9

%

2,749

 

22.2

%

15.8

%

Commercial mortgages

 

2,129

 

17.0

%

34.0

%

3,073

 

24.8

%

36.7

%

Residential construction—consumer

 

608

 

4.8

%

11.4

%

1,068

 

8.6

%

11.3

%

Residential mortgages

 

462

 

3.7

%

7.6

%

28

 

0.2

%

6.5

%

Consumer

 

5,108

 

40.7

%

22.6

%

2,928

 

23.6

%

20.6

%

Unallocated

 

1,723

 

13.7

%

 

1,627

 

13.1

%

 

Total

 

$

12,550

 

100.0

%

100.0

%

$

12,399

 

100.0

%

100.0

%

 

The following table provides information concerning nonperforming assets and past-due loans:

 

 

June 30,

 

December 31,

 

June 30,

 

 

 

2007

 

2006

 

2006

 

 

 

(dollars in thousands)

 

Nonaccrual loans

 

$

16,590

 

$

4,158

 

$

2,995

 

Real estate acquired by foreclosure

 

15,388

 

2,440

 

1,065

 

Total nonperforming assets

 

$

31,978

 

$

6,598

 

$

4,060

 

 

 

 

 

 

 

 

 

Loans past-due 90 days or more and accruing

 

$

15,425

 

$

27,274

 

$

4,466

 

 

Based upon management’s evaluation, provisions are made to maintain the allowance as a best estimate of inherent losses within the portfolio. The allowance for loan losses totaled $12.550 million and $12.399 million as of June 30, 2007 and December 31, 2006, respectively.  The provision for loan losses recognized to maintain the allowance was $2.515 million and $3.053 million for the three and six months ended June 30, 2007, respectively, as compared to $623,000 and $1.045 million for the same period in 2006,

18




respectively. The provision for loan losses increased primarily due to additional declines in value associated with our repurchased mortgage portfolio, which resulted in increases in allocated reserves for residential first mortgages of $381,000 and consumer second mortgages of $2.233 million. We recorded net charge-offs of $2.902 million during the first six months of 2007 compared to net charge-offs of $676,000 for the same period in 2006.   This increase was primarily attributable to increases in net charge-offs of commercial mortgages and repurchased second mortgages.  Total charge-offs for the Bank totaled $2.137 million, while Mariner Finance charge-offs were $1.013 million for the six months ended June 30, 2007.

During the first six months of 2007, annualized net charge-offs as compared to average loans outstanding increased to 0.69%, as compared to 0.16% during the same period of 2006, mostly due to a few large charge-offs in the commercial mortgage portfolio ($340,000) taken in the first half of 2007, increased charge-offs in our consumer portfolio consistent with the increase in our consumer loan portfolio balances and charge offs of previously repurchased second mortgages ($1.444 million).  The increases in the provision for loan losses from 2006 to 2007 and in the allocation of the allowance for consumer loans from $2.928 million to $5.108 million are also due to repurchased second mortgages.

Nonperforming assets, expressed as a percentage of total assets, totaled 2.55% at June 30, 2007, 0.52% at December 31, 2006 and 0.29% at June 30, 2006.  The increase as compared to June 30, 2006 reflects an increase in both residential real estate acquired by foreclosure and nonaccrual loans.  At June 30, 2007, there were a larger percentage of commercial and residential real estate loans classified as nonaccrual as compared to June 30, 2006, when a larger percentage consisted of commercial loans.  Loans past due 90 days or more and still accruing totaled $15.425 million as of June 30, 2007 compared to $27.274 million at December 31, 2006 and $4.466 million as of June 30, 2006.  Of the $15.425 million total, $948,000 is for two commercial construction loans, $4.158 million is for five commercial mortgage loans, and $10.296 million is for first-lien position residential mortgages.  The remainder of the loans past due 90 days or more represent $23,000 of consumer loans.

At June 30, 2007, the allowance for loan losses represented 39.2% of nonperforming assets compared to 187.9% at December 31, 2006.  Management believes the allowance for loan losses is adequate as of June 30, 2007.

Deposits

Deposits totaled $904.146 million as of June 30, 2007, decreasing $20.792 million or 2.2% from the December 31, 2006 balance of $924.938 million.  The decrease in deposits is primarily due to decreased time deposits and noninterest-bearing demand deposits, partially offset by increases in NOW, money market, and regular savings accounts.  The mix of deposits has changed somewhat during 2007, with a higher percentage of interest-bearing transaction accounts and regular savings accounts and less noninterest-bearing demand and time deposit accounts as of June 30, 2007 compared to December 31, 2006. The deposit breakdown is as follows:

 

 

June 30, 2007

 

December 31, 2006

 

 

 

 

 

Percent

 

 

 

Percent

 

 

 

Balance

 

of Total

 

Balance

 

of Total

 

 

 

(dollars in thousands)

 

NOW & money market savings deposits

 

$

322,305

 

35.6

%

$

282,871

 

30.6

%

Regular savings deposits

 

58,778

 

6.5

%

58,377

 

6.3

%

Time deposits

 

352,403

 

39.0

%

396,970

 

42.9

%

Total interest-bearing deposits

 

733,486

 

81.1

%

738,218

 

79.8

%

Noninterest-bearing demand deposits

 

170,660

 

18.9

%

186,720

 

20.2

%

Total deposits

 

$

904,146

 

100.0

%

$

924,938

 

100.0

%

 

Core deposits represent deposits that we believe to be less sensitive to changes in interest rates and therefore, will be retained regardless of the movement of interest rates.  We consider our core deposits to be all noninterest-bearing, NOW, money market accounts less than $100,000, and saving deposits, as well as all time deposits less than $100,000 that mature in greater than one year.  As of June 30, 2007, our core deposits were $462.917 million.  The remainder of our deposits could be susceptible to attrition due to interest rate movements.

Borrowings

Our borrowings consist of short-term promissory notes issued to certain qualified investors, short-term and long-term advances from the Federal Home Loan Bank at Atlanta (“FHLB”), a mortgage warehouse line of credit, a mortgage loan, a long-term line of credit, and junior subordinated deferrable interest debentures. Our short-term promissory notes are in the form of commercial paper, which reprice daily and have maturities of 270 days or less. Our advances from the FHLB may be in the form of short-term or long-term obligations. Short-term advances have maturities for one year or less and can be paid without penalty. Long-term borrowings through the FHLB have original maturities up to 15 years and generally contain prepayment penalties and call provisions.

