ITEM 1. BUSINESS.
General
Hamilton Bancorp Inc. ("Hamilton Bancorp"), through its subsidiary, Hamilton Bank, N.A. ("Hamilton Bank"), (Hamilton Bancorp and Hamilton Bank are collectively referred to herein as the "Company"), is engaged in providing global trade finance with particular emphasis on trade with and between South America, Central America and the Caribbean (collectively, the "Region") and the United States or otherwise involving the Region. Management believes that trade finance provides the Company with the opportunity for substantial and profitable growth, primarily with moderate credit risk, and that Hamilton Bank is the only domestic financial institution in the State of Florida focusing primarily on financing foreign trade. Through its relationships with approximately 500 correspondent banks and with importers and exporters in the United States and the Region, as well as its location in South Florida, which is becoming a focal point for trade in the Region, the Company has been able to take advantage of substantial growth in this trade. Much of this growth has been associated with the adoption of economic stabilization policies in the major countries of the Region.
The Company operates in all major countries throughout the Region and has been particularly active in several smaller markets, such as Guatemala, Ecuador, Panama and Peru. Management believes that these smaller markets are not primary markets for the larger, multinational
financial institutions and, therefore, customers in such markets do not receive a similar level of service from such institutions as that provided by the Company. To enhance its position in certain markets, the Company has made minority investments in indigenous financial institutions in Guyana, Peru and Nicaragua. The Company has also strengthened its relationships with correspondent financial institutions in the Region by acting as placement agent, from time to time, for debt instruments or certificates of deposit issued by many of such institutions.
The Company seeks to generate income by participating in multiple aspects of trade transactions that generate both fee and interest income. The Company earns fees primarily from opening and confirming letters of credit and discounting acceptances and earns interest on credit extended, primarily in the form of commercial loans, for pre- and post-export financing, such as refinancing of letters of credit, and to a lesser extent, from discounted acceptances. As the economy in the Region has grown and stabilized and the Company has begun to service larger customers, the balance of the Company's trade financing activities has shifted somewhat from letters of credit to the discounting of commercial trade paper and the granting of loans, resulting in relatively less fee income but increased interest income. Virtually all of the Company's business is conducted in United States dollars. Management believes that the Company's primary focus on trade finance, its wide correspondent banking network in the Region, broad range of services offered, management experience, reputation and prompt decision-making and processing capabilities provide it with important competitive advantages in the trade finance business. The Company seeks to mitigate its credit risk through its knowledge and analysis of the markets it serves, by obtaining third-party guarantees of both local banks and importers on many transactions, by often obtaining security interests in goods being financed and by the short-term, self-liquidating nature of trade transactions. At December 31, 1998, approximately 60% of the Company's loan portfolio consisted of short-term trade related loans with an average original maturity of approximately 180 days and approximately 70% maturing within 365 days. Credit is generally extended under specific credit lines for each customer and country. These credit lines are reviewed at least annually.
Lending activities are funded primarily through domestic consumer deposits gathered through a network of seven branches in Florida and one branch in San Juan, Puerto Rico as well as deposits received from correspondent banks, corporate customers and private banking customers within the Region. The Company's branches are strategically located in markets where it believes there is both a concentration of retail deposits and foreign trade activity. The Company also participates in various community lending activities, and under several United States and Florida laws and regulations Hamilton Bank is considered a minority bank and is able to participate in certain beneficial minority programs involving both deposits and loans.
Developments in Certain Emerging Market Countries
The economies of various countries in the Region, including Brazil, Ecuador and Venezuela, have been characterized by frequent and occasionally drastic intervention by the governments and volatile economic cycles. Governments have often changed monetary, credit, tariff and other policies to influence the course of their respective economies. The actions of the Brazilian,
Ecuadorian and Venezuelan Governments to control inflation and effect other policies have often involved wage and price controls as well as other interventionist measures, such as Ecuador's recent freezing of bank accounts. Changes in policies in other countries in the Region involving tariffs, exchange controls, regulations and taxation could significantly increase the likelihood of causing restrictions on transfers of Dollars out of such countries, as could inflation, devaluation, social instability and other political, economic or diplomatic developments.
Brazilian, Ecuadorian and Venezuelan financial and securities markets, as well as other financial and securities markets in the Region, are, to varying degrees, influenced by economic and market conditions in other emerging market countries and other countries in the Region. Although economic conditions are different in each country, investor reaction to developments in one country can have significant effects on the financial markets and securities of issuers in other countries. These developments as well as the recent devaluation of various Asian currencies have adversely affected the securities and other financial markets in many emerging markets, including Brazil, Ecuador and Venezuela. One result of these difficulties has been the closing of numerous banks in some countries in the Region, especially in Ecuador. To date, however, the Ecuadorian government has guaranteed the obligations of such closed banks in Ecuador. The ensuing increased market volatility in these securities and other financial markets has also been attributed, at least in part, to the effect of these and other similar events. There can be no assurance that the various financial and securities markets in the Region, including Brazil, Ecuador and Venezuela, will not continue to be adversely affected by events elsewhere, especially in other emerging markets and in other countries in the Region.
The Company will continue to take advantage of the United States and international economic environment by emphasizing the financing of trade from the Region into the United States. As a result of the recent deterioration of economic conditions in some countries in the Region, the Company expects that trade flows into the Region will on a relative basis diminish compared to recent years. In light of the United States' strong economy, government budget surplus, low interest rates, strong stock market, high employment levels and strong consumer demand, the Company expects trade flows from the Region into the United States will increase as such countries attempt to capitalize on export opportunities as a way to increase production, stimulate revenues and thereby "export out" of their economic difficulties. The Company has recently placed and expects to continue to place more emphasis on financing imports of goods into the United States and thereby increase the relative size of its assets employed in the United Sates as compared to its exposure in the Region. In addition, prudent risk management, in particular with regard to emerging market countries, calls for avoidance of high concentrations of risk in these countries in relation to a bank's capital. Currently, United States bank regulatory agencies consider that exposure in these markets should be limited to levels that would not impair the safety and soundness of a banking institution. As a consequence, the Company's exposure in the Region was significantly reduced at December 31, 1998 and will be further reduced in 1999. The Company, however, will continue to have significant exposure in the Region.
Background of the Company
Hamilton Bancorp was formed as a bank holding company in 1988 in Miami, Florida, to acquire 99.7% of the issued and outstanding shares of Hamilton Bank. Hamilton Bank was acquired by Hamilton Bancorp to take advantage of perceived opportunities to finance foreign trade between United States corporate customers and companies in the Region, as the area emerged from the Latin American debt crisis of the early 1980's, particularly since most non-Regional financial institutions had limited interest in financing trade with the Region at that time. Members of Bank management, who had extensive experience in trade finance in the Region, re-established contacts in the Region, primarily with banks. Hamilton Bank initially offered its services confirming letters of credit for banks in the Region. Hamilton Bank then began to market its other trade related services and products to beneficiaries of its letters of credit. As Hamilton Bank's relationships with correspondent banks developed and as it developed corporate clients in the United States, Hamilton Bank's trade finance activity continued to increase. Hamilton Bank's business expanded into its other products and services, which primarily included other types of trade financing instruments.
Market for Company Services
International trade between the United States and the Region as well as between the State of Florida and the Region has grown significantly during the five year period ended December 31, 1998. Recent treaties and agreements relating to trade are expected to eliminate certain trade barriers and open up certain economic sectors to competition, as well as to liberalize trade between the United States and many countries with respect to a variety of goods and services. A high and increasing percentage of this trade requires financing. The growth and importance of trade in the United States and the Region also increases the number of small and medium-sized firms engaged in trade and in need of trade finance services. Many financial institutions in the United States in general and Florida in particular are not adequately staffed to handle such financing on a large scale, or to judge the creditworthiness of companies or banks in the Region and, accordingly, eschew trade financing or limit the scope of their trade financing activity. This has been partially responsible for the expanding market for the Company's trade financing services.
Management believes that the Company has carved out a niche for itself as the only Florida financial institution the business of which is focused predominantly on financing foreign trade in the Region. The Company initially focused on providing services and products to smaller banks and corporate customers in the Region and smaller companies in Florida doing business in the Region, as well as financial institutions and customers in smaller countries in the Region where a more limited number of large, multinational banks conduct business. The Company's willingness to provide trade financing in these situations frequently results in it obtaining business from the same customers involving larger countries in the Region, as well. A significant percentage of the Company's trade financing business now involves such larger countries. The Company does not, however, have a significant share of the overall market in larger countries in the Region, such as Brazil and Argentina, where it competes more frequently with larger, multinational financial
institutions. The Company also provides products and services for multinational corporations, such as major commodities houses, and purchases participation interests in the trade financing of multinational financial institutions to companies in the Region. The Company's trade financing allows for the movement of commodities such as sugar, grain and steel, and consumer goods such as textiles and appliances, as well as computer hardware, capital equipment and other items.
Trade Finance Services and Products
The manufacture or production and distribution of any product or good generally results in a number of trade transactions which, together, make up a trade cycle. For example, a seller of shirts purchases buttons and materials, arranges for manufacture and often contracts with a distributor who sells the products to retailers. The Company attempts to become involved in and to finance as many stages of a trade cycle as possible. Since the Company's primary focus is on trade finance, the Company offers a wider array of trade finance products and services than most institutions it competes with, although some of the Company's products and services, such as import and export letters of credit, are offered by almost all financial institutions engaged in trade finance, and most of the Company's products are offered by some financial institutions. The principal trade related products and services which the Company offers include:
. Commercial Documentary Letters of Credit. Commercial documentary letters of credit are obligations issued by a financial institution in connection with trade transactions where the financial institution's credit is effectively substituted for that of its customer, who is buying goods or services from the beneficiaries of those letters of credit. When the bank issuing a letter of credit is not well known or is an unacceptable risk to the beneficiary, the issuing bank must obtain a guarantee or confirmation of the letter of credit by an acceptable bank in the beneficiary's market. When the Company confirms a letter of credit it assumes the credit risk of the issuing bank and generally takes a security interest in the goods being financed. These obligations, which are governed by their own special set of legal rules, call for payment by the financial institution against presentation of certain documents showing that the purchased goods or services have been provided or are forthcoming. From time to time, a financial institution issues a commercial documentary letter of credit ("back-to-back") against receipt of a letter of credit from another bank in order to finance the purchase of goods. The Company commenced its trade financing activities by confirming letters of credit for correspondent financial institutions in the Region and then began to sell other products and services to the beneficiaries of such letters of credit. Commercial letters of credit are contingent liabilities of the Company that are not recorded on the Company's balance sheet and which generate fee income. Upon payment of a letter of credit, the Company may refinance the obligation through a loan which will be reflected on the Company's balance sheet as "Loans-net."
. Bankers' Acceptances. A bankers' acceptance is a time draft drawn on a bank and accepted by it. Acceptance of the draft obligates the bank to unconditionally pay the face value to whomever presents it at maturity. Drafts accepted by the Company are reflected on the asset
side of the Company's balance sheet as "Due from Customers on Bankers' Acceptances" and on the liability side as "Bankers' Acceptances Outstanding." The Company receives a fee upon acceptance of a draft. Discounted bankers' acceptances represent the purchase by a financial institution of a draft at a discount. This assists an exporter in providing terms to an importer under a letter of credit and also provides liquidity to the exporter. Discounted bankers' acceptances are discounts of forward maturity items and are included on the Company's balance sheet under "Loans-net." The Company receives both fee and interest income from discounted bankers' acceptances.
. Discounted Trade Acceptances. Discounted trade acceptances represent an obligation of an importer to pay money on a certain date in the future, which obligation has been accepted by the importer as payable to the exporter, then sold by the exporter at a discount to a financial institution. If with recourse, the financial institution as holder of this instrument has recourse at maturity of the acceptance to the exporter as well as the accepting importer. If without recourse, the financial institution holding the acceptance has no recourse to the exporter, but only to the accepting importer. Discounted trade acceptances are discounts of forward maturity items and are included on the Company's balance sheet under "Loans-net." The Company receives primarily interest income from discounted trade acceptances.
. Pre-export Financing. Pre-export financing is provided by a financial institution, either directly or indirectly through a second bank, to an exporter who has a definitive international contract for the sale of certain goods or services. Such financing funds the exporter's manufacture, assembly and sale of these goods or services to the purchaser abroad. Pre-export financing is reflected on the balance sheet as "Loans-net". The Company receives primarily interest income from pre-export financing.
. Warehouse Receipt Financing. Warehouse receipt financing provides temporary financing, usually at a significant loan to collateral discount, for goods temporarily held in an independent warehouse pending their sale and/or delivery in a trade transaction. The goods are evidenced by a receipt issued by the independent warehouse where the goods are stored. Possession of that receipt gives the financial institution a perfected security interest in those goods to collateralize the credit that it is providing. Warehouse receipt financing is reflected on the balance sheet as "Loans-net". The Company receives primarily interest income from warehouse receipt financing.
