SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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
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PART I
ITEM I
BUSINESS
GENERAL
Shore Bancshares, Inc. (the "Company"), a Maryland corporation incorporated on
March 15, 1996, became a registered bank holding company on July 1, 1996 under
the Bank Holding Company Act of 1956, as amended. The Company engages in its
business through its sole subsidiary, The Centreville National Bank of Maryland
(the "Bank"), a national banking association. The Company acquired the Bank
through the merger of the Bank into an interim national banking association
formed as a Company subsidiary for the purpose of the merger, pursuant to a Plan
of Reorganization and Agreement to Merge (the "Plan") proposed by Bank
management and approved by the Bank's stockholders on April 16, 1996. Pursuant
to the Plan, each outstanding share of Bank common stock was exchanged for two
shares of the Company's common stock. The Bank's charter was not affected by the
merger. Currently, the Company has issued and outstanding 1,913,516 shares of
common stock, par value $0.01 per share ("Shares"), held by 1,102 holders of
record on February 22, 1999.
The Company's and the Bank's main office is located at 109 North Commerce
Street, Centreville, Queen Anne's County, Maryland. The Bank has five full
service branch offices located in Centreville, Chestertown, Stevensville and
Hillsboro, Maryland.
As of December 31, 1998, the Company had assets of approximately $181.1 million,
net loans of approximately $109.8 million, and deposits of $153.3 million.
Stockholders' equity has continued to grow over the last five years and has
increased $2.6 million (13.3%) over the preceding five years.
BANKING PRODUCTS AND SERVICES
The Bank has been doing business in Maryland since 1876 and is engaged in both
the commercial and consumer banking business. The Bank serves its customers
through a network of five banking offices. The Bank provides a wide range of
personal banking services designed to meet the needs of local consumers. Among
the services provided are checking accounts, savings and time accounts, safe
deposit boxes, and installment and other personal loans, especially residential
mortgages, as well as home equity loans, automobile and other consumer
financing. As a convenience to its customers, the Bank offers Saturday banking
hours, drive-thru teller windows, "Direct Dial," a telephone banking service,
debit cards, and 24-hour automated teller machines at all of its branch
locations.
The Bank is also engaged in the financing of commerce and industry by providing
credit and deposit services for small to medium sized businesses and for the
agricultural community in the Bank's market area. The Bank offers many forms of
commercial lending, including lines of credit, revolving credit, term loans,
accounts receivable financing, and commercial real estate mortgage lending and
other forms of secured financing. A full range of commercial banking services is
offered, including the acceptance of checking and savings deposits.
Additional types of real estate loans, discount brokerage services, credit
cards and related services are also offered through affiliates or correspondent
banks. The Bank does not offer trust services and does not engage in municipal
trading services.
BANK SERVICE CORPORATIONS
The Bank owns one-third of the outstanding common stock of two service
corporations: The Delmarva Bank Data Processing Center, Inc. and The Eastern
Shore Mortgage Corporation, both Maryland corporations. The Eastern Shore
Mortgage Corporation, located in Easton, Maryland, was engaged in mortgage
banking activities, including the origination of residential mortgage loans and
the subsequent sale of the loans to permanent investors but is currently in the
process of liquidation. Its primary customers were residents who live on
Maryland's Eastern Shore. The Delmarva Bank Data Processing Center, Inc., also
located in Easton, Maryland, provides data processing services to banks located
in Maryland, Delaware, Virginia and the District of Columbia.
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SEASONALITY
The management of the Bank does not believe that the deposits or the business
of the Bank in general are seasonal in nature. The deposits may, however,
vary with local and national economic conditions but not enough to have a
material effect on planning and policy making.
EMPLOYEES
As of December 31, 1998, the Company had no employees and the Bank employed 71
individuals, 11 of whom worked part-time.
DEPOSITS
No material portion of the Bank's deposits has been obtained from an individual
or a few individuals (including federal, state and local governments and
agencies) the loss of any one or more of which would have a materially adverse
effect on the Bank, nor is a material portion of the Bank's loans concentrated
within a single industry or group of related industries. On December 31, 1998,
the Bank had approximately 14,000 deposit customers representing $153.3 million
in deposits.
COMMITMENTS
As of the end of the last two fiscal years the Bank had the following
commitments to lend:
<TABLE>
<CAPTION>
% of % of
12/31/98 Total 12/31/97 Total
-------- --------- -------- --------
(in thousands) (in thousands)
<S><C>
Standby Letters of Credit $1,377 7.33% $1,770 12.59%
Commitments to Grant Loans 17,402 92.67 12,293 87.41
------ ----- ------ ------
Total $18,779 100.00% $14,063 100.00%
------ ----- ------ ------
</TABLE>
The above commitments are firm. The Bank expects approximately $6,000,000 of the
commitments to lend described above to be funded within the current year.
COMPETITION
The Bank offers many personalized services and attracts customers by being
responsive and sensitive to the needs of the community. The Bank relies on
goodwill and referrals from satisfied customers as well as traditional media
advertising to attract new customers. To enhance a positive image in the
community, the Bank supports and participates in many local events. Employees,
officers, and Directors represent the Bank on many boards and local civic and
charitable organizations.
The primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. Competition for deposits comes primarily from other
commercial banks, savings associations, credit unions, money market funds and
other investment alternatives. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services. Competition for loans comes primarily from other
commercial banks, savings associations, mortgage banking firms, credit unions
and other financial intermediaries.
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Recent changes in federal banking laws facilitate interstate branching and
merger activity among banks. Since September 1995, certain bank holding
companies are authorized to acquire banks throughout the United States. In
addition, as of June 1, 1997, certain banks are permitted to merge with banks
organized under the laws of different states. These changes have resulted in an
even greater degree of competition in the banking industry and the Company and
the Bank will continue to be brought into competition with institutions with
which it does not presently compete.
