This section is intended to help readers understand our financial performance
through a discussion of the factors affecting our consolidated financial
condition. This section should be read in conjunction with the consolidated
financial statements and accompanying notes.
Overview Bancorp is the holding company for the Bank. The Bank is a trust company chartered under Subtitle 2 of Title 3 of the Financial Institutions Article of the Annotated Code of
Maryland. The Bank was formed in March 2004and commenced banking operations on August 9, 2004. The Bank does not exercise trust powers, and our regulatory structure is the same as a Maryland-chartered commercial bank. As such, our business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. Typically, commercial real estate and business loans involve a higher degree of risk and carry a higher yield than one-to four-family residential loans. Although we plan to continue to focus on commercial customers, we intend to increase our originations of one- to four-family residential mortgage loans going forward, increasing our portfolio of mortgage lending and also selling select loans into the secondary markets. We are headquartered in Ellicott City, Marylandand we consider our primary market area to be The Greater BaltimoreMetropolitan Area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services to small to medium sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are primarily funded by core deposits of customers in our market. Our core business strategy is to deliver superior customer service that is supported by an extremely high level of banking sophistication. Our specialized community banking focus on both local markets and small business related market segments is combined with a broad array of products, new technology and seasoned banking professionals which positions the Bank differently than most competitors. Our experienced executives establish a relationship with each client and bring value to all phases of a client's business and personal banking needs. We call it Hands-On Service. Our results of operations depend mainly on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios and the interest expense we pay on deposits and borrowings. Results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest expense consists primarily of compensation and employee benefits, as well as office occupancy, business development, deposit insurance and general administrative and data processing expenses. Our operations are significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially affect our financial condition and results of operations. Total assets increased by over $33.6 millionor 6.7% when comparing June 30, 2014assets of $533.5 millionto the $499.9 millionat December 31, 2013. Total loans outstanding of $433.3 millionat the end of June 2014, showed an increase of $29.5 millionor 7.3% compared to total loans of $403.9 millionon December 31, 2013. Total deposits grew by $33.4 millionor 8.6% when comparing June 30, 2014to December 31, 2013. Net income was $1.0 millionduring the first half of both 2014 and 2013, and $.7 millionand $.5 million, respectively, during the three months ended June 30, 2014and 2013. Net interest income for the six months ended June 30, 2014was $9.3 millionversus $7.3 millionfor the first six months of 2013, an increase of approximately $2.0 millionor 27.4%. Total noninterest income was $0.6 millionfor the first half of 2013, compared to $2.7 millionfor the same period in 2014. The first half 2014 noninterest income was primarily impacted by increased mortgage banking activities of $1.3 million. Total noninterest expenses increased by $4.0 millionfrom $5.8 millionfor the six months ended June 30, 2013to $9.8 millionfor the same period in 2014. Most of the increase in expenses was due to additional compensation costs as we continued to expand our staff. During the first half of 2014, we have spent considerable financial and nonfinancial resources in putting together a highly professional team of mortgage bankers. To accommodate the mortgage banking initiative, we have leased additional office space in Annapolis, Maryland, and opened mortgage offices in Columbia, Marylandand in Timonium, Maryland. Over the twelve months from June 30, 2013to June 30, 2014, we added three new branch locations in Towson, Maryland, Bel Air, Maryland, and Aberdeen, Maryland, in addition to opening a regional office in Towson. This dramatic increase of both customer service offices and the related staff additions geographically extends our market presence and our brand, and provides a platform for continued growth in size and revenues.
In the second quarter of 2014, the Bank executed an agreement to acquire approximately
24 Critical Accounting Policies
Our accounting and financial reporting policies conform to GAAP and general practice within the banking industry. Accordingly, the financial statements require management to exercise significant judgment or discretion or make significant assumptions based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. In reviewing and understanding financial information for us, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements. We consider the allowance for credit losses to be our most significant accounting policy, which is further described in the notes to the financial statements. The allowance for credit losses is established through a provision for credit losses charged against income. Loans are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent losses in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on impacted loans, value of collateral, estimated losses on our loan portfolios as well as consideration of general loss experience. Based on our estimate of the level of allowance for credit losses required, we record a provision for credit losses to maintain the allowance for credit losses at an appropriate level. We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with respect to the allowance for credit losses. In addition, our regulatory agencies, as an integral part of their examination processes, periodically review our allowance for credit losses. Such agencies may require that we recognize additions to the allowance for credit losses based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes differ from management's estimates, additional provisions to the allowance for credit losses may be required that would adversely impact earnings in future periods.
We account for income taxes under the asset/liability method. We recognize deferred tax assets for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred tax assets could change in the near term. We follow the provisions of ASC Topic 718 "Compensation," which requires the expense recognition over a service period for the fair value of share based compensation awards, such as stock options, restricted stock, and performance based shares. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates which directly impact estimated fair value. The accounting standard also allows for the use of alternative option pricing models which may impact fair value as determined. Our practice is to utilize reasonable and supportable assumptions which are reviewed with the appropriate Board committee.
