[BAY NATIONAL LOGO OMMITED]
U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the year ended December 31, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number 333-87781
Bay National Corporation
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(Name of small business issuer in its charter)
Maryland 52-2176710
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2328 West Joppa Road, Lutherville, Maryland 21093
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: 410-494-2580
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Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: None
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 __
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [x]
The issuer's revenues for its most recent fiscal year were $8,162,411.
The aggregate market value of the common equity held by non-affiliates
was $21,024,425 as of March 25, 2005, based on a sales price of $14.49 per share
of Common Stock, which is the sales price at which shares of Common Stock were
last sold in over the counter trading on March 16, 2005.
The number of shares outstanding of the issuer's Common Stock was
1,920,194 as of March 25, 2005.
Transitional Small Business Disclosure Format (check one):
Yes __ No X
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PART I
Item 1. Description of Business
BUSINESS OF BAY NATIONAL CORPORATION AND BAY NATIONAL BANK
General
Bay National Corporation was incorporated under the laws of the State
of Maryland on June 3, 1999, primarily to serve as a bank holding company for a
proposed federally chartered commercial bank to be named Bay National Bank.
Bay National Bank commenced operations on May 12, 2000 with its main
office in North Baltimore, Maryland and a branch office in Salisbury, Maryland.
Bay National Bank accepts checking and savings deposits and offers a wide range
of commercial and industrial, real estate, consumer and residential mortgage
loans.
Marketing Focus
Bay National Bank was formed by a group of individuals active in
business, professional, banking, financial and charitable activities in the
Baltimore, Maryland metropolitan area and the Eastern Shore of Maryland. These
individuals believed that the banking needs of certain segments of these
communities were not being served adequately by existing banks. Specifically, as
a result of bank mergers in the 1990's, many banks in the Baltimore metropolitan
area and the Eastern Shore of Maryland became local branches of large regional
and national banks. Although size gave the larger banks some advantages in
competing for business from large corporations, including economies of scale and
higher lending limits, the organizers believed that these "megabanks" were
focused on a mass market approach which de-emphasized personal contact and
service. The organizers also believed that the centralization of decision-making
power at these large institutions had resulted in a lack of customer service. At
many of these institutions, determinations were made at the "home office" by
individuals who lacked personal contact with customers as well as an
understanding of the customers' needs and scope of the relationship with the
institution.
Bay National Bank's management believes that this trend is ongoing, and
has been particularly frustrating to owners of small and mid-sized businesses,
business professionals and high net worth individuals who traditionally were
accustomed to dealing directly with a bank executive who had an understanding of
their banking needs with the ability to deliver a prompt response.
Bay National Bank targets its commercial banking services to small and
mid-sized businesses and targets its retail banking services to the owners of
these businesses and their employees, to business professionals and high net
worth individuals.
Bay National Bank seeks to distinguish itself by
o Developing personal relationships with its customers.
o Customizing its products to fit the needs of its customers
instead of adopting a "one size fits all" mentality.
o Streamlining the decision making process.
o Offering its customers additional complementary services, such
as insurance and investment advice, through relationships with
strategic partners.
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Bay National Bank's offices are not organized in the traditional retail
branch structure, which is transaction and "bank teller" oriented. Instead, Bay
National Bank has adopted a "sit-down" model where customers are greeted by a
personal banker and taken to a private desk. Management believes that this
approach makes service more individualized and enhances the banker's
understanding of the customer's needs. Furthermore, Bay National Bank's branch
locations do not focus on capturing every customer within the surrounding area.
Instead, they are strategically located in areas convenient to Bay National
Bank's target customer base.
Market Area and Facilities
Bay National Bank's headquarters and Baltimore branch office are located
at 2328 West Joppa Road, Lutherville, Maryland 21093. Bay National Bank serves
the Baltimore metropolitan area from that location, with its primary service
area being Towson, Lutherville-Timonium, Cockeysville, Hunt Valley, Ruxton and
Roland Park. Bay National Bank's Salisbury, Maryland branch office is located at
109 Poplar Hill Avenue, Salisbury, Maryland 21801, from which it serves
Maryland's Eastern Shore.
Products and Services
Loan Portfolio.
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Bay National Bank offers a full range of loans, including commercial
and industrial loans, real estate loans, consumer loans and residential mortgage
and home equity loans. Commercial business and commercial real estate loans for
owner-occupied properties are Bay National Bank's primary loan products,
accounting for approximately 74% of the loan portfolio as of December 31, 2004.
Generally, Bay National Bank is subject to a lending limit to any one
borrower of 15% of Bay National Bank's unimpaired capital and surplus. However,
management is able to originate loans and to participate with other lenders in
loans that exceed Bay National Bank's lending limits.
The following is a description of the types of loans Bay National Bank
has targeted in building its loan portfolio:
o Commercial and industrial loans for business purposes
including working capital, equipment purchases, lines of
credit and government contract financing. Asset-based lending,
accounts receivable financing and lease financing are also
available. As of December 31, 2004, these loans represented
approximately 49% of Bay National Bank's loan portfolio. Bay
National Bank is targeting small and mid-sized businesses in
its market area with credit needs in the range of up to
$5,000,000.
o Commercial real estate loans, including mortgage loans on
non-residential properties, and land development and
construction loan financing, primarily for owner-occupied
premises. As of December 31, 2004, these loans represented
approximately 25% of Bay National Bank's loan portfolio.
o Consumer loans including automobile and personal loans. In
addition, Bay National Bank offers personal lines of credit.
As of December 31, 2004, these loans represented approximately
1% of Bay National Bank's loan portfolio. Bay National Bank's
consumer loans are targeted to business owners and their
employees, business professionals and high net worth
individuals.
o Mortgage loans and residential constructions loans secured by
residential property, including first and second mortgage
loans on owner occupied and investment properties (1 to 4
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family and multi-family), and home equity loans secured by
single-family owner-occupied residences. As of December 31,
2004, these loans represented approximately 25% of Bay
National Bank's loan portfolio. The majority of these loans,
approximately 16% of Bay National Bank's loan portfolio, are
home equity loans. Like its consumer loans, Bay National
Bank's home equity loans are targeted to business owners and
their employees, business professionals and high net worth
individuals.
Bay National Bank originates some of its Eastern Shore
residential mortgage loans through BNB Mortgage, LLC, a
Maryland limited liability company, which is a joint venture
between Bay National Bank and an Ocean City, Maryland real
estate investor. Bay National Bank is responsible for all of
the operations of BNB Mortgage, LLC. Bay National Bank's share
of net income from this entity amounted to $24,603 and $8,163
for the years ended December 31, 2004 and 2003, respectively.
All loans originated by BNB Mortgage, LLC are immediately sold
to Bay National Bank. These loans are then sold to third party
investors in the same fashion as other conventional first and
second residential mortgage loans originated by Bay National
Bank.
Bay National Bank's conventional first and second residential
mortgage loans adhere to standards developed by FNMA/FHLMC.
Management requires private mortgage insurance for loans in
excess of 80% of a property's value. Bay National Bank sells
most of its first and second residential mortgage loans in the
secondary market. Therefore, management sells those loans that
have a lower degree of risk, and a lower yield, relative to
the other types of loans that Bay National Bank is expected to
make. Since these loans are typically sold, Bay National Bank
offers these loans as well as certain residential construction
loans to a broader array of individuals than its home equity
loans and other consumer loan products. As of December 31,
2004, mortgage loans held for sale totaled $9,613,162.
Deposits.
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Bay National Bank offers a wide range of interest-bearing and
non-interest-bearing accounts, including commercial and retail checking
accounts, money market accounts, individual retirement accounts,
interest-bearing statement savings accounts and certificates of deposit with
fixed and variable rates and a range of maturity date options.
Other Banking and Financial Services.
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Bay National Bank offers commercial customers cash management services
such as sweep accounts, account reconciliation, lockbox services and wire
transfers of funds. Additionally, Bay National Bank makes available telephone
banking, ATM/debit cards, safe keeping boxes, after-hours deposit services,
travelers checks, direct deposit of payroll and automatic drafts for various
accounts. These services are provided either directly by Bay National Bank or
through correspondent banking relationships. Bay National Bank does not have
it's own network of ATM machines. In general, Bay National Bank waives fees on a
predetermined number of ATM transactions per month, thereby allowing its
customers to use any ATM machine.
In addition, Bay National Bank's customers are able to access
information about their accounts and view information about Bay National Bank's
services and products on Bay National Bank's website, which is located at
http://www.baynational.com. Bay National Bank's website also permits customers
to make transfers of funds among accounts, pay bills and send e-mail to Bay
National Bank personnel.
Bay National Bank offers, through strategic partners, investment
advisory, risk management and employee benefit services. Through these
affiliations, banking clients can receive a full range of financial services,
including investment advice, personal and business insurance products and
employee benefit products such as pension and 401(k) plan administration. To the
extent permitted by applicable regulations,
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the strategic partners may share fees and commissions with Bay National Bank. As
of December 31, 2004, Bay National Bank had not entered in to any such fee
arrangements. When sufficient volume is developed in any of these lines of
business, Bay National Bank may provide these services if permitted by
applicable regulations.
Competition
Deregulation of financial institutions and acquisitions of banks across
state lines has resulted in widespread changes in the financial services
industry. In both the Baltimore metropolitan area and on Maryland's Eastern
Shore, Bay National Bank faces strong competition from large banks headquartered
within and outside of Maryland. Bay National Bank also competes with other
community banks, savings and loan associations, credit unions, mortgage
companies, finance companies and others providing financial services. In
addition, insurance companies, securities brokers and other non-bank entities or
their affiliates may provide services, which historically have been considered
banking in nature.
Many of Bay National Bank's competitors can finance extensive
advertising campaigns, maintain extensive branch networks and technology
investments, and offer services, which Bay National Bank cannot offer or will
not offer initially. Also, larger institutions have substantially higher lending
limits than Bay National Bank. Some of Bay National Bank's competitors have
other advantages, such as tax exemption in the case of credit unions, and lesser
regulation in the case of mortgage companies and finance companies.
Employees
As of March 25, 2005, Bay National Bank employed forty-four individuals.
Thirty-three people operate from Bay National Bank's headquarters and banking
office in North Baltimore and eleven people from the Salisbury, Maryland banking
office. Bay National Corporation has no employees.
SUPERVISION AND REGULATION
General
Bay National Corporation and Bay National Bank are subject to extensive
regulation under state and federal banking laws and regulations. These laws
impose specific requirements and restrictions on virtually all aspects of
operations and generally are intended to protect depositors, not stockholders.
The following discussion is only a summary and readers should refer to
particular statutory and regulatory provisions for more detailed information. In
addition, management cannot predict the nature or the extent of the effect on
business and earnings that new federal or state legislation may have in the
future.
Bay National Corporation
Federal Bank Holding Company Regulation. Bay National Corporation is a
bank holding company registered under the Bank Holding Company Act of 1956, as
amended, and is subject to supervision by the Federal Reserve Board. As a bank
holding company, Bay National Corporation is required to file with the Federal
Reserve Board an annual report and such other additional information as the
Federal Reserve Board may require by statute. The Federal Reserve Board may also
examine Bay National Corporation and each of its subsidiaries.
The Federal Reserve Board must approve, among other things, the
acquisition by a bank holding company of control of more than five percent (5%)
of the voting shares, or substantially all the assets, of any bank or bank
holding company or the merger or consolidation by a bank holding company with
another bank holding company. Under the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994, the restrictions on interstate acquisitions of
banks by bank holding companies were repealed as of September 29,
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1995. The effect of the repeal of these restrictions is that, subject to certain
time and deposit base requirements, Bay National Corporation may acquire a bank
located in Maryland or any other state, and a bank holding company located
outside of Maryland can acquire any Maryland-based bank holding company or bank.
Unless it chooses to become a financial holding company, as further
described below, a bank holding company is prohibited from acquiring control of
any voting shares of any company which is not a bank or bank holding company and
from engaging directly or indirectly in any activity other than banking, or
managing or controlling banks or furnishing services for its authorized
subsidiaries. There are limited exceptions. A bank holding company may, for
example, engage in activities which the Federal Reserve Board has determined by
order or regulation to be so closely related to banking or managing or
controlling banks as to be "properly incident thereto." In making such a
determination, the Federal Reserve Board is required to consider whether the
performance of such activities can reasonably be expected to produce benefits to
the public, such as convenience, increased competition or gains in efficiency,
which outweigh possible adverse effects, such as undue concentration of
resources, decreased or unfair competition, conflicts of interest or unsound
banking practices. The Federal Reserve Board is also empowered to differentiate
between activities commenced de novo and activities commenced by the
acquisition, in whole or in part, of a going concern. Some of the activities
that the Federal Reserve Board has determined by regulation to be closely
related to banking include servicing loans, performing certain data processing
services, acting as a fiduciary, investment or financial advisor, and making
investments in corporations or projects designed primarily to promote community
welfare.
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by statute on any extensions of credit to the bank holding
company or any of its subsidiaries, or investments in their stock or other
securities, and on taking such stock or securities as collateral for loans to
any borrower. Further, a bank holding company and any subsidiary bank are
prohibited from engaging in certain tie-in arrangements in connection with the
extension of credit. In 1997, the Federal Reserve Board adopted amendments to
its Regulation Y, creating exceptions to the Bank Holding Company Act's
anti-tying prohibitions that give bank subsidiaries of holding companies greater
flexibility in packaging products and services with their affiliates.
In accordance with Federal Reserve Board policy, Bay National
Corporation is expected to act as a source of financial strength to Bay National
Bank and to commit resources to support Bay National Bank in circumstances in
which Bay National Corporation might not otherwise do so. The Federal Reserve
Board may require a bank holding company to terminate any activity or relinquish
control of a non-bank subsidiary (other than a non-bank subsidiary of a bank)
upon the Federal Reserve's determination that such activity or control
constitutes a serious risk to the financial soundness or stability of any
subsidiary depository institution of the bank holding company. Further, federal
bank regulatory authorities have additional discretion to require a bank holding
company to divest itself of any bank or non-bank subsidiary if the agency
determines that divestiture may aid the depository institution's financial
condition.
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act ("GLBA"). Effective March 11, 2000, pursuant to authority
granted under the GLBA, a bank holding company may elect to become a financial
holding company and thereby engage in a broader range of financial and other
activities than are permissible for traditional bank holding companies. In order
to qualify for the election, all of the depository institution subsidiaries of
the bank holding company must be well capitalized and well managed, as defined
by regulation, and all of its depository institution subsidiaries must have
achieved a rating of satisfactory or better with respect to meeting community
credit needs.
Pursuant to the GLBA, financial holding companies will be permitted to
engage in activities that are "financial in nature" or incidental or
complementary thereto, as determined by the Federal Reserve Board. The GLBA
identifies several activities as "financial in nature," including, among others,
insurance underwriting and agency, investment advisory services, merchant
banking and underwriting, and dealing
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or making a market in securities. Being designated a financial holding company
will allow insurance companies, securities brokers and other types of financial
companies to affiliate with and/or acquire depository institutions.
As a bank holding company with consolidated assets of more than
$150,000,000, Bay National Corporation also is subject to certain risk-based
capital guidelines imposed on bank holding companies by the Federal Reserve
Board to insure the holding company's capital adequacy.
The status of Bay National Corporation as a registered bank holding
company under the Bank Holding Company Act does not exempt it from certain
federal and state laws and regulations applicable to corporations generally,
including, without limitation, certain provisions of the federal securities
laws.
State Bank Holding Company Regulation. Bay National Corporation is a
Maryland-chartered bank holding company and is subject to various restrictions
on its activities as set forth in Maryland law, in addition to those
restrictions set forth in federal law.
Under Maryland law, a bank holding company that desires to acquire a
Maryland state-chartered bank or trust company, a federally chartered bank with
its main office in Maryland, or a bank holding company that has its principal
place of business in Maryland, must file an application with the Maryland
Commissioner of Financial Regulation (the "Commissioner"). In approving the
application, the Commissioner must consider whether the acquisition may be
detrimental to the safety and soundness of the entity being acquired or whether
the acquisition may result in an undue concentration of resources or a
substantial reduction in competition in Maryland. The Commissioner may not
approve an acquisition if, on consummation of the transaction, the acquiring
company, together with all its insured depository institution affiliates, would
control 30% or more of the total amount of deposits of insured depository
institutions in Maryland. The Commissioner has authority to adopt by regulation
a procedure to waive this requirement for good cause. In a transaction for which
the Commissioner's approval is not required due to an exemption under Maryland
law, or for which federal law authorizes the transaction without application to
the Commissioner, the parties to the acquisition must provide written notice to
the Commissioner at least 15 days before the effective date of the acquisition.
Bay National Bank
General. Bay National Bank, as a national banking association whose
accounts are insured by the Bank Insurance Fund ("BIF") of the Federal Deposit
Insurance Corporation ("FDIC") up to the maximum legal limits, is subject to
regulation, supervision and regular examinations by the Office of the
Comptroller of the Currency ("OCC"). Bay National Bank is a member of the
Federal Reserve System and, as such, is subject to certain regulations issued by
the Federal Reserve Board. Bay National Bank also is subject to applicable
banking provisions of Maryland law insofar as they do not conflict with or are
not preempted by federal law. The regulations of these various agencies govern
most aspects of Bay National Bank's business, including setting required
reserves against deposits, loans, investments, mergers and acquisitions,
borrowing, dividends, and location and number of branch offices.
The GLBA authorizes expanded activities for national banks, but requires
(with the exception of underwriting municipal revenue bonds and other state and
local obligations) that any expanded activities be conducted in a new entity
called a "financial subsidiary" that is a subsidiary of the bank rather than the
bank itself. A financial subsidiary may engage in any activities in which a
financial holding company or a financial holding company's non-bank subsidiaries
can engage, except that a financial subsidiary may not underwrite most
insurance, engage in real estate development or conduct merchant banking
activities. A financial subsidiary may be established through acquisition or de
novo.
In order for a national bank to operate a financial subsidiary, it must
be well capitalized and well managed, have a satisfactory or better rating with
respect to meeting community credit needs and the
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aggregate assets of all of the bank's financial subsidiaries may not exceed 45%
of the total assets of the bank, subject to certain exceptions. Existing
authority of the OCC and the FDIC to review subsidiary activities are preserved.
Banking is a business which depends on interest rate differentials. In
general, the differences between the interest paid by a bank on its deposits and
its other borrowings and the interest received by a bank on loans extended to
its customers and securities held in its investment portfolio constitute the
major portion of a bank's earnings. Thus, the earnings and growth of Bay
National Bank will be subject to the influence of economic conditions generally,
both domestic and foreign, and also on the monetary and fiscal policies of the
United States and its agencies, particularly the Federal Reserve Board, which
regulates the supply of money.
Branching and Interstate Banking. Beginning on June 1, 1997, the federal
banking agencies were authorized to approve interstate bank merger transactions
without regard to whether such a transaction is prohibited by the law of any
state, unless the home state of one of the banks has opted out of the interstate
bank merger provisions of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994. Furthermore, under the Riegle-Neal Act, interstate
acquisitions of branches are permitted if the law of the state in which the
branch is located permits such acquisitions. The Riegle-Neal Act also authorizes
the OCC and FDIC to approve interstate branching de novo by national and
non-member banks, respectively, but only in states which specifically allow for
such branching.
The District of Columbia, Maryland, Delaware and Pennsylvania have all
enacted laws which permit interstate acquisitions of banks and bank branches and
permit out-of-state banks to establish de novo branches.
Capital Adequacy Guidelines. The Federal Reserve Board, the OCC and the
FDIC have all adopted risk-based capital adequacy guidelines by which they
assess the adequacy of capital in examining and supervising banks and bank
holding companies and in analyzing bank regulatory applications. Risk-based
capital requirements determine the adequacy of capital based on the risk
inherent in various classes of assets and off-balance sheet items.
Since December 31, 1992, national banks have been expected to meet a
minimum ratio of total qualifying capital (the sum of core capital (Tier 1) and
supplementary capital (Tier 2)) to risk-weighted assets (a "Total Risk-Based
Capital Ratio") of 8%. At least half of this amount (4%) should be in the form
of core capital. These requirements apply to Bay National Bank.
Tier 1 capital for national banks generally consists of the sum of
common stockholders' equity and perpetual preferred stock (subject in the case
of the latter to limitations on the kind and amount of such stock which may be
included as Tier 1 capital), less goodwill, without adjustment in accordance
with Statement of Financial Accounting Standards No. 115. Tier 2 capital
consists of the following: hybrid capital instruments, perpetual preferred stock
which is not otherwise eligible to be included as Tier 1 capital, term
subordinated debt and intermediate-term preferred stock, and, subject to
limitations, general allowances for loan losses. Assets are adjusted under the
risk-based guidelines to take into account different risk characteristics, with
the categories ranging from 0% (requiring no risk-based capital) for assets such
as cash, to 100% for the bulk of assets which are typically held by a bank
holding company, including certain multi-family residential and commercial real
estate loans, commercial business loans and consumer loans. Residential first
mortgage loans on one-to-four-family residential real estate and certain
seasoned multi-family residential real estate loans, which are not 90 days or
more past-due or non-performing and which have been made in accordance with
prudent underwriting standards, are assigned a 50% level in the risk-weighing
system, as are certain privately issued mortgage-backed securities representing
indirect ownership of such loans. Off-balance sheet items also are adjusted to
take into account certain risk characteristics.
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In addition to the risk-based capital requirements, the OCC has
established a minimum 3% Leverage Capital Ratio (Tier 1 capital to total
adjusted assets) requirement for the most highly-rated national banks, with an
additional cushion of at least 100 to 200 basis points for all other national
banks, which effectively increases the minimum Leverage Capital Ratio for such
other banks to 4%-5% or more. Under the OCC's regulations, highest-rated banks
are those that the OCC determines are not anticipating or experiencing
significant growth and have well diversified risk, including no undue interest
rate risk exposure, excellent asset quality, high liquidity, good earnings and,
in general, those which are considered a strong banking organization. A national
bank that has less than the minimum Leverage Capital Ratio requirement must
submit, to the applicable district office for review and approval, a reasonable
plan describing the means and timing by which the bank will achieve its minimum
Leverage Capital Ratio requirement. A national bank which fails to file such a
plan is deemed to be operating in an unsafe and unsound manner and could be
subject to a cease-and-desist order.
The OCC's regulations also provide that any insured depository
institution with a Leverage Capital Ratio less than 2% is deemed to be operating
in an unsafe or unsound condition. Operating in an unsafe or unsound manner
could lead the FDIC to terminate deposit insurance. However, such an institution
will not be subject to an enforcement proceeding solely on account of its
capital ratios if it has entered into and is in compliance with a written
agreement with the OCC to increase its Leverage Capital Ratio to such level as
the OCC deems appropriate and to take such other action as may be necessary for
the institution to be operated in a safe and sound manner. The capital
regulations also provide, among other things, for the issuance by the OCC or its
designee(s) of a capital directive, which is a final order issued to a bank that
fails to maintain minimum capital or to restore its capital to the minimum
capital requirement within a specified time period. Such directive is
enforceable in the same manner as a final cease-and-desist order.
Prompt Corrective Action. Each federal banking agency is required to
implement a system of prompt corrective action for institutions which it
regulates. Under applicable regulations, a bank will be deemed to be: (i) "well
capitalized" if it has a Total Risk-Based Capital Ratio of 10% or more, a Tier 1
Risk-Based Capital Ratio of 6% or more, a Leverage Capital Ratio of 5% or more
and is not subject to any written capital order or directive; (ii) "adequately
capitalized" if it has a Total Risk-Based Capital Ratio of 8% or more, a Tier 1
Risk-Based Capital Ratio of 4% or more and a Leverage Capital Ratio of 4% or
more (3% under certain circumstances); (iii) "undercapitalized" if it has a
Total Risk-Based Capital Ratio that is less than 8%, a Tier 1 Risk-Based Capital
Ratio that is less than 4% or a Leverage Capital Ratio that is less than 4%
(3.3% under certain circumstances); (iv) "significantly undercapitalized" if it
has a Total Risk-Based Capital Ratio that is less than 6%, a Tier 1 Risk-Based
Capital Ratio that is less than 3% or a Leverage Capital Ratio that is less than
3%; and (v) "critically undercapitalized" if it has a ratio of tangible equity
to total assets that is equal to or less than 2%. Bay National Bank is "well
capitalized" as of December 31, 2004.
An institution generally must file a written capital restoration plan
which meets specified requirements with an appropriate federal banking agency
within 45 days of the date the institution receives notice or is deemed to have
notice that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. The federal banking agency must provide the institution with
written notice of approval or disapproval within 60 days after receiving the
capital restoration plan, subject to extensions by the applicable agency.
An institution which is required to submit a capital restoration plan
must concurrently submit a performance guaranty by each company that controls
the institution. Such guaranty is limited to the lesser of (i) an amount equal
to 5% of the institution's total assets at the time the institution was notified
or deemed to have notice that it was undercapitalized or (ii) the amount
necessary at such time to restore the relevant capital measures of the
institution to the levels required for the institution to be classified as
adequately capitalized. Such a guaranty expires after the federal banking agency
notifies the institution that it has remained adequately capitalized for each of
four consecutive calendar quarters. An institution which fails to submit a
written capital restoration plan within the requisite period, including any
required performance guaranty, or fails in any material respect to implement a
capital restoration plan, is subject to the restrictions
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in Section 38 of the Federal Deposit Insurance Act which are applicable to
significantly undercapitalized institutions.
A critically undercapitalized institution will be placed in
conservatorship or receivership within 90 days unless the FDIC formally
determines that forbearance from such action would better protect the deposit
insurance fund. Unless the FDIC or another appropriate federal banking
regulatory agency makes specific further findings and certifies that the
institution is viable and is not expected to fail, an institution that remains
critically undercapitalized on average during the four calendar quarters after
the date it becomes critically undercapitalized must be placed in receivership.
Immediately upon becoming undercapitalized, an institution becomes
subject to statutory provisions which (i) restrict payment of capital
distributions and management fees; (ii) require that the appropriate federal
banking agency monitor the condition of the institution and its efforts to
restore its capital; (iii) require submission of a capital restoration plan;
(iv) restrict the growth of the institution's assets; and (v) require prior
approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any number of discretionary
supervisory actions if the agency determines that any of these actions is
necessary to resolve the problems of the institution at the least possible
long-term cost to the deposit insurance fund, subject, in certain cases, to
specified procedures. These discretionary supervisory actions include requiring
the institution to raise additional capital, restricting transactions with
affiliates, requiring divestiture of the institution or the sale of the
institution to a willing purchaser, and any other supervisory action that the
agency deems appropriate. Significantly undercapitalized and critically
undercapitalized institutions are subject to these and additional mandatory and
permissive supervisory actions.
Regulatory Enforcement Authority. The Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 ("FIRREA") included substantial
enhancement to the enforcement powers available to federal banking regulators.
This enforcement authority included, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions against banking organizations and
institution-affiliated parties, as defined in FIRREA. In general, these
enforcement actions may be initiated for violations of laws and regulations and
unsafe or unsound practices. Other actions or inactions may provide the basis
for enforcement action, including misleading or untimely reports filed with
regulatory authorities. FIRREA significantly increased the amount of and grounds
for civil money penalties and requires, except under certain circumstances,
public disclosure of final enforcement actions by the federal banking agencies.
