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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
X ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- ----- ACT OF 1934
For the fiscal year ended: December 31, 1998
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TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File No.: 33-43317
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EASTON BANCORP, INC.
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(Name of small business issuer as specified in its charter)
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Maryland 52-1745344
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
501 Idlewild Avenue, Easton, Maryland 21601
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(Address of principal executive offices) (Zip Code)
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Issuer's telephone number, including area code: (410) 819-0300
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Securities registered under Section 12(b) of the Exchange Act:
Name of each exchange
Title of each class on which registered
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None None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock
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(Title of Class)
Check whether the small business issuer: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the small business issuer
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO ___
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Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the small business issuer's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
State the small business issuer's revenues for its most recent fiscal year:
$3,663,364.
The aggregate market value of the Common Stock held by non-affiliates of the
small business issuer on March 19, 1999, was $3,371,625. This calculation is
based upon an estimation by the Company's Board of Directors of fair market
value of the Common Stock of $12.50 per share. There is not an active trading
market for the Common Stock and it is not possible to identify precisely the
market value of the Common Stock.
On March 19, 1999, 560,318 shares of the small business issuer's Common Stock
were issued and outstanding.
Transitional Small Business Disclosure Format: YES ___ NO X
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DOCUMENTS INCORPORATED BY REFERENCE
The Company's Annual Report to Stockholders for the year ended December 31,
1998, is incorporated by reference in this Form 10-KSB in Part II Item 5, Item
6, and Item 7. The Company's Proxy Statement for Annual Meeting of Stockholders
to be held on May 26, 1999, is incorporated by reference in this Form 10-KSB in
Part III Item 9, Item 10, Item 11, and Item 12.
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This Report contains statements which constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These statements appear in a
number of places in this Report and include all statements regarding the intent,
belief or current expectations of the Company, its directors or its officers
with respect to, among other things: (i) the Company's financing plans; (ii)
trends affecting the Company's financial condition or results of operations;
(iii) the Company's growth strategy and operating strategy; and (iv) the
declaration and payment of dividends. Investors are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, and that actual results may differ materially from
those projected in the forward-looking statements as a result of various factors
discussed herein and those factors discussed in detail in the Company's filings
with the Securities and Exchange Commission.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Easton Bancorp, Inc. (the "Company") was incorporated as a Maryland
corporation on July 19, 1991, primarily to own and control all of the capital
stock of Easton Bank & Trust Company (the "Bank") upon its formation. On
December 31, 1992, the Company completed the initial public offering (the
"Offering") of its Common Stock, par value $0.10 per share (the "Common Stock"),
in which it sold 559,328 shares of Common Stock at a price of $10.00 per share.
Out of the proceeds of the Offering, the Company paid $5.0 million to the Bank
in exchange for all of its outstanding capital stock and retained approximately
$600,000 to cover expenses of the Company and to provide additional capital to
the Bank if required. The Bank commenced business on July 1, 1993, and the only
activity of the Company since then has been the ownership and operation of the
Bank.
The Bank was organized as a nonmember state bank under the laws of the
State of Maryland. The Bank is engaged in a general commercial banking business
from its main office location in its primary service area, Talbot County,
Maryland. In addition, in February 1999 the Bank opened a loan production office
in Denton, Maryland, which is in Caroline County.
The Company's holding company structure can assist the Bank in
maintaining its required capital ratios because the Company may, subject to
compliance with debt guidelines implemented by the Board of Governors of the
Federal Reserve System (the "Board of Governors" or the "Federal Reserve"),
borrow money and contribute the proceeds to the Bank as primary capital. The
holding company structure also permits greater flexibility in issuing stock for
cash, property or services and in reorganization transactions. Moreover, subject
to certain regulatory limitations, a holding company can purchase shares of its
own stock, which the Bank may not do. A holding company may also engage in
certain non-banking activities which the Board of Governors has deemed to be
closely related to banking and proper incidents to the business of a bank
holding company. These activities include making or servicing loans and certain
types of leases; performing certain data processing services; acting as a
fiduciary or investment or financial advisor; acting as a management consultant
for other depository institutions; providing courier, appraisal, and consumer
financial counseling services; providing tax planning and preparation services;
providing check guaranty and collection agency services; engaging in limited
real estate investment activities; underwriting, brokering, and selling credit
life and disability insurance; engaging in certain other limited insurance
activities; providing discount brokerage services; underwriting and dealing in
certain government obligations and money market instruments and providing
portfolio investment advice; acting as a futures commission merchant with
respect to certain financial instrument transactions; providing foreign exchange
advisory and transactional services; making investments in certain corporations
for projects designed primarily to promote community welfare; and owning and
operating certain healthy savings and loan associations. Although the Company
has no present intention of engaging in any of these activities, if
circumstances should lead the Company's management to believe that there is a
need for these services in the Bank's marketing area and that such activities
could be profitably conducted, the management of the Company would have the
flexibility of commencing these activities upon filing notice thereof with the
Board of Governors.
