|Closing Price ($)||Shares Out (MM)||Market Cap ($MM)|
|8-K||2018-11-28||Regulation FD, Other Events|
|8-K||2018-04-13||M&A, Officers, Exhibits|
|8-K||2018-03-28||Shareholder Vote, Other Events|
|FNHI||Franchise Holdings International||0|
|TOAD||TOA Distribution Systems||0|
|Item 1A. Risk Factors|
|Item 1B. Unresolved Staff Comments|
|Item 2. Properties|
|Item 3. Legal Proceedings|
|Item 4. Mine Safety Disclosures|
|Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities|
|Item 6. Selected Financial Data|
|Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations|
|Item 7A. Quantitative and Qualitative Disclosures About Market Risk|
|Item 8. Financial Statements|
|Part 1. Financial Information|
|Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure|
|Item 9A. Controls and Procedures|
|Item 9B. Other Information|
|Item 10. Directors, Executive Officers and Corporate Governance|
|Item 11. Executive Compensation|
|Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters|
|Item 13. Certain Relationships and Related Transactions, and Director Independence|
|Item 14. Principal Accounting Fees and Services|
|Item 15. Exhibits, Financial Statement Schedules|
|Item 16. Form 10-K Summary|
|Balance Sheet||Income Statement||Cash Flow|
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
|☒||ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the fiscal year ended December 31, 2018
|☐||TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
Commission File Number: 000-50345
Old Line Bancshares, Inc.
(Exact name of registrant as specified in its charter)
State or other jurisdiction of
incorporation or organization
1525 Pointer Ridge Place
Registrant’s telephone number, including area code: (301) 430-2500
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange
on which registered
|Common Stock, par value $0.01 per share||The Nasdaq Stock Market LLC|
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. ☐ Yes ☒ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
|Large accelerated filer ☐||Accelerated filer ☒|
|Non-accelerated filer ☐|
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ No
The aggregate market value of the common equity held by non-affiliates was $512.6 million as of June 30, 2018 based on a sales price of $34.91 per share of Common Stock, which is the sales price at which the Common Stock was last traded on June 29, 2018 as reported by the Nasdaq Stock Market LLC.
The number of shares outstanding of the issuer’s Common Stock was 17,043,232 as of March 1, 2019.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2019 Annual Meeting of Stockholders of Old Line Bancshares, Inc., to be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year, are incorporated by reference in Part III of this Annual Report on Form 10-K.
OLD LINE BANCSHARES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018
|Item 1A.||Risk Factors||16|
|Item 1B.||Unresolved Staff Comments||28|
|Item 3.||Legal Proceedings||32|
|Item 4.||Mine Safety Disclosures||32|
|Item 5.||Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities||32|
|Item 6.||Selected Financial Data||33|
|Item 7.||Management’s Discussion and Analysis of Financial Condition and Results of Operations||34|
|Item 7A.||Quantitative and Qualitative Disclosures About Market Risk||71|
|Item 8.||Financial Statements and Supplementary Data||74|
|Item 9.||Changes in and Disagreements with Accountants on Accounting and Financial Disclosure||134|
|Item 9A.||Controls and Procedures||134|
|Item 9B.||Other Information||135|
|Item 10.||Directors, Executive Officers and Corporate Governance||135|
|Item 11.||Executive Compensation||135|
|Item 12.||Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters||135|
|Item 13.||Certain Relationships and Related Transactions, and Director Independence||136|
|Item 14.||Principal Accounting Fees and Services||136|
|Item 15.||Exhibits, Financial Statement Schedules||137|
|Item 16.||Form 10-K Summary||143|
Cautionary Note About Forward Looking Statements
Some of the matters discussed in this annual report including under the captions “Business of Old Line Bancshares, Inc.,” “Business of Old Line Bank,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this annual report constitute forward looking statements. These forward-looking statements include: (a) our objectives, expectations and intentions, including (i) market expansion and growth in particular geographic areas, (ii) statements regarding anticipated increases in certain non-interest expenses and that net interest income will increase during 2019, (iii) maintenance of the net interest margin, (iv) our belief that we have identified any problem assets and that our borrowers will continue to remain current on their loans, (v) expected losses on and our intentions with respect to our investment securities, and (vi) earnings on bank owned life insurance; (b) sources of and sufficiency of liquidity; (c) the adequacy of the allowance for loan losses; (d) expected loan, deposit, balance sheet and earnings growth; (e) that the recent acquisition of Bay Bancorp, Inc. (“BYBK”) will continue to generate increased earnings and stockholder returns and our expectations regarding operating costs savings therefrom; (f) expectations with respect to the impact of pending legal proceedings; (g) improving earnings per share and stockholder value; (h) realization of the deferred tax asset; ; (j) the impact of recent accounting pronouncements we have not yet adopted; and (k) financial and other goals and plans.
Old Line Bancshares bases these statements on our beliefs, assumptions and on information available to us as of the date of this filing, which involves risks and uncertainties. These risks and uncertainties include, among others: our ability to retain key personnel; our ability to successfully implement our growth and expansion strategy; risk of loan losses; that the allowance for loan losses may not be sufficient; that changes in interest rates and monetary policy could adversely affect Old Line Bancshares; that changes in regulatory requirements and/or restrictive banking legislation may adversely affect Old Line Bancshares; that the market value of our investments could negatively impact stockholders’ equity; risks associated with our lending limit; expenses associated with operating as a public company; potential conflicts of interest associated with the interest in Pointer Ridge; deterioration in general economic conditions or a return to recessionary conditions; and changes in competitive, governmental, regulatory, technological and other factors which may affect us specifically or the banking industry generally; and other risks otherwise discussed in this report, including under “Item 1A. Risk Factors.”
Our actual results and the actual outcome of our expectations and strategies could differ materially from those anticipated or estimated because of these risks and uncertainties and you should not put undue reliance on any forward-looking statements. All forward-looking statements speak only as of the date of this filing, and we undertake no obligation to update the forward-looking statements to reflect factual assumptions, circumstances or events that have changed after we have made the forward-looking statements.
Old Line Bancshares, Inc. was incorporated under the laws of the State of Maryland on April 11, 2003 to serve as the holding company of Old Line Bank. The primary business of Old Line Bancshares, Inc. is to own all of the capital stock of Old Line Bank.
We also have an investment in a real estate investment limited liability company named Pointer Ridge Office Investment, LLC (“Pointer Ridge”). We currently own 100% of Pointer Ridge and we have consolidated its results of operations from the date of acquisition. In August 2016, Old Line Bank purchased the aggregate 37.5% minority interest in Pointer Ridge not held by Old Line Bancshares and on September 2, 2016, we paid off the entire $5.8 million principal amount of a promissory note previously issued by Pointer Ridge. On September 28, 2017, Old Line Bancshares transferred and assigned its ownership interest in Pointer Ridge to Old Line Bank, and as a result Old Line Bank acquired all rights, title and interest in Pointer Ridge. Pointer Ridge owns our headquarters building located at 1525 Pointer Ridge Place, Bowie, Maryland, containing approximately 40,000 square feet. We occupy 98% of this building for our main office and operate a branch of Old Line Bank from this address.
Old Line Bank is a Maryland-chartered trust company. Old Line Bank was originally chartered in 1989 as a national bank under the name “Old Line National Bank.” In June 2002, Old Line Bank converted to a Maryland-chartered trust company exercising the powers of a commercial bank and received a Certificate of Authority to do business from the Maryland Commissioner of Financial Regulation (the “Commissioner”).
Old Line Bank is a Maryland-chartered trust company (with all of the powers of a commercial bank). Old Line Bank does not exercise trust powers and its regulatory structure is the same as a Maryland-chartered commercial bank. Old Line Bank’s primary regulator is the Federal Deposit Insurance Corporation (“FDIC”) and it is subject to regulation, supervision and regular examination by the Commissioner and the FDIC. Old Line Bank’s deposits are insured to the maximum legal limits by the FDIC.
We are headquartered in Bowie, Maryland, approximately 10 miles east of Andrews Air Force Base and 20 miles east of Washington, D.C. We operate a general commercial banking business, making various types of loans and accepting deposits. We market our financial services to small to medium sized businesses, entrepreneurs, professionals, consumers and high net worth clients.
Our principal source of revenue is interest income and fees generated by lending and investing funds on deposit. We typically balance the loan and investment portfolio towards loans. Generally speaking, loans earn more attractive returns than investments and are a key source of product cross sales and customer referrals. Our loan and investment strategies balance the need to maintain adequate liquidity via excess cash or federal funds sold with opportunities to leverage our capital appropriately.
In June 2012, we established Old Line Financial Services as a division of Old Line Bank and hired an individual with over 25 years of experience to manage this division. Old Line Financial Services allows us to expand the services we provide our customers to include retirement planning and products. Additionally, this division offers investment services including investment management, estate and succession planning and allows our customers to directly purchase individual stocks, bonds and mutual funds. Through this division customers may also purchase life insurance, long term care insurance and key man/woman insurance.
Completed Mergers and Acquisitions
Bay Bancorp, Inc. On April 13, 2018, Old Line Bancshares completed its acquisition of BYBK, the parent company of Bay Bank, FSB (“Bay Bank”). In connection with the acquisition, Bay Bank was merged with and into Old Line Bank, with Old Line Bank the surviving bank. At April 13, 2018, BYBK had consolidated assets of approximately $663 million. We acquired 11 banking locations in BYBK’s primary market areas of Baltimore City and Baltimore, Anne Arundel, Howard and Harford Counties in Maryland.
DCB Bancshares, Inc. On July 28, 2017, Old Line Bancshares acquired DCB Bancshares, Inc. (“DCB”), the parent company of Damascus Community Bank (“Damascus”). Immediately thereafter Damascus was merged with and into Old Line Bank, with Old Line Bank the surviving bank. At July 28, 2017, DCB had consolidated assets of approximately $311 million. As a result of this merger we acquired six banking locations located in Montgomery, Frederick and Carroll Counties in Maryland.
Regal Bancorp, Inc. On December 4, 2015, Old Line Bancshares completed its acquisition of Regal Bancorp, Inc. (“Regal Bancorp”), the parent company of Regal Bank & Trust (“Regal Bank”). Immediately thereafter Regal Bank was merged with and into Old Line Bank, with Old Line Bank the surviving bank. We acquired Regal Bank’s three branches in the merger, facilitating Old Line Bank’s entry into the Baltimore County and Carroll County, Maryland markets. The merger strengthened Old Line Bank’s status as the third largest independent commercial bank based in Maryland, with assets of more than $1.5 billion at closing and 23 full service branches serving eight Maryland counties.
WSB Holdings, Inc. On May 10, 2013, Old Line Bancshares acquired WSB Holdings, Inc. (“WSB Holdings”), the parent company of The Washington Savings Bank, F.S.B. (“WSB”). In connection with the acquisition, WSB was merged with and into Old Line Bank, with Old Line Bank the surviving bank. We acquired five WSB branches, its headquarters building and its established mortgage origination group in this acquisition. The mortgage origination group originates residential real estate loans for our portfolio and loans classified as held for sale to be sold in the secondary market. We closed two of the acquired branches on December 31, 2014 and an additional two branches on September 30, 2016. This acquisition increased Old Line Bancshares’ total assets by more than $310 million immediately after closing.
Maryland Bankcorp, Inc. On April 1, 2011, Old Line Bancshares acquired Maryland Bankcorp, Inc. (“Maryland Bankcorp”), the parent company of Maryland Bank & Trust Company, N.A. (“MB&T”). In connection with the acquisition, MB&T was merged with and into Old Line Bank, with Old Line Bank the surviving bank. The acquisition of MB&T’s ten full-service branches expanded our market presence in Calvert and St. Mary’s Counties. The acquisition increased Old Line Bancshares’ total assets by more than $345 million immediately after closing to approximately $750 million. We closed two of the acquired branches on December 31, 2014.
For more information regarding our mergers and acquisitions, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Acquisition” and Note 2—Acquisition of Bay Bancorp, Inc. in the Notes to our Consolidated Financial Statements.
Location and Market Area
We consider our current market area to consist of the suburban Maryland counties of Anne Arundel, Calvert, Charles, Frederick, Harford, Howard, Prince George’s, Montgomery, and St. Mary’s (Washington, D.C. suburbs) and Baltimore and Carroll (Baltimore City suburbs). The economy in our current market area has focused on real estate development, high technology, retail and the government sector.
Our headquarters and a branch are located at 1525 Pointer Ridge Place, Bowie, Prince George’s County, Maryland. A critical component of our strategic plan and future growth is a focus on Prince George’s and Montgomery Counties. Prince George’s County wraps around the eastern boundary of Washington, D.C. and offers urban, suburban and rural settings for employers and residents. There are several national and international airports less than an hour away, as is Baltimore City. We currently have six branch locations, as well as the office that houses our mortgage origination group, in Prince George’s County.
We opened a loan production office in Silver Spring, in Montgomery County, Maryland in 2013. We opened our first branch in Rockville, Maryland, in Montgomery County in 2015 and a second location, located in the Rockville Town Center, in 2016. We acquired three more locations in Montgomery County in 2017 as a result of the DCB acquisition. These branches are located in Damascus, Clarksburg and Gaithersburg. Montgomery County is located just to the north of Washington, D.C., and is adjacent to Frederick, Howard and Prince George’s Counties in Maryland and Loudoun and Fairfax Counties in Virginia. Montgomery County is an important business and research center and is the third largest biotechnology cluster in the United States. The U.S. Department of Health and Human Services, the U.S. Department of Defense, and the U.S. Department of Commerce are among the top county employers. Several large firms are also based in the county, including Marriott International, Lockheed Martin, GEICO, and the Travel Channel. Montgomery County has the 17th highest median household income in the U.S., and the third highest in the state of Maryland. 1
We currently have four branch offices and a loan production office located in Charles County, Maryland. Just 15 miles south of the Washington Capital Beltway, Charles County is the gateway to Southern Maryland. The northern part of Charles County is the “development district” where the commercial, residential and business growth is focused. Waldorf, White Plains and the planned community of St. Charles are located here. Charles County has the 23rd highest median household income in the U.S., and the fifth highest in the state of Maryland. 1
Four of our branch offices, one of which includes a loan production office, are located in Anne Arundel County, Maryland. Anne Arundel County borders the Chesapeake Bay and is situated in the high tech corridor between Baltimore and Washington, D.C. With over 534 miles of shoreline, it provides waterfront living for many residential communities. Annapolis, the State Capital and home to the United States Naval Academy, and Baltimore/Washington International
Thurgood Marshal Airport (BWI) is located in Anne Arundel County. Anne Arundel County has one of the strongest economies in the State of Maryland and its unemployment rate is consistently below the national average.
We have two branches and a loan production office in St. Mary’s County and one branch and loan production office in Calvert County. The unemployment rates in Calvert and St. Mary’s Counties are among the lowest in the state of Maryland and also consistently rank below the national average. Calvert County, located approximately 25 miles southeast of Washington, D.C., is one of several Maryland counties that comprise the Washington Metropolitan Area and is adjacent to Anne Arundel, Prince George’s, St. Mary’s and Charles Counties. Major employers in Calvert County include municipal and government agencies and Exelon/Calvert Cliffs Nuclear Power Plant. St. Mary’s County is located approximately 35 miles southeast of Washington, D.C. It is adjacent to Charles and Calvert Counties and is home to the Patuxent River Naval Air Station, a major naval air testing facility on the east coast of the United States. Calvert and St. Mary’s Counties have the 18th and 46th highest median household income in the U.S., respectively.
We have five branches in Baltimore County and two branches in Baltimore City The market area with respect to these branches consists of the Baltimore metropolitan statistical area., The economy of the Baltimore metropolitan area constitutes a diverse cross-section of employment sectors, with a mix of services, manufacturing, wholesale/retail trade, federal and local government, health care facilities and finance related employment. The largest employers in the Baltimore area include University System of Maryland, Johns Hopkins Hospital and Fort Meade. The Baltimore region is the 30th most populous area in the United States. 2
We have two branches in Carroll County Carroll County is bordered on the north by the Mason–Dixon line with Pennsylvania, and on the south by Howard County Carroll County is bordered on the west by Frederick County Carroll County Public Schools is the largest employer in Carroll County followed by McDaniel College.
We have two branches in Frederick County, both of which we acquired in the Damascus acquisition. Frederick County is located in the northern part of Maryland. Frederick County has experienced a rapid population increase in recent years. The county is sometimes associated with Western Maryland, depending on the definition used. It borders the southern border of Pennsylvania and the northeastern border of Virginia. Frederick County is ranked 7th in medium household income in the state of Maryland. 3
We have one branch in each of Harford and Howard Counties, Maryland, both of which we acquired upon our acquisition of Bay Bank. Harford County straddles the border between the rolling hills of the Piedmont Plateau and the flatlands of the Atlantic Coastal Plain along the Chesapeake Bay and its tributaries. The county's development is a mix of rural and suburban. Howard County, located in central Maryland, is frequently cited for its affluence, quality of life, and excellent schools. With an estimated median household income of $120,941, Howard County had the second-highest median household income of any U.S. county in 2016. 1
General. Our primary market focus is on making loans to small and medium size businesses, entrepreneurs, professionals, consumers and high net worth clients in our market area. Our lending activities consist generally of short to medium term commercial business loans, commercial real estate loans, real estate construction loans, home equity loans and consumer installment loans, both secured and unsecured. We also originate residential loans for sale in the secondary market in addition to originating residential loans we maintain in our portfolio.
1 As reported by Wikipedia according to the 2016 American Community Survey prepared by the U.S. Census Bureau.
2 As of July 1, 2017, as reported by Wikipedia as estimated by the U.S. Census Bureau.
3 Data is from the 2010 United States Census Data and the 2010-2014 American Community Survey 5-Year Estimates
Credit Policies and Administration. We have adopted a comprehensive lending policy, which includes stringent underwriting standards for all types of loans. Our lending staff follows pricing guidelines established periodically by our management team. In an effort to manage risk, prior to funding, the loan committee which consists of four non-employee members of the board of directors and four executive officers must approve by majority vote all credit decisions in excess of a lending officer’s lending authority. Management believes that we employ experienced lending officers, secure appropriate collateral and carefully monitor the financial condition of our borrowers and the concentrations of loans in the portfolio.
In addition to the normal repayment risks, all loans in the portfolio are subject to risks stemming from the state of the economy and the related effects on the borrower and/or the real estate market. With the exception of loans provided to finance luxury boats, which we originated prior to 2008, generally longer term loans have periodic interest rate adjustments and/or call provisions. Senior management monitors the loan portfolio closely to ensure that we minimize past due loans and that we swiftly deal with potential problem loans.
Old Line Bank also engages an outside, independent firm to review the loan portfolio. This firm performs a detailed annual review and an interim update at least once a year. We use the results of the firm’s report to validate our internal loan ratings and we review their commentary on specific loans and on our loan administration activities in order to improve our operations.