. Documentary Collections. For a fee, a United States financial institution will assist financial institutions to collect at maturity various drafts, acceptances or other obligations which have come due and which are owed by parties abroad or in the United States. Documentary collections are not reflected on the balance sheet and are not contingent obligations of the Company. The Company receives fee income from documentary collections.
. Foreign Exchange Transactions. Foreign exchange services consist of the purchase of foreign currency on behalf of a customer. This service includes both spot and forward
transactions. Such transactions may be conducted in both hard and soft currencies (i.e., those which are widely accepted internationally and those that are not). The Company conducts such transactions in both types of currencies. Foreign exchange transactions are not reflected on the balance sheet and represent contingent liabilities of the Company. The Company receives fee income from foreign exchange transactions.
. Standby Letters of Credit. Standby letters of credit effectively represent a guarantee of payment to a third party by a financial institution, usually not in connection with an individual trade transaction. The Company does not favor standby letters of credit. They are only issued by the Company in situations where the Company believes it is adequately and properly secured or that the customer is in very strong financial condition. Standby letters of credit are not reflected on the balance sheet and represent contingent liabilities of the Company. The Company receives fee income from standby letters of credit.
. International Cash Management. The Company assists corporations and banks in the Region with the clearing of checks drawn on United States financial institutions. As a United States financial institution and a member of the Federal Reserve System, Hamilton Bank is able to provide quick and efficient clearing of these items. The provision of these services often leads to the Company providing other products and services to corporations and banks.
Most of the Company's customers are serviced through its International Banking and Domestic Corporate Trade Departments. The International Banking Department services the Company's international corporate and correspondent banking customers. The Domestic Corporate Trade Department services United States-based relationships, primarily with domestic corporate clients. Each corporate customer's account is coordinated by a specific officer at the Company. Each such customer will also generally do business with the Company officers responsible for the countries involved in a particular transaction. Company officers meet in person with key officials from each of the correspondent banks and corporate customers each year. In addition, the Company communicates with its correspondent banks and corporate customers in a variety of other ways.
Competition
International trade financing is a highly competitive industry that is dominated by large, multinational financial institutions such as Citibank, N.A., ABN-AMRO Bank and Barclays Bank PLC, among others. With respect to trade finance in or relating to larger countries in the Region, primarily in South America, these larger institutions are the Company's primary competition. The Company has less competition from these multinational financial institutions providing trade finance services with or in smaller countries in the Region, primarily in Central America and the Caribbean, because the volume of trade financing in such smaller countries has not been as attractive to these larger institutions. With respect to Central American and Caribbean countries, as well as United States domestic customers, the Company also competes with regional United States and smaller local financial institutions engaged in trade finance. Many of the Company's competitors, particularly
multinational financial institutions, have substantially greater financial and other resources than the Company. In general, the Company competes on the basis of the range of services offered, convenience and speed of service, correspondent banking relationships and on the basis of the rates of fees and commissions charged. Management believes that none of the Company's significant United States competitors have the focus on trade finance and offer the range of services that the Company offers. Management further believes that the Company's strong trade culture, range of services offered, liquid portfolio, management experience, reputation and prompt decision-making and processing capabilities provide it with a competitive advantage that allows it to compete favorably with its competitors for the trade finance business in the Region. The Company also has adjusted to its competition by often participating in transactions with certain of its competitors, particularly the larger, multinational financial institutions.
Although to date the Company has competed successfully, on a limited basis, in those countries in the Region which have high trade volumes, such as Brazil and Argentina, there can be no assurance that the Company will be able to continue competing successfully in those countries with either large, multinational financial institutions or regional United States or local financial institutions. Any significant decrease in the Company's trade volume in such large-volume countries could adversely affect the Company's result of operations. Although the Company faces less competition from multinational financial institutions in those countries in the Region, particularly countries in Central America and the Caribbean, where the trading volume has not been large enough to be meaningful for multinational financial institutions, there can be no assurance that such financial institutions will not seek to finance greater volumes of trade in those countries or that the Company would be able to successfully compete with such financial institutions in the event of increased competition. In addition, there is no assurance that the Company will be able to continue to compete successfully in smaller countries with the regional United States financial institutions and smaller local financial institutions engaged in trade finance in such countries. Continued political stability and improvement in economic conditions in such countries are likely to result in increased competition.
Employees
At December 31, 1998 the Company had 264 full-time employees. The Company's employees are not represented by a collective bargaining group, and the Company considers its overall relations with its employees to be good.
Hamilton Bancorp Regulation
General
As a result of its ownership of Hamilton Bank, Hamilton Bancorp is registered as a bank holding company and is regulated and subject to periodic examination by the Board of Governors of the Federal Reserve System ("Federal Reserve") under the United States Bank Holding Company Act.
Pursuant to the United States Bank Holding Company Act and the Federal Reserve's regulations, Hamilton Bancorp is limited to the business of owning, managing or controlling banks and engaging in certain other financial related activities, including those activities that the Federal Reserve determines from time to time to be so closely related to the business of banking as to be a proper incident thereto.
The United States Bank Holding Company Act requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire all or substantially all of the assets of a bank in the United States, (ii) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank in the United States (unless it already owns a majority of such bank's voting shares) or (iii) merge or consolidate with any other bank holding company.
Hamilton Bancorp is required by the Federal Reserve to act as a source of financial strength and to take measures to preserve and protect Hamilton Bank. As a result, Hamilton Bancorp may be required to inject capital in Hamilton Bank if Hamilton Bank at any time lacks such capital and requires it. The Federal Reserve may charge a bank holding company such as Hamilton Bancorp with unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. Any loans from Hamilton Bancorp to Hamilton Bank which would count as capital of Hamilton Bank must be on terms subordinate in right of payment to deposits and to most other indebtedness of Hamilton Bank.
The Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation collectively have extensive enforcement authority over bank holding companies and national banks in the United States. This enforcement authority, initiated generally for violations of law and unsafe or unsound practices, includes, among other things, the ability to assess civil money penalties, to initiate injunctive actions, to issue orders prohibiting or removing a bank holding company's or a bank's officers, directors and employees from participating in the institution and, in rare cases, to terminate deposit insurance.
The Federal Reserve's, the Office of the Comptroller of the Currency's and the Federal Deposit Insurance Corporation's enforcement authority was enhanced substantially by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). FIRREA significantly increased the amount and the grounds for civil money penalties. Also, under FIRREA, should a failure of Hamilton Bank cause a loss to the Federal Deposit Insurance Corporation, any other Federal Deposit Insurance Corporation-insured subsidiaries of Hamilton Bancorp could be required to compensate the Federal Deposit Insurance Corporation for the estimated amount of the loss (Hamilton Bancorp does not currently have any such subsidiaries). Additionally, pursuant to FDICIA, Hamilton Bancorp in the future could have the potential obligation to guarantee the capital restoration plans of any undercapitalized Federal Deposit Insurance Corporation insured depository institution subsidiaries it may control.
Capital Adequacy
The federal bank regulatory authorities have adopted risk-based capital guidelines to which Hamilton Bancorp and Hamilton Bank are each subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profile among banking organizations, takes off-balance sheet exposures into explicit account in assessing capital adequacy and minimizes disincentives to holding liquid, low-risk assets. These risk-based capital ratios are determined by allocating assets and specified off-balance sheet financial instruments into four weighting categories, with higher levels of capital being required for the categories perceived as representing greater risk.
Under these guidelines a banking organization's capital is divided into two tiers. The first tier (Tier 1) includes common equity, perpetual preferred stock (excluding auction rate issues) and minority interests that are held by others in a consolidated subsidiary, less goodwill and any disallowed intangibles. Supplementary (Tier 2) capital includes, among other items, cumulative and limited-life preferred stock, mandatory convertible securities, subordinated debt and the allowance for loan and lease losses, subject to certain limitations and less required deductions as provided by regulation.
Banking organizations are required to maintain a risk-based capital ratio of total capital (Tier 1 plus Tier 2) to risk-weighted assets of 8% of which at least 4% must be Tier 1 capital. The federal bank regulatory authorities may, however, set higher capital requirements when a banking organization's particular circumstances warrant. As a practical matter, banking organizations are expected to maintain capital ratios well above the regulatory minimums. The risk-based capital ratios of Hamilton Bancorp and Hamilton Bank as of December 31, 1997 and 1998 are discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations-Capital Resources."
In addition, the federal bank regulatory authorities have established guidelines for a minimum leverage ratio (Tier 1 capital to average total assets). These guidelines provide for a minimum leverage ratio of 3% for banking organizations that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate exposure and the highest regulatory rating. Banking organizations not meeting these criteria or which are experiencing or anticipating significant growth are required to maintain a leverage ratio which exceeds the 3% minimum by at least 100 to 200 basis points. The leverage ratios of Hamilton Bancorp and Hamilton Bank as of December 31, 1997 and 1998 are discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources."
Failure to meet applicable capital guidelines could subject a bank or bank holding company to a variety of "prompt corrective action" enforcement remedies available to the federal bank regulatory authorities, including limitation on the ability to pay dividends, the issuance of a capital directive to increase capital and, in the case of a bank, the issuance of a cease and desist order, the imposition of civil money penalties, the termination of deposit insurance by the Federal Deposit Insurance Corporation or (in severe cases) the appointment of a conservator or receiver.
While Hamilton Bancorp is well capitalized for the purposes of the "prompt corrective action" provisions of FDICIA, to date it has not paid any dividends and does not anticipate doing so. Nevertheless, due to economic difficulties being experienced by various countries in the Region, the Federal Reserve has requested that Hamilton Bancorp not pay any dividends or incur any debt (excluding "trust preferred" securities) without the consent of the Federal Reserve.
Interstate Banking
As of September 29, 1995, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 permitted adequately capitalized and managed bank holding companies to acquire control of banks in any state. Although individual states could authorize interstate branches earlier, beginning on June 1, 1997, the Interstate Banking Act allows banks to branch across state lines, unless a state elects to opt-out entirely. Florida did not so opt-out and allows out-of-state banks to enter Florida by merger with an existing Florida-based bank and to branch throughout the state. This has further increased competition for Hamilton Bank by allowing large banks from other parts of the United States to operate directly in Florida.
Regulation of Hamilton Bank
General
Hamilton Bank, as a Federal Deposit Insurance Corporation-insured national bank, is subject to regulation primarily by the Office of the Comptroller of the Currency and secondarily by the Federal Deposit Insurance Corporation. Also, as a national bank Hamilton Bank is a member of the Federal Reserve System and its operations are therefore also subject to certain Federal Reserve regulations. Various other federal and state consumer laws and regulations also affect the operations of Hamilton Bank.
As a national bank, Hamilton Bank may be able to engage in certain activities approved by the Office of the Comptroller of the Currency which the Federal Reserve would not necessarily approve for Hamilton Bancorp or its non-national bank subsidiaries. The Office of the Comptroller of the Currency has been particularly aggressive in recent years in allowing national banks to undertake an ever-increasing range of securities and insurance activities. Along these lines, pursuant to certain revisions to the Office of the Comptroller of the Currency's regulations pertaining to national bank activities effective on December 31, 1996, national banks, among other things, are permitted on a case-by-case basis to operate subsidiaries that may engage in activities some of which are not permissible for the bank itself. Although the revised regulations do not authorize any new activities per se, it is expected that national banks, if eligible and if they obtain the approval of the Office of the Comptroller of the Currency, will use them to expand further into the businesses of insurance and securities underwriting.
The revised Office of the Comptroller of the Currency regulations contain "fire walls" intended to protect a national bank from the risks taken by its subsidiary, including a 10% cap on
the amount of bank capital that may be invested in the new subsidiary, as well as requirements that extensions of credit to the operating subsidiary be fully-collateralized and that transactions between the bank and the subsidiary be conducted at arm's-length. Also, other safeguards are that the parent national bank's exposure to any losses the subsidiary may incur be limited to the bank's equity investment in the subsidiary, and that the parent national bank be well-capitalized both before and after the investment is made.
Since Office of the Comptroller of the Currency approval is required on a case-by-case basis for an eligible bank to be permitted to engage in activities not permissible for the bank to conduct directly, it is unclear at this time what the effect of these revised regulations on the operations of national banks will be.
As a national bank, Hamilton Bank may not ordinarily lend more than 15% of its capital unsecured to any one borrower, and may lend up to an additional 10% of its capital to that same borrower on a fully secured basis involving readily marketable collateral having a market value, as determined by reliable and continuously available price quotations, equal at least to the amount borrowed. In addition, there are various other circumstances in which Hamilton Bank may lend in excess of such limits, including authority to lend up to 35% of capital and surplus when the loan is secured by documents of title to readily marketable staples and certain other exceptions relevant to international trade finance.
Federal law also imposes additional restrictions on Hamilton Bank with respect to loans and extensions of credit to certain related parties and purchases from and other transactions with Hamilton Bancorp's principal shareholders, officers, directors and affiliates. Such loans and extensions of credit (i) must be made on substantially the same terms (including interest rates and collateral) as, and follow credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with members of the general public or otherwise available to any employee of Hamilton Bank, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. In addition, extensions of credit to each such person beyond certain limits set by applicable law must be approved by Hamilton Bank's Board of Directors, with the individual who is applying for the credit abstaining from participation in the decision. Hamilton Bank also is subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties against Hamilton Bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of Hamilton Bank or the imposition by the Federal Reserve of a cease and desist order.