Regional and local banks dominate the banking industry in Centreville,
Chestertown, Stevensville, and the Hillsboro areas where the Bank maintains
offices. The Bank competes for deposits and loans with these institutions and
with credit unions, savings institutions, insurance companies, and mortgage
companies, as well as other companies that offer financial services. To attract
new business and retain existing customers, the Bank offers a wide range of
banking products and services and relies on local promotional activity, personal
contact by its officers, staff, and Directors, referrals by current customers,
extended banking hours, and personalized service.
As of June 30, 1998, the most recent date for which comparative data is
available, bank deposits in Queen Anne's County (where the Bank's main office,
Centreville branch and Stevensville branch are located), Caroline County,
Maryland (where the Bank's Hillsboro branch is located), and Kent County (where
the Bank's Kent branch is located) ranked as follows:
<TABLE>
<CAPTION>
% of
Queen Anne's County Deposits Total
-------- -----
(in thousands)
<S><C>
The Queenstown Bank of Maryland $131,464 35.39%
THE CENTREVILLE NATIONAL BANK OF MARYLAND 116,600 31.39
The Chestertown Bank of Maryland 36,528 9.83
NationsBank, N.A. 33,941 9.14
The First National Bank of Maryland 21,530 5.80
Farmers Bank of Maryland 17,692 4.76
Annapolis National Bank 13,712 3.69
------ ----
Total $371,467 100.00%
-------- -------
SOURCE: FDIC DATA BOOK
% of
Caroline County Deposits Total
-------- -----
(in thousands)
The Peoples Bank of Maryland $76,830 30.74%
Provident State Bank of Preston 62,440 24.98
The First National Bank of Maryland 38,709 15.49
Farmers Bank of Maryland 25,990 10.40
Atlantic Bank 17,320 6.93
NationsBank, N.A. 15,097 6.04
THE CENTREVILLE NATIONAL BANK OF MARYLAND 13,552 5.42
------ ----
Total $249,938 100.00%
-------- -------
SOURCE: FDIC DATA BOOK
</TABLE>
4
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<TABLE>
<CAPTION>
% of
Kent County Deposits Total
-------- -----
(in thousands)
<S><C>
The Chestertown Bank of Maryland $103,222 32.60%
Peoples Bank of Kent County 100,078 31.60
The Chesapeake Bank and Trust Company 40,636 12.83
Farmers Bank of Maryland 32,704 10.33
Crestar Bank 21,331 6.74
THE CENTREVILLE NATIONAL BANK OF MARYLAND 18,683 5.90
------ ----
Total $316,654 100.00%
-------- -------
SOURCE: FDIC DATA BOOK
</TABLE>
SUPERVISION AND REGULATION
GENERAL. The Company and the Bank are extensively regulated under federal and
state law. Generally, these laws and regulations are intended to protect
depositors, not stockholders. The following is a summary description of certain
provisions of certain laws which affect the regulation of bank holding companies
and banks. The discussion is qualified in its entirety by reference to
applicable laws and regulations. Changes in such laws and regulations may have a
material effect on the business and prospects of the Company and the Bank.
FEDERAL BANK HOLDING COMPANY REGULATION AND STRUCTURE. The Company is a bank
holding company within the meaning of the Bank Holding Company Act of 1956, as
amended, and as such, it is subject to regulation, supervision, and examination
by the Federal Reserve Board ("FRB"). The Company is required to file annual and
quarterly reports with the FRB and to provide the FRB with such additional
information as the FRB may require. The FRB may conduct examinations of the
Company and its subsidiaries.
With certain limited exceptions, the Company is required to obtain prior
approval from the FRB before acquiring direct or indirect ownership or control
of more than 5% of any voting securities or substantially all of the assets of a
bank or bank holding company, or before merging or consolidating with another
bank holding company. Additionally, with certain exceptions, any person
proposing to acquire control through direct or indirect ownership of 25% or more
of any voting securities of the Company is required to give 60 days' written
notice of the acquisition to the FRB, which may prohibit the transaction, and to
publish notice to the public.
Generally, a bank holding company may not engage in any activities other than
banking, managing or controlling its bank and other authorized subsidiaries, and
providing services to these subsidiaries. With prior approval of the FRB, the
Company may acquire more than 5% of the assets or outstanding shares of a
company engaging in non-bank activities determined by the FRB to be closely
related to the business of banking or of managing or controlling banks. The FRB
provides expedited procedures for expansion into approved categories of non-bank
activities.
Subsidiary banks of a bank holding company are subject to certain quantitative
and qualitative restrictions on extensions of credit to the bank holding company
or its subsidiaries, on investments in their securities and on the use of their
securities as collateral for loans to any borrower. These regulations and
restrictions may limit the Company's ability to obtain funds from the Bank for
its cash needs, including funds for the payment of dividends, interest and
operating expenses. Further, subject to certain exceptions, a bank holding
company and its subsidiaries are prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit, lease or sale of
property or furnishing of services. For example, the Bank may not generally
require a customer to obtain other services from itself or the Company, and may
not require that a customer promise not to obtain other services from a
competitor as a condition to and extension of credit to the customer.