Commercial and Industrial Lending. Our commercial and industrial lending consists of lines of credit, revolving credit facilities, accounts receivable financing, term loans, equipment loans, Small Business Administration (“SBA”) loans, standby letters of credit and unsecured loans. We originate commercial loans for any business purpose including the financing of leasehold improvements and equipment, the carrying of accounts receivable, general working capital and acquisition activities. We have a diverse client base and we do not have a concentration of these types of loans in any specific industry segment. We generally secure commercial business loans with accounts receivable, equipment, deeds of trust and other collateral such as marketable securities, cash value of life insurance, and time deposits at Old Line Bank.
Commercial business loans have a higher degree of risk than residential mortgage loans because the availability of funds for repayment generally depends on the success of the business. They may also involve higher average balances, increased difficulty monitoring and a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business. To help manage this risk, we typically limit these loans to proven businesses and we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of the business. For loans in excess of $250,000, monitoring usually includes a review of the borrower’s annual tax returns and updated financial statements.
Commercial Real Estate Lending. We finance commercial real estate for our clients, usually for owner occupied properties. We generally will finance owner occupied commercial real estate at a loan to value that does not exceed 80%. Our underwriting policies and processes focus on the clients’ ability to repay the loan as well as an assessment of the underlying real estate. We originate commercial real estate loans on a fixed rate or adjustable rate basis. Usually, these rates adjust during a three, five or seven year time period based on the then current treasury or prime rate index. Repayment terms generally include amortization schedules ranging from three years to 25 years with principal and interest payments due monthly and with all remaining principal due at maturity. We also make commercial real estate construction loans, primarily for owner-occupied properties.
Commercial real estate lending entails significant additional risks as compared with residential mortgage lending. Risks inherent in managing a commercial real estate portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate that may detrimentally impact the borrower’s ability to repay. We attempt to mitigate these risks by carefully underwriting these loans. Our underwriting generally includes an analysis of the borrower’s capacity to repay, the current collateral value, a cash flow analysis and review of the character of the borrower and current and prospective conditions in the market. We generally limit loans in this category to 75% - 80% of the value of the property and require personal and/or corporate guarantees. For loans of this type in excess of $250,000, we monitor the financial condition and operating performance of the borrower through a review of annual tax returns and updated financial statements. In addition, we will meet with the borrower and/or perform site visits as required.
Hospitality loans are segregated into a separate category under commercial real estate. An individual review of these loans indicate that they generally have a low loan to value, more than acceptable existing or projected cash flow, are to experienced operators and are generally dispersed throughout our market area.
Residential Real Estate Lending. We offer a variety of consumer-oriented residential real estate loans. A portion of our portfolio is made up of home equity loans to individuals with a loan to value not exceeding 80%. We also offer fixed rate home improvement loans. Our home equity and home improvement loan portfolio gives us a diverse client base. Although most of these loans are in our market area, the diversity of the individual loans in the portfolio reduces our potential risk. Usually, we secure our home equity loans and lines of credit with a security interest in the borrower’s primary or secondary residence. Our initial underwriting includes an analysis of the borrower’s debt/income ratio which generally may not exceed 43%. We also consider the borrower’s length of employment and prior credit history in the approval process. Typically, we require borrowers to have a credit score of at least 640, except for loans originated for sale in the secondary market, as discussed below. We do not originate subprime residential real estate loans.
We obtain detailed loan applications to determine a borrower’s ability to repay and verify the more significant items on these applications through credit reports, financial statements and verifications. We also require appraisals of collateral and title insurance on secured real estate loans.
A portion of this segment of the loan portfolio consists of funds advanced for construction of custom single family residences (where the home buyer is the borrower), financing to builders for the construction of pre-sold homes, and loans for multi-family housing. These loans generally have short durations, meaning maturities typically of 12 months or less. Residential houses, multi-family dwellings and commercial buildings under construction and the underlying land for which the loan was obtained secure the construction loans. The vast majority of these loans are concentrated in our market area.
Construction lending entails significant risk. These risks generally involve larger loan balances concentrated with single borrowers with funds advanced upon the security of the land or the project under construction. An appraisal of the property estimates the value of the project “as is” and “as if completed.” Thus, initial funds are advanced based on the current value of the property, with the remaining construction funds advanced under a budget sufficient to successfully complete the project within the “as completed” loan to value. To further mitigate these risks, we generally limit loan amounts to 80% or less of appraised values, obtain first lien positions on the property securing the loan, and adhere to established underwriting procedures. In addition, we generally offer real estate construction financing only to experienced builders, commercial entities or individuals who have demonstrated the ability to obtain a permanent loan “take-out” (conversion to a permanent mortgage upon completion of the project). We also perform a complete analysis of the borrower and the project prior to construction. This analysis includes a review of the cost to construct, the borrower’s ability to obtain a permanent “take-out,” the cash flow available to support the debt payments and construction costs in excess of loan proceeds, and the value of the collateral. During construction, we advance funds on these loans on a percentage of completion basis. We inspect each project as needed prior to advancing funds during the term of the construction loan. We may provide permanent financing on the same projects for which we have provided the construction financing.
Under our loan approval policy, all residential real estate loans approved must comply with federal regulations. Generally, we will make residential mortgage loans in amounts up to the limits established by Fannie Mae and Freddie Mac for secondary market resale purposes. Currently this amount for single-family residential loans currently varies from $453,100 up to a maximum of $679,650 for certain high-cost designated areas. We also make residential mortgage loans up to limits established by the Federal Housing Administration, which currently is $679,650. The Washington, D.C. and Baltimore areas are both considered high-cost designated areas. We will, however, make loans in excess of these amounts if we believe that we can sell the loans in the secondary market or that the loans should be held in our portfolio. For loans we originate for sale in the secondary market, we typically require a credit score of 620 or higher, with some exceptions provided we receive an approval recommendation from FannieMae, FreddieMac or the Federal Housing Administration’s (“FHA”) automated underwriting approval system. Loans sold in the secondary market are sold to investors on a servicing released basis and recorded as loans as held for sale. The premium is recorded in income on marketable loans in non-interest income, net of commissions paid to the loan officers.
Land Acquisition and Development Lending. These loans are usually used to fund the acquisition and development of unimproved properties to be used for residential or non-residential construction. We may provide permanent financing on the same projects for which we have provided the construction financing.
Land acquisition and development lending, while providing higher yields, may also have greater risks of loss than long-term residential mortgage loans on improved, owner-occupied properties.
Old Line Bank generally makes land acquisition loans with terms of up to three years and loan to value ratios of up to 65%, and land development loans with terms of up to two years and loan-to-value ratios of up to 75%.
The primary loan-specific risks in land acquisition and land development lending are increases in local unemployment that decrease the demand for housing, deterioration of the business and/or collateral values, deterioration of the financial condition of the borrowers and/or guarantors that creates a risk of default, and that an appraisal on the collateral is not reflective of the true property value. Portfolio risks include the condition of the economy, changing demand for these types of loans, large concentration of these types of loans, and geographic concentrations of these types of loans.
Consumer Installment Lending. We offer various types of secured and unsecured consumer loans. We make consumer loans for personal, family or household purposes as a convenience to our customer base. This category includes our luxury boat loans, which we made prior to 2008 and that remain in our portfolio. Consumer loans, however, are not a focus of our lending activities. The underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of his or her ability to meet existing obligations and payments on the proposed loan. As a general guideline, the borrower’s total debt service should not exceed 40% of his or her gross income.
Our consumer loan portfolio, includes indirect loans, primarily auto and RV loans. These loans are financed through dealers and the dealers receive a percentage of the finance charge, which varies depending on the terms of each loan. We use the same underwriting standards in originating these indirect loans as we do for consumer loans generally.
Consumer loans may present greater credit risk than residential mortgage loans because many consumer loans are either unsecured or secured by rapidly depreciating assets. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation. Consumer loan collections depend on the borrower’s continuing financial stability. If a borrower suffers personal financial difficulties, the loan may not be repaid. Also, various federal and state laws, including bankruptcy and insolvency laws, may limit the amount we can recover on such loans.
Lending Limit. As of December 31, 2018, our legal lending limit for loans to one borrower was approximately $46.6 million. As part of our risk management strategy, we may attempt to participate a portion of larger loans to other financial institutions. This strategy allows Old Line Bank to maintain customer relationships yet reduce its credit exposure. However, this strategy may not always be available.
Investments and Funding
We balance our liquidity needs based on loan and deposit growth via the investment portfolio, purchased funds, and short term borrowings. It is our goal to provide adequate liquidity to support our loan growth. In the event we have excess liquidity, we use investments to generate positive earnings. In the event deposit growth does not fully support our loan growth, we can use a combination of investment sales, federal funds, other purchased funds and short term borrowings to augment our funding position.
We actively monitor our investment portfolio and we usually classify investments in the portfolio as “available for sale.” In general, under such a classification, we may sell investment instruments as management deems appropriate. On a monthly basis, we “mark to market” the investment portfolio through an adjustment to stockholders’ equity net of taxes. Additionally, we use the investment portfolio to balance our asset and liability position. We invest in fixed rate or floating rate instruments as necessary to reduce our interest rate risk exposure.
Other Banking Products
We offer our customers safe deposit boxes, wire transfer services, debit cards, prepaid cards, automated teller machines at all of our branch locations, investment services, and credit cards through a third party processor. Additionally, we provide Internet and mobile banking capabilities to our customers. With our Internet banking service, our customers may view their accounts online and electronically remit bill payments. Our commercial account services include direct deposit of payroll for our commercial clients’ employees, an overnight sweep service, lockbox services and remote deposit capture service. We also provide our customers investment services including investment management, estate and succession planning, and brokerage services.
As a result of the BYBK acquisition, Old Line Bank became a member of the Point of Sale (“POS”) network sponsorship program, which allows our customers to access several processing and settlement networks; when our customers use one of these networks, Old Line Bank receives a transaction fee from the network.
Deposits are the major source of our funding. We offer a broad array of deposit products that include demand, NOW, money market and savings accounts as well as certificates of deposit. We believe that we pay competitive rates on our interest bearing deposits. As a relationship-oriented organization, we generally seek to obtain deposit relationships with our loan clients.
As our overall balance sheet position dictates, we may become more or less competitive in our interest rate structure. We do use brokered deposits as a funding mechanism. Our primary source of brokered deposits is the Promontory Interfinancial Network (Promontory). Through this deposit matching network and its certificate of deposit account and money market registry services, we have the ability to offer our customers access to FDIC-insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through Promontory on behalf of a customer, we receive matching deposits through the network. At December 31, 2018, we do not have any brokered deposits. We did not purchase brokered deposits during 2018.
We face intense competition both in making loans and attracting deposits. We compete with other commercial banks, savings associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in our market area and elsewhere, including Internet-based and technology-oriented non-bank financial providers.
We believe that we have effectively leveraged our talents, contacts and location to achieve a strong financial position. However, our market area is highly competitive and heavily branched. Competition in our market area for loans to small and medium sized businesses, entrepreneurs, professionals and high net worth clients is intense, and pricing is important. Many of our competitors have substantially greater resources and lending limits than we do and offer extensive and established branch networks and other services that we do not offer. Moreover, larger institutions operating in our market area have access to borrowed funds at a lower rate than is available to us. Deposit competition also is strong among institutions in our market area. As a result, it is possible that to remain competitive we may need to pay above market rates for deposits.
As of December 31, 2018, we had 348 full time and 16 part time employees. No collective bargaining unit represents any of our employees and we believe that relations with our employees are good.
Supervision and Regulation
Old Line Bancshares, Inc. and Old Line Bank are subject to extensive regulation under state and federal banking laws and regulations. These laws and regulations impose specific requirements and restrictions on virtually all aspects of operations and generally are intended to protect depositors, not stockholders. The following summary sets forth certain material elements of the regulatory framework applicable to Old Line Bancshares, Inc. and Old Line Bank. It does not describe all of the provisions of the statutes, regulations and policies that are identified. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by express reference to each of the particular statutory and regulatory provisions. A change in applicable statutes, regulations or regulatory policy may have a material effect on our business.
Old Line Bancshares, Inc.
Old Line Bancshares, Inc. is a Maryland corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). We are subject to regulation by the Board of Governors of the Federal Reserve Board (the “Federal Reserve Board”) and the Commissioner, and are required to file periodic reports and any additional information that the Federal Reserve Board and the Commissioner may require. The Federal Reserve Board regularly examines the operations and condition of Old Line Bancshares. In addition, the Federal Reserve Board has enforcement authority over Old Line Bancshares, which includes the power to remove officers and directors and the authority to issue cease and desist orders to prevent Old Line Bancshares from engaging in unsafe or unsound practices or violating laws or regulations governing its business. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
Under the Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. Under this requirement, Old Line Bancshares in the future could be required to provide financial assistance to Old Line Bank should Old Line Bank experience financial distress. In addition, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board regulations or both. This doctrine is commonly known as the “source of strength” doctrine. The Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve Board’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
The Federal Reserve Board must approve, among other things, the acquisition by a bank holding company of control of more than 5% of the voting shares, or substantially all the assets, of any bank or bank holding company or the merger or consolidation by a bank holding company with another bank holding company. In general, the Bank Holding Company Act limits the business of bank holding companies to banking, managing or controlling banks, furnishing services for its authorized subsidiaries, and engaging in activities that the Federal Reserve Board has determined, by order or regulation, to be so closely related to banking and/or managing or controlling banks as to be properly incident thereto. Some of the activities that the Federal Reserve Board has determined by regulation to be closely related to banking include servicing loans, performing certain data processing services, acting as a fiduciary, investment or financial advisor, and making investments in corporations or projects designed primarily to promote community welfare.
The Change in Bank Control Act and the related regulations of the Federal Reserve Board require any person, or persons acting in concert, to file a written notice with the Federal Reserve Board before the person or persons acquire direct or indirect “control” of a bank or bank holding company. As a general matter, a party is deemed to control a bank or bank holding company if the party owns or controls 25% or more of any class of voting stock. Subject to rebuttal, a party may be presumed to control a bank or bank holding company if the investor owns or controls 10% or more of any class of voting stock and (i) the institution has registered securities under Section 12 of the Securities Exchange Act of 1934 and (ii) no other person owns, controls or has the power to vote a greater percentage of that class of voting stock. Ownership by affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party’s ownership of Old Line Bancshares, Inc. were to exceed the above thresholds, the investor could be deemed to “control” Old Line Bancshares, Inc. for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.
The Federal Reserve Board has adopted guidelines regarding the capital adequacy of bank holding companies, which require bank holding companies to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See “—Capital Adequacy Guidelines.” The Federal Reserve Board has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board’s view that a bank holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality, and overall financial condition.
The status of Old Line Bancshares as a registered bank holding company under the Bank Holding Company Act does not exempt it from certain federal and state laws and regulations applicable to Maryland corporations generally, including, without limitation, federal and state securities laws.
Old Line Bank
Old Line Bank is a Maryland-chartered trust company (with all of the powers of a commercial bank). Its primary federal regulator is the FDIC and it is subject to regulation, supervision and regular examination by the Commissioner and by the FDIC. The regulations of these agencies govern most aspects of Old Line Bank’s business, including required reserves against deposits, lending, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices. In addition, Old Line Bank is subject to numerous federal, state and local laws and regulations that set forth specific requirements with respect to extensions of credit, credit practices, disclosure of credit terms, and discrimination in credit transactions.
The FDIC and the Commissioner regularly examine the operations and condition of Old Line Bank, including, but not limited to, its capital adequacy, reserves, loans, investments, and management practices. These examinations are for the protection of Old Line Bank’s depositors and the Deposit Insurance Fund. In addition, Old Line Bank is required to furnish quarterly and annual reports to the FDIC. The enforcement authority of the FDIC and the Commissioner include the power to remove officers and directors and the authority to issue cease-and-desist orders to prevent a bank from engaging in unsafe or unsound practices or violating laws or regulations governing its business. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
The FDIC has adopted regulations regarding capital adequacy, which require member banks to maintain specified minimum ratios of capital to total assets and capital to risk-weighted assets. See “—Capital Adequacy Guidelines.” FDIC regulations and state law limit the amount of dividends that Old Line Bank may pay to Old Line Bancshares, Inc. See “—Dividends.”
Capital Adequacy Guidelines
Federal regulations require FDIC-insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. In addition, the regulations limit a banking organization’s ability to make capital distributions, engage in share repurchases, and pay certain discretionary bonus payments if it does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.
There are two main categories of capital under the capital adequacy guidelines. Tier 1 capital generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stock) and, in certain circumstances and subject to certain limitations, minority investments in certain subsidiaries, less goodwill and other non-qualifying intangible assets, and certain other deductions. Tier 2 capital consists of perpetual preferred stock that is not otherwise eligible to be included as Tier 1 capital, hybrid capital instruments, term subordinated debt and intermediate-term preferred stock and, subject to limitations, general allowances for credit losses. Tier 2 capital is limited to the amount of Tier 1 capital. We have elected to permanently opt out of the inclusion of accumulated other comprehensive income in our capital calculations, as permitted by the regulations. This opt-out will reduce the impact of market volatility on our regulatory capital levels.
Under federal prompt corrective action regulations, the bank regulatory agencies are authorized and, under certain circumstances, required, to take various “prompt corrective actions” to resolve the problems of any bank subject to their jurisdiction that is not adequately capitalized, as set forth in the next sentence. Pursuant to the Federal Deposit Insurance Corporation Improvement Act the agencies have established five capital tiers for depository institutions: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the prompt corrective action regulations, a bank is considered “well capitalized” if it (i) has a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common equity Tier 1 risk-based capital ratio of 6.5% or greater; (iv) a Tier 1 leverage capital ratio of 5.0% or greater; and (v) is not subject to any written order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Under certain circumstances, a bank regulatory agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the bank regulatory agency may not reclassify a significantly undercapitalized institution as critically undercapitalized). As of December 31, 2018, Old Line Bank was “well capitalized” for this purpose and its capital exceeded all applicable requirements.
As required by Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, the federal bank regulatory agencies have proposed a new rule to establish a community bank leverage ratio (“CBLR”) that will simplify the capital adequacy measures for certain depository institutions and their holding companies that, like Old Line Bancshares and Old Line Bank, have less than $10 billion in consolidated assets. Under the proposal, most of such depository institutions (and their holding companies) that meet certain risk-based qualifying criteria (generally, those with limited amounts of off-balance sheet exposure, trading assets and liabilities, mortgage servicing assets, and temporary difference in deferred tax assets) and maintain a CBLR of more than 9.0% may opt into the proposed community bank leverage framework. Such institutions and their holding companies would not be subject to the other risk-based and leverage requirements of the current rules, as discussed above, and will be considered to have met the requirements for being considered well capitalized.