19




Long-term borrowings consist of advances from the FHLB, a mortgage loan on our former headquarters building, and a line of credit, and totaled $147.278 million and $132.557 million at June 30, 2007 and December 31, 2006, respectively. The long-term line of credit is used to fund Mariner Finance’s lending business. As of June 30, 2007, total borrowings under this line were $51.500 million, up from $38.000 million at December 31, 2006. In March of 2005, we purchased our former headquarters building and assumed the existing mortgage loan on the property. As of June 30, 2007, the balance on the loan was $9.482 million compared to $9.557 million as of December 31, 2006.  FHLB long-term advances remained unchanged at $85.000 million; however, $60.000 million of the advances are now recorded at fair value ($61.296 million) in accordance with SFAS No. 159.  See more detailed discussion about the advances recorded at fair value under “Cumulative Effect of Accounting Change” above.

 Short-term borrowings consist of short-term promissory notes, short-term advances from the FHLB, and a mortgage warehouse line of credit secured by certain loans held for sale. Short-term borrowings increased $1.676 million, from $40.884 million at December 31, 2006 to $42.560 million at June 30, 2007, due to an increase in short-term promissory notes.

As an ongoing part of our funding and capital planning, we issue trust preferred securities from statutory trusts (“Trust Preferred Securities”), which are wholly owned by First Mariner Bancorp. The proceeds from the sales of Trust Preferred Securities ($71.500 million), combined with our equity investment in these trusts ($2.224 million), are exchanged for subordinated deferrable interest debentures. We currently maintain seven of these trusts with aggregated debentures of $73.724 million as of both June 30, 2007 and December 31, 2006.

The Trust Preferred Securities are mandatorily redeemable, in whole or in part, upon repayment of their underlying subordinated debt at their respective maturities or their earlier redemption. The subordinated debt is redeemable prior to maturity at our option on or after its optional redemption dates.

The junior subordinated deferrable interest debentures are the sole assets of the trusts. First Mariner has fully and unconditionally guaranteed all of the obligations of the trusts.

Under applicable regulatory guidelines, a portion of the Trust Preferred Securities will qualify as Tier I capital, and the remaining portion will qualify as Tier II capital. Under applicable regulatory guidelines, $24.528 million of the outstanding Trust Preferred Securities qualify as Tier I capital and the remaining $46.972 million of the Trust Preferred Securities qualify as Tier II capital at June 30, 2007.

Capital Resources

Stockholders’ equity decreased $5.190 million in the first six months of 2007 to $73.439 million from $78.629 million as of December 31, 2006.  Retained earnings declined by the net loss of $3.764 million for the first six months of 2007 and the net cumulative effect of accounting change adjustment of $2.244 million related to our adoption of SFAS No. 159 effective January 1, 2007.

Common stock and additional paid-in-capital increased by $105,000 due to the sale of stock through the exercise of options and warrants ($28,000), shares issued through the employee stock purchase plan ($179,000), and stock compensation awards ($38,000), partially offset by stock repurchases of $140,000.  Accumulated other comprehensive loss improved by $779,000 due to the increase in estimated fair values of the securities portfolio and the cumulative effect of accounting change adjustment related to investment securities.

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 risk.  Additionally, capital must be maintained to support certain off-balance sheet instruments.

Capital is classified as Tier 1 capital (common stockholders’ equity less certain intangible assets plus a portion of the Trust Preferred Securities) and Total Capital (Tier 1 plus the allowed portion of the allowance for loan losses plus any off-balance sheet reserves and the portion of Trust Preferred Securities not included in Tier 1 capital). Minimum required levels must at least equal 4% for Tier 1 capital and 8% for Total Capital. In addition, institutions must maintain a minimum of 4% leverage capital ratio (Tier 1 capital to average total assets for the previous quarter).

20




The Company and the Bank have exceeded their capital adequacy requirements to date.  We regularly monitor the Company’s capital adequacy ratios to assure that the Bank exceeds its regulatory capital requirements.  The regulatory capital ratios are shown below:

 

 

 

 

 

 

Minimum

 

 

 

June 30,

 

December 31,

 

Regulatory

 

 

 

2007

 

2006

 

Requirements

 

Regulatory capital ratios:

 

 

 

 

 

 

 

Leverage:

 

 

 

 

 

 

 

Consolidated

 

7.8

%

7.8

%

4.0

%

The Bank

 

7.4

%

7.3

%

4.0

%

Tier 1 capital to risk-weighted assets:

 

 

 

 

 

 

 

Consolidated

 

9.6

%

10.0

%

4.0

%

The Bank

 

9.2

%

9.6

%

4.0

%

Total capital to risk-weighted assets:

 

 

 

 

 

 

 

Consolidated

 

15.4

%

15.6

%

8.0

%

The Bank

 

11.3

%

11.7

%

8.0

%

 

Results of Operations

Net Income

Six Months Ended June 30, 2007:

For the six months ended June 30, 2007, we realized a net loss of $3.764 million compared to net income of $3.861 million for the six month period ended June 30, 2006.  Basic and diluted losses per share for the first six months of 2007 totaled $(0.59) compared to basic and diluted earnings of $0.62 and $0.58 per share, respectively, for the same period of 2006. Earnings for the six months ended June 30, 2007 were impacted by a higher provision for loan losses and charges to noninterest expenses for valuation allowances and write-downs of other real estate owned related to repurchased mortgages.

Return on average assets and return on average equity are key measures of a bank’s performance. Return on average assets, the product of net income divided by total average assets, measures how effectively we utilize the Company’s assets to produce income. Our return on average assets (annualized) for the six months ended June 30, 2007 was (0.61)% compared to 0.58% for the corresponding period in 2006. Return on average equity, the product of net income divided by average equity, measures how effectively we invest the Company’s capital to produce income. Return on average equity (annualized) for the six months ended June 30, 2007 was (9.98)% compared to 10.61% for the corresponding period in 2006.  All profitability indicators were significantly affected by the lower net income.