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LOCATION AND SERVICE AREA
The Bank conducts a general commercial banking business in its primary
service area, emphasizing the banking needs of individuals and small to
medium-sized businesses and professional concerns. The Bank operates from a main
office located at 501 Idlewild Avenue in Easton, Maryland, and from a branch
office in the William Hill Manor located on Dutchman Lane in Easton. In
addition, in February 1999 the Bank opened a loan production office in Denton,
Maryland, which is in Caroline County. See "Facilities" below. The Bank draws
most of its customer deposits and conducts most of its lending transactions from
within its primary service area which encompasses Talbot County, Maryland.
However, with the new loan production office in Caroline County, Maryland, the
Bank hopes to conduct significant lending transactions in Caroline County. The
Bank also recently filed the necessary regulatory applications seeking to
operate a full service branch in Denton. If the applications are ultimately
approved, the Bank intends to act quickly to increase its presence in Caroline
County by opening a full service branch in Denton.
Talbot County is centrally located on the eastern shore of the
Chesapeake Bay in eastern Maryland. Easton, the county seat, is approximately 59
miles southeast of Baltimore and 73 miles east of Washington, D.C. The City of
Easton and Talbot County have experienced growth in population in recent years.
The population of Easton increased from approximately 7,500 in 1980 to
approximately 9,000 in 1990, while the population of Talbot County increased
from approximately 25,000 to 30,000 during this period.
The principal components of the economy of Talbot County are
manufacturing (which accounts for approximately 30% of the economic activity),
agriculture, and tourism. Easton also has a strong component of health-care
related businesses. The largest employers in the county include Memorial
Hospital, Black & Decker, Allen Family Foods, a poultry producer, Cadmus Journal
Services, a printing company, and William Hill Manor, Inc., a continuing care
retirement community. The county has had a significant boating industry since
colonial days. At present, this industry is made up of over a dozen builders,
numerous supply companies, dealers and charter companies, and approximately 20
marinas. Talbot County's colonial homes and historical sites and boating,
hunting, and fishing opportunities have resulted in tourism constituting a
significant segment of the economy.
Caroline County is centrally located on the eastern shore of the
Chesapeake Bay in eastern Maryland. Denton, the county seat, is situated
approximately 60 miles from Baltimore and 60 miles from Washington, D.C.
Caroline County has experienced growth in its population in recent years. The
population of Caroline County increased from approximately 24,000 in 1990 to
27,000 in 1998, while the population of Denton remained steady with a population
of approximately 3,000 during this period.
The principal components of the economy of Caroline County are
manufacturing and agriculture. The largest employers in the county include
Preston Trucking, Solo Cup and Choptank Electric Company.
BANKING SERVICES
The Bank offers a full range of deposit services that are typically
available in most banks and savings and loan associations, including checking
accounts, NOW accounts, savings accounts and other time deposits of various
types, ranging from daily money market accounts to longer-term certificates of
deposit. The transaction accounts and time certificates are tailored to the
Bank's principal market area at rates competitive to those offered in the area.
In addition, the Bank offers certain retirement account services, such as
Individual Retirement Accounts ("IRAs"). All deposit accounts are insured by the
Federal Deposit Insurance Corporation (the "FDIC") up to the maximum amount
allowed by law (generally, $100,000 per depositor subject to aggregation rules).
The Bank solicits these accounts from individuals, businesses, associations and
organizations, and governmental authorities.