The risk-based qualifying criteria under the proposed rule include: (i) total off-balance sheet exposures of no more than 25.0% of total consolidated assets; (ii) total trading assets and liabilities of no more than 5.0% of total consolidated assets; (iii) mortgage servicing assets (“MSAs”) of no more than 25% of CBLR; and (iv) temporary difference deferred tax assets (“DTAs”) of no more than 25% of CBLR tangible equity. Under the proposed rule, CBLR would be calculated as the ratio of tangible equity capital (CBLR tangible equity) divided by average total consolidated assets. CBLR tangible equity would be defined as total equity capital prior to including minority interests and excluding accumulated other comprehensive income (AOCI), DTAs arising from net operating loss and tax credit carryforwards, goodwill, and other intangible assets (other than MSAs), each as of the most recent calendar quarter. Average total consolidated assets would be calculated in a manner similar to the current Tier 1 leverage ratio denominator in that amounts deducted from the CBLR numerator would also be excluded from the CBLR denominator. The proposed rule would also permit more flexibility with respect to the types of instruments that could qualify for CBLR tangible equity.
As an additional means to identify problems in the financial management of depository institutions, the Federal Deposit Insurance Act (“FDIA”) requires federal bank regulatory agencies to establish certain non-capital safety and soundness standards for institutions for which they are the primary federal regulator. The standards relate generally to operations and management, asset quality, interest rate exposure and executive compensation. The agencies are authorized to take action against institutions that fail to meet such standards.
Deposit Insurance Assessments
Old Line Bank’s deposits are insured by the FDIC generally up to a maximum of $250,000. The FDIC assesses deposit insurance premiums on all insured depository institutions. Under the FDIC’s risk-based assessment system, insured institutions are assigned to risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned and certain adjustments specified by FDIC regulations, with institutions deemed less risky to the deposit insurance fund paying lower rates. Assessment rates (inclusive of possible adjustments) currently range from 1.5 to 40 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the range of assessments uniformly, except that no adjustment can deviate more than two basis points from the base assessment rate without notice and comment rulemaking. Under the FDIA, the FDIC may terminate insurance of deposits upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Maryland Regulatory Assessment
The Commissioner assesses state chartered banks to cover the expense of regulating banking institutions. Old Line Bank’s asset size determines the amount of the assessment. In 2018, we paid $190 thousand to the Commissioner.
Transactions with Affiliates and Insiders
Federal and Maryland law impose restrictions on certain transactions between Maryland commercial banks and their insiders and affiliates. Generally, under Maryland law, a director, officer or employee of a commercial bank may not borrow, directly or indirectly, any money from the bank, unless the loan has been approved by a resolution adopted by and recorded in the minutes of the board of directors of the bank or the executive committee of the bank, if that committee is authorized to approve loans. If the executive committee approves such a loan, the loan approval must be reported to the board of directors at its next meeting. Certain commercial loans made to directors of a bank and certain consumer loans made to non-officer employees of the bank are exempt from the law’s coverage. Under federal law, section 22(h) of the Federal Reserve Act and the Federal Reserve Board’s Regulation O govern extensions of credit made by a bank to its directors, executive officers, and principal stockholders (“insiders”). Among other things, these provisions require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent, than those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features. Further, such extensions may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the bank’s capital. Extensions of credit in excess of certain limits must be also be approved by the board of directors. All of Old Line Bank’s loans to its and Old Line Bancshares’ executive officers, directors and greater than 10% stockholders, and affiliated interests of such persons, comply with the requirements of Regulation O.
Section 23A of the Federal Reserve Act and the Federal Reserve Board’s Regulation W limit the extent to which a bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such bank’s capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such bank’s capital stock and surplus. An affiliate of a bank is generally any company or entity that controls, is controlled by, or is under common control with the bank. In a holding company context, the parent bank holding company and any companies that are controlled by such parent holding company are affiliates of the bank. The term “covered transaction” includes the making of loans, purchase of assets, issuance of guarantees, and other similar transactions. In addition, loans or other extensions of credit by a bank to an affiliate are required to be collateralized in accordance with regulatory requirements and the bank’s transactions with affiliates must be consistent with safe and sound banking practices and may not involve the purchase by the bank of any low-quality asset from an affiliate. Section 23B of the Federal Reserve Act applies to covered transactions as well as certain other transactions between a bank and its affiliates and Section 23B and Regulation W require that all such transactions be on terms substantially the same, or at least as favorable, to the bank as those provided to non-affiliates. Regulation W generally excludes a bank subsidiary from treatment as an affiliate unless the subsidiary is a depository institution, a financial subsidiary, directly controlled by an affiliate or controlling shareholder of the bank, or unless the Federal Reserve Board or other appropriate federal regulator determines by regulation or order to treat the subsidiary as a bank affiliate. All of Old Line Bank’s transactions with its affiliates comply with the applicable provisions of Sections 23A and 23B and Regulation W.
We have entered into banking transactions with our directors and executive officers and the business and professional organizations with which they are associated in the ordinary course of business. We make such loans and loan commitments in accordance with all applicable laws.
Loans to One Borrower
Old Line Bank is subject to statutory and regulatory limits on the amount that it may lend to a single borrower or group of related borrowers. Generally, the maximum amount of total outstanding loans that Old Line Bank may have to any one borrower at any one time is 15% of Old Line Bank’s unimpaired capital and unimpaired surplus. Old Line Bank may lend an additional amount, equal to 10% of its unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion but generally does not include real estate.
Old Line Bank is subject to the reserve requirements imposed by the State of Maryland. A Maryland commercial bank is required to have at all times a reserve equal to at least 15% of its demand deposits and at least 3% of its time deposits. Old Line Bank is also subject to the reserve requirements of Federal Reserve Board’s Regulation D, which applies to all depository institutions. During 2018, amounts in transaction accounts above $16.0 million and up to $122.3 million were required to have reserves held against them in the ratio of 3% of such amounts. Amounts above $124.2 million required reserves of 10% of the amount in excess of $122.3 million. The Federal Reserve Board changes its reserve requirements on an annual basis and Old Line Bank is subject to new requirements for 2019. Old Line Bank was in compliance with its reserve requirements at December 31, 2018 and is in compliance with its current reserve requirements.
Old Line Bancshares, Inc. is a legal entity separate and distinct from Old Line Bank. Virtually all of Old Line Bancshares, Inc.’s revenue available for the payment of dividends on its common stock results from dividends paid to Old Line Bancshares, Inc. by Old Line Bank. Under Maryland law, Old Line Bank may declare a cash dividend, after providing for due or accrued expenses, losses, interest, and taxes, from its undivided profits or, with the prior approval of the Commissioner, from its surplus in excess of 100% of its required capital stock. Also, if Old Line Bank’s surplus is less than 100% of its required capital stock, then, until its surplus is 100% of its capital stock, Old Line Bank must transfer to its surplus annually at least 10% of its net earnings and may not declare or pay any cash dividends that exceed 90% of its net earnings. In addition to these specific restrictions, the FDIC has the ability to prohibit or limit proposed dividends if it determines that the payment of such dividends would result in Old Line Bank being in an unsafe and unsound condition.
Community Reinvestment Act
Old Line Bank is required to comply with the Community Reinvestment Act (“CRA”) regardless of its capital condition. The CRA requires that, in connection with its examinations of Old Line Bank, the FDIC evaluates Old Line Bank’s record in meeting the credit needs of its local community, including low and moderate income neighborhoods, consistent with its safe and sound operation. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. These factors are considered in, among other things, evaluating mergers, acquisitions and applications to open a branch or facility. The CRA also requires all institutions to make public disclosure of their CRA ratings. Old Line Bank received a “Satisfactory” rating in its latest CRA examination.
Standards for Safety and Soundness
Federal law requires the federal banking agencies to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Anti-Money Laundering and OFAC
Under federal law, financial institutions must maintain anti-money laundering programs that include: established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; testing of the program by an independent audit function and risk-based procedures for conducting ongoing customer due diligence. Financial institutions are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and customer identification in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and law enforcement authorities have been granted increased access to financial information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations, and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions on institutions found to be violating these obligations.
The Office of Foreign Assets Control, or OFAC, is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC sends bank regulatory agencies lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If Old Line Bancshares or Old Line Bank finds a name on any transaction, account, or wire transfer that is on an OFAC list, they must freeze such account, file a suspicious activity report, and notify the appropriate authorities.
Consumer Protection Laws
Old Line Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy. These laws include the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Fair and Accurate Credit Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, as well as various state law counterparts. Further, the Consumer Financial Protection Bureau (“CFPB”) is responsible for adopting rules and regulations under the federal consumer protection laws relating to financial products and services, with which Old Line Bank must comply. The CFPB also has a broad mandate to prevent unfair, deceptive or abusive acts and practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service, and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties. The FDIC is responsible for examining Old Line Bank for compliance with CFPB rules and for enforcing CFPB rules with respect to Old Line Bank.
In addition, federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, a financial institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Further, under the “Interagency Guidelines Establishing Information Security Standards,” banks must implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of customer information. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
You should consider carefully the following risks, along with other information contained in this Form 10-K. The risks and uncertainties described below are not the only ones that may affect us. Additional risks and uncertainties also may adversely affect our business and operations including those discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Any of the following events, should they actually occur, could materially and adversely affect our business and financial results.
Risk Factors Related to Old Line Bancshares’ Business
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses. We are subject to certain operational risks including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud, cybersecurity breaches, and catastrophic failures resulting from terrorist acts or natural disasters. We rely heavily on data processing, software, communications and information systems on a variety of computing platforms and networks and over the Internet to conduct our business. Despite instituted safeguards, we cannot be certain that that all of our systems and our network infrastructure are entirely free from vulnerability to attack or other technological difficulties or failures.
Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure we use, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by Internet problems, other users or unrelated third parties. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, subject us to additional regulatory scrutiny, damage our reputation, result in a loss of customers, and inhibit current and potential customers from using our Internet banking services, any or all of which could have a material adverse effect on our results of operations and financial condition. Information security risks have increased significantly due to the use of online, telephone and mobile banking channels by clients and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. Cyber threats are rapidly evolving and we may not be able to anticipate or prevent all such attacks. While we do not believe we have experienced a material cyber-security breach, we experience periodic threats to our data, systems and networks, including cyber-attacks, malware and computer virus attacks, malicious code, phishing attacks, attempted unauthorized access of accounts and attempts to disrupt our systems. Our clients’ devices, from which they may access our Internet banking services or mobile apps, are also subject to the same threats. Such threats are likely to continue, and may result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, the theft of client assets through fraudulent transactions or disruption of our or our clients’ or other third parties’ business operations. We may incur increasing costs in an effort to minimize these risks, and could be held liable for, lose business and suffer reputational damage as a result of any security breach or loss. We periodically review our security protocols and, as necessary, add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches, including firewalls and penetration testing. These precautions may not, however, be effective in preventing such breaches, damage or failures. We continue to monitor developments in this area and consider whether additional protective measures are necessary or appropriate, and we have obtained insurance protection intended to cover losses due to network security breaches; there is no guarantee, however, that such insurance would cover all costs associated with any breach, damage or failure of our computer systems and network infrastructure.
We have a comprehensive policy related to cybersecurity risks, and cybersecurity incidents are reported quarterly to our risk committee, which consists of members of both management and our board of directors. In the event of a material breach, damage or failure of our computer system or network, we will issue the appropriate disclosures. Any system failure could have a material adverse effect on our financial condition and results of operations.
Our business may be adversely affected by increasing prevalence of fraud and other financial crimes. As a financial institution, we are subject to risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes continue to increase. While we believe we have controls in place to detect and prevent such losses, in some cases multi-party collusion or other sophisticated methods of hiding fraud may not be readily detected or detectable and could result in losses that affect our financial condition and results of operations.
Further, financial crime is not limited to the financial services industry. Our customers could experience fraud in their businesses, which could materially impact their ability to repay their loans, and deposit customers in all financial institutions are constantly and unwittingly solicited by others in fraud schemes that vary from easily detectable and obvious attempts to high-level and very complex international schemes that could drain an account of millions of dollars and require detailed financial forensics to unravel. While we have controls in place, contractual agreements with our customers partitioning liability, and insurance to help mitigate the risk, none of these are guarantees that we will not experience a fraud-related loss, including potentially a loss that could have a material adverse effect on our financial condition, reputation and results of operations.
We rely on certain external vendors. Our business is dependent on the use of outside service providers that support our day-to-day operations including data processing and electronic communications. Our operations are exposed to the risk that a service provider may not perform in accordance with established performance standards required in our agreements for any number of reasons including equipment or network failure, a change in their senior management, their financial condition, their product line or mix and how they support existing customers, or a simple change in their strategic focus. While we have comprehensive policies and procedures in place to mitigate risk at all phases of service provider management from selection to performance monitoring and renewals, the failure of a service provider to perform in accordance with contractual agreements could be disruptive to our business, which could have a material adverse effect on our financial condition and results of operations.
Adverse changes in economic conditions could adversely affect our business, results of operations and financial condition. Our business and earnings are affected by general business conditions in the United States as well as in our local market area. Changes in prevailing economic conditions, including declining real estate values, changes in interest rates that may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal government and other significant external events may adversely affect our financial results. We continue to operate in a challenging and uncertain economic environment. Since the recession ended almost ten years ago, economic growth has been slow by historic standards and uneven. Further, the current expansion is the second longest in U.S. history, and many economists expect economic growth to slow this year. Signs of a slowdown have already begun to surface, and according to recent surveys most economists predict that the United States will fall into a recession within the next two years.1 A return to recessionary conditions or prolonged stagnant or deteriorating economic conditions could significantly affect the markets in which we do business, the demand for our products and services, the value of our loans and investments, and our ongoing operations, costs and profitability. In any case, we expect that the business environment in the State of Maryland and the entire United States will continue to present challenges for the foreseeable future. Economic uncertainties even outside a recession, including concerns about U.S. debt levels and related governmental actions, tariffs on imports into the United States, Congress’ inability to pass yearly budgets, and cuts in government spending, may negatively impact economic conditions going forward. A return to elevated levels of unemployment, declines in the values of real estate, additional federal government shutdowns, or other events that negatively affect household and/or corporate incomes may result in higher than expected loan delinquencies, increases in our non-performing and criticized classified assets and a decline in demand for our products and services. Any of these events may cause us to incur losses and may adversely affect our financial condition and results of operations.
A worsening of credit markets and economic conditions could adversely affect our liquidity. Old Line Bank must maintain sufficient liquidity to ensure cash flow is available to satisfy current and future financial obligations including demand for loans and deposit withdrawals, funding of operating costs and other corporate purposes. We obtain funding through deposits and various short term and long term wholesale borrowings, including federal funds purchased, unsecured borrowings, brokered certificates of deposits and borrowings from the Federal Home Loan Bank of Atlanta (the “FHLB”) and others. Economic uncertainty and disruptions in the financial system may adversely affect our liquidity. Dramatic declines in the housing market and falling real estate prices, coupled with increased foreclosures and unemployment, resulted in significant asset value write downs by financial institutions during and after the last U.S. recession, including government sponsored entities and investment banks. These investment write downs caused financial institutions to seek additional capital. Should we experience a substantial deterioration in our financial condition or should disruptions in the financial markets restrict our funding, it would negatively impact our liquidity. Our need to comply with extensive and complex governmental regulation could have an adverse effect on our business and growth strategy, and we may be adversely affected by changes in laws and regulations. The banking industry is subject to extensive regulation by state and federal banking authorities. Many of these regulations are intended to protect depositors, the public or the FDIC insurance funds, not stockholders. Regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy, ability to attract and retain personnel and many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The cost of compliance with regulatory requirements could adversely affect our ability to operate profitably. Further, if we are not in compliance with such requirements, we could be subject to fines or other regulatory action that could restrict our ability to operate or otherwise have a material adverse effect on our business and financial condition. Although we believe we are in material compliance with all applicable regulations, it is possible there are violations of which we are unaware that could be discovered by our regulators in the course of an examination or otherwise, which could trigger such fines or other adverse consequences.
1 E.g. National Association for Business Economics February 2019 Economic Policy Survey, Business Economists Expect Recession by 2021, Worry about Budget Deficits; NABE Policy Panel’s View Differs from Markets’ Regarding Likely Path for Interest Rates, available at https://files.constantcontact.com/668faa28001/286fb75e-4f63-46ac-b351-7f6e78c57f67.pdf
In addition, because regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal or state regulation of financial institutions may change in the future and impact our operations. In light of the performance of and government intervention in the financial sector, there may be significant changes to the banking and financial institutions’ regulatory agencies in the future. During the past two years that Republicans have been in control of the U.S. Congress and the White House, Congress has enacted legislation slightly easing the regulatory burdens on community banks and federal banking regulators have been easing some of their rules and enforcement activities. With Democrats gaining control of the House of Representatives in January, we do not expect any further such legislative relief in the foreseeable future, and if a Democratic candidate wins the presidency and/or Democrats retain control of the House and gain control of the U.S. Senate following the 2022 election, we expect that the pace of restrictive and burdensome banking legislation and regulatory enforcement and rule changes is likely to resume following such election. Changes in regulation and oversight, including in the form of changes to statutes, regulations or regulatory policies or changes in interpretation or implementation of statutes, regulations or policies, could affect the services and products we offer, increase our operating expenses, increase compliance challenges and otherwise adversely impact our financial performance and condition. In addition, the burden imposed by these federal and state regulations may place banks in general, and Old Line Bank specifically, at a competitive disadvantage compared to less regulated competitors.
Non-Compliance with the USA PATRIOT Act, the Bank Secrecy Act or other laws and regulations could result in fines or sanctions. Financial institutions are required under the USA PATRIOT and Bank Secrecy Acts to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, curtailment of expansion opportunities, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations. In addition, the U.S. Government has previously imposed laws and regulations relating to residential and consumer lending activities that create significant new compliance burdens and financial risks. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, we cannot assure you that these policies and procedures will be effective in preventing violations of these laws and regulations
Our internal controls and procedures may fail or be circumvented. Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well-designed and operated, is based in part on certain assumptions and can provide only reasonable assurances that the objectives of the system are met. Any (i) failure or circumvention of our controls and procedures, (ii) failure to adequately address any internal control deficiencies, or (iii) failure to comply with regulations related to controls and procedures could have a material effect on our business, consolidated financial condition and results of operations.
