10-Q 1 hcnb3-01q.txt HCNB BANCORP, INC. FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-QSB (Mark One) [x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the transition period from __________ to __________ Commission file number: 333-73385 HCNB Bancorp, Inc. (Exact name of small business issuer as specified in its charter) Maryland 52-2083046 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1776 East Jefferson Street, Rockville, MD 20852 (Address of principal executive offices) 301-468-8848 (Issuer's telephone number) Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the last 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 [ x ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date: As of April 30, 2001, 700,213 shares of the small business issuer's common stock, par value of $.01 per share, were issued and outstanding. Transitional Small Business Disclosure Format (Check one): Yes [ ] No [ x ] PART I - FINANCIAL INFORMATION Item 1. Financial Statements HCNB BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS MARCH 31, 2001 (UNAUDITED) AND DECEMBER 31, 2000

See accompanying notes to consolidated financial statements. HCNB BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2001 AND 2000 (unaudited)

See accompanying notes to consolidated financial statements. HCNB BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2001 AND 2000 (unaudited)

See accompanying notes to consolidated financial statements. HCNB BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. ORGANIZATION HCNB Bancorp, Inc. (the Company) was incorporated under the laws of the State of Maryland on February 24, 1998, primarily to hold all of the outstanding shares of capital stock of a national bank. Effective October, 1999, the Company completed an initial public offering (the Offering) in which it sold 700,213 shares of common stock for $10 per share. During 1999, the Company received proceeds from the Offering of $7,002,130. On December 14, 1999, Harbor Capital National Bank (the Bank) received authority from the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation to begin banking operations. From February 24, 1998 until December 14, 1999, the Company was considered a development stage enterprise. The Company's primary operations are conducted by the Bank, which operates one branch in Rockville, Maryland. The Bank is principally engaged in the business of attracting deposits and investing in commercial and consumer loans. The Bank is subject to certain risks inherent in making loans and accepting deposits. In addition to these risks, the Company is currently operating at a loss. Growth in operations will be necessary for the Company to be able to cover overhead and other operational costs. 2. BASIS OF PRESENTATION The accompanying consolidated financial statements include the activity of HCNB Bancorp, Inc. and its wholly owned subsidiary, Harbor Capital National Bank. All intercompany transactions have been eliminated in consolidation. The accompanying consolidated financial statements for March 31, 2001 and for the three-month periods ended March 31, 2001 and 2000 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2000, included in the Company's Annual Report to Stockholders on Form 10-KSB, filed with the Securities and Exchange Commission. The balance sheet as of December 31, 2000 has been derived from the audited financial statements at that date. The unaudited consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the financial position of the Company as of March 31, 2001 and the results of its operations for the three month periods ended March 31, 2001 and 2000 and the cash flows for the three month periods ended March 31, 2001 and 2000. The results of interim periods are not necessarily indicative of the results expected for the full fiscal year. 3. RELATED PARTY TRANSACTIONS The officers and directors of the Company and the Bank have deposits in the Bank approximating $2,745,300 at March 31, 2001. The officers and directors of the Company and the Bank have loans due to the Bank approximating $254,500 at March 31, 2001. All loans made to officers and directors are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated third parties and do not involve more than the normal risk of repayment or present other unfavorable features. 4. REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios. Management believes, as of March 31, 2001 that the Bank meets all capital adequacy requirements to which it is subject. The Bank has been categorized under the regulatory framework for prompt corrective action as "well capitalized". To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios. 5. INCOME TAXES The Company uses the liability method of accounting for income taxes as required by SFAS No. 119, "Accounting for Income Taxes". Under the liability method, deferred-tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when the differences reverse. Deferred income taxes will be recognized when it is deemed more likely than not that the benefits of such deferred income taxes will be realized; accordingly, no deferred income taxes or income tax benefits have been recorded by the Company. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This discussion and analysis provides an overview of the financial condition and results of operations of HCNB Bancorp, Inc. ("Company") and Harbor Capital National Bank ("Bank") as of March 31, 2001 and for the three month periods ended March 31, 2001 and 2000. Some of the information in this discussion and analysis includes "forward looking statements". These statements use words such as "may", "will", "expect", "anticipate", "plan", "estimate" or similar words, and they discuss our future expectations, projections of financial results or strategies that are subject to risks and uncertainties. When you read a forward-looking statement, you should keep in mind the risk factors set forth in our Annual Report to Stockholders on Form 10-KSB for the year ended December 31, 2000. Our actual results and the actual outcome of our expectations and strategies could be different from what have been described in this report because of these risks and uncertainties. General HCNB Bancorp, Inc. was incorporated under the laws of the State of Maryland on February 24, 1998, to serve as a bank holding company for a newly formed commercial bank, Harbor Capital National Bank. The Bank received its charter from the Office of the Comptroller of the Currency on December 14, 1999 and