<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999
000-22929
------------------------
Commission File No.
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
Securities Registered under Section 12(b) of the Act:
None.
Securities Registered under Section 12(g) of the Act:
Common Stock Par Value $.01
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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendement to this Form 10-K. X
The aggregate market value of the Corporation's voting stock held by non-
affiliates of the registrant as of March 22, 2000 was $54,893,318
The number of shares outstanding of the registrant's common stock, as
of March 22, 2000 was 1,193,333.
<PAGE>
Documents Incorporated by Reference
Portions of Talbot Bancshares, Inc definitive Proxy Statement for its 2000
Annual Stockholders' Meeting, as filed with the Commission on March 24, 2000 are
incorporated by reference into Part III of this report. Portions of the Annual
Report to Stockholders for the year ended December 31, 1999 are incorporated by
reference into Parts I and II of this report. Except for parts of the Talbot
Bancshares, Inc. Annual Report expressly incorporated herein by reference, this
Annual Report in not to be deemed filed with the Securities and Exchange
Commission.
<TABLE>
<CAPTION>
FORM 10K INDEX
Page(s)
Part I
<S> <C>
Item 1. Business 3
Item 2. Properties 10
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 11
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 7a. Quantitative and Qualitative Disclosures About Market Risk 11
Item 8. Financial Statements and Supplementary Data 12
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 12
Part III
Item 10. Directors and Executive Officers of the Registrant 12
Item 11. Executive Compensation 12
Item 12. Security Ownership of Certain Beneficial Owners and Management 12
Item 13. Certain Relationships and Related Transactions
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 12
</TABLE>
2
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Talbot Bancshares, Inc. (the "Company") is a Maryland corporation organized on
March 10, 1997 which became a registered bank holding company on May 1, 1997
under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The
Company engages in the business of banking through its sole subsidiary The
Talbot Bank of Easton, Maryland (the "Bank"), a commercial bank chartered under
the laws of the State of Maryland. The Company acquired the Bank under a Plan of
Reorganization and Share Exchange (the "Plan") proposed by management and
approved by the Bank's stockholders at their annual meeting held April 23, 1997.
Pursuant to the Plan each share of Bank stock was exchanged for two shares of
Company stock. The Bank's charter was not affected by the reorganization. The
Company has issued and outstanding 1,193,333 shares of common stock , par value
$0.01 per share ("Shares") held by 460 holders of record March 22, 2000.
The Bank currently accounts for substantially all of the Company's assets. The
deposits of the Bank are insured by the Federal Deposit Insurance Corporation
("FDIC"). The Company's and the Bank's main office is located in Talbot County,
Maryland, at 18 East Dover Street, Easton, Maryland 21601. The Bank commenced
operation in 1885 and is engaged in general commercial and retail banking
business serving individuals and businesses in Talbot and Dorchester Counties,
Maryland. The Bank currently operates four banking offices in Talbot County,
three in Easton, Maryland and one in Saint Michaels, Maryland. The Bank also
operates a branch in Dorchester County, Maryland in the city of Cambridge. At
December 31, 1999 the Company had total assets of $327 million, total loans of
$219 million and total deposits of $274 million.
PRINCIPAL SERVICES
The Bank is an independent community bank providing service to businesses and
individuals in its market area. Services offered are essentially the same as
those offered by larger regional institutions which compete with the Bank.
Services provided to businesses include commercial checking, savings,
certificate of deposit and overnight investment sweep accounts. The Bank offers
all forms of commercial lending including secured and unsecured loans, working
capital loans, lines of credit, term loans, accounts receivable financing, real
estate acquisition development, construction loans and letters of credit. Direct
Deposit of payroll, PC banking and telephone banking services are also
available.
Services to individuals include checking accounts, various savings programs,
mortgage loans, home improvement loans, installment and other personal loans,
credit cards, personal lines of credit, automobile and other consumer financing,
safe deposit services, debit cards, 24 hour telephone banking, PC banking, and
24 hour automatic teller machine services through the HONOR network. The Bank
has a branch in Cambridge, Maryland offering full service banking 6 days per
week with extended hours.
LENDING ACTIVITIES
The Company originates secured and unsecured loans for business purposes. It is
typical for commercial loans to be secured by real estate, accounts receivable,
inventory equipment or other assets of the business. Commercial loans generally
involve a greater degree of credit risk than one to four family residential
mortgage loans. Repayment is often dependent on the successful operation of the
business and may be affected by adverse conditions in the local economy or real
estate market. The financial condition and cash flow of commercial borrowers is
therefore, carefully analyzed during the loan approval process, and continues to
be monitored by obtaining business financial statements, personal financial
statements and income tax returns. The frequency of this on going analysis
depends upon the size and complexity of the credit and collateral which secures
the loan. It is also the Company's general policy to obtain personal guarantees
from the principals of the commercial loan borrowers.
The Company provides residential real estate construction loans to builders and
individuals for single family dwellings. Residential construction loans are
usually granted based upon "as completed" appraisals and are secured by the
property under construction. Additional collateral may be taken if loan to value
ratios exceed 75%. Site inspections are performed to determine pre-specified
stages of completion before loan proceeds are disbursed. These loans typically
have maturities of six
3
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to twelve months and may be fixed or variable rate. Permanent financing for
individuals offered by the Company includes fixed rate loans with three year
balloons, or variable rate loans with five year balloons. Permanent financing is
often provided by third party lenders for borrowers seeking longer term fixed
rate loans.
The risk of loss associated with real estate construction lending is controlled
through conservative underwriting procedures such as loan to value ratios of 75%
or less, obtaining additional collateral when prudent, and closely monitoring
construction projects to control disbursement of funds on loans.
The Company originates fixed and variable rate residential mortgage loans. As
with any consumer loan, repayment is dependent on the borrower's continuing
financial stability which can be adversely impacted by job loss, divorce,
illness, or personal bankruptcy. Underwriting standards recommend loan to value
ratios of 75% based on appraisals performed by approved appraisers of the
Company. Title insurance protecting the Company's lien priority as well as fire,
and casualty insurance are required.
Commercial real estate loans are primarily those secured by office condominiums,
retail buildings, warehouses and general purpose business space. The risk
associated with these loans is reduced by low loan to value ratio standards as
well as the thorough financial analysis performed and the Company's knowledge of
the local economy in which it lends.
A variety of consumer loans are offered to customers including home equity
loans, credit cards and other secured and unsecured lines of credit and term
loans. Careful analysis of an applicant's creditworthiness is performed before
granting credit and on going monitoring of loans outstanding is performed in an
effort to minimize risk of loss by identifying problem loans early.
COMPETITIVE CONDITIONS
The Bank is subject to substantial competition in all aspects of its business.
The Bank competes principally with five other commercial banks which operate
offices in Talbot County, four of which have resources substantially greater
than the Bank's. In Dorchester County the Bank competes principally with seven
other commercial banks and one savings bank. The Bank also encounters
competition from consumer loan companies, brokerage firms, credit unions and
other nonbank institutions in both Talbot and Dorchester counties. The Bank
engages in traditional marketing activities such as advertising in local
newspapers, trade journals and other publications, and radio advertising.
Officers, Directors and employees of the Bank represent the bank through their
involvement on boards of nonprofit organizations and other community
organizations, as well as their participation in community events. The Bank also
relies on referrals from satisfied customers.
The following table sets forth deposit data for Talbot and Dorchester Counties
as of June 30, 1999, the most recent date for which comparative information is
available.
<TABLE>
<CAPTION>
% of
Talbot County Deposits Total
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
The Talbot Bank of Easton, Maryland $232,339 39.61%
St. Michaels Bank 110,154 18.78
NationsBank, National Association 82,204 14.01
Crestar Bank 58,330 9.94
Easton Bank & Trust 40,844 6.96
Farmers Bank 29,354 5.01
Allfirst Bank 28,495 4.86
First Mariner Bank 4,877 .83
---------- --------
Total $586,597 100.00%
======== =======
</TABLE>
Source: FDIC DataBook
4
<PAGE>
<TABLE>
<CAPTION>
% of
Dorchester County Deposits Total
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
The National Bank of Cambridge $129,704 34.21%
Bank of the Eastern Shore 92,359 24.36
NationsBank, National Association 30,452 8.03
Atlantic Bank 28,987 7.65
Hebron Savings Bank 32,459 8.56
Allfirst Bank 26,223 6.92
Crestar Bank 18,851 4.97
Provident State Bank of Preston, Maryland 15,106 3.99
The Talbot Bank of Easton, Maryland 4,963 1.31
-------- ------
Total $379,104 100.00%
======== ======
</TABLE>
Source: FDIC DataBook
SUPERVISION AND REGULATION
The following is a summary of the material regulations and policies applicable
to the Company and its subsidiaries and is not intended to be a comprehensive
discussion. Changes in applicable laws and regulations may have a material
effect on the business of the Company and Bank.
General
The Company is a bank holding company, registered with the Federal Reserve under
the BHC Act and as such is subject to the supervision, examination and reporting
requirements of the BHC Act and the regulations of the Federal Reserve Board
(the "FRB").
The Bank is a state chartered bank in Maryland and is a member of the Federal
Deposit Insurance Corporation (the "FDIC"). The Bank is subject to the
regulation, supervision, and reporting requirements of the FDIC, as well as the
Maryland Commissioner of Financial Regulation. The Bank is also subject to
numerous state and federal statutes and regulations that affect its business,
activities.
Regulation of Bank Holding Companies
Under the BHC Act, the company may not directly or indirectly acquire the
ownership or control of five percent or more of the voting shares or
substantially all of the assets of any company, including a bank, without the
prior approval of the FRB. The BHC Act also restricts the types of businesses
and activities in which a bank holding company and its subsidiaries may engage.
Activities are generally limited to those which the FRB finds to be closely
related to, or incidental to, the business of banking.
Pursuant to the Gramm-Leach Bliley Act, the Company has elected to become a
"financial holding company" and may engage in activities that are in addition to
the business of banking. A financial holding company may engage in a full range
of financial activities, including, insurance and securities sales and
underwriting activities, and real estate development, with new expedited notice
procedures. The Gramm-Leach-Bliley Act is described in more detail below.
Subsidiary banks of bank holding companies are subject to certain statutory
limits of the transfer of funds to the holding company or any of its nonbank
subsidiaries, whether in the form of loans or other extensions of credit,
investments in their securities and on the use of their securities as collateral
for loans to any borrower. Such transfers of a subsidiary bank to a holding
company or one of its nonbanking subsidiaries is limited in amount, and such
loans and extensions of credit are required to be collateralized in specified
amounts.
Under FRB policy, the Company is expected to act as a source of strength to its
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
5
<PAGE>
when required. In addition, under the Financial Institutions Reform, Recovery
and Enforcement Act of 1989 ("FIRREA"), depository institutions insured by the
FDIC can be held liable for any losses incurred by, or reasonably anticipated to
be incurred by, the FDIC in connection with (i) the default of a commonly
controlled FDIC-insured depository institution or (ii) any assistance provided
by the FDIC to a commonly controlled FDIC-insured depository institution in
danger of default. 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 obligations of a financial institution to its stockholders and
obligations to other affiliates.
Capital Requirements
The Company is 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 financial statements. Under capital adequacy guidelines there are two
basic measures: a risk-based measure and a leverage measure.
The risk-based capital guidelines are established to make regulatory capital
requirements more sensitive to risk profiles of banks and bank holding companies
and to account for off balance sheet exposure. Assets and off balance sheet
items are assigned to broad risk categories, each with appropriate weights.
A banking organization's capital is divided into two tiers. "Tier 1", or core
capital, includes common equity, retained earnings, minority interest in the
equity accounts of consolidated subsidiaries, noncumulative perpetual preferred
stock, and a limited amount of cumulative perpetual preferred stock, less
goodwill and certain other intangible assets. "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. "Total Capital" is the sum of Tier 1
and Tier 2 capital. The Tier 1 component must comprise at least 50% of
qualifying total capital. Regulatory guidelines require a minimum of total
capital to risk-adjusted assets ratio of 8 percent and a minimum Tier 1 capital
to risk weighted assets ratio of 4 percent. Institutions which meet or exceed a
Tier 1 ratio of 6 percent, a total capital ratio of 10 percent and a tier 1
leverage ratio of 5 percent are considered well capitalized by regulatory
standards.
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) a recapitalization of the Bank Insurance Fund of
the FDIC (the "BIF") by increasing the FDIC's borrowing authority and providing
for adjustments in its assessment rates; (ii) annual on-site examinations of
federally-insured depository institutions by banking regulators; (iii) publicly
available annual financial condition and management reports for financial
institutions, including audits by independent accountants; (iv) the
establishment of uniform accounting standards by federal banking agencies; and
(v) the establishment of a "prompt corrective action" system of regulatory
supervision and intervention, based on capitalization levels, with more scrutiny
and restrictions placed on institutions with lower levels of capital.
FDICIA establishes a system of prompt corrective action to resolve the problems
of undercapitalized institutions. Under this system the federal banking
regulators are required to rate supervised institutions on the basis of five
capital categories: "well-capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized;" and to take certain mandatory actions, and are authorized to
take other discretionary actions, with respect to institutions in the three
undercapitalized categories. The severity of the actions will depend upon the
category in which the institution is placed. A depository institution is "well
capitalized" if it has a total risk based capital ratio of 10% of greater, a
Tier 1 risk based capital ratio of 6% of greater, and a leverage ratio of 5% or
greater and is not subject to any order, regulatory agreement, or written
directive to meet and maintain a specific capital level for any capital measure.
An "adequately capitalized" institution is defined as one that has a total risk
based capital ratio of 8% of greater, a Tier 1 risk based capital ratio of 4% or
greater and a leverage ratio of 4% or greater (or 3% or greater in the case of a
bank with a composite CAMEL rating of 1).
6
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FDICIA generally prohibits a depository institution from making any capital
distribution, including the payment of cash dividends, or paying a management
fee 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. For a capital
restoration plan to be acceptable, the depository institution's parent holding
company must guarantee (subject to certain limitations) that the institution
will comply with such capital restoration plan.
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 and requirements to
reduce total assets and stop accepting deposits from correspondent banks.
Critically undercapitalized depository 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.
At December 31, 1999 the Bank had the necessary capital levels to be considered
"well capitalized."
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 tot he acquisition of banks by out
of state bank holding companies are eliminated effective September 29, 1995. The
law also permitted interstate branching by banks effective 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.
Gramm-Leach Bliley Act
In November, 1999 the Gramm-Leach Bliley Act ("GLBA") was signed into law.
Effective in pertinent part on March 11, 2000, GLBA revises the Bank Holding
Company Act of 1956 and repeals the affiliation provisions of the Glass-Steagall
Act of 1933, which, taken together, limited the securities, insurance and other
non-banking activities of any company that controls an FDIC insured financial
institution. Under GLBA, bank holding companies can elect, subject to certain
qualifications, to become a "financial holding company." GLBA provides that a
financial holding company may engage in a full range of financial activities,
including insurance and securities sales and underwriting activities, and real
estate development, with new expedited notice procedures.
