UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004.
Commission file number: 333-87781
Bay National Corporation
(Exact name of small business issuer as specified in its charter)
Maryland 52-2176710
--------------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2328 West Joppa Road, Lutherville, MD 21093
-------------------------------------------
Address of principal executive offices
(410) 494-2580
--------------
Issuer's telephone number
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
---------- ---------
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:
At November 10, 2004, the issuer had 1,918,960 shares of Common Stock
outstanding.
Transitional Small Business Disclosure Format (Check One): Yes No X
--- ---
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
------- --------------------
BAY NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
---------------------------
As of September 30, 2004 and December 31, 2003
September 30, December 31,
2004 2003
---------------- ---------------
ASSETS (Unaudited)
Cash and due from banks $ 669,917 $ 573,124
Federal funds sold and other overnight investments 19,547,037 17,486,981
Loans held for sale 7,080,788 923,825
Investment securities available for sale (AFS) - at fair value 1,545,931 1,547,798
Other equity securities 537,690 481,090
Loans, net of unearned fees 128,825,220 101,391,975
Less: Allowance for credit losses (1,610,500) (1,266,500)
---------------- ---------------
Loans, net 127,214,720 100,125,475
Premises and equipment, net 631,190 637,612
Accrued interest receivable and other assets 708,623 552,351
---------------- ---------------
Total Assets $ 157,935,896 $ 122,328,256
================ ===============
LIABILITIES
Non-interest-bearing deposits $ 19,090,600 $ 14,277,909
Interest-bearing deposits 123,194,245 94,252,992
---------------- ---------------
Total deposits 142,284,845 108,530,901
Short-term borrowings 1,550,000 1,222,000
Accrued expenses and other liabilities 643,296 508,855
Note payable 500,000 -
---------------- ---------------
Total Liabilities 144,978,141 110,261,756
---------------- ---------------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, authorized:
9,000,000 shares authorized, 1,903,960 and 1,862,710 issued and
outstanding as of September 30, 2004 and December 31, 2003,
respectively: 19,040 18,627
Additional paid in capital 17,262,921 16,850,834
Accumulated deficit (4,324,206) (4,802,961)
---------------- ---------------
Total Stockholders' Equity 12,957,755 12,066,500
---------------- ---------------
Total Liabilities and Stockholders' Equity $ 157,935,896 $ 122,328,256
================ ===============
See accompanying notes to consolidated financial statements.
2
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS For the
---------------------------------------------
three and nine-month periods ended September 30, 2004 and 2003
(Unaudited)
Three Months Ending Nine Months Ending
September 30 September 30
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------- ------------
INTEREST INCOME:
Interest and fees on loans $ 1,947,348 $ 1,394,714 $ 5,186,493 $ 3,897,224
Interest on federal funds sold and other
overnight investments 46,725 37,699 99,224 88,528
Taxable interest and dividends on investment
securities 7,035 5,307 26,820 23,214
------------ ------------ ------------- ------------
Total interest income 2,001,108 1,437,720 5,312,537 4,008,966
------------ ------------ ------------- ------------
INTEREST EXPENSE:
Interest on deposits 649,532 505,284 1,725,216 1,439,069
Interest on short-term borrowings 6,178 2,942 12,618 8,767
------------ ------------ ------------- ------------
Total interest expense 655,710 508,226 1,737,834 1,447,836
------------ ------------ ------------- ------------
Net interest income 1,345,398 929,494 3,574,703 2,561,130
Provision for credit losses 136,500 48,000 350,221 355,500
------------ ------------ ------------- ------------
Net interest income after provision for
credit losses 1,208,898 881,494 3,224,482 2,205,630
------------ ------------ ------------- ------------
NON-INTEREST INCOME:
Service charges on deposit accounts 66,447 58,263 178,025 149,015
Gain on sale of mortgage loans 50,576 102,060 181,697 320,576
Other income 15,579 9,563 41,703 27,239
------------ ------------ ------------- ------------
Total non-interest income 132,602 169,886 401,425 496,830
------------ ------------ ------------- ------------
NON-INTEREST EXPENSES:
Salaries and employee benefits 621,937 530,946 1,805,823 1,585,238
Occupancy expenses 80,930 66,041 223,945 193,405
Furniture and equipment expenses 62,912 60,533 185,482 159,091
Legal and professional fees 49,087 39,508 122,335 119,368
Data processing and other outside services 133,391 138,096 416,051 396,553
Advertising and marketing related expenses 55,687 42,940 140,661 164,284
Other expenses 93,184 65,968 252,855 208,263
------------ ------------ ------------- ------------
Total non-interest expenses 1,097,128 944,032 3,147,152 2,826,202
------------ ------------ ------------- ------------
Income (loss) before income taxes 244,372 107,348 478,755 (123,742)
Income tax benefit - - - -
------------ ------------ ------------- ------------
NET INCOME (LOSS) $ 244,372 $ 107,348 $ 478,755 $ (123,742)
============ ============ ============= ============
Per Share Data:
Cash Dividends Paid $ - - $ - $ -
Net Income (Loss) (basic) $ .13 $ .06 $ .26 $ (.08)
Net Income (Loss) (diluted) $ .13 $ .06 $ .25 $ (.08)
Weighted Average shares outstanding (basic) 1,872,058 1,862,710 1,865,849 1,592,153
Effect of Dilution - Stock options and
Warrants 60,799 25,595 60,416 -
------------ ------------ ------------- ------------
Weighted Average shares outstanding (diluted) 1,932,857 1,888,305 1,926,265 1,592,153
============ ============ ============= ============
See accompanying notes to consolidated financial statements.
3
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
For the nine-months ended September 30, 2004 and 2003
(Unaudited)
Additional
Paid in Accumulated
Common Stock Capital Deficit Total
------------- -------------- ----------------- -------------
Balances at December 31, 2003 $ 18,627 $ 16,850,834 $ (4,802,961) $ 12,066,500
Issuance of Common Stock 413 412,087 - 412,500
Net Income - - 478,755 478,755
------------- -------------- ----------------- -------------
Balances at September 30, 2004 $ 19,040 $ 17,262,921 $ (4,324,206) $ 12,957,755
============= ============== ================= =============
Additional
Paid in Accumulated
Common Stock Capital Deficit Total
------------- -------------- ----------------- -------------
Balances at December 31, 2002 $ 12,420 $ 12,407,780 $ (4,810,542) $ 7,609,658
Issuance of Common Stock 6,207 4,443,054 - 4,449,261
Net Loss - - (123,742) (123,742)
------------- -------------- ----------------- -------------
Balances at September 30, 2003 $ 18,627 $ 16,850,834 $ (4,934,284) $ 11,935,177
============= ============== ================= =============
See accompanying notes to consolidated financial statements.