The level of our commercial real estate loans may subject us to increased lending risks and related loan losses and additional regulatory scrutiny. At December 31, 2018, our commercial real estate loan portfolio totaled $1.5 billion, or 62.5% of our total loan portfolio. Commercial real estate loans generally expose a lender to higher risk of non-payment and loss than do one-to-four family residential mortgage loans because of several factors, including that repayment of the loans often depends on the successful operation of the properties and the income stream of the borrowers, that the collateral securing these loans may not be sold as easily as residential real estate, and loan terms with a balloon payment rather than full amortization over the loan term. Further, these loans involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. Moreover, if loans that are collateralized by commercial real estate become troubled and the value of the real estate has been significantly impaired, then the Company may not be able to recover the full contractual amount of principal and interest that the Company anticipated at the time it originated the loan, which could cause us to increase its provision for loan losses and would adversely affect the our earnings and financial condition.
In addition, the FDIC, the Federal Reserve Board and the Office of the Comptroller of the Currency have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors, (i) total reported loans for construction, land development and other land represent 100% or more of total capital, or (ii) total reported loans secured by multi-family and non-farm non-residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. We have concluded that we have a concentration in commercial real estate lending under the foregoing standards because our balance in commercial real estate loans at December 31, 2018 represents more than 300% of total capital. While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.
We depend on the accuracy and completeness of information about our clients and counterparties and our financial condition could be adversely affected if we rely on misleading information. In deciding whether to extend credit or to enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information, which we do not independently verify as a matter of course. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to customers, we may assume that a customer’s audited financial statements conform with accounting principles generally accepted in the United States (“U.S. GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with U.S. GAAP or are materially misleading.
We may be adversely affected by the soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by Old Line Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to Old Line Bank. Any such losses could have a material adverse effect on our financial condition and results of operations.
Because we serve a limited market area in Maryland, we are susceptible to economic downturns in our market area. As discussed above, our lending and deposit operations are concentrated in a number of Maryland counties in the Washington, D.C. and Baltimore City suburbs, as well as in Baltimore City, Maryland. While we have expanded in Maryland both organically and through acquisitions during the past several years, broad geographic diversification is not currently part of our strategic plan. As a result, our success depends in part on economic conditions in our market area. Adverse changes in economic conditions in our market area could reduce our deposit base and demand for our services and products and negatively impact growth in our loans and deposits, impair our ability to collect on our outstanding loans, increase credit losses, problem loans and charge-offs, and otherwise negatively affect our performance and financial condition. Declines in real estate values could cause some of our residential and commercial real estate loans to be inadequately collateralized, which would expose us to a greater risk of loss in the event that the recovery on amounts due on defaulted loans is resolved by selling the real estate collateral. In addition, adverse changes in economic conditions in and around our market area may more severely impact our business and financial condition than our larger, more geographically diverse competitors. For example, decreases or even threatened decreases in spending or employment levels by the Federal government (a particular risk for us given the proximity of our market area to Washington, D.C.) or state and local governments could impact us to a greater degree than banking companies that serve a larger or a different geographical area. Our larger competitors may serve more geographically diverse market areas, parts of which may not be affected by the same economic conditions that may exist in our market area. Further, unexpected changes in the national and local economy may adversely affect our ability to attract deposits and to make loans. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our securities.
We originate and retain in our portfolio residential mortgage loans. A downturn in the local real estate market and economy could adversely affect our earnings. Our loan portfolio includes residential mortgage loans that we originate. Although the local real estate market and economy in our market areas have performed better than many other markets during the past few years, a downturn could cause higher unemployment; and more delinquencies, and could adversely affect the value of properties securing our loans. In addition, the real estate market may take longer to recover or not recover to previous levels. These risks increase the probability of an adverse impact on our financial results as fewer borrowers would be eligible to borrow and property values could be below necessary levels required for adequate coverage on the requested loan.
Recent changes in tax laws may negatively impact our financial performance. Recent tax law changes implemented pursuant to the Tax Cuts and Jobs Act (“TCJA”), which was enacted in December 2017, contain a number of provisions that could have an impact on the banking industry, borrowers and the market for single family residential and multifamily residential real estate. These changes include: lower limits on the deductibility of mortgage interest on single family residential mortgages; limitations on deductibility of business interest expense; and limitations on the deductibility of property taxes and state and local income taxes. Such changes may have an adverse effect on the market for and valuation of single family residential properties and multifamily residential properties, as well as on the demand for such loans in the future, particularly in states, like Maryland, with high residential home prices and state and local taxes. Further, while the tax changes were in effect for 2018, we expect that many taxpayers will not recognize the impact of these changes until they prepare their 2018 tax returns, so it is likely that the impacts of these changes in this regard have not yet been reflected in the market. If home ownership or multifamily residential property ownership become less attractive, demand for mortgage loans would decrease, which could have a material adverse effect on our residential mortgage originations and loan resales and as a result our revenues, net income, operating results and financial condition. In addition, the value of the properties securing loans in our portfolio may be adversely impacted as a result of the changing economics of home ownership and multifamily residential ownership, which could require an increase in our provision for credit losses that, in turn, would reduce our profitability and could materially adversely affect our business, financial condition and results of operations. Additionally, certain borrowers could become less able to service their debts as a result of higher tax obligations. These changes could adversely affect our business, financial condition and results of operations.
We are subject to liquidity risks. We require sufficient liquidity to fund loans, accommodate liability maturities and deposit withdrawals, pay debt obligations as they come due, meet contractual obligations, and fund asset growth . Market or economic conditions outside of our control could negatively affect our access to funding sources in amounts adequate to maintain adequate levels of liquidity or the cost thereof. Deposits are our primary source of funding, although we supplement this with FHLB advances and other borrowings. A significant decrease in our deposits, an inability to renew FHLB advances or access other borrowings, an inability to obtain alternative funding to deposits or our other traditional sources of funds, or a substantial, unexpected, or prolonged change in the level or cost of liquidity could have a negative effect on our business, financial condition and results of operations.
We depend on the services of key personnel. The loss of any of these personnel could disrupt our operations and our business could suffer. Our success depends substantially on the skills and abilities of our executive management team, including James W. Cornelsen, President and Chief Executive Officer, Jack Welborn, Executive Vice President and Chief Lending Officer, John Miller, Executive Vice President and Chief Credit Officer, Mark A. Semanie, Executive Vice President, Chief Operating Officer and Elise M. Hubbard, Executive Vice President and Chief Financial Officer. Although we have entered into employment agreement with these executives, the existence of such agreements does not assure that we will retain their services. These executives provide valuable services to us and would be difficult to replace.
Also, our growth and success and our anticipated future growth and success, in a large part, is due and will continue to be due to the relationships maintained by our banking executives with our customers. The loss of services of one or more of these executives or of other key employees could have a material adverse effect on our operations and our business could suffer. The experienced commercial lenders that we have hired are not a party to an employment agreement with us and they could terminate their employment with us at any time and for any reason.
We may not be able to manage future growth or our growth and expansion strategy may not be successful in other respects. We have grown rapidly during the past several years, through both acquisitions and organic growth. Our ability to continue to grow depends upon our ability to attract new deposits, identify loan and investment opportunities and maintain adequate capital levels. We may also continue to grow through acquisitions of existing financial institutions or branches thereof. There is no guarantee that we will be able to maintain our recent growth rate at acceptable risk levels or at all, that future growth would be as successful and result in similar levels of increased profitability as our recent growth, or that our expansion strategy will be successful otherwise. Also, in order to effectively manage our anticipated and/or actual loan growth we have made and may continue to make additional investments in equipment and personnel, which could increase our non-interest expense. If we grow too quickly and are not able to control costs and maintain asset quality, such growth could materially and adversely affect our financial performance.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease. We maintain an allowance for loan losses that we believe is adequate for absorbing any potential losses in our loan portfolio. Our management, through a periodic review and consideration of the loan portfolio, determines the amount of the allowance for loan losses. Although we believe the allowance for loan losses is adequate to absorb probable losses in our loan portfolio, we cannot predict such losses with certainty. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, our earnings will suffer.
As of December 31, 2018, commercial and industrial and commercial real estate mortgage loans comprise approximately 76.19% of our loan portfolio. It is more difficult to estimate loan losses for these types of loans as compared to, for example, residential mortgage loans. Further, these types of loans are generally viewed as having more risk of default than residential real estate or consumer loans and typically have larger balances than residential real estate loans and consumer loans. A deterioration of one or a few of these loans could cause a significant increase in non-performing loans. Such an increase could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.
The Financial Accounting Standards Board has adopted a new accounting standard that will become effective for us on January 1, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses as allowances for credit losses. This will change the current method of providing allowances for credit losses that are probable, which would likely require us to increase our allowance for credit losses and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses. Any increase in the allowance for loan losses, or expenses incurred to determine the appropriate level of the allowance for loan losses, may have a material adverse effect on our financial condition and results of operations.
We have relatively limited experience with the performance of loans acquired in our recent acquisitions of BYBK and DCB. Certain of our estimates related to accounting for acquired loans may differ from actual results. We acquired BYBK in April 2018 and DCB in July 2017. It is difficult to assess the future performance of loans recently added to our portfolio as part of these acquisitions because our relatively limited experience with such loans does not provide us with a significant history from which to judge future collectability. These loans may experience higher delinquency or charge-off levels than our historical loan portfolio experience, which could adversely affect our future performance.
In addition, under U.S. GAAP requirements for business combinations, there is no loan loss allowance initially recorded for acquired loans, which are recorded at net fair value on the acquisition date. This net fair value generally includes embedded loss estimates for acquired loans with deteriorated credit quality. These estimates are based on projections of expected cash flows for these problem loans, which in many cases rely on estimates deriving from the liquidation of collateral.
If the estimates we make and have made regarding the performance of loans we have acquired are inadequate, the fair value estimates may exceed the actual collectability of the balances, and this may result in the related loans being considered by us as impaired, which would result in a reduction in interest income. The tangible book value we measure is based in part on these estimates, and if fair value estimates differ from actual collectability, then subsequent earnings may also differ from original estimates. Measures of tangible book value and earnings impact of business combinations are frequently used in evaluating the merits and value of business combinations. Numerous assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.
Our profitability depends on interest rates and changes in monetary policy may impact us. Our results of operations depends to a large extent on our “net interest income,” which is the difference between the interest income received from our interest earning assets, such as loans and investment securities, and the interest expense incurred in connection with our interest bearing liabilities, such as interest on deposit accounts. Interest rates, because they are influenced by, among other things, expectations about future events, including the level of economic activity, federal monetary and fiscal policy, and geopolitical stability, are not predictable or controllable. Additionally, competitive factors heavily influence the interest rates we can earn on our loan and investment portfolios and the interest rates we pay on our deposits. Community banks are often at a competitive disadvantage in managing their cost of funds compared to the large regional, super-regional or national banks that have access to the national and international capital markets. These factors influence our ability to maintain a stable net interest margin.
We seek to maintain a neutral position in terms of the volume of assets and liabilities that mature or reprice during any period so that we may reasonably predict our net interest margin. Interest rate fluctuations, loan prepayments, loan production and deposit flows, however, are constantly changing and influence our ability to maintain this neutral position. Generally speaking, our earnings are more sensitive to fluctuations in interest rates the greater the variance in the volume of assets and liabilities that mature and reprice in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of interest rates, and whether we are more asset than liability sensitive. Accordingly, we may not be successful in maintaining this neutral position and, as a result, our net interest margin may suffer.
Furthermore, the Federal Reserve Board, in an attempt to help the overall economy, has among other things kept interest rates low through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. Although such an increase is not currently considered likely, if the Federal Reserve Board continues to increase the federal funds rate in the near term, as is expected, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic growth. In addition, an increase in interest rates may, among other things, reduce loan demand and our ability to originate loans (which would also decrease our ability to generate non-interest income through the sale of loans into the secondary market), and make it more difficult for borrowers to repay adjustable-rate loans or otherwise decrease loan repayment rates. Further, as market interest rates rise, we may experience competitive pressures to increase the rates we pay on deposits. Because interest rates we pay on our deposits could be expected to increase more quickly than the increase in the yields we earn on our interest-earning assets, our net interest income would be adversely affected. In addition, deflationary pressures, while possibly lowering our operating costs, could have a negative impact on our borrowers, especially our business borrowers, and the values of collateral securing our loans, which could negatively affect our financial performance.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the interest rates on existing loans and securities.
We face substantial competition that could adversely affect our growth and operating results. We operate in a competitive market for financial services and face intense competition from other financial institutions both in making loans and in attracting deposits. Many of these financial institutions have been in business for many years, are significantly larger, and have established customer bases and greater financial resources and lending limits than we do, and are able to offer certain products and services that we are not able to offer. There are also a number of smaller community-based banks that pursue operating strategies similar to ours.
We expect competitive pressures to continue to build as a result of legislative, regulatory and technological changes and as the financial services industry continues to consolidate. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks; we expect competition to increase in this regard as additional non-bank investment and financial services options for consumers become available and consumers become increasingly comfortable using such alternatives. Competition for deposits and the origination of loans could limit our ability to successfully implement our business plan, and if we cannot attract deposits and make loans at a sufficient level, our operating results will suffer, as will our opportunities for growth.
Furthermore, competition in the banking and financial services industry is coming not only from traditional competitors but from technology-oriented financial services (“FinTech”) companies, which are subject to limited regulation. They offer user friendly front-end, quick turnaround times for loans and other benefits. While we are considering the possibility of developing relationships with FinTech companies for efficiency in processing and/or as a source of loans and other, products and services we can provide to our customers, we cannot limit the possibility that our customers or future prospects will work directly with a FinTech company instead. This could impact our growth and profitability going forward.
Consumers may decide not to use banks to complete their financial transactions. Technology and other changes are allowing consumers to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that they have historically held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, which may increase as consumers become more comfortable with these new technologies and offerings, could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Failure to keep up with technological change could negatively impact us. The financial services industry is undergoing rapid technological change with frequent introductions of new or modified technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on our business and, in turn, our financial condition and results of operations. Further, as these technologies continue to improve, we may be required to make significant capital expenditures in order to remain competitive, which may increase our overall expenses and have a material adverse effect on our business, financial condition, and results of operations.
We are subject to laws regarding the privacy, information security, and protection of personal information, and any violation of these laws or another incident involving personal, confidential, or proprietary information of individuals could damage our reputation and otherwise adversely affect our business, financial condition, and results of operations. Our business requires the collection and retention of large volumes of customer data, including personally identifiable information, in various information systems that we maintain and in those maintained by third party service providers. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. We are subject to complex and evolving laws and regulations governing the privacy and protection of personally identifiable information of individuals (including customers, employees, and other third parties), as well as planning for responding to data security breaches. Various federal and state laws and regulations impose data security breach notification requirements with varying levels of individual, consumer, regulatory, or law enforcement notification in the event of a security breach. Ensuring that our collection, use, transfer and storage of personally identifiable information complies with all applicable laws and regulations may increase our costs.
Furthermore, we may not be able to ensure that all of our customers, employees, counterparties, and service providers have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential, or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information, or where such information was intercepted or otherwise compromised by third parties), we could be exposed to litigation or regulatory sanctions. Concerns regarding the effectiveness of our measures to safeguard personally identifiable information, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers and thereby reduce our revenues. Accordingly, any failure, or even perceived failure, to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations, and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties, and could damage our reputation and otherwise adversely affect our business, operations, financial condition, and results of operations.
Our investment securities portfolio is subject to credit risk, market risk, and liquidity risk. Our investment securities portfolio is subject to risks beyond our control that may significantly influence its fair value. These include, but are not limited to, rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and instability in the credit markets. Lack of market activity with respect to some securities has, in certain circumstances, required us to base their fair market valuation on unobservable inputs. Any changes in these risk factors, in current accounting principles or in interpretations of these principles could impact our assessment of fair value and thus the determination of other-than-temporary impairment of the securities in the investment securities portfolio. Investment securities that previously were determined to be other-than-temporarily impaired could require further write-downs due to continued erosion of the creditworthiness of the issuer. Write-downs of investment securities would negatively affect our earnings and regulatory capital ratios.
Further, we have designated all of our investment securities portfolio (or 7.5% of total assets) at December 31, 2018 as available for sale. We “mark to market” temporary unrealized gains and losses in the estimated value of the available for sale portfolio and reflect this adjustment as a separate item in stockholders’ equity, net of taxes. As of December 31, 2018, we had temporary unrealized losses in our available for sale portfolio of $7.6 million ($5.5 million, net of taxes). If the market value of the investment portfolio declines, this could cause a corresponding decline in stockholders’ equity. Further, adverse changes in economic conditions could cause municipalities to report budget deficits and companies continue to report lower earnings, as happened in the last recession. Any such budget deficits and lower earnings could cause temporary and other than temporary impairment charges in our investment securities portfolio and cause us to report lower net income and a decline in stockholders’ equity.
Our future acquisitions, if any, may cause us to become more susceptible to adverse economic events. While we currently have no agreements to acquire additional financial institutions, we may do so in the future if an attractive acquisition opportunity arises that is consistent with our business plan. Any future business acquisitions could be material to us, and the degree of success achieved in acquiring and integrating these businesses into Old Line Bancshares could have a material effect on the value of our common stock. In addition, any acquisition could require us to use substantial cash or other liquid assets or to incur debt. In those events, we could become more susceptible to future economic downturns and competitive pressures.
We face limits on our ability to lend. The amount of our capital limits the amount that we can loan to a single borrower. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. As of December 31, 2018, we were able to lend approximately $46.6 million to any one borrower. This amount is significantly less than that of many of our larger competitors and may discourage potential borrowers who have credit needs in excess of our legal lending limit from doing business with us. We generally try to accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy is not always available. We may not be able to attract or maintain customers seeking larger loans and we may not be able to sell participations in such loans on terms we consider favorable.
We may need to raise additional capital in the future. If we are unable to obtain such capital on favorable terms or at all, we may not be able to execute on our business plans and our business, financial condition and results of operations may be adversely affected. Federal and state regulatory authorities require us to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance future growth or acquisitions, if any, or we may otherwise elect to or our regulators may require that we raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control. Public or private financing may not be available to us on reasonable terms or at all. Accordingly, we may not be able to raise additional capital if needed or on terms that are favorable or otherwise not dilutive to existing stockholders. Further, if we cannot raise additional capital when needed, or on desirable terms, we may be required to delay, reduce the scope of, or eliminate our growth and acquisition activities or such inability to raise capital may otherwise have a material adverse effect on our financial condition, results of operations and prospects.
We may not have adequately assessed the fair value of acquired assets and liabilities. Current accounting guidance requires that we record assets and liabilities at their estimated fair values on the purchase date. The determination of fair value requires that we consider a number of factors including the remaining life of the acquired loans and deposits, estimated prepayments or withdrawals, estimated loss ratios, estimated value of the underlying collateral, and the net present value of expected cash flows. Actual deviations from these predicted cash flows, maturities or repayments or the underlying value of the collateral may mean that our present value determination is inaccurate. This may cause fluctuations in interest income, non-interest income, provision expense, interest expense and non-interest expense and negatively impact our results of operations.
