[SHORE BANCSHARES, INC. LETTERHEAD]
Via Edgar
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Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
RE: Shore Bancshares, Inc. Form 10-K/A
File Number 000-22345
Ladies and Gentlemen:
On March 31, 1999, Shore Bancshares, Inc. (the "Company") filed its Annual
Report on Form 10-K. Due to an error in the Edgar transmission beyond the
Company's control, portions of the Company's Exhibit 13 to the Form 10-K, the
1998 Annual Report, were inadvertently deleted. Attached please find a Form
10-K/A, which is revised solely to include a complete and correct version of
Exhibit 13. Please be advised that the remainder of the Form 10-K remains
unchanged.
If you have any questions regarding this filing, please do not hesitate to
call.
Very truly yours,
/s/ Carol I. Brownawell
Carol I. Brownawell
Treasurer
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
FOR ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
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 February 22, 1999 was $60,727,755, based on the sales price
as of that date.
As of February 22, 1999, Shore Bancshares, Inc. had 1,913,516 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, 1998 (the "Annual Report".)
Part III: Portions of the definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on April 20, 1999 (the
"Proxy Statement".)
1
[SHORE BANCSHARES, INC. LOGO HERE]
1998
Annual Report
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SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
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For the Year 1998 1997 1996 1995 1994
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<S><C>
Net interest income $ 7,087,069 $ 6,957,167 $ 6,265,431 $ 6,012,491 $ 6,097,626
Provision for credit losses -- -- -- -- 274,000
Net interest income after provision for credit losses 7,087,069 6,957,167 6,265,431 6,012,491 5,823,626
Non-interest income 872,645 909,049 999,423 877,386 856,585
Net income 2,218,939 2,370,198 2,307,742 2,138,500 2,030,864
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Per Share Data:*
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Diluted net income $ 1.12 $ 1.18 $ 1.14 $ 1.06 $ 1.01
Cash dividends declared 0.51 0.485 0.46 0.43 0.30
Book value 11.45 11.67 10.97 10.35 9.59
Weighted average common shares 1,985,142 2,014,848 2,014,848 2,014,848 2,014,848
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At Year End
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Total Assets $181,054,572 $175,115,011 $146,899,477 $138,100,669 $144,942,996
Loans, net of unearned income 111,196,511 109,167,283 88,892,757 87,049,483 79,329,222
Allowance for credit losses 1,348,805 1,403,747 1,503,268 1,478,555 1,481,501
Investment securities 47,118,489 48,742,568 43,652,747 37,131,443 53,209,881
Deposits 153,307,567 145,813,270 124,166,248 116,479,753 124,984,593
Long-term debt 5,000,000 5,000,000 -- -- -
Stockholders' equity 21,904,235 23,514,810 22,095,951 20,849,348 19,332,344
Allowance for credit losses to non-performing loans 164.59% 311.94% 102.82% 83.72% 77.44%
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Average Balances
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Total assets $176,964,561 $165,695,678 $141,410,379 $139,313,160 $143,919,722
Total deposits and borrowings 152,715,842 141,504,846 118,945,631 118,224,470 124,027,077
Stockholders' equity 23,314,674 22,789,823 21,626,308 20,318,612 19,027,257
Return on average total assets 1.25% 1.43% 1.63% 1.54% 1.41%
Return on average stockholders' equity 9.52% 10.40% 10.67% 10.52% 10.67%
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</TABLE>
* Per share data is restated to reflect the 2 for 1 stock split effected in the
form of a 100% stock dividend on May 20, 1994, the July 1, 1996 2 for 1 stock
split effected upon 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 and accounted as a purchase transaction.
1
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CONTENTS
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Letter to Stockholders 4
Management's Discussion and Analysis of
Financial Condition and Results of Operations 5-15
Consolidated Financial Statements 16-37
Independent Auditors' Report 38
Market Price of and Dividends on
Registrant's Common Equity and Related
Stockholder Matters 39
Average Balances, Yields, and Rates 40
Rate and Volume Variance Analysis 41
Board of Directors 42
Officers 43
Employees and Offices 44
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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 our most recent
addition in 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.
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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, 1998.
The year just past presented us with many challenges and opportunities.
Renovations on The Centreville National Bank's Commerce Street offices are
essentially complete. Interest rates declined during the year, resulting in the
refinancing of many loans, calls being exercised on many investment securities,
and reduced interest rate spread. This was the first full year amortizing the
goodwill associated with the purchase of Kent Savings and the decision was made
to close our subsidiary Eastern Shore Mortgage Corporation as a result of
continuing operating losses. Our team working on the Year 2000 issue has
continued to prepare our systems and procedures to minimize the impact on our
ability to provide the level of service that you have come to expect. We are
confident that we will be ready and that we will move smoothly from 1999 into
the year 2000.
As a result of the reduced interest rate spread, net income after taxes
declined slightly to $2.2 million in 1998, a decrease of 6.4%. Total assets grew
by $5.9 million to a new high of $181.0 million as of December 31, 1998. Your
Board of Directors declared cash dividends totaling $0.51 per share, an increase
of 5.1% over 1997. Our capital position continues to be strong and exceeds
regulatory guidelines to be considered well capitalized.
We look forward to another year of progress in 1999. Plans are underway
to grow our branch network. We have made application to the Office of the
Comptroller of the Currency for a new office to be located on Route 404 east of
Denton, Maryland and we are actively seeking sites for other branches. In
addition, we have recently entered into an agreement with PHH Mortgage
Corporation, through our Independent Bankers Association membership which will
enable us to continue to offer secondary mortgage market products, such as 30
year fixed rate mortgage loans, and generate fee income from their origination.
We also continue to examine the list of services and products offered in our
communities and to assess the need to expand our products. We recently
introduced an unsecured line of credit, Direct Line, and we now offer Checking
with no activity service charges for our depositors who use Direct Deposit for
their payroll or other payments due to them.
Our commitment to the communities we serve is our strength. The loyalty
and dedication of our stockholders and customers is our gift. You have our
pledge that we will never forget either. Thank you for your support. Please help
us improve by offering your comments and suggestions.
/s/ B. Vance Carmean, Jr. /s/ Daniel T. Cannon
_________________________ ____________________
B. Vance Carmean, Jr. Daniel T. Cannon
Chairman of the Board President
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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, liquidity levels, and the Year 2000 issue, 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.
RESULTS OF OPERATIONS OVERVIEW
The Company reported $2.22 million in net income for 1998 or $1.12
diluted earnings per share compared to 1997 net income of $2.37 million or $1.18
diluted earnings per share and 1996 net income of $2.31 million or $1.14 per
share diluted earnings. Per share items have been adjusted to reflect the 2 for
1 stock split paid in the form of a 100% stock dividend on March 31, 1998. Net
income for 1998 reflects a slight decline after absorbing the added depreciation
expense for the renovations at our Commerce Street office, a full year of
goodwill amortization from the Kent Savings and Loan Association, F.A. (Kent
Savings) purchase and the operating losses and write off of the remaining
goodwill of Eastern Shore Mortgage Corporation. Declining interest rates
resulted in the refinancing of many loans as well as the calls of investments
securities, negatively impacting net income. The Company experienced growth in
total assets of 3.39% and in total deposits of 5.14% in 1998. Return on average
assets was 1.25%, 1.43%, and 1.63% in 1998, 1997, and 1996, 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 1998 was 9.52% compared to 10.40% and 10.67% in
1997 and 1996, 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. For the Company, the year ended December 31, 1998 was characterized
by generally declining interest rates. During the prior year, 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. Net interest income for
1996 reflects increasing loan rates and generally declining deposit rates until
the second half of the year when deposit rates increased slightly. Net interest
income (on a tax equivalent basis) for 1998 increased by $159 thousand or 2.2%
compared to the year ended December 31, 1997, while 1997 increased by $688
thousand or 10.6% from the previous year ended December 31, 1996. During the
three years ended December 31, 1998, 1997 and 1996 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 40 sets forth the major
components
5
<PAGE>
of net interest income, on a tax equivalent basis, for 1998, 1997 and 1996. The
table titled "Rate and Volume Variance Analysis" on page 41 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.
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, 1998, 1997 and 1996 was 3.65%, 3.82%, and 3.87%, respectively.
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 of 12
basis points and an increase in the yield on average interest bearing
liabilities of 5 basis points. The 4.3% increase in total average loans 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. A change in the
balance sheet mix also accounted for a decrease in interest rate spread. 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. 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. The composition
of deposits changed as well. Other Time and IRA deposit average balances have
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.
The 1997 interest rate spread decreased compared to 1996 by 5 basis
points. The rate spread variance reflects a decrease in yield on earning assets
of 2 basis points as a result of a lower yielding loan portfolio and growth in
the investment securities portfolio, a lower yielding asset when compared to
loans. The yield on the loan portfolio was impacted by the introduction of the
Kent Savings loans which had yields slightly less than the loans originated by
the Company prior to the acquisition. The yield on Federal funds and securities
portfolio actually increased over 1996 by 13 basis points and 7 basis points,
respectively. Interest-bearing liabilities' yield increased 3 basis points over
1996, reflecting the higher cost of the $5 million Federal Home Loan Bank of
Atlanta (FHLB) long term borrowing and IRA deposits. Other deposit accounts
actually reflected a reduced yield compared to the previous 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 net interest margin for 1998 decreased to 4.45% from 4.64%
the previous year. This change is the result of repricing as previously
discussed and is illustrated in the table titled "Rate/Volume Variance Analysis"
on page 41. 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 rate of 6.6%
while net interest income increased at a rate of 2.2% which resulted in a
decline in net interest margin. Loan growth, specifically commercial mortgages,
adjustable rate mortgage loans and home equity loans accounted for the volume
increases. For 1997, the net interest margin decreased to 4.64% from 4.85% in
1996. This decrease is the result of earning assets growing 15.5% while net
interest income grew at a rate of 10.6%. Comparing 1997 and 1996 shows that
changes in rates increased net interest margin $6 thousand, while changes in
volume provided $682 thousand for a net increase of $688 thousand. Volume
increases accounted for the growth in net interest income and is attributed to
the Kent Savings merger. Excluding the $20.3 million in total loans from Kent
Savings, loan growth was flat. The majority of the $6.3 million growth in
average investment securities is attributed, primarily, to the purchase of bonds
to leverage the FHLB borrowing.
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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, 1998, the Bank recorded net charge offs
of $55 thousand compared to net charge offs of $115 thousand in 1997 and net
recoveries of $25 thousand in 1996. Internal loan review, in particular, is
effective in identifying problem credits and in achieving timely recognition of
potential and actual losses within the loan portfolio. Improved overall credit
quality and increased collection efforts have also contributed to the relatively
small amount of net charge offs in 1998 and 1997 and net recoveries in 1996.
Gross charge offs amounted to $104 thousand, $158 thousand and $78
thousand in 1998, 1997, and 1996, 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 $49 thousand in 1998, $44
thousand in 1997, and $103 thousand in 1996.