4
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the nine-months ended September 30, 2004 and 2003
(Unaudited)
2004 2003
------------- -------------
Cash Flows From Operating Activities
Net income (loss) $ 478,755 $ (123,742)
Adjustments to reconcile net income (loss) to net cash provided (used)
by operating activities:
Depreciation 146,386 141,611
Accretion of investment discounts (12,250) (11,052)
Provision for credit losses 350,221 355,500
Gain on sale of loans held for sale (181,697) (320,576)
Origination of loans held for sale (72,407,201) (30,896,141)
Proceeds from sale of loans 66,431,935 32,493,097
Net increase in accrued interest receivable and other assets (156,272) (92,677)
Net increase (decrease) in accrued expenses and other liabilities 134,441 (222,228)
------------- -------------
Net cash (used) provided by operating activities (5,215,682) 1,323,792
------------- -------------
Cash Flows From Investing Activities
Purchases of investment securities - AFS (4,635,883) (4,738,252)
Maturities of investment securities - AFS 4,650,000 4,150,000
Purchase of Federal Reserve Bank stock - (36,750)
Purchase of Federal Home Loan Bank of Atlanta stock (56,600) (88,500)
Loan disbursements in excess of principal payments (27,439,466) (28,433,940)
Capital expenditures (139,964) (109,801)
------------- -------------
Net cash used by investing activities (27,621,913) (29,257,243)
------------- -------------
Cash Flows From Financing Activities
Net increase in deposits 33,753,944 30,914,752
Net increase in short-term borrowings 328,000 947,000
Net proceeds from notes payable 500,000 -
Net proceeds from stock issuance 412,500 4,449,261
------------- -------------
Net cash provided by financing activities 34,994,444 36,311,013
------------- -------------
Net increase in cash and cash equivalents 2,156,849 8,377,562
Cash and cash equivalents at beginning of period 18,060,105 12,115,736
------------- -------------
Cash and cash equivalents at end of period $ 20,216,954 $ 20,493,298
============= =============
Cash paid for:
Interest $ 1,678,360 $ 1,430,001
Income taxes $ - $ -
See accompanying notes to consolidated financial statements.
5
BAY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
Organization
Bay National Corporation (the "Company") was incorporated on June 3,
1999 under the laws of the State of Maryland to operate as a bank holding
company of a national bank with the name Bay National Bank (the "Bank"). On May
12, 2000, the Company purchased all the shares of common stock issued by the
Bank. The Bank commenced operations on May 12, 2000 after successfully meeting
the conditions of the Office of the Comptroller of the Currency (the "OCC") to
receive its charter authorizing it to commence operations as a national bank,
and obtaining the approval of the Federal Deposit Insurance Corporation to
insure its deposit accounts, and meeting certain other regulatory requirements.
Basis of Presentation
The accompanying consolidated financial statements include the activity
of Bay National Corporation and its wholly owned subsidiary, Bay National Bank.
All significant intercompany transactions and balances have been eliminated in
consolidation.
The foregoing consolidated financial statements are unaudited; however,
in the opinion of management, all adjustments (comprising only normal recurring
accruals) necessary for a fair presentation of the results of the interim
periods have been included. The balances as of December 31, 2003 have been
derived from audited financial statements. These statements should be read in
conjunction with the financial statements and accompanying notes included in Bay
National Corporation's 2003 Annual Report on Form 10-KSB. There have been no
significant changes to the Company's Accounting Policies as disclosed in the
2003 Annual Report. The results shown in this interim report are not necessarily
indicative of results to be expected for the full year 2004.
The accounting and reporting policies of the Company conform to
accounting principles generally accepted in the United States of America.
Reclassifications
Certain reclassifications have been made to amounts previously reported
to conform to the current presentation. These reclassifications had no effect on
previously reported results of operations or accumulated deficit.
2. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital action, the
Bank must meet specific capital guidelines that involve quantitative measures of
the Bank's assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weighting and other factors.
6
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios. Management
believes, as of September 30, 2004, that the Bank meets all capital adequacy
requirements to which it is subject.
As of September 30, 2004, the Bank has been categorized as "Well
Capitalized" by the OCC under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, the Bank must maintain minimum
total risk-based, Tier I risk-based, and Tier I leverage ratios.
3. INCOME TAXES
The Company uses the liability method of accounting for income taxes as
required by SFAS No. 109, "Accounting for Income Taxes." Under the liability
method, deferred-tax assets and liabilities are determined based on differences
between the financial statement carrying amounts and the tax bases of existing
assets and liabilities (i.e., temporary differences) and are measured at the
enacted rates that will be in effect when these differences reverse. Deferred
income taxes will be recognized when it is deemed more likely than not that the
benefits of such deferred income taxes will be realized; accordingly, no
deferred income taxes or income tax benefits have been recorded by the Company.
4. EARNINGS PER SHARE
Earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per common share is computed by dividing net income by the weighted
average number of common shares outstanding during the period, including any
potential dilutive common shares outstanding, such as options and warrants.
For the nine-month period ended September 30, 2003, the effect of
incremental shares from options and warrants of 204,156 has been excluded from
diluted weighted average shares as the effect would have been antidilutive.
5. STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123) and Statement of Financial Accounting Standards No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS
No. 148), and applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its stock option plan. No compensation
expenses related to the Company's stock option plan were recorded during the
three-month and nine-month periods ended September 30, 2004 and 2003.
7
The following table illustrates the effect on net income (loss) and
earnings (loss) per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 and SFAS No. 148 to stock-based employee compensation
for the three-month and nine-month periods ended September 30:
Three Months Ending Nine Months Ending
September 30 September 30
----------------------------- --------------------------------
2004 2003 2004 2003
------------ ------------ ------------- ------------
INTEREST INCOME:
Net income (loss), as reported $ 244,372 $ 107,348 $ 478,755 $ (123,742)
Less pro forma stock-based compensation
expense determined under the fair value
method (1,404) (1,404) (73,076) (68,554)
------------ ------------ ------------- ------------
Pro forma net income (loss) $ 242,968 $ 105,944 $ 405,679 $ (192,296)
============ ============ ============= ============
Net income (loss) per share:
Basic - as reported $ .13 $ .06 $ .26 $ (.08)
Diluted - as reported $ .13 $ .06 $ .25 $ (.08)
Basic - pro forma $ .13 $ .06 $ .22 $ (.12)
Diluted - pro forma $ .13 $ .06 $ .21 $ (.12)
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion and analysis provides an overview of the financial
condition and results of operations of Bay National Corporation (the "Parent")
and its national bank subsidiary, Bay National Bank (the "Bank"), collectively
(the "Company"), as of September 30, 2004 and December 31, 2003 and for the
three-month and nine-month periods ended September 30, 2004 and 2003.
General
On May 12, 2000 the Parent became a bank holding company by purchasing
all of the common stock of the Bank. The Bank opened its first office on May 12,
2000 and its second office on May 26, 2000.
The Bank was formed to serve the business communities of North
Baltimore and Salisbury, Maryland.
