UNITED STATES




SECURITIES AND EXCHANGE COMMISSION


Washington, DC  20549





FORM 10-K


(Mark One)





x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended June 30, 2011


OR




 ̈
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from  to




Commission file number. 0-28032





PATAPSCO BANCORP, INC.(Exact name of registrant as specified in its charter)





Maryland

52-1951797(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification No.)





1301 Merritt Boulevard, Dundalk, Maryland

21222-2194(Address of principal executive offices)

(Zip Code)





Registrant’s telephone number, including area code:  (410) 285-1010





Securities registered pursuant to Section 12(b) of the Act:  None





Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $0.01 per share(Title of Class)





Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ̈   No x





Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.   Yes  ̈   No x





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YesxNo ̈





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ̈No ̈





Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ̈





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):





Large accelerated filer
 ̈
Accelerated filer
 ̈Non-accelerated filer
 ̈
Smaller reporting company
x(Do not check if a smaller reporting company)





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  ̈ No x





As of December 31, 2010, the aggregate market value of voting common stock held by nonaffiliates was approximately $2,938,000, computed by reference to the closing sales price on December 31, 2010 as reported on the OTC Electronic Bulletin Board.





Number of shares of Common Stock outstanding as of September 24, 2011:  1,971,843.





DOCUMENTS INCORPORATED BY REFERENCE





1.  Portions of the 2011 Annual Report to Stockholders. (Part II)


2.  Portions of the Proxy Statement for the 2011 Annual Meeting of Stockholders.  (Part III)








INDEX





PAGEPART IItem 1.

Business

1Item 1A.

Risk Factors

17Item 1B.

Unresolved Staff Comments

21Item 2.

Properties

21Item 3.

Legal Proceedings

21Item 4.

(Removed and Reserved)

21PART IIItem 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesItem 6.

Selected Financial Data

22Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operation

22Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

22Item 8.

Financial Statements and Supplementary Data

22Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

22Item 9A.

Controls and Procedures

22Item 9B.

Other Information

23PART IIIItem 10.

Directors, Executive Officers and Corporate Governance

24Item 11.

Executive Compensation

24Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13.

Certain Relationships and Related Transactions, and Director Independence

25Item 14.

Principal Accountant Fees and Services

25PART IVItem 15.

Exhibits and Financial Statement Schedules

25SIGNATURES


i





PART I




Forward-Looking Statements




When used in this Annual Report on Form 10-K, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company’s market area, competition and the other factors set forth in Item 1A in this Form 10-K that could cause actual results to differ materially from historical earnings and those presently anticipated or projected.  The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.




The Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.




Item 1.  Business




General




Patapsco Bancorp, Inc.Patapsco Bancorp, Inc. (the “Company”) was incorporated under the laws of the State of Maryland in November 1995.  On April 1, 1996, Patapsco Federal Savings and Loan Association (the “Association”), the predecessor of The Patapsco Bank (“the Bank”), converted from mutual to stock form and reorganized into the holding company form of ownership as a wholly owned subsidiary of the Company.




The Company has no significant assets other than its investment in the Bank.  The Company is primarily engaged in the business of directing, planning and coordinating the business activities of the Bank.  Accordingly, the information set forth in this report, including consolidated financial statements and related data, focuses primarily on the Bank.  In the future, the Company may become an operating company or acquire or organize other operating subsidiaries, including other financial institutions.  Currently, the Company does not maintain offices separate from those of the Bank or employ any persons other than its officers who are not separately compensated for such service.




The Company’s and the Bank’s executive offices are located at 1301 Merritt Boulevard, Dundalk, Maryland 21222-2194, and the main telephone number is (410) 285-1010.




The Patapsco Bank.  The Bank is a Maryland commercial bank operating through four full-service offices located in Dundalk, Carney, Glen Arm and Baltimore City, Maryland.  The primary business of the Bank is to attract deposits from individual and corporate customers and to originate residential and commercial mortgage loans, commercial loans and consumer loans, primarily in the Greater Baltimore Metropolitan area.  The Bank is subject to competition from other financial and mortgage institutions in attracting and retaining deposits and in making loans.  The Bank is subject to the regulations of certain agencies of the federal and state governments and undergoes periodic examination by those agencies.  The Bank has three active operating subsidiaries, Prime Business Leasing, Patapsco Financial Services and PFSL Holding Corp. (“PFSL”). The primary business of Prime Business Leasing is the servicing of commercial leases.  The primary business of Patapsco Financial Services is the sale of consumer investments.  The primary business of PFSL is to hold foreclosed real estate until disposition.




At June 30, 2011, the Bank had $56.1 million, $49.7 million, $12.3 million, $56.4 million, and $13.0 million in residential mortgage loans, small business loans, construction loans, commercial real estate loans, home equity and other consumer loans, respectively.


1


Available Information




The Company maintains a website at http://www.patapscobank.com, which makes available the Company’s Section 16 filings with the Securities and Exchange Commission (“SEC”).  The SEC maintains a website at http://www.sec.gov that makes available the Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, free of charge, on the site as soon as reasonably practicable after the Company has electronically filed these documents with, or otherwise furnished them to, the SEC.  The Company’s Internet website and the information contained therein or connected thereto are not intended to be incorporated into this annual report on Form 10-K.




Market Area




The Company’s market area for gathering deposits consists of the Hampden area of Baltimore City and eastern and northeastern Baltimore County, Maryland, while the Company makes loans to customers in much of the Mid-Atlantic area with a strong emphasis on the Baltimore metropolitan area.  The economy of the Company’s market area has historically been based on industries such as steel, shipyards and automobile assembly.  The economy in the Company’s market area continues to be dependent, to some extent, on a small number of major industrial employers.  A significant portion of eastern Baltimore County has been designated as an “Enterprise Zone.”  As a result, employers relocating to this area are entitled to significant tax and other economic incentives.  Based on 2004 United States Census data, the per capita personal income for Baltimore County ($42,852) is greater than that of Maryland as a whole ($39,631) and the United States ($33,050).  The per capita personal income for Baltimore City ($29,153) is lower than both the Maryland and United States averages.




Lending Activities




General.  The Company’s gross loan portfolio totaled $187.5 million at June 30, 2011, representing 70.9% of total assets at that date.  At June 30, 2011, $56.1 million, or 29.9%, of the Company’s gross loan portfolio, consisted of residential mortgage loans.  Other loans secured by real estate include construction and commercial real estate loans, which amounted to $68.7 million, or 36.7%, of the Company’s gross loan portfolio at June 30, 2011.  In addition, the Company originates consumer and other loans, including home equity loans, home improvement loans and loans secured by deposits.  At June 30, 2011, consumer and other loans totaled $13.0 million, or 6.9%, of the Company’s gross loan portfolio.  The Company’s commercial loan portfolio, which consists of small business loans and commercial leases totaled $49.7 million, or 26.5%, of the Company’s gross loan portfolio.




Originations, Purchases and Sales of Loans.  The Company generally has authority to originate and purchase loans throughout the United States.  Consistent with its emphasis on being a community-oriented financial institution, the Company concentrates its lending activities in its Maryland market area with limited loan originations in Delaware, Pennsylvania and Northern Virginia and on rare occasions, outside these markets.




The Company’s loan originations are derived from a number of sources, including loan brokers, advertising and referrals by depositors and borrowers.  The Company’s solicitation programs consist of advertisements in local media, in addition to participation in various community organizations and events.  All of the Company’s loan personnel are salaried; however, one originator receives commissions on loans approved by officers of the Bank.  With the exception of applications for home improvement loans, which loans were originated on an indirect basis through a limited number of approved home improvement contractors, loan applications are accepted at the Company’s offices.  In addition, the Company’s salaried loan originators may travel to meet prospective borrowers and take applications.  In all cases, the Company has final approval of the application.




In recent years, the Company has purchased whole loans and loan participation interests.  During the year ended June 30, 2011, the Company purchased no participation interests and no other loans.  In the future, management will continue to consider purchases of whole loans or participation interests in commercial business, residential and commercial real estate loans and consumer loans.


2


Loan Underwriting Policies.  The Company’s lending activities are subject to the Company’s non-discriminatory underwriting standards and to loan origination procedures prescribed by the Company’s Board of Directors and management.  Detailed loan applications are obtained to determine the borrower’s ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations.  Certain officers and committees have been granted authority by the Board of Directors to approve residential and commercial real estate, commercial business loans and equipment leases in varying amounts depending upon whether the loan is secured or unsecured and, with respect to secured loans, whether the collateral is liquid or illiquid.  Individual officers and certain committees of the Company have been granted authority by the Board of Directors to approve consumer loans up to varying specified dollar amounts, depending upon the type of loan.




Applications for single-family real estate loans are typically underwritten and closed in accordance with the standards of Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”).  Generally, upon receipt of a loan application from a prospective borrower, a credit report and verifications are ordered to confirm specific information relating to the loan applicant’s employment, income and credit standing.  If a proposed loan is to be secured by a mortgage on real estate, an appraisal of the real estate is undertaken, pursuant to the Company’s Appraisal Policy, by an appraiser approved by the Company and licensed by the State of Maryland.  In the case of single-family residential mortgage loans, except when the Company becomes aware of a particular risk of environmental contamination, the Company generally does not obtain a formal environmental report on the real estate at the time a loan is made.  A formal environmental report may be required in connection with nonresidential real estate loans.




It is the Company’s policy to record a lien on the real estate securing a loan and to obtain title insurance, which insures that the property is free of prior encumbrances and other possible title defects.  Borrowers must also obtain hazard insurance policies prior to closing, and when the property is in a flood plain as designated by the Department of Housing and Urban Development, pay flood insurance policy premiums.




With respect to single-family residential mortgage loans, the Company makes a loan commitment of between 30 and 60 days for each loan approved.  If the borrower desires a longer commitment, the commitment may be extended for good cause and upon written approval.  Typically, a $500 commitment fee is charged in connection with the issuance of a commitment letter; however, extension fees are usually charged.  The interest rate is guaranteed for the commitment term.