Three Months Ended June 30, 2007:

For the three months ended June 30, 2007, net losses totaled $3.864 million compared to net income of $2.201 million for the three month period ended June 30, 2006.  Basic and diluted losses per share for the first three months of 2007 totaled $(0.60) compared to basic and diluted earnings of $0.35 and $0.33 per share, respectively, for the same period of 2006.  Earnings for the three months ended June 30, 2007 reflected a higher provision for loan losses and charges to noninterest expenses for valuation allowances and write-downs of other real estate owned related to repurchased mortgages.  Our return on average assets (annualized) for the three months ended June 30, 2007 was (1.23)% compared to 0.64% for the corresponding period in 2006 and our return on average equity (annualized) for the three months ended June 30, 2007 was (20.66)% compared to 11.97% for the corresponding period in 2006.  The decline in these ratios was due to lower net income in the second quarter of 2007.

Net Interest Income

Six Months Ended June 30, 2007:

Net interest income, the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities, is the most significant component of our earnings. Net interest income is a function of several factors, including changes in the volume and mix of interest-earning assets and funding sources, and market interest rates. While management policies influence these factors, external forces, including customer needs and demands, competition, the economic policies of the federal government and the monetary policies of the Federal Reserve Board, are also determining factors.

Net interest income for the first six months of 2007 totaled $22.665 million, a decrease of $2.219 million from $24.884 million for the six months ended June 30, 2006. The decline in net interest income during 2007 was due to both an increase in the average rate paid on interest-bearing liabilities, from 4.00% for the six months ended June 30, 2006 to 4.40% for the six months ended June 30, 2007, a decrease in the volume of average earning assets, from $1.242 billion for the six months ended June 30, 2006 to $1.115 billion as of June 30, 2007, and a significantly higher level of loans moved to nonaccrual status.  In addition, we also experienced a decline in non-interest bearing funding sources.  The increased average rate paid on interest-bearing liabilities was partially offset by lower average balances of interest-bearing deposits and borrowings, which decreased from $1.091 billion for the six months ended June 30, 2006 to $993.733 million for the six months ended June 30, 2007. The yield on average earning assets increased from 7.49% for the six months ended June 30, 2006 to 7.94% for the six months ended June 30, 2007.  Rates on earning assets and interest-bearing liabilities increased due to increased market interest rates, as well as a different mix of earning assets and funding sources.  The net interest margin increased slightly to 4.02% for the six months ended June 30, 2007, as compared to 3.97% for the comparable period in 2006.

 

21




 

Interest income.  Total interest income decreased by $2.133 million due to decreased volume in average earning assets and the increase in the level of nonperforming assets.  Overall earning asset growth has moderated in 2007, as higher interest rates have dampened loan demand, loan principal prepayments have increased, and a flat treasury yield curve has discouraged the purchase of investment securities due to the narrow spread between investment yields and funding sources.  Average loans outstanding decreased slightly by $2.902 million, with decreases in commercial mortgages (-$44.820 million) and consumer residential construction loans (-$28.731 million), partially offset by increases in commercial loans and lines of credit (+$6.314 million), commercial/residential construction (+$24.079 million), residential mortgages (+$17.430 million), and consumer loans (+$22.826 million).  With respect to   the increase in consumer and residential mortgage loans, $26.862 million (net of valuation reserves of $2.989 million) is due to the repurchase of previously sold first- and second-lien mortgage loans.  Average loans held for sale decreased $14.012 million, primarily due to the closing of our wholesale mortgage operations and strengthened underwriting standards for mortgage loans sold.  Average investment securities decreased by $157.343 million.  Yields on earning assets for the period increased to 7.94% from 7.49% due primarily to the higher rate environment in 2007 and the sale of lower yielding investment securities in December of 2006.  The yield on total loans increased from 8.41% to 8.61%, driven by increased rates on most loan types.

Interest expense.  Interest expense remained relatively stable at $21.705 million for the six months ended June 30, 2007, compared to $21.619 million for the same period in 2006.  We experienced an increase in the average rate paid on interest-bearing liabilities, from 4.00% for the six months ended June 30, 2006 to 4.40% for the six months ended June 30, 2007, primarily as a result of the higher interest rate environment in 2007.  The increase in the rate paid on interest-bearing deposits from 3.09% for the six months ended June 30, 2006 to 3.80% for the six months ended June 30, 2007 was driven primarily by increases in the rates on money market accounts and time deposits.  Average interest-bearing deposits increased by $44.281 million primarily due to an increase in the volume of money market deposits.  A decrease in average borrowings of $141.429 million was due primarily from pay-offs of short-term advances from the FHLB and decreased borrowings on the mortgage loan warehouse line of credit, partially offset by subordinated debt issued late in 2006.

Three Months Ended June 30, 2007:

Net interest income for the second quarter of 2007 decreased by $1.184 million to $11.458 million for the three months ended June 30, 2007 compared to $12.642 million for the three months ended June 30, 2006.  The yield on average earning assets increased from 7.64% for the three months ended June 30, 2006 to 7.97% for the three months ended June 30, 2007 and the rates on average interest-bearing liabilities increased from 4.18% for the three months ended June 30, 2006 to 4.39% as of June 30, 2007.   Average earning assets decreased from $1.259 billion for the three months ended June 30, 2006 to $1.117 billion for the three months ended June 30, 2007 and average interest-bearing liabilities decreased from $1.108 billion for the three months ended June 30, 2006 to $997.778 million for the three months ended June 30, 2007.  Rates on earning assets and interest-bearing liabilities increased due to increased market interest rates.  As the yields on interest-earning assets increased more than the rates on funding sources, the net interest margin increased to 4.04% for the three months ended June 30, 2007, as compared to 3.97% for the comparable period in 2006.

Interest income.  Total interest income decreased by $1.797 million due primarily to the decreased volume of interest-earning assets and an increased volume of nonaccrual loans.  Yields on earning assets for the period increased to 7.97% from 7.64% due to the higher rate environment in 2007 and the restructure of the investment portfolio in December 2006.  Average loans outstanding decreased by $17.231 million, with decreases in commercial mortgages (-$57.032 million) and consumer residential construction loans (-$28.911 million), partially offset by increases in commercial loans and lines of credit (+$5.943 million), commercial/residential construction (+$22.386 million), residential mortgages (+$18.247 million) and consumer loans (+$22.136 million).  The increase in residential mortgage loans is due primarily to the repurchase of previously sold first mortgage loans.  Average loans held for sale decreased $20.032 million and average investment securities decreased by $172.266 million.  The yield on total loans increased from 8.52% to 8.66%.

