Item 1. Business
ITEM 1.
BUSINESS
General
BV Financial is a federally-chartered savings and loan holding company established in January 2005 to be the holding company for Bay-Vanguard Federal, a
federally-chartered savings bank. BV Financials business activity is the ownership of the outstanding capital stock of Bay-Vanguard Federal. BV Financial does not own or lease any property but instead uses the premises, equipment and other
property of Bay-Vanguard Federal. In the future, BV Financial may acquire or organize other operating subsidiaries; however, there are no current plans, arrangements, agreements or understandings, written or oral, to do so.
Bay-Vanguard Federal is the product of an April 1, 1996 merger of Bay Federal Savings and Loan Association and Vanguard Federal Savings and Loan
Association. Bay Federal Savings and Loan Association was incorporated in 1873 as a Maryland-chartered savings and loan association operating under the name Light Street Savings and Building Association of Baltimore City, later converting to a
federal charter. Bay Federal Savings and Loan Association had three full-service banking offices at the time of the merger. Vanguard Federal Savings and Loan Association was incorporated in 1959 as a Maryland-chartered savings and loan association
operating under the name Vanguard Savings and Loan Association. Vanguard Savings and Loan Association converted to a federal charter in 1987. Vanguard Federal Savings and Loan Association had one full-service banking office at the time of the
merger.
We operate as a community-oriented financial institution offering traditional financial services to consumers and businesses in
our market area. We attract deposits from the general public and use those funds to originate one- to four-family real estate, mobile home, construction, multi-family, commercial real estate, and consumer loans, which we hold for investment.
Our website address is www.bayvanguard.com. Information on our website should not be considered a part of this annual report.
Market Area
We are headquartered in Baltimore
County, Maryland. In addition to our main office, we operate two branch offices in Baltimore City and two branch offices in Anne Arundel County, one of which we acquired in August 2007 from Greater Atlantic Bank. We consider Baltimore City,
Baltimore County and Anne Arundel County to be our primary market area. The economy of our market area reflects a diverse cross-section of employment
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sectors. The economies of Baltimore City, Baltimore County and Anne Arundel County are primarily geared toward the service, trade, government, financial
services and manufacturing sectors. However, because of the Fort Meade Installation and the state government in Annapolis, Anne Arundel County has a stronger concentration of government employees. Additionally, Baltimore and Anne Arundel Counties
reported a higher level of construction employment than Baltimore City, reflecting the level of growth in those counties. According to the United States Census Bureau, the population of Baltimore City, Baltimore County and Anne Arundel County in
2008 was estimated to be approximately 637,000, 786,000 and 513,000, respectively. The economy of our market area is strongest in suburban Anne Arundel County, which has experienced higher growth rates in population and households while maintaining
low unemployment rates. Baltimore City, on the other hand, has seen its population and households decrease, which is reflective of the urban shift to suburban markets for job opportunities. Baltimore City also has a higher concentration of blue
collar workers, lower per capita income levels and a higher level of unemployment than the state or national averages.
Competition
We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has
historically come from the several financial institutions operating in our market area and, to a lesser extent, from other financial service companies such as brokerage firms, credit unions and insurance companies. We also face competition for
investors funds from money market funds, mutual funds and other corporate and government securities. At June 30, 2008, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation, we held
approximately 0.29% of the deposits in the Baltimore-Towson, Maryland Metropolitan Statistical Area, which was the 41 st largest market share out of the 78 financial institutions with offices in this metropolitan statistical area. In addition, banks
owned by large bank holding companies such as Bank of America Corporation, Wachovia Corporation, M&T Bank Corporation, PNC Financial Services Group, Inc., BB&T Corporation and Sun Trust Banks, Inc. also operate in our market area. These
institutions are much larger than us and, therefore, have significantly greater resources that allow them to offer a wider variety of products and services.
Our competition for loans comes primarily from financial institutions in our market area, and, to a lesser extent, from other financial service providers such as mortgage companies and mortgage brokers. Competition
for loans also comes from the increasing number of non-depository financial service companies entering the mortgage market such as insurance companies, securities companies and specialty finance companies.
We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of
consolidation in the financial services industry. Technological advances, for example, have lowered the barriers to market 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. Changes in federal law permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in
the financial services industry. Competition for deposits and the origination of loans could limit our future growth.
Lending Activities
General. Our loan portfolio consists primarily of one- to four-family residential real estate loans. To a much lesser
extent, our loan portfolio includes mobile home loans, construction loans, multi-family, commercial real estate loans, and consumer loans. Bay-Vanguard Federal historically originated and currently originates loans only for investment purposes. At
June 30, 2009, Bay-Vanguard Federal had no loans that were held for sale.
One- to Four-Family Residential Real Estate
Loans . Our primary lending activity is the origination of mortgage loans to enable borrowers to purchase or refinance existing homes in our market area. We only offer fixed- and adjustable- rate mortgage loans primarily with terms of
15, 20 or 30 years. We offer adjustable-rate mortgage loans with interest rates and payments that adjust annually or every three years. Interest rates and payments on our adjustable-rate loans generally are adjusted to a rate equal to a percentage
above the one year U.S. Treasury index. The maximum amount by which the interest rate may be increased or decreased is generally 200
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basis points per adjustment period and the lifetime interest rate cap is generally 600 basis points over the initial interest rate of the loan. The loan fees
charged, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.