Dividends
Hamilton Bank is subject to legal limitations on the frequency and amount of cash dividends that can be paid to Hamilton Bancorp. The Office of the Comptroller of the Currency, in general, also has the ability to prohibit cash dividends by Hamilton Bank which would otherwise be permitted under applicable regulations if the Office of the Comptroller of the Currency determines
that such distribution would constitute an unsafe or unsound practice.
For Hamilton Bank, the approval of the Office of the Comptroller of the Currency is required for the payment of cash dividends in any calendar year if the total of all cash dividends declared by Hamilton Bank in that year exceeds the current year's net income combined with the retained net income of the two preceding years. "Retained net income" means the net income of a specified period less any common or preferred stock cash dividends declared for that period. Moreover, no cash dividends may be paid by a national bank in excess of its undivided profits account.
In addition, the Federal Reserve and the Federal Deposit Insurance Corporation have issued policy statements which provide that, as a general matter, insured banks and bank holding companies may pay cash dividends only out of current operating earnings.
In accordance with the above regulatory restrictions, Hamilton Bank currently has the ability to pay cash dividends, and on December 31, 1998 an aggregate of $31.3 million was available for the payment of dividends to Hamilton Bancorp without prior regulatory approval.
There are also statutory limits on other transfer of funds to Hamilton Bancorp and any other future non-banking subsidiaries of Hamilton Bancorp by Hamilton Bank, whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by Hamilton Bank generally are limited in amount to 10% of Hamilton Bank's capital and surplus, to Hamilton Bancorp or any such future Hamilton Bancorp subsidiary, or 20% in the aggregate to Hamilton Bancorp and all such subsidiaries. Furthermore, such loans and extensions of credit are required to be fully collateralized in specified amounts depending on the nature of the collateral involved.
FDICIA
FDICIA was enacted on December 19, 1991. It substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to other federal banking statutes. FDICIA provided for, among other things, (i) a recapitalization of the Bank Insurance Fund of the Federal Deposit Insurance Corporation (the "BIF") by increasing the Federal Deposit Insurance Corporation's borrowing authority and providing for adjustments in its assessments rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; (v) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital; (vi) additional grounds for the appointment of a conservator or receiver; (vii) a requirement that the Federal Deposit Insurance Corporation use the least-cost method of resolving cases of troubled institutions in order to keep the costs to insurance funds at a minimum; (viii) more comprehensive regulation and examination of foreign banks; (ix) consumer protection provisions, including a Truth-in-Savings Act; (x) a requirement that the Federal Deposit Insurance Corporation establish a risk-based deposit
insurance assessment system; (xi) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements; and (xii) certain additional limits on deposit insurance coverage.
A central feature of FDICIA is the requirement that the federal banking agencies take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically under-capitalized." Based on the current regulatory capital position of Hamilton Bank, Hamilton Bancorp believes that Hamilton Bank is in the highest classification of "well capitalized."
FDICIA generally prohibits Hamilton Bank from making any capital distribution (including payment of a cash dividend) or paying any management fees to Hamilton Bancorp if Hamilton Bank would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans acceptable to the federal banking agencies. If a depository institution fails to submit an acceptable plan, it is treated as if it is "significantly undercapitalized."
Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, and requirements to reduce total assets and to stop accepting deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator, generally within 90 days of the date such institution is determined to be critically undercapitalized.
FDICIA also provided for increased funding of the Federal Deposit Insurance Corporation insurance funds. Under the Federal Deposit Insurance Corporation's risk-based insurance premium assessment system, each bank whose deposits are insured by the BIF is assigned one of the nine risk classifications based upon certain capital and supervisory measures and, depending upon its classification, is assessed premiums. On November 14, 1995, the Federal Deposit Insurance Corporation board of directors voted to lower the BIF premium range to zero from .27% effective January 1996. The rate schedule is subject to future adjustments by the Federal Deposit Insurance Corporation. In addition, the Federal Deposit Insurance Corporation has authority to impose special assessments from time to time. As a result of the enactment of the Federal Deposit Insurance Funds Act of 1996 on September 30, 1996, commercial banks are now required to pay part of the interest on the Financing Corporation's bonds issued to deal with the savings and loan crisis of the late 1980's. As a result, commercial bank deposits are now also subject to assessment by the Financing Corporation upon the approval by the Federal Deposit Insurance Corporation of such assessment. Beginning in 1997 and until the earlier of December 31, 1999 or the date on which the last saving association ceases to exist, the assessment rate the Financing Corporation imposes on a commercial
bank must be at a rate equal to one-fifth the assessment rate applicable to deposits assessable by the Savings Association Insurance Fund.
Reserve Requirements
Hamilton Bank is required to maintain reserves against its transaction account. The reserves must be maintained in an interest-free account at the Federal Reserve Bank of Atlanta. Reserve requirements and the amount of required reserves is subject to adjustment by the Federal Reserve from time to time. The current rate for reserves is 3% of a depository institution's transaction accounts (less certain permissible deductions) up to $52 million, plus 10% of the amount over $52 million.
ITEM 2.
ITEM 2. PROPERTIES.
The Company's operations are currently managed from their corporate headquarters located in Miami, Florida, where a branch office is also located. Hamilton Bank's other branch offices are located in Tampa, Winter Haven, Sarasota, West Palm Beach and Miami, Florida, and in San Juan, Puerto Rico. Three of the facilities are owned by the Company and five are leased (including the Company's headquarters).
The table below summarizes the Company's owned and leased facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
On January 13, 1998 Development Specialists, Inc., the Liquidating Trustee of the Model Imperial Liquidating Trust established under the Plan of Reorganization in the Model Imperial, Inc. Chapter 11 Bankruptcy proceeding, filed an action against Hamilton Bank in the United States Bankruptcy Court for the Southern District of Florida objecting to Hamilton Bank's proof of claim in the Chapter 11 proceeding and affirmatively seeking damages against Hamilton Bank in excess of $34 million for alleged involvement with former officers and directors of Model Imperial, Inc. in a scheme to defraud Model Imperial, Inc. and its bank lenders. The action is one of several similar actions that were filed by the Trustee against other defendants that were involved with Model Imperial seeking essentially the same amount of damages as in the action against Hamilton Bank. The Company believes the claims are without merit either as a matter of law or fact and intends to vigorously defend the action.
Neither Hamilton Bancorp nor Hamilton Bank is involved in any other legal proceedings except for routine litigation incidental to the business of banking, none of which is expected to have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) The Company's Common Stock is traded on the NASDAQ National Market (Symbol HABK). The following table sets forth the high and low sales prices of a share of Common Stock as reported by the NASDAQ National Market since the date of the public offering of Common Stock on March 26, 1997.
As of March 22, 1999 there were approximately 72 holders of record of the Company's Common Stock and the closing price of Common Stock as reported by the NASDAQ National Market for such date was $26.375. The Company has not paid any cash dividends to date on its Common Stock and does not intend to pay any such cash dividends in the foreseeable future. As stated in Part I above, due to economic difficulties being experienced by various countries in the Region, the Federal Reserve has requested that Hamilton Bancorp not pay any dividends without the consent of the Federal Reserve.
(b) As reported in Registrant's Form SR for the period ending June 25, 1997 relating to the use of proceeds from the sale of common stock pursuant to Registrant's Registration Statement No.2-20960 effective March 25, 1997 and in Registrant's Form 10-Q for the period ending June 30, 1998, US$3,600,000 of the proceeds remain temporarily invested in short term investments as of December 31, 1998. This remaining amount was invested by Registrant in Hamilton Bank in March, 1999.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA. TABLE ONE. FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA. (Dollars in thousands except per share amounts)
The selected consolidated financial data for the five years ended December 31, 1998 have been derived from the Company's audited financial statements. The data set forth below should be read in conjunction with the consolidated financial statements and related notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained elsewhere herein.
(1) Represents diluted earnings per share and average weighted shares outstanding respectively.
(2) Amount reflects operating expenses as a percentage of net interest income plus non-interest income.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
1998 COMPARED TO 1997
OVERVIEW
Hamilton Bancorp Inc. ("Bancorp") is a bank holding company which conducts operations principally through its 99.8 percent owned subsidiary Hamilton Bank, N.A. (the "Bank") collectively (the "Company"). The Bank is a national bank which specializes in financing trade flows between domestic and international companies on a global basis. The Bank has a network of seven FDIC-insured branches in Florida, with locations in Miami, Sarasota, Tampa, West Palm Beach and Winter Haven, and an FDIC-insured branch in San Juan, Puerto Rico opened in the first quarter of 1998.
The Company completed its initial public offering of 2,400,000 shares of common stock on March 26, 1997. Following the public offering, on April 9, 1997 the Company issued 360,000 additional shares of common stock upon the exercise of the over-allotment option granted to Oppenheimer and Company, Inc., and NatWest Securities Ltd.
On December 28, 1998, a trust formed by the Company issued $11.0 million of 9.75 percent Beneficial Unsecured Securities, Series A (the "Preferred Securities"). These securities are considered to be Tier 1 capital for regulatory purposes.
Net income for the year ended December 31, 1998 was $21.8 million, a 37 percent increase over the previous year's net income of $15.9 million. The growth in earnings is attributed primarily to the 58 percent increase in average loans to $1,168 million at December 31, 1998 from $738.0 million in the same period in 1997. Net income per share (basic) was reported at $2.18 from $1.81 and (diluted) reported at $2.12 from $1.73 for the years ended December 31, 1998 and 1997 respectively.
KEY PERFORMANCE HIGHLIGHTS FOR 1998
During 1998, the Company achieved significant earnings growth relative to the prior year, primarily as a result of (i) increases in net interest income of 39 percent as a result of the growth in average assets of 50 percent fueled in part by the Company's retention of earnings, (ii) an important increase of 6.8 percent in non-interest income related to the Company's core trade finance business (iii) overall favorable credit quality as evidenced by the 0.61 percent net charge offs to average loans, and (iv) improved operating efficiencies.
RESULTS OF OPERATIONS
1998 COMPARED TO 1997
NET INTEREST INCOME
An analysis of the Company's net interest income and average balance sheet for the last five years is presented in TABLE ONE and TABLE TWO. Net interest income is the difference between interest and fees earned on loans and investments and interest paid on deposits and other sources of funds, and it constitutes the Company's principal source of income. Net interest income increased to $54.0 million for the year ended December 31, 1998 from $39.0 million for the same period in 1997, a 39 percent increase. The increase was due largely to the growth in average earning assets offset, to some extent, by a decrease in net interest margin. Average earning assets increased to $1,389.0 million for the year ended December 31, 1998 from $903.4 million for the same period in 1997 a 54 percent increase while yields earned on average assets decreased by 25 basis points compared to the same period. Average loans and acceptances discounted increased to $1,168.5 million for the year ended December 31, 1998 from $737.9 million for the same period in 1997, a 58 percent increase, while average interest earning deposits due from other banks increased to $122.3 million for the year ended December 31, 1998 from $102.4 million for the same period in 1997, a 19 percent increase. Net interest margin decreased to 3.89 percent for the year ended December 31, 1998 from 4.31 percent for the same period in 1997, a 42 basis point decrease. The primary reasons for this decrease were (i) loan yields relative to reference rates decreased in certain countries in the Region and (ii) transactions with larger customers and transactions with multi-national customers, which command more competitive pricing.
Interest income increased to $124.3 million for the year ended December 31, 1998 from $83.2 million for the same period in 1997, a 49 percent increase, reflecting an increase in loans in the Region and the United States, partially offset by a decrease in prevailing interest
rates and a tightening of loan spreads in the Region as discussed above. Interest expense increased to $70.3 million for the year ended December 31, 1998 from $44.2 million for the same period in 1997, a 59 percent increase, reflecting the increase in deposits to fund asset growth and a two basis point increase in interest rates paid. Average interest-bearing deposits increased to $1,231.7 million for the year ended December 31, 1998 from $778.2 million for the same period in 1997, a 58 percent increase. The growth in deposits was primarily a result of the Company increasing its core deposit base from its expanding branch network, as well as its international customers. The Company's time deposits due from banks also increased to $129.0 million for the year ended December 31, 1998 from $128.0 million for the same period in 1997.
An analysis of the Company's yields earned and average loan balances segregating domestic and foreign earning assets is presented in TABLE THREE. The yields earned on domestic loans have decreased by three basis points to 10.1 percent from 10.4 percent.
PROVISION FOR CREDIT LOSSES
The Company's provision for credit-losses increased to $9.6 million for the year ended December 31, 1998 from $7.0 million for the same period in 1997. This 37 percent increase was largely a function of the 22 percent growth in total loans. Net loan chargeoffs during the year ended December 31, 1998 amounted to $7.1 million compared to $2.4 million for the year 1997. The allowance for credit losses was increased to $12.8 million at December 31, 1998 from $10.3 at December 31, 1997, a 24 percent increase. The ratio of the allowance for credit losses to total loans was 1.08 percent at December 31, 1998 from 1.07 percent for the same period in 1997. A more detailed review of the provision for credit losses is presented in TABLE SEVENTEEN through TABLE TWENTY.