Interest expense.  Interest expense decreased by $613,000, due to a decrease in the volume of interest-bearing liabilities, primarily borrowings, partially offset by an increase in the rates paid on interest-bearing liabilities from 4.18% for the three months ended June 30, 2006 to 4.39% for the three months ended June 30, 2007.  The decrease in average borrowings of $152.815 million was due to pay-offs of short-term advances from the FHLB, repurchase agreements, and decreased borrowings on the mortgage loan warehouse line of credit, partially offset by the additional subordinated debt issued late in 2006. The increase in the average rate paid on interest-bearing liabilities was primarily a result of the higher interest rate environment in 2007.

 

22




The following tables set forth, for the periods indicated, information regarding the average balances of interest-earning assets and interest-bearing liabilities and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

 

 

For the Six Months Ended June 30,

 

 

 

2007

 

2006

 

 

 

Average
Balance (1)

 

Interest (2)

 

Yield/
Rate

 

Average
Balance (1)

 

Interest (2)

 

Yield/
Rate

 

 

 

(dollars in thousands)

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial loans and lines of credit

 

$

74,644

 

$

2,906

 

7.74

%

$

68,330

 

$

2,224

 

6.47

%

Comm/res construction

 

138,939

 

5,333

 

7.63

%

114,860

 

5,000

 

8.66

%

Commercial mortgages

 

302,022

 

11,045

 

7.27

%

346,842

 

12,537

 

7.19

%

Residential construction—consumer

 

92,952

 

3,958

 

8.57

%

121,683

 

4,617

 

7.64

%

Residential mortgages

 

60,710

 

1,373

 

4.52

%

43,280

 

1,275

 

5.89

%

Consumer

 

182,588

 

12,169

 

13.31

%

159,762

 

10,381

 

12.98

%

Total loans

 

851,855

 

36,784

 

8.61

%

854,757

 

36,034

 

8.41

%

Loans held for sale

 

80,878

 

2,852

 

7.06

%

94,890

 

3,662

 

7.85

%

Investment securities, trading and AFS

 

112,558

 

2,941

 

5.23

%

269,901

 

6,244

 

4.63

%

Interest-bearing deposits

 

63,114

 

1,609

 

5.10

%

9,106

 

202

 

4.43

%

Restricted stock investments, at cost

 

6,265

 

184

 

5.86

%

13,208

 

361

 

5.47

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total earning assets

 

1,114,670

 

44,370

 

7.94

%

1,241,862

 

46,503

 

7.49

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

(12,091

)

 

 

 

 

(11,883

)

 

 

 

 

Cash and other nonearning assets

 

150,225

 

 

 

 

 

122,748

 

 

 

 

 

Total assets

 

$

1,252,804

 

44,370

 

 

 

$

1,352,727

 

46,503

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

9,988

 

11

 

0.23

%

$

11,911

 

13

 

0.22

%

Savings deposits

 

59,650

 

92

 

0.31

%

70,855

 

107

 

0.31

%

Money market deposits

 

290,908

 

5,398

 

3.74

%

225,183

 

3,181

 

2.85

%

Time deposits

 

377,422

 

8,408

 

4.49

%

385,738

 

7,331

 

3.83

%

Total interest-bearing deposits

 

737,968

 

13,909

 

3.80

%

693,687

 

10,632

 

3.09

%

Borrowings

 

255,765

 

7,796

 

6.15

%

397,194

 

10,987

 

5.58

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing liabilities

 

993,733

 

21,705

 

4.40

%

1,090,881

 

21,619

 

4.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing demand deposits

 

171,717

 

 

 

 

 

180,725

 

 

 

 

 

Other noninterest-bearing liabilities

 

11,262

 

 

 

 

 

7,757

 

 

 

 

 

Stockholders’ equity

 

76,092

 

 

 

 

 

73,364

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,252,804

 

21,705

 

 

 

$

1,352,727

 

21,619

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income/net interest spread

 

 

 

$

22,665

 

3.54

%

 

 

$

24,884

 

3.49

%

Net interest margin

 

 

 

 

 

4.02

%

 

 

 

 

3.97

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


(1)             Nonaccrual loans are included in average loans.

(2)             There are no tax equivalency adjustments

23




 

 

 

For the Three Months Ended June 30,

 

 

 

2007

 

2006

 

 

 

Average
Balance (1)

 

Interest (2)

 

Yield/
Rate

 

Average
Balance (1)

 

Interest (2)

 

Yield/
Rate

 

 

 

(dollars in thousands)

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial loans and lines of credit

 

$

75,998

 

$

1,670

 

8.69

%

$

70,055

 

$

1,205

 

6.81

%

Comm/res construction

 

139,247

 

2,721

 

7.73

%

116,861

 

2,553

 

8.64

%

Commercial mortgages

 

288,342

 

5,256

 

7.21

%

345,374

 

6,364

 

7.29

%

Residential construction - consumer

 

91,889

 

1,930

 

8.42

%

120,800

 

2,370

 

7.86

%

Residential mortgages

 

63,180

 

740

 

4.68

%

44,933

 

701

 

6.24

%

Consumer

 

185,756

 

6,117

 

13.09

%

163,620

 

5,300

 

12.88

%

Total loans

 

844,412

 

18,434

 

8.66

%

861,643

 

18,493

 

8.52

%

Loans held for sale

 

88,144

 

1,467

 

6.66

%

108,176

 

2,175

 

8.04

%

Investment securities, trading and AFS

 

93,648

 

1,297

 

5.53

%

265,914

 

3,223

 

4.85

%

Interest-bearing deposits

 

84,383

 

1,104

 

5.24

%

8,978

 

104

 

4.65

%

Restricted stock investments, at cost

 

5,983

 

89

 

5.92

%

13,930

 

193

 

5.55

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total earning assets

 

1,116,570

 

22,391

 

7.97

%

1,258,641

 

24,188

 