Borrower demand for adjustable-rate loans compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest
rates and loan fees offered for fixed-rate mortgage loans as compared to the interest rates and loan fees for adjustable-rate loans. The relative amount of fixed- and adjustable-rate mortgage loans that can be originated at any time is largely
determined by the demand for each in a competitive environment.
While one- to four-family residential real estate loans are normally
originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale of the property pledged as security or upon refinancing the original loan.
Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.
We generally make loans with loan-to-value ratios that do not exceed 80%; however, we may make loans with a loan-to-value ratio up to 97% when secured by
first liens on owner-occupied one- to four-family residences. Loans with loan-to-value ratios in excess of 80% generally require private mortgage insurance or additional collateral. We require all properties securing mortgage loans to be appraised
by a board-approved independent licensed appraiser. We also require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance and flood insurance for loans on property located in a flood zone before closing the loan.
We originate second mortgage loans on one- to four-family residential real estate properties under the same underwriting criteria utilized
for our originations of one- to four-family real estate loans. We make second mortgage loans with a maximum loan-to-value ratio of 80% of the appraised value of the property, less the outstanding balance of the first mortgage.
We also originate home equity loans and lines of credit. Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate
as reported in The Wall Street Journal . Home equity loans are fixed-rate loans. We will generally offer home equity loans and lines of credit with a maximum loan-to-value ratio of 80% of the appraised value of the property, less the then
outstanding balance on the first mortgage. A home equity line of credit may be drawn down by the borrower for an initial period of ten years from the date of the loan agreement. After the initial draw period, the line of credit is reviewed and may,
at our sole discretion, be renewed for another ten-year period. If the line is not renewed, the amount outstanding must be repaid over the remaining fifteen-year term.
Mobile Home Loans. We originate mobile home loans directly and purchase mobile home loans from Forward National and Mainland Financial, which specialize in mobile home lending. At June 30, 2009,
13.6% of our mobile home portfolio was originated by us directly and 70.4% and 16.0% was purchased from Forward National and Mainland Financial, respectively. Our mobile home loans, which are made primarily to borrowers in Maryland and Pennsylvania,
have terms of up to 25 years and fixed interest rates. We generally will finance up to a maximum of 90% of the value of the mobile home. We require that the borrower obtain hazard insurance. At June 30, 2009, we had 340 mobile home loans, the
average size of which was approximately $34,000.
In April 2000, we began purchasing mobile home loans from Forward National. Forward
National assembles credit applications from third parties and provides such applications for our underwriting review. We then have the opportunity to accept or reject the loan contemplated by each credit application. If we agree to purchase a loan,
we must notify Forward National of the minimum rate of interest we will accept on the loan. Forward National will then seek to originate the loan with the third party at an interest rate exceeding the interest rate agreed to by us. Once Forward
National provides us with the original executed loan, we then purchase the loan from Forward National. Forward National assigns to us its right, title and interest in the loan, its collateral and all payments under the loan.
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While we service the mobile home loans we purchase from Forward National, subject to our direction,
Forward National handles all delinquencies and collections on the loans at its expense. Forward National is advanced funds equal to the amount by which the interest rate on a loan we ultimately purchase exceeds the interest rate we prescribed to
Forward National. Forward National is then required to place half of that amount in a deposit account with us. This amount is recorded as a deposit on our financial statements. Additionally, the entire amount we compensate Forward National is
recorded as prepaid dealer interest, which is included in the loan balance and amortized in the same manner as deferred loan origination fees. If a loan amortizes fully and the borrower pays as agreed, Forward National receives all of the funds
related to that loan in the deposit account. However, if the mobile home is repossessed or prepaid, the amount of interest on such loan that otherwise would have been paid by the borrower and that has been previously advanced to Forward National by
us is returned to us by Forward National. The deposit account is used to fund (1) any costs of collections incurred on the loans we purchased from Forward National and (2) losses related to repossessions of these mobile home units. Any
debits to this account are recorded as a deposit withdrawal on our financial statements. Forward National has no right to make withdrawals from the deposit account. Thus, we may accrue excess balances and apply them against any future charges we
incur related to Forward National collections and repossessions.
In February 2007, we began purchasing mobile home loans from Mainland
Financial under the same terms and conditions as our agreement with Forward National with the exception of how delinquencies are handled. Delinquencies and collections are handled by us at our expense with the assistance of Mainland Financial.
However, the deposit account is used to fund losses related to repossessions of these mobile home units.
The following table presents the
activity and dollar amounts available to fund losses related to repossessions in the Forward National and Mainland Financial deposit accounts during the periods indicated.
Forward
National
Mainland
Financial
Year Ended June 30,
2009
2008
2009
2008
(In thousands)
Deposit account balance, beginning of period
$
242
$
407
$
146
$
17
Losses on repossessions and fees and expenses on collections absorbed by Forward National or Mainland Financial
(17
)
(65
)
(14
)
Deposits due to new loans
34
71
60
134
Withdrawals due to early payoffs
(51
)
(171
)
0
(5
)
Deposit account balance, end of period
$
208
$
242
$
192
$
146
Construction Loans . We originate loans to individuals and, to a lesser
extent, builders to finance the construction of residential dwellings. We also make construction loans for commercial development projects, including condominiums, apartment buildings, mixed-use properties with residential units, as well as retail
space and owner-occupied properties used for business. Our construction loans generally provide for the payment of interest only during the construction phase, which is usually 12 months. At the end of the construction period, the loan generally
converts into a permanent loan. With regard to construction loans that do not convert into permanent financing, the borrower is required to provide evidence of permanent financing by a qualified third party upon completion of the construction. Loans
generally can be made with a loan-to-value ratio of up to 80% of the completed project. Before making a commitment to fund a construction loan, we require an appraisal of the property by a board-approved independent licensed appraiser. We also
require an inspection of the property before disbursement of the funds during the term of the construction.
