Sandy Spring Bancorp, Inc.
2004 Annual Report on
Form 10-K

FORM 10-K

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

For the Year Ended December 31, 2004
Commission File Number 0-19065

SANDY SPRING BANCORP, INC.

Registrant’s telephone number, including area code: 301-774-6400.
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
(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 þ NO o

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. o

Indicate by a check mark if the registrant is an accelerated filer. YES þ NO o

The registrant’s Common Stock is traded on the NASDAQ National Market under the symbol SASR. The aggregate market value of approximately 13,985,000 shares of Common Stock of the registrant issued and outstanding held by nonaffiliates on June 30, 2004, the last day of the registrant’s most recently completed second fiscal quarter, was approximately $486 million based on the closing sales price of $34.75 per share of the registrant’s Common Stock on that date. For purposes of this calculation, the term “affiliate” refers to all directors and executive officers of the registrant.

As of the close of business on February 8, 2005, approximately 14,637,000 shares of the registrant’s Common Stock were outstanding.

Documents Incorporated By Reference

Part III: Portions of the definitive proxy statement for the Annual Meeting of Shareholders to be held on April 20, 2005 (the “Proxy Statement”).

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SANDY SPRING BANCORP, INC.
Index

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SANDY SPRING BANCORP, INC.
Form 10-K Cross Reference Sheet of Material Incorporated by Reference

The following table shows the location in this Annual Report on Form 10-K or the accompanying Proxy Statement of the information required to be disclosed by the United States Securities and Exchange Commission (“SEC”) Form 10-K. Where indicated below, information has been incorporated by reference in this Report from the Proxy Statement that accompanies it. Other portions of the Proxy Statement are not included in this Report. This Report is not part of the Proxy Statement. References are to pages in this report unless otherwise indicated.

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Sandy Spring Bancorp, Inc.

Sandy Spring Bancorp, Inc. is the holding company for Sandy Spring Bank and its principal subsidiaries, Sandy Spring Insurance Corporation and The Equipment Leasing Company. Sandy Spring Bancorp is the third largest publicly traded banking company headquartered in Maryland. Sandy Spring is a community banking organization that focuses its lending and other services on businesses and consumers in the local market area. Independent and community-oriented, Sandy Spring Bank was founded in 1868 and offers a broad range of commercial banking, retail banking and trust services through 29 community offices and 44 ATMs located in Anne Arundel, Frederick, Howard, Montgomery, and Prince George’s counties in Maryland.

About This Report

This report comprises the entire 2004 Form 10-K, other than exhibits, as filed with the SEC. The 2004 annual report to shareholders, included in this report and the annual proxy materials for the 2005 annual meeting are being distributed together to the shareholders. Please see page 74 for information regarding how to obtain copies of exhibits and additional copies of the Form 10-K.

     This report is provided along with the annual proxy statement for convenience of use and to decrease costs, but is not part of the proxy materials.

The SEC has not approved or disapproved this Report or passed upon its accuracy or adequacy.

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Five Year Summary of Selected Financial Data

(1)	Total stockholders’ equity, net of goodwill and other intangible assets, divided by the number of shares of common stock outstanding at year end.
(2)	See the discussion of the efficiency ratio in the section of Management’s Discussion and Analysis of Financial Condition and Results of Operations entitled “Operating Expense Performance.”

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Securities Listing, Prices and Dividends

Stock Listing

Common shares of Sandy Spring Bancorp, Inc. are traded on the National Association of Security Dealers (NASDAQ) National Market under the symbol SASR.

Transfer Agent and Registrar

American Stock Transfer and Trust Company
59 Maiden Lane
New York, New York 10038

Recent Stock Prices and Dividends

Shareholders received quarterly cash dividends totaling $11,332,000 in 2004 and $10,725,000 in 2003. Regular dividends have been declared for one hundred and four consecutive years. Sandy Spring Bancorp, Inc. (the “Company”) has increased its dividends per share each year for the past twenty-four years. Since 1999, dividends per share have risen at a compound annual growth rate of 9%. The increase in dividends per share was 5% in 2004.

The ratio of dividends per share to diluted net income per share was 80% in 2004, compared to 34% for 2003. The dividend amount is established by the Board of Directors each quarter. In making its decision on dividends, the Board considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns and other factors.

Shares issued under the employee stock purchase plan, which commenced on July 1, 2001, totaled 18,896 in 2004 and 16,801 in 2003, while issuances pursuant to the stock option plan were 161,133 and 49,923 in the respective years. Shares issued under the director stock purchase plan, which commenced on May 1, 2004 totaled 1,120 shares.

The Company has a stock repurchase program that permits the repurchase of up to 5% (approximately 727,000 shares) of its outstanding common stock. Repurchases are made in connection with shares expected to be issued under the Company’s stock option and benefit plans, as well as for other corporate purposes. A total of 1,106,120 shares have been repurchased since 1997, when stock repurchases began, through December 31, 2004 under the stock repurchase program. There were 45,150 shares repurchased in 2004 and 105,460 shares repurchased in 2003 under the stock repurchase program and 3,101 shares repurchased in 2004 under the employee stock option plan.

The following table provides information on the Company’s purchases of its common stock during the three months ended December 31, 2004.

Issuer Purchases of Equity Securities⁽¹⁾

(1)	Includes purchases of the Company’s stock made by, or on behalf of, the Company or any affiliated purchasers of the Company as defined in Securities and Exchange Commission Rule 10b-18.
(2)	On March 26, 2003, the Company publicly announced a stock repurchase program that permits the repurchase of up to 5%, or 726,804 shares, of its outstanding common stock. The current program replaced a similar plan that expired on March 31, 2003. Repurchases under the program may be made on the open market and in privately negotiated transactions from time to time until March 31, 2005, or earlier termination of the program by the Board. The repurchases are made in connection with shares expected to be issued under the Company’s stock option and benefit plans, as well as for other corporate purposes. All of the shares purchased in December 2004 were acquired in a private transaction at the then current market price.
(3)	Indicates the number of shares remaining under the plan at the end of the indicated month.

