SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported):
July 15, 1999
------------------------------
F&M BANCORP
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 0-12638 52-1316473
- ------------------------ ------------------------ ------------------------
(State of Incorporation) (Commission File Number) (IRS Identification No.)
110 Thomas Johnson Drive
Frederick, MD 21702
---------------------------------------------------
(Address of Principal executive offices) (Zip Code)
(301) 694-4000
----------------------------------------------------
(Registrant's telephone number, including area code)
ITEM 5. OTHER EVENTS.
On July 15, 1999, F&M Bancorp consummated a merger with Potomac Basin Group
Associates, Inc. ("Potomac Basin"), in a tax-free exchange of shares
accounted for as a pooling-of-interests. Potomac Basin is a Beltsville,
MD-based, full-line independent insurance agency specializing in corporate
employee benefit plans.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(c) Exhibits
99.1 Restated MD&A and Annual Report for the year ended
December 31, 1998
99.2 Restated MD&A and Unaudited Financial Statements for
the Quarterly Period Ended June 30, 1999
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: November 1, 1999 F&M BANCORP
By: /s/Gordon M Cooley
Gordon M. Cooley
Secretary and General Counsel
EXHIBIT INDEX
99.1. Restated MD&A and Annual Report for the year ended December 31, 1998
99.2 Restated MD&A and Unaudited Financial Statements for the Quarterly
Period Ended June 30, 1999
EXHIBIT 99.1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion provides an overview of the financial
condition and results of operations of F&M Bancorp and Subsidiaries
("Bancorp") for the three years in the period ended December 31, 1998, and
is intended to assist readers in their analysis and understanding of the
accompanying consolidated financial statements and notes thereto.
Bancorp's acquisition of Keller-Stonebraker Insurance, Inc.
("K-S"), completed in May 1998, and Monocacy Bancshares, Inc. and its
wholly owned subsidiary, Taneytown Bank & Trust Company ("TBT"), completed
in November 1998, are accounted for as poolings-of-interests transactions.
Accordingly, the consolidated financial statements, notes, and historical
financial data contained herein were restated for all prior periods
presented to include the financial condition and results of operations for
K-S and TBT. Refer to Note 2, Notes to Consolidated Financial Statements,
for further information regarding acquisition activity within the periods
reported.
All per share amounts in this report have been restated to give
effect to subsequent stock dividends and shares issued in
pooling-of-interest transactions.
FORWARD-LOOKING STATEMENTS
Certain information included in the following section of this
report, other than historical information, may contain certain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements are
identified by terminology such as "may", "will", "believe", "expect",
"estimate", "anticipate", "likely", "unlikely", "continue", or similar
terms. Although Bancorp believes that the expectations reflected in such
forward-looking statements are reasonable, actual results may differ
materially from those projected in the forward-looking statements.
1998 COMPARED TO 1997
OVERVIEW
Net income for 1998 decreased 8% to $13.1 million, or $1.49 per
share, from $14.2 million, or $1.64 per share, for 1997, largely reflecting
the influence of special items of an unusual or nonrecurring nature
recognized in the periods compared and as set forth in Table 1. Excluding
special items in both years, net (operating) income increased 7% to $15.0
million, or $1.71 per share, from $14.0 million, or $1.61 per share, for
1997. Per share amounts are stated throughout this section on a diluted
basis unless specifically noted otherwise.
SPECIAL ITEMS - 1998
Special items for 1998, as shown in Table 1 on an after-tax basis,
included $2.332 million of merger-related expense, or $0.27 per share. This
amount included $192 thousand ($0.02 per share) of merger-related expenses
pertaining to the 1998 integration of core processing systems and
administrative functions at the Savings Bank, acquired in November 1996,
$190 thousand ($0.02 per share) related to the May 1998 acquisition of K-S,
and $1.922 million ($0.23 per share) related to the acquisition and
integration of TBT. A special provision for possible loan losses related to
the acquisition of TBT amounted to $460 thousand after tax, or $0.05 per
share The integration of TBT's core processing systems and administrative
functions was completed in February 1999. Net securities gains realized by
TBT during 1998 amounted to $661 thousand ($0.07 per share), and Bancorp
realized a net gain of $270 thousand ($0.03 per share) on the sale of
bank-owned real estate.
SPECIAL ITEMS - 1997
Special items for 1997, as shown in Table 1 on an after-tax basis,
included a $552 thousand gain on the sale of the credit card merchant
processing business ($0.06 per share). Recognizing the difficulty in
achieving sufficient economies of scale over the near term, Bancorp elected
to exit this highly competitive line of business in favor of alternatives
expected to produce greater profitability over the long term. TBT incurred
litigation costs of $177 thousand ($0.02 per share) and realized a $110
thousand gain on the sale of loans in 1997 ($0.01 per share) and a $59
thousand gain on the sale of investment securities ($0.01 per share).
Pursuant to the provisions of the Plan and Agreement to Merge with
Home Federal, compensatory payments were recognized in 1997 for two
executive officers who elected to resign during the year. Such compensation
expense totaled $294 thousand ($0.03 per share) and was to be paid over a
24-month period.
<TABLE>
<CAPTION>
TABLE 1. NET INCOME EXCLUDING SPECIAL ITEMS
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
(In thousands, except per share amounts) 1998 EPS(1) 1997 EPS(1) 1996 EPS(1)
- ---------------------------------------- ---- ------ ---- ------ ---- ------
<S> <C> <C> <C> <C> <C> <C>
Net income as reported....................... $13,092 $1.49 $14,226 $1.64 $10,401 $1.21
Adjustments (net of income taxes):
Merger-related expense....................... 2,332 0.27 294 0.03 1,176 0.14
Special provision for credit losses.......... 460 0.05 - - 200 0.02
Gain on sale of property..................... (270) (0.03) - - - -
Gain on sale of merchant services............ - - (552) (0.06) - -
Gain on sale of loans........................ - - (110) (0.01) - -
Litigation expense........................... - - 177 0.02 - -
SAIF assessment.............................. - - - - 724 0.08
Securities losses (gains).................... (661) (0.07) (59) (0.01) 203 0.02
Net income excluding special items........... $14,953 $1.71 $13,976 $1.61 $12,704 $1.47
- -----------
(1) Diluted earnings per share
</TABLE>
RESULTS OF OPERATIONS
NET INTEREST INCOME
Approximately 72% of Bancorp's gross revenue was derived from net
interest income in 1998, down from 74% in 1997. Net interest income is
principally the sum of interest and fees on loans plus interest and
discount on investment securities, less interest paid on deposits and
borrowings. Although interest-bearing deposits continued to represent
Bancorp's principal funding source, factors largely related to intense
competition for bank deposits throughout the financial services industry
have forced banks to seek dependable, relatively low-cost alternative
sources of funds. Bancorp frequently supplements its funding with Federal
Home Loan Bank ("FHLB") borrowings, which have proven to be reliable and
cost-effective across all maturities selected. Other, more traditional,
funding sources include repurchase agreements and federal funds purchased.
Net interest income is influenced by a number of external economic
and competitive factors such as Board monetary policy and its influence on
market interest rates; loan demand and competition from nonbank lenders;
and competition with investment managers, brokerage firms and investment
bankers for consumer and commercial business assets that might otherwise be
deposited in banks. Internal factors impacting levels and changes in net
interest income are attributed to Bancorp's interest rate risk management
policies, which address a variety of issues including loan and deposit
pricing practices, funding alternatives and maturity schedules.
Historically, Bancorp has not made use of derivatives, interest rate hedges
or similar instruments or transactions to manage interest rate risk, but is
prepared to employ such instruments as circumstances dictate.
TABLE 2. AVERAGE BALANCES, INTEREST, AND AVERAGE RATES (CONSOLIDATED)
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------- ----------------------------- -----------------------------
(Dollars in thousands) AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCES INTEREST RATE BALANCES INTEREST RATE BALANCES INTEREST RATE
-------- -------- ------- -------- -------- ------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
INTEREST-EARNING ASSETS
Short-term funds................ $30,255 $1,868 6.17% $12,729 $619 4.86% $16,055 $891 5.55%
-------- -------- -------- -------- ------- -------- -------
Investment securities:(1)
Taxable....................... 255,798 15,772 6.17 221,361 14,273 6.45 224,510 14,039 6.25
Tax-exempt(2)................. 100,352 7,040 7.02 98,559 7,185 7.29 104,210 7,791 7.48
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total investment securities(2).. 356,150 22,812 6.40 319,920 21,458 6.71 328,720 21,830 6.64
-------- -------- ------- -------- -------- ------- -------- -------- -------
Loans, net, including loans
held for sale(2).............. 879,705 77,129 8.77 864,986 76,892 8.89 789,604 70,560 8.94
-------- -------- ------- -------- -------- ------- -------- -------
Total interest-earning assets
and average yield(2).......... 1,266,110 $101,809 8.04% 1,197,635 $98,969 8.26% $1,134,379 $93,281 8.22%
-------- ------- -------- ------- -------- -------
Total noninterest-earning
assets........................ 102,034 100,908 97,744
-------- -------- --------
Total assets.................... $1,368,144 $1,298,543 1,232,123
========== ========== =========
LIABILITIES AND SHAREHOLDERS'
EQUITY
INTEREST-BEARING LIABILITIES
Interest bearing deposits:
Checking...................... $138,948 $2,670 1.92% $130,624 $2,653 2.03% $116,971 $2,505 2.14%
Savings....................... 154,762 3,893 2.52 163,897 4,310 2.63 172,101 4,707 2.74
Money market accounts......... 146,577 4,797 3.27 126,654 3,850 3.04 127,497 3,860 3.03
Certificates of deposit....... 502,458 27,439 5.46 482,398 26,428 5.48 464,991 25,792 5.55
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total interest bearing
deposits................... 942,745 38,799 4.12 903,573 37,241 4.12 881,560 36,864 4.18
-------- -------- ------- -------- -------- ------- -------- -------- -------
Short-term borrowings:
Federal funds purchased
and securities sold under
agreements to repurchase.... 49,095 2,399 4.89 44,280 2,264 5.11 38,565 1,908 4.95
Other short-term borrowings... 26,703 1,476 5.53 62,001 3,663 5.91 41,819 2,393 5.72
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total short-term borrowings..... 75,798 3,875 5.11 106,281 5,927 5.58 80,384 4,301 5.35
Long-term borrowings............ 73,964 4,204 5.68 24,350 1,434 5.89 18,765 1,213 6.46
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total borrowed funds............ 149,762 8,079 5.39 130,631 7,361 5.63 99,149 5,514 5.56
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total interest-bearing
liabilities and average
rate incurred................. 1,092,507 46,878 4.29 1,034,204 44,602 4.31 980,709 42,378 4.32
--------- -------- ------- --------- -------- ------- -------- -------- -------
NONINTEREST-BEARING LIABILITIES
Demand deposits................. 134,457 131,769 127,323
Other liabilities............... 12,001 13,649 12,874
-------- -------- --------
Total noninterest-bearing
liabilities................... 146,458 145,418 140,197
-------- -------- --------
Total liabilities............... 1,238,965 1,179,622 1,120,906
--------- --------- ---------
Shareholders' equity............ 129,179 118,921 111,217
-------- -------- --------
Total liabilities and
shareholders' equity.......... $1,368,144 $1,298,543 $1,232,123
========== ========== ==========
Net interest income............. $54,931 $54,367 $50,903
======= ======= =======
Net interest spread(3).......... 3.75% 3.95% 3.90%
===== ===== =====
Net interest margin (4)......... 4.34% 4.54% 4.49%
===== ===== =====
See footnotes, next page.
- -------------
(1) Average Balances and the related average rate are based on
amortized cost.
(2) Interest and yields on obligations of states and political
subdivisions and tax-exempt loans are computed on a taxable
equivalent basis using the U.S. statutory tax rate of 35 percent.
In addition, loan fee income is included in the interest income
calculations, and nonaccrual loans are included in the average
loan base upon which the interest rate earned on loans is
calculated.
(3) Net interest spread is the difference between the ratios
(expressed as percentages) of taxable-equivalent interest income
to earning assets and of interest expense to interest-bearing
liabilities.
(4) Net interest margin is the difference between the ratios
(expressed as percentages) of taxable-equivalent interest income
to earning assets and of interest expense to earning assets.
</TABLE>
Table 2 displays average balances, interest and interest rates for
each major category of interest-earning assets and interest-bearing
liabilities over a three-year period. Total interest income, expressed on a
taxable- equivalent basis as if every dollar of interest income was fully
taxable at the same federal and state tax rate, increased 3% to $101.8
million for 1998 from $99.0 million for 1997. The increase was attributed
largely to an 11% increase in average investment securities supplementing a
modest 2% growth in average loans. Bancorp took deliberate action to reduce
its indirect loan portfolio by approximately $17.8 million in 1998 and was
not willing to compete with the aggressive tactics of loan syndicates
regarding commercial loan pricing and credit structure evident during most
of the year. Favoring growth in lower yielding investment securities then,
the yield on average earning assets declined to 8.04% for 1998, from 8.26%
for 1997.
Total interest expense increased 5%, to $46.9 million for 1998,
from $44.6 million for 1997, but trailed the rate of growth of
interest-bearing liabilities as the average cost of funds declined to 4.29%
for 1998, from 4.31% for 1997. Average interest-bearing deposits, led by a
$27.4 million increase in Bancorp's successful new T-Bill Plus Money Market
Deposit Account, with interest rates tied to the 13-week Treasury Bill,
increased by 4% for 1998, and average borrowings, principally long term,
increased by 15%. While the 11% growth in average repurchase balances
between 1998 and 1997 reflected growth in underlying commercial account
relationships, a 19% increase in FHLB borrowings was related chiefly to
investment opportunities with unusually attractive terms and contributions
to growth in net interest income in 1998.
The net interest margin ("margin"), which is the ratio of taxable-
equivalent net interest income to average earning assets, has been under
considerable pressure throughout the banking industry, especially over the
past two years. In contrast to 1997, when loan growth and a stable cost of
funds prevented Bancorp's margin from declining, a moderate decline in the
margin to 4.34% for 1998 compared with 4.54% for 1997 was principally the
result of modest growth in total average loans, with stronger growth in
lower-yielding investment securities. Furthermore, Bancorp's earning assets
have a tendency to re-price more quickly than its interest-bearing
liabilities, further exacerbating the margin decline as interest rates
moved lower in 1998. Inasmuch as interest rates may decline further in
1999, Bancorp is prepared to evaluate available options to mitigate any
possible adverse impact on net interest income.
Table 3, Analysis of Changes in Net Interest Income, quantifies
the change in net interest income for the periods presented and, as
discussed above, shows how much was attributed to volume factors and how
much was influenced by interest rate movements. Bancorp endeavors to
maintain a relatively balanced position between interest-sensitive assets
and interest-sensitive liabilities without forgoing opportunities to
benefit from relevant interest rate conditions within the boundaries of
prudent risk management and established corporate policy. Further
information may be found on page 26, Asset and Liability Management
("ALM"), Market Risk, and in Table 15, Effects of Changes in Interest Rates
on MVE, page 28.
<TABLE>
<CAPTION>
TABLE 3. ANALYSIS OF CHANGES IN NET INTEREST INCOME
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
1998 OVER 1997 1997 OVER 1996
-------------------------------- ----------------------------------
DUE TO CHANGE IN(1) DUE TO CHANGE IN(1)
------------------- -------------------
(In thousands) INCREASE INCREASE
(DECREASE) VOLUME RATES (DECREASE) VOLUME RATES
---------- ------ ----- ---------- ------ -----
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans(2)(3)........... $237 $1,299 $(1,062) $6,332 $6,703 $(371)
Interest and dividends on investment
securities:
Taxable.................................. 1,499 2,146 (647) 234 (199) 433
Tax-exempt(4)............................ (145) 129 (274) (606) (416) (190)
Interest on federal funds sold............. 335 77 258 (319) (345) 26
Interest-bearing deposits with banks....... 914 834 80 47 124 (77)
------- ------- -------- ------- ------- -------
Total...................................... 2,840 4,485 (1,645) 5,688 5,867 (179)
------- ------- -------- ------- ------- -------
INTEREST EXPENSE
Interest on deposits....................... 1,558 1,662 (104) 377 993 (616)
Interest on federal funds purchased and
securities sold under agreements to
repurchase............................... 135 238 (103) 356 290 66
Interest on other short-term borrowings.... (2,187) (1,966) (221) 1,270 1,190 80
Interest on long-term borrowings........... 2,770 2,820 (50) 221 336 (115)
------- ------- -------- ------- ------- -------
Total...................................... 2,276 2,754 (478) 2,224 2,809 (585)
------- ------- -------- ------- ------- -------
Net Interest Income........................ $564 $1,731 $(1,167) $3,464 $3,058 $406
======= ======= ======== ======= ======= =======
- -----------------
(1) The change in interest due to both rate and volume has been
allocated to rate and volume changes in porportion to the
relationship of the absolute dollar amounts of the change in each.
(2) Included in the change in interest income are decreased fees on
loans of $431 for the year ended December 31, 1998 over 1997 and
increased fees on loans of $355 for the year ended December 31,
1997 over 1996.
(3) Tax equivalent adjustments of $235 for 1998, $127 for 1997 and
$160 for 1996 are included in the calculation of rate changes for
interest and fees on loans.
(4) Tax-equivalent adjustments of $2,394 for 1998, $2,443 for 1997 and
$2,648 for 1996 are included in the calculation of rate changes
for tax-exempt investment securities changes for tax-exempt
investment securities.
</TABLE>
PROVISION FOR CREDIT LOSSES
The provision for credit losses was increased by 5% for 1998, to
$3.1 million, from $2.9 million for 1997, related to modest loan growth for
the year and the relatively high, but declining, level of consumer loan
losses. Total net loan losses for 1998 declined by 11% from 1997, and
amounted to 0.26% of average total loans for the year. The decrease was
attributed principally to a 25% reduction in net consumer loan losses. A
five-year history of the allowance for credit losses is displayed in Table
13, page 23.
NONINTEREST INCOME
Noninterest income increased 8% in 1998, to $19.8 million, from
$18.3 million in 1997. Excluding special items of an unusual or
nonrecurring nature described below, noninterest income from continuing
operations increased 7% in 1998.
Included in the results for 1998 were net investment securities
gains of $1.0 million realized by TBT in the eleven-month period prior to
the merger and a $467 thousand gain realized by Bancorp on the sale of real
estate previously used as a branch office facility. Noninterest income for
1997 included a $179 thousand gain on the sale of loans and $89 thousand in
gains on sales of investment securities by TBT. Bancorp realized a $900
thousand gain on the sale of the credit card merchant processing business
discussed earlier. If the operating income recognized in 1997 from this
line of business was also eliminated, comparable noninterest income before
special items increased 12% in 1998.
Trust income declined 2% in 1998. Excluding approximately $240
thousand represented by an unusually large estate administration fee
realized in 1997, the underlying rate of increase in trust income was 8%
for 1998. Trust assets under management, having declined significantly
related to the late-summer 1998 stock market correction, rebounded to close
1998 at $432 million, 13% above $383 million in assets under management at
year-end 1997.
Service charges on deposit accounts increased 3% in 1998, to $6.0
million, from $5.8 million for 1997 related largely to transaction volume.
Insurance income increased 15% to $2.3 million for 1998 from $2.0
million for 1997 related to increased sales of consumer and commercial
business insurance products.
Gains on sales of loans increased 38% to $2.0 million for 1998
from $1.4 million for 1997. The historically low mortgage rate environment
that was sustained throughout 1998 triggered high refinancing volume.
Other operating income declined 15% to $5.3 million for 1998 from
$6.2 million for 1997 principally related to the mid-year 1997 sale of the
credit card merchant processing business and the termination of revenue
therefrom.
NONINTEREST EXPENSE
Total noninterest expense, sometimes referred to as overhead
expense, increased 7% to $50.9 million for 1998 from $47.7 million for
1997. Excluding merger related expense and other special items of an
unusual or nonrecurring nature as disclosed in Table 1 and discussed below,
noninterest expense increased 2% reflecting stringent cost controls and
significant efficiencies realized through the 1998 integration of the
Savings Bank's core processing systems and administrative functions.
Salaries increased 5% to $21.6 million for 1998 from $20.6 million
for 1997. Excluding $454 thousand in 1997 compensation expense recognized
pursuant to the provisions of an agreement with Savings Bank, salaries
increased 7% attributed to merit increases, new hires, promotions, and
performance-based incentive payments.
Pension and other employee benefits declined 1% to $4.88 million
for 1998 from $4.95 million for 1997 related to favorable experience in
medical and health programs.
Merger-related expense increased to $3.2 million for 1998 from
$0.5 million for 1997 largely associated with legal and accounting fees,
severance payments, contract terminations, and similar expenses incurred in
connection with the acquisition and merger of Monocacy Bancshares, Inc.
which closed on November 30, 1998.
Occupancy and equipment expense declined 1% to $7.8 million for
1998 from $7.9 million for 1997 attributed to cost reductions associated
with a systems conversion at the Savings Bank completed in June 1998.
Other operating expense decreased 3% to $13.4 million for 1998
from $13.8 million for 1997 related principally to discontinued operating
expense associated with the sale of the credit card merchant processing
business in the third quarter of 1997.
INCOME TAXES
Income tax expense decreased by 4% to $5.0 million for 1998, from
$5.3 million for 1997, largely related to a 7% decrease in income before
taxes. Tax expense varies with changes in the level of income before taxes,
the amount of tax-exempt income realized, and the relationship of these
changes to each other. Also, the amount of income tax expense differs from
the amount computed at statutory rates primarily because interest realized
on state and municipal obligations and certain loans is tax-exempt. See
Note 8, Income Taxes, Notes to Consolidated Financial Statements.
The effective tax rate, which is the provision for income taxes
divided by income before taxes, increased slightly to 27.8% for 1998
compared with 27.0% for 1997 largely related to non-tax-deductible expenses
associated with the acquisitions of K-S and Monocacy Bancshares in 1998.
FINANCIAL CONDITION
SOURCES AND USES OF FUNDS
Bancorp's financial condition can be evaluated by analyzing its
sources and uses of funds. The comparison of average balances in Table 4
shows an increase in average earning assets ("Uses") for 1998 of $68.5
million, or 6% above 1997, and indicates how that increase was funded
("Sources").
Investment Securities
The investment securities portfolio is structured and managed to
meet several important financial objectives:
- To maintain sufficient balance sheet liquidity to meet
any reasonable decline in deposits and any anticipated
increase in loans.
- To insure safety of principal and interest by investing
only in securities permitted by regulation.
- To maximize income consistent with liquidity and safety
requirements.
- To maintain a source of assets which can be pledged as
collateral for federal, state and municipal deposits.
The investment securities portfolio is held in two categories for
accounting and reporting purposes: (1) available-for-sale ("AFS")
securities are those which are intended to be held for an indefinite period
of time, but not necessarily to maturity, and (2) held-to-maturity ("HTM")
securities are those for which there is both a positive intent and an
ability to hold to maturity. These determinations are made when the
securities are purchased and are integral to Bancorp's asset/liability
("ALM") policies. The accounting policy for investment securities is set
forth in Note 1, Nature of Banking Activities and Significant Accounting
Policies, Notes to Consolidated Financial Statements.
Short-term uses of funds, shown in Table 4 as federal funds and
interest-bearing deposits with banks, are principally a function of the
management of Bancorp's daily cash and liquidity requirements. An increase
in these accounts, for example, may indicate a temporary excess of
investable funds not otherwise required for increases in loans or
investments, or decreases in deposits. Conversely, a decrease in these
categories usually indicates the opposite.