Maryland law generally permits Maryland state chartered banks, including the
Bank, to engage in the same activities, directly or through an affiliate, as
national banking associations. GLBA permits certain qualified national banking
associations to form financial subsidiaries, which have broad authority to
engage in all financial activities except insurance underwriting, insurance
investments, real estate investment or development, or merchant banking. Thus,
the GLBA has the effect of broadening the permitted activities of Maryland state
chartered banks.
Effects of Monetary Policy
The Company and its bank subsidiary are effected by the ongoing and changing
monetary policies set forth by regulatory authorities including the FRB. Through
its powers the FRB can influence the supply of bank credit and affect the level
of economic activity. Changes in the discount rate and reserve requirements are
among the instruments used to influence the market. These influences can impact
the overall growth and distribution of bank loans, investments, and deposits,
and can also, affect the rates charged on loans and paid for deposits.
The monetary policies of the FRB have in the past and will continue to affect
the operating results of all financial institutions including Talbot Bancshares,
Inc., and its subsidiary.
Federal Securities Law
The Company's common stock is registered with the SEC under Section 12(g) of the
Securities and Exchange Act of 1934 , as amended (the "Exchange Act"). The
Company is subject to information, proxy solicitation, insider trading
restrictions and other requirements under the Exchange Act.
7
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EMPLOYEES
At March 22, 2000 the Company and the Bank had 81 full-time employees and 4
part-time employees.
SEASONALITY
Seasonality does not have a material impact on the Company's operations.
RISK FACTORS
Regulatory Risks. The banking industry is subject to many laws and regulations.
Regulations protect depositors, not stockholders. The Maryland Division of
Financial Regulation, Federal Deposit Insurance Corporation 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 put the Company at a disadvantage with less regulated
competitors, such as finance companies, mortgage banking companies, and leasing
companies.
Exposure to Local Economic Conditions. Most of the loans made by the Bank are
made to Maryland 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 established by
competition, the Company cannot completely control its net interest income.
Risks Associated with Real Estate Lending. The Bank makes many real estate
secured loans. Real estate loans are in 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. Many of these factors are beyond the Company's
control.
Competition. Other banks and non-banks, including savings and loan associations,
credit unions, insurance companies, leasing companies, small loan companies,
finance companies, and mortgage companies, compete with the Company. Some of the
Company's competitors offer services and products that the Company does not
offer. Larger banks and non-bank lenders can make larger loans and service
larger customers. Law changes now permit interstate banks which may increase
competition. Increased competition may decrease the Company's earnings.
No Assurance of Cash or Stock Dividends. Whether dividends may be paid to
stockholders depends on the Company's earnings, its capital needs, law and
regulations, and other factors. The Company's payment of dividends in the past
does not mean that the Company will be able to pay dividends in the future.
Stock Not Insured. Investments in the shares of the Company's common stock are
not deposits that are insured against loss by the government.
Risk Involved in Acquisitions. Part of the Company's growth may come from buying
other banks and companies. A newly purchased bank or company may not be
profitable after the Company buys it and may lose money, particularly at first.
The new bank or company may bring with it unexpected liabilities or bad loans,
bad employee relations, or the new bank or company may lose customers.
8
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Risk of Claims. Customers may sue the Company for losses due to the Company's
alleged breach of fiduciary duties, errors and omissions of employees, officers
and agents, incomplete documentation, the Company's failure to comply with
applicable laws and regulations, or many other reasons. Also, employees of the
Company conduct all of the Company's business. The employees may knowingly or
unknowingly violate laws and regulations. Company management may not be aware of
any violations until after their occurrence. This lack of knowledge will not
insulate the Company from liability. Claims and legal actions may result in
legal expenses and liabilities that may reduce the Company's profitability and
hurt its financial condition.
Developments in Technology. Financial services use technology, including
telecommunications, data processing, computers, automation, Internet-based
banking, debit cards, and "smart" cards. Technology changes rapidly. The
Company's ability to compete successfully with other banks and non-banks may
depend on whether it can exploit technological changes. The Company may not be
able to exploit technological changes and expensive new technology may not make
the Company more profitable.
Market for Common Stock. The Company's shares of common stock are not listed on
any exchange, and there is currently no organized trading market. Prices for the
Company's common stock may not be the actual value or the trading price in a
liquid trading market.
Anti-Takeover Effects of Certain Charter and Bylaw Provisions. The Company's
Articles of Incorporation and Bylaws divide the Company's Board of Directors
into three classes and each class serves for a staggered three-year term. No
director may be removed except for cause, and then only by a vote of at least
two-thirds of the total eligible stockholder votes. In addition, Maryland law
contains anti-takeover provisions that apply to the Company. These provisions
may discourage or make it more difficult for another company to buy the Company
or may reduce the market price of the Company's common stock.
STATISTICAL INFORMATION
<TABLE>
<CAPTION>
Maturities of Loan Portfolio
ecember 31, 1999
(In Thousands)
Maturing
Maturing After one Maturing
Within But Within After Five
One Year Five Years Years Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Real Estate Construction
and land development $ 5,092 $6,276 $ - $ 11,368
Commercial, financial and agricultural 24,341 26,251 2,822 53,414
Mortgage 38,031 98,784 9,388 146,203
Consumer 4,171 3,378 242 7,791
-------- ------- ------ --------
Total $71,635 $134,689 $12,452 $218,776
======= ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
Classified by Sensitivities of Loans to Changes in Interest Rates
<S> <C> <C> <C> <C>
Fixed-Interest Rate Loans $51,751 $122,076 $10,212 $184,039
Adjustable-Interest Rate Loans 19,884 12,613 2,240 34,737
------- ------- ------ -------
Total $71,635 $134,689 $12,452 $218,776
======= ======== ======= ========
</TABLE>
9
<PAGE>
Allocation of the Allowance for Credit Losses
(In Thousands)
<TABLE>
<CAPTION>
December 31,
1999 1998 1997 1996 1995
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial Financial and Agricultural $1,219 $767 $880 $883 $768
Real Estate-Construction 54 92 100 71 69
Real Estate-Mortgage 1,241 1,004 944 936 984
Consumer 229 148 238 155 138
Unallocated - 571 376 683 118
---------- ------ ------ ------ ------
$2,743 $2,582 $2,538 $2,728 $2,077
====== ====== ====== ====== ======
</TABLE>
Other statistical information required in this Item 1 is incorporated by
reference from the information appearing in the Company's Annual Report to
Stockholders for the year ended December 31, 1999, as follows:
<TABLE>
<CAPTION>
DISCLOSURE REQUIRED BY GUIDE 3 REFERENCE TO 1999 ANNUAL REPORT
- ------------------------------ -------------------------------
<S> <C>
(I) Distribution of Assets, Liabilities and Average Balances; Yields and Rates (page 4)
Stockholders' Equity; Interest Rates and Rate/Volume Analysis (page 5)
Interest Differential Non-performing Assets (page 7)
(II) Investment Portfolio Weighted Average Maturities and
Weighted Average Yields (page 9)
Notes to Financial Statements, Note 3 - Investment in
Debt Securities - (pages 23 and 24)
(III) Loan Portfolio Year End Loan Composition (page 10)
Non-performing Assets (page 7)
(IV) Summary of Loan Loss Experience Provision and Allowance for Credit Losses (page 6)
(V) Deposits Deposits (pages 10 and 11)
(VI) Return on Equity and Assets Return on Equity and Assets (page 15)
(VII) Short-Term Borrowings Short Term Borrowings (page 11)
Notes to Financial Statements, Note 8-Short Term
Borrowings (page 27)
Notes to Financial Statements, Note 14 -
Line of Credit (page 33)
</TABLE>
Item 2. PROPERTIES
The Company's and the Bank's main office is located at 18 East Dover Street,
Easton, Maryland. A second Easton office is located on Marlboro Road at Tred
Avon Square and the Third Easton office is located on Elliott Road in the
Carlton Business Park. The Saint Michaels office is located on Route 33 at Saint
Michaels Village.
The Bank owns three of the four banking offices it currently operates in Talbot
County. The Bank leases the office located on Route 33 in Saint Michaels
Village. The annual rent for this office which lease expires in 2001 is $36,700.
10
<PAGE>
The Bank also owns the building at 21 Dover Street, Easton, Maryland which
contains its bookkeeping and loan services departments.
The Bank operates a branch in Cambridge, Maryland, located at 2745 Dorchester
Square Shopping Center pursuant to a lease agreement. The annual rent under this
lease agreement is $42,360.
Item 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings other than the ordinary routine
litigation incidental to the business to which the Company, the Bank, or its
subsidiaries is a party or to which any of their properties is subject. There
are also no material proceedings known to management 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, or any associate of any such
Director, officer or security holder is a party.
Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to security holders for vote during the fourth quarter
of 1999. Information required for this Item for Executive Officers of the
Registrant is included in Item 10 -- "Directors and Executive Officers of the
Registrant" which is incorporated herein by reference.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Incorporated by reference from Annual Report to Stockholders for the year ended
December 31, 1999 under "Managements Discussion and Analysis of Financial
Condition and Results of Operations - Recent Stock Prices and Dividends," page
14, and "Notes to Financial Statements - Regulatory Capital Requirements" on
pages 32 and 33. The Company has issued and outstanding 1,193,333 shares of
common stock, par value $0.01 per share ("Shares") held by 460 holders of record
March 22, 2000.
Item 6. SELECTED FINANCIAL DATA
Incorporated by reference from Annual Report to Stockholders for the year ended
December 31, 1999, page 15.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Incorporated by reference from Annual Report to Stockholders for the year ended
December 31, 1999 under "Managements Discussion and Analysis of Financial
Condition and Results of Operations," pages 3 through 14. Reference is also made
to the information provided under the heading "Statistical Information" in Part
I, Item I, 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 "Managements Discussion and Analysis of Financial Condition and Results of
Operations, Market Risk and Interest Rate Sensitivity" on pages 12 and 13 of the
Annual Report to Stockholders for the year ended December 31, 1999. The
Company's principal market risk exposure is to interest rates.
11
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Incorporated by reference from the Annual Report to Stockholders for the year
ended December 31, 1999 under "Consolidated Financial Statements and Independent
Auditors' Report" on pages 16 through 37.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on accounting and
financial disclosure.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A listing of Directors of the Registrant is incorporated by reference from
Definitive Proxy Statement to Stockholders for the 2000 Annual Meeting under
"Election of Directors," pages 1 through 4.
A listing of Executive Officers of the Registrant is incorporated by reference
from the Definitive Proxy Statement to Stockholders for the 2000 Annual Meeting
under "Executive Officers, " page 12.
A description of compliance with reporting requirements under Section 16(a) of
the Securities and Exchange Act is incorporated by reference from the Definitive
Proxy Statement to Stockholders for the 2000 Annual Meeting "Section 16(a)
Beneficial Ownership Reporting Compliance."
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference from the Definitive Proxy Statement to Stockholders
for the 2000 Annual Meeting under "Executive Compensation, Benefit Plans and
Executive Compensation Committee Report," pages 7 through 11, under "Performance
Graph," pages 12 and 13, and the Director compensation discussion on page 5.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the Definitive Proxy Statement to Stockholders
for the 2000 Annual Meeting under "Beneficial Ownership of Common Stock," pages
5 through 7.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the Definitive Proxy Statement to Stockholders
for the 2000 Annual Meeting under "Election of Directors" pages 1 through 5.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1),(2) FINANCIAL STATEMENTS
Consolidated Statements of Income -- Years Ended December 31,
1999, 1998, and 1997
Consolidated Balance Sheets at December 31, 1999 and 1998
Consolidated Statements of Changes in Stockholders' Equity -- Years
Ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows -- Years Ended December 31,
1999, 1998 and 1997
Notes to Consolidated Financial Statements as of December 31, 1999,
1998 and 1997
Report of Independent Auditors
(3) Exhibits Required to be Filed by Item 601 of Regulation S-K
<PAGE>
12
EXHIBIT INDEX
3.1 Articles of Incorporation of the Company is incorporated by reference
from the Company's Form 8-A, filed with the Commission on August 1,
1997 (File No. 000-22929)
3.2 Bylaws of the Company is incorporated by reference from the Company's
Form 8-A, filed with the Commission on August 1, 1997 (File No.
000-22929)
13 1999 Annual Report to Stockholders filed herewith.
21 List of Subsidiaries is incorporated by reference from the Company's
Form 8-K, filed with the Commission on August 25, 1997 (File No.
000-22929)
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 required by Item 601 of Regulation S-K
See the Exhibits described in Item 14(a)(3) above.
13
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on March 29, 2000.
Talbot Bancshares, Inc.
Date: March 29, 2000 By: /s/W. Moorhead Vermilye
-----------------------
W. Moorhead Vermilye
Date: March 29, 2000 By: /s/ Susan E. Leaverton
----------------------
Susan E. Leaverton, Secretary/Treasurer
(Principal Accounting and Financial Officer)
DIRECTORS
/s/ Herbert L. Andrew, III
-------------------------------
Herbert L. Andrew, III
/s/ Jerome M. McConnell
-------------------------------
Jerome M. McConnell
-------------------------------
Blenda W. Armistead
/s/ Shari L. McCord
-------------------------------
Shari L. McCord
/s/Lloyd L. Beatty, Jr.
-------------------------------
Lloyd L. Beatty, Jr.
-------------------------------
William H. Myers
/s/Donald D. Casson
-------------------------------
Donald D. Casson
/s/David L. Pyles
-------------------------------
David L. Pyles
/s/Gary L. Fairbank
-------------------------------
Gary L. Fairbank
/s/Christopher F. Spurry
-------------------------------
Christopher F. Spurry
/s/Ronald N. Fox
-------------------------------
Ronald N. Fox
/s/Richard C. Granville
-------------------------------
Richard C. Granville
/s/W. Moorhead Vermilye
-------------------------------
W. Moorhead Vermilye
14
<PAGE>
[LOGO] TALBOT
BANKSHARES
----------
INC.
1999
ANNUAL
REPORT
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Percent
Increase
Years ended December 31, 1999 1998 (Decrease)
- ----------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
<S> <C> <C> <C>
For the Year
Interest income $ 22,377 $ 21,048 6.3%
Interest expense 9,891 9,463 4.5%
Net interest income 12,486 11,585 7.8%
Net income 4,520 4,015 12.6%
Cash dividends 1,371 1,131 21.2%
- ----------------------------------------------------------------------------------------------------------
Average
Total assets $309,126 $279,177 10.7%
Total deposits 255,270 230,944 10.5%
Total loans 207,786 189,606 9.6%
Stockholders' equity 35,248 32,857 7.3%
- ----------------------------------------------------------------------------------------------------------
At Year End
Total assets $327,069 $302,254 8.2%
Total deposits 273,948 249,929 9.6%
Total loans, net of unearned income 218,776 194,363 12.6%
Stockholders' equity 35,882 34,284 4.7%
- ----------------------------------------------------------------------------------------------------------
Per Share
Basic net income $3.79 $3.37 12.5%
Diluted net income 3.72 3.33 11.7%
Cash dividends 1.15 .95 21.1%
Book value at year-end 30.07 28.76 4.6%
- ----------------------------------------------------------------------------------------------------------
</TABLE>
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS PAGE 1
LETTER TO SHAREHOLDERS PAGE 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PAGE 3
SELECTED FINANCIAL DATA PAGE 15
CONSOLIDATED FINANCIAL STATEMENTS PAGE 16
INDEPENDENT AUDITORS' REPORT PAGE 36
DIRECTORS AND OFFICERS PAGE 37
DESCRIPTION OF BUSINESS AND EMPLOYEES PAGE 38
PAGE 1
<PAGE>
[LOGO]--------------------------------------------------------------------------
LETTER TO SHAREHOLDERS
Dear Shareholder,
I am pleased to present the enclosed audited financial statements for Talbot
Bancshares, Inc. This year we mark the sixth consecutive year of earnings growth
for the Company. Net income was $4,519,962 or $3.72 per share compared to
$4,014,686 or $3.33 per share for 1998. This represents an increase in net
income of 12.6% for the year. Return on average stockholders' equity and return
on average assets both increased totalling 12.82% and 1.46%, respectively.