Balance Sheet Analysis and Comparison of Financial Condition
A comparison between
Assets Total assets increased
$33.6 million, or 6.7%, to $533.5 millionat June 30, 2014compared to $499.9 millionat December 31, 2013. This asset growth was primarily due to $29.5 milliongrowth in total loans, partially offset by decreases of $9.2 millionin cash and cash equivalents and $12.6 millionin investment securities. In addition, total assets were impacted by the increase in loans held for sale, which are directly attributable to the Bank's newly created mortgage banking division. The asset growth was funded primarily from increases in customer deposits, which increased from $388.9 millionat December 31, 2013to $422.3 millionat June 30, 2014, an increase of $33.4 millionor 8.9%. 25
Securities Available for Sale
We currently hold both U.S. agency securities and mortgage backed securities in our securities portfolio, all of which are categorized as available for sale. Our securities portfolio is used to provide the required collateral for funding via commercial customer repurchase agreements as well as to provide sufficient liquidity to fund our loans and provide funds for withdrawals of deposited funds. At
June 30, 2014and December 31, 2013we held an investment in stock of the Federal Home Loan Bank of Atlanta("FHLB") of $2.6 millionand $2.3 million, respectively. This investment is required for continued FHLB membership, and is based partially upon the amount of borrowings outstanding from the FHLB. These investments are carried at cost. We have never held stock in Fannie Mae or Freddie Mac.
The following tables set forth the composition of our investment securities portfolio at the dates indicated.
(in thousands) June 30, 2014 December 31, 2013 Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value U.S. Government agencies
$ 15,998 $ 15,999 $ 28,522 $ 28,521Mortgage-backed 123 131 157 167 $ 16,121 $ 16,130 $ 28,679 $ 28,688
We had securities available for sale of
$16.1 millionand $28.7 millionat June 30, 2014and December 31, 2013, respectively, which were recorded at fair value. This represents a decrease of $12.6 million, or 43.8%, from the prior year end. The decrease in our securities portfolio resulted from scheduled maturities, and we used the funds received to partially fund the growth in loans and loans held for sale, while maintaining an appropriate amount of securities to collateralize our repurchase agreements at June 30, 2014. We did not record any gains or losses on the sales or calls of securities or mortgage backed securities in either period presented. With respect to our total portfolio of securities available for sale, we held no securities that had unrealized losses at June 30, 2014, and at December 31, 2013held certain securities that had unrealized losses of less than $1 thousand. The minimal changes in the fair value of these securities resulted primarily from interest rate fluctuations. Loan and Lease Portfolio Total loans and leases increased by $29.5 millionor 7.3%, to $433.3 millionat June 30, 2014from $403.9 millionat December 31, 2013. At June 30, 2014, total loans were 81.2% of total assets, up from 80.8% of total assets at December 31, 2013. As the economy in our market area has started to improve so has demand for certain types of credit, especially commercial real estate, commercial and construction loans. In addition, with the expansion of our mortgage banking activities, our portfolio of residential mortgages also reflected growth during the six month period.
The following table sets forth the composition of our loan portfolio at the dates indicated. We had loans held for sale of
June 30, December 31, (in thousands) 2014 % of Total 2013 % of Total Real estate Construction and land
$ 62,34914.4 % $ 50,88412.6 % Residential - first lien 52,794 12.2 39,249 9.7 Residential - junior lien 9,362 2.2 8,266 2.0 Total residential real estate 62,156 14.3 47,515 11.7 Commercial - owner occupied 88,374 20.4 90,333 22.4
Commercial - non-owner occupied 111,101 25.6 113,559
28.1 Total commercial real estate 199,475 46.0 203,892 50.5 Total real estate loans 323,980 74.8 302,291 74.8 Commercial loans and leases 108,291 25.0 100,410 24.9 Consumer 1,065 0.2 1,174 0.3 Total loans
$ 433,336100.0 % $ 403,875100.0 % 26 Deposits Our deposits increased from $388.9 millionat December 31, 2013to $422.3 millionat June 30, 2014, an increase of $33.4 millionor 8.9%. The increase resulted primarily from increases of $16.5 millionor 17.1% in money market accounts, $8.8 millionor 5.6% in other certificates of deposit and $7.8 millionor 8.7% in non-interest bearing accounts from December 31, 2013to March 31, 2014. Every category of deposit experienced growth from the December 2013levels, with the exception of savings that had a slight decline. The following tables set forth the distribution of total deposits, by account type, at the dates indicated (dollars in thousands) June 30, 2014 December 31, 2013 % of % of Amount Total Amount Total Noninterest-bearing demand $ 97,54023 % $ 89,75923 % Interest-bearing checking 32,027 7 31,443 8 Money market accounts 112,872 27 96,365 25 Savings 12,169 3 12,496 3 Certificates of deposit $100,000and over 120,746 29 110,516 29 Certificates of deposit under $100,00046,981 11
48,370 12 Total deposits
$ 422,335100 % $ 388,949100 % Borrowings
Customer deposits remain the primary source utilized to meet funding needs. Borrowings consist of overnight unsecured master notes, overnight securities sold under agreement to repurchase ("repurchase agreements") and FHLB advances. Our borrowings totaled