<TABLE>
<CAPTION>
TABLE 4. SOURCES AND USES OF FUNDS
1998 1997 1996
--------------------------------- ---------------------------------- ---------
AVERAGE INCREASE AVERAGE INCREASE AVERAGE
BALANCE (DECREASE) % BALANCE (DECREASE) % BALANCE
------- ---------- ----- ------- ---------- ----- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
FUNDING USES
Federal funds sold........... $5,959 $1,123 23.2% $4,836 $(5,972) (55.3)% $10,808
Interest-bearing deposits
with banks................. 24,296 16,403 207.8 7,893 2,646 50.4 5,247
Taxable investment
securities................. 255,798 34,437 15.6 221,361 (3,149) (1.4) 224,510
Tax-exempt investment
securities................. 100,352 1,793 1.8 98,559 (5,651) (5.4) 104,210
Loans, net................... 879,705 14,719 1.7 864,986 75,382 9.5 789,604
---------- ------- ------ ---------- ------- ------ ----------
Total uses................... $1,266,110 $68,475 5.7% $1,197,635 $63,256 5.6% $1,134,379
========== ======== ====== ========== ======= ====== ==========
FUNDING SOURCES
Interest-bearing checking.... $138,948 $8,324 6.4% $130,624 $13,653 11.7% $116,971
Savings...................... 154,762 (9,135) (5.6) 163,897 (8,204) (4.8) 172,101
Money market accounts........ 146,577 19,923 15.7 126,654 (843) (0.7) 127,497
Certificates of deposit...... 502,458 20,060 4.2 482,398 17,407 3.7 464,991
Short-term borrowings........ 75,798 (30,483) (28.7) 106,281 25,897 32.2 80,384
Long-term borrowings......... 73,964 49,614 203.8 24,350 5,585 29.8 18,765
Noninterest-bearings
funds (net)(1)............. 173,603 10,172 6.2 163,431 9,761 6.4 153,670
---------- ------- ------ ---------- ------- ------ ----------
Total sources................ $1,266,110 $68,475 5.7% $1,197,635 $63,256 5.6% $1,134,379
========== ======== ====== ========== ======= ====== ==========
- ---------------
(1) Noninterest-bearing liabilities and shareholders' equity, less
noninterest-earning assets.
</TABLE>
TABLE 5. INVESTMENT PORTFOLIO DISTRIBUTION-AMORTIZED COST(1)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
U. S. Treasury securities and obligations of U.S.
government corporations and agencies................... $118,271 $116,387 $103,553
Obligations of states and political subdivisions......... 125,347 102,545 100,272
Mortgage-backed securities............................... 154,848 89,544 103,632
Other securities......................................... 22,055 18,217 8,512
-------- -------- --------
Total.................................................... $420,521 $326,693 $315,969
======== ======== ========
- -----------
(1) Reflects the cost of securities purchased, adjusted for
amortization of premiums and accretion of discounts, which differs
from the amounts reflected in the consolidated balance sheets due
to fair value adjustments made in accordance with Financial
Accounting Standards Board Statement No. 115.
</TABLE>
TABLE 6. INVESTMENT PORTFOLIO ANALYSIS-DECEMBER 31, 1998
<TABLE>
<CAPTION>
MATURING IN:
----------------------------------------------------------------------------------------------
AFTER ONE AFTER FIVE
ONE YEAR THROUGH THROUGH
OR LESS FIVE YEARS TEN YEARS AFTER TEN YEARS TOTAL
---------------- ----------------- ---------------- ----------------- ----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Available-for-sale:(1)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies....... $13,016 5.29% $56,065 5.72% $49,190 6.46% $ - -% $118,271 5.98%
Obligations of states and
political subdivisions(2)....... 250 6.21 5,082 6.87 16,285 6.60 19,973 6.56 41,590 6.61
Other bonds....................... - - 2,328 5.51 - - - - 2,328 5.51
Mortgage-backed securities(3)..... 5,862 7.24 61,979 6.19 23,186 6.49 49,347 6.44 140,374 6.37
Equity securities................. - - - - - - 19,727 5.42 19,727 5.42
------- ----- ------- ---- ------- ---- ------- ---- -------- -----
Total available-for-sale.......... 19,128 5.90 125,454 5.99 88,661 6.50 89,047 6.24 322,290 6.19
------- ----- ------- ---- ------- ---- ------- ---- -------- -----
Held-to-maturity:
Obligations of states and
political subdivisions(2)....... 7,471 7.75 29,868 7.22 25,855 6.97 20,563 6.62 83,757 7.04
Mortgage-backed securities(3)..... - - 2,355 6.78 10,932 7.11 1,187 6.40 14,474 7.00
------- ----- ------- ---- ------- ---- ------- ---- -------- -----
Total held-to-maturity............ 7,471 7.75 32,223 7.19 36,787 7.01 21,750 6.61 98,231 7.04
------- ----- ------- ---- ------- ---- ------- ---- -------- -----
Total investment securities....... $26,599 6.42% $157,677 6.24% $125,448 6.65% $110,797 6.31% $420,521 6.39%
======= ===== ======== ===== ======== ===== ======== ===== ======== =====
- -----------
(1) Reflects the cost of securities purchased, adjusted for
amortization of premiums and accretion of discounts, which differs
from the amounts reflected in the 1998 consolidated balance sheet
due to fair value adjustments made in accordance with Financial
Accounting Standards Board Statement No. 115.
(2) Yields are presented on a fully taxable equivalent basis using the
federal statutory rate of 35%.
(3) Estimated prepayment assumptions have been incorporated into the
maturities for mortgage-backed securities based upon historical
trends.
</TABLE>
Table 5, Investment Portfolio Distribution, displays the year-end
amortized cost of the investment securities portfolio, which increased 29%
in 1998 to $420.5 million at December 31. The most significant change was
evidenced by a $65.3 million, or 73% increase in mortgage-backed securities
as yields and terms were relatively attractive in 1998.
As shown in Table 6, Investment Portfolio Analysis, the amortized
cost of AFS securities totaled $322.3 million and represented 77% of the
total securities portfolio and 22% of consolidated total assets at December
31, 1998. AFS securities provide substantial liquidity, chiefly for
unexpected loan growth or deposit withdrawal requirements. Conversely, HTM
securities, which amounted to $98.2 million, or 23% of the total portfolio
at December 31, 1998, are expected to be held until their scheduled
maturities and are composed of longer-term, tax-exempt state and municipal
obligations and mortgage-backed securities.
In management's opinion, no securities presented any material risk
characteristics at December 31, 1998. Approximately 99% of all obligations
of states and political subdivisions were rated A or higher by either
Moody's Investors Service or Standard and Poors, and approximately 83% were
rated AAA at December 31, 1998.
Loans
As presented in Table 4, Sources and Uses of Funds, average loans
increased 2% in 1998, whereas total loans at December 31, 1998 increased 1%
to $891.7 million from $882.6 million at December 31, 1997 as shown in
Table 7, Loan Portfolio Mix. The table reveals an $18.2 million, or 7%
reduction in consumer loans, primarily lower-yielding indirect automobile
loans, and a $27.4 million, or 16% increase in higher-yielding commercial
mortgage loans. The mix change improved the overall quality and yield of
the total loan portfolio.
Management believes that its underwriting standards are
conservative and consistently applied. Although geographically focused on
its growing primary marketplace, which has proven to be economically
vibrant and stable over the years, Bancorp's credit risk is well
diversified as to loan type and average loan size.
TABLE 7. LOAN PORTFOLIO MIX
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- --------------- --------------- ----------------- ----------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
Construction and land development... $61,328 6.9% $67,026 7.6% $65,453 7.9% $53,149 6.9% $56,808 7.4%
Secured by farmland................. 8,452 0.9 8,479 1.0 9,006 1.1 8,633 1.1 8,645 1.1
Residential mortgage................ 265,394 29.8 257,121 29.1 241,275 29.1 232,543 30.4 225,185 29.3
Other mortgage...................... 198,131 22.2 170,742 19.3 161,284 19.4 155,754 20.4 173,153 22.5
Agricultural.......................... 560 0.1 819 0.1 985 0.1 1,690 0.2 2,183 0.3
Commercial and industrial............. 92,091 10.3 99,043 11.2 84,569 10.2 80,957 10.6 71,348 9.3
Consumer.............................. 257,968 28.9 276,134 31.3 258,493 31.2 227,764 29.8 226,802 29.4
Other loans........................... 7,817 0.9 3,186 0.4 8,164 1.0 4,821 0.6 5,737 0.7
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans........................... $891,741 100.0% $882,550 100.0% $829,229 100.0% $765,311 100.0% $769,861 100.0%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
Loans are classified according to security, borrower or purpose.
</TABLE>
TABLE 8. LOAN MATURITIES AND INTEREST SENSITIVITY(1)AT DECEMBER 31, 1998
<TABLE>
<CAPTION>
MATURING IN:
------------------------------------------------------
AFTER ONE
ONE YEAR THROUGH AFTER FIVE
OR LESS(2) FIVE YEARS YEARS TOTAL
---------- ---------- ---------- -----
(In thousands)
<S> <C> <C> <C> <C>
Real estate:
Construction and land development................. $24,485 $23,585 $13,258 $61,328
Secured by farmland............................... 1,367 6,599 486 8,452
Agricultural........................................ 167 394 - 561
Commercial and industrial........................... 38,582 39,997 13,511 92,090
Other loans......................................... 6,064 547 1,206 7,817
------- ------- ------- --------
Total............................................. $70,665 $71,122 $28,461 $170,248
======= ======= ======= ========
Rate sensitivity:
Predetermined rate................................ $54,117 $22,959
Floating rate..................................... 17,005 5,502
======= =======
Total............................................. $71,122 $28,461
======= =======
- -----------
(1) Excludes real estate mortgage loans and consumer loans.
(2) Includes demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts.
</TABLE>
Deposits
Representing the principal source of funds for loans and
investments, average total deposits, as shown in Table 9, Average Deposits
and Rates Paid, increased by 4% in 1998 over 1997, with increases in every
major deposit type except Savings. However, owing to the strong inflow of
deposits in the fourth quarter of 1998, total deposits for the year
increased 8% to $1.138 billion at December 31 from $1.054 billion at
December 31, 1997. The Bank's new money market deposit account called
T-Bill Plus, introduced in the last half of 1997, increased 250%, or $31.0
million in 1998, from $12.4 million at December 31, 1997, to $43.4 million
at December 31, 1998. The yield on T-Bill Plus re-sets weekly with the
13-week Treasury Bill providing a tangible, money market rate of return to
depositors. Of further significance, both noninterest-bearing and
interest-bearing checking balances increased by 10% during 1998
contributing to Bancorp's overall lower cost of deposits for the year
compared with 1997.
Table 10, Maturity of Time Deposits $100,000 and Over, reflects a
growth rate of 45% for 1998, most notably in the popular six- through
twelve-month maturities. Generally the highest cost source of deposits,
they are also a relatively stable source coming largely from local
municipalities. Bancorp does not expect to see this category exceed recent
levels of 5-7% of total deposits.
TABLE 9. AVERAGE DEPOSITS AND RATES PAID
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
------- ---- ------- ---- ------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand deposits............. $134,457 $131,769 $127,323
---------- ---------- ----------
Interest-bearing deposits:
Checking...................................... 138,948 1.92% 130,624 2.03% 116,971 2.14%
Money market.................................. 146,577 3.27 126,654 3.04 127,497 3.03
Savings....................................... 154,762 2.52 163,897 2.63 172,101 2.74
Time.......................................... 502,458 5.46 482,398 5.48 464,991 5.55
---------- ----- ---------- ----- ---------- -----
Total interest-bearing deposits............... 942,745 4.12 903,573 4.12 881,560 4.18
---------- ----- ---------- ----- ---------- -----
Total average deposits........................ $1,077,202 3.60% $1,035,342 3.60% $1,008,883 3.65%
========== ===== ========== ===== ========== =====
</TABLE>
TABLE 10. MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
DECEMBER 31,
-------------------------------
1998 1997 1996
---- ---- ----
(In thousands)
Maturing in:
3 months or less...................... $23,793 $15,543 $15,318
Over 3 months through 6 months........ 13,092 9,887 12,781
Over 6 months through 12 months....... 20,830 10,849 7,738
Over 12 months........................ 13,308 12,568 14,592
------- ------- -------
Total................................. $71,023 $48,847 $50,429
======= ======= =======
Borrowings
Table 4, Sources and Uses of Funds, reveals a shift from
short-term borrowings, which are composed principally of federal funds
purchased and securities sold under agreements to repurchase, to long-term
borrowings. Short-term borrowings decreased $30.5 million to an average of
$75.8 million for 1998, and long-term borrowings, which are mainly composed
of Federal Home Loan Bank advances maturing beyond one year, increased
$49.6 million to an average of $74.0 million for 1998. As a member of the
Federal Home Loan Bank of Atlanta, Bancorp takes advantage of a wide
variety of attractively priced funding options supported by residential
mortgage lending and community reinvestment activities.
Table 11, Short-Term Borrowings, discloses continued growth,
largely in repo relationships with commercial business customers, to $57.6
million at December 31, 1998. Short-term advances from the Federal Home
Loan Bank declined to $23.9 million at December 31, 1998 as Bancorp locked
in some attractive longer-term spreads during the year.
TABLE 11. SHORT-TERM BORROWINGS
FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
End of period outstanding............. $57,626 $45,051 $41,876
Highest month-end balance............. 62,266 61,745 52,079
Average balance....................... 49,095 44,280 38,565
Average rate of interest:
At end of year...................... 4.13% 5.33% 5.03%
During year......................... 4.89 5.11 4.95
SHORT-TERM ADVANCES FROM FEDERAL HOME LOAN BANK
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
---- ---- ----
(Dollars in thousands)
End of period outstanding............. $14,228 $54,051 $62,728
Highest month-end balance............. 50,051 68,551 64,808
Average balance....................... 23,858 58,745 36,452
Average rate of interest:
At end of year...................... 5.62% 5.95% 5.92%
During year......................... 5.63 5.91 6.15
RISK ELEMENTS
Nonperforming Assets
Table 12, Nonperforming Assets and Contractually Past-Due Loans,
displays a five-year history of steadily declining nonperforming assets.
Totaling just $5.9 million, or 0.41% of total consolidated assets at
December 31, 1998, Bancorp resolved its historical loan problems at an
annual rate of 33% over the period shown, largely reflecting substantial
progress by the Savings Bank in dealing with a legacy of the late-1980s.
Furthermore, as nonaccrual loans have continued to decline, the coverage
ratio of the allowance-to-nonperforming loans increased to a five-year high
of 305%.
Loans that were past due 90 days or more and not classified as
nonperforming totaled $2.0 million at December 31, 1998, or 0.22% of
year-end total loans, compared with $1.3 million one year earlier, or 0.15%
of total loans at December 31, 1997. Historically, there has been no direct
correlation between loans past due 90 days or more and nonperforming loans
or loan losses.
TABLE 12. NONPERFORMING ASSETS AND CONTRACTUALLY PAST-DUE LOANS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Nonperforming assets:
Nonaccrual loans(1).............................................. $4,196 $7,357 $8,074 $8,212 $18,271
Other real estate owned net of valuation allowance(2)............ 1,705 5,192 8,113 10,737 10,287
------- ------- ------- ------- -------
Total nonperforming assets......................................... $5,901 $12,549 $16,187 $18,949 $28,558
======= ======= ======= ======= =======
Loans past due 90 or more days as to interest or principal(3)...... $1,991 $1,298 $2,977 $1,121 $1,379
======= ======= ======= ======= =======
Nonperforming loans to total loans................................. 0.47% 0.83% 0.97% 1.07% 2.37%
Nonperforming assets to total loans plus other real estate owned... 0.66% 1.41% 1.93% 2.44% 3.66%
Nonperforming assets to total assets............................... 0.41 0.94 1.27 1.55 2.54
Allowance for credit losses times nonperforming loans.............. 3.05X 1.64X 1.45X 1.42X 0.73X
Allowance for credit losses times nonperforming assets............. 2.17 0.96 0.73 0.62 0.47
- -----------
(1) Loans are placed on nonaccrual status when, in the option of
management, reasonable doubt exists as to the full, timely
collection of interest or principle or a specific loan meets the
criteria for nonaccrual status established by regulatory
authorities. When a loan is placed on nonaccrual status, all
interest previously accrued but not collected is reversed against
current period interest income. No interest is taken into income
on nonaccrual loans unless received in cash or until such time the
borrower demonstrates sustained performance over a period of time
in accordance with contractual terms.
(2) Other real estate owned includes: banking premises no longer used
for business purposes, real estate acquired by foreclosure (in
partial or complete satisfaction of debt) or otherwise surrendered
by by the borrower to Bancorp's possession. Other real estate
owned is recorded at the lower of cost or fair value on the date
of acquisition or transfer from loans. Write-downs to fair value
at the date of acquisition are charged to the allowance for credit
losses. Subsequent to transfer, these assets are adjusted through
a valuation allowance to the lower of the net carrying value or
the fair value (net of estimated selling expenses) based on
periodic appraisals.
(3) Nonaccrual loans are not included.
</TABLE>
Potential Problem Loans
At December 31, 1998, there were $23.1 million in loans that
management had reasonable concerns might become contractually past due or
be classified as a nonperforming asset. This amount includes $5.1 in loans
to borrowers who may not be able to meet the contractual terms of their
obligations because of uncertainties pertaining to their state of readiness
for Year 2000 issues as disclosed under the caption, Year 2000 Computer
Readiness, which follows.
These loans are subject to the same close attention and regular
credit reviews as extended to loans past due 90 days or more and
nonperforming assets.
Allowance for Credit Losses
Provisions charged to earnings are made to the allowance for
credit losses in periodic amounts determined by management as necessary to
absorb possible future loan losses. Bancorp's policy regarding the
maintenance of an adequate allowance is set forth in Note 1, Notes to
Consolidated Financial Statements, on page 39.
Table 13, Analysis of Allowance for Credit Losses, shows a
five-year history of activity reflecting relative stability in both the
annual charge-off ratio and the level of the allowance related to total
loans. Of particular significance is that net consumer loan losses, which
had been increasing annually to a peak of $2.0 million in 1997, declined
substantially in 1998 to $1.5 million. Stringent credit standards
pertaining to indirect consumer loans have resulted in a substantial
decrease in losses and a recovery ratio of 57% for 1998.
Table 14, Allocation of Allowance for Credit Losses, discloses
management's allocation of the allowance to various loan categories,
notably a re-allocation from consumer and construction loans to commercial
and commercial real estate loans, with a substantial increase in the
unallocated portion. This reflects the underlying trends in loan growth and
the change in mix discussed earlier. As they are estimates, this allocation
is not intended to limit the amount of the allowance available to absorb
losses from any type of loan and should not be viewed as an indicator of
the specific amount or specific loan category in which future charge-offs
may ultimately occur.
See Note 4, Loans, Notes to Consolidated Financial Statements, for
disclosures pertaining to impaired loans and the specific allowance related
thereto.
While management believes the allowance for credit losses was
adequate at December 31, 1998, the estimate of losses and related allowance
may change in the near term due to economic and other uncertainties
inherent in the estimation process.
TABLE 13. ANALYSIS OF ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
(In thousands) 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Average loans outstanding less average unearned income(1)..... $875,196 $860,585 $788,669 $777,394 $707,837
======== ======== ======== ======== ========
Allowance for credit losses at beginning of year.............. $12,069 $11,739 $11,700 $13,336 $13,705
-------- -------- -------- -------- --------
Charge-offs:
Real estate................................................. 1,053 849 605 2,855 1,000
Commericial and industrial.................................. 273 168 10 570 332
Consumer.................................................... 4,010 4,426 3,629 2,942 2,215
-------- -------- -------- -------- --------
Total charge-offs............................................. 5,336 5,443 4,244 6,367 3,547
-------- -------- -------- -------- --------
Recoveries:
Real estate................................................. 430 431 462 435 79
Commercial and industrial................................... 104 7 2 63 18
Consumer.................................................... 2,494 2,425 1,997 1,697 1,206
-------- -------- -------- -------- --------
Total recoveries.............................................. 3,028 2,863 2,461 2,195 1,303
-------- -------- -------- -------- --------
Net charge-offs............................................... 2,308 2,580 1,783 4,172 2,244
-------- -------- -------- -------- --------
Additions charged to operating expense........................ 3,056 2,910 1,822 2,536 1,875
-------- -------- -------- -------- --------
Allowance for credit losses at end of year.................... $12,817 $12,069 $11,739 $11,700 $13,336
======== ======== ======== ======== ========
Net charge-offs to average loans outstanding.................. 0.26% 0.30% 0.23% 0.54% 0.32%
======== ======== ======== ======== ========
Allowance for credit losses to year-end loans................. 1.44% 1.37% 1.42% 1.53% 1.73%
======== ======== ======== ======== ========
(1) Excludes loans held for sale.
</TABLE>
TABLE 14. ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- ---------------- ---------------- ---------------- ----------------
% GROSS % GROSS % GROSS % GROSS % GROSS
(Dollars in thousands) AMOUNT LOANS(1) AMOUNT LOANS(1) AMOUNT LOANS(1) AMOUNT LOANS(1) AMOUNT LOANS(1)
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
Construction and land development... $1,767 6.9% $2,193 7.6% $2,121 7.9% $2,617 6.9% $3,055 7.4%
Residential mortgage................ 920 29.8 737 29.1 570 29.1 554 30.4 1,048 29.3
Other mortgage...................... 3,419 22.2 2,936 19.3 2,987 19.4 2,670 20.4 4,189 22.5
Commercial and industrial............. 1,764 10.3 1,088 11.2 1,105 10.2 1,396 10.6 1,647 9.3
Consumer.............................. 3,599 28.9 4,167 31.3 2,837 31.2 2,449 29.8 2,643 29.4
Unallocated........................... 1,348 1.9 948 1.5 2,119 2.2 2,014 1.9 754 2.1
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total allowance for credit losses..... $12,817 100.0% $12,069 100.0% $11,739 100.0% $11,700 100.0% $13,336 100.0%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
(1) Reflects the percentage of loans in each category to total loans.
</TABLE>
Year 2000 Computer Readiness
This disclosure is provided pursuant to the Securities and
Exchange Commission's Interpretation entitled "Disclosure of Year 2000
Issues and Consequences by Public Companies, Investment Advisors,
Investment Companies and Municipal Securities Issuers" effective August 4,
1998.
The Year 2000 issue arose because many existing date-sensitive
computer programs, hardware, software, and other devices relying on
imbedded chip technology do not recognize a year that begins with "2"
because traditional programming has been limited to utilization of a
two-digit code for a year (such as "98" for the year 1998). Bancorp and its
subsidiaries have undertaken to review their operating and information
technology systems and other mechanical equipment such as elevators to
identify systems in which the Year 2000 issue exists and to undertake the
necessary renovation or replacement of these systems so that the companies
will continue to operate as usual after January 1, 2000.
In July 1997, Bancorp established a Year 2000 issue task force
comprised of representatives across functional lines representing all of
its subsidiaries. The Year 2000 issue task team developed a Year 2000 issue
assurance plan to coordinate and direct its efforts. The plan was approved
by the board of directors on September 11, 1997. The task force provides
quarterly reports to the board outlining the status of its efforts and its
anticipated work in the coming quarter.