Return on average stockholders' equity and return on average assets were
12.22% and 1.44%, respectively for 1998.
Growth in assets in 1999 was driven by loan growth. Total assets of the Company
were $327,069,267, an 8.2% increase over 1998. Loans totalled $218,776,099 at
December 31, 1999, an increase of $24,412,738 or 12.6% for the year when
compared to 1998. This growth was funded primarily by a 9.6% increase in
deposits. Total deposits were $273,948,351 at December 31, 1999.
Net interest income, the driving force behind earnings growth, increased
$900,596 or 7.8% for 1999. Although the Company's net interest margin declined
14 basis points during the year, increased volume of earning assets and a
decline in rates paid for interest bearing liabilities contributed to increased
net interest income. The net interest margin, on a tax equivalent basis, for
1999 was 4.25% compared to 4.37% in 1998. Another positive factor contributing
to increased earnings in 1999 was growth in noninterest income of $198,014. This
increase is the result of service charge policy changes, implemented in mid year
1998, which were in effect for the full year as well as a decline in losses from
an unconsolidated subsidiary which is in the process of liquidation.
Many efforts expended in 1999 relating to the final preparation for the century
date rollover were successful as the Company experienced no customer service
interruptions or reporting errors on January 1, 2000. The operations staff of
the Company are commended on the successful completion of this enormous task.
The Company began evaluating internet banking solutions in late 1999 and entered
into an agreement with a vendor to provide this service in 2000. We anticipate
the internet banking system will be available to customers in the second quarter
of 2000.
The Board of Directors was pleased to increase the cash dividends paid on common
stock in 1999 by 21% over 1998. Cash dividends for 1999 totalled $1.15 per share
compared to $.95 per share for 1998. Capital ratios remain well above regulatory
minimums with total risk based capital of 17.78% and the leverage capital ratio
of 11.47%.
We look forward to the opportunities and challenges that the new millennium
presents to the banking industry. Technology and regulatory reform will provide
many opportunities for us to expand services in the next several years.
Alternative delivery systems, such as internet banking, are already being
implemented. We also recognize the need to expand nontraditional banking
services, such as investment services and sales of insurance products, to
generate additional income for the Company. We continue to look for
opportunities to enhance shareholder value.
Thank you for your continued support of The Talbot Bank and Talbot Bancshares,
Inc.
/s/ W. Moorhead Vermilye
---------------------------
W. MOORHEAD VERMILYE
President
PAGE 2
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Talbot Bancshares, Inc. (the "Company") is a one-bank holding company which was
formed on May 1, 1997. The Company is based in Easton, Maryland and is the sole
shareholder of The Talbot Bank of Easton, Maryland (the "Bank"). The Bank
commenced operations in 1885 and is a Maryland chartered commercial bank
providing general commercial banking services in Talbot and Dorchester Counties
in Maryland. The Bank provides a full range of financial services to
individuals, businesses and other organizations at five conveniently located
branches and nine Automated Teller Machines ("ATM's"). Deposits are insured by
the Federal Deposit Insurance Corporation (the "FDIC").
Services provided to businesses include commercial checking, savings and related
depository services. The Bank offers all forms of commercial lending including
lines of credit, term loans, accounts receivable financing, commercial and
construction real estate, and other forms of secured financing.
Services provided to individuals include checking accounts, various savings
programs, mortgage loans, home improvement loans, installment and other personal
loans, credit cards, personal lines of credit, automobile and other consumer
financing, safe deposit services, debit cards, 24 hour ATM's, telephone banking
and PC Banking.
FORWARD LOOKING STATEMENTS
Portions of this Annual Report contain forward looking statements within the
meaning of The Private Securities Litigation and Reform Act of 1995. Such
statements are not historical facts and include expressions about the Company's
confidence, policies, and strategies, the adequacy of capital levels and
liquidity. Such forward-looking statements involve certain risks and
uncertainties, including general economic conditions, competition in the
geographic and business areas in which the Company and its affiliates operate,
inflation, fluctuations in interest rates, legislation, and governmental
regulation. These risks and uncertainties are described in more detail in the
Company's Form 10-K, under the heading "Risk Factors". Actual results may differ
materially from such forward-looking statements, and the Company assumes no
obligation to update forward-looking statements at any time.
OVERVIEW
Net income increased for the sixth consecutive year, totalling $4.52 million at
December 31, 1999. This represents a 12.6% increase over the $4.02 million net
income for 1998. On a per share basis, fully diluted net income was $3.72
compared to $3.33 for 1998. Return on average assets and return on shareholders'
equity for 1999 were 1.46% and 12.82%, respectively.
Total assets of the Company increased 8.2% in 1999 totalling $327 million. Total
asset growth was comprised primarily of growth in loans and federal funds sold.
This growth was funded by increased deposits and a decline in investment
securities. Total loans increased $24.4 million or 12.6%, totalling $218.8
million at December 31, 1999. Total deposits increased $24 million or 9.6%,
totalling $273.9 million at December 31, 1999.
---------------------
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income remains the most significant component of the Company's
earnings. It is the excess of interest and fees earned on loans, federal funds
sold, and investment securities, over interest paid to depositors and interest
paid on short term borrowings. The increase in net interest income is the result
of changes in the volume and mix of earning assets and interest bearing funding
sources, as well as the changes in market interest rates. Net interest income
for 1999 was $12,486,000 compared to $11,585,000 for 1998 and $11,076,000 for
1997. This represents an increase of 7.8% and 4.6% for 1999 and 1998,
respectively.
PAGE 3
<PAGE>
[LOGO]--------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth the major components of net interest income, on a
tax equivalent basis, as of December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands) 1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate(1) Balance Interest Rate(1) Balance Interest Rate(1)
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Earning Assets
Investment securities:
Taxable $ 74,476 $ 4,307 5.78% $ 60,352 $ 3,564 5.91% $ 53,900 $ 3,189 5.92%
Non-taxable 3,639 234 6.42 5,321 332 6.24 7,287 443 6.08
Loans(2)(3) 207,786 17,411 8.38 189,606 16,596 8.75 174,865 15,681 8.97
Federal funds sold 10,836 549 5.06 12,899 693 5.37 9,590 531 5.54
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total earning assets 296,737 22,501 7.58% 268,178 21,185 7.90% 245,642 19,844 8.08%
------- ------- -------
Non-interest earning assets 12,389 10,999 10,008
-------- -------- --------
Total assets $309,126 $279,177 $255,650
======== ======== ========
Interest bearing liabilities:
Demand $ 49,718 $ 1,272 2.56% $ 46,865 $ 1,468 3.13% $ 42,945 $ 1,334 3.11%
Savings 66,104 1,960 2.97 62,578 1,918 3.06 62,908 1,939 3.08
Time 113,974 5,982 5.25 99,617 5,474 5.50 88,326 4,859 5.50
-------- ------- ---- -------- ------- ---- -------- ------- ----
Interest bearing deposits 229,796 9,214 4.01 209,060 8,860 4.24 194,179 8,132 4.19
Borrowings 17,482 677 3.87 14,559 603 4.14 10,862 464 4.29
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest bearing
liabilities 247,278 9,891 4.00% 223,619 9,463 4.23% 205,041 8,596 4.19%
------- ------- -------
Non-interest bearing 26,600 22,701 21,260
liabilities 35,248 32,857 29,349
-------- -------- --------
Stockholders' equity
Total liabilities and
stockholders' equity $309,126 $279,177 $255,650
======== ======== ========
Net interest spread $12,610 3.58% $11,722 3.67% $11,248 3.89%
======= ======= =======
Net interest margin 4.25% 4.37% 4.58%
</TABLE>
(1) All amounts are reported on a fully taxable equivalent basis computed using
the statutory federal income tax rate, exclusive of the alternative minimum tax
rate, of 34% and nondeductible interest expense.
(2) Average loan balances include nonaccrual loans.
(3) Interest income on loans includes amortized loan fees, net of costs, for
each category and yields are stated to include all.
Net interest income on a tax equivalent basis increased $888,000 or 7.6% in
1999. The increase is attributable to growth in the average balance of interest
earning assets of approximately $28.6 million or 10.6%. Growth in average loans
was $18.2 million or 9.6% during 1999 when compared to 1998. The average balance
of investment securities increased $12.4 million or 18.9%. As a percentage of
total average earning assets loans and investment securities totalled 70% and
26.3%, respectively, for 1999 compared to 70.7% and 24.5%, respectively for
1998.
PAGE 4
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Rate/Volume Variance Analysis identifies the portion of the
changes in net interest income which are attributable to changes in volume of
average balances or to changes in the yield on earning assets and rates paid on
interest bearing liabilities.
<TABLE>
<CAPTION>
1999 over(under) 1998 1998 over(under) 1997
------------------------------ -------------------------------
Caused By Caused By
Total ------------------- Total ----------------
(dollars in thousands) Variance Rate Volume Variance Rate Volume
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest income from earning assets:
Federal funds sold $(144) $ (40) $ (104) $162 $ (15) $177
Taxable investment securities 743 (73) 816 375 (6) 381
Non-taxable investment securities (98) 10 (108) (111) 11 (122)
Loans 815 (733) 1,548 915 (376) 1,291
- -----------------------------------------------------------------------------------------------------------------
Total interest income 1,316 (836) 2,152 1,341 (386) 1,727
- -----------------------------------------------------------------------------------------------------------------
Interest expense on deposits
and borrowed funds:
Interest bearing demand (196) (235) 39 134 (35) 169
Savings deposits 61 (62) 123 (40) (12) (28)
Time deposits 489 (216) 705 634 (9) 643
Securities sold under
agreements to repurchase 55 (43) 98 137 (13) 150
Short term borrowings 19 -- 19 2 -- 2
- -----------------------------------------------------------------------------------------------------------------
Total interest expense 428 (556) 984 867 (69) 936
- -----------------------------------------------------------------------------------------------------------------
Net interest income $888 $(280) $1,168 $474 $(317) $791
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
INTEREST INCOME
Although interest income increased during the year, the net interest margin
declined from 4.37% for 1998 to 4.25% for 1999. This decline was caused by
declining yields on earning assets. The average yield on earning assets for 1999
was 7.58% compared to 7.90% for 1998 and 8.08% for 1997. The average loan yield
declined 37 basis points from 8.75% to 8.38% in 1999. Despite lower yields,
increased volume of loans contributed to an increase in interest income of
$1,548,000. Similarly, increased volume of taxable investment securities
contributed to an increase in net interest income of $816,000.
INTEREST EXPENSE
The average rate paid on interest bearing liabilities declined 23 basis points
from 4.23% to 4.00% for 1999. Rates paid for interest bearing liabilities
declined in all categories during 1999, however, volume increases caused an
overall increase in interest expense of $428,000.
The most significant volume increase was in time deposits. The average balance
of Certificates of Deposit $100,000 or more, increased $10,259,000 or 28.3%.
This growth is primarily attributable to a municipal customer of the Bank. The
average balance of other time deposits increased $4,098,000 or 6.5% and money
management savings accounts increased $4,233,000 or 8.6% during 1999. The
average balance of securities sold under agreements to repurchase increased
$2,552,000 or 17.6%, contributing an additional $98,000 to interest expense.
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
The Company has established an allowance for credit losses, which is increased
by provisions charged against earnings and recoveries of previously charged off
loans. The allowance is decreased by current period charge-off of uncollectible
loans. Management evaluates the adequacy of the allowance for credit losses on a
quarterly basis. The provision for credit losses is adjusted to bring the
allowance for credit losses within an appropriate range of balances which is
considered adequate to absorb potential losses within the loan portfolio. The
provision for credit losses was $240,000 for both 1999 and 1998 and $225,000 for
1997. In 1996, the Company increased the provision for credit losses due to
concerns over local economic trends, continuing high levels of net losses
charged-off and nonperforming loans, and the rapid growth of the loan portfolio.
Improved credit quality
PAGE 5
<PAGE>
[LOGO]--------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
and stable economic conditions in 1997 enabled the Company to reduce the
provision for credit losses to $225,000, Net loans charged-off and nonperforming
loans both declined in 1998 and 1999 which allowed management to further
stabilize the provision for credit losses. Past due loans at December 31, 1999
increased when compared to 1998, however, they consisted primarily of well
secured loans.
The evaluation of the adequacy of the allowance for credit losses is based upon
a risk rating system of individual loans as well as collective evaluation of
smaller balance homogenous loans based on factors such as past credit loss
experience, local economic trends, and other factors which may impact
collectibility such as the Year 2000. Review of the loan portfolio is performed
by the Company's staff. In addition, bank supervisory authorities and
independent consultants periodically review the loan portfolio. The allowance
for credit losses as a percentage of average loans was 1.32% at December 31,
1999 compared to 1.36% at December 31, 1998 and 1.45% at December 31, 1997. The
allowance for credit losses of $2,743,000 at December 31, 1999 is considered by
management to be sufficient to address the credit risk in the portfolio.
The following table sets forth a summary of the Company's loan loss experience
for the years ended December 31.
<TABLE>
<CAPTION>
(Dollars in thousands) 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, beginning of year $ 2,582 $ 2,538 $ 2,728 $ 2,077 $ 1,868
-------- -------- -------- -------- --------
Loans charged-off:
Real estate loans (118) (55) (137) (107) (120)
Installment loans (30) (32) (69) (67) (58)
Commercial and other (52) (193) (268) (237) (236)
-------- -------- -------- -------- --------
(200) (280) (474) (411) (414)
-------- -------- -------- -------- --------
Recoveries:
Real estate loans 50 27 5 11 5
Installment loans 18 33 34 48 34
Commercial and other 53 24 20 48 44
-------- -------- -------- -------- --------
121 84 59 107 83
-------- -------- -------- -------- --------
Net losses charged off (79) (196) (415) (304) (331)
Provision 240 240 225 955 540
-------- -------- -------- -------- --------
Balance, end of year $ 2,743 $ 2,582 $ 2,538 $ 2,728 $ 2,077
-------- -------- -------- -------- --------
Average loans outstanding $207,786 $189,606 $174,865 $168,607 $151,292
======== ======== ======== ======== ========
Percentage of net charge-offs to average
loans outstanding during the year .03% .10% .24% .18% .22%
Percentage of allowance for loan losses
at year-end to average loans 1.32% 1.36% 1.45% 1.62% 1.37%
</TABLE>
Total non-accrual loans of the Company decreased and represented .35% of total
loans, net of unearned income at December 31, 1999 compared to .43% one year
earlier.