$60.1 millionat June 30, 2014and $61.7 millionat December 31, 2013. Short-term borrowings totaled $36.6 millionat June 30, 2014and $45.7 millionat December 31, 2013. We had nine long-term FHLB advances outstanding totaling $23.5 millionat June 30, 2014compared to six FHLB advances outstanding totaling $16 millionat December 31, 2013. Shareholders' Equity Total shareholders' equity increased by $1.0 million, or 2.1%, from $48.6 millionat December 31, 2013to $49.6 millionat June 30, 2014. The increase in shareholders' equity is primarily the result of the retention of the earnings for the first half of 2014. Total shareholders' equity at June 30, 2014represents a capital to asset ratio of 9.3%, while the total shareholders' equity at December 31, 2013represents a capital to asset ratio of 9.7%. Even though capital levels increased, the overall growth in asset levels resulted in a decline in the capital to asset ratio. 27 Average Balance and Yields The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, and have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. For the six months ended June 30, 2014 2013 Average Income Yield Average Income Yield (dollars in thousands) Balance / Expense / Rate Balance / Expense / Rate Earning assets Loans and leases: 1 Commercial loans and leases $ 98,433 $ 2,4485.02 % $ 87,807 $ 2,1054.83 % Commercial real estate 202,984 4,888 4.86 162,697 4,040 5.01 Construction and land 55,146 1,462 5.34 39,692 1,050 5.34 Residential real estate 54,487 1,170 4.33 38,029 835 4.43 Consumer 1,017 29 5.80 1,226 31 5.08 Total loans and leases 412,067 9,997 4.89 329,450 8,062 4.93 Loans held for sale 15,245 265 3.51 1,390 24 3.48 Federal funds sold 20,908 21 0.20 21,231 23 0.22 Securities: 2 U.S Gov agencies 21,086 11 0.11 15,724 18 0.22 Mortgage-backed 150 3 4.54 294 7 4.58 Other investments 2,386 43 3.60 1,555 16 2.13 Total securities 23,622 57 0.49 17,573 41 0.47 Total earning assets 471,842 10,340 4.42 369,645 8,149 4.45 Cash and due from banks 5,311 4,702
Bank premises and equipment, net 11,251
Other assets 17,528
Less: allowance for credit losses (2,696 )
(2,886 ) Total assets
$ 503,236 $ 395,076Interest-bearing liabilities Deposits:
Interest-bearing demand accounts
$ 31,857 $ 400.25
$ 25,054 $ 350.28 % Money market 102,021 210 0.42 74,613 174 0.47 Savings 12,659 15 0.24 11,991 25 0.41
$100,000and over 70,543 412 1.18 55,438 332 1.21 Other time deposits 87,952 249 0.57 58,557 220 0.76 Total interest-bearing deposits 305,032 926 0.61
225,653 786 0.70 Short-term borrowings 36,602 56 0.31 22,501 57 0.51 Long-term borrowings 18,972 101 1.08 13,017 40 0.63 Total interest-bearing funds 360,606 1,083 0.61 261,171 883 0.68 Noninterest-bearing deposits 92,870 85,736 Other liabilities and accrued expenses 780 923 Total liabilities 454,256 347,830 Shareholders' equity 48,980 47,246 Total liabilities & shareholders' equity
$ 503,236 $ 395,076Net interest rate spread 3 $ 9,2573.81 % $ 7,2663.76 % Effect of noninterest-bearing funds 0.14 0.20 Net interest margin on earning assets 4 3.96 % 3.96 %
(1) Loan fee income is included in the interest income calculation, and
nonaccrual loans are included in the average loan base upon which the
interest rate earned on loans is calculated.
(2) Available for sale securities and loans held for sale are presented at fair
(3) Net interest rate spread represents the difference between the yield on
average interest-earning assets and the cost of average interest-bearing
(4) Net interest margin represents net interest income divided by average total interest-earning assets. 28 For the three months ended June 30, 2014 2013 Average Income Yield Average Income Yield (dollars in thousands) Balance / Expense / Rate Balance / Expense / Rate Earning assets Loans and leases: 1 Commercial loans and leases
$ 100,173 $ 1,2745.10 % $ 90,683 $ 1,0634.70 % Commercial real estate 202,813 2,463 4.87 165,843 2,059 4.98 Construction and land 58,240 786 5.42 41,687 563 5.41 Residential real estate 58,638 630 4.31 38,123 419 4.41 Consumer 1,058 15 5.84 1,220 15 5.06 Total loans and leases 420,922 5,168 4.92 337,556 4,119 4.89 Loans held for sale 22,733 195 3.44 903 10 4.44 Federal funds sold 15,857 7 0.18 21,231 12 0.23 Securities: 2 U.S. Gov agencies 16,477 5 0.12 12,218 7 0.21 Mortgage-backed 141 2 4.51 271 3 4.47 Other investments 2,517 20 3.26 1,623 9 2.24 Total securities 19,135 27 0.56 14,112 19 0.53 Total earning assets 478,647 5,397 4.52 373,802 4,160 4.46 Cash and due from banks 5,503 4,832
Bank premises and equipment, net 11,438
Other assets 17,368
Less: allowance for credit losses (2,804 )
(2,955 ) Total assets
$ 510,152 $ 399,286Interest-bearing liabilities Deposits:
Interest-bearing demand accounts
$ 32,277 $ 200.25 % $ 26,012 $ 180.28 % Money market 104,289 116 0.45 75,389 88 0.47 Savings 12,569 7 0.21 12,322 13 0.41
$100,000and over 72,055 220 1.22 54,560 169 1.24 Other time deposits 89,859 122 0.54 61,974 110 0.71 Total interest-bearing deposits 311,049 485 0.63
230,257 398 0.69 Short-term borrowings 34,068 25 0.29 21,407 27 0.51 Long-term borrowing 21,522 58 1.08 13,934 19 0.55 Total interest-bearing funds 366,639 568 0.62 265,598 444 0.67 Noninterest-bearing deposits 93,625 85,417 Other liabilities and accrued expenses 740 867 Total liabilities 461,004 351,882 Shareholders' equity 49,148 47,404 Total liabilities & shareholders' equity
$ 510,152 $ 399,286Net interest rate spread 3 $ 4,8293.90 % $ 3,7163.79 % Effect of noninterest-bearing funds 0.15 0.19 Net interest margin on earning assets 4 4.05 % 3.99 %
(1) Loan fee income is included in the interest income calculation, and
nonaccrual loans are included in the average loan base upon which the
interest rate earned on loans is calculated.