Overview
The Company continued a pattern of strong growth during the three-month
and nine-month periods ended September 30, 2004. This growth has resulted in
improved operating results as compared to prior periods. Key measurements for
the three-month and nine-month periods ended September 30, 2004 include the
following:
o Total assets at September 30, 2004 increased by 29.11% to
$157.9 million as compared to $122.3 million as of December
31, 2003.
o Net loans outstanding increased by 27.06% from $100.1 million
as of December 31, 2003 to $127.2 million as of September 30,
2004.
o Nonperforming loans at September 30, 2004 totaled
approximately $11,000. Appropriate reserves for loan losses
continue to be maintained.
o Deposits at September 30, 2004 were $142.3 million, an
increase of $33.8 million or 31.10% from December 31, 2003.
o On September 28, 2004, the Company entered into a $5 million,
three year unsecured non-revolving credit facility with
another financial institution. The proceeds from the credit
facility will be used to provide regulatory capital to the
Bank. The loan bears interest at the prime rate. As of
September 30, 2004, $500,000 was outstanding under this
facility.
o The Company realized net income of $244,372 and $478,755 for
the three-month and nine-month periods ended September 30,
2004. This compares to net income of $107,348 and a net loss
of $(123,742) for the three-month and nine-month periods ended
September 30, 2003.
o Net interest income, the Company's main source of income, was
$1.3 million and $3.6 million during the three-month and
nine-month periods ended September 30, 2004 compared to
$929,494 and $2.6 million for the same periods in 2003. This
represents increases of 44.75% and 39.58% for the three-months
and nine-months ended September 30, 2004 as compared to the
same periods in 2003.
9
o Loan charge-offs were $6,221 for the nine-month period ended
September 30, 2004. There were no charge-offs for the same
period in 2003.
o Non-interest income declined by $37,284 and $95,405, or 21.95%
and 19.20%, for the three-month and nine-month periods ended
September 30, 2004, as compared to the three-month and
nine-month periods ended September 30, 2003.
o Non-interest expenses increased by $153,096 or 16.22%, and
$320,950 or 11.36% for the three-month and nine-month periods
ended September 30, 2004, as compared to the same periods
ended September 30, 2003.
o The market price of common shares ended the quarter at $11.25,
up 11.39% from the closing price of $10.10 on December 31,
2003.
A detailed discussion of the factors leading to these changes can be
found in the discussion below.
Results of Operations
Overview
The Company recorded net income of $244,372 and $478,755 for the
three-month and nine-month periods ended September 30, 2004. This compares to
net income of $107,348 and a net loss of $(123,742) for the same periods in
2003. This is an improvement of $137,024 for the three-month period and $602,497
for the nine-month period. This significant improvement in results for the
periods is due to the continued strong growth of the loan portfolio, which
reached the levels necessary to generate sufficient net interest income to cover
operating expenses. The losses incurred through May 31, 2003 were expected since
loan and deposit growth initially were not expected to produce net interest
income sufficient to cover operating expenses. On average, community banks do
not achieve profitability for the first 24 to 36 months of operation. The
Company achieved marginal monthly profitability for the month of June 2003, its
37th full month of operations.
Bay National Bank's mortgage division, based in Salisbury, Maryland,
originates conventional first and second residential mortgage loans. Bay
National Bank sells most of its first and second residential mortgage loans in
the secondary market and typically recognizes a gain on the sale of these loans
after the payment of commissions to the loan origination officer. Since its
inception in February 2001, the mortgage division has been a significant
contributor to operating results. For the three-month periods ended September
30, 2004 and 2003, gains on the sale of mortgage loans totaled $50,576 and
$102,060, respectively. For the nine-month periods ended September 30, 2004 and
2003, gains on the sale of mortgage loans totaled $181,697 and $320,576,
respectively. The level of gains on the sale of mortgage loans has declined in
2004 due to the strengthening of economic conditions and the resulting increase
in long-term interest rates as compared to the rates in effect during the first
half of 2003. An increase in rates traditionally has a negative impact on
mortgage loan production due to a reduction in the incentive for borrowers to
refinance existing mortgages or purchase new homes.
During the second quarter of 2004, the Company introduced a new loan
program for conventional first and second residential mortgage loans. Under this
program the Company purchases a 100% participation in mortgage loans originated
by a mortgage company in the Baltimore metropolitan area. These participations
are for loans which a secondary market investor has committed to purchase. The
participations are typically held for a period of three to
10
four weeks before being sold to the secondary market investor. This holding
period represents the amount of time taken by the secondary market investor to
review the loan files for completeness and accuracy. During this holding period,
the Company earns interest on these loans at a rate indexed to the prime rate.
The primary risk to the Company is that the secondary market investor may
decline to purchase the loans due to documentary deficiencies or errors. The
Company attempts to manage this risk by conducting a thorough review of the
documentation prior to purchasing the participation. If the secondary market
investor declines to purchase the loan, the Company could attempt to sell the
loan to other investors or hold the loan in its loan portfolio. As of September
30, 2004, the Company held $7.0 million of these loans which were classified as
held for sale. The Company earned $186,407 of interest on this program from
inception through September 30, 2004.
Management expects continued improvement in operating results over the
remainder of 2004; however, actual results will be subject to the volatility of
the provision for credit losses, which is related to loan growth, and the
volatility of mortgage loan production, which is sensitive to economic and
interest rate fluctuations.
Net Interest Income
Net interest income is the difference between income on assets and the
cost of funds supporting those assets. Earning assets are composed primarily of
loans, investments, and federal funds sold. Interest-bearing deposits and other
short-term borrowings make up the cost of funds. Non-interest bearing deposits
and capital are also funding sources. Changes in the volume and mix of earning
assets and funding sources along with changes in associated interest rates
determine changes in net interest income.
As previously stated, net interest income was $1.3 million and $3.6
million during the three-month and nine-month periods ended September 30, 2004
as compared to $929,494 and $2.6 million for the same periods in 2003. This
represents increases of 44.75% and 39.58% for the three-month and nine-months
ended September 30, 2004 as compared to the same periods in 2003.
Interest income from loans and investments for the three-month and
nine-month periods ended September 30, 2004 was $2,001,108 and $5,312,537,
respectively, compared to $1,437,720 and $4,008,966 for the three-month and
nine-month periods ended September 30, 2003. The 39.19% and 32.52% increases
over the same periods in 2003 are directly related to the 31.05% increase in
average interest-earning assets for the nine-months ended September 30, 2004 as
compared to the same period in 2003. The increase in average interest-earning
assets was also aided by a slight increase in average yields due to three .25%
increases in the target federal funds rate since June 30, 2004. The yields on
these assets increased from 5.08% for the nine months ended September 30, 2003
to 5.14% for the nine months ended September 30, 2004.
The percentage of average interest-earning assets represented by loans
was 87.12% and 82.33% for the nine-month periods ended September 30, 2004 and
2003, respectively. An increase in the percentage of interest-earning assets
represented by the loan portfolio would normally result in an increase in
average yields on interest-earning assets. However, loan yields have fluctuated
as a result of actions taken by the Federal Reserve to reduce its target for the
federal funds rate from 1.25% at December 31, 2002 to 1.00% effective June 25,
2003. For the nine-month period ended September 30, 2004, the average yield on
the loan portfolio decreased to 5.76% from 6.00% for the nine-month period ended
September 30, 2003. This decrease is primarily due to the difference in the
target federal funds rate in effect for the periods. The Federal Reserve
increased its target for the federal funds rate to: 1.25% effective June 30,
2004; 1.50% effective August 10, 2004; and 1.75% effective September 21, 2004.