PAGE 6
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table summarizes the past due and non-performing assets of the
Company as of December 31.
<TABLE>
<CAPTION>
(Dollars in thousands) 1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-performing assets:
Non-accrual loans $ 773 $ 827 $1,282 $1,551 $2,539
Other real estate and other assets owned 74 164 114 299 147
------ ------ ------ ------ ------
Total non-performing assets 847 991 1,396 1,850 2,686
Past due loans 1,146 671 1,422 654 356
------ ------ ------ ------ ------
Total non-performing assets and past due loans $1,993 $1,662 $2,818 $2,504 $3,042
====== ====== ====== ====== ======
Non-accrual loans to total loans,
net of unearned income, at period end .35% .43% .69% .90% 1.56%
Non-accrual loans and past due loans,
to total loans, net of unearned income, at period end .88% .77% 1.46% 1.28% 1.78%
</TABLE>
NONINTEREST INCOME
Noninterest income increased $198,000 or 25.2% in 1999 compared to an increase
of $74,000 or 10.3% in 1998. Sources of growth in noninterest income for the
year were increases in direct services charges assessed on deposit accounts
($136,000), gain on sale of securities ($22,000) and a decline in the losses
from the Company's unconsolidated subsidiary, Eastern Shore Mortgage
Corporation. Increased service charge income is the result of a full year of
service charge increases which were implemented in mid year 1998. The Company
does not expect any further losses from Eastern Shore Mortgage Corporation which
is in the process of liquidation.
<TABLE>
<CAPTION>
Years Ended Change from Prior Year
--------------------------- ------------------------------------------
1999/98 1998/97
------------------- -------------------
1999 1998 1997 Amount Percent Amount Percent
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Service charges on deposit
accounts $761,330 $623,698 $536,801 $137,632 22.1% $86,897 16.2%
Other service charges and fees 169,302 151,266 120,700 18,036 11.9% 30,566 25.3%
Gain (loss) on sale of securities 12,171 (9,692) 5,519 21,863 225.6% (15,211) (275.6)
Loss from unconsolidated subsidiary (23,813) (49,723) (8,681) 25,910 52.1% (41,042) (472.8)
Other noninterest income 65,895 71,322 59,023 (5,427) (7.6)% 12,299 20.8%
- --------------------------------------------------------------------------------------------------------------------
Total $984,885 $786,871 $713,362 $198,014 25.2% $73,509 10.3%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
NONINTEREST EXPENSES
Total noninterest expense increased $330,000 or 5.5% in 1999 compared to an
increase of $143,000 or 2.4% in 1998. Increased personnel and data processing
costs associated with the growth of the Company, and increased occupancy
expenses are the primary causes of the increase. The Company had 84 full-time
equivalent employees at December 31, 1999 compared to 81 at December 31, 1998
and 78 at December 31, 1997. Salaries and benefits cost increased $40,000 in
1998. This increase would have been approximately $125,000 or 3.7%, had it not
been for a decrease in pension expense of $85,000 relating to the Company's
liability under its frozen defined benefit plan. Data processing costs increased
due to an increased customer base as well as costs associated with new products
and services offered to customers and those utilized internally. Occupancy
expense increases were the result of increased lease expense associated with two
branch locations and three new ATM locations, increased repair and maintenance
expenses, and increased depreciation expense associated with leasehold
improvements.
PAGE 7
<PAGE>
[LOGO]--------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended Change from Prior Year
----------------------------- -----------------------------------------
1999/98 1998/97
------------------- ------------------
1999 1998 1997 Amount Percent Amount Percent
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Salaries and Employee benefits $3,604,873 $3,421,405 $3,381,687 $183,468 5.4% $ 39,718 1.2%
Occupancy expense 450,249 394,101 396,753 56,148 14.2% (2,652) (0.7)%
Furniture and equipment expense 330,478 306,890 285,208 23,588 7.7% 21,682 7.6%
Data processing 382,172 331,979 320,430 50,193 15.1% 11,549 3.6%
Other operating expenses 1,533,544 1,516,655 1,444,346 16,889 1.1% 72,309 5.0%
- -------------------------------------------------------------------------------------------------------------------
Total $6,301,316 $5,971,030 $5,828,424 $330,286 5.5% $142,606 2.4%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
INCOME TAXES
Income tax expense was $2.4 million for 1999 compared to $2.1 million for 1998
and $2 million for 1997. The effective tax rates on earnings were 34.8%, 34.8%
and 35.9%, respectively. The decline in the Company's overall effective tax rate
in 1998 is primarily attributable to lower state income taxes resulting from a
change in the taxation of interest on U.S. Government and certain U.S.
Government Agency securities and Bank Qualified Maryland municipal securities.
Deferred tax assets and liabilities are recognized based on the differences
between financial statement and tax bases of assets and liabilities measured
using current tax rates. If it is likely that deferred tax assets will not be
fully realized a valuation allowance is provided against deferred tax assets.
Management feels that no such valuation allowance is necessary at December 31,
1999 and 1998. Deferred tax expense is measured by the change in net deferred
tax assets or liabilities for the period.
-----------------------------
REVIEW OF FINANCIAL CONDITION
Asset and liability composition, asset quality, capital resources, liquidity,
market risk and interest sensitivity are all factors which are used to measure
the Company's financial condition.
ASSETS
Total assets increased 8.2% to $327,069,000 at December 31, 1999 compared to an
increase of 13.2% for 1998. Average total assets increased 10.7% for 1999
compared to an increase of 9.2% for 1998. The loan portfolio represents 70% of
earning assets and is the primary source of income for the Company. Funding for
loans is primarily provided by core deposits and short term borrowings. Total
deposits increased 9.6% to $273,948,000 at December 31, 1999 compared to an
11.1% increase for 1998.
The following table sets forth the average balance of the components of average
earning assets as a percentage of total average earning assets as of December
31:
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Investment Securities 26.33% 24.49% 24.91% 25.50% 29.03%
Loans 70.02 70.70 71.18 70.86 68.33
Federal funds sold 3.65 4.81 3.91 3.64 2.64
------ ------ ------ ------ ------
100.00% 100.00% 100.00% 100.00% 100.00%
====== ====== ====== ====== ======
</TABLE>
INVESTMENT SECURITIES
The investment portfolio is structured to provide liquidity for the Company and
also plays an important role in the overall management of interest rate risk.
The securities in the investment portfolio are classified as either held to
maturity or available for sale. Investment securities held to maturity are
stated at cost adjusted for amortization of premiums and accretion of discounts.
The Company has the intent and ability to hold such securities until maturity.
Investment securities available for sale are stated at estimated fair value
based on quoted market prices. They represent securities
PAGE 8
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
which may be sold as part of the Company's asset/liability strategy or which may
be sold in response to changing interest rates. Net unrealized holding gains and
losses on these securities are reported as a separate component of stockholders'
equity, net of related income taxes. At December 31, 1999 the Company had
classified 89% of the portfolio as available for sale and 11% as held to
maturity compared to 83% and 17% one year ago. The percentage of securities
designated as available for sale has continued to increase since 1996 to support
the anticipated growth and liquidity needs of the Company.
The average balance of the investment portfolio increased $12,442,000 or 18.9%
for 1999 as a result of strong deposit growth for the year. The increase in the
average balance of investment securities for 1998 was $4,486,000. Reinvestment
of maturities in the investment portfolio and new investments resulting from
growth were concentrated in U.S. Government Agency bonds whose earnings are
exempt from state income tax. These bonds yield higher returns without affecting
the overall safety and liquidity of the portfolio. The Company does not
generally invest in structured notes or other derivative securities.
The following table sets forth the maturities and weighted average yields of the
investment portfolio based upon the earliest possible repricing date as of
December 31, 1999.
<TABLE>
<CAPTION>
1 Year or Less 1-5 Years 5-10 Years Over 10 Years
------------------------ ---------------------------------------------------------------
Book Average Book Average Book Average Book Average
(Dollars in thousands) Value Yield Value Yield Value Yield Value Yield
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Held to Maturity:
U.S. Treasury securities and
obligations of U.S. government
agencies $ 5,001 5.95% $ 1,000 5.75% $ -- --%
Obligations of states and
political subdivisions(1) 318 6.72 382 5.45 951 7.30
Mortgage backed securities 650 5.53 -- -- -- --
------- ---- ------- ---- ------ ----
Total Held to Maturity $ 5,969 5.95% $ 1,382 5.67% 951 7.30%
======= ==== ======= ==== ====== ====
Available for Sale:
U.S. Treasury securities and
obligations of U.S. government
agencies $29,624 5.84% $24,212 5.80% 7,048 5.45% $ -- --%
Obligations of states and
political subdivisions(1) 425 6.12 406 6.40 -- -- -- --
Equity Securities -- -- -- -- -- -- 3,173 --
------- ---- ------- ---- ------ ---- ------ ---
Total Available for Sale $30,049 5.84% $24,618 5.80% $7,048 5.45% $3,173 --
======= ==== ======= ==== ====== ==== ====== ===
</TABLE>
(1) Yields adjusted to reflect a tax equivalent basis assuming a federal tax
rate of 34%.
LOANS
Average loans increased 9.6% in 1999 compared to 8.4% growth experienced in
1998. Total loans, net of unearned income totalled $218,776,000 on December 31,
1999 an increase of $24,413,000 or 12.6% when compared to 1998.
The most significant component of loan growth in 1999 was commercial loans.
Commercial loans increased 37.8% or $14,617,000 totalling $53,241,000 at
December 31, 1999. A strong local economy was the primary reason for the healthy
lending environment in 1999. Real estate construction loans increased $2,628,000
or 30%, totalling $11,368,000 and real estate mortgage loans increased
$6,228,000 or 4.5%, totalling $146,152,000 for the year. Consumer loans also
increased in 1999 after two years of decline. They totalled $8,015,000, an
increase of $940,000 or 13.3%. 1998 loan growth was concentrated in commercial
loans. Refinancing activity resulting from lower long term interest rates made
it difficult to grow the loan portfolio in 1998.
PAGE 9
<PAGE>
[LOGO]--------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table below sets forth the composition of the loan portfolio at December 31.
<TABLE>
<CAPTION>
(Dollars in thousands) 1999 1998 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial, financial and agricultural $ 53,241 $ 38,624 $ 31,348 $ 32,662 $ 28,054
Real Estate--Construction 11,368 8,740 9,537 6,808 6,631
Real Estate--Mortgage 146,152 139,924 137,193 122,723 118,798
Consumer 8,015 7,075 7,215 9,508 8,801
-------- -------- -------- -------- --------
Total Loans $218,776 $194,363 $185,293 $171,701 $162,284
======== ======== ======== ======== ========
</TABLE>
FEDERAL FUNDS SOLD
The Company invests excess cash balances in overnight investments, or federal
funds sold, with its correspondent banks. Federal funds sold are maintained at a
level necessary to meet the immediate liquidity needs of the Company. The
average balance of federal funds sold decreased $2,063,000 to $10,836,000 during
1999 representing a 16% decrease when compared to 1998. In 1998, the average
balance of federal funds sold increased $3,309,000 to $12,899,000 an increase of
34.5% over 1997.
DEPOSITS
The Company utilizes core deposits to fund its earning assets. At December 31,
1999 and 1998 deposits provided funding for 86% of average earning assets.
Average deposits increased 10.5% in 1999 and 7.8% in 1998. The average rate paid
on interest bearing deposits decreased 23 basis points to 4.00% for 1999
compared to 4.23% for 1998. During 1999, the rates paid for deposits declined in
all categories. In 1998, there was a slight increase in the overall rate paid
for interest bearing deposits due to growth in time deposits which have the
highest overall rate. The average balances of certificates of deposit $100,000
or more increased $10,259,000 or 28% in 1999, $8,384,000 or 30% in 1998 and
$1,606,000 or 6.1% in 1997. The growth from 1997 through 1999 was primarily
attributable to growth in deposits of counties and municipalities in the
Company's market area. Other certificates of deposit increased $4,098,000 or
6.5% in 1999. An additional $6,443,000 of deposit growth was achieved increased
balances of transaction accounts as well as $4,233,000 growth in money
management accounts. A decline in traditional savings account balances occurred
in 1999 as depositors shifted money into investment vehicles with higher
returns.
The Company does not accept brokered deposits, nor does it rely on purchased
deposits as a funding source for loans.
The following table sets forth the average balances of deposits and the
percentage of each category to total deposits for the years ended December 31.
<TABLE>
<CAPTION>
(Dollars in thousands) Average Balances
- ------------------------------------------------------------------------------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Non interest-bearing demand $ 25,474 9.98% $ 21,884 9.48% $ 20,119 9.39%
Interest-bearing deposits
NOW and SuperNOW 49,718 19.48% 46,865 20.29% 42,945 20.04%
Savings 12,633 4.95% 13,340 5.78% 12,931 6.03%
Money Management 53,471 20.94% 49,238 21.32% 49,977 23.32%
CD's and other Time deposits
less than $100,000 67,513 26.45% 63,415 27.46% 60,508 28.24%
CD's $100,000 or more 46,461 18.20% 36,202 15.67% 27,818 12.98%
-------- ----- -------- ----- -------- ------
$255,270 100.00% $230,944 100.00% $214,298 100.00%
======== ====== ======== ====== ======== ======
</TABLE>
PAGE 10
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth the maturity ranges of certificates of deposit
with balances of $100,000 or more on December 31, 1999 (in thousands):
Three months or less $42,151
Three through twelve months 7,574
Over twelve months 8,599
-------
$58,324
=======
SHORT TERM BORROWINGS
Short term borrowings consist primarily of securities sold under agreement to
repurchase. These short term obligations are issued in conjunction with cash
management services for deposit customers. The average balance of these
borrowings increased $2,923,000 or 20% in 1999 and $3,607,000 or 33.7% in 1998.
From time to time in order to meet short term liquidity needs the Company may
borrow from a correspondent bank under a federal funds line of credit
arrangement. The average borrowings under the federal funds purchased line of
credit were $409,000 and $38,000 for 1999 and 1998, respectively. There were no
borrowings under this arrangement during 1997.
The following table sets forth the Company's position with respect to short term
borrowings:
<TABLE>
<CAPTION>
1999 1998 1997
----------------- ----------------- -----------------
Interest Interest Interest
(Dollars in thousands) Balance Rate Balance Rate Balance Rate
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Federal funds purchased and securities sold
under agreements to repurchase:
Outstanding at year end $16,343 4.03% $17,111 3.99% $10,264 4.41%
Average outstanding for the year 17,482 3.87 14,559 4.14 10,862 4.29
Maximum outstanding at any month end 21,906 -- 19,879 -- 14,301 --
</TABLE>
The Company does not have any long term debt.