7.64

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

(11,803

)

 

 

 

 

(11,987

)

 

 

 

 

Cash and other nonearning assets

 

151,738

 

 

 

 

 

126,584

 

 

 

 

 

Total assets

 

$

1,256,505

 

22,391

 

 

 

$

1,373,238

 

24,188

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

10,446

 

6

 

0.23

%

$

11,679

 

7

 

0.22

%

Savings deposits

 

60,158

 

47

 

0.31

%

71,560

 

55

 

0.31

%

Money market deposits

 

300,417

 

2,806

 

3.75

%

234,021

 

1,810

 

3.10

%

Time deposits

 

367,170

 

4,121

 

4.50

%

378,090

 

3,713

 

3.94

%

Total interest-bearing deposits

 

738,191

 

6,980

 

3.79

%

695,350

 

5,585

 

3.22

%

Borrowings

 

259,587

 

3,953

 

6.11

%

412,402

 

5,961

 

5.80

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing liabilities

 

997,778

 

10,933

 

4.39

%

1,107,752

 

11,546

 

4.18

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing demand deposits

 

173,506

 

 

 

 

 

184,118

 

 

 

 

 

Other noninterest-bearing liabilities

 

10,215

 

 

 

 

 

7,609

 

 

 

 

 

Stockholders’ equity

 

75,006

 

 

 

 

 

73,759

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,256,505

 

10,933

 

 

 

$

1,373,238

 

11,546

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income/net interest spread

 

 

 

$

11,458

 

3.58

%

 

 

$

12,642

 

3.46

%

Net interest margin

 

 

 

 

 

4.04

%

 

 

 

 

3.97

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 


(1)             Nonaccrual loans are included in average loans.

(2)             There are no tax equivalency adjustments

A rate/volume analysis, which demonstrates changes in interest income and expense for significant assets and liabilities, appears below.  Changes attributable to mix (rate and volume) are allocated to volume and rate based on the relative size of the variance that can be separately identified with each.

24




 

 

 

For the Six Months Ended
June 30, 2007

 

For the Three Months Ended
June 30, 2006

 

 

 

Due to Variances in

 

Due to Variances in

 

 

 

Rate

 

Volume

 

Total

 

Rate

 

Volume

 

Total

 

 

 

(dollars in thousands)

 

Interest earned on:

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial loans and lines of credit

 

$

464

 

$

218

 

$

682

 

$

356

 

$

109

 

$

465

 

Comm/res construction

 

(1,385

)

1,718

 

333

 

(1,314

)

1,482

 

168

 

Commercial mortgages

 

409

 

(1,901

)

(1,492

)

(69

)

(1,039

)

(1,108

)

Residential construction - consumer

 

1,273

 

(1,932

)

(659

)

940

 

(1,380

)

(440

)

Residential mortgages

 

(715

)

813

 

98

 

(851

)

890

 

39

 

Consumer

 

270

 

1,518

 

1,788

 

87

 

730

 

817

 

Total loans

 

316

 

434

 

750

 

(851

)

792

 

(59

)

Loans held for sale

 

(329

)

(481

)

(810

)

(340

)

(368

)

(708

)

Securities available for sale, at fair value

 

2,039

 

(5,342

)

(3,303

)

2,644

 

(4,570

)

(1,926

)

Interest-bearing deposits

 

35

 

1,372

 

1,407

 

15

 

985

 

1,000

 

Restricted stock investments, at cost

 

70

 

(247

)

(177

)

81

 

(185

)

(104

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

2,131

 

(4,264

)

(2,133

)

1,549

 

(3,346

)

(1,797

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest paid on:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

1

 

(3

)

(2

)

1

 

(2

)

(1

)

Savings deposits

 

1

 

(16

)

(15

)

2

 

(10

)

(8

)

Money market deposits

 

1,147

 

1,070

 

2,217

 

422

 

574

 

996

 

Time deposits

 

1,524

 

(447

)

1,077

 

1,055

 

(647

)

408

 

Total interest-bearing deposits

 

2,673

 

604

 

3,277

 

1,480

 

(85

)

1,395

 

Borrowings

 

2,794

 

(5,985

)

(3,191

)

1,966

 

(3,974

)

(2,008

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest expense

 

5,467

 

(5,381

)

86

 

3,446

 

(4,059

)

(613

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

(3,336

)

$

1,117

 

$

(2,219

)

$

(1,897

)

$

713

 

$

(1,184

)

 

Noninterest Income

Noninterest income for the six months ended June 30, 2007 was $12.358 million, a decrease of $1.025 million or 7.7% for the comparable period of 2006 primarily due a decrease in total mortgage-banking revenue, including gains on sales of mortgage loans, and decreases in ATM fee income and service fees on deposits, partially offset by increases in bank owned life insurance (“BOLI”) income, brokerage fees and the gains on sales of investment securities recognized during the first six months of 2007.

Mortgage-banking revenue decreased from $5.130 million for the six months ended June 30, 2006 to $3.399 million for the six months ended June 30, 2007 due primarily to the lower volume of loans sold, the repurchase of previously sold mortgage loans, and lower profit spreads on loans sold.  The volume of loans we have originated has declined due to the declining housing market, the discontinuance of certain mortgage products, and the closure of our wholesale lending division.  Brokerage commissions increased $334,000 for the six months ended June 30, 2007, primarily due to increased mutual fund and annuity sales.  Deposit service charges declined to $3.113 million for the six months ended June 30, 2007 from $3.448 million for the six months ended June 30, 2006 due to reduced overdraft fee income.  Income from BOLI increased by $192,000 due to the purchase of additional insurance policies in the second half of 2006 and the conversion of several existing policies to new carriers with higher crediting yields.  Other noninterest income decreased $285,000, or 24.7%, from $1.154 million to $869,000 for the six month periods ended June 30, 2006 and 2007, respectively, due to decreased rental income.

