UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
0-22929
TALBOT BANCSHARES, INC.
-----------------------
(Exact name of registrant as specified in its charter)
Maryland 52-2033630
______________________________ _________________
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
18 East Dover Street, Easton, Maryland 21601
_______________________________________ _________
(Address of Principal Executive Offices) (Zip Code)
(410) 822-1400
--------------
Registrant's Telephone Number, Including Area Code
Former name, former address and former fiscal year, if changed since last
report.
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 .
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
As of October 31, 1998, registrant had outstanding 1,191,616 shares of common
stock.
<PAGE>
INDEX
Part I.
Item 1. Financial Statements Page
Condensed Consolidated Balance Sheets -
September 30, 1998 and 1997 (unaudited) and December 31, 1997 4
Condensed Consolidated Statements of Income -
Three and nine months ended September 30, 1998 and 1997 (unaudited) 5
Condensed Consolidated Statements of changes in Stockholders' Equity -
For the nine month period ended September 30, 1998 and 1997
(unaudited) 6
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 1998 and 1997 (unaudited) 7
Notes to Condensed Consolidated Financial Statements (unaudited) 8-9
Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations 10-14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 15
Part II.
Item 6. Exhibits and Reports on Form 8-K 15
<PAGE>
Part I
Item 1. Financial Statements
TALBOT BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, September 30, December 31,
ASSETS: 1998 1997 1997
------------- ------------- ------------
(unaudited) (unaudited)
<S><C>
Cash and due from banks $ 6,552 $ 5,723 $ 8,108
Federal funds sold 23,667 12,601 8,057
Investment in debt securities:
Held-to-maturity, at amortized cost (fair value of $16,523,
$28,678, $24,257 respectively) 16,414 28,559 24,149
Available for sale, at fair value 53,171 33,643 37,330
Loans, less allowance for credit losses ($2,523,
$2,553, $2,538 respectively) 188,305 176,541 182,755
Bank premise and equipment 3,042 3,057 3,144
Other real estate owned 192 216 114
Accrued interest receivable on loans and investment securities 2,241 2,084 1,949
Investments in unconsolidated subsidiary 153 145 174
Deferred income tax benefits 177 629 455
Other assets 856 737 794
-------- -------- --------
TOTAL ASSETS $294,770 $263,935 $267,029
======== ======== ========
LIABILITIES:
Deposits:
Non-interest bearing demand $ 22,374 $ 20,946 $ 23,696
NOW and Super NOW 48,581 40,952 51,159
Certificates of deposit $100,000 or more 45,717 34,052 25,763
Other time and savings 125,401 122,580 124,296
-------- -------- --------
Total Deposits 242,073 218,530 224,914
Securities sold under agreements to repurchase 18,088 14,245 10,264
Other liabilities 901 925 880
-------- -------- --------
TOTAL LIABILITIES 261,062 233,700 236,058
-------- -------- --------
STOCKHOLDERS' EQUITY:
Common Stock, Par Value $.01; authorized 25,000,000 shares;
issued and outstanding:
September 30, 1998 1,191,616
September 30, 1997 1,188,834
December 31, 1997 1,189,610 12 12 12
Surplus 12,632 12,513 12,548
Retained earnings 20,490 17,682 18,280
Net unrealized holding gain on debt securities 574 28 131
-------- -------- --------
available for sale
TOTAL STOCKHOLDERS' EQUITY 33,708 30,235 30,971
-------- -------- --------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $294,770 $263,935 $267,029
======== ======== ========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
TALBOT BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1998 1997 1998 1997
-------- -------- -------- --------
<S><C>
INTEREST INCOME
Loans, including fees $4,203 $ 3,913 $ 12,405 $ 11,577
Interest and dividends on investment securities
Taxable 883 772 2,477 2,320
Tax-exempt 55 79 180 233
Federal funds sold 249 178 441 388
------ ------- -------- --------
Total interest income 5,390 4,942 15,503 14,518
------ ------- -------- --------
INTEREST EXPENSE
Certificates of deposit, $100,000 or more 539 384 1,281 1,050
Other deposits 1,759 1,694 5,163 4,945
Other interest 172 120 434 339
------ ------- -------- --------
Total interest expense 2,470 2,198 6,878 6,334
------ ------- -------- --------
NET INTEREST INCOME 2,920 2,744 8,625 8,184
PROVISION FOR CREDIT LOSSES 60 45 180 195
------ ------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR
CREDIT LOSSES 2,860 2,699 8,445 7,989
------ ------- -------- --------
NONINTEREST INCOME
Service charges on deposit accounts 193 145 482 419
Loss on sale of securities - 1 9 1
Other noninterest income 36 20 100 66
------ ------- -------- --------