(2) Available for sale securities and loans held for sale are presented at fair
(3) Net interest rate spread represents the difference between the yield on
average interest-earning assets and the cost of average interest-bearing
(4) Net interest margin represents net interest income divided by average total
interest-earning assets. 29 Rate/Volume Analysis The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column is further broken down to show the impact of changes in either rates or volumes. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume. For the six months ended June 30, For the three months ended June 30, 2014 vs. 2013 2014 vs. 2013 Due to variances in Due to variances in (in thousands) Total Rates Volumes 1 Total Rates Volumes 1 Interest earned on: Loans and leases: Commercial loans and leases
$ 343 $ 159$
$ 211 $ 361 $ (150 )Commercial real estate 848 (246 ) 1,094 404 (181 ) 585 Construction and land 412 4 408 223 0 223 Residential real estate 335 (38 ) 373 211 (39 ) 250 Consumer (2 ) 9 (11 ) 0 10 (10 ) Loans held for sale 241 0 241 185 (9 ) 194 Taxable securities 16 4 12 8 5 3 Federal funds sold (2 ) (4 ) 2 (5 ) (12 ) 7 Total interest income 2,191 (112 ) 2,303 1,237 135 1,102 Interest paid on: Savings deposits (10 ) (22 ) 12 (6 ) (25 ) 19
Checking plus interest deposits 5 (7 ) 12 2 (7 ) 9 Money market accounts 36 (40 ) 76 28 (16 ) 44 Time deposit
$100,000and over 80 (16 )
96 51 (11 ) 62 Other time deposits 29 (110 ) 139 12 (104 ) 116 Short-term borrowings (1 ) (45 ) 44 (2 ) (46 ) 44 Long-term borrowing 61 59 2 39 74 (35 ) Total interest expense 200 (181 ) 381 124 (135 ) 259 Net interest earned
$ 1,991 $ 69 $ 1,922 $ 1,113 $ 270 $ 843
(1) Change attributed to mix (rate and volume) are included in volume variance
Comparison of Results of Operations
A comparison between the six months ended
General Net income available to common shareholders increased
$45 thousand, or 5.0%, to $940 thousandfor the six months ended June 30, 2014compared to $895 thousandfor the six months ended June 30, 2013. This increase was primarily due to an increase in total revenues of $4.0 millionor 51.0%, led by growth in net interest income and higher noninterest income from our mortgage banking activities, offset by an increase in noninterest expenses of $4.0 millionor 69.7% given our recent investments in geographic expansion and the commencement of our mortgage operations. Interest Income
Interest income increased
$2.2 million, or 26.9%, to $10.3 millionfor the six months ended June 30, 2014compared to $8.1 millionfor the same period in 2013. The increase was due to a $2.2 millionor 26.9% increase in interest income on loans and leases, and included $265 thousandin interest on mortgage loans held for sale. The increase in interest income on loans was due to a nearly $83 millionor 25.1% increase in the average balance of the loan portfolio during the six months ended June 30, 2014compared to the six months ended June 30, 2013. In addition to the growth in our portfolio of loans, an increase of $13.9 millionin the average balance of loans held for sale drove a $241 thousandincrease in interest income on loans held for sale. Interest income from our securities portfolio increased $16 thousandor 39.0% primarily as a result of a 34.4% increase in their average balances. 30 Interest Expense
Interest expense increased by
$200 thousand, or 22.6%, to $1.1 millionfor the six months ended June 30, 2014, compared to $0.9 millionfor the same period in 2013. Even though we were able to grow average interest bearing sources of funds by $79.4 millionor 35.2% for the first half of 2014 compared to the first half of 2013, total interest expense only rose 17.8% as the average rates paid on deposits decreased from .70% to .61% when comparing the two periods, primarily as a result of a continuing shift in the composition of our deposits towards lower cost deposit products including noninterest-bearing deposits, the average balance of which grew $7.1 millionwhen comparing the six months ended June 30, 2014to the same period of the prior year. In addition to the growth of deposits, the average balance of borrowings increased 55.2% which also increased overall interest expense. Net Interest Income Net interest income is our largest source of operating revenue. Net interest income is affected by various factors including changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities and maturities. Net interest income is determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income increased $2.0 million, or 27.4%, during the six months ended June 30, 2014compared to the six months ended June 30, 2013. As noted above, the increase in net interest income was primarily due to an increase in interest income of $2.2 million, reduced by an increase of $200 thousandin interest expense. Provision for Credit Losses
We establish a provision for credit losses, which is a charge to earnings, in order to maintain the allowance for credit losses at a level we consider adequate to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for credit losses, management considers past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower's ability to repay a loan and the levels of nonperforming loans. The amount of the allowance is based on estimates and actual losses may vary from such estimates as more information becomes available or economic conditions change. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as circumstances change as more information becomes available. The allowance for credit losses is assessed on a quarterly basis and provisions are made for credit losses as required in order to maintain the allowance. Based on management's evaluation of the above factors, we had a provision for credit losses of
$501 thousandfor the six months ended June 30, 2014compared to $526 thousandfor the same period in 2013, a decrease of $25 thousand. The provision for 2014 reflects additional general provisions that are required given our continued growth in the size of the loan portfolio, as well as any specific provisions required on loans that are individually evaluated and deemed to be impaired. Management analyzes the allowance for credit losses as described in the section entitled "Allowance for Credit Losses." The provision that is recorded is sufficient, in management's judgment, to bring the allowance for credit losses to a level that reflects the losses inherent in our loan portfolio relative to loan mix, economic conditions and historical loss experience. Management believes, to the best of its knowledge, that all known losses as of the balance sheet dates have been recorded. However, although management uses the best information available to make determinations with respect to the provisions for credit losses, additional provisions for credit losses may be required to be established in the future should economic or other conditions change substantially. In addition, as an integral part of their examination process, the Commissioner and the Federal Deposit Insurance Corporation("FDIC") will periodically review the allowance for credit losses. The Commissioner and the FDICmay require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.