NON-INTEREST INCOME
Non-interest income increased to approximately $17.6 million for the year ended December 31, 1998 from $16.4 million for the same period in 1997, a 7 percent increase. Trade finance fees and commissions increased by $333 thousand due largely to lending facility fees which increased by $185 thousand during the year 1998 compared to 1997 as a result of the growth in loans. Structuring and syndication fees increased by $817 thousand as a result of various structuring and syndication transactions completed during the year; increasing these fees to $3.4 million from $2.5 million for the periods ended December 31, 1998 and 1997 respectively. Customer service fees decreased by $157 thousand as a result of lower overdrafts experienced in the period. The changes in non-interest income from year to year are analyzed in TABLE SIX.
TABLE TWO. YIELDS EARNED AND RATES PAID (Dollars in thousands)
TABLE THREE. YIELDS EARNED - DOMESTIC AND FOREIGN EARNING ASSETS (Dollars in thousands)
TABLE FOUR. RATE VOLUME ANALYSIS (Dollars in thousands)
TABLE FIVE. RATE VOLUME ANALYSIS - DOMESTIC AND FOREIGN (Dollars in thousands)
TABLE SIX. NON-INTEREST INCOME (Dollars in thousands)
OPERATING EXPENSES
Operating expenses increased to $28.1 million for the year ended December 31, 1998 from $23.4 million for the same period in 1997, a 20 percent increase. The growth in expenditures was primarily to support revenue growth. A discussion of the significant components of noninterest expense in 1998 compared to 1997 is as follows: employee compensation and benefits increased to $14.5 million for the year ended December 31, 1998 from $13.2 million for the same period in 1997, a 10 percent increase. This was primarily due to an increase in the number of employees to 264 at December 31, 1998 from 250 at the same period in 1997. The majority of the employees were added to support the Puerto Rico branch and other areas within the bank. There were also salary increases for existing personnel. Occupancy expenses increased to $4.2 million for the year ended December 31, 1998 from $3.3 million for the same period in 1997, a 27 percent increase as a result of the additional branches. Other expenses increased to $9.3 million for the year ended December 31, 1998 from $7.0 million for the same period in 1997, primarily due to the increase in legal expense as a result of various litigation actions commenced by or against the Company in 1998. The Company's efficiency ratio experienced a favorable decrease to 39 percent in 1998 from 42.3 percent in 1997. The changes in operating expenses from year to year are analyzed in TABLE SEVEN.
The Company's income tax expense for 1998 was $12.0 million, for an effective tax rate of 36 percent of pretax income. Income tax expense for 1997 was $9.1 million for an effective rate of 36 percent. The decrease in the effective tax rate is the result of a state income tax refund for prior year filings. The year to year increase of income tax expense was the result of the 35 percent
increase in pretax income. As the Company increases its foreign loans and investments in relation to total assets these activities are not taxable in the State of Florida thus reducing the overall effective tax rate. NOTE SIX of the consolidated financial statements includes an analysis of the components of the provision for income taxes.
TABLE SEVEN. OPERATING EXPENSES (Dollars in thousands)
YEAR 2000
The ability of computers, software and other equipment utilizing microprocessors to recognize and properly process data fields containing a 2-digit year after 1999 is commonly referred to as the "Year 2000" compliance issue. The Year 2000 issue is the result of computer programs and equipment which are dependent on "embedded chip technology" using two digits rather than four to define the applicable year. Any of the Company's computer programs or equipment that are date dependent may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, or a temporary inability to process transactions, send invoices or engage in similar normal business activities.
The Company began the process of assessing and preparing its computer systems and applications to be functional on January 1, 2000 in June 1996. The Company has also been communicating with third parties which it interfaces with, such as customers, counter parties, payment systems, vendors and others to determine whether they will be functional on or before January 1, 2000.
The Company has provided compliance certification questionnaires to each of its customers in order to determine their ability to be Year 2000 compliant. The Company has amended its Credit Policy Manual to require the Company to terminate business with a customer unless the Company is assured that such customer is or will be Year 2000 compliant in the near future, except in such instances where the customer's failure to be Year 2000 compliant will not, either individually or in the aggregate, have a material adverse effect on the Company. If a customer does not respond to the questionnaire or if its response does not provide the Company with adequate assurance that such customer's failure to be Year 2000 compliant would not have a material adverse effect on the Company, the Company will not renew its current relationship with that customer. Since 70 percent of the loan portfolio matures within 365 days, the majority of the portfolio would be subject to the amended credit policy. There can be no assurance that the parties mentioned above will become Year 2000 compliant on a timely basis. We believe that the process of modifying all mission critical applications of the Company will continue as planned and expect all of the testing, changes and verifications by June 30, 1999 as dictated by FFIEC guidelines.
Research to verify compatibility of counter parties, payment systems, vendors and others has been conducted. These systems were divided into critical and non-critical categories. The Company expects to have all testing, changes and verification on the critical systems completed by June 30, 1999 as dictated by FFIEC guidelines. The non-critical systems will continue to be reviewed and tested and management will determine if changes or replacement is deemed necessary.
Concurrently, the Company is in the process of upgrading its computers systems to accommodate the growth of the past two years. These new systems when installed are Year 2000 compliant. We believe the total costs relating exclusively to Year 2000 compliance will be approximately $250,000, which amount is not material to the Company's financial position or results of operations. To date, the Company has incurred approximately $100,000 of these estimated expenses. Any purchased hardware
or software in connection with this process will be capitalized in accordance with normal Company policy. Personnel and all other costs are being expensed as incurred
The costs and dates on which the Company plans to complete the Year 2000 process are based on our best estimates. However, there can be no assurance that these estimates will be achieved and actual results could differ.
1997 COMPARED TO 1996
NET INTEREST INCOME
Net interest income increased to $39.0 million for the year ended December 31, 1997 from $27.2 million for the same period in 1996, a 43 percent increase. The increase was due largely to the growth in average earning assets offset, to some extent, by a decrease in net interest margin. Average earning assets increased to $903.4 million for the year ended December 31, 1997 from $597.2 million for the same period in 1996, a 51 percent increase while yields earned on average assets decreased by 29 basis points comparing the same period. Average loans and acceptances discounted increased to $737.9 million for the year ended December 31, 1997 from $485.8 million for the same period in 1996, a 52 percent increase, while average interest earning deposits due from other banks increased to $102.4 million for the year ended December 31, 1997 from $62.4 million for the same period in 1996, a 64.1 percent increase. Net interest margin decreased to 4.31 percent for the year ended December 31, 1997 from 4.56 percent for the same period in 1996, a 25 basis point decrease. The primary reasons for this decrease were (i) loan yields relative to reference rates decreased in certain countries in the Region as a result of perceived economic stability and lower credit risk, (ii) loans to larger corporate and bank customers, which command more competitive pricing and (iii) excess liquidity in the Region.
Interest income increased to $83.2 million for the year ended December 31, 1997 from $56.7 million for the same period in 1996, a 47 percent increase, reflecting an increase in loans in the Region and the United States, partially offset by a decrease in prevailing interest rates and a tightening of loan spreads in the Region as discussed above. Interest expense increased to $44.2 million for the year ended December 31, 1997 from $29.4 million for the same period in 1996, a 50 percent increase, reflecting the increase in deposits to fund asset growth and 5 basis points increase in interest rates paid. Average interest-bearing deposits increased to $778.2 million for the year ended December 31, 1997 from $525.3 million for the same period in 1996, a 48 percent increase. The growth in deposits was primarily a result of the Company increasing its core deposit base from its expanding branch network as well as its international customers. The Company's time deposits due from banks also increased to $128.0 million for the year ended December 31, 1997 from $93.7 million for the same period in 1996.
An analysis of the Company's yields earned and average loan balances segregating domestic and foreign earning assets is presented in TABLE THREE. The yields earned on domestic loans have decreased by 50 basis points to 10.4 percent from 11 percent.
PROVISION FOR CREDIT LOSSES
The Company's provision for credit-losses increased to $7.0 million for the year ended December 31, 1997 from $3.0 million for the same period in 1996. This $4.0 million increase was largely to support the 80 percent loan portfolio growth. Net loan chargeoffs during the year ended December 31, 1997 amounted to $2.4 million compared to $1.8 million for the year 1996. The allowance for credit losses was increased to $10.3 million at December 31, 1997 from $5.7 million for the end of the fiscal year 1996, an 81 percent increase. The ratio of the allowance for credit losses to total loans remained the same at 1.07 percent at December 31, 1997 and 1996. A more detailed review of the provision for credit losses is presented in TABLE SEVENTEEN through TABLE TWENTY.
NON-INTEREST INCOME
Non-interest income increased to approximately $16.4 million for the year ended December 31, 1997 from $11.0 million for the same period in 1996, a 49 percent increase. Trade finance fees and commissions increased by $3.4 million due largely to higher letters of credit volume, which registered an increase of 20 percent in overall volume in 1997 relative to 1996. In addition, lending facility fees increased by $1.2 million during the year ended December 31, 1997 compared to 1996 as a result of the growth in loans. Structuring and syndication fees increased by $2.4 million as a result of various structuring and syndication transactions completed during the year compared to almost a flat year for 1996. The globalization of investments in the region created more structuring and syndication opportunities. Customer service fees decreased by $538 thousand as a result of lower overdrafts experienced in the period. The changes in non-interest income from year to year are analyzed in TABLE SIX.
OPERATING EXPENSES
Operating expenses increased to $23.4 million for 1997 from $19.6 million for 1996, a 19.3 percent increase. The growth in expenditures was primarily to support revenue growth. A discussion of the significant components of noninterest expense in 1997 compared to 1996 is as follows: Employee compensation and benefits increased to $13.2 million for 1997 from $10.9 million for 1996, a 20.4 percent increase. This was primarily due to an increase in the number of employees to 250 at December 31, 1997 from 220 at December 31, 1996, the majority of the employees were added to support the two branches opened during 1997 as well as salary increases for existing personnel. Occupancy expenses increased slightly to $3.3 million from $2.9 million as a result of the two new branches. Other expenses increased to $7.0 million for 1997 from $5.8 million for 1996, primarily due to a loss realized as a result of a default on a loan in which inventory was acquired in 1996 and fully liquidated in 1997. As a result of the enactment of the Federal Deposit Insurance Funds Act of 1996 on September 30, 1996, commercial banks are now required to pay part of the interest on the Financing Corporation ("FICO") bonds issued to deal with the savings and loan crisis of the late 1980's. The Company's efficiency ratio experienced a favorable decrease to 42.3 percent from 51.3 percent for 1997 and 1996, respectively. The changes in operating expenses from year to year are analyzed in TABLE SEVEN.
The Company's income tax expense for 1997 was $9.1 million, for an effective tax rate of 36.4 percent of pretax income. Income tax expense for 1996 was $5.9 million for an effective rate of 37.5 percent. The year to year increase of income tax expense was the result of the 61 percent increase in pretax income. As the Company increases its foreign loans and investments in relation to total assets these activities are not taxable in the State of Florida thus reducing the overall effective tax rate. NOTE SIX of the consolidated financial statements includes an analysis of the components of the provision for income taxes.
BALANCE SHEET REVIEW
The Company manages its balance sheet by monitoring interest rate sensitivity, credit risk, liquidity risk and capital positions to reduce the potential adverse impact on net interest income that might result from changes in interest rates. Control of interest rate risk is conducted through systematic monitoring of maturity mismatches. The Company's investment decision-making takes into account not only the rates of return and their underlying degree of risk, but also liquidity requirements, including minimum cash reserves, withdrawal and maturity of deposits and additional demand for funds.
Total consolidated assets increased 27 percent, or $365.4 million for the year ended December 31, 1998, which included an increase of $383.7 million in interest earning assets and a decrease of $18.3 million in non-interest earning assets. The increase in consolidated assets reflects increases of $211.3 million in net loans and $86.5 million in interest-earning deposits with other banks. These increases were principally funded by deposits from the branch network, time deposits due to banks and deposits due to other financial institutions as well as increases in retained earnings. The Company opened a branch in Puerto Rico during the first quarter to further support asset growth.
CASH, DEMAND DEPOSITS WITH OTHER BANKS AND FEDERAL FUNDS SOLD
Cash, demand deposits with other banks and federal funds sold are considered cash and cash equivalents. Balances of these items fluctuate daily depending on many factors which include or relate to the particular banks that are clearing funds, loan payoffs, deposit gathering and reserve requirements. Cash, demand deposits with other banks and federal funds sold were $111.8 million at December 31, 1998 compared to $91.4 million at December 31, 1997.