commenced operations that day from its sole location at 1776 East Jefferson Street, Rockville, Maryland. The Bank is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation. The Company completed its initial offering of its shares of common stock ($.01 par value) in October, 1999. In the initial offering, 700,213 shares were sold at a price of $10.00 per share; total proceeds from the offering were $7,002,130. After offering expenses, the net proceeds to the Company were $6,828,075. The Bank was initially capitalized by the Company in an amount of $6,000,000. Financial Condition As of March 31, 2001, assets were $19,138,080. This represents a growth of $1,805,272 or 10.42% since December 31, 2000. Deposits at March 31, 2001 were $14,079,112, an increase since year-end 2000 of $2,024,011 or 16.79%. Net loans outstanding at March 31, 2001 were $10,234,920 as compared to $8,634,181at December 31, 2000, which reflects as increase of 18.54%. This growth in business activity was mostly attributable to increased calling activities within the Bank's market area. In addition, management has set the interest rates paid on deposits to be competitive in the market and has seen an increase in the business development activities of its directors and officers. The Bank has no brokered funds. As of March 31, 2001, loans (net of an allowance for loan losses and deferred loan fees) totaled $10,234,920, the majority of which were commercial and commercial real estate loans. However, the Bank has developed a growing niche in home equity lending. The growth in the portfolio, 18.54% since December 31, 2000, is also the result of increased business development activities within the Bank's market area. Funds not extended in loans are held in the investment portfolio, which includes Federal funds sold. At March 31, 2001, the Bank had investment securities totaling $2,103,743 which were short-term obligations of government agencies and were all held to maturity. Federal funds sold totaled $5,390,443 and other investments included Federal Reserve Bank stock and a $100,000 certificate of deposit. Total capital at March 31, 2001 was $5,026,543. Management believes this capital will be adequate to fund the Company's and Bank's operations for the next twelve-month period. Results of Operations On a consolidated basis, the Company recorded a net loss of $117,399 for the three-month period ended March 31, 2001. This compares to a net loss of $207,514 for the three-month period ended March 31, 2000. The reduction is due mostly to growth realized by the Bank and an increase in net interest margin which provided a greater coverage of overhead expenses. Operating results for the year ending December 31, 2001 are projected to reflect losses as loan and deposit growth is not expected to be produce net interest income sufficient to cover operating expenses, however it is expected that the Bank will continue to reduce its losses in subsequent periods. Net Interest Income Net interest income is the difference between income on assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans and investments; interest bearing deposits make up the cost of funds. Non-interest bearing deposits and capital are also funding sources. Changes in the volume and mix of earning assets and funding sources along with changes in associated interest rates determine changes in net interest income. The net interest income for the three-month period ended March 31, 2001 was $201,216, as compared to $95,398 for the same period in 2000. Most of the growth came as a result of an increase in the loan portfolio whereby interest on loans totaled $258,839 for the three months ended March 31, 2001, as compared to $20,249 for the three months ended March 31, 2000. Growth in the loan portfolio resulted in greater contributions to interest income in the first quarter of 2001, because the yields on loans are normally 3% to 5% higher than yields on investment securities. At March 31, 2001, the weighted average yield on the loan portfolio was 9.43%; the weighted average yield on the investment portfolio was 5.04%. The Bank is located in a competitive environment and the rates of interest paid on its deposits are somewhat driven by those paid by other depository institutions. Management has taken a position to be competitive within the market, normally placing the Bank in the upper one-quarter of those depository institutions competing with it for deposits, however the Bank has chosen not to aggressively compete for jumbo certificates of deposits which are highly rate sensitive. At March 31, 2001, the Bank's weighted average cost of deposits was 4.64%. It is anticipated that both the volume of deposits and the interest expense will increase during the next twelve-month period based upon increased marketing activities. Allowance and Provision for Credit Losses The provision for credit losses represents an expense to fund the allowance for credit losses. These funds are set aside in anticipation of potential of credit losses in the current loan portfolio. The amount allocated is based on many factors which are considered in management's assessment of the loan portfolio. These factors are generally defined by regulatory directives and include lending policies and procedures, local economic and business conditions, the nature and volume of the loan portfolio, the Bank's lending management and staff, past-due history, the Bank's loan review system, concentrations of credit and external factors which may adversely affect the credit risk of the loan portfolio. In addition to the overall analysis of the portfolio, management evaluates every major credit and may assign a risk adjustment, based upon the specific credit. Based upon management's analysis of the loan portfolio as of March 31, 2001, management did not increase the provision for loan and lease losses. As of March 31, 2001, the provision for credit losses totaled $412,650. This amount was deemed adequate by management and the Board of Directors based upon the analysis methodology used by the Bank and as suggested by regulatory directives. At March 31, 2001, the provision for credit losses was 3.87% of total loans outstanding. The level of the Provision for Credit Losses reflects a higher than normal risk exposure. This exposure is mostly due to loan underwriting and structure issues as well as credit administration concerns. Management is committed to improving its lending practices and operations. Two lending professionals with