At June 30, 2009, the
largest residential construction loan commitment was for $525,000, of which $475,000 was outstanding. This loan was performing according to its terms at June 30, 2009.
At June 30, 2009, the largest commercial construction loan commitment was for $1.8 million, $1.6 million of which was outstanding. This loan was
performing according to its terms at June 30, 2009.
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Multi-Family and Commercial Real Estate Loans . We offer fixed rate and
adjustable-rate mortgage loans secured by multi-family and commercial real estate. Our multi-family and commercial real estate loans are generally secured by condominiums, apartment buildings and mixed-use properties with residential units, as well
as retail space.
We originate multi-family and commercial real estate loans for terms up to 25 years. Interest rates and payments on our
adjustable-rate loans adjust every three, five or seven years after an initial three-, five- or seven- year period to a rate typically equal to 3-3.5% above the three-, five- or seven-year constant maturity Treasury index. There are no adjustment
period or lifetime interest rate caps. Loan amounts generally do not exceed 75% of the appraised value. We require all properties securing multi-family and commercial real estate loans to be appraised by a board-approved independent licensed
appraiser. Multi-family and commercial real estate loans also are generally supported by personal guarantees. At June 30, 2009, the largest multi-family and commercial real estate loan was a $1.9 million loan. This loan is secured by a
waterfront restaurant building in Baltimore, Maryland and was performing according to its terms at June 30, 2009.
We also originate
loans secured by undeveloped and developed land. Land loans are offered with a five-year term based on an amortization term of 15 years. A balloon payment for the principal plus any accrued interest is due at the end of the five-year period.
Additionally, we offer fixed-rate fully-amortized land loans with terms of 15 years. Land loans generally can be made with a maximum loan-to-value ratio of 75%. Loans secured by undeveloped land or improved lots generally involve greater risks than
residential mortgage lending because land loans are more difficult to evaluate. If the estimate of value proves to be inaccurate, in the event of default and foreclosure, we may be confronted with a property the value which is insufficient to assure
full repayment.
Other Consumer Loans . Our consumer loans are primarily loans secured by passbook or certificate
accounts, automobile and boat loans and secured personal loans. The procedures for underwriting consumer loans include an assessment of the applicants payment history on other debts and ability to meet existing obligations and payments on the
proposed loan. Although the applicants creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.
Loan Underwriting Risks. While we anticipate that adjustable-rate loans will better offset the adverse effects of an increase in interest
rates as compared to fixed-rate mortgages, the increased mortgage payments required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying
property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans help make our loan portfolio more responsive to changes in interest rates, the extent of this interest sensitivity is
limited by the annual and lifetime interest rate adjustment limits.
Mobile home lending generally entails greater risk than traditional
residential mortgage lending. Loans secured by mobile homes involve more credit risk than mortgage loans because of the type and nature of the collateral, which depreciates over time, and because mobile home borrowers, on average, tend to have lower
incomes than our residential mortgage borrowers. In many cases, any repossessed collateral for a defaulted mobile home loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation or improper repair
and maintenance of the underlying security. Our arrangement with Forward National and Mainland Financial substantially mitigates the risks normally associated with mobile home lending. However, if Forward National or Mainland Financial ceases doing
business or terminates their arrangement with us, we would likely need to hire additional staff to service our mobile home loan portfolio.
Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial
estimate of the propertys value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of
construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, we may be confronted, at or before the
maturity of the loan, with a building having a value that is insufficient to assure full repayment. If we are forced to foreclose on a building before or at completion due to a default, there can be no
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assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
In addition, we make loans to home builders who, at the time of loan origination, have not yet secured an end buyer for the home under construction. These loans typically carry higher risks than those associated with traditional construction loans.
These increased risks arise because of the risk that there will be inadequate demand to ensure the sale of the property within an acceptable time. As a result, in addition to the risks associated with traditional construction loans, speculative
construction loans carry the added risk that the builder will have to pay the property taxes and other carrying costs of the property until an end buyer is found.
Loans secured by multi-family and commercial real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential real estate loans. Of primary concern in multi-family
and commercial real estate lending is the borrowers creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on the successful operation and management of the
properties. As a result, repayment of such loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than residential real estate loans. To monitor cash flows on income properties, we require borrowers
and loan guarantors, if any, to provide annual financial statements on multi-family and commercial real estate loans. In reaching a decision on whether to make a multi-family or commercial real estate loan, we consider the net operating income of
the property, the borrowers expertise, credit history and profitability and the value of the underlying property. In addition, with respect to commercial real estate rental properties, we will also consider the term of the lease and the credit
quality of the tenants. We have generally required that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.2x.