INTEREST-EARNING DEPOSITS WITH OTHER BANKS AND SECURITIES
Interest-earning deposits with other banks increased to $200.2 million at December 31, 1998 from $113.7 million at December 31, 1997. As part of its overall liquidity management process, the Company places funds with foreign correspondent banks. These placements are typically short-term, typically 180 days or less. The purpose of these placements is to obtain an enhanced return on high quality short-term instruments and to solidify existing relationships with correspondent banks. The banks with which placements are made and the amount placed are currently approved by the Bank's Asset Liability Committee. In addition, this Committee reviews adherence with internal interbank liability policies and procedures. As indicated in TABLE EIGHT these interest-earning deposits with other banks are well-diversified throughout the Region and in other countries. The level of such deposits has grown as the overall assets of the Company have increased during the year ended December 31, 1998. The short-term nature of these deposits allows the Company the flexibility to redeploy these assets into higher yielding loans which are largely related to the financing of trade.
Investment securities increased to $115.0 million at December 31, 1998 from $54.6 million at December 31, 1997. The increase has been primarily in U.S. Government Agency Mortgage backed securities classified as held to maturity. These securities diversify the Company's portfolio, are eligible collateral for securing public funds and qualify as community Reinvestment Act investment. During the year the Company also invested $15 million in investment grade perpetual subordinated euronotes of multinational banks. These investments further diversify the portfolio and are eligible as collateral for overnight investments.
NOTE TWO of the consolidated financial statements reports amortized fair value and maturity information on the securities portfolio.
TABLE EIGHT. INTEREST-EARNING DEPOSITS WITH OTHER BANKS (Dollars in thousands)
(1) Consists of placements in the Bahamas branch of a multinational financial institution.
LOAN PORTFOLIO
The Company's loan portfolio increased by $214.7 million, or 22 percent, during the year ended December 31, 1998 in relation to December 31, 1997. This was due to management's ability to increase lending to its existing customer base. In addition, the growth also reflected the overall increased economic trade activity throughout the Region. At December 31, 1998 commercial-domestic loans increased by $109.6 million, commercial foreign loans increased by $85.9 million and government and official institutions increased by $37.5 million from the balances at December 31, 1997. Details on the loans by type are shown in TABLE NINE below. At December 31, 1998 approximately 30 percent of the Company's portfolio consisted of loans to domestic borrowers and 70 percent of the Company's portfolio consisted of loans to foreign borrowers. The Company's loan portfolio is relatively short-term, as approximately 60 percent of loans at December 31, 1998 were short-term trade finance loans with average maturities of approximately 180 days as detailed on TABLE TEN.
The Company's loan portfolio is an important source of liquidity since the Company's predominant business, international trade finance, is self liquidating in nature and a significant part of the loans and extensions of credit mature within one year. The term to maturity of the Company's loans at December 31, 1998 are shown on TABLE TEN.
TABLE NINE. LOANS BY TYPE (In thousands)
(1) Includes pre-export financing, warehouse receipts and refinancing of letters of credits.
TABLE TEN. LOAN MATURITIES (In thousands)
(1) Does not include mortgage loans and installment loans in the aggregate amount of $10.7 million.
TABLE ELEVEN reflects both the Company's growth and diversification in financing trade flows between the United States and the Region in terms of loans by country and cross-border outstanding by country. The aggregate amount of the Company's crossborder outstandings by primary credit risk includes cash and demand deposits with other banks, interest earning deposits with other banks, investment securities, due from customers on bankers acceptances, due from customers on deferred payment letters of credit and loans-net. Exposure levels in any given country at the end of each period may be impacted by the flow of trade between the United States (and to a large extent, Florida) and the given countries, as well as the price of the underlying goods or commodities being financed.
At December 31 1998 approximately 34.6 percent in principal amount of the Company's loans were outstanding to borrowers in five countries other than the United States: Panama (10.1 percent), Guatemala (10.1 percent), Brazil (5.1 percent), Honduras (5.1 percent) and Peru (4.2 percent).
TABLE ELEVEN. LOANS BY COUNTRY (Dollars in thousands)
(1) Other consists of loans to borrowers in countries in which loans did not exceed 1 percent of total loans.
(2) These Countries had loans which did not exceed 1 percent of total loans in the periods indicated.
At December 31, 1998 approximately 30.6 percent in cross-border outstanding were due from borrowers in five countries other than the United States: Guatemala (7.7 percent), Panama (7.0 percent), Brazil (5.9 percent), Ecuador (5.9 percent) and Honduras (4.1 percent).
TABLE TWELVE. TOTAL CROSS-BORDER OUTSTANDING BY COUNTRY AND TYPE (Dollars in million)
(1) Other consists of cross-border outstanding to countries in which such cross-border outstanding did not exceed 0.75 percent of the Company's total assets at any of the period indicated.
(2) These countries had cross-border outstanding which did not exceed .75 percent of total assets at any of the period indicated.
TOTAL CROSS-BORDER OUTSTANDINGS BY TYPE
DUE FROM CUSTOMERS ON BANKERS' ACCEPTANCES AND DEFERRED PAYMENT LETTERS OF CREDIT.
Due from customers on bankers' acceptances and deferred payment letters of credit were $75.6 million and $6.5 million, respectively, at December 31, 1998 compared to $95.3 million and $8.4 million, respectively, at December 31, 1997. These assets represent a customer's liability to the Company while the Company's corresponding liability to third parties is reflected on the balance sheet as "Bankers Acceptances Outstanding" and "Deferred Payment Letters of Credit Outstanding".
DEPOSITS
The primary sources of Company's domestic time deposits are its seven Bank branches located in Florida and one in Puerto Rico. The Company has three Bank branches in Miami, one in Tampa, Winter Haven, Sarasota and West Palm Beach. The Company has opened a branch in San Juan, Puerto Rico in the first quarter of fiscal 1998. In pricing its deposits, the Company analyzes the market carefully, attempting to price its deposits competitively with the larger financial institutions in the area. TABLE TWO provides information on average deposit amounts and rates paid to each deposit category. Total deposits were $1,477.1 million at December 31, 1998 compared to $1,135.0 million at December 31, 1997.
Average interest bearing deposits increased by 58.3 percent to $1,231.7 million at December 31, 1998 from $778.2 million at December 31, 1997. During the year the Company also increased deposits from other financial institutions. In addition, the Company obtained deposits from the State of Florida as the Bank is a qualified public depository pursuant to Florida law and has also obtained approximately $75.5 million of brokered deposits participated out by the broker in denominations of less than $100,000 through a retail certificate of deposit program. These deposits were used to further diversify the Company's deposit base and as a cost effective alternative for the short term funding needs of the Company.
OTHER BORROWINGS
The Company entered into two transactions in which foreign debt securities were purchased using proceeds from the other borrowings described in Note 7 to the Consolidated Financial Statements. The securities collaterize the borrowings. The borrowings and the related securities mature at the same time.
TRUST PREFERRED SECURITIES
Trust Preferred Securities increased by $11 million as a result of the issuance of Beneficial Unsecured Securities, of Series A (the "Preferred Securities") out of a guarantor trust at a rate of 9.75 percent. The Preferred Securities are considered Tier I capital for regulatory purposes.
In addition, on January 14, 1999, the Trust issued an additional $1.7 million of Preferred Securities upon the exercise of an over-allotment option by the underwriter. See Note 8 of the Consolidated Financial Statements on page 57 for further details.
TABLE THIRTEEN reports maturity periods of certificate of deposits of $100,000 and greater.
TABLE THIRTEEN. MATURITIES OF AND AMOUNTS OF CERTIFICATES OF DEPOSITS AND OTHER TIME DEPOSITS $100,000 OR MORE
(In thousands)
OFF-BALANCE SHEET
CONTINGENCIES
In the normal course of business, the Company utilizes various financial instruments with off-balance sheet risk to meet the financing needs of its customers, including commitments to extend credit, commercial letter of credit, shipping guarantees, standby letters of credit and forward foreign exchange contracts.
TABLE FOURTEEN reports the total volume and average monthly volume of the Company's export and import letters of credit for the periods indicated. The letter of credit volume decreased by 10 percent to $746.8 million from $819.5 million as a result of shifts toward more on-balance sheet financing.
TABLE FOURTEEN. CONTINGENCIES - COMMERCIAL LETTERS OF CREDIT (In thousands)
(1) Represents certain contingent liabilities not reflected on the Company's balance sheet.
The Company provides letter of credit services globally. TABLE FIFTEEN sets forth the distribution of the Company's contingent liabilities by country of the applicant and issuing bank for import and export letters of credit, respectively. As shown by the table, contingent liabilities decreased by 35 percent to $128.7 million at December 31, 1998 from December 31, 1997 as a result of shifts toward more on-balance sheet financing.
TABLE FIFTEEN. CONTINGENT LIABILITIES (1) (In thousands)
(1) Includes export and import letters of credit, standby letters of credit and letters of indemnity.
(2) Other includes those countries in which contingencies represent less than 1 percent of the Company's total contingencies at each of the above dates.
(3) These countries had contingencies, which did not exceed 1 percent of the Company's total contingencies during the period indicated.
LIQUIDITY
The Company seeks to manage its assets and liabilities to reduce the potential adverse impact on net interest income that might result from changes in interest rates through systematic monitoring of maturity mismatches. The Company's investment decision-making takes into account not only the rates of return and their underlying degree of risk, but also liquidity requirements, including minimum cash reserves, withdrawal and maturity of deposits and additional demand for funds. For any given period, the pricing structure is matched when an equal amount of assets and liabilities reprice. An excess of assets or liabilities over these matched items results in a gap or mismatch, as shown on TABLE SIXTEEN. A positive gap denotes asset sensitivity and normally means that an increase in interest rates would have a positive effect on net interest income while a decrease in interest rates would have a negative effect on net interest income. However, because different types of assets and liabilities with similar maturities may reprice at different rates or may otherwise react differently to changes in overall market rates or conditions, changes in prevailing interest rates may not necessarily have such effects on net interest income. All of the Company's assets and liabilities are denominated in dollars and therefore the Company has no material foreign exchange risk.
Cash and cash equivalents were $111.8 million on December 31, 1998, an increase from $91.4 million from December 31, 1997. During 1998, net cash provided by operating activities was $114.2 million, net cash used in investing activities was $455.0 million and net cash provided by financing activities was $361.2 million. For further information on cash flows, see the Consolidated Statement of Cash Flows on page 47 in the Consolidated Financial Statements.
The Company's principal sources of liquidity and funding are its diverse deposit base and the sales of bankers' acceptances as well as loan participations. The level and maturity of deposits necessary to support the Company's lending and investment activities is determined through monitoring loan demand and through its asset/liability management process. The other borrowings mentioned in the balance sheet review and in Note Seven of the Financial Statements were a result of a security transaction. The trust preferred offering completed December 28, 1998 will provide adequate liquidity for the next year so that management does not consider the request by the Federal Reserve that was mentioned in Part I Item 1 of this document to have a material effect on the operations for the remainder of calendar year 1999. Considerations in managing the Company's liquidity position include, but is not limited to, scheduled cash flows from existing assets, contingencies and liabilities, as well as projected liquidity needs arising from anticipated extensions of credit. Furthermore, the liquidity position is monitored daily by management to maintain a level of liquidity conducive to efficient operations and is continuously evaluated as part of the asset/liability management process.
Historically, the Company has increased its level of deposits to allow for its planned asset growth. Customer deposits have increased through the branch network, and private banking customers, as well as deposits related to the trade activity. The majority of the Company's deposits are short-term and closely match the short-term nature of the Company's assets. At December 31, 1998 interest-earning assets maturing within 180 days were $1,022 million, representing 65 percent of total earning assets. The short-term nature of the loan portfolio and the fact that a portion of the loan portfolio consists of bankers' acceptances provides additional liquidity to the Company. Liquid assets at December 31, 1998 were $353 million, 21 percent of total assets, and consisted of cash and cash equivalents, due from banks-time and foreign treasury bills. At December 31, 1998 the Company had been advised of $94.5 million in available interbank funding.
TABLE SIXTEEN presents the projected maturities or interest rate adjustments of the Company's earning assets and interest-bearing funding sources based upon the contractual maturities or adjustment dates at December 31, 1998. The interest-earning assets and interest-bearing liabilities of the Company and the related interest rate sensitivity gap given in the following table may not be reflective of positions in subsequent periods.
TABLE SIXTEEN. INTEREST RATE SENSITIVITY REPORT (Dollars in thousands)
CREDIT QUALITY REVIEW
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses reflects management's judgment of the level of allowance adequate to provide for reasonably foreseeable losses, based upon the following factors: (i) the economic conditions in those countries in the Region in which the Company conducts trade finance activities; (ii) the credit condition of its customers and correspondent banks, as well as the underlying collateral, if any; (iii) historical experience; and (iv) the average maturity of its loan portfolio.
In addition, although the Company's credit losses have been relatively limited to date, management believes that the level of the Company's allowance should reflect the potential for political and economic instability in certain countries of the Region and the possibility that serious economic difficulties in a country could adversely affect all of the Company's loans to borrowers in or doing business with that country.