extensive backgrounds in community bank lending and the local markets have been employed and are beginning to address the regulatory concerns. Non-Interest Income Non-interest income is primarily deposit account service charges and fees for ancillary services such as ATM access and safe deposit rentals. For the three-month period ended March 31, 2001, the Bank realized non-interest income in the amount of $6,243. This compares to $2,591 realized in the first quarter of 2000. These fees are volume driven, based mostly on the deposit customer base and should increase as the customer base increases. The Bank has seen increased use of its automated teller machine especially by consumers holding debit/ATM cards issued by other financial institutions. Non-Interest Expense Non-interest expense for the three-month periods ended March 31, 2001 and 2000 were $324,858 and $286,645. The largest portion of these operating expenses was salaries and employee benefits. For the three-month period ended March 31, 2001, $150,494 was salary and employee benefits expenses. This represents 46% of all other operating expenses. It is anticipated that operating expenses will increase but it is also anticipated that net interest income will increase in subsequent periods. Liquidity and Capital Resources Stockholders' equity at March 31, 2001 was $5,026,543 compared to $5,143,942 at December 31, 2000. The decline in stockholders' equity is due mostly to the operating results of the Bank. No cash dividends have been declared by the Company since its inception. Banking regulatory authorities have implemented strict capital guidelines directly related to the credit risk associated with an institution's assets. Banks and bank holding companies are required to maintain capital levels based on their "risk adjusted" assets so that categories of assets with higher "defined" credit risks will require more capital support that assets with lower risks. The Bank has exceeded its capital adequacy requirements to date and is considered to be "well capitalized", under regulatory standards. The Bank's liquidity is provided by its cash and cash equivalents, which are its cash on hand and on deposit with other financial institutions and its federal funds sold. The levels of such assets are dependent upon the Bank's operating, financing and investment activities at any given time. Variations in levels of cash and cash equivalents are mostly influenced by deposit flows and loan activity. At March 31, 2001, the Bank held cash and cash equivalents totaling $587,822 and Federal funds sold of $5,390,443. Management believes that this liquidity level is adequate to meet the anticipated needs of the Bank. PART II - OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities and Use of Proceeds (a) Not applicable (b) Not applicable (c) Not applicable (d) Not applicable Item 3 Defaults Upon Senior Securities Not Applicable Item 4 Submission of Matters to a Vote of Security Holders None Item 5 Other Information On March 8, 2001, the Bank entered into a Memorandum of Understanding ("Memorandum") with the Office of the Comptroller of the Currency, the Bank's primary regulator, as a result of the OCC's examination of the Bank in December, 2000. The Memorandum is an informal agreement with the OCC that is not enforceable by the OCC; entry into the Memorandum was a voluntary act by the Bank. The Bank agreed, among other things, to take the following actions: o Retain a senior lending officer with appropriate qualifications; o Review and revise the Bank's loan policy, so that the policy more clearly identifies acceptable levels of risk, administrative responsibilities and acceptable underwriting and documentation standards; o Correct certain credit and collateral exceptions on loans that have such deficiencies, and make future grants, extensions, renewals or restructuring of credit only after a formal credit analysis is performed and all necessary credit information is obtained; o Retain an independent person or firm to perform on-going loan review and develop a loan review system that will contain certain information requested by the OCC; and, o Develop and adhere to written programs, including an asset diversification program, a program regarding maintenance of an adequate allowance for loan and lease losses, a program to improve construction loan underwriting standards and a consumer compliance program. The Bank has established a Compliance Committee of the Board of Directors to address the issues in the Memorandum, to ensure the compliance of all regulatory issues and to report findings to the OCC on a quarterly basis. Management is committed to complying with the terms of the Memorandum as quickly as possible. The Bank has retained an experienced community bank lender to serve as its Senior Lending Officer and as an executive officer of the Bank subject to approval of the OCC. This individual does have sufficient authority to ensure the Bank's compliance with the Memorandum of Understanding and the safe and sound operation of the Bank's lending function. As is required by regulation, this individual's background and experience in light of the executive management position held in a de novo bank and the requirements of the Memorandum of Understanding are being evaluated by the Bank's primary regulator, The Office of the Comptroller of the Currency. The Bank's new Senior Lending Officer is actively involved in a review of the Bank's lending policies and practices and will make recommendations to specifically address the regulatory concerns expressed in the Report of Examination and Memorandum and to effectively manage the risks associated with the extensions of credit. The Bank has retained an outside vendor to provide loan review services, as is required by the Memorandum, and the formal external loan review process has begun. An Allowance for Loan and Lease Losses Program was developed and approved by the Board of Directors of the Bank in April, as was a Consumer Compliance Program Item 6 Exhibits (a) No reports on Form 8-K were filed during the quarter ended March 31, 2001. Signatures In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HCNB Bancorp, Inc. (Registrant) Date -------------------------- ------------------------------------ Michael J. Burke, Chairman/President (Principal Executive Officer) Date -------------------------- ------------------------------------ Li-Min Lee, Treasurer (Principal Accounting and Financial Officer)

HCNB BANCORP INC 10-Q