ITEM 1. BUSINESS
General
Community Financial Corporation is a Virginia corporation, which owns Community Bank. Community Bank was organized in 1928 as a Virginia-chartered building and loan association, converted to a federally-chartered savings and loan association in 1955 and to a federally-chartered savings bank in 1983. In 1988, Community Bank converted to the stock form of organization through the sale and issuance of shares of our common stock. References in this document to we, us, our, the Corporation, the Company and the Bank refer to Community Financial and/or Community Bank as the context requires.
Our principal asset is the outstanding stock of Community Bank, our wholly owned subsidiary. Our common stock trades on The Nasdaq Stock Market under the symbol “CFFC.”
Community Financial Corporation and Community Bank are subject to comprehensive regulation, examination and supervision by the Office of the Comptroller of the Currency, Department of the Treasury, the Board of Governors of the Federal Reserve System and by the Federal Deposit Insurance Corporation. The Bank is a member of the Federal Home Loan Bank (“FHLB”) System and our deposits are backed by the full faith and credit of the United States Government and are insured to the maximum extent permitted by the Federal Deposit Insurance Corporation. At March 31, 2012, we had $503.9 million in assets, deposits of $372.4 million and stockholders' equity of $50.4 million. Our primary business consists of attracting deposits from the general public and originating real estate loans and other types of investments through our offices located in Staunton, Waynesboro, Stuarts Draft, Raphine, Verona, Lexington, Harrisonburg, Buena Vista and Virginia Beach, Virginia.
Like all financial institutions our operations are materially affected by general economic conditions, the monetary and fiscal policies of the federal government and the policies of the various regulatory authorities, including the Office of the Comptroller of the Currency and the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). Our results of operations are largely dependent upon our net interest income, which is the difference between the interest we receive on our loan portfolio and our investment securities portfolio, and the interest we pay on our deposit accounts and borrowings.
Dramatic declines in the housing market over the past four years, with decreasing home prices and increasing delinquencies and foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. General downward economic trends, reduced availability of commercial credit, and increasing unemployment and under-employment have negatively impacted the credit performance of commercial and consumer credit as well, resulting in additional write-downs for many financial institutions. Concerns over the stability of the financial markets and the economy also have resulted in decreased lending by many financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased delinquencies and foreclosures, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Some financial institutions have experienced decreased access to deposits or borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets has and may continue to adversely affect our business, results of operations and stock price.
Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our loan portfolio is more complex under these difficult market and economic conditions. We expect to face increased regulation and government oversight as a result of these downward trends. This increased government action may increase our costs and limit our ability to pursue certain business opportunities.
We do not expect these difficult conditions to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers and the other financial institutions in our market. As a result, we may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds. We also may be required to pay even higher FDIC premiums, because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the FDIC insurance fund and reduce the FDIC’s ratio of reserves to insured deposits.
As previously mentioned, we are subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. The laws and regulations governing our business are subject to frequent change. Any change in these regulations and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums could have a material impact on our operations.
In response to the financial crisis of 2008 and early 2009, Congress has taken actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the Federal Deposit Insurance Corporation has taken actions to increase insurance coverage on deposit accounts. In addition, there have been proposals made by members of Congress and others that would reduce the amount delinquent borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral.
The potential exists for additional federal or state laws and regulations, or changes in policy, affecting lending and funding practices and liquidity standards. Moreover, bank regulatory agencies have been active in responding to concerns and trends identified in examinations, and have issued many formal enforcement orders requiring capital ratios in excess of regulatory requirements. Bank regulatory agencies, such as the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, govern the activities in which we may engage, primarily for the protection of depositors, and not for the protection or benefit of investors. New laws and regulations may increase our costs of regulatory compliance and of doing business, and otherwise affect our operations. New laws and regulations also may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability.
Congress passed the Dodd-Frank financial reform legislation. This legislation will have a significant impact on the regulation and operations of financial institutions and their holding companies. The legislation will subject Community Financial to regulatory capital requirements. The legislation also created a new consumer financial protection agency that will issue and enforce consumer protection initiatives governing financial products and services. Any legislative or regulatory changes in the future could adversely affect our operations and financial condition.
Our main office is located at 38 North Central Avenue, Staunton, Virginia 24401. Our telephone number is (540) 886-0796. This annual report on Form 10-K, as well as other public information that we file with the Securities and Exchange Commission, is also available on our website at www.cbnk.com and on the Securities and Exchange Commission’s website at www.sec.gov.
Our Operating Strategy
Our goal is to operate and grow a profitable community-oriented financial institution, and to maximize stockholder value by:
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retaining our community-oriented focus to meet the financial needs of the communities we serve;
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enhancing our focus on core deposits, including savings and checking accounts;
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improving asset quality;
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selectively emphasizing products and services to provide diversification of revenue sources and to capture our customer’s full relationship. We intend to continue to expand our business by cross selling our loan and deposit products and services to our customers;
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growing, when economic conditions are suitable, and diversifying our loan portfolio by emphasizing the origination of commercial and multi-family real estate loans, one- to four-family residential mortgage loans, construction loans, secured business loans and consumer loans;
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expanding our banking network by opening de novo branches and by selectively acquiring branch offices, although currently we do not have any specific expansion plans;
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controlling operating expenses while continuing to provide quality personal service to our customers; and
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utilizing borrowings as needed to fund growth and enhance profitability.
Market Area
Our primary market area includes the counties of Shenandoah, Rockingham, Page, Highland, Augusta, Albemarle, Bath, Rockbridge, Nelson, and the Hampton Roads area in Virginia. Our headquarters are located in Historic Downtown Staunton, Virginia in Augusta County. We conduct our business through our headquarters and 10 branch offices located in Staunton (2), Waynesboro, Stuarts Draft, Raphine, Verona, Lexington, Harrisonburg, Buena Vista and Virginia Beach (2), Virginia.
The state’s economy is likely to experience sustained high levels of unemployment throughout 2012 and may not return to pre-recession levels of unemployment until after 2014.
Harrisonburg-Rockingham County has a population of approximately 122,858. Major employment sectors include educational services, healthcare, manufacturing, trade, government, and construction. The largest employers headquartered here include James Madison University, Rockingham Memorial Hospital, Pilgrim’s Pride Corp., R.R. Donnelly & Sons Co., and Merck & Co., Inc.
The Staunton-Waynesboro-Augusta County area has a population of approximately 116,299. Major employment sectors include manufacturing, healthcare, retail trade, hospitality, and educational services. Major employment sectors include services, manufacturing, trade, government, and construction. The largest employers headquartered here include Augusta Medical Center, McKee Foods Corporation, Hershey Chocolate of VA, Target Mid-Atlantic Distribution Center, Hollister, and McQuay International.
Lexington-Buena Vista-Rockbridge County has a population of approximately 35,740. Major employment sectors include educational services, government, manufacturing, trade, and construction. The largest employers headquartered here include Lees Carpets, Washington & Lee University, Stonewall Jackson Hospital, Wal-Mart, Inc. and Virginia Military Institute.
The Virginia Beach and Hampton Roads region has a combined population of approximately 1.5 million. The military and military contractors have a large presence in this region. Major employment sectors include food service, employment service, agricultural & engineering services, physicians offices (medical), and services to buildings/dwellings. The largest employers headquartered here include Northrop Grumman, Newport News, Sentara Healthcare, Virginia Beach City Public School, Norfolk Naval Shipyard and Riverside Health System.
Lending Activities
General. We concentrate our lending activities on first mortgage conventional loans secured by residential properties, commercial and multi-family real estate with an emphasis on multi-family housing and, to a lesser extent, construction loans secured by commercial and multi-family real estate and one- to four-family residential properties, and commercial business loans. Additionally, we make consumer loans in order to increase the diversification and decrease the interest rate sensitivity of our loan portfolio, and to increase interest income as these loans typically carry higher interest rates than residential mortgage loans. Beginning in fiscal 2011, we substantially curtailed our construction lending due to the lingering effects of the recession. Substantially all of our loans are originated within our market area.
Residential loan originations come primarily from walk-in customers, real estate brokers and builders. Commercial and multi-family real estate loan originations are obtained through direct solicitation of developers and continued business from customers. All completed loan applications are reviewed by our salaried loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment and credit history of the applicant and any related business interests. If commercial or multi-family real estate is involved, information is also obtained concerning cash flow after debt service. The quality of loans is analyzed based on our experience and on guidelines with respect to credit underwriting as well as the guidelines issued by Freddie Mac and Fannie Mae and other purchasers of loans, depending on the type of loans involved. All real estate is appraised by independent fee appraisers who have been pre-approved by our Board of Directors.
Our loan commitments are approved at different levels, depending on the size and type of the loan being sought. Our Board of Directors has authorized different loan limits for individual loan officers depending on the types of loans being approved. Individual loan officer limits for one- to four-family real estate loans range from $125,000 to $300,000 and for commercial real estate loans range from $100,000 to $175,000. One- to four-family real estate loans not exceeding $350,000 and commercial real estate loans not exceeding $225,000 may be approved by the President of the Bank. One- to four-family real estate loans not exceeding $950,000 and commercial real estate loans not exceeding $875,000 may be approved by one member of senior management and two other officers. Any loan not exceeding $1,000,000 may be approved by the Bank’s loan committee. All loans in excess of $1,000,000 must be
approved by the Board of Directors. Individual loan officer limits for unsecured consumer and commercial business loans range from $10,000 to $50,000 and for secured consumer and commercial business loans range from $25,000 to $175,000. Consumer and commercial business loans up to $375,000 on a secured basis and $150,000 on an unsecured basis require the approval of one member of senior management and two other officers. Consumer and commercial business loans in excess of individual loan officer or collective senior management loan authority must be approved by a majority of our Loan Committee or Board of Directors.
The aggregate amount of loans that the Bank is permitted to make to any one borrower, including related entities, and the aggregate amount that the Bank may invest in any one real estate project, with certain exceptions, is limited to the greater of 15% of our unimpaired capital and surplus or $500,000. At March 31, 2012, the maximum amount which we could have loaned to one borrower and the borrower’s related entities or invested in any one project was approximately $8.4 million. At March 31, 2012, we had only 14 borrowers, or groups of related borrowers, with an aggregate outstanding loan balance in excess of $3.0 million, with the largest being a $6.6 million relationship, consisting of one secured business loan. At March 31, 2012, we had one relationship in excess of $3.0 million that was not performing in accordance with its payment terms. We also had 28 other borrowers, or groups of related borrowers, with an aggregate outstanding loan balance at March 31, 2012 of between $2.0 million and $3.0 million. At March 31, 2012, we had four relationships between $2.0 million and $3.0 million not performing in accordance with their payment terms.
Loan Portfolio Composition. The following table sets forth the composition of our total loan portfolio in dollars and percentages as of the dates indicated.
The following table shows the composition of our loan portfolio by fixed and adjustable-rate, at the dates indicated.
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(1) Includes residential real estate construction loans of $3.4 million, $0, $3.2 million, $1.9 million and $247,000, and commercial real estate construction loans of $537,000, $537,000, $4.3 million, $1.6 million and $6.6 million at March 31, 2012, 2011, 2010, 2009 and 2008 respectively.
(2) Includes residential real estate construction loans of $8.6 million, $19.3 million, $39.3 million, $45.2 million and $43.3 million, and commercial real estate construction loans of $9.3 million, $7.6 million, $17.0 million, $14.2 million and $3.7 million at March 31, 2012, 2011, 2010, 2009 and 2008, respectively.
Loan Maturity and Repricing. The following schedule illustrates the contractual maturity of our real estate construction and commercial business loan portfolios as of March 31, 2012, before net items. Loans that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
The total amount of loans in the above table due after March 31, 2013, which have fixed interest rates is $12.0 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $5.0 million.
One- to Four-Family Residential Real Estate Lending. We originate loans secured by one- to four-family residences, substantially all of which are located in our market areas. We evaluate both the borrower’s ability to make principal and interest payments and the value of the property that will secure the loan. Although federal law permits us to make loans in amounts of up to 100% of the appraised value of the underlying real estate, we generally make one- to four-family residential real estate loans in amounts of 80% or less of the appraised value. In certain instances, we will lend up to 90% of the appraised value of the underlying real estate and require the borrower to purchase private mortgage insurance in an amount sufficient to reduce our exposure to 80% or less.
In order to manage our exposure to changes in interest rates, in the past we originated only a limited amount of 30-year and 15-year fixed-rate, one-to four-family residential mortgage loans for our portfolio. For the year ended March 31, 2012, 83.0% of all one-to four-family residential loans we originated had adjustable interest rates. At March 31, 2012, only $16.9 million, or 3.7%, of our total loans receivable, before net items, consisted of fixed-rate residential mortgage loans. During the year ended March 31, 2012, we originated $230,000 of fixed rate residential loans with terms of 15 years or more for our portfolio.
To compete with other lenders in our market area, we make one, three and five year adjustable-rate mortgage (“ARM”) loans at interest rates which, for the initial period, may be below the index rate which would otherwise apply to these loans. Borrowers are qualified, however, at the fully indexed interest rate. Our one- to four-family residential ARM loans primarily have interest rates that adjust annually after the initial fixed period based on a stated interest margin over the yields on one year U.S. Treasury Bills. Although our one- to four-family ARM loans primarily adjust annually after the initial period, we currently offer residential ARM loans which adjust every three and five years generally in accordance with the rates based on a stated margin over the yields on the applicable U.S. Treasury Bills. At March 31, 2012 we had the following loans that adjust on an annual basis after the initial period: $24.3 million that adjust after three years, $56.1 million after five years, $404,000 after seven years and $4.6 million after ten years. An additional $191,000 of loans adjust every three years. We do not currently offer residential ARM loans with an initial adjustment period greater than five years. Our ARM loans
generally limit interest rate increases to 2% each rate adjustment period and have an established ceiling rate at the time the loans are made of up to 6% over the original interest rate. At March 31, 2012, residential ARM loans totaled $118.6 million, representing 87.5% of our total residential real estate loans and 26.0% of our total loans receivable, before net items. ARM loans generally pose different credit risks than fixed-rate loans primarily because during periods of rising interest rates, the risk of defaults on ARM loans may increase due to the upward adjustment of interest costs to borrowers.
All one- to four-family real estate mortgage loans originated by us contain a “due-on-sale” clause that allows us to declare the unpaid principal balance due and payable upon the sale of the mortgaged property. It is our policy to enforce these due-on-sale clauses concerning fixed-rated loans and to permit assumptions of ARM loans, for a fee, by qualified borrowers.