Under FRB policy, a bank holding company is expected to act as a source of
financial strength to its subsidiary banks and to make capital injections into a
troubled subsidiary bank, and the FRB may charge the bank holding company with
engaging in unsafe and unsound practices for failure to commit resources to a
subsidiary bank when required. A required capital injection may be called for at
a time when the holding company does not have the resources to provide it. In
addition,
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depository institutions insured by the Federal Deposit Insurance Corporation
("FDIC") can be held liable for any losses incurred by, or reasonably
anticipated to be incurred by, the FDIC in connection with the default of, or
assistance provided to, a commonly controlled FDIC-insured depository
institution. Accordingly, in the event that any insured subsidiary of the
Company causes a loss to the FDIC, other insured subsidiaries of the Company
could be required to compensate the FDIC by reimbursing it for the estimated
amount of such loss. Such cross guaranty liabilities generally are superior in
priority to the obligations of the depository institution to its stockholders
due solely to their status as stockholders and obligations to other affiliates.
FEDERAL BANK REGULATION. The Company's banking subsidiary is a
federally-chartered national bank regulated by the Office of Comptroller of the
Currency ("OCC"). The OCC may prohibit the institutions over which it has
supervisory authority from engaging in activities or investments that the agency
believes constitutes unsafe or unsound banking practices. Federal banking
regulators have extensive enforcement authority over the institutions they
regulate to prohibit or correct activities which violate law, regulation or a
regulatory agreement or which are deemed to constitute unsafe or unsound
practices. Enforcement actions may include the appointment of a conservator or
receiver, the issuance of a cease and desist order, the termination of deposit
insurance, the imposition of civil money penalties on the institution, its
directors, officers, employees and institution-affiliated parties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the removal of or restrictions on directors, officers, employees and
institution-affiliated parties, and the enforcement of any such mechanisms
through restraining orders or other court actions.
The Bank is subject to certain restrictions on extensions of credit to executive
officers, directors, principal stockholders or any related interest of such
persons which generally require that such credit extensions be made on
substantially the same terms as are available to third persons dealing with the
Bank and not involve more than the normal risk of repayment. Other laws tie the
maximum amount which may be loaned to any one customer and its related interests
to capital levels.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), each federal banking agency is required to prescribe, by regulation,
non-capital safety and soundness standards for institutions under its authority.
The federal banking agencies, including the OCC, have adopted standards covering
internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, and
compensation, fees and benefits. An institution which fails to meet those
standards may be required by the agency to develop a plan acceptable to the
agency, specifying the steps that the institution will take to meet the
standards. Failure to submit or implement such a plan may subject the
institution to regulatory sanctions. The Company, on behalf of the Bank,
believes that it meets substantially all standards which have been adopted.
FDICIA also imposed new capital standards on insured depository institutions.
See "Capital Requirements."
Before establishing new branch offices, the Bank must meet certain minimum
capital stock and surplus requirements and the Bank must obtain OCC approval.
DEPOSIT INSURANCE. As a FDIC member institution, the Bank's deposits are insured
to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"),
administered by the FDIC, and each institution is required to pay semi-annual
deposit insurance premium assessments to the FDIC. The BIF assessment rates have
a range of 0 cents to 27 cents for every $100 in assessable deposits. The
federal Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"1996 Act"), included provisions that, among other things, recapitalized the
Savings Association Insurance Fund ("SAIF") through a special assessment on
savings association deposits and bank deposits that had been acquired from
savings associations. As a result of the April 1997 merger of Kent Savings and
Loan Association, F.A. into the Bank, approximately $21.8 million of the Bank's
deposits are assessed at SAIF rates. The SAIF assessment rates are determined
quarterly and the SAIF is also administered by the FDIC.
CAPITAL REQUIREMENTS. The federal banking regulators have adopted certain
risk-based capital guidelines to assist in the assessment of the capital
adequacy of a banking organization's operations for both transactions reported
on the balance sheet as assets and transactions, such as letters of credit, and
recourse arrangements, which are recorded as off balance sheet items. Under
these guidelines, nominal dollar amounts of assets and credit equivalent amounts
of off balance sheet items are multiplied by one of several risk adjustment
percentages, which range from 0% for assets with low credit risk, such as
certain U.S. Treasury securities, to 100% for assets with relatively high credit
risk, such as business loans.
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A banking organization's risk-based capital ratios are obtained by dividing its
qualifying capital by its total risk adjusted assets. The regulators measure
risk-adjusted assets, which include off balance sheet items, against both total
qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2
capital) and Tier 1 capital. "Tier 1," or core capital, includes common equity,
perpetual preferred stock (excluding auction rate issues) and minority interest
in equity accounts of consolidated subsidiaries, less goodwill and other
intangibles, subject to certain exceptions. "Tier 2," or supplementary capital,
includes, among other things, limited-life preferred stock, hybrid capital
instruments, mandatory convertible securities, qualifying subordinated debt, and
the allowance for loan and lease losses, subject to certain limitations and less
required deductions. The inclusion of elements of Tier 2 capital is subject to
certain other requirements and limitations of the federal banking agencies.
Banks and bank holding companies subject to the risk-based capital guidelines
are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at
least 4% and a ratio of total capital to risk-weighted assets of at least 8%.
The appropriate regulatory authority may set higher capital requirements when
particular circumstances warrant. Institutions which meet or exceed a Tier 1
ratio of 6% and a total capital ratio of 10% are considered well capitalized. As
of December 31, 1998, the Bank's ratio of Tier 1 to risk-weighted assets stood
at 19.95% and its ratio of total capital to risk-weighted assets stood at
21.20%. In addition to risk-based capital, banks and bank holding companies are
required to maintain a minimum amount of Tier 1 capital to total assets,
referred to as the leverage capital ratio, of at least 3% or 5% to be considered
well capitalized. As of December 31, 1998, the Bank's leverage capital ratio was
11.04%.