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The number of common shareholders of record was approximately 2,300 as of February 8, 2005.

Quarterly Stock Information

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

Overview

Sandy Spring Bancorp, Inc. and subsidiaries’ (the “Company”) net income for the year ended December 31, 2004, totaled $14.4 million ($0.98 per diluted share), as compared to $32.1 million ($2.18 per diluted share) for the prior year, a decrease of 55%. These results reflect the following events:

	n	Prepayment penalties related to the payoff of $195 million in advances from the Federal Home Loan Bank (the “FHLB”) and the concurrent sale of the same amount of securities which together resulted in an $11.1 million ($0.76 per diluted share) after-tax expense. This balance sheet repositioning is intended to improve the company’s net interest margin and interest rate risk position. The Company is increasing its emphasis on producing consistent earnings results from its core loan, deposit and non-interest income businesses, without significant non-core leverage programs.
	n	An after-tax charge of $0.8 million ($0.05 per diluted share) related to the write-down of goodwill associated with the Company’s investment in its leasing subsidiary, The Equipment Leasing Company.

A number of positive trends became evident as 2004 drew to a close. Loan balances grew 25% over the prior year with solid growth in all major categories of loans, while deposits grew 11% over 2003. Both reflect the Company’s emphasis on the basic fundamentals of relationship banking under the Company’s “The Difference” initiative. As in prior years, the Company’s asset quality remained strong with no provision for credit losses in either 2004 or 2003.

Net interest income declined slightly by $413,000, or 1%, due primarily to a decline in the net interest margin to 3.69% for the year 2004 from 3.80% for the year 2003. The decline in margin was largely offset by the growth in loans mentioned above. Noninterest income decreased 9% to $30.8 million compared to the prior year. This decline was due primarily to decreases of 43% in mortgage banking revenues and 7% in service charges on deposits as well as the recognition of a one-time gain of $1,100,000 on the early termination of a sublease in 2003. These decreases were mitigated by increases of 13% in income from trust operations, 11% in insurance agency revenues and 12% in fees from sales of investment products. Expressed as a percentage of net interest income and noninterest income, noninterest income increased to 29% from 19% five years ago. Noninterest expenses increased 38% over the prior year primarily due to the prepayment of the FHLB advances and the write-down of the goodwill associated with the Company’s leasing subsidiary as discussed above. Excluding these transactions, noninterest expenses increased 9% over 2003.

Comparing December 31, 2004 balances to December 31, 2003, total assets remained virtually the same at $2.3 billion. Total deposits increased 11% to $1.73 billion, while total loans and leases grew to $1.45 billion from $1.15 billion, a 25% increase. During the same period, stockholders’ equity increased to $195.0 million or 8% of total assets.

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Asset quality, as measured by the following ratios, continued to be favorable. Non-performing assets represented 0.08% of total assets at year-end 2004, versus 0.13% at year-end 2003. The ratio of net charge-offs to average loans and leases was 0.02% in 2004, as compared to 0.01% for the prior year.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements may reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation allowance to be established, or when an asset or liability must be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility.

The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.

The allowance for loan and lease losses is an estimate of the losses that may be sustained in the loan and lease portfolio. The allowance is based on two basic principles of accounting: (1) Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and estimable, and (2) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the loan’s or lease’s contractual terms.

Management believes that the allowance is adequate. However, its determination requires significant judgment, and estimates of probable losses in the credit portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future additions to the allowance may be necessary based on changes in the credits comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Company, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgments of information available at the time of each examination.

The Company’s allowance for loan and lease losses has two basic components: the formula allowance reflecting historical losses by credit category as adjusted by several factors whose effects are not reflected in historical loss ratios, and specific allowances. Each of these components, and the systematic allowance methodology used to establish them, are described in detail in Note 1 of the Notes to the Consolidated Financial Statements. The amount of the allowance is reviewed monthly by the Senior Loan Committee, and reviewed and approved quarterly by the Audit Committee and Board of Directors.

The portion of the allowance that is based upon historical loss factors, as adjusted, establishes allowances for the major loan categories based upon adjusted historical loss experience over the prior eight quarters, weighted so that losses realized in the most recent quarters have the greatest effect. The use of these historical loss factors is intended to reduce the differences between estimated losses inherent in the loan and lease portfolio and observed losses. The factors used to adjust the historical loss ratios address changes in the risk characteristics of the Company’s loan and lease portfolio that are related to (1) trends in delinquencies and other non-performing loans (2) changes in the risk level of the loan portfolio related to large loans (3) changes in the categories of loans comprising the loan portfolio (4) concentrations of loans to specific industry segments (5) changes in economic conditions on both a local and national level (6) changes in the Company’s credit administration and loan and lease portfolio management processes, and (7) quality of the Company’s credit risk identification processes. This component comprised 82% of the total allowance at December 31, 2004.

The specific allowance is used primarily to establish allowances for risk-rated credits on an individual or portfolio basis, and accounted for 18% of the total allowance at December 31, 2004. The Company has historically had favorable credit quality. The actual occurrence and severity of losses involving risk-rated credits can differ substantially from estimates, and some risk-rated credits may not be identified. A 10% increase or decrease in risk-rated credits without specific allowances would have resulted in a corresponding increase or decrease of approximately $162,000 in the recommended allowance computed by the allowance methodology at December 31, 2004.

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Table 1—Consolidated Average Balances, Yields and Rates⁽¹⁾

(Dollars in thousands and tax equivalent)