Impairment in the carrying value of goodwill could negatively impact our earnings. At December 31, 2018, goodwill totaled $93.3 million. Goodwill represents the excess purchase price paid over the fair value of the net assets acquired in a business combination. The estimated fair values of the acquired assets and assumed liabilities may be subject to refinement as additional information relative to closing date fair values becomes available and may result in adjustments to goodwill within the first 12 months following the closing date of the relevant acquisition. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable. There could be a requirement to evaluate the recoverability of goodwill prior to the normal annual assessment if there is a disruption in our business, unexpected significant declines in operating results, or sustained market capitalization declines. These types of events and the resulting analyses could result in goodwill impairment charges in the future, which would adversely affect the results of operations. A goodwill impairment charge does not adversely affect regulatory capital ratios or tangible capital. Based on an analysis, we determined that the fair value of our reporting units exceeded the carrying value of their assets and liabilities and, therefore, goodwill was not considered impaired at December 31, 2018.
Risks Related to our Common Stock
We may issue shares of common stock in the future in connection with acquisitions or otherwise, and any such issuances could be at varying prices and dilute your ownership of Old Line Bancshares. We may use our common stock to acquire other companies or to make investments in banks and other complementary businesses in the future. We may also issue common stock, or securities convertible into common stock, through public or private offerings, in order to raise additional capital in connection with future acquisitions, to satisfy regulatory capital requirements or for general corporate purposes. We have an effective shelf registration statement on Form S-3 on file with the U.S. Securities and Exchange Commission (“SEC”) pursuant to which we may, from time to time, sell up to an aggregate of $100 million of our common stock, preferred stock, warrants, units and debt securities. The existence of such shelf registration statement allows us to sell securities quickly from time to time as market conditions warrant. Any such common stock issuances, or issuance of other securities under which shares of common stock may be issued, could be dilutive to our other stockholders.
The market price of our common stock can be volatile. Stock price volatility may make it more difficult for an investor to resell our common stock when desired and at attractive prices. The market price of our common stock can fluctuate significantly in response to a variety of factors including, among other things:
|·||actual or anticipated variations in our operating results;|
|·||changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts or others in the industry;|
|·||changes in the regulatory or legal environment in which we operate;|
|·||news reports or other publicity relating to Old Line Bancshares or our competitors or relating to trends in our industry;|
|·||perceptions in the marketplace regarding Old Line Bancshares and/or its competitors;|
|·||future sales of common stock;|
|·||the announcement of a significant acquisition or business combination, strategic partnership, joint venture or capital commitment by or involving Old Line Bancshares or its competitors; and|
|·||geopolitical conditions such as acts or threats of terrorism or military conflicts.|
General market fluctuations, industry factors and general economic and political conditions and events in the U.S. or globally, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.
Shares of our common stock are equity interests and therefore subordinate to our existing and future indebtedness and preferred stock we may issue in the future. Shares of our common stock are equity interests in Old Line Bancshares and do not constitute indebtedness. As such, shares of our common stock rank junior to all indebtedness and other non-equity claims on us with respect to assets available to satisfy claims, including upon our liquidation. Holders of our common stock are also subject to the prior dividend and liquidation rights of any holders of our preferred stock that we may issue in the future.
In addition, our right to participate in any distribution of assets of any of our subsidiaries, including Old Line Bank, upon the subsidiary’s liquidation or otherwise, and thus our stockholders’ ability to benefit indirectly from such distribution, will be subject to the prior claims of creditors of that subsidiary, except to the extent that any of our claims as a creditor of such subsidiary may be recognized. As a result, shares of our common stock are effectively subordinated to all existing and future liabilities and obligations of our subsidiaries.
Our ability to declare and pay dividends is limited by law, and we may be unable to pay future dividends. Old Line Bancshares is a separate and distinct legal entity from Old Line Bank, and it receives substantially all of its revenue from dividends from Old Line Bank. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on debt. Various federal and/or state laws and regulations limit the amount of dividends that Old Line Bank may pay to Old Line Bancshares. In the event Old Line Bank is unable to pay dividends to Old Line Bancshares, Old Line Bancshares may not be able to service debt, pay obligations or pay dividends on its common stock. The inability to receive dividends from Old Line Bank could have a material adverse effect on Old Line Bancshares’ business, financial condition and results of operations.
Anti-takeover provisions could adversely affect our stockholders. Federal and Maryland banking laws, including regulatory approval requirements, and provisions contained in our articles of incorporation and bylaws, could make it difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. For example, our articles of incorporation authorizes our board of directors to determine the designation, preferences, limitations and relative rights of unissued preferred stock, without any vote or action by stockholders. As a result, our board of directors could authorize and issue shares of our preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our common stock or with other terms that could impede the completion of a merger, tender offer or other takeover attempt. In addition, certain provisions of Maryland law, including a provision that restricts certain business combinations between a Maryland corporation and certain interested stockholders, may delay, discourage or prevent an attempted acquisition or change in control of Old Line Bancshares that some or all of our stockholders might consider to be desirable. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock. These provisions could also discourage proxy contests and make it more difficult and expensive for holders of our common stock to elect directors other than the candidates nominated by our board of directors or otherwise remove existing directors and management, even if current management is not performing adequately. As a result, efforts by our stockholders to change our direction or management may be unsuccessful.
As of December 31, 2018, we operate a total of 37 branch locations and nine loan production offices. Our headquarters, as discussed above, is located at 1525 Pointer Ridge Place, Bowie, Maryland in Prince George’s County. We also own the property and building located at 4201 Mitchellville Road, Bowie, Maryland, which houses our mortgage origination group.
In February 2018, we opened a new loan origination office in Towson, Maryland. Also, in February 2018, we closed our College Park, Maryland location and merged the office with the loan origination department located at our Bowie headquarters.
The following table sets forth information about the properties we own or lease at December 31, 2018.
|2530 Riva Road, |
|9/2011||3,899||$||15,378||10yrs 7mos||(2) 5 years|
|2530 Riva Road, |
|Bowie||1525 Pointer Ridge Place |
|Clinton||7801 Old Branch Avenue |
|9/2002||2,550||$||3,070||10 years||(3) 5years|
|College Park(1) |
|9658 Baltimore Avenue |
College Park, Maryland
|3/2008||1,916||$||5,756||10 years||(2) 5 years|
|Waldorf - Crain Highway||2995 Crain Highway |
|Crofton||1641 Maryland Route 3 N, Suite 109 |
|7/2009||2,459||$||8,512||10 years||(3) 5 years|
|Fairwood||12100 Annapolis Road, Suite 1 |
Glen Dale, Maryland
|Greenbelt||6421 Ivy Lane |
|9/2009||33,000||$||10,137||30 years||(2) 10 years|
|Leonardtown||23152 Newtowne Neck Road |
|Riverdale||6611 Baltimore Avenue, Suite 3C |
Riverdale Park, Maryland
|6/2017||2,860||$||11,917||10 years||(2) 5 years|
|Rockville Mortgage||1682 East Guide Drive, Suite 202 |
|Rockville Pike||1801 Rockville Pike, Suite 100 |
|11/2015||3,251||$||10,361||5 years||(3) 5 years|
|Rockville Town Center||196A East Montgomery Avenue |
|6/2016||2,142||$||10,046||10 years||(2) 5 years|
|Silver Spring||12501 Prosperity Drive, Suite 215 |
Silver Spring, Maryland
|3/2013||2,131||$||4,531||3 years 2 mos||(1) 3 years|
|Towson||849 Fairmont Avenue, Suite 205 |
|2/2018||3,974||$||9,210||7 years 3 mos||(1) 5 years|
|Properties Acquired April 1, 2011|
|Bryans Road||7175 Indian Head Highway |
Bryans Road, Maryland
|California||22741 Three Notch Road |
|4/1985||3,366||$||6,751||5 years||(2) 5 years|
|Fort Washington||12740 Old Fort Road |
Fort Washington, Maryland
|2/1973||2,800||$||6,489||5 years||(1) 5 years|
|La Plata||101 Charles Street, Suite 102 |
La Plata, Maryland
|4/1974||2,910||$||9,670||15 years||(3) 10 years|
|Waldorf - Leonardtown Road||3135 Leonardtown Road |
|Prince Frederick||691 Prince Frederick Boulevard |
Prince Frederick, Maryland
|Waldorf Operations||3220 Old Washington Road |
|Properties Acquired May 10, 2013|
|Bowie||4201 Mitchellville Road |
|Millersville||676 Old Mill Road |
|8/2005||2,000||$||5,417||5 years||(2) 5 years|
|Properties Acquired December 4, 2015|
|Hunt Valley (1)||10620 York Road |
Hunt Valley, Maryland
|6/2005||6,160||$||14,852||20 years||(4) 5 years|
|Westminster||1046 Baltimore Boulevard |
|12/2001||3,391||$||7,585||20 years||(1) 10 years|
|Properties Acquired July 29, 2017|
|Airpark||7601 - I Airpark Road |
|2/2016||1,440||$||2,649||5 years||(3) 5 years|
|Clarksburg||23400 Frederick Road |
|Damascus||26500 Ridge Road |
|Damascus Mortgage||26437 Ridge Road, Suite 3 |
|10/2015||2,500||$||4,456||5 years||(1) 5 years|
|Frederick||5010 Buckeystown Pike, Suite 112 |
|1/2017||1,401||$||3,716||5 years||(1) 5 years|
|Green Valley||11801 Fingerboard Road |
|11/2004||1,200||$||1,480||3 years||(2) 3 years|
|Mount Airy||201 East Ridgeville Boulevard |
Mount Airy, Maryland
|Properties Acquired April 13, 2018|
|Arbutus||4600 Wilkens Avenue, Suite 105 |
|5/2016||2,234||$||3,912||5 years||(1) 5 years|
|Bel Air||602 Hoagie Drive |
Bel Air, Maryland
|11/2003||38,515||$||9579||20 years||(4) 5 years|
|Canton-Highlandtown||531 South Conkling Street |
|Cockeysville||10301 York Road |
|1/2006||29,427||$||14,766||20 years||(4) 5 years|
|Columbia||7151 Columbia Gateway Drive, Suite A |
|East Joppa Road||1740 East Joppa Road |
|10/2016||2,565||$||4,275||5 years||(2) 5 years|
|Glen Burnie||427 Crain Highway, NE |
Glen Burnie, Maryland
|Lutherville||2328 West Joppa Road, Suite 100 |
|North Charles Street||344 N. Charles Street |
|4/2013||3,600||$||6,624||10 years||(2) 5 years|
|Perry Hall||4040 Schroeder Avenue |
Perry Hall, Maryland
|8/2007||42,000||$||17,082||20 years||(4) 5 years|
|Pikesville||1726 Reisterstown Road, Suite 101 |
|10/2010||2,000||$||3,750||5 years||(3) 5 years|
|(1) Location closed effective July 2018|
From time to time we may be involved in litigation relating to claims arising out of our normal course of business. Currently, we are not involved in any legal proceedings the outcome of which, in management’s opinion, would be material to our financial condition or results of operations.
Our common stock trades on the Nasdaq Capital Market under the trading symbol “OLBK”.
At December 31, 2018, there were 17,031,052 shares of our common stock issued and outstanding held by approximately 1,797 stockholders of record. There were 296,523 shares of common stock issuable on the exercise of outstanding stock options, 210,813 of which were issuable pursuant to options that are currently exercisable.
Issuer Purchases of Equity Securities
As reflected in the following table, we repurchased 8,364 shares of our common stock during the quarter ended December 31, 2018:
|Shares Purchased during the period:||Total number of|
paid per share
|Total number of|
share purchased as
part of publicly
|Maximum number of|
shares that may yet be
purchased under the
|October 1 - December 31, 2018||8,364||24.76||8,364||841,636|
|(1)||On November 28, 2018, Old Line Bancshares’ board of directors approved the repurchase of up to 850,000 shares of our outstanding common stock. This repurchase approval replaces the previous authorization for Old Line Bancshares to repurchase up to 500,000 shares of its common stock, approved in February 2015, pursuant to which there were 160,763 shares remaining available to be repurchased, which prior authorization was terminated upon approval of the new repurchase authorization. As of December 31, 2018, 8,364 shares had been repurchased under the current authorization at an average price of $24.76 per share or a total cost of approximately $207 thousand.|
The following table summarizes Old Line Bancshares, Inc.’s selected financial information and other financial data. The selected balance sheet and statement of income data are derived from our audited financial statements. You should read this information together with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Mergers and Acquisitions” and our financial statements and the related notes included elsewhere in this report. Results for past periods are not necessarily indicative of results that may be expected for any future period.
|(Dollars in thousands except per share data)|
|Earnings and dividends:|
|Net interest income||89,946||62,114||52,940||46,589||41,703|
|Provision for loan losses||1,849||955||1,585||1,311||2,827|
|Less: Net gain (loss) attributable to the non-controlling interest||-||-||62||(4||)||(37||)|
|Net income available to common stockholders||27,218||15,964||13,217||10,468||7,130|
|Per common share data:|
|Common stockholders book value, period end||21.77||16.61||13.81||13.31||12.51|
|Common stockholders tangible book value, period end||15.39||14.10||12.59||12.00||11.38|
|Average common shares outstanding|
|Common shares outstanding, period end||17,031,052||12,508,332||10,910,915||10,802,560||10,810,930|
|Balance Sheet Data:|
|Total loans, less allowance for loan losses||2,420,793||1,700,765||1,369,594||1,155,147||931,121|
|Total investment securities||219,706||218,353||199,505||194,706||161,680|
|Return on average assets||1.01||%||0.84||%||0.83||%||0.79||%||0.60||%|
|Return on average stockholders’ equity||8.29||%||8.53||%||8.83||%||7.54||%||5.45||%|
|Total ending equity to total ending assets||12.57||%||9.87||%||8.82||%||9.54||%||11.02||%|
|Average equity to average total assets||12.15||%||9.86||%||9.37||%||10.49||%||10.95||%|
|Net interest margin(1)||3.75||%||3.69||%||3.79||%||4.08||%||4.15||%|
|Dividend payout ratio for period||22.43||%||23.50||%||19.79||%||21.47||%||27.23||%|
|Asset Quality Ratios:|
|Allowance to period-end loans||0.31||%||0.35||%||0.45||%||0.43||%||0.46||%|
|Non-performing assets to total assets||0.20||%||0.18||%||0.59||%||0.56||%||0.65||%|
|Non-performing loans to allowance for loan losses||65.58||%||31.76||%||103.04||%||120.04||%||121.61||%|
|Tier 1 risk-based capital||10.2||%||9.6||%||9.5||%||10.7||%||12.3||%|
|Total risk-based capital||11.8||%||11.8||%||12.3||%||11.1||%||12.7||%|
|Leverage capital ratio||9.4||%||8.8||%||8.6||%||9.1||%||9.9||%|
|Common Equity Tier 1||10.0||%||9.4||%||9.2||%||10.7|
|(1)||See “Management’s Discussion and Analysis of Financial Condition and Results of Operating—Reconciliation of Non-GAAP Measures.”|
We operate a general commercial banking business, accepting deposits and making loans and investments.
The following highlights contain financial data and events that occurred during 2018:
|·||The merger with BYBK became effective on April 13, 2018, resulting in total assets of $2.9 billion.|
|·||Net income increased $11.3 million or 70.5% to $27.2 million, or $1.73 per basic and $1.71 per diluted share, for the twelve month period ended December 31, 2018, from $16.0 million, or $1.38 per basic and $1.35 per diluted share, for the twelve months ended December 31, 2017.|
|·||Return on average assets (“ROAA”) and return on average equity (“ROAE”) were 1.01% and 8.29%, respectively, compared to ROAA and ROAE of 0.84% and 8.53%, respectively, for the twelve months ended December 31, 2017. Excluding merger-related expenses, adjusted ROAA and ROAE (each a non-GAAP financial measure) would have been 1.29% and 10.62%, respectively, for the twelve months ended December 31, 2018 and 0.99% and 9.77% for the twelve months ended December 31, 2017.|
|·||Our efficiency ratio was 61.51% and 64.14%, respectively, for the twelve months ended December 31, 2018 and 2017. Excluding merger-related expenses, the adjusted efficiency ratio (a non-GAAP financial measure) was 52.28% for the twelve months ended December 31, 2018 compared to 58.44% for the same period of 2017.|
|·||The net interest margin was 3.75% compared to 3.69% for the twelve months ended December 31, 2017. Total yield on interest earning assets increased to 4.63% compared to 4.35% for the twelve months ended December 31, 2017.|
|·||Net loans held for investment increased $712.9 million to $2.4 billion from $1.7 billion at December 31, 2017. Organic loan growth was $313.5 million, or 23.15%.|
|·||Average gross loans increased $675.6 million, or 44.29%, during the twelve month periods ended December 31, 2018, to $2.4 billion from $1.5 billion during the twelve month period ended December 31, 2017. This increase is the result of the acquisition of BYBK and organic growth.|
|·||We sold troubled acquired loans totaling $25.3 million.|
|·||Total assets increased $844.4 million, or 40.10%, primarily due to increases of $712.9 million in loans held for investment, $68.2 million in goodwill, $26.3 million in bank owned life insurance, $9.1 million in core deposit intangibles, and $9.3 million in cash and cash equivalents.|
|·||Total deposits grew by $643.1 million, or 38.91%, since December 31, 2017.|
|·||Non-performing assets to total assets remain consistent at 0.20% at December 31, 2018 compared to 0.18% for the same period of 2017.|
|·||We ended 2018 with a book value of $21.77 per common share and a tangible book value of $15.39 per common share compared to $16.61 and $14.10, respectively, at December 31, 2017.|
|·||We maintained appropriate levels of liquidity and by all regulatory measures remained “well capitalized.”|
We have based our strategic plan on the premise of enhancing stockholder value and growth through branching and operating profits. Our short term goals include continuing our strong pattern of organic loan and deposit growth, enhancing and maintaining credit quality, collecting payments on non-accrual and past due loans, profitably disposing of certain acquired loans and other real estate owned (“OREO”), maintaining an attractive branch network, expanding fee income, generating extensions of core banking services, and using technology to maximize stockholder value. During the past few years, we have expanded organically and by acquisition in Montgomery County, Maryland, organically in Prince George’s County and Anne Arundel County, Maryland, and by acquisition into Baltimore, Carroll, Frederick, Harford and Howard Counties, Maryland as well as Baltimore City. We use the Internet and technology to augment our growth plans. Currently, we offer our customers image technology, Internet banking with online account access and bill pay service and mobile banking. We provide selected commercial customers the ability to remotely capture their deposits and electronically transmit them to us. We will continue to evaluate cost effective ways that technology can enhance our management capabilities, products and services.