In August, 1995 and May, 1996, the federal banking agencies adopted final
regulations specifying that the agencies will include, in their evaluations of a
bank's capital adequacy, an assessment of the Bank's interest rate risk ("IRR")
exposure. The standards for measuring the adequacy and effectiveness of a
banking organization's interest rate risk management includes a measurement of
board of director and senior management oversight, and a determination of
whether a banking organization's procedures for comprehensive risk management
are appropriate to the circumstances of the specific banking organization. The
Bank has internal IRR models that are used to measure and monitor IRR.
Additionally, the regulatory agencies have been assessing IRR on an informal
basis for several years. For these reasons, the Company does not expect the
addition of IRR evaluation to the agencies' capital guidelines to result in
significant changes in capital requirements for the Bank.
Failure to meet applicable capital guidelines could subject a banking
organization to a variety of enforcement actions, including limitations on its
ability to pay dividends, the issuance by the applicable regulatory authority of
a capital directive to increase capital and, in the case of depository
institutions, the termination of deposit insurance by the FDIC, as well as to
the measures described under "--Federal Deposit Insurance Corporation
Improvement Act of 1991" below, as applicable to undercapitalized institutions.
In addition, future changes in regulations or practices could further reduce the
amount of capital recognized for purposes of capital adequacy. Such a change
could affect the ability of the Bank to grow and could restrict the amount of
profits, if any, available for the payment of dividends to the Company.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. In December,
1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding
provisions of the Federal Deposit Insurance Act and made significant revisions
to several other federal banking statutes. FDICIA provides for, among other
things, (i) publicly available annual financial condition and management reports
for financial institutions, including audits by independent accountants, (ii)
the establishment of uniform accounting standards by federal banking agencies,
(iii) the establishment of a "prompt corrective action" system of regulatory
supervision and intervention, based on capitalization levels, with more scrutiny
and restrictions placed on depository institutions with lower levels of capital,
(iv) additional grounds for the appointment of a conservator or receiver, and
(v) restrictions or prohibitions on accepting brokered deposits, except for
institutions which significantly exceed minimum capital requirements. FDICIA
also provides for increased funding of the FDIC insurance funds and the
implementation of risked-based premiums. See "Deposit Insurance."
A central feature of FDICIA is the requirement that the federal banking agencies
take "prompt corrective action" with respect to depository institutions that do
not meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." The Bank is currently classified as
"well-capitalized." An institution may be deemed by the regulators to be in a
capitalization category that is lower than is indicated by its actual capital
position if, among other things, it receives an unsatisfactory examination
rating with respect to asset quality, management, earnings or liquidity.
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FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a cash dividend) or paying any management
fees to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to growth
limitations and are required to submit capital restoration plans. If a
depository institution fails to submit an acceptable plan, it is treated as if
it is significantly undercapitalized. Significantly undercapitalized depository
institutions may be subject to a number of other requirements and restrictions,
including orders to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets and stop accepting deposits
from correspondent banks. Critically undercapitalized institutions are subject
to the appointment of a receiver or conservator, generally within 90 days of the
date such institution is determined to be critically undercapitalized.
FDICIA provides the federal banking agencies with significantly expanded powers
to take enforcement action against institutions which fail to comply with
capital or other standards. Such action may include the termination of deposit
insurance by the FDIC or the appointment of a receiver or conservator for the
institution. FDICIA also limits the circumstances under which the FDIC is
permitted to provide financial assistance to an insured institution before
appointment of a conservator or receiver.
INTERSTATE BANKING LEGISLATION. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 was enacted into law on September 29, 1994. The law
provides that, among other things, substantially all state law barriers to the
acquisition of banks by out-of-state bank holding companies were eliminated
effective on September 29, 1995. The law also permits interstate branching by
banks effective as of June 1, 1997, subject to the ability of states to opt-out
completely or to set an earlier effective date. Maryland generally established
an earlier effective date of September 29, 1995.
MONETARY POLICY. The earnings of a bank holding company are affected by the
policies of regulatory authorities, including the FRB, in connection with the
FRB's regulation of the money supply. Various methods employed by the FRB are
open market operations in United States Government securities, changes in the
discount rate on member bank borrowing and changes in reserve requirements
against member bank deposits. These methods used in varying combinations to
influence overall growth and distribution of bank loans, investments and
deposits, and their use may also affect interest rates charged on loans or paid
on deposits. The money policies of the FRB have had a significant effect on the
operating results of commercial banks in the past and are expected to continue
to do so in the future.
RISK FACTORS
REGULATORY RISKS. The banking industry is subject to many laws and regulations.
Regulations protect depositors, not stockholders. The Office of the Comptroller
of the Currency and the Board of Governors of the Federal Reserve System
regulate the Company and the Bank. Regulations and laws increase the Company's
operating expenses, affect the Company's earnings, and may put the Company at a
disadvantage with less regulated competitors, such as finance companies,
mortgage banking companies, credit unions, and leasing companies.
EXPOSURE TO LOCAL ECONOMIC CONDITIONS. Most of the loans made by the Bank are
made to local borrowers. A decline in local economic conditions would affect
the Company's earnings.
CREDIT RISKS AND INADEQUACY OF LOAN LOSS RESERVE. When borrowers default and do
not repay the loans made to them by the Bank, the Company loses money.
Experience shows that some borrowers either will not pay on time or will not pay
at all. In these cases, the Bank will cancel, or "write off," the defaulted loan
or loans. A "write off" reduces the Company's assets and affects the Company's
earnings. The Company anticipates losses by reserving what it believes to be an
adequate cushion so that it does not have to take a large loss at any one time.
However, actual loan losses cannot be predicted, and the Company's loan loss
reserve may not be sufficient.
