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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission File Number: 0-22345
Shore Bancshares, Inc.
(Exact name of registrant as specified in its charter)
Maryland 52-1974638
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
109 North Commerce Street
Centreville, Maryland 21617
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including are code: (410) 758-1600
Securities registered under Section 12(b) of the Act: None
Securities registered
under Section 12(g) of the Act: Common Stock, Par Value $0.01
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes __x__ 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. _____
The aggregate market value of Shore Bancshares, Inc. voting stock held by
non-affiliates as of March 8, 2000 was $34,987,132, based on the sales price as
of that date.
As of March 8, 2000, Shore Bancshares, Inc. had 1,913,910 shares of Common Stock
$.01 Par Value outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts I, II and IV: Portions of the Annual Shareholders Report for the year
ended December 31, 1999 (the "Annual Report".)
Part III: Portions of the definitive Proxy Statement for the Annual Meeting of
Shareholders to be held on April 18, 2000 (the "Proxy Statement".)
1
PART I
ITEM I
BUSINESS
GENERAL
Shore Bancshares, Inc. (the "Company"), a Maryland corporation incorporated on
March 15, 1996, became a registered bank holding company on July 1, 1996 under
the Bank Holding Company Act of 1956, as amended. The Company engages in its
business through its sole subsidiary, The Centreville National Bank of Maryland
(the "Bank"), a national banking association. The Company acquired the Bank
through the merger of the Bank into an interim national banking association
formed as a Company subsidiary for the purpose of the merger, pursuant to a Plan
of Reorganization and Agreement to Merge (the "Plan") proposed by Bank
management and approved by the Bank's stockholders on April 16, 1996. Pursuant
to the Plan, each outstanding share of Bank common stock was exchanged for two
shares of the Company's common stock. The Bank's charter was not affected by the
merger. Currently, the Company has issued and outstanding 1,913,910 shares of
common stock, par value $0.01 per share ("Shares"), held by 1,220 holders of
record on March 8, 2000.
The Company's and the Bank's main office is located at 109 North Commerce
Street, Centreville, Queen Anne's County, Maryland. The Bank has five full
service offices located in Centreville, Chestertown, Stevensville and Hillsboro,
Maryland.
As of December 31, 1999, the Company had assets of approximately $191.1 million,
net loans of approximately $125.8 million, and deposits of $162.0 million.
Stockholders' equity has continued to grow over the last five years and has
increased $1.7 million (8.4%) over the preceding five years.
BANKING PRODUCTS AND SERVICES
The Bank has been doing business in Maryland since 1876 and is engaged in both
the commercial and consumer banking business. The Bank serves its customers
through a network of five banking offices. The Bank provides a wide range of
personal banking services designed to meet the needs of local consumers. Among
the services provided are checking accounts, savings and time accounts, safe
deposit boxes, and installment and other personal loans, especially residential
mortgages, as well as home equity loans, automobile and other consumer
financing. As a convenience to its customers, the Bank offers Saturday banking
hours, drive-thru teller windows, "Direct Dial," a telephone banking service,
debit cards, and 24-hour automated teller machines at all of its branch
locations.
The Bank is also engaged in the financing of commerce and industry by providing
credit and deposit services for small to medium sized businesses and for the
agricultural community in the Bank's market area. The Bank offers many forms of
commercial lending, including lines of credit, revolving credit, term loans,
accounts receivable financing, and commercial real estate mortgage lending and
other forms of secured financing. A full range of commercial banking services is
offered, including the acceptance of checking and savings deposits.
Additional types of real estate loans, discount brokerage services, credit cards
and related services are also offered through affiliates or correspondent banks.
The Bank does not offer trust services and does not engage in municipal trading
services.
BANK SERVICE CORPORATIONS
The Bank owns one-third of the outstanding common stock of two service
corporations: The Delmarva Bank Data Processing Center, Inc. and The Eastern
Shore Mortgage Corporation, both Maryland corporations. The Eastern Shore
Mortgage Corporation, located in Easton, Maryland, was engaged in mortgage
banking activities, including the origination of residential mortgage loans and
the subsequent sale of the loans to permanent investors but is currently in the
process of liquidation. Its primary customers were residents who live on
Maryland's Eastern Shore. The Delmarva Bank Data Processing Center, Inc., also
located in Easton, Maryland, provides data processing services to banks located
in Maryland, Delaware, Virginia and the District of Columbia.
SEASONALITY
The management of the Bank does not believe that the deposits or the business of
the Bank in general, are seasonal in nature. The deposits may, however, vary
with local and national economic conditions but not enough to have a material
effect on planning and policy making.
2
EMPLOYEES
As of December 31, 1999, the Company had no employees and the Bank employed 74
individuals, 13 of whom worked part-time.
DEPOSITS
No material portion of the Bank's deposits has been obtained from an individual
or a few individuals (including federal, state and local governments and
agencies) the loss of any one or more of which would have a materially adverse
effect on the Bank, nor is a material portion of the Bank's loans concentrated
within a single industry or group of related industries. On December 31, 1999,
the Bank had approximately 14,600 deposit customers representing $162.0 million
in deposits.
COMMITMENTS
As of the end of the last two fiscal years the Bank had the following
commitments to lend:
% OF % OF
12/31/99 TOTAL 12/31/98 TOTAL
-------- ----- -------- -----
(in thousands) (in thousands)
Standby Letters of Credit $ 1,117 4.41% $ 1,377 7.33%
Commitments to Grant Loans 24,229 95.59 17,402 92.67
------- ------ ------- ------
Total $25,346 100.00% $18,779 100.00%
======= ====== ======= ======
The above commitments are firm. The Bank estimates approximately $8,000,000 of
the commitments to lend described above to be funded within the current year.
COMPETITION
The Bank offers many personalized services and attracts customers by being
responsive and sensitive to the needs of the community. The Bank relies on
goodwill and referrals from satisfied customers as well as traditional media
advertising to attract new customers. To enhance a positive image in the
community, the Bank supports and participates in many local events. Employees,
officers, and Directors represent the Bank on many boards and local civic and
charitable organizations.
The primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. Competition for deposits comes primarily from other
commercial banks, savings associations, credit unions, money market funds and
other investment alternatives. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services. Competition for loans comes primarily from other
commercial banks, savings associations, mortgage banking firms, credit unions
and other financial intermediaries.
Recent changes in federal banking laws facilitate interstate branching and
merger activity among banks. Since September 1995, certain bank holding
companies are authorized to acquire banks throughout the United States. In
addition, as of June 1, 1997, certain banks are permitted to merge with banks
organized under the laws of different states. These changes have resulted in an
even greater degree of competition in the banking industry and the Company and
the Bank will continue to be brought into competition with institutions with
which it does not presently compete.
Regional and local banks dominate the banking industry in Centreville,
Chestertown, Stevensville, and the Hillsboro areas where the Bank maintains
offices. The Bank competes for deposits and loans with these institutions and
with credit unions, savings institutions, insurance companies, and mortgage
companies, as well as other companies that offer financial services. To attract
new business and retain existing customers, the Bank offers a wide range of
banking products and services and relies on local promotional activity, personal
contact by its officers, staff, and Directors, referrals by current customers,
extended banking hours, and personalized service.
As of June 30, 1999, the most recent date for which comparative data is
available, bank deposits in Queen Anne's County (where the Bank's main office,
Centreville branch and Stevensville branch are located), Caroline County,
Maryland (where the Bank's Hillsboro branch is located), and Kent County (where
the Bank's Kent branch is located) ranked as follows:
3
% of
QUEEN ANNE'S COUNTY DEPOSITS TOTAL
-------- -----
(in thousands)
The Queenstown Bank of Maryland $151,404 37.89%
THE CENTREVILLE NATIONAL BANK OF MARYLAND 121,869 30.50
The Chestertown Bank of Maryland 38,589 9.66
NationsBank, N.A 34,769 8.70
Allfirst Bank 22,415 5.61
Annapolis National Bank 15,663 3.92
Farmers Bank of Maryland 14,888 3.72
-------- ------
Total $399,597 100.00%
======== ======
SOURCE: FDIC DATA BOOK
% of
CAROLINE COUNTY DEPOSITS TOTAL
-------- -----
(in thousands)
The Peoples Bank of Maryland $ 75,014 30.21%
Provident State Bank of Preston 65,369 26.33
Allfirst Bank 37,129 14.96
Farmers Bank of Maryland 25,278 10.18
THE CENTREVILLE NATIONAL BANK OF MARYLAND 15,950 6.43
NationsBank, N.A. 15,339 6.18
Atlantic Bank 14,190 5.72
-------- ------
Total $248,269 100.00%
======== =======
SOURCE: FDIC DATA BOOK
% of
KENT COUNTY DEPOSITS TOTAL
-------- -----
(in thousands)
Peoples Bank of Kent County $107,287 32.47%
The Chestertown Bank of Maryland 103,631 31.36
The Chesapeake Bank and Trust Company 45,212 13.68
Farmers Bank of Maryland 30,433 9.21
THE CENTREVILLE NATIONAL BANK OF MARYLAND 22,078 6.68
Crestar Bank 21,792 6.60
-------- ------
Total $330,433 100.00%
======== =======
SOURCE: FDIC DATA BOOK
SUPERVISION AND REGULATION
GENERAL. The Company and the Bank are extensively regulated under federal and
state law. Generally, these laws and regulations are intended to protect
depositors, not stockholders. The following is a summary description of certain
provisions of certain laws which affect the regulation of bank holding companies
and banks. The discussion is qualified in its entirety by reference to
applicable laws and regulations. Changes in such laws and regulations may have a
material effect on the business and prospects of the Company and the Bank.
FEDERAL BANK HOLDING COMPANY REGULATION AND STRUCTURE. The Company is a bank
holding company within the meaning of the Bank Holding Company Act of 1956, as
amended, and as such, it is subject to regulation, supervision, and examination
by the Federal Reserve Board ("FRB"). The Company is required to file annual and
quarterly reports with the FRB and to provide the FRB with such additional
information as the FRB may require. The FRB may conduct examinations of the
Company and its subsidiaries.
4
With certain limited exceptions, the Company is required to obtain prior
approval from the FRB before acquiring direct or indirect ownership or control
of more than 5% of any voting securities or substantially all of the assets of a
bank or bank holding company, or before merging or consolidating with another
bank holding company. Additionally, with certain exceptions, any person
proposing to acquire control through direct or indirect ownership of 25% or more
of any voting securities of the Company is required to give 60 days' written
notice of the acquisition to the FRB, which may prohibit the transaction, and to
publish notice to the public.