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 1998, 1997, or 1996. $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, the Year
2000 issue, 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 $1.3 million as of December 31, 1998 amounted to 1.21% of the
outstanding loan portfolio. The allowance for credit losses of $1.4 million as
of December 31, 1997 represented 1.29% 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 remained relatively unchanged, however, 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, 1998.
See Note 4 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. 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 $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 income decreased $90 thousand or 9.0% in 1997 compared to
the year ended December 31, 1996. However, excluding the securities gains,
noninterest income actually increased $105 thousand or 13.2%. Increased service
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charges from a rise in the number of checks drawn against insufficient funds
accounted for $46 thousand of the increase. Increase in value of life insurance
of $31 thousand and $47 thousand increase in earnings from unconsolidated
subsidiaries also contributed to the improvement in non-interest income.
NONINTEREST EXPENSES
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. This
trend which began in 1997 continues in 1998 when a full year of depreciation
expense was recorded for the Commerce Street renovation. The Company began the
Commerce Street renovation in January 1997, and anticipates completion of this
office 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 in
1999 with the addition of two new branch locations; one in Denton, Maryland
(Caroline County) and the other in Chester, Maryland, (Queen Anne County.)
Increases were noted in marketing. The Company has adopted a full scale
marketing program including direct mail, cable television commercials and
product promotion. Marketing plays a significant role in banking today, more so
than in the past. As the banking industry continues to consolidate, both banking
and non-banking companies are competing much more aggressively. Direct
competition for deposits comes from other commercial banks, savings banks,
savings and loan associations, and credit unions as well as brokerage houses,
mutual funds and the securities market. The Bank also competes with the same
banking entities for loans, as well as with mortgage banking companies and
institutional lenders. 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.
The year ended December 31, 1997 reflected a $583 thousand increase or
15.4% when compared to 1996. A significant portion, or $248 thousand, of the
increase is related to employee salaries and benefits. The number of full time
equivalent employees increased by 4 when comparing the year ended December 31,
1997 to the same period in 1996, primarily the result of additional staff
positions as well as a branch manager position with the addition of the Kent
Branch. Salaries and benefits also include cost of living increases and benefit
cost increases.
FDIC insurance premiums increased in 1997 with the inclusion of Savings
Association Insurance Fund (SAIF) deposits from Kent Savings. Premises and fixed
assets expenses continued to increase. Facility improvements and equipment
upgrades resulted in increased depreciation expense, maintenance costs and
equipment service contracts.
INCOME TAXES
For 1998, the effective tax rate for the Company increased slightly to
32.7% compared to 32.3% for 1997 and 33.7% for 1996. The reduction in 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 12 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.
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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.
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, 1998 the Company had 49% of the portfolio designated as available for sale
and 51% held to maturity compared to 19% and 81% as of December 31, 1997. 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 $47.1 million and $48.7 million
as of December 31, 1998 and 1997, respectively. The slightly lower level of
investments in securities resulted primarily from the investments called at a
rate faster than they were replaced. 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 3 to the Consolidated Financial Statements provides detail by type and
contractual maturity for the years ended December 31, 1998 and 1997.
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 4 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.
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, 1998.
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
9
<PAGE>
prospects of future contractual payments are no longer in doubt. At December 31,
1998 and 1997, $55 thousand and $199 thousand, respectively, of non-accrual
loans were secured by collateral with an estimated value of $343 thousand of
December 31, 1998 and $1.1 million as of December 31, 1997.
DEPOSITS
Deposit liabilities grew $7.5 million or 5.1% to $153.3 million
compared to $145.8 million in 1997. Average deposits increased at a rate of
5.3%. The table below presents the average balance of deposits and percentage of
each category to total average deposits. The average balance of other time
deposits grew 12.9% and the average balance of noninterest bearing demand
deposits grew 18.6% compared to the year ended December 31, 1997. This is the
result of the introduction of new products and 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
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------------------------------------------
<S><C>
Interest-bearing liabilities
Super NOW accounts $ 18,433 12.48% $ 17,215 12.28%
Money market deposit accounts 18,886 12.79 21,028 15.00
Time, $100,000 or more 12,698 8.60 13,298 9.49
Other time deposits 46,305 31.35 41,023 29.27
IRA deposits 15,430 10.45 14,733 10.51
Savings deposits 17,819 12.06 16,636 11.87
Demand deposits 18,144 12.27 16,216 11.58
- ------------------------------------------------------------------------------------------------------
$147,715 100.00% $140,149 100.00%
- ------------------------------------------------------------------------------------------------------
</TABLE>
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 3 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, not currently in use, 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, 1997
the Company had outstanding loan commitments and unused lines of credit of $17.4
million. Of this total, management expects to fund $6 million within one year.
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. Loan growth of
$19.9 million or 22.4% and deposit growth of $21.6 million or 17.4% in 1997
resulted primarily from the Kent Savings merger. Investment security growth was
funded by the long-term borrowing from the Federal Home Loan Bank of Atlanta.
Management knows of no trend or event which will have a material impact on the
Company's ability to maintain liquidity at satisfactory levels.
10
<PAGE>
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, 1998 based
on contractual maturity if fixed rate or earliest repricing date if variable
rate.
INTEREST RATE SENSITIVITY ANALYSIS
December 31, 1998
(ALL DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
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
- -----------------------------------------------------------------------------------------------------------------------
<S><C>
ASSETS
Loans $19,786 $11,554 $41,126 $38,455 ($ 1,073) $109,848
Investment Securities 2,068 1,360 28,190 13,539 45,157
Investments in Equity Securities 893 1,068 1,961
Federal Funds Sold 9,752 9,752
Non-interest earning assets 14,336 14,336
----------- --------- --------- -------- --------- ----------
TOTAL ASSETS 32,499 12,914 69,316 51,994 14,331 181,054
----------- --------- --------- -------- --------- ----------
LIABILITIES
Time Certificates of Deposit over $100,000 1,192 5,649 8,516 15,357
All Other Time Deposits 11,714 16,507 34,167 62,388
Savings and Money Market Deposits 35,322 35,322
Interest-bearing Transaction 20,467 20,467
Other borrowed funds 5,000 5,000
Noninterest-bearing Liabilities 20,616 20,616
----------- --------- --------- -------- --------- ----------
TOTAL LIABILITIES 68,695 27,156 42,683 0 20,616 $159,150
----------- --------- --------- -------- --------- ----------
NET(ASSETS LESS LIABILITIES) ($36,196) ($14,242) $26,633 $51,994 ($ 6,285)
=========== ========= ========= ======== =========
Interest Sensitivity Gap
Asset Sensitive (Liability Sensitive) ($36,196) ($50,438) ($23,805) $28,189 $21,904
=========== ========= ========= ======== =========
Interest Sensitivity GAP /
Total Assets -19.99% -27.86% -13.15% 15.57% 12.10%
=========== ========= ========= ======== =========
</TABLE>
11
<PAGE>
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 nonaccrual 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, 1998
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 $64 thousand
if rates were to increase by that amount and would increase $70 thousand if
rates would decline a similar amount.
CAPITAL RESOURCES AND ADEQUACY
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 believe it was in the best interest of the Company and its
shareholders to have repurchased 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 increases each remaining shareholder's relative percentage of
ownership in the Company.
Total stockholders' equity increased $1.4 million or 6.4% in 1997 to
$23.5 million from $22.1 million at December 31, 1996. Earnings of $2.4 million
was the primary contributor to this increase. The change in accumulated other
comprehensive income accounted for a $26 thousand improvement and dividends paid
reduced stockholders' equity $977 thousand.
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, 1998 was 11.08% for the Company, and as of
December 31, 1997 was 12.23%.
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.
12
<PAGE>
Federal banking regulators require a minimum total risk based capital ratio of
8%. As of December 31, 1998, the Company's ratio was 21.05%. The Bank's ratio at
December 31, 1997 was 23.61%. According to FDIC capital guidelines, the Bank is
considered to be "Well Capitalized."
On December 5, 1996 the Company entered into an agreement to acquire
Kent Savings and Loan Association, F.A.(Kent Savings) of Chestertown, Maryland.
The effective date of the merger was April 1, 1997 and was accounted for as a
purchase transaction. Under the terms of the agreement, the Company paid
approximately $5.1 million for all of the outstanding shares of Kent Savings. As
of March 31, 1997, total assets of Kent Savings were approximately $24.0 million
and total stockholders' equity was approximately $2.9 million.
Management knows of no other trend or event which will have a material
impact on capital. Please also refer to Note 16 in the Consolidated Financial
Statements for additional discussion of regulatory matters.
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 is common 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 as the Year 2000
approaches. This issue is caused by the fact that many of the world's existing
computer programs use 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 formed a Year 2000 Committee, which is comprised of a
cross-section of the Company's employees, in the fourth quarter of 1997. This
Committee is leading the Company's Year 2000 efforts to ensure that the Company
is properly prepared for the Year 2000. The Company's Board of Directors has
approved a plan submitted by the Year 2000 Committee that was developed in
accordance with guidelines set forth by the Federal Financial Institutions
Examination Council. This plan has five primary phases related to internal Year
2000 compliance:
1. Awareness -- this phase is ongoing and is designed to inform the
Company's Board of Directors (the "Board") and Executive management
("Management"), employees, customers and vendors of the impact of the Year 2000
Issue. Since January 1998, the Board has been apprised of the Company's efforts
at their regular meetings. In addition, customers and the community continue to
be updated with respect to the Company's Year 2000 efforts through mailings,
published articles, lobby brochures and a Year 2000 Readiness Disclosure posted
in the branch lobbies. A public seminar was presented in April 1998. The
Company's ongoing outreach efforts include Year 2000 presentations to business
organizations and community groups.
2. Assessment -- during this phase an inventory was conducted of all
known Company processes that could reasonably be expected to be impacted by the
Year 2000 Issue and their related vendors, if applicable. The identification
process included information technology and communication systems such as
personal computers, local area networks and servers, ATM modems, printers, copy
machines, facsimile machines, telephones and the operating systems and software
for these systems. It also included non-information technology systems, such as
heating, air conditioning and vault controls, alarm systems, surveillance
systems, and postage meters. The Company inventoried all the systems listed
above in the second and third quarters of 1998 and performed an initial
assessment of potential risks from either under or nonperformance arising from
incorrect processing and usage of dates after December 31, 1999. All outside
servicers and major vendors were contacted to ascertain their individual levels
of Year 2000 compliance. From vendor responses and/or certifications of Year
2000 compliance the Company determined that all vendors and service providers
who provide mission critical and significant systems to the Company are
addressing Year 2000 compliance for the products and services they provide to
the Company and the Company expects all of the mission critical and significant
vendors to be Year 2000 compliant by December 31, 1999. The assessment phase is
complete, although it is updated periodically as necessary.
13
<PAGE>
3. Renovation and/or replacement -- this phase includes programming
code enhancements, hardware and software upgrades, system replacements, vendor
certification and any other changes necessary to make any hardware, software and
other equipment Year 2000 compliant.
The Company does not perform in-house programming, and thus is
dependent on external vendors to ensure and modify, if needed, the hardware,
software or other services they provide to the Company for Year 2000 compliance.
The Company's primary service provider has a comprehensive Year 2000 Plan in
place and has successfully completed Year 2000 testing of their mission critical
systems.