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are secured by assets that
depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection
efforts against the borrower. In addition, consumer loan collections depend on the borrowers continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Loan Originations, Purchases and Sales . Loan originations come from a number of sources. The primary sources of loan originations
include existing customers, our in-house loan originators, advertising, referrals from customers and personal contacts by our staff. We currently utilize local mortgage brokers to assist with loan originations. We generally retain all of the loans
that we originate for our portfolio; however, we will sell participation interests to local financial institutions, primarily on the portion of loans that exceed our legal lending limit. We sold $3.3 million and $890,000 of participation interests
in fiscal 2009 and fiscal 2008, respectively.
From time to time, we purchase participation interests, primarily commercial real estate
loans. At June 30, 2009 and 2008, we had approximately $6.2 million and $7.1 million of purchased participation loans, respectively. We perform our own underwriting analysis on each of our participation interests before purchasing such loans
and therefore believe there is no greater risk of default on these obligations. However, in a purchased participation loan, we do not service the loan and thus are subject to the policies and practices of the lead lender with regard to monitoring
delinquencies, pursuing collections and instituting foreclosure proceedings. We are permitted to review all of the documentation relating to any loan in which we participate, including any annual financial statements provided by a borrower.
Additionally, we receive periodic updates on the loan from the lead lender.
In addition to purchasing participation interests, we
purchased $283,000 and $660,000 of mobile home loans from Forward National in fiscal 2009 and fiscal 2008, respectively. We purchased $530,000 and $869,000 of mobile home loans from Mainland Financial in fiscal 2009 and fiscal 2008, respectively. We
performed the underwriting on these mobile home loans.
Loan Approval Procedures and Authority . We follow written,
non-discriminatory, underwriting standards and loan origination procedures established by our board of directors and management. Loans up to $500,000 require the approval of two of five members of an employee loan committee, consisting of the
President
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and Chief Executive Officer, the Chairman and Chief Financial Officer and three Senior Vice Presidents. Loans up to $750,000 require the approval of three of
the members of the employee loan committee. All extensions of credit that exceed $750,000 in the aggregate require the approval of either the Executive Committee of the board of directors or the full board of directors.
Loans to One Borrower . The maximum amount that we may lend to one borrower and the borrowers related entities is
limited by regulation to generally 15% of our unimpaired capital and surplus. At June 30, 2009, our regulatory limit on loans to one borrower was $1.4 million. At that date, our largest lending relationship was a $1.9 million loan secured by a
waterfront restaurant building in Baltimore, Maryland originated in 2006. At the time of origination, this loan did not exceed our legal lending limit. That loan was performing according to its original terms at June 30, 2009.
Loan Commitments . We issue commitments for fixed-rate and adjustable-rate mortgage loans conditioned upon the
occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers and generally expire in 60 days.
Investment Activities
We have legal authority to invest in various types of liquid assets, including U.S. Treasury
obligations, securities of various federal agencies and municipal governments, deposits at the Federal Home Loan Bank of Atlanta and certificates of deposit of federally insured institutions. Within certain regulatory limits, we also may invest a
portion of our assets in mutual funds. We also are required to maintain an investment in Federal Home Loan Bank of Atlanta stock. While we have the authority under applicable law to invest in derivative securities, our investment policy does not
permit this investment. We had no investments in derivative securities at June 30, 2009.
At June 30, 2009, our investment
portfolio totaled $13.8 million and consisted primarily of U.S. Treasury obligations and federal agency securities, mortgage-backed securities issued primarily by Fannie Mae, Freddie Mac and Ginnie Mae, and a mutual fund that invests in
adjustable-rate mortgages.
Our investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest
rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. Our board of directors has the overall responsibility for the investment portfolio, including approval of
our investment policy. The board of directors is also responsible for the implementation of the investment policy and monitoring our investment performance. Individual investment transactions, portfolio composition and performance are reviewed and
ratified by our board of directors monthly.
Deposit Activities and Other Sources of Funds
General . Deposits and loan repayments are the major sources of our funds for lending and other investment purposes. Loan repayments
are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions.
Deposit Accounts . Substantially all of our depositors are residents of the State of Maryland. Deposits are attracted from within our market area through the offering of a broad selection of
deposit instruments, including checking accounts, NOW and money market accounts, passbook and savings accounts and certificates of deposit. Additionally, our customers may use any M&T Bank ATM without a surcharge. At June 30, 2009, core
deposits, which consist of savings, NOW and money market accounts, comprised 49.0% of our deposits. We do not utilize brokered funds. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on
deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our liquidity needs, profitability to us, matching deposit and loan products and customer
preferences and concerns. We generally review our deposit mix and pricing monthly. We use our money market account as a primary source of liquidity. Consequently, when we require additional liquidity we will offer the highest rates in our market
area. When we do not require liquidity, our money market account rates are competitive. With regard to other deposit products, our current strategy is to offer competitive rates, and even higher rates on checking accounts, but not to be the market
leader in every type and maturity.
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Borrowings . We utilize advances from the Federal Home Loan Bank of Atlanta to
supplement our supply of lendable funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member, we are required to own capital stock
in the Federal Home Loan Bank and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided
certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based
either on a fixed percentage of an institutions net worth or on the Federal Home Loan Banks assessment of the institutions creditworthiness. At June 30, 2009, we had the ability to borrow an additional $40.0 million from the
Federal Home Loan Bank of Atlanta. Additionally, at June 30, 2009, the Bank had a $2.0 million unsecured demand line of credit facility with M&T Bank, which had no outstanding balance.
Personnel
As of June 30, 2009, we had 34
full-time employees and two part-time employees, none of whom is represented by a collective bargaining unit. We believe our relationship with our employees is good.