LIQUIDITY
Liquidity describes the ability of the Company to meet financial obligations
that arise during the normal course of business. Liquidity is primarily needed
to meet the borrowing and deposit withdrawal requirements of customers and to
fund current and planned expenditures. Liquidity is derived through increased
customer deposits, maturities in the investment portfolio, loan repayments and
income from earning assets. To the extent that deposits are not adequate to fund
customer loan demand, liquidity needs can be met in the short-term funds
markets. The Company has an arrangement with a correspondent bank whereby it has
a $10,000,000 line of credit available to meet any short-term needs (30 days)
which may not otherwise be funded by its large portfolio of readily marketable
investments that can be converted to cash. The bank is also a member of the
Federal Home Loan Bank of Atlanta which provides another source of liquidity.
At December 31, 1999, the Company's loan to deposit ratio was 80%. Investment
securities available for sale totalling $64,888,000 were available for the
management of liquidity and interest rate risk. Cash and cash equivalents at
December 31, 1999 were $30,250,000, up $9,843,000 from one year ago. Management
is not aware of any demands, commitments, events or uncertainties which will
materially affect the Company's ability to maintain liquidity at satisfactory
levels.
PAGE 11
<PAGE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MARKET RISK AND INTEREST RATE SENSITIVITY
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to changes in interest rates, exchange rates or
equity pricing. The Company's principal market risk is interest rate risk which
arises from its lending, investing and deposit taking activities. The Company's
profitability is dependent on the Bank's net interest income. Interest rate risk
can significantly affect net interest income to the degree that interest bearing
liabilities mature or reprice at different intervals than interest earning
assets. The Asset/Liability Committee of the Board of Directors (the "ALCO")
oversees the management of interest rate risk. The ALCO's primary purpose is to
manage the exposure of net interest margins to unexpected changes due to
interest rate fluctuations. These efforts affect the loan pricing and deposit
rate policies of the Company as well as the asset mix, volume guidelines, and
liquidity and capital planning.
The Company does not utilize derivative financial or commodity instruments, or
hedging strategies in its management of interest rate risk. Since the Company is
not exposed to market risk from trading activities, does not utilize hedging
strategies or off-balance sheet management strategies, the ALCO relies primarily
on "gap" analysis as its primary tool in managing interest rate risk. Gap
analysis summarizes the amount of interest sensitive assets and liabilities
which will reprice over various time intervals. The difference between the
volume of assets and liabilities repricing in each interval is the interest
sensitivity "gap". "Positive gap" occurs when more assets reprice in a given
time interval, while "negative gap" occurs when more liabilities reprice. As of
December 31, 1999, the Company had a positive gap position within the one year
repricing interval. Loans, federal funds sold, time deposits and short-term
borrowings are classified based upon contractual maturities if fixed rate or
earliest repricing date if variable rate. Investment securities are classified
by contractual maturities or, if they have call provisions, by the most likely
repricing date. Management has classified money management, savings and NOW
accounts primarily in the over 1 year interval because they have not
historically repriced in accordance with general changes in interest rates. The
following table summarizes the Company's interest sensitivity at December 31,
1999.
<TABLE>
<CAPTION>
3 Months Total Over 1 Year
3 Months Through Within and not
(Dollars in thousands) Immediate or Less 12 Months One Year Classified Total
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS:
Loans - net of unearned income $35,312 $24,205 $36,471 $ 95,988 $122,788 $218,776
Investment securities -- 8,090 7,295 15,385 57,805 73,190
Federal Funds Sold 24,714 -- -- 24,714 -- 24,714
- ------------------------------------------------------------------------------------------------------------------
TOTAL EARNING ASSETS 60,026 32,295 43,766 136,087 180,593 316,680
- ------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Money management, Savings and NOW's -- -- 11,579 11,579 105,121 116,700
Certificates of deposit $100,000 and over -- 42,151 7,574 49,725 8,599 58,324
All other time deposits -- 12,400 14,513 26,913 40,320 67,233
Short-term borrowings 16,343 -- -- 16,343 -- 16,343
- ------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES 16,343 54,551 33,666 104,560 154,040 258,600
- ------------------------------------------------------------------------------------------------------------------
NET NON-INTEREST BEARING LIABILITIES AND
AND OTHER FUNDING SOURCES -- -- -- -- 58,080 58,080
- ------------------------------------------------------------------------------------------------------------------
INTEREST SENSITIVITY GAP
ASSET SENSITIVE (LIABILITY SENSITIVE) $43,683 $(22,256) $10,100 $ 31,527 $(31,527) $ --
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
PAGE 12
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In addition to gap analysis, the Company utilizes a simulation model to quantify
the effect a hypothetical immediate 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
prepayments 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 December
31, 1999 the model produced the following sensitivity profile for net interest
income and the fair value of capital:
<TABLE>
<CAPTION>
Immediate Change in Rates
-------------------------------------------------------
+200 Basis Points -200 Basis Points Policy Limit
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
% Change in Net Interest Income 15.0% (17.9)% + 25%
-
% Change in Fair Value of Capital 2.5% (7.0)% + 15%
-
</TABLE>
CAPITAL RESOURCES AND ADEQUACY
The Company continues to maintain capital at levels in excess of those required
by the federal banking agencies. Total stockholders' equity was $35,882,000 at
December 31, 1999, 4.7% higher than the previous year. Average stockholders'
equity was $35,248,000 for 1999, an increase of 7.3% compared to 1998. The
increase in stockholders' equity is primarily due to earnings of the Company for
the year of $4.5 million, reduced by dividends paid on common stock of $1.4
million and a decrease in other accumulated comprehensive income, consisting
solely of unrealized losses from the Company's investment securities available
for sale, of $1.6 million.
The Company records unrealized holding gains(losses), net of tax, on investment
securities available-for-sale as a separate component of stockholders' equity.
As of December 31, 1999, the portion of the Bank's investment portfolio
designated as "available-for-sale" had unrealized holding losses, net of tax, of
$1,166,000, compared to net unrealized holding gains, net of tax, of $455,000 at
December 31, 1998.
The following table compares the Company's capital ratios to the regulatory
requirements as of December 31.
<TABLE>
<CAPTION>
Regulatory
(Dollars in thousands) 1999 1998 Requirements
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tier 1 capital $ 36,744 $ 33,839
Tier 2 capital 2,743 2,405
- ----------------------------------------------------------------------------------------------------------------------
Total capital, less deductions $ 39,487 $ 36,244
Risk-adjusted assets 222,122 $192,214
Risk-based capital ratios:
Tier 1 16.54% 17.60% 4.0%
Total capital 17.78% 18.86% 8.0%
- ----------------------------------------------------------------------------------------------------------------------
Total capital $ 36,744 $ 33,839
Total adjusted assets $320,280 $302,724
Leverage capital ratio 11.47% 11.18% 4.0%
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
Management knows of no trends or demands, commitments, events or uncertainties
which may materially affect capital.
PAGE 13
<PAGE>
[LOGO]--------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RECENT STOCK PRICES AND DIVIDENDS
The Company's stock is quoted on the OTC Bulletin Board(OTCBB) under the symbol
TABS and is traded infrequently. Price information listed on the OTCBB is based
upon the participation of market makers for the Company's stock. The following
table indicates cash dividends paid per share for each quarter of 1999, 1998 and
1997 and the ranges of representative sales prices for the stated periods, based
on actual transfers recorded by the transfer agent.
<TABLE>
<CAPTION>
1999 1998 1997
------------------------- ------------------------ ----------------------
Price Range Price Range Price Range
----------- Dividends ----------- Dividends ----------- Dividends
High Low Paid High Low Paid High Low Paid
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter $ 55.00-52.75 $ .25 $ 50.00-45.50 $ .20 $ 26.00-25.00 $.15
Second Quarter 55.00-55.00 .25 51.50-50.00 .20 33.75-27.25 .15
Third Quarter 58.00-55.00 .25 53.25-51.00 .20 40.00-40.00 .15
Fourth Quarter 60.00-55.00 .40 54.50-53.00 .35 40.50-40.00 .40
----- ----- ----
$1.15 $ .95 $.85
===== ===== ====
</TABLE>
PAGE 14
<PAGE>
- --------------------------------------------------------------------------------
SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data for the five
years ended December 31, 1999 and is qualified in its entirety by the detailed
information and financial statements, including notes thereto, included
elsewhere or incorporated by reference in this annual report. This data should
be read in conjunction with the financial statements and related notes thereto,
included elsewhere in this annual report and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
($ in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATING RESULTS:
Total interest income $22,377 $21,048 $19,672 $19,019 $17,435
Total interest expense 9,891 9,463 8,596 8,448 8,207
---------- ------- ------- ------- -------
Net interest income 12,486 11,585 11,076 10,571 9,228
Provision for credit losses 240 240 225 955 540
---------- ------- ------- ------- -------
Net interest income after provision for credit losses 12,246 11,345 10,851 9,616 8,688
Noninterest income 985 787 713 574 617
Noninterest expense 6,302 5,971 5,828 5,219 5,083
---------- ------- ------- ------- -------
Income before income taxes 6,929 6,161 5,736 4,971 4,222
Provision for income taxes 2,409 2,146 2,062 1,751 1,538
---------- ------- ------- ------- -------
NET INCOME $ 4,520 $ 4,015 $ 3,674 $ 3,220 $ 2,684
========== ======= ======= ======= =======
PER SHARE DATA:
Diluted Net income $3.72 $3.33 $3.06 $2.72 $2.27
Dividends paid 1.15 .95 .85 .70 .625
Book value at end of period 30.07 28.76 26.04 23.54 21.32
Weighted average common shares(1) 1,214,898 1,207,028 1,199,130 1,185,410 1,180,154
OTHER DATA (AT YEAR END):
Total assets $327,069 $302,254 $267,029 $253,184 $234,406
Total deposits 273,948 249,929 224,914 215,101 195,447
Total loans, net of unearned income
and allowance for credit losses 216,033 191,781 182,756 168,972 160,207
Total stockholders' equity 35,882 34,284 30,972 27,920 25,193
RETURN ON EQUITY AND ASSETS:
Return on average total assets 1.46% 1.44% 1.44% 1.30% 1.17%
Return on average stockholders' equity 12.82% 12.22% 12.52% 12.14% 11.25%
Dividend payout ratio 30.34% 28.18% 27.48% 25.73% 27.46%
Average stockholders' equity to average total assets 11.40% 11.77% 11.48% 10.72% 10.37%
</TABLE>
(1) The weighted average common shares includes the effect of dilution of stock
options outstanding at period end.
PAGE 15
<PAGE>
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CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks (Notes 1 and 2) $ 5,535,294 $ 8,003,809
Federal funds sold 24,714,372 12,402,615
Investment securities: (Notes 1, 3 and 8)
Available for sale - at fair value 64,887,961 69,500,252
Held to maturity - at amortized cost - fair value of
$8,161,653 (1999) and $13,962,764 (1998) 8,301,833 13,870,709
Loans, less allowance for credit losses (1999) $2,742,984
(1998) $2,582,433 (Notes 1 and 4) 216,033,115 191,780,928
Premises and equipment (Notes 1 and 5) 2,977,982 2,976,637
Accrued interest receivable on loans and investment securities 2,121,616 2,169,505
Deferred income taxes (Notes 1 and 12) 1,430,702 342,440
Other real estate (Note 1) 74,116 163,765
Other assets (Notes 6 and 9) 992,276 1,043,083
------------ ------------
Total assets $327,069,267 $302,253,743
============ ============
LIABILITIES
Deposits: (Notes 3 and 7)
Noninterest-bearing demand $ 31,691,459 $ 25,483,195
NOW and Super NOW 50,103,825 50,206,909
Certificates of deposit, $100,000 or more 58,324,287 45,733,348
Other time and savings 133,828,780 128,505,823
------------ ------------
273,948,351 249,929,275
Short term borrowings(Notes 1, 3 and 8) 16,343,413 17,111,375
Accrued interest payable on deposits and borrowings 474,006 483,148
Other liabilities (Note 9) 421,340 446,215
------------ ------------
Total liabilities 291,187,110 267,970,013
------------ ------------
COMMITMENTS (Notes 5, 9 and 16)
STOCKHOLDERS' EQUITY (Notes 10 and 13)
Common stock, par value $.01, authorized 25,000,000 shares;
issued and outstanding (1999) 1,193,308 shares;
(1998) 1,192,202 shares 11,933 11,922
Surplus 12,724,287 12,663,141
Retained earnings 24,312,342 21,163,696
Accumulated other comprehensive income (loss) (Notes 1 and 3) (1,166,405) 444,971
------------ ------------
Total stockholders' equity 35,882,157 34,283,730
------------ ------------
Total liabilities and stockholders' equity $327,069,267 $302,253,743
============ ============
</TABLE>
The notes to consolidated financial statements are an integral part of these
statements.
PAGE 16
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME
Loans, including fees (Notes 1 and 4) $17,366,724 $16,571,485 $15,659,584
Interest and dividends on investment securities
Taxable 4,307,242 3,564,032 3,189,376
Tax-exempt 154,139 219,038 292,467
Federal funds sold 548,672 693,272 530,721
----------- ----------- -----------
Total interest income 22,376,777 21,047,827 19,672,148
----------- ----------- -----------
INTEREST EXPENSE
NOW and Super NOW accounts 1,272,386 1,468,201 1,333,672
Certificates of deposit, $100,000 or more 2,324,481 1,936,399 1,463,450
Other time and savings 5,616,962 5,455,539 5,334,401
Securities sold under agreements to repurchase 677,198 602,534 464,496
----------- ----------- -----------
Total interest expense 9,891,027 9,462,673 8,596,019
----------- ----------- -----------
NET INTEREST INCOME 12,485,750 11,585,154 11,076,129
PROVISION FOR CREDIT LOSSES (Notes 1 and 4) 240,000 240,000 225,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 12,245,750 11,345,154 10,851,129
NONINTEREST INCOME
Service charges on deposit accounts 761,330 623,698 536,801
Other service charges, commissions and fees 169,302 151,266 120,700
Gain (loss) on sale of securities (Note 3) 12,171 (9,692) 5,519
Other operating income, net (Note 6) 42,082 21,599 50,342
----------- ----------- -----------
984,885 786,871 713,362
----------- ----------- -----------
NONINTEREST EXPENSES
Salaries and wages 2,671,492 2,559,543 2,490,013
Employee benefits (Notes 9, 10 and 11) 933,381 861,862 891,674
Occupancy expense (Note 5) 450,249 394,101 396,753
Furniture and equipment expense 330,478 306,890 285,208
Data processing 382,172 331,979 320,430
Other operating expenses 1,533,544 1,516,655 1,444,346
----------- ----------- -----------
6,301,316 5,971,030 5,828,424
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 6,929,319 6,160,995 5,736,067
Federal and State income taxes (Note 12) 2,409,357 2,146,309 2,062,055
----------- ----------- -----------
NET INCOME $ 4,519,962 $ 4,014,686 $ 3,674,012
=========== =========== ===========
Basic earnings per common share (Notes 1 and 18) $ 3.79 $ 3.37 $ 3.09
====== ====== ======
Diluted earnings per common share $ 3.72 $ 3.33 $ 3.06
====== ====== ======
</TABLE>
The notes to consolidated financial statements are an integral part of these
statements.