We may continue to take advantage of strategic opportunities presented to us via mergers occurring in our marketplace. For example, we may purchase branches that other banks close or lease branch space from other banks or hire additional loan officers. We also continually evaluate and consider opportunities with financial services companies or institutions with which we may become a strategic partner, merge or acquire. We believe that the recent BYBK acquisition will continue to generate increased earnings and increased returns for our stockholders.
Although the current interest rate environment continues to present challenges for our industry, we have worked diligently towards our goal of becoming the premier community bank in Maryland. While we are uncertain about the continued pace of economic growth or the impact of the current political environment, uncertainty regarding recent tariffs imposed and that may be imposed on imports into the United States, and the growing national debt, we remain cautiously optimistic that we have identified any problem assets, that our remaining borrowers will stay current on their loans and that we can continue to grow our balance sheet and earnings.
Although the Federal Reserve Board has been slowly increasing the federal funds rate (which in turn increases market interest rates) since December 2015, including four times during 2018, interest rates are still low compared to typical interest rates before the 2007-2009 recession, and it is currently expected that any rate hikes this year will be fewer than during 2018 and not in the immediate future. Given the expectation that interest rates will, therefore, remain at historically low levels during 2019, coupled with forecasts of increased business and consumer borrowings during 2019, we believe that we can continue to grow total loans during 2019 even with a modest slowdown in the economy during 2019, although this may not come to fruition if the United States economy experiences a more severe slowdown. We also believe that we can continue to grow total deposits during 2019. As a result of this expected growth, we expect that net interest income will increase during 2019, although there can be no guarantee that this will be the case.
We also expect that salaries and benefits expenses and occupancy and equipment expenses will be higher in 2019 and going forward generally than they were in 2018 as a result of including the expenses related to the new employees and branches we acquired in the BYBK merger for the full year 2019 and then on an ongoing basis; such expenses may increase even further if we selectively take the opportunity to add more business development talent. We will continue to look for opportunities to reduce expenses. We believe with our existing branches, our lending staff, our corporate infrastructure and our solid balance sheet and strong capital position, we can continue to focus our efforts on improving earnings per share and enhancing stockholder value.
Bay Bancorp, Inc. On April 13, 2018, Old Line Bancshares acquired BYBK, the parent company of Bay Bank. The aggregate merger consideration was approximately $143.6 million based on the closing sales price of Old Line Bancshares’ common stock on April 13, 2018.
In connection with the merger, Bay Bank merged with and into Old Line Bank, with Old Line Bank the surviving bank.
At April 13, 2018, BYBK had consolidated assets of approximately $633 million. This merger added 11 banking locations located in Baltimore City and Baltimore, Anne Arundel, Howard and Harford Counties in Maryland.
DCB Bancshares, Inc. On July 28, 2017, Old Line Bancshares acquired DCB, the parent company of Damascus. The aggregate merger consideration was approximately $40.9 million based on the closing sales price of Old Line Bancshares’ common stock on July 28, 2017.
In connection with the merger, Damascus merged with and into Old Line Bank, with Old Line Bank the surviving bank.
At July 28, 2017, DCB had consolidated assets of approximately $311 million. This merger added six banking locations located in Montgomery, Frederick and Carroll Counties in Maryland.
The acquired assets and assumed liabilities of BYBK and DCB were measured at estimated fair value. Management made significant estimates and exercised significant judgment in accounting for the acquisitions of BYBK and DCB. Management judgmentally assigned risk ratings to loans based on appraisals and estimated collateral values, expected cash flows, prepayment speeds and estimated loss factors to measure fair value for loans. Management used quoted or current market prices to determine the fair value of Bay Bank’s and Damascus’ investment securities.
Critical Accounting Policies and Estimates
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. They require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. The following are the accounting policies that we believe are critical. For a discussion of recent accounting pronouncements, see Note 1—Summary of Significant Accounting Policies in the Notes to our Consolidated Financial Statements.
We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which we operate. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. We base these estimates, assumptions, and judgments on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third party sources, when available.
The most significant accounting policies that we follow are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how we value significant assets and liabilities in the financial statements and how we determine those values. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses as the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
Allowance for Loan Losses—We evaluate the adequacy of the allowance for loan losses based upon loan categories except for delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with loan collateral, which management evaluates separately and assigns loss amounts based upon the evaluation. We apply loss ratios to each category of loans, where we further divide the loans by risk rating and apply loss ratios by risk rating, to determine estimated loss amounts. Categories of loans are consumer loans, residential real estate, commercial real estate and commercial loans. We further divide commercial real estate by owner occupied, investment, hospitality, land acquisition and development, and junior liens.
The allowance for loan losses represents management’s best estimate of the losses known and inherent in the loan portfolio that are both probable and reasonable to estimate, based on, among other factors, prior loss experience, volume and type of lending conducted, estimated value of any underlying collateral, economic conditions (particularly as such conditions relate to Old Line Bank’s market area), regulatory guidance, peer statistics, management’s judgment, past due loans in the loan portfolio, loan charge off experience and concentrations of risk (if any). Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant estimates, assumptions, and judgments. The loan portfolio also represents the largest asset type on the consolidated balance sheets.
Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral and the financial condition of the borrower, and in establishing loss ratios and risk ratings. The establishment of allowance factors is a continuing exercise and allowance factors may change over time, resulting in an increase or decrease in the amount of the provision or allowance based upon the same volume and classification of loans.
Changes in allowance factors or in management’s interpretation of those factors will have a direct impact on the amount of the provision, and a corresponding effect on income and assets. Also, errors in management’s perception and assessment of the allowance factors could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge offs, which would adversely affect income and capital. For additional information regarding the allowance for loan losses, see the “Asset Quality” section of this annual report.
Other-Than-Temporary Impairment—Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) the structure of the security. A decline in the market value of any available for sale security below cost that is deemed other-than-temporary results in a charge to earnings and establishment of a new cost basis for that security.
Goodwill and Other Intangible Assets—Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed related to the acquisitions of Maryland Bankcorp, WSB Holdings, Regal Bancorp, DCB and BYBK. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in these transactions. The core deposit intangible is being amortized over 18 years for Maryland Bankcorp, ten years for WSB Holdings, and eight years for Regal Bancorp and DCB, and 20 years for BYBK, and the estimated useful lives are periodically reviewed for reasonableness.
Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing the reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill assigned to that reporting unit is considered not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment of goodwill assigned to that reporting unit.
We engaged an external valuation specialist to assist us in the goodwill assessment performed at September 30, 2018, our annual test date, and determined that no impairment charge was necessary for our goodwill at that date. There have been no events subsequent to the September 30, 2018 evaluation that caused us to perform an interim review of the carrying value of goodwill.
Business Combinations— U.S. GAAP requires that the acquisition method of accounting, formerly referred to as purchase method, be used for all business combinations and that an acquirer be identified for each business combination. Under U.S. GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. U.S. GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date.
Acquired Loans—These loans are recorded at fair value at the date of acquisition, and accordingly no allowance for loan losses is transferred to the acquiring entity in connection with purchase accounting. The fair values of loans with evidence of credit deterioration (purchased, credit-impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For purchased, credit-impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the purchase price of the purchase credit-impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The purchased credit-impaired loan’s contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, in the form of a loss accrual or a valuation allowance.
If a loan that was previously rated a pass performing loan, from our acquisitions, deteriorates subsequent to the acquisition, the subject loan will be assessed for risk and, if necessary, evaluated for impairment. If the risk assessment rating is adversely changed and the loan is determined to not be impaired, the loan will be placed in a migration category and the credit mark established for the loan will be compared to the general reserve allocation that would be applied using the current allowance for loan losses formula for General Reserves. If the credit mark exceeds the allowance for loan losses formula for General Reserves, there will be no change to the allowance for loan losses. If the credit mark is less than the current allowance for loan losses formula for General Reserves, the allowance for loan losses will be increased by the amount of the shortfall by a provision recorded in the income statement. If the loan is deemed impaired, the loan will be subject to evaluation for loss exposure and a specific reserve. If the estimate of loss exposure exceeds the credit mark, the allowance for loan losses will be increased by the amount of the excess loss exposure through a provision. If the credit mark exceeds the estimate of loss exposure there will be no change to the allowance for loan losses. If a loan from the acquired loan portfolio is carrying a specific credit mark and a current evaluation determines that there has been an increase in loss exposure, the allowance for loan losses will be increased by the amount of the current loss exposure in excess of the credit mark.
Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each purchased, credit-impaired loan in comparison to management’s initial performance expectations. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
Acquired performing loans are accounted for using the contractual cash flows method of recognizing discount accretion or premium amortization based on the acquired loans’ contractual cash flows. Acquired performing loans are recorded as of the purchase date at fair value. Credit losses on the acquired performing loans are estimated based on analysis of the performing portfolio. A provision for loan losses is recognized for any further credit deterioration that occurs in these loans subsequent to the acquisition date.
Income Taxes—The provision for income taxes includes taxes payable for the current year and deferred income taxes. We determine deferred tax assets and liabilities based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse. If needed, we use a valuation allowance to reduce the deferred tax assets to the amount we expect to realize. We allocate tax expense and tax benefits to Old Line Bancshares and its subsidiaries based on their proportional share of taxable income.
TCJA significantly changed U.S. tax law by, among other things, lowering the corporate income tax rate and implementing changes to business-related exclusions. TCJA permanently reduced the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income at the time of enactment of such change in tax rates. Accordingly, in the fourth quarter 2017 we recorded a provisional tax expense, based on estimates, for the effects of TCJA.
In its consolidated financial statements for the year ended December 31, 2017, Old Line Bancshares recorded an expense of $2.9 million for the effects of the change in tax law, including all materially impacted items and for which the accounting under Statement of Financial Accounting Standards, Accounting Standards Codification (“ASC”) 740, Income Taxes, is complete. Provisional amounts would include, for example, reasonable estimates that give rise to new current or deferred taxes based on certain provisions within TCJA, as well as adjustments to existing current or deferred taxes that existed prior to TCJA’s enactment date. Old Line Bancshares had maintained a deferred tax asset valuation allowance in relation to net operating loss carryovers and other items in relation to the acquisition of Regal Bank, which occurred in December 2015. Management determined that the concerns that existed at the time we established the valuation reserve relating to this acquisition no longer existed and Old Line Bancshares therefore reversed this valuation allowance in total during the fourth quarter. The effect of the reversal of the valuation reserve increased net deferred income taxes in the amount of $3.4 million, resulting in a decrease in income tax expense. The net impact of these two items was a reduction of income tax expense by $472 thousand. There were no other items for which we were unable to make reasonable estimates for effects of the tax law change.
Average Balances, Yields and Accretion of Fair Value Adjustments Impact
The following table illustrates average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders’ equity and related income, expense and corresponding weighted average yields and rates. Non-accrual loans are included in total loan balances lowering the effective yield for the portfolio in the aggregate. The average balances used in this table and other statistical data were calculated using average daily balances.
|Twelve months ended||Average||Yield or||Average||Yield or||Average||Yield or|
|December 31,||Balance||Interest||Rate Paid||Balance||Interest||Rate Paid||Balance||Interest||Rate Paid|
|Federal funds sold(1)||$||731,560||$||14,739||2.01||%||$||528,260||$||6,441||1.22||%||$||490,653||$||2,350||0.48||%|
|Interest bearing deposits||4,197,275||35,995||0.86||1,227,606||874||0.07||1,350,471||429||0.03|
|U.S. government agency||13,960,007||373,082||2.67||11,197,975||288,597||2.58||17,576,233||281,652||1.60|
|Mortgage backed securities||108,721,401||2,325,176||2.14||113,386,984||2,213,346||1.95||111,803,259||2,060,415||1.84|
|Other equity securities||10,808,617||1,163,814||10.77||8,415,799||583,180||6.93||6,408,092||383,296||5.98|
|Total investment securities||233,758,553||7,372,818||3.15||219,643,520||6,517,071||2.97||201,504,562||5,382,609||2.67|
|Mortgage real estate||1,844,508,062||87,035,727||4.72||1,310,301,829||59,758,168||4.56||1,089,605,816||50,554,758||4.64|
|Allowance for loan losses||6,590,366||-||5,940,338||-||5,867,612||-|
|Total loans, net of allowance||2,194,358,343||105,237,730||4.80||1,519,404,083||69,254,584||4.56||1,241,578,435||56,953,260||4.59|
|Total interest earning assets(1)||2,433,045,731||112,661,282||4.63||1,740,803,469||75,778,970||4.35||1,444,924,121||62,338,648||4.31|
|Non-interest bearing cash||43,935,661||33,307,218||35,498,836|
|Premises and equipment||42,809,849||38,834,701||36,196,496|
|Liabilities and Stockholders’ Equity:|
|Interest bearing deposits|
|Money market and NOW||628,305,210||3,533,063||0.56||473,125,699||1,863,164||0.39||394,821,212||1,014,981||0.26|
|Total interest bearing deposits||1,528,746,393||14,619,507||0.96||1,088,590,744||7,321,031||0.67||941,270,023||5,508,834||0.59|
|Total interest bearing liabilities||1,794,557,718||21,328,533||1.19||1,305,260,258||11,498,633||0.88||1,102,128,415||7,525,112||0.68|
|Non-interest bearing deposits||562,396,759||394,246,163||324,555,990|
|Total liabilities and stockholders’ equity||$||2,701,379,033||$||1,898,733,959||$||1,591,458,457|
|Net interest spread(1)||3.44||3.47||3.63|
|Net interest margin(1)||$||91,332,749||3.75||%||$||64,280,337||3.69||%||$||54,813,536||3.79||%|
|(1)||Interest revenue is presented on a fully taxable equivalent (FTE) basis. The FTE basis adjusts for the tax favored status of these types of assets. Management believes providing this information on a FTE basis provides investors with a more accurate picture of our net interest spread and net interest income and we believe it to be the preferred industry measurement of these calculations. See “Reconciliation of Non-GAAP Measures.”|
|(2)||Available for sale investment securities are presented at amortized cost.|
The following table describes the impact on our interest income and expense resulting from changes in average balances and average rates for the periods indicated. The change in interest income due to both volume and rate is reported with the rate variance.
|Twelve Months Ended December 31,||Twelve Months Ended December 31,|
|2018 compared to 2017||2017 compared to 2016|
|Variance due to:||Variance due to:|
|Interest earning assets:|
|Federal funds sold(1)||$||8,298||$||5,219||$||3,079||$||4,091||$||3,898||$||193|
|Interest bearing deposits||35,121||28,811||6,310||445||487||(42||)|
|U.S. government agency||84,485||11,012||73,473||6,945||405,696||(398,751||)|
|Mortgage backed securities||111,830||205,523||(93,693||)||152,931||3,534,038||(3,381,107||)|
|Mortgage real estate||27,277,559||2,136,387||25,141,172||9,203,410||(875,293||)||10,078,703|
|Total interest income(1)||36,882,312||3,838,969||33,043,343||13,440,322||1,880,760||11,559,562|
|Interest bearing liabilities:|
|Money market and NOW||1,669,899||945,338||724,561||848,183||617,803||230,380|
|Total interest expense||9,829,900||5,298,104||4,531,796||3,973,521||2,328,324||1,645,197|
|Net interest income(1)||$||27,052,412||$||(1,459,135||)||$||28,511,547||$||9,466,801||$||(447,564||)||$||9,914,365|
|(1)||Interest revenue is presented on a fully taxable equivalent (FTE) basis. Management believes providing this information on a FTE basis provides investors with a more accurate picture of our net interest spread and net interest income and we believe it to be the preferred industry measurement of these calculations. See “Reconciliation of Non-GAAP Measures.|
The fair value yield on loan accretion increased in 2018 due to an increase in the level of payoffs on acquired loans with positive accretion as compared to payoffs in 2017. The fair value accretion increased the net interest margin as follows:
|Twelve Months Ended December 31,|
|Fair Value||% Impact on||Fair Value||% Impact on||Fair Value||% Impact on|
|Accretion||Net Interest||Accretion||Net Interest||Accretion||Net Interest|
|Interest bearing deposits||282,259||0.01||249,095||0.02||259,835||0.02|
|Total Fair Value Accretion||$||3,188,890||0.13||%||$||1,236,065||0.07||%||$||1,249,742||0.09||%|
Comparison of Operating Results for the Years Ended December 31, 2018 and 2017.
Net Interest Income. Net interest income before provision for loan losses for the year ended December 31, 2018 increased $27.8 million or 44.81% to $89.9 million from $62.1 million for the year ended December 31, 2017. As discussed below and outlined in detail in the Rate/Volume Analysis, this increase was almost entirely due to an increase in loan interest income resulting primarily from a $675.6 million increase in the average balance of our loans, partially offset by an increase in interest expense resulting from increases in both the average balance of and average interest rate on our interest bearing liabilities.
The growth in average interest bearing liabilities during 2018 resulted primarily from increases of $440.2 million in average interest bearing deposits, which increased to $1.5 billion for the year ended December 31, 2018 from $1.1 billion for the year ended December 31, 2017, and $49.1 million in borrowings. The average balance of our borrowings increased due to an increase in our FHLB advances. The average rate on our interest bearing liabilities increased 31 basis points in 2018 compared to 2017 due to higher rates paid on both our interest bearing deposits, primarily time deposits and, to a lesser extent, our money market and NOW deposits, and our borrowings. We increased the interest rates we paid on our deposits in order to maintain competitive rates as market interest rates increased following increases in the targeted federal funds rate during 2018. The average rate paid on our borrowings increased as a result of higher rates on our FHLB advances, which resulted from increases in the prime interest rate. We continue to adjust the mix and volume of interest earning assets and interest bearing liabilities on the balance sheet to maintain a relatively strong net interest margin.
The increases in the average balances of both our loans and interest bearing deposits was a result of the loans and deposits we acquired in the BYBK acquisition in April 2018 and, to a lesser extent, organic growth.
The average yield on our interest earning assets increased by 28 basis points from 4.35% for the year ended December 31, 2017 to 4.63% for the year ended December 31, 2018, which also contributed to the increase in interest income. This increase was primarily due to higher yields on our loans held for investment due to yields on new mortgage and commercial loans with higher average rates than those already in our portfolio and re-pricing in the loan portfolio, as well as higher yields on our investment securities available for sale. The net effect of fair value accretion/amortization on acquired loans affects our net interest income. The fair value accretion/amortization is recorded on paydowns during the period recognized and the fair value accretion on loans increased to 13 basis points in 2018 from seven basis points in the prior year. The net interest margin in 2018 benefited from a higher level of accretion on acquired loans due to a greater level of early payoffs on acquired loans with credit marks.