Subsidiaries
BV Financials only direct subsidiary is Bay-Vanguard Federal.
Bay-Vanguard Federal has one subsidiary, Housing Recovery Corporation. Housing Recovery Corporation holds real estate and other assets acquired through
foreclosure or repossession by Bay-Vanguard Federal.
Regulation and Supervision
General
As a federal mutual holding company,
Bay-Vanguard, M.H.C. is required by federal law to report to, and otherwise comply with the rules and regulations of, the Office of Thrift Supervision. BV Financial, as a federally chartered corporation, is also subject to reporting to and
regulation by the Office of Thrift Supervision.
Bay-Vanguard Federal, as an insured federal savings association, is subject to extensive
regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer. Bay-Vanguard Federal is a member of the Federal Home Loan Bank
System and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the Federal Deposit Insurance Corporation. Bay-Vanguard Federal must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance
Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The Office of Thrift
Supervision and/or the Federal Deposit Insurance Corporation conduct periodic examinations to test Bay-Vanguard Federals safety and soundness and compliance with various regulatory requirements.
This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the
protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance
Corporation or Congress, could have a material adverse impact on Bay-Vanguard, M.H.C., BV Financial, Bay-Vanguard Federal and their operations.
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Certain regulatory requirements applicable to Bay-Vanguard Federal and to Bay-Vanguard, M.H.C. are
referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth below and elsewhere in this document does not purport to be a complete
description of such statutes and regulations and their effects on Bay-Vanguard Federal and Bay-Vanguard, M.H.C. and is qualified in its entirety by reference to the actual statutes and regulations.
Holding Company Regulation
General .
Bay-Vanguard, M.H.C. is a federal savings and loan holding company within the meaning of federal law. As such, Bay-Vanguard, M.H.C. is registered with the Office of Thrift Supervision and is subject to Office of Thrift Supervision regulations,
examinations, supervision and reporting requirements. In addition, the Office of Thrift Supervision has enforcement authority over Bay-Vanguard, M.H.C. and its non-savings institution subsidiaries. Among other things, this authority permits the OTS
to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
Activities
Restrictions Applicable to Mutual Holding Companies . Pursuant to federal law and Office of Thrift Supervision regulations, a mutual holding company such as Bay-Vanguard, M.H.C., with appropriate OTS approvals, may engage in the
following activities: (1) investing in the stock of a savings association; (2) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings
association subsidiary of such holding company; (3) merging with or acquiring another holding company, one of whose subsidiaries is a savings association; (4) investing in a corporation, the capital stock of which is available for purchase
by a savings association under federal law or under the law of any state where the subsidiary savings association or associations share their home offices; (5) furnishing or performing management services for a savings association subsidiary of
such company; (6) holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company; (7) holding or managing properties used or occupied by a savings association subsidiary of such company properties used
or occupied by a savings association subsidiary of such company; (8) acting as trustee under deeds of trust; (9) any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding
companies under Section 4(c) of The Bank Holding Company Act, unless the Office of Thrift Supervision, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan
holding companies were authorized (by regulation) to directly engage on March 5, 1987; and (10) purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings
and loan holding company is approved by the Office of Thrift Supervision.
The Gramm-Leach Bliley Act of 1999 was designed to modernize the
regulation of the financial services industry by expanding the ability of bank holding companies to affiliate with other types of financial services companies such as insurance companies and investment banking companies. The legislation also
expanded the activities permitted for mutual savings and loan holding companies to also include any activity permitted a financial holding company under the legislation, including a broad array of insurance and securities activities.
Federal law prohibits a savings and loan holding company, including a federal mutual holding company, from, directly or indirectly or
through one or more subsidiaries, acquiring more than 5% of the voting stock of another savings institution, or holding company thereof, without prior written approval of the Office of Thrift Supervision from acquiring or retaining, with certain
exceptions, more than 5% of a non-subsidiary holding company or savings association. A savings and loan holding company is also prohibited from acquiring more than 5% of a company engaged in activities other than those authorized by federal law; or
acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must
consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any acquisition that would result in a multiple savings and loan holding
company controlling savings institutions in more than one state, except: (1) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (2) the acquisition of a
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savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the
extent to which they permit interstate savings and loan holding company acquisitions.
If the savings institution subsidiary of a savings
and loan holding company fails to meet the qualified thrift lender test set forth in federal law, the holding company must register with the Federal Reserve Board as a bank holding company within one year of the savings institutions failure to
so qualify.
Although savings and loan holding companies are not currently subject to regulatory capital requirements or specific
restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. Bay-Vanguard Federal must notify the Office of Thrift Supervision 30
days before declaring any dividend and comply with the additional restrictions described below. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Office of Thrift Supervision
and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
Stock Holding Company Subsidiary Regulation . The Office of Thrift Supervision has adopted regulations governing the two-tier mutual holding company form of organization and mid-tier stock holding
companies, such as BV Financial, that are controlled by mutual holding companies. Under these rules, the stock holding company subsidiary holds all the shares of the mutual holding companys savings association subsidiary and issues the
majority of its own shares to the mutual holding company parent. In addition, the stock holding company subsidiary is permitted to engage in activities that are permitted for its mutual holding company parent subject to the same terms and
conditions. Finally, Office of Thrift Supervision regulations maintain that the stock holding company subsidiary must be federally chartered for supervisory reasons.