4. Testing -- The next phase for the Company under the plan is to
complete a comprehensive testing of all known processes. As noted in the
renovation and/or replacement phase above, the Company's primary service
provider has already successfully tested their system for Year 2000 compliance.
The next step, which is scheduled for the first and second quarters of fiscal
1999, is to complete testing of the Company's network mission critical software
applications and hardware. The Company has performed Year 2000 testing of all
employee computer work stations, and is in the process of updating or replacing
work stations which are not Year 2000 compliant. The testing of the remainder of
the Company's processes is expected to be substantially complete by June 1999.
5. Implementation -- this phase will occur when Year 2000 processing
commences. On some applications the Company is already entering dates greater
than December 31, 1999 into their systems. In these situations no adverse events
have been noted. The significant part of the implementation phase will occur
after December 31,1999.
The Company is in the process of developing contingency plans for
processes that do not process information reliably and accurately after December
31, 1999. The contingency plans for all systems should be substantially complete
by the end of the second calendar quarter of fiscal 1999.
Senior management completed a contingency plan to provide operating
alternatives for continuation of services to the Company's customers in the
event of systems or communication failures at the beginning of the Year 2000.
Contingency plans will be updated as necessary. Based on preliminary planning
during development of the contingency plan, management expects that the Company
will be able to continue to operate in the Year 2000 even if some systems fail.
At the end of December 1999, the Company will generate paper and systems backup
of all customer and general ledger accounts. Due to the size of the Company, the
Company expects that it will be able to operate with all transactions processed
manually until normal operations can be restored. This procedure could require
changing of schedules and hiring of temporary staff, which would increase cost
of operations. If this procedure were to continue for any extended period of
time, or if the Company ultimately had to change data service providers, the
cost could be material.
The Company is in the process of assessing the Year 2000 readiness of
significant borrowers and depositors. The Company has completed its initial
review of these significant relationships and assessed the risks these
relationships may pose to the Company. The Company will continue to monitor the
risk and expects any potential losses to the Company caused by Year 2000
problems of significant borrowers and depositors not to be material. This step
is not expected to require a significant amount of time or resources.
As of December 31, 1998 the following chart shows the current and
projected status of the Company's Year 2000 compliance efforts:
Phase 9/30/98 12/31/98 3/31/99 6/30/99
------------------------------------------------------------------
Awareness 100% 100% 100% 100%
Assessment 98 98 100 100
Renovation 89 96 100 100
Validation 58 78 85 100
Implementation 54 67 80 100
14
<PAGE>
The Company expensed approximately $47 thousand on Year 2000 costs in
1998. Based on an analysis of projected expenses performed during the first
quarter of 1998 and subsequent updates, the total cost of the Year 2000 project
is currently estimated at $110 thousand. Funding of the Year 2000 project costs
has come and is expected to come from normal operating cash flow. Additional
costs including staff time will be expensed in the normal course of business and
will 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 will directly reduce otherwise reported net
income for the Company. Should the Company have to resort to alternative
operating procedures due to major systems or communications failures at the
beginning of the Year 2000, the extra cost could be material.
Management of the Company believes that the potential effects on the
Company's internal operations of the Year 2000 Issue can and will be addressed
prior to the Year 2000. However, if required modifications or conversions are
not made or are not completed on a timely basis prior to the Year 2000, the Year
2000 Issue could disrupt normal business operations. The most reasonably likely
worst case Year 2000 scenarios foreseeable at this time would include the
Company temporarily not being able to process, in some combination, various
types of customer transactions. This could affect the ability of the Company to,
among other things, originate new loans, post loan payments, accept deposits or
allow immediate withdrawals, and, depending on the amount of time such a
scenario lasted, could have a material adverse effect on the Company.
Because of the serious implications of these scenarios, the primary
emphasis of the Company's Year 2000 efforts is to correct, with complete
replacement if necessary, any systems or processes whose Year 2000 test results
are not satisfactory prior to the Year 2000. Nevertheless, should one of the
most reasonably likely worst case scenarios occur in the Year 2000, the Company,
as noted above, is in the process of formalizing a contingency plan that would
allow for limited transactions until the Year 2000 problems are fixed.
The costs of the Year 2000 project and the date on which the Company
plans to complete Year 2000 compliance are based on management's best estimates,
which were derived using numerous assumptions of future events such as the
availability of certain resources (including internal and external resources),
third party vendor plans and other factors. However, there can be no guarantee
that these estimates will be achieved at the cost disclosed or within the
timeframe indicated, and actual results could differ materially from these
plans. Factors that might affect the timely and efficient completion of the
Company's Year 2000 project include, but are not limited to, vendor's ability to
adequately correct or convert software and the effect on the Company's ability
to test its systems, the availability and cost of personnel trained in the Year
2000 area, the ability to identify and correct all relevant computer programs
and similar uncertainties.
Bank regulatory agencies have recently issued additional guidance under
which they are assessing Year 2000 readiness. The failure of a financial
institution to take appropriate action to address deficiencies in the Year 2000
project management process may result in enforcement actions which could have a
material adverse effect on such institution, result in the imposition of civil
money penalties or result in the delay (or receipt of an unfavorable or critical
evaluation of management of a financial institution in connection with
regulatory review) of applications seeking to acquire other entities or
otherwise expand the institution's activities.
Ultimately, the success of the Company's efforts to address the Year
2000 issue depends to a large extent not only on the corrective measures that
the Company undertakes, but also on the efforts undertaken by businesses and
other independent entities who provide data to, or receive data from, the
Company such as borrowers, vendors or customers. In particular, the Company's
credit risk associated with its borrowers may increase as a result of problems
such borrowers may have resolving their own Year 2000 issues. Although it is not
possible to evaluate the magnitude of any potential increased credit risk at
this time, the impact of the Year 2000 issue on borrowers could result in
increases in problem loans and credit losses in future years. From now until
2000, the Company will endeavor to monitor the Year 2000 efforts of its
borrowers and will implement a course of action and procedures designed to
reduce any increased potential risk as a result of Year 2000 issues.
15
<PAGE>
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
1998 1997
- ----------------------------------------------------------------------------------------------------------------------------
<S><C>
ASSETS
Cash and due from banks $ 4,536,510 $ 5,091,798
Federal funds sold 9,752,503 3,503,900
Investment securities available for sale, at fair value 23,202,856 9,444,463
Investment securities held to maturity, fair value of $24,253,286 (1998) and
$39,498,436 (1997) 23,915,633 39,298,105
Loans, less allowance for credit losses of $1,348,805 (1998) and
$1,403,747 (1997) 109,847,706 107,763,536
Premises and equipment, net 3,369,014 3,258,876
Accrued interest receivable 1,354,754 1,475,994
Investment in unconsolidated subsidiaries 1,167,306 1,187,206
Goodwill 1,917,009 2,087,803
Other assets 1,991,281 2,003,330
- ----------------------------------------------------------------------------------------------------------------------------
Total assets $181,054,572 $175,115,011
- ----------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Deposits:
Noninterest-bearing demand $ 19,773,634 $ 17,727,129
Interest-bearing transaction 20,467,422 19,176,281
Savings and money market 35,321,550 37,575,341
Time, $100,000 or more 15,357,184 13,473,763
Other time 62,387,777 57,860,756
- ----------------------------------------------------------------------------------------------------------------------------
Total deposits 153,307,567 145,813,270
Long-term debt 5,000,000 5,000,000
Accrued interest payable 208,433 189,276
Other liabilities 634,337 597,655
- ----------------------------------------------------------------------------------------------------------------------------
Total liabilities 159,150,337 151,600,201
- ----------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized 10,000,000 shares; issued and
outstanding:
1,913,516 shares (1998) and 1,007,424 shares (1997) 19,135 10,074
Surplus 10,064,166 10,064,166
Retained earnings 11,865,853 13,480,311
Accumulated other comprehensive income (44,919) (39,741)
- ----------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 21,904,235 23,514,810
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $181,054,572 $175,115,011
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
16
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
<S><C>
INTEREST INCOME:
Interest and fees on loans $ 9,701,677 $ 9,346,631 $ 8,103,983
Interest and dividends on investment securities:
Taxable 2,269,577 2,286,192 1,834,979
Tax-exempt 473,689 417,895 424,202
Interest on federal funds sold 565,449 354,331 378,246
- ------------------------------------------------------------------------------------------------------------------------
Total interest income 13,010,392 12,405,049 10,741,410
- ------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits 5,636,282 5,370,057 4,475,979
Interest on long-term debt 287,041 77,825 --
- ------------------------------------------------------------------------------------------------------------------------
Total interest expense 5,923,323 5,447,882 4,475,979
- ------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 7,087,069 6,957,167 6,265,431
PROVISION FOR CREDIT LOSSES -- -- --
- ------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 7,087,069 6,957,167 6,265,431
- ------------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Service charges on deposit accounts 686,571 664,708 639,631
Gains on sales of investment securities 6,495 8,568 203,997
Equity in net (loss) income of unconsolidated subsidiaries (19,900) 72,978 25,884
Other income 199,479 162,795 129,911
- ------------------------------------------------------------------------------------------------------------------------
Total noninterest income 872,645 909,049 999,423
- ------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSES:
Salaries and employee benefits 2,381,839 2,238,125 1,990,238
Premises and equipment expenses 604,248 577,544 552,368
Marketing and promotion 159,402 142,101 92,450
Stationery, printing and supplies 147,433 160,037 120,105
Professional fees 78,679 114,601 175,957
Director and committee fees 211,734 195,007 178,054
Outside data processing 326,668 283,164 248,579
Amortization of goodwill 170,794 116,383 11,489
Other expenses 582,049 539,073 414,194
- ------------------------------------------------------------------------------------------------------------------------
Total noninterest expenses 4,662,846 4,366,035 3,783,434
- ------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE TAXES ON INCOME 3,296,868 3,500,181 3,481,420
FEDERAL AND STATE INCOME TAXES 1,077,929 1,129,983 1,173,678
- ------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 2,218,939 $ 2,370,198 $ 2,307,742
- ------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 1.12 $ 1.18 $ 1.14
- ------------------------------------------------------------------------------------------------------------------------
Diluted earnings per common share $ 1.12 $ 1.18 $ 1.14
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
17
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Accumulated
Other Total
Common Retained Comprehensive Stockholders'
Stock Surplus Earnings Income Equity
- ----------------------------------------------------------------------------------------------------------------------------------
<S><C>
Balances at January 1, 1996 $ 10,074 $ 10,064,166 $ 10,706,407 $ 68,701 $ 20,849,348
Comprehensive income:
Net income -- -- 2,307,742 -- 2,307,742
Other comprehensive income, net of tax:
Unrealized loss on available
for sale securities -- -- -- (134,307) (134,307)
- ----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- 2,173,435
- ----------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared
($.46 per common share)* -- -- (926,832) -- (926,832)
- ----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 10,074 10,064,166 12,087,317 (65,606) 22,095,951
Comprehensive income:
Net income -- -- 2,370,198 -- 2,370,198
Other comprehensive income, net of tax:
Unrealized gain on available
for sale securities -- -- -- 25,865 25,865
- ----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- 2,396,063
- ----------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared ($.485
per common share)* -- -- (977,204) -- (977,204)
- ----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 10,074 10,064,166 13,480,311 (39,741) 23,514,810
Comprehensive income:
Net income -- -- 2,218,939 -- 2,218,939
Other comprehensive income, net of tax:
Unrealized loss on available for
sale securities of $7,101, net
of reclassification adjustment of $1,923 -- -- -- (5,178) (5,178)
- ----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- 2,213,761
- ----------------------------------------------------------------------------------------------------------------------------------
Two-for-one split effected in the
form of a 100% stock dividend 10,074 -- (10,074) -- --
Stock repurchased and retired (1,013) -- (2,810,950) -- (2,811,963)
Cash dividends declared ($.51
per common share)* -- -- (1,012,373) -- (1,012,373)
- ----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 $19,135 $10,064,166 $11,865,853 ($44,919) $21,904,235
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
* Restated to reflect a two-for-one stock split on March 31, 1998.