Deposit insurance. The FDIC has adopted a risk-based deposit insurance
assessment system. The FDIC assigns an institution to one of three capital
categories based on the institution's financial information, as of the reporting
period ending seven months before the assessment period, consisting of (i) well
capitalized, (ii) adequately capitalized or (iii) undercapitalized, and one of
three supervisory subcategories within each capital group. The supervisory
subgroup to which an institution is assigned is based on a supervisory
evaluation provided to the FDIC by the institution's primary federal regulator
and information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds. An
institution's assessment rate depends on the capital category and supervisory
subcategory to which it is assigned. Assessment rates for BIF deposits currently
range from 0 basis points to 27 basis points. Bay National Bank is currently
assigned to a capital and supervisory subcategory that has an assessment rate of
0. The FDIC is authorized to raise the assessment rates in certain
circumstances, including to maintain or achieve the designated reserve ratio of
1.25%, which requirement the BIF currently meets. The FDIC has exercised its
authority to raise rates in the past and may raise insurance premiums in the
future. If such action is taken by the FDIC, it could have an adverse effect on
the earnings of Bay National Bank.
Under the Federal Deposit Insurance Act, insurance of deposits may be
terminated by the FDIC upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition
11
to continue operations or has violated any applicable law, regulation, rule,
order or condition imposed by the FDIC.
Transactions with Affiliates and Insiders. Bay National Bank is subject
to the provisions of Section 23A of the Federal Reserve Act, which place limits
on the amount of loans or extensions of credit to affiliates, investments in or
certain other transactions with affiliates and on the amount of advances to
third parties collateralized by the securities or obligations of affiliates.
Section 23A limits the aggregate amount of transactions with any individual
affiliate to ten percent (10%) of the capital and surplus of Bay National Bank
and also limits the aggregate amount of transactions with all affiliates to
twenty percent (20%) of capital and surplus. Loans and certain other extensions
of credit to affiliates are required to be secured by collateral in an amount
and of a type described in Section 23A, and the purchase of low quality assets
from affiliates is generally prohibited.
Bay National Bank also is subject to the provisions of Section 23B of
the Federal Reserve Act which, among other things, prohibit an institution from
engaging in certain transactions with certain affiliates unless the transactions
are on terms substantially the same, or at least as favorable to such
institution and/or its subsidiaries, as those prevailing at the time for
comparable transactions with non-affiliated entities. In the absence of
comparable transactions, such transactions may only occur under terms and
circumstances, including credit standards that in good faith would be offered to
or would apply to non-affiliated companies.
Bay National Bank also is subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
Regulation O thereunder on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer or
a greater-than-10% stockholder of a bank as well as certain affiliated interests
of any of the foregoing may not exceed, together with all other outstanding
loans to such person and affiliated interests, the loans-to-one-borrower limit
applicable to national banks (generally 15% of the institution's unimpaired
capital and surplus), and all loans to all such persons in the aggregate may not
exceed the institution's unimpaired capital and unimpaired surplus. Regulation O
also prohibits the making of loans in an amount greater than $25,000 or 5% of
capital and surplus but in any event not over $500,000, to directors, executive
officers and greater-than-10% stockholders of a bank, and their respective
affiliates, unless such loans are approved in advance by a majority of the Board
of Directors of the bank with any "interested" director not participating in the
voting. Further, Regulation O requires that loans to directors, executive
officers and principal stockholders be made on terms substantially the same as
those that are offered in comparable transactions to other persons. Regulation O
also prohibits a depository institution from paying overdrafts over $1,000 of
any of its executive officers or directors unless they are paid pursuant to
written pre-authorized extension of credit or transfer of funds plans.
Loans to One Borrower. As a national bank, Bay National Bank is subject
to the statutory and regulatory limits on the extension of credit to one
borrower. Generally, the maximum amount of total outstanding loans that a
national bank may have to any one borrower at any one time is 15% of the bank's
unimpaired capital and surplus. A national bank may lend an additional 10% on
top of the 15% if the amount that exceeds 15% of the bank's unimpaired capital
and surplus is fully secured by readily marketable collateral.
Liquidity. Bay National Bank is subject to the reserve requirements of
Federal Reserve Board Regulation D, which applies to all depository
institutions. Specifically, as of January 31, 2004, amounts in transaction
accounts above $7,000,000 and up to $47,600,000 must have reserves held against
them in the ratio of three percent of the amount. Amounts above $47,600,000
require reserves of $1,218,000 plus 10 percent of the amount in excess of
$47,600,000. Bay National Bank is in compliance with the applicable liquidity
requirements.
12
Community Reinvestment Act. The Community Reinvestment Act ("CRA")
requires that, in connection with examinations of financial institutions within
their respective jurisdictions, the Federal Reserve Board, the FDIC, the OCC or
the Office of Thrift Supervision shall evaluate the record of the financial
institutions in meeting the credit needs of their local communities, including
low and moderate income neighborhoods, consistent with the safe and sound
operation of those institutions. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
An institution's CRA activities are considered in, among other things,
evaluating mergers, acquisitions and applications to open a branch or facility
as well as determining whether the institution will be permitted to exercise
certain of the powers allowed by the GLBA. The CRA also requires all
institutions to make public disclosure of their CRA ratings. Bay National Bank
received a "satisfactory" rating in its latest CRA examination in May 2003.
USA PATRIOT Act. On October 26, 2001, the President signed into law
comprehensive anti-terrorism legislation known as the USA PATRIOT Act of 2001
(the "USA Patriot Act"). Title III of the USA Patriot Act substantially
broadened the scope of U.S. anti-money laundering laws and regulations by
imposing significant new compliance and due diligence obligations, creating new
crimes and penalties and expanding the extra-territorial jurisdiction of the
United States. The U.S. Treasury Department ("Treasury") has issued a number of
implementing regulations that apply to various requirements of the USA Patriot
Act to financial institutions such as Bay National Bank. Those regulations
impose new obligations on financial institutions to maintain appropriate
policies, procedures and controls to detect, prevent and report money laundering
and terrorist financing. Treasury may issue additional regulations that will
further clarify the USA Patriot Act's requirements.
Failure of a financial institution to comply with the USA Patriot Act's
requirements could have serious legal and reputational consequences for the
institution. The Company has adopted appropriate policies, procedures and
controls to address compliance with the requirements of the USA Patriot Act
under the existing regulations and will continue to revise and update its
policies, procedures and controls to reflect changes required by the USA Patriot
Act and Treasury's regulations.
FACTORS AFFECTING FUTURE RESULTS
Some of the matters discussed in this annual report including under the
captions "Business of Bay National Corporation and Bay National Bank," and
"Management's Discussion And Analysis Of Financial Condition And Results Of
Operations" include forward-looking statements. These forward-looking statements
include statements regarding profitability, liquidity, allowance for loan
losses, interest rate sensitivity, market risk and financial and other goals.
Forward-looking statements often use words such as "believe," "expect," "plan,"
"may," "will," "should," "project," "contemplate," "anticipate," "forecast,"
"intend", or other words of similar meaning. You can also identify them by the
fact that they do not relate strictly to historical or current facts. When you
read a forward-looking statement, you should keep in mind the risk factors
described below and any other information contained in this annual report which
identifies a risk or uncertainty. Bay National Corporation's actual results and
the actual outcome of Bay National Corporation's expectations and strategies
could be different from that described in this annual report because of these
risks and uncertainties and you should not put undue reliance on any
forward-looking statements. All forward-looking statements speak only as of the
date of this filing, and Bay National Corporation undertakes no obligation to
make any revisions to the forward-looking statements to reflect events or
circumstances after the date of this filing or to reflect the occurrence of
unanticipated events.
Bay National Corporation has a limited operating history upon which to
evaluate future success. Bay National Corporation and Bay National Bank
commenced operations in May 2000, and their operating history is limited. Bay
National Corporation's profitability depends on the results of operations of its
principal asset, Bay National Bank. Bay National Corporation incurred operating
losses during each of the
13
years of its operations through December 31, 2002. Bay National Corporation
reported net income of $802,264 and $7,581 for the years ended December 31, 2004
and 2003, respectively. Management expects that additional capital may be
required in the future to support growth of Bay National Bank. Any additional
capital, if available at all, may be on terms which are not as favorable to the
Company as that desired by management and may result in dilution to the
Company's shareholders. If adequate capital is not available, the Company may be
required to curtail significantly its expected growth strategy.
If Bay National Bank decides to open additional offices, that decision
may result in future operating losses, or slow the growth of operating
profitability because of the increased expenses of expansion and because the new
branch offices may not enhance the results of operations as anticipated. Bay
National Bank has no current plans to open additional branch offices.
Bay National Corporation and Bay National Bank depend heavily on one
key employee, Mr. Hugh W. Mohler, and business would suffer if something were to
happen to Mr. Mohler. Mr. Mohler is the Chairman, President and Chief Executive
Officer of Bay National Bank. If he were to leave for any reason, Bay National
Corporation's and Bay National Bank's business would suffer because he has
banking experience and relationships with clients and potential clients that
would not be easy to replace. In addition, because Bay National Bank's business
is relationship driven, the loss of an employee who has primary contact with one
or more of Bay National Bank's clients could cause Bay National Bank to lose
those clients' business, possibly resulting in a decline in revenues.
Bay National Bank's lending strategy involves risks resulting from the
choice of loan portfolio. Bay National Bank's loan strategy emphasizes
commercial business loans and commercial real estate loans. At December 31,
2004, such loans accounted for approximately 74% of the loan portfolio. Bay
National Bank also offers construction loans, consumer loans and mortgage loans
for residential properties, although most of the residential mortgage loans are
sold in the secondary market. Commercial business and commercial real estate
loans generally carry a higher degree of credit risk than do residential
mortgage loans because of several factors including larger loan balances,
dependence on the successful operation of a business or a project for repayment,
or loan terms with a balloon payment rather than full amortization over the loan
term.
Bay National Bank's lending limit may limit its growth and the growth
of Bay National Corporation. Bay National Bank is limited in the amount it can
loan to a single borrower by the amount of its capital. Specifically, under
current law, Bay National Bank may lend up to 15% of its unimpaired capital and
surplus to any one borrower. Bay National Bank's lending limit is significantly
less than that of many of its competitors and may discourage potential borrowers
who have credit needs in excess of Bay National Bank's lending limit from
conducting business with Bay National Bank.
Bay National Bank faces substantial competition which could adversely
affect its ability to attract depositors and borrowers. Bay National Bank
operates in a competitive market for financial services and faces intense
competition from other institutions both in making loans and in attracting
deposits. Many of these institutions have been in business for many years, are
significantly larger, have established customer bases, have greater financial
resources and lending limits than Bay National Bank, and are able to offer
certain services that Bay National Bank is not able to offer. If Bay National
Bank cannot attract deposits and make loans at a sufficient level, its operating
results will suffer, as will its opportunities for growth.
Government regulation could restrict Bay National Corporation's or Bay
National Bank's growth or cause Bay National Corporation or Bay National Bank to
incur higher costs. Bay National Corporation and Bay National Bank operate in a
highly regulated environment and are subject to examination, supervision and
comprehensive regulation by several federal and state regulatory agencies.
Banking regulations, designed primarily for the safety of depositors, may limit
the growth of Bay National Bank and the return to investors by restricting
activities such as the payment of dividends; mergers with, or acquisitions by,
other institutions; investments; loans and interest rates; interest rates paid
on deposits; and the creation of branch offices. Laws
14
and regulations could change at any time, and changes could adversely affect Bay
National Corporation's and Bay National Bank's business. In addition, the cost
of compliance with regulatory requirements could adversely affect Bay National
Corporation's and Bay National Bank's ability to operate profitably.
Bay National Bank's ability to compete may suffer if it cannot take
advantage of technology to provide banking services or if its customers fail to
embrace that technology. Bay National Bank's business strategy relies less on
customers' access to a large branch network and more on access to technology and
personal relationships. Further, the market for financial services is
increasingly affected by advances in technology, including developments in
telecommunications, data processing, computers, automation, Internet-based
banking and, tele-banking. Bay National Bank's ability to compete successfully
may depend on the extent to which Bay National Bank can take advantage of
technological changes and the extent to which Bay National Bank's customers
embrace technology to complete their banking transactions.
Because we currently serve limited market areas, we could be more adversely
affected by an economic downturn in our market areas than our larger competitors
which are more geographically diverse. Currently, our primary market area is
limited to the Baltimore metropolitan area and Maryland's Eastern Shore. If
either of these areas suffer an economic downturn, our business and financial
condition may be severely affected. Our larger competitors serve a more
geographically diverse market area, parts of which may not be affected by the
same economic conditions that exist in our primary market areas.
If economic conditions deteriorate, our results of operations and financial
condition could be adversely affected as borrowers' ability to repay loans
declines and the value of the collateral securing our loans decreases. Our
financial results may be adversely affected by changes in prevailing economic
conditions, including decreases in real estate values, changes in interest rates
which may cause a decrease in interest rate spreads, adverse employment
conditions, the monetary and fiscal policies of the federal government and other
significant external events. Because a significant portion of our loan portfolio
is comprised of real estate related loans, decreases in real estate values could
adversely affect the value of property used as collateral. Adverse changes in
the economy also may have a negative effect on the ability of our borrowers to
make timely repayments of their loans, which would have an adverse impact on our
earnings.
If our allowance for loan losses is not sufficient to cover actual loan losses,
our earnings could decrease. We make various assumptions and judgments about the
collectibility of our loan portfolio, including the creditworthiness of our
borrowers and the value of collateral for the repayment of many of our loans. In
determining the amount of the allowance for loan losses, we review, among other
things, our loans and our loss and delinquency experience, and we evaluate
economic conditions. If our assumptions are incorrect, our allowance for loan
losses may not be sufficient to cover losses inherent in our loan portfolio,
resulting in additions to our allowance.
We are particularly susceptible to this risk because we are a
relatively new bank and have experienced significant growth over the past few
years. In general, loans do not begin to show signs of credit deterioration or
default until they have been outstanding for some period of time, a process
referred to as "seasoning." As a result, a portfolio of older loans will usually
behave more predictably than a newer portfolio. Because a large portion of our
loan portfolio is relatively new, the current level of delinquencies and
defaults may not be representative of the level that will prevail when the
portfolio becomes more seasoned, which may be higher than current levels. If
delinquencies and defaults increase, we may be required to increase our
provision for loan losses.
Material additions to our allowance would materially decrease our net
income. In addition, bank regulators periodically review our allowance for loan
losses and may require us to increase our provision for loan losses or recognize
further loan charge-offs. Any increase in our allowance for loan losses or loan
charge-offs may have a material adverse effect on our results of operations and
financial condition.
15
Item 2. Description of Property
Baltimore
---------
On July 16, 1999, Bay National Corporation entered into two lease
agreements for its main office, which is located at 2328 West Joppa Road,
Lutherville, Maryland 21093. These leases were amended during February and
October 2004 to add additional space and extended in October 2004 to February
28, 2010. Bay National Corporation has the right to extend the leases for one
additional five year term, to February 28, 2015. In January 2005, the leases
were again amended to add additional space, effective March 1, 2005. The
amendments also effectively combined both leases.
As of December 31, 2004, Bay National Corporation was leasing 6,206
square feet on the third floor of the building and 1,712 square feet on the
first floor of the building, and was paying $19,425 in monthly rent, which
includes Bay National Corporation's share of taxes and building operating costs.
The space on the first floor is used as Bay National Bank's Baltimore branch
office. The space on the third floor is used for Bay National Corporation and
Bay National Bank's administrative offices.
The January 2005 lease amendment adds 1,429 square feet of space in the
basement of the building, for a total of 9,347 square feet. This space will
initially be used for Bay National Bank's Baltimore residential mortgage
operation. Pursuant to this lease amendment, Bay National Corporation also
agreed, beginning with the March 2005 to February 2006 lease year, to pay rent
of $269,119.12 per year or $22,433.26 per month for all of the leased space in
the building. For each lease year thereafter, including any lease years during
any renewal term, the yearly base rent will increase by three percent. The rent
includes Bay National Corporation's share of taxes and building operating costs.
On March 7, 2005, Bay National Corporation agreed to lease, effective
September 1, 2005, 2,355 additional square feet of space on the first floor of
the building. It is anticipated that this additional space will be used for Bay
National Bank's Baltimore residential mortgage operation, which will be moved
from the basement space. Once the mortgage operation moves, Bay National
Corporation and Bay National Bank will likely use the basement space for
administrative purposes.
Beginning November 15, 2004, Bay National Corporation sublet
approximately 850 square feet of the space on the first floor for a term through
December 31, 2006 at a monthly rent for the first year of $1,893, which amount
increases at the rate of three percent per year.
The Landlord, Joppa Green II Limited Partnership, LLLP, is beneficially
owned by the MacKenzie Companies. Gary T. Gill, who has been a director of Bay
National Corporation and Bay National Bank since January 2003, is the president
and chief executive officer of the MacKenzie Companies. See "Item 12 - Certain
Relationships and Related Transactions."
Salisbury
---------
On September 16, 1999, Bay National Corporation entered into a lease
agreement for Bay National Bank's Salisbury, Maryland branch office, which is
located at 109 Poplar Hill Avenue, Salisbury Maryland 21801 in a two-story
building containing approximately 2,500 square feet of office space. This lease,
which became effective as of September 1, 1999, was for a term of five years
with Bay National Corporation having the option to extend the term for three
five-year renewal terms. During the initial lease term, Bay National Corporation
paid monthly rent of approximately $1,980, plus all real estate taxes and
utilities.
Bay National Corporation exercised its option to extend this lease and
it will now terminate on August 31, 2009, unless extended. During the new lease
term, Bay National Corporation is paying monthly rent of approximately $2,292,
plus all real estate taxes and utilities. Pursuant to this lease, Bay National
Corporation
16
has a right of first refusal to purchase the building in the event the landlord
receives a bona fide offer to sell. This property is owned by John R. Lerch, who
has been a director of Bay National Corporation and Bay National Bank since
their formation. See "Item 12 - Certain Relationships and Related Transactions."
On September 1, 2002, Bay National Corporation entered into a lease
agreement for Bay National Bank's Salisbury, Maryland mortgage division office,
which is located at 318 East Main Street, Salisbury Maryland 21801. The leased
space consists of two office suites totaling approximately 420 square feet. This
lease, which became effective as of January 1, 2003, was for a term of one year
with Bay National Corporation having the option to extend the term for one
additional one-year renewal term. Bay National Corporation renewed the lease for
an additional one year term effective as of January 1, 2004. During the initial
lease term and the renewal term, Bay National Corporation paid monthly rent of
$700. On January 1, 2005, Bay National Corporation obtained an additional 200
square feet in the same building. The total space of 620 square feet is
currently rented on a month to month basis at a cost of $1,000 per month. The
landlord is responsible for all real estate taxes and utilities.
Item 3. Legal Proceedings
There are no pending legal proceedings to which Bay National
Corporation or Bay National Bank is a party or to which any of their properties
are subject, nor are there proceedings known to Bay National Corporation to be
contemplated by any governmental authority. There are no material proceedings
known to Bay National Corporation, pending or contemplated, in which any
director, officer or affiliate or any principal security holder of Bay National
Corporation is a party adverse to Bay National Corporation or Bay National Bank
or has a material interest adverse to Bay National Corporation or Bay National
Bank.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the year ended
December 31, 2004 to a vote of security holders of Bay National Corporation.
17
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
As of March 18, 2005, the number of holders of record of Bay National
Corporation's common stock was approximately 428. Bay National Corporation's
common stock is traded on the Over the Counter Bulletin Board ("OTCBB") under
the symbol "BANI.OB."
Bay National Corporation completed an initial public offering ("IPO")
of its common stock on April 30, 2000. Stock prices subsequent to the IPO are
based upon limited trading on the OTCBB. The following table reflects the high
and low sales information as reported on the OTCBB for the periods presented.
Quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commission and may not represent actual transactions.
2004 2003
Bid Price Range Bid Price Range
Quarter Low High Low High
-------------------------- ---------------------------
1st $ 10.10 $ 14.00 $ 8.05 $ 9.00
2nd 11.75 14.00 8.10 11.00
3rd 10.00 12.50 9.05 9.75
4th 10.50 13.25 9.50 10.25
To date, Bay National Corporation has not declared or paid any dividends
on its common stock. Management anticipates that Bay National Corporation will
retain all earnings, if any, in order to provide more funds to operate and
expand Bay National Corporation's business and, therefore, Bay National
Corporation has no plans to pay any cash dividends at least until its
profitability exceeds the level necessary to support capital growth in excess of
regulatory capital needs. If Bay National Corporation decides to pay dividends
in the future, its ability to do so will depend on the ability of Bay National
Bank to pay dividends to Bay National Corporation. In addition, management would
consider a number of other factors before deciding to pay dividends, including
Bay National Corporation's earnings prospects, financial condition and cash
needs.
The amount of dividends that may be paid by Bay National Bank to Bay
National Corporation depends on Bay National Bank's earnings and capital
position and is limited by statute, regulations and regulatory policies. As a
national bank, Bay National Bank may not pay dividends from its permanent
capital. All cash dividends must be paid out of undivided profits then on hand,
after deducting expenses, including provisions for loan losses and bad debts. In
addition, a national bank is prohibited from declaring a cash dividend on its
shares of common stock until its surplus equals its stated capital, unless there
has been transferred to surplus no less than one-tenth of the bank's net profits
for the preceding two consecutive half-year periods (in the case of an annual
dividend). The approval of the OCC is required if the total of all cash
dividends declared by a national bank in any calendar year exceeds the total of
its net profits for that year combined with its retained net profits for the
preceding two years, less any required transfers to surplus. In addition, Bay
National Bank may not pay a dividend if, after paying the dividend, it would be
"undercapitalized" as defined in the applicable regulations.
Recent Sales of Unregistered Securities
---------------------------------------
From July 13, 2004 to November 12, 2004, Bay National Corporation
issued 55,000 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 $550,000.
The shares were issued upon the exercise of outstanding warrants.
18
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. 1,250 of the warrants were not
exercised prior to their expiration.
There were 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.
19
SELECTED FINANCIAL DATA
AS OF DECEMBER 31, 2004, 2003, 2002, 2001 and 2000
(dollars in thousands, except per share data)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Total assets $ 170,763 $ 122,328 $ 84,609 $ 47,026 $ 24,026
Cash and due from banks 1,403 573 363 3,065 561
Federal funds sold and other overnight
investments 16,709 17,487 11,753 6,488 16,587
Loans held for sale 9,613 924 2,819 682 -
Investment securities available for sale 1,544 1,548 948 - -
Federal Reserve Bank stock 313 313 276 276 276
Federal Home Loan Bank stock 243 168 80 - -
Loans, net 139,603 100,125 67,227 35,415 5,578
Deposits 153,927 108,531 76,079 38,139 13,657
Short-term borrowings 1,381 1,222 507 - -
Note payable 1,250 - - - -
Stockholders' equity 13,419 12,067 7,610 8,602 10,218
Common shares outstanding 1,917,710 1,862,710 1,242,020 1,242,020 1,242,020
Book value per share $ 7.00 $ 6.48 $ 6.13 $ 6.93 $ 8.23
Ratio of interest earning assets to interest
bearing liabilities 124.95% 127.61% 127.68% 134.86% 202.05%
Stockholders' equity as a percentage of assets 7.86% 9.86% 8.99% 18.29% 42.53%
SELECTED FINANCIAL RATIOS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, 2002, 2001 and 2000
Weighted average yield/rate on: 2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Loans and loans held for sale 5.89% 5.98% 6.52% 7.38% 7.19%
Investments and interest bearing cash balances 1.11% .80% 1.36% 3.79% 6.35%
Deposits and short-term borrowings 2.17% 2.26% 2.84% 3.70% 5.25%
Net interest spread 3.14% 2.81% 2.80% 2.31% 1.17%
Net interest margin 3.60% 3.29% 3.43% 3.58% 4.75%
SELECTED OPERATIONAL DATA
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, 2002, 2001 and 2000
(dollars in thousands, except per share data)
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Interest income $ 7,624 $ 5,520 $ 3,486 $ 1,882 $ 782
Interest expense 2,464 1,937 1,367 760 203
Net interest income 5,160 3,583 2,119 1,122 579
Provision for credit losses 560 415 405 377 70
Net interest income after provision for credit 4,600 3,168 1,714 745 509
losses
Non-interest income 539 626 479 187 15
Non-interest expenses 4,337 3,786 3,185 2,548 2,177
Income (loss) before income taxes 802 8 (992) (1,616) (1,653)
Income taxes - -
- - -
Net income (loss) $ 802 $ 8 $ (992) $ (1,616) $ (1,653)
PER COMMON SHARE
Basic net income (loss) per share $ .43 $ .00 $ (.80) $ (1.30) $ (1.98)
Diluted net income (loss) per share $ .41 $ .00 $ (.80) $ (1.30) $ (1.98)
Average shares outstanding (Basic) 1,877,929 1,660,348 1,242,020 1,242,020 834,652
Average shares outstanding (Diluted) 1,936,693 1,682,905 1,242,020 1,242,020 834,652
20
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of Bay National Corporation's financial
condition and results of operations should be read in conjunction with Bay
National Corporation's consolidated financial statements, the notes thereto and
the other information included in this annual report.
This discussion and analysis provides an overview of the financial
condition and results of operations of Bay National Corporation ("Parent") and
its national bank subsidiary, Bay National Bank ("Bank"), (collectively the
"Company"), as of December 31, 2004 and 2003 and for the years ended December
31, 2004, 2003, and 2002.
General
The Parent was incorporated on June 3, 1999 under the laws of the State
of Maryland to operate as a bank holding company of the Bank. The Bank commenced
operations on May 12, 2000.
The principal business of the Company is to make loans and other
investments and to accept time and demand deposits. The Company's primary market
areas are in the areas North of Baltimore and the areas surrounding Salisbury,
Maryland, although the Company's business development efforts generate business
outside of these areas. The Company offers a broad range of banking products,
including a full line of business and personal savings and checking accounts,
money market demand accounts, certificates of deposit, and other banking
services. The Company funds a variety of loan types including commercial and
residential real estate loans, commercial term loans and lines of credit,
consumer loans, and letters of credit with an emphasis on meeting the borrowing
needs of small businesses. The Company's target customers are small closely held
businesses, business owners, professionals and high net worth individuals.
Overview
The Company continued a pattern of strong growth during the year ended
December 31, 2004. This growth has resulted in improved operating results as
compared to prior years. Key measurements for the year ended December 31, 2004
include the following:
o Total assets at December 31, 2004 increased by 39.59% to
$170.8 million as compared to $122.3 million as of December
31, 2003.
o Net loans outstanding increased by 39.43% from $100.1 million
as of December 31, 2003 to $139.6 million as of December 31,
2004.
o There were no nonperforming loans at December 31, 2004. We
believe appropriate reserves for loan losses continue to be
maintained.
o Deposits at December 31, 2004 were $153.9 million, an increase
of $45.4 million or 41.83% 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 offered by
the other financial institution. As of December 31, 2004,
$1,250,000 was outstanding under this facility.
21
o The Company realized net income of $802,264 for the year ended
December 31, 2004. This compares to net income of $7,581 and a
net loss of $(992,494) for the years ended December 31, 2003
and 2002, respectively.
o Net interest income, the Company's main source of income, was
$5.2 million for the year ended December 31, 2004 compared to
$3.6 million and $2.1 million for the years ended December 31,
2003 and 2002, respectively. This represents increases of
43.98% and 143.50% over the two prior years.
o Net loan charge-offs were $16,096 for the year ended December
31, 2004. These represent the first charge-offs since the
inception of the Bank in 2000.
o Non-interest income for the year ended December 31, 2004
declined by $86,416 or 13.82% as compared to the year ended
December 31, 2003, primarily as a result of a decline in
mortgage loan originations.
o Non-interest expenses increased by $550,318 or 14.54% for the
year ended December 31, 2004, as compared to the year ended
December 31, 2003.
o The market price of common shares ended the year at $13.25, up
31.19% 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 $802,264 for the year ended December
31, 2004. This compares to the Company's first annual profit of $7,581 for the
year ended December 31, 2003, an improvement of $794,683. The Company reported a
net loss of $992,494 for the year ended December 31, 2002. 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
2002 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 years ended December 31, 2004, 2003
and 2002, gains on the sale of mortgage loans totaled $244,716, $370,326 and
$334,815, 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 lien and second lien residential mortgage loans.
Under this program the Company purchases a 100% participation in mortgage loans
originated by a mortgage company in the Baltimore metropolitan area. These
22
participations are for loans which a secondary market investor has committed to
purchase. The participations are typically held for a period of three to four
weeks before being sold to the secondary market investor. This holding period
represents the amount of time taken by the secondary market investor to review
the loan files for completeness and accuracy. During this holding period, the
Company earns interest on these loans at a rate indexed to the prime rate.
The primary risk to the Company from this program is that the secondary
market investor may decline to purchase the loans due to documentary
deficiencies or errors. The Company attempts to manage this risk by conducting a
thorough review of the documentation prior to purchasing the participation. If
the secondary market investor declines to purchase the loan, the Company could
attempt to sell the loan to other investors or hold the loan in its loan
portfolio. As of December 31, 2004, the Company held $8.0 million of these loans
which were classified as held for sale. The Company expects that all of these
loans will be purchased by the secondary market investor. The Company earned
$287,835 of interest on this program from inception through December 31, 2004.
Management expects continuous improvement in operating results as asset
levels continue to grow. 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 / MARGINS
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
borrowings make up the cost of funds. Non-interest bearing deposits and capital
are also funding sources. Changes in the volume and mix of earning assets and
funding sources along with changes in associated interest rates determine
changes in net interest income.
Interest income from loans and investments for the year ended December
31, 2004 was $7,623,564, compared to $5,520,068 and $3,486,302 for the years
ended December 31, 2003 and 2002, respectively. The 38.11% increase over 2003,
and the 118.67% increase over 2002, is directly related to the 31.89% increase
in average interest earning assets from 2003, and the 132.22% increase in
average interest earning assets from 2002. The change in interest income was
also impacted by changes in average yields due to a rising interest rate
environment in 2004 and a declining interest rate environment in 2003. The
yields on these assets declined from 5.64% for the year ended December 31, 2002
to 5.07% for the year ended December 31, 2003 and rose to 5.31% for the year
ended December 31, 2004.
The percentage of average interest-earning assets represented by loans
was 88.0%, 82.5% and 83.0% for the years ended December 31, 2004, 2003, and
2002, respectively. For the year ended December 31, 2004, the average yield on
the loan portfolio was 5.89%, as compared to 5.98% for the year ended December
31, 2003 and 6.52% for the year ended December 31, 2002. Loan yields have
declined as a result of actions taken by the Federal Reserve to reduce its
target for the federal funds rate from 1.75% at December 31, 2001, to 1.25%
effective November 6, 2002, and finally to 1.00% effective June 25, 2003. The
Federal Reserve reversed this trend during 2004 when it increased its target for
the federal funds rate to: 1.25% effective June 30, 2004; 1.50% effective August
10, 2004; 1.75% effective September 21, 2004; 2.00% effective November 10, 2004;
and 2.25% effective December 14, 2004. These actions began to have an impact on
the Company's loan yields during the third quarter and the most recent increases
began to have a measurable effect on the Company's results during the fourth
quarter of 2004. The timing and amount of the impact on loan yields of changes
to the federal funds rates varies from period to period as a result of
differences in the mix of fixed rate loans to variable rate loans at any point
in time.
23
The average yield on the investment portfolio and other earning assets
such as federal funds sold was 1.11% for the year ended December 31, 2004 as
compared to 0.80% and 1.36% for the years ended December 31, 2003 and 2002,
respectively. The fluctuations in the average yields were a direct result of the
Federal Reserve actions discussed above as well as an increase in the holdings
of Federal Reserve and Federal Home Loan Bank of Atlanta stocks, which pay
dividend yields greater than the prevailing federal funds rate. The percentage
of average interest-earning assets represented by investments was 12.0%, 17.5%
and 17.0% for the years ended December 31, 2004, 2003, and 2002, respectively.
Interest expense from deposits and borrowings for the year ended
December 31, 2004 was $2,464,209, compared to $1,936,726 and $1,367,502 for the
years ended December 31, 2003 and 2002, respectively. The 27.2% increase over
2003 and the 80.2% increase over 2002 are directly related to the 32.7% increase
in average interest-bearing liabilities from 2003 and the 136.5% increase in
average interest-bearing liabilities from 2002. Interest expense was also
impacted by changes in average rates paid due to the fluctuating interest rate
environment. The average rates paid on these liabilities changed from 2.84% for
the year ended December 31, 2002 to 2.26% for the year ended December 31, 2003
as a result of the declining interest rate environment during these periods.
Even though interest rates began to increase in 2004, the average rate on
liabilities declined to 2.17% for the year ended December 31, 2004 because
management was able to delay raising rates following the actions of the Federal
Reserve. Management expects that pressure to increase rates paid on deposits
will increase as the target for the federal funds rate continues to rise. In
fact upward pressure began to appear on shorter term rates in the fourth quarter
of 2004.
24
The following tables set forth, for the periods indicated, information
regarding the average balances of interest-earning assets and interest-bearing
liabilities, the amount of interest income and interest expense, and the
resulting yields on average interest-earning assets and rates paid on average
interest-bearing liabilities. Average balances are also provided for
non-interest-earning assets and non-interest-bearing liabilities.
No tax equivalent adjustments were made and no income was exempt from
federal income taxes. All average balances are monthly average balances. We do
not believe that the monthly averages differ materially from what the daily
averages would have been. The amortization of loan fees is included in computing
interest income, however, such fees are not material.
Year Ended December 31, 2004
Average Interest Yield/
Balance and fees Rate
------- -------- ----
ASSETS
Loans and loans held for sale $ 126,212,414 $ 7,431,368 5.89%
Investment securities 2,038,432 45,173 2.22
Federal funds sold and other overnight investments 15,232,288 147,023 .97
------------- ------------
Total Earning Assets 143,483,134 7,623,564 5.31%
------------
Less: Allowance for credit losses (1,473,985)
Cash and due from banks 909,590
Premises and equipment, net 641,550
Accrued interest receivable and other assets 534,261
-------------
Total Assets $ 144,094,550
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 46,627,122 509,308 1.09%
Regular savings deposits 4,363,244 28,396 .65
Time deposits 61,184,843 1,901,183 3.11
Short-term borrowings 1,475,148 19,020 1.29
Note payable 129,098 6,302 4.88
------------- ------------
Total interest-bearing liabilities 113,779,455 2,464,209 2.17%
------------ ------------
Net interest income and spread $ 5,159,355 3.14%
============ ============
Non-interest-bearing demand deposits 17,391,401
Accrued expenses and other liabilities 515,639
Stockholders' equity 12,408,055
-------------
Total Liabilities and Stockholders' Equity $ 144,094,550
=============
Interest and fee income/earning assets 5.31%
Interest expense/earning assets 1.71
-------------
Net interest margin 3.60%
=============
Return on Average Assets .56%
=============
Return on Average Equity 6.47%
=============
Average Equity to Average Assets 8.61%
=============
25
Year Ended December 31, 2003
Average Interest Yield/
Balance and fees Rate
------- -------- ----
ASSETS
Loans and loans held for sale $ 89,721,871 $ 5,367,997 5.98%
Investment securities 1,833,052 37,317 2.04
Federal funds sold and other overnight investments 17,238,474 114,754 .67
------------- ------------
Total Earning Assets 108,793,397 5,520,068 5.07%
------------
Less: Allowance for credit losses (1,090,526)
Cash and due from banks 903,675
Premises and equipment, net 689,080
Accrued interest receivable and other assets 396,583
-------------
Total Assets $ 109,692,209
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 33,884,963 381,985 1.13%
Regular savings deposits 2,997,371 20,532 .69
Time deposits 47,675,682 1,522,525 3.19
Short-term borrowings 1,172,658 11,684 1.00
------------- ------------
Total interest-bearing liabilities 85,730,674 1,936,726 2.26%
------------ ------------
Net interest income and spread $ 3,583,342 2.81%
============ ============
Non-interest-bearing demand deposits 13,158,325
Accrued expenses and other liabilities 386,732
Stockholders' equity 10,416,478
-------------
Total Liabilities and Stockholders' Equity $ 109,692,209
=============
Interest and fee income/earning assets 5.07%
Interest expense/earning assets 1.78
-------------
Net interest margin 3.29%
=============
Return on Average Assets - %
=============
Return on Average Equity - %
=============
Average Equity to Average Assets 9.50%
=============
26
Year Ended December 31, 2002
Average Interest Yield/
Balance and fees Rate
ASSETS
Loans and loans held for sale $ 51,267,330 $ 3,342,790 6.52%
Investment securities 796,439 25,949 3.26
Federal funds sold and other overnight investments 9,724,297 117,563 1.21
------------- ------------
Total Earning Assets 61,788,066 3,486,302 5.64%
------------
Less: Allowance for credit losses (607,823)
Cash and due from banks 688,916
Premises and equipment, net 770,440
Accrued interest receivable and other assets 287,930
-------------
Total Assets $ 62,927,529
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits $ 22,882,007 495,510 2.17%
Regular savings deposits 2,530,480 30,352 1.20
Time deposits 22,379,802 836,763 3.74
Short-term borrowings 325,786 4,877 1.50
------------- ------------ ------------
Total interest-bearing liabilities 48,118,075 1,367,502 2.84%
------------ ------------
Net interest income and spread $ 2,118,800 2.80%
============ ============
Non-interest-bearing demand deposits 6,512,685
Accrued expenses and other liabilities 226,776
Stockholders' equity 8,069,993
-------------
Total Liabilities and Stockholders' Equity $ 62,927,529
=============
Interest and fee income/earning assets 5.64%
Interest expense/earning assets 2.21
-------------
Net interest margin 3.43%
=============
Return on Average Assets (1.58)%
=============
Return on Average Equity (12.30)%
=============
Average Equity to Average Assets 12.82%
=============
27
RATE/VOLUME ANALYSIS
A rate/volume analysis, which demonstrates changes in
taxable-equivalent interest income and expense for significant assets and
liabilities, appears below. The calculation of rate, volume and rate/volume
variances is based on a procedure established for bank holding companies by the
Securities and Exchange Commission. Rate, volume and rate/volume variances
presented for each component may not total to the variances presented on totals
of interest income and interest expense because of shifts from year to year in
the relative mix of interest-earning assets and interest-bearing liabilities.
Year ended December 31,
----------------------------------------------------------------------
2004 vs. 2003
Due to variances in
Total Rates Volumes Rate/ Volume
----------------------------------------------------------------------
Interest earned on:
Loans and loans held for sale $ 2,063,371 $ (85,187) $ 2,183,204 $ (34,646)
Investment Securities 7,856 3,305 4,181 370
Federal funds sold and other
overnight investments 32,269 51,633 (13,355) (6,009)
------------- -------------- ----------------- -------------
Total interest income 2,103,496 (30,249) 2,174,030 (40,285)
Interest paid on:
Interest-bearing demand deposits 127,323 (11,860) 143,642 (4,459)
Regular savings deposits 7,864 (1,025) 9,356 (467)
Time deposits 378,658 (41,109) 431,416 (11,649)
Short-term borrowings 7,336 3,436 3,014 886
Note payable 6,302 - - 6,302
------------- -------------- ----------------- -------------
Total interest expense 527,483 (50,558) 587,428 (9,387)
------------- -------------- ----------------- -------------
Net interest earned $ 1,576,013 $ 20,309 $ 1,586,602 $ (30,898)
============= ============== ================= =============
Year ended December 31,
----------------------------------------------------------------------
2003 vs. 2002
Due to variances in
Total Rates Volumes Rate/ Volume
----------------------------------------------------------------------
Interest earned on:
Loans and loans held for sale $ 2,025,207 $ (275,501) $ 2,507,356 $ (206,648)
Investment Securities 11,368 (9,735) 33,774 (12,671)
Federal funds sold and other
overnight investments (2,809) (52,830) 90,844 (40,823)
------------- -------------- ----------------- -------------
Total interest income 2,033,766 (338,066) 2,631,974 (260,142)
Interest paid on:
Interest-bearing demand deposits (113,525) (237,561) 238,269 (114,233)
Regular savings deposits (9,820) (13,018) 5,600 (2,402)
Time deposits 685,762 (122,063) 945,793 (137,968)
Short-term borrowings 6,807 (1,631) 12,678 (4,240)
------------- -------------- ----------------- -------------
Total interest expense 569,224 (374,273) 1,202,340 (258,843)
------------- -------------- ----------------- -------------
Net interest earned $ 1,464,542 $ 36,207 $ 1,429,634 $ (1,299)
============= ============== ================= =============
PROVISION FOR CREDIT LOSSES
The provision for loan losses was $559,596 for the year ended December
31, 2004, as compared to $415,000 for the year ended December 31, 2003, and
$404,500 for the year ended December 31, 2002. The provisions for each year were
the direct result of growth in loan balances outstanding in all segments of the
portfolio. 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."
28
NON-INTEREST INCOME
Non-interest income consists primarily of gains on the sale of mortgage
loans, deposit account service charges and cash management fees. For the year
ended December 31, 2004, the Company realized non-interest income in the amount
of $538,847 as compared to $625,263 and $478,516 for the years ended December
31, 2003 and 2002, respectively.
Gains on the sale of mortgage loans of $244,716 represented 45.42% of
non-interest income for the year ended December 31, 2004. This compares to gains
on the sale of mortgage loans of $370,326 or 59.23% of total non-interest income
for the year ended December 31, 2003 and $334,815 or 69.97% of total
non-interest income for the year ended December 31, 2002. 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 generate non-interest income associated with mortgage loan
production.
In February 2005, the Company added additional residential construction
and mortgage capability in the Baltimore market area. It is expected that these
additional capabilities will increase future levels of gains on the sale of
mortgage loans, while also providing interest income on construction loans.
This capability was added through the hiring of a team of eight individuals,
including originators, processors and servicers from another financial
institution. These individuals have extensive experience in the industry and the
Company's market area.
Service charges on deposit accounts totaled $237,980 for the year ended
December 31, 2004, as compared to $212,787 and $105,766 for the years ended
December 31, 2003 and 2002, respectively. The increases of 11.84% over 2003 and
125.01% over 2002 can be directly attributed to the growth in the Company's
deposit portfolio and to the fact that the Company introduced additional fee
based commercial deposit products in 2002.
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
2004 compared to 2003
---------------------
Non-interest expense for the year ended December 31, 2004 totaled
$4,336,342 compared to $3,786,024 for the year ended December 31, 2003. The
increase of $550,318, or 14.54%, was primarily due to increases in staffing and
employee benefit expenses, occupancy expenses, data processing and other outside
services, furniture and equipment expenses and other expenses.
Salaries and benefits increased by $327,423 or 15.48% as a result of
staffing growth initiated to increase marketing efforts, manage the growth of
the loan and deposit portfolios and support increased operational volume.
Occupancy expenses increased by $52,831, or 20.34% due in part to scheduled rent
increases as well as a reduction in sublease income of approximately $10,900 due
to expansion of the Company's corporate office into previously sublet space and
$20,400 of rental expenses associated with new space obtained to facilitate the
expansion of the Company's corporate offices. The $45,963, or 8.57%, increase in
data processing and other outside services resulted from 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
$40,293, or 18.72%, increase in furniture and equipment expenses is related to
increased costs associated
29
with expanded staffing and facilities. The increase of $83,808, or 12.71%, in
all other expenses relates to various costs associated with the increased size
and complexity of the Company.
Substantially all of the occupancy costs are paid to directors of Bay
National Corporation or entities controlled by directors of Bay National
Corporation. Management believes that the terms of these leases are at least as
favorable as could be obtained from independent third parties. However,
management has not conducted a recent market analysis to confirm this fact. For
a discussion of the terms of the leases with these persons, see "Item 12 -
Certain Relationships and Related Transactions."
The growth of the Company's customer base will continue to require
additional staffing in order to service customers, and manage the business
properly. Management believes that continued growth in the customer base can be
accommodated without proportionate increases in these costs.
The rate of increase in non-interest expenses is substantially less
than the 43.98% increase in net interest income for the year ended December 31,
2004 as compared to year ended December 31, 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.
2003 compared to 2002
---------------------
Non-interest expense for the year ended December 31, 2003 totaled
$3,786,024 compared to $3,185,310 for the year ended December 31, 2002. The
increase of $600,714, or 18.86%, was primarily due to increases in staffing and
employee benefit expenses, data processing and other outside services,
advertising and marketing related expenses, and other expenses.
Salaries and benefits increased by $301,722, or 16.64% as a result of
staffing growth initiated to increase marketing efforts, manage the growth of
the loan and deposit portfolios, and support increased operational volume.
Occupancy expenses increased by $47,052, or 22.12%, due to scheduled rent
increases as well as a reduction in sublease income of approximately $17,000 due
to expansion of the Company's corporate office into previously sublet space, and
$8,400 of rental expense associated with new space obtained for the mortgage
division. The $136,731, or 34.21%, increase in data processing and other outside
services resulted from increased courier expenses incurred to facilitate
commercial deposit gathering with a limited branch presence, and increased data
and item processing costs paid to external service providers. The data and item
processing costs are volume driven based upon the number of customer accounts
and related transaction volume. As a result, these costs increase with the
growth of the Company. The $36,435, or 20.96% increase in advertising and
marketing related expenses is related to increased efforts to enhance the
visibility of the Bank and attract new customers. The increase of $41,792, or
16.80%, in other expenses relates to various costs associated with the increased
size and complexity of the Company.
Substantially all of the occupancy costs are paid to directors of Bay
National Corporation or entities controlled by directors of Bay National
Corporation. Management believes that the terms of these leases are at least as
favorable as could be obtained from independent third parties. However,
management has not conducted a recent market analysis to confirm this fact. For
a discussion of the terms of the leases with these persons, see "Item 12 -
Certain Relationships and Related Transactions."
30
INCOME TAXES
The Company has not incurred any income tax liability since its
inception. At December 31, 2004 and 2003, the Company had net operating loss
carryforwards of approximately $2.5 million and $3.9 million available to offset
future taxable income, respectively. If not utilized, the carryforwards at
December 31, 2004 will expire beginning in 2019.
When the realization of deferred income taxes is deemed to be more
likely than not, the Company will be required to record previously unrecorded
net deferred income tax assets, which have a positive effect on the earnings in
the period when such determination is made. As of December 31, 2004, the Company
had net deferred tax assets of approximately $1.4 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
Total assets of the Company were $170,763,474 as of December 31, 2004,
compared to total assets of $122,328,256 as of December 31, 2003. This
represents growth of approximately $48.4 million or 39.6% since December 31,
2003. The growth in assets was funded by growth in deposits. Deposits at
December 31, 2004 were $153,927,042 compared to deposits of $108,530,901 at
December 31, 2003. Deposit growth resulted from the marketing efforts of
officers and directors of the Bank and the use of two Internet based listing
services for certificates of deposit. Management has set the interest rates paid
on deposits to be competitive in the market and has continued to increase
marketing activities throughout the year.
As of December 31, 2004, loans including loans held for sale (net of a
$1,810,000 allowance for credit losses), totaled $149,216,599. This represents
an increase of $48,167,299, or 47.67%, from December 31, 2003. The composition
of the loan portfolio as of December 31, 2004 was approximately $73.8 million of
commercial loans (excluding real estate loans), $2.2 million of consumer loans
and $65.4 million of real estate loans excluding $9,613,162 of mortgage loans
held for sale. The composition of the loan portfolio as of December 31, 2003 was
approximately $61.9 million of commercial loans (excluding real estate loans),
$1.7 million of consumer loans and $37.8 million of real estate loans excluding
$923,825 of mortgage loans held for sale. Growth in the loan portfolio is a
direct result of the marketing efforts of bank employees as well as members of
the Board of Directors and the Baltimore and Salisbury Advisory Boards. The mix
of loans is consistent with the plans for the business.
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.
Funds not extended in loans are held in cash and due from banks, and
various investments including federal funds sold and other overnight
investments, United States Treasury securities, Federal Reserve Bank stock and
Federal Home Loan Bank stock. These investments totaled $18,809,114 as of
December 31, 2004 compared to $19,515,869 as of December 31, 2003. Other than
the investments in Federal Reserve Bank stock and Federal Home Loan Bank stock,
totaling $556,090 and $481,090 at December 31, 2004 and 2003, respectively, all
investments have maturities of 90 days or less. The Treasury securities are used
to collateralize repurchase agreements which are classified as short-term
borrowings under which $1,381,000
31
and $1,222,000 were outstanding as of December 31, 2004 and December 31, 2003,
respectively. Management has made a decision to maintain liquidity in the
investment portfolio in order to ensure that funds are readily available to fund
the growth of the loan portfolio.
As of December 31, 2004, the Company had borrowed $1,250,000 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 are used to provide regulatory capital to the Bank. The loan
bears interest at the prime rate as offered by the financial institution.
Total capital at December 31, 2004 was $13,418,764 as compared to
$12,066,500 at December 31, 2003. The increase in capital is a result of the
positive operating results for the year ended December 31, 2004 and $550,000
received upon the issuance of 55,000 shares of common stock upon the exercise of
warrants. Management believes that the Company will need additional capital, in
excess of the $3.75 million still available under the credit facility, to
support projected asset growth over the next 12 months. Management and the
Capital Committee of the Board of Directors are currently evaluating available
alternatives. Any additional capital, if available at all, may be on terms which
are not as favorable to the Company as that desired by management and may result
in dilution to the Company's shareholders. If adequate capital is not available,
the Company may be required to curtail significantly its expected growth
strategy.
COMPOSITION OF LOAN PORTFOLIO
Because yields on loans typically exceed the yields on investments, the
Company's business strategy is to continue to increase the overall level of
loans, as well as maintain a relatively high percentage of loans to total
earning assets. Increasing loans and loans as a percentage of total earning
assets will maximize net interest margin. As of December 31, 2004 and 2003,
loans represented 88.93% and 83.98% of total earning assets, respectively.
The following table sets forth the composition of the principal
balances of Company's loan portfolio as of December 31, 2004 and 2003,
respectively.
2004 2003
---- ----
Real Estate - Home Equity Line of
Credit $ 24,548,506 17.36% $ 16,078,166 15.86%
Real Estate - Construction 12,968,251 9.17 8,101,017 7.99
Real Estate - Mortgage 27,854,130 19.70 13,687,709 13.50
Commercial 73,836,994 52.21 61,868,002 61.02
Consumer 2,205,556 1.56 1,657,081 1.63
-------------- ------------- --------------- -------------
Total loans $ 141,413,437 100.00% $ 101,391,975 100.00%
============== ============= =============== =============
32
The following table sets forth the maturity distribution for the Company's
loan portfolio at December 31, 2004. Some of the loans may be renewed or repaid
prior to maturity. Therefore, the following table should not be used as a
forecast of future cash flows.
Within one One to three Three to Over five
year years five years years
---- ----- ---------- -----
Real Estate - Home Equity Line of Credit $ 24,093,174 $ 455,332 $ - $ -
Real Estate - Construction 12,762,671 136,566 69,014 -
Real Estate - Mortgage 19,017,874 4,167,229 4,669,027 -
Commercial 58,621,806 6,540,270 7,846,632 828,286
Consumer 1,782,351 401,968 21,237 -
--------------- -------------- --------------- --------------
Total $ 116,277,876 $ 11,701,365 $ 12,605,910 $ 828,286
=============== ============== =============== ==============
Fixed interest rate $ 8,634,237 $ 11,701,365 $ 12,605,910 $ 828,286
Variable interest rate 107,643,639 - - -
--------------- -------------- --------------- --------------
Total $ 116,277,876 $ 11,701,365 $ 12,605,910 $ 828,286
=============== ============== =============== ==============
The scheduled repayments as shown above are reported in the maturity
category in which the payment is due, except for the adjustable rate loans,
which are reported in the period of repricing.
The Company's loan portfolio composition as of December 31, 2004
reflects a 76.12% concentration in variable rate loans. Fixed rate loans total
$33,769,798 or 23.88% of the Company's loan portfolio. Interest rates on
variable rate loans adjust to the current interest rate environment, whereas
fixed rates do not allow this flexibility. If interest rates were to increase in
the future, the interest earned on the variable rate loans would improve, and,
if rates were to fall, the interest earned would decline. See "Liquidity and
Interest Rate Sensitivity."
The officers and directors of the Company have loans from the Bank of
$5,828,095 at December 31, 2004. All loans made to officers and directors are
made on substantially the same terms, including interest rates and collateral,
as those prevailing at the time for comparable transactions with unaffiliated
third parties and do not involve more than the normal risk of repayment or
present other unfavorable features.
ALLOWANCE FOR CREDIT LOSSES AND CREDIT RISK MANAGEMENT
Originating loans involves a degree of risk that credit losses will
occur in varying amounts according to, among other factors, the type of loans
being made, the credit-worthiness of the borrowers over the term of the loans,
the quality of the collateral for the loan, if any, as well as general economic
conditions. The Company charges the provision for credit losses to earnings to
maintain the total allowance for credit losses at a level considered by
management to represent its best estimate of the losses known and inherent in
the portfolio that are both probable and reasonable to estimate, based on, among
other factors, prior loss experience, volume and type of lending conducted,
estimated value of any underlying collateral, economic conditions (particularly
as such conditions relate to the Company's market area), regulatory guidance,
peer statistics, management's judgment, past due loans in the loan portfolio,
loan charge off experience and concentrations of risk (if any). The Company
charges losses on loans against the allowance when it is believed that
collection of loan principal is unlikely. Recoveries on loans previously charged
off are added back to the allowance.
Management uses a loan grading system where all loans are graded based
on management's evaluation of the risk associated with each loan. A factor,
based on the loan grading, is applied to the loan balance to reserve for
potential losses. In addition, management judgmentally establishes an additional
33
nonspecific reserve. The nonspecific portion of the allowance reflects
management's estimate of probable inherent but undetected losses within the
portfolio due to uncertainties in economic conditions, delays in obtaining
information, including unfavorable information about a borrower's financial
condition, the difficulty in identifying triggering events that correlate
perfectly to subsequent loss rates and risk factors that have not yet manifested
themselves in loss allocation factors.
The reserve factors used are based on management's judgment as to
appropriate reserve percentages for various categories of loans, and adjusts
those values based on the following: historical losses in each category,
historical and current delinquency in each category, underwriting standards in
each category, comparison of losses and delinquencies to peer group performance
and an assessment of the likely impact of economic and other external conditions
on the performance of each category.
A test of the adequacy of the allowance for credit losses is performed
and reported to the Board of Directors on a monthly basis. Management uses the
information available to make a determination with respect to the allowance for
credit losses, recognizing that the determination is inherently subjective and
that future adjustments may be necessary depending upon, among other factors, a
change in economic conditions of specific borrowers or generally in the economy
and new information that becomes available. However, there are no assurances
that the allowance for credit losses will be sufficient to absorb losses on
nonperforming assets or that the allowance will be sufficient to cover losses on
nonperforming assets in the future.
The allowance for credit losses as of December 31, 2004 and December
31, 2003 was $1,810,000 and $1,266,500, respectively. The amount equates to
1.20% and 1.24% of outstanding loans, including loans held for sale, as of
December 31, 2004 and 2003, respectively. This percentage has fluctuated based
upon changes in the level of loans held for sale. These loans are secured by
residential real estate and, as a result, have a lower risk of loss. Bay
National Corporation has no exposure to foreign countries or foreign borrowers.
Management believes that the allowance for loan losses is adequate for each
period presented.
The following table represents an analysis of the activity in the
allowance for credit losses for the periods presented:
2004 2003 2002
---- ---- ----
Balance at beginning of year $ 1,266,500 $ 851,500 $ 447,000
Provision for credit losses 559,596 415,000 404,500
Loan charge-offs
Commercial (15,222) - -
Consumer (2,134) - -
Loan recoveries
Commercial 1,260 - -
------------- ------------- -----------
Net charge-offs (16,096) - -
------------- ------------- -----------
Balance at end of year $ 1,810,000 $ 1,266,500 $ 851,500
============= ============= ===========
There were no loans that were considered impaired under Statements of
Financial Accounting Standards No. 114 ("SFAS No. 114") as of December 31, 2004,
2003 and 2002 and for the years then ended.
The ratio of net charge-offs during 2004 to average loans outstanding,
net, during 2004 was .01%.
34
The following table presents the allocation of the allowance for credit
losses, reflecting use of the methodology presented above, along with the
percentage of total loans in each category as of December 31, 2004 and 2003.
As of December 31, 2004
Amount Loan Mix
Real Estate - Home Equity Line of Credit $ 122,918 17.36%
Real Estate - Construction 150,346 9.17
Real Estate - Mortgage 179,798 19.70
Commercial 1,279,472 52.21
Consumer 11,032 1.56
Nonspecific 66,434 -
-------------- -------------
Total Allowance $ 1,810,000 100.00%
============== =============
As of December 31, 2003
Amount Loan Mix
Real Estate - Home Equity Line of Credit $ 80,370 15.86%
Real Estate - Construction 86,252 7.99
Real Estate - Mortgage 133,109 13.50
Commercial 954,623 61.02
Consumer 10,324 1.63
Nonspecific 1,822 -
-------------- -------------
Total Allowance $ 1,266,500 100.00%
============== =============
The unallocated portion of the allowance for credit losses increased in
2004. This occurred because the Company calculates an overall reserve level
while the underlying portfolio experienced a moderate shift in the mix of loans
by risk grade. The shift in the mix of loans by risk grade is a normal result of
the addition of new loans, the decrease in balances of more mature loans and the
ongoing reassessment of all loans.
NONPERFORMING LOANS AND OTHER DELINQUENT ASSETS
Management performs reviews of all delinquent loans. Management will
generally classify loans as non-accrual when collection of full principal and
interest under the original terms of the loan is not expected or payment of
principal or interest has become 90 days past due. Classifying a loan as
non-accrual results in the Company no longer accruing interest on such loan and
reversing any interest previously accrued but not collected. A non-accrual loan
may be restored to accrual status when delinquent principal and interest
payments are brought current and future monthly principal and interest payments
are expected to be collected. The Company will recognize interest on non-accrual
loans only when received. As of December 31, 2004, the Company did not have any
non-accrual loans. As of December 31, 2003 the Company had one loan with a
balance of $4,087 classified as a non-accrual loan. This loan was subsequently
charged off in January 2004.
Any property acquired by the Company as a result of foreclosure on a
mortgage loan will be classified as "real estate owned" and will be recorded at
the lower of the unpaid principal balance or fair value at the date of
acquisition and subsequently carried at the lower of cost or net realizable
value. Any required write-down of the loan to its net realizable value will be
charged against the allowance for credit losses. Upon foreclosure, the Company
generally will require an appraisal of the property and, thereafter, appraisals
of the property on at least an annual basis with external inspections on at
least a quarterly basis. As of December 31, 2004, and December 31, 2003, the
Company held no real estate acquired as a result of foreclosure.
35
The Company applies the provisions of Statements of Financial
Accounting Standards No. 114 ("SFAS No. 114"), "Accounting by Creditors for
Impairment of a Loan," as amended by Statements of Financial Accounting
Standards No. 118 ("SFAS No. 118"), "Accounting by Creditors for Impairment of a
Loan-Income Recognition and Disclosure." SFAS No. 114 and SFAS No. 118 require
that impaired loans, which consist of all modified loans and other loans for
which collection of all contractual principal and interest is not probable, be
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate, or at the loan's observable market price or
the fair value of the collateral if the loan is collateral dependent. If the
measure of the impaired loan is less than the recorded investment in the loan,
an impairment is recognized through a valuation allowance and corresponding
provision for credit losses. The Company considers consumer loans as homogenous
loans and thus does not apply the SFAS No. 114 impairment test to these loans.
Impaired loans will be written off when collection of the loan is doubtful.
Other than the one non-accrual loan as of December 31, 2003 discussed
above, the Company had no impaired loans as of December 31, 2004 or December 31,
2003.
INVESTMENT PORTFOLIO
The Company has chosen to invest its available funds primarily in
federal funds sold and other overnight investments. As a result, investment
securities as of December 31, 2004, consisted of $312,690 of Federal Reserve
Bank stock, $243,400 of Federal Home Loan Bank stock and $1,544,496 of U.S.
Treasury securities which mature within three months. Investment securities for
the year ended December 31, 2003, consisted of $312,690 of Federal Reserve Bank
stock, $168,400 of Federal Home Loan Bank stock and $1,547,798 of U.S. Treasury
securities which matured within three months.
Management has made the decision to maintain its available funds in
highly liquid assets because it wishes to ensure that funds are readily
available to fund the growth of the loan portfolio. Management believes that
this strategy will allow the Company to maximize interest margins while
maintaining appropriate levels of liquidity to fund loan growth.
SOURCES OF FUNDS
General
-------
Deposits, short-term borrowings in the form of repurchase agreements,
borrowings under the credit facility, scheduled amortization and prepayment of
loans, funds provided by operations and capital are the current sources of funds
utilized by the Company for lending and investment activities, and other general
business purposes.
Deposits
--------
The Company offers a variety of deposit products having a range of
interest rates and terms. The Company's deposits consist of checking accounts,
savings accounts, money market accounts and certificates of deposit.
36
The following table sets forth the composition of the Company's deposits as of
December 31, 2004 and December 31, 2003:
2004 2003
---- ----
Demand Deposits $ 52,121,451 33.86% $ 36,345,970 33.49%
Savings 5,255,422 3.41 3,202,587 2.95
Money Market and sweep 28,304,367 18.39 18,554,644 17.10
Certificates of deposit 68,245,802 44.34 50,427,700 46.46
--------------- ------------- --------------- -------------
Total deposits $ 153,927,042 100.00% $ 108,530,901 100.00%
=============== ============= =============== =============
The mix of deposits has remained relatively steady from year to year.
The slight increase in the percentage of deposits represented by money market
and sweep accounts is due to an effort to attract more commercial depositors to
interest bearing money-market accounts.
Of the total deposits at December 31, 2004, $16.6 million, or 10.79%
were related to two customers in one industry and a third customer in another
industry. Of the total deposits at December 31, 2003, $7.7 million or 7.14% were
related to the two customers in one industry. The deposits for these customers
tend to fluctuate significantly; as a result, management monitors these deposits
on a daily basis to ensure that liquidity levels are adequate to compensate for
these fluctuations.
The following table sets forth the maturity distribution for the
Company's deposits at December 31, 2004. Some of the deposits may be renewed or
withdrawn prior to maturity. Therefore, the following table should not be used
as a forecast of future cash flows.
Within one One to three Three to Over five
year years five years years
---- ----- ---------- -----
Demand deposits $ 52,121,451 $ - $ - $ -
Savings 5,255,422 - - -
Money Market and sweep 28,304,367 - - -
Certificates of deposit 33,253,349 20,687,755 14,304,698 -
--------------- --------------- ---------------- --------------
Total $ 118,934,589 $ 20,687,755 $ 14,304,698 $ -
=============== =============== ================ ==============
Certificates of deposit in amounts of $100,000 or more, and their
remaining maturities at December 31, 2004, are as follows:
Three months or less $ 4,285,752
Over three months through six months 3,553,729
Over six months through twelve months 3,351,703
Over twelve months 10,745,359
-----------
Total $ 21,936,543
===========
The market in which the Company operates is very competitive and the
rates of interest paid on deposits are affected by rates paid by other
depository institutions. Management closely monitors rates offered by other
institutions and seeks to be competitive within the market. The Company has
chosen to selectively compete for large certificates of deposits. The Company
will choose to pursue such deposits when expected loan growth provides for
adequate spreads to support the cost of those funds. As of December 31, 2004,
the Company had outstanding certificates of deposit of approximately $29 million
that were obtained through the listing of certificate of deposit rates on two
Internet-based listing services. These certificates of deposit were issued with
an average yield of 2.91% and an average term of 31.5 months. Included in the
$29 million of Internet-originated certificates of deposit is $394,666 that has
been classified as "Brokered Deposits" for bank regulatory purposes. These
"Brokered Deposits" were issued in average amounts of
37
approximately $99,000 with an average yield of 3.62% and an average term of 40.3
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 was approximately $25 million, of which $790,157 were
classified as "Brokered Deposits." The Company has never paid broker fees for
deposits and has not accepted any new "Brokered Deposits" since August 2002.
Core deposits, which management categorizes as all deposits other than
national market certificates of deposit and all but $5.0 million of deposits
from the three large customers described above (which management considers to be
a stable deposit amount from these customers based upon historical trends),
stood at $113,412,507 as of December 31, 2004, up 45.88% 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.
Borrowings.
-----------
On September 28, 2004, the Company entered into a five million, three
year unsecured non-revolving credit facility with Drovers Bank of York,
Pennsylvania, a division of Fulton Bank. The loan bears interest at the prime
rate as offered by Drovers Bank. The credit facility will expire on September
28, 2007, at which time all outstanding amounts under the credit facility,
including accrued but unpaid interest, will be due and payable. The Company may
repay interest and principal under the credit facility at any time without
premium or penalty.
The credit facility agreement contains usual and customary covenants
for transactions of this type. In addition, the credit facility provides for the
following additional covenants:
o The Bank's Total Risk-Based Capital Ratio (as defined for bank
regulatory purposes) will be maintained at a minimum of 10%;
o The Bank's Tier 1 Risk-Based Capital Ratio (as defined for
bank regulatory purposes) will be maintained at a minimum of
6%; and
o The bank will maintain Loan Loss Reserves at a level required
by federal regulatory agencies, provided that such Loan Loss
Reserve also equals not less than three hundred percent
(300.00%) of the sum of the balances of loans in a non-accrual
status, loans more than 90 days past due, and renegotiated
loans.
In the event of a default by the Company under the credit facility,
Drovers Bank may terminate the credit facility, declare the amount outstanding,
including all accrued interest and unpaid fees, payable immediately, and enforce
any and all rights created and existing under the credit facility documents, and
other rights available under applicable law. Upon default, interest on the
outstanding loan balance bears interest at 5% over the prime rate.
The Company was in compliance with all covenants for this credit
facility as of December 31, 2004. The Company has borrowed $1,250,000 under the
credit facility as of December 31, 2004.
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 $1,381,000 at December 31, 2004, due to
increases in the balance of available funds for customers participating in this
program.
In addition, during 2004, the Company received commitments for a total
of $7.0 million of borrowing availability under unsecured Federal funds lines of
credit with three separate financial institutions,
38
one of which is Fulton Bank. The Company also had approximately $10 million of
borrowing capacity with the Federal Home Loan Bank of Atlanta as of December 31,
2004.
INTEREST RATE SENSITIVITY
The primary objective of asset/liability management is to ensure the
steady growth of the Company's primary earnings component, net interest income.
Net interest income can fluctuate with significant interest rate movements. To
minimize the risk associated with these rate swings, management works to
structure the Company's balance sheet so that the ability exists to adjust
pricing on interest-earning assets and interest-bearing liabilities in roughly
equivalent amounts at approximately the same time intervals. Imbalances in these
repricing opportunities at any point in time constitute interest rate
sensitivity.
The measurement of the Company's interest rate sensitivity, or "gap,"
is one of the principal techniques used in asset/liability management. The
interest sensitive gap is the dollar difference between assets and liabilities
which are subject to interest rate pricing within a given time period, including
both floating rate or adjustable rate instruments, and instruments which are
approaching maturity.
The following table sets forth the amount of the Company's
interest-earning assets and interest-bearing liabilities as of December 31,
2004, which are expected to mature or reprice in each of the time periods shown:
Maturity or repricing within
Percent
of 0 to 3 4 to 12 1 to 5 Over 5
Amount Total Months Months Years Years
Interest-earning assets
Federal funds sold and
other overnight
investments $ 16,708,52 9.84% $ 16,708,528 - $ - $ -
Loans held for sale 9,613,162 5.66 9,613,162 - - -
Investment securities
available for sale 1,544,496 .91 1,544,496 - - -
Loans - Variable rate 107,643,639 63.38 107,643,639 - - -
Loans - Fixed rate 33,769,798 19.88 3,460,872 5,173,365 24,307,275 828,286
Other earning assets 556,090 .33 - - - 556,090
----------- -------- ---------- ---------- ---------- ---------
Total interest-earning
assets $ 169,835,713 100.00% $ 138,970,697 5,173,365 $ 24,307,275 $ 1,384,376
=========== ======== =========== ========== ========== =========
Interest-bearing liabilities
Deposits - Variable rate $ 65,042,644 47.85% $ 65,042,644 - $ - $ -
Deposits - Fixed rate 68,245,802 50.21 15,673,714 17,579,635 34,992,453 -
Short-term borrowings 2,631,000 1.94 2,631,000 - - -
----------- -------- ---------- ---------- ---------- --------
Total interest-bearing
liabilities $ 135,919,446 100.00% $ 83,347,358 17,579,635 $ 34,992,453 $ -
=========== ======== ========== ========== ========== ========
Periodic repricing differences
Periodic gap $ 55,623,339 (12,406,270) $ (10,685,178) 1,384,376
========== ========== =========== =========
Cumulative gap $ 55,623,339 43,217,069 $ 32,531,891 $ 33,916,267
========== ========== ========== ==========
Ratio of rate sensitive assets
to rate sensitive
liabilities 166.74% 29.43% 69.46% -
The Company has 73.22% of its interest-earning assets and 49.79% of its
interest-bearing liabilities in variable rate balances. The excess of
interest-earning assets over interest-bearing liabilities of $43,217,069 in the
categories of items maturing or repricing within 12 months comprises the
majority of the overall gap.
39
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
rising market rates of interest. However, since all interest rates and yields do
not adjust at the same pace, the gap is only a general indicator of interest
rate sensitivity. The analysis of the Company's interest-earning assets and
interest-bearing liabilities presents only a static view of the timing of
maturities and repricing opportunities, without taking into consideration the
fact that changes in interest rates do not affect all assets and liabilities
equally. Net interest income may be affected by other significant factors in a
given interest rate environment, including changes in the volume and mix of
interest-earning assets and interest-bearing liabilities.
Management constantly monitors and manages the structure of the
Company's balance sheet, seeks to control interest rate exposure and evaluate
pricing strategies. Strategies to better match maturities of interest-earning
assets and interest-bearing liabilities include structuring loans with rate
floors and ceilings on variable rate notes and by providing for repricing
opportunities on fixed rate notes. Management believes that a lending strategy
focusing on variable rate loans and short-term fixed rate loans will best
facilitate the goal of minimizing interest rate risk. However, management will
opportunistically enter into longer term fixed rate loans and/or investments
when, in management's judgment, rates adequately compensate the Company for the
interest rate risk. The Company's current investment concentration in federal
funds sold and other overnight investments provides the most flexibility and
control over rate sensitivity since it generally can be restructured more
quickly than the loan portfolio. On the liability side, deposit products can be
restructured so as to offer incentives to attain the maturity distribution
desired although competitive factors sometimes make control over deposit
maturity difficult.
In theory, maintaining a nominal level of interest rate sensitivity can
diminish interest rate risk. In practice, this is made difficult by a number of
factors, including cyclical variation in loan demand, different impacts on
interest sensitive assets and liabilities when interest rates change and the
availability of funding sources. Management generally attempts to maintain a
balance between rate-sensitive assets and liabilities as the exposure period is
lengthened to minimize the overall interest rate risk to the Company.
LIQUIDITY
The Company's overall asset/liability strategy takes into account the
need to maintain adequate liquidity to fund asset growth and deposit runoff.
Management monitors the liquidity position daily.
The Company's primary sources of funds are deposits, short-term
borrowings in the form of repurchase agreements, borrowings under the credit
facility, scheduled amortization and prepayment of loans, funds provided by
operations and capital. While scheduled principal repayments on loans are a
relatively predictable source of funds, deposit flows and loan prepayments are
greatly influenced by market interest rates, economic conditions, and rates
offered by our competition.
The Company's most liquid assets are cash and assets that can be
readily converted into cash, including investment securities maturing within one
year. As of December 31, 2004, the Company had $1,403,424 in cash and due from
banks, $16,708,528 in federal funds sold and other overnight investments and
$1,544,496 in three-month U.S. Treasury Securities. As of December 31, 2003, the
Company had $573,124 in cash and due from banks, $17,486,981 in federal funds
sold and other overnight investments and $1,547,798 in three-month U.S. Treasury
Securities.
The stability in the overall level of liquid assets is the result of an
ongoing effort by management to maintain adequate liquidity to fund loan growth
and declines in deposit levels. Growth in the Company's loan portfolio, without
corresponding growth in deposits, would reduce liquidity, as would reductions in
the level of customer deposits.
40
During 2004, the Company received commitments for a total of $7.0
million of borrowing availability under unsecured Federal funds lines of credit
with three separate financial institutions. The Company also has approximately
$10 million of borrowing capacity with the Federal Home Loan Bank of Atlanta as
of December 31, 2004. These credit facilities can be used in conjunction with
the normal deposit strategies, which include pricing changes to increase
deposits as necessary. From time to time, the Company may sell or participate
out loans to create additional liquidity as required.
The Company has sufficient liquidity to meet its loan commitments as
well as fluctuations in deposits. The Company will choose to retain maturing
certificates of deposit, when necessary, by offering competitive rates.
Management is not aware of any known trends, events or uncertainties
that will have or are reasonably likely to have a material effect on our
liquidity, capital or operations, nor are we aware of any current recommendation
by regulatory authorities, which if implemented, would have a material effect on
liquidity, capital or operations.
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES, AND OFF-BALANCE
SHEET ARRANGEMENTS
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business. These financial instruments primarily
include commitments to extend credit, lines of credit and standby letters of
credit. The Company uses these financial instruments to meet the financing needs
of its customers. These financial instruments involve, to varying degrees,
elements of credit, interest rate and liquidity risk. In addition, the Company
also has operating lease obligations and purchase commitments.
Outstanding loan commitments and lines and letters of credit at
December 31 of 2004 and 2003 are as follows:
2004 2003
---- ----
Loan commitments $ 9,867,893 $ 11,458,333
Unused lines of credit 40,423,986 32,234,145
Letters of credit 1,578,379 2,167,501
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have interest rates fixed at current market amounts, fixed
expiration dates or other termination clauses and may require payment of a fee.
Unused lines of credit represent the unused portion of lines of credit
previously extended and available to the customer as long as there is no
violation of any contractual condition. These lines generally have variable
interest rates. Since many of the commitments are expected to expire without
being drawn upon, and since it is unlikely that customers will draw upon their
line of credit in full at any time, the total commitment amount or line of
credit amount does not necessarily represent future cash requirements. The
Company is not aware of any loss it would incur by funding its commitments or
lines of credit.
Standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. The Company's exposure
to credit loss in the event of nonperformance by the customer is the contract
amount of the commitment.
In general, loan commitments, lines of credit and letters of credit are
made on the same terms, including with respect to collateral, as outstanding
loans. Each customer's credit-worthiness and the collateral required is
evaluated on a case-by-case basis.
The increase in the overall level of loan commitments and unused lines
of credit as of December 31,
41
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 39.5% increase in outstanding loans.
The Company has various financial obligations, including contractual
obligations and commitments that may require future cash payments.
The following table presents, as of December 31, 2004, significant
fixed and determinable contractual obligations to third parties by payment date.
Within one One to three Three to Over five
year years five years years
---- ----- ---------- -----
Deposits without a
stated maturity(a) $ 85,681,646 $ $ $
Certificates of deposit(a) 33,475,545 20,687,755 14,304,698 -
Other borrowings 1,381,000 1,250,000 - -
Operating leases 290,684 615,136 640,081 50,498
Purchase obligations 205,060 - - -
-------------- --------------- ---------------- --------------
Total $ 121,033,935 $ 21,304,141 $ 14,944,779 $ 50,498
============== =============== ================ ==============
(a) Includes accrued interest payable.
The Company's operating lease obligations represent short and long-term
lease and rental payments for facilities. Purchase obligations represent
estimated obligations under agreements to purchase goods or services that are
enforceable and legally binding on the Company. The purchase obligation amounts
presented above primarily relate to estimated obligations under data and item
processing contracts and accounts payable for goods and services received
through December 31, 2004.
CAPITAL RESOURCES
The Company had stockholders' equity at December 31, 2004 of
$13,418,764 as compared to $12,066,500 at December 31, 2003. The increase in
capital is a result of the positive operating results and $550,000 received upon
the issuance of 55,000 shares of common stock upon the exercise of warrants. The
Company has declared no cash dividends since its inception.
Banking regulatory authorities have implemented strict capital
guidelines directly related to the credit risk associated with an institution's
assets. Banks and bank holding companies are required to maintain capital levels
based on their "risk adjusted" assets so that categories of assets with higher
"defined" credit risks will require more capital support than assets with lower
risks. The Bank has exceeded its capital adequacy requirements to date.
Banking regulations also limit the amount of dividends that may be paid
without prior approval of the Bank's regulatory agencies. Regulatory approval is
required to pay dividends that exceed the Bank's net profits for the current
year plus it's 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 December 31, 2004.
42
The tables below present the Bank's capital position relative to its
various minimum regulatory capital requirements as of December 31, 2004, and
2003. For a discussion of these capital requirements, see "Item 1 Description of
Business - Supervision and Regulation - Bay National Bank - Capital Adequacy
Guidelines."
December 31, 2004
-------------------------------------------------------------------------------------------------------------------------
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purpose Action Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital (to Risk Weighted
Assets): $ 16,242,797 10.32% $ 12,592,000 8.00% $ 15,740,000 10.00%
Tier I Capital (to Risk Weighted
Assets): 14,432,797 9.17% 6,296,000 4.00% 9,444,000 6.00%
Tier I Capital (to Average Assets): 14,432,797 8.98% 4,821,000 3.00% 8,034,000 5.00%
December 31, 2003
-------------------------------------------------------------------------------------------------------------------------
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purpose Action Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital (to Risk Weighted
Assets): $ 11,729,127 10.16% $ 9,238,000 8.00% $ 11,547,000 10.00%
Tier I Capital (to Risk Weighted
Assets): 10,462,627 9.06% 4,619,000 4.00% 6,928,000 6.00%
Tier I Capital (to Average Assets): 10,462,627 8.93% 3,516,000 3.00% 5,860,000 5.00%
Impact of Inflation and Changing Prices
The consolidated financial statements and notes thereto presented
herein have been prepared in accordance with accounting principles generally
accepted in the United States of America, which require the measurement of
financial position and operating results in terms of historical dollars without
considering the change in the relative purchasing power of money over time and
due to inflation. The impact of inflation is reflected in the increased cost of
the Company's operations. Unlike most industrial companies, nearly all the
assets of the Company are monetary in nature. As a result, interest rates have a
greater impact on the Company's performance than do the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the price of goods and services.
Reconciliation of Non-GAAP Measures
Below is a reconciliation of total deposits to core deposits as of
December 31, 2004 and December 31, 2003, respectively:
December 31, December 31, 2003
2004
----------------- -------------------
Total deposits $ 153,927,042 $ 108,530,901
National market certificates of deposit (28,908,592) (25,039,281)
Variable balance accounts (3 customers in 2004; 2 customers in
2003) (16,605,943) (7,749,590)
Portion of variable balance accounts considered to be core 5,000,000 2,000,000
----------------- -------------------
Core deposits $ 113,412,507 $ 77,742,030
================= ===================
43
Application of Critical Accounting Policies
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America and follow general practices within the industries in which it operates.
Application of these principles requires management to make estimates,
assumptions and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions and judgments. Certain policies inherently have
a greater reliance on the use of estimates, assumptions and judgments and as
such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established or when an asset or liability must be recorded contingent upon a
future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
The most significant accounting policies followed by the Company are
presented in Note 1 to the consolidated financial statements. These policies,
along with the disclosures presented in the other financial statement notes and
in this financial review, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the sensitivity of
financial statement amounts to the methods, assumptions and estimates underlying
those amounts, management has identified the determination of the allowance for
credit losses as 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.
The allowance for credit losses represents management's best estimate of
losses known and inherent in the loan portfolio that are both probable and
reasonable to estimate, based on, among other factors: prior loss experience of
the Company and peer institutions; current economic conditions, review of the
ongoing financial conditions of borrowers; and the views of the Company's
regulators and the firm that conducts an annual independent loan review.
Determining the amount of the allowance for credit losses is considered a
critical accounting estimate because it requires significant estimates,
assumptions and judgments. The loan portfolio also represents the largest asset
type on the consolidated balance sheets.
The Company uses a loan grading system where loans are graded based on
management's evaluation of the risk associated with each loan. A factor, based
on the loan grading is applied to the loan balance to reserve for losses. In
addition, management judgmentally establishes an additional nonspecific reserve.
The nonspecific portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates and risk factors that have not yet manifested themselves in loss
allocation factors.
Management has significant discretion in making the judgments inherent
in the determination of the provision and allowance for credit losses, including
the valuation of collateral and the financial condition of the borrower, and in
establishing allowance percentages and risk ratings. The establishment of
allowance factors is a continuing exercise and allowance factors may change over
time, resulting in an increase or decrease in the amount of the provision or
allowance based upon the same volume and classification of loans.
44
Changes in allowance factors or in management's interpretation of those
factors will have a direct impact on the amount of the provision and a
corresponding effect on income and assets. Also, errors in management's
perception and assessment of the allowance factors could result in the allowance
not being adequate to cover losses in the portfolio and may result in additional
provisions or charge-offs, which would adversely affect income and capital. For
additional information regarding the allowance for loan and lease losses, see
the "Provision for Credit Losses and Credit Risk Management" section of this
financial review.
Recent Accounting Pronouncements And Developments
Note 1 to the consolidated financial statements discusses new accounting
policies adopted by the Company during 2004 and the expected impact of
accounting policies, recently issued or proposed, but not yet required to be
adopted. To the extent the adoption of new accounting standards materially
affects the Company's financial condition, results of operations or liquidity,
the impacts are discussed in the applicable section(s) of this financial review
and notes to the consolidated financial statements.
Risk Management
The Board of Directors is the foundation for effective corporate
governance and risk management. The Board demands accountability of management,
keeps stockholders' and other constituencies' interests in focus and fosters a
strong internal control environment. Through its Executive, Asset/Liability and
Audit Committees, the Board actively reviews critical risk positions, including
market, credit, liquidity and operational risk. The Company's goal in managing
risk is to reduce earnings volatility, control exposure to unnecessary risk and
ensure appropriate returns for risk assumed. Senior management actively manages
risk at the line of business level, supplemented with corporate-level oversight
through the Asset/Liability Committee, the internal audit process and quality
control functions and other risk management groups within the Company. This risk
management structure is designed to uncover risk issues through a systematic
process, enabling timely and appropriate action to avoid and mitigate risk. The
risk management process establishes risk limits and other measurement systems,
with a focus on risk reduction strategies and capital allocation practices.
45
Item 7. Financial Statements
The following consolidated financial statements are filed with this
report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets - December 31, 2004 and 2003
Consolidated Statements of Operations - For the years ended December
31, 2004, 2003 and 2002
Consolidated Statements of Changes in Stockholders' Equity - For the
years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows - For the year ended December 31,
2004, 2003 and 2002
Notes to Consolidated Financial Statements
46
Report of Independent Registered Public Accounting Firm
Audit Committee of the
Board of Directors and Stockholders
Bay National Corporation
We have audited the accompanying consolidated balance sheets of Bay
National Corporation and subsidiary as of December 31, 2004 and 2003, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the three years in the period ended December 31,
2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of Bay
National Corporation and subsidiary as of December 31, 2004 and 2003, and the
results of their operations and cash flows for each of the three years in the
period ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Stegman & Company
---------------------
Baltimore, Maryland
February 2, 2005
47
BAY NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31, 2004 and 2003
2004 2003
---------------- ---------------
ASSETS
Cash and due from banks $ 1,403,424 $ 573,124
Federal funds sold and other overnight investments 16,708,528 17,486,981
Loans held for sale 9,613,162 923,825
Investment securities available for sale (AFS) - at fair value 1,544,496 1,547,798
Other equity securities 556,090 481,090
Loans, net of unearned fees 141,413,437 101,391,975
Less: Allowance for credit losses (1,810,000) (1,266,500)
---------------- ---------------
Loans, net 139,603,437 100,125,475
Premises and equipment, net 593,583 637,612
Accrued interest receivable and other assets 740,754 552,351
---------------- ---------------
Total Assets $ 170,763,474 $ 122,328,256
================ ===============
LIABILITIES
Non-interest-bearing deposits $ 20,638,596 $ 14,277,909
Interest-bearing deposits 133,288,446 94,252,992
---------------- ---------------
Total deposits 153,927,042 108,530,901
Short-term borrowings 1,381,000 1,222,000
Note payable 1,250,000 -
Accrued expenses and other liabilities 786,668 508,855
---------------- ---------------
Total Liabilities 157,344,710 110,261,756
---------------- ---------------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, authorized:
9,000,000 shares authorized, 1,917,710 and 1,862,710 issued and
outstanding as of December 31, 2004 and 2003, respectively: 19,177 18,627
Additional paid in capital 17,400,284 16,850,834
Accumulated deficit (4,000,697) (4,802,961)
---------------- ---------------
Total Stockholders' Equity 13,418,764 12,066,500
---------------- ---------------
Total Liabilities and Stockholders' Equity $ 170,763,474 $ 122,328,256
================ ===============
See accompanying notes to consolidated financial statements.
48
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
For the years ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------- ------------- -------------
INTEREST INCOME:
Interest and fees on loans $ 7,431,368 $ 5,367,997 $ 3,342,790
Interest on federal funds sold and other overnight
investments 147,023 114,754 117,563
Taxable interest and dividends on investment securities 45,173 37,317 25,949
------------- ------------- -------------
Total interest income 7,623,564 5,520,068 3,486,302
------------- ------------- -------------
INTEREST EXPENSE:
Interest on deposits 2,438,887 1,925,042 1,362,625
Interest on short-term borrowings 19,020 11,684 4,877
Interest on note payable 6,302 - -
------------- ------------- -------------
Total interest expense 2,464,209 1,936,726 1,367,502
------------- ------------- -------------
Net interest income 5,159,355 3,583,342 2,118,800
Provision for credit losses 559,596 415,000 404,500
------------- ------------- -------------
Net interest income after provision for credit losses 4,599,759 3,168,342 1,714,300
------------- ------------- -------------
NON-INTEREST INCOME:
Service charges on deposit accounts 237,980 212,787 105,766
Gain on sale of mortgage loans 244,716 370,326 334,815
Other income 56,151 42,150 37,935
------------- ------------- -------------
Total non-interest income 538,847 625,263 478,516
------------- ------------- -------------
NON-INTEREST EXPENSE:
Salaries and employee benefits 2,442,774 2,115,351 1,813,629
Occupancy expenses 312,550 259,719 212,667
Furniture and equipment expenses 255,547 215,254 192,900
Legal and professional fees 175,757 158,406 143,778
Data processing and other outside services 582,396 536,433 399,702
Advertising and marketing related expenses 212,237 210,289 173,854
Other expenses 355,081 290,572 248,780
------------- ------------- -------------
Total non-interest expenses 4,336,342 3,786,024 3,185,310
------------- ------------- -------------
Income (Loss) before income taxes 802,264 7,581 (992,494)
Income tax (expense) benefit - - -
------------- ------------- -------------
Net Income (Loss) $ 802,264 $ 7,581 $ (992,494)
============= ============= =============
Per Share Data:
Net Income (Loss) (Basic) $ .43 $ .00 $ (.80)
Net Income (Loss) (Diluted) $ .41 $ .00 $ (.80)
Average Shares Outstanding (Basic) 1,877,929 1,660,348 1,242,020
Effect of dilution - Stock options and Warrants 58,764 22,557 -
------------- ------------- -------------
Average Shares Outstanding (Diluted) 1,936,693 1,682,905 1,242,020
============= ============= =============
See accompanying notes to consolidated financial statements.
49
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
For the years ended December 31, 2004, 2003 and 2002
Additional
Paid in Accumulated
Common Stock Capital Deficit Total
------------- -------------- ----------------- -------------
Balances at December 31, 2001 $ 12,420 $ 12,407,780 $ (3,818,048) $ 8,602,152
Net Loss - - (992,494) (992,494)
------------- -------------- ----------------- -------------
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 Income - 7,581 7,581
------------- -------------- ----------------- -------------
Balances at December 31, 2003 18,627 16,850,834 (4,802,961) 12,066,500
Issuance of Common Stock 550 549,450 - 550,000
Net Income - - 802,264 802,264
------------- -------------- ----------------- -------------
Balances at December 31, 2004 $ 19,177 $ 17,400,284 $ (4,000,697) $ 13,418,764
============= ============== ================= =============
See accompanying notes to consolidated financial statements.
50
BAY NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the years ended December 31, 2004, 2003 and 2002
2004 2003 2002
--------------- --------------- ---------------
Cash Flows From Operating Activities:
Net Income (Loss) $ 802,264 $ 7,581 $ (992,494)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation 204,204 189,858 189,872
Loss on disposal of equipment 17,018 - -
Amortization of investment (discounts) premiums,
net (19,251) (14,804) (7,648)
Provision for credit losses 559,596 415,000 404,500
Gain on sale of loans (244,716) (370,326) (334,815)
Origination of loans held for sale (108,988,138) (35,629,285) (32,594,732)
Proceeds from sale of loans 100,543,517 37,894,286 30,793,047
Net increase in accrued interest
receivable and other assets (188,403) (117,569) (166,517)
Net increase in accrued
expenses and other
liabilities 277,813 95,061 129,247
--------------- --------------- ---------------
Net cash (used) provided by
operating activities (7,036,096) 2,469,802 (2,579,540)
--------------- --------------- ---------------
Cash Flows From Investing Activities:
Purchases of investment securities (6,177,447) (6,284,633) (2,440,713)
Maturities of investment securities 6,200,000 5,700,000 1,500,000
Purchase of Federal Reserve Bank stock - (36,750) -
Purchase of Federal Home Loan Bank of Atlanta
stock (75,000) (88,500) (79,900)
Loan disbursements in excess of principal payments (40,037,558) (33,313,714) (32,216,206)
Expenditures for premises and equipment (177,193) (118,267) (68,449)
--------------- --------------- ---------------
Net cash used by investing activities (40,267,198) (34,141,864) (33,305,268)
--------------- --------------- ---------------
Cash Flows From Financing Activities:
Net increase in deposits 45,396,141 32,452,170 37,939,604
Net increase in short-term borrowings 159,000 715,000 507,000
Proceeds from notes payable 1,250,000 - -
Issuance of common stock 550,000 4,449,261 -
--------------- --------------- ---------------
Net cash provided by financing activities 47,355,141 37,616,431 38,446,604
--------------- --------------- ---------------
Net increase in cash and cash equivalents 51,847 5,944,369 2,561,796
Cash and cash equivalents at beginning of year 18,060,105 12,115,736 9,553,940
--------------- --------------- ---------------
Cash and cash equivalents at end of year $ 18,111,952 $ 18,060,105 $ 12,115,736
=============== =============== ===============
Cash paid for:
Interest $ 2,366,155 $ 1,926,169 $ 1,296,200
=============== =============== ===============
Income taxes $ - $ - $ -
=============== =============== ===============
See accompanying notes to consolidated financial statements.
51
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Bay
National Corporation and its subsidiary, Bay National Bank (the "Bank"),
collectively (the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation. The investment in subsidiary
is recorded on the parent's books on the basis of its equity in the net assets.
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices in the banking industry.
Certain reclassifications have been made to amounts previously reported
to conform to the classifications made in 2004.
Nature of Business
------------------
Bay National Corporation 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. On May 12, 2000, the Company purchased all
the shares of common stock issued by the Bank. The Company's operations through
that date were limited to taking the necessary actions to organize and
capitalize the Company and 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, obtaining the approval of the Federal Deposit
Insurance Corporation to insure its deposit accounts and meeting certain other
regulatory requirements.
The principal business of the Company is to make loans and other
investments and to accept time and demand deposits. The Company's primary market
areas are Baltimore and Salisbury, Maryland, although the Company's business
development efforts generate business outside of these areas. The Company offers
a broad range of banking products, including a full line of business and
personal savings and checking accounts, money market demand accounts,
certificates of deposit and other banking services. The Company funds a variety
of loan types including commercial and residential real estate loans, commercial
term loans and lines of credit, consumer loans and letters of credit. The
Company's customers are primarily individuals and small businesses.
Use of Estimates
----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Cash and Cash Equivalents
-------------------------
The Company has included cash and due from banks, and federal funds
sold and other overnight investments as cash and cash equivalents for the
purpose of reporting cash flows.
52
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
Investments Available-for-Sale and Other Equity Securities
----------------------------------------------------------
Marketable equity securities and debt securities, not classified as
held-to-maturity or trading, are classified as available-for-sale. Securities
available-for-sale are acquired as part of the Company's asset/liability
management strategy and may be sold in response to changes in interest rates,
loan demand, changes in prepayment risk and other factors. Securities
available-for-sale are carried at fair value, with unrealized gains or losses
based on the difference between amortized cost and fair value reported as
accumulated other comprehensive income, a separate component of stockholders'
equity, net of deferred tax. Realized gains and losses, using the specific
identification method, are included as a separate component of non-interest
income. Related interest and dividends are included in interest income. Declines
in the fair value of individual available-for-sale securities below their cost,
that are other than temporary, result in write-downs of the individual
securities to their fair value. Factors affecting the determination of whether
an other-than-temporary impairment has occurred include a downgrading of the
security by a rating agency, a significant deterioration in the financial
condition of the issuer, or the fact that management would not have the intent
and ability to hold a security for a period of time sufficient to allow for any
anticipated recovery in fair value.
Other equity securities represented by Federal Reserve Bank and Federal
Home Loan Bank of Atlanta stock are considered restricted as to marketability.
Loans Held for Sale
-------------------
The Company engages in sales of residential mortgage loans originated
by the Bank and by a third party. Loans held for sale are carried at the lower
of aggregate cost or fair value. Fair value is derived from secondary market
quotations for similar instruments. Gains and losses on sales of the loan
originated by the Bank are recorded as a component of non-interest income in the
accompanying consolidated statements of operations. No gains or losses are
realized on the sale of loans originated by third parties. The Company's current
practice is to sell loans on a servicing released basis, and, therefore, it has
no intangible asset recorded for the value of such servicing at either December
31, 2004 or December 31, 2003. The Company earns interest on the outstanding
balances of all loans that are held for sale.
Loans
-----
Loans are stated at the principal amount outstanding net of any
deferred fees and direct costs. Interest income on loans is accrued at the
contractual rate on the principal amount outstanding. It is the Company's policy
to discontinue the accrual of interest when circumstances indicate that
collection is doubtful. Fees charged and costs capitalized for originating
certain loans are amortized on the interest method over the term of the loan.
Loans are considered impaired when, based on current information, it is
improbable that the Company will collect all principal and interest payments
according to contractual terms. Generally, loans are considered impaired once
principal and interest payments are 90 days past due and they are placed on
non-accrual. Management also considers the financial condition of the borrower,
cash flows of the loan and the value of the related collateral. Impaired loans
do not include large groups of smaller balance homogeneous credits such as
residential real estate, consumer installment loans and commercial leases, which
are evaluated collectively for impairment. Loans specifically reviewed for
impairment are not considered impaired during
53
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
periods of "minimal delay" in payment (usually ninety days or less) provided
eventual collection of all amounts due is expected. Impaired loans are measured
based on the present value of expected future cash flows discounted at the
loan's effective interest rate, except that as a practical expedient, the
Company may measure impairment based on a loan's observable market price or the
fair value of the collateral, if the loan is collateral dependent. The Company
recognizes interest income on impaired loans on a cash basis if the borrower
demonstrates the ability to meet the contractual obligation and collateral is
sufficient. If there is doubt regarding the borrower's ability to make payments,
or if the collateral is not sufficient, payments received are accounted for as a
reduction in principal.
Allowance for Credit Losses
---------------------------
The allowance for credit losses is established through a provision for
credit losses charged to expense. Loans are charged against the allowance for
credit losses when management believes that the collectibility of the principal
is unlikely. The allowance, based on evaluations of the collectibility of loans,
is an amount that management believes will be adequate to absorb possible losses
on existing loans that may become uncollectible. The evaluations take into
consideration such factors as changes in the nature and volume of the loan
portfolio, overall portfolio quality, review of specific problem loans and
current economic conditions and trends that may affect the borrowers' ability to
pay.
The allowance for credit losses represents an estimation done pursuant
to either Statement of Financial Accounting Standards ("SFAS") No. 5 "Accounting
for Contingencies" or SFAS No. 114 "Accounting by Creditors for Impairment of a
Loan." The Company uses a loan grading system where loans are graded based on
management's evaluation of the risk associated with each loan. A factor, based
on the loan grading, is applied to the loan balance to reserve for losses. In
addition, management judgmentally establishes an additional nonspecific reserve.
The nonspecific portion of the allowance reflects management's estimate of
probable inherent, but undetected, losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates and risk factors that have not yet manifested themselves in loss
allocation factors. The adequacy of the allowance is determined through careful
and continuous evaluation of the credit portfolio and involves consideration of
a number of factors to establish a prudent level. Determination of the allowance
is inherently subjective and requires significant estimates, including estimated
losses on pools of homogeneous loans based on historical loss experience and
consideration of current economic trends, which may be susceptible to
significant change.
While management believes it has established the allowance for credit
losses in accordance with generally accepted accounting principles and has taken
into account the views of its regulators and the current economic environment,
there can be no assurance that in the future the Company's regulators or the
economic environment will not require further increases in the allowance.
Premises and Equipment
----------------------
Premises and equipment are stated at cost less accumulated depreciation
and amortization computed using the straight-line method. Premises and equipment
are depreciated over the useful lives of the assets, except for leasehold
improvements which are amortized over the terms of the respective leases or the
estimated useful lives of the improvements, whichever is shorter. Useful lives
range from: five to ten years
54
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
for furniture, fixtures and equipment; and three to five years for software,
hardware and data handling equipment. Leasehold improvements are amortized over
the term of the respective lease plus the first optional renewal period, if
applicable. Maintenance and repairs are charged to expense as incurred, while
improvements, which extend the useful life, are capitalized and depreciated over
the estimated remaining life of the asset.
Long-lived depreciable assets are evaluated periodically for impairment
when events or changes in circumstances indicate the carrying amount may not be
recoverable. Impairment exists when the expected undiscounted future cash flows
of a long-lived asset are less than its carrying value. In that event, the
Company recognizes a loss for the difference between the carrying amount and the
estimated fair value of the asset based on a quoted market price, if applicable,
or a discounted cash flow analysis.
Transfers of Financial Assets
-----------------------------
Transfers of financial assets are accounted for as sales, when control
over the assets has been surrendered. Control over transferred assets is deemed
to be surrendered when: (1) the assets have been isolated from the Company; (2)
the transferee obtains the right (free of conditions that constrain it from
taking advantage of that right) to pledge or exchange the transferred assets;
and (3) the Company does not maintain effective control over the transferred
assets through an agreement to repurchase them before their maturity.
Stock-Based Compensation
------------------------
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123), but applies Accounting Principles Board Opinion
No. 25 and related interpretations in accounting for its stock option plan.
Compensation expense for stock option awards is disclosed as a pro forma income
adjustment, ratably recognized over the vesting period, based on the fair value
of the stock on the date of grant under SFAS No. 123 and SFAS No. 148
"Accounting for Stock-Based Compensation - Transition and Disclosure."
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants during the year ended December 31:
2002
-------------
Dividend yield -
Expected volatility 20.00%
Risk-free interest rate 4.17%
Expected lives (in years) 8
55
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
No compensation expenses related to the Company's stock option plan was
recorded during the years ended December 31, 2004, 2003 and 2002. The following
table illustrates the effect on net income (loss) and earnings per share if the
Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation for the years ending December 31:
2004 2003 2002
---- ---- ----
Net income (loss), as reported $ 802,264 $ 7,581 $ (992,494)
Less pro forma stock-based compensation expense determined
under the fair value method, net of related tax effects (92,474) (84,163) (15,445)
------------- ------------ -----------
Pro forma net income (loss) $ 709,790 $ (76,582) $ (1,007,939)
============= ============ ===========
Net income (loss) per share:
Basic - as reported $ .43 $ .00 $ (.80)
Diluted - as reported .41 .00 (.80)
Basic - pro forma $ .38 $ (.05) $ (.81)
Diluted - pro forma .37 (.05) (.81)
Advertising Costs
-----------------
Advertising costs are generally expensed as incurred.
Income Taxes
------------
The Company uses the liability method of accounting for income taxes.
Under the liability method, deferred-tax assets and liabilities are determined
based on differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities (i.e., temporary differences) and
are measured at the enacted rates in effect when these differences reverse.
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.
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 year ended December 31, 2003 there were 56,250 shares excluded from the
diluted net income per share computation because the exercise price exceeded the
average market price and therefore, their effect would be anti-dilutive.
The Company's common stock equivalents were not considered in the
computation of diluted earnings per share for the year ended December 31, 2002
because the result would have been anti-dilutive.
56
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
New Accounting Standards
------------------------
In November 2002, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" ("FIN 45"), which covers guarantees such as standby letters of credit,
performance guarantees, and direct or indirect guarantees of the indebtedness of
others, but not guarantees of funding. FIN 45 requires a guarantor to recognize,
at the inception of a guarantee, a liability in an amount equal to the fair
value of the obligation undertaken in issuing the guarantee, and requires
disclosure about the maximum potential payments that might be required, as well
as the collateral or other recourse obtainable. The recognition and measurement
provisions of FIN 45 were effective on a prospective basis after December 31,
2002, and its adoption by the Company on January 1, 2003 has not had a
significant effect on the Company's consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("Interpretation No. 46"), which explains
identification of variable interest entities and the assessment of whether to
consolidate these entities. Interpretation No. 46 requires existing
unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among the
involved parties. The provisions of Interpretation No. 46 effect all financial
statements issued after January 1, 2003.
In December 2003, the FASB reissued FIN 46 with certain modifications
and clarifications. Application of this guidance was effective for interests in
certain VIEs commonly referred to as special-purpose entities (SPEs) as of
December 31, 2003. Application for all other types of entities was required as
of March 31, 2004, unless previously applied. The Company has no significant
variable interests in any entities which would require disclosure or
consolidation.
In April 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities". SFAS No. 149 amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The Statement is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. There was no material impact on the Company's financial condition or
results of operations upon adoption of this Statement.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both a liability and equity. It
requires that an issuer classify certain financial instruments as a liability,
although the financial instrument may previously have been classified as equity.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003 and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. There was no material impact on
the Company's financial condition or results of operations upon adoption of this
Statement.
In December 2003, the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 03-3, "Accounting for Certain
Loans or Debt Securities Acquired in a Transfer." SOP 03-3
57
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
requires acquired loans, including debt securities, to be recorded at the amount
of the purchaser's initial investment and prohibits carrying over valuation
allowances from the seller for those individually-evaluated loans that have
evidence of deterioration in credit quality since origination, and it is
probable all contractual cash flows on the loan will be unable to be collected.
SOP 03-3 also requires the excess of all undiscounted cash flows expected to be
collected at acquisition over the purchaser's initial investment to be
recognized as interest income on a level-yield basis over the life of the loan.
Subsequent increases in cash flows expected to be collected are recognized
prospectively through an adjustment of the loan's yield over its remaining life,
while subsequent decreases are recognized as impairment. Loans carried at fair
value, mortgage loans held for sale, and loans to borrowers in good standing
under revolving credit agreements are excluded from the scope of SOP 03-3. The
guidance is effective for loans acquired in fiscal years beginning after
December 15, 2004 and is not expected to have a material impact on financial
condition, results of operations, or liquidity.
In March 2004, the FASB Emerging Issues Task Force (EITF) released
Issue 03-01, "Meaning of Other Than Temporary Impairment", which addressed
other-than-temporary impairment for certain debt and equity investments. The
recognition and measurement requirements of Issue 03-01, and other disclosure
requirements not already implemented, were effective for periods beginning after
June 15, 2004. In September 2004, the FASB staff issued FASB Staff Position
(FSP) EITF 03-1-1, which delayed the effective date for certain measurement and
recognition guidance contained in Issue 03-1. The FSP requires the application
of pre-existing other-than-temporary guidance during the period of delay until a
final consensus is reached. Management does not anticipate the issuance of the
final consensus will have a material impact on financial condition, the results
of operations, or liquidity.
In December 2004, the FASB revised SFAS 123, "Accounting for
Stock-Based Compensation." SFAS 123R establishes accounting requirements for
share-based compensation to employees and carries forward prior guidance on
accounting for awards to non-employees. The provisions of this statement will
become effective January 1, 2006 for non-accelerated filers for all equity
awards granted after the effective date. SFAS 123R requires an entity to
recognize compensation expense based on an estimate of the number of awards
expected to actually vest, exclusive of awards expected to be forfeited. The
adoption of this standard is not expected to have a material effect on financial
condition, the results of operations, or liquidity.
In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29", Accounting for Nonmonetary
Transactions. This statement amends the principle that exchanges of nonmonetary
assets should be measured based on the fair value of the assets exchanged and
more broadly provides for exceptions regarding exchanges of nonmonetary assets
that do not have commercial substance. This Statement is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. The adoption of this standard is not expected to have a material impact on
financial condition, results of operations, or liquidity.
58
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
2. INVESTMENT SECURITIES
Investments available-for-sale
------------------------------
The amortized cost and estimated fair values of investments
available-for-sale at December 31, 2004 are as follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
-------------- --------------- ---------------- --------------
U.S. Treasury securities $ 1,544,496 $ - $ - $ 1,544,496
-------------- --------------- ---------------- --------------
Total investments available-for-sale $ 1,544,496 $ - $ - $ 1,544,496
============== =============== ================ ==============
The amortized cost and estimated fair values of investments
available-for-sale at December 31, 2004 by contractual maturity are shown below.
Amortized Cost Estimated
Fair Value
---------------- --------------
Due in one year or less $ 1,544,496 $ 1,544,496
---------------- --------------
Total investments available-for-sale $ 1,544,496 $ 1,544,496
================ ==============
The amortized cost and estimated fair values of investments
available-for-sale at December 31, 2003 were as follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
-------------- --------------- ---------------- --------------
U.S. Treasury securities $ 1,547,798 $ - $ - $ 1,547,798
-------------- --------------- ---------------- --------------
Total investments available-for-sale $ 1,547,798 $ - $ - $ 1,547,798
============== =============== ================ ==============
The amortized cost and estimated fair values of investments
available-for-sale at December 31, 2003 by contractual maturity are shown below.
Amortized Estimated
Cost Fair Value
---------------- --------------
Due in one year or less $ 1,547,798 $ 1,547,798
---------------- --------------
Total investments available-for-sale $ 1,547,798 $ 1,547,798
================ ==============
There were no sales of investments available-for-sale during 2004, 2003
or 2002.
At December 31, 2004 and 2003, investments available-for-sale with a
carrying value of $1,381,000 and $1,222,000, respectively, were pledged as
collateral for certain short-term borrowings.
59
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
Other equity securities
-----------------------
At December 31, the Company's investment in other equity securities
consisted of:
2004 2003
---------------- ---------------
Federal Reserve Bank stock $ 312,690 $ 312,690
Federal Home Loan Bank stock 243,400 168,400
---------------- ---------------
Total investments in other
equity securities $ 556,090 $ 481,090
================ ===============
3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Major loan categories at December 31 are presented below:
2004 2003
---- ----
Real Estate - Home Equity Line of Credit $ 24,548,506 $ 16,078,166
Real Estate - Construction 12,968,251 8,101,017
Real Estate - Mortgage 27,854,130 13,687,709
Commercial 73,836,994 61,868,002
Consumer 2,205,556 1,657,081
-------------- -------------
Total Loans 141,413,437 101,391,975
Less: Allowance for credit losses (1,810,000) (1,266,500)
-------------- -------------
Net Loans $ 139,603,437 $ 100,125,475
============== =============
Activity in the allowance for credit losses for the year ended December
31, 2004, 2003 and 2002 is shown below:
2004 2003 2002
---- ---- ----
Balance at beginning of year $ 1,266,500 $ 851,500 $ 447,000
Provision for credit losses 559,596 415,000 404,500
Loan charge-offs (17,356) - -
Loan recoveries 1,260 - -
------------- ------------- -----------
Net charge-offs (16,096) - -
------------- ------------- -----------
Balance at end of year $ 1,810,000 $ 1,266,500 $ 851,500
============= ============= ===========
Other than one non-accrual loan of $4,087 as of December 31, 2003,
there were no loans that were considered impaired under SFAS No. 114 as of
December 31, 2004, 2003 and 2002 and for the years then ended.
60
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
4. PREMISES AND EQUIPMENT
Premises and equipment at December 31 include the following:
2004 2003
---- ----
Furniture and equipment $ 404,269 $ 389,594
Computer hardware and software 511,369 582,703
Leasehold improvements 338,157 329,580
----------- -----------
1,253,795 1,301,877
Less accumulated depreciation (660,212) (664,265)
----------- -----------
Net premises and equipment $ 593,583 $ 637,612
=========== ===========
The Company rents office space in three locations under four
non-cancelable lease arrangements accounted for as operating leases. The initial
lease periods are from one to five years and provide for one or more one to
five-year renewal options. The two leases for the Baltimore location provide for
percentage annual rent escalations. One of the leases for the Salisbury location
requires that the lessee pay certain operating expenses applicable to the leased
space.
Rent expense applicable to operating leases, for the periods ended
December 31, was as follows:
2004 2003 2002
---- ---- ----
Minimum rentals $ 241,097 $ 202,720 $ 187,760
Less: Sublease rentals (12,930) (23,843) (40,784)
------------- ------------- -----------
Net rent expense $ 228,167 $ 178,877 $ 146,976
============= ============= ===========
At December 31, 2004, future minimum lease payments under
non-cancelable operating leases having an initial term in excess of one year are
as follows:
Years ending December 31:
2005 $ 290,684
2006 303,429
2007 311,707
2008 320,233
2009 319,849
------------
Total minimum lease payments $ 1,545,902
============
Total minimum future rental payments have not been reduced by $46,218
of sublease rentals expected to be received in 2005 and 2006 under a
non-cancelable sublease expiring in December 2006.
61
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
5. DEPOSITS
Certificates of deposit in amounts of $100,000 or more and their
remaining maturities at December 31 are as follows:
2004 2003
---- ----
Three months or less $ 4,285,752 $ 4,258,011
Over three months through six months 3,553,729 3,069,247
Over six months through twelve months 3,351,703 2,897,570
Over twelve months 10,745,359 5,226,650
------------- -------------
Total $ 21,936,543 $ 15,451,478
============= =============
Interest expense on deposits, for the years ended December 31, is as
follows:
2004 2003 2002
---- ---- ----
Interest-bearing transaction $ 293,076 $ 206,695 $ 141,073
Savings and money market 244,628 195,822 384,789
Time, $100,000 or more 531,287 444,882 281,304
Other time 1,369,896 1,077,643 555,459
-------------- -------------- -------------
Total interest on deposits $ 2,438,887 $ 1,925,042 $ 1,362,625
============== ============== =============
6. BORROWINGS
Information relating to short-term borrowings, as of December 31, 2004 and 2003,
is as follows:
2004 2003
----------------------------- --------------------------------
Amount Rate Amount Rate
------ ---- ------ ----
As of year end $ 1,381,000 2.00% $ 1,222,000 .50%
Average for the year $ 1,475,148 1.24% $ 1,172,658 1.00%
Maximum month end balance $ 1,550,000 $ 1,550,000
The Company pledges U.S. Government Treasury Securities, based upon
their market values, as collateral for 100% of the principal and accrued
interest of its short-term borrowings.
In the first quarter of 2004, the Company received commitments for a
total of $7.0 million of borrowing availability under unsecured federal funds
lines of credit with three separate financial institutions. The Company also has
approximately $10 million of borrowing capacity with the Federal Home Loan Bank
of Atlanta as of December 31, 2004. These borrowing facilities will be used, as
necessary, to supplement short-term liquidity needs.
62
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
Information relating to note payable as of December 31, 2004 and 2003
is as follows:
2004 2003
----------------------------- --------------------------------
Amount Rate Amount Rate
------ ---- ------ ----
As of year end $ 1,250,000 5.25% $ - - %
Average for the year $ 129,098 4.88% $ - - %
Maximum month end balance $ 1,250,000 $ -
Note payable consists of $1,250,000 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.
7. ISSUANCE OF COMMON STOCK
On October 31, 2002, Bay National Corporation commenced a private
offering, to accredited investors only, of an aggregate of 550,000 shares of its
common stock, which was subsequently increased to 620,690 shares of its common
stock. The purchase price per share was $7.25 for an aggregate purchase price of
$4,500,002. The private offering terminated on April 30, 2003 with all shares
issued. Net proceeds after offering costs were $4,449,261.
On August 31, 1999, the Board of Directors of the Company authorized
the issuance on September 10, 1999, to each stockholder of record of the Company
on August 31, 1999, a warrant to purchase one share of common stock at $10 per
share for every two shares that the stockholder purchased in the organizational
offering. As a result, the Company issued warrants to purchase 56,250 shares.
The warrants were issued in recognition of the financial and organizational risk
undertaken by the purchasers in the organizational offering. The warrants became
exercisable on April 30, 2001 and were exercisable in whole or in part until
November 16, 2004. During the second half of 2004, 55,000 of these warrants were
exercised resulting in the issuance of 55,000 shares of common stock and the
receipt of $550,000 of additional capital.
8. STOCK OPTIONS
The Company's 2001 Stock Option Plan ("Option Plan") provides for the
granting of incentive and non-qualifying stock options to the Company's
directors and to selected employees on a periodic basis at the discretion of the
Board of Directors. The Option Plan authorizes the issuance of up to 200,000
shares of common stock, has a term of ten years, and is administered by the
Compensation Committee of the Board of Directors. The Compensation Committee
consists of at least two non-employee directors appointed by the Board of
Directors. In general, the options have an exercise price, which may not be less
than 100% of the fair market value on the date of the grant, must be exercised
within eight years and vest over a period of six years.
63
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
The following is a summary of changes in shares under options for the
years ended December 31, 2004, 2003 and 2002:
Weighted
Average
Number of Exercise
Shares Price
------------ --------------
Balance, January 1, 2002 $ 141,533 $ 7.58
Granted 16,815 8.37
Cancelled (9,523) 7.58
Exercised - -
------------ --------------
Balance, December 31, 2002 148,825 7.67
Granted - -
Cancelled (919) 7.58
Exercised - -
------------ --------------
Balance, December 31, 2003 147,906 7.67
Granted - -
Cancelled (414) 7.58
Exercised - -
------------ --------------
Balance, December 31, 2004 147,492 $ 7.67
============ ==============
Weighted average fair value of options granted
during 2002 $ 3.05
============
The following table summarizes information about options outstanding at
December 31, 2004:
Range of Exercise
Price Options Outstanding Options Exercisable
---------------------- ------------------------------------------- -----------------------------
Weighted
Average
Remaining Weighted Weighted
Contractual Average Average
Life Exercise Exercise
Price Number (in years) Price Number Price
----- ------ ---------- ----- ------ -----
$ 7.58 130,677 5 $ 7.58 69,721 $ 7.58
$ 8.37 16,815 6 8.37 1,875 8.37
----------
147,492
==========
64
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
8. RETIREMENT PLAN
The Company has a 401(k) profit sharing plan covering substantially all
full-time employees. The plan requires the Company to match 25% of employee
contributions of up to 3% of compensation as defined under the plan. The Company
has also elected to make a safe harbor contribution to the plan on behalf of all
eligible employees, as defined under the plan. The safe harbor contribution is
equal to 3% of compensation as defined under the plan. The plan permits
additional contributions at the discretion of management. Expenses under this
plan totaled $77,180, $67,388 and $58,447 for the years ended December 31, 2004,
2003 and 2002, respectively.
9. INCOME TAXES
Federal and state income tax expense (benefit) consists of the
following for the periods ended December 31:
2004 2003 2002
---- ---- ----
Current federal income tax $ - $ - $ -
Current state income tax - - -
Deferred federal income tax expense (benefit) - - -
Deferred state income tax expense (benefit) - - -
-------------- -------------- -------------
Total income tax expense (benefit) $ - $ - $ -
============== ============== =============
The following table is a summary of the tax effect of temporary
differences that give rise to a significant portion of deferred tax assets:
Deferred tax assets: 2004 2003
---- ----
Net operating loss carryforwards $ 955,000 $ 1,506,000
Other 18,000 4,000
Allowance for credit losses 525,000 333,000
-------------- --------------
Total deferred tax assets 1,498,000 1,843,000
Less valuation allowance (1,381,000) (1,791,000)
-------------- --------------
Deferred tax assets, net of valuation allowance 117,000 52,000
-------------- --------------
Deferred tax liabilities:
Depreciation and amortization (114,000) (46,000)
Deferred loan costs, net (3,000) (6,000)
-------------- --------------
Net deferred tax assets (liabilities) $ - $ -
============== ==============
No income tax benefit or deferred tax asset is reflected in the
financial statements. Deferred tax assets are recognized for future deductible
temporary differences and tax loss carryforwards if their realization is "more
likely than not".
At December 31, 2004, the Company had approximately $2.5 million in tax
loss carryforwards, which expire between 2019 and 2022. Realization depends on
generating sufficient taxable income before the expiration of the loss
carryforward periods. The amount of loss carryforward available for any one year
may be limited if the Company is subject to the alternative minimum tax.
65
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
10. RELATED PARTY TRANSACTIONS
Certain directors and executive officers have loan transactions with
the Company. Such loans were made in the ordinary course of business on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with outsiders. The following
schedule summarizes changes in amounts of loans outstanding, both direct and
indirect, to these persons during 2004 and 2003.
2004 2003
---- ----
Balance at beginning of period $ 4,672,104 $ 4,972,128
Additions 12,385,135 7,969,736
Repayments (11,229,144) (8,269,760)
-------------- --------------
Balance at December 31 $ 5,828,095 $ 4,672,104
============== ==============
An individual, who is a director of the Company, owns an office
building which is leased to the Company. The lease term commenced September 1,
1999 for a term of five years and contains renewal options for three additional
five-year terms. Rent expense under this agreement was $25,004 for the year
ended December 31, 2004 and $23,756 for each of the periods ended December 31,
2003 and 2002, respectively. Management believes that the terms of the foregoing
lease are no more and no less favorable to the Company than those which could
have been received from unaffiliated parties.
An individual, who became a director of the Company in 2003, is an
executive officer for the company which owns an office building in which the
Company has leased space under two separate operating leases. The leases were
effectively combined during 2004 and extended to February 28, 2010. Bay National
Corporation has the right to extend the leases for one additional five year
term, to February 28, 2015. Rent expense under these leases was $202,945,
$170,099 and $163,556 for the periods ended December 31, 2004, 2003 and 2002,
respectively. Management believes that the terms of the foregoing leases are no
more and no less favorable to the Company than those which could have been
received from unaffiliated parties.
11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business. These financial instruments may include
commitments to extend credit, standby letters of credit and purchase
commitments. The Company uses these financial instruments to meet the financing
needs of its customers. Financial instruments involve, to varying degrees,
elements of credit, interest rate and liquidity risk. These do not represent
unusual risks and management does not anticipate any losses which would have a
material effect on the accompanying financial statements.
66
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
Outstanding loan commitments and lines and letters of credit at
December 31 are as follows:
2004 2003
---- ----
Loan commitments $ 9,867,893 $ 11,458,333
Unused lines of credit 40,423,986 32,234,145
Standby letters of credit 1,578,379 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. The
Company generally requires collateral to support financial instruments with
credit risk on the same basis as it does for on-balance sheet instruments. The
collateral is based on management's credit evaluation of the counter party.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. Each customer's
credit-worthiness is evaluated on a case-by-case basis.
Standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers.
12. REGULATORY MATTERS
As of December 31, 2004, the Company was required to maintain a weekly
average of $958,000 of non-interest-bearing deposits with the Federal Reserve
Bank. As of December 31, 2003, the Company was required to maintain a weekly
average of $543,000 of non-interest-bearing deposits with the Federal Reserve
Bank. The average weekly balance maintained with the Federal Reserve Bank for
the weekly period ended December 31, 2004 was $1,511,000. The average weekly
balance maintained with the Federal Reserve Bank for the weekly period ended
December 31, 2003 was $598,000. The actual balances maintained with the Federal
Reserve Bank at December 31, 2004 and 2003 were $1,217,580 and $428,616,
respectively.
The Company and the Bank are subject to various regulatory capital
requirements administered by federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's and the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined) and Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2004, that the Bank
met all capital adequacy requirements to which it is subject.
The Bank has been categorized as "well capitalized" by the OCC under
the regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-
67
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
based, Tier I risk-based and Tier I leverage ratios. There are no conditions or
events that management believes would prevent the Bank from continuing to be
categorized as well capitalized.
The Bank's actual capital amounts and ratios as of December 31, 2004
and 2003 are presented in the following table:
December 31, 2004
-------------------------------------------------------------------------------------------------------------------------
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purpose Action Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital (to Risk Weighted
Assets): $ 16,242,797 10.32% $ 12,592,000 8.00% $ 15,740,000 10.00%
Tier I Capital (to Risk Weighted
Assets): 14,432,797 9.17% 6,296,000 4.00% 9,444,000 6.00%
Tier I Capital (to Average Assets): 14,432,797 8.98% 4,821,000 3.00% 8,034,000 5.00%
December 31, 2003
-------------------------------------------------------------------------------------------------------------------------
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purpose Action Provisions
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital (to Risk Weighted
Assets): $ 11,729,127 10.16% $ 9,238,000 8.00% $ 11,547,000 10.00%
Tier I Capital (to Risk Weighted
Assets): 10,462,627 9.09% 4,619,000 4.00% 6,928,000 6.00%
Tier I Capital (to Average Assets): 10,462,627 8.93% 3,516,000 3.00% 5,860,000 5.00%
Banking regulations also limit the amount of dividends that may be paid
without prior approval of the Bank's regulatory agencies. Regulatory approval is
required to pay dividends which exceed the Bank's net profits for the current
year, plus it's 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 December 31, 2004.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company discloses fair value information about financial
instruments, for which it is practicable to estimate the value, whether or not
such financial instruments are recognized on the balance sheet. Financial
instruments have been defined broadly to encompass 99.3% of the Company's assets
and 99.7% of its liabilities. Fair value is the amount at which a financial
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation, and is best evidenced by a quoted
market price, if one exists.
Quoted market prices, where available, are shown as estimates of fair
market values. Because no quoted market prices are available for a significant
part of the Company's financial instruments, the fair
68
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
values of such instruments have been derived based on the amount and timing of
future cash flows and estimated discount rates.
Present value techniques used in estimating the fair value of many of
the Company's financial instruments are significantly affected by the
assumptions used. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate cash settlement of the instrument. Additionally, the
accompanying estimates of fair values are only representative of the fair values
of the individual financial assets and liabilities and should not be considered
an indication of the fair value of the Company.
The estimated fair values of the Company's financial instruments at
December 31 are as follows:
2004 2003
--------------------------------------------------------------------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
(In thousands) Amount Value Amount Value
--------------------------------------------------------------------------------------------------------------------
Financial Assets
Cash and temporary investments (1) $ 27,725,114 $ 27,725,114 $ 18,983,930 $ 18,983,930
Investments available-for-sale 1,544,496 1,544,496 1,547,798 1,547,798
Other equity securities 556,090 556,090 481,090 481,090
Loans, net of allowances 139,603,437 139,652,670 100,125,475 100,408,763
Accrued interest receivable and other assets (2) 591,844 591,844 380,088 380,088
Financial Liabilities
Deposits $ 153,927,042 $ 153,676,261 $ 108,530,901 $ 108,144,977
Short-term borrowings 1,381,000 1,381,000 1,222,000 1,222,000
Note payable 1,250,000 1,250,000 - -
Accrued interest payable and other liabilities (2) 222,602 222,602 130,851 130,851
(1) Temporary investments include federal funds sold and overnight
investments, and loans held for sale.
(2) Only financial instruments as defined in Statement of
Financial Accounting Standards No. 107, "Disclosure about Fair
Value of Financial Instruments," are included in other assets
and other liabilities.
The following methods and assumptions were used to estimate the fair
value of each category of financial instruments for which it is practicable to
estimate that value:
Cash and due from banks, federal funds sold and overnight investments. The
carrying amount approximated the fair value.
Loans held for sale. The fair value of residential mortgage loans held for sale
was derived from secondary market quotations for similar instruments.
Investment Securities. The fair value for U.S. Treasury securities was based
upon quoted market bids.
69
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
Other equity securities. The fair value of Federal Reserve Bank and Federal Home
Loan Bank of Atlanta stock is not readily determinable since these stocks are
restricted as to marketability.
Loans. The fair value was estimated by computing the discounted value of
estimated cash flows, adjusted for potential credit losses, for pools of loans
having similar characteristics. The discount rate was based upon the current
loan origination rate for a similar loan. Non-performing loans have an assumed
interest rate of 0%.
Accrued interest receivable. The carrying amount approximated the fair value of
accrued interest, considering the short-term nature of the receivable and its
expected collection.
Other assets. The carrying amount approximated the fair value.
Deposit liabilities. The fair value of demand, money market savings and regular
savings deposits, which have no stated maturity, were considered equal to their
carrying amount, representing the amount payable on demand. These estimated fair
values do not include the intangible value of core deposit relationships, which
comprise a significant portion of the Bank's deposit base. Management believes
that the Bank's core deposit relationships provide a relatively stable, low-cost
funding source that has a substantial intangible value separate from the value
of the deposit balances.
The fair value of time deposits was based upon the discounted value of
contractual cash flows at current rates for deposits of similar remaining
maturity.
Short-term borrowings. The carrying amount approximated the fair value of
repurchase agreements due to their variable interest rates.
Note payable. The carrying amount approximated the fair value of the note
payable due to their variable interest rates.
Other liabilities. The carrying amount approximated the fair value of accrued
interest payable, accrued dividends and premiums payable, considering their
short-term nature and expected payment.
Off-balance sheet instruments. The Company charges fees for commitments to
extend credit. Interest rates on loans, for which these commitments are
extended, are normally committed for periods of less than one month. Fees
charged on standby letters of credit and other financial guarantees are deemed
to be immaterial and these guarantees are expected to be settled at face amount
or expire unused. It is impractical to assign any fair value to these
commitments.
70
BAY NATIONAL CORPORATION
Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003 and 2002
14. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Bay National Corporation (Parent
Only) is as follows:
CONDENSED BALANCE SHEETS
------------------------
December 31, 2004 and 2003
2004 2003
----------------- ----------------
ASSETS
Cash and cash equivalents $ 104,769 $ 653,687
Due from subsidiary 137,500 950,186
Investment in subsidiary 14,432,797 10,462,627
----------------- ----------------
Total Assets $ 14,675,066 $ 12,066,500
================= ================
LIABILITIES
Accrued expenses and other liabilities $ 6,302 $ -
Note payable 1,250,000 -
----------------- ----------------
Total Liabilities 1,256,302 -
----------------- ----------------
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, authorized:
9,000,000 shares authorized, 1,917,710 and 1,862,710 issued and
outstanding as of December 31, 2004 and 2003, respectively:
19,177 18,627
Additional paid in capital 17,400,284 16,850,834
Accumulated Deficit (4,000,697) (4,802,961)
----------------- ----------------
Total Stockholders' Equity 13,418,764 12,066,500
----------------- ----------------
Total Liabilities and Stockholders' Equity $ 14,675,066 $ 12,066,500
================= ================
71
BAY NATIONAL CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
------------------------------------------
For the years ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------- ------------- -------------
Interest and dividends on investment securities $ 2,231 $ 5,146 $ 23,931
Interest expense 6,302 - -
------------- ------------- -------------
Net interest income (expense) (4,071) 5,146 23,931
------------- ------------- -------------
Non-interest expense 1,335 3,219 2,886
------------- ------------- -------------
Income (loss) before income taxes and equity in undistributed (5,406) 1,927 21,045
losses of subsidiary
Income tax expense (benefit) - - -
------------- ------------- -------------
Income (loss) before equity in undistributed income (losses) (5,406) 1,927 21,045
of subsidiary
Equity in undistributed income (losses) of subsidiary 807,670 5,654 (1,013,539)
------------- ------------- -------------
Net Income (Loss) $ 802,264 $ 7,581 $ (992,494)
============= ============= =============
CONDENSED STATEMENTS OF CASH FLOWS
----------------------------------
For the years ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------- ------------- -------------
Cash Flows From Operating Activities
Net Income (Loss) $ 802,264 $ 7,581 $ (992,494)
Adjustments to reconcile net income (loss) to net cash
(used) provided by operating activities:
Equity in undistributed (income) loss of subsidiary (807,670) (5,654) 1,013,539
Net decrease (increase) in other assets 812,686 (699,450) (250,736)
Net increase (decrease) in other liabilities 6,302 (250,292) 250,240
------------- ------------- -------------
Net cash (used) provided by operating activities 813,582 (947,815) 20,549
------------- ------------- -------------
Cash Flows From Investing Activities
Investment in subsidiary (3,162,500) (3,500,000) (2,000,000)
------------- ------------- -------------
Net cash used by investing activities (3,162,500) (3,500,000) (2,000,000)
------------- ------------- -------------
Cash Flows From Financing Activities
Net proceeds from note payable 1,250,000 - -
Issuance of common stock 550,000 4,449,261 -
------------- ------------- -------------
Net cash provided by financing activities 1,800,000 4,449,261 -
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents (548,918) 1,446 (1,979,451)
Cash and cash equivalents at beginning of year 653,687 652,241 2,631,692
------------- ------------- -------------
Cash and cash equivalents at end of year $ 104,769 $ 653,687 $ 652,241
============= ============= =============
72
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There has been no occurrence requiring a response to this Item.
Item 8A. Controls and Procedures
As of the end of the period covered by this annual report on Form
10-KSB, Bay National Corporation's Chief Executive Officer and Chief Financial
Officer evaluated the effectiveness of Bay National Corporation's disclosure
controls and procedures. Based upon that evaluation, Bay National Corporation's
Chief Executive Officer and Chief Financial Officer concluded that Bay National
Corporation's disclosure controls and procedures are effective. Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed by Bay National Corporation in
the reports that it files or submits under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
In addition, there were no changes in Bay National Corporation's
internal controls over financial reporting (as defined in Rule 13a-15 or Rule
15d-15 under the Securities Act of 1934, as amended) during the quarter ended
December 31, 2004, that have materially affected, or are reasonably likely to
materially affect, Bay National Corporation's internal control over financial
reporting.
Item 8B. Other Information
On December 7, 2004, the Compensation Committee of the Board of
Directors of Bay National Bank increased, effective January 1, 2005, Hugh
Mohler's annual base compensation from $164,000 to $200,000 and Mark Semanie's
annual base compensation from $150,000 to $165,000
On December 7, 2004, the Compensation Committee of the Board of
Directors of Bay National Bank authorized a $50,000 discretionary bonus to Mr.
Mohler, and a $40,000 discretionary bonus to Mr. Semanie. These bonuses were
paid on January 21, 2005.
73
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act
Directors, Executive Officers, Promoters and Control Persons
The directors of Bay National Corporation, their ages, the years in
which their terms expire and the year in which they became directors are as
follows:
Name Age Term to Expire (1) Director Since
---- --- ------------------ --------------
Hugh W. Mohler 59 2006 Annual Meeting June 1999
Carroll A. Bodie 59 2005 Annual Meeting June 1999
Charles E. Bounds 86 2005 Annual Meeting June 1999
Gary T. Gill 52 2005 Annual Meeting January 2003
John R. Lerch 60 2005 Annual Meeting June 1999
Donald G. McClure, Jr. 61 2006 Annual Meeting April 2000
Robert L. Moore 51 2006 Annual Meeting February 2001
James P. O'Conor 76 2005 Annual Meeting July 2004
H. Victor Rieger, Jr. 67 2006 Annual Meeting June 1999
Margaret Knott Riehl 71 2006 Annual Meeting June 1999
William B. Rinnier 63 2007 Annual Meeting August 1999
Edwin A. Rommel, III 55 2007 Annual Meeting June 1999
Henry H. Stansbury 65 2007 Annual Meeting June 1999
Kenneth H. Trout 56 2007 Annual Meeting October 1999
Eugene M. Waldron, Jr. 61 2007 Annual Meeting June 1999
Carl A.J. Wright 50 2005 Annual Meeting March 2003
(1) All of the directors with terms to expire in 2005 have been nominated
to serve on the Board of Directors for an additional three (3) year
term. Elections for these directors will take place at the 2005 Annual
Meeting of Stockholders to be held on May 24, 2005.
74
Biographical information concerning the directors is set forth below.
Hugh W. Mohler serves as chairman, president, and chief executive
officer. He has been a director of Bay National Corporation since June 1999 and
a director of Bay National Bank since April 2000. Mr. Mohler has 36 years
experience in the financial services industry, holding positions in executive
management, commercial lending and business development. From 1977 to 1999, Mr.
Mohler was affiliated with Mercantile Bankshares Corporation, which is
headquartered in Baltimore, Maryland, most recently serving as executive vice
president with responsibility for 20 community banks in a three-state area. For
17 years, from 1977 to 1994, he was president of Mercantile's Salisbury,
Maryland-based affiliate, Peninsula Bank, the largest financial institution on
Maryland's Eastern Shore. Earlier he was a vice president in commercial lending
at First National Bank of Maryland.
A native of Baltimore, Mr. Mohler earned his undergraduate degree in
economics from Loyola College of Maryland and his master of business
administration degree from the University of Baltimore. He is a past president
of the board of trustees of Associated Catholic Charities, Inc. in the Roman
Catholic Archdiocese of Baltimore. In the past, Mr. Mohler has served as a
trustee of Loyola Blakefield, Goucher College and the Independent College Fund
of Maryland. Mr. Mohler serves on the Board of Sponsors of the Sellinger School
of Business at Loyola College of Maryland and the Board of Governors of The
Maryland Club. In 2004, he was appointed by Governor Robert L. Ehrlich, Jr. to
the Maryland Economic Development Commission. He also serves on the President's
Advisory Council of Villa Julie College.
Mr. Mohler's prior civic experiences include serving as chairman of the
Greater Salisbury Committee, chairman of the Salisbury School, and chairman of
the Governor's Lower Shore Economic Task Force. He also served on the boards of
Peninsula Regional Medical Center, Maryland Chamber of Commerce,
Salisbury-Wicomico Economic Development Committee and the Somerset County
Economic Development Committee. Mr. Mohler also served as president of the
Maryland Bankers Association and on several committees of the American Bankers
Association.
Carroll A. Bodie has been a director of Bay National Corporation since
June 1999 and a director of Bay National Bank since April 2000. Mr. Bodie is
vice president and general counsel of Noxell Corporation, a Hunt Valley,
Maryland-based subsidiary of Procter & Gamble Company for which he also serves
as associate general counsel. Mr. Bodie has served in that capacity since 1987.
Prior to joining Noxell, Mr. Bodie spent more than two decades in the brewing
industry, his most recent position being with the Miller Brewing Company
subsidiary of Philip Morris Companies, Inc.
A Baltimore native, Mr. Bodie holds an undergraduate degree in
marketing from the University of Baltimore and earned his law degree from the
University of Baltimore School of Law. Admitted to practice before numerous
courts, including those in the State of Maryland and the United States Supreme
Court, he is a member of the Baltimore County, Maryland Bar Association, the
American Bar Association and the American Corporate Counsel Association. Mr.
Bodie is immediate past chairman of the board of trustees of Loyola Blakefield
and a Trustee at the College of Notre Dame of Maryland. He is a past director
and board chairman for the YMCA of Central Maryland and a past board member of
the Independent College Fund.
Charles E. Bounds has been a director of Bay National Corporation since
June 1999 and a director of Bay National Bank since April 2000. Mr. Bounds is a
retired executive who served from 1944 to 1969 as director of purchases and
inventory for Symington Wayne Corporation, an international conglomerate
headquartered in Salisbury, Maryland, which operated businesses in the United
States and seven foreign
75
countries. From 1969 to 1999, he was a vice president-investments for Morgan
Stanley Dean Witter, working in the Salisbury, Maryland office of the investment
banking firm.
A native of Salisbury, Maryland, Mr. Bounds is past chairman of the
Salvation Army Boys Club in Salisbury, Maryland, and headed the Salisbury,
Maryland Salvation Army administrative board. He has also chaired fund raising
efforts for the Boy Scouts of America, Delmarva District. Mr. Bounds was an
original member of the Ward Foundation, which is a Salisbury, Maryland based
non-profit organization, which operates The Ward Museum of Wildfowl Art. Mr.
Bounds is an alumnus of Beacom College.
Gary T. Gill has been a director of Bay National Corporation and Bay
National Bank since January 2003. Mr. Gill is president and chief executive
officer of the MacKenzie Companies, a Baltimore-based full-service commercial
real estate firm comprising Mackenzie Commercial Real Estate Services, LLC,
Mackenzie Management Corporation, MacKenzie Services Corporation, MacKenzie
Contracting Company, LLC, and MacKenzie Drywall Construction. Mr. Gill joined
MacKenzie in 1977 and has served in his capacity as president since 1985. Mr.
Gill serves also as executive vice president of MacKenzie Properties, Inc., the
managing partner of over 35 partnerships of income-producing commercial
properties.
A native of Towson, Maryland, Mr. Gill received his Bachelor of Arts
degree in Business Administration in 1974 from Towson University. Mr. Gill
currently serves on the Baltimore County Economic Advisory Board, Towson
University Stadium Committee, USLacrosse Foundation Board, and chairs the Lax 4
Baltimore Committee for the NCAA National Men's Lacrosse Championships.
John R. Lerch has been a director of Bay National Corporation since
June 1999 and a director of Bay National Bank since April 2000. Since January
1999, Mr. Lerch has been self-employed as a private investor trading as the
Chesapeake Venture Group. From 1973 to January 1999, Mr. Lerch was president of
Chesapeake Insurance-The Harris Riggin Agency, an independent insurance agency
based in Salisbury, Maryland. Mr. Lerch began his business career in the
securities industry, serving as a stockbroker at firms in Washington, D.C. and
Salisbury, Maryland. Mr. Lerch is a past director of the Independent Insurance
Agents of Maryland.
Mr. Lerch is an alumnus of Dickinson College of Carlisle, Pennsylvania.
He served as an officer in the U.S. Army and holds a Bronze Star from his
service in Vietnam. He is a director of Barr International, Inc., a regional
medium and heavy truck sales and service organization. He is a past director of
Peninsula Bank, a subsidiary of Baltimore-based Mercantile Bankshares
Corporation. He is a past director and vice-chairman of the Greater Salisbury
Committee, past trustee of the Peninsula Regional Medical Center in Salisbury,
past president of Salisbury-Wicomico Economic Development Corporation and past
president and campaign chairman of the United Way of the Lower Eastern Shore. He
also has served as a director for the Mid-Delmarva Family YMCA and was a former
chairman and a current trustee for The Ward Foundation.
Donald G. McClure, Jr. has been a director of Bay National Corporation
and Bay National Bank since April 2000. Mr. McClure is a principal in the
McClure Group, Inc, a Baltimore-based private equity investment firm originated
in 1979. He is the former Chairman and Co-Chief Executive of Americom Wireless
Services, Inc., which merged with a Fortune 200 company in 2000.
Mr. McClure is Chairman of the board of trustees of Loyola Blakefield
and serves on several private company boards as well as devoting substantial
time to various civic, charitable and educational organizations here and in
other states.
76
Robert L. Moore has been a director of Bay National Corporation since
February 2001 and Bay National Bank since June 2001. Mr. Moore is a certified
public accountant. He received his CPA designation twenty-five years ago, and is
the owner and founder of the Salisbury, Maryland accounting firm of Moore &
Company, P.A. His professional concentration is income tax and all facets of
business consulting.
Mr. Moore received his Bachelor of Science degree from the University
of Virginia in 1976. Currently, he serves as Chairman of the Trustees of the
Wicomico County Pension System, a board member of Salisbury-Wicomico Economic
Development Corporation, a board member of the Greater Salisbury Committee, and
a member of the Salisbury Area Chamber of Commerce.
Mr. Moore is a past president of the Eastern Shore Chapter of the
Maryland Association of CPAs. He served as Chairman of the Administrative Board
of Asbury United Methodist Church. In addition, Mr. Moore served on the Board of
Directors of the Bank of Fruitland, Maple Shade Residential Homes, Inc., and the
Holly Foundation. He was also a member of the Executive Committee and Board of
Directors of the Green Hill Yacht & Country Club and a member and officer of the
Salisbury Jaycees.
James P. O'Conor has been a director of Bay National Corporation and
Bay National Bank since July 2004. Mr. O'Conor is the general partner of O'Conor
Enterprises, a real estate investment and consulting company , and he has served
in that capacity since 2002. Mr. O'Conor co-founded the Maryland real estate
brokerage firm of O'Conor & Flynn in 1961. In 1984, that firm merged with
another large Maryland real estate brokerage firm, creating O'Conor, Piper &
Flynn. Mr. O'Conor served as its Chairman and CEO. In 1998, O'Connor, Piper &
Flynn was sold to NRT. At the time of the sale, O'Conor, Piper & Flynn was the
sixth largest residential real estate brokerage company in the United States.
Mr. O'Conor currently serves on the Board of Directors of the
University of Maryland Medical System, the Baltimore Symphony Orchestra,
Sheppard & Enoch Pratt Hospital, Loyola College, Towson University and is
Chairman of Maryland General Hospital.
H. Victor Rieger, Jr. has been a director of Bay National Corporation
since June 1999 and a director of Bay National Bank since April 2000. Mr. Rieger
retired from Signet Banking Corporation, successor to Union Trust Company of
Maryland, in December 1997 after nearly four decades of service. Mr. Rieger
served in numerous capacities for Signet, including regional executive vice
president of international banking and as part of Signet's Maryland commercial
banking group. Mr. Rieger has extensive experience in commercial relationship
banking, credit administration and loan policy.
An alumnus of Johns Hopkins University, Mr. Rieger is a graduate of the
Stonier School of Banking at Rutgers University. He is past president and a
current trustee of Family and Children's Services of Central Maryland, past
treasurer and board member of the National Flag Day Foundation and a past
vice-president and director of the Baltimore Junior Association of Commerce. He
is a former member of the loan committee for the Minority Small Business
Investment Company and a past advisory board member of the U.S. Small Business
Administration. Mr. Rieger also is past president of the Chesapeake Chapter of
Robert Morris Associates.
Margaret K. Riehl has been a director of Bay National Corporation since
June 1999 and a director of Bay National Bank since April 2000. Mrs. Riehl is a
retired nurse and civic volunteer. She is currently a trustee of the Marion I.
and Henry J. Knott Foundation, a Baltimore, Maryland-based philanthropic
organization and has served in that capacity from 1978 to 1985 and again from
1993 to present. She serves as
77
a trustee of St. Mary's Seminary & University, also in Baltimore. Mrs. Riehl is
a former president of the board of trustees of Baltimore's Associated Catholic
Charities, Inc., and a former trustee of the Community Foundation of Baltimore,
Mercy Medical Center, the Institute of Notre Dame and St. Paul's School for
Girls. A Baltimore native, Mrs. Riehl is an alumna of the Mercy Hospital School
of Nursing.
William B. Rinnier has been a director of Bay National Corporation
since August 1999 and a director of Bay National Bank since April 2000. Mr.
Rinnier is the owner and president of Rinnier Development Company, a Salisbury,
Maryland based real estate development company, which specializes in the
development and sale or management of resort condominiums, multi-family
apartments, and commercial and industrial buildings. He joined Rinnier
Development Company nearly three decades ago after his honorable discharge from
the U.S. Navy.
A native of Salisbury, Maryland, Mr. Rinnier earned a degree in
aerospace engineering from the Georgia Institute of Technology and attended the
Graduate School of Business at the University of Virginia. He is a board member
of the Greater Salisbury Committee and is past president of the
Salisbury-Wicomico Economic Development Corporation and the Coastal Board of
Realtors.
Edwin A. Rommel III has been a director of Bay National Corporation
since June 1999 and a director of Bay National Bank since April 2000. Mr. Rommel
is a certified public accountant that, since 1974, has been a partner in the
Salisbury, Maryland, accounting firm of Twilley, Rommel & Stephens, P.A. Mr.
Rommel has been certified as a valuation analyst and accredited in business
evaluation by the American Institute of Certified Public Accountants.
A Baltimore native, Mr. Rommel earned his undergraduate degree from
Loyola College of Maryland. Mr. Rommel is Chairman of the Maryland Association
of Certified Public Accountants, and is a member of the governing board of the
American Institute of Certified Public Accountants. Mr. Rommel is a current
director of the Greater Salisbury Committee and past president of the Salisbury
Area Chamber of Commerce. He serves as a director of the Maryland Association of
Certified Public Accountants and an officer of its Eastern Shore Chapter. Mr.
Rommel is past president of the St. Francis de Sales Board of Trustees and past
member of the Wicomico County Democratic Central Committee.
Henry H. Stansbury has been a director of Bay National Corporation
since June 1999 and a director of Bay National Bank since April 2000. Since
1975, Mr. Stansbury has been the chief executive officer of Agency Services,
Inc., an independently owned premium finance company. Since 1989, Mr. Stansbury
has been the chief executive officer of Agency Insurance Company of Maryland,
Inc., a privately owned multi-line property/casualty insurance company. Mr.
Stansbury is a past president of the Maryland Association of Premium Finance
Companies and is a past president of the National Association of Premium Finance
Companies.
Mr. Stansbury is a vice president and trustee of the Maryland
Historical Society and a trustee of the Ward Museum of Wildfowl Art. He served
as director and chairman of the museum committee for the Lacrosse Hall of Fame
at the Johns Hopkins University and is vice president and a trustee of the St.
Paul's School for Boys. He is also past president of ReVisions, Inc., a
nonprofit organization that serves the mentally ill. Mr. Stansbury is a graduate
of Leadership Maryland and a director of Leadership Baltimore County. He is the
author of two books; LLOYD J. TYLER: FOLK ARTIST AND DECOY MAKER and IRA HUDSON
AND FAMILY, CHINCOTEAGUE CARVERS. He is also a contributing writer for Decoy
Magazine. Mr. Stansbury is an alumnus of the University of Maryland and holds a
master of business administration degree from George Washington University.
78
Kenneth H. Trout has been a director of Bay National Corporation since
October 1999 and a director of Bay National Bank since April 2000. Since January
1999, Mr. Trout has served as the president and chief executive officer of
Rosemore, Inc., a Baltimore-based privately held investment company primarily
engaged in the business of oil and gas exploration and production. He also
serves as a director of Rosemore Holdings, Inc., Rosemore Calvert, Inc., Tema
Oil and Gas Company and Gateway Gathering and Marketing Company, which are all
subsidiaries of Rosemore, Inc. He is also a director of KCI Technologies, Inc.
From 1970 to November 1997, Mr. Trout was employed by Signet Banking
Corporation. During his last five years of tenure with Signet, he served as
senior executive vice president-commercial banking and as president and chief
executive officer of Signet Bank-Maryland. Mr. Trout was retired from December
1997 to December 1998.
A Bridgeton, New Jersey native, Mr. Trout received his undergraduate
degree in economics and business administration from Methodist College in North
Carolina. He is vice chairman of the Board of Trustees of The College of Notre
Dame of Maryland.
Eugene M. Waldron, Jr. has been a director of Bay National Corporation
since June 1999 and a director of Bay National Bank since April 2000. Mr.
Waldron is a Chartered Financial Analyst and since September 1998 has been a
senior vice president in the Washington, D.C., office of Capital Guardian Trust
Company, an employee-owned firm based in Los Angeles dedicated to institutional
investment management. From March 1994 to August 1998, Mr. Waldron was employed
by Loomis, Sayles & Company, an investment management firm. Mr. Waldron's more
than three decades of investment experience include employment at CS First
Boston Asset Management, Fidelity Management Trust Company, T. Rowe Price
Associates and Ferris, Baker, Watts & Company.
An alumnus of Mt. St. Mary's College, Emmitsburg, Maryland, Mr. Waldron
earned his master of business administration degree at the Bernard M. Baruch
College of the City University of New York. A native of Annapolis, Maryland, he
is a member of the Mt. St. Mary's Board of Trustees and the Newton,
Massachusetts Country Day School of the Sacred Heart's Endowment Committee.
Carl A.J. Wright has been a director of Bay National Corporation and
Bay National Bank since March 2003. Mr. Wright is the senior vice president of
Spherion (formerly Interim Financial Solutions), an executive search and
staffing firm specializing in finance, human resources and information systems,
and he has served in that capacity since 1998. Mr. Wright operated the Baltimore
office of A.J. Burton from 1980 until its sale to Spherion in 1998. Mr. Wright
served in the auditing and tax departments of Ernst & Young from 1976 to 1980.
Along with his corporate responsibilities, he is an involved community member
and active in professional, civic and political organizations.
Mr. Wright is an alumnus of Loyola College and Loyola Blakefield and
has served on boards and committees of both institutions. He is past president
of the Baltimore Junior Association of Commerce and serves on Maryland Governor
Robert Ehrlich's Strategic and Finance Committees. He was appointed as the
chairman of the Maryland Stadium Authority in 2003. In addition, he is an active
supporter of the Catholic Charities and Maryland Business for Responsive
Government.
Other than Mr. Mohler and Mr. Waldron who are first cousins, there are
no family relationships between any director or executive officer and any other
director or executive officer of Bay National Corporation.
79
The one executive officer and significant employee of Bay National
Corporation and Bay National Bank that does not serve on the Board of Directors
of Bay National Corporation is Mark A. Semanie.
Mr. Semanie, age 41, serves as Executive Vice President and Chief
Financial Officer, Treasurer and Secretary of Bay National Corporation and
Executive Vice President and Chief Financial Officer, Chief Compliance Officer,
Treasurer and Secretary of Bay National Bank. Mr. Semanie is a Certified Public
Accountant. Mr. Semanie worked in the insurance industry for over seven years.
From July 1996 to October 2000, he served as Executive Vice President and Chief
Financial Officer for Agency Holding Company of Maryland, Inc., parent company
of Baltimore-based Agency Services, Inc., an insurance premium finance company,
and Agency Insurance Company of Maryland, Inc., a multi-line property/casualty
insurance company. From March 1993 to July 1996, he was associated with USF&G
Corporation where he served in various capacities, including Manager of SEC and
External Reporting. From August 1985 to March 1993, Mr. Semanie worked in the
Boston and Baltimore offices of the international accounting firm of KPMG LLP.
He last served as a Senior Manager in the Audit practice with the firm. His
background includes experience in financial planning and reporting, backroom
operations, human resources and regulatory compliance.
A native of Connecticut, Mr. Semanie earned a Bachelor of Science
degree in accounting from Bentley College. He currently serves on the Board of
Directors of Agency Insurance Company of Maryland, Inc. He also serves as a
director of the Baltimore Child Abuse Center and as Chairman of its Finance
Committee. He is a member of the American Institute of Certified Public
Accountants, the Maryland Association of Certified Public Accountants, the
American Institute of Chartered Property Casualty Underwriters, and Financial
Executives International.
Bay National Corporation's charter and bylaws provide that Bay National
Corporation shall have at least three (3) directors, and that the number of
directors may be increased or decreased by the Board of Directors. As of March
25, 2005, the number of directors has been fixed at 16 with all positions
filled. Pursuant to Bay National Corporation's charter and bylaws, the Board of
Directors is divided into three classes, with each class serving a three-year
term, and the term of one class expiring each year. A director may only be
removed by the affirmative vote of at least 80% of the votes entitled to be cast
on the matter and only for cause.
Bay National Corporation's officers are appointed by the Board of
Directors and hold office at the will of the board or as otherwise provided in
an employment agreement between an officer and Bay National Corporation.
As Bay National Corporation is the sole stockholder of Bay National
Bank, each director of Bay National Bank is elected by the Board of Directors of
Bay National Corporation. Directors of Bay National Bank serve for a term of one
year and are elected each year at Bay National Bank's annual meeting of
stockholders. Bay National Bank's officers are appointed by its Board of
Directors and hold office at the will of the board.
Bay National Corporation has established an advisory board of
directors, which is comprised of professionals and business persons, who provide
advice to Bay National Corporation's and Bay National Bank's Board of Directors
and who promote the interests of Bay National Corporation and Bay National Bank.
An advisory board of directors is not required by any Maryland or federal law or
regulation and advisory directors are not subject to regulatory approval or
supervision. The advisory directors do not have the power to vote on any matter
considered by the Board of Directors and they serve at the pleasure of the
board.
80
Audit Committee Matters
Bay National Corporation has a standing Audit Committee. The Audit
Committee currently has four members: Carroll A. Bodie, Chairman, William B.
Rinnier, Henry H. Stansbury and Kenneth H. Trout. As of the date of this report,
each of the members of the Audit Committee is "independent" under rules
promulgated by the Securities and Exchange Commission. The Audit Committee's
functions and responsibilities are described in a written charter that was
adopted by Bay National Corporation's Board of Directors.
Pursuant to Securities and Exchange Commission regulations, Bay
National Corporation is required to disclose in this annual report whether one
or more members of the audit committee are "audit committee financial experts"
and the names of those members. If Bay National Corporation does not have an
audit committee financial expert on the audit committee, it is required to
explain why that is the case.
The Securities and Exchange Commission has defined an "audit committee
financial expert" as a person who has the following attributes:
o An understanding of generally accepted accounting principles
and financial statements;
o The ability to assess the general application of such
principles in connection with the accounting for estimates,
accruals and reserves;
o Experience preparing, auditing, analyzing or evaluating
financial statements that present a breadth and level of
complexity of accounting issues that are generally comparable
to the breadth and complexity of issues that can reasonably be
expected to be raised by the financial statements, or
experience actively supervising one or more persons engaged in
such activities;
o An understanding of internal controls and procedures for
financial reporting; and
o An understanding of audit committee functions.
Bay National Corporation's Board of Directors determined that none of
the members of the audit committee meet this definition and, accordingly, the
audit committee does not have an "audit committee financial expert." In its
proposing release regarding financial experts on audit committees, the
Securities and Exchange Commission indicated that a "primary benefit of having a
financial expert serving on a company's audit committee is that the person, with
his or her enhanced level of financial sophistication or expertise, can serve as
a resource for the audit committee as a whole in carrying out its functions."
The Board of Directors believes that the audit committee, as it is
presently constituted, is able to carry out its functions fully and in the best
interests of stockholders notwithstanding the lack of an audit committee
financial expert. In that regard, the Board of Directors believes that the
combined knowledge and experience of the committee's four members, as described
under the heading "Directors, Executive Officers, Promoters and Control
Persons," serve as a valuable resource to that committee. In light of the
foregoing, the Board of Directors has no current plans to add a new director to
the audit committee who would qualify as an audit committee financial expert.
81
Compliance with Section 16(a) of the Exchange Act
The Company did not have a class of equity securities registered
pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), at any time during the Company's fiscal year ended December 31, 2004.
Accordingly, there is no requirement upon the Company's officers, directors and
10% or greater shareholders to file any reports required pursuant to Section
16(a) of the Exchange Act.
Code of Ethics
Bay National Corporation's Board of Directors has adopted a code of
ethics that applies to its principal executive officer, principal accounting
officer or controller and persons performing similar functions. That Code of
Ethics for Senior Financial Officers has been posted on Bay National Bank's
internet website at www.baynational.com. A copy of the Code of Ethics for Senior
Financial Officers is also included as an exhibit to this annual report.
Item 10. Executive Compensation
Director Compensation
Except for discretionary grants of options to purchase shares of common
stock as described below and discretionary payments based on special
circumstances, the directors of Bay National Corporation and Bay National Bank
were not compensated for their attendance at regularly scheduled or special
board meetings or for other services prior to July 2004.
In July 2004, Bay National Bank began paying directors who are not
officers or employees of Bay National Corporation or Bay National Bank (e.g.,
all directors other than Mr. Mohler) ("Qualified Directors") $200 for each
attended regularly scheduled meeting and each special meeting of the Board of
Directors of Bay National Bank, and $150 for each attended regularly scheduled
meeting and each special meeting of a committee of the Board of Directors of Bay
National Bank. In addition, the chair of the Executive Committee and the chair
of the Audit Committee of the Board of Directors of Bay National Bank received
an additional $100 for each attended regularly scheduled meeting and each
special meeting. During 2004, Bay National Bank paid (or accrued the payment of)
$23,250 for these meeting fees.
During 2004, all Qualified Directors of Bay National Bank were also
entitled to reimbursement for their reasonable travel costs related to their
attendance at board and committee meetings, and all directors of Bay National
Corporation and Bay National Bank are reimbursed for reasonable expenses
incurred on behalf of Bay National Corporation and Bay National Bank. During
2004, Bay National Corporation and Bay National Bank did not reimburse any
travel costs or expenses.
In December 2004, the Compensation Committee of the Board of Directors
of Bay National Bank authorized a special payment of $20,000 to Mr. H. Victor
Rieger, Jr., a director of Bay National Corporation and Bay National Bank, in
recognition of Mr. Rieger's outstanding service as a key member of Bay National
Bank's Executive Committee. Since 2001, Bay National Bank has made annual
special payments to Mr. Rieger in recognition of his outstanding service.
Bay National Corporation does not pay cash remuneration to its
directors. It is expected that unless and until Bay National Corporation becomes
actively involved in additional businesses other than owning all the capital
stock of Bay National Bank, no separate cash compensation will be paid to the
directors of Bay
82
National Corporation in addition to that paid to them by Bay National Bank in
their capacities as directors of Bay National Bank. However, Bay National
Corporation may determine in the future that such separate cash compensation is
appropriate.
On January 25, 2005, the Board of Directors of Bay National Corporation
and Bay National Bank adopted a formal Director Compensation Policy. The
Director Compensation Policy provides for compensation for attendance at
meetings and reimbursement of expenses in substantially the same manner as that
paid from July 2004 to December 2004 except that directors of Bay National Bank
will receive $300 for attended meetings of the Board of Directors instead of
$200. The Director Compensation Policy also provides that the Board of Directors
or the compensation committee of the Board of Directors of Bay National Bank may
authorize discretionary payments to Qualified Directors as a result of
outstanding service by the Qualified Director. Furthermore, the Director
Compensation Policy provides that the policy may be changed from time to time. A
copy of the Director Compensation Policy is included as an exhibit to this
annual report.
In November 2001, Bay National Corporation granted each of its then
directors options to purchase 3,000 shares of its common stock at $7.58 per
share, the then fair market value. A total of 39,000 options were issued. The
options vest in four (4) equal installments with the first 25% installment
vesting on the third anniversary of the individual director's appointment to Bay
National Corporation's Board of Directors. The remaining 25% installments vest
on the fourth, fifth, and sixth anniversary of the individual director's
appointment to the Board of Directors. As of December 31, 2004, options to
purchase 27,000 shares were exercisable. The options expire on November 19, 2009
and none have been exercised.
83
Executive Compensation
Summary Compensation Table
The following table sets forth the compensation paid by Bay National
Corporation and Bay National Bank to the Chief Executive Officer of Bay National
Corporation and Bay National Bank and to any other executive officer of Bay
National Corporation and Bay National Bank who received compensation in excess
of $100,000 during 2004.
Summary Compensation Table
--------------------------
Long Term Compensation
------------------------------------
Annual Compensation Awards Payouts
---------------------------------- ------------------------- ----------
Securities
Other Annual Restricted Underlying LTIP All Other
Name and Principal Salary Bonus Compensation Stock Options/ Payouts Compensation
Position Year ($) ($) ($) Award(s) ($) SARs (#) ($) ($)
----------------------- ------ --------- --------- -------------- ------------- ----------- ---------- -------------
Hugh W. Mohler
President and Chief
Executive Officer (1)
2004 $170,308 $ 30,000 $ 7,500 - - - $ 7,654
2003 164,000 - - - - - $ 6,798
2002 164,000 - - - - - $ 6,032
Mark A. Semanie
Executive Vice
President and CFO (2) 2004 $155,192 $ 30,000 - - - - $ 7,519
2003 $135,000 $ 30,000 - - - - $ 6,838
2002 $135,000 $ 30,000 - - - - $ 6,838
(1) Other compensation includes $7,003, $6,150 and $5,533 of contributions
to the Company's 401(k) retirement plan for 2004, 2003 and 2002,
respectively, and $651, $648 and $499 of term life insurance premiums
paid by the Bank on Mr. Mohler's behalf for 2004, 2003 and 2002,
respectively. Other annual compensation for 2004 includes $7,500 which
represents the difference between the fair market value of 5,000 shares
of common stock purchased upon the exercise of warrants and the $10 per
share exercise price of the warrants. The aggregate market value of the
stock purchased was $57,500 as of the exercise date of September 16,
2004, based on a sales price of $11.50 per share of Common Stock, which
is the sales price at which shares of Common Stock were last sold in
over the counter trading on August 31, 2004. The summary of Mr.
Mohler's 2004 compensation does not include a bonus of $50,000 approved
by the Compensation Committee of the Board of Directors on December 7,
2004 and paid on January 21, 2005.
(2) Other compensation includes $6,651, $5,962 and $5,947 of contributions
to the Company's 401(k) retirement plan for 2004, 2003 and 2002,
respectively, and $868, $864 and $891 of term life insurance premiums
paid by the Bank on Mr. Semanie's behalf for 2004, 2003 and 2002,
respectively. The summary of Mr. Semanie's 2004 compensation does not
include a bonus of $40,000 approved by the Compensation Committee of
the Board of Directors on December 7, 2004 and paid on January 21,
2005.
84
Aggregate Options Table
The following table sets forth information on the aggregate number of
shares of common stock underlying unexercised options held as of December 31,
2004 by Mr. Mohler and Mr. Semanie and the aggregate dollar value of
in-the-money unexercised options held as of December 31, 2004 by Mr. Mohler and
Mr. Semanie.
Number of Securities
Underlying Unexercised Value of Unexercised
Options at in-the-Money Options at
Name December 31, 2004 December 31, 2004
-------------------- ----------------------------- ----------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Hugh W. Mohler 18,630 18,631 $ 105,632 $ 105,638
Mark A. Semanie 9,315 9,315 52,816 52,816
The exercise price of these options is $7.58 per share. The market
value of the common stock was $13.25 per share, which is the sales price at
which shares of common stock were last sold in over the counter trading on
December 20, 2004.
Employment Arrangements
Bay National Bank has entered into a written employment agreement with
Mr. Mohler dated September 14, 1999, which became effective upon the opening of
Bay National Bank on May 12, 2000. Under this agreement, Mr. Mohler serves as
the president of Bay National Bank at an initial annual base salary of $154,000,
subject to annual review. The Compensation Committee of the Board of Directors
of the Bank provided Mr. Mohler with base salary increases of $10,000 beginning
with the 2002 calendar year and $36,000 beginning with the 2005 calendar year.
Accordingly, Mr. Mohler's current base salary is $200,000. Also, the
Compensation Committee of the Board of Directors of the Bank approved
discretionary bonuses to Mr. Mohler of $30,000 and $50,000 in December 2003 and
2004, respectively (the agreement is silent with respect to the payment of
bonuses to Mr. Mohler). These bonuses were paid in February 2004 and January
2005, respectively.
The agreement had an initial term of three years, automatically
renewable for one-year terms unless written notice is provided by either party
90 days before expiration of a term. Written notice was not provided by either
party 90 days before the expiration of the term which was set to expire on
September 13, 2004 and, accordingly the new term is set to expire on September
13, 2005. It is anticipated that the term set to expire in September 2005 will
automatically renew to September 2006.
Bay National Bank may terminate the employment agreement without cause
upon 30 days' prior written notice and may terminate the employment agreement
for cause at any time without prior notice. Mr. Mohler may terminate his
employment agreement at any time upon 30 days' prior written notice. In the
event Mr. Mohler is terminated without cause, he will continue to receive salary
payments for the earlier of six months from the date of termination or until he
has found comparable employment. Mr. Mohler is required to use his best efforts
to obtain comparable employment. In the event Bay National Bank elects to
terminate the employment agreement at the expiration of a term, Bay National
Bank must pay Mr. Mohler his then base salary for three months.
Pursuant to the agreement, if Mr. Mohler is employed by Bay National
Bank on the date of a "change of control," he is entitled to a payment of 290%
of his "base amount" (as that term is defined in Section 280G(b)(3) of the
Internal Revenue Code) from Bay National Bank. In general, the employment
85
agreement defines "change of control" as: (i) the acquisition by any person of
beneficial ownership of forty percent (40%) or more of the outstanding shares of
common stock of Bay National Bank or Bay National Corporation; (ii) the election
of a majority of the members of the Board of Directors who were not approved or
nominated by then incumbent board; or (iii) the approval by the stockholders of
Bay National Bank or Bay National Corporation of: (a) a reorganization, merger
or consolidation of Bay National Bank or Bay National Corporation, subject to
certain exceptions; (b) a liquidation or dissolution of Bay National Bank or Bay
National Corporation; or (c) the sale or other disposition of all or
substantially all of the assets of Bay National Bank or Bay National
Corporation.
If the change of control severance payment were required to be paid in
2005, Mr. Mohler would receive approximately $580,000.
In the employment agreement, Mr. Mohler agrees that for a period of six
(6) months after employment with Bay National Bank or any affiliate, he will
not, directly or indirectly, own, operate or otherwise be associated with, any
financial institution which is located in the Bank's market area. Mr. Mohler
also agrees that for a period of one (1) year after employment with Bay National
Bank or any affiliate, he will not (i) solicit any person or entity which at the
time of his termination was, or within one (1) year prior thereto had been, a
customer of Bay National Bank or any of its affiliates or (ii) solicit the
employment of any person who was employed by Bay National Bank or any of its
affiliates on a full or part time basis at the time of his termination of
employment, unless such person (a) was involuntarily discharged by Bay National
Bank or the affiliate or (b) voluntarily terminated his relationship with Bay
National Bank or the affiliate prior to Mr. Mohler's termination of employment.
Bay National Bank has purchased "key man" life insurance on Mr. Mohler.
Bay National Bank has agreed to employ Mr. Semanie on an at will basis
at a rate of pay of $165,000 as of January 1, 2005. Mr. Semanie is also eligible
for incentive bonuses at the discretion of the Compensation Committee of the
Board of Directors, and is entitled to all benefits available to full time
employees of Bay National Bank. Mr. Semanie is not a party to a written
agreement with Bay National Bank.
The Compensation Committee of the Board of Directors of the Bank
approved discretionary bonuses to Mr. Semanie of $30,000 in December 2001, 2002
and 2003 and $40,000 in December 2004, respectively. These bonuses were paid in
the subsequent calendar year.
86
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Securities Authorized For Issuance Under Equity Compensation Plans
The following table sets forth certain information as of December 31, 2004,
with respect to compensation plans under which equity securities of Bay National
Corporation are authorized for issuance.
Equity Compensation Plan Information
---------------------------------------------------------------------------------------------------------------------
Plan category Number of securities Weighted-average Number of securities
to be issued upon exercise price of remaining available
exercise of outstanding options and for future issuance
outstanding options warrants under equity
and warrants compensation plans
(excluding
securities reflected
in column (a))
(a) (b) (c)
---------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved
by security holders 147,492 $ 7.67 52,508
---------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders - -
---------------------------------------------------------------------------------------------------------------------
147,492 $ 7.67 52,508
Total
---------------------------------------------------------------------------------------------------------------------
87
Security Ownership
The following table sets forth the beneficial ownership of Bay National
Corporation's common stock as of March 25, 2005 by its directors, executive
officers named in the Summary Compensation Table in Item 10 above, directors and
officers as a group and persons believed by management to beneficially own more
than five percent (5%) of the common stock. The table includes warrants and
options beneficially owned by these persons. Unless otherwise noted below,
management believes that each person named in the table has the sole voting and
sole investment power with respect to each of the shares of common stock
reported as beneficially owned by such person.
Name and Address Number of Shares Percentage
of Beneficial Owner
(16) (16) of Class
--------------------------------------------------------------------------------
18,250 .90%
Carroll A. Bodie (1)
4005 Greenway
Baltimore, MD 21218
Charles E. Bounds (2)
1707 Upper Millstone Lane
Salisbury, MD 21801 7,130 .35%
Citizens, Inc.
P.O. Box 1550
Butler, PA 16003 163,624 8.11%
Gary T. Gill
6 Brierleigh Court
Lutherville, Maryland 21093 5,949 .29%
John R. Lerch (3)
618 Indian Lane
Salisbury, MD 21801 45,250 2.42%
Donald G. McClure, Jr. (4)
24 Dockside Lane
Key Largo, FL 33037 16,250 .81%
Hugh W. Mohler (5)
23 Buchanan Road
Baltimore, MD 21212 83,995 4.16%
Robert L. Moore (6)
10 79th #403
Ocean City, MD 21842 9,000 .45%
James P. O'Conor
2 Fieldspring court
Lutherville, MD 21093 5,000 .25%
88
H. Victor Rieger, Jr. (7)
1015 Ivy Hill Road
Cockeysville, MD 21030 28,250 1.40%
Margaret K. Riehl (8)
7A Devon Hill Road
Baltimore, MD 21210 24,750 1.23%
William B. Rinnier (9)
616 Manor Drive
Salisbury, MD 21801 14,750 .73%
Edwin A. Rommel, III (10)
5281 Silver Run Lane
Salisbury, MD 21801 32,750 1.62%
Mark A. Semanie (11)
1200 Corinthian Court
Bel Air, MD 21014 10,995 .55%
Henry H. Stansbury (12)
6200 Foxhall Farm Road
Catonsville, MD 21228 41,050 2.04%
Kenneth H. Trout (13)
804 Hillstead Drive
Lutherville, MD 21093 4,250 .21%
Eugene M. Waldron, Jr. (14)
5309 Woodlawn Avenue
Chevy Chase, MD 20815 42,250 2.09%
Carl A.J. Wright
8609 Marburg Manor Drive
Lutherville, MD 21093 14,000 .69%
All directors and executive officers as a group:
Seventeen persons 403,869 20.01%
(1) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
(2) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
89
(3) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
Includes 6,000 shares held by LFI partnership, of which Mr. Lerch is a general
partner; and 3,000 shares held by Mr. Lerch's spouse. Mr. Lerch disclaims
beneficial ownership as to the shares held by his spouse.
(4) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in April 2006.
Includes 9,000 shares held in trust for the benefit of Mr. McClure's children
for which Mr. McClure is a co-trustee.
(5) Includes 30,195 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 10,066 shares
issuable upon the exercise of options that are exercisable starting in June
2005. Includes 1,000 shares held by Mr. Mohler's spouse. Mr. Mohler disclaims
beneficial ownership as to the shares held by his spouse.
(6) Includes 1,500 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 1,500 shares issuable
upon the exercise of options that are exercisable starting in February 2006.
(7) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
Includes 1,000 shares held by Mr. Rieger's spouse. Mr. Rieger disclaims
beneficial ownership as to the shares held by his spouse.
(8) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
Includes 1,000 shares held by Mrs. Riehl's spouse. Mrs. Riehl disclaims
beneficial ownership as to the shares held by her spouse.
(9) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in August 2005.
Includes 3,000 shares held by Mr. Rinnier's spouse, and 2,000 shares held by Mr.
Rinnier's children. Mr. Rinnier disclaims beneficial ownership as to the shares
held by his spouse and his children.
(10) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
(11) Includes 9,315 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 9,315 shares issuable
upon the exercise of options that are exercisable starting in October 2005.
(12) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
Includes 12,500 shares held by Mr. Stansbury's spouse. Mr. Stansbury disclaims
beneficial ownership as to the shares held by his spouse.
90
(13) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in October 2005.
(14) Includes 2,250 shares issuable upon the exercise of options that
are exercisable within 60 days of March 25, 2005. Excludes 750 shares issuable
upon the exercise of options that are exercisable starting in June 2005.
Includes 3,000 shares held by Mr. Waldron's children. Mr. Waldron disclaims
beneficial ownership as to the shares held by his children.
(15) All of the named individuals, other than Mr. Semanie, are
directors of Bay National Corporation. Mr. Mohler is a director and executive
officer of Bay National Corporation.
The number of shares beneficially owned includes shares of common stock
subject to held by the named persons that are exercisable as of, or within 60
days of, March 25, 2005. Such shares are deemed outstanding for the purpose of
computing the percentage ownership of the person holding the options or
warrants, but are not deemed outstanding for the purpose of computing the
percentage ownership of any other person.
In November 2001, Bay National Corporation granted each of its then
directors, including Mr. Mohler, options to purchase 3,000 shares of Bay
National Corporation common stock at $7.58 per share, the then fair market
value. A total of 39,000 options were issued. The options vest in four (4) equal
installments with the first 25% installment vesting on the third anniversary of
the individual director's appointment to the Board of Directors of Bay National
Corporation. The remaining 25% installments vest on the fourth, fifth and sixth
anniversary of the individual director's appointment to the Board of Directors
of Bay National Corporation. A total of 28,500 of these options to purchase
shares were exercisable as of, or within 60 days of March 25, 2005. The options
expire on November 19, 2009 and none have been exercised.
In November 2001, Mr. Mohler was granted options to purchase 37,261
shares of Bay National Corporation common stock, and Mr. Semanie was granted
options to purchase 18,630 shares of Bay National Corporation common stock. The
options vest in four (4) equal installments with the first 25% installment
vesting on the third anniversary of the officer's date of employment with Bay
National Bank. The remaining 25% installments vest on the fourth, fifth and
sixth anniversary of the individual officer's date of employment with Bay
National Bank. A total of 37,260 of these options to purchase shares were
exercisable as of, or within 60 days of, March 25, 2005. The options expire on
November 19, 2009. They are exercisable at $7.58 per share. None have been
exercised.
Item 12. Certain Relationships and Related Transactions
Prior to Bay National Corporation's initial public offering, the
organizers of Bay National Corporation and Bay National Bank and certain other
investors purchased an aggregate of 112,500 shares of Bay National Corporation's
common stock at a purchase price of $10.00 per share. The primary purpose of
this "organizational offering" was to provide Bay National Corporation and Bay
National Bank with the capital necessary to fund some of the initial
organizational and prepaid operating expenses.
In recognition of the financial and organizational risk undertaken by
the purchasers in the organizational offering, on September 10, 1999, the
purchasers in the organizational offering received, for no additional
consideration, a warrant to purchase one share of common stock at $10.00 per
share for every two
91
shares that they purchased in the organizational offering. As a result, Bay
National Corporation issued warrants to purchase an aggregate of 56,250 shares
of common stock to the purchasers in the organizational offering.
The warrants became exercisable on April 30, 2001 and were exercisable
in whole or in part until November 16, 2004. Prior to expiration on November 16,
2004, 55,000 of the warrants were exercised. The remaining 1,250 warrants
expired. Bay National Corporation received an aggregate of $550,000 from the
exercise of the warrants.
Lucy Mohler, the spouse of Hugh W. Mohler, serves as Bay National
Corporation's and Bay National Bank's Vice President of Marketing and Investor
Relations. Ms. Mohler earned an aggregate compensation of $64,371 plus benefits
valued at $2,932 during 2003 and aggregate compensation of $72,308, plus
benefits valued at $3,239, during 2004 from Bay National Bank.
Matthew Waldron and Bradford Wright, the sons of directors Eugene
Waldron and Carl A.J. Wright, respectively, became employees of Bay National
Bank during 2004. Neither of them earned aggregate compensation in excess of
$60,000 during 2004.
Director John R. Lerch owns a 100% interest in the property being leased
for Bay National Bank's Salisbury, Maryland branch office. This lease, which
became effective as of September 1, 1999, was for a term of five years with Bay
National Corporation having the option to extend the term for three five-year
renewal terms. During the initial lease term, Bay National Corporation paid
monthly rent of approximately $1,980, plus all real estate taxes and utilities.
Bay National Corporation exercised its option to extend this lease and it will
now terminate on August 31, 2009, unless extended. During the new lease term,
Bay National Corporation will pay monthly rent of approximately $2,292, plus all
real estate taxes and utilities. Pursuant to this lease, Bay National
Corporation has a right of first refusal to purchase the building in the event
the landlord receives a bona fide offer to sell. Bay National Corporation paid
Mr. Lerch $23,756 during 2003 and $25,004 during 2004.
At the time of entering into the lease in 1999, Bay National
Corporation believed that the lease rate was at fair market value, based, in
part, on an evaluation of the lease terms by William E. Martin of ERA Martin
Associates, a Salisbury-based real estate brokerage firm. Bay National
Corporation engaged Mr. Martin to review the lease terms for the purpose of
determining whether the terms were consistent with the lease terms for similar
properties in the downtown Salisbury area. Although Bay National Corporation did
not have an independent third party reevaluate the lease terms in connection
with the renewal, management believes that the terms of the lease are at least
as favorable as could be obtained from an independent third party.
Director Gary T. Gill is president and chief executive officer of the
MacKenzie Companies, which owns the property being leased for Bay National
Bank's Lutherville, Maryland corporate and branch offices. Bay National
Corporation is a party to two leases with this landlord dated July 16, 1999.
These leases were amended during February and October 2004 to add additional
space and extended in October 2004 to February 28, 2010. Bay National
Corporation has the right to extend the leases for one additional five year
term, to February 28, 2015. The amendments also effectively combined both
leases.
As of December 31, 2004, Bay National Corporation was leasing 1,712
square feet on the first floor of the building and 6,206 square feet on the
third floor of the building, and was paying $19,425 in monthly rent,
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which includes Bay National Corporation's share of taxes and building operating
costs. Bay National Corporation paid the landlord $170,099 during 2003 and
$202,945 during 2004.
The leases were originally entered into well in advance of Mr. Gill's
appointment to the Board of Directors in January 2003. Although Bay National
Corporation did not have an independent third party reevaluate the lease terms
in connection with the renewal, management believes that the terms of the lease
are at least as favorable as could be obtained from an independent third party.
Some of Bay National Bank's directors and officers and the business and
professional organizations with which they are associated have banking
transactions with Bay National Bank in the ordinary course of business. It is
Bay National Bank's policy that any loans and loan commitments will be made in
accordance with applicable laws and on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with other persons of comparable credit standing. Loans to
directors and officers must comply with Bay National Bank's lending policies and
statutory lending limits; directors with a personal interest in any loan
application will be excluded from considering any such loan application.
The officers and directors of Bay National Corporation and Bay National
Bank have loans due to Bay National Bank in the amount of $5,828,095 at December
31, 2004 and $4,672,104 at December 31, 2003. All loans were made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unaffiliated third
parties and do not involve more than the normal risk of repayment or present
other unfavorable features.
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Item 13. Exhibits
The following exhibits are filed with or incorporated by reference into
this report.
Exhibit
No. Description of Exhibit
--------- ----------------------
3.1* Articles of Incorporation of Bay National Corporation
3.2* Bylaws of Bay National Corporation
4.1* Rights of Holders of Common Stock (as contained in Exhibit
3.1)
4.2* Form of Common Stock Certificate
10.1 Employment Agreement between Bay National Bank and Hugh W.
Mohler
10.2 Terms of December 2005 Amendment to Employment Agreement
between Bay National Bank and Hugh W. Mohler
10.3 Terms of Employment Relationship between Bay National Bank and
Mark A. Semanie
10.4** Bay National Corporation Stock Option Plan
10.5** Form of Incentive Stock Option Agreement for Stock Option Plan
10.6# Bay National Corporation and Bay National Bank Director
Compensation Policy
10.7* Office Lease Agreement dated July 16, 1999 between Bay
National Corporation and Joppa Green II Limited Partnership
10.8* Office Lease Agreement dated July 16, 1999 between Bay
National Corporation and Joppa Green II Limited Partnership
10.9## Amendment to Lease Agreement dated February 12, 2004 between
Bay National Corporation and Joppa Green II Limited
Partnership
10.10## Amendment to Lease Agreement dated October 5, 2004 between Bay
National Corporation and Joppa Green II Limited Partnership
10.11## Amendment to Lease Agreement dated January 3, 2005 between Bay
National Corporation and Joppa Green II Limited Partnership
10.12## Amendment to Lease Agreement dated March 7, 2005 between Bay
National Corporation and Joppa Green II Limited Partnership
10.13* Lease Agreement dated September 16, 1999 between Bay National
Corporation and John R. Lerch and Thomas C. Thompson
14@ Code of Ethics for Senior Financial Officers
21.1 Subsidiaries of Bay National Corporation
23.1 Consent of Stegman & Company
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.
The exhibits which are denominated with an asterisk (*) were previously
filed by Bay National Corporation as a part of, and are hereby incorporated by
reference from, Bay National Corporation's Registration Statement on Form SB-2,
as amended, under the Securities Act of 1933, Registration Number 333-87781.
94
The exhibit which are denominated by two asterisks (**) were previously
filed by Bay National Corporation as a part of, and is hereby incorporated by
reference from, Bay National Corporation's Registration Statement on Form S-8,
as amended, under the Securities Act of 1933, Registration Number 333-69428.
The exhibit which is denominated by the at sign (@) was previously
filed by Bay National Corporation as a part of, and is hereby incorporated by
reference from, Bay National Corporation's Annual Report on Form 10-KSB, as
amended, filed on March 30, 2004.
The exhibit which is denominated by the number sign (#) was previously
filed by Bay National Corporation as a part of, and is hereby incorporated by
reference from, Bay National Corporation's Current Report on Form 8-K filed on
January 26, 2005.
The exhibit which is denominated by two number signs (##) was
previously filed by Bay National Corporation as a part of, and is hereby
incorporated by reference from, Bay National Corporation's Current Report on
Form 8-K filed on March 11, 2005.
Note: Exhibits 10.1 through 10.6 relate to management contracts or
compensatory plans or arrangements.
95
Item 14. Principal Accountant Fees and Services.
Audit and Non-Audit Fees
The following table presents fees for professional audit services
rendered by Stegman & Company for the audit of Bay National Corporation's annual
consolidated financial statements for the years ended December 31, 2004 and
December 31, 2003 and fees billed for other services rendered by Stegman &
Company during those periods.
Years Ended December 31
-------------------------------
2004 2003
------------- -------------
Audit Fees (1) $ 37,669 $ 34,151
Audit Related Fees (2) - -
Tax Fees (3) 4,000 4,000
All Other Fees (4) - -
------------- -------------
Total $ 41,669 $ 38,151
============= =============
(1) Audit Fees consist of fees billed for professional services rendered for the
audit of the Company's consolidated annual financial statements and review of
the interim consolidated financial statements included in quarterly reports and
services that are normally provided by Stegman & Company in connection with
statutory and regulatory filings or engagements.
(2) Audit-Related Fees would normally consist of fees billed for assurance and
related services that are reasonably related to the performance of the audit or
review of the Company's consolidated financial statements and are not reported
under "Audit Fees."
(3) Tax Fees consist of fees billed for professional services rendered for
federal and state tax compliance, tax advice and tax planning.
(4) All Other Fees would normally consist of fees for services other than the
services reported above.
Policy on Audit Committee Pre-Approval of Audit and Non-Audit Services of
Independent Auditor
Before the accountant is engaged by Bay National Corporation or Bay
National Bank to render any audit or non-audit services, the engagement is
approved by Bay National Corporation's audit committee.
96
SIGNATURES
In accordance with Section 13 or 15(d) 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: March 25, 2005 By: /s/ Hugh W. Mohler
----------------------
Hugh W. Mohler, President
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Name Position Date
---- -------- ----
Director and President
/s/ Hugh W. Mohler (Principal Executive Officer) March 25, 2005
------------------
Hugh W. Mohler
/s/ Mark A. Semanie. Executive Vice President and CFO
------------------- (Principal Accounting and March 22, 2005
Mark A. Semanie Financial Officer)
/s/Carroll A. Bodie. Director March 22, 2005
--------------------
Carrol1 A. Bodie
/s/ Charles E. Bounds Director March 22, 2005
---------------------
Charles E. Bounds
/s/ Gary T. Gill Director March 21, 2005
----------------
Gary T. Gill
/s/ John R. Lerch Director March 22, 2005
-----------------
John R. Lerch
/s/_____________________________ Director
Donald G. McClure, Jr.
/s/ Robert L. Moore Director March 22, 2005
-------------------
Robert L. Moore
/s/ James P. O'Conor Director March 22, 2005
--------------------
James P. O'Conor
/s/ H. Victor Rieger, Jr. Director March 25, 2005
-------------------------
H. Victor Rieger, Jr.
97
/s/_____________________________ Director
Margaret Knott Riehl
/s/ William B. Rinnier Director March 22, 2005
----------------------
William B. Rinnier
/s/ Edwin A. Rommel Director March 22, 2005
---------------------
Edwin A. Rommel, III
/s/ Henry H. Stansbury Director March 22, 2005
----------------------
Henry H. Stansbury
/s/ Kenneth H. Trout Director March 22, 2005
--------------------
Kenneth H. Trout
/s/_____________________________ Director
Eugene M. Waldron, Jr.
/s/ Carl A. J. Wright Director March 22, 2005
---------------------
Carl A.J. Wright
98
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION
15(D) OF THE EXCHANGE ACT BY NON-REPORTING ISSUERS
Subsequent to the date of this filing, Bay National Corporation intends
to provide proxy materials and an annual report to its security holders in
connection with its annual meeting of security holders. A copy of such proxy
materials and annual report will be furnished to the Securities and Exchange
Commission for its information and Bay National Corporation understands that
such materials will not be considered to be filed or subject to the liabilities
of Section 18 of the Exchange Act.
99
EXHIBIT INDEX
Exhibit
No. Description of Exhibit
--- ----------------------
3.1* Articles of Incorporation of Bay National Corporation
3.2* Bylaws of Bay National Corporation
4.1* Rights of Holders of Common Stock (as contained in Exhibit 3.1)
4.2* Form of Common Stock Certificate
10.1 Employment Agreement between Bay National Bank and Hugh W. Mohler
10.2 Terms of December 2005 Amendment to Employment Agreement between Bay
National Bank and Hugh W. Mohler
10.3 Terms of Employment Relationship between Bay National Bank and Mark A.
Semanie
10.4** Bay National Corporation Stock Option Plan
10.5** Form of Incentive Stock Option Agreement for Stock Option Plan
10.6# Bay National Corporation and Bay National Bank Director Compensation
Policy
10.7* Office Lease Agreement dated July 16, 1999 between Bay National
Corporation and Joppa Green II Limited Partnership
10.8* Office Lease Agreement dated July 16, 1999 between Bay National
Corporation and Joppa Green II Limited Partnership
10.9## Amendment to Lease Agreement dated February 12, 2004 between Bay
National Corporation and Joppa Green II Limited Partnership
10.10## Amendment to Lease Agreement dated October 5, 2004 between Bay National
Corporation and Joppa Green II Limited Partnership
10.11## Amendment to Lease Agreement dated January 3, 2005 between Bay National
Corporation and Joppa Green II Limited Partnership
10.12## Amendment to Lease Agreement dated March 7, 2005 between Bay National
Corporation and Joppa Green II Limited Partnership
10.13* Lease Agreement dated September 16, 1999 between Bay National
Corporation and John R. Lerch and Thomas C. Thompson
14@ Code of Ethics for Senior Financial Officers
21.1 Subsidiaries of Bay National Corporation
23.1 Consent of Stegman & Company
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.
The exhibits which are denominated with an asterisk (*) were previously
filed by Bay National Corporation as a part of, and are hereby incorporated by
reference from, Bay National Corporation's Registration Statement on Form SB-2,
as amended, under the Securities Act of 1933, Registration Number 333-87781.
The exhibit which are denominated by two asterisks (**) were previously
filed by Bay National Corporation as a part of, and is hereby incorporated by
reference from, Bay National Corporation's Registration Statement on Form S-8,
as amended, under the Securities Act of 1933, Registration Number 333-69428.
100
The exhibit which is denominated by the at sign (@) was previously
filed by Bay National Corporation as a part of, and is hereby incorporated by
reference from, Bay National Corporation's Annual Report on Form 10-KSB, as
amended, filed on March 30, 2004.
The exhibit which is denominated by the number sign (#) was previously
filed by Bay National Corporation as a part of, and is hereby incorporated by
reference from, Bay National Corporation's Current Report on Form 8-K filed on
January 26, 2005.
The exhibit which is denominated by two number signs (##) was
previously filed by Bay National Corporation as a part of, and is hereby
incorporated by reference from, Bay National Corporation's Current Report on
Form 8-K filed on March 11, 2005.
Note: Exhibits 10.1 through 10.6 relate to management contracts or
compensatory plans or arrangements.
101