Generally, a bank holding company may not engage in any activities other than
banking, managing or controlling its bank and other authorized subsidiaries, and
providing services to these subsidiaries. With prior approval of the FRB, the
Company may acquire more than 5% of the assets or outstanding shares of a
company engaging in non-bank activities determined by the FRB to be closely
related to the business of banking or of managing or controlling banks. The FRB
provides expedited procedures for expansion into approved categories of non-bank
activities.
Subsidiary banks of a bank holding company are subject to certain quantitative
and qualitative restrictions on extensions of credit to the bank holding company
or its subsidiaries, on investments in their securities and on the use of their
securities as collateral for loans to any borrower. These regulations and
restrictions may limit the Company's ability to obtain funds from the Bank for
its cash needs, including funds for the payment of dividends, interest and
operating expenses. Further, subject to certain exceptions, a bank holding
company and its subsidiaries are prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. For example, the Bank may not generally
require a customer to obtain other services from itself or the Company, and may
not require that a customer promise not to obtain other services from a
competitor as a condition to and extension of credit to the customer.
Under FRB policy, a bank holding company is expected to act as a source of
financial strength to its subsidiary banks and to make capital injections into a
troubled subsidiary bank, and the FRB may charge the bank holding company with
engaging in unsafe and unsound practices for failure to commit resources to a
subsidiary bank when required. A required capital injection may be called for at
a time when the holding company does not have the resources to provide it. In
addition, depository institutions insured by the Federal Deposit Insurance
Corporation ("FDIC") can be held liable for any losses incurred by, or
reasonably anticipated to be incurred by, the FDIC in connection with the
default of, or assistance provided to, a commonly controlled FDIC-insured
depository institution. Accordingly, in the event that any insured subsidiary of
the Company causes a loss to the FDIC, other insured subsidiaries of the Company
could be required to compensate the FDIC by reimbursing it for the estimated
amount of such loss. Such cross guaranty liabilities generally are superior in
priority to the obligations of the depository institution to its stockholders
due solely to their status as stockholders and obligations to other affiliates.
FEDERAL BANK REGULATION. The Company's banking subsidiary is a
federally-chartered national bank regulated by the Office of Comptroller of the
Currency ("OCC"). The OCC may prohibit the institutions over which it has
supervisory authority from engaging in activities or investments that the agency
believes constitutes unsafe or unsound banking practices. Federal banking
regulators have extensive enforcement authority over the institutions they
regulate to prohibit or correct activities which violate law, regulation or a
regulatory agreement or which are deemed to constitute unsafe or unsound
practices. Enforcement actions may include the appointment of a conservator or
receiver, the issuance of a cease and desist order, the termination of deposit
insurance, the imposition of civil money penalties on the institution, its
directors, officers, employees and institution-affiliated parties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the removal of or restrictions on directors, officers, employees and
institution-affiliated parties, and the enforcement of any such mechanisms
through restraining orders or other court actions.
The Bank is subject to certain restrictions on extensions of credit to executive
officers, directors, principal stockholders or any related interest of such
persons which generally require that such credit extensions be made on
substantially the same terms as are available to third persons dealing with the
Bank and not involve more than the normal risk of repayment. Other laws tie the
maximum amount which may be loaned to any one customer and its related interests
to capital levels.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), each federal banking agency is required to prescribe, by regulation,
non-capital safety and soundness standards for institutions under its authority.
The federal banking agencies, including the OCC, have adopted standards covering
internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, and
compensation, fees and benefits. An institution which fails to meet those
standards may be required by the agency to develop a plan acceptable to the
agency, specifying the steps that the institution will take to meet the
standards. Failure to submit or implement such a plan may subject the
institution to regulatory sanctions. The Company, on behalf of the Bank,
believes that it meets substantially all standards which have been adopted.
FDICIA also imposed new capital standards on insured depository institutions.
See "Capital Requirements."
Before establishing new branch offices, the Bank must meet certain minimum
capital stock and surplus requirements and the Bank must obtain OCC approval.
5
DEPOSIT INSURANCE. As a FDIC member institution, the Bank's deposits are insured
to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"),
administered by the FDIC, and each institution is required to pay semi-annual
deposit insurance premium assessments to the FDIC. The BIF assessment rates have
a range of 0 cents to 27 cents for every $100 in assessable deposits. The
federal Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"1996 Act"), included provisions that, among other things, recapitalized the
Savings Association Insurance Fund ("SAIF") through a special assessment on
savings association deposits and bank deposits that had been acquired from
savings associations. As a result of the April 1997 merger of Kent Savings and
Loan Association, F.A. into the Bank, approximately $21.8 million of the Bank's
deposits are assessed at SAIF rates. The SAIF assessment rates are determined
quarterly and the SAIF is also administered by the FDIC.
CAPITAL REQUIREMENTS. The federal banking regulators have adopted certain
risk-based capital guidelines to assist in the assessment of the capital
adequacy of a banking organization's operations for both transactions reported
on the balance sheet as assets and transactions, such as letters of credit, and
recourse arrangements, which are recorded as off balance sheet items. Under
these guidelines, nominal dollar amounts of assets and credit equivalent amounts
of off balance sheet items are multiplied by one of several risk adjustment
percentages, which range from 0% for assets with low credit risk, such as
certain U.S. Treasury securities, to 100% for assets with relatively high credit
risk, such as business loans.
A banking organization's risk-based capital ratios are obtained by dividing its
qualifying capital by its total risk adjusted assets. The regulators measure
risk-adjusted assets, which include off balance sheet items, against both total
qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2
capital) and Tier 1 capital. "Tier 1," or core capital, includes common equity,
perpetual preferred stock (excluding auction rate issues) and minority interest
in equity accounts of consolidated subsidiaries, less goodwill and other
intangibles, subject to certain exceptions. "Tier 2," or supplementary capital,
includes, among other things, limited-life preferred stock, hybrid capital
instruments, mandatory convertible securities, qualifying subordinated debt, and
the allowance for loan and lease losses, subject to certain limitations and less
required deductions. The inclusion of elements of Tier 2 capital is subject to
certain other requirements and limitations of the federal banking agencies.
Banks and bank holding companies subject to the risk-based capital guidelines
are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at
least 4% and a ratio of total capital to risk-weighted assets of at least 8%.
The appropriate regulatory authority may set higher capital requirements when
particular circumstances warrant. Institutions which meet or exceed a Tier 1
ratio of 6% and a total capital ratio of 10% are considered well capitalized. As
of December 31, 1999, the Bank's ratio of Tier 1 to risk-weighted assets stood
at 18.57% and its ratio of total capital to risk-weighted assets stood at
19.66%. In addition to risk-based capital, banks and bank holding companies are
required to maintain a minimum amount of Tier 1 capital to total assets,
referred to as the leverage capital ratio, of at least 3% or 5% to be considered
well capitalized. As of December 31, 1999, the Bank's leverage capital ratio was
11.05%.
In August, 1995 and May, 1996, the federal banking agencies adopted final
regulations specifying that the agencies will include, in their evaluations of a
bank's capital adequacy, an assessment of the Bank's interest rate risk ("IRR")
exposure. The standards for measuring the adequacy and effectiveness of a
banking organization's interest rate risk management includes a measurement of
board of director and senior management oversight, and a determination of
whether a banking organization's procedures for comprehensive risk management
are appropriate to the circumstances of the specific banking organization. The
Bank has internal IRR models that are used to measure and monitor IRR.
Additionally, the regulatory agencies have been assessing IRR on an informal
basis for several years. For these reasons, the Company does not expect the
addition of IRR evaluation to the agencies' capital guidelines to result in
significant changes in capital requirements for the Bank.
Failure to meet applicable capital guidelines could subject a banking
organization to a variety of enforcement actions, including limitations on its
ability to pay dividends, the issuance by the applicable regulatory authority of
a capital directive to increase capital and, in the case of depository
institutions, the termination of deposit insurance by the FDIC, as well as to
the measures described under "--Federal Deposit Insurance Corporation
Improvement Act of 1991" below, as applicable to undercapitalized institutions.
In addition, future changes in regulations or practices could further reduce the
amount of capital recognized for purposes of capital adequacy. Such a change
could affect the ability of the Bank to grow and could restrict the amount of
profits, if any, available for the payment of dividends to the Company.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. In December,
1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding
provisions of the Federal Deposit Insurance Act and made significant revisions
to several other federal banking statutes. FDICIA provides for, among other
things, (i) publicly available annual financial condition and management reports
for financial institutions, including audits by independent accountants, (ii)
the establishment of uniform accounting standards by federal banking agencies,
(iii) the establishment of a "prompt corrective action" system of regulatory
supervision and intervention, based on capitalization levels, with more scrutiny
and restrictions placed on depository institutions with lower levels of capital,
(iv) additional grounds for the appointment of a conservator or receiver, and
(v) restrictions or prohibitions on accepting brokered deposits, except for
institutions which significantly exceed minimum capital requirements. FDICIA
also provides for increased funding of the FDIC insurance funds and the
implementation of risked-based premiums. See "Deposit Insurance."
6
A central feature of FDICIA is the requirement that the federal banking agencies
take "prompt corrective action" with respect to depository institutions that do
not meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." The Bank is currently classified as
"well-capitalized." An institution may be deemed by the regulators to be in a
capitalization category that is lower than is indicated by its actual capital
position if, among other things, it receives an unsatisfactory examination
rating with respect to asset quality, management, earnings or liquidity.
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a cash dividend) or paying any management
fees to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to growth
limitations and are required to submit capital restoration plans. If a
depository institution fails to submit an acceptable plan, it is treated as if
it is significantly undercapitalized. Significantly undercapitalized depository
institutions may be subject to a number of other requirements and restrictions,
including orders to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets and stop accepting deposits
from correspondent banks. Critically undercapitalized institutions are subject
to the appointment of a receiver or conservator, generally within 90 days of the
date such institution is determined to be critically undercapitalized.
FDICIA provides the federal banking agencies with significantly expanded powers
to take enforcement action against institutions which fail to comply with
capital or other standards. Such action may include the termination of deposit
insurance by the FDIC or the appointment of a receiver or conservator for the
institution. FDICIA also limits the circumstances under which the FDIC is
permitted to provide financial assistance to an insured institution before
appointment of a conservator or receiver.