We require, in connection with the origination of residential real estate loans, title opinions and fire and casualty insurance coverage, as well as flood insurance where appropriate, to protect our interests. The cost of this insurance coverage is paid by the borrower. We generally do not require escrows for taxes and insurance.
Commercial Real Estate and Construction Lending. We have originated and, in the past have purchased, commercial real estate loans and loan participations. We also make commercial and residential real estate construction loans. Our commercial real estate loans are secured by various types of collateral, including raw land, multi-family residential buildings, hotels and motels, convenience stores, commercial and industrial buildings, shopping centers and churches. At March 31, 2012, commercial real estate and construction loans aggregated $191.9 million or 42.0% of our total loans receivable, before net items, with $156.3 million of these loans having adjustable interest rates and $35.6 million having fixed interest rates. Our commercial real estate and construction loans are secured primarily by properties located in our market areas.
Our commercial real estate loans are generally made at interest rates that adjust annually based on yields for one-year U.S. Treasury securities, with a 2% annual cap on rate adjustments and a 6% cap on interest rates over the life of the loan. Typically, we charge origination fees ranging from 1% to 2% on these loans. Commercial real estate loans made by us are fully amortizing with maturities ranging from five to 30 years. Our construction loans are generally for a term of 12 months or less with interest only due monthly. Construction loans are generally made with permanent financing to be provided by us, although not required. Construction loans to builders may be made on a basis where a buyer has contracted to buy the house or the construction may be on a speculative basis. Limits are set by us as to the number of each type of construction loan for each builder, whether speculative or pre-sold, dependent on the determination made by us during the underwriting process.
In our underwriting of commercial real estate and construction loans, we may lend, under federal regulations, up to 100% of the security property’s appraised value, although the loan to original appraised value ratio on such properties is generally 80% or less. Our commercial real estate and construction loan underwriting requires an examination of debt service coverage ratios, the borrower’s creditworthiness and prior credit history and reputation, and we generally require personal guarantees or endorsements of borrowers. We also carefully consider the location of the security property.
At March 31, 2012, we had commercial real estate loans totaling $170.2 million, including 61 commercial real estate loans (or multiple loans to one borrower) in excess of $1.0 million with an aggregate balance of $78.7 million. The largest loan or lending relationship to a single borrower was for $4.9 million, which consisted of one loan secured by commercial real estate. Loans secured by commercial and industrial buildings decreased from $52.7 million at March 31, 2011 to $50.1 million at March 31, 2012, loans secured by hotels and motels decreased from $21.0 million at March 31, 2011 to
$16.6 million at March 31, 2012, and loans secured by raw land decreased from $44.0 million at March 31, 2011 to $40.2 million at March 31, 2012, accounting for the decrease in our commercial real estate loan portfolio.
The following table presents information as to our commercial real estate and commercial construction lending portfolio as of March 31, 2012, by type of project.
At March 31, 2012, we had 19 commercial construction loans totaling $9.9 million, the largest one having an outstanding balance of $2.9 million. At that date, all commercial construction loans were performing in accordance with their payment terms. Our commercial construction loans are generally made for a one year term or less, with a requirement that the borrower have a commitment for permanent financing prior to funding the construction loan. Our construction loans generally provide for a fixed rate of interest at or above the prevailing prime rate. Such loans are generally secured by the personal guarantees of the borrowers and by first mortgages on the projects.
A large portion of our commercial real estate portfolio consists of loans secured by raw land. The Company originates loans to local real estate developers with whom it has established relationships for the purpose of developing residential subdivisions (i.e., installing roads, sewers, water and other utilities), as well as loans to individuals to purchase building lots. Land development loans are secured by a lien on the property and made for a period usually not to exceed twelve months with an interest rate that adjusts with the prime rate, and are made with loan-to-value ratios not exceeding 80%. Monthly interest payments are required during the term of the loan. Subdivision loans are structured so that we are repaid in full upon the sale by the borrower of approximately 90% of the subdivision lots. All of our land loans are secured by property located in our primary market area. We also generally obtain personal guarantees from financially capable parties based on a review of personal financial statements.
Loans secured by undeveloped land or improved lots involve greater risks than one- to four- family residential mortgage loans because these loans are advanced upon the predicted future value of the developed property. If the estimate of the future value proves to be inaccurate, in the event of default and
foreclosure, the Company may be confronted with a property the value of which is insufficient to assure full repayment. Loans on raw land may run the risk of adverse zoning changes, environmental or other restrictions on future use. At March 31, 2012, we had $3,149,000 of non-performing raw land loans.
We also make construction loans to individuals for the construction of their residences as well as to builders and developers for the construction of non-residential properties, one- to four-family residences and the development of one- to four-family lots in Virginia. These construction loans are generally for a term of 12 months or less with interest only due monthly. Construction loans are generally made with permanent financing to be provided by us, although not required. Construction loans to builders may be made on a basis where a buyer has contracted to buy the house or the construction may be on a speculative basis. Limits are set by us as to the number of each type of construction loan for each builder, whether speculative or pre-sold, dependent on the determination made by us during the underwriting process. At March 31, 2012, we had $11.9 million or 2.6% of our total loans receivable, before net items, in 62 residential construction loans, the largest of which was $520,000, compared to $21.3 million or 4.3% at March 31, 2011. Residential construction loans totaled approximately 54.6% of the total construction loan portfolio. Unfunded commitments on residential construction loans totaled $3.2 million at March 31, 2012. At March 31, 2012, we had $520,000 of non-performing residential construction loans.
Commercial real estate and construction lending is generally considered to involve a higher level of credit risk than one- to four-family residential lending due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on real estate developers and managers. Our risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s sale value upon completion of the project and the estimated cost of the project. If the estimated cost of construction or development proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project with value which is insufficient to assure full repayment. Because we usually provide loans to a developer for the entire estimated cost of the project, defaults in repayment generally do not occur during the construction period and it is therefore difficult to identify problem loans at an early stage. When loan payments become due, borrowers may experience cash flow from the project which is not adequate to service total debt. This cash flow shortage can result in the failure to make loan payments. In such cases, we may be compelled to modify the terms of the loan. In addition, the nature of these loans is such that they are generally less predictable and more difficult to evaluate and monitor. We have reduced our non-owner occupied commercial real estate loans from $148.9 million and 270% of risk based capital at March 31, 2011 to $146.5 million and 264% of risk based capital at March 31, 2012.
Consumer Lending. We offer a variety of secured consumer loans, including new and used automobile loans, home equity loans and lines of credit, and deposit account, installment and demand loans. We also offer unsecured loans. We originate our consumer loans primarily in our market areas. At March 31, 2012, our consumer loans totaled $81.3 million or 17.8% of our total loans receivable, before net items. With the exception of $39.1 million of home equity loans and lines of credit at March 31, 2012, our consumer loans primarily have fixed interest rates and generally have terms ranging from 90 days to six years.
The largest component of our consumer loans is home equity loans and lines of credit. At March 31, 2012, our home equity loans and lines of credit totaled $46.7 million and comprised 10.2% of our total loan portfolio, before net items, including $39.1 million of home equity lines of credit. Home equity loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 90% of the value of the property securing the loan. Home equity lines of credit generally are originated with an
adjustable rate of interest, based on the prime rate of interest. Home equity lines of credit have a 20 year term and amounts may be re-borrowed after payment at any time during the life of the loan. At March 31, 2012, unfunded commitments on these lines of credit totaled $17.8 million.
We originate automobile loans on a direct and indirect basis. Automobile loans totaled $27.4 million at March 31, 2012, or 12.5% of our total loan portfolio, before net items, with $5.2 million in direct loans and $22.2 million in indirect loans. Our automobile loan portfolio decreased from $31.3 million at March 31, 2011 to $27.4 million at March 31, 2012, or 6.0%. The decrease in automobile loans is attributable to a slower economic environment and increased competition. The bulk of our indirect lending comes from relationships with approximately 40 car dealerships under an arrangement providing a premium for the amount over our interest rate to the referring dealer, with approximately half of these loans originated through four dealerships located in our market area. Indirect lending is highly competitive; however, our ability to provide same day funding makes our product competitive. Automobile loans may be written for a term of up to six years and have fixed rates of interest. Loan-to-value ratios are up to 110% of the manufacturer's suggested retail price for new direct auto loans and 125% of the manufacturer's invoice for new indirect auto loans. For used car loans we use the same loan-to-value ratios based on National Automobile Dealers Association ("NADA") retail value for direct loans and NADA trade-in value for indirect loans.
The automobile loans are generally evenly divided between new and used vehicles. The automobile loans are primarily without recourse to the dealer, but the Bank may require either full or partial recourse to the dealer if the customer’s credit history or the loan to value ratio of the vehicle warrants such recourse.
We follow our internal underwriting guidelines in evaluating direct automobile loans, including credit scoring. Indirect automobile loans are underwritten by a third party on our behalf, using substantially similar guidelines to our internal guidelines. However, because these loans are originated through a third party and not directly by us, they present greater risks than other types of lending activities. At March 31, 2012, we had $82,000 in non-performing automobile loans, which included $61,000 in indirect automobile loans.
The underwriting standards employed by us for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security in relation to the proposed loan amount.
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured, such as credit card receivables, or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loan such as us, and a borrower may be able to assert against such assignee claims and defenses which it has against the seller of the underlying collateral. We add general provisions to our loan loss allowance, in amounts determined in accordance with industry
standards, at the time the loans are originated. Consumer loan delinquencies often increase over time as the loans age. The level of non-performing assets in our consumer loan portfolio increased from $455,000 at March 31, 2011 to $1.4 million at March 31, 2012 due primarily to additions to repossessed assets and an increase in non-accruing loans. There can be no assurance that delinquencies will not increase in the future.
Commercial Business Lending. At March 31, 2012, our commercial business loans totaled $48.6 million, or 10.6%, of our total loans receivable, before net items. We offer commercial business loans to service existing customers, to consolidate our banking relationships with these customers, and to further our asset/liability management goals. Our commercial business lending activities encompass loans with a variety of purposes and security, including but not limited to business secured and unsecured lines of credit, business automobiles, equipment and accounts receivable. We recognize the generally increased credit risk associated with commercial business lending. Our commercial business lending practice emphasizes credit file documentation and analysis of the borrower’s character, management capabilities, capacity to repay the loan, the adequacy of the borrower’s capital and collateral. An analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis.
Unlike residential mortgage loans which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be dependent upon the success of the business itself. Our commercial business loans almost always include personal guarantees and are usually, but not always, secured by business assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. At March 31, 2012, $1.2 million of commercial business loans were non-accruing.
Loan Originations
Federal regulations authorize us to make real estate loans anywhere in the United States. At March 31, 2012, substantially all of our real estate loans were secured by real estate located in our market area.
We originate both fixed-rate and adjustable-rate loans. Our ability to originate loans, however, is dependent upon customer demand for loans in our market areas. Demand is affected by competition and the interest rate environment.
Loans purchased must conform to our underwriting guidelines. We have not purchased any loans during the last seven fiscal years and did not sell any loans during the last fiscal year. We sold $3.2 million in loans during fiscal year 2011. Management believes that purchases of loans and loan participations are generally desirable only when local mortgage demand is less than the supply of funds available for local mortgage origination.
During the past few years, we, like many other financial institutions, have experienced significant prepayments on loans due to the low interest rate environment prevailing in the United States. In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in interest income.
The following table shows our loan origination and repayment activities for the periods indicated.
Asset Quality
Delinquent Loans. When a borrower fails to make a required payment on a loan, we attempt to cause the deficiency to be cured by contacting the borrower, generally within 15 days of the loan becoming delinquent. A notice is mailed to the borrower after a payment is 15 days past due and again when the loan is 30 days past due. For most loans, if the delinquency is not cured within 30 days we issue a notice of intent to foreclose on the property and if the delinquency is not cured within 60 days, we may institute foreclosure action. If foreclosed on, real property is sold at a public sale and may be purchased by us.
The following table sets forth information concerning delinquent mortgage and other loans at March 31, 2012. The amounts presented represent the total remaining principal balances of the related loans, rather than the actual payment amounts which are overdue.
Risk Elements. The table below sets forth the amounts and categories of non-performing assets and troubled debt restructurings in our loan portfolio. Non-performing assets include non-accruing loans, accruing loans delinquent 90 days or more as to principal or interest payments and real estate acquired through foreclosure, which include assets acquired in settlement of loans. Typically, a loan becomes nonaccruing when it is 90 days delinquent. All consumer loans more than 120 days delinquent are charged against the allowance for loan losses. Accruing mortgage loans delinquent more than 90 days are loans that we consider to be well secured and in the process of collection.
Non-performing assets at March 31, 2012 were comprised primarily of non-accruing loans, real estate owned and repossessed automobiles. Real estate acquired through foreclosure consisted of $910,000 in residential construction, $1.6 million in land, $4.6 million in 1-4 family residences and $2.1 million in commercial real estate. Based on current market values of the properties securing these loans, management anticipates no significant losses in excess of the reserves for losses previously recorded. Our
largest non-accruing loan relationship at March 31, 2012 totaled $3.1 million and is located in the Virginia Beach, Virginia area secured by a hotel. The next largest non-accruing loan relationship was $2.2 million secured by eight 1-4 family residences.
Nonaccrual loans amounted to $12.2 million at March 31, 2012. If interest on these loans had been accrued, such income would have approximated $212,000 for the year ended March 31, 2012, none of which is included in interest income.
Troubled debt restructurings amounted to $21.1 million at March 31, 2012, of which $6.1 million is also included in non-performing assets.
Other Loans Of Concern. In addition to the non-performing assets set forth in the table above, as of March 31, 2012, we had approximately $24.0 million of loans with respect to which known information about the possible credit problems of the borrowers or the cash flows of the security properties have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories. Although management believes that these loans are adequately secured and no material loss is expected, certain circumstances may cause the borrower to be unable to comply with the present loan repayment terms at some future date. These loans have been considered in management's determination of our allowance for loan losses.
Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the Office of the Comptroller of the Currency to be of lesser quality, as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, which may order the establishment of additional general or specific loss allowances.
We regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of our assets, at March 31, 2012, we had classified $34.8 million of our assets as substandard, $1.2 million as doubtful and none as loss. The $34.8 million in classified loans is comprised primarily of residential and commercial real estate loans and commercial business loans. The $1.2 million in doubtful loans is comprised primarily of commercial business loans.