It is the policy of the Company that appraisals be obtained in connection with all loans for the purchase of real estate or to refinance real estate loans where the existing mortgage is held by a party other than the Company.  It is the Company’s policy that all appraisals be performed by appraisers approved by the Company’s Board of Directors and licensed by the State of Maryland, for properties located in the state of Maryland.  Broker price opinions (“BPOs”) may be used as a supplemental source of information to be used in the evaluation of collateral value.




Under applicable law, with certain limited exceptions, loans and extensions of credit by a commercial bank to a person, including commitments, at one time shall not exceed 15% of the Company’s unimpaired capital and surplus.  Under these limits, the Company’s loans to one borrower were limited to $3.85 million at June 30, 2011.  At that date, the Company had no lending relationships in excess of the loans-to-one-borrower limit.  At June 30, 2011, the Company’s largest lending relationship was represented by a loan totaling $3.2 million, secured by commercial real estateand business assets, which is included in non-accrual loans at June 30, 2011.




Interest rates charged by the Company on loans are affected principally by competitive factors, the demand for such loans and the supply of funds available for lending purposes.  These factors are, in turn, affected by general economic conditions, monetary policies of the federal government, including the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), legislative tax policies and government budgetary matters.




Residential Real Estate Lending.  The Company historically has been an originator of residential real estate loans in its market area.  Residential real estate loans consist of both single-family and multi-family residential real estate loans.  At June 30, 2011, residential mortgage loans totaled $56.1 million, or 29.9%, of the Company’s gross loan portfolio.  Of such loans, $22.2 million were secured by nonowner-occupied investment properties.


3


The Company’s multi-family residential loan portfolio consists primarily of loans secured by small apartment buildings.  Such loans generally range in size from $100,000 to $2.0 million.  At June 30, 2011, the Company had $5.8 million of multi-family residential real estate loans, which amounted to 3.1% of the Company’s gross loan portfolio at such date.  Multi-family real estate loans either are originated on an adjustable-rate basis with terms of up to 25 years or are amortized over a maximum of 25 years with a three or five-year note maturity, and are underwritten with loan-to-value ratios of up to 80% of the lesser of the appraised value or the purchase price of the property.




Multi-family residential real estate lending entails additional risks as compared with single-family residential property lending.  Multi-family residential real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans typically is dependent on the successful operation of the real estate project.  These risks can be significantly impacted by supply and demand conditions in the market for residential space, and, as such, may be subject to a greater extent to adverse conditions in the economy in general.  To minimize these risks, the Company generally limits itself to its market area or to borrowers with which it has prior experience or who are otherwise known to the Company.  It has been the Company’s policy to obtain annual financial statements of the business of the borrower or the project for which multi-family residential real estate loans are made.  The Company seeks to expand multi-family residential real estate lending.




Construction Lending.The Company also offers residential and commercial construction loans and land acquisition and development loans.  Residential construction loans are offered to individuals who are having their primary or secondary residence built, as well as to local builders to construct single-family dwellings.  Residential construction advances are made on a stage of completion basis.  Generally, loans to owner/occupants for the construction of residential properties are originated in conjunction with the permanent mortgage on the property.  The term of the construction loans is normally from 6 to 18 months and has a variable interest rate, which is normally up to 2% above the prime interest rate.  Upon completion of construction, the permanent loan rate will be set at the interest rate offered by the Company on that loan product not sooner than 60 days prior to completion.  Interest rates on residential loans to builders are set at the prime interest rate plus a margin of 0.5% to 2.0% as may be adjusted from time to time.  Interest rates on commercial construction loans and land acquisition and development loans are based on the prime rate plus a negotiated margin of between 0.5% and 2.0% and adjust from time to time, with construction terms generally not exceeding 18 months.  Advances are made on a percentage of completion basis.  At June 30, 2011, $12.3 million, or 6.6%, of the Company’s loan portfolio consisted of construction loans.




Prior to making a commitment to fund a loan, the Company requires an appraisal of the property by appraisers approved by the Board of Directors and may require a study of the feasibility of the proposed project.  The Company also reviews and inspects each project at the commencement of construction and prior to payment of draw requests during the term of the construction loan.  Dependent upon market forces, the Bank generally charges a loan fee between 1% and 2%.




Construction financing generally is 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 is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development 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 and the borrower is unable to meet the Company’s requirements of putting up additional funds to cover extra costs or change orders, then the Company will demand that the loan be paid off and, if necessary, institute foreclosure proceedings, or refinance the loan.  If the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with collateral having a value that is insufficient to assure full repayment.  The Company has sought to minimize this risk by limiting construction lending to qualified borrowers (i.e., borrowers who satisfy all credit requirements and whose loans satisfy all other underwriting standards which would apply to the Company’s permanent mortgage loan financing for the subject property) in the Company’s market area.  On loans to builders, the Company works only with selected builders with whom it has experience and carefully monitors the creditworthiness of the builders.




Commercial Real Estate Lending.The Company’s commercial real estate loan portfolio consists of loans to finance the acquisition of small office buildings, shopping centers and commercial and industrial buildings.  Such loans generally range in size from $100,000 to $2.0 million.  At June 30, 2011, the Company had $56.4 million of commercial real estate loans, which amounted to 30.0% of the Company’s gross loan portfolio at such date.  Commercial real estate loans are typically originated on an adjustable-rate basis with terms of up to 25 years or are amortized over a maximum of 25 years with a maturity generally of three to ten years, and are underwritten with loan-to-value ratios of up to 80% of the lesser of the appraised value or the purchase price of the property.  Because of the inherently greater risk involved in this type of lending, the Company generally limits its commercial real estate lending to borrowers within its market area or with which it has had prior experience.  The Company seeks to expand commercial real estate lending.


4


Commercial real estate lending entails additional risks as compared with single-family residential property lending.  Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans typically is dependent on the successful operation of the real estate project, retail establishment or business.  These risks can be significantly impacted by supply and demand conditions in the market for office, retail and residential space, and, as such, may be subject to a greater extent to adverse conditions in the economy generally.  To minimize these risks, the Company generally limits itself to its market area or to borrowers with which it has prior experience or who are otherwise known to the Company.  It has been the Company’s policy to obtain annual financial statements of the business of the borrower or the project for which commercial real estate loans are made.  In addition, in the case of commercial mortgage loans made to a partnership or a corporation, the Company seeks, whenever possible, to obtain personal guarantees and annual financial statements of the principals of the partnership or corporation.




Consumer Lending.  The consumer loans currently in the Company’s loan portfolio consist of home improvement loans, home equity loans, loans secured by savings deposits and overdraft protection for checking accounts and other consumer loans.  At June 30, 2011, consumer and other loans totaled $13.0 million, or 6.9%, of the Company’s gross loan portfolio.




In July 1995, the Company instituted a home improvement loan program.  Such loans were made to finance a variety of other home improvement projects, such as replacement windows, siding and room additions.  The Company originated home improvement loans throughout Maryland, Virginia, Delaware, New Jersey and Southern Pennsylvania.  In June 2011, the Company exited the origination of home improvement loans.  At June 30, 2011 home improvement loans amounted to $7.1 million, or 3.8%, of the Company’s loan portfolio, with $416,000 of originated loans being secured by real estate.




Consumer lending affords the Company the opportunity to earn yields higher than those obtainable with other types of lending.  However, consumer loans entail greater risk than do other loans, particularly in the case of loans that are unsecured or secured by rapidly depreciable assets.  Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  The remaining deficiency often does not warrant further substantial collection efforts against the borrower.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by events such as job loss, divorce, illness or personal bankruptcy.




Commercial Lending.The Company’s commercial loans consist of commercial business loans and the financing of lease transactions, which may not be secured by real estate.




At June 30, 2011, the Company’s commercial loans, excluding leases, totaled $47.5 million, or 25.3%, of the Company’s loan portfolio.  This commercial lending program employs many of the alternative financing and guarantee programs available through the U.S. Small Business Administration and other state and local economic development agencies.




The Company originates commercial business loans to small and medium-sized businesses in its market area.  The Company’s commercial business loans may be structured as term loans, lines of credit, or mortgages.  The Company’s commercial borrowers are generally small businesses engaged in manufacturing, distribution or retailing, or professionals in healthcare, accounting and law.  Commercial business loans are generally made to finance the purchase of inventory, new or used commercial business assets or for short-term working capital, or the purchase of real estate to be occupied by the operating company.  Such loans generally are secured by business assets and, when applicable, cross-collateralized by a real estate lien, although commercial business loans are sometimes granted on an unsecured basis.  Such loans are generally made for terms of seven years or less, depending on the purpose of the loan and the collateral.  Interest rates on commercial business loans and lines of credit are either fixed for the term of the loan or adjusted periodically. Generally, commercial business loans are made in amounts ranging between $10,000 and $2.0 million.


5


The Company underwrites its commercial business loans on the basis of the borrower’s cash flow and ability to service the debt from earnings and the Company seeks to structure such loans to have more than one source of repayment.  The borrower is required to provide the Company with sufficient information to allow the Company to make its lending determination.  In most instances, this information consists of at least two years of financial statements, a statement of projected cash flows, current financial information on any guarantor and any additional information on the collateral.  For loans with maturities exceeding one year, the Company requires that borrowers and guarantors provide updated financial information at least annually throughout the term of the loan.




Commercial business term loans are generally made to finance the purchase of assets and have maturities of five years or less.  Commercial business lines of credit are typically made for the purpose of providing working capital and are usually approved with a term of 12 months and are reviewed at that time to determine if extension is warranted.  The Company also offers standby letters of credit for its commercial borrowers.  The terms of standby letters of credit generally do not exceed one year but may contain a renewal option.