While these increases
11
had minimal effect on the Company's results for the three-month and nine-month
periods ended September 30, 2004, improved yields on earning assets in future
periods should occur.
The average yield on the investment portfolio, including overnight
investments, was .95% for the nine-month period ended September 30, 2004 as
compared to .80% for the same period in 2003. The improvement in the average
yield was a direct result of the most recent Federal Reserve actions discussed
above, as well as an increase in the holdings of Federal Reserve and Federal
Home Loan bank stocks, which pay dividend yields greater than the prevailing
federal funds rates. The percentage of average interest-earning assets
represented by investments was 12.88% and 17.67% for the nine-month periods
ended September 30, 2004 and 2003, respectively.
Interest expense from deposits and short-term borrowings for the
three-month and nine-month periods ended September 30, 2004 was $655,710 and
$1,737,834, respectively. This compares to $508,226 and $1,447,836 for the
comparable periods in 2003. The 29.02% and 20.03% increases over the three and
nine-month periods in 2003 are a result of a 30.80% increase in average
interest-bearing liabilities for the nine-month period ended September 30, 2004
as compared to the same period in 2003. The increase in interest expense
resulting from the growth in interest-bearing liabilities was offset by
decreases in average rates paid. Average rates paid on these liabilities
declined from 2.31% for the nine-month period ended September 30, 2003 to 2.12%
for the nine-month period ended September 30, 2004.
12
The following tables set forth, for the periods indicated, information
regarding the average balances of interest-earning assets and interest-bearing
liabilities, the amount of interest income and interest expense and the
resulting yields on average interest-earning assets and rates paid on average
interest-bearing liabilities. Average balances are also provided for
non-interest-earning assets and non-interest-bearing liabilities.
Nine Months Ended September 30, 2004
Average Interest Yield/
Balance and fees Rate
------- -------- ----
ASSETS
Loans $ 120,097,860 $ 5,186,493 5.76%
Investment Securities 2,022,488 26,820 1.77
Federal funds sold and other overnight investments 15,729,612 99,224 .84
---------------- ------------
Total Earning Assets 137,849,960 5,312,537 5.14%
------------
Less: Allowance for credit losses (1,406,395)
Cash and due from banks 859,704
Premises and equipment, net 650,349
Accrued interest receivable and other assets 556,700
----------------
Total Assets $ 138,510,318
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 44,806,717 359,507 1.07%
Regular savings deposits 4,015,492 19,556 .65
Time deposits 59,201,495 1,346,153 3.03
Short-term borrowings 1,456,369 12,618 1.16
---------------- ------------
Total interest-bearing liabilities 109,480,073 1,737,834 2.12%
------------
Non-interest-bearing demand deposits 16,306,404
Accrued expenses and other liabilities 463,110
Stockholders' equity 12,260,731
----------------
Total Liabilities and Stockholders' Equity $ 138,510,318
================
Net interest income and spread $ 3,574,703 3.02%
============
Interest and fee income/earning assets 5.14 %
Interest expense/earning assets 1.68
----------------
Net interest margin 3.46 %
================
13
Nine Months Ended September 30, 2003
Average Interest Yield/
Balance and fees Rate
------- -------- ----
ASSETS
Loans $ 86,597,916 $ 3,897,224 6.00%
Investment Securities 1,767,831 23,214 1.75
Federal funds sold and other overnight investments 16,824,118 88,528 .70
---------------- ------------
Total Earning Assets 105,189,865 4,008,966 5.08%
------------
Less: Allowance for credit losses (1,048,040)
Cash and due from banks 966,645
Premises and equipment, net 697,910
Accrued interest receivable and other assets 420,175
----------------
Total Assets $ 106,226,555
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 33,305,177 289,794 1.16%
Regular savings deposits 2,757,423 14,460 .70
Time deposits 46,480,030 1,134,815 3.26
Short-term borrowings 1,159,959 8,767 1.01
---------------- ------------
Total interest-bearing liabilities 83,702,589 1,447,836 2.31%
------------
Non-interest-bearing demand deposits 12,181,260
Accrued expenses and other liabilities 357,272
Stockholders' equity 9,985,434
----------------
Total Liabilities and Stockholders' Equity $ 106,226,555
================
Net interest income and spread $ 2,561,130 2.77%
============
Interest and fee income/earning assets 5.08 %
Interest expense/earning assets 1.84
----------------
Net interest margin 3.24 %
================
Provision for Credit Losses
The provision for credit losses was $136,500 and $350,221 for the
three-month and nine-month periods ended September 30, 2004, as compared to
$48,000 and $355,500 for the three-month and nine-month periods ended September
30, 2003. The provisions for each period were the direct result of growth in
loan balances outstanding in all segments of the portfolio. The provision for
the nine-month period ended September 30, 2004 was nominally lower than the same
period in the prior year due to fact that gross loans outstanding increased by
approximately $27.4 million during that period as compared to an increase of
approximately $28.4 million for the same period in 2003. For additional
information regarding the methodology used to determine the provision for credit
losses see the Management Discussion and Analysis section entitled "Allowance
for Credit Losses and Credit Risk Management."
Non-Interest Income
Non-interest income consists primarily of gains on the sale of mortgage
loans, deposit account service charges, and cash management fees. For the
three-month period ended September 30, 2004, the Company realized non-interest
income in the amount of $132,602 as compared to $169,886 for the three-month
period ended September 30, 2003. Gains on the sale of mortgage loans of $50,576
comprise 38.14% of the total for the three-month period ended September 30,
14
2004. This compares to gains on the sale of mortgage loans of $102,060, or
60.01% of total non-interest income, for the three-month period ended September
30, 2003.
For the nine-month period ended September 30, 2004, the Company
realized non-interest income in the amount of $401,425 as compared to $496,830
for the nine-month period ended September 30, 2003. Gains on the sale of
mortgage loans of $181,697 comprised 45.26% of the total for the nine-month
period ended September 30, 2004. This compares to gains on the sale of mortgage
loans of $320,576, or 64.52% of total non-interest income, for the nine-month
period ended September 30, 2003.
The level of gains on the sale of mortgage loans has declined due to
recent increases in long-term interest rates driven by stronger economic
conditions. Additional increases in interest rates, or a slow down in the
housing market, could further impact the Company's ability to maintain the same
level of non-interest income associated with mortgage loan production.
Service charges on deposit accounts totaled $66,447 and $178,025 for
the three-month and nine-month periods ended September 30, 2004, as compared to
$58,263 and $149,015 for the three-month and nine-month periods ended September
30, 2003. The increases of 14.05% and 19.47% for the three and nine-month
periods, as compared to the same periods in 2003, can be directly attributed to
the ongoing growth in the Company's deposit portfolio.
The Company will continue to seek ways to expand its sources of
non-interest income. In the future, the Company may enter into fee arrangements
with strategic partners that offer investment advisory services, risk management
and employee benefit services. No assurance can be given that such fee
arrangements will be obtained or maintained.