PAGE 17
<PAGE>
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Accumulated
Other Total
Common Retained Comprehensive Stockholders'
Stock Surplus Earnings Income Equity
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances, January 1, 1997 $ 11,862 $ 12,435,292 $ 15,616,264 $ (143,413) $27,920,005
Comprehensive income:
Net income -- -- 3,674,012 -- 3,674,012
Other comprehensive income, net of tax:
Unrealized gain on available for
sale securities, net of reclassification
adjustment of $(17,120) -- -- -- 274,644 274,644
-----------
Total comprehensive income 3,948,656
-----------
2,968 shares issued under 401(k) plan 30 105,023 -- -- 105,053
Exercise of stock options 4 7,796 -- -- 7,800
Cash dividends paid, $.85 per share -- -- (1,009,900) -- (1,009,900)
-------- ----------- ----------- ------------- -----------
Balances, December 31, 1997 11,896 12,548,111 18,280,376 131,231 30,971,614
Comprehensive income:
Net income -- -- 4,014,686 -- 4,014,686
Other comprehensive income, net of tax:
Unrealized gain on available for
sale securities, net of reclassification
adjustment of $20,943 -- -- -- 313,740 313,740
-----------
Total comprehensive income -- -- -- -- 4,328,426
-----------
2,017 shares issued under 401(k) plan 20 101,761 -- -- 101,781
Exercise of stock options 6 13,269 -- -- 13,275
Cash dividends paid, $.95 per share -- -- (1,131,366) -- (1,131,366)
-------- ----------- ----------- ------------- -----------
Balances, December 31, 1998 11,922 12,663,141 21,163,696 444,971 34,283,730
Comprehensive income:
Net income -- -- 4,519,962 4,519,962
Other comprehensive income, net of tax:
Unrealized loss on available for
sale securities, net of reclassification
adjustment of $(101,010) -- -- -- (1,611,376) (1,611,376)
-----------
Total comprehensive income -- -- -- -- 2,908,586
-----------
2,130 shares issued under 401(k) plan 21 119,269 -- -- 119,290
Exercise of stock options -- 605 -- 605
Stock repurchased and retired (10) (58,728) -- -- (58,738)
Cash dividends paid, $1.15 per share -- -- (1,371,316) -- (1,371,316)
-------- ----------- ----------- ------------- -----------
Balances, December 31, 1999 $ 11,933 $12,724,287 $24,312,342 $ (1,166,405) $35,882,157
======== =========== =========== ============= ===========
</TABLE>
The notes to consolidated financial statements are an integral part of these
statements.
PAGE 18
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,519,962 $ 4,014,686 $ 3,674,012
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 610,523 501,229 453,830
Discount accretion on debt securities (132,444) (65,608) (119,149)
Discount accretion on matured debt securities 79,976 61,631 79,100
(Gain) loss on sale of securities (12,171) 9,692 (5,519)
Provision for credit losses, net 160,551 44,513 (190,400)
Deferred income taxes (74,654) (84,775) 108,745
(Gain) loss on disposal of premises and equipment 18,692 7,713 (15)
Loss on other real estate owned 7,614 18,124 19,061
Net changes in:
Accrued interest receivable 47,889 (220,897) (120,478)
Other assets 50,807 (74,805) (143,405)
Accrued interest payable on deposits and borrowings (9,142) 94,949 (4,890)
Other liabilities (24,875) (45,924) (9,640)
----------- ----------- -----------
Net cash provided by operating activities 5,242,728 4,260,528 3,741,252
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available for sale 7,073,600 9,054,240 5,954,000
Proceeds from maturities and principal payments
of securities available for sale 22,204,101 3,465,196 5,981,895
Purchases of securities available for sale (26,492,239) (42,418,520) (16,911,099)
Proceeds from maturities and principal payments
of securities held to maturity 15,892,131 14,327,204 8,329,268
Purchases of securities held to maturity (11,346,647) (6,023,906) (1,709,507)
Net increase in loans (23,943,575) (9,291,576) (14,823,887)
Purchase of loans (1,400,000) - (700,000)
Proceeds from sale of loan 880,837 - 1,728,508
Purchase of premises and equipment (341,134) (151,678) (251,019)
Proceeds from sale of other real estate owned 132,035 153,337 308,380
Proceeds from sale of premises and equipment 450 19,203 20,000
----------- ----------- -----------
Net cash used in investing activities (17,340,441) (30,866,500) (12,073,461)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand, NOW,
money market, and savings deposits 10,946,664 128,089 8,153,158
Net increase in certificates of deposit 13,072,412 24,887,527 1,659,061
Net increase (decrease) in securities sold
under agreement to repurchase (767,962) 6,847,847 995,835
Proceeds from issuance of common stock 119,895 115,056 112,853
Repurchase of common stock (58,738)
Dividends paid (1,371,316) (1,131,366) (1,009,900)
----------- ----------- -----------
Net cash provided by financing activities 21,940,955 30,847,153 9,911,007
----------- ----------- -----------
</TABLE>
PAGE 19
<PAGE>
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CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
NET INCREASE IN CASH
AND CASH EQUIVALENTS 9,843,242 4,241,181 1,578,798
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 20,406,424 16,165,243 14,586,445
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $30,249,666 $20,406,424 $16,165,243
=========== =========== ===========
Supplemental cash flows information:
Interest paid $ 9,900,169 $ 9,372,177 $ 8,600,909
=========== =========== ===========
Income taxes paid $ 2,538,154 $ 2,248,519 $ 1,956,219
=========== =========== ===========
Transfers from loans to other real estate $ 50,000 $ 221,647 $ 202,507
=========== =========== ===========
</TABLE>
The notes to consolidated financial statements are an integral part of these
statements.
PAGE 20
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1999, 1998 and 1997
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Talbot Bancshares,
Inc. (the "Company") and its subsidiary, The Talbot Bank of Easton, 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 prevailing practices within the banking industry. Certain reclassifications
have been made to amounts previously reported to conform with the
classifications made in 1999.
Nature of Operations
The Company, through its bank subsidiary, provides commercial banking services
from its locations in Talbot and Dorchester Counties, Maryland. Its primary
source of revenue is from providing commercial and real estate loans to
customers who are predominately small businesses, professionals and middle
income individuals located in the general Talbot County area of Maryland's
eastern shore.
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 Available for Sale
Investment securities available for sale are stated at estimated fair value
based on quoted market prices. They represent those securities which management
may sell as part of its asset/liability strategy or which may be sold in
response to changing interest rates, changes in prepayment risk or other similar
factors. The cost of securities sold is determined by the specific
identification method. Net unrealized holding gains and losses on these
securities are reported as accumulated other comprehensive income, a separate
component of stockholders' equity, net of related income taxes.
Investment Securities Held to Maturity
Investment securities held to maturity are stated at cost adjusted for
amortization of premiums and accretion of discounts. The Company intends and has
the ability to hold such securities until maturity. When securities are
transferred into the held to maturity category from available for sale, they are
accounted for at estimated fair value with any unrealized holding gain or loss
at the date of the transfer reported as a separate component of stockholders'
equity and amortized over the remaining life of the security as an adjustment of
yield.
Loans
Loans are stated at their principal amount outstanding net of any deferred fees
and costs. Interest income on loans is accrued at the contractual rate based on
the principal amount outstanding. Fees charged and costs capitalized for
originating loans are being amortized primarily on the interest method over the
term of the loan. A loan is placed on nonaccrual when it is specifically
determined to be impaired or when principal or interest is delinquent for 90
days or more. Any unpaid interest previously accrued on those loans is reversed
from income. 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 reduction of the loan principal balance.
Interest income on other nonaccrual loans is recognized only to the extent of
interest payments received.
Loans are considered impaired when it is probable that the Bank will not collect
all principal and interest payments according to the loan's contractual 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 if the loan is collateral
dependent.
Impaired loans do not include groups of smaller balance homogeneous loans such
as residential mortgage and consumer installment loans that are evaluated
collectively for impairment. Reserves for probable credit losses related to
these loans are based upon historical loss ratios and are included in the
allowance for credit losses.
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,
review of specific problem loans, and current economic conditions and trends
that may affect the borrowers' ability to pay.
PAGE 21
<PAGE>
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Long-Lived Assets
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed under the straight-line and accelerated methods over
the estimated useful lives of the assets.
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 asset.
Other Real Estate
Other real estate represents assets acquired in satisfaction of loans either by
foreclosure or deeds taken in lieu of foreclosure. Properties acquired are
recorded at the lower of cost or fair value less estimated selling costs at the
time of acquisition with any deficiency charged to the allowance for credit
losses. Thereafter, costs incurred to operate or carry the properties as well as
reductions in value as determined by periodic appraisals are charged to
operating expense. Gains and losses resulting from the final disposition of the
properties are included in noninterest expense.
Repurchase Agreements
Repurchase agreements are securities sold to the Bank's customers, at the
customer's request, under a continuing "roll-over" contract that matures in one
business day. The underlying securities sold are U.S. Treasury notes or Federal
Agency bonds which are segregated from the Company's other investment securities
by the Bank's safekeeping agent.
Income Taxes
Deferred income taxes are provided under the liability method based on the
difference between the financial statement and tax bases of assets and
liabilities and are measured at the current statutory tax rates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers cash and due
from banks, and federal funds sold to be cash and cash equivalents.
Stock-Based Compensation
Stock-based compensation is recognized using the intrinsic value method. For
disclosure purposes, pro forma net income and earnings per share effects are
provided as if the fair value method had been applied.
New Accounting Standards
Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), Accounting
for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133, requires derivative instruments be
carried at fair value on the balance sheet. The statement continues to allow
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 Company plans to adopt the provisions of this statement, as amended, for its
quarterly and annual reporting beginning January 1, 2001, the statement's
effective date. The impact of adopting the provisions of this statement on the
Company's financial position, results of operations and cash flows subsequent to
the effective date is not currently estimable and will depend on the financial
position of the Company and the nature and purpose of any derivative instruments
in use at that time.
NOTE 2. CASH AND DUE FROM BANKS
The Federal Reserve requires banks to maintain certain minimum cash balances
consisting of vault cash and deposits in the Federal Reserve Bank or in other
commercial banks. Such balances averaged approximately $3,758,000 and $2,954,000
during 1999 and 1998, respectively.
PAGE 22
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENT SECURITIES
The amortized cost and estimated fair values of investment securities are as
follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- --------- ------------ ----------
<S> <C> <C> <C> <C>
Available for sale securities:
December 31, 1999:
U.S. Treasury securities $22,427,930 $31,294 $ 189,184 $22,270,040
Obligations of U.S. Government agencies
and corporations 39,858,184 940 1,244,893 38,614,231
Obligations of states and political subdivisions 834,320 -- 3,343 830,977
Federal Home Loan Bank Stock 906,700 -- -- 906,700
Federal Home Loan Mortgage Corporation Cumulative
Preferred Stock 2,480,513 -- 494,500 1,986,013
Other Equity Securities 280,000 -- -- 280,000
------------ --------- ---------- -----------
$66,787,647 $ 32,234 $1,931,920 $64,887,961
=========== ========= ========== ===========
December 31, 1998:
U.S. Treasury securities $30,394,816 $ 733,314 $ -- $31,128,130
Obligations of U.S. Government agencies
and corporations 33,505,975 135,130 139,820 33,501,285
Obligations of states and political subdivisions 1,463,930 12,553 -- 1,476,483
Federal Home Loan Bank Stock 801,100 -- -- 801,100
Federal National Mortgage Association Cumulative
Preferred Stock 2,475,675 -- -- 2,475,673
------------ --------- ---------- -----------
68,641,496 880,997 139,820 69,382,673
Mortgage-backed securities 117,694 -- 115 117,579
------------ --------- ---------- -----------
$68,759,190 $ 880,997 $ 139,935 $69,500,252
=========== ========= ========== ===========
Held to Maturity securities:
December 31, 1999:
U.S. Treasury securities $ 2,001,083 $ 177 $ -- $ 2,001,260
Obligations of U.S. Government agencies
and corporations 4,000,000 -- 93,640 3,906,360
Obligations of states and political subdivisions 1,650,917 898 40,984 1,610,831
------------ --------- ---------- -----------
7,652,000 1,075 134,624 7,518,451
Mortgage-backed securities 649,833 231 6,862 643,202
------------ --------- ---------- -----------
$ 8,301,833 $ 1,306 $ 141,486 $ 8,161,653
=========== ========= ========== ===========
December 31, 1998:
U.S. Treasury securities $ 7,029,615 $ 53,225 $ -- $ 7,082,840
Obligations of U.S. Government agencies
and corporations 3,000,000 9,980 -- 3,009,980
Obligations of states and political subdivisions 2,859,909 22,824 95 2,882,638
------------ --------- ---------- -----------
12,889,524 86,029 95 12,975,458
Mortgage-backed securities 981,185 6,996 875 987,306
------------ --------- ---------- -----------
$13,870,709 $ 93,025 $ 970 $13,962,764
=========== ========= ========== ===========
</TABLE>
PAGE 23
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amortized cost and estimated fair values of investment securities by
earliest possible repricing date at December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
------------------------ --------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Due in one year or less $30,702,021 $30,049,268 $5,968,868 $5,880,502
Due after one year through five years 25,067,059 24,617,530 1,381,713 1,358,009
Due after five years through ten years 7,351,354 7,048,450 951,252 923,142
----------- ----------- ---------- ----------
63,120,434 61,715,248 8,301,833 8,161,653
Investments in equity securities 3,667,213 3,172,713 -- --
----------- ----------- ---------- ----------
$66,787,647 $64,887,961 $8,301,833 $8,161,653
=========== =========== ========== ==========
</TABLE>
The Company has pledged certain securities as collateral for obligations to
federal, state and local government agencies as follows:
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
--------------------------- ------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Available for sale $62,120,433 $60,715,248 $50,406,743 $51,163,509
Held to maturity 7,241,448 7,118,510 10,997,672 11,071,384
----------- ----------- ----------- -----------
$69,361,881 $67,833,758 $61,404,415 $62,234,893
=========== =========== =========== ===========
</TABLE>
There were no obligations of states and political subdivisions whose carrying
value, as to any issuer, exceeded 10% of stockholders' equity at December 31,
1999 or 1998.
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Company grants residential mortgage, consumer and commercial loans to
customers primarily in Talbot County, Maryland. The principal categories of the
loan portfolio at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Real estate loans:
Construction and land development $ 11,368,045 $ 8,740,083
Secured by farmland 8,606,777 4,962,831
Secured by residential properties 80,927,334 75,241,449
Secured by nonfarm, nonresidential properties 65,209,493 64,618,451
Loans to farmers (loans to finance agricultural production and other loans) 280,045 462,533
Commercial and industrial loans 42,846,083 31,600,515
Loans to individuals for household, family, and other personal expenditures 7,793,386 7,074,632
Obligations of States and political subdivisions in the United States, tax-exempt 1,469,657 1,546,268
All other loans 210,645 50,782
------------ ------------
218,711,465 194,297,544
Net deferred loan costs 64,634 65,817
------------ ------------
218,776,099 194,363,361
Allowance for credit losses (2,742,984) (2,582,433)
------------ ------------
$216,033,115 $191,780,928
============ ============
</TABLE>
PAGE 24
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the normal course of banking business, loans are made to officers and
directors and their affiliated interests. These loans are made on substantially
the same terms and conditions as those prevailing at the time for comparable
transactions with outsiders and are not considered to involve more than the
normal risk of collectibility. As of December 31, 1999 and 1998, such loans
outstanding, both direct and indirect (including guarantees), to directors,
their associates and policy making officers, totaled approximately $5,857,000
and $4,299,000, respectively. During 1999 and 1998, loan additions were
approximately $3,345,000 and $1,407,000, and loan repayments were approximately
$1,787,000 and $2,120,000, respectively.