Commercial business loans are often larger and may involve greater risk than other types of lending. Because payments on such loans are often dependent on successful operation of the business involved, repayment of such loans may be subject to a greater extent to adverse conditions in the economy.  The Company seeks to minimize these risks through its underwriting guidelines, which require that the loan be supported by adequate cash flow of the borrower, profitability of the business, collateral and personal guarantees of the individuals in the business.  In addition, the Company generally limits this type of lending to its market area and to borrowers with which it has prior experience or who are otherwise well known to the Company.




Prior to October 2008, the Company offered loans to finance lease transactions, secured by the lease and the underlying equipment, to businesses of various size through its subsidiary, Prime Business Leasing.  In extending the financing in a commercial lease transaction, the Company reviewed the borrower’s financial statements, credit reports, tax returns and other documentation.  Generally, commercial lease financing were made in amounts ranging between $3,000 and $120,000 with terms of up to five years and carry fixed interest rates.  Note that in October 2008, management made a strategic decision to cease origination of leases.  At June 30, 2011, the remaining portfolio of commercial lease finance transaction loans totaled $2.2 million, or 1.2%, of the Company’s loan portfolio.




Loan Fees and Servicing.  The Company receives fees in connection with late payments and for miscellaneous services related to its loans.  The Company also charges fees in connection with loan originations typically up to two points (one point being equal to 1% of the loan amount) on real estate loan originations.  The Company generally does not service loans for others.  The Company has sold participating interests on residential, commercial real estate and commercial business loans to other local financial institutions.  At June 30, 2011, the Company was servicing these participation interests for others totaling approximately $14.5 million.




Nonperforming Loans and Other Problem Assets.  It is management’s policy to continually monitor its loan portfolio to anticipate and address potential and actual delinquencies.  When a borrower fails to make a payment on a loan, the Company takes immediate steps to have the delinquency cured and the loan restored to current status.  Loans, which are delinquent between ten and 15 days, depending on the type of loan, typically incur a late fee of 5% of principal and interest due.  As a matter of policy, the Company will contact the borrower after the date the late payment is due.  If payment is not promptly received, the borrower is contacted again, and efforts are made to formulate an affirmative plan to cure the delinquency.  Generally, after any loan is delinquent 90 days or more, formal legal proceedings are commenced to collect amounts owed.




Loans generally are placed on nonaccrual status if the loan becomes past due more than 90 days, except in instances where in management’s judgment there is no doubt as to full collectibility of principal and interest.  At June 30, 2011, all loans past due more than 90 days were on nonaccrual. Consumer loans are generally charged off after they become more than 90 days past due.  All other loans are charged off when management concludes that they are uncollectible.  See Notes 1, 3 and 4 of the Notes to Consolidated Financial Statements.


6


Real estate acquired by the Company as a result of foreclosure is classified as real estate acquired through foreclosure until such time as it is sold.  When such property is acquired, it is initially recorded at the estimated fair value less costs to sell, establishing a new cost basis.  Subsequent to acquisition, the property is carried at the lower of cost or fair value less estimated costs to sell.  Fair value is defined as the amount in cash or cash-equivalent value or other consideration that a real estate parcel would yield in a current sale between a willing buyer and a willing seller, as measured by market transactions.  If a market does not exist, fair value of the item is estimated based on selling prices of similar items in active markets or, if there are no active markets for similar items, by discounting a forecast of expected cash flows at a rate commensurate with the risk involved. Fair value is generally determined through an appraisal at the time of foreclosure.  Any required write-down of the loan to its fair value upon foreclosure is charged against the allowance for loan losses, with subsequent write-downs reflected in other expense.  See Notes 1 and 5 of the Notes to Consolidated Financial Statements.




Investment Activities




General.  The Company makes investments in order to maintain the levels of liquid assets preferred by regulatory authorities and manage cash flow, diversify its assets, obtain yield and to satisfy certain requirements for favorable tax treatment.  The investment activities of the Company consist primarily of investments in mortgage-backed securities and other investment securities.  Typical investments include federally sponsored agency mortgage pass-through, federally sponsored agency debt securities, U.S. treasury obligations and investment grade corporate securities.  Investment and aggregate investment limitations and credit quality parameters of each class of investment are prescribed in the Company’s investment policy.  The Company performs analyses on securities prior to purchase and on an ongoing basis to determine the impact on earnings and market value under various interest rate and prepayment conditions.  Senior management and the Company’s Asset/Liability Management Committee have limited authority to sell investment securities and purchase comparable investment securities with similar characteristics.  The Board of Directors reviews all securities transactions on a monthly basis.




Under applicable accounting rules, investment securities classified as held-to-maturity are recorded at amortized cost and those classified as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity.  At June 30, 2011, the Company’s entire portfolio of investment securities was classified as available for sale and had an aggregate carrying value of $39.8 million and an unrealized net gain after tax of $39,000.  Management of the Company currently does not anticipate that the presence of unrealized losses in the Company’s portfolio of investment securities and mortgage-backed securities is likely to have a material adverse effect on the Company’s financial condition, results of operations or liquidity.




Deposit Activity and Other Sources of Funds




General.  Deposits are the primary source of the Company’s funds for lending, investment activities and general operational purposes.  In addition to deposits, the Company derives funds from loan principal and interest repayments, maturities of investment securities and mortgage-backed securities and interest payments thereon.  Although loan repayments are a relatively stable source of funds, deposit inflows and outflows are significantly influenced by general interest rates and money market conditions.  Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds, or on a long-term basis for general operational purposes.  The Company may borrow from the Federal Home Loan Bank of Atlanta and Pacific Coast Bankers Bank.




Deposits.  The Company attracts deposits principally from within its market area by offering a variety of deposit instruments, including checking accounts, Christmas Club accounts, money market accounts, statement and passbook savings accounts, Individual Retirement Accounts, and certificates of deposit which range in maturity from seven days to 66 months.  Deposit terms vary according to the minimum balance required, the length of time the funds must remain on deposit, and the interest rate.  Maturities, terms, service fees and withdrawal penalties for its deposit accounts are established by the Company on a periodic basis.  The Company reviews its deposit mix and pricing on a weekly basis. In determining the characteristics of its deposit accounts, the Company considers the rates offered by competing institutions, lending and liquidity requirements, growth goals and federal regulations.  Management believes it prices its deposits comparably to rates offered by its competitors.




The Company attempts to compete for deposits with other institutions in its market area by offering competitively priced deposit instruments that are tailored to the needs of its customers.  Additionally, the Company seeks to meet customers’ needs by providing convenient customer service to the community, efficient staff and convenient hours of service.  Substantially all of the Company’s depositors are Maryland residents.  To provide additional convenience, the Company participates in the STAR Automatic Teller Machine network at locations throughout the United States, through which customers can gain access to their accounts at any time.


7


Borrowings.  While deposits historically have been the primary source of funds for the Company’s lending, investments and general operating activities, the Company utilizes advances from the Federal Home Loan Bank of Atlanta to supplement its supply of lendable funds and to meet deposit withdrawal requirements.  The Federal Home Loan Bank of Atlanta functions as a central reserve bank providing credit for member financial institutions.  As a member of the Federal Home Loan Bank System, the Company is required to own stock in the Federal Home Loan Bank of Atlanta and is authorized to apply for advances.  Advances are pursuant to several different programs, each of which has its own interest rate and range of maturities.  The Company has a Blanket Agreement for advances with the Federal Home Loan Bank under which the Company may borrow up to 25% of assets subject to normal collateral and underwriting requirements.  Advances from the Federal Home Loan Bank of Atlanta are secured by the Company’s stock in the Federal Home Loan Bank of Atlanta and other eligible assets.  At June 30, 2011, the Company had outstanding Federal Home Loan Bank of Atlanta advances of $12.0 million with an average rate of 3.62%.




Troubled Asset Relief Program Capital Purchase Program




On December 19, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program, the Company sold to the U.S. Department of the Treasury (“Treasury”) 6,000 shares of its Series A cumulative perpetual preferred stock and a warrant for the purchase of 300 shares of its Series B cumulative perpetual preferred stock, for an aggregate purchase price of $6.0 million in cash.  Contemporaneously with that transaction, Treasury exercised its warrant and received 300 shares of Series B cumulative perpetual preferred stock.  The TARP Capital Purchase Program is a voluntary program for healthy U.S. financial institutions designed to encourage these institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the weakened U.S. economy.  Participation in this program provided additional capital for the Company.




Subsidiary Activities




The Bank has three subsidiaries, PFSL Holding Corp. (“PFSL”), which it formed to hold certain real estate owned, Prime Business Leasing that was formed in October 1998 and is discussed under commercial lending and Patapsco Financial Services, Inc., which was formed in order to sell alternative investment products to the Company’s customers.




Competition




The Company faces strong competition both in originating loans and in attracting deposits.  The Company competes for loans principally on the basis of interest rates, the types of loans it originates, the deposit products it offers and the quality of services it provides to borrowers.  The Company also competes by offering products that are tailored to the local community.  Its competition in originating loans comes primarily from other commercial banks, savings institutions and mortgage bankers, credit unions and finance companies.  The regulatory environment in which the Company and the Bank operate is subject to change and such changes may adversely affect operating results.




Management considers its market area for gathering deposits to be eastern Baltimore County, Baltimore City, and Harford County in Maryland.  The Company originates loans throughout much of the Mid-Atlantic area.  The Company attracts its deposits through its offices in Dundalk, Carney, Hampden and Glen Arm which are primarily from the local community.  Consequently, competition for deposits is principally from other commercial banks, savings institutions, credit unions, mutual funds and brokers in the local community.  The Company competes for deposits and loans by offering what it believes to be a variety of deposit products at competitive rates, convenient business hours, a commitment to outstanding customer service and a well-trained staff.




Employees




As of June 30, 2011, the Company had 57 full-time and 13 part-time employees, none of who were represented by a collective bargaining agreement.  Management considers the Company’s relationships with its employees to be good.