Noninterest income was
$2.7 millionfor the six months ended June 30, 2014compared to $0.6 millionfor the six months ended June 30, 2013, a $2.0 millionincrease. The largest increase was generated from mortgage banking activities. Realized and unrealized gains from these activities increased from $0.1 millionin the first half of 2013 to 1.5 million in the first half of 2014, and included the effect of implementing the fair value method for mortgage loans held for sale which accelerated mortgage related revenues by $836 thousand. Fees generated from mortgage banking, included in other operating income, increased 100% for the first half of 2014 compared to the comparable prior year period, representing $376 thousandin revenues. Additionally, the approximately $3.0 millionexpansion of our BOLI program in generated an increase of $49 thousandin income from bank owned life insurance, to $186 thousandduring the first six months of 2014 compared to $137 thousandduring the first half of 2013. Service charges on deposit accounts, which consists of account activity fees and other traditional banking fees, increased 82.5% to $307 thousandfor the six months ended June 30, 2014from $168 thousandfor the same period in 2013 due mostly to an increase in overdraft-related fees. Other operating income, besides fees generated from mortgage banking activities, consists mainly of certain loan fees and non-depository account fees. Noninterest income benefited in the first half of 2014 from loan fees of $31 thousandassociated with letters of credit from two credit relationships. These fees for customer related services such as wire, merchant card and ATM increased $26 thousandduring the six months ended June 30, 2014compared to the same period of 2013 due to increases in these transactions. 31 Noninterest Expenses Noninterest expenses increased $4.0 millionor 69.7%, to $9.8 millionfor the six months ended June 30, 2014from $5.8 millionfor the six months ended June 30, 2013. This increase reflects the large investments in staff and infrastructure made during the first half of 2014 to build the mortgage banking platform, which is also evident in the additional revenues that were generated, from continuing branch expansion efforts, and increased marketing related to our business development initiatives. Compensation and employee benefits increased $2.3 millionor 68.9% in the first six months of 2014 compared to the same period in 2013. Full time equivalent employees at June 30, 2014increased nearly 50% from June 30, 2013as the Bank has built its mortgage banking team, added branch and other sales staff, and also expanded support and compliance areas of the Bank. The increase in occupancy and equipment costs of $309 thousandor 41.3% reflects our adding three new branch locations, a regional office, and two additional mortgage offices since June 30, 2013. Our newly established mortgage banking group had an impact on nearly all areas of our noninterest expenses relating to both start-up and ongoing operating costs when comparing the six months ended June 30, 2014to the six months ended June 30, 2013. Marketing and business development expenses increased a total of $409 thousand, of which $223 thousandpertained to mortgage sales activities. Professional fees consists of legal, consulting and outside service providers, increased $182 thousandin total, $40 thousandrelating to start-up mortgage banking legal matters, and the reminder due to ongoing banking related growth initiatives. Other operating expensed consists of loan related expenses (including credit reports, appraisals and collection costs), and a variety of general expenses such as phone and data lines, supplies and postage and courier services. Of the total $669 thousandincrease in other operating expenses, $362 thousandcorresponded to the development of the mortgage banking infrastructure and a 150% increase in loan related cost associated with the additional volume in processing mortgages requests.
Net Income Available to Common Shareholders
Net income available to common shareholders during the six months ended
June 30, 2014increased $45 thousandor 5.0% to $940 thousandcompared to $895 thousandduring the six months ended June 30, 2013. This reflects our ongoing growth initiatives that included expanding regional markets into Baltimoreand Harfordcounties, and commencing our mortgage banking platform, which depressed earnings for the first quarter, versus the additional revenues that were generated in the second quarter as our mortgage banking operation continues to transition from the building stage into the full operating phase. Preferred stock dividends were lower during the 2014 period because of a reduction in the dividend rate paid on our SBLF Preferred Stock given the growth in applicable loan categories in accordance with the terms of the program.