The assurance plan is composed of five phases: 1) awareness; 2)
assessment; 3) renovation; 4) validation; and, 5) implementation, which
mirror guidelines developed by the Federal Financial Institutions
Examination Council ("FFIEC") to deal with the Year 2000 issue. The
assurance plan includes a timeline for completion of all tasks identified.
As of December 31, 1998, all critical tasks are current to the timeline.
Activities under each of the phases are ongoing as new vendor and customer
relationships are created, including specifically, as the result of
Bancorp's November 30, 1998 acquisition of Monocacy Bancshares, Inc. and
its principal subsidiary, Taneytown Bank & Trust Company.
The task team has undertaken the education of all associates
regarding the Year 2000 issue both for internal systems and as the problem
may affect customers. Education of customers has begun through periodic
information in the form of brochures and seminars. The task team has also
received guidance from various regulators including the OCC, Securities and
Exchange Commission ("SEC"), OTS, and FFIEC.
All vendors who supply hardware, software and/or services of any
type which may be affected by this issue have been identified and
contacted. A total of four hundred and eighty-seven (487) products and
services are represented by this vendor listing and have been categorized
as either mission critical (those that directly impact daily operations),
concern (those that can be replaced with manual processes), or low priority
(little or no impact on daily operations). Vendors have been surveyed as to
their Year 2000 issue readiness. The task team has confirmed vendor
responses by testing products and services where possible to verify their
readiness.
Of the one hundred and eighteen (118) products and services
identified as mission critical:
A. Thirty-eight (38) are not date sensitive and are
deemed Year 2000 issue ready.
B. Twenty-one (21) cannot be tested internally. The
progress of these service providers' efforts
addressing the Year 2000 issue are being closely
monitored. All twenty-one (21) advise that their
products and/or services are either Year 2000
issue ready now or will be in advance of January
1, 2000. Examples of products and/or services
that are not capable of internal testing include
utilities and communications services.
C. Forty-six (46) have been successfully tested.
D. One (1) has been tested and failed. A Year 2000
issue ready replacement system has been
identified and is being installed currently.
E. Twelve (12) have not yet been tested. Testing on
these twelve (12) was suspended because of
vendor commitments to either update existing
products and/or services or to support testing.
Bancorp anticipates that these twelve (12)
remaining products and/or services will be
tested by March 31, 1999. Of the twelve (12),
six (6) are the same make and model ATM machine.
Bancorp relies on Kirchman Corporation's Dimension 3000 software
for maintaining customer accounting records. Kirchman is a provider of
accounting systems for more than 1,000 banking clients worldwide.
Kirchman's internal methodologies addressing Year 2000 issues have been
reviewed and have received ITAA*2000 certification by the Information
Technology Association of America, an independent non-profit organization.
Further, Kirchman systems have passed all internal tests and testing is
complete. Conversion of the Monocacy Bancshares, Inc. core processing
system, also Kirchman, to Bancorp's system is scheduled for February, 1999.
The task team has developed procedures for assessing Year 2000
issue risk for its funds providers including depositors, which are intended
to manage and limit potential risks associated with large or significant
concentrations of retail and commercial deposits. The Year 2000 issue
readiness of providers of lines of credit have been reviewed.
The task team has also established procedures, utilizing the
standard risk classifications employed to manage credit risk, for reviewing
the Year 2000 issue readiness of borrowers. Loan relationships with
balances exceeding $250,000 or which are particularly computer reliant have
been reviewed. Fifteen (15) relationships totaling $4,916,400 have been
risk rated "watch" one (1) totaling $689,500 has been risk rated "OLEM" and
one (1) totaling $1,720,000 has been risk rated "substandard". The total
value of these seventeen (17) relationships is $7,325,900. The increase
over the last quarter reflects loan relationships acquired through the
Monocacy Bancshares, Inc. transaction. These credits are being reviewed
further to determine borrower progress in becoming Year 2000 issue ready.
The internal audit department is performing progress audits of the
work of the Year 2000 issue task force and reporting those results to
Bancorp's audit committee quarterly.
During the last quarter, efforts have been made to enhance
Bancorp's existing contingency plan for Year 2000 issues. The contingency
planning committee adopted the four phase model as recommended by the FFIEC
and OCC advisory letter 98-7. Phase 1, organization and planning, and Phase
2, business impact analysis, were complete at September 30, 1998 as
required by regulators. Phase 3, the contingency plan itself, and Phase 4,
designing a method of validation, were completed at December 31, 1998, also
as required by the regulators. Testing of business resumption plans will be
complete by March 31, 1999.
To date, Bancorp has spent a total of $102,000 addressing Year
2000 issues and anticipates additional out-of-pocket expenses of $177,000
to complete. Work is done predominantly by existing associates as part of
their normal work responsibilities. Bancorp has hired one additional
associate whose primary responsibility is testing. Bancorp does not
separately track these internal costs which are principally payroll
related.
Bancorp believes its efforts, and those of its third-party
providers will effectively address Year 2000 issues before January 1, 2000.
Because Bancorp is so reliant on third-party providers (which products and
services cannot be effectively tested) for support, normal business
operations could be disrupted in the event one or more third-party
providers fail to provide products and services as contracted. The most
reasonably likely worst case Year 2000 issue scenario identified to date
involves Bancorp's inability, for short periods, to provide services to
customers. The worst case scenario is mitigated somewhat by an ability to
manually process customer transactions, by the geographic penetration of
the branch network, and by alternative service delivery methods, which
include both proprietary and network ATMs, PC banking, telephone banking,
and Express Bank, a full-service mobile branch. Power and telecommunication
services are critical but might be interrupted for only a part of the
branch network. Bancorp has a generator to provide power to operate
computer systems and, by contract, has geographically-remote facilities
served by alternative sources of power to process work, if needed. Longer
periods of disruption could affect Bancorp's ability to develop new
business and could increase costs of operation and decrease revenues.
ASSET AND LIABILITY MANAGEMENT
The primary objectives for ALM are to identify opportunities to
maximize net interest income while ensuring adequate liquidity and
carefully managing interest rate risk. ALM policies are approved by the
Board of Directors and administered by the Asset/Liability Management
Committee ("ALCO"), which is primarily composed of executive officers.
ALCO's principal responsibilities include:
- Monitoring corporate financial performance.
- Determining liquidity requirements.
- Establishing interest rates, indices, and terms for loan
and deposit products.
- Assessing and evaluating the competitive rate
environment.
- Reviewing and ratifying investment portfolio transactions
under established policy guidelines.
- Monitoring and measuring interest rate risk.
Liquidity
Liquidity management involves the ability to meet the demand for
funds from both depositors and borrowers with either balance sheet assets
or access to incremental borrowings. These needs are met with cash on hand,
the sale of non-cash assets, or with funds received from depositors or
lenders. The primary focus of liquidity management is to match the cash
inflows and outflows within Bancorp's natural market for loans and
deposits. The primary cash and liquidity management tools are short-term
investments, FHLB borrowings and repurchase agreements. Secondary liquidity
is provided by the investment securities portfolio.
Asset liquidity includes monitoring the amount of available cash
on hand and assets maturing in the near term, limiting the amount of
securities that may be pledged, and maintaining relatively short duration
of investment securities. Tables 6 and 8 show a combined total of $97.3
million of investment securities and certain loans coming due within 12
months, or approximately 7% of total assets at December 31, 1998.
Funding liquidity is monitored primarily by the ratio of loans to
deposits. As deposit growth resumed in 1998, the loan-to-deposit ratio
declined sharply to 78% at December 31, 1998 from 84% one year earlier.
Funding liquidity is also augmented by a wide variety of borrowing sources
including the FHLB and credit lines available through correspondent banking
relationships.
Market Risk
Market risk is defined as the future changes in market prices that
increase or decrease the value of financial instruments, i.e., cash,
investments, loans, deposits and debt. Included in market risk are interest
rate risk, foreign currency exchange risk, commodity price risk, and other
relevant market risks. The primary source of market risk is interest rate
risk. Market risk-sensitive financial instruments are entered into for
purposes other than trading.
Interest rate risk refers to the exposure of earnings and capital
to changes in interest rates. The magnitude of the effect of changes in
market rates depends on the extent and timing of such changes and on
Bancorp's ability to adjust. The ability to adjust is controlled by the
time remaining to maturity on fixed-rate obligations, the contractual
ability to adjust rates prior to maturity, competition, and customer
actions.
There are several common sources of interest rate risk that must
be effectively managed if there is to be minimal impact on earnings and
capital. Re-pricing risk arises largely from timing differences in the
pricing of assets and liabilities. Reinvestment risk refers to the
reinvestment of cash flows from interest payments and maturing assets at
lower rates. Basis risk exists when different yield curves or pricing
indices do not change at precisely the same time or in the same magnitude
such that assets and liabilities with the same maturity are not affected
equally. Yield curve risk refers to unequal movements in interest rates
across a full range of maturities.
In determining the appropriate level of interest rate risk,
Bancorp considers the impact on earnings and capital of the current outlook
for interest rates, potential changes in interest rates, regional
economies, liquidity, business strategies, and other factors. To
effectively measure and manage interest rate risk, traditional cumulative
gap and simulation analyses are used to determine the impact on net
interest income and the market value of portfolio equity ("MVE"). Bancorp
attempts to manage interest rate sensitivity on the basis of when assets
and liabilities will reprice as opposed to when they can reprice.
Cumulative gap analysis presents the net amount of assets and
liabilities that will most likely reprice through specified periods if
there are no changes in balance sheet mix. Using that analysis, the effect
of changes in market interest rates, both rising and falling, on net
interest income can be calculated. Because of inherent limitations in
traditional cumulative gap analysis, however, ALCO also employs more
sophisticated interest rate risk measurement techniques. Simulation
analysis is used to subject the current re-pricing conditions to rising and
falling interest rates in increments and decrements of 100, 200, and 300
basis points, and to determine how net interest income varies under
alternative interest rate and business activity scenarios. ALCO also
measures the effects of changes in interest rates on the MVE, i.e., the net
present value of all future cash flows from financial instruments expressed
as the percentage change in portfolio value of equity for any given change
in prevailing interest rates. Table 15 presents MVE at December 31, 1998.
TABLE 15. EFFECTS OF CHANGES IN INTEREST RATES ON MVE AT DECEMBER 31, 1998
<TABLE>
<CAPTION>
PERCENT CHANGE
(Dollars in thousands) -------------------------
HYPOTHETICAL
MARKET VALUE CHANGE HYPOTHETICAL
CHANGE IN OF PORTFOLIO INCREASE INCREASE BOARD
INTEREST RATES EQUITY (DECREASE) (DECREASE) LIMIT(1)
- -------------- ------------ ------------ ------------ --------
<S> <C> <C> <C> <C>
300 bp rise.................................. $155,454 $(27,830) (15.2)% (30.0)%
200 bp rise.................................. 174,011 (9,273) (5.1)% (20.0)%
100 bp rise.................................. 179,247 (4,037) (2.2)% (10.0)%
Base scenario................................ 183,284 - - -
100 bp decline............................... 179,426 (3,858) (2.1)% (10.0)%
200 bp decline............................... 173,618 (9,666) (5.3)% (20.0)%
300 bp decline............................... 168,261 (15,023) (8.2)% (30.0)%
(1) Established by Bancorp's Board of Directors
</TABLE>
Computations of prospective effects of hypothetical interest rate
changes are based on many assumptions, including relative levels of market
interest rates, loan prepayments and changes in deposit levels. They are
not intended to be a forecast and should not be relied upon as indicative
of actual results. Further, the computations do not contemplate certain
actions that management could take in response to changes in interest
rates. At December 31, 1998 and 1997, the changes in net interest income
and or MVE calculated under these alternative methods were within limits
established by the Board of Directors and monitored by ALCO.
CAPITAL RESOURCES
It is Bancorp's policy to maintain a level of capital sufficient
to protect the company's depositors, creditors, and shareholders, and to
support Bancorp's growth. The principal source of capital is retained
earnings.
The Board, the OCC and the OTS maintain capital adequacy
guidelines applicable to Bancorp, the Bank, and the Savings Bank,
respectively, as disclosed in Note 15, Shareholders' Equity, Notes to
Consolidated Financial Statements. Under each measure, Bancorp and its
subsidiaries were substantially in excess of the minimum regulatory
requirements and, by definition, were "well capitalized" at December 31,
1998 and 1997.
In accordance with regulatory guidelines, fair value adjustments
to shareholders' equity for changes in the fair value of investment
securities classified as available-for-sale are excluded from the
calculations.
EFFECTS OF CHANGING PRICES
Inasmuch as virtually all of a financial institution's assets and
liabilities are monetary in nature, changes in interest rates, or the price
paid for money, may have a significant effect on earnings performance.
Interest rates, though affected by inflation, do not necessarily move in
the same direction, or in the same magnitude, as the prices of other goods
and services. Movements in interest rates are a result of the perceived
changes in the rate of inflation and the effects of monetary and fiscal
policies. Reference to Net Interest Income and Market Risk in this section
will assist the reader's understanding of how Bancorp is positioned to
address changing interest rates.
Several major categories of noninterest expense are more directly
affected by inflationary factors such as salaries and employee benefits and
other operating expenses. Management endeavors to overcome, or mitigate,
the effects of inflation by seeking opportunities to improve operating
efficiency and productivity, and by developing strategies for growth that
will exceed the projected rate of inflation.
1997 COMPARED TO 1996
OVERVIEW
Net income for 1997 increased 37% to $14.2 million, or $1.64 per
share, from $10.4 million, or $1.21 per share, for 1996, largely reflecting
the influence of special items in both years as set forth in Table 1.
Excluding special items in both years, net (operating) income increased 10%
to $14.0 million, or $1.61 per share, from $12.7 million, or $1.47 per
share for 1996.
SPECIAL ITEMS-1997
Special items for 1997, as shown in Table 1 on an after-tax basis,
included a $552 thousand gain on the sale of the credit card merchant
processing business ($0.06 per share). Recognizing the difficulty in
achieving sufficient economies of scale over the near term, Bancorp elected
to exit this highly competitive line of business in favor of alternatives
expected to produce greater profitability over the long term. TBT incurred
litigation costs of $177 thousand ($0.02 per share) and realized a $110
thousand gain on the sale of loans in 1997 ($0.01 per share) and a $59
thousand gain on the sale of investment securities ($0.01).
Pursuant to the provisions of the Plan and Agreement to Merge with
Home Federal, compensatory payments were recognized in 1997 for two
executive officers who elected to resign during the year. Such compensation
expense totaled $294 thousand ($0.03 per share) and was to be paid over a
24-month period.
SPECIAL ITEMS-1996
Special items for 1996, as shown in Table 1 on an after-tax basis,
included merger-related expenses of $1.2 million ($0.14 per share) and
securities losses of $203 thousand ($0.02 per share) incurred in Bancorp's
acquisition of the Savings Bank. A one-time assessment by the FDIC on
deposits insured by the Savings Association Insurance Fund amounted to $724
thousand ($0.08 per share).
NET INTEREST INCOME
Net interest income, on a tax-equivalent basis, increased 7% to
$54.4 million for 1997, from $50.9 million for 1996, related principally to
a 10% increase in average loans coupled with effective management of
funding sources. The yield on average earning assets increased four basis
points driven by the increase in average loans and an increase in average
rates earned on the investment securities portfolio. Although there was an
increased reliance on borrowed funds in 1997, the average rate paid on
interest-bearing liabilities declined one basis point assisted by lower
average rates paid on core deposit products. The net interest margin
increased to 4.54% for 1997, from 4.49% for 1996.
NONINTEREST INCOME
Noninterest income increased 22% to $18.3 million for 1997, from
$15.0 million for 1996. Excluding special items in both years as previously
described, operating noninterest income increased 12% for 1997 over 1996
driven largely by a 39% increase in trust income and investment management
fees, including an unusually large estate settlement fee realized in 1997.
Service charges on deposit accounts increased 14% to $5.9 million for 1997,
from $5.1 million for 1996. The increase was related primarily to service
fee adjustments made early in 1997, but also included fees related to new
services and special promotions. Other components of noninterest income,
exclusive of special items, increased 6%.
NONINTEREST EXPENSE
Noninterest expense was virtually flat at $47.7 million for both
1997 and 1996. Excluding merger related expense and other special items in
both years as previously described, noninterest expense increased 5% for
1997 from 1996.
Salaries, the largest component on noninterest expense, increased
10% to $20.6 million for 1997, from $18.7 million for 1996, attributed to
merit increases, new hires, promotions, and performance-based incentive and
bonus payments. Pension and other employee benefits increased 5% to $4.9
million for 1997, from $4.7 million for 1996, reflecting cost containment
initiatives and favorable experience in medical and health programs.
Occupancy and equipment expense increased 11% to $7.9 million for
1997, from $7.1 million for 1996 primarily associated with branch and
corporate headquarters expansion and additional investments in computer
hardware and software technology.
Other operating expense, exclusive of special items in both years,
declined 4% related principally to the sale of the credit card merchant
processing business.
INCOME TAXES
Income tax expense increased 64% to $5.3 million for 1997, from
$3.2 million for 1996, largely related to a 43% increase in income before
taxes. The effective tax rate was 27% for 1997 compared with 24% for 1996.
The ratio of tax-exempt income on investment securities to income before
taxes declined in 1997 to 24.3%, from 37.8% in 1996, thereby accounting for
most of the increase in the effective tax rate.
FINANCIAL CONDITION
Total assets were $1.339 billion at December 31, 1997, up $65.3
million, or 5%, from a year earlier. The increase was principally reflected
in loans, which were funded by a variety of sources, the largest component
being short-term borrowings, closely followed by certificates of deposit
and interest-bearing checking products. The capital position was
strengthened as the increase in average shareholders' equity, 6.9% over
1996, outpaced the 5.4% growth in average assets leading to an increase in
the average equity capital-to-assets ratio to 9.16% for 1997, from 9.03%
for 1996. All capital ratios were substantially in excess of regulatory
minimums for Bancorp and its subsidiaries at each of the years ended
December 31, 1997 and 1996.
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses was increased by 60%, to $2.9
million for 1997, from $1.8 million for 1996, due to a $797 thousand
increase in net charge-offs coupled with a 6.4% increase in total loans.
The ratio of net charge-offs to average loans outstanding increased to
0.30% for 1997, from 0.23% for 1996.
NONPERFORMING ASSETS
Continuing a trend extending over the previous four years,
nonperforming assets declined further in 1997, by 22% to $12.5 million at
December 31, 1997, from $16.2 million at year-end 1996. The ratio of
nonperforming assets to total assets declined to 0.94% at December 31, 1997
from 1.27% one year earlier.
RECENT DEVELOPMENTS
On July 15, 1999, F&M Bancorp consummated a merger with Potomac
Basin Group Associates, Inc. ("Potomac Basin"), in a tax-free exchange of
shares accounted for as a pooling of interests. Potomac Basin is a
Beltsville, MD-based, full-line independent insurance agency specializing
in corporate employee benefit plans. Restated financial information is
provided in the table below. Due to the nature and size of the business
acquired, the balance sheet effects of the merger were immaterial and the
principal effects of the merger on the statements of income were reflected
in increased insurance income, included in noninterest income, and
increased salaries and benefits, included in noninterest expense.
<TABLE>
<CAPTION>
AS OF OR FOR THE
(Dollars in thousands except per YEARS ENDED DECEMBER 31,
share data)
----------------------------------------------------------
1998 1997 1996 1995 1994
----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
Net interest income.................. $52,340 $51,820 $48,105 $46,929 $45,386
Provision for credit losses.......... 3,056 2,910 1,822 2,536 1,875
Net interest income after
provision for credit losses....... 49,284 48,910 46,283 44,393 43,511
Noninterest income (1)............... 23,252 21,352 17,476 18,558 14,670
Noninterest expenses (2)............. 53,934 50,674 50,199 46,249 42,083
Income before provision for
income taxes....................... 18,602 19,588 13,560 16,702 16,098
Provision for (benefit from)
income taxes....................... 5,046 5,251 3,196 3,261 4,077
Net income........................... 13,556 14,337 10,364 13,441 12,021
Earnings per share................... 1.45 1.55 1.12 1.46 1.31
BALANCE SHEET DATA (AT PERIOD END):
Loans, net of unearned income........ $891,741 $882,550 $829,229 $765,311 $769,861
Total assets......................... 1,450,647 1,339,461 1,273,803 1,222,267 1,123,401
Total deposits....................... 1,138,194 1,053,562 1,022,854 1,008,037 925,180
Total shareholders' equity........... 131,365 125,861 115,062 109,431 95,050
(1) Dollar amount of insurance
income from Potomac Basin...... $3,467 $3,052 $2,493 $2,828 $2,484
(2) Dollar amount of salaries
and benefits expense from
Potomac Basin.................. 2,362 2,265 2,006 1,852 1,482
</TABLE>
EXHIBIT 99.1 CONT. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of F&M Bancorp:
We have audited the accompanying consolidated balance sheets of
F&M Bancorp (a Maryland bank holding company) and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
income and comprehensive income, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1998, as
restated for the pooling-of-interests transaction with Potomac Basin Group
Associates, Inc. described in Note 2. These financial statements are the
responsibility of F&M Bancorp's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We
did not audit the consolidated financial statements of Monocacy Bancshares,
Inc., a bank holding company acquired during 1998 in a transaction
accounted for as a pooling-of-interests, as discussed in Note 2, for the
years ended December 31, 1997 and 1996. Such statements are included in the
consolidated financial statements of F&M Bancorp and reflect 22% of
consolidated total assets at December 31, 1997 and 20% of consolidated
total income for 1997 and 1996. These statements were audited by other
auditors whose report has been furnished to us and our opinion, insofar as
it relates to amounts included for Monocacy Bancshares, Inc., is based
solely on the report of the other auditors.
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 and
the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other
auditors, the financial statements referred to above present fairly, in all
material respects, the financial position of F&M Bancorp and subsidiaries
as of December 31, 1998 and 1997, and the results of their operations and
their cash flows for each of the three years in the period ended December
31, 1998 in conformity with generally accepted accounting principles.
Washington, D.C.
July 28, 1999
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Monocacy Bancshares, Inc.
We have audited the consolidated balance sheet of Monocacy
Bancshares, Inc. and Subsidiaries as of December 31, 1997, and the related
consolidated statements of income and comprehensive income, changes in
stockholders' equity, and cash flows for each of the years in the two-year
period ended December 31, 1997. These consolidated statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated 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 consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the consolidated financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Monocacy Bancshares, Inc. and Subsidiaries as of December 31, 1997, and the
results of their operations and their cash flows for each of the years in
the two-year period ended December 31, 1997, in conformity with generally
accepted accounting principles.