INTEREST RATE RISK. The Company's earnings depend greatly on its net interest
income, the difference between the interest earned on loans and investments and
the interest paid on deposits. If the interest rate paid on deposits is high and
the interest rate earned on loans and investments is low, net interest income is
small and the Company earns less. Because interest rates are influenced by
competition, the Company cannot completely control its net interest income.
RISKS ASSOCIATED WITH REAL ESTATE LENDING. The Bank makes real estate secured
loans. Real estate loans are in greater demand when interest rates are low and
economic conditions are good. Even when economic conditions are good and
interest rates are low, these conditions may not continue. The Company may lose
money if the borrower does not pay a real estate loan. If real estate values
decrease, then the Company may lose more money when borrowers default.
NO ASSURANCE OF GROWTH. The Company's ability to increase assets and earnings
depends upon many factors, including competition for deposits and loans, the
Company's branch and office locations, avoidance of credit losses, and hiring
and training of personnel. Some of these factors are beyond the Company's
control.
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COMPETITION. Other banks and non-banks, including savings and loan associations,
credit unions, insurance companies, leasing companies, small loan companies,
finance companies, and mortgage companies, compete with the Company. Some of the
Company's competitors offer services and products that the Company does not
offer. Larger banks and non-bank lenders can make larger loans and service
larger customers. Law changes now permit interstate banks, which may increase
competition. Increased competition may decrease the Company's earnings.
NO ASSURANCE OF CASH OR STOCK DIVIDENDS. Whether dividends may be paid to
stockholders depends on the Company's earnings, its capital needs, law and
regulations, and other factors. The Company's payment of dividends in the past
does not mean that the Company will be able to pay dividends in the future.
STOCK NOT INSURED. Investments in the shares of the Company's common stock are
not deposits that are insured against loss by the government.
RISK INVOLVED IN ACQUISITIONS. Part of the Company's growth may come from buying
other banks and companies. A newly purchased bank or company may not be
profitable after the Company buys it and may lose money, particularly at first.
The new bank or company may bring with it unexpected liabilities or bad loans,
bad employee relations, or the new bank or company may lose customers.
RISK OF CLAIMS. Customers may sue the Company for losses due to the Company's
alleged breach of fiduciary duties, errors and omissions of employees, officers
and agents, incomplete documentation, the Company's failure to comply with
applicable laws and regulations, or many other reasons. Also, employees of the
Company conduct all of the Company's business. The employees may knowingly or
unknowingly violate laws and regulations. Company management may not be aware of
any violations until after their occurrence. This lack of knowledge will not
insulate the Company from liability. Claims and legal actions may result in
legal expenses and liabilities that may reduce the Company's profitability and
hurt its financial condition.
DEVELOPMENTS IN TECHNOLOGY. Financial services use technology, including
telecommunications, data processing, computers, automation, Internet-based
banking, debit cards, and "smart" cards. Technology changes rapidly. The
Company's ability to compete successfully with other banks and non-banks may
depend on whether it can exploit technological changes. The Company may not be
able to exploit technological changes and expensive new technology may not make
the Company more profitable.
YEAR 2000. The "Year 2000 Issue" describes the problems that may result from the
improper processing of dates and date-sensitive calculations beginning in the
Year 2000. Many 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. A
system failure or other disruptions of operations could occur if the Company's
computer programs and other equipment identify a year designated "00" as the
Year 1900 rather than the Year 2000. The Company cannot be certain that its
computer programs and other equipment, and the computer programs and other
equipment of its customers, vendors, suppliers and even the government will be
Year 2000 compliant. Any systems failure, disruption, or other losses could
affect the Company's earnings.
MARKET FOR COMMON STOCK. The Company's shares of common stock are not listed on
any exchange, and there is currently no organized trading market. Prices for
the Company's common stock may not be the actual value or the trading price in a
liquid trading market.
ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER AND BYLAW PROVISIONS. The Company's
Articles of Incorporation and Bylaws divide the Company's Board of Directors
into three classes and each class serves for a staggered three-year term. No
director may be removed except for cause and then only by a vote of at least
two-thirds of the total eligible stockholder votes. In addition, Maryland law
contains anti-takeover provisions that apply to the Company. These provisions
may discourage or make it more difficult for another company to buy the Company
or may reduce the market price of the Company's common stock.
9
<PAGE>
STATISTICAL INFORMATION:
The following supplementary information required under Guide 3 for the
respective periods and at the indicated respective dates is set forth on the
pages indicated below. The information should be read in conjunction with the
related Consolidated Financial Statements and Notes thereto for the year ended
December 31, 1998.
Table of Contents: Page
Investment Securities Portfolio Analysis 10
Summary of Loan Portfolio 11
Maturities of Loan Portfolio 11
Risk Elements of Loan Portfolio 11
Analysis of the Allowance for Credit Losses 12
Allocation of the Allowance for Credit Losses 12
Maturity of Time Certificates of Deposit $100,000 or More 13
Summary of Significant Ratios 13
Other statistical information required in this Item 1 is incorporated by
reference from the information appearing in the Company's Annual Report to
Stockholders as follows:
<TABLE>
<CAPTION>
Disclosure Required by Guide 3 Reference to the 1998 Annual Report
- ------------------------------ -----------------------------------
<S><C>
(I) Distribution of Assets, Liabilities, and Stockholders' Average Balances, Yields and Rates (page 40)
Equity: Interest Rates and Interest Differential Rate and Volume Variance Analysis (page 41)
(II) Investment Portfolio Notes to Financial Statements - Investment Securities
(pages 23 and 24)
(III) Loan Portfolio Management's Discussion and Analysis of Financial
Condition and Results of Operations "Loan Portfolio"
(page 9)
(V) Deposits Average Balances, Yields and Rates (page 40)
Rate and Volume Variance Analysis (page 41)
(VI) Return on Equity and Assets Selected Financial Data (page 1)
</TABLE>
Investment Securities Portfolio Analysis
December 31, 1998
(In Thousands)
<TABLE>
<CAPTION>
AVAILABLE FOR SALE
================================================================================
U.S. Treasury U.S. Govt. Agencies
Amortized Avg.T.E. Amortized Avg.T.E.