Determining the appropriate level of the allowance for credit losses requires management's judgment, including application of the factors described above to assumptions and estimates made in the context of changing political and economic conditions in many of the countries of the Region. Accordingly, there can be no assurance that the Company's current allowance for credit losses will prove to be adequate in light of future events and developments. At December 31, 1998, the allowance for credit losses was approximately $12.8 million, an increase of 24 percent from $10.3 million at December 31, 1997. This increase is largely a function of the loan growth during the year.
TABLE SEVENTEEN PROVIDES certain information with respect to the Company's allowance for credit losses, provision for credit losses and chargeoff and recovery activity for the periods shown.
TABLE SEVENTEEN. CREDIT LOSS EXPERIENCE (In thousands)
(1) Related to extension of credit to a domestic-based business operated by a company organized under the laws of a foreign country.
TABLE EIGHTEEN SETS forth an analysis of the allocation of the allowance for credit losses by category of loans and the allowance for credit losses allocated to foreign loans. The allowance is established to cover potential losses inherent in the portfolio as a whole or is available to cover potential losses on any of the Company's loans.
TABLE EIGHTEEN. ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES (In thousands)
TABLE NINETEEN. ANALYSIS OF ALLOWANCE FOR CREDIT LOSSES ALLOCATED TO FOREIGN LOANS (In thousands)
(1) Related to extensions of credit to a domestic-based business operated by a company organized under the laws of a foreign country.
The Company usually places an asset on nonaccrual status when any payment of principal or interest is over 90 days past due or earlier if management determines the collection of principal or interest to be unlikely. Loans over 90 days past due may not be placed on nonaccrual if they are in the process of collection and are either secured by property having a realizable value at least equal to the outstanding debt and accrued interest or are fully guaranteed by a financially responsible party whom the Company believes is willing and able to discharge the debt, including accrued interest. In most cases, if a borrower has more than one loan outstanding under its line with the Company and any of its individual loans becomes over 90 days past due, the Company places all outstanding loans to that borrower on nonaccrual status.
The Company does not have a rigid chargeoff policy but instead charges off loans on a case-by-case basis as determined by management and approved by the Board of Directors. In some instances, loans may remain in the nonaccrual category for a period of time during which the borrower and the Company negotiate restructured repayment terms.
The Company attributes its consistent basis of asset quality to the short-term nature of its loan portfolio, the composition of its borrower base, the importance that borrowers in the Region attach to maintaining their continuing access to financing for foreign trade and to the Company's loan underwriting policies.
The Company accounts for impaired loans in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan. Under these standards, individually identified impaired loans are measured based on the present value of payments expected to be received, using the historical effective loan rate as the discount rate. Alternatively, measurement may also be based on observable market prices or, for loans that are solely dependent on the collateral for repayment, measurement may be based on the fair value of the collateral. The Company evaluates commercial loans individually for impairment, while groups of smaller-balance homogeneous loans (generally residential mortgage and installment loans) are collectively evaluated for impairment.
The following table sets forth information regarding the Company's nonperforming loans at the dates indicated. Total nonperforming loans to total loans remains within the historical levels. However, the nonperforming loans to total assets ratio has improved when compared to prior year results.
TABLE TWENTY. NONPERFORMING LOANS (In thousands)
(1) During such periods the Company did not have any loans which were deemed to be "troubled debt restructurings" as defined in SFAS No. 15.
At December 31, 1997, and December 31, 1998 the Company had no nonaccruing investment securities.
For the year ended December 31, 1998 the amount of interest income that was accrued and that would have been accrued on the loans in the previous table in accordance with their contractual terms were approximately $7 thousand, all of which represented interest income on domestic loans, and $615 thousand of which $96 thousand represented interest income on domestic loans and $519 thousand represented interest income on foreign loans, respectively.
Management does not believe that there is a material amount of loans not included in the foregoing table where known information about possible credit problems of the borrowers would cause management to have serious doubts as to the ability of the borrowers to comply with the present loan repayment terms and which may result in such loans becoming nonaccruing loans.
CAPITAL RESOURCES
Stockholders' equity at December 31, 1998 was $123.5 million compared to $98.3 million at December 31, 1997. This increase was due to $21.8 million of retained earnings and $2.0 million of common stock issued from exercise of stock options. During 1997 the Company paid dividends on preferred stock of $319 thousand, which were within the amounts allowed by banking and holding Company regulations.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. The regulations require the Company and the Bank to meet specific capital adequacy guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital classification is also subject to qualitative judgments by the regulators about interest rate risk, concentration of credit risk and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Tier I capital (as defined in the regulations) to total average assets (as defined) and minimum ratios of Tier I and total capital (as defined) to risk-weighted assets (as defined).
NOTE NINE of the consolidated financial statements reports Company and Bank capital ratios.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK MANAGEMENT
In the normal course of conducting business activities, the Company is exposed to market risk which includes both price and liquidity risk. The Company's price risk arises from fluctuations in interest rates, and foreign exchange rates that may result in changes in values of financial instruments. The Company does not have material direct market risk related to commodity and equity prices. Liquidity risk arises from the possibility that the Company may not be able to satisfy current and future financial commitments or that the Company may not be able to liquidate financial instruments at market prices. Risk management policies and procedures have been established and are utilized to manage the Company's exposure to market risk. The strategy of the Company is to operate at an acceptable risk environment while maximizing its earnings.
Market risk is managed by the Asset Liability Committee which formulates and monitors the performance of the Company based on established levels of market risk as dictated by policy. In setting the tolerance levels of market risk, the Committee considers the impact on both earnings and capital potential changes in the outlook in market rates, global and regional economies, liquidity, business strategies and other factors.
The Company's asset and liability management process is utilized to manage interest rate risk through the structuring of balance sheet and off-balance sheet portfolios. It is the strategy of the Company to maintain as neutral an interest rate risk position as possible. By utilizing this strategy the Company "locks in" a spread between interest earning assets and interest-bearing liabilities. Given the matching strategy of the Company and the fact that it does not maintain significant medium and/or long-term exposure positions, the Company's interest rate risk will be measured and quantified through an interest rate sensitivity report. For any given period, the Company's pricing structure is matched when an equal amount of assets and liabilities reprice. An excess of assets or liabilities over these matched items results in a gap or mismatch. A positive gap denotes asset sensitivity and normally means that an increase in interest rates would have a positive effect on net interest income. On the other hand a negative gap denotes liability sensitivity and normally means that a decline in interest rates would have a positive effect in net interest income. However, because different types of assets and liabilities with similar maturities may reprice at different rates or may otherwise react differently to changes in overall market rates or conditions, changes in prevailing interest rates may not necessarily have such effects on net interest income.
TABLE SIXTEEN provides the Company's Interest Rate Sensitivity Reports as of December 31, 1998. This table shows that interest-bearing liabilities maturing or repricing within one year exceeded interest-earning assets by $191.6 million. The Company monitors that the assets and liabilities are closely matched to minimize interest rate risk. On December 31, 1998 the interest rate risk position of the Company was not significant since the impact of a 100 basis point rise or fall of interest rates over the next 12 months is estimated at 2 percent of net income.
Substantially all of the Company's assets and liabilities are denominated in dollars therefore the Company has no material foreign exchange risk. In addition, the Company has no trading account securities; therefore it is not exposed to market risk resulting from trading activities.
NOTE FOURTEEN of the consolidated financial statements reports fair value calculations of financial instruments. As reported in this note, the carrying values approximate their fair values which generally minimizes the exposure to market risk resulting from interest from interest rate fluctuations. This minimal risk is the result of the short-term nature of the Company's interest earning assets and the matching maturity level of the interest bearing liabilities.
On a daily basis the Bank's Senior Vice President of Finance and the Bank's Treasurer are responsible for measuring and managing market risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Hamilton Bancorp Inc.:
We have audited the accompanying consolidated statements of condition of Hamilton Bancorp Inc. and its subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial condition of the Company at December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP Miami, Florida
February 5, 1999
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION DECEMBER 31, 1998 AND 1997 (Dollars in Thousands, Except Share Information)
See accompanying notes to consolidated financial statements.
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (Dollars in Thousands, Except Share Information)
See accompanying notes to consolidated financial statements.
\ HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (Dollars in Thousands)
See accompanying notes to consolidated financial statements.
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (Dollars in Thousands, Except Share Information) - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (Dollars in Thousands) - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
HAMILTON BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 - --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Hamilton Bancorp Inc. (the "Company") is a holding company formed in 1988 primarily to acquire ownership in Hamilton Bank, N.A. (the "Bank"), a national Federal Reserve member bank which commenced operations in February 1983. As of December 31, 1998, the Company owned 99.78% of the outstanding common stock of the Bank. The Bank's business is focused primarily on foreign trade and providing innovative services for its financial correspondents and exporting/importing firms. The Bank offers these services through its main office and three branches in Miami, Florida, and a branch in Tampa, Winter Haven, Sarasota, West Palm Beach, Florida and San Juan, Puerto Rico.
The accounting and reporting policies of the Company conform to generally accepted accounting principles and to general practices within the banking industry. The following summarizes the more significant of these policies:
BASIS OF PRESENTATION - The accompanying consolidated financial statements include the accounts of the Company, the Bank and Hamilton Capital Trust I (the "Trust", see Note 8). All significant intercompany amounts have been eliminated in consolidation.
USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS - For purposes of the consolidated statements of cash flows, the Company considers cash, demand deposits with other banks, and federal funds sold as cash and cash equivalents. Generally, federal funds are sold for one-day periods.
The Federal Reserve requires banks to maintain certain average reserve balances, in the form of vault cash or funds on deposit with the Federal Reserve, based upon the total of a bank's net transaction accounts. At December 31, 1998 and 1997, the Bank met its average reserve requirement.
INVESTMENT SECURITIES - Investment securities are accounted for under Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS No. 115, investment securities must be classified and accounted for under the following conditions:
TRADING ACCOUNT SECURITIES - Trading account securities are held in anticipation of short-term sales or market movements. Trading account securities are stated at fair value. Gains or losses on the sale of trading account securities, as well as unrealized fair value adjustments, are included in operating income. At December 31, 1998 and 1997, the Company held no trading account securities.
SECURITIES AVAILABLE FOR SALE - Securities to be held for unspecified periods of time including securities that management intends to use as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk, or other similar factors are classified as available for sale and are carried at fair value. Unrealized gains or losses are reported as a net amount in a separate component of stockholders' equity until realized. Gains and losses are recognized using the specific identification method upon realization.
SECURITIES HELD TO MATURITY - Securities that management has a positive intent and the ability to hold to maturity are carried at cost, adjusted for amortization of premiums and accretions of discounts over the life of the securities using a method which approximates the level-yield method. At December 31, 1997, the Company held no securities classified as securities held to maturity.
OTHER INVESTMENTS - The Company's investment in investment grade perpetual subordinated euronotes are carried at cost, as these securities do not have a readily determinable fair value or stated maturity date.
ALLOWANCE FOR CREDIT LOSSES - The allowance for credit losses is established through a provision for credit losses charged to expense based on management's evaluation of the potential losses in its loan portfolio. Such evaluation, which includes a review of all loans for which full collectability may not be reasonably assured, considers, among other matters, historical loss experience, net realizable value of collateral, current economic conditions and trends, geographical considerations, and such other factors as in management's judgment deserve recognition. Many of these factors involve a significant degree of estimation and are beyond management's control or are subject to changes which may be unforeseen. Although management believes the allowance is adequate to absorb losses on existing loans that may become uncollectible, the ultimate losses may vary significantly from the current estimates.
IMPAIRED LOANS - A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is not impaired during a period of delay in payment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. Individually identified impaired loans are measured based on the present value of payments expected to be received, using the historical effective loan rate as the discount rate. Alternatively, measurement may also be based on observable market prices, or for loans that are solely dependent on the collateral for repayment, measurement may be based on the fair value of the collateral. The Company evaluates commercial loans individually for impairment, while groups of smaller-balance homogeneous loans (generally residential mortgage and installment loans) are collectively evaluated for impairment. The Company has classified all non-accrual loans as impaired.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed by the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized by the straight-line method over the remaining term of the applicable leases or their useful lives, whichever is shorter. The useful lives used are as follows:
GOODWILL - Goodwill of approximately $861,000 arising from the acquisition of the Bank during 1988 and of approximately $1,980,000 arising from the Bank's branch purchase and assumption of deposits during 1994 are being amortized on a straight-line basis over a period of twenty and fifteen years, respectively. The Company reviews goodwill periodically for events or changes in circumstances that may indicate that the carrying amount is not recoverable on an undiscounted cash flow basis.
FEDERAL FUNDS PURCHASED - Federal funds purchased generally mature within one to four days from the transaction date. At December 31, 1998 and 1997, there were no federal funds purchased outstanding.
INCOME RECOGNITION - Interest income on loans is recognized based upon the principal amounts outstanding. Loans over 90 days past due may not be placed on nonaccrual if they are in the process of collection and are either secured by property having a realizable value at least equal to the outstanding debt and accrued interest or are fully guaranteed by a financially responsible party whom the Bank believes is willing and able to discharge the debt, including accrued interest. Loans are placed on a nonaccruing status when management believes that interest on such loans may not be collected in the normal course of business.
Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan.
Trade finance fees and commissions include fees for letters of credit and acceptances. Nonrefundable fees on letters of credit and acceptances are recognized at execution date.
Syndication and structuring fees are earned in connection with the purchase, participation and placement, without recourse or future obligation, of trade finance obligations and for arranging financing for domestic and foreign customers. Nonrefundable fees earned for such transactions are fully recognized in income at the time the transaction is consummated.
INCOME TAXES - The provision for income taxes is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. The Company provides for deferred taxes under the liability method. Under such method, deferred taxes are adjusted for tax rate changes as they occur. Deferred income tax assets and liabilities are computed annually for differences between the financial statements and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
NET INCOME PER COMMON SHARE - Basic earnings per share is computed based on the average number of common shares outstanding and diluted earnings per share is computed based on the average number of common and potential common shares (consisting of stock options, see Note 10) outstanding under the treasury stock method.
STOCK SPLIT - On January 21, 1997, the Company's Board of Directors (the "Board") approved a 6.5 for 1 common stock split (see Note 9). Retroactive restatement has been made to all share amounts to reflect the stock split.
STOCK - BASED COMPENSATION - SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee and non-employee members of the Board compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation to employees and non-employee members of the Board using the intrinsic value method as prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options issued to employees and non-employee members of the Board are measured as the
excess, if any, of the fair value of the Company's stock at the date of grant over the amount an employee or non-employee member of the Board must pay for the stock.
RECLASSIFICATIONS - Certain amounts in the 1997 and 1996 financial statements have been reclassified for comparative purposes.
NEW ACCOUNTING PRONOUNCEMENTS - In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which is effective for transactions occurring after December 31, 1996. SFAS No. 125 provides guidance for determining whether a transfer of a financial asset is treated as a sale versus a financing. Additionally, if a transfer qualifies as a financing transaction, the statement contains provisions that may require the recognition of collateral received or provided, in addition to the financing balance.
In December 1996, the FASB issued SFAS No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125, which defers for one year the effective date of the collateral provisions for all transactions and the sale provisions for repurchase agreement, securities lending, and similar transactions. The provisions of SFAS No. 125 deferred by SFAS No. 127 have been adopted as of January 1, 1998, and did not have a material impact on the Company's results of operations.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general purpose financial statements. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 was adopted as of January 1, 1998.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 changes the way public companies report information about segments of their business in their annual financial statement and requires them to report selected segment information in their quarterly reports issued to shareholders. SFAS No. 131 also requires entitywide disclosures about the products and services an entity provides, the foreign countries in which it holds assets and reports revenues, and its major customers. SFAS No. 131 was adopted as of January 1, 1998 and did not have a material impact on the Company's consolidated financial statement presentation.
In March 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1 provides guidance for capitalizing and expensing the costs of computer software developed or obtained for internal use. SOP 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. Management does not expect the adoption of SOP 98-1 to have a significant impact on the Company's consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Among other provisions, SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It also requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 is effective for financial statements for fiscal years beginning after June 15, 1999. Management has not determined what effects, if any, the adoption of SFAS No. 133 will have on the Company's consolidated financial statements.
2. INVESTMENT SECURITIES
A comparison of the amortized cost and fair value of investment securities at December 31, 1998 and 1997 is as follows (dollars in thousands):
There were no sales of securities available for sale during the years ended December 31, 1998 and 1996. During the year ended December 31, 1997, gross realized gains on the sale of securities available for sale were approximately $109,000 and gross realized losses were approximately $1,000.
Investment securities with an amortized cost and fair value of approximately $38,031,000 and $37,896,000, respectively, at December 31, 1998, were pledged as collateral for public deposits. In addition, investment securities with an amortized cost and fair value of approximately $7,920,000 and $7,889,000, respectively, at December 31, 1998, were pledged as collateral for other borrowings (see Note 7).
The following table shows the amortized cost and the fair value by maturity distribution of the securities portfolio at December 31, 1998:
3. LOANS
Loans consist of the following at December 31, 1998 and 1997 (dollars in thousands):
The Bank's business activity is mostly with customers and correspondent banks located in South Florida, Central America, South America, and the Caribbean. The majority of the credits are for the finance of imports and exports and have maturities of up to 180 days. These credits are secured either by banks, factored receivables, cash, or the underlying goods. Management closely monitors its credit concentrations by industry, geographic locations, and type of collateral as well as individual customers.
A summary of the activity in the allowance for credit losses for the years ended December 31, 1998, 1997 and 1996 is as follows (dollars in thousands):
At December 31, 1998 and 1997, the recorded investment in impaired loans was approximately $8,586,000 and $6,049,000, respectively. These impaired loans required an allowance for credit losses of approximately $2,786,000 and $2,294,000, respectively. The average recorded investment in impaired loans during the years ended December 31, 1998 and 1997 was approximately $8,562,000 and $5,743,000, respectively. For the years ended December 31, 1998 and 1997, the Bank recognized interest income on these impaired loans prior to their classification as impaired of approximately $412,000 and $65,000, respectively.
4. PROPERTY AND EQUIPMENT
The following is a summary of property and equipment at December 31, 1998 and 1997 (dollars in thousands):
Depreciation and amortization expense related to property and equipment for the years ended December 31, 1998, 1997 and 1996 was approximately $944,000, $841,000 and $899,000, respectively.
The Bank owns the land and the building for one of its Miami branches, the Winter Haven and Sarasota branches and leases its main facilities, five branches and certain equipment under noncancelable agreements (accounted for as operating leases). The leases have renewal periods of five to ten years, available to the Bank under the same terms and conditions as the initial leases and one subject to annual rent adjustments based upon the Consumer Price Index.
The approximate future minimum payments, by year and in the aggregate, on these leases at December 31, 1998 are as follows (dollars in thousands):
Rent expense was approximately $1,726,000, $1,381,000 and $1,006,000, for the years ended December 31, 1998, 1997 and 1996, respectively.
5. DEPOSITS
Deposits consist of the following at December 31, 1998 and 1997 (dollars in thousands):
Time deposits in amounts of $100,000 and over at December 31, 1998 mature as follows (dollars in thousands):
6. INCOME TAXES
The components of the provision for income taxes are as follows for the years ended December 31, 1998, 1997 and 1996 (dollars in thousands):
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to pretax income for the following reasons:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. The tax effects of significant items comprising the Company's net deferred tax asset as of December 31, 1998 and 1997 are as follows (dollars in thousands):
Recognition of deferred tax assets is based on management's belief that it is more likely than not that the tax benefit associated with certain temporary differences and tax credits will be realized. A valuation allowance is recorded for those deferred tax items for which it is more likely than not that realization will not occur. No valuation allowances have been recorded at December 31, 1998 and 1997, respectively.
7. OTHER BORROWINGS
Other borrowings consist of the following at December 31, 1998 (dollars in thousands):
8. TRUST PREFERRED SECURITIES
On December 28, 1998, the Company issued $11,000,000 of 9.75% Beneficial Unsecured Securities, Series A (the "Preferred Securities") out of a guarantor trust. The Trust holds 9.75% Junior Subordinated Deferrable Interest Debentures, Series A (the "Subordinated Debentures") of the Company purchased with the proceeds of the securities issued. Interest from the Subordinated Debentures of the Company is used to fund the preferred dividends of the Trust. Distributions on the Preferred Securities are cumulative and are payable quarterly. The Trust must redeem the Preferred Securities when the Subordinated Debentures are paid at maturity on or after December 31, 2028, or upon earlier redemption. Subject to the Company having received any required approval of regulatory agencies, the Company has the option at any time on or after December 31, 2008 to redeem the Subordinated Debentures, in whole or in part. Additionally, the Company has the option at any time prior to December 31, 2008 to redeem the Subordinated Debentures, in whole but not in part, if certain regulatory or tax events occur or if there is a change in certain laws that require the Trust to register under the law. The Preferred Securities are considered to be Tier I capital for regulatory purposes.
On January 14, 1999, the Trust issued an additional $1,650,000 of Preferred Securities upon the exercise of an over-allotment by the underwriters.
9. STOCKHOLDERS' EQUITY
REGULATORY MATTERS - The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1998, that the Bank meets all capital adequacy requirements to which its is subject.
As of December 31, 1998, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.
The Company's consolidated and the Bank's actual capital amounts and ratios are also presented in the table (dollars in thousands).
The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 1998, approximately $43,797,000 of retained earnings were available for dividend declaration without prior regulatory approval. During 1998 and 1997, approximately $2,252,000 and $1,104,000 of dividends were paid by the Bank to the Company, respectively, which are within the amounts allowed by regulations.
The Company has recently placed and expects to continue to place more emphasis on financing imports of goods into the United States and thereby increase the relative size of its assets employed in the United States as compared to its exposure in the Region (as defined in Note 15). In addition, prudent risk management, in particular with regard to emerging market countries, calls for avoidance of high concentrations of risk in these countries in relation to a bank's capital. Currently, United States bank regulatory agencies consider that exposure in these markets should be limited to levels that would not impair the safety and soundness of a banking institution. As a consequence, the Company's exposure in the Region was significantly reduced at December 31, 1998 and will be further reduced in 1999. While the Company is well capitalized for the purposes of the "prompt corrective action" provisions, to date it has not paid any dividends and does not anticipate doing so. Nevertheless, due to economic difficulties being experienced by various countries in the Region, the Federal Reserve has requested that the Company not pay any dividends or incur any debt (excluding "trust preferred securities") without the consent of the Federal Reserve.
PUBLIC OFFERING - On March 26, 1997 the Company completed its initial public offering issuing an aggregate of 2,760,000 shares at $15.50 per share with net proceeds of approximately $38,994,000. In connection with the initial public offering, the Board amended and restated the articles of incorporation of the Company authorizing 75,000,000 shares of common stock and 10,000,000 shares of "blank check" preferred stock. In addition, the Board approved a 6.5 for 1 common stock split and reorganization of the capital structure of the Company consisting of (i) the conversion of all outstanding shares of the Company's Preferred Shares (Series B and C) into 466,160 shares (post-stock split) of common stock and (ii) the issuance of an aggregate of 1,396,759 shares (post-stock split) of common stock for all outstanding warrants to purchase shares of common stock of the Bank.
PREFERRED STOCK - During June 1994, the Company's Board amended and restated the Company's articles of incorporation providing for the issuance of shares of Series B and Series C ("Preferred Shares"), 14% fixed rate, non-cumulative, non-voting, perpetual preferred stock.
The Company, on June 30, 1994, issued an aggregate of 60,207 shares of Series B Preferred Shares at $50 per share and on December 31, 1994 issued 41,000 shares of Series C Preferred Shares at $50 per share. In connection with the public offering and reorganization the preferred shares were converted into 466,160 shares (post-stock split) of common stock.
WARRANTS - In connection with the stock purchase and sale agreement dated March 21, 1988, stock warrants were issued which granted an option to acquire additional common shares of the Bank in an amount equal to twenty percent of the outstanding common shares of the Bank at the time of exercise, at $.01 per share. The option was for a period of ten years that commenced on May 28, 1988. In connection with the public offering and reorganization the warrants (and bank stock resulting from exercise of warrants) were converted into 1,396,759 shares (post-stock split) of common stock.
10. STOCK OPTION PLAN
In December 1993, the Company adopted the 1993 Stock Option Plan (the "1993 Plan"), pursuant to which 877,500 shares of Common Stock (post-stock split) were reserved for issuance upon exercise of options. The 1993 Plan is designed as a means to retain and motivate key employees and directors. The Company's Compensation Committee, or in the absence thereof, the Board, administers and interprets the 1993 Plan and is authorized to grant options thereunder to all eligible employees of the Company, including executive officers and directors (whether or not they are employees) of the Company or affiliated companies. Options granted under the 1993 Plan are on such terms and at such prices as determined by the Compensation Committee, except that the per share exercise price of incentive stock options cannot be less than the fair market value of the Common Stock on the date of grant. The 1993 Plan will terminate on December 31, 2003, unless sooner terminated by the Company's Board.
Option activity for the years ended December 31, 1998, 1997 and 1996 are presented below:
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(1) - Shares reflect 6.5 to 1 stock split.
(2) - The grants vest immediately as to 50% of the grant with the remaining 50% vesting fifteen months after grant or upon the death of the option holder if earlier.
(3) - The grants vest twelve months after the grant as to 33.3% of the grant, 33.3% vesting eighteen months after grant and the remaining 33.4% vesting twenty-four months after grant or upon the death of the option holder if earlier.
The following table summarizes information about all stock options outstanding at December 31, 1998:
The Company applies APB No. 25 and related interpretations in accounting for its stock options plan to employees and non-employee members of the Board as described in Note 1. Accordingly, no compensation expense has been recognized in the years ended December 31, 1998, 1997 and 1996, related to this plan.
For purposes of the following proforma disclosures, the fair value of the options granted in 1998 and 1997 have been estimated on the date of grant using the Black-Scholes options pricing model with the following assumptions used for grants in 1998 and 1997, respectively: no dividend yield; expected volatility of 48% and 32%; risk-free interest rate of 4.5% and 5.68% and an expected term of two years and the fair value of the options granted in 1996 was estimated using the minimum value method prescribed by SFAS No. 123 for nonpublic entities. Had compensation cost been determined based on the fair value at the date of grant consistent with requirement of SFAS 123 the Company's net income and net income and per common share would have been reduced to the proforma amounts indicated below (dollars in thousands, except share information).
11. 401(K) PLAN
The Company maintains a 401(k) plan, which was initiated in 1993, for its executive officers and other employees. Under the terms of the 401(k) plan, for each dollar contributed by an employee, the Company intends to contribute a discretionary amount on behalf of participants (the "Matching Contribution"). In addition, at the end of the plan year, the Company may make an additional contribution (the "Additional Contributions") on behalf of participants. Additional Contributions are allocated in the same proportion that the Matching Contribution made on the participant's behalf bears to the Matching Contribution made on behalf of all participants during the year. The amount that the Company contributes to the 401(k) plan has historically varied from year to year. During the years ended December 31, 1998, 1997 and 1996, the Company's matching and additional contributions amounted to approximately $155,000, $128,000 and $52,000, respectively.
12. RELATED PARTY TRANSACTIONS
Directors, officers and their related entities have borrower and depositor relationships with the Bank in the ordinary course of business. Loan balances to these individuals and their related entities approximated $324,000 and $4,936,000 at December 31, 1998 and 1997, respectively, and the balance of deposit accounts approximated $1,722,000 and $2,154,000 at December 31, 1998 and 1997, respectively. At December 31, 1998 there were approximately $100,000 of outstanding commercial and standby letters of credit transactions with these individuals and their related entities. There were no outstanding commercial and standby letters of credit transactions outstanding with these individuals at December 31, 1997.
13. OFF-BALANCE SHEET RISK, COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Bank utilizes various financial instruments with off-balance sheet risk to meet the financing needs of its customers, including commitments to extend credit, commercial letters of credit, shipping guarantees, standby letters of credit and forward foreign exchange contracts. These financial instruments involve, to varying degrees, elements of credit risk. The credit risk associated with these financial instruments, as further discussed herein, is not recorded in the statement of condition. The contractual or notional amounts of such instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The credit risks associated with financial instruments are generally managed in conjunction with the Bank's statements of condition activities and are subject to normal credit policies, financial controls, and risk limiting and monitoring procedures.
Credit losses are incurred when one of the parties fails to perform in accordance with the terms of the contract. The Bank's exposure to credit loss is represented by the contractual or notional amount of the commercial letters of credit, shipping guarantees, and standby letters of credit. This is the maximum potential loss of principal in the event the commitment is drawn upon and the counterparty defaults.
A summary of the Bank's contractual or notional amounts for financial instruments with off-balance sheet risk as of December 31, 1998 and 1997 along with a further discussion of these instruments, is as follows (dollars in thousands):
A commercial letter of credit is an instrument containing the commitment of the Bank stating that the Bank will honor drawings under and in full compliance with the terms of the letter of credit. The letters of credit are usually drawn on the presentation of certain required documents, such as commercial invoice and bills of lading. Essentially, letters of credit facilitate the purchase of merchandise by the Bank's customers by substituting the credit standing of the Bank for that of the Bank's customer. Commercial letter of credit contracts are generally for a short commitment period.
Standby letters of credit are commitments issued to guarantee the performance of a customer to a third party. The Bank issues standby letters of credit to ensure contract performance or assure payment by its customers. The guarantees extend for periods up to 12 months. The risk involved in issuing standby letters of credit is the same as the credit risk involved in extending loan facilities to customers and they are subject to the same credit approvals and monitoring procedures. The Bank holds certificates of deposit and guarantees from other banks as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held for standby letters of credit commitments at December 31, 1998 varies from zero percent to 100 percent.
Shipping guarantees (also known as indemnity letters) are letters of guarantee issued by the Bank on behalf of its customer in favor of shipping agents. Normally, such facility is extended in instances where goods purchased under letters of credit have arrived at the port of destination and the shipping documents necessary for the release of the goods have not been received by the Bank. The purpose of the shipping guarantee is to indemnify the transportation company for any loss that might arise from the release of goods to the Bank's customer in the absence of the shipping documents.
The Bank enters into forward foreign exchange contracts with its customers for the delayed exchange of foreign currency for U.S. dollars on behalf of such customers. These contracts provide a vehicle for the Bank's customers to hedge their future obligations in foreign currency. Upon entering such contracts with its customers, the Bank meets these foreign currency commitments by entering into equivalent contracts with other banks to purchase or sell equal amounts of the foreign currency to be delivered or received. Risks arise from the possible inability of the Bank's counterparties to meet the terms of their contracts and from movements in foreign currency exchange rates. However, the full notional amount of the contract is not at risk, as the Bank has the ability to settle these contracts in the foreign exchange market.
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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit, is based on management's credit evaluation of the counterparty.
On January 31, 1998, Development Specialists, Inc., the Liquidating Trustee of the Model Imperial Liquidating Trust established under the Plan of Reorganization in the Model Imperial, Inc. Chapter 11 Bankruptcy proceeding, filed an action against the Bank in the United States Bankruptcy Court for the Southern District of Florida objecting to the Bank's proof of claim in the Chapter 11 proceeding and affirmatively seeking damages against the Bank in excess of $34 million for alleged involvement with former officers and directors of Model Imperial, Inc. in a scheme to defraud Model Imperial, Inc. and its bank lenders. The action is one of several similar actions filed by the Trustee against other defendants that were involved with Model Imperial seeking the same damages as in the action against the Bank. The Bank believes the claims are without merit either as a matter of law or fact and intends to vigorously defend the action.
From time to time the Bank is engaged in additional litigation incidental to its operations.
While any litigation contains an element of uncertainty, the Bank, after considering the advice of legal counsel, believes the outcome of all aforementioned litigation will not have a material adverse effect on the Bank's financial position, results of operations or liquidity.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since December 31, 1998 and, therefore, current estimates of fair value may differ significantly from the amounts presented herein (dollars in thousands).
CASH AND CASH EQUIVALENTS - The carrying amount of cash on hand, demand deposits with other banks, and federal funds sold is a reasonable estimate of fair value.
INTEREST-EARNING DEPOSITS WITH OTHER BANKS - The fair value of time deposits with other banks (several of which are foreign) is estimated using the rates currently offered for deposits of similar remaining maturities and taking into account the creditworthiness of the other bank.
SECURITIES AVAILABLE FOR SALE, SECURITIES HELD TO MATURITY AND TRUST PREFERRED SECURITIES - The fair values 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.
LOANS - The interest rates for commercial loans and acceptances discounted are based on the prime lending rate. The Bank updates these interest rates on a monthly basis. Thus, the carrying amount of commercial loans and acceptances discounted is a reasonable estimate of fair value. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
DEMAND DEPOSITS AND TIME DEPOSITS - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
OTHER INVESTMENTS AND OTHER BORROWINGS - The carrying amount of other investments and other borrowings is a reasonable estimate of fair value.
CONTINGENT ASSETS AND LIABILITIES - The fair values of these assets and corresponding liabilities are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.
OFF-BALANCE SHEET INSTRUMENTS - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness 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 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. The fair values of commitments to purchase and sell foreign currency are based on quoted market prices or dealer quotes.
15. FOREIGN ACTIVITIES
The Company's foreign activities primarily consist of providing global trade finance, with particular emphasis on trade finance, with and between South America, Central America, the Caribbean (the "Region") and the United States or otherwise involving the Region. The Company considers assets and revenues as associated with foreign activities on the basis of the country of domicile of the customer. The nature of the Company's operations make it difficult to determine precisely foreign activities profitability since it involves the use of certain judgmental allocations. Rates used to determine charges or credits for funds used or generated by foreign activities are based on actual costs during the period for selected interest-bearing sources of funds. Other operating income and expenses are determined based upon internal allocations appropriate to the individual activities. A summary of
the Company's domestic and foreign activities as of and for the years ended December 31, 1998, 1997 and 1996 is as follows (dollars in thousands):
16. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Hamilton Bancorp Inc. (Parent Company only) is as follows (dollars in thousands):
STATEMENTS OF CONDITION
* * * * *
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Reference is made to information under the captions "Information as to Directors and Executive Officers" and "Meetings of the Board of Directors and Committees" in the Registrant's definitive proxy statement relating to its 1999 Annual Meeting of Stockholders, which will be filed with the Commission within 120 days after the close of the Registrant's fiscal year ended December 31, 1998, all of which information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Reference is made to the information set forth in the Registrant's definitive proxy statement relating to its 1999 Annual Meeting of Stockholders under the caption "Executive Compensation" and continuing through the caption "Certain Transactions with Management" (excluding the information set forth under the caption "Compensation Committee Report") which will be filed with the Commission within 120 days after the close of the Registrant's fiscal year ended December 31, 1998, which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Reference is made to the information set forth under the caption "Ownership of Equity Securities" in the Registrant's definitive proxy statement relating to its 1999 Annual Meeting of Stockholders, which will be filed with the Commission within 120 days after the close of the Registrant's fiscal year ended December 31, 1998, which information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Reference is made to the information set forth under the caption "Certain Transactions with Management" in the Registrant's definitive proxy statement relating to its 1999 Annual Meeting of Stockholders, which will be filed with the Commission within 120 days after the close of the Registrant's fiscal year ended December 31, 1998, which information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements. The following financial statements and financial statement schedules are contained herein or are incorporated herein by reference:
2. Exhibits. The following exhibits are contained herein or are incorporated herein by reference:
DESCRIPTION OF EXHIBIT
3.1 Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1, Registration No. 333-20435)
3.2 Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 of the Company's Registration Statement on Form S-1, Registration No. 333-20435)
4.1 Form of Common Stock certificate (incorporated by reference to Exhibit 4.1 of the Company's Registration Statement on Form S-1, Registration No. 333-20435)
4.2 Certificate of Trust for Hamilton Capital Trust I (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement, Registration No. 333-68453)
4.3 Declaration of Trust for Hamilton Capital Trust I (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement, Registration No. 333-68453)
4.4 Form of Amended and Restated Declaration of Trust (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement, Registration No. 333-68453)
4.5 Form of Series A Subordinated Debenture (incorporated by reference to Exhibit 4.4 to the Company's Registration Statement, Registration No. 333-68453)
4.6 Form of Series A Capital Security (incorporated by reference to Exhibit 4.5 to the Company's Registration Statement, Registration No. 333-68453)
4.7 Form of Indenture (incorporated by reference to Exhibit 4.6 to the Company's Registration Statement, Registration No. 333-68453)
10.1 Company's 1993 Stock Option Plan, as amended (incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, Registration No. 333-20435)
10.2 Lease Agreement, dated December 20, 1997, by and between Hamilton Bank, N.A. and System Realty Twelve, Inc. regarding the Company's corporate headquarters (incorporated by reference to Exhibit 10.2 of the Company's Registration Statement on Form S-1, Registration No. 333-20435)
21.1 Subsidiaries of the Company*
23.1 Consent of Deloitte & Touche LLP.
27.1 Financial Data Schedule (for SEC use only)
(b) No reports on Form 8-K were filed during the fourth quarter of 1998.
* To be filed by amendment
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, this 30th day of March, 1999.
HAMILTON BANCORP INC.
/s/ Eduardo A. Masferrer ------------------------------------ Eduardo A. Masferrer, Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on March 30, 1999 on behalf of the Registrant and in the capacities indicated.
/s/ Eduardo A. Masferrer /s/ Maura A. Acosta ------------------------- ------------------------------------------ Eduardo A. Masferrer Maura A. Acosta Director Director
/s/ William Alexander /s/ William Bickford ------------------------- ------------------------------------------ William Alexander William Bickford Director Director
/s/ Thomas F. Gaffney /s/ Virgilio E. Sosa, Jr. ------------------------- ------------------------------------------ Thomas F. Gaffney Virgilio E. Sosa, Jr. Director Director
/s/ Ronald A. Lacayo /s/ John M. R. Jacobs ------------------------- ------------------------------------------ Ronald A. Lacayo John M. R. Jacobs, Senior Vice President Director Finance and Treasurer (principal financial officer and principal accounting officer)
INSERT FOR EXHIBIT INDEX TO HAMILTON BANCORP 10-K
4.2 Certificate of Trust for Hamilton Capital Trust I (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement, Registration No. 333-68453)
4.3 Declaration of Trust for Hamilton Capital Trust I (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement, Registration No. 333-68453)
4.4 Form of Amended and Restated Declaration of Trust (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement, Registration No. 333-68453)
4.5 Form of Series A Subordinated Debenture (incorporated by reference to Exhibit 4.4 to the Company's Registration Statement, Registration No. 333-68453)
4.6 Form of Series A Capital Security (incorporated by reference to Exhibit 4.5 to the Company's Registration Statement, Registration No. 333-68453)
4.7 Form of Indenture (incorporated by reference to Exhibit 4.6 to the Company's Registration Statement, Registration No. 333-68453)
27.1 Financial Data Schedule (for SEC use only)