The allowance for credit losses at December 31 is summarized as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Balance, beginning of year $2,582,433 $2,537,920 $2,728,320
---------- ---------- ----------
Recoveries:
Real estate loans 49,556 26,543 4,603
Installment loans 18,497 33,456 34,290
Commercial and other 52,551 24,013 20,274
---------- ---------- ----------
120,604 84,012 59,167
---------- ---------- ----------
Provision 240,000 240,000 225,000
---------- ---------- ----------
Loans charged-off:
Real estate loans (117,805) (54,586) (136,946)
Installment loans (30,561) (32,239) (69,625)
Commercial and other (51,687) (192,674) (267,996)
---------- ---------- ----------
(200,053) (279,499) (474,567)
---------- ---------- ----------
Balance, end of year $2,742,984 $2,582,433 $2,537,920
========== ========== ==========
</TABLE>
Information with respect to impaired loans and the related valuation allowance
as of December 31 is as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Impaired loans with valuation allowance $ -- $ 108,954
Impaired loans with no valuation allowance 773,114 717,773
---------- -------
Total impaired loans $ 773,114 $ 826,727
========== ==========
Allowance for loan losses related to impaired loans $ -- $ 78,928
Allowance for loan losses related to other than impaired loans 2,742,984 2,503,505
---------- ----------
Total allowance for loan losses $2,742,984 $2,582,433
========== ==========
Interest income on impaired loans recorded on the cash basis $ 31,962 $ 22,545
========== ==========
Average recorded investment in impaired loans for the year $ 877,398 $1,152,944
========== ==========
</TABLE>
PAGE 25
<PAGE>
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31 is as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Land:
Dover Street $ 189,734 $ 189,734
Tred Avon 90,000 90,000
Elliott Road 172,905 172,905
Edgar Building 150,000 150,000
Premises:
Dover Street 927,949 921,454
Tred Avon 467,949 467,949
St. Michaels 91,626 70,875
Edgar Building 503,423 503,423
Elliott Road 435,532 435,532
Cambridge 275,939 248,222
Equipment:
Dover Street 1,058,938 1,042,489
Tred Avon 285,462 290,122
St. Michaels 255,509 218,500
Elliott Road 278,574 284,626
Cambridge 227,930 157,534
----------- -----------
5,411,470 5,243,365
Accumulated depreciation (2,433,488) (2,266,728)
----------- -----------
$ 2,977,982 $ 2,976,637
=========== ===========
</TABLE>
Depreciation expense totaled $320,647, $292,561 and $274,262 for the years ended
December 31, 1999, 1998 and 1997, respectively.
The Bank leases facilities under operating leases. Rental expense for the years
ended December 31, 1999, 1998, and 1997 was $89,373, $49,555 and $32,400,
respectively. Future minimum annual rental payments are approximately as
follows:
2000 $92,000
2001 58,000
2002 15,000
2003 6,500
2004 5,000
Thereafter 28,000
NOTE 6. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY
The Company had a 33% ownership interest in Eastern Shore Mortgage Corporation
(the "Corporation"). This investment was carried on the Company's books based on
its proportionate share of the net realizable assets of the Corporation. As of
December 31, 1999, the Corporation is in the process of liquidation and the
Company does not expect to receive any further distributions.
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1999 1998 1997
--------- -------- --------
<S> <C> <C> <C>
Balance, beginning of year $ 123,813 $173,536 $182,217
Equity Distribution (100,000) -- --
Equity in loss for the year (23,813) (49,723) (8,681)
--------- -------- --------
Balance, end of year $ -- $123,813 $173,536
========= ======== ========
</TABLE>
PAGE 26
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company had $62,000 in outstanding letters of credit to Eastern Shore
Mortgage Corporation at December 31, 1998. Interest income on loans to Eastern
Shore Mortgage Corporation totaled approximately $38,700 and $47,800 for 1998
and 1997, respectively. There was no interest income earned in 1999.
NOTE 7. SIGNIFICANT DEPOSITS
The approximate maturities or earliest repricing interval of certificates of
deposit of $100,000 or more at December 31 are as follows:
1999 1998
----------- -----------
Three months or less $42,151,000 $26,702,000
Three through twelve months 7,574,000 6,162,000
Over twelve months 8,599,000 12,869,000
----------- -----------
$58,324,000 $45,733,000
=========== ===========
NOTE 8. SHORT TERM BORROWINGS
Short term borrowings, at December 31, 1999, consisted of securities sold under
agreements to repurchase. These short term obligations represent securities sold
to customers, at the customers' request, under a "roll-over" contract that
matures in one business day. The underlying securities sold are U.S. Treasury
Notes or Federal agency securities which are segregated in the company's
custodial accounts from other investment securities. From time to time in order
to meet short term liquidity needs the Company may borrow from a correspondent
bank under a federal funds line of credit arrangement. The following table
summarizes certain information for short-term borrowings:
1999 1998
----------- -----------
Average amount outstanding during the year $17,481,711 $14,558,849
Weighted average interest rate during the year 3.87% 4.11%
Amount outstanding at year end 16,343,413 17,111,375
Weighted average rate at year end 4.03% 3.99%
Maximum amount at any month end 21,905,911 19,879,370
NOTE 9. BENEFIT PLANS
401(k) Plan
The Company has a 401(k) Plan into which employees may direct up to 15% of their
compensation. Several investment options are available to Plan participants. The
Company makes matching contributions to the Plan in the form of its common
stock. These matching contributions amount to 100% of the first 3% of
participants' compensation and 50% of the next 2% and vest at the rate of 20%,
per year from the second to the sixth year of the employees' service. Company
contributions included in expense totaled $98,944 (1999), $71,751 (1998) and
$76,117 (1997).
Defined Benefit Pension Plan
Effective January 1, 1995, the Company froze its defined benefit pension plan so
that no future benefits will accrue after that date. The Plan covered
substantially all full-time employees with more than six months of service.
Projected benefits are based on the participants' compensation, years of service
and age at retirement and vest at the rate of 20% per year from the
participants' second to sixth year of service. The Company's policy has been to
fund the actuarially determined minimum annual required amount.
PAGE 27
<PAGE>
[LOGO]--------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the Plan's funded status and amounts recognized
in the Company's balance sheets at December 31:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Change in benefit obligation
Benefit obligation at beginning of year $1,092,792 $1,031,994
Interest cost 76,186 74,409
Actuarial gain (3,506) (2,273)
Benefits paid (93,010) (11,338)
---------- ----------
Benefit obligation at end of year 1,072,462 1,092,792
---------- ----------
Change in plan assets
Fair value of plan assets at beginning of year 1,107,344 940,765
Actual return on plan assets 211,820 143,458
Employer contribution -- 34,459
Benefits paid (100,577) (11,338)
---------- ----------
Fair value of plan assets at end of year 1,218,587 1,107,344
---------- ----------
Funded status 146,125 14,552
Unrecognized net actuarial loss (144,717) (21,059)
Adjustment for minimum liability -- --
---------- ----------
Prepaid (accrued) benefit cost $ 1,408 $ (6,507)
========== ==========
<CAPTION>
Components of net periodic benefit cost 1999 1998 1997
-------- --------- -------
<S> <C> <C> <C>
Service cost -- -- --
Interest cost $ 76,186 $ 74,409 $ 69,304
Expected return on plan assets (80,850) (71,375) (59,629)
Amortization of prior service cost -- -- --
Recognized net actuarial loss -- -- --
-------- -------- --------
Net periodic benefit cost $ (4,664) $ 3,034 $ 9,675
======== ======== ========
</TABLE>
Assumptions used in the determination of pension information consisted of the
following:
<TABLE>
<CAPTION>
1999 1998 1997
-------- --------- ---------
<S> <C> <C> <C>
Discount rate 7.25% 7.25% 7.25%
Expected return on plan assets 7.50 7.50 7.50
Rate of compensation increase N/A N/A N/A
</TABLE>
Profit Sharing Plan
Effective January 1, 1995, the Bank adopted The Talbot Bank Profit Sharing and
Retirement Plan which covers substantially all full-time employees with more
than six months of service. The Bank makes discretionary contributions to the
Plan based on profits. Contributions included in expense totaled $112,000
(1999), $100,000 (1998) and $100,000 (1997).
PAGE 28
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. STOCK OPTION PLAN
During 1999, the Company adopted a 1999 Stock Option Plan (the "1999 Plan").
Options granted under the 1999 Plan may be either incentive stock options or
nonqualified stock options. The terms of the options granted are at the sole
discretion of the Company's Board of Directors, and are for a term not to exceed
ten years. Options that have been granted are immediately exercisable and are
granted at an exercise price not less than the fair market value at the date of
grant. The 1999 Plan allows for up to 85,000 options for common stock be granted
to certain key employees of the Company. The Company also has a plan adopted in
1995 with similar provisions to the 1999 Plan whereby options for not more than
40,000 shares of common stock may be granted.
Following is a summary of changes in shares under option for both Plans for the
years indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------
1999 1998
------------------------------ ---------------------------
Number Weighted Average Number Weighted Average
of Shares Exercise Price of Shares Exercise Price
--------- ---------------- --------- ----------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 37,400 $22.08 38,000 $22.08
Granted 9,400 55.00 -- --
Exercised (31) (19.50) (575) (23.09)
Expired -- -- (25) --
------ ------ ------ ------
Outstanding at end of year 46,769 $28.73 37,400 $22.08
====== ======
Weighted average fair value of options
granted during the year $26.53 $ --
====== ======
</TABLE>
The following summarizes information about options outstanding at December 31,
1999:
<TABLE>
<CAPTION>
Options Outstanding and Exercisable
-----------------------------------
Weighted Average
Remaining
Exercise Price Number Contract Life
-------------- ------ ---------------
<S> <C> <C> <C>
19.50 19,569 5.61
25.00 17,800 6.95
55.00 9,400 9.93
</TABLE>
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions used for
grants during the year ended December 31, 1999. No options were granted during
1998.
Dividend yield 2.0%
Expected volatility 10.0%
Risk free interest 6.55%
Expected lives (in years) 10
PAGE 29
<PAGE>
[LOGO]--------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION" (SFAS
123), but applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its Plan. No compensation expense related to
the Plan was recorded during the year ended December 31, 1999. If the Company
had elected to recognize compensation cost based on fair value at the grant
dates for awards under the Plan consistent with the method prescribed by SFAS
123, net income and earnings per share would have been changed to the pro forma
amounts as follows for the years ended December 31:
1999
----------
Net income:
As reported $4,519,962
Pro forma 4,270,554
Basic net income per share:
As reported 3.79
Pro forma 3.58
Diluted earnings per share
As reported 3.72
Pro forma 3.52
The pro forma amounts are not representative of the effects on reported net
income for future years.
NOTE 11. DEFERRED COMPENSATION
During 1996, the Company adopted a supplemental deferred compensation plan to
provide retirement benefits to its President and Chief Executive Officer. The
plan calls for fixed annual payments of $20,000 to be credited to the
participant's account. The participant is 100% vested in amounts credited to his
account. Contributions to the plan were $20,000 in 1999, 1998 and 1997.
NOTE 12. INCOME TAXES
Income taxes included in the balance sheets as of December 31 are as follows:
1999 1998
-------- -------
Federal income taxes currently payable $ 64,121 $135,092
State income taxes currently receivable 8,047 20,997
Deferred income tax benefits 1,430,702 342,440
Components of income tax expense for each of the three years ended December 31
are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
--------- ------- -------
<S> <C> <C> <C>
Currently payable:
Federal $2,279,504 $2,020,753 $1,729,786
State 204,507 210,331 223,524
---------- ---------- ----------
2,484,011 2,231,084 1,953,310
---------- ---------- ----------
Deferred income taxes (benefits):
Federal (61,123) (69,414) 89,035
State (13,531) (15,361) 19,710
---------- ---------- ----------
(74,654) (84,775) 108,745
---------- ---------- ----------
$2,409,357 $2,146,309 $2,062,055
========== ========== ==========
</TABLE>
PAGE 30
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of tax computed at the statutory federal tax rates of 34% to
the actual tax expense for the three years ended December 31 follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Tax at federal statutory rate 34.0% 34.0% 34.0%
Tax effect of:
Tax-exempt income (1.1) (1.5) (1.6)
Non-deductible expenses -- .1 .1
Other .1 .1 .6
State income taxes, net of federal benefit 1.8 2.1 2.8
---- ---- ----
Income tax expense 34.8% 34.8% 35.9%
==== ==== ====
</TABLE>
The sources of deferred income taxes (benefits) and the tax effects of each for
the years ended December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Depreciation $(18,070) $(13,832) $ 17,322
Provision for credit losses (92,688) (92,684) 59,755
Income on loans 6,974 21,671 17,555
Pension expense (1,491) 32,720 --
Other 30,621 (32,650) 14,113
-------- -------- --------
$(74,654) $(84,775) $108,745
======== ======== ========
</TABLE>
Significant components of the Company's deferred tax assets and liabilities as
of December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998
---------- --------
<S> <C> <C>
Deferred tax assets:
Allowance for credit losses $ 779,074 $686,386
Loan interest 8,494 15,488
Provision for loss on other real estate 39,252 49,340
Pension expense -- 2,513
Loan fees 32,140 32,122
Deferred compensation 54,109 49,560
Unrealized losses on available for sale securities 733,658 --
---------- --------
Total deferred tax assets 1,646,727 835,409
---------- --------
Deferred tax liabilities:
Depreciation 143,676 161,745
Pension expense 544 --
Other 71,805 51,275
Unrealized gains on available for sale securities -- 279,949
---------- --------
Total deferred tax liabilities 216,025 492,969
---------- --------
Net deferred tax assets $1,430,702 $342,440
========== ========
</TABLE>
PAGE 31
<PAGE>
[LOGO]--------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13. REGULATORY CAPITAL REQUIREMENTS
The Company is 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 financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company must meet
specific capital guidelines that involve quantitative measures of the Company's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Company's capital amounts and
classification are also subject to qualitative judgements by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes as of December 31, 1999, that the
Company meets all capital adequacy requirements to which it is subject.
As of December 31, 1999, the most recent notification from the Federal Deposit
Insurance Corporation 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 1 risk-based,
and Tier 1 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.