8


Depository Institution Regulation




General.  The Company is a Maryland commercial bank and its deposit accounts are insured by the Deposit Insurance Fund (“DIF”) administered by the Federal Deposit Insurance Corporation (“FDIC”).  The Company also is a member of the Federal Reserve System.  The Company is subject to supervision, examination and regulation by the State of Maryland Commissioner of Financial Regulation (“Commissioner”), the Federal Reserve Board, Maryland and federal statutory and regulatory provisions governing such matters as capital standards, mergers and establishment of branch offices, and it is subject to the FDIC’s authority to conduct special examinations.  The Company is required to file reports with the Commissioner and the Federal Reserve Board concerning its activities and financial condition and is required to obtain regulatory approvals prior to entering into certain transactions, including mergers with, or acquisitions of, other depository institutions.




The system of regulation and supervision applicable to the Company establishes a comprehensive framework for the operations of the Company and is intended primarily for the protection of the FDIC and the depositors of the Bank.  Changes in the regulatory framework could have a material effect on the Company and its respective operations.




Recent Regulatory Reform.The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted on July 21, 2010, will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository institutions, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. In addition, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets. The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months. These new leverage and capital requirements must take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.





The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10.0 billion in assets. Banks and savings institutions with $10.0 billion or less in assets will be examined by their applicable bank regulators. The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives the state attorneys general the ability to enforce applicable federal consumer protection laws.




The Dodd-Frank Act contains a wide variety of provisions affecting the regulation of depository institutions in addition to those stated above.  Those include restrictions related to mortgage originations, risk retention requirements as to securitized loans and the Consumer Financial Protection Bureau.  The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted.  The Dodd-Frank Act may have a material impact on the Company’s and the Bank’s operations, particularly through increased compliance costs resulting from possible future consumer and fair lending regulations.




Business Activities.The Commissioner regulates the Company’s internal organization as well as its deposit, lending and investment activities.  The basic authority for the Company’s activities is specified by Maryland law.  Additionally, Maryland law contains a parity statute by which Maryland commercial banks may, with the approval of the Commissioner, engage in any additional activity, service or practice permitted for national banks.




The Federal Reserve and FDIC also regulate many of the areas regulated by the Commissioner and federal law may limit some of the authority provided to the Company by Maryland law.  Approval of the Commissioner and the Federal Reserve is required for, among other things, business combinations and the establishment of branch offices.


9


Capital Requirements.  The Company is subject to Federal Reserve Board capital requirements, as well as statutory capital requirements imposed under Maryland law.  Federal Reserve Board regulations establish two capital standards for state-chartered banks that are members of the Federal Reserve System (“state member banks”): a leverage requirement and a risk-based capital requirement.  In addition, the Federal Reserve may, on a case-by-case basis, establish individual minimum capital requirements for a bank that vary from the requirements that would otherwise apply under Federal Reserve Board regulations.  A bank that fails to satisfy the capital requirements established under the Federal Reserve Board’s regulations will be subject to such administrative action or sanctions as the Federal Reserve Board deems appropriate.




The leverage ratio adopted by the Federal Reserve Board requires a minimum ratio of “Tier 1 capital” to adjusted total assets of 3% for banks rated composite 1 under the CAMELS examination rating system for banks.  Banks not rated composite 1 under the CAMELS rating system for banks are required to maintain a minimum ratio of Tier 1 capital to adjusted total assets of at least 4%.  Additional capital may be necessary for institutions with supervisory, financial, operational or managerial weaknesses, as well as institutions experiencing significant growth.  For purposes of the Federal Reserve Board’s leverage requirement, Tier 1 capital consists primarily of common stockholders’ equity, certain perpetual preferred stock (which must be noncumulative with respect to banks), and minority interests in the equity accounts of consolidated subsidiaries; less most intangible assets, except for specified servicing assets and purchased credit card receivables and other specified deductions.




The risk-based capital requirements established by the Federal Reserve Board’s regulations require state member banks to maintain “total capital” equal to at least 8% of total risk-weighted assets.  For purposes of the risk-based capital requirement, “total capital” means Tier 1 capital (as described above) plus “Tier 2 capital” (as described below), provided that the amount of Tier 2 capital may not exceed the amount of Tier 1 capital, less certain assets.  Tier 2 capital elements include, subject to certain limitations, the allowance for losses on loans and leases, perpetual preferred stock that does not qualify for Tier 1 and long-term preferred stock with an original maturity of at least 20 years from issuance, hybrid capital instruments, including perpetual debt and mandatory convertible securities, and subordinated debt and intermediate-term preferred stock and up to 45% of unrealized gains on equity securities.  Total risk-weighted assets are determined under the Federal Reserve Board’s regulations, which generally establish four risk categories, with general risk weights of 0%, 20%, 50% and 100%, based on the risk believed inherent to the type of asset involved.




In addition, the Company is subject to the statutory capital requirements imposed by the State of Maryland.  Under Maryland statutory law, if the surplus of a Maryland commercial bank at any time is less than 100% of its capital stock, then, until the surplus is 100% of the capital stock, the commercial bank: (i) must transfer to its surplus annually at least 10% of its net earnings; and (ii) may not declare or pay any cash dividends that exceed 90% of its net earnings.




The table below provides information with respect to the Bank’s compliance with its regulatory capital requirements at the dates indicated.  The holding company ratios do not differ significantly from the Bank’s ratios.




Actual


Regulatory

Requirements for

Capital

Adequacy Purposes


Regulatory

Requirements to be

Well Capitalized

Under Prompt

Corrective

Action ProvisionsAmount


Ratio


Amount


Ratio


Amount


Ratio(Dollars in thousands)As of June 30, 2011:Total Capital (to Risk Weighted Assets)

$
21,432



12.94
%

$
13,250



8.00
%

$
16,563



10.00
%Tier 1 Capital (to Risk Weighted Assets)


19,335



11.67



6,625



4.00



9,938



6.00Tier 1 Leverage


19,335



7.26



10,659



4.00



13,323



5.00As of June 30, 2010:Total Capital (to Risk Weighted Assets)

$
23,009



12.35
%

$
15,000



8.00
%

$
18,750



10.00
%Tier 1 Capital (to Risk Weighted Assets)


20,663



11.09



7,500



4.00



11,250



6.00Tier 1 Leverage


20,663



7.76



10,649



4.00



13,311



5.00


10


Prompt Corrective Regulatory Action.  Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), the federal banking regulators are required to take prompt corrective action if an insured depository institution fails to satisfy certain minimum capital requirements.  All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees if the institution would thereafter fail to satisfy the minimum levels for any of its capital requirements.  An institution that fails to meet the minimum level for any relevant capital measure (an “undercapitalized institution”) may be, among other things, subject to increased monitoring by the appropriate federal banking regulator, required to submit an acceptable capital restoration plan within 45 days and are subject to asset growth limits.  The capital restoration plan must include a guarantee by the institution’s holding company that the institution will comply with the plan until it has been adequately capitalized on average for four consecutive quarters, under which the holding company would be liable up to the lesser of 5% of the institution’s total assets or the amount necessary to bring the institution into capital compliance as of the date it failed to comply with its capital restoration plan.  A “significantly undercapitalized” institution, as well as any undercapitalized institution that did not submit an acceptable capital restoration plan, may be subject to regulatory demands for recapitalization, broader application of restrictions on transactions with affiliates, limitations on interest rates paid on deposits, asset growth and other activities, possible replacement of directors and officers, and restrictions on capital distributions by any bank holding company controlling the institution.  Any company controlling the institution could also be required to divest the institution or the institution could be required to divest subsidiaries.  In their discretion, the federal banking regulators may also impose the foregoing sanctions on an undercapitalized institution if the regulators determine that such actions are necessary to carry out the purposes of the prompt corrective action provisions.  If an institution’s ratio of tangible capital to total assets falls below a “critical capital level,” the institution will be subject to conservatorship or receivership within 90 days unless periodic determinations are made that forbearance from such action would better protect the deposit insurance fund.  Unless appropriate findings and certifications are made by the appropriate federal bank regulatory agencies, a critically undercapitalized institution must be placed in receivership if it remains critically undercapitalized on average during the calendar quarter beginning 270 days after the date it became critically undercapitalized.




For purposes of these restrictions, an “undercapitalized institution” is a depository institution that has (i) a total risk-based capital ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or less than 3.0% if the institution has a composite 1 CAMELS rating).  A “significantly undercapitalized” institution is defined as a depository institution that has:  (i) a total risk-based capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%.  A “critically undercapitalized” institution is defined as a depository institution that has a ratio of “tangible equity” to total assets of less than 2.0%.  The appropriate federal banking agency may reclassify a well capitalized depository institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with the supervisory actions applicable to institutions in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically under-capitalized) if it determines, after notice and an opportunity for a hearing, that the institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any examination rating category.  At June 30, 2011, the Company and the Bank were classified as well capitalized under Federal Reserve regulations.




Safety and Soundness Guidelines.  Under FDICIA, as amended by the Riegle Community Development and Regulatory Improvement Act of 1994, each federal banking agency was required to establish safety and soundness standards for institutions under its authority.  The federal banking agencies, including the Federal Reserve Board, have released Interagency Guidelines Establishing Standards for Safety and Soundness.  The guidelines require depository institutions to maintain internal controls and information systems and internal audit systems that are appropriate for the size, nature and scope of the institution’s business, establish certain basic standards for loan documentation, credit underwriting, asset quality, capital adequacy, earnings, interest rate risk exposure and asset growth, information security and further provide that depository institutions should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss.  If the appropriate federal banking agency determines that a depository institution is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines.  Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions.




Federal Home Loan Bank System.  The Federal Home Loan Bank System consists of 12 district Federal Home Loan Banks.  The Federal Home Loan Banks provide a central credit facility primarily for member institutions.  As a member of the Federal Home Loan Bank of Atlanta, the Bank is required to acquire and hold specified amounts of capital stock in that Federal Home Loan Bank.  The Bank was in compliance with this requirement with an investment in Federal Home Loan Bank of Atlanta stock at June 30, 2011 of $1.7 million.