Allowance for Losses on Loans and Real Estate. We provide valuation allowances for anticipated losses on loans and real estate when management determines that a significant decline in the value of the collateral has occurred, as a result of which the value of the collateral is less than the amount of the unpaid principal of the related loan plus estimated costs of acquisition and sale. In addition, we also provide allowances based on the dollar amount and type of collateral securing our loans in order to protect against unanticipated losses. Although management believes that it uses the best information available to make such determinations, future adjustments to allowances may be necessary, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Provision for Loan Losses” in Item 7 of this report and Note 2 of the Notes to Consolidated Financial Statements in Item 8 of this report.
The following table sets forth an analysis of our allowance for loan losses.
The distribution of the allowance for losses on loans at the dates indicated is summarized as follows:
The allowance for loan loss balances is subject to change dependent on both the anticipated losses on specific loans and the charge-off percentage for the loan portfolio as a whole. These factors can affect the total allowance for loan losses and the allocation by loan category.
Investment Activities
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper and
corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. See "Regulation - Qualified Thrift Lender Test" below for a discussion of additional restrictions on our investment activities.
The senior vice president/chief financial officer has the basic responsibility for the management of our investment portfolio, subject to the direction and guidance of the President and Board of Directors. The senior vice president/chief financial officer considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
The general objectives of our investment portfolio are to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See also "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" in Item 7 of this Form 10-K.
As a member of the Federal Home Loan Bank of Atlanta, we had $5.2 million in stock of the Federal Home Loan Bank of Atlanta at March 31, 2012, and for the year ended March 31, 2012, we received $49,000 in dividends on such stock.
The contractual maturities and weighted average yields of our investment securities portfolio, excluding FHLB of Atlanta stock and Freddie Mac stock, are indicated in the following table.
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(1) Included in the above table are $10.0 million of securities that are callable in one year or less.
(2) The weighted average yield is not computed on a tax equivalent basis.
The following table sets forth the composition of our available for sale and held to maturity securities portfolios at the dates indicated. At March 31, 2012, our securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our equity capital, excluding those issued by the United States Government or its agencies. See Note 1 of the Notes to Consolidated Financial Statements in Item 8 of this report for additional information on our investment securities.
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(1) Excludes Freddie Mac common stock and other marketable equity securities.
During fiscal 2012, the market rates paid on investment securities decreased. During fiscal 2010 through 2011, we made limited investment securities purchases due to the minimal spread between short and long term rates during most of these reporting periods. We increased investment security purchases during fiscal 2012 to increase our liquidity position and offset the decline in interest income due to the decline in our loan balances.
During fiscal 2009, due to the conservatorship of Fannie Mae and Freddie Mac in September, 2008 and the related restrictions on its outstanding preferred stock (including the elimination of dividends), the Company recorded an other than temporary impairment (OTTI) non-cash charge with respect to the Fannie Mae and Freddie Mac preferred stock it owned of $11,536,000. The Company sold its remaining 57,000 shares of Fannie Mae and Freddie Mac preferred stock during fiscal year 2011.
Sources of Funds
General. Deposits have traditionally been the principal source of our funds for use in lending and for other general business purposes. In addition to deposits, we derive funds from loan repayments, cash flows generated from operations, which includes interest credited to our deposit accounts, repurchase agreements entered into with commercial banks and FHLB of Atlanta advances.
Contractual loan payments are a relatively stable source of funds, while deposit inflows and outflows and the related cost of such funds have varied widely. Borrowings may be used on a short-term basis to compensate for reductions in deposits or deposit inflows at less than projected levels and may be used on a longer-term basis to support expanded lending activities.
Deposits. We attract both short-term and long-term deposits from the general public by offering a wide assortment of accounts and rates. We have been required by market conditions to rely on short-term accounts and other deposit alternatives that are more responsive to market interest rates than fixed interest rate, fixed-term certificates that were our primary source of deposits in the past. We offer regular savings accounts, checking accounts, various money market accounts, fixed-rate long-term certificates with varying maturities, $100,000 or more jumbo certificates of deposit and individual retirement accounts. During fiscal 2012, 2011, 2010 and 2009 we utilized brokered deposits due to their lower relative costs. At March 31, 2012, we had total brokered deposits of $19.1 million.
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by us at the periods indicated.
The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility (by paying rates of interest more closely approximating market rates of interest) to, although not eliminate the threat of, disintermediation (the flow of funds away from depository institutions such as thrift institutions into direct investment vehicles such as government and corporate securities). In addition, we have become much more subject to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. Our ability to attract and maintain deposits, and our cost of funds, has been, and will continue to be, significantly affected by money market conditions.
The following table sets forth our deposit flows during the periods indicated.
During fiscal 2010, the change in deposits was related primarily to the utilization of brokered deposits and our continued emphasis on increasing transaction accounts. During fiscal 2011 and 2012, the change in deposits was related to the decrease in loans and lower time deposit rates with continued emphasis on transaction accounts. We remained competitive on deposit rates. We may use borrowings from time to time as an alternative source of funds. See “Borrowings.”
The following table contains information pertaining to the average amount of and the average rate paid on each of the following deposit categories for the periods indicated.
The following table shows rate information for our certificates of deposit as indicated.
The following table indicates the amount of the certificates of deposit by time remaining until maturity as of March 31, 2012.
Borrowings
We generally utilize borrowings to supplement deposits when they are available at a lower overall cost to us or they can be invested at a positive rate of return. Our borrowings generally consist of advances from the FHLB of Atlanta. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB of Atlanta may prescribe the acceptable uses to which these advances may be put, as well as limitations on the size of the advances and repayment provisions.
Our borrowings, from time to time, also include securities sold under agreements to repurchase, with mortgage-backed securities or other securities pledged as collateral. At March 31, 2012, we did not have any securities sold under agreements to repurchase which adjust with the federal funds rate. For additional information on our borrowings and securities sold under agreements to repurchase, see Notes 6 and 7 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
The following table sets forth information as to our borrowings and the weighted average interest rate paid on such borrowings at the dates indicated.
Information related to short-term borrowing activity from the Federal Home Loan Bank is as follows:
Subsidiary Activities
There are no significant subsidiary activities.
Competition
Community faces strong competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily from other thrift institutions, commercial banks, credit unions and mortgage bankers who also make loans in our market area. We compete for loans principally on the basis of our interest rates and loan fees, the types of loans and the quality of services provided to borrowers.
We face substantial competition in attracting deposits from other thrift institutions, commercial banks, money market and mutual funds, credit unions and other investment vehicles. Our ability to attract and retain deposits depends on our ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk and other factors. We compete for these deposits by offering a variety of deposit accounts at competitive rates and convenient business hours.
We consider our primary markets for deposits to be Augusta County and Hampton Roads and for loans to be Augusta and Rockingham Counties and the Hampton Roads area. We estimate that our market share of savings deposits in Augusta County is approximately 15% and our share of loans in Augusta and Rockingham Counties is less than 10%.
Regulation
General. Set forth below is a brief description of certain laws and regulations that are applicable to Community Financial and Community Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. Legislative or regulatory changes in the future could adversely affect our operations and financial condition.
The Office of the Comptroller of the Currency has extensive enforcement authority over all savings associations and their holding companies, including Community Financial and Community Bank. The Federal Reserve has the same type of authority over Community Financial. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed
with the Office of the Comptroller of the Currency or the Federal Reserve. Except under certain circumstances, public disclosure of final enforcement actions by the Office of the Comptroller of the Currency or the Federal Reserve is required by law.
Recently Enacted Regulatory Reform. On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Dodd-Frank Act imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. In addition, the new law changes the jurisdictions of existing bank regulatory agencies and in particular transfers the regulation of federal savings associations from the Office of Thrift Supervision (OTS) to the Office of Comptroller of the Currency, effective July 21, 2011. At the same time, responsibility for regulation of savings and loan holding companies will be transferred to the Board of Governors of the Federal Reserve System. The new law also establishes an independent federal consumer protection bureau within the Federal Reserve, the Consumer Financial Protection Bureau (CFPB). The following discussion summarizes significant aspects of the Dodd-Frank Act that may affect Community Bank and Community Financial. Regulations implementing many of these changes have not been promulgated, so we cannot determine the full impact of the Dodd-Frank Act on our business and operations at this time.
The following aspects of the Dodd-Frank Act are related to the operations of Community Bank:
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Effective July 21, 2011,The OTS was merged into the Comptroller of the Currency which assumed the OTS’s authority and responsibilities to regulate and supervise federal savings associations under the same laws as the Office of the Comptroller of the Currency (except where modified by the Dodd-Frank Act). The regulations and policies of the Office of Thrift Supervision for savings associations will continue to apply unless and until the Office of the Comptroller of the Currency modifies them.
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The federal thrift charter has been preserved and the Federal Reserve assumed the authority and responsibilities of the Office of the Comptroller of the Currency to regulate and supervise savings and loan holding companies under the same laws as the Office of the Comptroller of the Currency (except where modified by the Dodd-Frank Act). The regulations and policies of the Office of Thrift Supervision for savings and loan holding companies will continue to apply unless and until modified by the OCC or the Federal Reserve. There have been no substantial modifications to these regulations to date.
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The Consumer Financial Protection Bureau (the “CFPB”), an independent consumer compliance regulatory agency within the Federal Reserve, has been established. The CFPB is empowered to exercise broad regulatory, supervisory and enforcement authority over financial institutions with total assets over $10 billion with respect to both new and existing consumer financial protection laws. Smaller financial institutions, like Community Bank, will be subject to supervision and enforcement by their primary federal banking regulators with respect to federal consumer financial protection laws and regulations. The CFPB also has authority to promulgate new consumer financial protection regulations and amend existing consumer financial protection regulations.
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The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries.
Tier
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Tier 1 capital treatment for “hybrid” capital items like trust preferred securities is eliminated, subject to various grandfathering and transition rules. The federal banking agencies must promulgate new rules on regulatory capital for both depository institutions and their holding companies, to include leverage capital and risk-based capital measures at least as stringent as those now applicable to Community Bank under the prompt corrective action regulations. To date, the federal banking agencies have not yet established such new regulatory capital requirements. Recently, new regulations were proposed for this purpose and for the purpose of compliance with certain agreements of the Basel Committee on Banking Supervision (Basel III). We cannot predict when or in what form such regulations may be adopted in final form, but the final regulations may impose more stringent capital requirements on Community Financial and Community Bank.
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The current prohibition on payment of interest on demand deposits was repealed, effective July 21, 2011.
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State consumer financial protection law will be preempted only if it would have a discriminatory effect on a federal savings association or is preempted by any other federal law. The OCC must make a preemption determination with respect to a state consumer financial protection law on a case-by-case basis with respect to a particular state law or other state law with substantively equivalent terms.
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Deposit insurance is permanently increased to $250,000 and unlimited deposit insurance for noninterest-bearing transaction accounts applies through December 31, 2012.
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The deposit insurance assessment base for FDIC insurance is the depository institution's average consolidated total assets less average tangible equity during the assessment period.
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The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent of estimated annual insured deposits or the comparable percentage of the assessment base; however, the FDIC is directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion. Pursuant to the Dodd-Frank Act, the FDIC recently issued a rule setting a designated reserve ratio at 2.0% of insured deposits.
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Public companies are required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have a “say on pay” vote every one, two or three years.
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A separate, non-binding shareholder vote is required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments.
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Securities exchanges are required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain “significant” matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be significant.
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Stock exchanges, not including the OTC Bulletin Board, are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation that is based on financial information required to be reported under the securities laws, and (ii) the recovery from current or former executive officers,
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following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount that would have been paid on the basis of the restated financial information.
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Disclosure in annual proxy materials is required concerning the relationship between the executive compensation paid and the financial performance of the issuer.
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Item 402 of Regulation S-K is amended to require companies to disclose the ratio of the median annual total compensation of all employees (excluding the Chief Executive Officer’s compensation) to the Chief Executive Officer’s annual total compensation.
Federal Regulation of Savings Associations. Community Bank, as a federally chartered savings bank, is subject to regulation and oversight by the Office of the Comptroller of the Currency extending to all aspects of its operations. This regulation of Community Bank is intended for the protection of depositors and the insurance of accounts fund and not for the purpose of protecting shareholders. Community Bank is required to maintain minimum levels of regulatory capital and is subject to some limitations on the payment of dividends to Community Financial. See “- Regulatory Capital Requirements” and “- Limitations on Dividends and Other Capital Distributions.” Community Bank also is subject to regulation and examination by the Federal Deposit Insurance Corporation, which insures the deposits of Community Bank to the maximum extent permitted by law.
We are subject to periodic examinations by the Office of the Comptroller of the Currency. During these examinations, the examiners may require Community Bank to provide for higher general or specific loan loss reserves, which can impact our capital and earnings. As a federal savings bank, Community Bank is subject to a semi-annual assessment, based upon its total assets, to fund the operations of the Office of the Comptroller of the Currency.
The Office of the Comptroller of the Currency has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution regulated by the Office of the Comptroller of the Currency that fails to comply with these standards must submit a compliance plan.
Insurance of Accounts and Regulation by the FDIC. The Deposit Insurance Fund (“DIF”) of the FDIC insures deposit accounts in Community Bank up to $250,000 per separately insured depositor. Transaction accounts have unlimited coverage until December 31, 2012.
The FDIC assesses deposit insurance premiums on each FDIC-insured institution quarterly based on annualized rates for one of four risk categories applied to its deposits, subject to certain adjustments. Each institution is assigned to one of four risk categories based on its capital levels, supervisory ratings and other factors. Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk Category I. Risk Categories II, III and IV present progressively greater risks to the DIF.
As a result of a decline in the reserve ratio (the ratio of the net worth of the DIF to estimated insured deposits) and concerns about expected failure costs and available liquid assets in the DIF, the FDIC adopted a rule requiring each insured institution to prepay on December 30, 2009 the estimated amount of its quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012 (in addition to the regular quarterly assessment for the third quarter due on December 30, 2009). The
prepaid amount is recorded as an asset with a zero risk weight and the institution will continue to record quarterly expenses for deposit insurance. For purposes of calculating the prepaid amount, assessments were measured at the institution’s assessment rate as of September 30, 2009, with a uniform increase of 3 basis points effective January 1, 2011, and were based on the institution’s assessment base for the third quarter of 2009, with growth assumed quarterly at an annual rate of 5%. If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess assessments in cash, or receive a rebate of prepaid amounts not exhausted after collection of assessments due on June 30, 2013, as applicable. Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment system in the future.