Waivers of Dividends. Office of Thrift Supervision regulations require mutual holding companies to notify the agency if they propose to waive receipt of dividends from their stock subsidiary. The Office
of Thrift Supervision reviews dividend waiver notices on a case-by-case basis and, in general, does not object to a waiver if: (1) the waiver would not be detrimental to the safe and sound operation of the savings association; and (2) the
mutual holding companys board of directors determines that their waiver is consistent with such directors fiduciary duties to the mutual holding companys members. Bay-Vanguard, M.H.C. anticipates waiving dividends, if any are paid.
Conversion of Bay-Vanguard, M.H.C. to Stock Form. Office of Thrift Supervision regulations permit Bay-Vanguard, M.H.C. to
convert from the mutual form of organization to the capital stock form of organization. There can be no assurance when, if ever, a conversion transaction will occur. In a conversion transaction, a new holding company would be formed as the successor
to BV Financial, Bay-Vanguard, M.H.C.s corporate existence would end, and certain depositors of Bay-Vanguard Federal would receive the right to subscribe for additional shares of the new holding company. In a conversion transaction, each share
of common stock held by stockholders other than Bay-Vanguard, M.H.C. would be automatically converted into a number of shares of common stock of the new holding company based on an exchange ratio determined at the time of conversion that ensures
that stockholders other than Bay-Vanguard, M.H.C. own the same percentage of common stock in the new holding company as they owned in BV Financial immediately before conversion. The total number of shares held by stockholders other than
Bay-Vanguard, M.H.C. after a conversion transaction would be increased by any purchases by such stockholders in the stock offering conducted as part of the conversion transaction.
Acquisition of Bay-Vanguard, M.H.C. Under the Federal Change in Control Act, a notice must be submitted to the Office of Thrift Supervision
if any person (including a company), or group acting in concert, seeks to acquire direct or indirect control of a savings and loan holding company or savings institution. Under certain circumstances, a change of control may occur, and
prior notice is required, upon the acquisition of 10% or more of the outstanding voting stock of the company or institution, unless the Office of Thrift Supervision has found that the acquisition will not result in a change of control of
Bay-Vanguard, M.H.C. Under the Change in Control Act, the Office of Thrift Supervision generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of
the acquirer and the anti-trust effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company.
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Federal Savings Institution Regulation
Business Activities . The activities of federal savings associations are governed by federal law and regulations. These laws and
regulations delineate the nature and extent of the activities in which federal savings institutions may engage. In particular, certain lending authority for federal savings institutions, e.g., commercial, non-residential real property loans and
consumer loans, is limited to a specified percentage of the institutions capital or assets.
Capital
Requirements . The Office of Thrift Supervision capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio; a 4% Tier 1 capital to total assets leverage ratio
(3% for institutions receiving the highest rating on the CAMELS examination rating system); and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible
capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The Office of Thrift Supervision
regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national
bank.
The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is
defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations,
residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital
is generally defined as common stockholders equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles
other than certain mortgage servicing rights and credit card relationships. The components of supplementary (Tier 2) capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities,
subordinated debt and intermediate preferred stock, the allowance for loan and lease losses, limited to a maximum of 1.25% of risk-weighted assets, and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable
fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.
The
Office of Thrift Supervision also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institutions capital level is or may become inadequate in light of the particular
circumstances. At June 30, 2009, Bay-Vanguard Federal met each of its capital requirements.
The following table presents Bay-Vanguard
Federals capital position at June 30, 2009.
Actual
Capital
Required
Capital
Excess
Amount
Capital
Actual
Percent
Required
Percent
(Dollars in thousands)
Tangible
$
10,597
$
2,291
$
8,306
6.9
%
> 1.5
%
Tier 1/Leverage
10,597
6,097
4,500
6.9
> 4.0
Tier 1/Risk-based
10,597
11.5
N/A
Total/Risk-based
11,454
7,401
4,053
12.4
> 8.0
Prompt Corrective Regulatory Action. The Office of Thrift Supervision is required to
take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institutions degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted
assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be
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undercapitalized. A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a
leverage ratio that is less than 3% is considered to be significantly undercapitalized and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be critically
undercapitalized. Subject to a narrow exception, the Office of Thrift Supervision is required to appoint a receiver or conservator within specified time frames for an institution that is critically undercapitalized. The regulation
also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings institution is deemed to have received notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. Compliance with the plan must be guaranteed by any parent holding company in an amount of up to the lesser of 5% of the savings associations total assets when it was deemed to
be undercapitalized or the amount necessary to achieve compliance with applicable capital regulations. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited
to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The Office of Thrift Supervision could also take any one of a number of discretionary supervisory actions, including the issuance of a capital
directive and the replacement of senior executive officers and directors. Significantly undercapitalized institutions are subject to additional mandatory and discretionary restrictions.