11


Federal Reserve System.Pursuant to regulations of the Federal Reserve Board, a financial institution must maintain average daily reserves equal to 3% on transaction accounts of between $10.7 million and $58.8 million, plus 10% on the remainder.  The first $10.7 million of transaction accounts are exempt.  These percentages are subject to adjustment by the Federal Reserve Board.  Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets.  As of June 30, 2011, the Bank met its reserve requirements.




The monetary policies and regulations of the Federal Reserve Board have a significant effect on the operating results of commercial banks.  The Federal Reserve Board’s policies affect the levels of bank loans, investments and deposits through its open market operation in United States government securities, its regulation of the interest rate on borrowings from Federal Reserve Banks and its imposition of nonearning reserve requirements on all depository institutions, such as the Bank, that maintain transaction accounts or non-personal time deposits.




Insurance of Deposit Accounts. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. Under the FDIC’s previous risk-based assessment system, insured institutions were 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 institution’s assessment rate depends upon the category to which it is assigned and assessment rates ranged from seven to 77.5 basis points. On February 7, 2011, however, the FDIC approved a final rule that implemented changes to the deposit insurance assessment system mandated by the Dodd-Frank Act. The final rule, which took effect for the quarter beginning April 1, 2011, requires that the base on which deposit insurance assessments are charged be revised from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. Under the final rule, insured depository institutions are required to report their average consolidated total assets on a daily basis, using the regulatory accounting methodology established for reporting total assets. For purposes of the final rule, tangible equity is defined as Tier 1 capital. No institution may pay a dividend if in default of the federal deposit insurance assessment.





Due to stress on the Deposit Insurance Fund caused by bank failures, the FDIC imposed on all insured institutions a special emergency assessment of five basis points of total assets minus Tier 1 capital, as of June 30, 2009 (capped at ten basis points of an institution’s deposit assessment base), in order to cover losses to the Deposit Insurance Fund.  That special assessment was collected on September 30, 2009.  The FDIC provided for similar assessments during the final two quarters of 2009, if deemed necessary.  However, in lieu of further special assessments, the FDIC required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012.  The estimated assessments, which include an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 30, 2009.  As of December 31, 2009, and each quarter thereafter, a charge to earnings will be recorded for each regular assessment with an offsetting credit to the prepaid asset.




Because of the recent difficult economic conditions, deposit insurance per account owner had been raised to $250,000 for all types of accounts until January 1, 2014.  That level was made permanent by the Dodd-Frank Act.  In addition, the FDIC adopted an optional Temporary Liquidity Guarantee Program (“TLGP”) under which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2012.  The Dodd-Frank Act extends the unlimited coverage of noninterest-bearing transaction accounts until December 31, 2012 without providing an opt out.  The TLGP also included a debt component under which certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the FDIC through June 30, 2012, or in some cases, December 31, 2012.  The Bank opted to participate in the unlimited noninterest-bearing transaction account coverage and the Bank and Company opted not to participate in the unsecured debt guarantee program.




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.  This payment is established quarterly and during the four quarters ended June 30, 2011 averaged 1.04 basis points of assessable deposits.


12


The FDIC 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 the Bank.  Management cannot predict what insurance assessment rates will be in the future.




Insurance of deposits may be terminated by the FDIC 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 FDIC.  The management of the Company does not know of any practice, condition or violation that might lead to termination of deposit insurance.




Dividend Restrictions.  The Bank’s ability to pay dividends is governed by Maryland law and the regulations of the Federal Reserve Board.  Maryland law provides that dividends may be paid out of individual profits or with approval of the Commissioner, surplus up to 100% of capital stock.  Under Maryland law relating to financial institutions, if the surplus of a commercial bank at any time is less than 100% of its capital stock, then, until the surplus is 100% of the capital stock, the commercial bank:  (i) must transfer to its surplus annually at least 10% of its net earnings; and (ii) may not declare or pay any cash dividends that exceed 90% of its net earnings.




The Bank’s payment of dividends is also subject to the Federal Reserve Board’s Regulation H, which provides that a state member bank may not pay a dividend if the total of all dividends declared by the bank in any calendar year exceeds the total of its net profits for the year combined with its retained net profits for the preceding two calendar years, less any required transfers to surplus or to a fund for the retirement of preferred stock, unless the bank has received the prior approval of the Federal Reserve Board.  The previously referenced prompt corrective action requirements prohibit dividends where the Bank would be “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” after the dividend.  Additionally, both the Commissioner and the Federal Reserve Board has the authority to prohibit the payment of dividends by a Maryland commercial bank when it determines such payment to be an unsafe and unsound banking practice.  Finally, the Bank is not able to pay dividends on its capital stock if its regulatory capital would thereby be reduced below the remaining balance of the liquidation account established in connection with its conversion in April 1996 from mutual to stock form.  See Note 11 of the Notes to Consolidated Financial Statements appearing in Item 7 of this Annual Report on Form 10-K.




In addition, under the terms of the TARP Capital Purchase Program, (1) prior to the earlier of (a) December 5, 2011, or (b) the date on which all of the Company’s preferred shares held by Treasury have been redeemed in full, the Company cannot increase its quarterly cash dividend above $0.07 per common share; (2) during the period beginning on December 6, 2011 and ending on the earlier of (a) December 5, 2018 or (b) the date on which the preferred shares held by Treasury have been redeemed in full or the Treasury has transferred all its preferred shares to non-affiliates, Treasury’s consent shall be required for any increase in aggregate common dividends per share greater than 3% per annum; and (3) during the period beginning on December 6, 2018 and ending on the date on which all of the preferred shares held by Treasury have been redeemed in full or the Treasury has transferred all of its preferred shares to non-affiliates, the Company, without the consent of the Treasury, cannot pay any cash dividends.




Uniform Lending Standards.  Under Federal Reserve Board regulations, state member banks must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate.  These policies must establish loan portfolio diversification standards, prudent underwriting standards, including loan-to-value limits that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements.  The real estate lending policies of state member banks must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies (the “Interagency Guidelines”) that have been adopted by the federal banking agencies.




Management will periodically evaluate its lending policies to assure conformity to the Interagency Guidelines and does not anticipate that the Interagency Guidelines will have a material effect on its lending activities.




Limits on Loans to One Borrower.  The Bank has chosen to be subject to federal law with respect to limits on loans to one borrower.  Generally, under federal law, the maximum amount that a commercial bank may loan to one borrower at one time may not exceed 15% of the unimpaired capital and surplus of the commercial bank, plus an additional 10% if secured by specified “readily marketable collateral.”  The Bank’s lending limit to one borrower as of June 30, 2011 was $3.5 million.


13


Transactions with Related Parties.  Transactions between a state member bank and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act.  An affiliate of a state member bank is any company or entity, which controls, is controlled by or is under common control with the state member bank.  In a holding company context, at a minimum, the parent holding company of a state member bank and any companies which are controlled by such parent holding company are affiliates of the state member bank.  Generally, Sections 23A and 23B (i) limit the extent to which an institution or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such institution’s capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to a nonaffiliate.  The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions.  Certain types of covered transactions must be collateralized according to a schedule set forth in the statute based on the type of collateral.




State member banks are also subject to the restrictions contained in Section 22(h) of the Federal Reserve Act and the Federal Reserve’s Regulation O on loans to executive officers, directors and principal stockholders (“insiders”).  Under Section 22(h), aggregate loans to directors, executive officers and greater than 10% stockholders may not exceed the institution’s unimpaired capital and unimpaired surplus.  Section 22(h) also prohibits loans, above amounts prescribed by the appropriate federal banking agency, to insiders of a state member bank, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the institution with any “interested” director not participating in the voting.  Regulation O prescribes the loan amount (which includes all other outstanding loans to such person) as to which prior board of director approval is required as being the greater of $25,000 or 5% of capital and surplus; however loans aggregating to $500,000 or more always require such approval.  Further, Section 22(h) requires that loans to insiders be made on terms substantially the same as offered in comparable transactions to other persons with an exception for loans made to a bank-wide benefit or compensation program that does not give preference to insiders.  Section 22(g) of the Federal Reserve Act places further restrictions on the types of loans that can be made to executive officers.




Additionally, Maryland statutory law imposes restrictions on certain transactions with affiliated persons of Maryland commercial banks. Generally, under Maryland law, a director, officer or employee of a commercial bank may not borrow, directly or indirectly, any money from the bank, unless the loan has been approved by a resolution adopted at and recorded in the minutes of the board of directors of the bank, or the executive committee of the bank, if that committee is authorized to make loans.  If such a loan is approved by the executive committee, the loan approval must be reported to the board of directors at its next meeting.  Certain commercial loans made to non-employee directors of a bank and certain consumer loans made to nonofficer and nondirector employees of the bank are exempt from the statute’s coverage.




Enforcement.The Federal Reserve has primary federal enforcement responsibility over member banks 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 or 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 FDIC has the authority to recommend to the Federal Reserve Board that enforcement action to be taken with respect to a particular institution.  If action is not taken by the Federal Reserve Board, the FDIC has authority to take such action under certain circumstances.  Federal law also establishes criminal penalties for certain violations.




The Commissioner has extensive enforcement authority over Maryland banks.  Such authority includes the ability to issue cease and desist orders and civil money penalties and to remove directors or officers.  The Commissioner may also take possession of a Maryland bank whose capital is impaired and seek to have a receiver appointed by a court.


14


Regulation of the Company




General.  The Company, as the sole shareholder of the Bank, is a bank holding company and is registered as such with the Federal Reserve Board.  Bank holding companies are subject to comprehensive regulation and examination by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the regulations of the Federal Reserve Board.  The Federal Reserve Board also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries).  In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.