Total noninterest income 229 166 591 486
------ ------- -------- --------
NONINTEREST EXPENSES
Salaries and employee benefits 867 841 2,641 2,547
Expenses of premises and fixed assets 194 173 544 516
Other noninterest expense 460 436 1,405 1,373
------ ------- -------- --------
Total noninterest expense 1,521 1,450 4,590 4,436
------ ------- -------- --------
INCOME BEFORE TAXES ON INCOME 1,568 1,415 4,446 4,039
Federal and State income taxes 536 509 1,522 1,439
------ ------- -------- --------
NET INCOME $1,032 $ 906 $ 2,924 $ 2,600
====== ======= ======== ========
Diluted earnings per common share $ .90 $ .76 $ 2.41 $ 2.17
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
TALBOT BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Accumulated
other
Common Retained Comprehensive
Stock Surplus Earnings Income Total
------ ------- -------- ------------- -----
<S><C>
Balances, December 31, 1996 $12 $12,435 $15,616 ($143) $27,920
Net Income - - 2,600 - 2,600
Cash Dividends Paid $0.45 per share - - (534) - (534)
Comprehensive income, net of tax:
Net unrealized holding gain on
debt securities, available-for-sale - - - 171 171
-------
Other comprehensive income 171
-------
Shares issued - 78 - - 78
--- -------- -------- ---- -------
Balances, September 30, 1997 $12 $ 12,513 $ 17,682 $28 $30,235
=== ======== ======== ==== =======
Balances, December 31, 1997 $12 $12,548 $18,280 $131 $30,971
Net Income - - 2,924 - 2,924
Cash Dividends Paid $0.60 per share - - (714) - (714)
Comprehensive income, net of tax:
Net unrealized holding gain on
debt securities, available-for-sale - - - 443 443
-------
Other comprehensive income 443
-------
Shares issued - 84 - - 84
--- -------- -------- ---- -------
Balances, September 30, 1998 $12 $12,632 $20,490 $574 $33,708
=== ======== ======== ==== =======
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
<PAGE>
TALBOT BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Nine Months Ended September 30,
1998 1997
---------------- ---------------
<S><C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2,924 $ 2,600
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 396 324
Discount accretion on debt securities (52) (76)
Discount accretion on matured debt securities 120 47
Gain on sale of securities (9) (1)
(Gain)Loss on sale of bank equipment 3 (1)
Provision for credit losses (15) (175)
Loss on other real estate owned 4
Net changes in:
Accrued interest receivable (292) (256)
Other assets (41) (58)
Accrued interest payable on deposits 71 19
Other liabilities (50) 12
------------- -------------
Net cash provided by operating activities 3,059 2,435
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale 5,062 2,973
Proceeds from maturities and principal payments of securities
available for sale 1,299 5,730
Purchase of securities available for sale (21,711) (10,073)
Proceeds from maturities and principal payments of securities
held to maturity 13,789 3,880
Purchase of securities held to maturity (6,024) (1,709)
Net increase in loans (5,535) (7,884)
Purchase of loans - (700)
Proceeds from sale of loans - 1,098
Purchase of bank premises and equipment (180) (97)
Proceeds from sale of equipment 24 20
Proceeds from sale of other real estate owned 139 115
Purchase other real estate owned (221) -
------------- -------------
Net cash provided by investing activities (13,358) (6,647)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in demand, NOW, money market and
savings deposits (4,746) (6,032)
Net increase(decrease) in certificates of deposit 21,905 9,460
Net increase in securities sold under agreement to repurchase 7,824 4,977
Proceeds from issuance of common stock 84 78
Dividends paid (714) (534)
------------- -------------
Net cash provided(used) by financing activities 24,353 7,949
------------- -------------
NET INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS 14,054 3,737
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 16,165 14,587
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 30,219 $ 18,324
============= =============
</TABLE>
<PAGE>
Talbot Bancshares, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1) Effective May 1, 1997, the common shareholders of The Talbot Bank of Easton,
Maryland (the "Bank") exchanged each one of their common shares of the Bank
for two shares of common stock of Talbot Bancshares, Inc (the "Holding
Company") and at that time the Bank became a wholly-owned subsidiary of the
Holding Company. The only current business of the Holding Company is the
ownership and operation of the Bank. The Holding Company and the Bank are
collectively referred to as the "Company." The formation of the Holding
Company and exchange of shares has been accounted for as a pooling of
interests.
In the opinion of the management of the Company the accompanying condensed
consolidated financial statements contain all adjustments necessary to
present fairly the financial position at September 30, 1998, the results of
operations for the three and nine month periods ended September 30, 1998 and
1997, and cash flows for the nine month period ended September 30, 1998 and
1997. The results of operations for the three and nine months ended September
30, 1998 are not necessarily indicative of the results to be expected for the
full year.
2) In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, Earnings Per Share, which became effective for the Company for reporting
periods ending after December 31, 1998. Under the provisions of SFAS No. 128,
primary and fully-diluted earnings per share were replaced with basic diluted
earnings per share in an effort to simplify the computation of these measures
and align them more closely with the methodology used internationally. Basic
earnings per share is arrived at by dividing net income available to common
stockholders by the weighted-average number of common shares outstanding and
does not include the impact of any potentially dilutive common stock
equivalents. The diluted earnings per share calculation method is arrived at
by dividing net income by the weighted-average number of shares outstanding,
adjusted for the dilutive effect of outstanding stock options and warrants.
For purposes of comparability, the prior-period earnings per share data has
been restated.
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------- -------------
<S><C>
Basic:
Net income (applicable to common stock) 2,924,000 2,600,000
Average common shares outstanding 1,190,397 1,187,473
Basic net income per share 2.46 2.19
Diluted:
Net income (applicable to common stock) 2,924,000 2,600,000
Average common shares outstanding 1,190,397 1,187,473
Dilutive effect of stock options 20,819 11,616
--------- ---------
Average common shares outstanding diluted 1,211,216 1,199,089
Diluted net income per share 2.41 2.17
</TABLE>
On January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" (Statement
125), relating to repurchase agreements, securities lending and other similar
transactions and pledged collateral, which had been delayed until after
December 31, 1997 by Statement of Financial Accounting Standards No. 127,
"Deferral of the Effective Date of Certain Provisions of FASB Statement No.
125, an amendment of FASB Statement No. 125" (Statement 127), Statement 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishment of liabilities based on a consistent
application of a "financial-components approach" that focuses on control.
Under that approach, after a transfer of financial assets, an entity
recognized the financial and servicing assets it controls and the liabilities
it has incurred, derecognizes financial assets when control has been
surrendered and derecognizes labilities when extinguished. Statement 125
provides standards for consistently distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. The
adoption of the additional provisions of Statement 125 as amended by
Statement 127 resulted in no material impact on the Company's financial
condition or results of operations.
<PAGE>
On January 1, 1998, the Company also adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This
statement establishes standards for reporting the components of comprehensive
income and requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be included in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income includes net income as well as
certain items that are reported directly within a separate component of
shareholders' equity and bypass net income. The adoption of Statement 130 did
not have a material impact on the Company's financial condition or results of
operations.
In February 1998, the Financial Accounting Standards Board issued Statement
132, "Employers' Disclosures about Pension and Other Postretirement Benefits
- an amendment of FASB Statements No. 87, 88, and 106." This statement
revised employers' disclosures about pension and other postretirement benefit
plans, but does not change the measurement or recognition of those plans. It
standardizes the disclosure requirements to the extent practicable, requires
additional information on changes in the benefit obligations and fair values
of plan assets that will facilitate financial analysis and eliminates certain
disclosures that are no longer as useful as they were when Statements 87, 88
and 106 were issued. This statement is effective for fiscal years beginning
after December 15, 1997. Restatement of disclosures for previous periods
provided for comparative purposes is required unless the information is not
readily available, in which case the notes to the financial statements should
include all available information and a description of the information not
available. These disclosure requirements will have no material impact on the
Company's financial position or results of operations.
3) Under the provisions of Statements of Financial Accounting Standards (SFAS)
Nos. 114 and 118, "Accounting by Creditors for Impairment of a Loan" a loan
is considered impaired if it is probable that the Company will not collect
all principal and interest payments according to the loan's contracted terms.
The impairment of a loan is measured at the present value of expected future
cash flows using the loan's effective interest rate, or at the loan's
observable market price or the fair value of the collateral of the loan is
collateral dependent. Interest income generally is not recognized on specific
impaired loans unless the likelihood of further loss is remote. Interest
payments received on such loans are applied as a principal balance. Interest
income on other nonaccrual loans is recognized only to the extent of interest
payments received. Interest income on impaired loans is recognized on a cash
basis.
Information with respect to impaired loans and the related valuation
allowance is shown below:
<TABLE>
<CAPTION>
September 30, September 30, December 31,
(Dollars in thousands) 1998 1997 1997
- -------------------------------------------------------------------------------------------------------------------
<S><C>
Impaired loans with valuation allowance $ 110 $ 403 $ 587
Impaired loans with no valuation allowance 731 851 695
------- ------- -------
Total impaired loans $ 841 $ 1,254 $ 1,282
======= ======= =======
Allowance for credit losses applicable to impaired loans $ 43 $ 88 $ 122
Allowance for credit losses applicable to other than impaired loans 2,480 2,465 2,416
------- ------- -------
Total allowance for credit losses $ 2,523 $ 2,553 $ 2,538
======= ======= =======
Interest income on impaired loans recorded on the cash basis $18,095 $15,420 $18,988
======= ======= =======
</TABLE>
Interest income of $39,450 would have been recorded for the period ended
September 30, 1998 had the loans been current and in accordance with their
original terms. Impaired loans do not include groups of smaller balance
homogenous loans such as residential mortgage and consumer installment loans
that are evaluated collectively for impairment. Reserves for probable future
credit losses related to these loans are based upon historical loss ratios
and are included in the allowance for credit losses.
4) In the normal course of business, to meet the financial needs of its
customers, the Bank is a party to financial instruments with off-balance
sheet risk. These financial instruments include commitments to extend credit
and standby letters of credit. At September 30, 1998 total commitments to
extend credit were approximately $49,800,000. Outstanding letters of credit
were approximately $2,991,000 at September 30, 1998
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Forward - Looking Information
Portions of this Quarterly Report on Form 10-Q contain forward-looking
statements with respect to the adequacy of the allowance for loan losses,
interest rate risk, and the Year 2000 issue which, by their nature, are
subject to significant uncertainties. Because of 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.
Overview
Net income for the third quarter of 1998 was $1,032,000 an increase of 13.9%
over the $906,000 for the third quarter of 1997. On a per share basis
earnings were $ .90 compared to $ .76 for the same period last year.
Net income for the nine months ended September 30, 1998 was $2,924,000
compared to $2,600,000 for the same period in 1997. This represents a 12.5%
increase. Net income per share was $2.41 and $2.17 for the nine months ended
September 30, 1998 and 1997, respectively.
Net Interest Income
Net interest income for the nine months ended September 30, 1998 was higher
than the same period last year due to an increase in the average balance of
loans. Average loans for the nine month period ended September 30, 1998 and
1997 were $188,460,000 and $172,747,000, respectively. The average yield on
loans declined from 8.95% at September 30, 1997 to 8.81% at September 30,
1998. The overall yield on earning assets declined 5 basis points to 8.01%.
The average balance of interest bearing liabilities increased $14,337,000
totalling $216,822,000 at September 30, 1998 when compared to one year ago,
and the average rate paid on interest bearing liabilities increased from
4.17% to 4.24% during the same period. Both the decline in average yield on
loans and the increased rate paid on interest bearing deposits caused an
overall decline in the Company's net interest margin from 4.57% to 4.48%.
Non-interest Income
Non-interest income increased 38% and 22% for the quarter and nine months
ended September 30, 1998 compared to the same periods in 1997. Income from
the sale of non-deposit products and a decline in the losses from an
unconsolidated subsidiary contributed an additional $37,000 to income for the
nine month period ended September 30, 1998 when compared to the same period
last year. Service charges on deposit accounts increased 33% and 15%,
respectively for the quarter and nine months ended September 30, 1998 when
compared to the same periods in 1997.
Non-interest expense
Total non-interest expense, excluding the provision for loan losses,
increased 5% for the quarter ended September 30, 1998 from the comparable
period in 1997. For the nine month period ended September 30, 1998, the
percentage increase in non-interest expenses was 3.5% when compared to the
same period in 1997. Increases in salaries and employee benefits, as well as
a general increase in operating expenses were the cause of the increases.
Analysis of Financial Condition
Loan growth during the nine month period ended September 30, 1998 was funded
through increased deposits, as well as an increase in securities sold under
agreements to repurchase. Investment securities increased $8,106,000 or 13%
totalling $69,585,000 at September 30, 1998 from $61,479,000 at December 31,
1997. Total loans increased $5,535,000 to $190,828,000 at September 30, 1998
from $185,293,000 at December 31, 1997. Total deposits increased $17,159,000
to $242,073,000 from $224,914,000 at December 31, 1997. Securities sold under
agreements to repurchase increased $7,824,000 to $18,088,000 at September 30,
1998 from $10,264,000 at December 31, 1997.
Liquidity and Capital Resources
The Company derives liquidity through increased customer deposits, maturities
in the investment portfolio, loan repayments and income from earning assets.
At September 30, 1998 the Company's liquidity ratio was approximately 22%.
There are no known trends or demands, commitments, events or uncertainties
that management is aware of which will materially affect the Company's
ability to maintain liquidity at satisfactory levels.
<PAGE>
Total Stockholders' equity was $33.7 million at September 30, 1998, 11.5%
higher than one year ago.
Regulatory agencies have adopted various capital standards for financial
institutions, including risk-based capital standards. The primary objectives
of the risk-based capital framework are to provide a more consistent system
for comparing capital positions of financial institutions and to take into
account the different risks among financial institutions' assets and
off-balance sheet items.
Risk-based capital standards have been supplemented with requirements for a
minimum Tier 1 capital to assets ratio (leverage ratio). In addition,
regulatory agencies consider the published capital levels as minimum levels
and may require a financial institution to maintain capital at higher levels.
A comparison of the Company's capital as of September 30, 1998, with the
minimum requirements is presented below.
Minimum
Actual Requirements
------ ------------
Tier 1 Risk-based Capital 17.81% 4.00%
Total Risk-based Capital 19.06% 8.00%
Leverage Ratio 11.69% 3.00%
Loans
The Company maintains an allowance for credit losses based upon its analysis
of non-performing and problem loans, as well as historical credit loss
experience and local economic trends. A loan is placed on nonaccrual when it
is specifically determined to be impaired and principal or interest is
delinquent for 90 days or more.
The following table summarizes past due and non-performing assets of the
company.
<TABLE>
<CAPTION>
September 30, September 30, December 31,
1998 1997 1997
------------- ------------- ------------
<S><C>
Non-performing Assets:
Non-accrual loans 841 1,254 1,282
Other real estate owned 192 216 114
------ ------ ------
1,033 1,470 1,396
Past due loans 697 1,143 1,422
------ ------ ------
Total non-performing and past due loans $1,730 $2,613 $2,818
====== ====== ======
</TABLE>
The following table presents a summary of the activity in the Allowance for
Loan Losses.
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in thousands) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------
<S><C>
Allowance balance - beginning $ 2,524 $ 2,583 $ 2,538 $ 2,728
Charge-offs:
Commercial and other - 37 55 235
Real estate 45 40 172 100
Consumer 19 13 35 68
-------- -------- ------- --------
Totals 64 90 262 403
-------- -------- ------- --------
Recoveries:
Commercial - 4 26 8
Real Estate - 2 19 4
Consumer 3 9 22 21
-------- -------- -------- --------
Totals 3 15 67 33
-------- -------- -------- --------
Net Charge-offs: 61 75 195 370
Provision for loan losses 60 45 180 195
-------- -------- -------- --------
Allowance balance-ending $ 2,523 $ 2,553 $ 2,523 $ 2,553
======== ======== ======== ========
Average Loans outstanding during period $190,085 $174,367 $188,460 $172,747
======== ======== ======== ========
Net charge-offs (annualized) as a percentage of
average loans outstanding during period .13% .17% .14% .29%
======== ======== ========= ========
Allowance for loan losses at period end as a
percentage of average loans 1.33% 1.46% 1.34% 1.48%
======== ======== ========= ========
</TABLE>
<PAGE>
Because the Company's loans are predominately real estate secured, weaknesses in
the local real estate market may have an adverse effect on collateral values.
The Company does not have any concentrations of loans in any particular
industry, nor does it engage in foreign lending activities.
Analysis of Interest Rates and Interest Differentials.
The following table presents the distribution of the average consolidated
balance sheets, interest income/expense and yields earned and rates paid through
the first nine months of the year.
<TABLE>
<CAPTION>
1998 1997
---- ----
- -----------------------------------------------------------------------------------------------------
Average Income* Yield* Average Income* Yield*
(Dollars in thousands) Balance Expense Rate Balance Expense Rate
- -----------------------------------------------------------------------------------------------------
<S><C>
Earning Assets
Investment Securities $ 61,342 $ 2,746 5.99% $ 60,292 $ 2,667 5.90%
Loans 188,460 12,424 8.81 172,747 11,595 8.95
Federal Funds Sold 10,570 441 5.50 9,438 387 5.47
-------- -------- ---- -------- ------- ----
Total earning assets 260,372 15,611 8.01% 242,477 14,649 8.06%
------- ------
Non-interest earning assets 10,876 9,648
-------- --------
Total Assets $271,248 $252,125
======== ========
Interest bearing liabilities
Interest bearing deposits $203,172 $ 6,445 4.24% $191,897 $ 5,995 4.17%
Borrowings 13,650 437 4.22 10,588 339 4.27
-------- ------- ---- -------- ------- ----
Total interest bearing liabilities 216,822 6,882 4.24% 202,485 6,334 4.17%
------ ------
Non-interest bearing liabilities 22,542 20,674
Stockholders' equity 31,884 28,966
-------- --------
Total liabilities and stockholders' equity $271,248 $252,125
======== ========
Net interest spread $ 8,729 3.77% $ 8,315 3.89%
======= =======
Net interest margin 4.48% 4.57%
</TABLE>
* Presented on a tax equivalent basis using its statutory federal corporate
income tax rate of 34%.
Year 2000 Issue
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 1996. 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 September 1997, the Board has been apprised of the Company's efforts
at their regular meetings. In addition, all customers were updated with
respect to the Company's Year 2000 efforts through several mailings sent
in 1998.
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.
<PAGE>
It also included non-information technology systems, such as heating, air
conditioning and vault controls, alarm systems, surveillance systems, time
clocks, coin and currency counters, and postage meters. The Company
inventoried all the systems listed above in October 1997 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 services and major vendor 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 are aware of the issue and are working toward compliance. The
assessment phase is complete, although it is updated periodically as
necessary.
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 it
provides to the Company for Year 2000 compliance. The Company's data
processing for its core services (deposit, loan and related support
processing) is performed by Delmarva Bank Data Processing Center,
Inc.("Delmarva"). Delmarva reports the progress to the Company on a
regular basis. These reports indicate that they are on or ahead of
schedule in all areas.
4. Validation - The next phase for the Company under the plan is to complete
a comprehensive testing of all known processes. Testing with the Company's
primary service provider was completed in August, 1998. All core systems
tested compliant. The Company has performed Year 2000 testing of all
employee computer work stations, and all were either upgraded or replaced
with compliant systems. The testing of the Company's mission critical
processes is expected to be substantially complete by December 31, 1998.
The testing of the remainder of the Company's processes is expected to be
substantially completed by March 31, 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. Senior management has developed and presented to the Board of
Directors an outline for a contingency plan to provide operating alternatives
for continuation of services to the Bank's customers in the event of systems or
communication failures at the beginning of the Year 2000. We expect to complete
the contingency plan by December 31, 1998. Based on preliminary planning during
development of the contingency plan, management believes 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, we will generate paper and spreadsheet backup of all
customer and general ledger accounts. Due to the size of the Bank, we believe
that we would 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. We expect this procedure, if necessary,
to be short term and not materially increase our operating cost, however, if
this procedure were to continue for any extended period of time, or if we
ultimately had to change data service providers, the cost could be material.
The Company is also in the process of assessing the Year 2000 readiness of
significant borrowers and depositors. Surveys of each borrowers' awareness of
the issue and their ability to become compliant are being performed. Surveys of
significant depositors will be performed in the next quarter. This step is not
expected to require a significant amount of time or resources. At this time
Management is not aware of any third party risks.
As of October 31, 1998 the following chart shows the current and projected
status of the Bank's Year 2000 compliance efforts:
Phase 9/28/98 10/15/98 12/31/98 3/31/99 6/30/99
- ----- ------- -------- -------- ------- -------
Awareness 100% -- -- -- --
Assessment 100% -- -- -- --
Renovation 90% 90% 95% 100% --
Validation 40% 60% 80% 90% 100%
<PAGE>
The Company expensed $79,234 on Year 2000 costs during the nine month
period ended September 30, 1998 and $57,986 in 1997. Based on an analysis of
projected expenses performed the total cost of the Year 2000 project is
currently estimated at $280,000. Funding of the Year 2000 project costs will
come from normal operating cash flow, however, the majority of expenses
associated with the Year 2000 Issue are the cost of existing personnel and will
not have a material effect on the reported net income for the Company. Should
the Company have to resort to alternative operating procedures due to major
systems or communication failures at the beginning of the Year 2000, the extra
costs could be material. Other projects have been delayed due to time spent on
the Year 2000 project, however, these have not had a material effect on our
financial condition or results of operations.
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 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, vendors' abilities
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, such as Compass, 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.
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company utilizes a simulation model to quantify the effect a hypothetical
plus or minus 200 basis point change in rates would have on net interest income
and the fair value of capital. The model takes into consideration the effect of
call features of investments as well as repayments of loans in periods of
declining rates. When actual changes in interest rates occur the changes in
interest earning assets and interest bearing liabilities may differ from the
assumptions used in the model. As of June 30, 1998 the model produced the
following sensitivity profile for net interest income and the fair value
capital:
<TABLE>
<CAPTION>
Immediate Change in Rates
-----------------------------------------------------
+200 Basis Points -200 Basis Points Policy Limit
- ------------------------------------------------------------------------------------------
<S><C>
% Change in Net Interest Income 11.03% (12.14%) +/-25%
% Change in Fair Value of Capital 8.76% (13.10%) +/-15%
</TABLE>
Part II
Other Information
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits
Exhibit 27 - Financial Data Schedule
b) No Forms 8-K filed.
<PAGE>
Signatures
Under the requirements of the Securities Exchange Act of 1934, the Company has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
TALBOT BANCSHARES, INC.
Date:November 12, 1998 By: /s/ W. Moorhead Vermilye
________________________________
W. Moorhead Vermilye
President
Date:November 12, 1998 By: /s/ Susan E. Leaverton
________________________________
Susan E. Leaverton, CPA
Treasurer/Principal Accounting Officer
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements as of and for the period ended September 30, 1998, and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<CIK> 0001043056
<NAME> TALBOT BANCSHARES, INC.
<MULTIPLIER> 1,000
<CURRENCY> USD
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 6,552
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<LOANS> 190,828
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0
0
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<NET-INCOME> 2,924
<EPS-PRIMARY> 2.46
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<LOANS-NON> 841
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<LOANS-PROBLEM> 5,100
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</TABLE>