Insurance of Deposit Accounts. Deposits of Bay-Vanguard Federal are insured up to applicable limits by the Deposit Insurance Fund of the
Federal Deposit Insurance Corporation. Under the Federal Deposit Insurance Corporations risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels
and certain other factors, with less risky institutions paying lower assessments. An institutions assessment rate depends upon the category to which it is assigned, with less risky institutions paying lower assessments. For 2008, assessments
ranged from five to forty-three basis points of an institutions deposit assessment base. Due to losses incurred by the Deposit Insurance Fund in 2008 from failed institutions, and anticipated future losses, the Federal Deposit Insurance
Corporation, pursuant to a Restoration Plan to replenish the fund, adopted an across the board seven basis point increase in the assessment range for the first quarter of 2009. The Federal Deposit Insurance Corporation adopted further refinements to
its risk-based assessment that were effective April 1, 2009 and effectively make the range seven to seventy-seven and one half basis points. On May 22, 2009, the Federal Deposit Insurance Corporation issued a final rule that will impose a
special five basis points assessment on each institutions assets minus Tier 1 capital as of June 30, 2009, which would be payable to the Federal Deposit Insurance Corporation on September 30, 2009. If after June 30, 2009, the
reserve ratio of the Deposit Insurance Fund falls to a level that the Board of the Federal Deposit Insurance Corporation (the Board) believes would adversely affect public confidence or to a level close to or below zero, the Board may
impose an additional special assessment of up to five basis points on each institutions assets minus Tier 1 capital for the third and fourth quarters of 2009 as deemed necessary. The cost of the special five basis points assessment to
Bay-Vanguard Federal based on assets minus Tier 1 capital as of June 30, 2009 was $75,200. No institution may pay a dividend if in default of the federal deposit insurance assessment.
Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000 for all types of accounts until
December 31, 2013. Thereafter, regular deposit accounts will be insured up to a maximum of $100,000 and self-directed retirement accounts up to a maximum of $250,000.
In addition, the Federal Deposit Insurance Corporation adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest bearing
transaction accounts would receive unlimited insurance coverage until December 31, 2009 and certain senior unsecured debt issued by institutions and their holding companies would be guaranteed by the Federal Deposit Insurance Corporation
through June 30, 2012 and in certain conditions through December 31, 2012. Bay-Vanguard Federal made the business decision to participate in the unlimited noninterest bearing transaction account coverage and Bay-Vanguard Federal, BV
Financial and Bay-Vanguard M.H.C. opted not to participate in the unsecured debt guarantee program.
Federal law also provides for the
possibility that the Federal Deposit Insurance Corporation may pay dividends to insured institutions once the Deposit Insurance fund reserve ratio equals or exceeds 1.35% of estimated insured deposits.
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In addition to the assessment for deposit insurance, institutions are required to make payments on bonds
issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. That payment is established quarterly and during the fiscal year ending June 30, 2009 averaged 1.08 basis points of assessable deposits.
The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in insurance premiums
would likely have an adverse effect on the operating expenses and results of operations of Bay-Vanguard Federal. Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that the 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 Federal Deposit Insurance Corporation or the Office of Thrift Supervision. The management
of Bay-Vanguard Federal does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Loans to One Borrower . Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Subject to certain exceptions, a savings institution may
not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified
readily-marketable collateral.
QTL Test . Federal law requires savings institutions to meet a qualified thrift lender
test. Under the test, a savings association is required to either qualify as a domestic building and loan association under the Internal Revenue Code or maintain at least 65% of its portfolio assets (total assets less:
(1) specified liquid assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain qualified thrift investments (primarily residential mortgages
and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be
considered qualified thrift investments.
A savings institution that fails the qualified thrift lender test is subject to
certain operating restrictions and may be required to convert to a bank charter. As of June 30, 2009, Bay-Vanguard Federal maintained 74.0% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender
test.
Limitation on Capital Distributions . Office of Thrift Supervision regulations impose limitations upon all
capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and prior approval of the
Office of Thrift Supervision is required prior to any capital distribution if the institution does not meet the criteria for expedited treatment of applications under Office of Thrift Supervision regulations (i.e., generally, examination
and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be
undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the Office of Thrift Supervision. If an application is not required, the institution must still provide prior
notice to the Office of Thrift Supervision of the capital distribution if, like Bay-Vanguard Federal, it is a subsidiary of a holding company. In the event Bay-Vanguard Federals capital fell below its regulatory requirements or the Office of
Thrift Supervision notified it that it was in need of increased supervision, Bay-Vanguard Federals ability to make capital distributions could be restricted. In addition, the Office of Thrift Supervision could prohibit a proposed capital
distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determines that such distribution would constitute an unsafe or unsound practice.
Standards for Safety and Soundness . The federal banking agencies have adopted Interagency Guidelines prescribing Standards for
Safety and Soundness in various areas such as internal controls and information systems, internal audit, loan documentation and credit underwriting, interest rate exposure, asset growth and quality, earnings and
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compensation, fees and benefits. The 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 Office of Thrift Supervision determines that a savings association fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may
require the institution to submit an acceptable plan to achieve compliance with the standard.
Transactions with Related
Parties . Bay-Vanguard Federals authority to engage in transactions with affiliates (e.g., any entity that controls or is under common control with an institution, including Bay-Vanguard, M.H.C. and its non-savings
institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited to 20% of the savings institutions capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low
quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with
non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
Bay-Vanguard Federal may make loans to its executive officers and directors in compliance with federal
banking laws. Under such laws, Bay-Vanguard Federals authority to extend credit to executive officers, directors and 10% shareholders (insiders), as well as entities such persons control, is limited. The law limits both the
individual and aggregate amount of loans Bay-Vanguard Federal may make to insiders based, in part, on Bay-Vanguard Federals capital position and requires certain board approval procedures to be followed. Such loans are required to be made on
terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all
employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional restrictions as to type and amount.