Under the BHCA, a bank holding company must obtain Federal Reserve Board approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.  In evaluating such applications, the Federal Reserve Board considers a variety of financial, managerial and competitive factors.




The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries.  The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve Board regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks.  The list of activities includes, among other things, operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.




The Gramm-Leach-Bliley Act of 1999 authorized bank holding companies that meet certain management, capital and other criteria to choose to become a “financial holding company” and thereby engage in a broader array of financial activities including insurance underwriting and investment banking.  The Company has not, up to now, opted to become a financial holding company.




Acquisitions of Bank Holding Companies and Banks.  Under the BHCA, any company must obtain approval of the Federal Reserve Board prior to acquiring control of the Company or the Bank.  For purposes of the BHCA, control is defined as ownership of more than 25% of any class of voting securities of the Company or the Bank, the ability to control the election of a majority of the directors, or the exercise of a controlling influence over management or policies of the Company or the Bank.  Any bank holding company must secure Federal Reserve Board approval prior to acquiring 5% or more of the stock of the Company or the Bank.




The Change in Bank Control Act and the related regulations of the Federal Reserve Board require any person or persons acting in concert (except for companies required to make application under the BHCA), to file a written notice with the Federal Reserve Board before such person or persons may acquire control of the Company or the Bank.  The Change in Bank Control Act presumes control as the power, directly or indirectly, to vote 10% or more of any voting securities or to direct the management or policies of a bank holding company, such as the Company, that has securities registered under the Securities Exchange Act of 1934.




Under Maryland law, acquisitions of 25% or more of the voting stock of a commercial bank or a bank holding company and other acquisitions of voting stock of such entities which affect the power to direct or to cause the direction of the management or policy of a commercial bank or a bank holding company must be approved in advance by the Commissioner.  Any person proposing to make such an acquisition must file an application with the Commissioner at least 60 days before the acquisition becomes effective.  The Commissioner may deny approval of any such acquisition if the Commissioner determines that the acquisition is anticompetitive or threatens the safety or soundness of a banking institution.  Any voting stock acquired without the approval required under the statute may not be voted for a period of five years.  This restriction is not applicable to certain acquisitions by bank holding companies of 5% or more of the stock of Maryland banks or Maryland bank holding companies which are governed by Maryland’s holding company statute and also require prior approval of the Commissioner.


15


Dividends.  The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board’s view that a bank holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company’s capital needs, asset quality and overall financial condition.  The Federal Reserve Board also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends.  Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve Board pursuant to FDICIA, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”  See “Depository Institution Regulation — Prompt Corrective Regulatory Action.”




Under the terms of its trust preferred securities, the Company may not declare or pay dividends on its common or preferred stock while it has deferred interest payments on its debentures.  Under the terms of the Articles Supplementary establishing the preferred shares issued to the US Treasury, the Company may not pay dividends on its common stock unless it has paid all accrued and unpaid dividends on the preferred shares.  As a result, the Company currently is not permitted to pay dividends on its common stock. See Note 11 of the Notes to Consolidated Financial Statements appearing in Item 7 of this Annual Report on Form 10-K.




Capital Requirements.  The Federal Reserve Board has established capital requirements generally similar to the capital requirements for state member banks described above, for bank holding companies.  Formerly, these were applied to bank holding companies with total assets of $150 million or above, including the Company.  However, in 2007, the Federal Reserve Board raised the threshold for the applicability of its capital requirements to a $500 million asset size except where the company (i) engages in significant non-banking activities; (ii) conducts significant off balance sheet activities or has a material amount of debt or equity securities outstanding registered with the Securities Exchange Commission.  The Federal Reserve Board has reserved the right to apply its requirements to bank holding companies of any size when required for supervisory purposes.  The Dodd-Frank Act requires the Federal Reserve Board to issue consolidated regulatory capital requirements for holding companies that are at least as stringent as those applicable to the bank.  However, the Act appears to allow the Federal Reserve Board to continue to exempt bank holding companies of less than $500 million in consolidated assets from the holding company capital requirements.




Stock Repurchases.As a bank holding company, the Company is required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Company’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would violate any law, regulation, Federal Reserve Board order, directive, or any condition imposed by, or written agreement with, the Federal Reserve Board.  This requirement does not apply to bank holding companies that are “well-capitalized,” received one of the two highest examination ratings at their last examination and are not the subject of any unresolved supervisory issues.




Taxation





For fiscal year 2011, the Company’s maximum federal income tax rate was 34%.  The Company and the Bank, together with the Bank’s subsidiary, to date have not filed a consolidated federal income tax return for the fiscal year ended June 30, 2011.




The Bank’s federal income tax returns have been audited through June 30, 1995. The Company’s tax returns have never been audited.




State Income Taxation.  The State of Maryland imposes an income tax of 8.25% on income measured substantially the same as federally taxable income, except that U.S. Government interest is not fully taxable.  For years ended prior to July 1, 2008, the rate was 7.00%.




For additional information regarding taxation, see Note 10 of Notes to Consolidated Financial Statements.


16


Executive Officers Who Are Not Directors




The following sets forth information with respect to executive officers of the Bank who do not serve on the Board of Directors.





Age at June 30,Name

2011

TitleLaurence S. Mitchell

64

Senior Vice President – Commercial Business LendingPhillip P. Phillips

55

Senior Vice President – Lending and Loan AdministrationWilliam C. Wiedel, Jr.

51

Senior Vice President and Chief Financial Officer of the Company and the Bank




Laurence S. Mitchell is a Senior Vice President who joined the Company in November of 1999 as a commercial lending officer. Prior to joining Patapsco, Mr. Mitchell held positions in various banks relating to commercial lending and business development.  He is an active member of the Harford County Chamber of Commerce, a Board member of the Baltimore County Chamber of Commerce, a member of the Leadership and Development Committee of the Maryland Bankers Association and an instructor for the Center for Financial Training Mid-Atlantic, formerly known as the American Institute of Banking.  Formerly, Mr. Mitchell was a member of the Town of Bel Air Economic and Community Development Commission.




Phillip P. Phillipswas appointed Senior Vice President upon joining the Company in March 2010.  Prior to that, Mr. Phillips was a Senior Vice President and Manager of Special Assets at Provident Bank, and M&T Bank through merger, from July 2008 to March 2010. From January 2007 until rejoining Provident Bank, he was a Senior Vice President and Regional Senior Credit Officer for Wells Fargo Bank where he assisted in establishing the Maryland Commercial Lending Office. Mr. Phillips’ banking experience spans 32 years and a variety of Credit and Lending positions at Maryland National Bank, NationsBank, Signet Bank and Provident Bank.  Mr. Phillips is also an Adjunct Professor at Towson University.




William C. Wiedel, Jr. was appointed Senior Vice President and Chief Financial Officer of the Company and the Bank in March 2008.  From April 1986 to March 2008, Mr. Wiedel was employed by Provident Bank where he held a variety of financial positions. From January 2001 to March 2008, Mr. Wiedel was Senior Vice President of Financial Planning and Analysis. From January 1993 to December 2000, Mr. Wiedel was Chief Financial Officer of Provident Mortgage Corp., a wholly owned subsidiary of Provident Bank. From April 1986 to January 1993, Mr. Wiedel was Vice President and Assistant Controller of Provident Bank. From September 1981 to April 1986, Mr. Wiedel was employed by Ernst and Whinney (currently known as Ernst and Young), advancing to the level of audit manager. Mr. Wiedel is a Certified Public Accountant (“CPA”). He is a member of the American Institute of Certified Public Accountants and the Maryland Association of Certified Public Accountants.





Item 1A.  Risk Factors




A continuation of recent turmoil in the financial markets could have an adverse effect on our financial position or results of operations.




Beginning in 2008, United States and global markets have experienced severe disruption and volatility, and general economic conditions have declined significantly. Adverse developments in credit quality, asset values and revenue opportunities throughout the financial services industry, as well as general uncertainty regarding the economic and regulatory environment, have had a marked negative impact on the industry. The United States and the governments of other countries have taken steps to try to stabilize the financial system, including investing in financial institutions, and have also been working to design and implement programs to improve general economic conditions.  There can be no assurances that these efforts will be successful in restoring industry, economic or market conditions and that they will not result in adverse unintended consequences. Factors that could continue to pressure financial services companies, including the Company, are numerous and include: (1) worsening credit quality, leading among other things to increases in loan losses and reserves; (2) continued or worsening disruption and volatility in financial markets, leading among other things to continuing reductions in asset values; (3) capital and liquidity concerns regarding financial institutions generally; (4) limitations resulting from or imposed in connection with governmental actions intended to stabilize or provide additional regulation of the financial system; and/or (5) recessionary conditions that are deeper or last longer than currently anticipated.


17


Changes in interest rates may hurt our earnings.




Short-term market interest rates (which we use as a guide to price our deposits) have until recently risen from historically low levels, while longer-term market interest rates (which we use as a guide to price our longer-term loans) have not.  This “flattening” of the market yield curve had a negative impact on our net interest margin, which reduced our profitability.  Our net interest margin was 3.32% for the year ended June 30, 2011 compared to 3.40% for the year ended June 30, 2010.  The U.S. Federal Reserve has decided to maintain the federal funds rate at 0 to .25%.  Decreases in interest rates can result in increased prepayments of loans, as borrowers refinance to reduce their borrowing costs.  Under these circumstances, we are subject to reinvestment risk as we may have to redeploy such loan proceeds into lower-yielding assets, which might also negatively impact our income.  Additionally, if short-term interest rates rise, and if rates on our deposits reprice upwards faster than the rates on our long-term loans and investments, we would experience compression of our net interest margin, which would have a negative effect on our profitability.  For further discussion of how changes in interest rates could impact us, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations―Risk Management―Interest Rate Risk Management” in the 2011 Annual Report, filed as Exhibit 13 to this Form 10-K.