Noninterest income for the three months ended June 30, 2007 decreased $1.978 million or 26.8% to $5.409 million compared to $7.387 million for the same period of 2006, reflecting lower levels of revenue in most major categories.  Commissions on nondeposit investment products increased by $121,000 or 99.2%, as compared to the same period in 2006 due to higher sales of annuities and mutual funds.  Deposit service charges declined by $127,000 or 7.2% due to lower levels of overdraft income. Gains on sales of mortgage loans and other mortgage-banking revenue decreased $1.986 million or 64.9% due to the lower volume of loans sold into the secondary market, the repurchase of previously sold mortgage loans, and lower profit spreads on loans sold.  Other noninterest income decreased $166,000 or 27.6% from the level in 2006 due to decreased rental income.

25




Noninterest expenses

For the six months ended June 30, 2007, noninterest expenses increased $6.322 million or 19.9% to $38.124 million compared to $31.802 million for the same period of 2006. A significant part of the increase was the recording of additional secondary marketing reserves of $2.352 million through noninterest expenses to reflect the declines in fair market value incurred for residential mortgage loans repurchased during the second quarter and to increase our reserves for potential loan repurchases.  The loans repurchased have been  “ALT A” loans that have higher original loan to value ratios and were primarily originated in 2006. The loans are being repurchased due to delinquent payments by the borrower within the first 30 to 90 days of the loans term. Reserves established during 2006 for these loans approximated 10% of the principal amount of the anticipated repurchases. Throughout the first two quarters of 2007, the Company has repurchased a significant portion of the anticipated buybacks and progressed through the collection process. Throughout this time, declines in real estate values have continued and we provided for additional reserves during this quarter to reflect the further value reductions and our experience with properties that have been foreclosed upon and are awaiting sale, resulting in costs of other real estate owned expense of $923,000.  Of the loans repurchased, approximately 50% of the loans are for single family residential properties located in Northern Virginia, with the remainder made up of single-family properties in various other states. Excluding the valuation allowances and write-downs of other real estate owned, noninterest expense increased $3.047 million or 9.6%.

Salary and employee benefits expenses increased $879,000 due to additional personnel costs for staffing hired to support the expansion of the consumer finance company and increased cost of employer provided health care.  Also included is $200,000 for severance benefits for the quarter, mostly related to the closing of the wholesale lending division.  Occupancy expenses increased $928,000 to $4.563 million for the six months ended June 30, 2007 from $3.635 million for the six months ended June 30, 2006 due to additional space for the new executive and administrative offices occupied during the third quarter of 2006.  Service and maintenance expense and furniture, fixtures and equipment expense also increased ($237,000 and $219,000, respectively) due to increased locations.

For the three months ended June 30, 2007, noninterest expenses increased $4.192 million or 25.7% to $20.478 million from $16.286 million for the same period of 2006.  We recognized $2.319 in secondary marketing reserves and $837,000 in write-downs on foreclosed real estate during the quarter.  Excluding the valuation allowances and write-downs of other real estate owned, noninterest expense increased $1.036 million or 6.4%.  Occupancy expense increased $390,000 or 20.2% to $2.322 million for the three months ended June 30, 2007 compared to $1.932 million for the three months ended June 30, 2006 due to increased lease expense related to the headquarters move and new branches.

During the quarter, the Company identified new opportunities for increased efficiency to reduce its operating costs. We closed our wholesale lending division and will realize these cost savings beginning in the third quarter of this year. We are expanding our focus on on-line banking services, and will slow the addition of new branches, locate them in only the most promising markets, and eliminate any poor-performing locations. Additionally, we are aligning our staffing with our new direction, which will be accomplished largely through attrition.  We expect the impact of these decisions to be meaningful and positively impact our results for the last quarter of 2007, and more significantly in 2008.

26




The following table shows the breakout of noninterest expense:

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(dollars in thousands)

 

Salaries and employee benefits

 

$

8,961

 

$

9,006

 

$

18,317

 

$

17,438

 

Occupancy

 

2,322

 

1,932

 

4,563

 

3,635

 

Furniture, fixtures and equipment

 

907

 

750

 

1,769

 

1,550

 

Secondary marketing valuation

 

2,319

 

 

2,352

 

 

Professional services

 

449

 

257

 

799

 

459

 

Advertising

 

409

 

397

 

920

 

863

 

Data processing

 

485

 

468

 

914

 

917

 

Service and maintenance

 

559

 

528

 

1,303

 

1,066

 

Office supplies

 

200

 

180

 

397

 

373

 

ATM servicing expenses

 

279

 

242

 

508

 

525

 

Printing

 

123

 

161

 

303

 

320

 

Corporate insurance

 

125

 

117

 

241

 

221

 

Write-downs and costs of other real estate owned

 

837

 

4

 

923

 

 

Consulting fees

 

176

 

176

 

370

 

336

 

Marketing/promotion

 

228

 

305

 

448

 

617

 

Postage

 

226

 

235

 

502

 

486

 

Overnight delivery/courier

 

209

 

229

 

436

 

445

 

Security

 

60

 

30

 

154

 

91

 

Dues and subscriptions

 

141

 

156

 

262

 

316

 

Loan expenses

 

258

 

158

 

434

 

304

 

Other

 

1,205

 

955

 

2,209

 

1,840

 

 

 

$

20,478

 

$

16,286

 

$

38,124

 

$

31,802

 

 

Income Taxes

We recorded an income tax benefit of $2.390 million on a net loss before taxes of $6.154 million, resulting in an effective tax rate of (38.8)% for the six month period ended June 30, 2007 in comparison to income tax expense of $1.559 million on income before taxes of $5.420 million, resulting in an effective tax rate of 28.8% for the six month period ended June 30, 2006. The effective tax rate decreased due to the realization of a net loss during 2007.  There were no changes in the statutory income tax rates in 2007.

We recorded an income tax benefit of $2.262 million on a net loss before taxes of $6.126 million, resulting in an effective tax rate of (36.9)% for the three month period ended June 30, 2007 in comparison to income tax expense of $919,000 on income before taxes of $3.120 million, resulting in an effective tax rate of 29.5% for the three month period ended June 30, 2006.  The effective tax rate decreased due to the realization of a net loss during 2007.

Liquidity

Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, that arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers, as well as to meet current and planned expenditures. These cash requirements are met on a daily basis through the inflow of deposit funds, and the maintenance of short-term overnight investments, maturities and calls in our investment portfolio and available lines of credit with the FHLB, which requires pledged collateral. Fluctuations in deposit and short-term borrowing balances may be influenced by the interest rates paid, general consumer confidence and the overall economic environment. There can be no assurances that deposit withdrawals and loan fundings will not exceed all available sources of liquidity on a short-term basis. Such a situation would have an adverse effect on our ability to originate new loans and maintain reasonable loan and deposit interest rates, which would negatively impact earnings.