The Bank also offers a full range of short- to medium-term commercial
and personal loans. Commercial loans include both secured and unsecured loans
for working capital (including inventory and receivables), business expansion
(including acquisition of real estate and improvements), and purchase of
equipment and machinery. Consumer loans include secured and unsecured loans for
financing automobiles, home improvements, education,
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and personal investments. The Bank also originates and holds or sells into the
secondary market fixed and variable rate mortgage loans and real estate
construction and acquisition loans. The Bank's lending activities are subject to
a variety of lending limits imposed by state and federal law. The Bank may not
make any loans to any director, officer, or employee of the Bank (except for
commercial loans to directors who are not officers or employees) unless the loan
is approved by the Board of Directors of the Bank. Any such loan must be
reviewed every six months by the Board of Directors.
Other bank services include cash management services, safe deposit
boxes, travelers checks, direct deposit of payroll and social security checks,
and automatic drafts for various accounts. The Bank is associated with the HONOR
network of automated teller machines that may be used by Bank customers
throughout Maryland and other regions. The Bank also offers MasterCard and VISA
credit card services through a correspondent bank as an agent for the Bank.
The Bank does not presently exercise trust powers. The Bank may in the
future offer a full-service trust department, but cannot do so without the prior
approval of the Maryland State Bank Commissioner (the "Commissioner").
COMPETITION
The banking business is highly competitive. The Bank competes as a
financial intermediary with other commercial banks, savings and loan
associations, credit unions, and money market mutual funds operating in Talbot
County and elsewhere. As of December 31, 1998, there were seven commercial banks
operating a total of twenty offices in Talbot County, Maryland. Of these
institutions, only The Talbot Bank of Easton is locally owned and operated. The
Talbot Bank has a main office in Easton and three branches: two located in
Easton and one in St. Michaels. St. Michaels Bank, while locally chartered, is
controlled by a holding company in Baltimore. It operates a main office and four
branches in Talbot County. NationsBank, Signet Bank - Maryland, First National
Bank of Maryland, and Crestar Bank, all of which are based in Baltimore, operate
four, two, two, and two branches in Talbot County, respectively. One credit
union operates in the county; however, it has only nominal deposits. Financial
service companies, such as Legg Mason Wood Walker, Inc., Ferris Baker Watts,
Inc., Merrill Lynch, A.G. Edwards & Sons, Inc. and H.C. Wainwright, Inc. also
operate offices in Talbot County.
As of December 31, 1998, there were five commercial banks operating a
total of twelve offices in Caroline County, Maryland. Of these institutions,
only Provident State Bank of Preston, Maryland is locally owned and operated.
Provident State Bank has a main office in Preston and three branches located in
Caroline County. Peoples Bank of Denton, while locally chartered, is controlled
by a holding company in Baltimore. It operates a main office and three branches
in Caroline County. First National Bank of Maryland, based in Baltimore, and
NationsBank, based in Charlotte, North Carolina, each operate one branch in
Caroline County. First Virginia Bank of Richmond, Virginia, operates two
branches in Caroline County.
FACILITIES
The Bank's main office is located at 501 Idlewild Avenue, Easton,
Maryland on approximately 53,000 square feet of land at the corner of Idlewild
Avenue and Caulk Lane. The Bank also operates a branch facility at William Hill
Manor located on Dutchman's Lane in Easton with approximately 72 square feet of
leased space. This branch is limited to accepting deposits and cashing checks
and is open only for limited hours each business day. See Item 12. "Certain
Relationships and Related Transactions." In addition, the Bank operates a loan
production office in Denton, Maryland. The Bank recently filed the necessary
applications seeking to operate a full service branch in Denton. The Company
will continue to investigate other branching possibilities during 1999, but
currently has no definite plans for other branches.
The Bank acquired the site for the main office for $281,000 and spent
approximately $1,081,000 for construction of the building, landscaping, paving,
and sidewalks. Construction of the main office was completed in June 1993. The
main office building is a two story building consisting of approximately 14,000
square feet. The Bank presently occupies only approximately 8,000 square feet
for housing the main branch of the Bank, the
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operations center of the Bank, and the executive offices of the Company and the
Bank. In July 1997, the Bank completed improvements to the second floor of the
main office building at a cost of $243,792. The improvements provided
approximately 5,100 additional square feet of office space, of which the Bank
occupies approximately 1,500 square feet. The remaining additional space has
been leased to two third parties.
One of the third party leases consists of 1,820 square feet with an
initial lease term of eight years and it commenced August 1, 1997. The annual
rent for this lease is $20,020. The other third party lease consists of 1,800
square feet with an initial lease term of five years and it commenced on July 1,
1997. The annual rent for this lease is $18,000. The annual rent on both leases
is subject to adjustment each year during the initial term and during the
renewal term, if any; provided, however, the annual rent shall only be
increased.