A comparison of the Company's capital as of December 31, 1999 and 1998 with the
minimum requirements is presented below:
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------- ------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- -------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999:
Total Capital (to Risk Weighted Assets):
Company $39,487,000 17.78% $17,770,000 8.00%
The Talbot Bank 38,948,000 17.57 17,731,000 8.00 $22,164,000 10.00%
Tier 1 Capital (to Risk Weighted Assets):
Company 36,744,000 16.54 8,866,000 4.00
The Talbot Bank 36,205,000 16.34 8,866,000 4.00 13,298,000 6.00
Tier 1 Capital (to Average Assets):
Company 36,744,000 11.47 12,811,000 4.00
The Talbot Bank 36,205,000 11.30 12,811,000 4.00 16,014,000 5.00
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ---------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- -------- ----- --------- -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total Capital (to Risk Weighted Assets)
Company $36,244,000 18.86% $15,377,000 8.00%
The Talbot Bank 36,009,000 18.74 15,375,000 8.00 $19,219,000 10.00%
Tier 1 Capital (to Risk Weighted Assets)
Company 33,839,000 17.60 7,688,000 4.00
The Talbot Bank 33,604,000 17.49 7,687,000 4.00 11,531,000 6.00
Tier 1 Capital (to Average Assets)
Company 33,839,000 11.18 12,109,000 4.00
The Talbot Bank 33,604,000 11.10 12,108,000 4.00 15,135,000 5.00
</TABLE>
PAGE 32
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on divided payments by the Bank, as well as restricting extensions
of credit and transfers of assets between the Bank and the Company. At December
31, 1999, the Bank could have paid dividends to its parent company from
undivided profits and, with the prior consent and approval of the Bank
Commissioner, from surplus in excess of $5,937,740 after providing for expenses,
losses, interest and taxes accrued or due. There were no loans outstanding
between the Bank and the Company at December 31,1999 and 1998.
NOTE 14. LINE OF CREDIT
The Bank has a $10,000,000 unsecured federal funds line of credit expiring
September 30, 2000, which is available on a short-term basis. In addition, the
Bank has credit availability of approximately $49,000,000 from the Federal Home
Loan Bank of Atlanta. The Company has pledged, under blanket lien, all
qualifying residential loans as collateral under the borrowing agreement with
the Federal Home Loan Bank.
NOTE 15. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and Cash Equivalents
-------------------------
For those short-term instruments, the carrying amount is a reasonable
estimate of fair value.
Investment Securities
----------------------
For all investments in debt securities, fair values are based on quoted
market prices. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loan Receivables
----------------
The fair value of categories of fixed rate loans, such as commercial loans,
residential mortgage, and other consumer loans is estimated by discounting
the future cash flows using the current rates at which similar loans would
be made to borrowers with similar credit ratings and for the same remaining
maturities. Other loans, including variable rates loans, are adjusted for
differences in loan characteristics.
Financial Liabilities
---------------------
The fair value of demand deposits, savings accounts, and certain money
market deposits is the amount payable on demand at the reporting date. The
fair value of fixed-maturity certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining maturities. These
estimates do not take into consideration the value of core deposit
intangibles. The fair value of securities sold under agreements to
repurchase is estimated using the rates offered for similar borrowings.
Commitments to Extend Credit and Standby Letters of Credit
----------------------------------------------------------
The fair value of commitments is estimated using the fees currently charged
to enter into similar agreements, taking into account the remaining terms
of the agreements and the present creditworthiness of the counterparties.
PAGE 33
<PAGE>
[LOGO]--------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair values of the Bank's financial instruments, excluding
goodwill, as of December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998
----------------------------- ------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- --------- ---------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 30,249,666 $ 30,250,000 $ 20,406,424 $ 20,406,000
Investment securities 73,189,794 71,875,000 83,370,961 83,463,000
Loans 218,776,099 215,275,000 194,363,361 192,000,000
Less: allowance for loan losses (2,742,984) -- (2,582,433) --
------------ ------------ ------------ ------------
$319,472,575 $317,400,000 $295,558,313 $295,869,000
============ ============ ============ ============
Financial liabilities:
Deposits $273,948,351 $260,341,000 $249,929,275 $247,638,000
Securities sold under agreements to repurchase 16,343,413 16,343,000 17,111,375 17,111,000
------------ ------------ ------------ ------------
$290,291,764 $276,684,000 $267,040,650 $264,749,000
============ ============ ============ ============
Unrecognized financial instruments:
Commitments to extend credit $ 51,534,000 $ 51,534,000 $ 44,189,000 $ 44,189,000
Standby letters of credit 3,133,000 3,133,000 2,754,000 2,754,000
------------ ------------ ------------ ------------
$ 54,667,000 $ 54,667,000 $ 46,943,000 $ 46,943,000
============ ============ ============ ============
</TABLE>
NOTE 16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, to meet the financial needs of its customers,
the Company is a party to financial instruments with off-balance sheet risk.
These financial instruments include commitments to extend credit and standby
letters of credit.
The Company's exposure to credit loss in the event of nonperformance by the
other party to these financial instruments is represented by the contractual
amount of the instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
The Company generally requires collateral or other security to support the
financial instruments with credit risk. The amount of collateral or other
security is determined based on management's credit evaluation of the
counterparty. The Company evaluates each customer's creditworthiness on a
case-by-case basis.
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. 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.
Commitments outstanding as of December 31 are as follows:
1999 1998
---------- --------
Commitments to extend credit $51,534,000 $44,189,000
Letters of credit 3,133,000 2,754,000
----------- -----------
$54,667,000 $46,943,000
=========== ===========
PAGE 34
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Talbot Bancshares, Inc. (Parent Company
Only) is as follows:
Condensed Balance Sheets
December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
---------- --------
<S> <C> <C>
Assets
Cash $ 36,537 $ 31,058
Securities purchased under agreement to resell 18,140 176,378
Investment in subsidiary 35,533,101 34,048,994
Investment in equity securities 280,000 --
Other assets 14,379 27,300
----------- ----------
Total assets $35,882,157 $34,283,730
=========== ===========
Liabilities -- --
Stockholders' equity
Common stock $ 11,933 $ 11,922
Surplus 12,724,287 12,663,141
Retained earnings 24,312,342 21,163,696
Accumulated other comprehensive income (1,166,405) 444,971
----------- ----------
Total stockholders' equity 35,882,157 34,283,730
----------- ----------
Total liabilities and stockholders' equity $35,882,157 $34,283,730
=========== ===========
</TABLE>
Condensed Statements of Income
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- --------
<S> <C> <C> <C>
Dividends from subsidiary $1,456,317 $1,131,365 $ 891,283
Interest income 1,074 4,453 1,104
---------- ---------- ----------
1,457,391 1,135,818 892,387
Operating expenses 47,290 23,425 12,986
---------- ---------- ----------
Income before income tax benefit and
equity in undistributed income of subsidiary 1,410,101 1,112,393 879,401
Income tax benefit 14,379 6,605 3,055
---------- ---------- ----------
Income before equity in undistributed income of subsidiary 1,424,480 1,118,998 882,456
Equity in undistributed income of subsidiary 3,095,482 2,895,688 2,791,556
---------- ---------- ----------
Net income $4,519,962 $4,014,686 $3,674,012
========== ========== ==========
</TABLE>
PAGE 35
<PAGE>
[LOGO]--------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Statements of Cash Flows
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 4,519,962 $ 4,014,686 $ 3,674,012
Adjustments to reconcile net income to cash provided
by operating activities:
Equity in undistributed income of subsidiary (3,095,482) (2,895,688) (2,791,556)
Net increase (decrease) in other assets 12,920 (1,312) (25,988)
----------- ----------- -----------
Net cash provided by operating activities 1,437,400 1,117,686 856,468
----------- ----------- -----------
Cash flows from investing activities:
Sale (purchase) of securities order agreement to resell 158,238 (100,850) (75,528)
Purchase of other equity securities (280,000) -- --
----------- ----------- -----------
Net cash used by investing activities (121,762) (100,850) (75,528)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 119,895 115,056 81,497
Purchase of common stock (58,738) -- --
Dividends paid (1,371,316) (1,131,366) (831,905)
----------- ----------- -----------
Net cash used by financing activities (1,310,159) (1,016,310) (750,408)
----------- ----------- -----------
Net increase in cash and cash equivalents 5,479 526 30,532
Cash and cash equivalents at beginning of year 31,058 30,532 --
----------- ----------- -----------
Cash and cash equivalents at end of year $ 36,537 $ 31,058 $ 30,532
=========== =========== ===========
</TABLE>
NOTE 18. EARNINGS PER COMMON SHARE
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, all prior-period earnings per share data has been
restated.
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Basic:
Net income (applicable to common stock) $4,519,962 $4,014,686 $3,674,012
Average common shares outstanding 1,192,457 1,190,705 1,187,814
Basic earnings per share $3.79 $3.37 $3.09
Diluted:
Net income (applicable to common stock) $4,519,962 $4,014,686 $3,674,012
Average common shares outstanding 1,192,457 1,190,705 1,187,814
Diluted effect of stock options 22,441 16,323 11,316
---------- ---------- ----------
Average common shares outstanding - diluted 1,214,898 1,207,028 1,199,130
Diluted earnings per share
$3.72 $3.33 $3.06
</TABLE>
PAGE 36
<PAGE>
- --------------------------------------------------------------------------------
[STEGMAN & COMPANY LOGO]
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Talbot Bancshares, Inc.
Easton, Maryland
We have audited the accompanying consolidated balance sheets of Talbot
Bancshares, Inc. as of December 31, 1999 and 1998, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Talbot
Bancshares, Inc. as of December 31, 1999 and 1998, and the consolidated results
of its operations and cash flows for each of the three years in the period ended
December 31, 1999, in conformity with generally accepted accounting principles.
/s/ Stegman & Company
Baltimore, Maryland
January 21, 2000
PAGE 37
<PAGE>
[LOGO]--------------------------------------------------------------------------
BOARD OF DIRECTORS
TALBOT BANCSHARES, INC.
THE TALBOT BANK OF EASTON, MARYLAND
<TABLE>
<CAPTION>
<S> <C>
HERBERT L. ANDREW, III JEROME M. MCCONNELL
Farmer Vice President, Talbot Bancshares, Inc.
Executive Vice President, The Talbot Bank
BLENDA W. ARMISTEAD
Investor SHARI L. MCCORD
Owner, Chesapeake Travel Services, Inc.
LLOYD L. BEATTY, JR.
Certified Public Accountant WILLIAM H. MYERS
President, Darby Advisors, Inc. Chairman of the Board
Farmer
DONALD D. CASSON
Certified Public Accountant &Real Estate Broker DAVID L. PYLES
Investor
GARY L. FAIRBANK
Owner, Fairbank Tackle CHRISTOPHER F. SPURRY
President, Spurry & Associates, Inc.
RONALD N. FOX
Investor W. MOORHEAD VERMILYE
President, Talbot Bancshares, Inc.
RICHARD C. GRANVILLE President and CEO, The Talbot Bank
Investor
</TABLE>
- --------------------------------------------------------------------------------
OFFICERS
TALBOT BANCSHARES, INC.
W. Moorhead Vermilye President
Jerome M. McConnell Vice President
Susan E. Leaverton Secretary/Treasurer
THE TALBOT BANK OF EASTON, MARYLAND
W. Moorhead Vermilye President & CEO
Jerome M. McConnell Executive Vice President
G. Rodney Taylor Senior Vice President
Susan E. Leaverton Vice President Finance
Robert J. Meade Vice President Human Resources
Mildred C. Bullock Vice President Bookkeeping
Bruce M. Burkhardt Vice President Operations
Linda S. Cheezum Vice President Lending
Robyn K. Gannon Vice President New Accounts
W. David Morse Vice President
Nancy B. Chance Assistant Vice President
Deborah L. Danenmann Assistant Vice President
Laura P. Heikes Assistant Vice President
Dawn D. Henckel Assistant Vice President
Wanda W. Hutchison Assistant Vice President
J. Michael Lawrence Assistant Vice President
Jennifer W. Lister Assistant Vice President
Bonnie R. Meade Assistant Vice President
Donald E. Morris Commercial Banking Officer
Robin B. O'Brien Assistant Vice President
Donna D. Parks Assistant Vice President
Valerie C. Pelkey Assistant Vice President
Charles J. Selby Assistant Vice President
Parker K. Spurry Assistant Vice President
PAGE 38
<PAGE>
- --------------------------------------------------------------------------------
TALBOTBANK EMPLOYEES
Nancy L. Bartlett Amy L. Hutchison N. Melissa Riggins
Barbara A. Bell Suzanne S. Jefferson Jacqueline D. Ruark
Lori A. Cain Tunisia C. Johns Maryilyn P. Russell
Carol J. C. Callahan Christy D. Jones Celeste M. Sanborn
Susie M. Collins Linda N. Jones Kay Schaar-Wagenblatt
J. Kellee Cooper Patricia A. Jones Kristin E. Shaw
Elizabeth H. Dise Beatrice T. Juliano Misty M. Simms
Donna L. Elburn Sandra A. Kenton Terri M.Tarr
Diana S. Evans Blaire W. Knode Paula I. Taylor
Andrew M. Ewing Stephanie D. Layton Kelly A. Tebbenkamp
Laura L. Edwards Kathryn V. Lister Samuel J. Townsend
Dale E. Fike George H. Lord, Jr. Nancy J. Urbanczk
Pamela E. Fox LaVonne D. Medford Margaret B. Voshell
Bonnie J. Freburger Stephanie L. Miller Daphne L. Wagner
Jay B. Geib Cortney L. Moore Deborah C. Watson
Jennifer A. Gowe Donna L. Neal Kendall B. Williams
Michaele Ann Graves Cynthia S. Parks Sandra G. Wilson
Sarah L. Griffith Dawn A. Patrick Brenda L. Wooden
Robin L. Haddaway Lauren Pokrywka
Rose M. Hurst Melissa K. Potts
PAGE 39
<PAGE>
[LOGO]--------------------------------------------------------------------------
NOTES
PAGE 40
<PAGE>
TALBOT BANK LOCATIONS
Main Office
18 East Dover Street
Easton, MD 21601
Tred Avon Square Branch
210 Marlboro Road
Easton, MD 21601
Elliott Road Branch
8275 Elliott Road
Easton, MD 21601
St. Michaels Branch
1013 S. Talbot Street
St. Michaels, MD 21663
Cambridge Branch
2745 Dorchester Square
Cambridge, MD 21613
ATM LOCATIONS
Memorial Hospital at Easton
219 S. Washington Street
Easton, MD 21601
Sailwinds Amoco
511 Maryland Avenue
Cambridge, MD 21613
Talbottown
218 N. Washington Street
Easton, MD 21601
Chesapeake Bay Outfitters
100 N. Talbot Street
St. Michaels, MD 21663
Phone (410) 822-1400 Fax (410) 820-4238
E-Mail: [email protected]
Website: http://talbot-bank.com
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation by reference in the Registration
Statement No. 333-82813 on Form S-8, and in the Annual Report on Form 10-K of
Talbot Bancshares, Inc., for the year ended December 31, 1999, of our report
dated January 21, 2000, relating to the consolidated financial statements of
Talbot Bancshares, Inc.
/S/ Stegman and Company
Baltimore, Maryland
March 29, 2000
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS AS OF AND FOR THE PERIOD ENDED DECEMBER 31, 1999, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<NAME> TALBOT BANCSHARES, INC.
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