We may be more susceptible to increases in interest rates because of the relatively small amount of adjustable-rate loans currently in our portfolio and our heavy reliance on core deposits, especially our money market accounts, which reprice frequently.  At June 30, 2011, $71.5 million, or 38.1% of our total loan portfolio, consisted of adjustable-rate loans.  We attempt to limit our exposure to rises in interest rates through: offering adjustable-rate one-to-four family residential real estate loans; an increased focus on multi-family and commercial real estate lending, which emphasizes the origination of shorter-term adjustable-rate loans; and efforts to originate shorter-term fixed-rate loans.  Our inability to successfully originate adjustable-rate multi-family and commercial real estate loans or shorter-term fixed-rate loans could result in further compression of our net interest margin in a rising interest rate environment, which could hurt our profits.




Our emphasis on multi-family and commercial lending may expose us to increased lending risks.




At June 30, 2011, $56.4 million, or 30.1%, of our loan portfolio consisted of multi-family and commercial real estate loans.  We intend to continue our emphasis on these types of higher-yielding loans to provide us with the opportunity to increase profits.  However, these types of loans generally expose a lender to greater risk of non-payment and loss than one- to- four-family residential real estate loans because repayment of the loans often depends on the successful operation of the property and the income stream of borrowers.  Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to- four-family residential real estate loans.  Also, many of our commercial borrowers have more than one loan outstanding with us.  Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to- four-family residential real estate loan.




Our level of nonperforming loans expose us to increased lending risks.  Further, our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.




At June 30, 2011, our non-performing loans totaled $9.9 million, representing 5.33% of total loans.  If these loans continue to not perform according to their terms and the collateral is insufficient to pay any remaining loan balance, we may experience loan losses, which could have a material effect on our operating results.  Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety.  We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date.  However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results.


18


In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and classified loans.  In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers.  Finally, we also consider many qualitative factors, including general and economic business conditions, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid.  Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors.  Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates.




At June 30, 2011, our allowance for loan losses as a percentage of total loans was 2.25%.  Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries.  Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.




The Company may be forced to accept administrative decisions with respect to certain participation loans that might not be in the Company’s best interests and that could cause it to experience losses with respect to such loans that might be larger than it might otherwise incur on a similar portfolio of distressed loans where it was the lead lender.




At June 30, 2011, the Company had approximately $1.5 million in participation loans originated by a bank that has since been placed into receivership, with the FDIC appointed as receiver.  Approximately $41,000 of these loans were classified as nonaccrual loans at June 30, 2011.  The assets and liabilities of that bank, including the loan participations in which the Company has participation interests, have been sold to a successor bank.  That successor bank may have financial interests that differ from those of the Company with respect to the participation loans, and in $311,000 of those loans has the sole right to administer the loan, which includes the right to make decisions with respect to the disposition of collateral securing the loans.  As a result the Company may be forced to accept administrative decisions with respect to such loans that might not be in the Company’s best interests and that could cause it to experience losses with respect to such loans that might be larger than it might otherwise incur on a similar portfolio of distressed loans where it was the lead lender.




A downturn in the local economy or a decline in real estate values could hurt our profits.




Nearly all of our real estate loans are secured by real estate in the Baltimore metropolitan area.  As a result of this concentration, a downturn in the local economy could cause significant increases in non-performing loans, which would hurt our profits.  Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would hurt our profits.  Several years ago, there had been significant increases in real estate values in our market area.  As a result of rising home prices, our loans have been well collateralized.  However, in the next few years, these real estate values have declined, in some cases dramatically, which could cause some of our mortgage loans to become inadequately collateralized, which would expose us to a greater risk of loss.  For a discussion of our market area, see “Business―Market Area.”




Strong competition within our market area could hurt our profits and slow growth.




We face intense competition both in making loans and attracting deposits.  This competition has made it more difficult for us to make new loans and has occasionally forced us to offer higher deposit rates.  Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income.  As of June 30, 2011, we held 0.40% of the deposits in the Baltimore-Towson, Maryland Metropolitan Statistical Area, which was the 28th largest market share of deposits out of the 84 financial institutions in the metropolitan statistical area.  Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide.  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.  Our profitability depends upon our continued ability to compete successfully in our market area.  For more information about our market area and the competition we face, see “Business―Market Area”and “Business―Competition.”


19


The limitations on executive compensation imposed through our participation in the TARP Capital Purchase Program may restrict our ability to attract, retain and motivate key employees, which could adversely affect our operations.




As part of our participation in the TARP Capital Purchase Program, we agreed to be bound by certain executive compensation restrictions, including limitations on severance payments and the clawback of any bonus and incentive compensation that were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria. Subsequent to the issuance of the preferred stock, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted, which provides more stringent limitations on severance pay and the payment of bonuses. To the extent that any of these compensation restrictions do not permit us to provide a comprehensive compensation package to our key employees that is competitive in our market area, we have difficulty in attracting, retaining and motivating our key employees, which could have an adverse effect on our results of operations.




Future dividend payments and common stock repurchases are restricted by the terms of the U.S. Treasury’s equity investment in us.




Under the terms of the TARP Capital Purchase Program, until the earlier of the third anniversary of the date of issuance of the Company’s Series A Cumulative Perpetual Preferred Stock and the date on which the Series A Cumulative Perpetual Preferred Stock has been redeemed in whole or the U.S. Treasury has transferred all of the Series A Cumulative Perpetual Preferred Stock to third parties, we are prohibited from increasing dividends on our common stock from the last quarterly cash dividend per share ($0.07) declared on the common stock prior to December 5, 2008, as adjusted for subsequent stock dividends and other similar actions, and from making certain repurchases of equity securities, including our common stock, without the consent of the U.S. Treasury. Furthermore, as long as the Series A Cumulative Perpetual Preferred Stock is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.




The terms governing the issuance of the preferred stock to the U.S. Treasury may be changed, the effect of which may have an adverse effect on our operations.




The terms of the Securities Purchase Agreement in which we entered into with U.S. Treasury pursuant to the TARP Capital Purchase Program provides that the U.S. Treasury may unilaterally amend any provision of the Purchase Agreement to the extent required to comply with any changes in applicable federal law that may occur in the future. We have no assurances that changes in the terms of the transaction will not occur in the future. Such changes may place restrictions on our business or results of operation, which may adversely affect the market price of our common stock.




The Standard & Poor’s downgrade in the U.S. government’s sovereign credit rating, and in the credit ratings of instruments issued, insured or guaranteed by certain related institutions, agencies and instrumentalities, could result in risks to the Company and general economic conditions that we are not able to predict.





On August 5, 2011, Standard & Poor’s downgraded the United States long-term debt rating from its AAA rating to AA+.   On August 8, 2011, Standard & Poor’s downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. Instruments of this nature are key assets on the balance sheets of financial institutions, including the Bank.  These downgrades could adversely affect the market value of such instruments, and could adversely impact our ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. We cannot predict if, when or how these changes to the credit ratings will affect economic conditions. These ratings downgrades could result in a significant adverse impact to the Company, and could exacerbate the other risks to which the Company is subject, including those described under this Item 1A. Risk Factors.


20


Item 1B.  Unresolved Staff Comments




Not applicable.




Item 2.  Properties




The following table sets forth the location and certain additional information regarding the Bank’s offices at June 30, 2011.





Net Book ValueYear

Owned or

at June 30,


ApproximateOpened

Leased

2011


Square Footage(Dollars in thousands)Headquarters and Branch Office1301 Merritt Boulevard

1970

Owned

$
310



9,600Dundalk, Maryland 21222Branch Office2028 Joppa RoadBaltimore, Maryland 21234

2007

Leased


2,676



7,000Branch Office821 W. 36th StreetBaltimore, Maryland 21211

1988

Owned


99



1,100Branch Office12128 Long Green PikeGlen Arm, Maryland 21057

1988

Leased


15



1,400Branch Office11630 Glen Arm RoadGlen Arm, Maryland 21057

2006

Leased


-



400




The net book value of the Bank’s investment in premises and equipment totaled $3.6 million at June 30, 2011.  See Note 6 of Notes to Consolidated Financial Statements.  The branch office located at 7802 Harford Rd, Baltimore, Maryland 21234 was closed in December, 2009 and is included in other assets at June 30, 2011.




Item 3. Legal Proceedings




From time to time, the Company is a party to various legal proceedings incident to its business.  At June 30, 2011, there were no legal proceedings to which the Company was a party, or to which any of their property was subject, which were expected by management to result in a material loss to the Company.  There are no pending regulatory proceedings to which the Company is a party or to which any of their properties is subject which are currently expected to result in a material loss.





Item 4.  Removed and Reserved




Not applicable.


21




PART II




Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities




(a)           The information contained under the section captioned “Market Information” in the Company’s Annual Report to Stockholders for the Fiscal Year Ended June 30, 2011 (the “Annual Report”) filed as Exhibit 13 hereto is incorporated herein by reference.




(b)           Not applicable.




(c)           The Company did not repurchase any shares of its common stock during the fourth quarter of the fiscal year ended June 30, 2011 and does not have any pending stock repurchase programs.




Item 6.  Selected Financial Data




This item is not applicable as the Company is a smaller reporting company.




Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations




The information contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report is incorporated herein by reference.




Item 7A.  Quantitative and Qualitative Disclosures About Market Risk




This item is not applicable as the Company is a smaller reporting company.




Item 8.  Financial Statements and Supplementary Data




The financial statements contained in the Annual Report and listed in Item 15 hereof are incorporated herein by reference.




Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure




None.




Item 9A.  Controls and Procedures




(a)
Disclosure Controls and Procedures




The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”).  Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.


22


(b)
Internal Controls Over Financial Reporting




MANAGEMENT’S ANNUAL REPORT ON


INTERNAL CONTROL OVER FINANCIAL REPORTING




Management of Patapsco Bancorp, Inc. (the Company) is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and, as such, include some amounts that are based on the best estimates and judgments of management.