Baltimore, Maryland
January 23, 1998
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
F&M BANCORP AND SUBSIDIARIES
DECEMBER 31,
(Dollars in thousands, except per share amounts) 1998 1997
---- ----
<S> <C> <C>
ASSETS
Cash and due from banks.......................................................... $47,653 $37,372
Federal funds sold............................................................... 11,652 14,314
Interest-bearing deposits with banks............................................. 16,749 9,083
---------- ----------
Total cash and cash equivalents................................................ 76,054 60,769
---------- ----------
Loans held for sale.............................................................. 4,810 5,223
---------- ----------
Investment Securities:
Held-to-maturity, fair value of $100,478 in 1998 and $96,650 in 1997........... 98,231 94,940
Available-for-sale, at fair value.............................................. 322,651 232,413
---------- ----------
Total investment securities.................................................... 420,882 327,353
---------- ----------
Loans, net of unearned income of $406 in 1998 and $643 in 1997................... 891,741 882,550
Less: Allowance for credit losses................................................ (12,817) (12,069)
---------- ----------
Net loans...................................................................... 878,924 870,481
---------- ----------
Bank premises and equipment, net................................................. 31,251 33,173
Other real estate owned, net..................................................... 1,705 5,192
Interest receivable.............................................................. 9,478 9,545
Intangible assets................................................................ 6,875 7,462
Other assets..................................................................... 20,668 20,263
---------- ----------
Total other assets............................................................. 69,977 75,635
---------- ----------
Total assets..................................................................... $1,450,647 $1,339,461
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing............................................................ $152,076 $138,440
Interest-bearing............................................................... 986,118 915,122
---------- ----------
Total deposits................................................................. 1,138,194 1,053,562
---------- ----------
Short-term borrowings:
Federal funds purchased and securities sold under agreements to repurchase..... 57,626 45,051
Other short-term borrowings.................................................... 14,776 57,252
Long-term borrowings............................................................. 94,246 43,862
Accrued interest and other liabilities........................................... 14,440 13,873
---------- ----------
Total liabilities................................................................ 1,319,282 1,213,600
---------- ----------
Commitments and contingencies (Note 12)
SHAREHOLDERS' EQUITY
Common stock, par value $5 per share; authorized 50,000,000 shares;
issued and outstanding 8,834,242 in 1998 and 8,477,710 in 1997................. 44,172 42,389
Surplus.......................................................................... 61,214 48,874
Retained earnings................................................................ 25,760 34,245
Accumulated other comprehensive income........................................... 219 353
---------- ----------
Total shareholders' equity....................................................... 131,365 125,861
---------- ----------
Total liabilities and shareholders' equity....................................... $1,450,647 $1,339,461
========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
F&M BANCORP AND SUBSIDIARIES
YEAR ENDED DECEMBER 31,
(Dollars in thousands, except per share amounts) 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans............................................... $76,894 $76,764 $70,400
Interest and dividends on investment securities:
Taxable................................................................ 15,772 14,273 14,039
Tax-exempt............................................................. 4,645 4,741 5,143
Interest on deposits with banks.......................................... 1,292 365 302
Interest on federal funds sold........................................... 615 280 599
------- ------- -------
Total interest income.................................................. 99,218 96,423 90,483
------- ------- -------
INTEREST EXPENSE
Interest on deposits:
Checking............................................................... 2,670 2,653 2,505
Savings................................................................ 3,893 4,310 4,707
Money market accounts.................................................. 4,797 3,850 3,860
Certificates of deposit................................................ 27,439 26,428 25,792
Interest on federal funds purchased and securities sold
under agreements to repurchase......................................... 2,399 2,264 1,908
Interest on Federal Home Loan Bank borrowings............................ 5,529 4,907 3,453
Interest on other short-term borrowings.................................. 151 191 153
------- ------- -------
Total interest expense................................................. 46,878 44,603 42,378
------- ------- -------
Net interest income...................................................... 52,340 51,820 48,105
Provision for credit losses.............................................. 3,056 2,910 1,822
------- ------- -------
Net interest income after provision for credit losses.................... 49,284 48,910 46,283
------- ------- -------
NONINTEREST INCOME
Trust income............................................................. 2,671 2,715 1,956
Service charges on deposit accounts...................................... 6,007 5,855 5,122
Insurance income......................................................... 5,793 5,083 4,590
Gains on sales of loans.................................................. 1,968 1,421 1,187
Net gains (losses) on sales of securities................................ 1,104 76 (550)
Net gains on sales of property........................................... 450 17 140
Other operating income................................................... 5,259 6,185 5,031
------- ------- -------
Total noninterest income............................................... 23,252 21,352 17,476
------- ------- -------
NONINTEREST EXPENSE
Salaries................................................................. 23,541 22,561 20,526
Pension and other employee benefits...................................... 5,344 5,254 4,921
Merger-related expense................................................... 3,217 480 1,795
Occupancy and equipment expense.......................................... 7,919 7,979 7,207
Other operating expense.................................................. 13,913 14,400 15,750
------- ------- -------
Total noninterest expense.............................................. 53,934 50,674 50,199
------- ------- -------
Income before provision for income taxes................................. 18,602 19,588 13,560
Provision for income taxes............................................... 5,046 5,251 3,196
------- ------- -------
NET INCOME............................................................... $13,556 $14,337 $10,364
======= ======= =======
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized (losses) gains on securities.................................. $ (812) $1,274 $ (631)
Reclassification adjustment for gains (losses) included in income........ 678 47 (338)
------- ------- -------
Other comprehensive income (loss)........................................ (134) 1,321 (969)
------- ------- -------
Comprehensive income..................................................... $13,422 $15,658 $9,395
======= ======= =======
EARNINGS PER COMMON SHARE-BASIC
Based on weighted average shares outstanding of 9,253,113 in 1998,
9,202,878 in 1997, and 9,174,628 in 1996............................... $1.47 $1.56 $1.13
======= ======= =======
EARNINGS PER COMMON SHARE-DILUTED
Based on weighted average shares outstanding of 9,361,846 in 1998,
9,275,924 in 1997, and 9,233,409 in 1996............................... $1.45 $1.55 $1.12
======= ======= =======
The accompanying notes are an integral part of these consolidated
financial statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
F&M BANCORP AND SUBSIDIARIES
THREE YEARS ENDED DECEMBER 31, 1998
--------------------------------------------------------------------------
(Dollars in thousands, except per ACCUMULATED
share amounts) COMMON STOCK OTHER
--------------------- RETAINED COMPREHENSIVE
SHARES PAR VALUE SURPLUS EARNINGS INCOME (LOSS) TOTAL
------ --------- ------- -------- ------------- -----
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995.......... 8,134,120 $40,671 $40,190 $28,568 $1 $109,430
Net income............................ - - - 10,364 - 10,364
Dividend reinvestment plan............ - - - (25) - (25)
Cash dividends paid ($.49 per share).. - - - (4,279) - (4,279)
Stock consideration for options (7,448) (37) (40) (137) - (214)
exercised...........................
Stock options exercised............... 25,133 126 629 - - 755
Other comprehensive income............ - - - (969) (969)
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1996.......... 8,151,805 40,760 40,779 34,491 (968) 115,062
Net income............................ - - - 14,337 - 14,337
Dividend reinvestment plan............ - - - (80) - (80)
Cash dividends paid ($.67 per share).. - - - (5,853) - (5,853)
Stock consideration for options (9,514) (48) (59) (221) - (328)
exercised...........................
Stock options exercised............... 52,097 260 1,142 - - 1,402
Stock dividend........................ 283,322 1,417 7,012 (8,429) - -
Other comprehensive income............ - - - - 1,321 1,321
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1997.......... 8,477,710 42,389 48,874 34,245 353 125,861
Net income............................ - - - 13,556 - 13,556
Dividend reinvestment plan............ - - - (120) - (120)
Cash dividends paid ($1.06 per share). - - - (9,340) - (9,340)
Stock consideration for options (3,217) (16) (19) (90) - (125)
exercised...........................
Stock options exercised............... 56,930 285 1,382 - - 1,667
Stock dividend........................ 302,819 1,514 10,977 (12,491) - -
Other comprehensive income............ - - - - (134) (134)
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1998.......... 8,834,242 $44,172 $61,214 $25,760 $219 $131,365
========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
F&M BANCORP AND SUBSIDIARIES
YEAR ENDED DECEMBER 31,
------------------------------------
(dollars in thousands) 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................................................... $13,556 $14,337 $10,364
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses....................................................... 3,056 2,910 1,822
Provision for other real estate owned............................................. 2 156 436
Depreciation and amortization..................................................... 2,728 2,834 3,039
Amortization of intangibles....................................................... 779 758 1,001
Net premium amortization on investment securities................................. 36 424 615
Decrease (increase) in interest receivable........................................ 67 (905) (448)
Increase in interest payable...................................................... 760 208 197
Deferred income tax benefit....................................................... (452) (413) (316)
Amortization (accretion) of net loan origination costs (fees)..................... (221) (75) 67
Gains on sales of property........................................................ (450) (4) (140)
(Gains) losses on sales/calls of securities....................................... (1,104) (76) 550
(Increase) decrease in loans held for sale........................................ 413 6,347 (8,695)
Increase in other assets.......................................................... (375) (547) (3,889)
Increase (decrease) in other liabilities.......................................... (193) (844) 1,338
Gains on sales of loans........................................................... (1,968) (1,421) (1,187)
Other............................................................................. (864) 1,021 (1,072)
--------- --------- ---------
Net cash provided by operating activities........................................... 15,770 24,710 3,682
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investment securities to be held-to-maturity........................... (26,729) (7,722) (62,945)
Purchases of investment securities available-for-sale............................... (426,451) (178,099) (93,704)
Proceeds from calls of securities held-to-maturity.................................. 17,038 8,420 10,728
Proceeds from sales/calls of securities available-for-sale.......................... 129,322 58,059 63,197
Proceeds from maturing securities available-for-sale................................ 209,194 106,889 47,470
Proceeds from maturing securities held-to-maturity.................................. 6,103 3,719 13,023
Net increase in loans............................................................... (7,999) (54,201) (66,033)
Purchases of premises and equipment................................................. (1,708) (3,189) (10,060)
Proceeds from sales of property..................................................... 4,173 1,699 746
Other investing activities.......................................................... (624) (862) 2,022
--------- --------- ---------
Net cash used in investing activities............................................... (97,681) (65,287) (95,556)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in noninterest-bearing deposits, interest-bearing
checking, savings and money market accounts....................................... 49,446 20,515 (189)
Net increase in certificates of deposits............................................ 35,186 10,533 11,941
Net increase in federal funds purchased and securities sold under
agreements to repurchase.......................................................... 12,575 3,175 1,718
Net increase (decrease) in other short-term borrowings.............................. (42,476) (7,926) 36,581
Net increase (decrease) in long-term borrowings..................................... 50,384 28,691 (8,298)
Cash dividends paid................................................................. (9,340) (5,853) (4,279)
Dividend reinvestment plan.......................................................... (121) (80) (25)
Proceeds from issuance of common stock.............................................. 1,542 1,074 541
--------- --------- ---------
Net cash provided by financing activities........................................... 97,196 50,129 37,990
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents................................ 15,285 9,552 (53,884)
Cash and cash equivalents at beginning of year...................................... 60,769 51,217 105,101
--------- --------- ---------
Cash and cash equivalents at end of year............................................ $76,054 $60,769 $51,217
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments for interest.......................................................... $46,554 $44,717 $42,507
Cash payments for income tax........................................................ 5,989 6,258 4,744
NONCASH INVESTING AND FINANCING ACTIVITIES:
Fair value adjustment for securities available for sale,
net of income taxes............................................................... (134) 1,321 (969)
Transfers of securities from the held-to-maturity portfolio to the
available-for-sale portfolio...................................................... - 24,027 -
Loans originated on sale of real estate owned held for sale......................... - 1,320 636
Net transfer to real estate owned held for sale from loans receivable............... 705 73 716
Transfers of loans to held for sale................................................. - - 10,118
Retirement of common stock.......................................................... 117 - -
The accompanying notes are an integral part of these consolidated
financial statements.
</TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BANKING ACTIVITIES AND SIGNIFICANT ACCOUNTING POLICIES
F&M Bancorp (the "Parent Company") is a bank holding company that
provides its customers with banking and bank-related financial services
through its wholly owned subsidiaries, Farmers & Mechanics National Bank
and Subsidiaries (the "Bank") and Home Federal Savings Bank and
Subsidiaries (the "Savings Bank"). The Bank and the Savings Bank offer
various loan, deposit and other financial products and services to
individuals and commercial businesses located primarily within the State of
Maryland. The primary market area encompasses Frederick, Carroll,
Montgomery and Washington Counties, MD, with additional community office
presence in Allegany, Baltimore, and Howard Counties, MD and Adams County,
PA. The Bank and the Savings Bank maintain correspondent banking
relationships with whom they may execute daily federal funds transactions
on an unsecured basis.
The accounting and reporting policies and practices of F&M Bancorp
and Subsidiaries ("Bancorp") conform with generally accepted accounting
principles ("GAAP") and with prevailing practice in the banking industry.
The following is a summary of Bancorp's significant accounting policies:
Principles of Consolidation
The consolidated financial statements include the accounts of the
Parent Company and its wholly owned subsidiaries. All material
inter-company accounts and transactions are eliminated in consolidation. In
the Parent Company financial statements, investment in subsidiaries is
accounted for using the equity method of accounting.
Comprehensive Income
Bancorp adopted Financial Accounting Standards Board ("FASB")
Statement No. 130, "Reporting Comprehensive Income", effective January 1,
1998. Other comprehensive income consists entirely of unrealized gains
(losses) on available-for-sale securities. Income taxes allocated to other
comprehensive income amounted to benefits of $84,000 and $609,000 in 1998
and 1996, respectively, and a provision of $831,000 in 1997.
Use of Estimates
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that effect 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.
Presentation of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, cash items in the process of
clearing, federal funds sold, and interest-bearing deposits with banks.
Generally, federal funds are sold for one-day periods.
Loans Held for Sale
Loans held for sale are carried at the lower of aggregate cost or
fair value. Fair value is estimated to equal the carrying amount due to the
anticipated short holding period of these loans.
Investment Securities
Bancorp classifies its investment securities as held-to-maturity
("HTM"), available-for-sale ("AFS"), or trading.
Securities classified as HTM are those debt securities that
Bancorp has both the positive intent and ability to hold until maturity.
These securities are carried at cost, adjusted for amortization of premiums
and accretion of discounts which are recognized as adjustments to interest
income using the interest method.
Securities classified as AFS are equity securities with readily
determinable fair values and those debt securities that Bancorp intends to
hold for an indefinite period of time but not necessarily to maturity.
These securities may be sold as part of Bancorp's asset/liability
management strategy, in response to significant movements in interest
rates, for liquidity needs, for regulatory capital considerations, or for
other similar purposes. These securities are carried at fair value, with
any unrealized gains and losses included in other comprehensive income as a
separate component of shareholders' equity, net of the related deferred tax
effect.
Securities classified as trading, if any, are those securities
bought and held principally for the purpose of selling them in the near
term. These securities are carried at fair value, with any unrealized gains
and losses included in net income.
Regardless of the classification, dividend and interest income,
including amortization of premiums and accretion of discounts arising at
acquisition, is included in interest income in the consolidated statements
of income and comprehensive income. Realized gains and losses, if any,
determined based on the adjusted cost of the specific securities sold, are
reported in noninterest income in the consolidated statements of income and
comprehensive income.
Transfers and Servicing of Financial Assets
In June 1996, the FASB issued Statement No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities," which provides accounting and reporting standards for sales,
securitizations, and servicing of receivables and other financial assets
and extinguishment of liabilities. The standards are based on consistent
application of a financial-components approach that focuses on control, and
the appropriate measurement and allocation of the financial components at
fair value, if practical.
In addition, Statement No. 125 requires that a liability be
de-recognized if, and only if, either (a) the debtor pays the creditor and
is relieved of its obligation for the liability, or (b) the debtor is
legally released from being the primary obligor under the liability either
judicially or by the creditor. Therefore, a liability is not considered
extinguished by an in-substance defeasance.
Statement No. 125 is effective for transactions occurring after
December 31, 1996, except for the provisions relating to repurchase
agreements, securities lending and other similar transactions and pledged
collateral, which were delayed until after December 31, 1997 by FASB
Statement No. 127, "Deferral of the Effective Date of Certain Provisions of
FASB Statement No. 125, an amendment of FASB Statement No. 125." The
adoption of Statements No. 125 and 127 were not material to Bancorp's
financial statements.
Interest and Fees on Loans
Interest on loans is accrued at the contractual rate on the
principal amount outstanding. However, the accrual of interest is
discontinued when reasonable doubt exists as to the full, timely collection
of interest or principal. Loans on which the accrual of interest has been
discontinued, which includes impaired loans, are designated as nonaccrual
loans. When a loan is placed on nonaccrual status, all interest previously
accrued but not collected is reversed against current period interest
income. Income on such loans is then recognized only to the extent that
cash is received and where the future collection of principal is probable.
Interest accruals are resumed on such loans only when they are brought
current with respect to interest and principal and when, in management's
judgment, the loans are estimated to be fully collectible as to both
principal and interest.
Loan fees and related direct costs of loan origination are
deferred and recognized over the life of the loan as a component of
interest income.
Allowance for Credit Losses
The allowance for credit losses (the "allowance") is maintained at
a level which, in management's judgment, is adequate to absorb losses
inherent in the loan portfolio.
The adequacy of the allowance is reviewed regularly by management.
Additions to the allowance are made by charges to the provision for credit
losses. On a quarterly basis, a comprehensive review of the adequacy of the
allowance is performed considering factors such as historical relationships
among loans outstanding, loss experience, delinquency levels, individual
loan reviews, and evaluation of the present and future local and national
economic environment. Management's estimates regarding the allowance are
subject to change related to economic and other uncertainties inherent in
the estimation process.
Bank Premises and Equipment
Bank premises, furniture and equipment, and leasehold improvements
are stated at cost less accumulated depreciation and amortization.
Depreciation and amortization are computed principally by the straight-line
method for bank premises and leasehold improvements, and by accelerated
methods for equipment. The estimated useful lives for computing
depreciation and amortization are as follows:
YEARS
Bank premises........................................... 15 to 50
Furniture and equipment................................. 3 to 10
Leasehold improvements.................................. 10 to 25
Leasehold improvements are amortized over the shorter of the terms
of the leases or their estimated useful lives. Major alterations and
improvements to bank premises are capitalized and depreciated over the
remaining useful life of the asset. Gains and losses on dispositions are
included in net income in the year of disposition. Maintenance and repairs
are reflected in noninterest expense as incurred.
Other Real Estate Owned
Other real estate owned ("OREO") includes: banking premises no
longer used for business operations, real estate acquired in foreclosure
(in partial or complete satisfaction of debt), or otherwise surrendered by
the borrower to Bancorp's possession.
OREO is recorded at the lower of cost or fair value on the date of
acquisition. Write-downs to fair value at the date of acquisition are
charged to the allowance for credit losses. Subsequently, OREO is adjusted
through a valuation allowance to the lower of net carrying value or fair
value (net of estimated selling expenses) based upon periodic appraisals.
Adjustments arising from changes in the valuation allowance and operating
expenses are reflected in noninterest expense, and gains and losses
realized on disposition are reflected in noninterest income.
Intangible Assets
Intangible assets represent the excess of the fair value of
liabilities assumed over the fair value of tangible assets acquired in
branch office acquisitions. These intangible assets are initially amortized
over a period of 10 years using the straight-line method subject to
periodic review and acceleration should subsequent events and circumstances
dictate.
Income Taxes
FASB Statement No. 109, "Accounting for Income Taxes," is applied
in calculating the provision for income taxes. As prescribed therein,
provisions for income taxes are based on taxes payable or refundable for
the current year (after exclusion of nontaxable income such as interest on
state and municipal securities) and deferred taxes on temporary differences
between the amount of taxable income and pre-tax financial income, and
between the tax bases of assets and liabilities and their reported amounts
in the financial statements. Deferred tax assets and liabilities are
included in the financial statements at currently enacted income tax rates
applicable to the period in which the deferred tax assets and liabilities
are expected to be realized or settled. As changes in tax laws or rates are
enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
Per Share Data
Earnings per share ("EPS") are computed and presented in
accordance with FASB Statement No. 128, "Earnings Per Share." As prescribed
therein, the presentation of primary EPS has been replaced with the dual
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income available to common shareholders
("numerator") by the weighted-average number of common shares outstanding
for the period after giving retroactive effect to stock dividends and stock
splits ("denominator"). Diluted EPS reflects the potential dilution that
could occur if outstanding stock options or other contracts to issue common
stock, if any, were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of Bancorp.
Diluted EPS is equal to the numerator divided by the denominator plus
112,753 shares, 70,720 shares, and 56,004 shares represented by outstanding
stock options assumed to be exercised for the years ended December 31,
1998, 1997 and 1996, respectively.
Trust Assets and Income
Assets held in an agency or fiduciary capacity are not assets of
Bancorp and, accordingly, are not included in the accompanying consolidated
balance sheets. Trust income is recorded on a cash basis and would not be
materially different using the accrual method.
Deferred Compensation
The cost of supplemental retirement benefits (deferred
compensation) payable to certain key employees is accrued over their
service periods to the date such employees, or their beneficiaries, are
fully eligible for benefits.
Stock Compensation
Employee stock options are recorded under the intrinsic
value-based method of accounting prescribed by Accounting Principles Board
Opinion No. 25, and disclosures pertaining to fair value-based accounting
of stock options under the provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation," are included in Note 9, Employee
Benefits, Notes to Consolidated Financial Statements. Statement No. 123
provides for a fair value-based method of accounting for stock options and
similar equity transactions to be reported in the financial statements, or
alternatively, disclosure of the fair-value impact on net income and EPS,
on a pro forma basis, in the notes to consolidated financial statements.
Reclassifications
Certain reclassifications to prior year amounts have been made to
conform with the current year presentation.
2. ACQUISITIONS
On July 15, 1999, Bancorp consummated a merger with Potomac Basin
Group Associates, Inc. ("Potomac Basin"), in a tax-free exchange of shares
accounted for as a pooling-of-interests. Potomac Basin is a Beltsville,
MD-based, full-line independent insurance agency specializing in corporate
employee benefit plans.
On November 30, 1998, Bancorp completed the acquisition of
Monocacy Bancshares, Inc. ("MNOC"), headquartered in Taneytown, MD, in a
tax-free exchange of stock, and the merger of its principal subsidiary,
Taneytown Bank & Trust Company ("TBT"), into the Bank. Shareholders of MNOC
received 1.251 newly issued shares of Bancorp Common Stock, or a total of
2,267,790 shares, for all 1,812,777 outstanding shares of MNOC and cash in
lieu of each fractional share at the rate of $33.696. At closing, TBT had
reported total assets of $304.3 million, loans of $167.0 million, and
deposits of $243.8 million.
On May 29, 1998, Bancorp completed the acquisition of
Keller-Stonebraker Insurance, Inc. ("K-S"), a Hagerstown, MD-based
independent insurance agency, in a tax-free exchange of 52,117 shares of
newly issued Bancorp Common Stock for all outstanding shares of K-S.
On November 15, 1996, Bancorp completed its merger with Home
Federal Corporation ("HF"), Hagerstown, MD, in a tax-free exchange of
stock. Shareholders of HF received .49535 shares of newly issued Bancorp
Common Stock, or a total of 1,247,791 shares, for all 2,519,010 shares of
HF Common Stock and cash in lieu of each fractional share at the rate of
$23.90. At closing, the Savings Bank, HF's principal subsidiary, had total
assets of $230.1 million, loans of $154.0 million, and deposits of $162.7
million.
All four acquisitions are accounted for as poolings of interest.
3. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investments at
December 31, 1998 and 1997, summarized by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities because
borrowers have the right to call or prepay obligations with, or without,
call or prepayment penalties.
Proceeds from sales/calls of investment securities
available-for-sale during 1998 were $129,322,000. Gross gains of $1,162,000
and gross losses of $83,000 were realized on those sales. Proceeds from
calls of investment securities held-to-maturity during 1998 were
$17,038,000. Gross gains of $25,000 were realized on those calls.