The William Hill Manor branch office space is leased pursuant to a five
year lease dated July 1, 1995. Rent is fixed at $3,600 annually. At the end of
the current term, the lease provides an option to extend with rent increases
contingent on the performance of the Bank and based on the consumer price index.
The office space for the loan production office in Denton is leased
pursuant to a six month lease which commenced January 1, 1999. Rent for this
space is $600 per month. The lease provides for a six month extension term at
the discretion of the Bank.
EMPLOYEES
As of March 19, 1999, the Bank had twenty full-time employees and five
part-time employees. The Company's operations are conducted through the Bank.
Consequently, the Company does not have any separate employees. None of the
employees of the Bank are represented by any collective bargaining unit. The
Bank considers its relations with its employees to be good.
SUPERVISION AND REGULATION
The Company and the Bank are subject to state and federal banking laws
and regulations which impose specific requirements or restrictions on, and
provide for general regulatory oversight with respect to, virtually all aspects
of operations. These laws and regulations are generally intended to protect
depositors, not stockholders. The following is a brief summary of certain
statutes, rules and regulations affecting the Company and the Bank. To the
extent that the following summary describes statutory or regulatory provisions,
it is qualified in its entirety by reference to the particular statutory and
regulatory provisions. Any change in applicable laws or regulations may have a
material adverse effect on the business and prospects of the Company. Beginning
with the enactment of the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") and following with the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"), numerous additional
regulatory requirements have been placed on the banking industry in the past
eight years, and additional changes have been proposed. The banking industry is
also likely to change significantly as a result of the passage of the
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act"). The operations of the Company and the Bank may be
affected by legislative changes and the policies of various regulatory
authorities. The Company is unable to predict the nature or the extent of the
effect on its business and earnings that fiscal or monetary policies, economic
control, or new federal or state legislation may have in the future.
THE COMPANY
Because it owns the outstanding common stock of the Bank, the Company
is a bank holding company within the meaning of the federal Bank Holding Company
Act of 1956 (the "BHCA"). Under the BHCA, the Company is subject to periodic
examination by the Federal Reserve and is required to file periodic reports of
its operations and such additional information as the Federal Reserve may
require. The Company's and the Bank's activities are limited to banking,
managing or controlling banks, furnishing services to or performing services for
its subsidiaries, or engaging in any other activity that the Federal Reserve
determines to be so closely related to banking or managing or controlling banks
as to be a proper incident thereto.
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Investments, Control, and Activities. With certain limited exceptions,
the BHCA requires every bank holding company to obtain the prior approval of the
Federal Reserve before (i) acquiring substantially all the assets of any bank,
(ii) acquiring direct or indirect ownership or control of any voting shares of
any bank if after such acquisition it would own or control more than 5% of the
voting shares of such bank (unless it already owns or controls the majority of
such shares), or (iii) merging or consolidating with another bank holding
company.
In addition, and subject to certain exceptions, the BHCA and the Change
in Bank Control Act, together with regulations thereunder, require Federal
Reserve approval (or, depending on the circumstances, no notice of disapproval)
prior to any person or company acquiring "control" of a bank holding company,
such as the Company. Control is conclusively presumed to exist if an individual
or company acquires 25% or more of any class of voting securities of the bank
holding company. Because the Company's Common Stock is registered under the
Securities Exchange Act of 1934, under Federal Reserve regulations control will
be rebuttably presumed to exist if a person acquires at least 10% of the
outstanding shares of any class of voting securities of the Company. The
regulations provide a procedure for challenge of the rebuttable control
presumption.
Under the BHCA, the Company is generally prohibited from engaging in,
or acquiring direct or indirect control of more than 5% of the voting shares of
any company engaged in, nonbanking activities, unless the Federal Reserve, by
order or regulation, has found those activities to be so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
Some of the activities that the Federal Reserve has determined by regulation to
be proper incidents to the business of banking include making or servicing loans
and certain types of leases, engaging in certain insurance and discount
brokerage activities, performing certain data processing services, acting in
certain circumstances as a fiduciary or investment or financial advisor, owning
savings associations, and making investments in certain corporations or projects
designed primarily to promote community welfare.