Non-Interest Expense
Non-interest expense for the three-month and nine-month periods ended
September 30, 2004, totaled $1,097,128 and $3,147,152, respectively. This
compares to non-interest expense for the comparable periods in 2003 of $944,032
and $2,826,202, respectively. The increase of $320,950, or 11.36%, for the
nine-month period resulted from an increase in salaries and benefits of $220,585
related to staffing growth to increase marketing efforts, manage the growth of
the loan and deposit portfolios, and support increased operational volume.
Occupancy expenses increased by $30,540, or 15.79%, for the nine-months ended
September 30, 2004 as compared to the same period in 2003. This increase was due
in part to scheduled rent increases as well as a reduction in sublease income of
approximately $7,700 due to expansion of the Company's corporate office into
previously sublet space, and $14,400 of rental expenses associated with new
space obtained to facilitate the expansion of the Company's corporate offices.
The $19,498, or 4.92%, increase in data processing and other outside services
for the nine-months ended September 30, 2004 as compared to the same period in
2003 is the result of increased data and item processing costs paid to external
service providers. These costs are volume-driven based upon the number of
customer accounts and related transaction volume. As a result, these costs
increase with the growth of the Company. The $23,623, or 14.38%, decrease in
advertising and marketing-related expenses for the nine-months ended September
30, 2004 as compared to the same period in 2003 is related to a reduction in the
number of events and marketing campaigns conducted. This reduction was made
possible through the use of more efficient marketing methods and through the
success of prior campaigns which increased the visibility of the Bank in its
markets. The increase of $73,950, or 15.20%, in all other expenses relates to
various costs associated with the increased size and complexity of the Company.
Non-interest expense for the three-month period ended September 30,
2004 increased by $153,096, or 16.22%, as compared to the same period for the
prior year. The increase is directly
15
attributable to the same factors that resulted in the increase for the
comparable nine-month periods.
The rate of increase in non-interest expenses is substantially less than
the 39.58% increase in net interest income for the nine-month period ended
September 30, 2004 as compared to the nine-month period ended September 30,
2003. Management believes this indicates that the Company is continuing to
effectively leverage its cost structure to generate profitable growth. While
management expects that the ongoing growth of the Company's customer base will
continue to require additional staffing in order to appropriately service
customers and manage the business effectively, management believes that
additional growth in the customer base can continue to be accomplished without
proportionate increases in these costs.
Income Taxes
When the realization of deferred income taxes is deemed to be more
likely than not, the recordation of previously unrecorded net deferred income
tax assets will have a positive effect on the earnings in the period when such
determination is made. As of December 31, 2003, the Company had net deferred tax
assets of approximately $1.8 million that were eliminated through a valuation
allowance. Subsequent to the recordation of deferred taxes, the Company will
begin to record income tax expense at the statutory rate. Since inception, the
Company has not recorded any income tax expense or benefit. Recognizing income
tax expense in future periods will have a detrimental effect on reported
earnings.
Financial Condition
Composition of the Balance Sheet
As of September 30, 2004, total assets were $157,935,896. This
represents growth of $35,607,640 or 29.11% since December 31, 2003. The growth
in total assets included increases of $96,793 in cash and due from banks,
$2,060,056 in federal funds sold and other overnight investments, $6,156,963 in
loans held for sale, $56,600 in other equity securities, $27,089,245 in loans
net of the allowance for credit losses and $149,850 in other non-earning assets.
These increases were offset by a slight decrease of $1,867 in investment
securities available for sale.
During the second quarter of 2004, the Company introduced a new loan
program for conventional first and second residential mortgage loans. Under this
program the Company purchases a 100% participation in mortgage loans originated
by a mortgage company in the Baltimore metropolitan area. These participations
are for loans that a secondary market investor has committed to purchase. The
participations are typically held for a period of three to four weeks before
being sold to the secondary market investor. The Company earns interest on these
loans at a rate indexed to the prime rate. As of September 30, 2004, the Company
held $7.0 million of these loans which were classified as held for sale.
As of September 30, 2004, loans, excluding loans held for sale (net of
a $1,610,500 allowance for credit losses), totaled $127,214,720. The increase of
27.06%, from a balance of $100,125,475 as of December 31, 2003, is a
continuation of the growth trend established in prior periods. The Company
continues to emphasize prudent growth through the hiring of experienced
commercial lenders, and the development and use of referral sources including
accountants, lawyers and existing customers, as well as members of the Board of
Directors and the Baltimore and Salisbury Advisory Boards.
The composition of the loan portfolio as of September 30, 2004 was
approximately $69.6 million of commercial loans, $2.3 million of consumer loans,
and $56.9 million of real estate loans (excluding mortgage loans held for sale).
The composition of the loan portfolio
16
as of December 31, 2003 was approximately $61.9 million of commercial loans,
$1.7 million of consumer loans, and $37.8 million of real estate loans
(excluding mortgage loans held for sale). Mortgage loans held for sale were $7.1
million and $923,825 as of September 30, 2004 and December 31, 2003,
respectively.
Funds not extended in loans are invested in cash and due from banks,
federal funds sold and other overnight investments, and short-term U.S. Treasury
securities. At September 30, 2004, the Company had federal funds sold and other
overnight investments totaling $19,547,037 as compared to $17,486,981 as of
December 31, 2003. The Company held $312,690 of Federal Reserve Bank stock at
September 30, 2004 and December 31, 2003, respectively. The Company also held
Federal Home Loan Bank of Atlanta stock of $225,000 and $168,400 as of September
30, 2004 and December 31, 2003, respectively, and United States Treasury bills
with a maturity value of $1,550,000 as of both September 30, 2004 and December
31, 2003. The Treasury securities are used to collateralize repurchase
agreements which are classified as short-term borrowings under which $1,550,000
and $1,222,000 were outstanding as of September 30, 2004 and December 31, 2003,
respectively. The increase in total assets is related to the strong deposit
growth of $33.8 million or 31.10% since December 31, 2003, as well as $328,000
in additional short-term borrowings, $500,000 in borrowings under a note
payable, and $412,500 in proceeds from the issuance of common stock upon the
exercise of stock warrants. Management has made a decision to maintain an
appropriate level of liquidity in the investment portfolio in order to ensure
that funds are readily available to fund the growth of the loan portfolio and to
meet the needs of deposit customers.
Deposits at September 30, 2004 were $142,284,845, of which $7,798,704,
or 5.48% are related to two customers in one industry. Deposits at December 31,
2003 were $108,530,901, of which deposits for these same customers stood at
$7,749,590 or 7.14% of total deposits. The deposits for these customers tend to
fluctuate significantly; as a result, management monitors these deposits on a
daily basis to ensure that liquidity levels are adequate to compensate for these
fluctuations. Deposit growth resulted from the continued marketing efforts of
officers and directors, direct mail campaigns and the listing of money market
and certificate of deposit rates in print publications and on the national
market. Management has set the interest rates paid on deposits to be competitive
in the market and will continue its marketing activities to generate growth in
deposits.