Description & Term Cost Yield Cost Yield
- ------------------
====================================== ===============================
<S><C>
0 - 3 Months $1,000 6.35% $0 N/A
3 - 6 Months 500 7.05 0 N/A
6 - 12 Months 0 N/A 0 N/A
1 - 3 Years 3,485 6.55 4,524 6.04%
3 - 4 Years 0 N/A 5,000 6.33
4 - 5 Years 0 N/A 2,500 6.46
5 - 10 Years 0 N/A 4,076 6.86
10 - 30 Years 0 N/A 114 7.67
====================================== ===============================
Total $4,985 6.56% $16,214 7.38%
====================================== ===============================
HELD TO MATURITY
================================================================================
U.S. Govt. Agencies Municipals
Amortized Avg.T.E. Amortized Avg.T.E.
Description & Term Cost Yield Cost Yield
- ------------------
=========================================== ====================================
0 - 3 Months $0 N/A $765 6.78%
3 - 6 Months 0 N/A 290 9.73
6 - 12 Months 0 N/A 567 8.19
1 - 3 Years 2,496 6.28% 494 6.99
3 - 4 Years 4,497 6.62 0 N/A
4 - 5 Years 2,495 6.50 343 6.80
5 - 10 Years 5,014 7.38 3,914 7.11
10 - 30 Years 0 N/A 0 N/A
==================================== =====================================
Total $14,502 6.23% $6,373 7.26%
==================================== =====================================
</TABLE>
<TABLE>
<CAPTION>
========================
AVAILABLE FOR SALE ==============
=====================
Securities Mutual Fund Other Securities
Amortized Avg.T.E. Book Avg.T.E. Total
Description & Term Cost Yield Value Yield Value
- ------------------ ============ ========== ============================ ====================
<S><C>
0 - 3 Months $0 N/A $0 N/A $1,000
3 - 6 Months 0 N/A 0 N/A 500
6 - 12 Months 0 N/A 0 N/A 0
1 - 3 Years 0 N/A 0 N/A 8,009
3 - 4 Years 0 N/A 0 N/A 5,000
4 - 5 Years 0 N/A 0 N/A 2,500
5 - 10 Years 0 N/A 0 N/A 4,076
10 - 30 Years 1,010 6.79% 1,068 7.02% 2,192
========== ========== ============================ ====================
Total $1,010 6.79% $1,068 7.02% $23,277
========== ========== ============================ ====================
Municipals - In State
Amortized Avg.T.E.
HELD TO MATURITY Cost Yield Total
Description & Term Value
- ------------------ ============================================= ===========
$300 7.58% $1,065
0 - 3 Months 0 N/A 290
3 - 6 Months 0 N/A 567
6 - 12 Months 793 7.07 3,783
1 - 3 Years 917 7.66 5,414
3 - 4 Years 599 7.20 3,437
4 - 5 Years 270 9.78 9,198
5 - 10 Years 161 6.59 161
10 - 30 Years ============================================= ===========
Total $3,040 7.54% $23,915
============================================= ===========
</TABLE>
The above yields have been adjusted to reflect a tax equivalent basis assuming a
federal tax rate of 34% and a state tax rate of 7%. Tax equivalent yields have
been weighted by settled par amount and are calculated using amortized cost.
10
<PAGE>
Summary of Loan Portfolio
(In Thousands)
<TABLE>
<CAPTION>
Loans Outstanding as of December 31,
------------------------------------
1998 1997
---- ----
Amount Amount
------ ------
<S><C>
Real Estate:
Construction and land development $4,488 $2,946
Commercial 14,459 12,973
Residential 76,483 78,273
Commercial 8,448 8,353
Consumer installment 7,318 6,622
----- -----
TOTAL $111,196 $109,167
======== ========
</TABLE>
Maturities of Loan Portfolio
December 31, 1998
(In Thousands)
<TABLE>
<CAPTION>
Maturing
Maturing After One Maturing
Within But Within After Five
One Year Five Years Years Total
------------------------------------------------------------
<S><C>
Real estate - Construction and land development $ 4,370 $ 118 $ - $ 4,488
Commercial 4,096 3,157 1,195 8,448
-----------------------------------------------------------
TOTAL $ 8,466 $ 3,275 $ 1,195 $ 12,936
============================================================
</TABLE>
Classified by Sensitivities of Loans to Changes in Interest Rates
<TABLE>
<S><C>
Real estate - Construction and land development
Fixed - Interest Rate Loans $ 2,555 $ 118 $ - $ 2,673
Adjustable - Interest Rate Loans 1,815 - - 1,815
====================================================================
TOTAL $ 4,370 $ 118 $ - $ 4,488
====================================================================
Commercial
Fixed - Interest Rate Loans $ 2,041 $ 2,432 $ 1,022 $ 5,495
Adjustable - Interest Rate Loans 2,055 725 173 2,953
====================================================================
TOTAL $ 4,096 $ 3,157 $ 1,195 $ 8,448
====================================================================
</TABLE>
Risk Elements of Loan Portfolio
(In Thousands)
<TABLE>
<CAPTION>
December 31,
1998 1997
---- ----
<S><C>
Non-accrual loans $55 $199
Accruing loans past due 90 Days or more 765 251
Restructured loans 872 209
Information with respect to non-accrual loans and restructured loans at December 31, 1998:
Interest income that would have been recorded under original terms 74
Interest income recorded during the period 72
</TABLE>
At December 31, 1998 the Company had $2.8 million in loans on the watch list for
which payments were current, but the borrowers have the potential for
experiencing financial difficulties. These loans are subject to on going
management attention and their classifications are reviewed regularly.