A comparison between the three months ended
General Net income available to common shareholders increased
$224 thousand, or 46.5%, to $705 thousandfor the three months ended June 30, 2014compared to $481 thousandfor the three months ended June 30, 2013. This resulted in earnings per share increasing to $.17for the second quarter 2014 compared to $.12in the same period of 2013. Interest Income Interest income increased $1.2 million, or 29.8%, to $5.4 millionfor the three months ended June 30, 2014compared to $4.2 millionfor the same period 2013. The increase was primarily due to a $1.2 million, or 30.0%, increase in interest income on loans. The increase in interest income on loans was due to a $83.3 millionor 24.7% increase in the average balance of the loan portfolio compared to the three months ended June 30, 2013, slightly enhanced by a 3 basis point increase in the average yield. In addition to the portfolio loans, the $21.8 millionincrease in the average balance of loans held for sale quarter over quarter contributed to the increase in interest and fees on loans. In addition, interest and dividends on securities increased during the first quarter of 2014 compared to the same period last year as a result of a $5.0 millionincrease in the average balance of investment securities quarter over quarter. Partially offsetting these increases was a decline in interest income on federal funds sold, which decreased $5 thousandover the same period in 2013 as a result of a five basis point decrease in the average yield and a $5.3 milliondecrease in the average balance of federal funds sold quarter over quarter. Interest Expense Interest expense increased $124 thousand, or 27.8%, to $568 thousandfor the three months ended June 30, 2014, compared to $444 thousandfor the same period 2013, primarily as a result of increases in the average balance of both interest-bearing deposits and borrowing of $80.8 millionand $20.2 million, respectively. The average rate paid on interest-bearing deposits decreased to 0.63% during the three months ended June 30, 2014from 0.69% during the same period of 2013, partially offsetting the impact of the increase in the average balances 32 Net Interest Income Net interest income increased $1.1 million, or 29.9%, during the three months ended June 30, 2014compared to the three months ended June 30, 2013. As noted above, the increase in net interest income was due to an increase of $1.2 millionin interest income coupled with only a $0.1 millionincrease in interest expense during the three month period. Provision for Credit Losses Based on management's evaluation, we had a provision for credit losses of $325 thousandfor the three months ended June 30, 2014compared to $165 thousandfor the same period in 2013, an increase of $160 thousand. The provision for the second quarter of 2014 was primarily due to additional general provisions that were required given the continued growth in the size of our loan portfolio.
Noninterest Income Noninterest income was
$2.1 millionfor the three months ended June 30, 2014compared to $0.3 millionfor the three months ended June 30, 2013, a $1.7 millionor 553.4% increase. This increase was primarily due to the $1.3 millionof income generated from the mortgage banking activities during the second
quarter of 2014. Noninterest Expenses Noninterest expenses increased by
$2.3 millionor 75.5%, during the three months ended June 30, 2014compared to the three months ended June 30, 2013. As discussed above with respect to the six month period ended June 30, 2014, expanding regional markets and our mortgage banking platform were the greatest factors impacting the increase in noninterest expenses. Compensation and employee benefits increased $1.1 millionor 64.9% quarter over quarter. Occupancy and equipment expenses increased $227 thousandor 63.2%, as a result of our increased locations as mentioned above. Additionally, as previously stated our mortgage banking initiative has had an impact on all other areas of noninterest expenses. Marketing and business development increased $280 thousand; professional cost increased $99 thousand; data process increased $48 thousand. Other noninterest expense increased nearly 100% to $1.9 millionfor the three months ended June 30, 2014compared to $0.9 millionfor the same period of 2013.
Nonperforming and Problem Assets
Management performs reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a timely manner. When in the best interests of the Bank and the customer, we will do a troubled debt restructure with respect to a particular loan. When not possible, we are aggressively moving loans through the legal and foreclosure process within applicable legal constraints. Loans are generally placed on non-accrual status when payment of principal or interest is 90 days or more past due and the value of the collateral securing the loan, if any, is less than the outstanding balance of the loan. Loans are also placed on non-accrual status if management has serious doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are placed on non-accrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received. The loan may be returned to accrual status if the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time and ultimate collectability of the total contractual principal and interest is no longer in doubt. 33
The table below sets forth the amounts and categories of our nonperforming assets, which consist of nonaccrual loans, troubled debt restructurings and OREO (which includes real estate acquired through, or in lieu of, foreclosure),
at the dates indicated. (in thousands) June 30, 2014 December 31, 2013 Non-accrual loans: Real estate loans: Residential - First Lien $ 319 $ 331 Commercial 256 258 Commercial and leases 1,207 2,593 Total non-accrual loans 1,782 3,182 Troubled debt restructure loans: Accruing troubled debt restructure loans 230
- Total non-performing loans 2,012 3,182 Other real estate owned: Land 595 595 Commercial 1,782 1,782
Total other real estate owned 2,377
Total non-performing assets $ 4,389 $
Non-performing loans to total gross loans 0.46 % 0.79 % Non-performing assets to total assets 0.82 %
1.11 % Included in total non-accrual loans at
June 30, 2014are six trouble debt restructured loans totaling $0.8 millionthat were not performing in accordance with the modified terms, and the accrual of interest has ceased. There was one commercial real estate credit totaling $159 thousandand one residential mortgage totaling $320 thousandthat was 90 days or more past due and still accruing interest at June 30, 2014. At December 31, 2013there one commercial real estate credit totaling $159 thousandand one commercial credit totaling $296 thousand90 days or more past due and still accruing interest. Under GAAP, we are required to account for certain loan modifications or restructurings as "troubled debt restructurings." In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if Howard Bank, for economic or legal reasons related to the borrower's financial difficulties, grants a concession, such as a reduction in the effective interest rate, to the borrower that we would not otherwise consider. However, all debt restructurings or loan modifications for a borrower do not necessarily always constitute troubled debt restructurings. Nonperforming assets amounted to $4.4 million, or 0.82% of total assets, at June 30, 2014compared to $5.6 millionor 1.11% of total assets at December 31, 2013. Total nonperforming assets have decreased by $1.2 millionduring 2014, with OREO remaining unchanged as there were no new properties added, no current properties sold and no additional valuation adjustments required on current assets. The decrease in non-accrual loans was impacted by the reductions in the balances of several non-accrual loans as principal payments were received from the borrowers and also as funds were received from the Small Business Administration(the "SBA") for claims made under their guarantees.