The market in which the Company operates is very competitive;
therefore, the rates of interest paid on deposits are affected by rates paid by
other depository institutions. Management closely monitors rates offered by
other institutions and seeks to be competitive within the market. The Company
has chosen to selectively compete for large certificates of deposits. The
Company will choose to pursue such deposits when expected loan growth provides
for adequate spreads to support the cost of those funds. As of September 30,
2004, the Company had outstanding certificates of deposit of approximately $30.2
million that were obtained through the listing of certificate of deposit rates
on two Internet-based listing services (such deposits are sometimes referred to
herein as national market certificates of deposit). These certificates of
deposit were issued with an average yield of 2.82% and an average term of 29.6
months. Included in the $30.2 million of Internet-originated certificates of
deposit is $394,013 that has been classified as "Brokered Deposits" for bank
regulatory purposes. These "Brokered Deposits" were issued in average amounts of
approximately $98,503 with an average yield of 3.62% and an average term of
40.53 months. As of December 31, 2003, the total certificates of deposit
obtained through the listing of certificate of deposit rates on the
Internet-based listing services were approximately $25 million, of which
$790,157 were classified as "Brokered Deposits." The Company has never paid
broker fees for deposits. Additionally, the Company has not accepted any new
"Brokered Deposits" since August 2002.
17
Core deposits, which management categorizes as all deposits other than
national market certificates of deposit and all but $2.0 million of deposits
from the two large customers described above (which management considers to be a
stable deposit amount from these customers based upon historical trends), stood
at $106,271,575 as of September 30, 2004, up 36.70% from $77,742,030 as of
December 31, 2003. Core deposits are closely monitored by management because
they consider such deposits not only a relatively stable source of funding but
also reflective of the growth of commercial and consumer depository
relationships.
Short-term borrowings consist of repurchase agreements collateralized
by pledges of U.S. Government Treasury Securities, based upon their market
values, equal to 100% of the principal and accrued interest of its short-term
borrowings. The outstanding balance of short-term borrowings increased from
$1,222,000 at December 31, 2003 to $1,550,000 at September 30, 2004, due to
increases in the balance of available funds for customers participating in this
program.
Note payable consists of $500,000 borrowed under a $5 million,
three-year unsecured non-revolving credit facility executed on September 28,
2004 with another financial institution. Borrowings under the credit facility
will be used to provide regulatory capital to the Bank. The loan bears interest
at the prime rate.
Total stockholders' equity at September 30, 2004 was $12,957,755 as
compared to $12,066,500 at December 31, 2003. The increase in stockholders'
equity is a result of the positive operating results for the nine-months ended
September 30, 2004, and $412,500 received upon the issuance of 41,250 shares of
common stock upon the exercise of warrants. Management believes that this level
of capital is adequate to support projected asset growth for at least the next
12 months.
Allowance for Credit Losses and Credit Risk Management
Originating loans involves a degree of risk that credit losses will
occur in varying amounts according to, among other factors, the type of loans
being made, the credit-worthiness of the borrowers over the term of the loans,
the quality of the collateral for the loan, if any, as well as general economic
conditions. The Company charges the provision for credit losses to earnings to
maintain the total allowance for credit losses at a level considered by
management to represent its best estimate of the losses known and inherent in
the portfolio that are both probable and reasonable to estimate, based on, among
other factors, prior loss experience, volume and type of lending conducted,
estimated value of any underlying collateral, economic conditions (particularly
as such conditions relate to Bay National Corporation's market area), regulatory
guidance, peer statistics, management's judgment, past due loans in the loan
portfolio and concentrations of risk (if any). The Company charges losses on
loans against the allowance when it is believed that collection of loan
principal is unlikely. Recoveries on loans previously charged off are added back
to the allowance.
Management uses a loan grading system where all loans are graded based
upon management's evaluation of the risk associated with each loan. A factor,
based on the loan grading, is applied to the loan balance to reserve for
potential losses. In addition, management judgmentally establishes an additional
nonspecific reserve. The nonspecific portion of the allowance reflects
management's estimate of probable inherent, but undetected losses, within the
portfolio due to uncertainties in economic conditions, delays in obtaining
information, including unfavorable information about a borrower's financial
condition, the difficulty in identifying triggering events that correlate
perfectly to subsequent loss rates and risk factors that have not yet manifested
themselves in loss allocation factors.
18
The reserve factors used are based on management's judgment as to
appropriate reserve percentages for various categories of loans, and adjusting
those values based on the following: historical losses in each category;
historical and current delinquency in each category; underwriting standards in
each category; comparison of losses and delinquencies to peer group performance;
and an assessment of the likely impact of economic and other external conditions
on the performance of each category.
A test of the adequacy of the allowance for credit losses is performed
and reported to the Board of Directors on a monthly basis. Management uses the
information available to make a determination with respect to the allowance for
credit losses, recognizing that the determination is inherently subjective and
that future adjustments may be necessary depending upon, among other factors, a
change in economic conditions of specific borrowers, or generally in the
economy, and new information that becomes available. However, there are no
assurances that the allowance for credit losses will be sufficient to absorb
losses on nonperforming assets, or that the allowance will be sufficient to
cover losses on nonperforming assets in the future.
The allowance for credit losses as of September 30, 2004 and December
31, 2003 was $1,610,500 and $1,266,500, respectively. The amount equates to
1.25% of outstanding loans, net of loans held for sale, as of September 30, 2004
and December 31, 2003. This percentage has remained consistent because no
additional information has indicated that the overall level of reserves is
inappropriate. Bay National Corporation has no exposure to foreign countries or
foreign borrowers. Management believes that the allowance for credit losses is
adequate for each period presented.
As of September 30, 2004 the Company had one loan of approximately
$11,000 that was more than 90 days past due and therefore classified as a
non-accrual loan. The Company had loan charge-offs of $6,221 during the
nine-months ended September 30, 2004 with no charge-offs occurring during the
three-months ended September 30, 2004. These charge-offs were the first loan
charge-offs incurred since the Company's inception in 2000.
Liquidity and Interest Rate Sensitivity
The Company's principal sources of liquidity are cash and assets that
can be readily converted into cash, including investment securities, and loans
held for sale which can be liquidated in a timeframe which is usually less than
30 days. The Company also has commitments for a total of $7 million of borrowing
availability under unsecured Federal funds lines of credit with three separate
financial institutions, approximately $10 million of borrowing capacity with the
Federal Home Loan Bank of Atlanta and $4,500,000 of borrowing capacity under its
three-year note payable. The credit facilities can be used in conjunction with
the normal deposit strategies, which include pricing changes to increase
deposits as necessary.
As of September 30, 2004, the Company had $669,917 in cash and due from
banks, and $19,547,037 in federal funds sold and other overnight investments.
This represents an increase in liquid assets of $2,156,849, or 11.94%, since
December 31, 2003, at which time liquid assets consisted of $573,124 in cash and
due from banks and $17,486,981 in federal funds sold and other overnight
investments. The increase in the overall level of liquid assets is the result of
strong deposit growth of $33.8 million or 31.10% since December 31, 2003, as
well as $328,000 in additional short-term borrowings, $500,000 in borrowings
under the note payable, and $412,500 in proceeds from the issuance of common
stock upon the exercise of warrants.
19
The Company has sufficient liquidity to meet its loan commitments as
well as fluctuations in deposits. The Company will choose to retain maturing
certificates of deposit, when necessary, by offering competitive rates.