11
<PAGE>
Analysis of the Allowance for Credit Losses
(In Thousands)
<TABLE>
<CAPTION>
For the Years Ended December 31,
1998 1997
---- ----
<S><C>
Balance at beginning of period $1,404 $1,503
Charge-offs:
Real Estate:
Construction and land development 0 0
Commercial 0 0
Residential 14 22
Commercial 0 37
Consumer installment 90 99
-- --
104 158
--- ---
Recoveries:
Real Estate:
Construction and land development 0 0
Commercial 0 0
Residential 0 0
Commercial 26 4
Consumer installment 23 40
-- --
49 44
-- --
Net charge-offs (recoveries) 55 114
Provision for credit losses 0 0
Allowance acquired 0 15
- --
Balance at end of period $1,349 $1,503
====== ======
Average daily balance of loans $108,180 $103,742
Ratio of net charge-offs to average loans outstanding 0.05% 0.11%
</TABLE>
Allocation of the Allowance for Credit Losses
(In Thousands)
<TABLE>
<CAPTION>
Percent of loans Percent of loans
December 31, in each category December 31, in each category
1998 to total loans 1997 to total loans
------------------------------------------------------------------------------------
<S><C>
Real Estate:
Construction and land development $56 4.04% $38 2.70%
Commercial 578 13.00% 518 11.88%
Residential 46 68.78% 47 71.70%
Commercial 180 7.60% 194 7.65%
Consumer 148 6.58% 112 6.07%
Unallocated 341 N/A 495 N/A
------------------------------------------------------------------------------------
TOTAL $1,349 100.00% $1,404 100.00%
====================================================================================
</TABLE>
12
<PAGE>
Maturity of Time Certificates of Deposit $100,000 or More
(In Thousands)
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
---- ----
<S><C>
Three months or less $1,192 $2,360
Three months through six months 1,810 2,245
Six months through twelve months 3,839 3,368
Over twelve months 8,516 5,501
----- -----
TOTAL $15,357 $13,474
======= =======
</TABLE>
Summary of Significant Ratios
<TABLE>
<CAPTION>
1998 1997
---- ----
<S><C>
Return on average total assets 1.25% 1.43%
Return on average total equity 9.52% 10.40%
Dividend payout ratio 45.54% 41.28%
Total average equity to total average assets ratio 13.17% 13.75%
</TABLE>
ITEM 2
PROPERTIES
The Bank owns real property at the location of its main office at 109 North
Commerce Street, Centreville, Maryland 21617, and at its four branch locations
at 2609 Centreville Road, Centreville, Maryland 21617 ("Route 213 South Branch
Office"), 408 Thompson Creek Road, Stevensville, Maryland 21666 ("Stevensville
Branch Office"), at 21913 Shore Highway, Hillsboro, Maryland 21614 ("Hillsboro
Branch Office") and 305 East High Street, Chestertown, Maryland ("Kent Branch
Office".) There are no encumbrances on any of these properties. The Company owns
no real property.
ITEM 3
LEGAL PROCEEDINGS
There are no material pending legal proceedings other than ordinary routine
litigation incidental to the business to which the Company, the Bank, or its
subsidiaries is a party or of which any of their properties is subject.
Management is not aware of any material proceedings to which any Director,
officer, or affiliate of the Company, any person holding beneficially in excess
of five (5) percent of the Company's shares of common stock, or any associate of
any such Director, officer, or securing holder is a party.
ITEM 4
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1998 to a vote of
security holders, through the solicitation of proxies.
PART II
ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The sections entitled "Market Price of and Dividends on Registrant's Common
Equity and Related Stockholder Matters" and "Market Information" on page 39 of
the Annual Report is incorporated by reference herein.
For information regarding regulatory restrictions on the Bank's and, therefore,
the Company's payment of dividends, see Note 16 "Regulatory Matters" on page 35
of the Annual Report, which is incorporated by reference herein.
ITEM 6
SELECTED FINANCIAL DATA
The table entitled "Selected Financial Data" on page 1 of the Annual Report is
incorporated by reference herein. Reference is also made to the information
described in Part I, Item 1 of this Form 10K under the heading "Statistical
Information."
13
<PAGE>
ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Pages 5 through 15 of the Annual Report are incorporated by reference herein.
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the market risk of the Company's financial
instruments, see "Management Discussion and Analysis of Financial Condition and
Results of Operations - Market Risk Management" on page 11 of the Annual Report
and incorporated by reference herein. The Company's principal market risk
exposure is to interest rates.
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages 16 through 38 of the Annual Report are incorporated by reference herein.
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Board of Directors of the Company, upon recommendation of the Bank's
Audit/Compliance Committee, proposed and recommended the election of Stegman &
Company as independent certified public accountants to make an examination of
the accounts of the Company and the Bank for the year ending December 31, 1998.
Stegman and Company served as the Company's and the Bank's independent public
auditor for 1996 and 1997.
There were no disagreements with Stegman and Company on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedures.
PART III
ITEM 10
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference in the section entitled "Election of Directors" on
pages 2 - 4 and section entitled "Executive Officers" on page 7 in the Proxy
Statement as filed with the Securities and Exchange Commission March 24, 1999.