Source of Strength; Cross-Guarantee. In accordance with Federal Reserve
policy, the Company is expected to act as a source of financial strength to the
Bank and to commit resources to support the Bank in circumstances in which the
Company might not otherwise do so. Under the BHCA, the Federal Reserve may
require a bank holding company to terminate any activity or relinquish control
of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the
Federal Reserve's determination that such activity or control constitutes a
serious risk to the financial soundness or stability of any subsidiary
depository institution of the bank holding company. Further, federal bank
regulatory authorities have additional discretion to require a bank holding
company to divest itself of any bank or nonbank subsidiary if the agency
determines that divestiture may aid the depository institution's financial
condition. The Bank may be required to indemnify, or cross-guarantee, the FDIC
against losses it incurs with respect to any other bank controlled by the
Company, which in effect makes the Company's equity investments in healthy bank
subsidiaries available to the FDIC to assist any failing or failed bank
subsidiary of the Company.
THE BANK
General. The Bank operates as a state nonmember banking association
incorporated under the laws of the State of Maryland and is subject to
examination by the FDIC and the Commissioner. Deposits in the Bank are insured
by the FDIC up to a maximum amount (generally $100,000 per depositor, subject to
aggregation rules). The Commissioner and the FDIC regulate or monitor all areas
of the Bank's operations, including security devices and procedures, adequacy of
capitalization and loss reserves, loans, investments, borrowings, deposits,
mergers, issuances of securities, payment of dividends, interest rates payable
on deposits, interest rates or fees chargeable on loans, establishment of
branches, corporate reorganizations, maintenance of books and records, and
adequacy of staff training to carry on safe lending and deposit gathering
practices. The FDIC requires the Bank to maintain certain capital ratios and
imposes limitations on the Bank's aggregate investment in real estate, bank
premises, and furniture and fixtures. The Bank is required by the FDIC and the
Commissioner to prepare quarterly reports on the Bank's financial condition and
to conduct an annual audit of its financial affairs in compliance with minimum
standards and procedures prescribed by the Commissioner.
Under FDICIA, all insured institutions must undergo periodic on-site
examination by their appropriate banking agency. The cost of examinations of
insured depository institutions and any affiliates may be assessed by
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the appropriate agency against each institution or affiliate as it deems
necessary or appropriate. Insured institutions are required to submit annual
reports to the FDIC and the appropriate agency (and state supervisor when
applicable). FDICIA also directs the FDIC to develop with other appropriate
agencies a method for insured depository institutions to provide supplemental
disclosure of the estimated fair market value of assets and liabilities, to the
extent feasible and practicable, in any balance sheet, financial statement,
report of condition, or other report of any insured depository institution.
FDICIA also requires the federal banking regulatory agencies to prescribe, by
regulation, standards for all insured depository institutions and depository
institution holding companies relating, among other things, to: (i) internal
controls, information systems, and audit systems; (ii) loan documentation; (iii)
credit underwriting; (iv) interest rate risk exposure; and (v) asset quality.
State nonmember banks which have been newly chartered within the past
two years, and state nonmember banks and their holding companies which have
undergone a change in control within the past two years or which have been
deemed by the FDIC to be troubled institutions, must give the FDIC or the Board
of Governors, respectively, 30 days prior notice of the appointment of any
senior executive officer or director. Within the 30 day period, the FDIC or the
Board of Governors, as the case may be, may disapprove any such appointment.
Transactions With Affiliates and Insiders. The Bank is subject to
Section 23A of the Federal Reserve Act, which places limits on the amount of
loans or extensions of credit to, or investments in, or certain other
transactions with, affiliates and on the amount of advances to third parties
collateralized by the securities or obligations of affiliates. In addition, most
of these loans and certain other transactions must be secured in prescribed
amounts. The Bank is also subject to Section 23B of the Federal Reserve Act
which, among other things, prohibits an institution from engaging in certain
transactions with certain affiliates unless the transactions are on terms
substantially the same, or at least as favorable to such institution or its
subsidiaries, as those prevailing at the time for comparable transactions with
non-affiliated companies. The Bank is subject to certain restrictions on
extensions of credit to executive officers, directors, certain principal
stockholders, and their related interests. Such extensions of credit (i) must be
made on substantially the same terms, including interest rates and collateral,
as those prevailing at the time for comparable transactions with third parties
and (ii) must not involve more than the normal risk of repayment or present
other unfavorable features.