18
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------------
<S><C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,218,939 $ 2,370,198 $ 2,307,742
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 457,337 424,302 296,599
Equity in net earnings of unconsolidated subsidiaries 19,900 (72,978) (25,844)
Provision for credit losses, net (54,942) (114,521) 24,713
Deferred income taxes (31,239) 265,591 59,892
Net (gains) losses on sales of assets (5,101) 37,920 (205,286)
Decrease (increase) in accrued interest receivable 121,240 10,317 (48,626)
Decrease (increase) in other assets 46,725 (1,346,040) 34,117
Increase (decrease) in accrued interest payable 19,157 (118,486) 7,162
Increase (decrease) in other liabilities 36,682 (88,744) (141,452)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 2,828,698 1,367,559 2,309,017
- ---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of investment securities held to maturity 34,267,718 16,220,939 752,344
Proceeds from maturities of investment securities available for sale 2,651,227 1,081,113 10,776,721
Proceeds from sales of investment securities available for sale -- 3,373,351 957,127
Purchase of investment securities held to maturity (18,767,297) (22,899,682) (11,034,144)
Purchase of investment securities available for sale (16,499,297) (1,693,125) (7,988,166)
(Increase) decrease in loans, net (2,029,228) 46,114 (1,963,160)
Purchase of premises and equipment (428,467) (1,276,182) (210,521)
Proceeds from sale of premises and equipment -- 301 7,200
Investment in unconsolidated subsidiary -- -- (15,000)
Proceeds from sale of other real estate owned -- -- 118,070
Acquisition, net of cash acquired -- (2,799,492) --
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (805,344) (7,946,663) (8,599,529)
- ---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in demand, transaction, savings, and money market deposits 1,083,855 6,923,212 2,928,474
Increase (decrease) in time deposits 6,410,442 (6,033,946) 4,758,021
Proceeds from long-term debt -- 5,000,000 --
Cash dividends paid (1,012,373) (977,204) (926,832)
Common stock repurchased and retired (2,811,963) -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 3,669,961 4,912,062 6,759,663
- ---------------------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in cash and cash equivalents 5,693,315 (1,667,042) 469,151
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of year 8,595,698 10,262,740 9,793,589
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 14,289,013 $ 8,595,698 $10,262,740
- ---------------------------------------------------------------------------------------------------------------------------------
Supplemental cash flows information:
Interest paid $ 5,617,125 $ 5,416,606 $ 4,468,817
- ---------------------------------------------------------------------------------------------------------------------------------
Income taxes paid $ 1,239,695 $ 1,120,005 $ 1,099,707
- ---------------------------------------------------------------------------------------------------------------------------------
Noncash investing activities:
Transfers from loans to other real estate owned $ -- $ -- $ (119,886)
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
Note 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of
Shore Bancshares, Inc. (the "Company") and its subsidiary, The
Centreville National Bank of Maryland (the "Bank") with all
significant intercompany transactions eliminated. The
investment in subsidiary is recorded on the Company's books on
the basis of its equity in the net assets of the subsidiary.
The accounting and reporting policies of the Company conform to
generally accepted accounting principles and to general
practices in the banking industry. Certain reclassifications
have been made to amounts previously reported to conform with
the classifications made in 1998.
NATURE OF OPERATIONS
The Company, through its bank subsidiary, provides domestic
financial services primarily in the Maryland counties of
Queen Anne's, Kent and Caroline. The primary financial
services include real estate, commercial and consumer
lending, as well as traditional demand deposits and savings
products.
USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could
differ from those estimates.
INVESTMENT SECURITIES
Investment securities that management has the ability and
intent to hold to maturity are classified as held to maturity
and carried at cost, adjusted for amortization of premium and
accretion of discounts. Other investment securities are
classified as available for sale and are carried at estimated
fair value. Unrealized gains and losses on investment
securities available for sale, net of related deferred income
taxes, are recognized as direct increases or decreases in
stockholders' equity. The cost of investment securities sold
is determined using the specific identification method.
LOANS
Loans are stated at the principal amount outstanding, net of
unearned income. Interest income on loans is accrued at the
contractual rate on the principal amount outstanding. It is
the Company's policy to discontinue the accrual of interest
when circumstances indicate that collection is doubtful. Fees
charged and costs capitalized for originating mortgage loans
are being amortized on the interest method over the term of
the loan.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is established through a
provision for credit losses charged to expense. Loans are
charged against the allowance for credit losses when
management believes that the collectibility of the principal
is unlikely. The allowance, based on evaluations of the
collectibility of loans and prior loan loss experience, is an
amount that management believes will be adequate to absorb
possible losses on existing loans that may become
uncollectible. The evaluations take into consideration such
factors as changes in the nature and volume of the loan
portfolio, overall portfolio quality,
20
<PAGE>
review of specific problem loans, and current economic
conditions and trends that may affect the borrowers' ability
to pay.
While management believes it has established the allowance
for credit losses in accordance with generally accepted
accounting principles and has taken into account the views of
its regulators and the current economic environment, there
can be no assurance that in the future the Company's and the
Bank's regulators or its economic environment will not
require further increases in the allowance.
LONG-LIVED ASSETS
Premises and equipment are stated at cost less accumulated
depreciation. Depreciation of physical properties is computed
on the straight-line method over the estimated useful lives
of the properties. Expenditures for maintenance, repairs, and
minor renewals are charged to operating expenses;
expenditures for betterments are charged to the property
accounts. Upon retirement or other disposition of properties,
the carrying value and the related accumulated depreciation
are removed from the accounts.
Long-lived assets are evaluated regularly for
other-than-temporary impairment. If circumstances suggest
that their value may be impaired and the write-down would be
material, an assessment of recoverability is performed prior
to any write-down of the assets.
OTHER REAL ESTATE OWNED
Real estate acquired in foreclosure of loans is carried at
cost or fair value, less estimated costs of disposal,
whichever is lower. Fair value is based on independent
appraisals and other relevant factors. At the time of
acquisition, any excess of loan balance over fair value is
charged to the allowance for credit losses. Any subsequent
reduction in value, as well as any operating expenses, are
included in other operating expenses.
INCOME TAXES
Income tax expense is based on the results of operations,
adjusted for permanent differences between items of income or
expense reported in the financial statements and those
reported for tax purposes. Under the liability method,
deferred income taxes are determined based on the differences
between the financial statement carrying amounts and the
income tax bases of assets and liabilities and are measured
at the enacted tax rates that will be in effect when these
differences reverse.
EARNINGS PER SHARE
Basic earnings per share is calculated based on the weighted
average number of shares outstanding during the period. For
the years ended December 31, 1998, 1997 and 1996, the Company
had no common stock equivalents.
NEW ACCOUNTING STANDARDS
In June 1996, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 125,
Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities (SFAS 125), which provides
new accounting and reporting standards for sales,
securitizations, and servicing of receivables and other
financial assets and extinguishments of liabilities. SFAS 125
is effective for transactions occurring after December 31,
1996, except for the provisions relating to repurchase
agreements, securities lending and other similar transactions
and pledged collateral, which have been delayed until after
December 31, 1997 by SFAS 127, Deferral of the Effective Date
of Certain Provisions of SFAS Statement No. 125, an amendment
of SFAS 125. Adoption of SFAS 125 was not material; SFAS 127
was adopted as required in 1998 and did not have a material
financial impact on the Company.
21
<PAGE>
In June 1997, Statement of Financial Accounting Standards No.
130 Reporting Comprehensive Income (SFAS 130), was issued and
establishes standards for reporting and displaying
comprehensive income and its components. SFAS 130 requires
comprehensive income and its components, as recognized under
the accounting standard, to be displayed in a financial
statement with the same prominence as other financial
statements. The Company adopted the standard, as required,
beginning in 1998. Adoption of this disclosure requirement
did not have a material impact on the Company.
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131,
Disclosures About Segments of an Enterprise and Related
Information (SFAS 131), which establishes new standards for
reporting information about operating segments in annual and
interim financial statements. The standard requires
descriptive information about the way that operating segments
are determined, the products and services provided by the
segments and the nature of differences between reportable
years beginning after December 15, 1997. Operating segments
are defined under the standard based on the availability and
utilization of discrete financial information as well as the
necessity for this discrete financial information to meet
certain quantitative thresholds. Management believes that it
has no components that qualify as an operating segment under
SFAS 131 for the year ended December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities (SFAS 133). The
provisions of this statement require that derivative
instruments be carried at fair value on the balance sheet.
The statement allows derivative instruments to be used to
hedge various risks and sets forth specific criteria to be
used to determine when hedge accounting can be used. The
statement also provides for offsetting changes in fair value
or cash flows of both the derivative and the hedged asset or
liability to be recognized in earnings in the same period;
however, any changes in fair value or cash flow that
represent the ineffective portion of a hedge are required to
be recognized in earnings and cannot be deferred. For
derivative instruments not accounted for as hedges, changes
in fair value are required to be recognized in earnings. The
provisions of this statement become effective for quarterly
and annual reporting beginning January 1, 2000, and allow for
early adoption in any quarterly period after June 1998. The
Company will adopt SFAS 133 as required in 2000. It is
expected that adoption of this standard will have no material
impact.
CASH AND CASH EQUIVALENTS
The Company has included cash and due from banks and federal
funds sold as cash and cash equivalents for the purpose of
reporting cash flows.
Note 2 ACQUISITIONS
On April 1, 1997 the Company completed the acquisition of Kent
Savings and Loan Association for a purchase price of $5,111,000
in cash. The transaction was accounted for as a purchase and,
therefore, results of operations subsequent to March 31, 1997
are included in the consolidated statements of income and cash
flows from the date of acquisition. The excess cost over the
estimated fair value of the tangible net assets acquired was
approximately $2,107,000 and is being amortized on a
straight-line basis over 15 years.