Proceeds from sales/calls of investment securities
available-for-sale during 1997 were $58,059,000. Gross gains of $128,000
and gross losses of $58,000 were realized on those sales. Proceeds from
calls of investment securities held-to-maturity during 1997 were
$8,420,000. Gross gains of $6,000 were realized on those calls.
Proceeds from sales/calls of investment securities
available-for-sale during 1996 were $63,197,000. Gross gains of $89,000 and
gross losses of $380,000 were realized on those sales. Proceeds from calls
of investment securities held-to-maturity during 1996 were $10,728,000.
Gross losses of $259,000 were realized on those calls.
The carrying value of investment securities pledged to secure
public deposits, securities sold under repurchase agreements, Federal Home
Loan Bank (the "FHLB") advances, and for other purposes as required and
permitted by law, totaled $158,458,000 at December 31, 1998, and
$148,888,000 at December 31, 1997.
Interest earned on obligations of states and political
subdivisions is exempt from federal income taxes. However, the federal
interest expense deduction is limited for interest deemed to be incurred to
purchase or carry tax-exempt obligations. Such tax-exempt securities
composed 29.9% and 31.6% of the total carrying value of the investment
portfolio at December 31, 1998 and 1997, respectively.
INVESTMENT SECURITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-------------------------------------------------
(In thousands) GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies:
Within 1 year............................................. $13,016 $29 $1 $13,044
After 1 but within 5 years................................ 56,065 301 13 56,353
After 5 but within 10 years............................... 49,190 288 96 49,382
-------- ------- ------- --------
118,271 618 110 118,779
-------- ------- ------- --------
Obligations of states and political subdivisions:
Within 1 year............................................. 250 1 - 251
After 1 but within 5 years................................ 5,082 94 - 5,176
After 5 but within 10 years............................... 16,285 323 19 16,589
After 10 years............................................ 19,973 136 214 19,895
-------- ------- ------- --------
41,590 554 233 41,911
-------- ------- ------- --------
Other bonds:
After 1 but within 5 years................................ 2,328 9 - 2,337
-------- ------- ------- --------
Mortgage-backed securities................................ 140,374 275 485 140,164
-------- ------- ------- --------
Total debt securities....................................... 302,563 1,456 828 303,191
Equity securities........................................... 19,727 - 267 19,460
-------- ------- ------- --------
Total securities available-for-sale......................... $322,290 $1,456 $1,095 $322,651
======== ======= ======= ========
Held-to-maturity:
Obligations of states and political subdivisions:
Within 1 year............................................. $7,471 $72 $- $7,543
After 1 but within 5 years................................ 29,868 953 - 30,821
After 5 but within 10 years............................... 25,855 925 - 26,780
After 10 years............................................ 20,563 216 140 20,639
-------- ------- ------- --------
83,757 2,166 140 85,783
-------- ------- ------- --------
Mortgage-backed securities................................ 14,474 221 - 14,695
-------- ------- ------- --------
Total securities held-to-maturity........................... $98,231 $2,387 $140 $100,478
======== ======= ======= ========
</TABLE>
INVESTMENT SECURITIES
<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------------------------------------
(In thousands) GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies:
Within 1 year..................................................... $14,570 $14 $14 $14,570
After 1 but within 5 years........................................ 50,318 103 109 50,312
After 5 but within 10 years....................................... 46,532 368 7 46,893
-------- -------- -------- --------
111,420 485 130 111,775
-------- -------- -------- --------
Obligations of states and political subdivisions:
Within 1 year..................................................... 2,101 8 - 2,109
After 1 but within 5 years........................................ 4,027 24 4 4,047
After 5 but within 10 years....................................... 28,338 596 4 28,930
-------- -------- -------- --------
34,466 628 8 35,086
-------- -------- -------- --------
Mortgage-backed securities........................................ 67,650 276 441 67,485
-------- -------- -------- --------
Total debt securities............................................... 213,536 1,389 579 214,346
Equity securities................................................... 18,217 - 150 18,067
-------- -------- -------- --------
Total securities available-for-sale................................. $231,753 $1,389 $729 $232,413
======== ======== ======== ========
Held-to-maturity:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies:
After 1 but within 5 years........................................ $4,967 $33 $- $5,000
-------- -------- -------- --------
4,967 33 - 5,000
-------- -------- -------- --------
Obligations of states and political subdivisions:
Within 1 year..................................................... 4,073 33 - 4,106
After 1 but within 5 years........................................ 33,293 713 2 34,004
After 5 but within 10 years....................................... 30,607 697 8 31,296
After 10 years.................................................... 106 1 - 107
-------- -------- -------- --------
68,079 1,444 10 69,513
-------- -------- -------- --------
Mortgage-backed securities........................................ 21,894 243 - 22,137
-------- -------- -------- --------
Total securities held-to-maturity................................... $94,940 $1,720 $10 $96,650
======== ======== ======== ========
</TABLE>
4. LOANS
Loans consist of the following:
DECEMBER 31,
-----------------------
(In thousands) 1998 1997
---- ----
Real estate loans:
Construction and land development........ $61,328 $67,026
Secured by farmland...................... 8,452 8,479
Residential mortgage..................... 265,394 257,121
Other mortgage........................... 198,131 170,742
Agricultural............................... 560 819
Commercial and industrial loans............ 92,091 99,043
Consumer................................... 257,968 276,134
Other loans................................ 7,817 3,186
-------- --------
Total loans................................ $891,741 $882,550
======== ========
Loans to states and political subdivisions and industrial revenue
bonds are included in other loans and in total loans in the consolidated
balance sheet. Interest income from these loans is included in interest and
fees on loans in the consolidated statements of income and comprehensive
income.
Transactions in the allowance for credit losses were:
DECEMBER 31,
------------------------------
(In thousands) 1998 1997 1996
---- ---- ----
Balance at beginning of year................. $12,069 $11,739 $11,700
Provision for credit losses.................. 3,056 2,910 1,822
Recoveries of loans previously charged-off... 3,028 2,863 2,461
Loans charged off............................ (5,336) (5,443) (4,244)
-------- -------- --------
Balance at end of year....................... $12,817 $12,069 $11,739
======== ======== ========
In the ordinary course of business, directors and officers of the
Bank, the Savings Bank, and their affiliates, were customers of, and had
other transactions with the Bank and/or the Savings Bank. Loan transactions
with directors and officers were made on substantially the same terms as
those prevailing at the time for comparable loans to other persons, and
neither involved more than normal risk of collectibility nor presented
other unfavorable features. The aggregate dollar amount of all loans to
officers, directors, and their affiliates was $16,592,027 and $19,246,376
at December 31, 1998 and 1997, respectively. During 1998, $46,939,657 of
new loans were made, or became reportable, and repayments and other
decreases totaled $49,594,006.
The loan portfolio includes loans that are not currently accruing
interest income. The total outstanding principal amount of these loans at
December 31, 1998, 1997, and 1996, and the effect on interest income for
the years then ended, are as follows:
DECEMBER 31,
---------------------------
(In thousands) 1998 1997 1996
---- ---- ----
Principal balance................................ $4,196 $7,357 $8,074
====== ====== ======
Gross amount of interest which would have
been recorded under original terms............ $468 $847 $754
====== ====== ======
Recorded interest income on these loans.......... $167 $246 $188
====== ====== ======
The net reduction in interest income on renegotiated loans was not
material in 1998, 1997, and 1996. At December 31, 1998, there were no
material commitments to lend additional funds to borrowers whose loans had
been modified in troubled debt restructurings or were in a nonaccrual
status.
Loans amounting to approximately $2,508,000 and $8,105,000 at
December 31, 1998 and 1997, respectively, were specifically classified as
impaired and are included in nonaccrual loans disclosed above. The average
balance of impaired loans amounted to $9,083,000 and $7,081,000 for the
years ended December 31, 1998 and 1997, respectively. Cash receipts
totaling $2,512,000 and $3,965,000 during 1998 and 1997, respectively, were
applied to reduce the principal balance of those impaired loans, and no
interest income was recognized. The specific allowance for credit losses
related to these impaired loans was $296,000 and $732,000 at December 31,
1998 and 1997, respectively.
5. BANK PREMISES AND EQUIPMENT
Investments in bank premises and equipment are as follows:
DECEMBER 31,
--------------------
(In thousands) 1998 1997
---- ----
Bank premises and land............................. $28,978 $29,184
Furniture and equipment............................ 24,430 23,430
Leasehold improvements............................. 2,908 2,901
------- -------
56,316 55,515
------- -------
Less accumulated depreciation and amortization..... 25,065 22,342
Bank premises and equipment, net................... $31,251 $33,173
======= =======
Depreciation and amortization related to premises and equipment in
the consolidated statements of income and comprehensive income amounted to
$2,701,000 in 1998, $2,820,000 in 1997, and $3,031,000 in 1996.
6. DEPOSITS
The carrying amounts of deposits are as follows:
DECEMBER 31,
-------------------------
(In thousands) 1998 1997
---- ----
Noninterest-bearing.................... $152,076 $138,440
Interest-bearing:
Checking............................. 152,609 138,868
Savings.............................. 151,970 156,327
Money market accounts................ 160,071 133,645
Certificates of deposits:
Under $100,000....................... 450,445 437,435
$100,000 and over.................... 71,023 48,847
---------- ----------
Total deposits......................... $1,138,194 $1,053,562
========== ==========
7. BORROWINGS
Short-term Borrowings
Short-term borrowings include securities sold under agreements to
repurchase, which are secured transactions with customers and generally
mature in one day. Short-term borrowings may also include balances in the
treasury tax and loan account, federal funds purchased, which are unsecured
overnight borrowings from other financial institutions, and advances from
the FHLB, which are secured either by 1-4 family residential properties,
FHLB Stock, or other mortgage-related assets.
Unused lines of credit for short-term borrowings totaled
approximately $210,313,000 at December 31, 1998.
The table below presents selected information on the combined
totals of repurchase agreements and other short-term borrowings.
DECEMBER 31,
--------------------
(Dollars in thousands) 1998 1997
---- ----
Maximum balance at any month end during the year... $100,259 $122,663
Average balance for the year....................... 74,872 105,415
Weighted average rate for the year................. 5.47% 5.55%
Weighted average rate at year end.................. 4.42% 5.66%
Estimated fair value............................... $72,402 $102,303
Long-term Borrowings
The table below presents a summary of long-term advances from the
FHLB:
DECEMBER 31,
-------------------
(In thousands) 1998 1997
---- ----
Due within 1 to 5 years........................... $37,121 $39,726
Due after 5 years through 10 years................ 56,991 3,998
Due after 10 years................................ 134 138
------- -------
$94,246 $43,862
======= =======
These advances had weighted average interest rates of 5.29% and
5.90% at December 31, 1998 and 1997, respectively. These advances are
secured either by a blanket floating lien on all real estate mortgage loans
secured by 1-4 family residential properties, FHLB Stock, or other
mortgage-related assets. All advances carry a fixed rate. In 1999, 2000 and
2003, $38.5 million, $25.0 million and $10.0 million, respectively, of
advances are convertible at the FHLB's option to a variable rate based on
LIBOR.
8. INCOME TAXES
Significant components of deferred tax assets and liabilities are
as follows:
DECEMBER 31,
-----------------
(In thousands) 1998 1997
---- ----
Deferred tax assets:
Allowances for credit and other real estate owned losses. $4,805 $4,227
Deferred compensation.................................... 1,645 1,591
Intangibles.............................................. 1,202 941
Other.................................................... 883 624
------ ------
Total deferred tax assets.............................. 8,535 7,383
Valuation allowance for deferred tax assets.............. (474) (474)
------ ------
Total deferred tax assets after valuation allowance.... 8,061 6,909
------ ------
Deferred tax liabilities:
Depreciation and amortization............................ 1,144 721
Unrealized gains on securities available for sale........ 83 165
Other.................................................... 354 77
------ ------
Total deferred tax liabilities......................... 1,581 963
------ ------
Net deferred tax assets................................ $6,480 $5,946
====== ======
A reconciliation of the statutory income tax rate to the provision
for income taxes attributed to continuing operations included in the
consolidated statements of income and comprehensive income, is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
(Dollars in thousands) 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Income before income tax.................................. $18,138 $19,477 $13,597
Tax rate.................................................. 35% 35% 35%
------- ------- -------
Income tax at statutory rate.............................. 6,348 6,817 4,759
Increases (decreases) in tax resulting from:
Tax-exempt interest income.............................. (1,787) (1,778) (1,362)
State income taxes, net of federal income tax benefit... 272 326 152
Other................................................... 213 (114) (237)
Change in valuation allowance........................... - - (116)
------- ------- -------
Actual tax expense........................................ $5,046 $5,251 $3,196
======= ======= =======
Effective tax rate........................................ 27.8% 27.0% 23.5%
</TABLE>
Significant components of the provision for income taxes
attributed to continuing operations are as follows:
YEAR ENDED DECEMBER 31,
---------------------------
(In thousands) 1998 1997 1996
---- ---- ----
Current payable:
Federal................................. $5,258 $5,074 $3,221
State................................... 240 590 291
------ ------ ------
Total currently payable................. 5,498 5,664 3,512
------ ------ ------
Deferred tax benefit...................... (452) (413) (200)
------ ------ ------
Change in valuation allowance........... - - (116)
------ ------ ------
Provision for income taxes................ $5,046 $5,251 $3,196
====== ====== ======
The components of the provision for deferred tax expense (benefit)
are as follows:
YEAR ENDED DECEMBER 31,
----------------------------
(In thousands) 1998 1997 1996
---- ---- ----
Provision for credit losses............... $(578) $(166) $46
Amortization of intangibles............... (261) (128) (213)
Other..................................... 387 (119) (33)
------ ------ ------
Deferred tax benefit.................... $(452) $(413) $(200)
====== ====== ======
9. EMPLOYEE BENEFITS
The Bank Profit Sharing Plan
Retirement benefits are provided through a Section 401(k) profit
sharing plan (the "Plan") to employees meeting certain age and service
eligibility requirements. The annual profit sharing contribution to the
Plan is discretionary, based primarily on earnings, and amounted to
$468,000 for 1998, $540,000 for 1997, and $430,000 for 1996. The Plan also
provides for employer matching contributions equal to 2% for the first 2%
of eligible compensation, and an additional 1% for the next 2% of eligible
compensation for a maximum total matching contribution of 3% for the first
4% of eligible compensation. Employer matching contributions totaled
$343,000 in 1998, $268,000 in 1997, and $234,000 in 1996.
TBT, which was merged with and into the Bank on November 30, 1998,
had a 401(k) contributory thrift plan which was terminated in conjunction
with the merger. Contributions to this plan, included in pension and other
employee benefits expense, were $79,000 for 1998, $75,000 for 1997, and
$61,000 for 1996.
Potomac Basin, which was merged with the bank on July 15, 1999,
has a 401(k) plan covering substantially all employees, which requires
Company contributions equal to 3% of each participant's salary.
Contributions to the plan totaled $138,000 and 134,000 for the years ended
December 31, 1998 and 1997, respectively.
The Savings Bank Profit Sharing Plan
The Savings Bank provides a retirement savings plan and trust,
which is a deferred compensation plan (401(k)) and a profit sharing plan
(the "Savings Plan") for all employees who meet certain age and eligibility
requirements. The Savings Plan permits eligible participants to defer up to
15% of their annual salary and the Savings Bank to contribute to the 401(k)
part of the Savings Plan on a matching basis. The Savings Bank may also
elect to contribute a portion of its profits to the profit sharing portion
of the Savings Plan.
Contributions are made based on matching $0.50 of every dollar up
to 5% of the employee's salary. The Savings Bank's additional matching
contribution amounted to $57,000 in 1998, $58,000 in 1997, and $52,000 in
1996. In addition, the Savings Bank made profit sharing contributions of
$180,000, $135,000, and $185,000, in 1998, 1997, and 1996, respectively.
Executive Supplemental Income Plan
Supplemental retirement benefits (deferred compensation) for
certain key employees are provided under an Executive Supplemental Income
Plan (the "ESIP"). Benefits payable under the ESIP are integrated with
other retirement benefits expected to be received by ESIP participants,
including those under the 401(k) profit sharing plan. Amounts paid under
the ESIP will be partially or fully recovered through life insurance
policies purchased on the lives of the participants.
Deferred compensation costs charged to expense for the years ended
December 31, 1998, 1997, and 1996 were $372,000, $344,000, and $292,000,
respectively.
Other Benefits
Both the Savings Bank and Bancorp maintain a director's deferred
compensation program pursuant to which directors may elect to defer their
fees for attending meetings in order to provide retirement benefits. The
expense for these benefits was $117,000, $128,000, and $242,000, for 1998,
1997, and 1996, respectively.
Employee Stock Purchase Plan
Bancorp has an Employee Stock Purchase Plan (the "ESPP") whereby
eligible employees may authorize payroll deductions ranging from $120 to
$2,400 per year for the purpose of acquiring Bancorp Common Stock at
current market prices. To encourage employee participation in the ESPP,
Bancorp contributes an additional 20% of each participant's voluntary
payroll deduction. Bancorp's contributions amounted to $17,000, $11,000,
and $9,000, for 1998, 1997, and 1996, respectively. Contributions to the
ESPP are typically transmitted to Bancorp's designated agent to acquire
Bancorp Common Stock in the open market. Under the terms of the ESPP,
shares may also be purchased directly from Bancorp at current market
prices. A total of 60,775 shares of Bancorp Common Stock are reserved for
this purpose. Bancorp pays all administrative costs of the ESPP and, at its
discretion, reserves the right to amend, modify, suspend, or terminate the
ESPP at any time.
Stock Option Plans
Bancorp has a 1983 Stock Option Plan and a 1995 Stock Option Plan
(the "Plans") which are coordinated in their administration and similar in
their terms and conditions for key employees. The Plans permit the granting
of both incentive stock options and nonqualified stock options to purchase
Bancorp Common Stock. The exercise price per share for incentive stock
options and nonqualified stock options shall not be less than 100% and 85%,
respectively, of the fair market value of a share of Common Stock on the
date of grant and may be exercised in increments commencing after one year
from the date of grant. Options are fully exercisable after four years from
the date of grant and expire after 10 years.
OPTIONS ISSUED
AND OUTSTANDING PRICE
--------------- --------------------
Balance, December 31, 1995........ 266,817 $10.66 to $25.59
Exercised......................... (27,657) 10.66 to 25.59
Granted........................... 38,263 13.98 to 26.42
Terminated........................ (12,772) 10.66 to 26.42
-------- ------ ------
Balance, December 31, 1996........ 264,651 10.66 to 26.42
Exercised......................... (55,716) 10.66 to 26.42
Granted........................... 88,036 14.54 to 24.38
Terminated........................ (6,309) 18.44 to 26.42
-------- ------ ------
Balance, December 31, 1997........ 290,662 10.66 to 26.42
Exercised......................... (58,750) 10.66 to 26.42
Granted........................... 45,330 19.59 to 33.69
Terminated........................ (5,873) 19.33 to 33.69
-------- ------ ------
Balance, December 31, 1998........ 271,369 $10.66 to $33.69
======== ====== ======
At December 31, 1998, there were 207,133 options exercisable at
prices ranging from $10.66 to $26.42. Shares reserved for future grants
totaled 86,195 at December 31, 1998.
The Plans are accounted for pursuant to the provisions of APB
Opinion No. 25. Had compensation cost for the Plans been determined in
accordance with the provisions of FASB Statement No. 123 (see Note 1), net
income and earnings per share would have been reduced to the following pro
forma amounts:
1998 1997 1996
---- ---- ----
Net Income: As reported.................... $13,556 $14,337 $10,364
Pro forma...................... 13,319 13,793 10,142
EPS: As reported, basic............. 1.47 1.56 1.13
As reported, diluted........... 1.45 1.55 1.12
Pro forma, basic............... 1.44 1.50 1.11
Pro forma, diluted............. 1.42 1.49 1.10
Because the Statement No. 123 method of accounting has not been
applied to options granted prior to January 1, 1995, the resulting pro
forma compensation cost may not be representative of the cost to be
expected in future years. Additionally, the pro forma amounts include a de
minimus amount related to the purchase discount offered under the Employee
Stock Purchase Plan.
A summary of the status of the Plans at December 31, 1998 and
1997, and changes during the years then ended, is presented as follows:
<TABLE>
<CAPTION>
1998 1997
------------------- -------------------
WTD. AVG. WTD. AVG.
SHARES EX. PRICE SHARES EX. PRICE
------ --------- ------ ---------
<S> <C> <C> <C> <C>
Outstanding at beginning of year........... 290,662 $18.58 264,651 $17.82
Granted.................................... 45,330 28.40 88,036 19.44
Exercised.................................. (58,750) 17.10 (55,716) 16.11
Forfeited.................................. (5,873) 25.51 (2,116) 24.01
Expired.................................... - - (4,193) 18.44
Outstanding at end of year................. 271,369 20.39 290,662 18.58
Exercisable at end of year................. 207,133 17.77 212,620 16.36
Weighted average fair value of
options granted during the year.......... - 33.97 - 28.54
</TABLE>
OUTSTANDING AND EXERCISABLE BY PRICE RANGE AS OF DECEMBER 31, 1998
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------------------------- ----------------------------------
NUMBER WEIGHTED AVERAGE NUMBER
RANGE OF OUTSTANDING REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
EXERCISE PRICES AS OF 12/31/98 CONTRACTUAL LIFE EXERCISE PRICE AS OF 12/31/98 EXERCISE PRICE
- --------------- -------------- ---------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C> <C>
$10.66-$15.00....... 79,737 4.78 $13.35 79,737 $13.35
15.01- 20.00....... 82,098 7.61 17.82 82,098 17.28
20.01- 25.00....... 27,663 8.20 24.30 11,867 24.19
25.01- 30.00....... 55,021 6.72 25.98 33,431 25.92
30.01- 33.69....... 26,850 9.06 33.69 - -
------- ---- ------ ------- ------
$10.66-$33.69....... 271,369 6.80 $20.39 207,133 $17.77
======= ==== ====== ======= ======
</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
weighted-average assumptions used for grants in 1998, 1997, and 1996,
respectively: risk-free interest rates of 5.0%, 4.8%, and 4.3%; expected
dividend yields of 3.2%, 3.2%, and 3.2%; expected lives of 3.26, 3.38, and
3.55 years; and expected volatility of 19%, 15%, and 12%.