The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting.  This internal control system is designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of the Company’s financial reporting and the preparation and presentation of financial statements for external reporting purposes in conformity with accounting principles generally accepted in the United States of America, as well as to safeguard assets from unauthorized use or disposition.  The system of internal control over financial reporting is evaluated for effectiveness by management and tested for reliability through a program of internal audit with actions taken to correct potential deficiencies as they are identified.  Because of inherent limitations in any internal control system, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of the circumvention or overriding of controls.  Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation.  Further because of changes in conditions, internal control effectiveness may vary over time.




Management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2011 based upon criteria set forth in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).




Based on this assessment and on the forgoing criteria, management has concluded that, as of June 30, 2011, the Company’s internal control over financial reporting is effective.




This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report..




/s/ Michael J. Dee

/s/ William C. Wiedel, Jr.Michael J. Dee

William C. Wiedel, Jr.President and Chief Executive Officer

Senior Vice President andChief Financial Officer




(c)
Changes to Internal Control Over Financial Reporting




There were no changes in the Company’s internal control over financial reporting during the year ended June 30, 2011 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.




Item 9B.  Other Information




Not applicable.


23




PART III




Item 10.  Directors, Executive Officers and Corporate Governance




Directors




The information relating to the directors of the Company is incorporated herein by reference to the section captioned “Items to be Voted on by Stockholders – Item 1 – Election of Directors” in the Company’s Proxy Statement for the 2011 Annual Meeting of Stockholders (the “Proxy Statement”).




Executive Officers




The information relating to executive officers of the Company is incorporated herein by reference to Item 1. “Business – Executive Officers Who Are Not Directors” in the Proxy Statement.




Corporate Governance




Information regarding the Company’s Audit Committee and audit committee financial expert is incorporated herein by reference to the section captioned “Corporate Governance and Board Matters – Audit Committee” in the Proxy Statement.




Compliance with Section 16(a) of the Exchange Act




Information regarding compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the section captioned “Other Information Relating to Directors and Executive Officers – Section 16(a) Beneficial Ownership Compliance” in the Proxy Statement.




Code of Ethics




The Company has adopted a written code of ethics, which applies to all employees and Directors.  The Company intends to disclose any amendments to or waivers from our Code of Ethics applicable to any senior financial officers on our website at http://www.patapscobank.com or in a report on Form 8-K.  A copy of the Code of Ethics is available, without charge, upon written request to Secretary, Patapsco Bancorp, Inc., 1301 Merritt Boulevard, Dundalk, Maryland 21222-2194.




Item 11.  Executive Compensation




The information required by this item is incorporated herein by reference to the sections captioned “Corporate Governance and Board Matters – Director Compensation” and “Executive Compensation” in the Proxy Statement.




Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters




(a)  Security Ownership of Certain Beneficial Owners.Information with respect to security ownership of certain beneficial owners required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.




(b)  Security Ownership of Management.Information with respect to security ownership of management required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.




(c)   Changes in Control.Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.


24


(d)  Equity Compensation Plans.  The following table sets forth certain information with respect to the Company’s equity compensation plans.




(a)


(b)


(c)Number of securities to be

issued upon exercise of

outstanding options,

warrants & rights


Weighted-average exercise

price of outstanding

options, warrants and rights


Number of securities

remaining

available for future issuance

under equity compensation

plans (excluding securities

reflected in column (a))Equity compensation plansapproved by security holders


20,832


$
6.29



10,114Equity compensation plans notapproved by security holders


-



-



-Total


20,832


$
6.29



10,114





Item 13.  Certain Relationships and Related Transactions, and Director Independence




Certain Relationships and Related Transactions




The information required by this item is incorporated herein by reference to the section captioned “Other Information Relating to Directors and Executive Officers – Transactions with Related Persons” in the Proxy Statement.




Corporate Governance




With respect to the information regarding director independence, the section captioned “Corporate Governance and Board Matters – Director Independence” in the Proxy Statement is incorporated herein by reference.





Item 14.  Principal Accounting Fees and Services




The information required by this item is incorporated herein by reference to the section captioned “Items to be Voted on by Stockholders – Item 3 – Ratification of the Independent Registered Public Accounting Firm – Audit Fees” in the Proxy Statement.




PART IV




Item 15.  Exhibits and Financial Statement Schedules




(a)          List of Documents Filed as Part of this Report




(1)         Financial Statements.  The following consolidated financial statements are incorporated by reference from Item 8 hereof (see Exhibit 13 to this Annual Report on Form 10-K):




Report of Registered Independent Accounting Firm


Consolidated Statements of Financial Condition as of June 30, 2011 and 2010


Consolidated Statements of Operations for the Years Ended June 30, 2011 and 2010


Consolidated Statements of Stockholders’ Equity for the Years Ended June 30, 2011 and 2010


Consolidated Statements of Cash Flows for the Years Ended June 30, 2011 and 2010


Notes to Consolidated Financial Statements




(2)         Exhibits.  The following is a list of exhibits filed as part of this Annual Report on Form 10-K and also constitutes the Exhibit Index.


25


No.
Description




3.1
Articles of Incorporation of Patapsco Bancorp, Inc. and Articles Supplementary (1)


3.2
Bylaws of Patapsco Bancorp, Inc., as amended (2)


4.1
Form of Common Stock Certificate of Patapsco Bancorp, Inc. (3)


4.2
Articles Supplementary establishing Fixed Rate Cumulative Perpetual Preferred Stock, Series A, of Patapsco Bancorp, Inc. (4)


4.3
Form of stock certificate for Fixed Rate Cumulative Perpetual Preferred Stock, Series A (4)


4.4
Form of warrant to purchase 300.003 shares of common stock of Patapsco Bancorp, Inc. (4)


4.5
Articles Supplementary establishing Fixed Rate Cumulative Perpetual Preferred Stock, Series B, of Patapsco Bancorp, Inc. (4)


4.6
Form of stock certificate for Fixed Rate Cumulative Perpetual Preferred Stock, Series B (4)


10.1
Letter Agreement and related Securities Purchase Agreement – Standard Terms, dated December 19, 2008, between Patapsco Bancorp, Inc. and United States Department of the Treasury (4)


10.2
Form of Waiver executed by each of Michael J. Dee, William C. Wiedel, Jr. and Laurence S. Mitchell (4)


10.3
Form of Letter Agreement between Patapsco Bancorp, Inc. and each of Michael J. Dee, William C. Wiedel, Jr. and Laurence S. Mitchell (4)


10.4
Patapsco Bancorp, Inc. 1996 Stock Option and Incentive Plan† (5)


10.5
Form of Severance Agreement by and between The Patapsco Bank and Francis Broccolino † (6)


10.6
Form of Amended and Restated Severance Agreement by and between The Patapsco Bank and Laurence S. Mitchell † (7)


10.7
Patapsco Bancorp, Inc. 2000 Stock Option and Incentive Plan† (8)


10.8
Patapsco Bancorp, Inc. 2004 Stock Incentive Plan† (9)


10.9
Employment Agreement by and between The Patapsco Bank and Michael J. Dee† (9)


10.10
Severance Agreement by and between The Patapsco Bank and William C. Wiedel, Jr. † (9)


10.11
Form of Amendment No. 1 to the Amended and Restated Severance Agreement by and between The Patapsco Bank and Laurence S. Mitchell † (10)


10.12
Severance Agreement between The Patapsco Bank and Phillip P. Phillips †


13
Annual Report to Stockholders for the Fiscal Year Ended June 30, 2011


21
Subsidiaries of the Registrant


23
Consent of ParenteBeard LLC


31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer


31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer


32
Section 1350 Certifications


99.1
31 C.F.R. § 30.15 Certification of Chief Executive Officer


99.2
31 C.F.R. § 30.15 Certification of Chief Financial Officer





†
Management contract or compensatory plan or arrangement.


(1)
Incorporated herein by reference from the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2000 (File No. 0-28032).


(2)
Incorporated herein by reference from the Company’s Current Report on Form 8-K for the event on July 23, 2008, filed with the SEC on July 25, 2008 (File No. 0-28032).


(3)
Incorporated herein by reference from the Company’s Registration Statement on Form 8-A (File No. 0-28032).


(4)
Incorporated by reference from the Company’s Current Report on Form 8-K for the event on December 18, 2008, filed with the SEC on December 23, 2008 (File No. 0-28032).


(5)
Incorporated herein by reference from the Company’s Annual Report on Form 10-KSB for the year ended June 30, 1996 (File No. 0-28032).


(6)
Incorporated herein by reference from the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2005 (File No. 0-28032).


(7)
Incorporated herein by reference from the Company’s Annual Report on Form 10-KSB/A for the year ended June 30, 2006 filed on December 6, 2006 (File No. 0-28032).


(8)
Incorporated herein by reference from the Company’s Registration Statement on Form S-8 (File No. 333-122300).


(9)
Incorporated herein by reference from the Company’s Quarterly Report on Form 10-QSB for the quarter ended March 31, 2008 (File No. 0-28032).


(10)
Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2008 (File No. 0-28032).




26




SIGNATURES




Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.




PATAPSCO BANCORP, INC.October 5, 2011By:
/s/ Michael J. DeeMichael J. DeePresident and Chief Executive Officer(Duly Authorized Officer)




Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.




/s/ Michael J. Dee

October 5, 2011Michael J. DeePresident, Chief Executive Officer and Director(Principal Executive Officer)/s/ William C. Wiedel, Jr.

October 5, 2011William C. Wiedel, Jr.Senior Vice President and Chief Financial Officer(Principal Financial and Accounting Officer)/s/ Thomas P. O’Neill

October 5, 2011Thomas P. O’NeillChairman of the Board/s/ Nicole N. Glaeser

October 5, 2011Nicole N. GlaeserDirector/s/ William R. Waters

October 5, 2011William R. WatersDirector/s/ Gary R. Bozel

October 5, 2011Gary R. BozelDirector/s/ J. Thomas Hoffman

October 5, 2011J. Thomas HoffmanDirector


27