22
<PAGE>
Note 3 INVESTMENT SECURITIES
The amortized cost and fair value of investment securities at
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------
<S><C>
Available for Sale
U.S. Treasury securities $ 4,984,665 $75,962 $ -- $ 5,060,627
Obligations of U.S. Government
agencies and corporations 16,213,717 10,766 (43,846) 16,180,637
U.S. Government Securities
Mutual Fund 1,010,001 -- (116,559) 893,442
Federal Reserve Bank stock 302,250 -- -- 302,250
Federal Home Loan Bank of
Atlanta stock 765,900 -- -- 765,900
-----------------------------------------------------------------------------------------------------------
$23,276,533 $86,728 $(160,405) $23,202,856
-----------------------------------------------------------------------------------------------------------
<CAPTION>
-----------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------
Held to Maturity
Obligations of U.S. Government
agencies and corporations $14,503,181 $ 96,949 $ -- $14,600,130
Obligations of states and political
subdivisions 9,412,452 240,704 -- 9,653,156
-----------------------------------------------------------------------------------------------------------
$23,915,633 $337,653 $ -- $24,253,286
-----------------------------------------------------------------------------------------------------------
</TABLE>
23
<PAGE>
The amortized cost and fair value of investment securities at
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------
<S><C>
Available for Sale
U.S. Treasury securities $6,965,733 $48,176 $ -- $7,013,909
Obligations of U.S. Government
agencies and corporations 465,328 9,448 (6) 474,770
U.S. Government Securities
Mutual Fund 1,010,001 -- (122,367) 887,634
Federal Reserve Bank stock 302,250 -- -- 302,250
Federal Home Loan Bank of
Atlanta stock 765,900 -- -- 765,900
-----------------------------------------------------------------------------------------------------------
$9,509,212 $57,624 $(122,373) $9,444,463
-----------------------------------------------------------------------------------------------------------
<CAPTION>
-----------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------
Held to Maturity
Obligations of U.S. Government
and other government
agencies and corporations $29,088,534 $ 47,182 $(22,780) $29,112,936
Obligations of states and political
subdivisions 10,209,571 185,246 (9,317) 10,385,500
-----------------------------------------------------------------------------------------------------------
$39,298,105 $232,428 $(32,097) $39,498,436
-----------------------------------------------------------------------------------------------------------
</TABLE>
Gross realized gains and gross realized losses on sales and
calls of investment securities available for sale are as
follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------------------------------------
<S><C>
Gross realized gains:
U.S. Treasury securities $ -- $ 8,103 $ --
Obligations of U.S. Government
agencies and corporations -- -- 7
Obligations of states and political subdivisions 6,495 -- --
Sallie Mae stock -- 2,313 203,990
-----------------------------------------------------------------------------------------------------------
6,495 10,416 203,997
Gross realized losses:
U.S. Treasury securities -- 325 --
Obligations of U.S. Government
agencies and corporations -- 1,524 --
-----------------------------------------------------------------------------------------------------------
Net realized gains $6,495 $ 8,567 $203,997
-----------------------------------------------------------------------------------------------------------
</TABLE>
Proceeds from sales and calls of investment securities were
$306,495, $3,373,351, and $957,127 for the years ended December
31, 1998, 1997 and 1996, respectively.
24
<PAGE>
The amortized cost and fair value of investment securities by
contractual maturity is as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
December 31, 1998
------------------------------------------------------------------------------------------------------------------
Available for Sale Held to Maturity
------------------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------------------------------------------------------------------------------------------------------------
<S><C>
Amounts maturing:
One year or less $ 1,499,627 $ 1,506,094 $ 1,921,582 $ 1,936,596
After one year through five years 15,508,696 15,555,229 12,634,696 12,761,980
After five years through ten years 4,075,446 4,060,391 9,198,027 9,391,028
After ten years 114,613 119,550 161,328 163,682
------------------------------------------------------------------------------------------------------------------
21,198,382 21,241,264 23,915,633 24,253,286
Investments in equity securities
and mutual funds 2,078,151 1,961,592 -- --
------------------------------------------------------------------------------------------------------------------
$23,276,533 $23,202,856 $23,915,633 $24,253,286
------------------------------------------------------------------------------------------------------------------
<CAPTION>
------------------------------------------------------------------------------------------------------------------
December 31, 1997
------------------------------------------------------------------------------------------------------------------
Available for Sale Held to Maturity
------------------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------------------------------------------------------------------------------------------------------------
Amounts maturing:
One year or less $2,091,729 $2,098,345 $10,161,118 $10,173,623
After one year through five years 5,020,609 5,062,859 21,296,112 21,378,018
After five years through ten years 124,421 127,032 7,840,875 7,946,795
After ten years 194,302 200,443 -- --
------------------------------------------------------------------------------------------------------------------
7,431,061 7,488,679 39,298,105 39,498,436
Investments in equity securities
and mutual funds 2,078,151 1,955,784 -- --
------------------------------------------------------------------------------------------------------------------
$9,509,212 $9,444,463 $39,298,105 $39,498,436
------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company has pledged certain investment securities as
collateral for deposits of certain government agencies and
municipalities at December 31 as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------------------------------------------------
<S><C>
Amortized cost $15,783,184 $17,415,482
Fair value 15,962,587 17,337,504
------------------------------------------------------------------------------------------------------------------
</TABLE>
25
<PAGE>
Note 4 LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Company makes loans to customers primarily in the Maryland
counties of Queen Anne's, Kent and Caroline, in an economy
closely tied to the agricultural industry. A substantial
portion of the Company's loan portfolio consists of residential
and commercial real estate mortgages.
The Bank's loan portfolio at December 31 is as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
1998 1997
- ---------------------------------------------------------------------------------------------------------
<S><C>
Real estate:
Construction and land development $ 4,487,910 $ 2,945,617
Commercial 14,459,230 12,973,142
Residential 76,483,152 78,273,549
Commercial 8,447,857 8,352,569
Consumer 7,318,362 6,622,406
- ---------------------------------------------------------------------------------------------------------
111,196,511 109,167,283
Less: Allowance for credit losses (1,348,805) (1,403,747)
- ---------------------------------------------------------------------------------------------------------
Loans-- net $109,847,706 $107,763,536
- ---------------------------------------------------------------------------------------------------------
</TABLE>
Loans on which the accrual of interest has been discontinued
amounted to approximately $55,000, $199,000, and $872,000 at
December 31, 1998, 1997, and 1996, respectively. If interest on
those loans had been accrued, such income would have
approximated $5,000, $33,000 and $58,000 for 1998, 1997 and
1996, respectively.
In the normal course of banking business, loans are made to
officers and directors and their affiliated interests. In the
opinion of management, these loans are consistent with sound
banking practices, are within regulatory lending limitations,
and do not involve more than the normal risk of collectibility.
Loans outstanding to such parties totaled $2,155,000 and
$1,673,000 at December 31, 1998 and 1997, respectively. During
1998, $824,000 of new loans were made and repayments totaled
$342,000.
26
<PAGE>
Changes in the allowance for credit losses are as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------------------------
<S><C>
Balance at beginning of year $1,403,747 $1,503,268 $1,478,555
------------------------------------------------------------------------------------------------------
Recoveries:
Real estate loans -- -- 10,421
Consumer loans 23,631 40,080 25,599
Commercial and other loans 25,641 4,330 66,791
------------------------------------------------------------------------------------------------------
49,272 44,410 102,811
------------------------------------------------------------------------------------------------------
Allowance applicable to loans of acquired
institution -- 15,000 --
------------------------------------------------------------------------------------------------------
Provision for credit losses -- -- --
------------------------------------------------------------------------------------------------------
Loans charged-off:
Real estate loans (14,239) (22,288) (10,421)
Consumer loans (89,658) (99,441) (62,699)
Commercial and other loans (317) (37,202) (4,978)
------------------------------------------------------------------------------------------------------
(104,214) (158,931) (78,098)
------------------------------------------------------------------------------------------------------
Balance at end of year $1,348,805 $1,403,747 $1,503,268
------------------------------------------------------------------------------------------------------
</TABLE>
Impaired loans are accounted for in accordance with Statement
of Financial Accounting Standards No. 114, Accounting by
Creditors for Impairment of a Loan, as amended by Statement No.
118, Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures. Statement No. 114 requires that
impaired loans, within its scope, be measured based on the
present value of expected future cash flows discounted at the
loan's effective interest rate, except that as a practical
expedient, a creditor may measure impairment based on a loan's
observable market price or the fair value of the collateral, if
the loan is collateral dependent. The statement excludes
smaller balance and homogeneous loans such as consumer and
residential mortgage loans from impairment reporting.
Information with respect to impaired loans at December 31 is as
follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------------------------------------
<S><C>
Impaired loans with a valuation allowance $ -- $ --
Impaired loans without a valuation allowance 55,000 199,070
------------------------------------------------------------------------------------------------------
Total impaired loans $ 55,000 $ 199,070
------------------------------------------------------------------------------------------------------
Allowance for credit losses related to impaired loans -- --
Allowance for credit losses related to other than
impaired loans 1,348,805 1,403,747
------------------------------------------------------------------------------------------------------
Total allowance for credit losses $1,348,805 $1,403,747
------------------------------------------------------------------------------------------------------
Average impaired loans for the year $ 583,654 $ 631,749
------------------------------------------------------------------------------------------------------
Interest income on impaired loans recognized
on the cash basis $ 8,815 $ 26,740
------------------------------------------------------------------------------------------------------
</TABLE>
The Company recognizes interest income on impaired loans on a
cash basis if the borrower demonstrates the ability to meet the
contractual obligation and collateral is sufficient. If there
is doubt regarding the borrowers ability to make payments or
the collateral is not sufficient, payments received are
accounted for as a reduction in principal.
27
<PAGE>
Note 5 PREMISES AND EQUIPMENT
Premises and equipment at December 31 consist of the following:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
1998
-----------------------------------------------------------------------------------------------------------------
Accumulated
Cost Depreciation Net
-----------------------------------------------------------------------------------------------------------------
<S><C>
Land $ 267,947 $ -- $ 267,947
Buildings and land improvements 2,959,727 632,436 2,327,291
Furniture, equipment, and software 1,922,384 1,148,608 773,776
-----------------------------------------------------------------------------------------------------------------
$5,150,058 $1,781,044 $3,369,014
-----------------------------------------------------------------------------------------------------------------
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
1997
-----------------------------------------------------------------------------------------------------------------
Accumulated
Cost Depreciation Net
-----------------------------------------------------------------------------------------------------------------
Land $ 265,914 $ -- $ 265,914
Buildings and land improvements 2,785,789 553,128 2,232,661
Furniture and equipment 1,695,669 935,368 760,301
-----------------------------------------------------------------------------------------------------------------
$4,747,372 $1,488,496 $3,258,876
-----------------------------------------------------------------------------------------------------------------
</TABLE>
Note 6 INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
The Company owns 33% of the outstanding common stock of the
Delmarva Bank Data Processing Center, Inc. (DBDPC.) The
investment is carried at cost, adjusted for the Company's
equity in the DBDPC's undistributed net income.
28
<PAGE>
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------------------
<S><C>
Balance at beginning of year $1,007,809 $ 934,831 $876,889
Equity in net income 41,600 72,978 57,942
----------------------------------------------------------------------------------
Balance at end of year $1,049,409 $1,007,809 $934,831
----------------------------------------------------------------------------------
</TABLE>
Data processing expense paid to DBDPC totaled approximately
$266,000, $248,000 and $211,000 for the years ended December
31, 1998, 1997 and 1996, respectively.