10. OTHER OPERATING INCOME AND EXPENSE
Other operating income in the consolidated statements of income
and comprehensive income includes the following:
(In thousands) 1998 1997 1996
---- ---- ----
Bank card income...................... $877 $1,341 $1,714
Miscellaneous......................... 4,382 4,844 3,317
------ ------ ------
Total other operating income.......... $5,259 $6,185 $5,031
====== ====== ======
Other operating expense in the consolidated statements of income
and comprehensive income includes the following:
(In thousands) 1998 1997 1996
---- ---- ----
Insurance (including FDIC)........... $658 $766 $2,565
Stationery and supplies.............. 1,149 1,212 1,372
Advertising.......................... 974 999 894
Professional services................ 2,424 2,104 1,591
Credit card processing............... 203 623 1,465
Postage.............................. 848 904 906
Director fees........................ 329 334 276
Telephone............................ 1,089 1,010 803
Computer software and maintenance.... 705 503 625
Other real estate owned expense...... 262 199 531
Amortization of intangibles.......... 779 758 1,001
Miscellaneous........................ 4,493 4,988 3,721
------- ------- -------
Total other operating expense........ $13,913 $14,400 $15,750
======= ======= =======
Transactions in the allowances for other real estate owned are
summarized as follows:
(In thousands) 1998 1997 1996
---- ---- ----
Balance at beginning of of year..................... $1,792 $2,016 $2,218
Provision for decline in value and selling expenses. 2 156 436
Losses charged to the allowances.................... (1,369) (380) (638)
------- ------- -------
Balance at end of year.............................. $425 $1,792 $2,016
======= ======= =======
11. CONDENSED FINANCIAL INFORMATION OF F&M BANCORP (PARENT COMPANY)
F&M BANCORP BALANCE SHEETS (PARENT COMPANY)
DECEMBER 31,
----------------------
(In thousands) 1998 1997
---- ----
ASSETS
Cash and cash equivalents...................... $4,351 $1,851
Investment securities
available for sale, at fair value.......... 2,882 2,012
Investment in subsidiaryes .................... 124,360 121,985
Other assets................................... 1,967 282
-------- --------
Total assets................................... $133,560 $126,130
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Total liabilities.............................. $2,195 $269
-------- --------
Common stock................................... 44,172 42,389
Surplus........................................ 61,214 48,874
Retained earnings.............................. 25,760 34,245
Accumulated other comprehensive income......... 219 353
-------- --------
Total shareholder's equity..................... 131,365 125,861
-------- --------
Total liabilities and shareholders' equity..... $133,560 $126,130
======== ========
F&M BANCORP STATEMENTS OF INCOME (PARENT COMPANY)
YEAR ENDED DECEMBER 31,
--------------------------------
(In thousands) 1998 1997 1996
---- ---- ----
INCOME
Interest on investment securities............. $246 $150 $123
Interest expense on borrowings................ - - 101
------- ------- -------
Net interest income......................... 246 150 22
Dividends from subsidiaries................... 11,207 5,887 5,487
------- ------- -------
Total income.................................. 11,453 6,037 5,509
EXPENSE....................................... 618 436 696
------- ------- -------
Income before income tax benefits and
Equity in undistributed earnings
of subsidiaries............................. 10,835 5,601 4,813
Income tax benefit............................ (112) (95) (164)
------- ------- -------
Income before equity in undistributed
earnings of subsidiaries.................... 10,947 5,696 4,977
Equity in undistributed earnings
of subsidiaries............................. 2,609 8,641 5,387
------- ------- -------
Net income.................................... $13,556 $14,337 $10,364
======= ======= =======
F&M BANCORP STATEMENTS OF CASH FLOWS (PARENT COMPANY)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
(In thousands) 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income..................................................................... $13,556 $14,337 $10,364
Adjustments to reconcile net
income to net cash provided by
operating activities
(Increase) decrease in other assets.......................................... (1,685) 61 -
Increase (decrease) in other expenses payable................................ 1,926 (6) (60)
Equity in undistributed earnings of subsidiaries............................. (2,609) (8,641) (5,387)
-------- -------- --------
Net cash provided by operating activities...................................... 11,188 5,751 4,917
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investment securities
available-for-sale........................................................... (994) (1,992) (4)
Distribution of undivided profits of
Bank subsidiary.............................................................. - - 868
-------- -------- --------
Net cash (used in) provided by investing activities............................ (994) (1,992) 864
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid............................................................ (9,190) (5,853) (4,225)
Other financing activities..................................................... 1,496 997 510
Repayments of debt............................................................. - - (3,000)
-------- -------- --------
Net cash used in financing activities.......................................... (7,694) (4,856) (6,715)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents........................... 2,500 (1,097) (934)
Cash and cash equivalents at beginning of year................................. 1,851 2,948 3,882
-------- -------- --------
Cash and cash equivalents at end of year....................................... $4,351 $1,851 $2,948
======== ======== ========
NON-CASH INVESTING AND FINANCING ACTIVITIES
Fair value adjustment for securities available-for-sale, net of income taxes... $(134) $1,321 $(969)
======== ======== ========
</TABLE>
12. COMMITMENTS AND CONTINGENCIES
Leases
Bancorp conducts part of its branch banking and insurance
operations from leased facilities. The initial terms of the leases range
from a period of 1-25 years. Most of the existing leases contain options
which allow renewals for periods up to 20 years. In addition to minimum
rentals, certain leases have escalation clauses based upon various price
indexes and include provisions for the payment of taxes, insurance and
maintenance.
Total rental expense was as follows:
(In thousands) Year ended December 31,
-----------------------------
1998 1997 1996
---- ---- ----
Bank premises....................... $1,196 $1,170 $1,071
Equipment........................... 43 46 92
------ ------ ------
Total rental expense................ $1,239 $1,216 $1,163
====== ====== ======
The future minimum rental payments required under operating leases
that have initial or remaining noncancelable lease terms in excess of one
year as of December 31, 1998 are:
YEAR ENDING DECEMBER 31, (In thousands)
- ------------------------ --------------
1999..................................... $1,137
2000..................................... 1,163
2001..................................... 1,067
2002..................................... 909
2003..................................... 786
Later years.............................. 3,363
------
Total minimum payments required.......... $8,425
======
Contingencies
Bancorp is subject to various legal proceedings which are
incidental to the ordinary course of business. It is management's opinion
that there were no legal matters pending as of December 31, 1998 which
would have a material effect on the consolidated financial statements.
Credit Extension Commitments
Bancorp is a party to financial instruments in the normal course
of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of
credit, which involve, to varying degrees, elements of credit and interest
rate risk in excess of the amounts recognized in the consolidated financial
statements.
Exposure to credit loss, in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit
and standby letters of credit, is represented by the contractual amount of
those instruments. The same credit policies are applied to commitments and
conditional obligations as are applied to on-balance sheet instruments.
A summary of the contractual amount of exposure under these
financial instruments is as follows:
DECEMBER 31,
----------------------
(In thousands) 1998 1997
---- ----
Financial instruments whose contractual
amounts represent credit risk:
Commitments to extend credit.................. $177,751 $168,476
Stand-by letters of credit.................... 14,048 15,949
Commitments to extend credit are agreements to lend to customers
as long as there are no violations of any conditions established in the
contracts. Certain commitments have fixed expiration dates or other
termination clauses and may require payment of a fee. Many of the
commitments are expected to expire without being drawn upon. Accordingly,
the total commitment amounts do not necessarily represent future cash
requirements. Each customer's credit worthiness is evaluated on a
case-by-case basis, and the amount of collateral or other security
obtained, if any, is based upon management's assessment of credit risk.
Collateral varies, but may include deposits held in financial institutions,
U.S. Treasury or other marketable securities, accounts receivable,
inventory, property and equipment, personal residences, income-producing
commercial properties, and land under development. Personal guarantees are
also obtained to provide added security for certain commitments.
Stand-by letters of credit are conditional commitments issued to
guarantee the performance of a contract to a third party and are used
primarily to guarantee the installation of real property infrastructure and
similar transactions. Credit risk involved in issuing letters of credit is
essentially the same as that involved in lending and may involve collateral
and personal guarantees as deemed appropriate.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes the carrying amounts and fair value
estimates of financial instruments at December 31, 1998 and 1997. All fair
value estimates were made at a specific point in time and were based on
existing on- and off-balance sheet financial instruments without
consideration of the value of anticipated future business or the value of
assets and liabilities that were not considered financial instruments.
These estimates do not reflect any premium or discount that could result
from a block sale of a particular instrument. Because of the absence of a
genuine market for a significant portion of these financial instruments,
fair value estimates were based on judgments regarding risk
characteristics, economic conditions, and other subjective factors and
uncertainties that do not allow such estimates to be made with precision.
Changes in assumptions or methodologies could have a significant effect on
the estimates.
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1998 1997
---------------------- ----------------------
(In thousands) CARRYING FAIR CARRYING FAIR
AMOUNTS VALUE AMOUNTS VALUE
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents....................... $76,054 $76,054 $60,769 $60,769
Loans held for sale............................. 4,810 4,810 5,223 5,223
Investment securities held-to-maturity.......... 98,231 100,478 94,940 96,650
Investment securities available-for-sale........ 322,651 322,651 232,413 232,413
Net loans....................................... 878,924 888,529 870,481 894,593
Interest receivable............................. 9,478 9,478 9,545 9,545
Financial liabilities:
Deposits........................................ 1,138,194 1,030,336 1,053,562 1,053,514
Short-term borrowings........................... 72,402 72,402 102,303 102,303
Long-term borrowings............................ 94,246 95,346 43,862 42,464
Interest payable................................ 2,864 2,864 2,375 2,375
</TABLE>
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments:
Cash and Cash Equivalents
Because of the short-term nature of these financial instruments,
carrying amounts were deemed to approximate fair value.
Loans Held for Sale
Fair value was deemed equal to the carrying amounts because of the
anticipated short holding period of these instruments.
Investment Securities
Fair value for obligations of state and political subdivisions was
estimated by an independent pricing service using a pricing matrix, and the
fair value for all other debt securities was based on quoted market prices
or dealer quotes.
Loans
Fair value was estimated by segregating the portfolio into
categories having similar financial characteristics. Each loan category was
then further segmented into fixed-rate and variable-rate interest terms and
by their status as performing or nonperforming.
The fair value of performing loans was estimated by discounting
estimated future cash flows using discount rates equal to the current rates
at which similar loans would be made with similar credit ratings and for
the same remaining maturity except that, in the absence of increased credit
risk, the carrying amount was generally deemed to approximate fair value
for variable-rate loans because of the frequent re-pricing of these
instruments at market rates.
The fair value of nonperforming loans was based principally on
recent external appraisals. If appraisals were not available, estimated
cash flows were discounted using a rate commensurate with the risk
associated with the estimated cash flows. Assumptions regarding credit
risk, cash flows, and discount rates were judgmentally determined using
available market information and specific borrower information.
Interest Receivable
Because of the short-term nature of interest receivable, fair
value was deemed to approximate carrying amounts.
Deposits
The fair value of deposits with no stated maturity, such as
noninterest-bearing deposits, interest-bearing checking, savings, and money
market accounts, was equal to the carrying amount. Carrying amount
approximates fair value for variable-rate certificates of deposit, and
fixed-rate certificates of deposit with original maturities of 12 months or
less, because of the frequent re-pricing of these instruments at market
rates. The fair value for all other fixed-rate certificates of deposit was
estimated by discounting contractual cash flows using discount rates equal
to the rates currently offered for deposits of similar remaining
maturities.
Short-term Borrowings
Because of the frequent re-pricing of these instruments at current
market rates, fair value was deemed to approximate the carrying amounts.
Long-term Borrowings
Fair value was estimated by discounting contractual cash flows
using discount rates equal to the current rates for long-term borrowings
with similar remaining maturities.
Interest Payable
Because of the short-term nature of interest payable, fair value
was deemed to approximate carrying amounts.
Off-balance Sheet Financial Instruments
Carrying amounts for commitments to extend credit and standby
letters of credit represent the deferred income attributed to these
unrecognized financial instruments. The majority of commitments to extend
credit and standby letters of credit are at variable rates and/or have
relatively short maturities. Therefore, fair value of these financial
instruments were deemed to closely approximate their carrying amounts,
which were immaterial.
14. REGULATORY RESTRICTIONS
Restrictions on Dividends
Approval of the Comptroller of the Currency is required to pay
dividends which exceed the Bank's net profits for the current year plus its
retained net profits for the preceding two years. Amounts available for the
payment of dividends during 1998 aggregated $22,383,000. The rules and
regulations of the OTS require prenotification of dividend payments by the
Savings Bank, and such payments may not exceed prescribed formulas without
OTS approval. Also, the Savings Bank's earnings appropriated to loan loss
reserves and deducted for federal income tax purposes are not available for
dividends without the payment of taxes at the then current income tax rates
on the amount used.
Restrictions on Lending from Affiliates to Parent
Section 23A of the Federal Reserve Act prohibits affiliates from
transferring funds to the Parent Company in the form of loans or advances
exceeding 10% of its capital stock and surplus, as defined in the Act. In
addition, all loans or advances to nonbank affiliates must be secured by
specific collateral. Based on this limitation, there was approximately
$13,671,000 available for loans or advances to the Parent Company as of
December 31, 1998, at which time there were no material loans or advances
outstanding.
Restrictions on Cash and Due From Banks
The Bank is required to maintain average daily reserve balances
with the Federal Reserve Bank. The amount of these required reserves,
calculated based on percentages of certain deposit balances, was $7,889,000
at December 31, 1998.
15. SHAREHOLDERS' EQUITY
Capital Requirements
Bancorp, the Bank, and the Savings Bank are required by regulation
to maintain specified minimum levels of capital. Under the regulatory
framework pertaining to prompt corrective action, each entity is considered
to be "well-capitalized" at December 31, 1998, as disclosed in the
following table:
BANCORP
-----------------------------------
(Dollars in thousands) COMPONENTS ACTUAL REQUIRED
OF CAPITAL RATIO RATIO
---------- ------ --------
Tangible capital..................... $125,463 8.84% 3.00%
Core capital......................... 125,463 12.59 4.00
Core and supplementary capital....... 137,911 13.84 8.00
THE BANK
-----------------------------------
COMPONENTS ACTUAL REQUIRED
OF CAPITAL RATIO RATIO
---------- ------ --------
Tangible capital..................... $100,077 8.37% 3.00%
Core capital......................... 100,077 11.80 4.00
Core and supplementary capital....... 110,110 12.99 8.00
THE SAVINGS BANK
-----------------------------------
COMPONENTS ACTUAL REQUIRED
OF CAPITAL RATIO RATIO
---------- ------ --------
Tangible capital..................... $18,304 8.13% 1.50%
Core capital......................... 18,304 8.13 3.00
Core and supplementary capital....... 20,074 14.25 8.00
Dividend Reinvestment Plan
Registered shareholders are eligible to participate in Bancorp's
Dividend Reinvestment and Stock Purchase Plan (the "DRP"). The DRP allows
participants to purchase additional shares of Bancorp Common Stock, at a 5%
discount to the market price, through the automatic reinvestment of cash
dividends. Additionally, shareholders may make optional cash payments of
$25 to $3,000 in a single calendar quarter to purchase additional shares at
100% of the market price. Typically, DRP shares are purchased in the open
market by Bancorp's agent, but the DRP also provides for purchases directly
from Bancorp at current market prices. A total of 60,775 shares are
reserved for direct purchase. Bancorp absorbs all costs of administering
the DRP and reserves the right to amend, modify, suspend, or terminate the
DRP at its discretion.
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Following is a summary of unaudited quarterly results of
operations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------
1998 DEC. 31 SEPT. 30 JUNE 30 MARCH 31
------- -------- ------- --------
(Dollars in thousands,
except per share amounts)
<S> <C> <C> <C> <C>
Interest income........................................ $25,013 $24,847 $24,673 $24,685
Interest expense....................................... 12,172 11,768 11,562 11,376
Net interest income.................................... 12,841 13,079 13,111 13,309
Provision for credit losses............................ 1,275 625 525 631
Income before income taxes............................. 1,430 5,739 5,294 6,139
Net income............................................. 1,170 4,127 3,858 4,401
Earnings per common share:
Net income, basic.................................... 0.13 0.45 0.42 0.48
Net income, diluted.................................. 0.12 0.44 0.41 0.47
THREE MONTHS ENDED
------------------------------------------------
1997 DEC. 31 SEPT. 30 JUNE 30 MARCH 31
------- -------- ------- --------
(Dollars in thousands,
except per share amounts)
Interest income........................................ $25,081 $24,580 $23,674 $23,088
Interest expense....................................... 11,749 11,460 10,783 10,611
Net interest income.................................... 13,332 13,120 12,891 12,477
Provision for credit losses............................ 500 850 930 630
Income before income taxes............................. 4,779 5,327 4,808 4,674
Net income............................................. 3,550 3,825 3,500 3,462
Earnings per common share:
Net income, basic.................................... 0.39 0.42 0.38 0.38
Net income, diluted.................................. 0.38 0.41 0.38 0.37
</TABLE>
17. FUTURE CHANGES IN ACCOUNTING PRINCIPLES
In June, 1998, FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and for Hedging Activities", which calls for
derivatives to be recognized in the consolidated balance sheet at fair
value and for subsequent changes in fair value to be recognized in the
consolidated statement of income. However, because non-derivative and
non-financial transactions are still measured using a mix of historical and
current prices, the Statement keeps special accounting for gains and losses
when derivatives are used in qualifying hedges of assets, liabilities, and
future transactions. The Statement unifies qualifying criteria for hedges
involving all kinds of derivatives, requiring that a company document,
designate, and assess the effectiveness of its hedges. For hedges that meet
the Statement's criteria, the derivative's gains and losses will be allowed
to offset gains and losses on, or forecasted cash flows of, the hedged
item.
Among a number of other provisions, the Statement will also allow
entities to reclassify available-for-sale and held-to-maturity securities
without calling into question management's intent for the remainder of its
securities portfolios.
For calendar-year companies such as Bancorp, the Statement will
take effect beginning January 1, 2000. Historically, Bancorp has not made
use of hedges and other financial derivatives and is unable to predict the
impact, if any, that the application of Statement No. 133 will have on
consolidated financial statements issued after 1999.
EXHIBIT 99.2
CONSOLIDATED BALANCE SHEETS
F&M BANCORP AND SUBSIDIARIES
<TABLE>
<CAPTION>
June 30, June 30, December 31,
1999 1998 1998
(Dollars in thousands, except per share amounts) (Unaudited) (Unaudited)
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 36,986 $ 44,842 $ 47,653
Federal funds sold 33,405 10,590 11,652
Interest-bearing deposits with banks 5,758 7,001 16,749
- ----------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 76,149 62,433 76,054
- ----------------------------------------------------------------------------------------------------------
Loans held for sale 1,095 4,631 4,810
- ----------------------------------------------------------------------------------------------------------
Investment securities:
Available-for-sale, at fair value 322,412 271,434 322,651
Held-to-maturity, fair value $104,680
$91,361 and $100,478, respectively 104,680 89,876 98,231
- ----------------------------------------------------------------------------------------------------------
Total investment securities 427,092 361,310 420,882
- ----------------------------------------------------------------------------------------------------------
Loans, net of unearned income 897,857 878,573 891,741
Less: Allowance for credit losses (12,457) (12,408) (12,817)
- ----------------------------------------------------------------------------------------------------------
Net loans 885,400 866,165 878,924
- ----------------------------------------------------------------------------------------------------------
Bank premises and equipment, net 31,015 32,120 31,251
Other real estate owned 1,305 2,228 1,705
Interest receivable 9,735 9,535 9,478
Intangible assets 7,126 7,219 6,875
Other assets 24,656 20,929 20,668
- ----------------------------------------------------------------------------------------------------------
Total assets $1,463,573 $1,366,570 $1,450,647
==========================================================================================================
</TABLE>
CONSOLIDATED BALANCE SHEETS
F&M BANCORP AND SUBSIDIARIES (CONT.)