INTERSTATE BANKING LEGISLATION. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 was enacted into law on September 29, 1994. The law
provides that, among other things, substantially all state law barriers to the
acquisition of banks by out-of-state bank holding companies were eliminated
effective on September 29, 1995. The law also permits interstate branching by
banks effective as of June 1, 1997, subject to the ability of states to opt-out
completely or to set an earlier effective date. Maryland generally established
an earlier effective date of September 29, 1995.
FINANCIAL SERVICES MODERNIZATION. In November, 1999, the Gramm-Leach-Bliley Act
("GLBA") was signed into law. Effective in pertinent part on March 11, 2000,
GLBA revises the Bank Holding Company Act of 1956 and repeals the affiliation
provisions of the Glass-Steagall Act of 1933, which, taken together, limited the
securities, insurance and other non-banking activities of any company that
controls a FDIC insured financial institution. Under GLBA, bank holding
companies, such as Shore Bancshares, Inc., can elect, subject to certain
qualifications, to become a "financial holding company." GLBA provides that a
financial holding company may engage in a full range of financial activities,
including, insurance and securities sales and underwriting activities, and real
estate development, with new expedited notice procedures. GLBA also permits
certain qualified national bank subsidiaries to form financial subsidiaries,
which have broad authority to engage in all financial activities except
insurance underwriting, insurance investments, real estate investment or
development, or merchant banking.
MONETARY POLICY. The earnings of a bank holding company are affected by the
policies of regulatory authorities, including the FRB, in connection with the
FRB's regulation of the money supply. Various methods employed by the FRB are
open market operations in United States Government securities, changes in the
discount rate on member bank borrowing and changes in reserve requirements
against member bank deposits. These methods used in varying combinations to
influence overall growth and distribution of bank loans, investments and
deposits, and their use may also affect interest rates charged on loans or paid
on deposits. The money policies of the FRB have had a significant effect on the
operating results of commercial banks in the past and are expected to continue
to do so in the future.
RISK FACTORS
REGULATORY RISKS. The banking industry is subject to many laws and regulations.
Regulations protect depositors, not stockholders. The Office of the Comptroller
of the Currency and the Board of Governors of the Federal Reserve System
regulate the Company and the Bank. Regulations and laws increase the Company's
operating expenses, affect the Company's earnings, and may put the Company at a
disadvantage with less regulated competitors, such as finance companies,
mortgage banking companies, credit unions, and leasing companies.
EXPOSURE TO LOCAL ECONOMIC CONDITIONS. Most of the loans made by the Bank are
made to local borrowers. A decline in local economic conditions would affect the
Company's earnings.
CREDIT RISKS AND INADEQUACY OF LOAN LOSS RESERVE. When borrowers default and do
not repay the loans made to them by the Bank, the Company loses money.
Experience shows that some borrowers either will not pay on time or will not pay
at all. In these cases, the Bank will cancel, or "write off," the defaulted loan
or loans. A "write off" reduces the Company's assets and affects the Company's
earnings. The Company anticipates losses by reserving what it believes to be an
adequate cushion so that it does not have to take a large loss at any one time.
However, actual loan losses cannot be predicted, and the Company's loan loss
reserve may not be sufficient.
7
INTEREST RATE RISK. The Company's earnings depend greatly on its net interest
income, the difference between the interest earned on loans and investments and
the interest paid on deposits. If the interest rate paid on deposits is high and
the interest rate earned on loans and investments is low, net interest income is
small and the Company earns less. Because interest rates are influenced by
competition, the Company cannot completely control its net interest income.
RISKS ASSOCIATED WITH REAL ESTATE LENDING. The Bank makes real estate secured
loans. Real estate loans are in greater demand when interest rates are low and
economic conditions are good. Even when economic conditions are good and
interest rates are low, these conditions may not continue. The Company may lose
money if the borrower does not pay a real estate loan. If real estate values
decrease, then the Company may lose more money when borrowers default.
NO ASSURANCE OF GROWTH. The Company's ability to increase assets and earnings
depends upon many factors, including competition for deposits and loans, the
Company's branch and office locations, avoidance of credit losses, and hiring
and training of personnel. Some of these factors are beyond the Company's
control.
COMPETITION. Other banks and non-banks, including savings and loan associations,
credit unions, insurance companies, leasing companies, small loan companies,
finance companies, and mortgage companies, compete with the Company. Some of the
Company's competitors offer services and products that the Company does not
offer. Larger banks and non-bank lenders can make larger loans and service
larger customers. Law changes now permit interstate banks, which may increase
competition. Increased competition may decrease the Company's earnings.
NO ASSURANCE OF CASH OR STOCK DIVIDENDS. Whether dividends may be paid to
stockholders depends on the Company's earnings, its capital needs, law and
regulations, and other factors. The Company's payment of dividends in the past
does not mean that the Company will be able to pay dividends in the future.
STOCK NOT INSURED. Investments in the shares of the Company's common stock are
not deposits that are insured against loss by the government.
RISK INVOLVED IN ACQUISITIONS. Part of the Company's growth may come from buying
other banks and companies. A newly purchased bank or company may not be
profitable after the Company buys it and may lose money, particularly at first.
The new bank or company may bring with it unexpected liabilities or bad loans,
bad employee relations, or the new bank or company may lose customers.
RISK OF CLAIMS. Customers may sue the Company for losses due to the Company's
alleged breach of fiduciary duties, errors and omissions of employees, officers
and agents, incomplete documentation, the Company's failure to comply with
applicable laws and regulations, or many other reasons. Also, employees of the
Company conduct all of the Company's business. The employees may knowingly or
unknowingly violate laws and regulations. Company management may not be aware of
any violations until after their occurrence. This lack of knowledge will not
insulate the Company from liability. Claims and legal actions may result in
legal expenses and liabilities that may reduce the Company's profitability and
hurt its financial condition.
DEVELOPMENTS IN TECHNOLOGY. Financial services use technology, including
telecommunications, data processing, computers, automation, Internet-based
banking, debit cards, and "smart" cards. Technology changes rapidly. The
Company's ability to compete successfully with other banks and non-banks may
depend on whether it can exploit technological changes. The Company may not be
able to exploit technological changes and expensive new technology may not make
the Company more profitable.
MARKET FOR COMMON STOCK. The Company's shares of common stock are not listed on
any exchange, and there is currently no organized trading market. Prices for the
Company's common stock may not be the actual value or the trading price in a
liquid trading market.
ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS. The Company's
Articles of Incorporation and Bylaws divide the Company's Board of Directors
into three classes and each class serves for a staggered three-year term. No
director may be removed except for cause and then only by a vote of at least
two-thirds of the total eligible stockholder votes. In addition, Maryland law
contains anti-takeover provisions that apply to the Company. These provisions
may discourage or make it more difficult for another company to buy the Company
or may reduce the market price of the Company's common stock.
8
STATISTICAL INFORMATION:
The following supplementary information required under Guide 3 for the
respective periods and at the indicated respective dates is set forth on the
pages indicated below. The information should be read in conjunction with the
related Consolidated Financial Statements and Notes thereto for the year ended
December 31, 1999.
Table of Contents: Page
Investment Securities Portfolio Analysis 10
Summary of Loan Portfolio 11
Maturities of Loan Portfolio 11
Risk Elements of Loan Portfolio 11
Allocation of the Allowance for Credit Losses 12
Summary of Significant Ratios 12
Other statistical information required in this Item 1 is incorporated by
reference from the information appearing in the Company's Annual Report to
Stockholders as follows:
DISCLOSURE REQUIRED BY GUIDE 3 REFERENCE TO THE 1999 ANNUAL REPORT
- ------------------------------ -----------------------------------
(I) Distribution of Assets, Liabilities, and Stockholders' Average Balances, Yields and Rates (page 14)
Equity: Interest Rates and Interest Differential Rate and Volume Variance Analysis (page 15)
(II) Investment Portfolio Notes to Financial Statements - Investment Securities
(pages 23 - 25)
(III) Loan Portfolio Management's Discussion and Analysis of Financial
Condition and Results of Operations - Loan Portfolio
(page 8)
(IV) Summary of Credit Loss Experience Management's Discussion and Analysis of Financial
Condition and Results of Operations - Provision and
Allowance for Credit Losses (page 6)
Notes to Financial Statements - Loans and Allowance
for Credit Losses (page 26)
(V) Deposits Average Balances, Yields and Rates (page 14)
Rate and Volume Variance Analysis (page 15)
Notes to Financial Statements - Deposits (page 28)
(VI) Return on Equity and Assets Selected Financial Data (page 1)
9
Investment Securities Portfolio Analysis
December 31, 1999
(In Thousands)
AVAILABLE FOR SALE
- ------------------
U.S. Govt. Agencies
AMORTIZED AVG.T.E.
DESCRIPTION & TERM COST YIELD
- ------------------ ---- -----
0 - 3 Months $ 995 4.05%
3 - 6 Months 0 N/A
6 - 12 Months 500 5.48
1 - 3 Years 14,503 5.91
3 - 4 Years 6,998 6.46
4 - 5 Years 6,500 6.33
5 - 10 Years 1,298 6.35
10 - 30 Years 1,555 7.08
------- ----
Total $32,349 6.07%
======= ====
U.S. GOVT. AGENCIES SECURITIES /
MUTUAL FUNDS OTHER SECURITIES
TOTAL
AMORTIZED AVG.T.E. BOOK AVG.T.E. AVAILABLE
DESCRIPTION & TERM COST YIELD VALUE YIELD FOR SALE
- ------------------ ---- ----- ----- ----- --------
0 - 3 Months $ 0 N/A $ 0 N/A $ 995
3 - 6 Months 0 N/A 0 N/A 0
6 - 12 Months 0 N/A 0 N/A 500
1 - 3 Years 0 N/A 0 N/A 14,503
3 - 4 Years 0 N/A 0 N/A 6,998
4 - 5 Years 0 N/A 0 N/A 6,500
5 - 10 Years 0 N/A 0 N/A 1,298
10 - 30 Years 1,010 5.77% 1,015 7.06% 3,580
------- ---- ------- ---- -------
Total $ 1,010 5.77% $ 1,015 7.06% $34,374
======= ==== ======= ==== =======
HELD TO MATURITY
U.S. GOVT. AGENCIES MUNICIPALS
AMORTIZED AVG.T.E. AMORTIZED AVG.T.E.