The Company owns 33% of the outstanding common stock of Eastern
Shore Mortgage Corporation (ESMC.) The investment is carried at
cost, adjusted for the Company's equity in ESMC's undistributed
net earnings. The excess of cost over the Company's equity in
ESMC's underlying net assets at dates of acquisition, amounting
to $48,085, has been classified as goodwill and was amortized
over 15 years. As a result of ESMC's history of continuing
losses, the remaining goodwill balance of $24,308 was written
off during 1998.
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------------------
<S><C>
Balance at beginning of year $179,397 $179,397 $196,495
Equity in net loss (61,500) -- (32,098)
Capital contribution -- -- 15,000
----------------------------------------------------------------------------------
Balance at end of year $117,897 $179,397 $179,397
----------------------------------------------------------------------------------
</TABLE>
Interest income from this affiliate totaled approximately
$31,500, $39,000 and $21,000 for the years ended December 31,
1998, 1997 and 1996, respectively. There were no outstanding
loans to this affiliate at December 31, 1998.
Note 7 DEPOSITS
Certificates of deposit in amounts of $100,000 or more and
their remaining maturities at December 31 are as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------
1998 1997
---------------------------------------------------------------------------
<S><C>
Three months or less $ 1,191,746 $ 2,359,614
Three months through twelve months 5,649,278 5,613,156
Over twelve months 8,516,160 5,500,993
---------------------------------------------------------------------------
$15,357,184 $13,473,763
---------------------------------------------------------------------------
</TABLE>
Interest expense on deposits for each of the years ended
December 31 is as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------
<S><C>
Interest bearing transaction $ 513,745 $ 510,209 $ 489,827
Savings and money market 1,172,510 1,223,276 1,027,146
Time, $100,000 or more 789,210 786,304 705,707
Other time 3,160,817 2,850,268 2,253,299
------------------------------------------------------------------------------------
$5,636,282 $5,370,057 $4,475,979
------------------------------------------------------------------------------------
</TABLE>
29
<PAGE>
At December 31, 1998 and 1997, the Bank had deposits of
approximately $2,600,000 and $4,500,000, respectively, from a
local County government.
Note 8 SHORT-TERM BORROWINGS
The Company has commitments from correspondent banks under
which it can purchase up to $7,000,000 in federal funds and
secured reverse repurchase agreements on a short-term basis. No
borrowings were outstanding under these arrangements during
1998 or 1997.
Note 9 LONG-TERM DEBT
As of December 31, 1998, the Company had a convertible advance
from the Federal Home Loan Bank of Atlanta in the amount of
$5,000,000 at an interest rate of 5.66%. The advance is
callable September 24, 1999 and is due September 24, 2002. The
Bank has pledged its wholly owned residential first mortgage
loan portfolio under a blanket floating lien as collateral for
this advance.
Note 10 RETIREMENT PLAN
The Company has a 401(k) profit sharing plan covering
substantially all full-time employees. The plan requires the
Company to match 50% of employee contributions of up to 6% of
compensation as defined under the plan and permits additional
contributions at the discretion of management. Expense under
this plan totaled $133,000, $130,000, and $137,330 for the
years ended December 31, 1998, 1997 and 1996, respectively.
Note 11 DEFERRED COMPENSATION
The Company has agreements with certain directors under which
they have deferred part of their fees and compensation. The
amounts deferred are invested in insurance policies, owned by
the Company, on the lives of the respective individuals.
Amounts to be available under the policies are to be paid to
the individuals as retirement benefits over future years. Cash
surrender values and the accrued benefit obligation included in
other assets and other liabilities at December 31 are as
follows:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------------------------
<S><C>
Cash surrender value $1,705,646 $1,654,838
Accrued benefit obligations 533,601 529,106
--------------------------------------------------------------------------------------
</TABLE>
30
<PAGE>
Note 12 INCOME TAXES
Components of income tax expense for each of the years ended
December 31 are as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------------
<S><C>
Currently payable:
Federal $1,014,000 $ 773,337 $ 929,996
State 95,168 171,201 183,790
-----------------------------------------------------------------------------------
1,109,168 944,538 1,113,786
-----------------------------------------------------------------------------------
Deferred income taxes:
Federal (25,577) 151,833 49,036
State (5,662) 33,612 10,856
-----------------------------------------------------------------------------------
(31,239) 185,445 59,892
-----------------------------------------------------------------------------------
$1,077,929 $1,129,983 $1,173,678
-----------------------------------------------------------------------------------
</TABLE>
Components of the Company's deferred tax assets and liabilities
at December 31 are as follows:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------------------------------------------
<S><C>
Deferred tax assets:
Allowance for credit losses $196,895 $161,513
Deferred compensation 125,317 132,213
Interest income 2,525 2,525
Unrealized loss on investment securities available for sale 28,333 25,009
--------------------------------------------------------------------------------------------------------
Total deferred tax assets 353,070 321,260
--------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Cash to accrual conversion 37,109 53,356
Discount accretion 15,477 44,517
Depreciation 38,992 54,639
Federal Home Loan Bank dividends 27,613 27,613
Undistributed income of unconsolidated subsidiaries 61,329 59,824
Loan origination fees and costs 70,739 14,058
--------------------------------------------------------------------------------------------------------
Total deferred tax liabilities 251,259 254,007
--------------------------------------------------------------------------------------------------------
Net deferred tax assets $101,811 $ 67,253
--------------------------------------------------------------------------------------------------------
</TABLE>
31
<PAGE>
A reconciliation between income tax expense and taxes computed
at the maximum statutory federal rate for 1987, 1997 and 1996
is as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------------------------------------------------
Percent Percent Percent
of of of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
----------------------------------------------------------------------------------------------------------------
<S><C>
Computed at
statutory rate $1,120,935 34.0% $1,190,178 34.0% $1,183,683 34.0%
Increases
(decreases) in tax
resulting from:
Tax-exempt
interest income (144,442) (4.4) (130,930) (3.7) (138,947) (4.0)
State income
taxes, net of
federal income
tax benefit 65,051 2.0 101,760 2.9 128,157 3.7
Loss (earnings) of
unconsolidated
subsidiaries 5,413 .2 (9,139) (.3) (7,030) (.2)
Goodwill
amortization 55,709 1.7 37,211 1.1 -- .0
Rehabilitation tax
credit (11,616) (.4) (51,245) (1.5) -- .0
Other -- net (13,121) (.4) (7,852) (.2) 7,815 .2
----------------------------------------------------------------------------------------------------------------
Actual tax
expense $1,077,929 32.7% $1,129,983 32.3% $1,173,678 33.7%
----------------------------------------------------------------------------------------------------------------
</TABLE>
Note 13 STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS
The Company's 1998 Stock Option Plan was approved by
stockholders on April 21, 1998 and provides for the granting of
incentive and nonqualified options to directors, executive
officers and key employees on a periodic basis at the
discretion of the Company's Executive Committee. The Company
has reserved 80,000 shares of common stock under the Plan and
no more than 16,000 shares may be granted under the Plan in any
calendar year.
The Company's 1998 Employee Stock Purchase Plan which was also
approved by stockholders on April 21, 1998, allows employees to
receive options to purchase common stock at an amount equal to
85% of the fair market value of the common stock. The Company
has reserved 20,000 shares of common stock for issuance upon
the exercise of options under the Plan. Options to purchase no
more than 4,000 shares may be granted under the Plan in any
calendar year.
No options were granted under either plan during 1998.
32
<PAGE>
Note 14 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with
off-balance sheet risk in the normal course of business. These
financial instruments may include commitments to extend credit,
standby letters of credit and purchase commitments. The Company
uses these financial instruments to meet the financing needs of
its customers. Financial instruments involve, to varying
degrees, elements of credit, interest rate, and liquidity risk.
These do not represent unusual risks and management does not
anticipate any losses which would have a material effect on the
accompanying financial statements.
Outstanding loan commitments and lines and letters of credit at
December 31 are as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------------
<S><C>
Loan commitments $ 3,031,900 $ 1,440,050
------------------------------------------------------------------------------
Unused lines of credit $14,369,978 $10,853,207
------------------------------------------------------------------------------
Letters of credit $ 1,377,434 $ 1,769,618
------------------------------------------------------------------------------
</TABLE>
Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition
established in the contract. The Company generally requires
collateral to support financial instruments with credit risk on
the same basis as it does for on-balance sheet instruments. The
collateral is based on management's credit evaluation of the
counterparty. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without
being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. Each customer's
credit-worthiness is evaluated on a case-by-case basis.
Standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. The
credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan
facilities to customers.
33
<PAGE>
Note 15 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table shows the carrying values and the related
estimated fair value of the Company's financial instruments at
December 31:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
1998 1997
----------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------------------------------------------------------------------------------------------------------
<S><C>
Financial assets:
Cash and due from banks $ 4,536,510 $ 4,536,510 $ 5,091,798 $ 5,091,798
Federal funds 9,752,503 9,752,503 3,503,900 3,503,900
Investment securities available
for sale 23,276,533 23,202,856 9,444,463 9,444,463
Investment securities held
to maturity 23,915,633 24,253,286 39,298,105 39,498,436
Loans, net of allowance
for credit losses 109,847,706 114,005,000 107,763,536 110,420,000
Accrued interest receivable 1,354,754 1,354,754 1,475,994 1,475,994
<CAPTION>
----------------------------------------------------------------------------------------------------------------
1998 1997
----------------------------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------------------------------------------------------------------------------------------------------
Financial liabilities:
Deposits $153,307,567 $155,088,000 $145,813,270 $145,907,000
Accrued interest payable 208,433 208,433 189,276 189,276
Long-term debt 5,000,000 5,156,000 5,000,000 4,921,000
Unrecognized financial
instruments:
Commitments to extend credit 17,401,878 17,401,878 12,293,257 12,293,257
Standby letters of credit 1,377,434 1,377,434 1,769,618 1,769,618
----------------------------------------------------------------------------------------------------------------
</TABLE>
For purposes of the above disclosures of estimated fair value,
the following assumptions were used. The estimated fair value
for cash and due from banks and federal funds sold is
considered to approximate cost. The estimated fair value for
securities available for sale and securities held to maturity
are based on quoted market values from the individual
securities or for equivalent securities. The estimated fair
value of loans is determined by discounting future cash flows
using current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same
remaining maturities. The estimated fair value of demand
deposits, savings accounts, and certain money market deposits
is the amount payable on demand at the reporting date. The
estimated fair value of fixed maturity certificates of deposits
is estimated using the rates currently offered for deposits of
similar remaining maturities.
In cases where quoted market prices are not available, fair
values are based on estimates using present value or other
valuation techniques. Those techniques are significantly
affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. Accordingly, the
aggregate fair value amounts presented do not represent the
underlying value of the Company.