Our net interest margin increased to 3.75% for the year ended December 31, 2018 from 3.69% for the year ended December 31, 2017. The net interest margin increased in 2018 due to an improvement in the yield on interest earning assets and an increase in non-interest bearing deposits as a source of funding, partially offset by the increase in interest expense. The net interest margin also benefited from a higher level of accretion on acquired loans due to a higher level of early payoffs on acquired loans with credit marks during the twelve months ended December 31, 2018 compared to the same period of 2017.
Provision for Loan Losses. The provision for loan losses totaled $1.8 million for the year ended December 31, 2018, an increase of $894 thousand, or 93.56%, from the 2017 amount of $955 thousand. Management identified additional probable losses in the loan portfolio and we recorded charge-offs of $403 thousand for the year ended December 31, 2018, compared to $1.3 million for the year ended December 31, 2017. We recognized recoveries of $105 thousand in 2018 compared to $41 thousand in 2017. The increase in our provision for loan losses during the twelve months ended December 31, 2018 compared to the same period of 2017 is due to the organic growth in the loan portfolio. All our impaired loans have been adequately reserved for at December 31, 2018. The allowance for loan losses to gross loans held for investment was 0.31%, and the allowance for loan losses to non-accrual loans was 160.43%, at December 31, 2018.
Non-Interest Income. Non-interest income totaled $12.0 million for the year ended December 31, 2018, an increase of $4.2 million, or 53.59%, from the 2017 amount of $7.8 million. The following chart outlines the amounts of and changes in non-interest income for the years ended December 31, 2018 and 2017:
|Years ended December 31,|
|2018||2017||$ Change||% Change|
|Service charges on deposit accounts||$||2,773,659||$||1,982,981||$||790,678||39.87||%|
|POS sponsorship program||2,026,142||-||2,026,142||100.00|
|Gain on sales or calls of investment securities||-||35,258||(35,258||)||(100.00||)|
|Write down on stock||(152,496||)||-||(152,496||)||100.00|
|Earnings on bank owned life insurance||1,806,381||1,167,467||638,914||54.73|
|Gain (loss) on disposal of assets||13,266||73,663||(60,397||)||(81.99||)|
|Gain on sale of loans||556,358||94,714||461,644||100.00|
|Income on marketable loans||1,822,024||2,319,806||(497,782||)||(21.46||)|
|Other fees and commissions||2,318,810||1,440,499||878,311||60.97|
|Total non-interest income||$||11,980,951||$||7,800,605||$||4,180,346||53.59||%|
Non-interest income increased during 2018 compared to the prior year primarily as a result of income of $2.0 million from our new POS sponsorship program, as well as increases of $878 thousand in other fees and commissions, $639 thousand in earnings on bank owned life insurance (“BOLI”), $791 thousand in service charges on deposit accounts and $462 thousand in gain on sale of loans, partially offset by a decrease of $498 thousand in income on marketable loans.
The increase in other fees and commissions is primarily due to increases of $131 thousand in rental income and $415 thousand in miscellaneous income, including other fee income and other loan fees, and $182 thousand of reversals on previously charged-off loans during 2018
The increase in earnings on BOLI is due to the $16.3 million of BOLI acquired in the BYBK acquisition and $8.5 million in new BOLI policies purchased since December 31, 2017.
The increase in service charges on deposit accounts is the result of increased income on bank debit cards due to the higher deposit base primarily as a result of the DCB and BYBK acquisitions.
The increase in gain on sale of loans (other than residential mortgage loans held for sale) is due to the sale of troubled acquired loans totaling $25.3 million during the year ended December 31, 2018, compared to the sale of one SBA loan during in the amount of $2.4 million during 2017.
Income on marketable loans consists of gain on the sale of residential mortgage loans originated for sale and any fees we receive in connection with such sales. The decrease in income on marketable loans is the result of a decrease in the premium amounts we received on residential mortgage loans that we sold in the secondary market compared to the same period of 2017 as a result on lower premium amounts on each loan sold, resulting primarily from increased competition.
Non-Interest Expenses. Non-interest expense increased $17.8 million, or 39.80%, for the year ended December 31, 2018 compared to the year ended December 31, 2017. The following chart outlines the amounts of and changes in non-interest expenses during 2018 and 2017.
|Years ended December 31,|
|2018||2017||$ Change||% Change|
|Salaries and benefits||$||26,921,563||$||20,551,526||$||6,370,037||31.00||%|
|Occupancy and equipment||8,911,848||7,073,696||1,838,152||25.99|
|FDIC insurance and State of Maryland assessments||1,050,536||1,001,522||49,014||4.89|
|Merger and integration||9,404,507||3,985,514||5,418,993||135.97|
|Core deposit premium amortization||2,179,452||968,880||1,210,572||124.95|
|Gain on sale of other real estate owned||52,937||(13,589||)||66,526||(489.56||)|
|Total non-interest expenses||$||62,691,238||$||44,843,047||$||17,848,191||39.80||%|
The increase in non-interest expenses during 2018 compared to 2017 is primarily a result of increases in salaries and benefits, merger and integration, and, to a lesser degree, occupancy and equipment, data processing, core deposit amortization and other operating expenses.
We incurred $9.4 million in merger and integration expenses during the twelve months ended December 31, 2018 due to the BYBK acquisition, compared to $4.0 million of merger and integration expenses due to the DCB acquisition during 2017.
Salaries and benefits increased $6.4 million during 2018 compared to the prior year primarily as a result of the additional staff that we acquired in the BYBK and DCB acquisitions.
Occupancy and equipment expenses increased $1.8 million primarily as a result of the new branches that we acquired in the DCBB and BYBK acquisitions.
The $1.0 million increase in data processing expenses resulted from additional customer transactions due to growth.
Core deposit amortization increased $1.2 million as a result of the higher premiums resulting from the deposits we acquired in the DCBB and BYBK acquisitions.
Other operating expenses increased $1.9 million during the 2018 period due to increases in general operating costs primarily as a result of the additional branches and staff we acquired in the BYBK and DCB mergers.
Income Taxes. Income tax expense was $10.2 million (27.20% of pre-tax income) for the year ended December 31, 2018 compared to $8.2 million (33.81% of pre-tax income) for 2017. The effective tax rate decreased for 2018 primarily as a result of the decrease in the federal corporate tax income rate from 35% to 21% enacted as part of the TCJA, although the impact of the lower tax rate was partially offset by our incurring an additional $5.4 million of non-deductible merger expenses during the year ended December 31, 2018 compared to 2017.
Net Income. Net income was $27.2 million or $1.73 per basic and $1.71 per diluted common share for the year ended December 31, 2018 compared to net income of $16.0 million or $1.38 per basic and $1.35 per diluted common share for the year ended December 31, 2017. The increase in net income for 2018 was primarily the result of the increases of $27.8 million in net interest income and $4.2 million in non-interest income, partially offset by the $17.8 million increase in non-interest expenses.
Comparison of Operating Results for the Years Ended December 31, 2017 and 2016
Net Interest Income. Net interest income before provision for loan losses for the year ended December 31, 2017 increased $9.2 million or 17.33% to $62.1 million from $52.9 million for the year ended December 31, 2016. As discussed below and outlined in detail in the Rate/Volume Analysis, this increase was the result of an increase in total interest income resulting primarily from a $277.9 million increase in the average balance of our loans, partially offset by an increase in interest expense resulting from increases in both the average balance and average rate on our interest bearing liabilities.
The growth in average interest bearing liabilities during 2017 resulted primarily from increases of $147.3 million in average interest bearing deposits, which increased to $1.1 billion for the year ended December 31, 2017 from $941.3 million for the year ended December 31, 2016, and $55.8 million in borrowings. The average balance of our borrowings increased due to an increase in our FHLB advances and the subordinated notes we issued in August 2016 (the “Notes”) being outstanding for the full year in 2017 compared to five months in 2016. The average rate paid on our borrowings increased as a result of higher rates on our FHLB advances, which resulted from the increase in the prime interest rate and switching from fixed rate advances to daily-rate FHLB advances, which have a higher interest rate, combined with the 5.625% interest rate on the Notes.
The growth in both average interest earning assets and average interest bearing deposits was a result of the loans and deposits we acquired in the DCB acquisition in July 2017 and, to a lesser extent, organic growth.
We had a slight increase in the average yield on interest earning assets for the year ended December 31, 2017 compared to the prior year, primarily as a result of higher average yields on our investment securities available for sale, partially offset by a slight decrease in the average yield on our loans held for investment portfolio. The competitive rate environment also resulted in an increase in the rates we paid on our money market and NOW accounts and time deposits.
Our net interest margin was 3.69% for the year ended December 31, 2017 compared to 3.79% for the year ended December 31, 2016. The yield on average interest earning assets increased by four basis points from 4.31% for the year ended December 31, 2016 to 4.35% for the year ended December 31, 2017. This increase was primarily due to higher yields on our investment securities, partially offset by a slight decrease in the yield on loans due to yields on new loans and re-pricing in the loan portfolio. The net effect of fair value accretion/amortization on acquired loans affects our net interest income. The fair value accretion/amortization is recorded on paydowns during the period recognized and the fair value accretion on loans decreased to seven basis points in 2017 from nine basis points in the prior year. The net interest margin in 2016 benefited from a higher level of accretion on acquired loans due to a greater level of early payoffs on acquired loans with credit marks.
Provision for Loan Losses. The provision for loan losses totaled $955 thousand for the year ended December 31, 2017, a decrease of $629 thousand, or 39.72%, from the 2016 amount of $1.6 million. Management identified additional probable losses in the loan portfolio and we recorded charge-offs of $1.3 million for the year ended December 31, 2017, compared to $410 thousand for the year ended December 31, 2016. We recognized recoveries of $41 thousand in 2017 compared to $111 thousand in 2016. The decrease in our provision for loan losses during the twelve months ended December 31, 2017 compared to the same period of 2016 is due to a decrease in our specific reserves primarily due to one large commercial borrower, consisting of 23 commercial loans totaling $3.0 million, of which $1.0 million was charged-off against the allowance for loan losses and $2.0 million was reclassified as trouble debt restructurings during the first quarter of 2017. Amounts charged off in relation to these loans during 2017 were in line with specific reserves at December 31, 2016. These trouble debt restructurings are classified as impaired and all our impaired loans have been adequately reserved for at December 31, 2017. The allowance for loan losses to gross loans held for investment was 0.35%, and the allowance for loan losses to non-accrual loans was 335.51%, at December 31, 2017.
Non-Interest Income. Non-interest income totaled $7.8 million for the year ended December 31, 2017, a decrease of $455 thousand, or 5.52%, from the 2016 amount of $8.3 million. The following chart outlines the amounts of and changes in non-interest income for the years ended December 31, 2017 and 2016:
|Years ended December 31,|
|2017||2016||$ Change||% Change|
|Service charges on deposit accounts||$||1,982,981||$||1,728,636||$||254,345||14.71||%|
|Gain on sales or calls of investment securities||35,258||1,227,915||(1,192,657||)||(97.13||)|
|Earnings on bank owned life insurance||1,167,467||1,132,401||35,066||3.10|
|Gain (loss) on disposal of assets||73,663||(27,176||)||100,839||(371.06||)|
|Gain on sale of loans||94,714||-||94,714||100.00|
|Income on marketable loans||2,319,806||2,317,648||2,158||0.09|
|Other fees and commissions||1,419,726||1,132,575||287,151||25.35|
|Total non-interest income||$||7,800,605||$||8,256,037||$||(455,432||)||(5.52||)%|
The primary reason for the decrease in non-interest income during 2017 was a decrease in gain on sales or calls of investment securities, partially offset by increases in service charges on deposit accounts, gain on disposal of assets, other fees and commissions and a gain on the sale of loans.
The decrease in gain on sales or calls or investment securities is the result of our re-positioning our investment portfolio during 2016, pursuant to which we sold approximately $108 million of our lowest yielding, longer duration investments; during the twelve months ended December 31, 2017, we had $61.9 million in sales and calls of investment securities, $41.8 million of which was from, and sold immediately after, the DCB merger, resulting in no gain or loss. We used the proceeds of these sales and calls to purchase investment securities with a slightly higher book yield.
The increase in service charges on deposits accounts is the result of increased income on bank debit cards due to the increased deposit base, primarily as a result of the DCB merger.
The increase in gain on disposal of assets is due to the sale of two of our previously-owned locations, the Accokeek branch that was closed in 2016 and the Callaway branch that was closed in 2017.
Other fees and commissions increased primarily due to the result of recoveries of previously charged-off acquired loans.
The increase in gain on sale of loans (other than residential mortgage loans held for sale) is due to the sale of one SBA loan during 2017, whereas we did not sell any portfolio loans during 2016.
Non-Interest Expenses. Non-interest expense increased $5.2 million, or 13.12%, for the year ended December 31, 2017 compared to the year ended December 31, 2016. The following chart outlines the amounts of and changes in non-interest expenses during 2017 and 2016.
|Years ended December 31,|
|2017||2016||$ Change||% Change|
|Salaries and benefits||$||20,551,526||$||20,031,638||$||519,888||2.60||%|
|Occupancy and equipment||7,073,696||6,788,213||285,483||4.21|
|FDIC insurance and State of Maryland assessments||1,001,522||1,040,507||(38,985||)||(3.75||)|
|Merger and integration||3,985,514||661,018||3,324,496||502.94|
|Core deposit premium amortization||968,880||830,805||138,075||16.62|
|Gain on sale of other real estate owned||(13,589||)||(77,943||)||64,354||(82.57||)|
|Total non-interest expenses||$||44,843,047||$||39,643,166||$||5,199,881||13.12||%|
The increase in non-interest expenses during 2017 compared to 2016 is primarily the result of increases in merger and integration expenses and, to a lesser extent, other operating expenses, salaries and benefits and occupancy and equipment expenses.
Merger and integration expenses increased $3.3 million to $4.0 million for the twelve months ended December 31, 2017 due to the DCB acquisition, compared to $661 thousand of merger and integration expenses during 2016 in connection with the Regal Bancorp acquisition that was consummated in December 2015.
Other operating expenses increased primarily as a result of increased Internet banking support and ATM expenses resulting from the increased deposit base in 2017 compared to the prior year, primarily as a result of the DCB acquisition.
Salaries and benefits increased $520 thousand, primarily as a result of the increased number of employees resulting from our acquisition of DCB as well as the addition of the staff at our new Riverdale branch and the inclusion of a full year of salaries and benefits for the employees at our Rockville Town Center branch compared to only six months of such expenses during 2016. The impact of these increases was partially offset by a lack of severance payments in 2017 compared to $443 thousand of such payments in 2016.
Occupancy and equipment expenses increased $285 thousand, primarily as a result of the additional branches that we acquired in the DCB acquisition.
Income Taxes. Income tax expense was $8.2 million (33.81% of pre-tax income) for the year ended December 31, 2017 compared to $6.8 million (34.12% of pre-tax income) for 2016. The effective tax rate decreased for 2017 due to an increase in non-deductible merger and integration expenses associated with the DCB acquisition, while the amount of taxes we paid increased due to the increased level of income before taxes, partially offset by the net tax effect of two non-recurring income tax matters during 2017. First was the TCJA, which as discussed above lowered corporate income tax marginal rates beginning in 2018. Upon its enactment, companies were required under applicable accounting standards to revalue their deferred tax assets and liabilities as of December 31, 2017 at the lower enacted rate. Based on an analysis of the deferred tax accounts, we estimated that the rate change resulted in a provisional adjustment of $2.9 million to the net deferred income taxes and a resulting increase in income tax expense. Second, and unrelated to TCJA, in 2016 we had maintained a deferred tax asset valuation allowance in relation to net operating loss carryovers and other items related to the acquisition of Regal Bank in December of 2015. We determined that the concerns that existed at the time we established this reserve no longer existed and we therefore reversed this valuation allowance in total. The effect of reversing the valuation reserve increased net deferred income taxes in the amount of $3.4 million, with a resulting decrease in income tax expense. The net impact of these two items was a reduction of the amount of our income tax in 2017.
Net Income Available to Common Stockholders. Net income available to common stockholders was $16.0 million or $1.38 per basic and $1.35 per diluted common share for the year ended December 31, 2017 compared to net income available to common stockholders of $13.2 million or $1.21 per basic and $1.20 per diluted common share for the year ended December 31, 2016. The increase in net income available to common stockholders for 2017 was primarily the result of the $9.2 million increase in net interest income, partially offset by increases of $5.2 million in non-interest expenses and $1.3 million in income tax expense and a $455 thousand decrease in non-interest income.
Comparison of Financial Condition at December 31, 2018 and 2017
Investment Securities. Our portfolio consists primarily of investment grade securities including U.S. Treasury securities, U.S. government agency securities, U.S. government sponsored entity securities, corporate bonds, securities issued by states, counties and municipalities, mortgage backed securities (“MBS”), certain equity securities (recorded at cost), Federal Home Loan Bank stock, Maryland Financial Bank stock, and Atlantic Community Bankers Bank stock.
We have prudently managed our investment portfolio to maintain liquidity and safety. The portfolio provides a source of liquidity and collateral for borrowings as well as a means of diversifying our earning asset portfolio. While we usually intend to hold the investment securities until maturity, currently we classify all of our investment securities as available for sale. This classification provides us the opportunity to divest of securities that may no longer meet our liquidity objectives. We account for investment securities at fair value and report the unrealized appreciation and depreciation as a separate component of stockholders’ equity, net of income tax effects. Although we may sell securities to reposition the portfolio, generally, we invest in securities for the yield they produce and not to profit from trading the securities. We continually evaluate our investment portfolio to ensure it is adequately diversified, provides sufficient cash flow and does not subject us to undue interest rate risk. There are no trading securities in our portfolio.
The available for sale investment securities at December 31, 2018 amounted to $219.7 million, an increase of $1.4 million, or 0.62%, from the December 31, 2017 amount of $218.4 million. As outlined above, at December 31, 2018, all securities were classified as available for sale. During the twelve months ended December 31, 2018, we received $72.4 million in proceeds from sales, maturities or calls of, and principal pay-downs on, investment securities. This includes our sale of $51.7 million of securities that we acquired in the BYBK merger and sold immediately after the closing of the merger, resulting in no gain or loss on such sales. We used the proceeds of these securities sales primarily to fund loan growth. By comparison, we sold approximately $53.8 million of investment securities during 2017, $41.8 million of which was from, and sold immediately after, the DCB merger; we also had $7.6 million of investment securities that were called or matured during 2017. We realized gains of $164 thousand and losses of $129 thousand for a total realized net gain of $35 thousand on the sale of investment securities for the twelve months ended December 31, 2017. Principal pay downs on our MBS portfolio was $15.9 million during 2017. We used the proceeds of these securities sales to purchase $51.0 million of investment securities with a slightly higher book yield.