DESCRIPTION & TERM COST YIELD COST YIELD
- ------------------ ---- ----- ---- -----
0 - 3 Months $ 0 N/A $ 0 N/A
3 - 6 Months 0 N/A 100 9.63%
6 - 12 Months 0 N/A 0 N/A
1 - 3 Years 1,501 6.52% 394 6.32
3 - 4 Years 1,997 6.57 341 6.83
4 - 5 Years 2,499 7.20 1,067 7.34
5 - 10 Years 2,512 7.53 4,407 6.83
10 - 30 Years 0 N/A 0 N/A
------ ---- ------ ----
Total $8,509 7.03% $6,309 6.93%
====== ==== ====== ====
MUNICIPALS - IN STATE
TOTAL
AMORTIZED AVG.T.E. HELD TO
DESCRIPTION & TERM COST YIELD MATURITY
- ------------------ ---- ----- --------
0 - 3 Months $ 0 N/A $ 0
3 - 6 Months 385 6.52% 485
6 - 12 Months 100 10.26 100
1 - 3 Years 1,222 7.44 3,117
3 - 4 Years 599 7.20 2,937
4 - 5 Years 270 9.78 3,836
5 - 10 Years 158 6.73 7,077
10 - 30 Years 0 N/A 0
------- ----- -------
Total $ 2,734 7.55% $17,552
======= ===== =======
10
The above yields have been adjusted to reflect a tax equivalent basis assuming a
federal tax rate of 34% and a state tax rate of 7%. Tax equivalent yields have
been weighted by settled par amount and are calculated using amortized cost.
SUMMARY OF LOAN PORTFOLIO
(In Thousands)
LOANS OUTSTANDING AS OF
DECEMBER 31,
1999 1998
AMOUNT AMOUNT
------ ------
Real Estate:
Construction and land development $ 4,275 $ 4,488
Commercial 17,696 14,459
Residential 85,988 76,483
Commercial 10,834 8,448
Consumer installment 8,222 7,318
-------- --------
TOTAL $127,015 $111,196
======== ========
MATURITIES OF LOAN PORTFOLIO
DECEMBER 31, 1999
(In Thousands)
MATURING
MATURING AFTER ONE MATURING
WITHIN BUT WITHIN AFTER FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
-------- ---------- ----- -----
Real estate - Construction and
land development $ 3,029 $ 1,246 $ 0 $ 4,275
Commercial 5,859 3,843 1,132 10,834
------- ------- ------- -------
TOTAL $ 8,888 $ 5,089 $ 1,132 $15,109
======= ======= ======= =======
CLASSIFIED BY SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
DECEMBER 31, 1999
MATURING
MATURING AFTER ONE MATURING
WITHIN BUT WITHIN AFTER FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
-------- ---------- ----- -----
Real estate - Construction and land development
Fixed - Interest Rate Loans $ 2,388 $ 1,246 $- $ 3,634
Adjustable - Interest Rate Loans 641 -- -- 641
------- ------- ------- -------
TOTAL $ 3,029 $ 1,246 $- $ 4,275
======= ======= ======= =======
Commercial
Fixed - Interest Rate Loans $ 1,236 $ 3,820 $ 1,132 $ 6,188
Adjustable - Interest Rate Loans 4,623 23 -- 4,646
------- ------- ------- -------
TOTAL $ 5,859 $ 3,843 $ 1,132 $10,834
======= ======= ======= =======
11
RISK ELEMENTS OF LOAN PORTFOLIO
(In Thousands)
December 31,
1999 1998
---- ----
Non-accrual loans $1,047 $ 55
Accruing loans past due 90 Days or more 187 765
Restructured loans 278 872
Information with respect to non-accrual loans and restructured loans at
December 31, 1999:
Interest income that would have been
recorded under original terms $ 123
Interest income recorded during
the period $ 61
At December 31, 1999 the Company had $2.2 million in loans on the watch list for
which payments were current, but the borrowers have the potential for
experiencing financial difficulties. These loans are subject to on going
management attention and their classifications are reviewed regularly.
ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES
(In Thousands)
PERCENT OF PERCENT OF
LOANS IN EACH LOANS IN EACH
DECEMBER 31, CATEGORY TO DECEMBER 31, CATEGORY TO
1999 TOTAL LOANS 1998 TOTAL LOANS
---- -------------- ---- --------------
Real Estate:
Construction and
land development $ 54 3.37% $ 56 4.04%
Commercial 724 13.93% 578 13.00%
Residential 26 67.70% 46 68.78%
Commercial 218 8.53% 180 7.60%
Consumer 209 6.47% 148 6.58%
Unallocated 17 N/A 341 N/A
------ ------ ------ ------
TOTAL $1,248 100.00% $1,349 100.00%
====== ====== ====== ======
SUMMARY OF SIGNIFICANT RATIOS
1999 1998
---- ----
Return on average total assets 1.21% 1.25%
Return on average total equity 10.30% 9.52%
Dividend payout ratio 45.23% 45.64%
Total average equity to total average assets ratio 11.76% 13.17%
ITEM 2
PROPERTIES
The Bank owns real property at the location of its main office at 109 North
Commerce Street, Centreville, Maryland 21617, and at its four branch locations
at 2609 Centreville Road, Centreville, Maryland 21617 ("Route 213 South Branch
Office"), 408 Thompson Creek Road, Stevensville, Maryland 21666 ("Stevensville
Branch Office"), at 21913 Shore Highway, Hillsboro, Maryland 21614 ("Hillsboro
Branch Office") and 305 East High Street, Chestertown, Maryland ("Kent Branch
Office".) There are no encumbrances on any of these properties. In addition, the
Bank, in 1999, purchased a lot at the corner of 404 and Sharp Road, in Denton
Maryland (Caroline County) for the construction of a branch location.
12
ITEM 3
LEGAL PROCEEDINGS
There are no material pending legal proceedings other than ordinary routine
litigation incidental to the business to which the Company, the Bank, or its
subsidiaries is a party or of which any of their properties is subject.
Management is not aware of any material proceedings to which any Director,
officer, or affiliate of the Company, any person holding beneficially in excess
of five (5) percent of the Company's shares of common stock, or any associate of
any such Director, officer, or securing holder is a party.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1999 to a vote of
security holders, through the solicitation of proxies.
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The sections entitled "Market Price of and Dividends on Registrant's Common
Equity and Related Stockholder Matters" and "Market Information" on page 37 of
the Annual Report is incorporated by reference herein.
For information regarding regulatory restrictions on the Bank's and, therefore,
the Company's payment of dividends, see Note 15 "Regulatory Matters" on page 34
of the Annual Report, which is incorporated by reference herein.
ITEM 6
SELECTED FINANCIAL DATA
The table entitled "Selected Financial Data" on page 1 of the Annual Report is
incorporated by reference herein. Reference is also made to the information
described in Part I, Item 1 of this Form 10K under the heading "Statistical
Information."
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Pages 4 through 12 of the Annual Report are incorporated by reference herein.
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the market risk of the Company's financial
instruments, see "Management Discussion and Analysis of Financial Condition and
Results of Operations - Market Risk Management" on page 10 of the Annual Report
and incorporated by reference herein. The Company's principal market risk
exposure is to interest rates.
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages 16 through 36 of the Annual Report are incorporated by reference herein.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Board of Directors of the Company, upon recommendation of the Bank's
Audit/Compliance Committee, proposed and recommended the election of Stegman &
Company as independent certified public accountants to make an examination of
the accounts of the Company and the Bank for the year ending December 31, 1999.
Stegman and Company served as the Company's and the Bank's independent public
auditor since 1996.
There were no disagreements with Stegman and Company on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedures.
13
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference in the section entitled "Election of Directors" on
pages 2 - 3 and section entitled "Executive Officers" on page 9 and "Section
16(a) Beneficial Ownership Reporting Compliance" on page 12 in the Proxy
Statement as filed with the Securities and Exchange Commission March 20, 2000.
ITEM 11
EXECUTIVE COMPENSATION
Incorporated by reference in the sections entitled "Executive Compensation," on
page 9, "Director Compensation," on page 5, "Bank's Board of Directors'
Executive Compensation Committee Report" on page 8, "Compensation Committee
Interlocks and Insider Participation," on page 8, "Employment Agreement" on
pages 9-10, "Stock Option Plans," on page 10, and "Performance Graph," on page
11, in the Proxy Statement as filed with the Securities and Exchange Commission
March 20, 2000.
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference in the section entitled "Beneficial Ownership of
Common Stock" on pages 6 and 7 in the Proxy Statement as filed with the
Securities and Exchange Commission March 20, 2000.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference in the section entitled "Election of Directors" on
pages 2 and 3 in the Proxy Statement as filed with the Securities and Exchange
Commission March 20, 2000.
PART IV
ITEM 14
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1), (2) Financial Statements
The following consolidated financial statements included in the Annual Report to
Shareholders for the year ended December 31, 1999, are incorporated herein by
reference in Item 8 of this Report.
The following financial statements are filed as a part of this report:
Consolidated Balance Sheets at December 31, 1999 and 1998
Consolidated Statements of Income for the years ended December 31, 1999, 1998
and 1997
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended December 31, 1999,
1998 and 1997
Notes to the Consolidated Financial Statements
Independent Auditors' Report
All financial statement schedules have been omitted, as the required information
is either inapplicable or included in the consolidated financial statements or
related notes.
(a) (3) Exhibits required to be filed by Item 601 of Regulation S-K
14
EXHIBIT INDEX
(3) Charter and Bylaws
(3.1) Articles of Amendment and Restatement of the Company are incorporated by
reference from the Company's June 30, 1998 Form 10-Q, filed with the Commission
on August 13, 1998.
(3.2) Bylaws of the Company as amended and restated are incorporated by
reference from the Company's June 30, 1998 Form 10-Q, filed with the Commission
on August 13, 1998.
(10.1) 1998 Employee Stock Purchase Plan is incorporated by reference from the
Company's Registration Statement on Form S-8 filed with the Commission on
September 25, 1998 (Registration No. 333-64317).
(10.2) 1998 Stock Option Plan is incorporated by reference from the Company's
Registration Statement on Form S-8 filed with the Commission on September 25,
1998 (Registration No. 333-64319).