34
<PAGE>
Other assets, such as property and equipment, and certain
liabilities of the Bank that are not defined as financial
instruments are not included in the above disclosures. Also,
nonfinancial instruments typically not recognized in the
financial statements nevertheless may have value but are not
included in the above disclosures. These include, among other
items, the estimated earnings power of core deposit accounts,
the trained work force, customer goodwill, and similar items.
Note 16 REGULATORY MATTERS
The Company is required to maintain noninterest-bearing
deposits with the Federal Reserve Bank. During 1998 and 1997,
the daily average balances were approximately $2,263,000 and
$2,247,000, respectively.
The Company and the Bank are subject to various regulatory
capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can
initiate certain mandatory -- and possibly additional
discretionary -- actions by regulators that, if undertaken,
could have a direct material effect on the Company's and the
Bank's financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the
Bank must meet specific capital guidelines that involve
quantitive measures of the Bank's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other
factors.
Quantitive measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain amounts
and ratios (set forth in the table below) of total and Tier I
capital (as defined in the regulations) to risk-weighted assets
(as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31,
1998, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 1998, the most recent notification from the
Office of the Comptroller of the Currency categorized the Bank
as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the
Bank must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the table. There are
no conditions or events since that notification that management
believes have changed the Bank's category.
35
<PAGE>
The Company's and the Bank's actual capital amounts and ratios
are also presented in the table.
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
------------------------------------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------------------------------------------------------------------------------------------------
<S><C>
As of December 31, 1998:
Total Capital (to Risk
Weighted Assets):
Company $21,220,000 21.05% $8,069,000 8.00% $10,086,000 10.00%
Bank $21,127,000 21.20% $7,972,000 8.00% $ 9,965,000 10.00%
Tier I Capital (to Risk
Weighted Assets):
Company $19,959,000 19.80% $4,034,000 4.00% $ 6,051,000 6.00%
Bank $19,880,000 19.95% $3,986,000 4.00% $ 5,979,000 6.00%
Tier I Capital (to Average
Assets):
Company $19,959,000 11.08% $7,206,000 4.00% $ 9,008,000 5.00%
Bank $19,880,000 11.04% $7,206,000 4.00% $ 9,008,000 5.00%
As of December 31, 1997:
Total Capital (to Risk
Weighted Assets):
Company $22,633,000 23.61% $7,669,000 8.00% $ 9,586,000 10.00%
Bank $22,482,000 23.91% $7,523,000 8.00% $ 9,403,000 10.00%
Tier I Capital (to Risk
Weighted Assets):
Company $21,432,000 22.35% $3,836,000 4.00% $ 5,754,000 6.00%
Bank $21,304,000 22.66% $3,761,000 4.00% $ 5,641,000 6.00%
Tier I Capital (to Average
Assets):
Company $21,432,000 12.23% $7,010,000 4.00% $ 8,762,000 5.00%
Bank $21,304,000 12.16% $7,008,000 4.00% $ 8,760,000 5.00%
------------------------------------------------------------------------------------------------------------------
</TABLE>
Banking regulations also limit the amount of dividends that may
be paid without prior approval of the Bank's regulatory
agencies. Regulatory approval is required to pay dividends
which exceed the Bank's net profits for the current year plus
its retained net profits for the preceding two years. The
amount of dividends that the Bank could have paid to the
Company without approval from bank regulatory agencies at
December 31, 1998 was approximately $4,000,000.
36
<PAGE>
Note 17 PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Shore Bancshares, Inc.
(Parent Company only) is as follows:
CONDENSED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
- -------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------
ASSETS:
Investment in subsidiary $21,870,938 $23,475,091
Other assets 33,297 39,719
- -------------------------------------------------------------------------------
TOTAL ASSETS $21,904,235 $23,514,810
- -------------------------------------------------------------------------------
LIABILITIES -- --
- -------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY:
Common stock 19,135 10,074
Surplus 10,064,166 10,064,166
Retained earnings 11,820,934 13,440,570
- -------------------------------------------------------------------------------
Total stockholders' equity 21,904,235 23,514,810
- -------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $21,904,235 $23,514,810
- -------------------------------------------------------------------------------
CONDENSED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
- -------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------
INCOME-- Dividends from subsidiary $ 3,824,336 $ 1,025,855
OPERATING EXPENSES 9,731 9,944
- -------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX BENEFIT AND EQUITY
IN UNDISTRIBUTED EARNINGS OF SUBSIDIARY 3,814,605 1,015,911
INCOME TAX BENEFIT 3,309 3,382
- -------------------------------------------------------------------------------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARY 3,817,914 1,019,293
EQUITY IN UNDISTRIBUTED EARNINGS OF SUBSIDIARY (1,598,975) 1,350,905
- -------------------------------------------------------------------------------
NET INCOME $ 2,218,939 $ 2,370,198
- -------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
- -------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------
NET INCOME $ 2,218,939 $ 2,370,198
- -------------------------------------------------------------------------------
ADJUSTMENT TO RECONCILE NET INCOME TO NET
CASH PROVIDED BY OPERATING ACTIVITIES:
Equity in undistributed earnings of subsidiary 1,598,975 (1,350,905)
Net decrease in other assets 6,422 4,435
Net decrease in accounts payable -- (46,525)
- -------------------------------------------------------------------------------
Net cash provided by operating activities 3,824,336 977,203
CASH FLOWS FROM FINANCING ACTIVITIES:
- -------------------------------------------------------------------------------
Dividends paid (1,012,373) (977,203)
Stock repurchased and retired (2,811,963) --
Net cash used in financing activities (3,824,336) (977,203)
- -------------------------------------------------------------------------------
CASH AT BEGINNING OF YEAR -- --
- -------------------------------------------------------------------------------
CASH AT END OF YEAR $-- $--
- -------------------------------------------------------------------------------
37
<PAGE>
(STEGMAN & COMPANY LOGO)
INDEPENDENT AUDITORS' REPORT
----------------------------
The Stockholders and Board of Directors
Shore Bancshares, Inc.
Centreville, Maryland
We have audited the accompanying consolidated balance sheets of Shore
Bancshares, Inc. and Subsidiary as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Shore Bancshares,
Inc. and Subsidiary as of December 31, 1998 and 1997, and the consolidated
results of their operations and its cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
/s/ Stegman & Company
Baltimore, Maryland
January 8, 1999
38
<PAGE>
MARKET PRICE OF AND DIVIDENDS ON REGISTRANT'S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION AND DIVIDENDS
There is no established public trading market for the Company's Shares.
Accordingly, there is no comprehensive record of trades or the prices of any
such trades. The following table reflects stock prices for Company shares to the
extent such information is available to management of the Company as well as
dividends paid per share for each quarter. All prices and dividends have been
restated to reflect the effect of the two for one stock split effected in the
form of a 100% stock dividend on March 31, 1998.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------------------------------------
PRICE RANGE DIVIDENDS Price Range Dividends
HIGH LOW PAID High Low Paid
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter $23.25 $22.50 $0.12 $17.75 $16.50 $0.115
Second Quarter 33.50 24.00 0.12 18.25 17.50 0.115
Third Quarter 34.00 27.75* 0.12 20.00 16.50 0.115
Fourth Quarter 33.00 31.00 0.15 22.00 20.25 0.14
- ------------------------------------------------------------------------------------------------------------
$0.51 $0.485
- ------------------------------------------------------------------------------------------------------------
</TABLE>
* Price reflects stock repurchased and retired September 16, 1998.
There are no contractual restrictions that currently limit the Company's ability
to pay dividends or that the Company reasonably believes are likely to limit
materially the future payment of dividends on the Company's Shares. Banking
regulators, however, limit under certain circumstances the amount of dividends
that may be paid without prior approval of the Bank's regulatory agencies.
STOCKHOLDERS
As of February 22, 1999, a total of 1,913,516 shares of Shore Bancshares, Inc.
common stock was held by approximately 1,102 registered and beneficial owners.
39
<PAGE>
AVERAGE BALANCES, YIELDS AND RATES
(Unaudited)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, 1998 For the Year Ended December 31, 1997
- ------------------------------------------------------------------------------------------------------------------------------
AVERAGE INCOME/ YIELD/ Average Income/ Yield/
BALANCE EXPENSE RATE Balance Expense Rate
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C> <C> <C> <C> <C>
Federal funds sold $ 10,142,579 $ 565,449 5.58% $ 6,493,959 $ 354,331 5.46%
Investment securities:
U.S. Treasury securities and
obligations of U.S. government
agencies 33,866,198 2,104,154 6.21 32,996,468 2,102,149 6.37
Obligations of States and
political subdivisions (1) 10,479,431 739,527 7.06 8,858,428 673,659 7.60
All other investment securities 1,999,592 143,606 7.18 2,396,970 143,558 5.99
- ------------------------------------------------------------------------------------------------------------------------------
Total investment securities 46,345,221 2,987,287 6.45 44,251,866 2,919,366 6.60
Loans, net of unearned income (2) (3)
Commercial loans 9,482,733 983,333 10.37 9,293,896 982,599 10.57
Installment loans 5,768,858 573,173 9.94 5,264,677 536,637 10.19
Mortgage loans 92,928,827 8,145,171 8.76 89,183,164 7,827,395 8.78
- ------------------------------------------------------------------------------------------------------------------------------
Total loans 108,180,418 9,701,677 8.97 103,741,737 9,346,631 9.01
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST EARNING ASSETS 164,668,218 $ 13,254,413 8.05% 154,487,562 $ 12,620,328 8.17%
Cash and due from banks 4,066,234 4,012,120
Other assets 9,614,821 8,641,143
Allowance for credit losses (1,384,712) (1,445,147)
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 176,964,561 $165,695,678
- ------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Interest-bearing liabilities
Super NOW accounts $ 18,432,796 $ 513,745 2.79% $ 17,214,551 $ 510,209 2.96%
Money market deposit accounts 18,886,098 630,397 3.34 21,027,750 702,261 3.34
Time, $100,000 or more 12,697,789 689,999 5.43 13,297,892 704,290 5.30
Other time deposits 46,304,774 2,481,333 5.36 41,023,454 2,135,522 5.21
IRA deposits 15,429,668 778,695 5.05 14,732,561 796,760 5.41
Savings deposits 17,819,091 542,113 3.04 16,636,078 521,015 3.13
Other borrowed funds 5,001,849 287,041 5.74 1,356,164 77,825 5.74
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST BEARING LIABILITIES 134,572,065 5,923,323 4.40% 125,288,450 5,447,882 4.35%
Demand deposits 18,143,777 16,216,396
Other liabilities 934,045 1,401,009
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities 153,649,887 142,905,855
Stockholders' equity 23,314,674 22,789,823
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 176,964,561 $165,695,678
- ------------------------------------------------------------------------------------------------------------------------------
Net interest income and
interest rate spread $ 7,331,090 3.65% $ 7,172,446 3.82%
Net interest income as a percent
of earning assets 4.45% 4.64%
- ------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
For the Year Ended December 31, 1996
- -----------------------------------------------------------------------------------
Average Income/ Yield/
Balance Expense Rate
- -----------------------------------------------------------------------------------
ASSETS
Federal funds sold $ 7,095,343 $ 378,246 5.33%
Investment securities:
U.S. Treasury securities and
obligations of U.S. government
agencies 27,640,017 1,703,420 6.16
Obligations of States and
political subdivisions (1) 8,896,963 683,213 7.68
All other investment securities 1,387,606 91,075 6.56
- -----------------------------------------------------------------------------------
Total investment securities 37,924,586 2,477,708 6.53
Loans, net of unearned income (2) (3)
Commercial loans 10,263,061 1,074,769 10.47
Installment loans 5,097,131 512,414 10.05
Mortgage loans 73,406,929 6,516,800 8.88
- -----------------------------------------------------------------------------------
Total loans 88,767,121 8,103,983 9.13
- -----------------------------------------------------------------------------------
TOTAL INTEREST EARNING ASSETS 133,787,050 $ 10,959,937 8.19%
Cash and due from banks 3,589,220
Other assets 5,503,965
Allowance for credit losses (1,469,856)
- -----------------------------------------------------------------------------------
TOTAL ASSETS $ 141,410,379
- -----------------------------------------------------------------------------------
LIABILITIES
Interest-bearing liabilities
Super NOW accounts $ 16,022,439 $ 489,828 3.06%
Money market deposit accounts 19,112,185 639,654 3.35
Time, $100,000 or more 11,632,139 633,460 5.45
Other time deposits 30,099,425 1,582,081 5.26
IRA deposits 14,451,599 738,622 5.11
Savings deposits 12,324,479 392,334 3.18
Other borrowed funds -- -- --
- -----------------------------------------------------------------------------------
TOTAL INTEREST BEARING LIABILITIES 103,642,266 4,475,979 4.32%
Demand deposits 15,303,365
Other liabilities 838,440
- -----------------------------------------------------------------------------------
Total liabilities 119,784,071
Stockholders' equity 21,626,308
- -----------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 141,410,379
- -----------------------------------------------------------------------------------
Net interest income and
interest rate spread $ 6,483,958 3.87%
Net interest income as a percent
of earning assets 4.85%
- -----------------------------------------------------------------------------------
</TABLE>
1. All amounts are reported on a tax equivalent basis computed using the
statutory federal income tax rate of 34%, exclusive of the alternative
minimum tax rate and nondeductible interest expense.