Management is not aware of any demands, trends, commitments, or events that
would result in the Company's inability to meet anticipated or unexpected
liquidity needs.
The primary objective of asset/liability management is to ensure the
steady growth of the Company's primary earnings component, net interest income.
Net interest income can fluctuate with significant interest rate movements. To
minimize the risk associated with these rate swings, management works to
structure the Company's balance sheet so that the ability exists to adjust
pricing on interest-earning assets and interest-bearing liabilities in roughly
equivalent amounts at approximately the same time intervals. Imbalances in these
repricing opportunities at any point in time constitute interest rate
sensitivity.
The measurement of the Company's interest rate sensitivity, or "gap,"
is one of the principal techniques used in asset/liability management. The
interest sensitive gap is the dollar difference between assets and liabilities
subject to interest rate pricing within a given time period, including both
floating rate or adjustable rate instruments and instruments which are
approaching maturity.
The following table sets forth the amount of the Company's
interest-earning assets and interest-bearing liabilities as of September 30,
2004, which are expected to mature or reprice in each of the time periods shown:
Maturity or repricing within
Percent 0 to 3 4 to 12 1 to 5 Over 5
Amount of Total Months Months Years Years
------ -------- ------ ------ ----- -----
Interest-earning assets
Federal funds sold and other
overnight investments $19,547,037 12.41% $ 19,547,037 $ - $ - $ -
Loans held for sale 7,080,788 4.50 7,080,788
Loans - Variable rate 95,251,495 60.46 95,251,495 - - -
Loans - Fixed rate 33,573,725 21.31 1,976,413 5,495,023 23,918,164 2,184,125
Other earning assets 2,083,621 1.32 1,545,931 - - 537,690
----------- ----------- ----------- ----------- ----------- -----------
Total interest-earning
assets $157,536,666 100.00% $125,401,664 $ 5,495,023 $23,918,164 $ 2,721,815
============= =========== =========== =========== =========== ===========
Interest-bearing liabilities
Deposits - Variable rate $ 56,882,111 45.42% $ 56,882,111 $ - $ - $ -
Deposits - Fixed rate 66,312,134 52.94 6,382,769 28,090,145 31,839,220 -
Short-term borrowings
- Variable rate 1,550,000 1.24 1,550,000 - - -
Note Payable 500,000 .40 500,000 - - -
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing
liabilities $125,244,245 100.00% $ 65,314,880 $28,090,145 $31,839,220 $ -
=========== =========== ============ =========== =========== ===========
Periodic repricing differences
Periodic gap $ 60,086,784 $(22,595,122) $(7,921,056) $ 2,721,815
============ ============ =========== ===========
Cumulative gap $ 60,086,784 $ 37,491,662 $29,570,606 $32,292,421
============ ============ =========== ===========
Ratio of rate sensitive assets
to rate sensitive liabilities 192.00% 19.56% 75.12% N/A
The Company has 77.37% of its interest-earning assets and 47.06% of its
interest-bearing liabilities in variable rate balances. Interest-earning assets
exceed interest-bearing liabilities by $32,292,421. The majority of this gap is
concentrated in items maturing or repricing within 12
20
months. This gap is generally reflective of the Company's emphasis on
originating variable rate loans and the demand in the market for higher yielding
fixed rate deposits. This analysis indicates that the Company generally will
benefit from increasing market rates of interest. However, since all interest
rates and yields do not adjust at the same pace, the gap is only a general
indicator of interest rate sensitivity. The analysis of the Company's
interest-earning assets and interest-bearing liabilities presents only a static
view of the timing of maturities and repricing opportunities, without taking
into consideration the fact that changes in interest rates do not affect all
assets and liabilities equally. Net interest income may be affected by other
significant factors in a given interest rate environment, including changes in
the volume and mix of interest-earning assets and interest-bearing liabilities.
Management constantly monitors and manages the structure of the
Company's balance sheet, seeks to control interest rate exposure, and evaluate
pricing strategies. Strategies to better match maturities of interest-earning
assets and interest-bearing liabilities include structuring loans with rate
floors and ceilings on variable-rate notes and by providing for repricing
opportunities on fixed rate notes. Management believes that a lending strategy
focusing on variable-rate loans and short-term fixed rate loans will best
facilitate the goal of minimizing interest rate risk. However, management will
opportunistically enter into longer term fixed-rate loans and/or investments
when, in management's judgment, rates adequately compensate the Company for the
interest rate risk. The Company's current investment concentration in federal
funds sold and other overnight investments provides the most flexibility and
control over rate sensitivity since it generally can be restructured more
quickly than the loan portfolio. On the liability side, deposit products can be
restructured so as to offer incentives to attain the maturity distribution
desired although competitive factors sometimes make control over deposit
maturity difficult.
In theory, maintaining a nominal level of interest rate sensitivity can
diminish interest rate risk. In practice, this is made difficult by a number of
factors, including cyclical variation in loan demand, different impacts on
interest sensitive assets and liabilities when interest rates change, and the
availability of funding sources. Management generally attempts to maintain a
balance between rate-sensitive assets and liabilities as the exposure period is
lengthened to minimize the overall interest rate risk to the Company.
Off-Balance Sheet Arrangements
In the normal course of business the Company is a party to financial
instruments with off-balance sheet risk. These financial instruments primarily
include commitments to extend credit, lines of credit and standby letters of
credit. The Company uses these financial instruments to meet the financing needs
of its customers. These financial instruments involve, to varying degrees,
elements of credit, interest rate, and liquidity risk.
Outstanding loan commitments and lines and letters of credit as of
September 30, 2004 and December 31, 2003 are as follows:
September 30, December 31,
2004 2003
------------------ ------------------
Loan commitments $ 9,367,094 $ 11,458,333
Unused lines of credit 43,897,329 32,234,145
Letters of credit 1,997,159 2,167,501
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have interest rates fixed at current market amounts, fixed
expiration dates or other termination clauses and may require payment of a fee.
Unused lines of credit represent the unused portion of lines of credit
previously extended and available to the customer as long as there is no
violation of any contractual condition.
21
These lines generally have variable interest rates. Since many of the
commitments are expected to expire without being drawn upon, and since it is
unlikely that customers will draw upon their line of credit in full at any time,
the total commitment amount or line of credit amount does not necessarily
represent future cash requirements. The Company is not aware of any loss it
would incur by funding its commitments or lines of credit.
Standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. The Company's exposure
to credit loss in the event of nonperformance by the customer is the contract
amount of the commitment.
In general, loan commitments, lines of credit and letters of credit are
made on the same terms, including with respect to collateral, as outstanding
loans. Each customer's credit-worthiness and collateral requirement is evaluated
on a case-by-case basis.
The increase in the overall level of loan commitments and unused lines
of credit as of September 30, 2004 as compared to loan commitments and unused
lines of credit as of December 31, 2003, is a direct result of the same
marketing activities that resulted in the 27.06% increase in outstanding loans.