(13) 1999 Annual Report filed herewith.
(21) List of Subsidiaries is incorporated by reference from the Company's Form
10, filed with the Commission on April 3, 1997, and Form 10/A, filed with the
Commission on May 30, 1997 (Registration No. 0-22523)
(23) Consent of Independent Auditors filed herewith.
(27) Financial Data Schedule is filed electronically herewith via EDGAR.
(b) Reports on Form 8-K
None
(c) Exhibits to Item 601 to Regulation S-K
See the Exhibits described in Item 14(a)(3) above.
15
SHORE BANCSHARES, INC.
1999
ANNUAL REPORT
- --------------------------------------------------------------------------------
CONTENTS
- --------------------------------------------------------------------------------
Business Profile 2
Letter to Stockholders 3
Management's Discussion and Analysis of
Financial Condition and Results of Operations 4-12
Average Balances, Yields, and Rates 14
Rate and Volume Variance Analysis 15
Consolidated Financial Statements 16-35
Independent Auditors' Report 36
Market Price of and Dividends on Registrant's
Common Equity and Related Stockholder
Matters 37
Board of Directors 38
Officers and Employees 39
Offices 40
- --------------------------------------------------------------------------------
SELECTED FINANCIAL DATA
- ---------------------------------------------------------------------------------------------------------
For the Year 1999 1998 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
Net interest income $ 6,909,460 $ 7,087,069 $ 6,957,167 $ 6,265,431 $ 6,012,491
Provision for credit losses -- -- -- -- --
Net interest income after provision
for credit losses 6,909,460 7,087,069 6,957,167 6,265,431 6,012,491
Noninterest income 1,152,943 872,645 909,049 999,423 877,386
Net income 2,284,726 2,218,939 2,370,198 2,307,742 2,138,500
- ---------------------------------------------------------------------------------------------------------
Per Share Data:*
- ---------------------------------------------------------------------------------------------------------
Diluted net income $ 1.19 $ 1.12 $ 1.18 $ 1.14 $ 1.06
Cash dividends declared 0.54 0.51 0.485 0.46 0.43
Book value (shares outstanding) 11.81 11.45 11.67 10.97 10.35
Weighted average common shares 1,913,741 1,985,142 2,014,848 2,014,848 2,014,848
- ---------------------------------------------------------------------------------------------------------
At Year End
- ---------------------------------------------------------------------------------------------------------
Total Assets $191,147,719 $181,054,572 $175,115,011 $146,899,477 $138,100,669
Loans, net of unearned income 127,014,752 111,196,511 109,167,283 88,892,757 87,049,483
Allowance for credit losses 1,247,574 1,348,805 1,403,747 1,503,268 1,478,555
Investment securities 50,937,031 47,118,489 48,742,568 43,652,747 37,131,443
Deposits 162,072,694 153,307,567 145,813,270 124,166,248 116,479,753
Long-term debt 5,000,000 5,000,000 5,000,000 -- --
Stockholders' equity 22,603,215 21,904,235 23,514,810 22,095,951 20,849,348
Allowance for credit losses to
non-performing loans 101.10% 164.59% 311.94% 102.82% 83.72%
- ---------------------------------------------------------------------------------------------------------
Average Balances
- ---------------------------------------------------------------------------------------------------------
Total assets $188,726,977 $176,964,561 $165,695,678 $141,410,379 $139,313,160
Total deposits and borrowings 165,508,361 152,715,842 141,504,846 118,945,631 118,224,470
Stockholders' equity 22,190,348 23,314,674 22,789,823 21,626,308 20,318,612
Return on average total assets 1.21% 1.25% 1.43% 1.63% 1.54%
Return on average stockholders'
equity 10.30% 9.52% 10.40% 10.67% 10.52%
- ---------------------------------------------------------------------------------------------------------
* PER SHARE DATA IS RESTATED TO REFLECT THE 2 FOR 1 STOCK SPLIT EFFECTED IN THE
FORM OF A 100% STOCK DIVIDEND UPON THE CONVERSION TO SHORE BANCSHARES, INC. AND
THE 2 FOR 1 STOCK SPLIT EFFECTED IN THE FORM OF A 100% STOCK DIVIDEND ON MARCH
31, 1998.
THE YEAR ENDED DECEMBER 31, 1997 REFLECTS THE MERGER OF KENT SAVINGS AND LOAN
ASSOCIATION, INC. ON APRIL 1, 1997 WHICH WAS ACCOUNTED FOR AS A PURCHASE
TRANSACTION.
1
BUSINESS PROFILE
Shore Bancshares Inc. (the Company), a Maryland corporation, incorporated on
March 15, 1996, became a registered bank holding company on July 1, 1996 under
the Bank Holding Company Act of 1956, as amended. The Company engages in its
business through its sole subsidiary, The Centreville National Bank of Maryland
(the Bank), a national banking association.
The Company's and Bank's main office is located at 109 North Commerce Street,
Centreville, Queen Anne's County, Maryland. Banking business is conducted at 5
full service branch offices, all in Maryland with two located in Centreville,
Queen Anne's County, a branch in Stevensville, Queen Anne's County, a Hillsboro
location, serving Queen Anne's and Caroline Counties, and Chestertown, Kent
County.
The Bank has been doing business in Centreville since 1876 and is engaged in
both the commercial and consumer banking business. The Bank provides a wide
range of personal banking services designed to meet the need of local consumers.
The Bank engages in the financing of commerce and industry by providing credit
and deposit services for small to medium sized businesses, local governments,
and for the agricultural community in the Bank's market area.
The Company's and the Bank's management are committed to providing personal,
friendly, quality service to our customers while earning a reasonable return for
our shareholders. Our commitment to the communities in which we operate and
their economic vitality is a crucial element of our focus. We believe in giving
back to the community we serve. We have grown and changed along with our local
region. Shore Bancshares Inc. will continue to respond to the changing business
environment through our investment in technology and products and services
developed to meet the needs of our customers, while remaining true to our
principle of excellent customer service.
2
TO OUR STOCKHOLDERS:
The Board of Directors and management of Shore Bancshares, Inc. are pleased to
present the Annual Report for the year ended December 31, 1999.
The financial results are positive even though the Company and its subsidiary
The Centreville National Bank of Maryland faced several challenges during the
past year.
Although interest rate spreads and net interest margin continued to decline due
to economic pressures, resulting in $178 thousand, or 2.5%, less net interest
income, net income after taxes rose by $66 thousand, or 3.0%, to a total of $2.3
million. Our loan portfolio grew by $15.9 million, or 14.5%, to $125.8 million,
net of allowance for loan losses. Deposits increased by $8.8 million, or 5.7%,
to $162.1 million and total assets ended the year at $191.1 million, an increase
of 5.6%, or just over $10 million.
One of the largest projects we completed last year was preparing for Y2K. We are
happy to report that all our planning and work paid off. There were no outages
or equipment failures as a result of the date rollover. All systems and
processes functioned normally before, during, and after midnight on December 31.
We opened for business on January 3, 2000 without fanfare or problems.
We expect that the new year will bring additional challenges and we are
confident that our management and staff are prepared to successfully respond to
each one and continue to offer the quality service and products that you and our
customers expect. Please accept our thanks for your investment in Shore
Bancshares and for your interest in our progress.
/S/ B. VANCE CARMEAN, JR. /S/ DANIEL T. CANNON
- ------------------------- --------------------
B. Vance Carmean, Jr. Daniel T. Cannon
Chairman of the Board President
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is designed to provide a better understanding
of the financial position of Shore Bancshares, Inc. (the Company), and should be
read in conjunction with the audited Consolidated Financial Statements and
Notes.
Portions of this annual report contain forward-looking statements (as
defined in the Private Securities Litigation Reform Act of 1995) with respect to
the adequacy of the allowance for loan losses, interest rate risk, realization
of deferred taxes, and liquidity levels which, by their nature, are subject to
significant uncertainties which are described in further detail in Item 1 of the
Company's Form 10-K, under the heading "Risk Factors." The Company believes that
the expectations reflected in such forward-looking statements are reasonable.
However, because these uncertainties and the assumptions on which statements in
this report are based, the actual future results may differ materially from
those indicated in this report.
ORGANIZATIONAL BACKGROUND
On July 1, 1996, the Company commenced operations as the parent company
of its sole subsidiary, The Centreville National Bank of Maryland ("the Bank"),
which has conducted the business of banking since 1876. Since the Bank is the
primary asset of the Company, the assets and liabilities of the Company are
comprised almost entirely of the assets and liabilities of the Bank. The same is
true for the income and expense of the Company. All data for periods on and
after July 1, 1996 is presented in this analysis in consolidated form and is
compared to like data for the Bank for prior years.
OVERVIEW - RESULTS OF OPERATIONS
The Company's results of operations depend primarily on its level of
net interest income, which is the difference between interest income on
interest-earning assets, primarily loans and investment securities, and the
interest paid on interest-bearing liabilities, primarily deposits and advances
from the Federal Home Loan Bank of Atlanta. Results of operations are also
affected by the amount of noninterest income, including loan fees and service
charges, and levels of noninterest expense, consisting of costs such as:
compensation, employee benefits, occupancy costs, data processing, professional
fees and other operating expenses.
Financial results for 1999 reflect growth in several key areas. The
Company earned $2.28 million in net income for 1999 or $1.19 diluted earnings
per share compared to 1998 net income of $2.22 million or $1.12 diluted earnings
per share and 1997 net income of $2.37 million or $1.18 diluted earnings per
share. Net income for 1999 improved 2.96% over 1998 net income. The increase is
the result of increased interest income from 14.5% growth in net loans, as well
as increases in fee income and maintaining noninterest expense at the same
levels are reported in 1998. Declining interest rates resulted in the
refinancing of many loans, to lower rates in the first half of the year, which
negatively impacted net income. Therefore, despite the loan growth, net interest
income decreased 2.51% as a result of declining yield on the loan portfolio,
increased interest expense from deposit growth and a competitive deposit market
which did not allow us to reduce deposit rates as quickly as the loan market
required loan rates to decline. The Company experienced growth in total assets
of 5.57% and in total deposits of 5.72% in 1999. Return on average assets was
1.21%, 1.25%, and 1.43% in 1999, 1998, and 1997, respectively, which reflects
the Company's growth in assets at a faster rate than the growth in earnings.