2. Loan fee income is included in interest income for each loan category and
yields are stated to include all. Fees approximated $81,000, $84,000 and
$88,000 for 1998, 1997 and 1996, respectively.
3. Balances of nonaccrual loans and related income have been included for
computational purposes.
40
<PAGE>
RATE AND VOLUME VARIANCE ANALYSIS
(Unaudited)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
1998 COMPARED TO 1997 1997 compared to 1996
- ------------------------------------------------------------------------------------------------------------
INCREASE CHANGE DUE TO Increase Change due to
INTEREST INCOME (DECREASE) RATE (2) VOLUME (Decrease) Rate (2) Volume
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Federal funds sold $211,118 $ 12,038 $199,080 ($ 23,915) $ 8,144 ($ 32,059)
- ------------------------------------------------------------------------------------------------------------
U.S. Treasury securities and obligations
of U.S. government agencies 2,005 (53,404) 55,409 398,729 68,618 330,111
Tax-exempt obligations of State and
political subdivisions (1) 65,868 (57,405) 123,273 (9,554) (6,595) (2,959)
All other investment securities 48 23,848 (23,800) 52,483 (13,766) 66,249
- ------------------------------------------------------------------------------------------------------------
Total investment securities 67,921 (86,961) 154,882 441,658 48,257 393,401
- ------------------------------------------------------------------------------------------------------------
Commercial loans 734 (19,231) 19,965 (92,170) 9,323 (101,493)
Installment loans 36,536 (14,856) 51,392 24,223 7,380 16,843
Mortgage loans 317,776 (10,972) 328,748 1,310,595 (89,962) 1,400,557
- ------------------------------------------------------------------------------------------------------------
Total loans (3) 355,046 (45,059) 400,105 1,242,648 (73,259) 1,315,907
- ------------------------------------------------------------------------------------------------------------
Total interest income $634,085 ($119,982) $754,067 $1,660,391 ($16,858) $1,677,249
- ------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Super NOW accounts $ 3,536 ($ 32,571) $ 36,107 $20,381 ($16,064) $ 36,445
Money market deposit accounts (71,864) (340) (71,524) 62,607 (1,504) 64,111
Time deposits of $100,000 or more (14,291) 17,492 (31,783) 70,830 (19,883) 90,713
Other time deposits 345,811 70,886 274,925 553,441 (20,746) 574,187
IRA deposits (18,065) (55,766) 37,701 58,138 43,778 14,360
Savings deposits 21,098 (15,952) 37,050 128,681 (8,573) 137,254
Other borrowed funds 209,216 -- 209,216 77,825 -- 77,825
- ------------------------------------------------------------------------------------------------------------
Total interest expense $475,441 ($ 16,251) $491,692 $ 971,903 ($22,992) $ 994,895
- ------------------------------------------------------------------------------------------------------------
Net interest margin/income $158,644 ($103,731) $262,375 $ 688,488 $6,134 $ 682,354
- ------------------------------------------------------------------------------------------------------------
</TABLE>
1. Income and yields are computed on a tax equivalent basis using the statutory
federal income tax rate of 34%, exclusive of the alternative minimum tax and
nondeductible interest expense.
2. Variances caused by the change in yield/rate times the average balance are
allocated to rate.
3. Balances of nonaccrual loans and related income have been included for
computational purposes.
41
<PAGE>
DIRECTORS
Shore Bancshares, Inc.
The Centreville National Bank of Maryland
(AS OF MARCH 1, 1999)
- --------------------------------------------------------------------------------
J. Robert Barton
Retired President and CEO, The Centreville National
Bank of Maryland
Paul M. Bowman
Attorney, Law Office of Paul M. Bowman
David C. Bryan
Member, Law Offices of Fountain, Bryan and Ritter,
LLC
Daniel T. Cannon
President, Shore Bancshares, Inc.
President and CEO, The Centreville National Bank of
Maryland
B. Vance Carmean, Jr.
President, Carmean Grain, Inc.
Mark M. Freestate
President, W.M. Freestate & Son, Inc.
Thomas K. Helfenbein
Funeral Director and Partner
Fellows, Helfenbein & Newnam Funeral Home
Neil R. LeCompte
Certified Public Accountant, Office of
Neil R. LeCompte
Susanne K. Nuttle
Retired Vice President, The Centreville National Bank
of Maryland
Jerry F. Pierson
President, Jerry F. Pierson, Inc.
Wm. Maurice Sanger
President, F.W., Inc.
President, Cloverbay Development Corporation
Walter E. Schmidt
Vice President, Schmidt Ventures, Inc.
DIRECTORS EMERITI
Shore Bancshares, Inc.
- --------------------------------------------------------------------------------
Sydney G. Ashley
The Centreville National Bank of Maryland
- --------------------------------------------------------------------------------
Sydney G. Ashley Royden N. Powell, Jr.
Madison B. Bordley, Jr. William E. Sylvester
William H. Harris William E. Thompson
James O Pippin, Jr. Howard Wood
42
<PAGE>
OFFICERS
(AS OF MARCH 1, 1999)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHORE BANCSHARES, INC.
- ----------------------
<S> <C>
B. Vance Carmean, Jr ................................................Chairman of the Board
Jerry F. Pierson ..............................................Vice President of the Board
Daniel T. Cannon ................................................................President
Carol I. Brownawell .............................................................Treasurer
Mary C. Quimby ..................................................................Secretary
THE CENTREVILLE NATIONAL BANK OF MARYLAND
- -----------------------------------------
Daniel T. Cannon ............................................................President/CEO
Carol I. Brownawell ..........................................Executive Vice President/CFO
Timothy J. Berrigan ........................................................Vice President
Thomas E. Beery ........................................................Vice President/SLO
Rita B. Mielke .........................................................Vice President/COO
Pamela C. Satchell .........................................................Vice President
Carolyn D. Spicher .........................................................Vice President
William E. Stoops ..........................................................Vice President
David E. Thompson ..........................................................Vice President
Ralph F. Twilley ...........................................................Vice President
Katharine M. Crook ...............................................Assistant Vice President
Cassandra A. Guy .................................................Assistant Vice President
Kathryn C. Walls .................................................Assistant Vice President
Elizabeth T. Clough ...............................................................Cashier
Brenda M. Beaver ........................................................Assistant Cashier
Lorrie S. Greenwood .....................................................Assistant Cashier
Florance R. Walls .......................................................Assistant Cashier
</TABLE>
43
<PAGE>
THE CENTREVILLE NATIONAL BANK OF MARYLAND
EMPLOYEES
(AS OF MARCH 1, 1999)
- --------------------------------------------------------------------------------
Maryanne C. Alderson Barri G. Horney
Janice S. Barkley Constance M. Lee
Joyce D. Bradley Edith P. Legg
Gertrude E. Brown Joyce S. Moore
Phyllis B. Carroll Corinne C. Palmer
Lois F. Carter Nancy L. Park
Susan C. Childress Gina A. Paul
Barry P. Coleman, Jr Howard S. Pinder, Sr.
Vonda K. Collier Mary C. Quimby
Rochelle L. Corkell Lisa A. Robinson
Connie L. Crossman Shartinese D. Rochester
Jeanene L. Earl Robin J. Rust
Lisa S. Fleetwood Donna M. Schaeffer
Virginia Lynn Foster Teresa M. Schelhouse
Margaret A. Fuller Wanda L. Shawyer
Goldie J. Garner Phyllis S. Skinner
Heather P. Garner Karen A. Stanavich
Francis M. Gibson, Jr. Cheryl T. Stansbury
Jessica C. Grande Donna J. Stevens
W. Allen Greiner Barbara B. Stoops
Christina A. Guy Deborah H. Thomas
Ann M. Haddaway James W. Thompson, III
Donna J. Hallock Katherine A. Thompson
Lisa R. Harris Ronald J. Walters
Tera Y. Henry Diane B. Whitby
Gail F. Hickman
THE CENTREVILLE NATIONAL BANK OF MARYLAND
OFFICES
- --------------------------------------------------------------------------------
MAIN OFFICE STEVENSVILLE OFFICE
- ----------------------------------- -------------------------------------
109 N. Commerce St. -- PO Box 400 408 Thompson Creek Road -- PO Box 279
Centreville, MD 21617 Stevensville, MD 21666
Phone (410) 758-1600 Phone (410) 643-2233
Fax (410) 758-2364 Fax (410) 643-4215
ROUTE 213 SOUTH OFFICE HILLSBORO OFFICE
- ----------------------------------- -------------------------------------
2609 Centreville Road -- PO Box 400 21913 Shore Highway --PO Box 118
Centreville, MD 21617 Hillsboro, MD 21641
Phone (410) 758-2414 Phone (410) 820-2121
Fax (410) 758-3867 Fax (410) 820-1341
KENT OFFICE
----------------------------------
305 East High Street -- PO Box 388
Chestertown, MD 21620
Phone (410) 778-1299
Fax (410) 778-6084
44