Capital Resources
The Company had stockholders' equity at September 30, 2004 of
$12,957,755 as compared to $12,066,500 at December 31, 2003. The increase in
capital is a result of the positive operating results for the nine months-ended
September 30, 2004, and $412,500 received upon the issuance of 41,250 shares of
common stock upon the exercise of warrants. Management believes that this level
of capital is adequate to support projected asset growth for at least the next
12 months.
Banking regulatory authorities have implemented strict capital
guidelines directly related to the credit risk associated with an institution's
assets. Banks and bank holding companies are required to maintain capital levels
based on their "risk adjusted" assets so that categories of assets with higher
"defined" credit risks will require more capital support than assets with lower
risks. The Bank has exceeded its capital adequacy requirements to date.
Banking regulations also limit the amount of dividends that may be paid
without prior approval of the Bank's regulatory agencies. Regulatory approval is
required to pay dividends that exceed the Bank's net profits for the current
year plus its retained net profits for the preceding two years. The Bank could
not have paid dividends to the Company without approval from bank regulatory
agencies at September 30, 2004.
Reconciliation of Non-GAAP Measures
Below is a reconciliation of total deposits to core deposits as of
September 30, 2004 and December 31, 2003, respectively:
September 30 December 31
2004 2003
-------------- ----------------
Total deposits $ 142,284,845 $ 108,530,901
National market certificates of deposit (30,214,566) (25,039,281)
Variable balance accounts (2 customers) (7,798,704) (7,749,590)
Portion of variable balance accounts considered to be core 2,000,000 2,000,000
-------------- ----------------
Core deposits $ 106,271,575 $ 77,742,030
============== ================
22
Application of Critical Accounting Policies
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America and follow general practices within the industries in which it operates.
Application of these principles requires management to make estimates,
assumptions and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions and judgments. Certain policies inherently have
a greater reliance on the use of estimates, assumptions and judgments and as
such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability must be recorded contingent upon a
future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
Based on the valuation techniques used and the sensitivity of financial
statement amounts to the methods, assumptions and estimates underlying those
amounts, management has identified the determination of the allowance for credit
losses as the accounting area that requires the most subjective or complex
judgments, and as such could be most subject to revision as new information
becomes available.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses. The
establishment of allowance factors is a continuing exercise and allowance
factors may change over time, resulting in an increase or decrease in the amount
of the provision or allowance based upon the same volume and classification of
loans. Changes in allowance factors or in management's interpretation of those
factors will have a direct impact on the amount of the provision, and a
corresponding effect on income and assets. Also, errors in management's
perception and assessment of the allowance factors could result in the allowance
not being adequate to cover losses in the portfolio, and may result in
additional provisions or charge-offs, which would adversely affect income and
capital.
For additional information regarding the allowance for loan and lease
losses, see the "Allowance for Credit Losses and Credit Risk Management" section
of this financial review.
Item 3. Controls and Procedures
As of the end of the period covered by this quarterly report on Form
10-QSB, Bay National Corporation's Chief Executive Officer and Chief Financial
Officer evaluated the effectiveness of Bay National Corporation's disclosure
controls and procedures. Based upon that evaluation, Bay National Corporation's
Chief Executive Officer and Chief Financial Officer concluded that Bay National
Corporation's disclosure controls and procedures are effective. Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed by Bay National Corporation in
the reports that it files or submits under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
In addition, there were no changes in Bay National Corporation's
internal controls over financial reporting (as defined in Rule 13a-15 or Rule
15d-15 under the Securities Act of 1934, as
23
amended) during the quarter ended September 30, 2004, that have materially
affected, or are reasonably likely to materially affect, Bay National
Corporation's internal control over financial reporting.
Information Regarding Forward-Looking Statements
In addition to the historical information contained in Part I of this
Quarterly Report on Form 10-QSB, the discussion in Part I of this Quarterly
Report on Form 10-QSB contains certain forward-looking statements.
Forward-looking statements often use words such as "believe," "expect," "plan,"
"may," "will," "should," "project," "contemplate," "anticipate," "forecast,"
"intend" or other words of similar meaning. You can also identify them by the
fact that they do not relate strictly to historical or current facts. Our actual
results and the actual outcome of our expectations and strategies could be
different from those anticipated or estimated.
The statements presented herein with respect to, among other things,
Bay National Corporation's plans, objectives, expectations and intentions,
including statements regarding profitability, liquidity, allowance for loan
losses, interest rate sensitivity, market risk and financial and other goals are
forward looking. These statements are based on Bay National Corporation's
beliefs and assumptions, and on information available to Bay National
Corporation as of the date of this filing, and involve risks and uncertainties.
These risks and uncertainties include, among others, those discussed in this
Quarterly Report on Form 10-QSB; Bay National Corporation's limited operating
history; dependence on key personnel; risks related to Bay National Bank's
choice of loan portfolio; risks related to Bay National Bank's lending limit;
risks of a competitive market; impact of government regulation on operating
results; and effect of developments in technology. For a more complete
discussion of these risks and uncertainties see the discussion under the caption
"Factors Affecting Future Results" in Bay National Corporation's Form 10-KSB.
Bay National Corporation's actual results could differ materially from
those discussed herein and you should not put undue reliance on any
forward-looking statements. All forward-looking statements speak only as of the
date of this filing, and Bay National Corporation undertakes no obligation to
make any revisions to the forward-looking statements to reflect events or
circumstances after the date of this filing or to reflect the occurrence of
unanticipated events.
24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) From July 13, 2004 to September 30, 2004, Bay National
Corporation issued 41,250 shares of its common stock, $0.01 par value per share,
at a purchase price of $10.00 per share, and received aggregate proceeds of
$412,500. The shares were issued upon the exercise of outstanding warrants.
On September 10, 1999, Bay National Corporation issued warrants to
purchase 56,250 shares of its common stock, $0.01 par value per share, to
purchasers in its organizational offering. The warrants became exercisable on
April 30, 2001 and expire on November 16, 2004.
There were and will be no underwriting discounts or commissions paid
with respect to the issuance of the common stock upon exercise of the warrants.
Bay National Corporation believes that the issuance of the shares of common
stock upon exercise of the warrants is exempt from the registration requirements
of the Securities Act of 1933 by virtue of Section 4(2) of the Securities Act of
1933 and Rule 506 promulgated thereunder. The transaction was not conducted by
any form of general solicitation or general advertising and, in connection with
the transaction, Bay National Corporation is taking reasonable care to assure
that the purchasers of the common stock upon exercise of the warrants are not
underwriters within the meaning of Section 2(11) of the Securities Act by, among
other things, placing appropriate restrictive legends on the share certificates.
(b) None
(c) None
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Securities Holders.
None
Item 5. Other Information.
None
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Item 6. Exhibits.
(a) Exhibits.
10.1 Promissory Note between Bay National Corporation and Fulton
Bank dated September 28, 2004
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Bay National Corporation
Date: November 12, 2004 By: /s/ Hugh W. Mohler
--------------------------------------------
Hugh W. Mohler, President
(Principal Executive Officer)
Date: November 12, 2004 By: /s/ Mark A. Semanie
--------------------------------------------
Mark A. Semanie, Treasurer
(Principal Accounting and Financial Officer)
27