Earnings reflect a shrinking net interest margin. The return on average
stockholders' equity for 1999 improved to 10.30% compared to 9.52% and 10.40% in
1998 and 1997, respectively.
NET INTEREST INCOME and NET INTEREST MARGIN
Net interest income is the principal source of earnings for a banking
company. It represents the difference between interest and fees earned on the
loan and investment portfolios over the interest paid on deposits and
borrowings. 1999 is characterized by increasing interest rates. For the Company,
net interest income for 1999 reflects increasing loan rates, mainly in the
second half of the year, and slightly declining deposit rates. Deposit rates
were not reduced at the same rate as loans rates were decreased in 1998 because
of a competitive deposit market which is slower to reduce rates in a declining
rate environment. The year ended December 31, 1998 was characterized by
generally declining interest rates. During 1997, rate activity reflected
slightly increasing loan rates in the first quarter and declining rates in the
fourth quarter. Deposit rates followed the same trends except that rate
reductions began in the third quarter of 1997.
4
Net interest income (on a tax equivalent basis) for 1999 decreased by
$197 thousand or 2.7% compared to the year ended December 31, 1998, while 1998
increased by $159 thousand or 2.2% from the previous year ended December 31,
1997. During the three years ended December 31, 1999, 1998 and 1997 there have
not been any material changes in the volume or quality of the Company's tax
exempt securities that would have a significant effect on tax exempt interest
income. The table titled "Average Balances, Yields and Rates" on page 14 sets
forth the major components of net interest income, on a tax equivalent basis,
for 1999, 1998 and 1997. The table titled "Rate and Volume Variance Analysis" on
page 15 illustrates the portion of the changes in net interest income which are
attributable to changes in volume of average balances or to changes in yield on
earning assets and rates paid on interest bearing liabilities. The information
revealed by these tables is analyzed below.
Despite a 7.8% increase in average total loans and a 6.9% increase in
average earning assets, total interest income (on a tax equivalent basis)
increased by only $28 thousand, or 0.2%, over the year ended December 31, 1998.
Loan growth provided a $768 thousand increase in interest income. However, loans
refinanced or repriced in the declining rate market of 1998 and early 1999
reduced interest earnings by $752 thousand. Growth in average total interest
bearing liabilities of $10.3 million, or 7.6%, increased interest expense by
$444 thousand. Changes in rates reduced interest expense by $219 thousand,
resulting in an increase in interest expense of $225 thousand, or 3.8%. The net
effect of these changes was a decrease in net interest income (on a tax
equivalent basis) of $197 thousand, or 2.7% for the year ended December 31,
1999.
Interest rate spread is the difference between the average yield on
interest earning assets and the average rate paid on interest bearing
liabilities (deposits and borrowings.) Interest rate spread for the years ended
December 31, 1999, 1998 and 1997 was 3.30%, 3.65%, and 3.82%, respectively.
The 1999 interest rate spread decreased 35 basis points compared to
1998. The rate spread variance reflects a decrease in yield on earning assets of
50 basis points and a decrease of only 16 basis points in the average rate
interest-bearing liabilities, reflecting the slower rate at which the local
deposit pricing moves in comparison to the general market. Steady rate increases
in the later half of 1999 began to improve interest rate spread in the fourth
quarter.
Interest rate spread in 1998 decreased 17 basis points compared to the
prior year as a result of the decreased yield on average interest earning assets
and an increase in the yield on average interest bearing liabilities. A change
in the balance sheet mix also accounted for a decrease in interest rate spread.
The 4.3% increase in total average loans in 1998 was the result of loan growth
and a full year of Kent Savings assets which increased total interest income in
1998 despite a decrease in loan yields. Despite some loan rate increases during
1998, overall loan yield decreased 10 basis points compared to 1997. Fourth
quarter loan rate decreases and more significantly, loans refinanced with the
Company or other lenders are reflected in decreased loan yield. Total loans as a
percentage of total interest earning assets has decreased 2.2%. However, the
average balances in each loan category have increased improving interest income.
As a result of a lower interest rate environment, the Company experienced a
large number of calls of investment securities. These securities were replaced
with lower yielding investments. To maintain as much of the investment yield as
prudent, a portion of the called investments were replaced with municipal bonds.
The average balance in municipal bonds increased $1.6 million or 18.3% providing
a higher tax equivalent yield than U.S. Treasuries and Government agency bonds
in the current market. The composition of deposits changed as well. Other Time
and IRA deposit average balances increased. These are more costly deposits which
account for increased deposit interest expense. Despite lowering deposit rates
in the first and fourth quarters of 1998, the change in deposit mix provided
higher yields on deposits, on average, for 1998 compared to the prior year.
Net interest margin is calculated as tax equivalent net interest income
divided by average earning assets and represents the Company's net yield on its
earning assets. The Company's net interest margin is affected by regulatory,
economic and competitive factors which impact interest rates, loan demand and
availability of funds for deposits. Like other financial institutions, the
Company is subject to interest rate risk to the degree that its interest earning
assets reprice at different times than its interest bearing liabilities. For
1999, the net interest margin decreased to 4.05% from 4.45% in 1998. This
decrease is the result of average earning assets growing $11.4 million or 6.9%
while net interest income declined $197 thousand or at a rate of 2.7%. Comparing
1999 and 1998 shows that changes in rates decreased net interest margin $706
thousand, while changes in volume provided $509 thousand for a net decrease of
$197 thousand. Mortgage loans, mainly residential and some commercial mortgages,
accounted for the majority of the loan growth.
The net interest margin for 1998 decreased to 4.45% from 4.64% the
previous year. When comparing 1998 verses 1997, repricing reduced the net
interest income $104 thousand and volume changes provided $263 thousand for a
net increase of $159 thousand. Average earning assets increased at a rate of
6.6% while net interest income increased at a rate of 2.2% which resulted in a
5
decline in net interest margin. Loan growth, specifically commercial mortgages,
adjustable rate mortgage loans and home equity loans accounted for the volume
increases.
Management and the Board of Directors monitor interest rates on a
regular basis to assess the Company's competitive position and to maintain a
reasonable and profitable interest rate spread. The Company also considers the
maturity distribution of loans, investments, and deposits and its effect on net
interest income as interest rates rise and fall over time.
For additional analysis see the Notes to the Consolidated Financial
Statements.
PROVISION and ALLOWANCE FOR CREDIT LOSSES
For the year ended December 31, 1999, the Bank recorded net charge-offs
of $101 thousand compared to net charge-offs of $55 thousand in 1998 and net
charge-offs of $115 thousand in 1997. Internal loan review is effective in
identifying problem credits and in achieving timely recognition of potential and
actual losses within the loan portfolio. Overall credit quality and increased
collection efforts have also contributed to the relatively small amount of net
charge-offs in each of the last three years.
Gross charge-offs amounted to $229 thousand, $104 thousand and $159
thousand in 1999, 1998, and 1997, respectively, the majority of which were
installment loans. Efforts to collect charged off loans are continuing and are
evidenced by the amount of recoveries, totaling $128 thousand in 1999, $49
thousand in 1998, and $44 thousand in 1997.
Provision for credit losses is an estimate of the amount necessary to
maintain the allowance for loan losses at a level sufficient to absorb potential
losses in the loan portfolio. The provision for credit losses has followed the
same general trend as the amount of charge-offs. No provision for credit losses
was charged to expense in 1999, 1998, or 1997. $15 thousand was added to the
allowance in 1997 upon the merger with Kent Savings. The allowance for credit
losses is maintained at a level believed adequate by management to absorb
estimated probable credit losses. Management's quarterly evaluation of the
adequacy of the allowance is based on analysis of the loan portfolio and its
known and inherent risks, assessment of current economic conditions,
diversification and size of the portfolio, adequacy of the collateral, past and
anticipated loss experience and the amount of non-performing loans. The
allowance for credit losses has remained relatively unchanged despite the
increase in outstanding loan balances. The allowance for credit losses of $1.2
million as of December 31, 1999 amounted to .98% of the outstanding loan
portfolio. The allowance for credit losses of $1.3 million as of December
31,1998 represented 1.21% of gross loans. The decrease in the percentage of
allowance to outstanding loans, despite the increasing outstanding gross loans,
is justified by lower levels of classified loans. Past due loan levels have
declined and they consist primarily of loans secured by real estate. Analysis by
loan review and internal audit supports the adequacy of the allowance. This
reduction in percentage of allowance to outstanding loans reflects improvements
in credit quality achieved through better credit underwriting and more
aggressive collection efforts and is further evidenced by lower past due loan
totals as a percentage of outstanding loans. In management's opinion, the
allowance for credit losses is adequate as of December 31, 1999. The Board of
Directors and management will continue to review the adequacy of the allowance
for credit losses. If evaluation indicates a provision is necessary, a charge
will be made to current earnings.
See Note 3 in the Notes to the Consolidated Financial Statements.
NONINTEREST INCOME
Noninterest income consists of service charges and fees, gains on sale
of securities, earnings or losses from unconsolidated subsidiaries and various
other income items. Noninterest income increased $280 thousand or 32.1% in 1999
compared to the year ended December 31, 1998. Noninterest income in 1998 was
reduced by an investment writedown as noted below. Increased service charges
from a rise in the number of checks drawn against insufficient funds accounted
for $130 thousand of the increase. Increase in the volume and fee charged to
noncustomers to use the Bank's ATMs and the addition of a fee for loan document
preparation also contributed to the improvement in noninterest income.
For the year ended December 31, 1998, noninterest income decreased $36
thousand or 4.0% compared to the prior year. The decrease was due largely to a
6
$61 thousand operating loss and writedown of the investment in our
unconsolidated subsidiary, Eastern Shore Mortgage Company. Combined with reduced
earnings of our other unconsolidated subsidiary, Delmarva Data Center, equity
earnings from unconsolidated subsidiaries decreased $93 thousand compared to
1997. This decrease was offset by an increase of $22 thousand in total service
charges on deposit accounts primarily the result of increased levels of checks
drawn against insufficient funds as well as ATM fees.
NONINTEREST EXPENSES
The year ended December 31, 1999 reflected a $4 thousand decrease in
noninterest expense when compared to 1998. Included in noninterest expense is a
$56 thousand increase in employee salaries and benefits. The number of full time
equivalent employees increased by 3 to 68 when comparing the year ended December
31, 1999 to the same period in 1998. Salaries and benefits include limited cost
of living and benefit cost increases.