The fair value of available for sale securities included net unrealized losses of $7.6 million at December 31, 2018 (reflected as $5.5 million net of taxes) compared to net unrealized losses of $3.9 million (reflected as $2.3 million net of taxes) at December 31, 2017. The decline in the value of the investment securities is due to an increase in market interest rates, which resulted in a decrease in bond values. We have evaluated securities with larger unrealized losses not backed by the U.S. government and unrealized losses for an extended period of time and determined that these losses are temporary, because at this point in time, we expect to hold them until maturity. We have no intent or plan to sell these securities, it is not likely that we will have to sell these securities and we have not identified any portion of the loss that is a result of credit deterioration in the issuer of the security. As the maturity date moves closer and/or interest rates decline, any unrealized losses in the portfolio are expected to decline or dissipate.
The following table sets forth a summary of the investment securities portfolio as of the dates indicated. Available for sale securities are reported at estimated fair value.
|Available For Sale Securities|
|U.S. government agency||18,606,178||17,733,766||7,266,315|
|Mortgage backed securities||98,479,054||103,400,054||113,384,665|
|Total Available for Sale Securities||$||219,705,762||$||218,352,558||$||199,505,204|
The following table shows the maturities for the securities portfolio at December 31, 2018:
|1 year or less||$||1,504,828||$||1,503,516||2.24|
|After 1 year through 5 years||1,498,582||1,488,984||2.09|
|After 5 years through 10 years||-||-|
|After 10 years||3,003,410||2,992,500|
|U. S. government agencies|
|1 year or less||-||-||-|
|After 1 year through 5 years||-||-||-|
|After 5 years through 10 years||11,005,726||10,692,505||2.85|
|After 10 years||8,117,927||7,913,672||2.78|
|1 year or less||1,000,000||997,595||2.05|
|After 1 year through 5 years||2,500,000||2,498,351||2.63|
|After 5 years through 10 years||18,615,768||18,843,380||5.56|
|After 10 years||-||-|
|1 year or less||275,000||275,355||3.70|
|After 1 year through 5 years||832,450||829,586||1.97|
|After 5 years through 10 years||32,279,147||31,404,369||2.24|
|After 10 years||46,030,323||44,779,394||2.69|
|1 year or less||-||-||-|
|After 1 year through 5 years||63,637||64,599||4.18|
|After 5 years through 10 years||3,649,345||3,497,177||1.67|
|After 10 years||99,961,408||94,917,279||2.41|
We have pledged U.S. government and municipal securities to customers who require collateral for overnight repurchase agreements and deposits. While we classify MBS based on the maturity date, the contractual maturities of these securities are not reliable indicators of their expected life because mortgage borrowers have the right to prepay mortgages at any time. Additionally, the issuer may call the U.S. government callable agency securities listed above prior to the contractual maturity. The weighted average yield in the table above does not include tax equivalent computation on tax exempt obligations.
Loan Portfolio. Net of allowance, unearned fees and origination costs, loans held for investment increased $712.9 million or 42.02% to $2.4 billion at December 31, 2018 from $1.7 billion at December 31, 2017. Commercial real estate loans increased by $365.2 million, residential real estate loans by $212.9 million, commercial and industrial loans by $143.9 million, and consumer loans decreased by $8.6 million, from their respective balances at December 31, 2017. The loan growth during the year was due to the loans that we acquired in the BYBK acquisition and, to a lesser extent, organic growth, primarily in our commercial real estate and construction permanent loan portfolios, resulting from the addition of several experienced loan officers to our team over the last year and our enhanced presence in our market area. The acquisition of the Bay Bank loan portfolio accounted for approximately $477.3 million of the growth in net loans held for investment during the year ended December 31, 2018.
Loans held for sale was $11.6 million at December 31, 2018, compared to $4.4 million at December 31, 2017. We originated $105.5 million loans sold in the secondary market resulting in income on the sale of loans of $1.8 million for the twelve months ended December 31, 2018, a decrease of $498 thousand compared to 2017.
Most of our lending activity occurs within the state of Maryland in the suburban Washington, D.C. and Baltimore market areas in Baltimore City and Anne Arundel, Baltimore, Calvert, Carroll, Charles, Frederick, Harford, Howard, Montgomery, Prince George’s and St. Mary’s Counties. The majority of our loan portfolio consists of commercial real estate loans and residential real estate loans.
Major classifications of loans held for investment at December 31, 2018, 2017, 2016, 2015 and 2014 are as follows:
|December 31, 2018||December 31, 2017|
|Commercial Real Estate|
|Land and A&D||71,908,761||21,760,867||93,669,628||67,310,660||9,230,771||76,541,431|
|Residential Real Estate|
|First Lien-Owner Occupied||108,696,078||140,221,589||248,917,667||67,237,699||62,524,794||129,762,493|
|Residential Land and A&D||42,639,161||16,828,434||59,467,595||35,879,853||6,536,160||42,416,013|
|HELOC and Jr. liens||20,749,184||41,939,123||62,688,307||21,520,339||16,019,418||37,539,757|
|Commercial and Industrial||239,766,662||91,431,724||331,198,386||154,244,645||33,100,688||187,345,333|
|Allowance for loan losses||(7,004,839||)||(466,184||)||(7,471,023||)||(5,738,534||)||(182,052||)||(5,920,586||)|
|Deferred loan costs, net||3,086,635||-||3,086,635||2,013,434||-||2,013,434|
|Total Net Loans||$||1,664,199,967||$||745,027,731||$||2,409,227,698||$||1,350,847,603||$||345,513,828||$||1,696,361,431|
|December 31, 2016||December 31, 2015|
|Commercial Real Estate|
|Land and A&D||51,323,297||6,015,813||57,339,110||50,584,469||7,538,964||58,123,433|
|Residential Real Estate|
|First Lien-Owner Occupied||54,732,604||42,443,767||97,176,371||37,486,858||52,204,717||89,691,575|
|Residential Land and A&D||39,667,222||5,558,232||45,225,454||35,219,801||6,578,950||41,798,751|
|HELOC and Jr. liens||24,385,215||2,633,718||27,018,933||24,168,289||4,350,956||28,519,245|
|Commercial and Industrial||136,259,560||5,733,904||141,993,464||105,963,233||9,519,465||115,482,698|
|Allowance for loan losses||(6,084,478||)||(110,991||)||(6,195,469||)||(4,821,214||)||(88,604||)||(4,909,818||)|
|Deferred loan costs, net||1,257,411||-||1,257,411||1,274,533||-||1,274,533|
|December 31, 2014|
|Commercial Real Estate|
|Land and A&D||40,260,506||4,785,753||45,046,259|
|Residential Real Estate|
|First Lien-Owner Occupied||31,822,773||51,242,355||83,065,128|
|Residential Land and A&D||22,239,663||8,509,239||30,748,902|
|HELOC and Jr. liens||20,854,737||3,046,749||23,901,486|
|Commercial and Industrial||98,310,009||9,694,782||108,004,791|
|Allowance for loan losses||(4,261,835||)||(20,000||)||(4,281,835||)|
|Deferred loan costs, net||1,283,455||(9,923||)||1,273,532|
|(1)||As a result of the acquisitions of Maryland Bankcorp, the parent company of MB&T, in April 2011, WSB Holdings, the parent company of WSB, in May 2013, Regal Bancorp, the parent company of Regal Bank, in December 2015, DCB, the parent company of Damascus in July 2017, and BYBK, the parent company of Bay Bank, in April 2018, we have segmented the portfolio into two components, loans originated by Old Line Bank (legacy) and loans acquired from MB&T, WSB, Regal Bank, Damascus and Bay Bank (acquired).|
The following table presents the maturities or re-pricing periods of loans outstanding at December 31, 2018:
|Loan Maturity Distribution at December 31, 2018|
|1 year or less||1 - 5 years||After 5 years||Total|
|(Dollars in thousands)|
|Commercial Real Estate:|
|Land and A & D||43,000,436||38,721,728||11,947,464||93,669,628|
|Residential First Lien-Investment||23,812,923||92,069,048||36,685,419||152,567,390|
|Residential First Lien-Owner Occupied||21,803,062||12,167,794||199,946,811||233,917,667|
|Residential—Land and A&D||43,965,565||13,908,389||1,593,641||59,467,595|
|HELOC and Jr. Liens||62,287,397||89,774||311,136||62,688,307|
|Commercial and Industrial||116,882,828||99,447,538||114,868,020||331,198,386|
Bank Owned Life Insurance. At December 31, 2018, we have invested $67.9 million in life insurance policies on our executive officers, other officers of Old Line Bank, retired officers of MB&T and former officers of WSB, Regal Bank, Damascus and Bay Bank. BOLI increased $26.3 million during the twelve months ended December 31, 2018, primarily due to $16.3 million of bank owned life insurance we acquired in the BYBK acquisition and $8.5 million in new BOLI policies purchased since December 31, 2017. The increase also includes interest earned on these policies. Gross earnings on BOLI were $1.8 million during the year ended December 31, 2018, which earnings were partially offset by $309 thousand in expenses associated with the policies, for total net earnings of $1.5 million in 2018. We anticipate that the earnings on these policies will continue to help offset our employee benefit expenses as well as our obligations under our salary continuation agreements and supplemental life insurance agreements that we have entered into with our executive officers and that MB&T and WSB had entered into with their executive officers. There are no post-retirement death benefits associated with the BOLI policies owned by Old Line Bank prior to the acquisition of MB&T. We have accrued a $196 thousand liability associated with the post-retirement death benefits of the BOLI policies acquired from MB&T and there are no such benefits related to the BOLI policies acquired from WSB, Regal Bank, Damascus or BYBK.
Annuity Plan. Our annuity plan is an interest earning investment that we purchased to fund a new supplemental retirement plan and amendments to existing retirement plans that will provide lifetime payments to two of our executive officers; we entered into these new agreements as of May 7, 2018, as described in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2018. We invested $6.0 million during the fourth quarter of 2017 and the annuity plan was effective January 1, 2018. The annuity plan was valued at $6.3 million at December 31, 2018.
Other Real Estate Owned. As a result of the acquisitions of MB&T, WSB, Regal Bank, Damascus and Bay Bank, we have segmented the OREO into two components, real estate obtained as a result of loans originated by Old Line Bank (legacy) and other real estate acquired from MB&T, WSB, Regal Bank, Damascus and Bay Bank or obtained as a result of loans originated by MB&T, WSB, Regal Bank and Bay Bank (acquired); we did not acquire any OREO properties as a result of the DCB acquisition. We are currently aggressively either marketing these properties for sale or improving them in preparation for sale.
The following outlines the transactions in OREO during 2018.
|December 31, 2018||Legacy||Acquired||Total|
|Real estate acquired through foreclosure of loans||-||-||-|
|Acquisition of Bay Bancorp, Inc.||-||1,041,079||1,041,079|
|Addiitonal valuation adjustment of real estate owned||(33,840||)||(33,840||)|
|Sales/deposits on sales||(425,000||)||(1,650,790||)||(2,075,790||)|
|Net realized gain/(loss)||(52,937||)||(52,937||)|
|Total end of period||$||-||$||882,510||$||882,510|
Goodwill and Core Deposit Intangible. At December 31, 2018, goodwill was $94.7 million and consisted of $633,790 related to the MB&T acquisition, $7.2 million related to the WSB acquisition, $2.0 million related to the Regal Bank acquisition, $15.3 million related to the Damascus acquisition and $69.6 million related to the Bay Bank acquisition. As a result of the acquisitions of MB&T, WSB, Regal Bank, Damascus and Bay Bank, we recorded core deposit intangibles of $21.1 million. This amount represented the premium that we paid to acquire MB&T, WSB, Regal Bank, Damascus, and Bay Bank’s core deposits over the fair value of such deposits. We are amortizing MB&T’s core deposit intangible on an accelerated basis over its estimated useful life of 18 years, WSB’s over its estimated useful life of ten years, Regal Bank’s over its estimated useful life of eight years, Damascus’ over its estimated useful life of eight years, and Bay Bank’s over its estimated useful life of 20 years. The core deposit intangible was $15.4 million and $6.3 million, respectively, at December 31, 2018 and 2017.
Deposits. Deposits increased $643.1 million, or 38.91%, to $2.3 billion at December 31, 2018, compared to $1.7 billion at December 31, 2017. This increase was comprised of a $107.3 million increase in our non-interest bearing deposits, to $559.1 million at December 31, 2018, and a $535.9 million increase in our interest bearing deposits, to $1.7 billion at December 31, 2018. These increases are due predominantly to the deposits acquired in the BYBK acquisition, which added approximately $541.4 million in deposits, as well as, to a lesser extent, new organic deposits, which increased approximately $101.7 million during the year ended December 31, 2018, due to the addition of several experienced loan officers to our team over the last year and our enhanced presence in our market area.
The following table outlines the growth in interest bearing deposits during 2018:
|December 31,||December 31,|
|2018||2017||$ Change||% Change|
|(Dollars in thousands)|
|Certificates of deposit||$||865,255||$||530,027||$||335,228||63.25||%|
|Interest bearing checking||657,061||538,102||118,959||22.11|
We acquired brokered money market and certificate of deposits through the Promontory Interfinancial Network (“Promontory”). Through this deposit matching network and its certificate of deposit account registry service (CDARS) and money market account service, we have the ability to offer our customers access to FDIC-insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through Promontory on behalf of a customer, we receive matching deposits through the network’s reciprocal deposit program. We can also place deposits through this network without receiving matching deposits. At December 31, 2018, we had $47.9 million in CDARS and $168.8 million in money market accounts through Promontory’s reciprocal deposit program compared to $49.2 million and $144.9 million, respectively, at December 31, 2017.
We do not currently have any brokered certificates of deposits other than CDARS. Old Line Bank did not obtain any brokered certificates of deposit during the year ended December 31, 2018. We may, however, use brokered deposits in the future as an element of our funding strategy if and when required to maintain an acceptable loan to deposit ratio.
The following is a summary of the maturity distribution of certificates of deposit of $100,000 or more at December 31, 2018.
|Certificate of Deposit Maturity Distribution|
|December 31, 2018|
|Over Three||Over Six|
|Three Months||Months through||Months through||Over|
|(Dollars in thousands)|
|Certificates of deposit|
|Time certificates of deposit $100,000 or more||$||69,138||$||53,930||$||171,237||$||288,008||$||582,313|
|Other time deposits of $100,000 or more||26,294||11,401||7,266||958||45,919|
Borrowings. Our borrowings consist of unsecured short-term promissory notes, securities sold under agreements to repurchase, a long-term senior note, the Notes, trust preferred subordinated debentures assumed in the Regal merger and, from time to time, advances from the FHLB. At December 31, 2018, borrowings totaled $266.6 million, an increase of $35.8 million from December 31, 2017. The increase was primarily due to increases in the FHLB daily rate advance. We used the additional borrowings primarily to fund new loan originations.
The following is a summary of our short-term and long-term borrowings at December 31, 2018, 2017 and 2016:
|December 31. 2018|
|Balance at End||Interest||Any Month||Balance||During|
|of Year||Rate||End||During Year||Year|
|FHLB daily rate advance||35,000,000||2.11||60,000,000||36,339,726||2.11|
|FHLB fixed rate advances||155,000,000||1.85||230,000,000||205,518,842||1.89|
|Total short-term borrowings||228,184,856||332,444,858||269,328,460|
|Senior note, fixed at 6.28%||-||-||-||-||-|
|Subordinated Note - fixed to floating, due 2026||35,000,000||35,000,000||35,000,000|
|Discount on subordinated note||(400,151||)||(448,192||)||(428,362||)|
|Issuance cost for subordinated note||(416,893||)||(466,944||)||(446,284||)|
|Net carrying value for subordinated note||34,182,956||5.625||34,084,864||34,125,354||5.625|
|Trust 1 - Floating 90-day LIBOR plus 2.85%, due 2034||4,000,000||4.78|
|Acquisition fair value adjustment||(1,378,199||)|
|Trust 2 - Floating 90-day LIBOR plus 1.60%, due 2035||2,500,000||3.53|
|Acquisition fair value adjustment||(1,135,466||)|
|Stock on subordinated debentures||202,000|
|Net carrying value||4,188,335||4.29||3,842,266||4,104,227||5.00|
|Total long-term borrowings||$||38,371,291||72,011,994||72,354,935|
|December 31. 2017|
|Balance at End||Interest||Any Month||Balance||During|
|of Year||Rate||End||During Year||Year|
|FHLB daily rate advance||45,000,000||1.59||45,000,000||28,098,630||1.22|
|FHLB fixed rate advances||110,000,000||1.40||165,000,000||176,881,966||0.97|
|Total short-term borrowings||192,611,971||247,611,971||232,450,488|
|Senior note, fixed at 6.28%||-||-||-||-||-|
|Subordinated Note - fixed to floating, due 2026||35,000,000||35,000,000||35,000,000|
|Discount on subordinated note||(452,651||)||(500,692||)||(480,755||)|
|Issuance cost for subordinated note||(471,590||)||(521,641||)||(500,870||)|
|Net carrying value for subordinated note||34,075,759||5.625||33,977,667||34,018,375||5.625|
|Trust 1 - Floating 90-day LIBOR plus 2.85%, due 2034||4,000,000||4.39|
|Acquisition fair value adjustment||(1,468,572||)|
|Trust 2 - Floating 90-day LIBOR plus 1.60%, due 2035||2,500,000||3.14|
|Acquisition fair value adjustment||(1,202,257||)|
|Stock on subordinated debentures||202,000|
|Net carrying value||4,031,171||3.91||3,887,101||3,947,384||4.34|
|Total long-term borrowings||$||38,106,930||71,842,435||71,984,134|
|December 31, 2016|
|Balance at End||Interest||Any Month||Balance||During|
|of Year||Rate||End||During Year||Year|
|FHLB daily rate advance||30,000,000||0.80||54,000,000||32,263,661||0.65|
|FHLB adjustable rate advances||-||-||4,000,000||1,478,698||0.59|
|FHLB fixed rate advances||120,000,000||0.61||159,000,000||104,822,830||0.39|
|Total short-term borrowings||183,433,892||250,880,864||169,138,208|
|Senior note, fixed at 6.28%||-||-||5,865,438||3,887,114||6.28|
|Subordinated Note - fixed to floating, due 2026||35,000,000||35,000,000||11,953,552|
|Discount on subordinated note||(505,151||)||(525,000||)||176,174|
|Issuance cost for subordinated note||(526,286||)||(535,427||)||173,339|
|Net carrying value for subordinated note||33,968,563||5.625||33,939,573||12,303,065||5.625|
|Trust 1 - Floating 90-day LIBOR plus 2.85%, due 2034||4,000,000||3.82|
|Acquisition fair value adjustment||(1,558,946||)|
|Trust 2 - Floating 90-day LIBOR plus 1.60%, due 2035||2,500,000||2.57|
|Acquisition fair value adjustment||(1,269,050||)|
|Stock on subordinated debentures||202,000|