<TABLE>
<CAPTION>
June 30, June 30, December 31,
1999 1998 1998
(Dollars in thousands, except per share amounts) (Unaudited) (Unaudited)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing $ 141,605 $ 143,547 $ 152,076
Interest-bearing 1,018,539 943,296 986,118
- -----------------------------------------------------------------------------------------------------------
Total deposits 1,160,144 1,086,843 1,138,194
Short-term borrowings:
Federal funds purchased and securities sold
under agreements to repurchase 57,869 50,599 57,626
Other short-term borrowings 1,971 8,903 14,776
Long-term borrowings 98,764 75,984 94,246
Accrued interest and other liabilities 14,164 14,966 14,440
- -----------------------------------------------------------------------------------------------------------
Total liabilities 1,332,912 1,237,295 1,319,282
- -----------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common stock, par value $5 per share;
authorized 50,000,000 shares;
issued and outstanding 8,908,865
shares, 8,505,654 shares, and
8,834,242 shares, respectively 44,545 42,529 44,172
Surplus 62,334 62,507 61,214
Retained earnings 14,370 11,956 25,760
Stock dividend distributable 14,347 12,491 ---
Accumulated other comprehensive (loss) income (4,935) (208) 219
- -----------------------------------------------------------------------------------------------------------
Total shareholders' equity 130,661 129,275 131,365
- -----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $1,463,573 $1,366,570 $1,450,647
===========================================================================================================
</TABLE>
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
F&M BANCORP AND SUBSIDIARIES
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
(Dollars in thousands, except per share amounts) 1999 1998 1999 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Interest and fees on loans $18,523 $19,236 $37,172 $38,717
Interest and dividends on investment securities:
Taxable 4,471 3,998 8,803 7,754
Tax-exempt 1,466 1,081 2,938 2,144
Interest on deposits with banks 286 155 581 283
Interest on federal funds sold 145 204 193 460
- ---------------------------------------------------------------------------------------------------------------
Total interest income 24,891 24,674 49,687 49,358
- ---------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits 9,824 9,619 19,550 18,999
Interest on federal funds purchased and
securities sold under agreements to repurchase 576 560 1,121 1,109
Interest on Federal Home Loan Bank borrowings 1,329 1,321 2,693 2,734
Interest on other short-term borrowings 11 62 29 96
- ---------------------------------------------------------------------------------------------------------------
Total interest expense 11,740 11,562 23,393 22,938
- ---------------------------------------------------------------------------------------------------------------
Net interest income 13,151 13,112 26,294 26,420
Provision for credit losses 325 525 850 1,156
- ---------------------------------------------------------------------------------------------------------------
Net interest income after provision
for credit losses 12,826 12,587 25,444 25,264
- ---------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME
Trust income 747 686 1,510 1,377
Service charges on deposit accounts 1,549 1,542 2,964 3,027
Insurance income 1,696 1,462 3,388 3,108
Gains (Losses) on sales of securities (1) (14) (1) 738
Gains on sales of loans 231 705 353 1,160
Other operating income 1,183 1,773 2,641 2,839
- ---------------------------------------------------------------------------------------------------------------
Total noninterest income 5,405 6,154 10,855 12,249
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
F&M BANCORP AND SUBSIDIARIES (CONT.)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
(Dollars in thousands, except per share amounts) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NONINTEREST EXPENSE
Salaries 5,555 5,820 11,047 11,806
Pension and other employee benefits 1,310 1,671 2,435 2,916
Occupancy and equipment expense 1,888 2,042 3,754 4,056
Other operating expense 4,260 3,914 7,741 7,302
- -------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 13,013 13,447 24,977 26,080
- -------------------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 5,218 5,294 11,322 11,433
Provision for income taxes 1,283 1,436 3,030 3,174
- -------------------------------------------------------------------------------------------------------------------------------
Net Income $ 3,935 $ 3,858 $ 8,292 $ 8,259
===============================================================================================================================
OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX:
Unrealized losses on securities $ (3,843) $ (26) $ (5,153) $ (1,048)
Reclassification adjustment for gains (losses)
included in net income (1) (9) (1) 487
- -------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income (3,844) (35) (5,154) (561)
- -------------------------------------------------------------------------------------------------------------------------------
Comprehensive (loss) income $ (54) $ 3,751 $ 2,816 $ 7,414
===============================================================================================================================
EARNINGS PER COMMON SHARE-BASIC (1)
Based on weighted average shares outstanding
of 9,331,642 for 1999, 9,242,353 for 1998 $.42 $.42 $.89 $.89
===============================================================================================================================
EARNINGS PER COMMON SHARE-DILUTED (1)
Based on weighted average shares outstanding
of 9,391,188 for 1999, 9,356,427 for 1998 $.42 $.41 $.88 $.88
===============================================================================================================================
Dividends per Share (1) $.26 $.24 $.54 $.56
===============================================================================================================================
</TABLE>
(1) Restated for 5% Stock Dividend paid July 28, 1999.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
F&M BANCORP AND SUBSIDIARIES
<TABLE>
<CAPTION>
Accumulated
Stock Other
Common Retained Dividend Comprehensive
(Dollars in thousands except per share amounts) Stock Surplus Earnings Distributable Income (Loss) Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997 $42,389 $48,874 $34,245 -- $ 353 $125,861
Net income -- -- 13,556 -- -- 13,556
Dividend reinvestment plan -- -- (120) -- -- (120)
Cash dividends paid ($1.01 per share) -- -- (9,340) -- -- (9,340)
Stock consideration for options exercised
(3,217 shares) (16) (19) (90) -- -- (125)
Stock options exercised 285 1,382 -- -- -- 1,667
Stock dividend (302,819 shares) 1,514 10,977 (12,491) -- -- --
Other comprehensive income -- -- -- -- (134) (134)
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 $44,172 $61,214 $25,760 -- $219 $131,365
Net income -- -- 8,292 -- -- 8,292
Dividend reinvestment plan -- -- (20) -- -- (20)
Cash dividends paid ($.54 per share) -- -- (5,054) -- -- (5,054)
Stock consideration for options exercised
(11,554 shares) (58) (50) (261) -- -- (369)
Stock options exercised (86,287 shares) 431 1,170 -- -- -- 1,601
Stock dividend declared (1) -- -- (14,347) 14,347 -- --
Other comprehensive income -- -- -- -- (5,154) (5,154)
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 1999 $44,545 $62,334 $14,370 $14,347 $(4,935) $130,661
===================================================================================================================================
</TABLE>
(1) 5% Stock Dividend paid July 28, 1999
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
F&M BANCORP AND SUBSIDIARIES
<TABLE>
<CAPTION>
Six Months Ended
June 30,
(Dollars in thousands) 1999 1998
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 8,292 $ 8,259
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for credit losses 850 1,156
Provision for other real estate owned -- 2
Depreciation and amortization 1,582 1,062
Amortization of intangibles 528 534
Net premium amortization on investment securities 453 121
(Increase) decrease in interest receivable (257) 11
Increase in interest payable 1,577 332
Deferred income tax benefit -- (187)
Accretion of net loan origination fees 91 599
Gain on sales of property (3) (862)
(Gain) Loss on sales/calls of securities 1 (738)
Decrease in loans held for sale 3,715 1,299
(Increase) decrease in other assets 394 (1,497)
Decrease in other liabilities (1,853) (968)
Other -- 118
- -----------------------------------------------------------------------------------------------
Net cash provided by operating activities 15,370 9,241
- -----------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of investment securities to be held-to-maturity (12,494) (6,303)
Purchases of investment securities available-for-sale (97,477) (188,073)
Proceeds from calls of securities held-to-maturity -- 8,924
Proceeds from sales/calls of securities available-for-sale 1,109 63,881
Proceeds from maturing securities available-for-sale 87,894 84,187
Proceeds from maturing securities held-to-maturity 5,865 2,309
Net (increase) decrease in loans (8,512) 5,009
Purchases of premises and equipment (1,345) (553)
Proceeds from sales of property 400 3,851
Other investing activities (779) 733
- -----------------------------------------------------------------------------------------------
Net cash used in investing activities (25,339) (26,035)
- -----------------------------------------------------------------------------------------------
</TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
F&M BANCORP AND SUBSIDIARIES (CONT.)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
(Dollars in thousands) 1999 1998
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in noninterest-bearing deposits, interest-bearing
checking, savings and money market accounts 22,123 17,339
Net increase (decrease) in certificates of deposit (173) 16,112
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase 243 5,548
Net increase (decrease) in long-term borrowings 4,518 (41,830)
Net increase (decrease) in other short-term borrowings (12,805) 25,602
Cash dividends paid (5,054) (5,182)
Dividend reinvestment plan (20) (18)
Proceeds from issuance of common stock 1,232 888
- ---------------------------------------------------------------------------------------------------
Net cash provided by financing activities 10,064 18,459
- ---------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 95 1,665
Cash and cash equivalents at beginning of period 76,054 60,768
- ---------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $76,149 $62,433
===================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for interest $21,816 $22,452
Cash payments for income tax 3,531 3,457
NON-CASH INVESTING AND FINANCING ACTIVITIES
Fair value adjustment for securities available for sale,
net of income taxes (5,154) (561)
Net transfer to real estate owned held for sale from loans receivable -- 705
</TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The foregoing financial statements are unaudited; however, in the opinion
of management, all adjustments (comprising only normal recurring accruals)
necessary for a fair presentation of the financial statements have been
included. A summary of F&M Bancorp and subsidiaries' ("Bancorp's")
significant accounting policies is set forth in Note 1 to the consolidated
financial statements in its Annual Report on Form 10-K for the year ended
December 31, 1998.
Certain reclassifications to prior year balances have been made in the
accompanying consolidated financial statements to make disclosures
consistent with those of the current year.
NOTE 2. ACQUISITIONS
On July 15, 1999, Bancorp consummated a merger with Potomac Basin Group
Associates, Inc. (Potomac Basin), in a tax-free exchange of shares
accounted for as a pooling-of-interests. Potomac Basin is a Beltsville,
MD-based, full-line independent insurance agency specializing in corporate
employee benefit plans.
On June 18, 1999, Bancorp, through its subsidiary, Farmers & Mechanics
National Bank (the "Bank"), purchased certain assets and liabilities
associated with the Fairfield, PA office of Farmers Bank, a First Maryland
Bancorp bank. Under the terms of the agreement, the Bank assumed
responsibility for services related to checking, savings and certificates
of deposit products totaling $10.8 million and purchased the branch office
and real estate located at 20 East Main Street, Fairfield, PA.
On May 31, 1998, Bancorp acquired Keller-Stonebraker Insurance, Inc.
("K-S"), Hagerstown, MD, in a tax-free exchange of shares accounted for as
a pooling-of-interests. K-S operates as an independent, wholly owned
subsidiary of the Bank and provides a full line of consumer and commercial
business insurance products through offices in Hagerstown, Cumberland, MD
and Keyser, WV. Consumer insurance products include annuities, homeowners,
automobile, life and personal umbrellas. Commercial business products
include property and casualty packages, workers' compensation, bonds,
professional liability, umbrella, and 401(k) and other benefit plans.
On November 30, 1998, Bancorp completed the acquisition of Monocacy
Bancshares, Inc. and its commercial banking subsidiary, Taneytown Bank &
Trust Company, Taneytown, MD, in a tax-free exchange of shares accounted
for as a pooling-of-interests. Under the terms of the merger agreement,
Taneytown Bank was merged with and into the Bank at closing, increasing the
Bank's assets by approximately $304 million, loans by approximately $167
million, and deposits by approximately $244 million.
NOTE 3. INVESTMENT SECURITIES
Investment securities are summarized as follows:
<TABLE>
<CAPTION>
June 30, 1999
- --------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 113,000 $ 23 $ 2,535 $ 110,488
Obligations of states and political subdivisions 38,629 449 1,385 37,693
Other debt securities 12,636 34 -- 12,670
Mortgage-backed securities 147,527 20 4,419 143,128
- --------------------------------------------------------------------------------------------------------------------
Total debt securities 311,792 526 8,339 303,979
Equity securities 18,700 -- 267 18,433
- --------------------------------------------------------------------------------------------------------------------
Total available-for-sale 330,492 526 8,606 322,412
- --------------------------------------------------------------------------------------------------------------------
Held-to-maturity:
Obligations of states and political subdivisions 93,062 777 1,084 92,755
Mortgage-backed securities 11,618 99 32 11,685
- --------------------------------------------------------------------------------------------------------------------
Total held-to-maturity 104,680 876 1,116 104,440
- --------------------------------------------------------------------------------------------------------------------
Total investment securities $435,172 $1,402 $9,722 $426,852
====================================================================================================================
<CAPTION>
June 30, 1998
- -------------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $132,953 $ 327 $ 154 $ 133,126
Obligations of states and political subdivisions 21,757 166 3 21,920
Other debt securities 31,139 158 57 31,240
Mortgage-backed securities 56,661 -- 417 56,244
- -------------------------------------------------------------------------------------------------------------------------
Total debt securities 242,510 651 631 242,530
Equity securities 29,178 -- 274 28,904
- -------------------------------------------------------------------------------------------------------------------------
Total available-for-sale 271,688 651 905 271,434
- -------------------------------------------------------------------------------------------------------------------------
Held-to-maturity:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies 985 15 -- 1,000
Obligations of states and political subdivisions 70,956 1,327 30 72,253
Mortgage-backed securities 17,935 173 -- 18,108
- -------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity 89,876 1,515 30 91,361
- -------------------------------------------------------------------------------------------------------------------------
Total investment securities $361,564 $ 2,166 $935 $362,795
=========================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998
- ----------------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 118,271 $ 618 $ 110 $ 118,779
Obligations of states and political subdivisions 41,590 554 233 41,911
Other debt securities 2,328 9 -- 2,337
Mortgage-backed securities 140,374 275 485 140,164
- ----------------------------------------------------------------------------------------------------------------------------
Total-debt securities 302,563 1,456 828 303,191
Equity securities 19,727 -- 267 19,460
- ----------------------------------------------------------------------------------------------------------------------------
Total available-for-sale 322,290 1,456 1,095 322,651
- ----------------------------------------------------------------------------------------------------------------------------
Held-to-maturity:
Obligations of states and political subdivisions 83,757 2,166 140 85,783
Mortgage-backed securities 14,474 221 -- 14,695
- ----------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity 98,231 2,387 140 100,478
- ----------------------------------------------------------------------------------------------------------------------------
Total investment securities $420,521 $3,843 $ 1,235 $423,129
============================================================================================================================
</TABLE>
Bancorp classifies its investments in debt and equity securities in two
categories: held-to-maturity and available-for-sale. Securities classified
as held-to-maturity are those debt securities that Bancorp has both the
positive intent and ability to hold to maturity. These securities are
carried at cost, adjusted for amortization of premiums and accretion of
discounts, which are recognized as adjustments to interest income using the
interest method.
Securities classified as available-for-sale are equity securities with
readily determinable fair values and those debt securities that Bancorp
intends to hold for an indefinite period of time, but not necessarily to
maturity. These securities may be sold as part of its asset/liability
management strategy, or in response to significant movements in interest
rates, liquidity needs, regulatory capital considerations, and other
similar factors. These securities are carried at fair value, with any
unrealized gains and losses reported as a separate component of
shareholders' equity, net of the related deferred tax effect.
Regardless of the classification, dividend and interest income, including
amortization of premiums and accretion of discounts arising at acquisition,
are included in interest income in the consolidated statements of income
and comprehensive income. Realized gains and losses, if any, determined
based on the adjusted cost of the specific securities sold, are reported as
a separate line item in noninterest income in the consolidated statements
of income and comprehensive income.
The amortized cost and estimated fair values of investments at June 30,
1999 by contractual maturity are shown below. Expected maturities may
differ from contractual maturities because borrowers have the right to call
or prepay obligations with or without call or prepayment penalties.
Estimated
Amortized Fair
(in thousands) Cost Value
- -------------------------------------------------------------------------
Available-for-sale:
Within 1 year $24,212 $24,232
After 1 but within 5 years 55,518 54,786
After 5 years but within 10 years 72,637 70,767
After 10 years 11,898 11,065
Mortgage-backed securities 147,527 143,129
Equity securities 18,700 18,433
- -------------------------------------------------------------------------
Total available-for-sale 330,492 322,412
- -------------------------------------------------------------------------
Held-to-maturity:
Within 1 year 7,088 7,133
After 1 but within 5 years 33,296 33,825
After 5 years but within 10 years 23,250 23,257
After 10 years 29,428 28,540
Mortgage-backed securities 11,618 11,685
- -------------------------------------------------------------------------
Total held-to-maturity 104,680 104,440
- -------------------------------------------------------------------------
Total investment securities $435,172 $426,852
=========================================================================
The carrying value of investment securities pledged to secure public
deposits, securities sold under repurchase agreements, Federal Home Loan
Bank advances, and for other purposes as required and permitted by law,
totaled $153.5 million at June 30, 1999.
NOTE 4. LOANS
Loans, net of unearned income, consist of the following:
June 30, December 31,
- -------------------------------------------------------------------------------
(In thousands) 1999 1998 1998
- -------------------------------------------------------------------------------
Real Estate Loans
Construction and land development $54,164 $ 67,223 $ 61,328
Secured by farmland 5,784 8,252 8,452
Residential mortgage 266,226 247,878 265,394
Other mortgage 203,067 181,620 198,131
Agricultural 732 587 560
Commercial and industrial loans 101,260 104,424 92,091
Consumer 257,238 260,375 257,968
Other loans 9,386 8,214 7,817
- -------------------------------------------------------------------------------
Totals $897,857 $878,573 $891,741
===============================================================================
Loans to states and political subdivisions and industrial revenue bonds are
included in all other loans in the schedule above and in total loans in the
balance sheet.
The allowance for credit losses is maintained at a level which, in
management's opinion, is considered adequate to provide for possible loan
losses on loans currently held in the loan portfolio.
NOTE 5. BANK PREMISES AND EQUIPMENT
Investments in bank premises and equipment are as follows:
June 30, December 31,
- ---------------------------------------------------------------------------
(In thousands) 1999 1998 1998
- ---------------------------------------------------------------------------
Bank premises and land $29,432 $29,061 $28,978
Furniture and equipment 24,323 23,975 24,430
Leasehold improvements 3,014 2,923 2,908
- ---------------------------------------------------------------------------
56,769 55,959 56,316
Less accumulated depreciation
and amortization (25,755) (23,839) (25,065)
- ---------------------------------------------------------------------------
Net premises and equipment $31,014 $32,120 $31,251
===========================================================================
NOTE 6. COMPREHENSIVE INCOME
Bancorp adopted Financial Accounting Standards Board ("FASB") Statement No.
130, "Reporting Comprehensive Income," effective January 1, 1998. Other
comprehensive income consists entirely of unrealized gains (losses) on
available-for-sale securities. Income taxes allocated to other
comprehensive income amounted to benefits of $2.4 million and $22 thousand
for the second quarter of 1999 and 1998, respectively and benefits of $3.2
million and $353 thousand for the six months ended June 30, 1999 and 1998,
respectively.
NOTE 7. EARNINGS PER SHARE
Earnings per share ("EPS") data is computed and presented in accordance
with FASB Statement No. 128, "Earnings Per Share." As prescribed by the
Statement, the presentation of primary EPS has been replaced with the dual
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income available to common shareholders
("numerator") by the weighted-average number of common shares outstanding
for the period after giving retroactive effect to stock dividends and stock
splits ("denominator"). Diluted EPS reflects the potential dilution that
could occur if outstanding stock options or other contracts to issue common
stock, if any, were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of Bancorp.
Diluted EPS is equal to the numerator divided by the denominator plus the
dilutive effect of outstanding stock options.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Six Months Ended June 30, Quarter Ended June 30,
(Dollars in thousands) 1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $8,292 $8,259 $3,790 $3,786
===== ===== ===== =====
Basic EPS
Shares 9,331,642 9,242,353 9,352,023 9,249,052
EPS $0.89 $0.88 $0.42 $0.42
Dilutive Shares
Stock options 59,546 114,074 55,521 118,215
EPS $0.01 $0.01 $ -- $0.01
Diluted EPS
Shares including options 9,371,188 9,356,427 9,407,544 9,367,267
EPS $0.88 $0.88 $0.42 $0.41
</TABLE>
NOTE 8. FUTURE CHANGES IN ACCOUNTING PRINCIPLES
In June, 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and for Hedging Activities", which calls for derivatives to be
recognized in the consolidated balance sheet at fair value and for
subsequent changes in fair value to be recognized in the consolidated
statement of income and comprehensive income. However, because
non-derivative and non-financial transactions are still measured using a
mix of historical and current prices, the Statement retains special
accounting for gains and losses when derivatives are used in qualifying
hedges of assets, liabilities, and future transactions. The Statement
unifies qualifying criteria for hedges involving all types of derivatives,
requiring that a company document, designate, and assess the effectiveness
of its hedges. For hedges that meet the Statement's criteria, the
derivative's gains and losses will be allowed to offset gains and losses
on, or forecasted cash flows of, the hedged item.
Among a number of other provisions, the Statement will also allow entities
to reclassify available-for-sale and held-to-maturity securities without
calling into question management's intent for the remainder of its
securities portfolios.
For calendar-year companies such as Bancorp, the Statement will take effect
beginning January 1, 2001. Historically, Bancorp has not made use of hedges
and other financial derivatives and is unable to predict the impact, if
any, that the application of Statement No. 133 will have upon consolidated
financial statements issued after 2000.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
F&M Bancorp's net income for the second quarter of 1999 was $3.790 million,
or $0.41 basic earnings per share, a decrease of 2% compared with earnings
before special items of $3.867 million, or $0.42 basic earnings per share,
for the second quarter of 1998. Per share amounts reported previously have
been restated to give effect to a 5% stock dividend declared in June 1999
and the acquisitions of Keller-Stonebraker, Inc., completed in May 1998,
and Monocacy Bancshares, Inc., completed in November 1998, both accounted
for as a pooling-of-interests. Including special items, net income of
$3.790 million for the second quarter of 1999 increased slightly from
$3.786 million for the second quarter of 1998. Second quarter 1999 earnings
were favorably impacted by a decrease in the provision for credit losses of
$200 thousand, or 38%, as well as a decrease in noninterest expense of $626
thousand, or 5%, compared to the second quarter of last year. These
decreases were offset by declines in gains on sales of loans of $474
thousand, or 67%, and nonrecurring gains on sales of real property of $395
thousand, or 100%, when compared to the second quarter of 1998. Returns on
average assets and average equity were 1.05% and 11.46%, respectively, for
the second quarter of 1999 compared with 1.12% and 11.75%, respectively,
for the second quarter of 1998.
For the six months ended June 30, 1999 compared with June 30, 1998, net
income including special items decreased 0.1% to $7.970 million, or $0.87
basic earnings per share, from $7.975 million, or $0.88 basic earnings per
share. Returns on average assets and average equity were 1.11% and 12.12%,
respectively, for the first half of 1999 compared with 1.20% and 12.63%,
respectively, for the first six months of 1998.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income, which is the sum of interest and certain fees
generated by earning assets minus interest paid on deposits and other
funding sources, is the principal source of Bancorp's earnings,
representing approximately 75% of gross revenue through the first six
months of 1999. Net interest income is influenced by a number of external
economic and competitive factors such as Federal Reserve Board monetary
policy and its influence on market interest rates; loan demand and
competition from nonbank lenders; and competition with investment managers,
brokerage firms and investment bankers for consumer and commercial business
assets that might otherwise be deposited in banks. Internal factors
impacting levels and changes in net interest income are attributed to
Bancorp's interest rate risk management policies, which address a variety
of issues including loan and deposit pricing strategies, funding
alternatives, and maturity schedules. Bancorp has not made use of
derivatives, interest rate hedges, or similar instruments or transactions
to manage interest rate risk.
Average balances and rates for each major category of interest-earning
assets and interest-bearing liabilities for the second quarter and
year-to-date periods are presented on a comparative basis in Table 1. Net
interest income on a taxable-equivalent basis increased by 2%, or $245
thousand for the second quarter of 1999, compared to the second quarter of
1998, and 1%, or $302 thousand for the first six months of 1999, compared
to the first six months of 1998. Average earning assets increased 8% for
the second quarter and first six months of 1999 compared with the same
periods in 1998. Average loan growth slowed to less than 1% for the quarter
and six months ended June 30, 1999 as compared to last year. The average
balance in the investment portfolio increased $84.3 million for the quarter
and $85.6 million for the six months partially in recognition of expected
loan demand. The yield on earning assets across all sectors decreased 46
basis points to 7.59% and 49 basis points to 7.67% for the three and six
months ended June 30, 1999, respectively, compared with the same periods
last year.
Table 1. Consolidated Average Balances, Interest and Average Rates (Taxable
Equivalent Basis)
<TABLE>
<CAPTION>
June 30,
- -----------------------------------------------------------------------------------------------------------------------------------
1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
QTD Average Average QTD Average Average
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
INTEREST-EARNING ASSETS:
Short-term funds $ 41,008 $ 422 4.12% $ 29,976 $ 345 4.60%
- -----------------------------------------------------------------------------------------------------------------------------------
Investment securities: (1)
Tax-exempt(2) 130,313 2,222 6.82 90,992 1,638 7.20
Taxable 298,891 4,471 5.98 253,872 3,998 6.30
- -----------------------------------------------------------------------------------------------------------------------------------
Total investment securities 429,204 6,693 6.24 344,864 5,636 6.54
- -----------------------------------------------------------------------------------------------------------------------------------
Loans, net, including loans held for sale 886,873 18,573 8.40 883,335 19,284 8.76
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets and average yield 1,357,085 25,688 7.59 1,258,175 25,265 8.05
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST-EARNING ASSETS 96,580 95,423
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $1,453,665 $1,353,598
===================================================================================================================================
LIABILITIES
INTEREST-BEARING LIABILITIES:
Interest-bearing deposits:
Savings $ 152,582 $ 883 2.32% $157,863 $ 999 2.54%
Checking 157,778 954 2.43 139,741 900 2.58
Money market accounts 177,063 1,235 2.80 143,409 987 2.76
Certificates of deposit 520,055 6,752 5.21 494,670 6,733 5.46
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 1,007,478 9,824 3.91 935,683 9,619 4.12
- -----------------------------------------------------------------------------------------------------------------------------------
Short-term borrowings:
Federal funds purchased and securities
sold under agreements to repurchase 55,944 576 4.13 44,469 560 5.05
Other short-term borrowings 7,209 93 5.17 31,236 411 5.28
- -----------------------------------------------------------------------------------------------------------------------------------
Total short-term borrowings 63,153 669 4.25 75,705 971 5.14
- -----------------------------------------------------------------------------------------------------------------------------------
Long-term borrowings 93,351 1,247 5.36 63,939 972 6.10
- -----------------------------------------------------------------------------------------------------------------------------------
Total borrowed funds 156,504 1,916 4.91 139,644 1,943 5.58
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities and 1,163,982 11,740 4.05 1,075,327 11,562 4.31
average rate incurred
- -----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST-BEARING LIABILITIES
Demand deposits 141,962 135,488
Other liabilities 15,016 13,573
Shareholders' equity 132,705 129,210
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $1,453,665 $1,353,598
===================================================================================================================================
Net interest income $13,948 $13,703
===================================================================================================================================
Net interest spread 3.54% 3.74%
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest margin 4.12% 4.37%
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Table 1. (continued) Consolidated Average Balances, Interest and Average
Rates (Taxable Equivalent Basis)
<TABLE>
<CAPTION>
June 30,
- -----------------------------------------------------------------------------------------------------------------------------------
1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
YTD Average Average YTD Average Average
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
INTEREST-EARNING ASSETS:
Short-term funds $ 35,133 $ 758 4.32% $ 24,643 $ 721 5.85%
- -----------------------------------------------------------------------------------------------------------------------------------
Investment securities: (1)
Tax-exempt(2) 129,018 4,452 6.90 91,224 3,249 7.12
Taxable 293,848 8,803 5.99 246,011 7,754 6.30
- -----------------------------------------------------------------------------------------------------------------------------------
Total investment securities 422,866 13,255 6.27 337,235 11,003 6.53
- -----------------------------------------------------------------------------------------------------------------------------------
Loans, net, including loans held for sale 890,146 37,272 8.44 886,868 38,804 8.82
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets and average yield 1,348,145 51,285 7.67 1,248,746 50,528 8.16
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST-EARNING ASSETS 95,928 95,129
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $1,444,073 $1,343,875
===================================================================================================================================
LIABILITIES
INTEREST-BEARING LIABILITIES:
Interest-bearing deposits:
Savings $ 151,949 $ 1,757 2.33% $158,677 $ 1,980 2.52%
Checking 153,310 1,815 2.39 138,325 1,778 2.59
Money market accounts 170,437 2,391 2.83 140,043 1,885 2.71
Certificates of deposit 521,343 13,587 5.26 491,997 13,356 5.47
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 997,039 19,550 3.95 929,042 18,999 4.12
Short-term borrowings:
Federal funds purchased and securities
sold under agreements to repurchase 54,274 1,121 4.17 44,513 1,109 5.02
Other short-term borrowings 7,535 197 5.27 39,179 1,077 5.54
- -----------------------------------------------------------------------------------------------------------------------------------
Total short-term borrowings 61,809 1,318 4.30 83,692 2,186 5.27
- -----------------------------------------------------------------------------------------------------------------------------------
Long-term borrowings 96,259 2,525 5.29 59,748 1,753 5.92
- -----------------------------------------------------------------------------------------------------------------------------------
Total borrowed funds 158,068 3,843 4.90 143,440 3,939 5.54
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities and 1,155,107 23,393 4.08 1,072,482 22,938 4.31
average rate incurred
- -----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST-BEARING LIABILITIES
Demand deposits 141,697 133,748
Other liabilities 14,705 10,355
Shareholders' equity 132,564 127,290
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity $1,444,073 $1,343,875
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income $27,892 $27,590
===================================================================================================================================
Net interest spread 3.59% 3.85%
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest margin 4.17% 4.46%
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Average Balances and the related average rate are based on amortized
cost.