Premises and fixed assets expenses reflect a slight decrease of $12
thousand. The prior year included $16 thousand in noncapital equipment purchases
as a result of additional offices built with the Commerce Street renovations.
Such expenses were not incurred in 1999, however, facility improvements and
equipment upgrades in the prior years did result in increased depreciation
expense, maintenance costs and equipment service contracts. The Company began
the Commerce Street renovation in January 1997, which was completed in 1999.
Larger buildings are more costly to maintain and the additional investment will
be depreciated over the estimated useful life of the asset. In addition to the
increased depreciation and maintenance expenses, opportunity costs negatively
impact the bottom line. However, the renovations provide a long term benefit for
customers and staff. The impact of this additional maintenance and depreciation
expense is not expected to have a material effect on the Company's net income in
the future. Facility costs are expected to increase with the addition of two new
branch locations; one in Denton, Maryland (Caroline County) and the other in
Chester, Maryland (Queen Anne's County.)
A strong cost reduction emphasis in 1999 helped to keep noninterest
expenses to approximately the same level as 1998. Costs such as marketing and
stationery, postage, legal and professional fees, printing and supplies were
reduced and were offset by cost increases in data processing and donations. As a
result of a change in accounting principle, $25 thousand in unamortized
organizational costs were written off in 1999 rather than the remaining three
year period.
The year ended December 31, 1998 reflected a $297 thousand or 6.8%
increase in noninterest expense compared to December 31, 1997. Salaries and
benefits accounted for $144 thousand of the increase as a result of the
additional salary and benefit costs of 3 full time equivalent staff as well as
cost of living and insurance premium increases. Facility improvements and
equipment upgrades resulted in increased depreciation expense, maintenance costs
and equipment service contracts. Increases were noted in marketing. The Company
adopted a full scale marketing program including direct mail, cable television
commercials and product promotion. Significant growth was also noted in
amortization expense primarily as a result of two items; the recording of a full
year amortization ($140 thousand) of the goodwill produced from the Kent Savings
merger and, after continuing losses, the write off of the remaining $24 thousand
goodwill balance associated with Eastern Shore Mortgage Corporation.
INCOME TAXES
For 1999, the effective tax rate for the Company increased slightly to
32.9% compared to 32.7% for 1998 and 32.3% for 1997. The reduced effective tax
rate in 1998 and 1997 resulted from a $12 thousand and $51 thousand,
respectively, rehabilitation tax credits associated with the renovations of the
main office. The Company's income tax expense differs from the amount computed
at statutory rates primarily due to tax-exempt interest from certain loans and
investment securities and, in 1998 and 1997, the rehabilitation tax credits.
Note 11 to the Consolidated Financial Statements includes a reconciliation of
the Federal tax expense computed using the Federal statutory rate of 34% and
provides additional detail. The Company noted a decrease in state income taxes
beginning in 1996 as the Maryland legislature exempted a portion of the interest
from securities issued by the United States Treasury, bank-qualified Maryland
municipals, and some United States Government agencies. This change in state
income taxes has not had a material impact on liquidity, financial condition or
operations.
Deferred tax assets and liabilities are based on the differences
between financial statement and tax bases of assets and liabilities. The tax
effect of these differences is calculated using current statutory rates.
Management believes it is more likely than not that all deferred tax assets will
be realized and therefore no valuation allowance is deemed necessary.
7
INVESTMENT SECURITIES
Investment securities classified as available for sale are held for an
indefinite period of time and may be sold in response to changing market and
interest rate conditions as part of the asset/liability management strategy.
Available for sale securities are carried at fair value, with unrealized gains
and losses excluded from earnings and reported as a separate component of
stockholders' equity net of income taxes. Investment securities classified as
held to maturity are those that management has both the positive intent and
ability to hold to maturity, and are reported at amortized cost. The Company
does not currently follow a strategy of making securities purchases with a view
to near-term sales, and, therefore, does not own trading securities. At December
31, 1999, the Company had 66% of the portfolio designated as available for sale
and 34% held to maturity compared to 49% and 51%, respectively, as of December
31, 1998. The increase in percentage of securities designated as available for
sale is to cover potential growth and liquidity needs. The Company manages the
investment portfolios within policies which seek to achieve desired levels of
liquidity, manage interest rate sensitivity risk, meet earnings objectives, and
provide required collateral support for deposit activities. The Company does not
generally invest in structured notes or other derivative securities.
Total investment securities amounted to $50.9 million and $47.1 million
as of December 31, 1999 and 1998, respectively. The slightly higher level of
investments in securities resulted primarily from the investment of funds with
deposit growth and the investment of funds previously in federal funds sold.
Excluding the U.S. Government and U.S. Government sponsored agencies, the
Company had no concentrations of investment securities from any single issuers
that exceeded 10% of shareholders' equity. Note 2 to the Consolidated Financial
Statements provides detail by type and contractual maturity for the years ended
December 31, 1999 and 1998.
LOAN PORTFOLIO
The Company is actively engaged in originating loans to customers in
Queen Anne's, Caroline, Kent, and Talbot Counties in the State of Maryland. The
Company has policies and procedures designed to mitigate credit risk and to
maintain the quality of the loan portfolio. These policies include underwriting
standards for new credits as well as the continuous monitoring and reporting of
asset quality and the adequacy of the allowance for credit losses. These
policies, coupled with continuous training efforts, have provided effective
checks and balances for the risk associated with the lending process. Lending
authority is based on the level of risk, size of the loan and the experience of
the lending officer. Note 3 to the Consolidated Financial Statements presents
the composition of the Company's loan portfolio by significant concentration.
The Company had no loan concentrations exceeding 10% of total loans which are
not otherwise disclosed.
In 1999, gross loans grew $15.8 million or 14.2% with $9.2 million or
58.0% of that growth coming in the fourth quarter. This unprecedented growth is
the result of intensive marketing efforts and very competitive pricing. Loan
growth, specifically commercial mortgages, consumer adjustable rate mortgage
loans and home equity loans accounted for the volume increases.
Company policy is to make the majority of its loan commitments in the
market area it serves. The Company attempts to reduce risk through its
management's familiarity with the credit histories of loan applicants and
in-depth knowledge of the risk to which a given credit is subject. Lending in a
limited market area does subject the Company to economic conditions of that
market area. The Company had no foreign loans in its portfolio as of December
31, 1999.
The Company places a loan in non-accrual status whenever there is
substantial doubt about the ability of a borrower to pay principal or interest
on any outstanding credit. Management considers such factors as payment history,
the nature of the collateral securing the loan and the overall economic
situation of the borrower when making a non-accrual decision. Non-accrual loans
are closely monitored by management. A non-accruing loan is restored to current
status when the prospects of future contractual payments are no longer in doubt.
At December 31, 1999 and 1998, $1.0 million and $55 thousand, respectively, of
non-accrual loans were secured by collateral with an estimated value of $1.3
million of December 31, 1999 and $343 thousand as of December 31, 1998.
8
DEPOSITS
Deposit liabilities grew $8.8 million or 5.7% to $162.1 million
compared to $153.3 million in 1998. Average deposits increased at a rate of
8.5%. The table below presents the average balance of deposits and percentage of
each category to total average deposits. The average balance of Super NOW
(interest bearing demand deposits), other time deposits and noninterest bearing
demand deposits grew 11.1%, 11.3% and 13.9%, respectively, compared to the year
ended December 31, 1998. This is the result of the introduction of new product
features as well as competitive pricing. The Company continues to experience
strong competition from other commercial banks, credit unions, the stock market
and mutual funds. The Company does not accept brokered deposits, nor does it
rely on purchased deposits as a funding source for loans. The Company has no
foreign banking offices.
Average Balance of Deposits and the Percentage of each
Category to Total Average Deposits
(All dollar amounts in thousands)
- --------------------------------------------------------------------------------
1999 1998
- --------------------------------------------------------------------------------
Interest-bearing liabilities
Super NOW accounts $ 20,483 12.78% $ 18,433 12.48%
Money market deposit accounts 19,737 12.32% 18,886 12.79%
Time, $100,000 or more 13,647 8.52% 12,698 8.60%
Other time deposits 51,551 32.18% 46,305 31.35%
IRA deposits 15,500 9.67% 15,430 10.45%
Savings deposits 18,637 11.63% 17,819 12.06%
Demand deposits 20,663 12.90% 18,144 12.27%
- --------------------------------------------------------------------------------
$160,218 100.00% $147,715 100.00%
- --------------------------------------------------------------------------------
LIQUIDITY MANAGEMENT
Liquidity describes the ability of the Company to meet financial
obligations that arise out of the ordinary course of business. Liquidity is
needed primarily to meet borrower and depositor withdrawal requirements and to
fund current and planned expenditures. The Company maintains its asset liquidity
position internally through short term investments, the maturity distribution of
the investment portfolio, loan repayments and income from earning assets. As
indicated in the Consolidated Statements of Cash Flows, primary sources of cash
are the maturity of investment securities and deposit growth. A substantial
portion of the investment portfolio contains readily marketable securities that
could be converted to cash immediately. Refer to Note 2 of the Consolidated
Financial Statements for a table showing the maturity distribution of the
Company's securities portfolio and the related estimated fair value. On the
liability side of the balance sheet, liquidity is affected by the timing of
maturing deposits and the ability to generate new deposits or borrowings as
needed. Other sources are available through borrowings from the Federal Reserve
Bank, the Federal Home Loan Bank of Atlanta (FHLB) and from lines of credit
approved at correspondent banks. As of December 31, 1999, the Company had
outstanding loan commitments and unused lines of credit of $24.2 million. Of
this total, management expects to fund approximately $8 million within one year.
During 1999, the $8.8 million decrease in federal funds sold and $8.8
million increase in deposits funded the $15.8 million increase in loans with the
remaining funds invested in investment securities. During 1998, the $1.6 million
or 3.3% decrease in investment securities and $7.4 million or 5.1% increase in
deposits funded the $2.0 million increase in loans with the remaining funds
placed into federal funds sold. Management knows of no trend or event which will
have a material impact on the Company's ability to maintain liquidity at
satisfactory levels.