Beginning with the second quarter of 2011, the Dodd-Frank Act requires the FDIC’s deposit insurance assessments to be based on assets instead of deposits. The FDIC has issued rules, effective as of the second quarter of 2011, which specify that the assessment base for a bank is equal to its total average consolidated assets less average tangible capital. The FDIC assessment rates range from approximately 5 basis points to 35 basis points, depending on applicable adjustments for unsecured debt issued by an institution and brokered deposits (and to further adjustment for institutions that hold unsecured debt of other FDIC-insured institutions), until such time as the FDIC’s reserve ratio equals 1.15%. Once the FDIC’s reserve ratio reaches 1.15% and the reserve ratio for the immediately prior assessment period is less than 2.0%, the applicable assessment rates may range from 3 basis points to 30 basis points (subject to adjustments as described above). If the reserve ratio for the prior assessment period is equal to or greater than 2.0% and less than 2.5%, the assessment rates may range from 2 basis points to 28 basis points and if the prior assessment period is greater than 2.5%, the assessment rates may range from 1 basis point to 25 basis points (in each case subject to adjustments as described above). No institution may pay a dividend if it is in default on its federal deposit insurance assessment.
Transactions with Affiliates. Transactions between Community Bank and its affiliates generally are required to be on terms as favorable to the institution as transactions with non-affiliates, and certain of these transactions, such as loans to an affiliate, are restricted to a percentage of Community Bank's capital and require eligible capital in specified amounts. In addition, Community Bank may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. Community Financial is an affiliate of Community Bank.
Regulatory Capital Requirements. To be considered well capitalized, an institution must have a ratio of Tier 1 capital to adjusted total assets of at least 5.0%, a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, and a ratio of total capital to risk-weighted assets of at least 10.0% and not be subject to any agreement, order or directive of the OCC to meet and maintain any specific capital measure. Tier 1 capital generally consists of common stockholders’ equity, retained earnings and certain noncumulative perpetual preferred stock, plus certain intangibles. At March 31, 2012, Community Bank had no intangibles in Tier 1 capital.
Total capital consists of Tier 1 and Tier 2 capital. Tier 2 capital generally consists of certain permanent and maturing capital instruments that do no qualify as Tier 1 capital and up to 1.25% of risk-weighted assets in allowance for loan and lease losses. The amount of Tier 2 capital includable in total capital may not exceed the amount of Tier 1 capital. Risk-weighted assets are determined by assigning a risk weight ranging from 0% to 100% to all assets and certain off-balance sheet items.
To be adequately capitalized, an institution must have a ratio of Tier 1 capital to adjusted total assets of at least 4.0%, a ratio of Tier 1 capital to risk-weighted assets of at least 4.0% and a ratio of total capital to risk-weighted assets of at least 8.0%. At March 31, 2012, Community Bank was well capitalized. The Office of the Comptroller of the Currency is authorized to require federal savings banks
on a case-by-case basis to maintain an additional amount of total capital to account for concentration of credit risk, level of interest rate risk, equity investments in non-financial companies and the risk of non-traditional activities.
The Office of the Comptroller of the Currency is authorized, and under certain circumstances required, to take certain actions against savings banks that are not at least adequately capitalized. Any such institution must submit a capital restoration plan and until such plan is approved by the Office of the Comptroller of the Currency may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. Additional restrictions may apply, including a forced merger, acquisition, or liquidation of the institution. The Office of the Comptroller of the Currency generally is authorized to reclassify an institution into a lower capital category and impose the restrictions if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The imposition by the Office of the Comptroller of the Currency of any of these measures on Community Bank may have a substantial adverse effect on our operations and profitability. Regulatory capital is discussed further in Note 11 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Any institution that meets the requirement to be “adequately capitalized” and not the requirements to be “well capitalized” may not accept, renew or rollover brokered deposits without a waiver from the FDIC. An institution that does not meet the requirements to be “adequately capitalized” may not accept, renew or rollover brokered deposits. Brokered deposits include deposits solicited by the institution or its employees if the interest rates on such deposits exceed certain thresholds.
Under recently proposed regulations, the criteria for an institution to be considered “well capitalized” and “adequately capitalized” would become more stringent. We cannot predict when or in what form such regulations may be adopted in final form.
Limitations on Dividends and Other Capital Distributions. Office of the Comptroller of the Currency regulations impose various restrictions on the ability of Community Bank to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Community Bank must file a notice or application with the Office of the Comptroller of the Currency before making any capital distribution. Community Bank generally may make capital distributions during any calendar year in an amount up to 100% of net income for the year-to-date plus retained net income for the two preceding years, so long as it is well-capitalized after the distribution. If, however, Community Bank proposes to make a capital distribution when it does not meet (or will not meet following the proposed capital distribution) the requirements to be adequately capitalized or to make a distribution that will exceed these net income limitations, it must obtain Office of the Comptroller of the Currency approval prior to making such distribution. The Office of the Comptroller of the Currency may object to any distribution based on safety and soundness concerns.
Community Financial is not subject to Office of the Comptroller of the Currency regulatory restrictions on the payment of dividends. Dividends from Community Financial, however, may depend, in part, upon its receipt of dividends from Community Bank. Issuance of preferred stock under the TARP and CPP restricts the Company from increasing its dividend distribution to stockholders without approval from the Office of the Comptroller of the Currency. Community Bank, as a federal savings bank, must notify the Federal Reserve prior to paying a dividend to Community Financial. The Federal Reserve may disapprove a dividend if, among other things, the Federal Reserve determines that the federal savings bank would be undercapitalized on a pro forma basis or the dividend is determined to raise safety or soundness concerns or violates a prohibition contained in applicable statutes, regulations, enforcement actions or agreements between the institution (or its holding company) and a federal bank regulator.
Qualified Thrift Lender Test and Asset Limitations. All savings associations, including Community Bank, are required to meet a qualified thrift lender test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by statute) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans and investments. At March 31, 2012, Community Bank met the test and has always met the test since its effective date.
Any savings institution that fails to meet the QTL test is subject to certain restrictions on its operations and the institution’s dividend payments are limited to amounts approved by the OCC and the Federal Reserve that are necessary to meet obligations of a company that controls the institution and would be permissible for a national bank, unless within one year it meets the test, and thereafter remains a qualified thrift lender. An institution that fails the test a second time must be subjected to the above restrictions and is subject to enforcement action. Any holding company of an institution that fails the test and does not re- qualify within a year must become a bank holding company. If such an institution has not converted to a bank within three years after it failed the test, it must divest all investments and cease all activities not permissible for both a national bank and a savings association.
Community Bank is subject to a 35% of total assets limit on consumer loans, commercial paper and corporate debt securities, a 20% limit on commercial loans, provided that the amount in excess of 10% of total assets can only be used for small business loans, and a 400% of capital limit on non-residential real property loans. At March 31, 2012, Community Bank had 6.87% of its assets in consumer loans, commercial paper and corporate debt securities, 9.65% of its assets in commercial loans and 336% of its capital in non-residential real property loans.
Community Reinvestment Act. Under the Community Reinvestment Act, every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Act. The Community Reinvestment Act requires the Office of the Comptroller of the Currency, in connection with the examination of Community Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by Community Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the Office of the Comptroller of the Currency. Community Bank was examined for Community Reinvestment Act compliance in November, 2010 and received a rating of “Satisfactory”.
Holding Company Regulation. Community Financial is a unitary savings and loan holding company subject to regulatory oversight by the Federal Reserve. As such, we are required to register and file reports with the Federal Reserve and are subject to regulation and examination by the Federal Reserve. In addition, the Federal Reserve has enforcement authority over us and our non-savings association subsidiaries, which also permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.
As a unitary savings and loan holding company that acquired Community Bank before May 4, 1999, we generally are not subject to activity restrictions. If we acquire control of one or more additional
savings associations as a separate subsidiary, our activities and those of any of our subsidiaries (other than Community Bank or any other insured savings association) would become subject to such restrictions unless such other associations each qualify as a QTL and were acquired in supervisory acquisitions.
Federal Securities Laws. The stock of Community Financial is registered with the SEC under the Securities Exchange Act of 1934, as amended. Community Financial is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Securities Exchange Act of 1934.
The SEC and the NASDAQ have adopted regulations and policies under the Sarbanes-Oxley Act of 2002 that apply to Community Financial as a registered company under the Securities Exchange Act of 1934 and a NASDAQ-traded company. The stated goals of these Sarbanes-Oxley requirements are to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SEC and NASDAQ Sarbanes-Oxley-related regulations and policies include very specific additional disclosure requirements and corporate governance rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
Capital Purchase Program. On December 19, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”) of the United States Department of the Treasury (“Treasury”), the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with Treasury, pursuant to which the Company (i) sold to Treasury 12,643 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation preference amount of $1,000 per share, for a purchase price of $12.6 million in cash and (ii) issued to Treasury a ten-year warrant (the “Warrant”) to purchase 351,194 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), at an exercise price of $5.40 per share.
The Series A Preferred Stock qualified as Tier 1 capital and will pay cumulative dividends on the liquidation preference amount on a quarterly basis at a rate of 5% per annum for the first five years, and 9% per annum thereafter. Subject to the prior approval of the Board of Governors of the Federal Reserve System, the Series A Preferred Stock is redeemable at the option of the Company in whole or in part at a redemption price of 100% of the liquidation preference amount plus any accrued and unpaid dividends.
The enactment of ARRA on February 17, 2009 permits the Company to repay the Treasury without penalty and without the need to raise new capital, subject to the Treasury’s consultation with the recipient’s appropriate regulatory agency. Additionally, upon repayment the Treasury will liquidate all outstanding warrants at their current market value.
The Series A Preferred Stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). In accordance with the Purchase Agreement, the Company subsequently registered the Series A Preferred Stock, the Warrant and the shares of Common Stock underlying the Warrant under the Securities Act.
Federal and State Taxation
Federal Taxation. In addition to the regular income tax, corporations, including savings associations such as Community Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of
a corporation’s regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation’s regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income.
To the extent earnings appropriated to a savings association’s bad debt reserves for “qualifying real property loans” and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association’s supplemental reserves for losses on loans (“Excess”), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses).
Community Financial and Community Bank file consolidated federal income tax returns on a fiscal year basis. Savings associations, such as the Community Bank, that file federal income tax returns as part of a consolidated group are required by applicable Treasury regulations to reduce their taxable income for purposes of computing the percentage bad debt deduction for losses attributable to activities of the non-savings association members of the consolidated group that are functionally related to the activities of the savings association member.
Our federal income tax returns and our consolidated subsidiary for the last three years are open to possible audit by the Internal Revenue Service. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, Community Bank) would not result in a deficiency which could have a material adverse effect on the financial condition of Community Financial and our consolidated subsidiaries.
Virginia Taxation. We conduct our business in Virginia and consequently are subject to the Virginia corporate income tax. The Commonwealth of Virginia imposes a corporate income tax on a basis similar to federal income tax at a rate of 6% on Virginia taxable income.
Executive Officers
The following information as to the business experience during the past five years is supplied with respect to executive officers of Community Financial. Except as otherwise indicated, the persons named have served as officers of Community Financial since it became the holding company of Community Bank, and all offices and positions described below are also with Community Bank.
Norman C. Smiley, III, age 50, was appointed President of Community Bank in March, 2008, and effective April 30, 2010, became the President and Chief Executive Officer of Community Financial and Community Bank. Prior to joining the Company in April 1996, Mr. Smiley was a Branch Manager for First Virginia where he was employed for 14 years. He is a 1987 graduate of the Virginia Bankers School of Bank Management at the University of Virginia and a 2001 graduate of the American Bankers Association Stonier Graduate School of Banking at Georgetown University. Mr. Smiley is currently a Board member of the American Frontier Museum and the Staunton Redevelopment Housing Authority. He is a past Board member of the Coordinated Area Transportation System, Big Brothers/Big Sisters, Salvation Army, the Red Cross, the City of Staunton Board of Zoning Appeals and past Elder of the First Presbyterian Church.
R. Jerry Giles, age 63, is our Chief Financial Officer and Senior Vice President, a position he has held since April 1994. Prior to joining the Company in April 1994, Mr. Giles was a Certified Public Accountant in public accounting and the Chief Financial Officer with a savings bank for eleven years.
Benny N. Werner, age 63, is our Senior Vice President and Chief Operations Officer, a position he has held since May 1998. Prior to joining the Company, Mr. Werner was employed by Crestar for three years as President-Warrenton area and employed by Jefferson Savings and Loan, Warrenton, Virginia as Senior Vice President of Retail Banking for seventeen years.
Lyle A. Moffett, age 43, is our Senior Vice President of Lending, a position he has held since March, 2008. Mr. Moffett joined Community Bank in 1997 and was Vice President and Commercial Loan Officer prior to his current position.
John J. Howerton, age 54, is our Senior Vice President of Retail Banking, a position he has held since September, 2008. Mr. Howerton has been employed in the banking industry since 1982 and prior to joining the Company, Mr. Howerton was the Senior Vice President of Retail Banking with Stellar One.
Clarence W. Keel, age 65, is the Senior Vice President in our Hampton Roads Region, a position he has held since March, 2010. Mr. Keel has been employed in the banking industry since 1971 and prior to joining the Company, Mr. Keel was the Senior Vice President and Manager of Shareholder Services with BB&T Corporation.
Employees
At March 31, 2012, we had a total of 159 employees, including 25 hourly employees. None of our employees are represented by any collective bargaining group. Management considers our employee relations to be good.
ITEM 1A.
ITEM 1A. RISK FACTORS - Not required by smaller reporting companies.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS- None.
ITEM 2.
ITEM 2. PROPERTIES
The following table sets forth information at March 31, 2012, with respect to our retail and operational offices, furniture and equipment. We believe that our current facilities are adequate to meet our present and foreseeable need
(1) Operational offices
Our accounting and record-keeping activities are maintained on an in-house computer system. The net book value of our computer equipment at March 31, 2012 was $33,572.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which we or our subsidiary is a party or to which any of our property is subject.
Item 4.
Item 4. Mine Safety Disclosures - Not Appplicable
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
As of May 31, 2012, there were approximately 400 holders of record of Community Financial common stock. Community Financial common stock is traded on The Nasdaq Capital Market under the symbol “CFFC.” The number of shareholders of record does not reflect persons or entities who hold their stock in nominee or “street” name.
The following tables present the high, low and closing sales prices of our common stock as reported by the Nasdaq Stock Market during the last two fiscal years and the common dividends declared by us for the stated periods.