(2) Based on an effective federal tax rate of 35% for 1999 and 1998.
Average interest-bearing deposits increased $71.8 million, or 8%, and $68.0
million, or 7%, for the three and six month periods, respectively, over
last year. Growth occurred in nearly all deposit products, with the
exception of basic savings. Additional long-term funding was provided
principally by Federal Home Loan Bank advances, which increased $29.4
million, or 46%, for the quarter and $36.5 million, or 61%, year-to-date as
compared to last year.
Challenged by the decline in market interest rates between the comparable
periods, and low growth in loans, the net interest margin, which is the
ratio of taxable-equivalent net interest income to average earning assets,
decreased 25 basis points to 4.12% and 29 basis points to 4.17% for the
three-and six-month periods ended June 30, 1999.
PROVISION FOR CREDIT LOSSES.
Bancorp decreased the provision for credit losses by 38% to $325 thousand
for the second quarter of 1999 compared with $525 thousand for the second
quarter of 1998. For the six-month period ended June 30, 1999, the
provision decreased $306 thousand or 26% as compared to last year. The
decreases were attributed to an improvement in credit quality.
NONINTEREST INCOME.
Total noninterest income decreased 19% to $4.3 million for the quarter
ended June 30, 1999 compared with $5.3 million for the quarter ended June
30, 1998. An increase in trust income of $61 thousand, or 9%, over the
second quarter of last year was effectively negated by decreases in
insurance income of $30 thousand, or 5%, and other operating income of $595
thousand, or 34%, as compared to the second quarter of 1998. Gains on sales
of loans decreased $474 thousand, or 67%, for the second quarter of 1999
compared with the same quarter last year due to the more favorable rate
environment and high refinance activity that occurred the second quarter of
1998. Other operating income for the quarter ended June 30, 1998 included a
$395,000 nonrecurring gain on the sale of real property.
For the comparable six month periods, total noninterest income declined by
17% to $8.6 million for 1999 from $10.4 million for 1998. Excluding gains
of $738 thousand from the sales of securities realized in 1998, which are
considered a special item, noninterest income decreased 11%. Trust and
investment management income increased $133 thousand, or 10%, relating to
growth in managed assets. Insurance income decreased $99 thousand, or 8%,
and service charges on deposit accounts decreased $63 thousand, or 2%, for
the six months ended June 30, 1999 as compared to last year. Gains on the
sales of loans decreased to $353 thousand for the first six months of 1999,
down 70% from $1.2 million for the same period in 1998 related to the same
factors described for the quarter. Other operating income decreased 7% at
June 30, 1999 compared to the first six months of last year. Excluding the
aforementioned $395 thousand gains on the sale of real property in 1998,
other operating income increased 8% over last year.
NONINTEREST EXPENSE.
Total noninterest expense decreased 5% to $12.0 million for the second
quarter of 1999 compared with $12.6 million for the second quarter of last
year. Salaries and benefits decreased $646 thousand, or 9%, and occupancy
and equipment expense decreased $161 thousand, or 8%, due largely to
synergies realized through recent acquisitions. Other operating expense
increased $181 thousand, or 5% compared to the second quarter of last year.
Bancorp's efficiency ratio (the ratio of adjusted noninterest expense to
the sum of net interest income on a tax equivalent basis and recurring
noninterest income) increased to 64.7% for the quarter ended June 30, 1999
from 63.3% for the quarter ended June 30, 1998.
For the comparable six-month periods, total noninterest expense decreased
6% to $23.1 million at June 30, 1999. Salaries and benefits expense
decreased to $12.2 million at June 30, 1999 versus $13.5 million at June
30, 1998, a decline of 9%. Occupancy and equipment expense fell $311
thousand, or 8% for the comparable six-month periods. Other operating
expense increased $140 thousand, or 2% to $7.2 million for the six months
ended June 30, 1999 from $7.0 million for the same period last year. For
the year-to-date periods, the efficiency ratio declined to 61.9% for 1999
compared with 63.4% for 1998, largely reflecting improved control of
operating expenses.
INCOME TAXES.
The provision for income taxes declined 11% to $1.283 million for the
second quarter of 1999, from $1.436 million for the second quarter of 1998.
Tax expense varies from one period to the next with changes in the level of
income before taxes, changes in the amount of tax-exempt income, and the
relationship of these changes to each other. The effective tax rate for the
second quarter of 1999 and 1998 was 25% and 28%, respectively. Income tax
expense differs from the amount computed at statutory rates primarily due
to tax-exempt interest from certain loans and investment securities. For
the six months ended June 30, 1999 and 1998, the effective tax rate was
28%.
NONPERFORMING ASSETS
Table 2 summarizes Bancorp's nonperforming assets and contractually
past-due loans. Through asset resolutions and sales, total nonperforming
assets at June 30, 1999 declined $5.2 million compared with year-earlier
levels and declined $1.8 million since year-end 1998. Loans past due 90
days or more as to interest or principal increased $1.4 million compared
with prior year levels and increased $513 thousand since year-end. Although
there is no direct correlation between nonperforming loans and ultimate
loan losses, an analysis of nonperforming loans may provide some indication
of the quality of the loan portfolio.
POTENTIAL PROBLEM LOANS
At June 30, 1999, Bancorp had $19.4 million in loans to borrowers who were
currently experiencing financial difficulties such that management had
reasonable concerns that such loans might become contractually past due or
be classified as a nonperforming asset.
These loans are subject to the same close attention and regular credit
reviews as extended to loans past due 90 days or more and nonperforming
assets. At December 31, 1998, potential problem loans totaled $23.1
million. Loans to borrowers who may not be able to meet the contractual
terms of their obligations because of uncertainties pertaining to their
state of readiness for year 2000 issues is disclosed under the caption,
Year 2000 Computer Readiness.
TABLE 2. NONPERFORMING ASSETS AND CONTRACTUALLY PAST-DUE LOANS
<TABLE>
<CAPTION>
June 30, December 31,
- -----------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1999 1998 1998
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------------------
Nonperforming assets:
Nonaccrual loans(1) $ 2,751 $ 6,979 $ 4,196
Other real estate owned net of valuation allowance(2) 1,305 2,228 1,705
- -----------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 4,056 $ 9,207 $ 5,901
- -----------------------------------------------------------------------------------------------------------------------------
Loans past due 90 or more days as to interest or principal(3) $ 2,504 $ 1,101 $ 1,991
- -----------------------------------------------------------------------------------------------------------------------------
Nonperforming loans to total loans 0.31% 0.79% 0.47%
Nonperforming assets to total loans and other real estate owned 0.45% 1.05% 0.66%
Nonperforming assets to total assets 0.28% 0.67% 0.41%
Allowance for credit losses times nonperforming loans 4.53x 1.78x 3.05x
Allowance for credit losses times nonperforming assets 3.07x 1.35x 2.17x
</TABLE>
(1) Loans are placed on nonaccrual status when, in the opinion of
management, reasonable doubt exists as to the full, timely collection of
interest or principal, or a specific loan meets the criteria for nonaccrual
status established by regulatory authorities. When a loan is placed on
nonaccrual status, all interest previously accrued but not collected is
reversed against current period interest income. No interest is taken into
income on nonaccrual loans unless received in cash, or until such time the
borrower demonstrates sustained performance over a period of time in
accordance with contractual terms.
(2) Other real estate owned includes: banking premises no longer used
for business purposes and real estate acquired by foreclosure (in partial
or complete satisfaction of debt), or otherwise surrendered by the borrower
to Bancorp's possession. Other real estate owned is recorded at the lower
of cost or fair value on the date of acquisition or transfer from loans.
Write-downs to fair value at the date of acquisition are charged to the
allowance for credit losses. Subsequent to transfer, these assets are
adjusted through a valuation allowance to the lower of the net carrying
value or the fair value (net of estimated selling expenses) based on
periodic appraisals.
(3) Nonaccrual loans are not included.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is maintained at a level, which in
management's judgement, is adequate to absorb losses inherent in the loan
portfolio. The adequacy of the allowance for credit losses is reviewed
regularly by management. Additions to the allowance are made by charges to
the provision for credit losses. On a quarterly basis, a comprehensive
review of the adequacy of the allowance is performed considering factors
such as historical relationships among loans outstanding, loss experience,
delinquency levels, individual loan reviews, and evaluation of the present
and future local and national economic environment. While management
believes the allowance for credit losses is adequate at June 30, 1999, the
estimate of losses and related allowance are subject to change due to
economic and other uncertainties inherent in the estimation process.
As reflected in Table 3, the allowance for credit losses as a percentage of
loans decreased to 1.39% as of June 30, 1999 from 1.41% at June 30, 1998.
Net loan charge-offs during the first six months of 1999 increased by
$393,000.
Bancorp had loans amounting to approximately $1.2 million and $5.2 million
at June 30, 1999 and June 30, 1998, respectively, that were specifically
classified as impaired and included in nonaccrual loans in Table 3. The
average balance of impaired loans for the six and three-month periods ended
June 30, 1999 and June 30, 1998 amounted to $1.9 million and $1.6 million,
and $2.1 million and $2.8 million, respectively. Cash receipts for these
same periods were $1.5 million and $1.1 million for 1999 and $414 thousand
and $239 thousand for 1998. Of these receipts, $37 thousand was recognized
as interest income for the six months ended June 30, 1999. All other cash
receipts were applied to the principal balance of the impaired loans. There
was no specific allowance for credit losses related to these impaired loans
at June 30, 1999. The specific allowance for credit losses related to
impaired loans at June 30, 1998 was $957,000.
TABLE 3. ANALYSIS OF ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
Period ended
- ------------------------------------------------------------------------------------------------------------------
June 30, December 31,
- ------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1999 1998 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Average loans outstanding less average unearned income (1) $891,397 $879,015 $875,196
==================================================================================================================
Allowance for credit losses at beginning of year $12,817 $ 12,069 $ 12,069
- ------------------------------------------------------------------------------------------------------------------
Charge-offs:
Real estate 373 385 1,053
Commercial and industrial 131 75 273
Consumer 1,702 1,938 4,010
- -----------------------------------------------------------------------------------------------------------------
Total loans charged-off 2,206 2,398 5,336
- -----------------------------------------------------------------------------------------------------------------
Recoveries:
Real estate 9 257 430
Commercial and industrial 12 80 104
Consumer 975 1,244 2,494
- -----------------------------------------------------------------------------------------------------------------
Total recoveries 996 1,581 3,028
- -----------------------------------------------------------------------------------------------------------------
Net charge-offs 1,210 817 2,308
- -----------------------------------------------------------------------------------------------------------------
Provisions for credit losses 850 1,156 3,056
- -----------------------------------------------------------------------------------------------------------------
Allowance for credit losses at end of period $12,457 $ 12,408 $ 12,817
=================================================================================================================
Net charge-offs to average loans outstanding, annualized 0.27% 0.18% 0.26%
=================================================================================================================
Allowance for credit losses to period-end loans 1.39% 1.41% 1.44%
=================================================================================================================
</TABLE>
(1) Exclusive of loans held for sale.
Table 4 presents an allocation of the allowance for credit losses to
various loan categories. This allocation does not limit the amount of the
allowance available to absorb losses from any type of loan and should not
be viewed as an indicator of the specific amount or specific loan
categories in which future charge-offs may ultimately occur.
TABLE 4. ALLOCATION OF ALLOWANCES FOR CREDIT LOSSES
<TABLE>
<CAPTION>
June 30, December 31 ,
- -----------------------------------------------------------------------------------------------------------------
1999 1998 1998
- -----------------------------------------------------------------------------------------------------------------
% Gross % Gross % Gross
(Dollars in thousands) Amount Loans(1) Amount Loans(1) Amount Loans(1)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Real estate
Construction and land development $1,201 6.0% $2,347 7.7% $1,767 6.9%
Residential mortgage 633 29.7 551 28.2 920 29.8
Other mortgage 2,983 22.6 3,252 20.7 3,419 22.2
Commercial and industrial 1,474 11.3 1,274 11.9 1,764 10.3
Consumer 2,845 28.7 3,553 29.6 3,599 28.9
Unallocated 3,321 1.7 1,431 1.9 1,348 1.9
- ----------------------------------------------------------------------------------------------------------------
Total allowance for credit losses $12,457 100.0% $12,408 100.0% $12,817 100.0%
================================================================================================================
</TABLE>
(1) Excludes loans held for sale.
YEAR 2000 COMPUTER READINESS
This disclosure is provided pursuant to the Securities and Exchange
Commission's Interpretation entitled "Disclosure of Year 2000 Issues and
Consequences by Public Companies, Investment Advisors, Investment Companies
and Municipal Securities Issuers" effective August 4, 1998.
The Year 2000 issue arose because many existing date-sensitive computer
programs, hardware, software, and other devices relying on imbedded chip
technology do not recognize a year that begins with "2" because traditional
programming has been limited to utilization of a two-digit code for a year
(such as "98" for the year 1998). F&M Bancorp and its subsidiaries have
undertaken to review their operating and information technology systems and
other mechanical equipment such as elevators to identify systems in which
the Year 2000 issue exists and to undertake the necessary renovation or
replacement of these systems so that the companies will continue to operate
as usual after January 1, 2000.
In July 1997, F&M Bancorp established a Year 2000 issue task team comprised
of representatives across functional lines representing all of its
subsidiaries. The Year 2000 issue task team developed a Year 2000 issue
assurance plan to coordinate and direct its efforts. The plan was approved
by the board of directors on September 11, 1997. The task team provides
quarterly reports to the board outlining the status of its efforts and its
anticipated work in the coming quarter.
The assurance plan is composed of five phases: 1) awareness; 2) assessment;
3) renovation; 4) validation; and, 5) implementation, which mirror
guidelines developed by the Federal Financial Institutions Examination
Council (FFIEC) to deal with the Year 2000 issue. The assurance plan
includes a timeline for completion of all tasks identified. As of June 30,
1999, all critical tasks are current according to the timeline. Activities
under each of the phases are ongoing as new vendor and customer
relationships are created.
The task team has received guidance from various regulators including the
Office of the Comptroller of the Currency (OCC), Securities and Exchange
Commission (SEC), Office of Thrift Supervision (OTS), and FFIEC.
The task team established a program to educate all associates regarding the
Year 2000 issue both for internal systems and as the issue may affect
customers. Education of customers is continuing through periodic
information in the form of brochures, seminars, a toll free information
line, a web page, and participation in community forums. Both activities
are consistent with the Year 2000 customer communication outline issued by
the FFIEC on February 17, 1999.
All vendors who supply hardware, software and/or services of any type which
may be affected by this issue have been identified and contacted. A total
of four hundred eighty-eight (488) products and services are represented by
this vendor listing and have been categorized as either mission critical
(those that directly impact daily operations), concern (those that can be
replaced with manual processes), or low priority (little or no impact on
daily operations). Vendors have been surveyed as to their Year 2000 issue
readiness. The task team has confirmed vendor responses by testing products
and services where possible to verify their readiness.
Of the one hundred twenty-four (124) products and services identified as
mission critical:
A. Forty-two (42) are not date sensitive and are deemed Year
2000 issue ready.
B. Nineteen (19) cannot be tested internally. The progress of
these service providers' efforts addressing the Year 2000
issue are being closely monitored. All nineteen (19) advise
that their products and/or services are either Year 2000
issue ready now or will be in advance of January 1, 2000.
Examples of products and/or services that are not capable of
internal testing include utilities and communications
services.
C. Sixty-three (63) have been successfully tested.
Bancorp relies on Kirchman Corporation's Dimension 3000 software for
maintaining customer accounting records. Kirchman is a provider of
accounting systems for more than 1,000 banking clients worldwide.
Kirchman's internal methodologies addressing Year 2000 issues have been
reviewed and have received ITAA*2000 certification by the Information
Technology Association of America, an independent non-profit organization.
Further, Kirchman systems have passed all internal tests, and testing is
complete.
The task team has developed procedures for assessing Year 2000 issue risk
for its funds providers including, depositors, which are intended to manage
and limit potential risks associated with large or significant
concentrations of retail and commercial deposits. The Year 2000 issue
readiness of providers of lines of credit have been reviewed.
The task team has also established procedures, utilizing the standard risk
classifications employed to manage credit risk, for reviewing the Year 2000
issue readiness of borrowers. Loan relationships with balances exceeding
$250,000, or which are particularly computer reliant, have been reviewed.
Four (4) relationships totaling $748,328 have been risk rated "watch" and
represent the total value of relationships adversely risk rated because of
Year 2000 issue risk.
Bancorp's existing contingency plan has been enhanced to provide responses
for Year 2000 issues. The contingency planning committee adopted the five
phase model as recommended by the FFIEC and OCC advisory letter 98-7 and
had an updated plan by December 31, 1998, as required by the regulators.
Testing of business resumption plans was substantially complete at March
31, 1999.
To date, Bancorp has spent a total of $197,000 addressing Year 2000 issues
and anticipates additional out-of-pocket expenses of $243,000 to complete.
Work is done predominantly by existing associates as part of their normal
work responsibilities. Bancorp does not separately track these internal
costs which are principally payroll related. Costs for dealing with Year
2000 issues are being provided from operating revenues.
Bancorp believes its efforts, and those of its third-party providers, will
effectively address Year 2000 issues before January 1, 2000. Because
Bancorp is so reliant on third-party providers (whose products and services
cannot be effectively tested such as utilities and telecommunications
services) for support, Bancorp's normal business operations could be
disrupted in the event one or more third-party providers fail to provide
products and services as contracted. The most reasonably likely worst case
Year 2000 issue scenario identified to date involves Bancorp's inability,
for short periods, to provide services to customers. The worst case
scenario is mitigated somewhat by an ability to manually process customer
transactions, by the geographic penetration of our branch network, and by
alternative service delivery methods, which include both proprietary and
network ATMs, PC banking, telephone banking, and Express Bank, Bancorp's
full-service mobile branch. Power and telecommunication services are
critical, but might be interrupted for only a part of the branch network.
Bancorp has a generator to provide power to operate computer systems and,
by contract, has geographically remote facilities served by alternative
sources of power to process work, if needed. Longer periods of disruption
could affect Bancorp's ability to develop new business and could increase
costs of operation and decrease revenues. Bancorp determined, in the most
recent quarter, to purchase five (5) additional generators for placement
strategically in its branch network. The generators will enhance Bancorp's
ability to conduct business as usual in any natural disaster, in addition
to any Year 2000 issue related power outage.
CAPITAL RESOURCES
Shareholders' equity totaled $130.0 million at June 30, 1999, a decrease of
1% compared with the 1998 year-end level of $130.8 million, and an increase
of 1% from the year earlier level of $128.9 million. The fair value of the
available-for-sale portfolio declined $5.2 million (net of deferred taxes)
since year-end, reflecting the negative impact of higher market interest
rates. Capital levels were considered sufficient to absorb anticipated
future price volatility in the available-for-sale portfolio.
Bancorp's risk-based capital and leverage capital ratios continue to exceed
regulatory guidelines as of June 30, 1999, as follows:
TABLE 5. CAPITAL RATIOS
Risk-based Capital
- ----------------------------------------------------------------------------
Tier 1 Total Leverage
Capital Capital Ratio
- ----------------------------------------------------------------------------
Actual 13.39% 14.64% 8.89%
Regulatory Minimum 4.00% 8.00% 3.00%
- ----------------------------------------------------------------------------
Excess 9.39% 6.64% 5.89%
============================================================================
Fair value adjustments to shareholders' equity for changes in the fair
value of securities classified as available-for-sale are excluded from the
calculation of these capital ratios in accordance with regulatory
guidelines.
RECENT DEVELOPMENTS
On July 15, 1999, F&M Bancorp consummated a merger with Potomac
Basin Group Associates, Inc. ("Potomac Basin"), in a tax-free exchange of
shares accounted for as a pooling of interests. Potomac Basin is a
Beltsville, MD-based, full-line independent insurance agency specializing
in corporate employee benefit plans. Restated financial information is
provided in the table below. Due to the nature and size of the business
acquired, the balance sheet effects of the merger were immaterial and the
principal effects of the merger on the statements of income were reflected
in increased insurance income, included in noninterest income, and
increased salaries and benefits, included in noninterest expense.
RESTATED FINANCIAL INFORMATION
AS OF OR FOR THE
SIX MONTHS
(Dollars in thousands ENDED JUNE 30,
except per share data)
------------------------
1999 1998
------------------------
OPERATING DATA:
Net interest income $26,294 $26,420
Provision for credit 850 1,156
losses
Net interest income after 25,444 25,264
provision for credit losses
Noninterest income (1) 10,855 12,249
Noninterest expenses (2) 24,977 26,080
Income before provision for income 11,322 11,433
taxes
Provision for (benefit from) 3,030 3,174
income taxes
Net income 8,292 8,259
Earnings per share 0.88 0.88
BALANCE SHEET DATA (AT PERIOD END):
Loans, net of unearned income $897,857 $878,573
Total assets 1,463,573 1,366,570
Total deposits 1,160,144 1,086,843
Total shareholders' 130,661 129,275
equity
(1) Dollar amount of insurance income $2,210 $1,831
from Potomac Basin
(2) Dollar amount of salaries and 1,269 1,237
benefits expense from Potomac Basin