9
MARKET RISK MANAGEMENT
Market risk is the risk of loss that arises from changes in interest
rates, foreign currency exchange prices, commodity prices, equity prices, and
other market changes that affect market sensitive financial instruments. The
market risk for the Company is composed primarily of interest rate risk, which
is the exposure of the Bank's earnings and capital arising from future interest
rate changes. This risk is a normal part of the banking business because assets
and liabilities do not reprice at the same rate, nor do they move to the same
degree as rates change. In addition, the maturity distribution of the Bank's
assets and liabilities do not match for given periods of time. The Bank's
interest rate sensitivity position is managed to maintain an appropriate balance
between the maturity and repricing characteristics of assets and liabilities
that is consistent with the Bank's liquidity, growth, earnings and capital
adequacy goals. The Board of Directors has adopted an Asset / Liability
Management Policy, which is administered by the Asset / Liability Committee. The
Committee is responsible for monitoring the Bank's interest rate sensitivity
position and recommending policies to limit exposure to interest rate risk while
maximizing net interest income.
One of the primary tools for monitoring interest rate sensitivity is
"Gap Analysis." This tool provides a general understanding of maturity and
repricing patterns of interest sensitive assets and liabilities. "Positive gap"
occurs when more assets reprice within a specific interval and "negative gap"
occurs when more liabilities reprice within a specific interval. The following
table summarizes the Company's interest sensitivity at December 31, 1999 based
on contractual maturity if fixed rate or earliest repricing date if variable
rate.
INTEREST RATE SENSITIVITY ANALYSIS
December 31, 1999
(ALL DOLLAR AMOUNTS IN THOUSANDS)
- -----------------------------------------------------------------------------------------------
AFTER 3 AFTER 1 NON-
MONTHS YEAR- INTEREST TOTAL
WITHIN WITHIN WITHIN AFTER SENSITIVE ALL
3 MONTHS 1 YEAR 5 YEARS 5 YEARS FUNDS CATEGORIES
- ------------------------------------------------------------------------------------------------
ASSETS
Loans $ 21,591 $ 11,654 $ 55,347 $37,291 $ (116) $125,767
Investment Securities 995 1,081 37,167 9,840 49,083
Investments in Equity Securities 839 1,015 1,854
Federal Funds Sold 971 971
Non-interest earning assets 13,473 13,473
-------- -------- -------- ------- -------- --------
TOTAL ASSETS 24,396 12,735 92,514 47,131 14,372 191,148
-------- -------- -------- ------- -------- --------
LIABILITIES
Time Certificates of
Deposit over $100,000 1,571 4,498 9,704 15,773
All Other Time Deposits 11,995 17,195 35,294 64,484
Savings and Money Market Deposits 38,342 38,342
Interest-bearing Transaction 21,989 21,989
Securities sold under
agreements to repurchase 590 590
Long term debt 5,000 5,000
Noninterest-bearing Liabilities 22,366 22,366
-------- -------- -------- ------- -------- --------
TOTAL LIABILITIES 74,487 26,693 44,998 0 22,366 $168,544
-------- -------- -------- ------- -------- --------
NET (ASSETS LESS LIABILITIES) $(50,091) $(13,958) $ 47,517 $47,131 $ (7,995)
======== ======== ======== ======= ========
Interest Sensitivity Gap
Asset Sensitive
(Liability Sensitive) $(50,091) $(64,049) $(16,532) $30,599 $ 22,604
======== ======== ======== ======= ========
Interest Sensitivity GAP /
Total Assets (26.21)% (33.51)% (8.65)% 16.01% 11.83%
======== ======== ======== ======= ========
10
The following assumptions were made in preparation of the "Interest
Rate Sensitivity Analysis":
Fixed rate loans are grouped in the appropriate category based on
scheduled amortization. Variable rate loans are classified based on the next
available repricing opportunity. Noninterest sensitive loans consists of the net
of non-accrual loans, allowance for credit losses and deferred fees and costs.
Taxable and nontaxable investment securities are categorized by final
maturity date or, if applicable, a definite call date.
Investment in equity securities within three months consists of a U.S.
Government securities mutual fund. Noninterest sensitive funds combines Federal
Reserve Bank and Federal Home Loan Bank of Atlanta stocks.
Time deposits with contractual maturities are categorized based on the
effective maturity of the deposit.
Savings, money market and interest-bearing transaction accounts are
assumed to be subject to repricing within a year, and generally within three
months of a rate change, based on the Company's historical experience.
The Bank uses earnings simulation modeling to measure the effect
specific rate changes would have on one year of net interest income. Key
assumptions include calls and maturities of investment securities, depositors'
rate sensitivity, maturity dates of fixed rate loans and investment securities
and repricing date of variable rate loans. As with any method of gauging risk,
there are inherent shortcomings and actual results may deviate significantly
from assumptions used in the model. Actual results will differ from simulated
results due to timing, magnitude and frequency of interest rate changes as well
as changes in market conditions and management strategies. At December 31, 1999,
the Bank's estimated earnings sensitivity profile reflected a modest sensitivity
to interest rate changes. Based on an assumed 100 basis point immediate change
in interest rates the Bank's net interest income would decrease by $259 thousand
if rates were to increase by that amount and would increase $174 thousand if
rates would decline a similar amount.
CAPITAL RESOURCES AND ADEQUACY
Total stockholders' equity increased $699 thousand or 3.2% in 1999 to
$22.6 million from $21.9 million at December 31, 1998. Earnings of $2.3 million
was the primary contributor to this increase. Stockholders' equity was reduced
$562 thousand for the change in accumulated other comprehensive income and $1.0
million for dividends paid.
Total stockholders' equity as of December 31, 1998 decreased $1.6
million or 6.8% compared to the prior year. Earnings of $2.2 million added to
stockholders' equity. The change in accumulated other comprehensive income
accounted for a $5 thousand reduction and dividends paid also decreased
stockholders' equity by $1.0 million. Dividends paid per share increased 5.1%
over the prior year without negatively impacting the Company's capital position.
A stock repurchase of $2.8 million accounted for the majority of the decrease.
On September 16, 1998, the Company repurchased 101,322 shares or approximately
5% of its outstanding common stock at $27.75 per share. The Board of Directors
and management believed it was in the best interest of the Company and its
shareholders to repurchase the stock considering the Company's high level of
capital and to lessen the dilutive effect of the stock-based employee and
incentive plans approved at the Company's 1998 Annual Meeting. The repurchase of
common shares also increased each remaining shareholder's relative percentage of
ownership in the Company.
One measure of capital adequacy is the leverage capital ratio which is
calculated by dividing average total assets for the most recent quarter into
Tier 1 capital, which for the Company subtracts goodwill from total
stockholders' equity. The regulatory minimum for this ratio is 4%. The leverage
capital ratio as of December 31, 1999 was 11.05% for the Company, and as of
December 31, 1998 was 11.08%.
Another measure of capital adequacy is the risk-based capital ratio or
the ratio of total capital to risk-adjusted assets. Total capital is composed of
both core capital (Tier 1) and supplemental capital (Tier 2) including
adjustments for off balance sheet items such as letters of credit and taking
into account the different degrees of risk among various assets. Federal banking
regulators require a minimum total risk-based capital ratio of 8%. As of
December 31, 1999, the Company's ratio was 19.78%. The Bank's ratio at December
31, 1998 was 21.05%. According to FDIC capital guidelines, the Bank is
considered to be "Well Capitalized."
Management knows of no other trend or event which will have a material
impact on capital. Please also refer to Note 15 in the Consolidated Financial
Statements for additional discussion of regulatory matters.
11
FUTURE TRENDS
This is a Year 2000 Readiness Disclosure under the Year 2000
Information and Readiness Disclosure Act of 1998.
The "Year 2000 Issue," which was applicable to most corporations,
including banks, is a general term used to describe the problems that may result
from the improper processing of dates and date-sensitive calculations for the
Year 2000 date rollover. This issue resulted from the fact that many of the
world's existing computer programs used only two digits to identify the year in
the date field of a program. These programs could experience serious
malfunctions when the last two digits of the year change to "00" as a result of
identifying a year designated "00" as the year 1900 rather than the Year 2000.
The Company completed contingency plans to provide operating
alternatives for continuation of services to the Company's customers for systems
that may not process information reliably and accurately after December 31,
1999. Management successfully managed the transition to the new century and
considers future problems unlikely. However, problems with noncompliant third
party vendors could appear. Therefore, management continues to monitor all
business processes to ensure they continue to operate properly.
The Company expensed approximately $40 thousand on Year 2000 costs in
1999. The total cost of the Year 2000 project was $86 thousand. Funding of the
Year 2000 project costs came from normal operating cash flow. Additional costs
including staff time will be expensed in the normal course of business and did
not have a material impact on the Company's results of operations, liquidity,
capital resources or financial condition. However, the expenses associated with
the Year 2000 issue directly reduced otherwise reported net income for the
Company. Costs expensed in 2000 to monitor systems and processes are expected to
be immaterial and will be funded from normal operating cash flow.
12
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13
AVERAGE BALANCES, YIELDS AND RATES
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1999 For the Year Ended December 31, 1998
- ---------------------------------------------------------------------------------------------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
- ---------------------------------------------------------------------------------------------------------------------
ASSETS
Federal funds sold $ 8,766,879 $ 438,631 5.00% $ 10,142,579 $ 565,449 5.58%
Investment securities:
U.S. Treasury securities and
obligations of U.S. government
agencies 39,178,072 2,333,863 5.96 33,866,198 2,104,154 6.21
Obligations of states and
political subdivisions(1) 9,573,990 660,390 6.90 10,479,431 739,527 7.06
All other investment securities 1,922,687 131,771 6.85 1,999,592 143,606 7.18
- ---------------------------------------------------------------------------------------------------------------------
Total investment securities 50,674,749 3,126,024 6.17 46,345,221 2,987,287 6.45
Loans, net of unearned income(2)(3)
Commercial loans 10,953,893 1,098,894 10.03 9,482,733 983,333 10.37
Installment loans 6,377,116 598,879 9.39 5,768,858 573,173 9.94
Mortgage loans 99,265,991 8,019,926 8.08 92,928,827 8,145,171 8.76
- ---------------------------------------------------------------------------------------------------------------------
Total loans 116,597,000 9,717,699 8.33 108,180,418 9,701,677 8.97
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST EARNING ASSETS 176,038,628 $ 13,282,354 7.55% 164,668,218 $13,254,413 8.05%