The Board of Directors of Community Financial makes dividend payment decisions after consideration of a variety of factors, including earnings, financial condition, market considerations and regulatory restrictions. Our ability to pay dividends is limited by restrictions imposed by the Virginia Stock Corporation Act, the Federal Reserve, contractually pursuant to our participation in the U.S. Treasury’s CPP and indirectly by the Office of the Comptroller of the Currency. Restrictions on dividend payments from Community Bank to Community Financial (Community Financials’ primary source of funds for the payment of dividends to its stockholders) are described in Note 10 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
The Equity Compensation Plan information contained in Item 12 of this Form 10-K is incorporated herein by reference. No stock was repurchased by the Company during the fourth quarter of fiscal 2012 and no stock repurchase plan or program currently exists. Our ability to repurchase stock is limited as a result of our participation in the U.S. Treasury’s CPP and, indirectly, by the Office of the Comptroller of the Currency.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
____________________
(1) Includes federal funds sold, securities purchased under resale agreements and overnight deposits.
(2) Other income includes customer service fees and commissions, gain or loss on disposal of property and other items.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Overview
Community Financial Corporation is a Virginia corporation. Certain of the information presented herein relates to Community Bank, a wholly owned subsidiary of Community Financial. Community Financial and Community Bank, like all thrift institutions and their holding companies, are subject to comprehensive regulation, examination and supervision by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System.
The following information is intended to provide investors a better understanding of our financial position and the operating results of Community Financial Corporation and its subsidiary, Community Bank. This discussion is primarily from management’s perspective and may not contain all information that is of importance to the reader. Accordingly, the information should be considered in the context of the consolidated financial statements and other related information contained herein.
Our net income is primarily dependent on the difference or spread between the average yield earned on loans and investments and the average rate paid on deposits and borrowings, as well as the relative amounts of such assets and liabilities. The interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Like other financial institutions, we are subject to interest rate risk to the degree that our interest bearing liabilities, primarily deposits and borrowings with short and medium term maturities, mature or reprice more rapidly, or on a different basis, than interest earning assets, primarily loans with longer term maturities than deposits and borrowings. While having liabilities that mature or reprice more frequently on average than assets may be beneficial in times of declining interest rates, such an asset/liability structure may result in lower net income or net losses during periods of rising interest rates, unless offset by other noninterest income. Our net income is also affected by, among other things, fee income, asset quality, provision for loan losses, operating expenses and income taxes.
The primary factors contributing to our increase in net income for the fiscal year was the decrease in the provision for loan losses and a 4.3% increase in our net interest income for the current fiscal year compared to the prior fiscal year.
The primary factor contributing to the increase in net interest income for the fiscal year ended March 31, 2012 was an increase in the interest rate spread. The increased interest rate spread is primarily attributable to a reduction in the cost of our interest-bearing liabilities due to the repricing of these liabilities during the current low interest rate environment. The aggressive rate reductions in prior fiscal years resulted in a timing difference in the repricing of assets and liabilities. We will monitor the impact a change in interest rates may have on both the growth in interest-earning assets and our interest rate spread. The pace and extent of future interest rate changes will impact our loan growth and interest rate spread, as well as interest rate adjustments on certain adjustable rate loans that are subject to caps.
Utilization of brokered deposits and management’s emphasis on increasing low and no interest bearing transaction accounts has impacted the composition of our interest-bearing liabilities. Deposits were the primary source of funding during the fiscal year ended March 31, 2012. We acquired lower cost brokered deposits and low interest bearing transaction accounts during the fiscal year to replace higher cost time deposits. While we have the capacity to continue to utilize borrowings to meet funding needs, management recognizes the practical long-term limitations of such a funding strategy. Management is
also cognizant of the potential for compression in our net interest margin related to the need to acquire funds and the pace of interest rate changes. Management will continue to monitor the level of deposits and borrowings in relation to the current interest rate environment.
Critical Accounting Policies
General. Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The financial information contained within our financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Allowance for Loan Losses. The allowance for loan losses is an estimate of the losses that may be inherent in our loan portfolio. The allowance is based on two basic principles of accounting: (i) that losses be accrued when they are probable of occurring and estimable and (ii) that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market, and the loan balance.
The allowance for loan losses is maintained at a level considered by management to be adequate to absorb future loan losses currently inherent in the loan portfolio. Management's assessment of the adequacy of the allowance is based upon type and volume of the loan portfolio, past loan loss experience, existing and anticipated economic conditions, and other factors which deserve current recognition in estimating future loan losses. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Additions to the allowance are charged to operations. Subsequent recoveries, if any, are credited to the allowance. Loans are charged-off partially or wholly at the time management determines collectibility is not probable. Management's assessment of the adequacy of the allowance is subject to evaluation and adjustment by our regulators.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers special mention and non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component may be maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The Corporation uses real estate appraisals, discounted cash flows or other appropriate methods to determine the value of impaired loans. With the use of these methods, the Corporation provides valuation allowances for anticipated losses when management determines that a decline in the value of the collateral or expected cash flows has occurred. Updated appraisals are obtained periodically and in those instances where management has reason to believe a material change may have occurred in the fair value of the collateral. Evaluation of impairment requires judgment and estimates and management uses all relevant and timely information available to determine specific reserves on impaired loans, including appraisals and cash flow analysis. Loans are partially or completely charged off in the period when they are deemed uncollectible in accordance with ASC 310-35.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement. These loans were included in the allowance calculation as pools of loans in the general component with allocations based on historic charge-offs and qualitative factor adjustments deemed appropriate by management for these types of loans and their nonaccrual status.
In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the valuation of real estate owned and the fair value of financial instruments.
Asset/Liability Management
Management believes it is important to manage the relationship between interest rates and the effect on our net portfolio value. This approach calculates the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities, as well as cash flows from off-balance sheet contracts. Management of our assets and liabilities is done within the context of the marketplace, but also within limits established by the board of directors on the amount of change in net portfolio value which is acceptable given certain interest rate changes.
Presented in the following table, as of March 31, 2012 and 2011, is an analysis of our interest rate risk as measured by changes in net portfolio value for instantaneous and sustained parallel shifts in the yield curve and compared to our board policy limits The Board limits have been established with consideration of the dollar impact of various rate changes and our capital position. The Board limit has been established as a minimum percentage of the Company’s net portfolio value. Our net portfolio values at March 31, 2012 were within the parameters set by the Board of Directors. As illustrated in the table, net portfolio value is not significantly impacted by rising or falling rates as of the date indicated. Information in the table for the fiscal year 2011 was provided by the Office of Thrift Supervision. Information for the 2012 fiscal year was provided by a third party engaged by the Bank due to the change in regulatory authorities to the Office of the Comptroller of the Currency.
Generally, management strives to maintain a neutral position regarding interest rate risk. In the current interest rate environment, our customers are interested in obtaining long-term credit products and short-term savings products. Management has taken action to counter this trend. A significant effort has
been made to reduce the duration and average life of our interest-earning assets. As of March 31, 2012, approximately 77.0% of our gross loan portfolio consisted of loans which reprice during the life of the loan. Applications are taken and processed for customers seeking longer term fixed-rate mortgage loans, 15 to 30 years, with the loan being closed and retained by other organizations.
On the deposit side, management has worked to reduce the impact of interest rate changes by emphasizing non-interest bearing or low interest deposit products and maintaining competitive pricing on longer term certificates of deposit. We have also used Federal Home Loan Bank advances to provide funding for loan originations and to provide liquidity as needed.
In managing our asset/liability mix, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, we may place somewhat greater emphasis on maximizing our net interest income rather than on strictly matching the interest rate sensitivity of our assets and liabilities. We believe the increased net income that may result from an acceptable mismatch in the actual maturity or repricing of our asset and liability portfolio can provide sufficient returns to justify the increased exposure to sudden and unexpected increases in interest rates which may result from such a mismatch. We have established limits, which may change from time to time, on the level of acceptable interest rate risk. There can be no assurance, however, that in the event of an adverse change in interest rates, our efforts to limit interest rate risk will be successful.
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumed in calculating the information in the table above. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We consider all of these factors in monitoring our exposure to interest rate risk.
Average Balances, Interest Rates and Yields
The following table sets forth certain information relating to categories of our interest-earning assets and interest-bearing liabilities for the periods indicated. All average balances are computed on a daily basis. Non-accruing loans have been included in the table as loans carrying a zero yield. The yields have not been adjusted for tax preferences.
Rate/Volume Analysis
The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected our interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), and (iii) total changes in rate and volume. The combined effect of changes in both volume and rate, which cannot be separately identified, has been allocated proportionately to the change due to volume and the change due to rate.
Financial Condition
Total assets decreased $26.2 million, or 4.9%, to $503.9 million at March 31, 2012 due primarily to a decrease in loans of $33.2 million and real estate owned of $1.0 million, partially offset by an increase in investments of $9.1 million. Deposits decreased $6.6 million, or 1.8% and borrowings decreased $20.4 million, or 20.8%. The decrease in deposits is reflected primarily in a decrease in time deposits of $28.6 million, partially offset by increases in transaction accounts of $13.1 million, money market accounts of $7.2 million and savings accounts of $1.7 million. The decrease in borrowings is reflected primarily in a decrease in FHLB borrowings of $19.0 million. Management believes the increase in transaction and money market deposits is primarily attributable to an increased emphasis on customer relationships, service and pricing. Management attributes the decrease in loans receivable primarily to weak economic conditions and related reduced loan demand.
The Hampton Roads region of the Bank experienced a loan decrease of $30.7 million, primarily commercial and residential real estate loans and construction loans, for the fiscal year ended 2012. The Shenandoah Valley region of the Bank had a loan decrease of approximately $2.5 million, primarily construction loans.
Asset quality is an important factor in the successful operation of a financial institution. The loss of interest income and principal that may result from non-performing assets has an adverse effect on earnings, while the resolution of those assets requires the use of capital and managerial resources. At March 31, 2012, non-performing assets, consisting of non-performing loans, foreclosed real estate and repossessed automobiles, totaled $21.6 million, or 4.29% of total assets, compared to $16.6 million or 3.13% of total assets at March 31, 2011. Non-performing assets at March 31, 2012 were comprised primarily of residential real estate and commercial real estate loans delinquent 90 days or more and real estate owned. Based on current market values of the collateral securing these loans, management anticipates no significant losses in excess of the reserves for losses previously recorded. Due to an uncertain real estate market and the economy in general, no assurances can be given that our level of non-performing assets will not increase in the future.
Stockholders' equity increased $642,000, or 1.3%, to $50.4 million at March 31, 2012 compared to $49.8 million at March 31, 2011. The increase was the result of earnings for the year ended March 31, 2012 offset by cash dividend payments on preferred stock and pension liability adjustments.
Results of Operations
Our results of operations depend primarily on the level of our net interest income and noninterest income and the level of our operating expenses. Net interest income depends upon the value of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.
Comparison of Years Ended March 31, 2012 and 2011
General. Net income for the year ended March 31, 2012 was $1.8 million or $0.24 diluted earnings per common share compared to $1.5 million or $0.18 diluted earnings per common share for the year ended March 31, 2011. Net income increased primarily due to an increase in net interest income and a decrease in the provision for loan losses, partially offset by an increase in noninterest expenses for the March 31, 2012 fiscal year.
Interest Income. Total interest income decreased $1.2 million, or 4.5%, to $26.4 million for the year ended March 31, 2012 as compared to $27.6 million for the year ended March 31, 2011. The decrease in total interest income can be attributed to a decrease in the average dollar volume of loans of $29.4 million partially offset by an increase in the yield on interest earning assets. Average yields on total interest-earning assets increased four basis points from 5.50% in fiscal 2011 to 5.54% for the current fiscal year due primarily to an increase in loan yields.
Interest Expense. Total interest expense decreased $2.2 million, or 38.6%, to $3.4 million for the year ended March 31, 2012 from $5.6 million for the year ended March 31, 2011. The decrease in total interest expense is primarily attributable to a decrease in the cost of interest-bearing liabilities. The cost of funds decreased 41 basis points from 1.16% for the year ended March 31, 2011 to 0.75% for the current year. There was also a decrease in the average volume of interest-bearing liabilities due to decreases in both deposits and borrowings. The decrease in average deposit balances was due primarily to decreases in time deposit accounts for the current fiscal year.
Provision for Loan Losses. We establish provisions for loan losses, which are charged to earnings, at a level required to reflect credit losses inherent in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers’ ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions and current factors. Large groups of smaller balance homogeneous loans, such as residential real estate, small
commercial real estate, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data. Larger non-homogeneous loans, such as commercial loans for which management has concerns about the borrowers’ ability to repay, are evaluated individually, and specific loss allocations are provided for these loans when necessary.
In the current economic environment, management has considered the potential impact of subprime lending in certain areas of the national economy. These circumstances appear to have impacted economic conditions in our market areas to a lesser extent than the national economy. We have experienced increases in delinquency rates during the fiscal year ended March 31, 2012. We have maintained experienced and stable lending personnel during that period.
Based on management’s evaluation of these factors, the provision for loan losses decreased $1.6 million, or 24.1%, to $4.9 million for the fiscal year ended March 31, 2012 from $6.5 million for the fiscal year ended March 31, 2011 due to a decrease in the provision for specific impaired loans. The loan loss allowance for specific impaired loans is dependent primarily on the value of the collateral relative to the outstanding loan balance. We monitor our loan loss allowance on a quarterly basis and make allocations as necessary. Management believes that the level of our loan loss allowance is adequate. As of March 31, 2012, the total allowance for loan losses amounted to $8.9 million. At March 31, 2012, our allowance as a percentage of total loans receivable was 1.96% and as a percentage of total non-performing loans was 73.0% compared to 1.61% and 127.0% respectively at March 31, 2011. The increase in the total allowance to loans was due to both an increase in the allowance and a decrease in total loans receivable. The decrease in the total allowance to non-performing loans was due to an increase in non-performing loans at March 31, 2012 compared to March 31, 2011 offset by an increase in the allowance for loan losses for the same periods.
Noninterest Income. Noninterest income decreased $270,000, or 6.7%, to $3.8 million in fiscal 2012 as compared to $4.1 million for the year ended March 31, 2011. The decrease was primarily due to lower secondary market mortgage loan fees, commercial and consumer loan fees and overdraft fees. The increase in other income is due to the increase in income from affiliates in the current fiscal year.