ITEM 11
EXECUTIVE COMPENSATION
Incorporated by reference in the sections entitled "Executive Compensation" on
pages 7-8, "Bank's Board of Directors' Executive Compensation Committee
Report" on pages 6-7, "Performance Graph" on page 8 and the discussion regarding
director compensation on pages 5-6, in the Proxy Statement as filed with the
Securities and Exchange Commission March 24, 1999.
14
<PAGE>
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference in the section entitled "Beneficial Ownership of
Common Stock" on pages 1 and 2 in the Proxy Statement as filed with the
Securities and Exchange Commission March 24, 1999.
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference in the section entitled "Election of Directors" on
page 2 in the Proxy Statement as filed with the Securities and Exchange
Commission March 24, 1999.
PART IV
ITEM 14
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1), (2) Financial Statements
The following consolidated financial statements included in the Annual Report to
Shareholders for the year ended December 31, 1998, are incorporated herein by
reference in Item 8 of this Report.
The following financial statements are filed as a part of this
report:
Consolidated Balance Sheets at December 31, 1998 and 1997
Consolidated Statements of Income for the years ended December 31,
1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December
31, 1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996
Notes to the Consolidated Financial Statements
Independent Auditors' Report
All financial statement schedules have been omitted as the required
information is either inapplicable or included in the consolidated
financial statements or related notes.
(a) (3) Exhibits required to be filed by Item 601 of Regulation S-K
EXHIBIT INDEX
(3) Charter and Bylaws
(3.1) Articles of Amendment and Restatement of the Company are
incorporated by reference from the Company's June 30, 1998 Form 10-Q, filed with
the Commission on August 13, 1998.
15
<PAGE>
(3.2) Bylaws of the Company as amended and restated are incorporated by
reference from the Company's June 30, 1998 Form 10-Q, filed with the Commission
on August 13, 1998.
(10.1) 1998 Employee Stock Purchase Plan is incorporated by reference
from the Company's Registration Statement on Form S-8 filed with the Commission
on September 25, 1998 (Registration No. 333-64317).
(10.2) 1998 Stock Option Plan is incorporated by reference from the
Company's Registration Statement on Form S-8 filed with the Commission on
September 25, 1998 (Registration No. 333-64319).
(13) 1998 Annual Report filed herewith.
(21) List of Subsidiaries is incorporated by reference from the Company's
Form 10, filed with the Commission on April 3, 1997, and Form 10/A, filed with
the Commission on May 30, 1997 (Registration No. 0-22523)
(23) Consent of Independent Auditors filed herewith.
(27) Financial Data Schedule is filed electronically herewith via EDGAR.
(b) Reports on Form 8-K
None
(c) Exhibits to Item 601 to Regulation S-K
See the Exhibits described in Item 14(a)(3) above.
16
<PAGE>
SIGNATURES
Pursuant to the requirements in Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf on March 17, 1998 by the undersigned, thereunto duly authorized.
SHORE BANCSHARES, INC.
/s/ Daniel T. Cannon
____________________
Daniel T. Cannon
President
/s/ Carol I. Brownawell
_______________________
Carol I. Brownawell
Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on March 16, 1999.
/s/ J. Robert Barton Director
___________________________
J. Robert Barton
/s/ Paul M. Bowman Director
___________________________
Paul M. Bowman
/s/ David C. Bryan Director
___________________________
David C. Bryan
/s/ Daniel T. Cannon Director
___________________________
Daniel T. Cannon
Director
___________________________
B. Vance Carmean, Jr.
/s/ Mark M. Freestate Director
___________________________
Mark M. Freestate
/s/ Thomas K. Helfenbien Director
___________________________
Thomas K. Helfenbein
/s/ Neil R. LeCompte Director
___________________________
Neil R. LeCompte
Director
___________________________
Susanne K. Nuttle
/s/ Jerry F. Pierson Director
___________________________
Jerry F. Pierson
/s/ Wm. Maurice Sanger Director
___________________________
Wm. Maurice Sanger
Director
___________________________
Walter E. Schmidt
17
[SHORE BANCSHARES, INC. LOGO HERE]
1998
Annual Report
<PAGE>
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
For the Year 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
<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
- ----------------------------------------------------------------------------------------------------------------------------------
Per Share Data:*
- ----------------------------------------------------------------------------------------------------------------------------------
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
- ----------------------------------------------------------------------------------------------------------------------------------
At Year End
- ----------------------------------------------------------------------------------------------------------------------------------
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%
- ----------------------------------------------------------------------------------------------------------------------------------
Average Balances
- ----------------------------------------------------------------------------------------------------------------------------------
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%
- ----------------------------------------------------------------------------------------------------------------------------------
</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
<PAGE>
- -------------------------------------------------------------------------------
CONTENTS
- -------------------------------------------------------------------------------
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
- -------------------------------------------------------------------------------
2
<PAGE>
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.
3
<PAGE>
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
4
<PAGE>
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.
6
<PAGE>
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
7
<PAGE>
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.
8
<PAGE>
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:
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation by reference in this Annual
Report on Form 10-K of Shore Bancshares, Inc. for the year ended December
31, 1998 of our report dated January 8, 1999 relating to the consolidated
financial statements of Shore Bancshares, Inc.
We also consent to the incorporation by reference in the
Registration Statements pertaining to the 1998 Employee Stock Purchase Plan
(Form S-8, No. 333-64317) and the 1998 Stock Option Plan (Form S-8, No.
333-64319) of our report dated January 8, 1999 with respect to the
consolidated financial statements of Shore Bancshares, Inc. incorporated
by reference in the Annual Report on Form 10-K for the year ended December
31, 1998.
/s/ STEGMAN AND COMPANY
- -----------------------
STEGMAN AND COMPANY
Baltimore, Maryland
March 25, 1999
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