The composition of our nonperforming loans at
· Six commercial loans to a local business totaling
loans have an SBA guarantee, and reserves have been taken to reflect the amount
expected to be received once claims are submitted to the SBA.
· Eleven small commercial loans totaling approximately
that are in various stages of collection. Each relationship is independently
evaluated, and no losses are anticipated.
· One commercial real estate loan for
local business and is also secured by the assets of the business. A specific
reserve has been established and based upon current valuations, no further
losses are anticipated.
· Two commercial loans to one customer totaling
carries an SBA guarantee. A settlement offer has been negotiated, and no
further losses are anticipated.
· One residential mortgage for
established and based upon current valuations, no further losses are anticipated.
Allowance for Credit Losses
We provide for credit losses based upon the consistent application of our documented allowance for credit loss methodology. All credit losses are charged to the allowance for credit losses and all recoveries are credited to it. Additions to the allowance for credit losses are provided by charges to income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio and make provisions for credit losses in order to maintain the allowance for credit losses in accordance with GAAP. The allowance for credit losses consists primarily of two components: 34
· Specific allowances are established for loans classified as substandard or
doubtful. For loans classified as impaired, the allowance is established when
the net realizable value (collateral value less costs to sell) of the impaired
loan is lower than the carrying amount of the loan. The amount of impairment
provided for as a specific allowance is represented by the deficiency, if any,
between the underlying collateral value and the carrying value of the loan.
Impaired loans for which the estimated fair value of the loan, or the loan's
observable market price or the fair value of the underlying collateral, if the
loan is collateral dependent, exceeds the carrying value of the loan are not
considered in establishing specific allowances for credit losses; and
· General allowances established for credit losses on a portfolio basis for loans
that do not meet the definition of impaired loans. The portfolio is grouped
into similar risk characteristics, primarily loan type and regulatory
classification. We apply an estimated loss rate to each loan group. The loss
rates applied are based upon our loss experience adjusted, as appropriate, for
the qualitative factors discussed below. This evaluation is inherently
subjective, as it requires material estimates that may be susceptible to
significant revisions based upon changes in economic and real estate market
conditions. The allowance for credit losses is maintained at a level to provide for losses that are probable and can be reasonably estimated. Management's periodic evaluation of the adequacy of the allowance is based on
Howard Bank'spast credit loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired when, based on current information and events, it is probable that Howard Bankwill be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record and the amount of the shortfall in relation to the principal and interest owed. The impairment of a loan may be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, Howard Bank'simpairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis. Our loan policies state that after all collection efforts have been exhausted, and the loan is deemed to be a loss, then the remaining loan balance will be charged to the established allowance for credit losses. All loans are evaluated for loss potential once it has been determined by the Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan is deemed not to be well secured, the loan should be moved to nonaccrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined a charge-off against the allowance for credit losses for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
The adjustments to historical loss experience are based on our evaluation of several qualitative factors, including:
· changes in lending policies, procedures, practices or personnel;
· changes in the level and composition of construction portfolio and related
· changes and migration of classified assets;
· changes in exposure to subordinate collateral lien positions;
· levels and composition of existing guarantees on loans by SBA or other
· changes in national, state and local economic trends and business conditions;
· changes and trends in levels of loan payment delinquencies; and
· any other factors that managements considers relevant to the quality or
performance of the loan portfolio.
We evaluate the allowance for credit losses based upon the combined total of the specific and general components. Generally when the loan portfolio increases, absent other factors, the allowance for credit loss methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally when the loan portfolio decreases, absent other factors, the allowance for credit loss methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease. 35 Commercial and commercial real estate loans generally have greater credit risks compared to the one- to four-family residential mortgage loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Actual credit losses may be significantly more than the allowance for credit losses we have established, which could have a material negative effect on our financial results. Generally, we underwrite commercial loans based on cash flow and business history and receive personal guarantees from the borrowers where appropriate. We generally underwrite commercial real estate loans and residential real estate loans at a loan-to-value ratio of 85% or less at origination. Accordingly, in the event that a loan becomes past due and, randomly with respect to performing loans, we will conduct visual inspections of collateral properties and/or review publicly available information, such as online databases, to ascertain property values. We will also obtain formal appraisals on a regular basis even if we are not considering liquidation of the property to repay a loan. It is our practice to obtain updated appraisals if there is a material change in market conditions or if we become aware of new or additional facts that indicate a potential material reduction in the value of any individual property collateral. For impaired loans, we utilize the appraised value in determining the appropriate specific allowance for credit losses attributable to a loan. In addition, changes in the appraised value of multiple properties securing our loans may result in an increase or decrease in our general allowance for credit losses as an adjustment to our historical loss experience due to qualitative and environmental factors, as described above. At
June 30, 2014and December 31, 2013, impaired loans amounted to $5.1 millionand $6.3 million, respectively. The amount of impaired loans requiring specific reserves totaled $1.1 millionand $1.3 million, respectively. The amount of impaired loans with no specific valuation allowance totaled $4.0 millionand $5.0 million, respectively. Nonperforming loans are evaluated and valued at the time the loan is identified as impaired on a case by case basis, at the lower of cost or market value. Market value is measured based on the value of the collateral securing the loan. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by us. Appraised values may be discounted based on management's historical experience, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the client and client's business. The difference between the appraised value and the principal balance of the loan will determine the specific allowance valuation required for the loan, if any. Nonperforming loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. We evaluate the loan portfolio on at least a quarterly basis, more frequently if conditions warrant, and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Commissioner and the FDICwill periodically review the allowance for credit losses. The Commissioner and the FDICmay require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination. The following table sets forth activity in our allowance for credit losses for the indicated periods: Six months ended June 30, Three months ended June 30, (in thousands) 2014 2013 2014 2013 Balance at beginning of year $ 2,506 $ 2,764 $ 2,700 $ 2,980Charge-offs: Real estate Residential first lien loans - (183 ) - - Commercial loans and leases - (202 )
- (202 ) - (385 ) - (202 ) Recoveries: Real estate
Commercial non-owner occupied loans 4 30 - - Commercial loans and leases 42 16 28 8 46 46 28 8 Net recoveries (charge-offs) 46 (339 ) 28 (194 ) Provision for credit losses 501 526
325 165 Balance at end of period
$ 3,053 $ 2,951 $ 3,053 $ 2,95136
Allocation of Allowance for Credit Losses
The following tables set forth the allowance for credit losses allocated by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance for credit losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories. June 30, 2014 December 31, 2013 (dollars in thousands) Amount Percent 1 Amount Percent 1 Real estate Construction and land loans
$ 15914.4 % $ 12212.6 % Residential first lien loans 196 12.2 200 9.7 Residential junior lien loans 17 2.2 34 2.0 Commercial owner occupied loans 138 20.4 131 22.4 Commercial non-owner occupied loans 661 25.6 541 28.1 Commercial loans and leases 1,871 25.0 1,464 24.9 Consumer loans 11 0.2 14 0.3 Total $ 3,053100.0 % $ 2,506100.0 % (1) Represents the percent of loans in each category to total loans
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, principal repayments and the sale of securities available for sale. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset Liability Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of
June 30, 2014and December 31, 2013. We regularly monitor and adjust our investments in liquid assets based upon our assessment of: 1) Expected loan demand;
2) Expected mortgage origination activities;
3) Expected deposit flows and borrowing maturities;
4) Yields available on interest-earning deposits and securities; and
5) The objectives of our asset/liability management program.
Excess liquid assets are invested generally in interest-earning deposits and short-term securities.
Our most liquid assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At
June 30, 2014and December 31, 2013, cash and cash equivalents totaled $26.6 millionand $35.7 million, respectively. Our cash flows are derived from operating activities, investing activities and financing activities as reported in our statements of cash flows included in our financial statements. At June 30, 2014and December 31, 2013, we had $105.1 millionand $75.8 million, respectively, in loan commitments outstanding, including commitments issued to originate loans of $59.4 millionand $34.5 millionat June 30, 2014and December 31, 2013, respectively, and $45.6 millionand $41.3 millionin unused lines of credit to borrowers at June 30, 2014and December 31, 2013, respectively. A large portion of the increase in the commitments to originate loans was derived from commitments for residential mortgage loans, now that our mortgage banking group is fully operational. In addition to commitments to originate loans and unused lines of credit we had $10.5 millionand $9.8 millionin letters of credit at June 30, 2014and December 31, 2013, respectively. Certificates of deposit due within one year of June 30, 2014totaled $103.1 million, or 24.4% of total deposits. Should these deposits not remain with us, we may be required to seek other sources of funds, including loan and securities sales, and FHLB advances. Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on the certificates of deposit. We believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of our certificates of deposit with maturities of one year or less. Our primary investing activity is originating loans. During the six months ended June 30, 2014cash was utilized to increase our portfolio of loans by $29.6 millionand our loans held for sale portfolio by $25.6 million. For the six month period ended June 30, 2013, these amounts were $29.8 millionand $0.01 million, respectively. During the first half of 2014 we purchased $6.0 millionin additional securities and we received $18.6 millionfrom security maturities; by comparison during the six months ended June 30, 2013we purchase $19.0 millionin additional securities while receiving $30.6 millionfrom security maturities. Total cash used to fund our activities totaled $9.1 millionand $12.6 millionfor the six months ended June 30, 2014and 2013, respectively. 37
Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced a net increase in deposits of
$33.5 millionduring the six months ended June 30, 2014. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors. Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB, which provide an additional source of funds. FHLB advances were $47 millionat June 30, 2014compared to $40 millionat December 31, 2013. At June 30, 2014, we had the ability to borrow up to a total of $101.5 millionbased upon our credit availability at the FHLB, subject to collateral requirements.
The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At
June 30, 2014and December 31, 2013, the Bank exceeded all regulatory capital requirements. The Bank is considered "well capitalized"
under regulatory guidelines.
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These financial instruments are limited to commitments to originate loans and involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses which would have a material effect on us. Outstanding loan commitments and lines of credit at
June 30, 2014and December 31, 2013are as follows: (in thousands) June 30, 2014 December 31, 2013 Unfunded loan commitments $ 59,419$ 34,464 Unused lines of credit 45,634 41,326 Letters of credit 10,531 9,676 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally have interest rates at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that all customers will draw upon their lines of credit in full at any one time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer's credit-worthiness on a case-by-case basis. Because we conservatively underwrite these facilities at inception, we have not had to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit. The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in the statement of financial condition at June 30, 2014or December 31, 2013as a liability for credit loss related to these commitments.
Impact of Inflation and Changing Prices
Our financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.