The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit (collectively “commitments”), which totaled $232.513 million at June 30, 2007. Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. Commitments for real estate development and construction, which totaled $97.109 million, or 41.7% of the total, are generally short-term in nature, satisfying cash requirements with principal repayments as construction properties financed are generally repaid with permanent financing. Available credit lines represent the unused portion of credit previously extended and available to the customer as long as there is no violation of material contractual conditions. Commitments to extend credit for residential mortgage loans of $15.751 million, or 6.8% of the total at June 30, 2007, generally expire within 60 days. Commercial commitments to extend credit and unused lines of credit of $932,000, or 0.4% of the total at June 30, 2007, generally do not extend for more than 12 months. Consumer commitments to extend credit and unused lines of credit of $37.395 million, or 16.1% of the total at June 30, 2007, are generally open ended. At June 30, 2007, available home equity lines totaled $81.326 million, or 35.0% of the total. Home equity credit lines generally extend for a period of 10 years. Capital expenditures for various branch locations and equipment can be a significant use of liquidity.

27




As of June 30, 2007, we plan on expending approximately $2.200 million in the next 12 months on our premises and equipment.

Customer withdrawals are also a principal use of liquidity, but are generally mitigated by growth in customer funding sources, such as deposits and short-term borrowings. While balances may fluctuate up and down in any given period, historically we have experienced a steady increase in total customer funding sources.

The Bank’s principal sources of liquidity are cash and cash equivalents (which are cash on hand or amounts due from financial institutions, federal funds sold, money market mutual funds, and interest bearing deposits), trading and available for sale securities, deposit accounts and borrowings.  The levels of such sources are dependent on the Bank’s operating, financing and investing activities at any given time.  Cash and cash equivalents totaled $111.114 million at June 30, 2007 compared to $42.969 million as of December 31, 2006.  Our loan to deposit ratio stood at 91.4% as of June 30, 2007 and 93.7% as of December 31, 2006.

We also have the ability to utilize established credit lines as additional sources of liquidity. To utilize the vast majority of our credit lines, we must pledge certain loans and/or investment securities before advances can be obtained.  As of June 30, 2007, we maintained lines of credit totaling $393.231 million, with available borrowing capacity of approximately $100.000 million based upon loans and investments available for pledging.

Inflation

Inflation may be expected to have an impact on our operating costs and thus on net income. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect our results of operations unless the fees we charge could be increased correspondingly. However, we believe that the impact of inflation was not material for 2007 or 2006.

Off-Balance Sheet Arrangements

We enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit and letters of credit. In addition, the Company has certain operating lease obligations.

Credit Commitments

Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. We are not aware of any accounting loss we would incur by funding our commitments.

Potential Loan Repurchases

We have established a reserve for potential loan repurchases in the amount of $1.705 million as of June 30, 2007.  This reserve is included in other liabilities and is based on projections made by management on the volume of future loans repurchases.  These projections contain assumptions that are continually updated as circumstances and experiences change.

Notional Amount of Derivatives

The Bank, through First Mariner Mortgage, enters into interest rate lock commitments, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate.  The Bank also has corresponding forward sales commitments related to these interest rate lock commitments.  The market value of rate lock commitments and best efforts contracts is not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded in stand-alone markets.  The Bank determines the fair value of rate lock commitments and best efforts contracts by measuring the change in the value of the underlying asset, while taking into consideration the probability that the rate

28




lock commitments will close.

During the first six months of 2007, we curtailed our forward loan commitments and the corresponding hedging using forward contracts to sell securities due to the significantly lower production volume of loans during that time.  Most of the loans sold during the first six months of 2007 were done so on a best efforts basis.  It is probable that we will resume selling loans on a mandatory delivery basis later in the year and at that time will also resume our hedging of the transactions.

As of June 30, 2007, we had no forward contracts to sell any securities.

Information pertaining to the notional amounts of our derivative financial instruments follows as of June 30, 2007.   These derivative financial instruments are recorded in our consolidated balance sheet at fair value.

 

Notional

 

Estimated

 

 

 

Amount

 

Fair Value

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

Interest rate lock commitments

 

$

25,769

 

$

25,000

 

 

 

 

 

 

 

Open hedge positions:

 

 

 

 

 

Forward sales commitments on loan pipeline and funded loans

 

$

105,426

 

$

106,194

 

 

 

 

 

 

 

Forward contracts to sell mortgage-backed securities and Eurodollars

 

$

 

$

 

 

The net effect on our income statement from marking to market the forward contracts, the interest rate lock commitments and mortgage loans held for sale are not considered material to the overall operations of the consolidated company.

Changes in interest rates could materially affect the fair value of derivative loan commitments on our consolidated financial statements. In reality, one would not expect all other assumptions to remain constant. Changes in one factor may result in changes in another (for example, changes in interest rates could result in changes in the fallout factor), which might magnify or counteract the sensitivities. This is because the impact of an interest rate shift on the fallout ratio is non-symmetrical and non-linear.

Item 3 — Quantitative and Qualitative Disclosures About Market Risk

Results of operations for financial institutions, including us, may be materially and adversely affected by changes in prevailing economic conditions, including declines in real estate values, rapid changes in interest rates and the monetary and fiscal policies of the federal government.  Our loan portfolio is concentrated primarily in central Maryland and portions of Maryland’s eastern shore and is, therefore, subject to risks associated with these local economies.

As of June 30, 2006, we have a significant amount of loans that we repurchased from investors with collateral located in Northern Virginia, where the housing market has declined dramatically.  See our discussion of repurchased loans in Item 2 -  “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Credit Risk Management.”