Enforcement . The Office of Thrift Supervision has primary enforcement responsibility over savings institutions and has the authority
to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance.
Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The Federal Deposit Insurance Corporation has the authority to recommend to the Director of the Office of
Thrift Supervision that enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances.
Federal law also establishes criminal penalties for certain violations.
Assessments . Savings institutions are
required to pay assessments to the Office of Thrift Supervision to fund the agencys operations. The general assessments, paid on a semi-annual basis, are computed based upon the savings institutions (including consolidated subsidiaries)
total asset size, condition and complexity of portfolio. The OTS assessments paid by Bay-Vanguard Federal for the fiscal year ended June 30, 2009 totaled $53,000.
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Federal Home Loan Bank System
Bay-Vanguard Federal is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member
institutions. Bay-Vanguard Federal, as a member of the Federal Home Loan Bank of Atlanta, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. Bay-Vanguard Federal was in compliance with this requirement with an
investment in Federal Home Loan Bank stock at June 30, 2009 of $631,000. This stock is carried at a cost of $100 per share. Due to concerns about the capital strength of the Federal Home Loan Bank of Atlanta and the entire Federal Home Loan
Bank system, there has been industry discussion about impairment issues on Federal Home Loan Bank stock. If the Federal Home Loan Bank stock were deemed to be impaired, the write-down for the Bank could be significant. However, due to the nature of
the Federal Home Loan Bank system and the heavy dependence of community banks on the Federal Home Loan Bank, it is believed that any determination about the valuation of Federal Home Loan Bank stock needs to be accomplished at the national level so
that the entire community banking system is not disrupted.
The Federal Home Loan Banks are required to provide funds for the resolution of
insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements, or the general financial condition of the Federal Home Loan Bank, could reduce the amount of dividends that the Federal Home Loan Banks
pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, Bay-Vanguard
Federals net interest income would likely also be reduced.
The Federal Home Loan Bank of Atlanta changed its dividend declaration
and payment schedule in the fourth quarter of 2008 so a dividend can be declared and paid to members after net income is calculated for the preceding quarter. No dividends were paid for the fourth quarter of 2008 and first quarter of 2009; however,
dividends were paid for the third quarter of 2008 and second quarter of 2009.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily
Negotiable Order of Withdrawal (NOW) and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to
and including $44.4 million; a 10% reserve ratio is applied above $44.4 million. The first $10.3 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts
are adjusted annually. Bay-Vanguard Federal complies with the foregoing requirements.
Federal and State Taxation
Federal Income Taxation
General. We
report our income on a fiscal year basis using the accrual method of accounting. The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly our reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. Our federal income tax returns have been either audited or closed under the
statute of limitations through tax year 2004. For its 2009 year, BV Financials maximum federal income tax rate was 34.0%.
BV
Financial and Bay-Vanguard Federal have entered into a tax allocation agreement. Because BV Financial owns 100% of the issued and outstanding capital stock of Bay-Vanguard Federal, BV Financial and Bay-Vanguard Federal are members of an affiliated
group within the meaning of Section 1504(a) of the Internal Revenue Code, of which group BV Financial is the common parent corporation. As a result of this affiliation, Bay-Vanguard Federal will be included in the filing of a consolidated
federal income tax return with BV Financial and the parties have agreed to compensate each other for their individual share of the consolidated tax liability and/or any tax benefits provided by them in the filing of the consolidated federal income
tax return.
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Bad Debt Reserves. For fiscal years beginning before June 30, 1996, thrift
institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad
debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The
reserve for nonqualifying loans was computed using the experience method. Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and
require savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves. Approximately $1.2 million of our accumulated bad debt reserves would not be recaptured into taxable income unless Bay-Vanguard
Federal makes a non-dividend distribution to BV Financial as described below.
Distributions. If Bay-Vanguard
Federal makes non-dividend distributions to BV Financial, the distributions will be considered to have been made from Bay-Vanguard Federals unrecaptured tax bad debt reserves, including the balance of its reserves as of
December 31, 1987, to the extent of the non-dividend distributions, and then from Bay-Vanguard Federals supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed,
but not more than the amount of those reserves, will be included in Bay-Vanguard Federals taxable income. Non-dividend distributions include distributions in excess of Bay-Vanguard Federals current and accumulated earnings and profits,
as calculated for federal income tax purposes, distributions in redemption of stock and distributions in partial or complete liquidation. Dividends paid out of Bay-Vanguard Federals current or accumulated earnings and profits will not be so
included in Bay-Vanguard Federals taxable income.
The amount of additional taxable income triggered by a non-dividend is an amount
that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if Bay-Vanguard Federal makes a non-dividend distribution to BV Financial, approximately one and one-half times the amount of the
distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. Bay-Vanguard Federal does not intend to pay dividends that would result in a
recapture of any portion of its bad debt reserves.
State Taxation
For fiscal 2009 BV Financial was subject to Marylands Corporation Business Tax at the rate of 8.25% on its taxable income, before net operating loss deductions and special deductions for federal income tax
purposes. The rate will remain the same for fiscal 2010. BV Financial and Bay-Vanguard, M.H.C. are required to file Maryland income tax returns because they are doing business in Maryland. For this purpose, taxable income generally means
federal taxable income subject to certain adjustments (including addition of interest income on state and municipal obligations).
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.