Noninterest Expense. Total noninterest expense increased $1.8 million, or 10.5%, to $19.0 million for the year ended March 31, 2012 from $17.2 million for the year ended March 31, 2011, due primarily to increased compensation expense of $334,000 and an increase in real estate owned expenses of $1.7 million, partially offset by a decreased deposit insurance expense of $283,000. The increase in compensation expenses is related to merit pay and benefit increases. The increase in other expenses is primarily due to the increase in nonperforming assets and related collection expenses.
Taxes. Total taxes increased $133,000 to $976,000 during the year ended March 31, 2012 from $843,000 during fiscal 2011. The effective tax rate for the year ended March 31, 2012 was 34.9%.
Comparison of Years Ended March 31, 2011 and 2010
General. Net income for the year ended March 31, 2011 was $1.5 million or $0.18 diluted earnings per common share compared to $3.6 million or $0.65 diluted earnings per common share for the year ended March 31, 2010. Net income decreased due primarily to an increase in the provision for loan losses, partially offset by an increase in net interest income for the March 31, 2011 fiscal year.
Interest Income. Total interest income decreased $613,000, or 2.2%, to $27.6 million for the year ended March 31, 2011 as compared to $28.2 million for the year ended March 31, 2010. The decrease in total interest income was attributed to a decrease in the yield on interest earning assets and a decrease in the average dollar volume of loans of $2.7 million. Average yields on total interest-earning assets decreased nine basis points from 5.59% in fiscal 2010 to 5.50% for the 2011 fiscal year due primarily to a decrease in loan yields in a decreasing rate environment.
Interest Expense. Total interest expense decreased $2.5 million, or 30.6%, to $5.6 million for the year ended March 31, 2011 from $8.1 million for the year ended March 31, 2010. The decrease in total interest expense was attributable to a decrease in the cost of interest-bearing liabilities slightly offset by an increase in the average dollar volume of deposits of $4.6 million. The cost of funds decreased 51 basis points from 1.67% for the year ended March 31, 2010 to 1.16% for the 2011 fiscal year. The increase in deposit balances was due primarily to increases in transaction accounts for the 2011 fiscal year.
Provision for Loan Losses We experienced increases in delinquency and charge-off rates during the fiscal year ended March 31, 2011. We have maintained experienced and stable lending personnel during that period.
Based on management’s evaluation of these factors, the provision for loan losses increased $4.1 million, or 102.7%, to $8.1 million for the fiscal year ended March 31, 2011 from $4.0 million for the fiscal year ended March 31, 2010. The loan loss allowance for specific impaired loans is dependent primarily on the value of the collateral relative to the outstanding loan balance. We monitor our loan loss allowance on a quarterly basis and make allocations as necessary. Management believes that the level of our loan loss allowance is adequate. As of March 31, 2011, the total allowance for loan losses amounted to $7.9 million. At March 31, 2011, our allowance as a percentage of total loans receivable was 1.61% and as a percentage of total non-performing loans was 127.1%.
Noninterest Income. Noninterest income increased $239,000, or 6.2%, to $4.1 million in fiscal 2011 as compared to $3.9 million for the year ended March 31, 2010. The increase was primarily due to higher secondary market mortgage loan fees, commercial loan fees and overdraft fees. The decrease in other income is due to the income from the sale of Fannie Mae and Freddie Mac preferred stock in the previous fiscal year ended March 31, 2010.
Noninterest Expense. Total noninterest expense increased $532,000, or 3.5%, to $15.5 million for the year ended March 31, 2011 from $15.0 million for the year ended March 31, 2010, primarily due to increased compensation expense of $369,000 and an increase in real estate owned expenses of $624,000, partially offset by a decreased deposit insurance expense of $409,000 due to a special
assessment in the previous year. The increase in compensation expenses is related to merit pay increases and additional loan and customer service personnel. The increase in other expenses is primarily due to the increase in nonperforming assets and related collection expenses.
Taxes. Total taxes decreased $506,000 to $843,000 during the year ended March 31, 2011 from $1.3 million during fiscal 2010. The effective tax rate for the year ended March 31, 2011 was 35.6%. Income taxes for the March 31, 2010 fiscal year included a historic tax credit of $483,000.
Liquidity and Capital Resources
Liquidity represents our ability to meet our on-going funding requirements for contractual obligations, the credit needs of customers, withdrawal of customers' deposits and operating expenses. Our principal sources of funds are customer deposits, advances from the Federal Home Loan Bank of Atlanta, amortization and prepayment of loans, proceeds from the sale of loans and funds provided from operations. Management maintains investments in liquid assets based upon its assessment of (i) our need for funds, (ii) expected deposit flows, (iii) the yields available on short-term liquid assets, (iv) the liquidity of our loan portfolio and (v) the objectives of our asset/liability management program.
Our dominant source of funds during the year ended March 31, 2012 was from deposits which decreased by $6.6 million. Our cash increased $335,000 from $7.9 million at March 31, 2011 to $8.2 million at March 31, 2012.
At March 31, 2012, we had commitments to originate $8.1 million of loans. Certificates of deposit scheduled to mature in one year or less at March 31, 2012 totaled $148.3 million. Based on our historical experience, management believes that a significant portion of such deposits will remain with us. Management further believes that loan repayments and other sources of funds will be adequate to meet our foreseeable short- and long-term liquidity needs.
The Bank had at March 31, 2012, a line of credit at the Federal Home Loan Bank of Atlanta in the amount of $133.9 million. The Bank had borrowings of $78.0 million in addition to a letter of credit of $4.0 million and a remaining balance available of $51.9 million at March 31, 2012.
At March 31, 2012, we had tangible and core capital of 9.96% of adjusted total assets, which was in excess of their respective requirements of 1.5% and 4.0%. We also had risk-based capital of 13.08% of risk weighted assets, which also exceeded its requirement of 8.0%. The Bank was considered “well capitalized” as of March 31, 2012. Regulatory capital is discussed further in Note 10 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Contractual Obligations and Off-Balance Sheet Arrangements
As of March 31, 2012, we have not participated in any unconsolidated entities or financial partnerships, often referred to as structured finance or special entities. We do have significant commitments to fund loans in the ordinary course of business. Such commitments and resulting off-balance sheet risk are further discussed in Note 14 of the Consolidated Financial Statements contained in Item 8 of this report.
The following table presents our contractual cash obligations, excluding deposit obligations, as of March 31, 2012.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and results of operations in terms of historical dollars without considering changes in the relative purchasing power of money over time because of inflation. Unlike most industrial companies, virtually all of 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 the same magnitude as the price of goods and services. In the current interest-rate environment, equity, maturity structure and quality of our assets and liabilities are critical to the maintenance of acceptable performance levels.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements implemented by us during fiscal 2012 and new pronouncements which will be implemented in the future, see “Summary of Accounting Policies” in our Consolidated Financial Statements contained in Item 8 of this report.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management” in Item 7 of this report.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Community Financial Corporation
Staunton, Virginia
We have audited the accompanying consolidated balance sheets of Community Financial Corporation and Subsidiary as of March 31, 2012 and 2011, and the related consolidated statements of income, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community Financial Corporation and Subsidiary as of March 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
Winchester, Virginia
June 26, 2012
50 South Cameron Street
P.O. Box 2560
Winchester, VA 22604
(540) 662-3417
Offices located in: Winchester, Middleburg, Leesburg, Culpeper, and Richmond, Virginia
FAX (540) 662-4211
Member: American Institute of Certified Public Accountants / Virginia Society of Certified Public Accountants
Community Financial Corporation
and Subsidiary
Consolidated Balance Sheets
See accompanying summary of accounting policies and notes to consolidated financial statements.
Community Financial Corporation
and Subsidiary
Consolidated Statements of Income
Community Financial Corporation
and Subsidiary
Consolidated Statements of Income
(Continued)
See accompanying summary of accounting policies and notes to consolidated financial statements.
Community Financial Corporation
and Subsidiary
Consolidated Statements of Stockholders’ Equity
See accompanying summary of accounting policies and notes to consolidated financial statements.
Community Financial Corporation
and Subsidiary
Consolidated Statements of Cash Flows
Community Financial Corporation
and Subsidiary
Consolidated Statements of Cash Flows
(Continued)
See accompanying summary of accounting policies and notes to consolidated financial statements.
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Community Financial Corporation (the "Corporation") and its wholly-owned subsidiary, Community Bank (the "Bank"). All material intercompany accounts and transactions have been eliminated in consolidation.
Nature of Business and Regulatory Environment
The Bank is a federally chartered savings association and the primary asset of the Corporation. The Corporation provides a full range of banking services to individual and corporate customers primarily in the Shenandoah Valley and Hampton Roads regions of Virginia through its wholly-owned subsidiary.
The Office of the Comptroller of the Currency ("OCC") System became the primary regulator for federally
chartered savings associations and the Board of Governors of the Federal Reserve System became the primary
regulator for savings and loan holding companies during the fiscal year ended March 31, 2012.
The Bank's deposits are insured up to applicable limits by the Deposit Insurance Fund ("DIF"), which is administered by the Federal Deposit Insurance Corporation ("FDIC"). The FDIC has specific authority to prescribe and enforce such regulations and issue such orders as it deems necessary to prevent actions or practices by savings associations that pose a serious threat to the DIF.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was effective January 1, 1993. FDICIA contained provisions which allow regulators to impose prompt corrective action on undercapitalized institutions in accordance with a categorized capital-based system.
Estimates
In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the valuation of real estate owned and the fair value of financial instruments.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits and federal funds sold.
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
(Continued)
Securities
Securities may be classified as either trading, held to maturity or available for sale. Trading securities are held principally for resale and recorded at their fair values. Unrealized gains and losses on trading securities are included immediately in operations. Held to maturity securities are those which the Corporation has the positive intent and ability to hold to maturity and are reported at amortized cost. Available for sale securities consist of securities not classified as trading securities nor as held to maturity securities. Unrealized holding gains and losses on available for sale securities are excluded from operations and reported in accumulated other comprehensive income. Gains and losses on the sale of available for sale securities are recorded on the trade date and are determined using the specific identification method. Premiums and discounts on securities are recognized in interest income using the interest method over the period to maturity.
Management evaluates securities for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) the Corporation intends to sell the security or (ii) it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis. If, however, the Corporation does not intend to sell the security and it is not more-than-likely that the Corporation will be required to sell the security before recovery, management must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.
Loans Receivable
Loans receivable consists primarily of long-term real estate loans secured by first deeds of trust on single family residences, other residential property, commercial property and land located primarily in the state of Virginia. Interest income on mortgage loans is recorded when earned and is recognized based on the level yield method. The Corporation provides an allowance for accrued interest deemed to be uncollectible, which is netted against accrued interest receivable in the consolidated balance sheets.
The Corporation defers loan origination and commitment fees, net of certain direct loan origination costs, and the net deferred fees are amortized into interest income over the lives of the related loans as yield adjustments. Any unamortized net fees on loans fully repaid or sold are recognized as income in the year of repayment or sale.
The Corporation generally places loans on nonaccrual status after being delinquent greater than 90 days or earlier if the Corporation becomes aware that the borrower has entered bankruptcy proceedings, or in situations in which the loans have developed inherent problems prior to being 90 days delinquent that indicate payments of principal or interest will not be made in full. Whenever the accrual of interest is stopped, previously accrued but uncollected interest income is reversed. Thereafter, interest is recognized only as cash is received until the loan is reinstated to accrual status. Loans are returned to accrual status when all the principal and interest amounts
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
(Continued)
contractually due are brought current and future payments are reasonably assured. The Corporation may continue to accrue interest on certain loans that are 90 days or more delinquent if the Corporation has reason to believe that all principal and interest payments will be collected such as well secured loans.
One-to-Four-Family Residential Real Estate Lending
Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. As part of the application process, information is gathered concerning income, employment and credit history of the applicant. The valuation of residential collateral is provided by independent fee appraisers who have been approved by the Bank’s Board of Directors.
Commercial Real Estate Lending
Commercial real estate lending entails significant additional risk as compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or the economy, in general.
Construction and Land Development Lending
There are two characteristics of construction lending which impact its overall risk as compared to residential mortgage lending. First, there is more concentration risk due to the extension of a large loan balance through several lines of credit to a single developer or contractor. Second, there is more collateral risk due to the fact that loan funds are provided to the borrower based upon the estimated value of the collateral after completion. This could cause an inaccurate estimate of the amount needed to complete construction or an excessive loan-to-value ratio. To mitigate the risks associated with construction lending, the Bank generally limits loan amounts to 80% of the estimated appraised value of the finished home.
Commercial and Industrial Lending
Commercial business loans generally have more risk than residential mortgage loans, but have higher yields. To manage these risks, the Bank generally obtains appropriate collateral and personal guarantees from the borrower’s principal owners and monitors the financial condition of the borrower. Commercial business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate.
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
(Continued)
Consumer Lending
Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral on a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.
Troubled Debt Restructurings
In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). Management strives to indentify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment extensions or forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans.
Real Estate Owned
Real estate acquired through foreclosure is initially recorded at the lower of fair value, less selling costs on the property at the date of foreclosure. Costs relating to the development and improvement of property are capitalized, whereas those relating to holding the property are charged to expense.
Valuations are periodically performed by management, and an allowance for losses is established by a charge to operations if the carrying value of a property exceeds its estimated net realizable value.
Property and Equipment
Land is carried at cost. Property and equipment is stated at cost less accumulated depreciation. Provisions for depreciation are computed using the straight-line method over the estimated useful lives of the individual assets. Expenditures for betterments and major renewals are capitalized and ordinary maintenance and repairs are charged to operations as incurred. Estimated useful lives are three to ten years for furniture and equipment and five to fifty years for buildings and improvements.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation - put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
(Continued)
receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Income Taxes
Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefit in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the consolidated statements of income.
Earnings Per Common Share
Basic earnings per common share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options and are determined using the treasury stock method.
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
(Continued)
Stock-Based Compensation Plan
The Corporation recognizes the costs resulting from all share-based payments in the financial statements. Share-based compensation is estimated at the date of grant using the Black-Scholes option valuation model for determining fair value. The cost is recognized over the period the employee is required to provide services for the award.
Advertising Costs
The Corporation follows the policy of charging the costs of advertising to expense as incurred.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities and pension liability adjustments, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
Fair Value Measurements
Fair value of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 6. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect estimates.
Reclassifications
Certain reclassifications have been made to prior period balances to conform to the current year presentation. Losses on OREO in the amount of $1,701,322 have been reclassified from the Provision for loan losses to Real estate owned and collections in the consolidated statement of income for the fiscal year ended March 31, 2011.
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
(Continued)
Recent Accounting Pronouncements
In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The adoption of the new guidance is not expected to have a material impact on the Corporation’s consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and International Accounting Standards Board (IASB) to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards (IFRS). The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Corporation does not expect the adoption of ASU 2011-04 to have a material impact on the Corporation’s consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Corporation does not expect the adoption of ASU 2011-05 to have a material impact on the Corporation’s consolidated financial statements.
Community Financial Corporation
and Subsidiary
Summary of Accounting Policies
(Continued)
Recent Accounting Pronouncements (continued)
In September 2011, the FASB issued ASU 2011-08, “Intangible - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The adoption of the new guidance did not have a material impact on the Corporation’s consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Corporation does not expect the adoption of ASU 2011-11 to have a material impact on its consolidated financial statements.
In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05. All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Corporation does not expect the adoption of ASU 2011-12 to have a material impact on the Corporation’s consolidated financial statements.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
1. Securities
A summary of the amortized cost and estimated market values of securities is as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
1. Securities (continued)
The amortized cost and estimated market value of securities at March 31, 2012, by contractual maturity, are as follows:
Securities having a market value of $1,500,155 at March 31, 2011 were pledged by the Corporation for purposes required by law. No securities were pledged at March 31, 2012.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
1. Securities (continued)
Information pertaining to securities with gross unrealized losses at March 31, 2012 and 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
1. Securities (continued)
United States government and agency obligations. The unrealized loss on the six investments in direct obligations of U.S. government agencies was caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle at a price less than the amortized cost bases of the investment. Because the Corporation does not intend to sell the investment and it is not more likely than not that the Corporation will be required to sell the investment before recovery of the amortized cost basis, which may be maturity, the Corporation does not consider this investment to be other-than-temporarily impaired at March 31, 2012.
During the year ended March 31, 2009 due to the conservatorship of Fannie Mae and Freddie Mac in September 2008 and the related restrictions on its outstanding preferred stock (including the elimination of dividends), the Corporation recorded an other-than-temporary impairment (OTTI) charge with respect to the Fannie Mae and Freddie Mac preferred stock it owned of $11.5 million. The OTTI charge was based on the closing quoted stock market values on March 31, 2009. The Corporation used guidance in ASC 320, Investments - Debt and Equity Securities, to determine the OTTI. The Company sold its remaining 57,000 shares of Fannie Mae and Freddie Mac preferred stock during fiscal year 2011.
The Corporation's investment in FHLB stock totaled $5,206,300 at March 31, 2012. FHLB stock is generally viewed as a long-term investment and as a restricted security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. We do not consider this investment to be other-than-temporarily impaired at March 31, 2012 and no impairment has been recognized. FHLB stock is shown in restricted investments on the balance sheet and is not part of the AFS securities portfolio.
2. Loans Receivable, Net
Loans receivable by segment are summarized as follows:
Loans serviced for others amounted to $138,129 and $211,616 at March 31, 2012 and 2011, respectively. The loans are not included in the accompanying consolidated balance sheets.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
A summary of the allowance for loan losses is as follows:
The allowance for loan losses allocated by segment is as follows:
The changes in the provision for loan losses are primarily determined by the loss experience for the applicable loan classification.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
The allowance for loan losses allocated by segment is as follows:
Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. No additional funds are committed to be advanced in connection with impaired loans.
Nonaccrual loans included in the impaired loan disclosure amounted to $12,206,705 and $6,175,599 at March 31, 2012 and 2011, respectively. If interest on these loans had been accrued, such income would have approximated $211,945 and $327,857 for the years ended March 31, 2012 and 2011, respectively.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
Impaired loans by class are as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
Impaired loans by class are as follows (continued):
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
Impaired loans by class are as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
Impaired loans by class are as follows (continued):
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
For the year ended March 31, 2012, loans modified as troubled debt restructurings and included in impaired loans in the disclosure above totaled $21,115,000. At March 31, 2012, $18,871,000 of the loans classified as troubled debt restructurings are in compliance with the modified terms. There was $21,042,000 in troubled debt restructurings at March 31, 2011. The following table provides further information regarding our troubled debt restructurings during the periods ended March 31, 2012:
The table below shows troubled debt restructurings that subsequently defaulted within twelve months of modification as of March 31, 2012:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
Nonaccrual and past due loans by class are as follows:
As of March 31, 2012, the Company had $2,927,756 of loans greater than 90 days past due and still accruing interest. These loans are well secured and in the process of collection. Nonaccrual loans are included in Total Past Due.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
Nonaccrual and past due loans by class are as follows:
As of March 31, 2011, the Company did not have any loans greater than 90 days past due and still accruing interest. Nonaccrual loans are included in Total Past Due.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
The Corporation uses the following rating system for evaluating the risks associated with loans:
Pass
A Pass loan’s primary source of repayment is satisfactory, with secondary sources very likely to be realized if necessary.
Special Mention
A Special Mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or the Corporation’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard
A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.
Doubtful
A loan classified Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss
A loan classified Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.
Credit Quality by class is as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
2. Loans Receivable, Net (continued)
Credit Quality by class is as follows:
3. Other Real Estate Owned (OREO)
At March 31, 2012 and 2011, OREO was $9,259,432 and $10,263,488, respectively. OREO is primarily comprised of residential single family properties, residential lots and commercial real estate. Changes in the balance for OREO are as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
3. Other Real Estate Owned (OREO) (Continued)
Changes in the allowance for OREO are as follows:
Expenses applicable to OREO, other than the valuation allowance, were $1,050,568 and $931,987 for the years ended March 31, 2012 and 2011, respectively.
4. Property and Equipment
Property and equipment are summarized as follows:
Depreciation expense for the years ended March 31, 2012 and 2011 amounted to $632,607 and $627,361, respectively.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
5. Deposits
Deposits are summarized as follows:
The aggregate amount of time deposit accounts with a minimum denomination of $100,000 was $79,886,523 and $83,906,174 at March 31, 2012 and 2011, respectively.
Time deposits mature as follows:
At March 31, 2012 and 2011, overdraft demand deposits reclassified to loans totaled $98,650 and $83,831, respectively.
Brokered time deposits totaled $19,097,035 and $15,323,370 at March 31, 2012 and 2011, respectively, and are included in time deposits above.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
5. Deposits (continued)
Interest expense on deposits is summarized as follows:
6. Fair Value Measurements
The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer the liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact business at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
Fair Value Hierarchy
In accordance with this guidance, the Corporation groups assets and liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value.
Level 1
-
Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2
-
Valuation is based on observable inputs, including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
6. Fair Value Measurements (continued)
Level 3 - Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
The following describes the valuation techniques used by the Corporation to measure certain financial assets recorded at fair value on a recurring basis in the financial statements:
Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and 2011:
Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the Corporation to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan, the fair value of the collateral or discounted cash flow analyses. Fair value is
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
6. Fair Value Measurements (continued)
Impaired Loans (continued): typically measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Corporation using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over twelve months old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Loans valued using discounted cash flow analyses are considered Level 3. Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
Real Estate Owned: Foreclosed assets and repossessions are adjusted to fair value upon transfer of the loans to foreclosed assets and repossessions. Subsequently, foreclosed assets and repossessions are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the foreclosed asset or repossession as nonrecurring Level 3. Any fair value adjustments are recorded in the period incurred as real estate owned expense in the Consolidated Statements of Income.
The following table summarizes the Corporation’s assets that were measured at fair value on a nonrecurring basis during the period.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
6. Fair Value Measurements (continued)
The estimated fair values of the Corporation's financial instruments are as follows:
Accounting guidance excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
Cash and cash equivalents
For those short-term investments, the carrying amount is a reasonable estimate of fair value.
Securities
Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
6. Fair Value of Financial Instruments (continued)
Loans receivable
For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Deposit liabilities
The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Borrowings
For advances that mature within one year of the balance sheet date, carrying value is considered a reasonable estimate of fair value. The fair values of all other advances are estimated using discounted cash flow analysis based on the Corporation's current incremental borrowing rate for similar types of advances.
Securities sold under agreements to repurchase
Securities sold under agreements to repurchase are treated as short-term borrowings and the carrying value approximates fair value.
Accrued interest
The carrying amounts of accrued interest approximate fair value.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
6. Fair Value of Financial Instruments (continued)
Off-balance sheet instruments
The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At March 31, 2012 and 2011, the fair value of loan commitments and standby letters of credit were deemed immaterial.
7. Borrowings
Advances from the Federal Home Loan Bank and other borrowings are summarized as follows:
The weighted average interest rate on borrowings was 0.22% and 0.23% at March 31, 2012 and 2011, respectively. The fixed-rate FHLB advances are collateralized by the investment in FHLB stock and the Corporation's portfolio of first mortgage loans, multi-family, commercial real estate, second mortgage and home equity lines of credit under a Blanket Floating Lien Agreement. Value of this collateral as of March 31, 2012 was $132,247,680.
Information related to borrowing activity of the borrowings is as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
8. Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase are secured borrowings that generally mature within one to four days from the transaction date. These amounts are recorded at the amount of cash received in connection with the transaction. The Corporation may be required to provide additional collateral based on the fair value of the underlying securities.
The following is a summary of certain information regarding the Corporation’s repurchase agreements:
9. Income Taxes
The Corporation files income tax returns in the U.S. federal jurisdiction and the state of Virginia. With few exceptions, the Corporation is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2008.
Deferred tax assets (liabilities), included in the consolidated balance sheets are as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
9. Income Taxes (continued)
In accordance with ASC 740, Income Taxes, the Corporation was unable to recognize the deferred tax benefit related to the OTTI charge on Fannie Mae and Freddie Mac preferred stock during the quarter ended September 30, 2008. Tax laws in effect at September 30, 2008 characterized the loss as a capital loss. The Company did not have sufficient capital gain income to offset the loss and therefore set up a valuation allowance related to the capital loss. Subsequent to the September 30, 2008 quarter, the U.S. Congress passed the Emergency Economic Stabilization Act which re-characterized the OTTI loss on the Company’s Fannie Mae and Freddie Mac preferred stock to ordinary from capital for tax purposes. The tax benefit related to this loss of $11.5 million based on the Company’s approximate income tax rate of 38% was $4.4 million. Therefore the Company recognized the deferred tax asset during the quarter ended December 31, 2008, the period of enactment, as required by ASC 740. The Company also determined that it had sufficient taxable income available in carryback years and probable future taxable income to fully recognize the deferred tax asset. The deferred tax asset related to the OTTI loss was $4,248 and $4,248 at March 31, 2012 and 2011, respectively. During the year ended March 31, 2011, the Corporation sold and therefore realized losses for tax purposes on a portion of the preferred stock.
The provision for income taxes charged to operations for the years ended March 31, 2012 and 2011, consists of the following:
Differences between the statutory and effective tax rates are summarized as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
10. Comprehensive Income
The components of comprehensive income are summarized as follows:
The components of accumulated other comprehensive income (loss), included in stockholders' equity, are as follows:
11. Stockholders’ Equity and Regulatory Capital Requirements
Savings institutions must maintain specific capital standards that are no less stringent than the capital standards applicable to national banks. The OCC regulations currently have three capital standards including (i) a tangible capital requirement, (ii) a core capital requirement, and (iii) a risk-based capital requirement. The tangible capital standard requires savings institutions to maintain tangible capital of not less than 1.5% of adjusted total assets. The core capital standard requires a savings institution to maintain core capital of not less than 4.0% of adjusted total assets. The risk-based capital standard requires risk-based capital of not less than 8.0% of risk-weighted assets.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
11. Stockholders’ Equity and Regulatory Capital Requirements (continued)
The following table represents the Bank's regulatory capital levels, relative to the OCC requirements applicable at that date:
The Bank may not declare or pay a cash dividend, or repurchase any of its capital stock if the effect thereof would cause the net worth of the Bank to be reduced below certain requirements imposed by federal regulations.
Capital distributions by OCC-regulated savings banks are limited by regulation ("Capital Distribution Regulation"). Capital distributions are defined to include, in part, dividends, stock repurchases and cash-out mergers. The Capital Distribution Regulation requires that savings banks provide the applicable OCC District Director and Federal Reserve with a 30-day advance written notice or, under certain circumstances an application in connection with all proposed capital distributions. Savings banks are generally permitted to make capital distributions during a calendar year equal to net income for the current year plus the previous two years net income, less capital distributions paid over that same time period.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
11. Stockholders’ Equity and Regulatory Capital Requirements (continued)
On December 19, 2008, the Corporation received an investment from the U.S. Treasury Department ("the Treasury") of $12,643,000 in the form of 5% cumulative preferred stock. The Corporation also issued a warrant to purchase 351,194 shares of common stock at $5.40 per share to the Treasury. This investment was part of the Treasury's Capital Purchase Plan. The preferred stock will pay cumulative dividends at a rate of 5% per year for the first five years and 9% per year thereafter. The preferred stock is generally nonvoting. The warrant is immediately exercisable.
12. Earnings Per Common Share
During the year ended March 31, 2003, the Board of Directors authorized a stock repurchase program under which 368,706 shares of the Corporation’s stock may be repurchased. No shares were repurchased during the fiscal years ended March 31, 2012 or 2011.
Earnings per common share are calculated as follows:
During the years ended March 31, 2012 and 2011, stock options and warrants representing 236,025 shares and 282,750 shares, respectively, on average were not included in the calculation of earnings per share because their effect would have been antidilutive.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
13. Employee Benefit Plans
Pension Plan
The Corporation has a noncontributory defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and final average compensation. The Corporation's funding policy is to contribute amounts to the pension trust at least equal to the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA), but not in excess of the maximum tax deductible amount. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. The following is a summary of information with respect to the plan:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
13. Employee Benefit Plans (continued)
The accumulated benefit obligation for the defined benefit pension plan was $5,311,163 and $4,156,158 as of March 31, 2012 and 2011, respectively.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
13. Employee Benefit Plans (continued)
The following assumed rates were used in determining the benefit obligations:
The following assumed rates were used in determining the net periodic pension costs:
Year Ended March 31,
Weighted average discount rate
5.75%
6.00%
Expected long-term rate of return on plan assets
7.00%
7.00%
Increase in future compensation levels
3.00%
4.00%
Long-Term Rate of Return
The plan sponsor, in consultation with management, selects the expected long-term rate of return on assets assumption in consultation with their investment advisors. The rate is intended to reflect the average rate of earnings expected to be earned on the funds invested to provide plan benefits. Historical performance is reviewed with respect to real rates of return (net of inflation) for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience that may not continue over the measurement period, with higher significance placed on current forecasts of future long-term economic conditions.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
The investment policy of the Plan is to employ a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return on plan assets for a prudent level of risk. The intent of this strategy is to minimize plan expenses by exceeding the interest growth in long-term plan liabilities. Risk tolerance is established through careful consideration of plan liabilities, plan funded status and corporate financial condition. This consideration involves the use of long-term measures that address both return and risk. The investment portfolio contains a diversified blend of equity and fixed income investments. Investment risks and returns are measured and monitored on an ongoing basis through regular investment portfolio reviews.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
13. Employee Benefit Plans (continued)
Asset Allocation
The pension plan’s weighted-average asset allocations at March 31, 2012 and 2011, by asset category are as follows:
The Corporation made a contribution of $550,595 to its pension plan for the year ended March 31, 2012 during the June 30, 2012 quarter.
Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
13. Employee Benefit Plans (continued)
Employee Stock Ownership Plan
The Employee Stock Ownership and 401(k) Profit Sharing Plan (the "Plan") is a combination of a profit sharing plan with 401(k) and a stock bonus plan. The Plan provides for retirement, death, and disability benefits for all eligible employees.
An employee becomes eligible for participation after completion of 90 days of service. After meeting the eligibility requirements, an employee becomes a member of the Plan on the earliest January 1, April 1, July 1, or October 1 occurring on or after his or her qualification.
The contributions to the Plan are discretionary and are determined by the Board of Directors. The contributions are limited annually to the maximum amount permitted as a tax deduction under the applicable Internal Revenue Code provisions.
Plan expenses were approximately $240,000 and $235,000 for the years ended March 31, 2012 and 2011, respectively.
Salary Continuation Agreements
The Bank has entered into Salary Continuation Agreements with Messrs. Smiley and Giles. Benefits will commence upon the later of the executive reaching age 65 or the executive’s termination of service, at a benefit level equal to 20% and 25%, respectively, of his final pay, as defined, and will be paid for a period of 15 years, except in the case of an executive’s voluntary termination of employment prior to reaching normal retirement age or termination for cause. In the event of an executive’s voluntary termination of employment prior to reaching age 65, the Corporation will pay the executive, over 15 years, the accrued balance in the executive’s account. In the event of an executive’s termination of employment for cause (as defined in the agreement), no benefit shall be payable under the Salary Continuation Agreement. Benefits payable under these agreements are unfunded, unsecured obligations of the Bank. The cost of benefits payable under the retirement agreements is expected to be offset by the eamings and death benefits from life insurance purchased by the Bank.
Director Plans
Directors may defer receipt of up to 100% of their retainer and meeting fees pursuant to a deferred compensation plan established by the Bank. Directors who elect to defer some or all of their fees are credited at the end of each plan year with interest on their deferred account balance at an annual rate equal to 75% of the Corporation’s return on equity for that year, compounded monthly, until reaching age 70 or retiring, whichever is later. Upon the later of age 70 or retiring, the Corporation will pay the director his or her deferred account balance in 60 equal monthly installments, including interest at 8%. As of March 31, 2012, the Bank had entered into retirement agreements with each non-employee director except for directors Richard and Mott. Under the terms of these agreements each non-employee director was granted an initial annual benefit of $10,800, which amount increases at 3% per year for each full year of
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
service after January 1, 2004. The benefit accrues to the director annually until reaching age 75. In the event the director ceases to be a member of the Corporation’s Board of Directors prior to reaching age 70, other than for death, disability, in connection with a change in control or for cause, then the director shall only be entitled to the accrued balance in the director’s account as of the date of early termination. The annual benefit will generally commence upon the later of the director reaching age 70 or the director’s retirement from the Board of Directors, and will be payable monthly for a period of 5 years. In the case of the director’s death or disability prior to retirement, the annual benefit will commence in the month following the director’s death or disability. No benefits are payable to the director under these agreements if he or she is terminated as a director for cause by stockholders. The costs of benefits payable under the retirement agreements are expected to be offset by the earnings and death benefits from life insurance purchased by the Bank.
14. Stock Option Plan
The Corporation has a noncompensatory stock option plan (the "Plan") designed to provide long-term incentives to employees. All options are exercisable at end of year.
The following table summarizes options outstanding:
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
14. Stock Option Plan (continued)
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by option holders had all option holders exercised their options on March 31, 2012. This amount changes based on changes in the market value of the Corporation's stock.
No stock option grants were made during the fiscal year ended March 31, 2012.
The expected volatility is based on historical volatility. The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life is based on historical experience. The dividend yield assumption is based on the Corporation's history and expectation of dividend payouts.
The following table summarizes information about stock options outstanding and exercisable at March 31, 2012:
15. Commitments and Contingencies
The Corporation is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Corporation’s exposure to credit loss is represented by the contractual amount of these commitments. The Corporation follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
15. Commitments and Contingencies (continued)
At March 31, 2012 and 2011, the following financial instruments were outstanding whose contract amounts represent credit risk:
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 expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Corporation, is based on management’s credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Corporation is committed.
Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation generally holds collateral supporting those commitments if deemed necessary.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
15. Commitments and Contingencies (continued)
Leases
The Corporation is obligated under several noncancellable operating leases. Future minimum annual rental commitments under the leases are as follows:
Total lease expense was approximately $198,428 and $194,513 for the years ended March 31, 2012 and 2011, respectively.
In the normal course of business, the Corporation has entered into employment or severance agreements with certain officers of the Bank.
The Corporation maintains its cash accounts in several correspondent banks. As of March 31, 2012, deposits in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) were approximately $2,794,000.
16. Related Party Transactions
The Corporation has had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, principal shareholders, executive officers, their immediate families and affiliated companies in which they are principal shareholders (commonly referred to as related parties), on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. At March 31, 2012 and 2011, these loans totaled $1,309,824 and $798,568, respectively. During the year ended March 31, 2012, total principal additions were $1,264,226 and total principal payments were $752,970. Principal additions include loan balances of a newly appointed director during the current year.
Deposits from related parties held by the Corporation at March 31, 2012 and 2011 amounted to $692,146 and $693,076, respectively.
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
17. Condensed Financial Information of the Corporation (Parent Company Only)
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
17. Condensed Financial Information of the Corporation (Parent Company Only) (continued)
Community Financial Corporation
and Subsidiary
Notes to Consolidated Financial Statements
17. Condensed Financial Information of the Corporation (Parent Company Only) (continued)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) as of March 31, 2012, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management. The Corporation's Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. In addition, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended March 31, 2012, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all errors and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people, or by override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
Management's Report on Internal Control over Financial Reporting
The management of Community Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of the Company’s published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The management of Community Financial Corporation has assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2012. To make the assessment, we used the criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that, as of March 31, 2012, the Company’s internal control over financial reporting was effective based on those criteria.
This annual report does not include the attestation report of the Corporation’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Corporation’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Corporation to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE
Directors and Executive Officers. Information concerning directors of the Registrant is incorporated herein by reference from our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, copy of which will be filed not later than 120 days after the close of the fiscal year.
Information concerning executive officers is set forth in Item 1 of this report under the caption “Executive Officers.”
Compliance with Section 16(a). Information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference from our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
Audit Committee Matters and Audit Committee Financial Expert. Information concerning the audit committee of the Company’s Board of Directors, including information regarding audit committee financial experts serving on the audit committee, is incorporated herein by reference from the definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
Code of Ethics. The Company has adopted a written Code of Ethics based upon the standards set forth under Item 406 of Regulation S-K of the Securities Exchange Act. The Code of Ethics applies to all of the Company’s directors, officers and employees. A copy of the Company’s Code of Ethics was filed with the SEC as Exhibit 14 to its Annual Report on Form 10-KSB for the year ended March 31, 2004 and is posted in the Investor Relations section of our web site at www.cbnk.com. You may obtain a copy of the Code of Ethics free of charge from the Company by writing to the Secretary of Community Financial Corporation at 38 North Central Avenue, Staunton, Virginia 24401, or by calling (540) 886-0796.
Nomination Procedures. There have been no material changes to the procedures by which shareholders may recommend nominees to the Company’s Board of Directors.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference from our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
The following table summarizes our equity compensation plans as of March 31, 2012.
Equity Compensation Plans
Plan Category
Number of securities
to be issued upon
exercise of out-
standing options,
warrants and rights
(a)
Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)
Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column (a))
(c)
Equity compensation
plans approved by
security holders
243,900
$ 9.23
17,100
Equity compensation
plans not approved
by security holders
Total
243,900
$ 9.23
17,100
The number of shares available for issuance are adjusted for changes in capitalization due to reorganization, recapitalization, stock splits, stock dividends combination or exchange of shares, merger, consolidation or any change in the corporate structure.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information concerning certain relationships and transactions and director dependence is incorporated herein by reference from our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning fees and services by our principal accountants is incorporated herein by reference from our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the close of the fiscal year.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
See Exhibit Index.
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.
COMMUNITY FINANCIAL CORPORATION
Date: June 27, 2012
By:
/s/ Norman C. Smiley, III
Norman C. Smiley, III, President and CEO
(Duly Authorized Representative)
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.
By:
/s/Norman C. Smiley, III
By:
/s/ James R. Cooke, Jr.
Norman C. Smiley, III
Director, President and Chief
Executive Officer
(Principal Executive Officer)
James R. Cooke, Jr.
Chairman of the Board
and Director
Date:
June 27, 2012
Date:
June 27, 2012
By:
/s/ P. Douglas Richard
By:
/s/ Charles F. Andersen
P. Douglas Richard
Vice Chairman of the Board
and Director
Charles F. Andersen
Director
Date:
June 27, 2012
Date:
June 27, 2012
By:
/s/ Dale C. Smith
By:
/s/ Morgan N. Trimyer, Jr.
Dale C. Smith
Director
Morgan N. Trimyer, Jr.
Director
Date:
June 27, 2012
Date:
June 27, 2012
By:
/s/ R. Jerry Giles
By:
/s/ Charles W. Fairchilds
R. Jerry Giles
Chief Financial Officer
(Principal Financial and Accounting Officer)
Charles W. Fairchilds
Director
Date:
June 27, 2012
Date:
June 27, 2012
INDEX TO EXHIBITS
Regulation
S-K Exhibit
Number
Document
3.1
Amended and Restated Articles of Incorporation, filed on July 5, 1996 as an exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A (SEC File No. 000-18265), are incorporated herein by reference.
3.2
Certificate of Amendment and Articles of Amendment for the Series A Preferred Stock, filed on December 22, 2008, as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference
3.3
Bylaws, as amended and restated and currently in effect
4.1
Registrant’s Specimen Common Stock Certificate, filed on June 29, 1999 as Exhibit 4 to the Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 1999, is incorporated herein by reference.
4.2
Registrant’s Form of Certificate for the Series A Preferred Stock, filed on December 22, 2008, as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
4.3
Registrant’s Form of Warrant for Purchase of Shares of Common Stock, filed on December 22, 2008, as Exhibit 4.2 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
10.1
Registrant’s 1996 Incentive Plan, filed on July 5, 1996 as an exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A (SEC File No. 000-18265), is incorporated herein by reference.
10.2
Form of Change in Control Agreement by and between Community Bank and each of R. Jerry Giles and Benny N. Werner, filed on May 5, 2006 as Exhibit 99.5 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
10.3
Retirement Agreements by and between Community Bank and Non-Employee Directors filed on June 29, 2004 as an exhibit to the Registrant’s Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 2004, and incorporated here by reference.
10.4
Form of First Amendment to the Retirement Agreements by and between Community Bank and Non-Employee Directors, filed on June 29, 2005 as an exhibit to the Registrant’s Annual Report on Form 10-K (SEC File No. 000-18265) for the fiscal year ended March 31, 2005, is incorporated here by reference.
10.5
Salary Continuance Agreements by and between Community Bank and Officers Giles, Smiley and Werner filed on June 29, 2004 as an exhibit to the Registrant’s Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 2004, and incorporated here by reference.
10.6
Form of Director Deferred Fee Agreement, as amended, filed on June 29, 2005 as an exhibit to the Registrant’s Annual Report on Form 10-K (SEC File No. 000-18265) for the fiscal year ended March 31, 2005, is incorporated here by reference.
10.7
Registrant’s 2003 Stock Option and Incentive Plan, filed on June 26, 2003 as an exhibit to the Registrant’s Definitive Proxy Statement on Schedule 14A (SEC File No. 000-18265), is incorporated herein by reference.
10.8
Form of Incentive Stock Option Agreement and Non-Qualified Stock Option Agreement for Registrant’s 2003 Stock Option and Incentive Plan, filed on August 12, 2005 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q (SEC File No. 000-18265) for the quarter ended June 30, 2005, are incorporated herein by reference.
10.9
Employment Agreement by and between Community Bank and Norman C. Smiley, III, filed on June 16, 2008 as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
10.10
Change in Control Agreement by and between Community Financial Corporation and Norman C. Smiley, III, filed on June 16, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
10.11
Form of Change in Control Agreement by and between Community Financial Corporation and Lyle Moffett, filed on July 1, 2008 as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference.
10.12
Form of Change in Control Agreement by and between Community Financial Corporation and John Howerton is filed with this Form 10-Q.
10.13
Letter Agreement, including Schedule A, and Securities Purchase Agreement, dated December 19, 2008, between Community Financial Corporation and United States Department of the Treasury, with respect to the issuance and sale of the Series A Preferred Stock and the Warrant, filed on December 22, 2008, as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference
10.14
Form of Compensation Modification Agreement and Waiver, executed by each of P. Douglas Richard, Norman C. Smiley, III and Chris P. Kyriakides, filed on December 22, 2008, as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K (SEC File No. 000-18265), is incorporated herein by reference
Statement re computation of per share earnings (see Note 12 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K).
Code of Ethics, filed on June 29, 2004 as an exhibit to the Registrant’s Annual Report on Form 10-KSB (SEC File No. 000-18265) for the fiscal year ended March 31, 2004, and incorporated here by reference.
Subsidiaries of the Registrant, filed on June 29, 2005 as an exhibit to the Registrant’s Annual Report on Form 10-K (SEC File No. 000-18265) for the fiscal year ended March 31, 2005, is incorporated here by reference.
Consent of Independent Auditors
31.1
Rule 13(a)-14(a) Certification (Chief Executive Officer)
31.2
Rule 13(a)-14(a) Certification (Chief Financial Officer)
Section 1350 Certifications
99.1
Certification of Principal Executive Officer Pursuant to 31 CFR §30.15
99.2
Certification of Principal Financial Officer Pursuant to 31 CFR §30.15
Interactive Data File*
*In accordance with rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.