Interest Rate Risk

Our profitability is in part a function of the spread between the interest rates earned on assets and the interest rates paid on deposits and other interest-bearing liabilities (net interest income), including advances from the FHLB and other borrowings.  Interest rate risk arises from mismatches (i.e., the interest sensitivity gap) between the dollar amount of repricing or maturing assets and liabilities and is measured in terms of the ratio of the interest rate sensitivity gap to total assets.  More assets repricing or maturing than liabilities over a given time period is considered asset-sensitive and is reflected as a positive gap, and more liabilities repricing or maturing than assets over a given time period is considered liability-sensitive and is reflected as negative gap.  An asset-sensitive position (i.e., a positive gap) will generally enhance earnings in a rising interest rate environment and will negatively impact earnings in a falling interest rate environment, while a liability-sensitive position (i.e., a negative gap) will generally enhance earnings in a falling interest rate environment and negatively impact earnings in a rising interest rate environment.  Fluctuations in interest rates are not predictable or controllable.  We have attempted to structure our asset and liability management strategies to mitigate the impact on net interest income of changes in market interest rates.  However, there can be no assurance that we will be able to manage interest rate risk so as to avoid significant adverse effects on net interest income.  At June 30, 2007, we had a one year cumulative positive gap of approximately $162.497 million.

29




In addition to the use of interest rate sensitivity reports, we test our interest rate sensitivity through the deployment of a simulation analysis.  Earnings simulation models are used to estimate what effect specific interest rate changes would have on our projected net interest income.  Derivative financial instruments, such as interest rate caps, are included in the analysis. Changes in prepayments have been included where changes in behavior patterns are assumed to be significant to the simulation, particularly mortgage related assets. Call features on certain securities and borrowings are based on their call probability in view of the projected rate change.  At June 30, 2007, the simulation model provided the following profile of our interest rate risk measured over a one-year time horizon, assuming a parallel shift in a yield curve based off the U.S. dollar forward swap curve adjusted for certain pricing assumptions:

 

Immediate Rate Change

 

 

 

+200BP

 

-200BP

 

Net interest income

 

2

%

-2

%

 

Both of the above tools used to assess interest rate risk have strengths and weaknesses.  Because the gap analysis reflects a static position at a single point in time, it is limited in quantifying the total impact of market rate changes which do not affect all earning assets and interest-bearing liabilities equally or simultaneously.  In addition, gap reports depict the existing structure, excluding exposure arising from new business.  While the simulation process is a powerful tool in analyzing interest rate sensitivity, many of the assumptions used in the process are highly qualitative and subjective and are subject to the risk that past historical activity may not generate accurate predictions of the future.  The model also assumes parallel movements in interest rates, which means both short-term and long-term rates will change equally.  Nonparallel changes in interest rates (short-term rates changing differently from long-term rates) could result in significant differences in projected income amounts when compared to parallel tests.  Both measurement tools taken together, however, provide an effective evaluation of our exposure to changes in interest rates, enabling management to better control the volatility of earnings.

We are party to mortgage rate lock commitments to fund mortgage loans at interest rates previously agreed (locked) by both us and the borrower for specified periods of time. When the borrower locks an interest rate, we effectively extend a put option to the borrower, whereby the borrower is not obligated to enter into the loan agreement, but we must honor the interest rate for the specified time period. We are exposed to interest rate risk during the accumulation of interest rate lock commitments and loans prior to sale. We utilize either a best efforts sell forward commitment or a mandatory sell forward commitment to economically hedge the changes in fair value of the loan due to changes in market interest rates. Failure to effectively monitor, manage and hedge the interest rate risk associated with the mandatory commitments subjects us to potentially significant market risk.

Throughout the lock period the changes in the market value of interest rate lock commitments, mandatory sell forward commitments are recorded as unrealized gains and losses and are included in the statement of operations in mortgage-banking revenue.  Management has made complex judgments in the recognition of gains and losses in connection with this activity. We utilize a third party and its proprietary simulation model to assist in identifying and managing the risk associated with this activity.

Item 4 — Controls and Procedures

(a) Evaluation of disclosure controls and procedures.  The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow for timely decisions regarding required disclosure.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls, as of the end of the period covered by this Quarterly Report on Form 10-Q, was carried out under the supervision and with the participation of the Company’s management, including the CEO and CFO.  Based on that evaluation, the Company’s management, including the CEO and CFO, has concluded that the Company’s disclosure controls and procedures are in fact effective at the reasonable assurance level.

(b) Changes in Internal Control Over Financial Reporting. There were no significant changes in our internal control over financial reporting or in other factors during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

30




PART II — OTHER INFORMATION

Item 1 —           Legal Proceedings

We are 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.

Item 1a — Risk Factors

There have been no material changes from the Risk Factors previously disclosed in Item 1A of Part I of our Form 10-K for the year ended December 31, 2006.

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds

 

 

Total
Number
of Shares
Purchased

 

Average
Price Paid
Per Share

 

Total Number
of Shares 
Purchased as
Part of Plan

 

Maximum
Number of 
Shares Yet
to Purchase
Under Plan

 

April 2007

 

 

$

 

170,825

 

129,175

 

May 2007

 

 

 

170,825

 

129,175

 

June 2007

 

 

 

170,825

 

129,175

 


(1)             On July 18, 2006, the Company announced that its Board of Directors approved an extension to its share repurchase program, originally approved on July 20, 2004, of up to 300,000 shares (approximately 5%) of our outstanding common stock, which provides for open market or private purchases of stock over the next 24 months.

Item 3 — Defaults Upon Senior Securities

None

Item 4 — Submission of Matters to a Vote of Security Holders

None

Item 5 — Other Information

None

Item 6 — Exhibits

31.1

 

Certifications of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended, filed herewith

 

 

 

31.2

 

Certifications of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended, filed herewith

 

 

 

32.1

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith

 

 

 

32.2

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith

 

31




SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

FIRST MARINER BANCORP

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

 

8/9/07

 

By:

 

/s/ Edwin F. Hale Sr.

 

 

 

 

 

 

Edwin F. Hale Sr.

 

 

 

 

 

 

Chairman and Chief Executive Officer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

 

8/9/07

 

By:

 

/s/ Mark A. Keidel

 

 

 

 

 

 

Mark A. Keidel

 

 

 

 

 

 

Chief Financial Officer

 

32




 

Exhibit Index

31.1

 

Certifications of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended, filed herewith

 

 

 

31.2

 

Certifications of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended, filed herewith

 

 

 

32.1

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith

 

 

 

32.2

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith