Item 1.
Cautionary Note About Forward Looking Statements
Some of the matters discussed in this annual report including under the captions “Business of Old Line Bancshares, Inc.,” “Business of Old Line Bank,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this annual report constitute forward looking statements. These forward-looking statements include: (a) our objectives, expectations and intentions, including (i) market expansion and growth in particular geographic areas, (ii) statements regarding anticipated increases in certain non-interest expenses and that net interest income will increase during 2019, (iii) maintenance of the net interest margin, (iv) our belief that we have identified any problem assets and that our borrowers will continue to remain current on their loans, (v) expected losses on and our intentions with respect to our investment securities, and (vi) earnings on bank owned life insurance; (b) sources of and sufficiency of liquidity; (c) the adequacy of the allowance for loan losses; (d) expected loan, deposit, balance sheet and earnings growth; (e) that the recent acquisition of Bay Bancorp, Inc. (“BYBK”) will continue to generate increased earnings and stockholder returns and our expectations regarding operating costs savings therefrom; (f) expectations with respect to the impact of pending legal proceedings; (g) improving earnings per share and stockholder value; (h) realization of the deferred tax asset; ; (j) the impact of recent accounting pronouncements we have not yet adopted; and (k) financial and other goals and plans.
Old Line Bancshares bases these statements on our beliefs, assumptions and on information available to us as of the date of this filing, which involves risks and uncertainties. These risks and uncertainties include, among others: our ability to retain key personnel; our ability to successfully implement our growth and expansion strategy; risk of loan losses; that the allowance for loan losses may not be sufficient; that changes in interest rates and monetary policy could adversely affect Old Line Bancshares; that changes in regulatory requirements and/or restrictive banking legislation may adversely affect Old Line Bancshares; that the market value of our investments could negatively impact stockholders’ equity; risks associated with our lending limit; expenses associated with operating as a public company; potential conflicts of interest associated with the interest in Pointer Ridge; deterioration in general economic conditions or a return to recessionary conditions; and changes in competitive, governmental, regulatory, technological and other factors which may affect us specifically or the banking industry generally; and other risks otherwise discussed in this report, including under “Item 1A.
Item 1A. Risk Factors
You should consider carefully the following risks, along with other information contained in this Form 10-K. The risks and uncertainties described below are not the only ones that may affect us. Additional risks and uncertainties also may adversely affect our business and operations including those discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Any of the following events, should they actually occur, could materially and adversely affect our business and financial results.
Risk Factors Related to Old Line Bancshares’ Business
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses. We are subject to certain operational risks including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud, cybersecurity breaches, and catastrophic failures resulting from terrorist acts or natural disasters. We rely heavily on data processing, software, communications and information systems on a variety of computing platforms and networks and over the Internet to conduct our business. Despite instituted safeguards, we cannot be certain that that all of our systems and our network infrastructure are entirely free from vulnerability to attack or other technological difficulties or failures.
Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure we use, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by Internet problems, other users or unrelated third parties. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, subject us to additional regulatory scrutiny, damage our reputation, result in a loss of customers, and inhibit current and potential customers from using our Internet banking services, any or all of which could have a material adverse effect on our results of operations and financial condition. Information security risks have increased significantly due to the use of online, telephone and mobile banking channels by clients and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. Cyber threats are rapidly evolving and we may not be able to anticipate or prevent all such attacks. While we do not believe we have experienced a material cyber-security breach, we experience periodic threats to our data, systems and networks, including cyber-attacks, malware and computer virus attacks, malicious code, phishing attacks, attempted unauthorized access of accounts and attempts to disrupt our systems. Our clients’ devices, from which they may access our Internet banking services or mobile apps, are also subject to the same threats. Such threats are likely to continue, and may result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, the theft of client assets through fraudulent transactions or disruption of our or our clients’ or other third parties’ business operations. We may incur increasing costs in an effort to minimize these risks, and could be held liable for, lose business and suffer reputational damage as a result of any security breach or loss. We periodically review our security protocols and, as necessary, add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches, including firewalls and penetration testing. These precautions may not, however, be effective in preventing such breaches, damage or failures. We continue to monitor developments in this area and consider whether additional protective measures are necessary or appropriate, and we have obtained insurance protection intended to cover losses due to network security breaches; there is no guarantee, however, that such insurance would cover all costs associated with any breach, damage or failure of our computer systems and network infrastructure.
We have a comprehensive policy related to cybersecurity risks, and cybersecurity incidents are reported quarterly to our risk committee, which consists of members of both management and our board of directors. In the event of a material breach, damage or failure of our computer system or network, we will issue the appropriate disclosures. Any system failure could have a material adverse effect on our financial condition and results of operations.
Our business may be adversely affected by increasing prevalence of fraud and other financial crimes. As a financial institution, we are subject to risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes continue to increase. While we believe we have controls in place to detect and prevent such losses, in some cases multi-party collusion or other sophisticated methods of hiding fraud may not be readily detected or detectable and could result in losses that affect our financial condition and results of operations.
Further, financial crime is not limited to the financial services industry. Our customers could experience fraud in their businesses, which could materially impact their ability to repay their loans, and deposit customers in all financial institutions are constantly and unwittingly solicited by others in fraud schemes that vary from easily detectable and obvious attempts to high-level and very complex international schemes that could drain an account of millions of dollars and require detailed financial forensics to unravel. While we have controls in place, contractual agreements with our customers partitioning liability, and insurance to help mitigate the risk, none of these are guarantees that we will not experience a fraud-related loss, including potentially a loss that could have a material adverse effect on our financial condition, reputation and results of operations.
We rely on certain external vendors. Our business is dependent on the use of outside service providers that support our day-to-day operations including data processing and electronic communications. Our operations are exposed to the risk that a service provider may not perform in accordance with established performance standards required in our agreements for any number of reasons including equipment or network failure, a change in their senior management, their financial condition, their product line or mix and how they support existing customers, or a simple change in their strategic focus. While we have comprehensive policies and procedures in place to mitigate risk at all phases of service provider management from selection to performance monitoring and renewals, the failure of a service provider to perform in accordance with contractual agreements could be disruptive to our business, which could have a material adverse effect on our financial condition and results of operations.
Adverse changes in economic conditions could adversely affect our business, results of operations and financial condition. Our business and earnings are affected by general business conditions in the United States as well as in our local market area. Changes in prevailing economic conditions, including declining real estate values, changes in interest rates that 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 may adversely affect our financial results. We continue to operate in a challenging and uncertain economic environment. Since the recession ended almost ten years ago, economic growth has been slow by historic standards and uneven. Further, the current expansion is the second longest in U.S. history, and many economists expect economic growth to slow this year. Signs of a slowdown have already begun to surface, and according to recent surveys most economists predict that the United States will fall into a recession within the next two years.1 A return to recessionary conditions or prolonged stagnant or deteriorating economic conditions could significantly affect the markets in which we do business, the demand for our products and services, the value of our loans and investments, and our ongoing operations, costs and profitability. In any case, we expect that the business environment in the State of Maryland and the entire United States will continue to present challenges for the foreseeable future. Economic uncertainties even outside a recession, including concerns about U.S. debt levels and related governmental actions, tariffs on imports into the United States, Congress’ inability to pass yearly budgets, and cuts in government spending, may negatively impact economic conditions going forward. A return to elevated levels of unemployment, declines in the values of real estate, additional federal government shutdowns, or other events that negatively affect household and/or corporate incomes may result in higher than expected loan delinquencies, increases in our non-performing and criticized classified assets and a decline in demand for our products and services. Any of these events may cause us to incur losses and may adversely affect our financial condition and results of operations.
A worsening of credit markets and economic conditions could adversely affect our liquidity. Old Line Bank must maintain sufficient liquidity to ensure cash flow is available to satisfy current and future financial obligations including demand for loans and deposit withdrawals, funding of operating costs and other corporate purposes. We obtain funding through deposits and various short term and long term wholesale borrowings, including federal funds purchased, unsecured borrowings, brokered certificates of deposits and borrowings from the Federal Home Loan Bank of Atlanta (the “FHLB”) and others. Economic uncertainty and disruptions in the financial system may adversely affect our liquidity. Dramatic declines in the housing market and falling real estate prices, coupled with increased foreclosures and unemployment, resulted in significant asset value write downs by financial institutions during and after the last U.S. recession, including government sponsored entities and investment banks. These investment write downs caused financial institutions to seek additional capital. Should we experience a substantial deterioration in our financial condition or should disruptions in the financial markets restrict our funding, it would negatively impact our liquidity. Our need to comply with extensive and complex governmental regulation could have an adverse effect on our business and growth strategy, and we may be adversely affected by changes in laws and regulations. The banking industry is subject to extensive regulation by state and federal banking authorities. Many of these regulations are intended to protect depositors, the public or the FDIC insurance funds, not stockholders. Regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy, ability to attract and retain personnel and many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The cost of compliance with regulatory requirements could adversely affect our ability to operate profitably. Further, if we are not in compliance with such requirements, we could be subject to fines or other regulatory action that could restrict our ability to operate or otherwise have a material adverse effect on our business and financial condition. Although we believe we are in material compliance with all applicable regulations, it is possible there are violations of which we are unaware that could be discovered by our regulators in the course of an examination or otherwise, which could trigger such fines or other adverse consequences.
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1 E.g. National Association for Business Economics February 2019 Economic Policy Survey, Business Economists Expect Recession by 2021, Worry about Budget Deficits; NABE Policy Panel’s View Differs from Markets’ Regarding Likely Path for Interest Rates, available at https://files.constantcontact.com/668faa28001/286fb75e-4f63-46ac-b351-7f6e78c57f67.pdf
In addition, because regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal or state regulation of financial institutions may change in the future and impact our operations. In light of the performance of and government intervention in the financial sector, there may be significant changes to the banking and financial institutions’ regulatory agencies in the future. During the past two years that Republicans have been in control of the U.S. Congress and the White House, Congress has enacted legislation slightly easing the regulatory burdens on community banks and federal banking regulators have been easing some of their rules and enforcement activities. With Democrats gaining control of the House of Representatives in January, we do not expect any further such legislative relief in the foreseeable future, and if a Democratic candidate wins the presidency and/or Democrats retain control of the House and gain control of the U.S. Senate following the 2022 election, we expect that the pace of restrictive and burdensome banking legislation and regulatory enforcement and rule changes is likely to resume following such election. Changes in regulation and oversight, including in the form of changes to statutes, regulations or regulatory policies or changes in interpretation or implementation of statutes, regulations or policies, could affect the services and products we offer, increase our operating expenses, increase compliance challenges and otherwise adversely impact our financial performance and condition. In addition, the burden imposed by these federal and state regulations may place banks in general, and Old Line Bank specifically, at a competitive disadvantage compared to less regulated competitors.
Non-Compliance with the USA PATRIOT Act, the Bank Secrecy Act or other laws and regulations could result in fines or sanctions. Financial institutions are required under the USA PATRIOT and Bank Secrecy Acts to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, curtailment of expansion opportunities, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations. In addition, the U.S. Government has previously imposed laws and regulations relating to residential and consumer lending activities that create significant new compliance burdens and financial risks. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, we cannot assure you that these policies and procedures will be effective in preventing violations of these laws and regulations
Our internal controls and procedures may fail or be circumvented. Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well-designed and operated, is based in part on certain assumptions and can provide only reasonable assurances that the objectives of the system are met. Any (i) failure or circumvention of our controls and procedures, (ii) failure to adequately address any internal control deficiencies, or (iii) failure to comply with regulations related to controls and procedures could have a material effect on our business, consolidated financial condition and results of operations.
The level of our commercial real estate loans may subject us to increased lending risks and related loan losses and additional regulatory scrutiny. At December 31, 2018, our commercial real estate loan portfolio totaled $1.5 billion, or 62.5% of our total loan portfolio. Commercial real estate loans generally expose a lender to higher risk of non-payment and loss than do one-to-four family residential mortgage loans because of several factors, including that repayment of the loans often depends on the successful operation of the properties and the income stream of the borrowers, that the collateral securing these loans may not be sold as easily as residential real estate, and loan terms with a balloon payment rather than full amortization over the loan term. Further, these loans involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. Moreover, if loans that are collateralized by commercial real estate become troubled and the value of the real estate has been significantly impaired, then the Company may not be able to recover the full contractual amount of principal and interest that the Company anticipated at the time it originated the loan, which could cause us to increase its provision for loan losses and would adversely affect the our earnings and financial condition.
In addition, the FDIC, the Federal Reserve Board and the Office of the Comptroller of the Currency have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors, (i) total reported loans for construction, land development and other land represent 100% or more of total capital, or (ii) total reported loans secured by multi-family and non-farm non-residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. We have concluded that we have a concentration in commercial real estate lending under the foregoing standards because our balance in commercial real estate loans at December 31, 2018 represents more than 300% of total capital. While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.
We depend on the accuracy and completeness of information about our clients and counterparties and our financial condition could be adversely affected if we rely on misleading information. In deciding whether to extend credit or to enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information, which we do not independently verify as a matter of course. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to customers, we may assume that a customer’s audited financial statements conform with accounting principles generally accepted in the United States (“U.S. GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with U.S. GAAP or are materially misleading.
We may be adversely affected by the soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by Old Line Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to Old Line Bank. Any such losses could have a material adverse effect on our financial condition and results of operations.
Because we serve a limited market area in Maryland, we are susceptible to economic downturns in our market area. As discussed above, our lending and deposit operations are concentrated in a number of Maryland counties in the Washington, D.C. and Baltimore City suburbs, as well as in Baltimore City, Maryland. While we have expanded in Maryland both organically and through acquisitions during the past several years, broad geographic diversification is not currently part of our strategic plan. As a result, our success depends in part on economic conditions in our market area. Adverse changes in economic conditions in our market area could reduce our deposit base and demand for our services and products and negatively impact growth in our loans and deposits, impair our ability to collect on our outstanding loans, increase credit losses, problem loans and charge-offs, and otherwise negatively affect our performance and financial condition. Declines in real estate values could cause some of our residential and commercial real estate loans to be inadequately collateralized, which would expose us to a greater risk of loss in the event that the recovery on amounts due on defaulted loans is resolved by selling the real estate collateral. In addition, adverse changes in economic conditions in and around our market area may more severely impact our business and financial condition than our larger, more geographically diverse competitors. For example, decreases or even threatened decreases in spending or employment levels by the Federal government (a particular risk for us given the proximity of our market area to Washington, D.C.) or state and local governments could impact us to a greater degree than banking companies that serve a larger or a different geographical area. Our larger competitors may serve more geographically diverse market areas, parts of which may not be affected by the same economic conditions that may exist in our market area. Further, unexpected changes in the national and local economy may adversely affect our ability to attract deposits and to make loans. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our securities.
We originate and retain in our portfolio residential mortgage loans. A downturn in the local real estate market and economy could adversely affect our earnings. Our loan portfolio includes residential mortgage loans that we originate. Although the local real estate market and economy in our market areas have performed better than many other markets during the past few years, a downturn could cause higher unemployment; and more delinquencies, and could adversely affect the value of properties securing our loans. In addition, the real estate market may take longer to recover or not recover to previous levels. These risks increase the probability of an adverse impact on our financial results as fewer borrowers would be eligible to borrow and property values could be below necessary levels required for adequate coverage on the requested loan.
Recent changes in tax laws may negatively impact our financial performance. Recent tax law changes implemented pursuant to the Tax Cuts and Jobs Act (“TCJA”), which was enacted in December 2017, contain a number of provisions that could have an impact on the banking industry, borrowers and the market for single family residential and multifamily residential real estate. These changes include: lower limits on the deductibility of mortgage interest on single family residential mortgages; limitations on deductibility of business interest expense; and limitations on the deductibility of property taxes and state and local income taxes. Such changes may have an adverse effect on the market for and valuation of single family residential properties and multifamily residential properties, as well as on the demand for such loans in the future, particularly in states, like Maryland, with high residential home prices and state and local taxes. Further, while the tax changes were in effect for 2018, we expect that many taxpayers will not recognize the impact of these changes until they prepare their 2018 tax returns, so it is likely that the impacts of these changes in this regard have not yet been reflected in the market. If home ownership or multifamily residential property ownership become less attractive, demand for mortgage loans would decrease, which could have a material adverse effect on our residential mortgage originations and loan resales and as a result our revenues, net income, operating results and financial condition. In addition, the value of the properties securing loans in our portfolio may be adversely impacted as a result of the changing economics of home ownership and multifamily residential ownership, which could require an increase in our provision for credit losses that, in turn, would reduce our profitability and could materially adversely affect our business, financial condition and results of operations. Additionally, certain borrowers could become less able to service their debts as a result of higher tax obligations. These changes could adversely affect our business, financial condition and results of operations.
We are subject to liquidity risks. We require sufficient liquidity to fund loans, accommodate liability maturities and deposit withdrawals, pay debt obligations as they come due, meet contractual obligations, and fund asset growth . Market or economic conditions outside of our control could negatively affect our access to funding sources in amounts adequate to maintain adequate levels of liquidity or the cost thereof. Deposits are our primary source of funding, although we supplement this with FHLB advances and other borrowings. A significant decrease in our deposits, an inability to renew FHLB advances or access other borrowings, an inability to obtain alternative funding to deposits or our other traditional sources of funds, or a substantial, unexpected, or prolonged change in the level or cost of liquidity could have a negative effect on our business, financial condition and results of operations.
We depend on the services of key personnel. The loss of any of these personnel could disrupt our operations and our business could suffer. Our success depends substantially on the skills and abilities of our executive management team, including James W. Cornelsen, President and Chief Executive Officer, Jack Welborn, Executive Vice President and Chief Lending Officer, John Miller, Executive Vice President and Chief Credit Officer, Mark A. Semanie, Executive Vice President, Chief Operating Officer and Elise M. Hubbard, Executive Vice President and Chief Financial Officer. Although we have entered into employment agreement with these executives, the existence of such agreements does not assure that we will retain their services. These executives provide valuable services to us and would be difficult to replace.
Also, our growth and success and our anticipated future growth and success, in a large part, is due and will continue to be due to the relationships maintained by our banking executives with our customers. The loss of services of one or more of these executives or of other key employees could have a material adverse effect on our operations and our business could suffer. The experienced commercial lenders that we have hired are not a party to an employment agreement with us and they could terminate their employment with us at any time and for any reason.
We may not be able to manage future growth or our growth and expansion strategy may not be successful in other respects. We have grown rapidly during the past several years, through both acquisitions and organic growth. Our ability to continue to grow depends upon our ability to attract new deposits, identify loan and investment opportunities and maintain adequate capital levels. We may also continue to grow through acquisitions of existing financial institutions or branches thereof. There is no guarantee that we will be able to maintain our recent growth rate at acceptable risk levels or at all, that future growth would be as successful and result in similar levels of increased profitability as our recent growth, or that our expansion strategy will be successful otherwise. Also, in order to effectively manage our anticipated and/or actual loan growth we have made and may continue to make additional investments in equipment and personnel, which could increase our non-interest expense. If we grow too quickly and are not able to control costs and maintain asset quality, such growth could materially and adversely affect our financial performance.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease. We maintain an allowance for loan losses that we believe is adequate for absorbing any potential losses in our loan portfolio. Our management, through a periodic review and consideration of the loan portfolio, determines the amount of the allowance for loan losses. Although we believe the allowance for loan losses is adequate to absorb probable losses in our loan portfolio, we cannot predict such losses with certainty. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, our earnings will suffer.
As of December 31, 2018, commercial and industrial and commercial real estate mortgage loans comprise approximately 76.19% of our loan portfolio. It is more difficult to estimate loan losses for these types of loans as compared to, for example, residential mortgage loans. Further, these types of loans are generally viewed as having more risk of default than residential real estate or consumer loans and typically have larger balances than residential real estate loans and consumer loans. A deterioration of one or a few of these loans could cause a significant increase in non-performing loans. Such an increase could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.
The Financial Accounting Standards Board has adopted a new accounting standard that will become effective for us on January 1, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses as allowances for credit losses. This will change the current method of providing allowances for credit losses that are probable, which would likely require us to increase our allowance for credit losses and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses. Any increase in the allowance for loan losses, or expenses incurred to determine the appropriate level of the allowance for loan losses, may have a material adverse effect on our financial condition and results of operations.
We have relatively limited experience with the performance of loans acquired in our recent acquisitions of BYBK and DCB. Certain of our estimates related to accounting for acquired loans may differ from actual results. We acquired BYBK in April 2018 and DCB in July 2017. It is difficult to assess the future performance of loans recently added to our portfolio as part of these acquisitions because our relatively limited experience with such loans does not provide us with a significant history from which to judge future collectability. These loans may experience higher delinquency or charge-off levels than our historical loan portfolio experience, which could adversely affect our future performance.
In addition, under U.S. GAAP requirements for business combinations, there is no loan loss allowance initially recorded for acquired loans, which are recorded at net fair value on the acquisition date. This net fair value generally includes embedded loss estimates for acquired loans with deteriorated credit quality. These estimates are based on projections of expected cash flows for these problem loans, which in many cases rely on estimates deriving from the liquidation of collateral.
If the estimates we make and have made regarding the performance of loans we have acquired are inadequate, the fair value estimates may exceed the actual collectability of the balances, and this may result in the related loans being considered by us as impaired, which would result in a reduction in interest income. The tangible book value we measure is based in part on these estimates, and if fair value estimates differ from actual collectability, then subsequent earnings may also differ from original estimates. Measures of tangible book value and earnings impact of business combinations are frequently used in evaluating the merits and value of business combinations. Numerous assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.
Our profitability depends on interest rates and changes in monetary policy may impact us. Our results of operations depends to a large extent on our “net interest income,” which is the difference between the interest income received from our interest earning assets, such as loans and investment securities, and the interest expense incurred in connection with our interest bearing liabilities, such as interest on deposit accounts. Interest rates, because they are influenced by, among other things, expectations about future events, including the level of economic activity, federal monetary and fiscal policy, and geopolitical stability, are not predictable or controllable. Additionally, competitive factors heavily influence the interest rates we can earn on our loan and investment portfolios and the interest rates we pay on our deposits. Community banks are often at a competitive disadvantage in managing their cost of funds compared to the large regional, super-regional or national banks that have access to the national and international capital markets. These factors influence our ability to maintain a stable net interest margin.
We seek to maintain a neutral position in terms of the volume of assets and liabilities that mature or reprice during any period so that we may reasonably predict our net interest margin. Interest rate fluctuations, loan prepayments, loan production and deposit flows, however, are constantly changing and influence our ability to maintain this neutral position. Generally speaking, our earnings are more sensitive to fluctuations in interest rates the greater the variance in the volume of assets and liabilities that mature and reprice in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of interest rates, and whether we are more asset than liability sensitive. Accordingly, we may not be successful in maintaining this neutral position and, as a result, our net interest margin may suffer.
Furthermore, the Federal Reserve Board, in an attempt to help the overall economy, has among other things kept interest rates low through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. Although such an increase is not currently considered likely, if the Federal Reserve Board continues to increase the federal funds rate in the near term, as is expected, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic growth. In addition, an increase in interest rates may, among other things, reduce loan demand and our ability to originate loans (which would also decrease our ability to generate non-interest income through the sale of loans into the secondary market), and make it more difficult for borrowers to repay adjustable-rate loans or otherwise decrease loan repayment rates. Further, as market interest rates rise, we may experience competitive pressures to increase the rates we pay on deposits. Because interest rates we pay on our deposits could be expected to increase more quickly than the increase in the yields we earn on our interest-earning assets, our net interest income would be adversely affected. In addition, deflationary pressures, while possibly lowering our operating costs, could have a negative impact on our borrowers, especially our business borrowers, and the values of collateral securing our loans, which could negatively affect our financial performance.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the interest rates on existing loans and securities.
We face substantial competition that could adversely affect our growth and operating results. We operate in a competitive market for financial services and face intense competition from other financial institutions both in making loans and in attracting deposits. Many of these financial institutions have been in business for many years, are significantly larger, and have established customer bases and greater financial resources and lending limits than we do, and are able to offer certain products and services that we are not able to offer. There are also a number of smaller community-based banks that pursue operating strategies similar to ours.
We expect competitive pressures to continue to build as a result of legislative, regulatory and technological changes and as the financial services industry continues to consolidate. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks; we expect competition to increase in this regard as additional non-bank investment and financial services options for consumers become available and consumers become increasingly comfortable using such alternatives. Competition for deposits and the origination of loans could limit our ability to successfully implement our business plan, and if we cannot attract deposits and make loans at a sufficient level, our operating results will suffer, as will our opportunities for growth.
Furthermore, competition in the banking and financial services industry is coming not only from traditional competitors but from technology-oriented financial services (“FinTech”) companies, which are subject to limited regulation. They offer user friendly front-end, quick turnaround times for loans and other benefits. While we are considering the possibility of developing relationships with FinTech companies for efficiency in processing and/or as a source of loans and other, products and services we can provide to our customers, we cannot limit the possibility that our customers or future prospects will work directly with a FinTech company instead. This could impact our growth and profitability going forward.
Consumers may decide not to use banks to complete their financial transactions. Technology and other changes are allowing consumers to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that they have historically held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, which may increase as consumers become more comfortable with these new technologies and offerings, could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Failure to keep up with technological change could negatively impact us. The financial services industry is undergoing rapid technological change with frequent introductions of new or modified technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on our business and, in turn, our financial condition and results of operations. Further, as these technologies continue to improve, we may be required to make significant capital expenditures in order to remain competitive, which may increase our overall expenses and have a material adverse effect on our business, financial condition, and results of operations.
We are subject to laws regarding the privacy, information security, and protection of personal information, and any violation of these laws or another incident involving personal, confidential, or proprietary information of individuals could damage our reputation and otherwise adversely affect our business, financial condition, and results of operations. Our business requires the collection and retention of large volumes of customer data, including personally identifiable information, in various information systems that we maintain and in those maintained by third party service providers. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. We are subject to complex and evolving laws and regulations governing the privacy and protection of personally identifiable information of individuals (including customers, employees, and other third parties), as well as planning for responding to data security breaches. Various federal and state laws and regulations impose data security breach notification requirements with varying levels of individual, consumer, regulatory, or law enforcement notification in the event of a security breach. Ensuring that our collection, use, transfer and storage of personally identifiable information complies with all applicable laws and regulations may increase our costs.
Furthermore, we may not be able to ensure that all of our customers, employees, counterparties, and service providers have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential, or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information, or where such information was intercepted or otherwise compromised by third parties), we could be exposed to litigation or regulatory sanctions. Concerns regarding the effectiveness of our measures to safeguard personally identifiable information, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers and thereby reduce our revenues. Accordingly, any failure, or even perceived failure, to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations, and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties, and could damage our reputation and otherwise adversely affect our business, operations, financial condition, and results of operations.
Our investment securities portfolio is subject to credit risk, market risk, and liquidity risk. Our investment securities portfolio is subject to risks beyond our control that may significantly influence its fair value. These include, but are not limited to, rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and instability in the credit markets. Lack of market activity with respect to some securities has, in certain circumstances, required us to base their fair market valuation on unobservable inputs. Any changes in these risk factors, in current accounting principles or in interpretations of these principles could impact our assessment of fair value and thus the determination of other-than-temporary impairment of the securities in the investment securities portfolio. Investment securities that previously were determined to be other-than-temporarily impaired could require further write-downs due to continued erosion of the creditworthiness of the issuer. Write-downs of investment securities would negatively affect our earnings and regulatory capital ratios.
Further, we have designated all of our investment securities portfolio (or 7.5% of total assets) at December 31, 2018 as available for sale. We “mark to market” temporary unrealized gains and losses in the estimated value of the available for sale portfolio and reflect this adjustment as a separate item in stockholders’ equity, net of taxes. As of December 31, 2018, we had temporary unrealized losses in our available for sale portfolio of $7.6 million ($5.5 million, net of taxes). If the market value of the investment portfolio declines, this could cause a corresponding decline in stockholders’ equity. Further, adverse changes in economic conditions could cause municipalities to report budget deficits and companies continue to report lower earnings, as happened in the last recession. Any such budget deficits and lower earnings could cause temporary and other than temporary impairment charges in our investment securities portfolio and cause us to report lower net income and a decline in stockholders’ equity.
Our future acquisitions, if any, may cause us to become more susceptible to adverse economic events. While we currently have no agreements to acquire additional financial institutions, we may do so in the future if an attractive acquisition opportunity arises that is consistent with our business plan. Any future business acquisitions could be material to us, and the degree of success achieved in acquiring and integrating these businesses into Old Line Bancshares could have a material effect on the value of our common stock. In addition, any acquisition could require us to use substantial cash or other liquid assets or to incur debt. In those events, we could become more susceptible to future economic downturns and competitive pressures.
We face limits on our ability to lend. The amount of our capital limits the amount that we can loan to a single borrower. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. As of December 31, 2018, we were able to lend approximately $46.6 million to any one borrower. This amount is significantly less than that of many of our larger competitors and may discourage potential borrowers who have credit needs in excess of our legal lending limit from doing business with us. We generally try to accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy is not always available. We may not be able to attract or maintain customers seeking larger loans and we may not be able to sell participations in such loans on terms we consider favorable.
We may need to raise additional capital in the future. If we are unable to obtain such capital on favorable terms or at all, we may not be able to execute on our business plans and our business, financial condition and results of operations may be adversely affected. Federal and state regulatory authorities require us to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance future growth or acquisitions, if any, or we may otherwise elect to or our regulators may require that we raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control. Public or private financing may not be available to us on reasonable terms or at all. Accordingly, we may not be able to raise additional capital if needed or on terms that are favorable or otherwise not dilutive to existing stockholders. Further, if we cannot raise additional capital when needed, or on desirable terms, we may be required to delay, reduce the scope of, or eliminate our growth and acquisition activities or such inability to raise capital may otherwise have a material adverse effect on our financial condition, results of operations and prospects.
We may not have adequately assessed the fair value of acquired assets and liabilities. Current accounting guidance requires that we record assets and liabilities at their estimated fair values on the purchase date. The determination of fair value requires that we consider a number of factors including the remaining life of the acquired loans and deposits, estimated prepayments or withdrawals, estimated loss ratios, estimated value of the underlying collateral, and the net present value of expected cash flows. Actual deviations from these predicted cash flows, maturities or repayments or the underlying value of the collateral may mean that our present value determination is inaccurate. This may cause fluctuations in interest income, non-interest income, provision expense, interest expense and non-interest expense and negatively impact our results of operations.
Impairment in the carrying value of goodwill could negatively impact our earnings. At December 31, 2018, goodwill totaled $93.3 million. Goodwill represents the excess purchase price paid over the fair value of the net assets acquired in a business combination. The estimated fair values of the acquired assets and assumed liabilities may be subject to refinement as additional information relative to closing date fair values becomes available and may result in adjustments to goodwill within the first 12 months following the closing date of the relevant acquisition. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. There could be a requirement to evaluate the recoverability of goodwill prior to the normal annual assessment if there is a disruption in our business, unexpected significant declines in operating results, or sustained market capitalization declines. These types of events and the resulting analyses could result in goodwill impairment charges in the future, which would adversely affect the results of operations. A goodwill impairment charge does not adversely affect regulatory capital ratios or tangible capital. Based on an analysis, we determined that the fair value of our reporting units exceeded the carrying value of their assets and liabilities and, therefore, goodwill was not considered impaired at December 31, 2018.
Risks Related to our Common Stock
We may issue shares of common stock in the future in connection with acquisitions or otherwise, and any such issuances could be at varying prices and dilute your ownership of Old Line Bancshares. We may use our common stock to acquire other companies or to make investments in banks and other complementary businesses in the future. We may also issue common stock, or securities convertible into common stock, through public or private offerings, in order to raise additional capital in connection with future acquisitions, to satisfy regulatory capital requirements or for general corporate purposes. We have an effective shelf registration statement on Form S-3 on file with the U.S. Securities and Exchange Commission (“SEC”) pursuant to which we may, from time to time, sell up to an aggregate of $100 million of our common stock, preferred stock, warrants, units and debt securities. The existence of such shelf registration statement allows us to sell securities quickly from time to time as market conditions warrant. Any such common stock issuances, or issuance of other securities under which shares of common stock may be issued, could be dilutive to our other stockholders.
The market price of our common stock can be volatile. Stock price volatility may make it more difficult for an investor to resell our common stock when desired and at attractive prices. The market price of our common stock can fluctuate significantly in response to a variety of factors including, among other things:
·actual or anticipated variations in our operating results;
·changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts or others in the industry;
·changes in the regulatory or legal environment in which we operate;
·news reports or other publicity relating to Old Line Bancshares or our competitors or relating to trends in our industry;
·perceptions in the marketplace regarding Old Line Bancshares and/or its competitors;
·future sales of common stock;
·the announcement of a significant acquisition or business combination, strategic partnership, joint venture or capital commitment by or involving Old Line Bancshares or its competitors; and
·geopolitical conditions such as acts or threats of terrorism or military conflicts.
General market fluctuations, industry factors and general economic and political conditions and events in the U.S. or globally, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.
Shares of our common stock are equity interests and therefore subordinate to our existing and future indebtedness and preferred stock we may issue in the future. Shares of our common stock are equity interests in Old Line Bancshares and do not constitute indebtedness. As such, shares of our common stock rank junior to all indebtedness and other non-equity claims on us with respect to assets available to satisfy claims, including upon our liquidation. Holders of our common stock are also subject to the prior dividend and liquidation rights of any holders of our preferred stock that we may issue in the future.
In addition, our right to participate in any distribution of assets of any of our subsidiaries, including Old Line Bank, upon the subsidiary’s liquidation or otherwise, and thus our stockholders’ ability to benefit indirectly from such distribution, will be subject to the prior claims of creditors of that subsidiary, except to the extent that any of our claims as a creditor of such subsidiary may be recognized. As a result, shares of our common stock are effectively subordinated to all existing and future liabilities and obligations of our subsidiaries.
Our ability to declare and pay dividends is limited by law, and we may be unable to pay future dividends. Old Line Bancshares is a separate and distinct legal entity from Old Line Bank, and it receives substantially all of its revenue from dividends from Old Line Bank. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on debt. Various federal and/or state laws and regulations limit the amount of dividends that Old Line Bank may pay to Old Line Bancshares. In the event Old Line Bank is unable to pay dividends to Old Line Bancshares, Old Line Bancshares may not be able to service debt, pay obligations or pay dividends on its common stock. The inability to receive dividends from Old Line Bank could have a material adverse effect on Old Line Bancshares’ business, financial condition and results of operations.
Anti-takeover provisions could adversely affect our stockholders. Federal and Maryland banking laws, including regulatory approval requirements, and provisions contained in our articles of incorporation and bylaws, could make it difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. For example, our articles of incorporation authorizes our board of directors to determine the designation, preferences, limitations and relative rights of unissued preferred stock, without any vote or action by stockholders. As a result, our board of directors could authorize and issue shares of our preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our common stock or with other terms that could impede the completion of a merger, tender offer or other takeover attempt. In addition, certain provisions of Maryland law, including a provision that restricts certain business combinations between a Maryland corporation and certain interested stockholders, may delay, discourage or prevent an attempted acquisition or change in control of Old Line Bancshares that some or all of our stockholders might consider to be desirable. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock. These provisions could also discourage proxy contests and make it more difficult and expensive for holders of our common stock to elect directors other than the candidates nominated by our board of directors or otherwise remove existing directors and management, even if current management is not performing adequately. As a result, efforts by our stockholders to change our direction or management may be unsuccessful.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of December 31, 2018, we operate a total of 37 branch locations and nine loan production offices. Our headquarters, as discussed above, is located at 1525 Pointer Ridge Place, Bowie, Maryland in Prince George’s County. We also own the property and building located at 4201 Mitchellville Road, Bowie, Maryland, which houses our mortgage origination group.
In February 2018, we opened a new loan origination office in Towson, Maryland. Also, in February 2018, we closed our College Park, Maryland location and merged the office with the loan origination department located at our Bowie headquarters.
The following table sets forth information about the properties we own or lease at December 31, 2018.
Item 3.
Item 3. Legal Proceedings
From time to time we may be involved in litigation relating to claims arising out of our normal course of business. Currently, we are not involved in any legal proceedings the outcome of which, in management’s opinion, would be material to our financial condition or results of operations.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock trades on the Nasdaq Capital Market under the trading symbol “OLBK”.
At December 31, 2018, there were 17,031,052 shares of our common stock issued and outstanding held by approximately 1,797 stockholders of record. There were 296,523 shares of common stock issuable on the exercise of outstanding stock options, 210,813 of which were issuable pursuant to options that are currently exercisable.
Issuer Purchases of Equity Securities
As reflected in the following table, we repurchased 8,364 shares of our common stock during the quarter ended December 31, 2018:
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(1)On November 28, 2018, Old Line Bancshares’ board of directors approved the repurchase of up to 850,000 shares of our outstanding common stock. This repurchase approval replaces the previous authorization for Old Line Bancshares to repurchase up to 500,000 shares of its common stock, approved in February 2015, pursuant to which there were 160,763 shares remaining available to be repurchased, which prior authorization was terminated upon approval of the new repurchase authorization. As of December 31, 2018, 8,364 shares had been repurchased under the current authorization at an average price of $24.76 per share or a total cost of approximately $207 thousand.
Item 6.
Item 6. Selected Financial Data
The following table summarizes Old Line Bancshares, Inc.’s selected financial information and other financial data. The selected balance sheet and statement of income data are derived from our audited financial statements. You should read this information together with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Mergers and Acquisitions” and our financial statements and the related notes included elsewhere in this report. Results for past periods are not necessarily indicative of results that may be expected for any future period.
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(1)See “Management’s Discussion and Analysis of Financial Condition and Results of Operating-Reconciliation of Non-GAAP Measures.”
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We operate a general commercial banking business, accepting deposits and making loans and investments.
The following highlights contain financial data and events that occurred during 2018:
·The merger with BYBK became effective on April 13, 2018, resulting in total assets of $2.9 billion.
·Net income increased $11.3 million or 70.5% to $27.2 million, or $1.73 per basic and $1.71 per diluted share, for the twelve month period ended December 31, 2018, from $16.0 million, or $1.38 per basic and $1.35 per diluted share, for the twelve months ended December 31, 2017.
·Return on average assets (“ROAA”) and return on average equity (“ROAE”) were 1.01% and 8.29%, respectively, compared to ROAA and ROAE of 0.84% and 8.53%, respectively, for the twelve months ended December 31, 2017. Excluding merger-related expenses, adjusted ROAA and ROAE (each a non-GAAP financial measure) would have been 1.29% and 10.62%, respectively, for the twelve months ended December 31, 2018 and 0.99% and 9.77% for the twelve months ended December 31, 2017.
·Our efficiency ratio was 61.51% and 64.14%, respectively, for the twelve months ended December 31, 2018 and 2017. Excluding merger-related expenses, the adjusted efficiency ratio (a non-GAAP financial measure) was 52.28% for the twelve months ended December 31, 2018 compared to 58.44% for the same period of 2017.
·The net interest margin was 3.75% compared to 3.69% for the twelve months ended December 31, 2017. Total yield on interest earning assets increased to 4.63% compared to 4.35% for the twelve months ended December 31, 2017.
·Net loans held for investment increased $712.9 million to $2.4 billion from $1.7 billion at December 31, 2017. Organic loan growth was $313.5 million, or 23.15%.
·Average gross loans increased $675.6 million, or 44.29%, during the twelve month periods ended December 31, 2018, to $2.4 billion from $1.5 billion during the twelve month period ended December 31, 2017. This increase is the result of the acquisition of BYBK and organic growth.
·We sold troubled acquired loans totaling $25.3 million.
·Total assets increased $844.4 million, or 40.10%, primarily due to increases of $712.9 million in loans held for investment, $68.2 million in goodwill, $26.3 million in bank owned life insurance, $9.1 million in core deposit intangibles, and $9.3 million in cash and cash equivalents.
·Total deposits grew by $643.1 million, or 38.91%, since December 31, 2017.
·Non-performing assets to total assets remain consistent at 0.20% at December 31, 2018 compared to 0.18% for the same period of 2017.
·We ended 2018 with a book value of $21.77 per common share and a tangible book value of $15.39 per common share compared to $16.61 and $14.10, respectively, at December 31, 2017.
·We maintained appropriate levels of liquidity and by all regulatory measures remained “well capitalized.”
Strategic Plan
We have based our strategic plan on the premise of enhancing stockholder value and growth through branching and operating profits. Our short term goals include continuing our strong pattern of organic loan and deposit growth, enhancing and maintaining credit quality, collecting payments on non-accrual and past due loans, profitably disposing of certain acquired loans and other real estate owned (“OREO”), maintaining an attractive branch network, expanding fee income, generating extensions of core banking services, and using technology to maximize stockholder value. During the past few years, we have expanded organically and by acquisition in Montgomery County, Maryland, organically in Prince George’s County and Anne Arundel County, Maryland, and by acquisition into Baltimore, Carroll, Frederick, Harford and Howard Counties, Maryland as well as Baltimore City. We use the Internet and technology to augment our growth plans. Currently, we offer our customers image technology, Internet banking with online account access and bill pay service and mobile banking. We provide selected commercial customers the ability to remotely capture their deposits and electronically transmit them to us. We will continue to evaluate cost effective ways that technology can enhance our management capabilities, products and services.
We may continue to take advantage of strategic opportunities presented to us via mergers occurring in our marketplace. For example, we may purchase branches that other banks close or lease branch space from other banks or hire additional loan officers. We also continually evaluate and consider opportunities with financial services companies or institutions with which we may become a strategic partner, merge or acquire. We believe that the recent BYBK acquisition will continue to generate increased earnings and increased returns for our stockholders.
Although the current interest rate environment continues to present challenges for our industry, we have worked diligently towards our goal of becoming the premier community bank in Maryland. While we are uncertain about the continued pace of economic growth or the impact of the current political environment, uncertainty regarding recent tariffs imposed and that may be imposed on imports into the United States, and the growing national debt, we remain cautiously optimistic that we have identified any problem assets, that our remaining borrowers will stay current on their loans and that we can continue to grow our balance sheet and earnings.
Although the Federal Reserve Board has been slowly increasing the federal funds rate (which in turn increases market interest rates) since December 2015, including four times during 2018, interest rates are still low compared to typical interest rates before the 2007-2009 recession, and it is currently expected that any rate hikes this year will be fewer than during 2018 and not in the immediate future. Given the expectation that interest rates will, therefore, remain at historically low levels during 2019, coupled with forecasts of increased business and consumer borrowings during 2019, we believe that we can continue to grow total loans during 2019 even with a modest slowdown in the economy during 2019, although this may not come to fruition if the United States economy experiences a more severe slowdown. We also believe that we can continue to grow total deposits during 2019. As a result of this expected growth, we expect that net interest income will increase during 2019, although there can be no guarantee that this will be the case.
We also expect that salaries and benefits expenses and occupancy and equipment expenses will be higher in 2019 and going forward generally than they were in 2018 as a result of including the expenses related to the new employees and branches we acquired in the BYBK merger for the full year 2019 and then on an ongoing basis; such expenses may increase even further if we selectively take the opportunity to add more business development talent. We will continue to look for opportunities to reduce expenses. We believe with our existing branches, our lending staff, our corporate infrastructure and our solid balance sheet and strong capital position, we can continue to focus our efforts on improving earnings per share and enhancing stockholder value.
Recent Acquisition
Bay Bancorp, Inc. On April 13, 2018, Old Line Bancshares acquired BYBK, the parent company of Bay Bank. The aggregate merger consideration was approximately $143.6 million based on the closing sales price of Old Line Bancshares’ common stock on April 13, 2018.
In connection with the merger, Bay Bank merged with and into Old Line Bank, with Old Line Bank the surviving bank.
At April 13, 2018, BYBK had consolidated assets of approximately $633 million. This merger added 11 banking locations located in Baltimore City and Baltimore, Anne Arundel, Howard and Harford Counties in Maryland.
DCB Bancshares, Inc. On July 28, 2017, Old Line Bancshares acquired DCB, the parent company of Damascus. The aggregate merger consideration was approximately $40.9 million based on the closing sales price of Old Line Bancshares’ common stock on July 28, 2017.
In connection with the merger, Damascus merged with and into Old Line Bank, with Old Line Bank the surviving bank.
At July 28, 2017, DCB had consolidated assets of approximately $311 million. This merger added six banking locations located in Montgomery, Frederick and Carroll Counties in Maryland.
The acquired assets and assumed liabilities of BYBK and DCB were measured at estimated fair value. Management made significant estimates and exercised significant judgment in accounting for the acquisitions of BYBK and DCB. Management judgmentally assigned risk ratings to loans based on appraisals and estimated collateral values, expected cash flows, prepayment speeds and estimated loss factors to measure fair value for loans. Management used quoted or current market prices to determine the fair value of Bay Bank’s and Damascus’ investment securities.
Critical Accounting Policies and Estimates
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. They require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. The following are the accounting policies that we believe are critical. For a discussion of recent accounting pronouncements, see Note 1-Summary of Significant Accounting Policies in the Notes to our Consolidated Financial Statements.
We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which we operate. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. We base these estimates, assumptions, and judgments on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. 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 that we follow 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 we value significant assets and liabilities in the financial statements and how we determine those values. 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 loan 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.
Allowance for Loan Losses-We evaluate the adequacy of the allowance for loan losses based upon loan categories except for delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with loan collateral, which management evaluates separately and assigns loss amounts based upon the evaluation. We apply loss ratios to each category of loans, where we further divide the loans by risk rating and apply loss ratios by risk rating, to determine estimated loss amounts. Categories of loans are consumer loans, residential real estate, commercial real estate and commercial loans. We further divide commercial real estate by owner occupied, investment, hospitality, land acquisition and development, and junior liens.
The allowance for loan losses represents management’s best estimate of the losses known and inherent in the loan 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 Old Line Bank’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). Determining the amount of the allowance for loan 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.
Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral and the financial condition of the borrower, and in establishing loss ratios and risk ratings. The establishment of allowance factors is a continuing exercise and allowance factors may change over time, resulting in an increase or decrease in the amount of the provision or allowance based upon the same volume and classification of loans.
Changes in allowance factors or in management’s interpretation of those factors will have a direct impact on the amount of the provision, and a corresponding effect on income and assets. Also, errors in management’s perception and assessment of the allowance factors could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge offs, which would adversely affect income and capital. For additional information regarding the allowance for loan losses, see the “Asset Quality” section of this annual report.
Other-Than-Temporary Impairment-Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) the structure of the security. A decline in the market value of any available for sale security below cost that is deemed other-than-temporary results in a charge to earnings and establishment of a new cost basis for that security.
Goodwill and Other Intangible Assets-Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed related to the acquisitions of Maryland Bankcorp, WSB Holdings, Regal Bancorp, DCB and BYBK. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in these transactions. The core deposit intangible is being amortized over 18 years for Maryland Bankcorp, ten years for WSB Holdings, and eight years for Regal Bancorp and DCB, and 20 years for BYBK, and the estimated useful lives are periodically reviewed for reasonableness.
Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing the reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill assigned to that reporting unit is considered not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment of goodwill assigned to that reporting unit.
We engaged an external valuation specialist to assist us in the goodwill assessment performed at September 30, 2018, our annual test date, and determined that no impairment charge was necessary for our goodwill at that date. There have been no events subsequent to the September 30, 2018 evaluation that caused us to perform an interim review of the carrying value of goodwill.
Business Combinations- U.S. GAAP requires that the acquisition method of accounting, formerly referred to as purchase method, be used for all business combinations and that an acquirer be identified for each business combination. Under U.S. GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. U.S. GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date.
Acquired Loans-These loans are recorded at fair value at the date of acquisition, and accordingly no allowance for loan losses is transferred to the acquiring entity in connection with purchase accounting. The fair values of loans with evidence of credit deterioration (purchased, credit-impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For purchased, credit-impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the purchase price of the purchase credit-impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The purchased credit-impaired loan’s contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, in the form of a loss accrual or a valuation allowance.
If a loan that was previously rated a pass performing loan, from our acquisitions, deteriorates subsequent to the acquisition, the subject loan will be assessed for risk and, if necessary, evaluated for impairment. If the risk assessment rating is adversely changed and the loan is determined to not be impaired, the loan will be placed in a migration category and the credit mark established for the loan will be compared to the general reserve allocation that would be applied using the current allowance for loan losses formula for General Reserves. If the credit mark exceeds the allowance for loan losses formula for General Reserves, there will be no change to the allowance for loan losses. If the credit mark is less than the current allowance for loan losses formula for General Reserves, the allowance for loan losses will be increased by the amount of the shortfall by a provision recorded in the income statement. If the loan is deemed impaired, the loan will be subject to evaluation for loss exposure and a specific reserve. If the estimate of loss exposure exceeds the credit mark, the allowance for loan losses will be increased by the amount of the excess loss exposure through a provision. If the credit mark exceeds the estimate of loss exposure there will be no change to the allowance for loan losses. If a loan from the acquired loan portfolio is carrying a specific credit mark and a current evaluation determines that there has been an increase in loss exposure, the allowance for loan losses will be increased by the amount of the current loss exposure in excess of the credit mark.
Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each purchased, credit-impaired loan in comparison to management’s initial performance expectations. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
Acquired performing loans are accounted for using the contractual cash flows method of recognizing discount accretion or premium amortization based on the acquired loans’ contractual cash flows. Acquired performing loans are recorded as of the purchase date at fair value. Credit losses on the acquired performing loans are estimated based on analysis of the performing portfolio. A provision for loan losses is recognized for any further credit deterioration that occurs in these loans subsequent to the acquisition date.
Income Taxes-The provision for income taxes includes taxes payable for the current year and deferred income taxes. We determine deferred tax assets and liabilities based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse. If needed, we use a valuation allowance to reduce the deferred tax assets to the amount we expect to realize. We allocate tax expense and tax benefits to Old Line Bancshares and its subsidiaries based on their proportional share of taxable income.
TCJA significantly changed U.S. tax law by, among other things, lowering the corporate income tax rate and implementing changes to business-related exclusions. TCJA permanently reduced the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income at the time of enactment of such change in tax rates. Accordingly, in the fourth quarter 2017 we recorded a provisional tax expense, based on estimates, for the effects of TCJA.
In its consolidated financial statements for the year ended December 31, 2017, Old Line Bancshares recorded an expense of $2.9 million for the effects of the change in tax law, including all materially impacted items and for which the accounting under Statement of Financial Accounting Standards, Accounting Standards Codification (“ASC”) 740, Income Taxes, is complete. Provisional amounts would include, for example, reasonable estimates that give rise to new current or deferred taxes based on certain provisions within TCJA, as well as adjustments to existing current or deferred taxes that existed prior to TCJA’s enactment date. Old Line Bancshares had maintained a deferred tax asset valuation allowance in relation to net operating loss carryovers and other items in relation to the acquisition of Regal Bank, which occurred in December 2015. Management determined that the concerns that existed at the time we established the valuation reserve relating to this acquisition no longer existed and Old Line Bancshares therefore reversed this valuation allowance in total during the fourth quarter. The effect of the reversal of the valuation reserve increased net deferred income taxes in the amount of $3.4 million, resulting in a decrease in income tax expense. The net impact of these two items was a reduction of income tax expense by $472 thousand. There were no other items for which we were unable to make reasonable estimates for effects of the tax law change.
Average Balances, Yields and Accretion of Fair Value Adjustments Impact
The following table illustrates average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders’ equity and related income, expense and corresponding weighted average yields and rates. Non-accrual loans are included in total loan balances lowering the effective yield for the portfolio in the aggregate. The average balances used in this table and other statistical data were calculated using average daily balances.
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(1)Interest revenue is presented on a fully taxable equivalent (FTE) basis. The FTE basis adjusts for the tax favored status of these types of assets. Management believes providing this information on a FTE basis provides investors with a more accurate picture of our net interest spread and net interest income and we believe it to be the preferred industry measurement of these calculations. See “Reconciliation of Non-GAAP Measures.”
(2)Available for sale investment securities are presented at amortized cost.
Rate/Volume Analysis
The following table describes the impact on our interest income and expense resulting from changes in average balances and average rates for the periods indicated. The change in interest income due to both volume and rate is reported with the rate variance.
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(1)Interest revenue is presented on a fully taxable equivalent (FTE) basis. Management believes providing this information on a FTE basis provides investors with a more accurate picture of our net interest spread and net interest income and we believe it to be the preferred industry measurement of these calculations. See “Reconciliation of Non-GAAP Measures.
The fair value yield on loan accretion increased in 2018 due to an increase in the level of payoffs on acquired loans with positive accretion as compared to payoffs in 2017. The fair value accretion increased the net interest margin as follows:
Comparison of Operating Results for the Years Ended December 31, 2018 and 2017.
Net Interest Income. Net interest income before provision for loan losses for the year ended December 31, 2018 increased $27.8 million or 44.81% to $89.9 million from $62.1 million for the year ended December 31, 2017. As discussed below and outlined in detail in the Rate/Volume Analysis, this increase was almost entirely due to an increase in loan interest income resulting primarily from a $675.6 million increase in the average balance of our loans, partially offset by an increase in interest expense resulting from increases in both the average balance of and average interest rate on our interest bearing liabilities.
The growth in average interest bearing liabilities during 2018 resulted primarily from increases of $440.2 million in average interest bearing deposits, which increased to $1.5 billion for the year ended December 31, 2018 from $1.1 billion for the year ended December 31, 2017, and $49.1 million in borrowings. The average balance of our borrowings increased due to an increase in our FHLB advances. The average rate on our interest bearing liabilities increased 31 basis points in 2018 compared to 2017 due to higher rates paid on both our interest bearing deposits, primarily time deposits and, to a lesser extent, our money market and NOW deposits, and our borrowings. We increased the interest rates we paid on our deposits in order to maintain competitive rates as market interest rates increased following increases in the targeted federal funds rate during 2018. The average rate paid on our borrowings increased as a result of higher rates on our FHLB advances, which resulted from increases in the prime interest rate. We continue to adjust the mix and volume of interest earning assets and interest bearing liabilities on the balance sheet to maintain a relatively strong net interest margin.
The increases in the average balances of both our loans and interest bearing deposits was a result of the loans and deposits we acquired in the BYBK acquisition in April 2018 and, to a lesser extent, organic growth.
The average yield on our interest earning assets increased by 28 basis points from 4.35% for the year ended December 31, 2017 to 4.63% for the year ended December 31, 2018, which also contributed to the increase in interest income. This increase was primarily due to higher yields on our loans held for investment due to yields on new mortgage and commercial loans with higher average rates than those already in our portfolio and re-pricing in the loan portfolio, as well as higher yields on our investment securities available for sale. The net effect of fair value accretion/amortization on acquired loans affects our net interest income. The fair value accretion/amortization is recorded on paydowns during the period recognized and the fair value accretion on loans increased to 13 basis points in 2018 from seven basis points in the prior year. The net interest margin in 2018 benefited from a higher level of accretion on acquired loans due to a greater level of early payoffs on acquired loans with credit marks.
Our net interest margin increased to 3.75% for the year ended December 31, 2018 from 3.69% for the year ended December 31, 2017. The net interest margin increased in 2018 due to an improvement in the yield on interest earning assets and an increase in non-interest bearing deposits as a source of funding, partially offset by the increase in interest expense. The net interest margin also benefited from a higher level of accretion on acquired loans due to a higher level of early payoffs on acquired loans with credit marks during the twelve months ended December 31, 2018 compared to the same period of 2017.
Provision for Loan Losses. The provision for loan losses totaled $1.8 million for the year ended December 31, 2018, an increase of $894 thousand, or 93.56%, from the 2017 amount of $955 thousand. Management identified additional probable losses in the loan portfolio and we recorded charge-offs of $403 thousand for the year ended December 31, 2018, compared to $1.3 million for the year ended December 31, 2017. We recognized recoveries of $105 thousand in 2018 compared to $41 thousand in 2017. The increase in our provision for loan losses during the twelve months ended December 31, 2018 compared to the same period of 2017 is due to the organic growth in the loan portfolio. All our impaired loans have been adequately reserved for at December 31, 2018. The allowance for loan losses to gross loans held for investment was 0.31%, and the allowance for loan losses to non-accrual loans was 160.43%, at December 31, 2018.
Non-Interest Income. Non-interest income totaled $12.0 million for the year ended December 31, 2018, an increase of $4.2 million, or 53.59%, from the 2017 amount of $7.8 million. The following chart outlines the amounts of and changes in non-interest income for the years ended December 31, 2018 and 2017:
Non-interest income increased during 2018 compared to the prior year primarily as a result of income of $2.0 million from our new POS sponsorship program, as well as increases of $878 thousand in other fees and commissions, $639 thousand in earnings on bank owned life insurance (“BOLI”), $791 thousand in service charges on deposit accounts and $462 thousand in gain on sale of loans, partially offset by a decrease of $498 thousand in income on marketable loans.
The increase in other fees and commissions is primarily due to increases of $131 thousand in rental income and $415 thousand in miscellaneous income, including other fee income and other loan fees, and $182 thousand of reversals on previously charged-off loans during 2018
The increase in earnings on BOLI is due to the $16.3 million of BOLI acquired in the BYBK acquisition and $8.5 million in new BOLI policies purchased since December 31, 2017.
The increase in service charges on deposit accounts is the result of increased income on bank debit cards due to the higher deposit base primarily as a result of the DCB and BYBK acquisitions.
The increase in gain on sale of loans (other than residential mortgage loans held for sale) is due to the sale of troubled acquired loans totaling $25.3 million during the year ended December 31, 2018, compared to the sale of one SBA loan during in the amount of $2.4 million during 2017.
Income on marketable loans consists of gain on the sale of residential mortgage loans originated for sale and any fees we receive in connection with such sales. The decrease in income on marketable loans is the result of a decrease in the premium amounts we received on residential mortgage loans that we sold in the secondary market compared to the same period of 2017 as a result on lower premium amounts on each loan sold, resulting primarily from increased competition.
Non-Interest Expenses. Non-interest expense increased $17.8 million, or 39.80%, for the year ended December 31, 2018 compared to the year ended December 31, 2017. The following chart outlines the amounts of and changes in non-interest expenses during 2018 and 2017.
The increase in non-interest expenses during 2018 compared to 2017 is primarily a result of increases in salaries and benefits, merger and integration, and, to a lesser degree, occupancy and equipment, data processing, core deposit amortization and other operating expenses.
We incurred $9.4 million in merger and integration expenses during the twelve months ended December 31, 2018 due to the BYBK acquisition, compared to $4.0 million of merger and integration expenses due to the DCB acquisition during 2017.
Salaries and benefits increased $6.4 million during 2018 compared to the prior year primarily as a result of the additional staff that we acquired in the BYBK and DCB acquisitions.
Occupancy and equipment expenses increased $1.8 million primarily as a result of the new branches that we acquired in the DCBB and BYBK acquisitions.
The $1.0 million increase in data processing expenses resulted from additional customer transactions due to growth.
Core deposit amortization increased $1.2 million as a result of the higher premiums resulting from the deposits we acquired in the DCBB and BYBK acquisitions.
Other operating expenses increased $1.9 million during the 2018 period due to increases in general operating costs primarily as a result of the additional branches and staff we acquired in the BYBK and DCB mergers.
Income Taxes. Income tax expense was $10.2 million (27.20% of pre-tax income) for the year ended December 31, 2018 compared to $8.2 million (33.81% of pre-tax income) for 2017. The effective tax rate decreased for 2018 primarily as a result of the decrease in the federal corporate tax income rate from 35% to 21% enacted as part of the TCJA, although the impact of the lower tax rate was partially offset by our incurring an additional $5.4 million of non-deductible merger expenses during the year ended December 31, 2018 compared to 2017.
Net Income. Net income was $27.2 million or $1.73 per basic and $1.71 per diluted common share for the year ended December 31, 2018 compared to net income of $16.0 million or $1.38 per basic and $1.35 per diluted common share for the year ended December 31, 2017. The increase in net income for 2018 was primarily the result of the increases of $27.8 million in net interest income and $4.2 million in non-interest income, partially offset by the $17.8 million increase in non-interest expenses.
Comparison of Operating Results for the Years Ended December 31, 2017 and 2016
Net Interest Income. Net interest income before provision for loan losses for the year ended December 31, 2017 increased $9.2 million or 17.33% to $62.1 million from $52.9 million for the year ended December 31, 2016. As discussed below and outlined in detail in the Rate/Volume Analysis, this increase was the result of an increase in total interest income resulting primarily from a $277.9 million increase in the average balance of our loans, partially offset by an increase in interest expense resulting from increases in both the average balance and average rate on our interest bearing liabilities.
The growth in average interest bearing liabilities during 2017 resulted primarily from increases of $147.3 million in average interest bearing deposits, which increased to $1.1 billion for the year ended December 31, 2017 from $941.3 million for the year ended December 31, 2016, and $55.8 million in borrowings. The average balance of our borrowings increased due to an increase in our FHLB advances and the subordinated notes we issued in August 2016 (the “Notes”) being outstanding for the full year in 2017 compared to five months in 2016. The average rate paid on our borrowings increased as a result of higher rates on our FHLB advances, which resulted from the increase in the prime interest rate and switching from fixed rate advances to daily-rate FHLB advances, which have a higher interest rate, combined with the 5.625% interest rate on the Notes.
The growth in both average interest earning assets and average interest bearing deposits was a result of the loans and deposits we acquired in the DCB acquisition in July 2017 and, to a lesser extent, organic growth.
We had a slight increase in the average yield on interest earning assets for the year ended December 31, 2017 compared to the prior year, primarily as a result of higher average yields on our investment securities available for sale, partially offset by a slight decrease in the average yield on our loans held for investment portfolio. The competitive rate environment also resulted in an increase in the rates we paid on our money market and NOW accounts and time deposits.
Our net interest margin was 3.69% for the year ended December 31, 2017 compared to 3.79% for the year ended December 31, 2016. The yield on average interest earning assets increased by four basis points from 4.31% for the year ended December 31, 2016 to 4.35% for the year ended December 31, 2017. This increase was primarily due to higher yields on our investment securities, partially offset by a slight decrease in the yield on loans due to yields on new loans and re-pricing in the loan portfolio. The net effect of fair value accretion/amortization on acquired loans affects our net interest income. The fair value accretion/amortization is recorded on paydowns during the period recognized and the fair value accretion on loans decreased to seven basis points in 2017 from nine basis points in the prior year. The net interest margin in 2016 benefited from a higher level of accretion on acquired loans due to a greater level of early payoffs on acquired loans with credit marks.
Provision for Loan Losses. The provision for loan losses totaled $955 thousand for the year ended December 31, 2017, a decrease of $629 thousand, or 39.72%, from the 2016 amount of $1.6 million. Management identified additional probable losses in the loan portfolio and we recorded charge-offs of $1.3 million for the year ended December 31, 2017, compared to $410 thousand for the year ended December 31, 2016. We recognized recoveries of $41 thousand in 2017 compared to $111 thousand in 2016. The decrease in our provision for loan losses during the twelve months ended December 31, 2017 compared to the same period of 2016 is due to a decrease in our specific reserves primarily due to one large commercial borrower, consisting of 23 commercial loans totaling $3.0 million, of which $1.0 million was charged-off against the allowance for loan losses and $2.0 million was reclassified as trouble debt restructurings during the first quarter of 2017. Amounts charged off in relation to these loans during 2017 were in line with specific reserves at December 31, 2016. These trouble debt restructurings are classified as impaired and all our impaired loans have been adequately reserved for at December 31, 2017. The allowance for loan losses to gross loans held for investment was 0.35%, and the allowance for loan losses to non-accrual loans was 335.51%, at December 31, 2017.
Non-Interest Income. Non-interest income totaled $7.8 million for the year ended December 31, 2017, a decrease of $455 thousand, or 5.52%, from the 2016 amount of $8.3 million. The following chart outlines the amounts of and changes in non-interest income for the years ended December 31, 2017 and 2016:
The primary reason for the decrease in non-interest income during 2017 was a decrease in gain on sales or calls of investment securities, partially offset by increases in service charges on deposit accounts, gain on disposal of assets, other fees and commissions and a gain on the sale of loans.
The decrease in gain on sales or calls or investment securities is the result of our re-positioning our investment portfolio during 2016, pursuant to which we sold approximately $108 million of our lowest yielding, longer duration investments; during the twelve months ended December 31, 2017, we had $61.9 million in sales and calls of investment securities, $41.8 million of which was from, and sold immediately after, the DCB merger, resulting in no gain or loss. We used the proceeds of these sales and calls to purchase investment securities with a slightly higher book yield.
The increase in service charges on deposits accounts is the result of increased income on bank debit cards due to the increased deposit base, primarily as a result of the DCB merger.
The increase in gain on disposal of assets is due to the sale of two of our previously-owned locations, the Accokeek branch that was closed in 2016 and the Callaway branch that was closed in 2017.
Other fees and commissions increased primarily due to the result of recoveries of previously charged-off acquired loans.
The increase in gain on sale of loans (other than residential mortgage loans held for sale) is due to the sale of one SBA loan during 2017, whereas we did not sell any portfolio loans during 2016.
Non-Interest Expenses. Non-interest expense increased $5.2 million, or 13.12%, for the year ended December 31, 2017 compared to the year ended December 31, 2016. The following chart outlines the amounts of and changes in non-interest expenses during 2017 and 2016.
The increase in non-interest expenses during 2017 compared to 2016 is primarily the result of increases in merger and integration expenses and, to a lesser extent, other operating expenses, salaries and benefits and occupancy and equipment expenses.
Merger and integration expenses increased $3.3 million to $4.0 million for the twelve months ended December 31, 2017 due to the DCB acquisition, compared to $661 thousand of merger and integration expenses during 2016 in connection with the Regal Bancorp acquisition that was consummated in December 2015.
Other operating expenses increased primarily as a result of increased Internet banking support and ATM expenses resulting from the increased deposit base in 2017 compared to the prior year, primarily as a result of the DCB acquisition.
Salaries and benefits increased $520 thousand, primarily as a result of the increased number of employees resulting from our acquisition of DCB as well as the addition of the staff at our new Riverdale branch and the inclusion of a full year of salaries and benefits for the employees at our Rockville Town Center branch compared to only six months of such expenses during 2016. The impact of these increases was partially offset by a lack of severance payments in 2017 compared to $443 thousand of such payments in 2016.
Occupancy and equipment expenses increased $285 thousand, primarily as a result of the additional branches that we acquired in the DCB acquisition.
Income Taxes. Income tax expense was $8.2 million (33.81% of pre-tax income) for the year ended December 31, 2017 compared to $6.8 million (34.12% of pre-tax income) for 2016. The effective tax rate decreased for 2017 due to an increase in non-deductible merger and integration expenses associated with the DCB acquisition, while the amount of taxes we paid increased due to the increased level of income before taxes, partially offset by the net tax effect of two non-recurring income tax matters during 2017. First was the TCJA, which as discussed above lowered corporate income tax marginal rates beginning in 2018. Upon its enactment, companies were required under applicable accounting standards to revalue their deferred tax assets and liabilities as of December 31, 2017 at the lower enacted rate. Based on an analysis of the deferred tax accounts, we estimated that the rate change resulted in a provisional adjustment of $2.9 million to the net deferred income taxes and a resulting increase in income tax expense. Second, and unrelated to TCJA, in 2016 we had maintained a deferred tax asset valuation allowance in relation to net operating loss carryovers and other items related to the acquisition of Regal Bank in December of 2015. We determined that the concerns that existed at the time we established this reserve no longer existed and we therefore reversed this valuation allowance in total. The effect of reversing the valuation reserve increased net deferred income taxes in the amount of $3.4 million, with a resulting decrease in income tax expense. The net impact of these two items was a reduction of the amount of our income tax in 2017.
Net Income Available to Common Stockholders. Net income available to common stockholders was $16.0 million or $1.38 per basic and $1.35 per diluted common share for the year ended December 31, 2017 compared to net income available to common stockholders of $13.2 million or $1.21 per basic and $1.20 per diluted common share for the year ended December 31, 2016. The increase in net income available to common stockholders for 2017 was primarily the result of the $9.2 million increase in net interest income, partially offset by increases of $5.2 million in non-interest expenses and $1.3 million in income tax expense and a $455 thousand decrease in non-interest income.
Comparison of Financial Condition at December 31, 2018 and 2017
Investment Securities. Our portfolio consists primarily of investment grade securities including U.S. Treasury securities, U.S. government agency securities, U.S. government sponsored entity securities, corporate bonds, securities issued by states, counties and municipalities, mortgage backed securities (“MBS”), certain equity securities (recorded at cost), Federal Home Loan Bank stock, Maryland Financial Bank stock, and Atlantic Community Bankers Bank stock.
We have prudently managed our investment portfolio to maintain liquidity and safety. The portfolio provides a source of liquidity and collateral for borrowings as well as a means of diversifying our earning asset portfolio. While we usually intend to hold the investment securities until maturity, currently we classify all of our investment securities as available for sale. This classification provides us the opportunity to divest of securities that may no longer meet our liquidity objectives. We account for investment securities at fair value and report the unrealized appreciation and depreciation as a separate component of stockholders’ equity, net of income tax effects. Although we may sell securities to reposition the portfolio, generally, we invest in securities for the yield they produce and not to profit from trading the securities. We continually evaluate our investment portfolio to ensure it is adequately diversified, provides sufficient cash flow and does not subject us to undue interest rate risk. There are no trading securities in our portfolio.
The available for sale investment securities at December 31, 2018 amounted to $219.7 million, an increase of $1.4 million, or 0.62%, from the December 31, 2017 amount of $218.4 million. As outlined above, at December 31, 2018, all securities were classified as available for sale. During the twelve months ended December 31, 2018, we received $72.4 million in proceeds from sales, maturities or calls of, and principal pay-downs on, investment securities. This includes our sale of $51.7 million of securities that we acquired in the BYBK merger and sold immediately after the closing of the merger, resulting in no gain or loss on such sales. We used the proceeds of these securities sales primarily to fund loan growth. By comparison, we sold approximately $53.8 million of investment securities during 2017, $41.8 million of which was from, and sold immediately after, the DCB merger; we also had $7.6 million of investment securities that were called or matured during 2017. We realized gains of $164 thousand and losses of $129 thousand for a total realized net gain of $35 thousand on the sale of investment securities for the twelve months ended December 31, 2017. Principal pay downs on our MBS portfolio was $15.9 million during 2017. We used the proceeds of these securities sales to purchase $51.0 million of investment securities with a slightly higher book yield.
The fair value of available for sale securities included net unrealized losses of $7.6 million at December 31, 2018 (reflected as $5.5 million net of taxes) compared to net unrealized losses of $3.9 million (reflected as $2.3 million net of taxes) at December 31, 2017. The decline in the value of the investment securities is due to an increase in market interest rates, which resulted in a decrease in bond values. We have evaluated securities with larger unrealized losses not backed by the U.S. government and unrealized losses for an extended period of time and determined that these losses are temporary, because at this point in time, we expect to hold them until maturity. We have no intent or plan to sell these securities, it is not likely that we will have to sell these securities and we have not identified any portion of the loss that is a result of credit deterioration in the issuer of the security. As the maturity date moves closer and/or interest rates decline, any unrealized losses in the portfolio are expected to decline or dissipate.
The following table sets forth a summary of the investment securities portfolio as of the dates indicated. Available for sale securities are reported at estimated fair value.
The following table shows the maturities for the securities portfolio at December 31, 2018:
We have pledged U.S. government and municipal securities to customers who require collateral for overnight repurchase agreements and deposits. While we classify MBS based on the maturity date, the contractual maturities of these securities are not reliable indicators of their expected life because mortgage borrowers have the right to prepay mortgages at any time. Additionally, the issuer may call the U.S. government callable agency securities listed above prior to the contractual maturity. The weighted average yield in the table above does not include tax equivalent computation on tax exempt obligations.
Loan Portfolio. Net of allowance, unearned fees and origination costs, loans held for investment increased $712.9 million or 42.02% to $2.4 billion at December 31, 2018 from $1.7 billion at December 31, 2017. Commercial real estate loans increased by $365.2 million, residential real estate loans by $212.9 million, commercial and industrial loans by $143.9 million, and consumer loans decreased by $8.6 million, from their respective balances at December 31, 2017. The loan growth during the year was due to the loans that we acquired in the BYBK acquisition and, to a lesser extent, organic growth, primarily in our commercial real estate and construction permanent loan portfolios, resulting from the addition of several experienced loan officers to our team over the last year and our enhanced presence in our market area. The acquisition of the Bay Bank loan portfolio accounted for approximately $477.3 million of the growth in net loans held for investment during the year ended December 31, 2018.
Loans held for sale was $11.6 million at December 31, 2018, compared to $4.4 million at December 31, 2017. We originated $105.5 million loans sold in the secondary market resulting in income on the sale of loans of $1.8 million for the twelve months ended December 31, 2018, a decrease of $498 thousand compared to 2017.
Most of our lending activity occurs within the state of Maryland in the suburban Washington, D.C. and Baltimore market areas in Baltimore City and Anne Arundel, Baltimore, Calvert, Carroll, Charles, Frederick, Harford, Howard, Montgomery, Prince George’s and St. Mary’s Counties. The majority of our loan portfolio consists of commercial real estate loans and residential real estate loans.
Major classifications of loans held for investment at December 31, 2018, 2017, 2016, 2015 and 2014 are as follows:
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(1)As a result of the acquisitions of Maryland Bankcorp, the parent company of MB&T, in April 2011, WSB Holdings, the parent company of WSB, in May 2013, Regal Bancorp, the parent company of Regal Bank, in December 2015, DCB, the parent company of Damascus in July 2017, and BYBK, the parent company of Bay Bank, in April 2018, we have segmented the portfolio into two components, loans originated by Old Line Bank (legacy) and loans acquired from MB&T, WSB, Regal Bank, Damascus and Bay Bank (acquired).
The following table presents the maturities or re-pricing periods of loans outstanding at December 31, 2018:
Bank Owned Life Insurance. At December 31, 2018, we have invested $67.9 million in life insurance policies on our executive officers, other officers of Old Line Bank, retired officers of MB&T and former officers of WSB, Regal Bank, Damascus and Bay Bank. BOLI increased $26.3 million during the twelve months ended December 31, 2018, primarily due to $16.3 million of bank owned life insurance we acquired in the BYBK acquisition and $8.5 million in new BOLI policies purchased since December 31, 2017. The increase also includes interest earned on these policies. Gross earnings on BOLI were $1.8 million during the year ended December 31, 2018, which earnings were partially offset by $309 thousand in expenses associated with the policies, for total net earnings of $1.5 million in 2018. We anticipate that the earnings on these policies will continue to help offset our employee benefit expenses as well as our obligations under our salary continuation agreements and supplemental life insurance agreements that we have entered into with our executive officers and that MB&T and WSB had entered into with their executive officers. There are no post-retirement death benefits associated with the BOLI policies owned by Old Line Bank prior to the acquisition of MB&T. We have accrued a $196 thousand liability associated with the post-retirement death benefits of the BOLI policies acquired from MB&T and there are no such benefits related to the BOLI policies acquired from WSB, Regal Bank, Damascus or BYBK.
Annuity Plan. Our annuity plan is an interest earning investment that we purchased to fund a new supplemental retirement plan and amendments to existing retirement plans that will provide lifetime payments to two of our executive officers; we entered into these new agreements as of May 7, 2018, as described in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2018. We invested $6.0 million during the fourth quarter of 2017 and the annuity plan was effective January 1, 2018. The annuity plan was valued at $6.3 million at December 31, 2018.
Other Real Estate Owned. As a result of the acquisitions of MB&T, WSB, Regal Bank, Damascus and Bay Bank, we have segmented the OREO into two components, real estate obtained as a result of loans originated by Old Line Bank (legacy) and other real estate acquired from MB&T, WSB, Regal Bank, Damascus and Bay Bank or obtained as a result of loans originated by MB&T, WSB, Regal Bank and Bay Bank (acquired); we did not acquire any OREO properties as a result of the DCB acquisition. We are currently aggressively either marketing these properties for sale or improving them in preparation for sale.
The following outlines the transactions in OREO during 2018.
Goodwill and Core Deposit Intangible. At December 31, 2018, goodwill was $94.7 million and consisted of $633,790 related to the MB&T acquisition, $7.2 million related to the WSB acquisition, $2.0 million related to the Regal Bank acquisition, $15.3 million related to the Damascus acquisition and $69.6 million related to the Bay Bank acquisition. As a result of the acquisitions of MB&T, WSB, Regal Bank, Damascus and Bay Bank, we recorded core deposit intangibles of $21.1 million. This amount represented the premium that we paid to acquire MB&T, WSB, Regal Bank, Damascus, and Bay Bank’s core deposits over the fair value of such deposits. We are amortizing MB&T’s core deposit intangible on an accelerated basis over its estimated useful life of 18 years, WSB’s over its estimated useful life of ten years, Regal Bank’s over its estimated useful life of eight years, Damascus’ over its estimated useful life of eight years, and Bay Bank’s over its estimated useful life of 20 years. The core deposit intangible was $15.4 million and $6.3 million, respectively, at December 31, 2018 and 2017.
Deposits. Deposits increased $643.1 million, or 38.91%, to $2.3 billion at December 31, 2018, compared to $1.7 billion at December 31, 2017. This increase was comprised of a $107.3 million increase in our non-interest bearing deposits, to $559.1 million at December 31, 2018, and a $535.9 million increase in our interest bearing deposits, to $1.7 billion at December 31, 2018. These increases are due predominantly to the deposits acquired in the BYBK acquisition, which added approximately $541.4 million in deposits, as well as, to a lesser extent, new organic deposits, which increased approximately $101.7 million during the year ended December 31, 2018, due to the addition of several experienced loan officers to our team over the last year and our enhanced presence in our market area.
The following table outlines the growth in interest bearing deposits during 2018:
We acquired brokered money market and certificate of deposits through the Promontory Interfinancial Network (“Promontory”). Through this deposit matching network and its certificate of deposit account registry service (CDARS) and money market account service, we have the ability to offer our customers access to FDIC-insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through Promontory on behalf of a customer, we receive matching deposits through the network’s reciprocal deposit program. We can also place deposits through this network without receiving matching deposits. At December 31, 2018, we had $47.9 million in CDARS and $168.8 million in money market accounts through Promontory’s reciprocal deposit program compared to $49.2 million and $144.9 million, respectively, at December 31, 2017.
We do not currently have any brokered certificates of deposits other than CDARS. Old Line Bank did not obtain any brokered certificates of deposit during the year ended December 31, 2018. We may, however, use brokered deposits in the future as an element of our funding strategy if and when required to maintain an acceptable loan to deposit ratio.
The following is a summary of the maturity distribution of certificates of deposit of $100,000 or more at December 31, 2018.
Borrowings. Our borrowings consist of unsecured short-term promissory notes, securities sold under agreements to repurchase, a long-term senior note, the Notes, trust preferred subordinated debentures assumed in the Regal merger and, from time to time, advances from the FHLB. At December 31, 2018, borrowings totaled $266.6 million, an increase of $35.8 million from December 31, 2017. The increase was primarily due to increases in the FHLB daily rate advance. We used the additional borrowings primarily to fund new loan originations.
The following is a summary of our short-term and long-term borrowings at December 31, 2018, 2017 and 2016:
The short-term promissory notes are issued to Old Line Bank’s commercial customers as an enhancement to our basic non-interest bearing demand deposit account. This service electronically sweeps excess funds from the customer’s account into a short term promissory note with Old Line Bank. These obligations are payable on demand and are secured by investments.
Short-term borrowings from the FHLB have a remaining maturity of less than one year. The repurchase agreements listed in short term borrowings roll over daily with no fixed maturity.
Long-term borrowings consists primarily of the Notes. The fair value of the Notes, which are due in 2026, at December 31, 2018 is $34.2 million. The initial interest rate on the Notes is 5.625% per annum from August 15, 2016 to August 14, 2021, payable semi-annually on each February 15 and August 15. Beginning August 15, 2021, the interest rate will reset quarterly to an interest rate per annum equal to the then current three-month LIBOR rate plus 450.2 basis points, payable quarterly on each February 15, May 15, August 15 and November 15 through maturity or early redemption. Also included in long-term borrowings are trust preferred subordinated debentures totaling $4.0 million (net of $2.5 million fair value adjustment) at December 31, 2018, which we acquired in the Regal acquisition. The trust preferred subordinated debentures consists of two trusts - Trust 1 in the amount of $4.0 million (fair value adjustment of $1.4 million) maturing on March 17, 2034 and Trust 2 in the amount of $2.5 million (fair value adjustment $1.1 million) maturing on December 14, 2035.
Old Line Bancshares also has lines of credit available as discussed in “Liquidity and Capital Resources.”
Stockholders’ Equity. Our stockholders’ equity was $370.8 million at December 31, 2018 and $207.7 million at December 31, 2017. We are considered “well capitalized” under the risk-based capital guidelines adopted by the Federal Reserve Board. Stockholders’ equity increased during 2018 primarily due to $142.6 million additional paid in capital from the BYBK acquisition, $27.2 million of net income, the issuance of $1.2 million of stock based compensation awards, and $1.0 million in proceeds from the exercise of stock options. These items were partially offset by the $6.1 million in dividends we paid on our common stock, $2.7 million in after-tax unrealized losses on available for sale securities, and $207 thousand used to repurchase outstanding shares of our common stock.
Asset Quality
Overview. Management performs reviews of all delinquent loans and foreclosed assets and directs relationship officers to work with customers to resolve potential credit issues in a timely manner. Management reports to Old Line Bank’s Loan Committee weekly and requests its approval for loans that require such approval pursuant to our loan policies. Management also reports to the board of directors with respect to certain loan matters on a monthly basis. Such reports include, among other things, information on delinquent loans and foreclosed real estate. We have formal action plans on criticized assets and provide status reports on OREO on a quarterly basis. These action plans include our actions and plans to cure the delinquent status of such loans and to dispose of foreclosed properties. The Loan Committee consists of four non-employee directors and four executive officers. We generally classify a loan as non-accrual when we do not expect collection of full principal and interest under the original terms of the loan or payment of principal or interest has become 90 days past due. Classifying a loan as non-accrual results in our no longer accruing interest on such loan and reversing any interest previously accrued but not collected. We will generally restore a non-accrual loan to accrual status when the borrower brings delinquent principal and interest payments current and we expect to collect future monthly principal and interest payments. We recognize interest on non-accrual loans only when received.
Substandard loans generally represent assets inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. These assets have one or more well-defined weakness that jeopardize liquidation of the debt and are characterized by the distinct possibility that Old Line Bank will sustain some loss if the deficiencies are not corrected. Special mention loans generally represent currently protected, but potentially weak assets that deserve management’s close attention. If left uncorrected, the potential weaknesses may, at some future date, result in deterioration of the repayment prospects for the loan. Special mention loans constitute an unwarranted credit risk but do not expose Old Line Bank to sufficient risk to warrant adverse classification.
We classify loans as troubled debt restructurings (“TDRs”) when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. We only restructure loans for borrowers in financial difficulty that have presented a viable business plan to fully pay off all obligations, including outstanding debt, interest, and fees, either by generating additional income from the business or through liquidation of assets. Generally, these loans are restructured to provide the borrower additional time to execute upon their plans. The concessions granted on TDRs generally include terms to reduce the interest rate or extend the term of the debt obligation.
Loans on non-accrual status at the date of modification are initially classified as non-accrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the loan is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as non-accrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructured agreement. TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).
We classify any property acquired as a result of foreclosure on a mortgage loan as OREO and record it at the lower of the unpaid principal balance or fair value at the date of acquisition and subsequently carry the property at the lower of cost or net realizable value. We charge any required write down of the loan to its net realizable value against the allowance for loan losses at the time of foreclosure. We charge to expense any subsequent adjustments to net realizable value. Upon foreclosure, Old Line Bank generally requires an appraisal of the property and, thereafter, appraisals of the property generally on an annual basis and external inspections on at least a quarterly basis.
As required by ASC Topic 310-Receivables and ASC Topic 450-Contingencies, we measure all impaired loans, which consist of all TDRs and other loans for which collection of all contractual principal and interest is not probable, 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, we recognize impairment through a valuation allowance and corresponding provision for loan losses. Old Line Bank considers consumer loans as homogenous loans and thus does not apply the impairment test to these loans. We write off impaired loans when collection of the loan is doubtful.
Potential problem loans are loans that management has serious doubts as to the ability of the borrowers to comply with present repayment terms. Management has identified potential problem loans classified as TDRs totaling $2.4 million that are complying with their repayment terms. With respect to these loans, management has concerns either about the ability of the borrower to continue to comply with repayment terms because of the borrower’s potential operating or financial difficulties or the underlying collateral has experienced a decline in value. These weaknesses have caused management to heighten the attention given to these loans. Potential problem loans, which are not included in non-performing assets, amounted to $26.2 million at December 31, 2018 compared to $28.9 million at December 31, 2017. At December 31, 2018, we had $13.0 million and $13.2 million, respectively, of potential problem loans attributable to our legacy and acquired loan portfolios, compared to $16.4 million and $12.5 million, respectively, at December 31, 2017.
We individually evaluate all acquired loans that we risk rated substandard subsequent to the acquisition, certain acquired special mention loans and all acquired TDRs for impairment. We also evaluate all loans acquired and recorded at fair value under ASC 310-30 for impairment.
Acquired Loans. Loans acquired in an acquisition are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. U.S. GAAP requires that we record acquired loans at fair value, which includes a discount for loans with credit impairment. These loans are not performing according to their contractual terms and meet our definition of a non-performing loan. The discounts that arise from recording these loans at fair value were due to credit quality. Although we do not accrue interest income at the contractual rate on these loans, we may accrete these discounts to interest income as a result of pre-payments that exceed our expectations or payment in full of amounts due. Purchased, credit-impaired loans that perform consistent with the accretable yield expectations are not reported as non-accrual or non-performing.
We recorded at fair value all acquired loans from MB&T, WSB, Regal Bank, Damascus and Bay Bank. The fair value of the acquired loans includes expected loan losses, and as a result there was no allowance for loan losses recorded for acquired loans at the time of acquisition. Accordingly, the existence of the acquired loans reduces the ratios of the allowance for loan losses to total gross loans and the allowance for loan losses to non-accrual loans, and this measure is not directly comparable to prior periods. Similarly, net loan charge-offs are normally lower for acquired loans since we recorded these loans net of expected loan losses. Therefore, the ratio of net charge-offs during the period to average loans outstanding is reduced as a result of the existence of acquired loans, and the measures are not directly comparable to prior periods. Other institutions may not have acquired loans, and therefore there may be no direct comparability of these ratios between and among other institutions when compared in total.
Applicable accounting guidance requires that if we experience a decrease in the expected cash flows subsequent to its acquisition date, we establish an allowance for loan losses for such acquired loan with decreased cash flows. The allowance for loan losses reserved for potential losses on acquired loans increased to $466 thousand at December 31, 2018 from $182 thousand at December 31, 2017, as a result of a decrease in the expected cash flows on our acquired loans subsequent to their acquisition dates.
Nonperforming Assets. At December 31, 2018, our nonperforming assets totaled $5.8 million and consisted of $4.7 million of non-accrual loans, $243 thousand of loans 90 days or more past due and still accruing and OREO of $883 thousand. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated:
The table below reflects certain ratios regarding our non-performing assets at December 31, 2018 and 2017.
The table below outlines loans on non-accrual status by loan category at December 31, 2018 and 2017:
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(1)U.S.GAAP requires that we record acquired loans at fair value which includes a discount for loans with credit impairment. These loans are not performing according to their contractual terms and meet our definition of a non-performing loan. The discounts that arise from recording these loans at fair value were due to credit quality. Although we do not accrue interest income at the contractual rate on these loans, we may accrete these discounts to interest income as a result of pre-payments that exceed our cash flow expectations or payment in full of amounts due even though we classify them as 90 or more days past due.
Non-accrual legacy loans at December 31, 2018 increased $466 thousand from December 31, 2017, primarily due to the addition of one land acquisition and development loan in the amount of $277 thousand and three commercial loans aggregating $191 thousand.
Non-accrual acquired loans at December 31, 2018 increased $2.4 million from December 31, 2017, primarily due to an additional six residential real estate loans and nine land acquisition and development loans being designated as non-accrual during 2018.
OREO at December 31, 2018 decreased $1.1 million to $883 thousand from the balance of $2.0 million at December 31, 2017.
We had no legacy OREO at December 31, 2018. We sold the $425 thousand of legacy OREO that we had on December 31, 2017 during the second quarter of 2018.
Acquired OREO at December 31, 2018, decreased $696 thousand from December 31, 2017, as a result of our sale of eight acquired OREO properties during 2018 including four of the 12 OREO properties we acquired in the BYBK merger.
Delinquent Loans. The tables below present a breakdown of the recorded book balance of past due loans at December 31, 2018 and 2017:
Allowance for Loan Losses. 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, and the quality of the collateral for the loan, if any, as well as general economic conditions. We charge the provision for loan losses to earnings to maintain the total allowance for loan 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 Old Line Bank’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). We charge losses on loans against the allowance when we believe that collection of loan principal is unlikely. We add back recoveries on loans previously charged-off to the allowance.
We review the adequacy of the allowance for loan losses at least quarterly. Our review includes evaluation of impaired loans as required by ASC Topic 310-Receivables, and ASC Topic 450-Contingencies. Also incorporated in determining the adequacy of the allowance is guidance contained in the SEC’s Staff Accounting Bulletin No. 102, Loan Loss Allowance Methodology and Documentation, the Federal Financial Institutions Examination Council’s Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. We also continue to measure the credit impairment at each period end on all loans that have been classified as a TDR using the guidance in ASC 310-10-35.
In the event that our review of the adequacy of the allowance results in any unallocated amounts, we reallocate such amounts to our loan categories based on the percentage that each category represents to total gross loans. We have in place risk management practices designed to ensure timely identification of changes in loan risk profiles. Undetected losses, however, inherently exist within the portfolio. We believe that the allocation of the unallocated portion of the reserve in the manner described above is appropriate. Although we may allocate specific portions of the allowance for specific credits or other factors, the entire allowance is available for any credit that we should charge off. We will not create a separate valuation allowance for a loan unless we consider the loan impaired.
The loans classified in our held for sale portfolio consists of loans that have been committed to be purchased by investors in the secondary market at the balance sheet date and will be settled subsequent to that date. Only loans purchased by investors with recourse obligations are included in other liabilities.
We categorize loans as residential real estate loans, commercial real estate loans, commercial loans and consumer loans. We further divide commercial real estate loans by owner occupied, investment, hospitality and land acquisition and development. We also divide residential real estate by owner occupied, investment, land acquisition and development, and home equity lines of credit (“HELOC”) and junior liens. We evaluate delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with collateral separately and assign loss amounts based upon the evaluation.
All loan categories are divided by risk rating and loss factors and weighted by risk rating to determine estimated loss amounts.
Within each of the above loan categories, each portfolio is sorted by the risk assessment rating of each loan as Pass, Pass-Watch, Special Mention or Substandard.
We aggregate Old Line Bank’s loss experience by category for each of the last 12 quarters and use that total to create a percentage of the loan portfolio as it existed at the beginning of the 12 quarter “look back.” We progressively tier Old Line Bank’s loss experience (Loss Factor) by risk category for Pass, Pass-Watch, Special Mention and Substandard loans by applying a higher loss factor to higher risk rated categories. Loans rated “Doubtful” or “Loss” are, by definition, impaired and will be specifically reserved based upon management’s best estimate of the loss exposure for each loan.
Qualitative factors we use to determine estimated loan loss amounts include: levels and trends in delinquencies and non-accruals; trends in volumes and terms of loans; effects of any changes in lending policies; the experience, ability and depth of management; regional and local economic trends and conditions; peer group loan loss history; concentrations of credit; quality of Old Line Bank’s loan review system; external factors, such as competition, legal and regulatory requirements; and management’s collective assessment of the appropriateness of the allowance for loan losses in light of recent trends, events, political impact and other relevant considerations.
The following tables detail activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2018, 2017, 2016, 2015 and 2014. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
The following table provides our ratio of allowance for loan losses:
The following tables provide a breakdown of the allowance for loan losses at the dates indicated.
We have no exposure to foreign countries or foreign borrowers. Based on our analysis and the satisfactory historical performance of the loan portfolio, we believe this allowance appropriately reflects the inherent risk of loss in our portfolio.
Overall, we continue to believe that the loan portfolio remains manageable in terms of charge-offs and non-performing assets as a percentage of total loans. We remain diligent and aware of our credit costs and the impact that these can have on our financial institution, and we have taken proactive measures to identify problem loans, including in-house and independent review of larger transactions. Our policy for evaluating problem loans includes obtaining new certified real estate appraisals as needed. We continue to monitor and review frequently the overall asset quality within the loan portfolio.
Liquidity and Capital Resources
Our overall asset/liability strategy takes into account our need to maintain adequate liquidity to fund asset growth and deposit runoff. Our management monitors the liquidity position daily in conjunction with regulatory guidelines. As outlined in the borrowing section of this report, we have credit lines, unsecured, available from several correspondent banks totaling $65.0 million. Additionally, we may borrow funds from the FHLB and the Federal Reserve Bank of Richmond. We can use these credit facilities in conjunction with our normal deposit strategies, which include pricing changes to increase deposits as necessary. We can also sell available for sale investment securities or pledge investment securities as collateral to create additional liquidity. From time to time we may sell or participate out loans to create additional liquidity as required. Additional sources of liquidity include funds held in time deposits and cash from the investment and loan portfolios.
Our immediate sources of liquidity are cash and due from banks, federal funds sold and time deposits in other banks. On December 31, 2018, we had $41.5 million in cash and due from banks, $2.1 million in interest bearing accounts, and $954 thousand in federal funds sold. As of December 31, 2017, we had $33.6 million in cash and due from banks, $1.4 million in interest bearing accounts, and $257 thousand in federal funds sold.
Old Line Bank has sufficient liquidity to meet its loan commitments as well as fluctuations in deposits. We usually retain maturing certificates of deposit as we offer competitive rates on certificates of deposit. Management is not aware of any demands, trends, commitments, or events that would result in Old Line Bank’s inability to meet anticipated or unexpected liquidity needs.
While we periodically experience large withdrawals, these have not resulted in liquidity issues for Old Line Bancshares. During the last recession and the turmoil in the financial markets that followed, some institutions experienced large deposit withdrawals that caused liquidity problems, although we did not. Although we plan for various liquidity scenarios, if turmoil in the financial markets occurs in the future and our depositors lose confidence in us, we could experience liquidity issues.
Old Line Bancshares has available a $5.0 million unsecured line of credit. In addition, Old Line Bank has available lines of credit, including overnight federal funds and repurchase agreements from its correspondent banks, totaling $65.0 million at December 31, 2018. Old Line Bank has an additional secured line of credit from the FHLB of $689.0 million at December 31, 2018. As a condition of obtaining the line of credit from the FHLB, the FHLB requires that Old Line Bank purchase shares of capital stock in the FHLB. Prior to allowing Old Line Bank to borrow under the line of credit, the FHLB also requires that Old Line Bank provide collateral to support borrowings. Therefore, we have provided the FHLB collateral to support up to $353.7 million of borrowings. We may increase availability by providing additional collateral. Additionally, we have provided collateral in the form of investment securities to support the $38.2 million repurchase agreement.
The following table shows Old Line Bancshares, Inc.’s regulatory capital ratios and the minimum capital ratios currently required by its banking regulator to be “well capitalized.” For a discussion of these capital requirements, see “Supervision and Regulation-Capital Adequacy Guidelines.”
Risk Based Capital Analysis
(Dollars in thousands)
Contractual Obligations, Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements
We are 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. We use these financial instruments to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These commitments do not represent unusual risks and management does not anticipate any losses that would have a material effect on Old Line Bancshares, Inc. We also have operating lease obligations.
Outstanding loan commitments and lines and letters of credit at December 31, 2018 and 2017 are as follows:
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. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally include expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that customers will draw upon their lines of credit in full at any time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer’s credit-worthiness on a case by case basis. During periods of economic turmoil, we reevaluate many of our commitments to extend credit. Because we conservatively underwrite these facilities at inception, we generally do not have to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit.
Commitments for real estate development and construction, which totaled $232.7 million, or 45.68% of the $509.4 million of standing loan commitments and lines and letters of credit at December 31, 2018, are generally short term and turn over rapidly, with principal repayment from permanent financing arrangements upon completion of construction or from sales of the properties financed.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Our exposure to credit loss in the event of non-performance by the customer is the contract amount of the commitment. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In general, we make loan commitments, credit lines and letters of credit on the same terms, including with respect to collateral, as outstanding loans. We evaluate each customer’s credit-worthiness and the collateral required on a case by case basis.
We have various financial obligations, including contractual obligations and commitments. The following table presents, as of December 31, 2018, significant fixed and determinable contractual obligations to third parties by payment date.
Our operating lease obligations represent rental payments for 26 branches and five loan production offices. The interest bearing obligations include accrued interest. Purchase obligations amounts represent estimated obligations under agreements to purchase goods or services that are enforceable and legally binding. The purchase obligations amounts include estimated obligations under data processing and network servicing and installation contracts, income tax payable, pension obligations and accounts payable for goods and services.
Reconciliation of Non-GAAP Measures
Below is a reconciliation of the federal tax exempt adjustments and the GAAP basis information presented in this report:
Twelve Months Ended December 31, 2018
Twelve Months Ended December 31, 2017
Twelve Months Ended December 31, 2016
Statements included in this this annual report on Form 10-K include non-GAAP financial measures that should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to U.S. GAAP financial measures. Our management uses these non-GAAP financial measures, and believes that these non-GAAP financial measures provide additional useful information that allows readers, to evaluate our ongoing performance and provide meaningful comparison to our peers. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under U.S. GAAP, and investors should consider our performance and financial condition as reported under U.S. GAAP and all other relevant information when assessing our performance or financial condition. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the results or financial condition as reported under U.S. GAAP.
Further, as the magnitude of merger-related expenses during the periods set forth below distorts our operational results, we present in the U.S. GAAP reconciliation below certain performance measures excluding the effect of the merger-related expenses during the twelve month periods ended December 31, 2018 and 2017. We believe this information is important to enable stockholders and other interested parties to assess our adjusted operational performance.
Impact of Inflation and Changing Prices and Seasonality
Management has prepared the financial statements and related data presented herein in accordance with U.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
Unlike industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services, and may frequently reflect government policy initiatives or economic factors not measured by price index. As discussed in Item 7A, we strive to manage our interest sensitive assets and liabilities in order to offset the effects of rate changes and inflation.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. Various factors, including interest rates, foreign exchange rates, commodity prices, or equity prices, may cause these changes. We are subject to market risk primarily through the effect of changes in interest rates on our portfolio of assets and liabilities. Foreign exchange rates, commodity prices, or equity prices do not pose significant market risk to us.
Interest Rate Sensitivity Analysis and Interest Rate Risk Management
A principal objective of Old Line Bank’s asset/liability management policy is to minimize exposure to changes in interest rates by an ongoing review of the maturity and re-pricing of interest earning assets and interest bearing liabilities. The Asset and Liability Committee of Old Line Bank’s board of directors oversees this review.
The Asset and Liability Committee establishes policies to control interest rate sensitivity. Interest rate sensitivity is the volatility of a bank’s earnings resulting from movements in market interest rates. Management monitors rate sensitivity in order to reduce vulnerability to interest rate fluctuations while maintaining adequate capital levels and acceptable levels of liquidity. Monthly financial reports supply management with information to evaluate and manage rate sensitivity and adherence to policy. Old Line Bank’s asset/liability policy’s goal is to manage assets and liabilities in a manner that stabilizes net interest income and net economic value within a broad range of interest rate environments. We periodically make adjustments to the mix of assets and liabilities in an effort to achieve dependable, steady growth in net interest income regardless of the behavior of interest rates in general.
As part of the interest rate risk sensitivity analysis, the Asset and Liability Committee examines the extent to which Old Line Bank’s assets and liabilities are interest rate sensitive and monitors the interest rate sensitivity gap. An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market rates. The interest rate sensitivity gap is the difference between interest earning assets and interest bearing liabilities scheduled to mature or reprice within such time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of declining interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. If repricing of assets and liabilities were equally flexible and moved concurrently, the impact of any increase or decrease in interest rates on net interest income would be minimal.
Old Line Bank currently has a negative gap, which suggests that the net interest income on interest earning assets may decrease during periods of rising interest rates. However, a simple interest rate “gap” analysis by itself may not be an accurate indicator of how changes in interest rates will affect net interest income. Changes in interest rates may not uniformly affect income associated with interest earning assets and costs associated with interest bearing liabilities. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. Although certain assets and liabilities may have similar maturities or periods of re-pricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market interest rates, while interest rates on other types may lag behind changes in general market rates. In the event of a change in interest rates, prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the interest rate gap. The ability of many borrowers to service their debts also may decrease in the event of an interest rate increase.
The table below presents Old Line Bank’s interest rate sensitivity at December 31, 2018. Because certain categories of securities and loans are prepaid before their maturity date even without regard to interest rate fluctuations, we have made certain assumptions to calculate the expected maturity of securities and loans.
Quarterly Data (unaudited)
(in 000’s)
Item 8.
Item 8. Financial Statements
The following consolidated financial statements are filed with this report:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets-December 31, 2018 and 2017
Consolidated Statements of Income-for the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Comprehensive Income-for the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Changes in Stockholders’ Equity-for the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows-for the years ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
Report Of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Old Line Bancshares, Inc.
Opinion on Internal Control Over Financial Reporting
We have audited Old Line Bancshares, Inc. and Subsidiaries (the “Company”)’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, Old Line Bancshares, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of Old Line Bancshares, Inc. as of December 31, 2018 and 2017, and for each of the years in the three years ended December 31, 2018, and our report dated March 13, 2019, expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
As described in Management’s Report on Internal Control over Financial Reporting, the scope of management’s assessment of internal control over financial reporting as of December 31, 2018 has excluded Bay Bancorp, Inc. acquired on April 13, 2018. We have also excluded Bay Bancorp, Inc. from the scope of our audit of internal control over financial reporting. Bay Bancorp, Inc. constituted 17.27 percent of consolidated revenue (total net interest income and total noninterest income) for the year ended December 31, 2017, and 17.26 percent of consolidated total assets as of December 31, 2018.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Dixon Hughes Goodman LLP
Atlanta, Georgia
March 13, 2019
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Old Line Bancshares, Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Old Line Bancshares, Inc. and Subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2019 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Dixon Hughes Goodman LLP
We have served as the Company’s auditor since 2013.
Atlanta, Georgia
March 13, 2019
Part 1. Financial Information
Old Line Bancshares, Inc. & Subsidiaries
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements
Old Line Bancshares, Inc. & Subsidiaries
Consolidated Statements of Income
The accompanying notes are an integral part of these consolidated financial statements
Old Line Bancshares, Inc. & Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
The accompanying notes are an integral part of these consolidated financial statements
Old Line Bancshares, Inc. & Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
The accompanying notes are an integral part of these consolidated financial statements
Old Line Bancshares, Inc. & Subsidiaries
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these consolidated financial statements.
Old Line Bancshares, Inc. & Subsidiaries
Consolidated Statements of Cash Flows (Continued)
The accompanying notes are an integral part of these consolidated financial statements
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Organization and Description of Business-Old Line Bancshares, Inc. (“Bancshares”) is the holding company for Old Line Bank (the “Bank”). We provide a full range of banking services to customers located in Baltimore City and Anne Arundel, Baltimore, Calvert, Carroll, Charles, Frederick, Harford, Howard, Montgomery, Prince George’s and St. Mary’s Counties in Maryland.
Basis of Presentation and Consolidation-The accompanying consolidated financial statements include the activity of Bancshares, its wholly owned subsidiary, the Bank, and the Bank’s wholly owned subsidiary Pointer Ridge Office Investment, LLC (“Pointer Ridge”). We have eliminated all significant intercompany transactions and balances.
We report the income of Pointer Ridge attributable to Bancshares from the date of Bancshares’ acquisition of majority interest on the consolidated statements of income.
Use of Estimates-The preparation of financial statements in conformity with generally accepted accounting principles 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. These estimates and assumptions may affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses.
Cash and Cash Equivalents-For purposes of the Consolidated Statements of Cash Flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits and federal funds sold. Generally, we purchase and sell federal funds for one day periods.
Investment Securities-As we purchase securities, management determines if we should classify the securities as held to maturity, available for sale or trading. We record the securities that management has the intent and ability to hold to maturity at amortized cost which is cost adjusted for amortization of premiums and accretion of discounts to maturity. We classify securities that we may sell before maturity as available for sale and carry these securities at fair value with unrealized gains and losses included in stockholders’ equity on an after tax basis. Management has not identified any investment securities as trading.
We record gains and losses on the sale of securities on the trade date and determine these gains or losses using the specific identification method. We amortize premiums and accrete discounts using the interest method.
Management systematically evaluates investment securities for other- than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) the structure of the security. A decline in the market value of any available for sale security below cost that is deemed other-than-temporary results in a charge to earnings and establishment of a new cost basis for that security.
Stock-Based Compensation Awards-The cost of employee services received in exchange for equity instruments, including stock options and restricted stock awards, is generally measured at fair value on the grant date. A Black-Scholes model is used to estimate the fair value of stock options, while the market price of Bancshares’ common stock at the date of grant is used as the fair value of restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards and as the restriction period for restricted stock awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Equity Securities-Equity securities include stock from Federal Home Loan Bank, Atlantic Central Bankers Bank, ICBA and Visa, which are carried at cost that approximates fair value.
Premises and Equipment-We record premises and equipment at cost less accumulated depreciation. Generally, we compute depreciation using the straight line method over the estimated useful life of the assets. Estimated useful life for our buildings is five to 50 years. Estimated useful life for our leasehold improvements is three to 30 years. Estimated useful life for our furniture and equipment is three to 23 years.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Other Real Estate Owned-Other real estate owned consists of properties obtained through foreclosure proceedings or acceptance of a deed in lieu of foreclosure, and is reported on an individual asset basis at net realizable value. Net realizable value equals fair value and is determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources less estimated selling costs. While initial fair value is determined by independent third parties, management may subsequently reassess these valuations and apply additional discounts if necessary. When properties are acquired through foreclosure, any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is recognized and charged to the allowance for loan losses. Subsequent write-downs are charged to a separate allowance for losses pertaining to real estate owned, established through provisions for estimated losses on other real estate owned charged to operations. Based upon management’s evaluation of the real estate acquired through foreclosure, additional expense is recorded when necessary in an amount sufficient to reflect any estimated declines in fair value. Gains and losses recognized on the disposition of the properties are also recorded in non-interest expense in the consolidated statements of income. Costs of improvements to real estate are capitalized, while costs associated with holding the real estate are charged to operations.
Mortgage Banking Activities-As part of normal business operations, we originate residential mortgage loans that have been pre-approved by secondary investors. The terms of the loans are set by the secondary investors, and the purchase price that the investor will pay for the loan is agreed to prior to the commitment of the loan. Generally, within three weeks after funding, the loans are transferred to the investor in accordance with the agreed-upon terms. At the date the loans are transferred to the investor, the servicing is released. On the settlement date of these loans, we record the gains from the sale of these loans equal to the difference between the proceeds to be received and the carrying amount of the loan.
Goodwill and Other Intangible Assets-Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed related to the acquisitions of Maryland Bankcorp, Inc., WSB Holdings, Inc., Regal Bancorp, Inc., DCB Bancshares, Inc. and Bay Bancorp, Inc. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in these transactions. The core deposit intangible is being amortized over 18 years for Maryland Bankcorp, Inc., ten years for WSB Holdings, Inc., eight years for Regal Bancorp, Inc., and DCB Bancshares, Inc., and 20 years for Bay Bancorp, Inc. The estimated useful lives are periodically reviewed for reasonableness.
Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, comparing the reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill assigned to that reporting unit is considered not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment of goodwill assigned to that reporting unit.
We evaluated the carrying value of goodwill as of September 30, 2018, our annual test date, and determined that no impairment charge was necessary. Additionally, should Bancshares’ future earnings and cash flows decline and/or discount rates increase, an impairment charge to goodwill and other intangible assets may be required. There have been no events subsequent to the September 30, 2018 evaluation that caused us to perform an interim review of the carrying value of goodwill.
Business Combinations-Accounting principles generally accepted in the United States (“U.S. GAAP”) requires that the acquisition method of accounting be used for all business combinations and that an acquirer be identified for each business combination. Under U.S. GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. U.S. GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
If required, the second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted. We have determined that Bancshares has one reporting unit.
As a result of the BYBK acquisition, the Bank became a member of the POS network sponsorship program, which allows our customers to access several processing and settlement networks; when our customers use one of these networks, the Bank receives a transaction fee from the network.
Loans and Interest Income-We report loans at face value plus deferred origination costs, less deferred origination fees and the allowance for loan losses. We accrue interest on loans based on the principal amounts outstanding. We amortize origination fees and costs to income over the terms of the loans using an approximate interest method.
We discontinue the accrual of interest when any portion of the principal or interest is 90 days past due and collateral is insufficient to discharge the debt in full. Based on current information, we consider loans impaired when management determines that it is unlikely that the borrower will make principal and interest payments according to contractual terms. Generally, we do not review loans for impairment until we have discontinued the accrual of interest. We consider several factors in determining impairment including payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Generally, we do not classify loans that experience insignificant payment delays and payment shortfalls as impaired. Management determines the significance of payment delays and payment shortfalls on a case by case basis. We consider all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. We measure impairment on a loan by loan basis for commercial and real estate loans by determining either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. If it is doubtful that we will collect principal, we apply all payments to principal.
We collectively evaluate large groups of smaller balance homogeneous loans for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment unless such loans are the subject of a restructuring agreement or the borrower has filed bankruptcy.
Acquired Loans-These loans are recorded at fair value at the date of acquisition, and accordingly no allowance for loan losses is transferred to the acquiring entity in connection with purchase accounting. The fair values of loans with evidence of credit deterioration (purchased, credit-impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For purchased, credit-impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the purchase price of the purchase credit-impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The purchased credit-impaired loan’s contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, in the form of a loss accrual or a valuation allowance.
Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each purchased, credit-impaired loan in comparison to management’s initial performance expectations. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Acquired performing loans are accounted for using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Acquired performing loans are recorded as of the purchase date at fair value. Credit losses on the acquired performing loans are estimated based on analysis of the performing portfolio. A provision for loan losses is recognized for any further credit deterioration that occurs in these loans subsequent to the acquisition date.
Loans Held for Sale-The loans classified in the held for sale portfolio consists of loans that have been committed to be purchased by investors in the secondary market at December 31, 2018 and will be settled subsequent to that date and reported at lower of cost or market.
Allowance for Loan Losses-The allowance for loan losses represent an amount that, in management’s judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. Management bases its judgment in determining the adequacy of the allowance on evaluations of the collectability of loans. Management takes into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect the borrowers’ ability to pay, overall portfolio quality, and review of specific problem areas. If the current economy or real estate market continues to suffer a severe downturn, we may need to increase the estimate for uncollectible accounts. We charge off loans that we deem uncollectible and deduct them from the allowance. We add recoveries on loans previously charged off to the allowance.
We base the evaluation of the adequacy of the allowance for loan losses upon loan categories. We categorize loans as residential real estate loans, commercial real estate loans, commercial loans and consumer loans. We further divide commercial real estate loans by owner occupied, investment, hospitality and land acquisition and development. We also divide residential real estate by owner occupied, investment, land acquisition and development and junior liens. All categories are divided by risk rating and loss factors and weighed by risk rating to determine estimated loss amounts. We evaluate delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with collateral separately and assign loss amounts based upon the evaluation.
Within each of the above loan types, each portfolio is sorted by the risk assessment rating of each loan as Pass, Pass-Watch, Special Mention or Substandard. The Bank’s loss experience (Loss Factor) is progressively tiered by risk category for Pass, Pass-Watch, Special Mention and Substandard loans by applying a higher loss factor to higher risk rated categories. Loans rated “Doubtful” or “Loss” are, by definition, impaired and will be specifically reserved based upon Bank management’s best estimate of the loss exposure for each loan.
The Bank’s loss experience for each of the last 12 quarters is aggregated and that total is used to create a percentage of the loan portfolio as it existed at the beginning of the 12 quarter “look back.” We collectively evaluate large groups of smaller balance homogeneous loans for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment unless such loans are the subject of a restructuring agreement or the borrower has filed bankruptcy.
Qualitative factors include: levels and trends in delinquencies and non-accruals; trends in volumes and terms of loans; effects of any changes in lending policies; the experience, ability and depth of management; regional and local economic trends and conditions; Peer Group loan loss history; concentrations of credit; quality of the bank’s loan review system; external factors, such as competition, legal and regulatory requirements; and, management’s collective assessment of the appropriateness of the allowance for loan losses in light of recent trends, events, political impact and other considerations.
Advertising-We expense advertising costs over the life of ad campaigns. We expense general purpose advertising as we incur it.
Income Taxes-The provision for income taxes includes taxes payable for the current year and deferred income taxes. We determine deferred tax assets and liabilities based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse. If needed, we use a valuation allowance to reduce the deferred tax assets to the amount we expect to realize. We allocate tax expense and tax benefits to Bancshares and its subsidiaries based on their proportional share of taxable income. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income at the time of enactment of such change in tax rates. In the fourth quarter 2017, the Tax Cut Jobs Act was signed into law, which requires the deferred tax assets and liabilities to be revalued using the 21% federal tax rate enacted. The provisional effect to revalue the deferred tax assets was recorded in the fourth quarter 2017 tax provision.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Earnings Per Share-We determine basic earnings per common share by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding giving retroactive effect to stock dividends.
We calculate diluted earnings per common share by including the average dilutive common stock equivalents outstanding during the period. Dilutive common equivalent shares consist of stock options and warrants, calculated using the treasury stock method.
Comprehensive Income-Comprehensive income includes net income attributable to Bancshares and the unrealized gain (loss) on investment securities available for sale net of related income taxes. The line item affected in the consolidated statements of income by the re-classified amounts is gain on sales or calls of investment securities.
Reclassifications-We have made certain reclassifications to the 2017 and 2016 financial presentation to conform to the 2018 presentation. Such reclassifications had no effect on previously reported cash flows, stockholders’ equity or net income.
Recent Accounting Pronouncements-In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 - Revenue from Contracts with Customers, which will supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principal of this ASU is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The ASU allows for either full retrospective or modified retrospective adoption. The ASU does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under U.S. GAAP. Our revenue is comprised of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of the new guidance, and non-interest income. The contracts that are within scope of the guidance are primarily related to service charges on deposit accounts, cardholder and merchant income, point of sale sponsorship program, wealth advisory services income, other service charges and fees, sales of other real estate owned, insurance commissions and miscellaneous fees. Bancshares adopted the ASU on January 1, 2018, utilizing the modified retrospective approach. The adoption of this ASU did not have a material impact on our consolidated financial position or consolidated results of operations.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
In January 2016, FASB issued ASU No. 2016-01, Financial Instruments - Recognition and Measurement of Financial Assets and Liabilities, which is intended to improve the recognition and measurement of financial instruments by: requiring equity investments (other than equity method or consolidation) to be measured at fair value with changes in fair value recognized in net income; requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; eliminating the requirement to disclose the fair value of financial instruments measured at amortized cost for organizations that are not public business entities; eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This ASU is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We adopted this ASU effective January 1, 2018. With the adoption of this ASU, equity securities can no longer be classified as available for sale, and as such marketable equity securities are disclosed as a separate line item on the balance sheet with changes in the fair value of equity securities reflected in net income. During the first quarter of 2018, we began using an exit price notion when measuring the fair value of our loan portfolio, excluding loans held for sale, for disclosure purposes. The adoption of this ASU did not have a significant impact on our consolidated financial statements.
In February 2016, FASB issued ASU 2016-02, Leases (Topic 842). The FASB issued this ASU to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet by lessees for those leases classified as operating leases under current U.S. GAAP and disclosing key information about leasing arrangements. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early application of this ASU is permitted for all entities. This ASU will be effective for us in our first quarter of 2019. Bancshares occupies certain banking offices under operating lease agreements which prior to adoption of the guidance are not reflected in its consolidated balance sheet at December 31, 2018 and 2017. We will adopt ASU 2016-02 on January 1, 2019 and recognize a right of use an asset and an increase in liabilities of approximately $24.2 million as a result. The consolidated statement of income impact is approximately $155 thousand for 2019.
In March 2016, FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 was effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The adoption of ASU 2016-09 on January 1, 2017 did not impact Bancshares’ consolidated financial statements.
In June 2016, FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which sets forth a “current expected credit loss” (“CECL”) model requiring Old Line Bancshares to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. For public business entities that are U.S. Securities and Exchange Commission filers, the amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Old Line Bancshares has constituted a committee that has the responsibility to gather loan information and consider acceptable methodologies to comply with this ASU. The committee meets periodically to discuss the latest developments and committee members keep themselves updated on such developments via webcasts, publications, and conferences. We have also evaluated and selected a third party vendor solution to assist us in the application of ASU 2016-13. The adoption of ASU 2016-13 is likely to result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. We expect to run our current model compared to the CECL model by the end of the second quarter in 2019. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses on debt securities. Old Line Bancshares’ evaluation indicates that the provisions of ASU 2016-13 will impact its consolidated financial statements, in particular the level of the reserve for loan losses. We are, however, continuing to evaluate the extent of the potential impact.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide guidance on the following nine specific cash flow issues: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned; 6) life insurance policies; 7) distributions received from equity method investees; 8) beneficial interests in securitization transactions; and 9) separately identifiable cash flows and application of the predominance principle. The ASU is effective for all annual and interim periods beginning January 1, 2018 and is required to be applied retrospectively to all periods presented. We adopted this guidance January 1, 2018, which did not result in a change in the classification in the statement of cash flows and did not have a material impact on our consolidated financial statements or on our financial position or results of operations.
In January 2017, FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the definition of a business, which clarifies the definition of a business and assists entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under this guidance, when substantially all of the fair value of gross assets acquired is concentrated in a single asset (or group of similar assets), the assets acquired would not represent a business. In addition, in order to be considered a business, an acquisition would have to include at a minimum an input and a substantive process that together significantly contribute to the ability to create an output. The guidance also narrows the definition of outputs by more closely aligning it with how outputs are described in FASB guidance for revenue recognition. We adopted this guidance effective January 1, 2018. The adoption of this ASU did not have a material impact on our consolidated financial statements.
In January 2017, FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. As a result, under the ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The ASU is effective for annual and interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Bancshares adopted this ASU in the fourth quarter of 2018. The adoption of ASU 2017-04 did not have a material impact on the consolidated financial statements.
In March 2017, FASB issued ASU No. 2017-08, Premium Amortization on Purchased Callable Debt Securities. This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. Today, entities generally amortize the premium over the contractual life of the security. The new guidance does not change the accounting for purchased callable debt securities held at a discount; the discount continues to be amortized to maturity. ASU No. 2017-08 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The adoption of this guidance is not expected to have a material impact on Bancshares’ consolidated financial statements.
In August 2017, FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities. This ASU’s objectives are to: (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities; and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. ASU No. 2017-12 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. Bancshares currently does not designate any derivative financial instruments as formal hedging relationships, and therefore, does not utilize hedge accounting. However, Bancshares is currently evaluating this ASU to determine whether its provisions will enhance its ability to employ risk management strategies, while improving the transparency and understanding of those strategies for financial statement users.
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In February 2018, FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (Topic 220). This ASU allows an entity to elect a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act that changed our income tax rate from 35% to 21%. The amount of that reclassification should include the effect of changes of tax rate on the deferred tax amount, any related valuation allowance and other income tax effects on the items in AOCI. The ASU requires an entity to state if an election to reclassify the tax effect to retained earnings is made along with the description of other income tax effects that are reclassified from AOCI. ASU 2018-02 is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years with early adoption permitted. Old Line Bancshares adopted ASU 2018-02 in the first quarter of 2018. The change in accounting principal was accounted for as a cumulative effect adjustment to the balance sheet resulting in a reclass of $459,973 from AOCI to retained earnings during the first quarter of 2018.
In July 2018, FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which amended ASU 2016-02, discussed above. These amendments provide entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current U.S. GAAP (Topic 840, Leases). The amendments also provide lessors with a practical expedient, by class of underlying asset, to not separate non-lease components from the associated lease component and, instead, to account for those components as a single component if the non-lease components otherwise would be accounted for under the new revenue guidance (Topic 606) and certain criteria are met: If the non-lease component or components associated with the lease component are the predominant component of the combined component, an entity is required to account for the combined component in accordance with Topic 606. Otherwise, the entity must account for the combined component as an operating lease in accordance with Topic 842. The amendments have the same effective date as ASU 2016-02 (January 1, 2019 for Bancshares). Bancshares expects to elect the transition options. Bancshares also expects to increase its assets and liabilities by approximately $24.2 million as a result of recognizing lease liabilities on its consolidated balance sheet. The consolidated statement of income impact is approximately $155 thousand for 2019.
2. ACQUISITION OF BAY BANCORP, INC.
On April 13, 2018, Bancshares acquired Bay Bancorp, Inc. (“BYBK”), the parent company of Bay Bank, FSB (“Bay Bank”). Upon the consummation of the merger, each share of common stock of BYBK outstanding immediately before the merger was converted into the right to receive 0.4088 shares of Bancshares’ common stock, provided that cash was paid in lieu of any fractional shares of Bancshares common stock. As a result, Old Line Bancshares issued 4,408,087 shares of its common stock in exchange for the shares of BYBK common stock in the merger. The aggregate merger consideration was approximately $143.6 million based on the closing sales price of Old Line Bancshares’ common stock on April 13, 2018.
In connection with the merger, Bay Bank merged with and into the Bank, with the Bank the surviving bank.
At April 13, 2018, BYBK had consolidated assets of approximately $661 million. This merger added 11 banking locations located in BYBK’s primary market areas of Baltimore City and Anne Arundel, Baltimore, Howard and Harford Counties in Maryland.
The BYBK transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the acquisition date. Management made significant estimates and exercised significant judgment in accounting for the acquisition of BYBK. Management judgmentally assigned risk ratings to loans based on appraisals and estimated collateral values, expected cash flows, prepayment speeds and estimated loss factors to measure fair value for loans. Management used quoted or current market prices to determine the fair value of BYBK’s investment securities.
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The following table provides the purchase price as of the acquisition date and the identifiable assets acquired and liabilities assumed at their estimated fair values.
Comparative and Pro Forma Financial Information for the BYBK Acquisition
The adjusted results of Bancshares for the periods ended December 31, 2018 and 2017, as presented below, include the results of the acquired assets and assumed liabilities from the BYBK acquisition since the acquisition date of April 13, 2018; adjusted net income figures shown below exclude merger and integration expenses incurred during the periods presented. Merger-related expenses of $9.4 million are recorded in the consolidated statement of income for the year ended December 31, 2018, and include costs related to the conversion of systems, termination of contracts, branch closures and severance.
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The following table discloses the impact of the merger with BYBK (excluding the impact of the merger-related expenses) for the year ended December 31, 2018. The table also presents certain pro forma information as if BYBK had been acquired on January 1, 2017. These results combine the historical results of BYBK into our consolidated statements of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition related activity, they are not necessarily indicative of what would have occurred had the acquisition actually taken place on January 1, 2017.
Bancshares incurred merger-related expenses of $9.4 million during the year ended December 31, 2018, which are excluded from the pro forma information below. In addition, no adjustments have been made to the pro formas to eliminate the $300 thousand BYBK provision for loans losses for the year ended December 31, 2018. No adjustments were made to reduce the impact of any other real estate owned (“OREO”) write downs, investment securities sold or repayment of borrowings recognized by BYBK during the year ended December 31, 2018. Bancshares also expects to achieve operating costs savings as a result of the BYBK acquisition that are not reflected in the pro forma amounts below.
The following is an outline of the expenses that we have incurred during the twelve months ended December 31, 2018 in conjunction with the BYBK merger.
3. Goodwill and Other Intangible Assets
The following is a summary of changes in the carrying amounts of goodwill as well as the gross carrying amounts and accumulated amortization of core deposit intangibles:
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We recorded amortization expense related to the core deposit intangible of $2,179,452, $968,881 and $830,805 for the years ended December 31, 2018, 2017 and 2016, respectively. Core deposit intangibles are being amortized as follows:
4. Cash and Cash Equivalents
The Bank may carry balances with other banks that exceed the federally insured limit. We did not have any accounts that exceeded the federally insured limit in 2018 or 2017. The Bank also sells federal funds on an unsecured basis to the same banks. The average balance sold was $292 thousand and $528 thousand at December 31, 2018 and 2017, respectively. Federal banking regulations require banks to carry non-interest bearing cash reserves at specified percentages of deposit balances. The Bank’s normal amount of cash on hand and on deposit with other banks is sufficient to satisfy the reserve requirements.
5. Investment Securities
Investment securities are summarized as follows:
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The table below summarizes investment securities with unrealized losses and the length of time the securities have been in an unrealized loss position as of December 31, 2018 and 2017:
At December 31, 2018, we had 34 investment securities that were in an unrealized loss position for less than 12 months and 166 investment securities in an unrealized loss position for 12 months or more.
We consider all unrealized losses on securities as of December 31, 2018 to be temporary losses because we will redeem each security at face value at or prior to maturity. We have the ability and intent to hold these securities until recovery or maturity. As of December 31, 2018, we do not have the intent to sell any of the securities classified as available for sale with unrealized losses and believe that it is more likely than not that we will not have to sell any such securities before a recovery of cost. In most cases, market interest rate fluctuations cause a temporary impairment in value. We expect the fair value to recover as the investments approach their maturity date or re-pricing date or if market yields for these investments decline. We do not believe that credit quality caused the impairment in any of these securities. Because we believe these impairments are temporary, we have not recognized any other than temporary impairment loss in our consolidated statement of income.
During the year ended December 31, 2018, we received $72.4 million in proceeds from sales, maturities or calls and principal pay-downs on investment securities. The net proceeds of these transactions were used to pay down our Federal Home Loan Bank of Atlanta (“FHLB”) borrowings and purchase new investment securities. We acquired a total of $55.2 million investment portfolio as a result of the BYBK merger. The securities sold included $51.7 million of securities that we acquired in the BYBK merger and sold immediately after the closing of the merger, resulting in no gain or loss on such sales.
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Contractual maturities and pledged securities at December 31, 2018 and 2017 are shown below. Actual maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties. In addition, we classify mortgage backed securities based on maturity date, although the Bank receives payments on a monthly basis. We have pledged securities to customers who have funds invested in overnight repurchase agreements and deposits.
6. Loans and Allowance for Loan Losses
Major classifications of loans are as follows:
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(1)As a result of the acquisitions of Maryland Bankcorp, Inc. (“Maryland Bankcorp”), the parent company of Maryland Bank & Trust Company, N.A. (“MB&T”), in April 2011, WSB Holdings Inc., the parent company of The Washington Savings Bank (“WSB”), in May 2013, Regal Bancorp, Inc. (“Regal”), the parent company of Regal Bank & Trust (“Regal Bank”), in December 2015, DCB Bancshares, Inc (“DCB”), the parent company of Damascus Community Bank (“Damascus”), in July 2017 and BYBK, the parent company of Bay Bank, in April 2018, we have segmented the portfolio into two components, “Legacy” loans originated by the Bank and “Acquired” loans acquired from MB&T, WSB, Regal Bank, Damascus and Bay Bank.
Credit Policies and Administration
We have adopted a comprehensive lending policy, which includes stringent underwriting standards for all types of loans. We have designed our underwriting standards to promote a complete banking relationship rather than a transactional relationship. Our lending staff follows pricing guidelines established periodically by our management team. In an effort to manage risk, prior to funding the loan committee, consisting of four non-employee members of the board of directors and four executive officers, must approve by majority vote all credit decisions in excess of a lending officer’s lending authority.
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Management believes that we employ experienced lending officers, secure appropriate collateral and carefully monitors the financial condition of our borrowers and the loan concentration of loans in the portfolio.
In addition to the internal business processes employed in the credit administration area, the Bank retains an outside independent firm to review the loan portfolio. This firm performs a detailed annual review and an interim update. We use the results of the firm’s report to validate our internal ratings and we review the commentary on specific loans and on our loan administration activities in order to improve our operations.
Commercial Real Estate Loans
We finance commercial real estate for our clients, for owner occupied and investment properties. Commercial real estate loans totaled $1.5 billion and $1.1 billion, respectively, at December 31, 2018 and 2017. This lending has involved loans secured by owner-occupied commercial buildings for office, storage and warehouse space, as well as non-owner occupied commercial buildings. Our underwriting criteria for commercial real estate loans include maximum loan-to-value ratios, debt coverage ratios, secondary sources of repayments, guarantor requirements, net worth requirements and quality of cash flows. Loans secured by commercial real estate may be large in size and may involve a greater degree of risk than one-to-four family residential mortgage loans. Payments on such loans are often dependent of successful operation or management of the properties. We will generally finance owner occupied commercial real estate that does not exceed loan to value of 80% and investor real estate at a maximum loan to value of 75%.
Commercial real estate lending entails significant risks. Risks inherent in managing our commercial real estate portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate that may detrimentally impact the borrower’s ability to repay. We monitor the financial condition and operating performance of the borrower through a review of annual tax returns and updated financial statements. In addition, we meet with the borrower and/or perform site visits as required.
At December 31, 2018 and 2017, we had approximately $185.3 million and $171.6 million, respectively, of commercial real estate loans outstanding to the hospitality industry. An individual review of these loans indicates that they generally have a low loan to value, more than acceptable existing or projected cash flow, are to experienced operators and are generally dispersed throughout the region.
Residential Real Estate Loans
We offer a variety of consumer oriented residential real estate loans including home equity lines of credit, home improvement loans and first or second mortgages on investment properties. Our residential loan portfolio amounted to $523.6 million and $310.7 million, respectively, at December 31, 2018 and 2017. Although most of these loans are in our market area, the diversity of the individual loans in the portfolio reduces our potential risk. Usually, we secure our residential real estate loans with a security interest in the borrower’s primary or secondary residence with a loan to value not exceeding 85%. Our initial underwriting includes an analysis of the borrower’s debt/income ratio which generally may not exceed 43%, collateral value, length of employment and prior credit history. A credit score of at least 640 is required, except for loans originated for sale in the secondary market, as discussed below. We do not originate any subprime residential real estate loans.
This segment of our portfolio also consists of funds advanced for construction of custom single family residences homes (where the home buyer is the borrower) and financing to builders for the construction of pre-sold homes and multi-family housing. These loans generally have short durations, meaning maturities typically of twelve months or less. The Bank limits its construction lending risk through adherence to established underwriting procedures. These loans generally have short durations, meaning maturities typically of twelve months or less. Residential houses, multi-family dwellings and commercial buildings under construction and the underlying land for which the loan was obtained secure the construction loans. The vast majority of these loans are concentrated in our market area.
Construction lending also entails significant risk. These risks generally involve larger loan balances concentrated with single borrowers with funds advanced upon the security of the land or the project under construction. An appraisal of the property estimates the value of the project “as is” and “as if completed.” An appraisal of the property estimates the value of the project prior to completion of construction. Thus, initial funds are advanced based on the current value of the property with the remaining construction funds advanced under a budget sufficient to successfully complete the project within the “as completed” loan to value. To further mitigate the risks, we generally limit loan amounts to 80% or less of appraised values and obtain first lien positions on the property.
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We generally only offer real estate construction financing only to experienced builders, commercial entities or individuals who have demonstrated the ability to obtain a permanent loan “take-out” (conversion to a permanent mortgage upon completion of the project). We also perform a complete analysis of the borrower and the project under construction. This analysis includes a review of the cost to construct, the borrower’s ability to obtain a permanent “take-out” the cash flow available to support the debt payments and construction costs in excess of loan proceeds, and the value of the collateral. During construction, we advance funds on these loans on a percentage of completion basis. We inspect each project as needed prior to advancing funds during the term of the construction loan. We may provide permanent financing on the same projects for which we have provided the construction financing.
We also offer fixed rate home improvement loans. Our home equity and home improvement loan portfolio gives us a diverse client base. Although most of these loans are in our market area, the diversity of the individual loans in the portfolio reduces our potential risk. Usually, we secure our home equity loans and lines of credit with a security interest in the borrower’s primary or secondary residence.
Under our loan approval policy, all residential real estate loans approved must comply with federal regulations. Generally, we will make residential mortgage loans in amounts up to the limits established by Fannie Mae and Freddie Mac for secondary market resale purposes. Currently this amount for single-family residential loans currently varies from $484,350 up to a maximum of $726,525 for certain high-cost designated areas. We also make residential mortgage loans up to limits established by the Federal Housing Administration, which currently is $726,525. The Washington, D.C. and Baltimore areas are both considered high-cost designated areas. We will, however, make loans in excess of these amounts if we believe that we can sell the loans in the secondary market or that the loans should be held in our portfolio. For loans we originate for sale in the secondary market, we typically require a credit score of 620 or higher, with some exceptions provided we receive an approval recommendation from FannieMae, FreddieMac or FHA’s automated underwriting approval system. Loans sold in the secondary market are sold to investors on a servicing released basis and recorded as loans as held for sale. The premium is recorded in income on marketable loans in non-interest income, net of commissions paid to the loan officers.
Commercial and Industrial Lending
Our commercial and industrial lending consists of lines of credit, revolving credit facilities, accounts receivable financing, term loans, equipment loans, SBA loans, standby letters of credit and unsecured loans. We originate commercial loans for any business purpose including the financing of leasehold improvements and equipment, the carrying of accounts receivable, general working capital, and acquisition activities. We have a diverse client base and we do not have a concentration of these types of loans in any specific industry segment. We generally secure commercial business loans with accounts receivable, equipment, deeds of trust and other collateral such as marketable securities, cash value of life insurance and time deposits at the Bank.
Commercial business loans have a higher degree of risk than residential mortgage loans because the availability of funds for repayment generally depends on the success of the business. They may also involve high average balances, increased difficulty monitoring and a high risk of default. To help manage this risk, we typically limit these loans to proven businesses and we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of the business. For loans in excess of $250,000, monitoring generally includes a review of the borrower’s annual tax returns and updated financial statements.
Consumer Loans
We offer various types of secured and unsecured consumer loans. We make consumer loans for personal, family or household purposes as a convenience to our customer base. This category includes our luxury boat loans, which we made prior to 2008 and that remain in our portfolio. Consumer loans, however, are not a focus of our lending activities. The underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of his or her ability to meet existing obligations and payments on the proposed loan. As a general guideline, a consumer’s total debt service should not exceed 40% of his or her gross income.
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Our consumer loan portfolio, includes indirect loans, which consists primarily of auto and RV loans. These loans are financed through dealers and the dealers receive a percentage of the finance charge, which varies dependent upon contract terms. We use the same underwriting standards in originating these indirect loans as we do for consumer loans generally.
Consumer loans may present greater credit risk than residential mortgage loans because many consumer loans are unsecured or rapidly depreciating assets secure these loans. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation. Consumer loan collections depend on the borrower’s continuing financial stability. If a borrower suffers personal financial difficulties, the consumer may not repay the loan. Also, various federal and state laws, including bankruptcy and insolvency laws, may limit the amount we can recover on such loans.
Concentrations of Credit
Most of our lending activity occurs within the state of Maryland within the suburban Washington, D.C. and Baltimore market areas in Baltimore City and Anne Arundel, Baltimore, Calvert, Carroll, Charles, Frederick, Harford, Howard, Montgomery, Prince George’s and St. Mary’s Counties. The majority of our loan portfolio consists of commercial real estate loans and residential real estate loans.
Non-Accrual and Past Due Loans
We consider loans past due if the borrower has not paid the required principal and interest payments when due under the original or modified terms of the promissory note and place a loan on non-accrual status when the payment of principal or interest has become 90 days past due. When we classify a loan as non-accrual, we no longer accrue interest on such loan and we reverse any interest previously accrued but not collected. We will generally restore a non-accrual loan to accrual status when the borrower brings delinquent principal and interest payments current and we expect to collect future monthly principal and interest payments. We recognize interest on non-accrual legacy loans only when received. We originally recorded purchased, credit-impaired loans at fair value upon acquisition, and an accretable yield is established and recognized as interest income on purchased loans to the extent subsequent cash flows support the estimated accretable yield. Purchased, credit-impaired loans that perform consistently with the accretable yield expectations are not reported as non-accrual or non-performing. However, purchased, credit-impaired loans that do not continue to perform according to accretable yield expectations are considered impaired, and presented as non-accrual and non-performing. Currently, management expects to fully collect the carrying value of acquired, credit-impaired loans.
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The table below presents an aging analysis of the loan held for investment portfolio at December 31, 2018 and 2017.
We evaluate all impaired loans, which includes non-performing loans and troubled debt restructurings (“TDRs”). We do not recognize interest income on non-performing loans during the time period that the loans are non-performing. We only recognize interest income on non-performing loans when we receive payment in full for all amounts due of all contractually required principle and interest, and the loan is current with its contractual terms.
We individually evaluate all legacy substandard loans risk rated seven, certain legacy special mention loans risk rated six and all legacy TDR for impairment. We individually evaluate all acquired loans that we risk rated substandard seven subsequent to the acquisition, certain acquired special mention loans risk rated six and all acquired TDRs for impairment. We also evaluate all loans acquired and recorded at fair value under ASC 310-30 for impairment.
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The table below presents our impaired loans at December 31, 2018.
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(1)Generally accepted accounting principles require that we record acquired loans at fair value at acquisition, which includes a discount for loans with credit impairment. These purchased credit impaired loans are not performing according to their contractual terms and meet the definition of an impaired loan. Although we do not accrue interest income at the contractual rate on these loans, we do recognize an accretable yield as interest income to the extent such yield is supported by cash flow analysis of the underlying loans.
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The table below presents our impaired loans at December 31, 2017.
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(1)Generally accepted accounting principles require that we record acquired loans at fair value at acquisition, which includes a discount for loans with credit impairment. These purchased credit impaired loans are not performing according to their contractual terms and meet the definition of an impaired loan. Although we do not accrue interest income at the contractual rate on these loans, we do recognize an accretable yield as interest income to the extent such yield is supported by cash flow analysis of the underlying loans.
We consider a loan a TDR when we conclude that both of the following conditions exist: the restructuring constitutes a concession and the debtor is experiencing financial difficulties. Restructured loans at December 31, 2018 consisted of seven loans for $2.4 million compared to seven loans at December 31, 2017 for $2.7 million.
The following table includes the recorded investment and number of modifications for TDRs for the years ended December 31, 2018 and 2017. We report the recorded investment in loans prior to a modification and also the recorded investment in the loans after the loans were restructured. Reductions in the recorded investment are primarily due to the partial charge-off of the principal balance prior to the modification. TDRs for 2018 consisted on one consumer loan of which we extended the original maturity date from the original term of 75 months to 117 months.
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There were no loans that were modified as TDRs during the previous 12 months and for which there was a payment default during the years ended December 31, 2018 or 2017.
Acquired Impaired Loans
The following table documents changes in the accretable discount/(premium) on all purchased credit impaired loans during the years ended December 31, 2018 and 2017, along with the outstanding balances and related carrying amounts for the beginning and end of those respective periods.
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(1)Represents amounts paid in full on loans, payments on loans with zero balances and an increase in cash flows expected to be collected.
For our acquisition of Bay Bank on April 13, 2018, we recorded all loans acquired at the estimated fair value on their purchase date with no carryover of the related allowance for loan losses. On the acquisition date, we segregated the loan portfolio into two loan pools, performing and non-performing.
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We had an independent third party determine the net discounted value of cash flows on 1,991 performing loans totaling $520.5 million. The valuation took into consideration the loans’ underlying characteristics including account types, remaining terms, annual interest rates, interest types, past delinquencies, timing of principal and interest payments, current market rates, loan-to-value ratios, loss exposures, and remaining balances. These performing loans were segregated into pools based on loan and payment type and, in some cases, risk grade. The effect of this fair valuation process was a net discount of $8.3 million at acquisition.
We also individually evaluated 132 impaired loans totaling $13.5 million to determine their fair value as of the April 13, 2018 measurement date. In determining the fair value for each individually evaluated impaired loan, we considered a number of factors including the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral and net present value of cash flows we expect to receive, among others.
We established a credit related non-accretable difference of $3.2 million relating to these purchased credit impaired loans, reflected in the recorded fair value.
We re-classified $21.7 million (net of fair value marks) of our acquired loans to available for sale. These loans consisted primarily of purchase credit impaired loans that we were working to market with brokers. Settlement occurred on these loans during the third quarter of 2018, resulting in no gain or loss on the sale.
The following table outlines the contractually required payments receivable, cash flows we expect to receive, non-accretable credit adjustment and the accretable yield for all of Bay Bank’s impaired loans as of the acquisition date, April 13, 2018.
Credit Quality Indicators
We review the adequacy of the allowance for loan losses at least quarterly. We base the evaluation of the adequacy of the allowance for loan losses upon loan categories. We categorize loans as residential real estate loans, commercial real estate loans, commercial loans and consumer loans. We further divide commercial real estate loans by owner occupied, investment, hospitality and land acquisition and development. We also divide residential real estate by owner occupied, investment, land acquisition and development and junior liens. All categories are divided by risk rating and loss factors and weighed by risk rating to determine estimated loss amounts. We evaluate delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with collateral separately and assign loss amounts based upon the evaluation.
We determine loss ratios for all loans based upon a review of the three year loss ratio for the category and qualitative factors.
With respect to commercial loans, management assigns a risk rating of one through nine as follows:
•Risk rating 1 (Highest Quality)-This category has the highest relative probability of repayment. Borrowers in this category would normally be investment grade risks, meaning entities having access (or capable of access) to the public capital markets and the supporting loan underwriting conforms to the standards of institutional credit providers. Credit risk is virtually absent due to the borrower’s substantial financial capacity, superior liquidity, and outstanding debt service coverage. This rating is generally reserved for the strongest customers of the Bank, or for loans that are secured by a perfected security interest in U. S. Government securities, investment grade government sponsored entities bonds, investment grade municipal bonds, insured savings accounts and insured certificates of deposit drawn on Old Line Bank or other high quality financial institutions. Loans to individuals of vast financial capacity, or those supported by conservatively margined liquid collateral, may warrant this Highest Quality rating.
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(Continued)
•Risk rating 2 (Very Good Quality) is normally assigned to a loan with a very high probability of repayment. Borrowers in this category may have access to alternative sources of financing. Credit risk is minimal due to the borrower’s sound primary and secondary repayments sources, strong debt capacity and coverage and good management in all key positions. This rating is generally reserved for strong customers of the Bank, or for loans secured by a properly margined portfolio of high quality traded stocks, lower grade municipal bonds and uninsured certificates of deposit at other financial institutions. Loans to individuals of substantial financial capacity, exhibiting significant liquidity, low leverage and a well-defined source of repayment may warrant this Very Good Quality rating.
•Risk rating 3 (Good Quality) is normally assigned to a loan with a sound primary and secondary source of repayment. This category represents a below average degree of risk as to repayment with no loss potential indicated. Borrowers in this category represent a reasonable credit risk with demonstrated ability to repay the debt from normal business operations. Borrowers should have a sound balance sheet, modest leverage, good liquidity and above average debt service coverage. There should be no significant departure from the intended source and timing of repayment and no undue reliance on secondary sources of repayment. To the extent that some variance exists in one or more criteria being measured, it may be offset by the relative strength of other factors and/or collateral pledged to secure the transaction. Loans to individuals of strong financial capacity, exhibiting good liquidity, reasonable leverage and defined primary and secondary sources of repayment may warrant this Good Quality rating.
•Risk rating 4 (Average Quality)-This category represents an average degree of risk as to repayment with minimal to no loss potential indicated. Borrowers in this category exhibit generally stable operating trends. Borrowers should have a satisfactory balance sheet, manageable leverage, moderate liquidity and average debt service coverage. There should be no adverse departure from the intended source and timing of repayment and secondary sources of repayment should be readily available. Loans to individuals with adequate to strong net worth and some liquidity may warrant an Average Quality rating.
•Risk rating 5 (Pass/Watch)-Borrowers in this category generally exhibit characteristics of an Average Quality credit, but may be experiencing income volatility, negative operating trends and a more highly leveraged balance sheet, thus warranting more than the normal level of supervision. Loans to borrowers with industry volatility, declining market share, marginal or new management, weak internal reporting systems, inadequate financial reporting to the Bank and loans to start-up businesses or businesses with untested management generally warrant a “Watch” designation; provided, however, that events or circumstances prompting this rating do not constitute an undue or unwarranted credit risk. Credits that require additional monitoring such as construction loans, asset based loans and loans granted under certain government lending programs (i.e. U. S. Small Business Administration-“SBA”) may be carried in this category where the risk or monitoring needs may be higher than the norm. Additionally, credits may be placed in this category because of an adverse event that has not weakened the credit, but which should be followed to assure that resolution occurs without material impact on the borrower.
•Risk rating 6 (Special Mention)-Loans in this category generally represent currently protected, but potentially weak assets that deserve management’s close attention. If left uncorrected, the potential weaknesses may, at some future date, result in deterioration of the repayment prospects for the loan or in the Bank’s credit position. These loans constitute an unwarranted credit risk, but do not expose the Bank to sufficient risk to warrant adverse classification. Loans in this category may include credits that the Bank may be unable to supervise properly because of a lack of expertise, inadequate loan agreement, outdated and /or incomplete financial reporting, the condition of and control over collateral, failure to obtain proper documentation, or any other deviations from prudent lending practices. Economic or market conditions that may, in the future, affect the borrower, an adverse trend in the borrower’s operations or an imbalanced position in the balance sheet that has not reached a point where liquidation is jeopardized may warrant this Special Mention designation.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
•Risk rating 7 (Substandard)-Loans in this category represent assets inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness, or weaknesses, that jeopardize liquidation of the debt and are characterized by the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected. Loss potential, while existing in the aggregate amount of Substandard credits, does not have to exist in individual extensions of credit classified Substandard. Loans in this category are subject to impairment analysis, may require a specific reserve allocation and may be placed on non-accrual status.
•Risk rating 8 (Doubtful)-Loans in this category have all the weaknesses inherent in a Substandard credit with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly improbable. The key issue that makes a loan Doubtful is the potential for loss. The possibility for some degree of loss is extremely high, but because of certain important and reasonably specific pending factors that may be advantageous and strengthen the credit, a classification as an estimated loss is deferred until a more exact status can be determined. Such pending factors could include a proposed merger, acquisition or liquidation procedures, additional capital injection, perfection of liens on additional collateral and refinancing plans. Doubtful assets are subject to impairment analysis, a specific reserve allocation and must be placed on non-accrual status.
•Risk rating 9 (Loss) is assigned to charged-off loans. We consider assets classified as loss as uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has no recovery value, but that it is not practical to defer writing off the worthless assets, even though partial recoveries may occur in the future. Loans are charged off within the period in which they are determined to be uncollectible.
We charge off loans that management has identified as losses. We consider suggestions from our external loan review firm and bank examiners when determining which loans to charge off. We automatically charge off consumer loan accounts based on regulatory requirements. We partially charge off real estate loans that are collateral dependent based on the value of the collateral.
If a loan that was previously rated a pass performing loan, from our acquisitions, deteriorates subsequent to the acquisition, the subject loan will be assessed for risk and, if necessary, evaluated for impairment. If the risk assessment rating is adversely changed and the loan is determined to not be impaired, the loan will be placed in a migration category and the credit mark established for the loan will be compared to the general reserve allocation that would be applied using the current allowance for loan losses formula for General Reserves. If the credit mark exceeds the allowance for loan losses formula for General Reserves, there will be no change to the allowance for loan losses. If the credit mark is less than the current allowance for loan losses formula for General Reserves, the allowance for loan losses will be increased by the amount of the shortfall by a provision recorded in the income statement. If the loan is deemed impaired, the loan will be subject to evaluation for loss exposure and a specific reserve. If the estimate of loss exposure exceeds the credit mark, the allowance for loan losses will be increased by the amount of the excess loss exposure through a provision. If the credit mark exceeds the estimate of loss exposure there will be no change to the allowance for loan losses. If a loan from the acquired loan portfolio is carrying a specific credit mark and a current evaluation determines that there has been an increase in loss exposure, the allowance for loan losses will be increased by the amount of the current loss exposure in excess of the credit mark.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
The following tables outline the allocation of the loan portfolio by risk rating at December 31, 2018 and 2017.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
The following tables detail activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2018 and 2017. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Our recorded investment in loans as of December 31, 2018 and 2017 related to each balance in the allowance for probable loan losses by portfolio segment and disaggregated on the basis of our impairment methodology was as follows:
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
The following table outlines the maturity and rate re-pricing distribution of the loan portfolio. For purposes of this disclosure, we have classified non-accrual loans as immediately re-pricing or maturing.
As of December 31, 2018, the Bank has pledged loans totaling $353.7 million to support Federal Home Loan Bank borrowings.
The Bank makes loans to customers located in the Maryland suburbs and the surrounding Baltimore area. Residential and commercial real estate secure substantial portions of the Bank’s loans. Although the loan portfolio is diversified, the regional real estate market and economy will influence its performance.
7. Equity Securities
We own the following equity securities:
We carry these securities at cost and have evaluated them for other than temporary impairment. In 2018 and 2017, we did not record any such impairment.
8. Pointer Ridge Office Investment, LLC
We currently own 100% of Pointer Ridge and we have consolidated its results of operations from the date of acquisition. In August 2016, the Bank purchased the remaining aggregate 37.5% minority interest in Pointer Ridge not held by Bancshares and on September 2, 2016, we paid off the entire $5.8 million principal amount of a promissory note previously issued by Pointer Ridge. On September 28, 2017, Bancshares transferred and assigned its ownership interest in Pointer Ridge to the Bank, and as a result the Bank acquired all rights, title and interest in Pointer Ridge.
Pointer Ridge owns our headquarters building located at 1525 Pointer Ridge Place, Bowie, Maryland, containing approximately 40,000 square feet. We lease 98% of this building for our main office and operate a branch of the Bank from this address.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
9. Premises and Equipment
A summary of our premises and equipment and the related depreciation expense follows:
10. Deposits
Major classifications of interest bearing deposits are as follows:
Time deposits mature as follows:
Interest on deposits for the years ended December 31, 2018, 2017 and 2016, consisted of the following:
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
11. Short Term Borrowings
Bancshares has available an unsecured $5.0 million line of credit. The Bank has available lines of credit including overnight federal funds and reverse repurchase agreements from its correspondent banks totaling $65.0 million as of December 31, 2018. The Bank has an additional secured line of credit from the FHLB of $689.0 million. Prior to allowing the Bank to borrow under the line of credit, the FHLB requires that the Bank provide collateral to support borrowings. This collateral consists primarily of our commercial real estate loans, residential real estate loans and our multi-family loans. At December 31, 2018, we had provided $353.7 million in lendable collateral value and as outlined below have borrowed $190.0 million. We have additional available borrowing capacity of $163.7 million. We may increase this availability by pledging additional collateral. As a condition of obtaining the line of credit from the FHLB, the FHLB also requires that the Bank purchase shares of capital stock in the FHLB.
Securities Sold Under Agreements to Repurchase
To support the $38.2 million in repurchase agreements at December 31, 2018, we have provided collateral in the form of investment securities. At December 31, 2018, we have pledged $115.2 million in U.S. government agency securities and mortgage-backed securities to customers who require collateral for overnight repurchase agreements and deposits. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. As a result, there is no offsetting or netting of the investment securities assets with the repurchase agreement liabilities. We monitor collateral levels on a continuous basis. We may be required to provide additional collateral based on the fair value of the underlying securities in the event the collateral fair value falls below stipulated levels. We closely monitor the collateral levels to ensure adequate levels are maintained. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agents. We have the right to sell or re-pledge the investment securities. For government entity repurchase agreements, the collateral is held by Old Line Bank in a segregated custodial account under a tri-party agreement. The repurchase agreements totaling $38.2 million mature daily and will remain fully collateralized until the account has been closed or terminated.
At December 31, 2018, the book and market values of securities pledged as collateral for repurchase agreements were $120.8 million and $115.2 million, respectively.
Federal funds purchased are unsecured, overnight borrowings from other financial institutions. Short-term borrowings from the FHLB have a remaining maturity of less than one year.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Information related to short term borrowings is as follows:
12. Long Term Borrowings
The table below presents Bancshares’ long term borrowings at December 31, 2018 and 2017. The trust preferred subordinated debentures, acquired in the Regal acquisition, consists of two trusts - Trust 1 in the amount of $4.0 million (fair value adjustment of $1.4 million) maturing in 2034 and Trust 2 in the amount of $2.5 (fair value adjustment of $1.1 million) maturing in 2035. Long term borrowings also include $35 million in aggregate principal amount of Bancshares’ 5.625% Fixed-to-Floating Rate Subordinated Notes due 2026 (the “Notes”). The Notes were issued pursuant to an indenture and a supplemental indenture, each dated as of August 15, 2016, between Old Line Bancshares and U.S. Bank National Association as Trustee. The Notes are unsecured subordinated obligations of Old Line Bancshares and rank equally with all other unsecured subordinated indebtedness currently outstanding or issued in the future. The Notes are subordinated in right of payment of all senior indebtedness. The fair value of the Notes is $34.2 million at December 31, 2018.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
______________________
(1) The effective yield of the acquired subordinated debentures
Principal payments on long term debt obligations are due as follows:
13. Related Party Transactions
The Bank has entered into various transactions with firms in which owners are also members of the board of directors. Fees charged for these services are at similar rates charged by unrelated parties for similar work. Amounts paid to these related parties totaled $0, $87,300 and $282,602, during the years ended December 31, 2018, 2017 and 2016, respectively. The fees paid include rental payments to one of our former directors who retired from the board of directors effective May 24, 2017. The fees listed are for the period that the noted director served as a director of Bancshares.
Effective November 1, 2008, we purchased Chesapeake Custom Homes, L.L.C.’s 12.5% membership interest in Pointer Ridge for the book value of $205,000. This purchase increased Bancshares’ membership interest from 50.0% to 62.5%. A director of Bancshares and the Bank is the President and 52.0% stockholder of Lucente Enterprises, Inc. Lucente Enterprises, Inc. is the manager and majority member of Chesapeake Custom Homes, L.L.C. Lucente Enterprises retained its 12.5% membership interest in Pointer Ridge until August 19, 2016. In August 2016, the Bank purchased the aggregate 37.5% minority interest in Pointer Ridge not held by Bancshares. In 2018, 2017 and 2016, the Bank paid Pointer Ridge $0, $0 and $653,380, respectively, in lease payments.
The directors, executive officers and their affiliated companies maintained deposits with the Bank of $6,064,607 and $4,929,631 at December 31, 2018 and 2017, respectively.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
The schedule below summarizes changes in amounts of loans outstanding to directors and executive officers or their affiliated companies:
In addition to the outstanding balances, the directors and executive officers or affiliated companies have $858,023 in unused commitments as of December 31, 2018. In the opinion of management, these transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated parties.
14. Income Taxes
On December 22, 2017 the Tax Cuts and Jobs Act was signed into law with sweeping modifications to the Internal Revenue Code. The primary change for Bancshares was to lower the Federal corporate income tax rate to 21% from 35%. Bancshares re-measured its deferred tax assets and liabilities based on the income tax rates, at which they are expected to reverse in the future, which is generally 21%. However, Bancshares will continue to analyze certain aspects of the Act, which may result in refinements of the calculations that could potentially affect the measurement of these balances or give rise to new deferred tax amounts. The provisional amount recorded related to the re-measurement of Bancshares’ deferred tax balance was $2.9 million, resulting in an increase of income tax expense for the year ended December 31, 2017. Additionally, we had maintained a deferred tax asset valuation allowance in relation to net operating loss carryovers and other items in relation to the acquisition of Regal Bank. Management determined that the concerns that existed at the time we established the valuation reserve relating to this acquisition no longer existed and Bancshares therefore reversed this valuation allowance of $3.4 million, resulting in a decrease to tax expense for 2017. The net impact of these two items was a reduction of income tax expense of $472 thousand. The components of income tax expense are as follows:
We determine deferred tax assets and liabilities based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse. We allocate tax expense and tax benefits to the Bank and Bancshares based on their proportional share of taxable income.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
The components of net deferred tax assets and liabilities are as follows:
Maryland Bankcorp had net operating loss (“NOL”) carryovers of $3.54 million at the time of our business combination. We succeed to these carryovers and may take limited annual deductions allowed by the Internal Revenue Code. We will be able to deduct $779,812 every year the Bank has taxable income until the NOL is fully utilized. The amount we may deduct in any year will be reduced if we recognize a built in loss in such year or if our taxable income is lower than the statutory NOL deduction. If the NOL is not used by the limited annual deductions, any remaining amount of NOL carryforward will expire in 2030.
WSB Holdings, Inc. had NOL carryovers of $12.1 million at the time of our business combination in May 2013. We succeed to these carryovers and may take limited annual deductions allowed by the Internal Revenue Code. We will be able to deduct $1,477,746 every year the Bank has taxable income until the NOL is fully utilized. The amount we may deduct in any year will be reduced if we recognize a built in loss in such year or if our taxable income is lower than the statutory NOL deduction. If the NOL is not used by the limited annual deductions, any remaining amount of NOL carryforward will expire in 2033.
Regal had NOL carryovers of $8.7 million at the time of our business combination in December 2015. We succeed to these carryovers and may take limited annual deductions allowed by the Internal Revenue Service Code. We will be able to deduct $182,620 every year the Bank has taxable income until the NOL is fully utilized. The amount we may deduct in any year will be reduced if we recognize a built in loss in such year or if our taxable income is lower than the statutory NOL deduction. If the NOL is not used by the limited annual deductions, any remaining amount of NOL carryforward will expire in 2035. Additionally, the deferred tax asset was increased by $3.6 million at the time of acquisition and will be analyzed for utilization in future years. Management has determined that the concerns that existed at the time we established the valuation reserve relating to this acquisition no longer existed and therefore Bancshares has reversed this valuation allowance in total.
DCB had NOL carryovers of $157 thousand at the time of our business combination in July 2017. We succeeded to these carryovers and may take limited annual deductions allowed by the Internal Revenue Code. The amount we may deduct in any year will be reduced if we recognize a built in loss in such year or if our taxable income is lower than the statutory NOL deduction. If the NOL is not used by the limited annual deductions, any remaining amount of NOL carryforward will expire in 2036.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
BYBK had NOL carryovers of $881 thousand at the time of our business combination in April 2018. We succeed to these carryovers and may take limited annual deductions allowed by the Internal Revenue Code. We will be able to deduct $350,815 every year Bancshares has taxable income until the NOL is fully utilized. If the NOL is not used by the limited annual deductions, any remaining amount of NOL carryforward will expire in 2034.
Additionally, BYBK had NOL carryovers of $1.91 million at the time of our business combination in April 2018. We succeed to these carryovers and may take annual deductions every year Bancshares has taxable income up to 80% of the Bank’s taxable income until the NOL is fully utilized. The NOL has no expiration period.
BYBK had Alternative Minimum Tax (“AMT”) credit carryovers of $149 thousand at the time of our business combination in April 2018. We succeed to these carryovers and may take limited annual deductions allowed by the Internal Revenue Code. After consumption of BYBK limited NOL carryovers, we will be able to deduct $73,671 every year Bancshares has taxable income until the NOL is fully utilized. The credit carryforward has no expiration period and may be fully refundable after the end of the year ended December 31, 2021, subject to further clarification from the Internal Revenue Service. The AMT credits have been classified as a tax receivable.
We classify interest and penalties related to income tax assessments, if any, in income tax expense in the consolidated statements of operations. Bancshares and its subsidiaries file a consolidated U.S. federal tax return and both Bancshares and the Bank file a Maryland state income tax return. These returns are subject to examination by taxing authorities for all years after 2009. We had no material uncertain tax positions at December 31, 2018 or 2017 and there was no unrecognized tax benefit as of December 31, 2018 or 2017.
The following table reconciles the differences between the federal income tax rate of 21.0 percent and our effective tax rate:
15. Employee Benefits
Eligible employees participate in a profit sharing plan that qualifies under Section 401(k) of the Internal Revenue Code. The plan allows for elective employee deferrals and the Bank makes matching contributions of up to 4% of eligible employee compensation. Our contributions to the plan, included in employee benefit expenses, were $828,574, $618,056 and $599,395 for 2018, 2017, and 2016, respectively.
The Bank also offers Supplemental Executive Retirement Plans (“SERPs”) to its executive officers providing for retirement income benefits. We accrue the present value of the SERPs over the remaining number of years to the executives’ expected retirement dates. The combined accrued liability for these plans at December 31, 2018 and 2017 was $6.0 million and $5.9 million, respectively. The Bank’s expenses for the SERPs were $518,511, $671,182 and $649,244 in 2018, 2017, and 2016, respectively.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
MB&T had an employee benefit plan entitled the Maryland Bankcorp, N.A. KSOP (“KSOP”). The KSOP included a profit sharing plan that qualified under section 401(k) of the Internal Revenue Code as an employee stock ownership plan. We have discontinued any future contributions to the employee stock ownership plan. At December 31, 2018, the employee stock ownership plan owned 29,308 shares of Bancshares’ common stock, had $19,305 invested in Bank certificates of deposit, and $20,094 in a Bank money market account. We have transferred the MB&T KSOP assets at acquisition of MB&T on April 2, 2011 into the Bank’s 401(k) plan discussed above.
The annuity plan is an interest earning investment that we purchased to fund a new supplemental retirement plan and amendments to existing retirement plans that will provide lifetime payments to two of our executive officers; we entered into these new agreements as of May 7, 2018, as described in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2018. We invested $6.0 million during the fourth quarter of 2017 and the annuity plan was effective January 1, 2018. The annuity plan was valued at $6.3 million at December 31, 2018.
Stock Options and Restricted Stock
We maintain the Old Line Bancshares, Inc. 2010 Equity Incentive Plan (the “Plan”) under which we may grant, among other awards, options to purchase Bancshares’ common stock and restricted shares of common stock. The Compensation Committee of the board of directors administers the Plan. As the Plans outlines, the Compensation Committee approves stock option grants to directors and employees, determines the number of shares, the type of option, the option price, the term (not to exceed 10 years from the date of issuance) and the vesting period of options granted. The Compensation Committee has approved and we have granted options vesting immediately as well as over periods of two, three and five years. We recognize the compensation expense associated with these grants over their respective vesting periods. In 2013, stockholders approved an amendment to increase the number of shares issuable under the Plan by 450,000 shares. As of December 31, 2018, there were 182,137 shares remaining available for future issuance under the Plan. Shares issued upon exercise of options are issued from authorized but unissued shares.
The intrinsic value of the options that directors and officers exercised for the years ended December 31, 2018, 2017 and 2016 was $1,742,133, $488,995 and $830,962, respectively.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
A summary of the status of outstanding options follows:
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
At December 31, 2018, there was $1.6 million of total unrecognized compensation cost related to non-vested stock options that we expect to realize over the next three years. The following table summarizes the fair values of the options granted and weighted-average assumptions used to calculate the fair values. We used the Black-Scholes option pricing model.
During the year ended December 31, 2018, we granted 34,312 restricted common stock awards under the Plan.
The following table outlines the vesting schedule of the unvested restricted stock awards.
At December 31, 2018, there is $3.8 million unrecognized compensation cost related to non-vested restricted stock awards that we expect to realize over the next three years. A summary of the restricted stock awards during the year follows:
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
16. Capital Standards
The Federal Deposit Insurance Corporation and the Federal Reserve Board have adopted risk based capital standards for banking organizations. These standards require ratios of capital to assets for minimum capital adequacy and to be classified as well capitalized under prompt corrective action provisions. Under the amended prompt corrective action regulations, effective January 1, 2015, a bank is considered “well capitalized” if it: (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of at least 6.5% or greater; (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
As of December 31, 2018 and 2017, the capital ratios and the capital requirements to remain adequately and well capitalized are as follows:
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(1)When fully phased-in on January 1, 2019, the Basel III capital rules include a capital conservation buffer of 2.5% that is added on top of each of the minimum risk-based capital ratios noted above. Implementation began on January 1, 2016 at the 0.625% level and will increase each subsequent January 1, until it reaches 2.5% on January 1, 2019.
(2)Prompt corrective action provisions are not applicable at the bank holding company level.
Tier 1 capital consists of common stock, additional paid-in capital and retained earnings. Total capital includes a limited amount of the allowance for loan losses. In calculating risk weighted assets, specified risk percentages are applied to each category of asset and off balance sheet items.
Failure to meet the capital requirement could affect our ability to pay dividends and accept deposits and may significantly affect our operations.
In the most recent regulatory report, we were categorized as well capitalized under the prompt corrective action regulations. Management knows of no events or conditions that should change this classification.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
17. Commitments and Contingencies
The Bank is party to financial instruments with off balance sheet risk in the normal course of business in order to meet the financing needs of customers. These financial instruments include commitments to extend credit, available credit lines and standby letters of credit.
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 fixed interest rates fixed at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so 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 all customers will draw upon their lines of credit in full at any time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer’s credit-worthiness on a case by case basis. We regularly reevaluate many of our commitments to extend credit. Because we conservatively underwrite these facilities at inception, we generally do not have to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Our exposure to credit loss in the event of non-performance by the customer is the contract amount of the commitment. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
We have recognized a reserve in the amount of $30,873, $74,908 and $19,547 for loans sold in the secondary market with recourse obligations as of December 31, 2018, 2017 and 2016. In addition, a reserve in the amount of $88,281, $60,719 and $51,808 has been established for the unfunded portion of loan commitments at December 31, 2018, 2017 and 2016, respectively. Both reserves are included in other liabilities.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
As of December 31, 2018, we leased 26 branch locations and five loan production offices from non-related parties under lease agreements expiring through 2040. Each of the leases provides extension options.
The approximate future minimum lease commitments under the operating leases as of December 31, 2018, are presented below. We have eliminated 62.5% of lease commitments to Pointer Ridge in consolidation that was paid prior to Bank’s purchase of the remaining interest in Pointer Ridge.
Rent expense was $2,919,544, $2,104,832 and $2,056,401 for the years ended December 31, 2018, 2017, and 2016, respectively.
18. Fair Value Measurement
The fair value of an asset or liability is the price that participants would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability, or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
The fair value hierarchy established by accounting standards defines three input levels for fair value measurement. The applicable standard describes three levels of inputs that may be used to measure fair value: Level 1 is based on quoted market prices in active markets for identical assets. Level 2 is based on significant observable inputs other than Level 1 prices. Level 3 is based on significant unobservable inputs that reflect a company’s own assumptions about the assumption that market participants would use in pricing an asset or liability. We evaluate fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. For the years ended December 31, 2018 and 2017, there were no transfers between levels.
At December 31, 2018, Bancshares holds, as part of its investment portfolio, available for sale securities reported at fair value consisting of municipal securities, U.S. government sponsored entities, corporate bonds and mortgage-backed securities. The fair value of the majority of these securities is determined using widely accepted valuation techniques including matrix pricing and broker-quote based applications. Inputs include benchmark yields, reported trades, issuer spreads, prepayments speeds and other relevant items. These are inputs used by a third-party pricing service used by us. To validate the appropriateness of the valuations provided by the third party, we regularly update the understanding of the inputs used and compare valuations to an additional third party source. We classify all our investment securities available for sale in Level 2 of the fair value hierarchy, with the exception of treasury securities, which fall into Level 1, and our corporate bonds, which fall into Level 3.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes our methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value. Furthermore, we have not comprehensively revalued the fair value amounts since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the above-presented amounts.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
The following table provides a reconciliation of changes in fair value included in assets measured in the Consolidated Balance sheet using inputs classified as level 3 in the fair value for the period indicated:
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
We may be required from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with U.S. GAAP. These include assets that are measured at the lower of cost or market that we recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Loans considered impaired are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are subject to nonrecurring fair value adjustments to reflect write-downs that are based on the market price or current appraised value of the collateral, adjusted to reflect local market conditions or other economic factors. After evaluating the underlying collateral, the fair value of the impaired loans is determined by allocating specific reserves from the allowance for loan losses to the loans. Thus, the fair value reflects the loan balance as adjusted by partial charge-offs less the specifically allocated reserve. Certain collateral-dependent impaired loans are reported at the fair value of the underlying collateral.
Impairment is measured based on the fair value of the collateral, which is typically derived from appraisals that take into consideration prices in observed transactions involving similar assets and similar locations. Discounts applied to appraisals have been in the range of 0% to 50%. Each appraisal is updated on an annual basis, either through a new appraisal or through our internal review process. Appraised values are reviewed and monitored internally and fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. The fair value of impaired loans that are not collateral dependent is measured using a discounted cash flow analysis considered to be a Level 3 input.
The fair value of OREO is based on property appraisals adjusted at management’s discretion to reflect a further decline in the fair value of properties since the time the appraisal analysis was performed. Discounts applied to appraisals have predominantly been in the range of 0% to 50%; however, in certain cases have ranged up to 75% which include estimated costs to sell or other reductions based on market expectations or an executed sales contract. Appraised values are reviewed and monitored internally and fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. Therefore, the inputs used to determine the fair value of OREO and repossessed assets fall within Level 3. We may include within OREO other repossessed assets received as partial satisfaction of a loan. These assets are not material and do not typically have readily determinable market values and are considered Level 3 inputs. As a result of the acquisition of Maryland Bankcorp, WSB Holdings and Regal, we have segmented the other real estate owned into two components, real estate obtained as a result of loans originated by the Bank (legacy) and other real estate acquired from MB&T, WSB, Regal Bank and Bay Bank or obtained as a result of loans originated by MB&T, WSB, Regal Bank and Bay Bank (acquired). We had no OREO acquired from the DCB acquisition. The increase in level 3 is due to an increase in our legacy non-accrual loans, and acquired other real estate owned.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
The following disclosures of the estimated fair value of financial instruments are made in accordance with the requirements of ASC 825, “Disclosures about Fair Value of Financial Instruments”. We have determined the fair value amounts by using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
19. Other Operating Expenses
Other operating expenses that are significant are as follows:
______________________
(1) Reclassification of ATM expenses and professional fees are now included in other expenses.
20. Parent Company-Condensed Financial Information
The condensed balance sheets, statements of income, and statements of cash flows for Bancshares (Parent Company) follow:
Old Line Bancshares, Inc.
Condensed Balance Sheets
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
Old Line Bancshares, Inc.
Condensed Statements of Income
Old Line Bancshares, Inc.
Statements of Cash Flows
Old Line Bancshares, Inc. & Subsidiaries
Notes to Consolidated Financial Statements
(Continued)
21. Litigation
From time to time we may be involved in ordinary routine litigation incidental to our business. We are not, however, involved in any legal proceedings the outcome of which, in management’s opinion, would be material to our financial condition.
22. Subsequent Events
None
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
There were no disagreements with accountants on accounting matters and financial disclosures for the reporting periods presented.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this annual report on Form 10-K, Old Line Bancshares’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of Old Line Bancshares, Inc.’s disclosure controls and procedures. Based upon that evaluation, Old Line Bancshares, Inc.’s Chief Executive Officer and Chief Financial Officer concluded that Old Line Bancshares, Inc.’s disclosure controls and procedures are effective as of December 31, 2018. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by Old Line Bancshares, Inc. in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
In addition, there were no changes in Old Line Bancshares, Inc.’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the quarter ended December 31, 2018, that have materially affected, or are reasonably likely to materially affect, Old Line Bancshares, Inc.’s internal control over financial reporting.
Management’s Report On Internal Control Over Financial Reporting
The management of Old Line Bancshares, Inc. (“the Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control over financial reporting has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
As permitted by guidance provided by the staff of the U.S. Securities and Exchange Commission, the scope of management’s assessment of internal control over financial reporting as of December 31, 2018 has excluded Bay Bancorp, Inc., acquired on April 13, 2018. We have also excluded Bay Bancorp, Inc. from the scope of our audit of internal control over financial reporting. Bay Bancorp, Inc. constituted 17.27 percent of consolidated revenue (total net interest income and total non-interest income) for the year ended December 31, 2018, and 17.26 percent of consolidated total assets as of December 31, 2018.
Management has conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, utilizing the framework established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2018 is effective.
Dixon Hughes Goodman LLP, the registered public accounting firm that audited the Company’s financial statements included in this report as of December 31, 2018 and 2017 and for the three-year period ended December 31, 2018, has issued an attestation report on the Company’s internal control over financial reporting as of December 31, 2018 that is included elsewhere in this report.
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Code of Ethics
Old Line Bancshares, Inc.’s board of directors has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. That Code of Ethics for Senior Financial Officers is posted on Old Line Bancshares, Inc.’s internet website at www.oldlinebank.com. A copy of the Code of Conduct that applies to all of Old Line Bancshares’ and Old Line Bank’s officers, directors and employees is also available on Old Line Bancshares, Inc.’s Internet website.
The remaining information required by this Item 10 is incorporated by reference to the information appearing under the captions “Election of Directors,” “Board Meetings and Committees” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement for the 2019 Annual Meeting of Stockholders of Old Line Bancshares, Inc.
Item 11.
Item 11. Executive Compensation
The information required by this Item 11 is incorporated by reference to the information appearing under the captions “Director Compensation,” “Executive Compensation” and “Board Meetings and Committees” in the Proxy Statement for the 2019 Annual Meeting of Stockholders of Old Line Bancshares, Inc.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Securities Authorized For Issuance Under Equity Compensation Plans
The following table sets forth certain information as of December 31, 2018, with respect to compensation plans under which equity securities of Old Line Bancshares are authorized for issuance.
Equity Compensation Plan Information
December 31, 2018
______________________
(1)Includes the 2010 Equity Incentive Plan.
The remaining information required by this Item 12 is incorporated by reference to the information appearing under the caption “Ownership of Old Line Bancshares Common Stock” in the Proxy Statement for the 2019 Annual Meeting of Stockholders of Old Line Bancshares, Inc.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item 13 is incorporated by reference to the information appearing under the captions “Certain Relationships and Related Transactions” and “Election of Directors” in the Proxy Statement for the 2019 Annual Meeting of Stockholders of Old Line Bancshares, Inc.
Item 14.
Item 14. Principal Accounting Fees and Services
Audit and Non-Audit Fees
The following table presents combined fees for professional audit services rendered by Dixon Hughes Goodman LLP for the audit of Old Line Bancshares, Inc.’s annual consolidated financial statements for the years ended December 31, 2018 and 2017 and fees billed for other services rendered by Dixon Hughes Goodman LLP.
______________________
(1)Audit fees consist of fees billed for professional services rendered for the audit of the Old Line Bancshares, Inc.’s consolidated (or Old Line Bank’s) annual financial statements and review of the interim consolidated financial statements included in quarterly reports that Dixon Hughes Goodman LLP normally provides in connection with statutory and regulatory filings or engagements.
(2)Audit-related fees in 2018 and 2017 are for reviewing filings and assistance related to the audits for the 401K plan and Housing and Urban Development programs.
(3)Tax fees consist of fees billed for professional services rendered for federal and state compliance, tax advice and tax planning.
(4)All other fees consists of other miscellaneous fees.
Policy on Audit Committee Pre-Approval of Audit and Non-Audit Services of Independent Auditor
Old Line Bancshares, Inc.’s audit committee approves the engagement before Old Line Bancshares, Inc. or Old Line Bank engages the independent auditor to render any audit or non-audit services.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
Exhibit No.
Description of Exhibits
2.1(V)
Agreement and Plan of Merger by and between Old Line Bancshares, Inc. and Maryland Bankcorp, Inc., dated as of September 1, 2010, and Amendment No. 1 thereto
2.2(R)
Agreement and Plan of Merger by and between Old Line Bancshares, Inc. and WSB Holdings, Inc., dated as of September 10, 2012, and Amendment No. 1 thereto
2.3(EE)
Agreement and Plan of Merger, dated as of August 5, 2015, by and between Old Line Bancshares, Inc. and Regal Bancorp, Inc.
2.4(S)
Agreement and Plan of Merger by and between DCB Bancshares, Inc. and Old Line Bancshares, Inc. dated as of February 1, 2017.
2.5(FF)
Agreement and Plan of Merger by and between Old Line Bancshares, Inc. and Bay Bancorp, Inc. dated as of September 27, 2017.
3.1(A)
Articles of Amendment and Restatement of Old Line Bancshares, Inc.
3.1.1(L)
Articles of Amendment of Old Line Bancshares, Inc.
3.1.2(L)
Articles of Amendment of Old Line Bancshares, Inc.
3.1.3(AA)
Articles of Amendment of Old Line Bancshares, Inc.
3.2(A)
Amended and Restated Bylaws of Old Line Bancshares, Inc.
3.2.1(B)
Amendment to the Amended and Restated Bylaws of Old Line Bancshares, Inc.
3.2.2(C)
Second Amendment to the Amended and Restated Bylaws of Old Line Bancshares, Inc.
4(Y)
Specimen Stock Certificate for Old Line Bancshares, Inc.
10.1(F)*
Second Amended and Restated Executive Employment Agreement between Old Line Bank and James W. Cornelsen dated December 10, 2015
10.1.1(D)*
First Amendment to Second Amended and Restated Executive Employment Agreement between Old Line Bank and James W. Cornelsen dated as of January 1, 2017
10.2(I)*
Purchase Agreement dated August 10, 2016, by and between Old Line Bancshares, Inc. and Sandler O’Neill & Associates, L.P., as representative of the Initial Purchasers
10.3(K)*
Salary Continuation Agreement dated January 3, 2006 between Old Line Bank and James W. Cornelsen
10.4(O)*
First Amendment dated December 31, 2007 to the Salary Continuation Agreement between Old Line Bank and James W. Cornelsen
10.5(L)*
Second Amendment dated May 7, 2018, to the Salary Continuation Agreement between Old Line Bank and James W. Cornelsen originally effective as of January 3, 2006
Exhibit No.
Description of Exhibits
10.6(K)*
Supplemental Life Insurance Agreement dated January 3, 2006 between Old Line Bank and James W. Cornelsen
10.7(O)*
First Amendment dated December 31, 2007 to the Supplemental Life Insurance Agreement between Old Line Bank and James W. Cornelsen
10.8(D)*
Sixth Amendment to Re-Stated Executive Employment Agreement by and between Old Line Bank and Joseph Burnett dated as of February 25, 2017
10.9(K)*
Salary Continuation Agreement dated January 3, 2006 between Old Line Bank and Joseph Burnett
10.10(O)*
First Amendment dated December 31, 2007 to the Salary Continuation Agreement between Old Line Bank and Joseph Burnett
10.11(K)*
Supplemental Life Insurance Agreement dated January 3, 2006 between Old Line Bank and Joseph Burnett
10.12(O)*
First Amendment dated December 31, 2007 to the Supplemental Life Insurance Agreement between Old Line Bank and Joseph Burnett
10.13(DD)*
Salary Continuation Plan Agreement (2014) by and between Old Line Bank and Mark Semanie dated as of March 27, 2014
10.14(L)*
First Amendment dated May 7, 2018, to the Salary Continuation Plan Agreement (2014) by and between Old Line Bank and Mark A. Semanie dated as of March 27,2014
10.15(L)*
Supplemental Executive Retirement Plan by and between Old Line Bank and James W. Cornelsen dated as of May 7, 2018
10.16(Q)*
Executive Employment Agreement by and between Old Line Bank and Elise Hubbard dated as of May 7, 2018
10.17(Q)*
Executive Employment Agreement by and between Old Line Bank and Jack Welborn dated as of May 7, 2018
10.18(O)*
First Amendment dated December 31, 2007 to the Supplemental Life Insurance Agreement between Old Line Bank and Christine Rush
10.19(E)*
2004 Equity Incentive Plan
10.20(G)*
Form of Incentive Stock Option Agreement for 2004 Equity Incentive Plan
10.21(X)*
Form of Nonqualified Stock Option Agreement for 2004 Equity Incentive Plan
10.22(U)*
Form of Restricted Stock Agreement for the 2004 Equity Incentive Plan
10.23(G)*
Old Line Bancshares, Inc. and Old Line Bank Director Compensation Policy
10.24(H)*
Incentive Plan Model and Stock Option Model
Exhibit No.
Description of Exhibits
10.25(BB)*
Old Line Bancshares, Inc. 2010 Equity Incentive Plan
10.26(Z)*
Form of Restricted Stock Agreement under 2010 Equity Incentive Plan
10.27(Z)*
Form of Non-Qualified Stock Option Grant Agreement under 2010 Equity Incentive Plan
10.28(Z)*
Form of Incentive Stock Option Grant Agreement under 2010 Equity Incentive Plan
10.29(J)
Agreement of Lease by and between Pointer Ridge Office Investment, LLC, a Maryland limited liability company (Landlord) and Old Line Bank (Tenant) dated December 29, 2011 (Suite 101)
10.30(J)
Agreement of Lease by and between Pointer Ridge Office Investment, LLC, a Maryland limited liability company (Landlord) and Old Line Bank (Tenant) dated December 29, 2011 (Suite 301)
10.31(M)*
Salary Continuation Plan Agreement (2012-A Plan) by and between Old Line Bank and James W. Cornelsen dated as of October 1, 2012, and form of Change in Control Benefit Election Form thereunder
10.32(L)*
First Amendment dated May 7, 2018, to the Salary Continuation Plan Agreement (2012-A Plan) by and between Old Line Bank and James W. Cornelsen dated as of October 1, 2012
10.33(M)*
Salary Continuation Plan Agreement (2012-B Plan) by and between Old Line Bank and James W. Cornelsen dated as of October 1, 2012, and form of Change in Control Benefit Election Form thereunder
10.34(L)*
First Amendment dated May 7, 2018, to the Salary Continuation Plan Agreement (2012-B Plan) by and between Old Line Bank and James W. Cornelsen dated as of October 1, 2012
10.35(T)*
Salary Continuation Plan Agreement (2010 Plan) by and between Old Line Bank and James W. Cornelsen dated as of February 26, 2010
10.36(L)*
First Amendment dated May 7, 2018, to the Salary Continuation Agreement between Old Line Bank and James W. Cornelsen originally effective as of June 7, 2010
10.37(T)*
Salary Continuation Plan Agreement (2010 Plan) by and between Old Line Bank and Joseph E. Burnett dated as of February 26, 2010
10.38(Q)*
Amended and Restated Executive Employment Agreement by and between Old Line Bank and Mark A. Semanie dated as of May 7, 2018
10.39(Q)*
Amended and Restated Executive Employment Agreement by and between Old Line Bank and Martin John Miller dated as of May 7, 2018
21(N)
Subsidiaries of Registrant
Exhibit No.
Description of Exhibits
23.1
Consent of Dixon Hughes Goodman LLP
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
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes- Oxley Act of 2002
99.1(A)
Agreement and Plan of Reorganization between Old Line Bank and Old Line Bancshares, Inc., including form of Articles of Share Exchange attached as Exhibit A thereto
Interactive Data Files pursuant to Rule 405 of Regulation S-T
______________________
*Management compensatory plan, contract or arrangement.
(A)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Registration Statement on Form 10-SB, as amended, under the Securities Exchange Act of 1934, as amended (File Number 000-50345).
(B)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on March 24, 2011.
(C)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Quarterly Report on Form 10-Q filed on August 10, 2012.
(D)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Registration Statement on Form S-4, under the Securities Act of 1933, as amended (File Number 333-221714).
(E)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Registration Statement on Form S-8, under the Securities Act of 1933, as amended (File Number 333-116845).
(F)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2015, filed on March 11, 2016.
(G)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on January 5, 2005.
(H)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from Old Line Bancshares, Inc.’s Quarterly Report on Form 10-QSB filed on August 10, 2005.
(I)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on August 15, 2016.
(J)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on January 4, 2012.
(K)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on January 6, 2006.
(L)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Quarterly Report on Form 10-Q filed with the Commission on August 9, 2018.
(M)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on October 4, 2012.
(N)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2017, filed on November 6, 2017.
(O)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on January 7, 2008.
(P)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Quarterly Report on Form 10-Q filed on August 15, 2011.
(Q)Previously filed by Old Line Bancshares, Inc. as a part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter period ended March 31, 2018, filed on May 9, 2018.
(R)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Annex A to Old Line Bancshares, Inc.’s Registration Statement on Form S-4 under the Securities Act of 1933, as amended (File Number 333-184924).
(S)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on February 1, 2017.
(T)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Amendment No. 1 to Old Line Bancshares, Inc.’s Registration Statement on Form S-4 under the Securities Act of 1933, as amended (File Number 333-184924).
(U)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K filed on January 28, 2010.
(V)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Annex A of Old Line Bancshares, Inc.’s Registration Statement on Form S-4 under the Securities Act of 1933, as amended (File Number 333-170464).
(W)Reserved.
(X)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2009, filed on March 26, 2010.
(Y)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Pre-Effective Amendment No. 1 on Form S-8 to Registration Statement on Form S-4 (File Number 333-184924) filed on May 20, 2013.
(Z)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Appendix A of Old Line Bancshares, Inc.’s Proxy Statement on Schedule 14A, filed with the Commission on April 19, 2010.
(AA)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Quarterly Report on Form 10-Q, filed with the Commission on November 14, 2013.
(BB)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Appendix B of Old Line Bancshares, Inc.’s Proxy Statement on Schedule 14A, filed with the Commission on July 12, 2013.
(CC)Reserved.
(DD)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Quarterly Report on Form 10-Q filed with the Commission on May 9, 2014.
(EE)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Amendment No. 1 to Current Report on Form 8-K filed with the Commission on August 5, 2015.
(FF)Previously filed by Old Line Bancshares, Inc. as part of, and incorporated by reference from, Old Line Bancshares, Inc.’s Current Report on Form 8-K/A filed with the Commission on September 28, 2017.
Item 16. Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ James W. Cornelsen
Director, President and Chief Executive Officer (Principal
March 13, 2019
James W. Cornelsen
Executive Officer)
/s/ Elise M. Hubbard
Chief Financial Officer (Principal Accounting and Financial
March 13, 2019
Elise M. Hubbard
Officer)
/s/ Craig E. Clark
Director and Chairman of the Board
March 13, 2019
Craig E. Clark
/s/ ROSIE ALLEN-HERRING
Director
March 13, 2019
Rosie Allen-Herring
/s/ STEVEN BREEDEN
Director
March 13, 2019
Steven Breeden
/s/ James R. Clifford, Sr.
Director
March 13, 2019
James R. Clifford, Sr.
/s/ Stephen J. Deadrick
Director
March 13, 2019
Stephen J. Deadrick
/s/ James F. Dent
Director
March 13, 2019
James F. Dent
/s/ Andre’ J. Gingles
Director
March 13, 2019
Andre’ J. Gingles
/s/ Thomas H. Graham
Director
March 13, 2019
Thomas H. Graham
/s/ ERIC D. HOVDE
Director
March 13, 2019
Eric D. Hovde
/s/ Gail D. Manuel
Director
March 13, 2019
Gail D. Manuel
/s/ Gregory S. Proctor, Jr.
Director
March 13, 2019
Gregory S. Proctor, Jr.
/s/ Jeffrey A. Rivest
Director
March 13, 2019
Jeffrey A. Rivest
/s/ Suhas R. Shah
Director
March 13, 2019
Suhas R. Shah
/s/ John M. Suit, II
Director
March 13, 2019
John M. Suit, II