Community Reinvestment Act. The Community Reinvestment Act requires
that each insured depository institution shall be evaluated by its primary
federal regulator with respect to its record in meeting the credit needs of its
local community, including low and moderate income neighborhoods, consistent
with the safe and sound operation of those institutions. These factors are also
considered in evaluating mergers, acquisitions, and applications to open a
branch or facility. The Bank received a satisfactory rating in its most recent
evaluation.
Other Regulations. Interest and certain other charges collected or
contracted for by the Bank are subject to state usury laws and certain federal
laws concerning interest rates. The Bank's loan operations are also subject to
certain federal laws applicable to credit transactions, such as the federal
Truth-In-Lending Act governing disclosures of credit terms to consumer
borrowers, the Home Mortgage Disclosure Act of 1975 requiring financial
institutions to provide information to enable the public and public officials to
determine whether a financial institution is fulfilling its obligation to help
meet the housing needs of the community it serves, the Equal Credit Opportunity
Act prohibiting discrimination on the basis of race, creed or other prohibited
factors in extending credit, the Fair Credit Reporting Act of 1978 governing the
use and provision of information to credit reporting agencies, the Fair Debt
Collection Act governing the manner in which consumer debts may be collected by
collection agencies, and the rules and regulations of the various federal
agencies charged with the responsibility of implementing such federal laws. The
deposit operations of the Bank also are subject to the Right to Financial
Privacy Act, which imposes a duty to maintain confidentiality of consumer
financial records and prescribes procedures for complying with administrative
subpoenas of financial records, and the Electronic Funds Transfer Act and
Regulation E issued by the Federal Reserve Board to implement that act, which
governs automatic deposits to and withdrawals from deposit accounts and
customers' rights and liabilities arising from the use of automated teller
machines and other electronic banking services.
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DEPOSIT INSURANCE
The FDIC establishes rates for the payment of premiums by federally
insured banks and thrifts for deposit insurance. A separate Bank Insurance Fund
("BIF") and Savings Association Insurance Fund ("SAIF") are maintained for
commercial banks and thrifts, respectively, with insurance premiums from the
industry used to offset losses from insurance payouts when banks and thrifts
fail. Since 1993, insured depository institutions like the Bank have paid for
deposit insurance under a risk-based premium system. Under this system, until
mid-1995 depository institutions paid to BIF or SAIF from $0.23 to $0.31 per
$100 of insured deposits depending on its capital levels and risk profile, as
determined by its primary federal regulator on a semi-annual basis. Once the BIF
reached its legally mandated reserve ratio in mid-1995, the FDIC lowered
premiums for well-capitalized banks, eventually to $.00 per $100, with a minimum
semiannual assessment of $1,000. However, in 1996 Congress enacted the Deposit
Insurance Funds Act of 1996, which eliminated this minimum assessment. It also
separated the Financial Corporation (FICO) assessment to service the interest on
its bond obligations. The amount assessed on individual institutions, including
the Bank, by FICO is in addition to the amount paid for deposit insurance
according to the risk-related assessment rate schedule. Increases in deposit
insurance premiums or changes in risk classification will increase the Bank's
cost of funds, and there can be no assurance that such cost can be passed on to
the Bank's customers.
DIVIDENDS
The principal source of the Company's cash revenues comes from
dividends received from the Bank. The amount of dividends that may be paid by
the Bank to the Company depends on the Bank's earnings and capital position and
is limited by federal and state law, regulations, and policies. The Federal
Reserve has stated that bank holding companies should refrain from or limit
dividend increases or reduce or eliminate dividends under circumstances in which
the bank holding company fails to meet minimum capital requirements or in which
earnings are impaired.
The Company's ability to pay any cash dividends to its stockholders in
the future will depend primarily on the Bank's ability to pay dividends to the
Company. In order to pay dividends to the Company, the Bank must comply with the
requirements of all applicable laws and regulations. Under Maryland law, the
Bank may pay a cash dividend only from the following, after providing for due or
accrued expenses, losses, interest, and taxes: (i) its undivided profits, or
(ii) with the prior approval of the Commissioner, its surplus in excess of 100%
of its required capital stock. Under FDICIA, the Bank may not pay a dividend if,
after paying the dividend, the Bank would be undercapitalized. See "Capital
Regulations" below. See Item 5 below for a discussion of dividends paid by the
Bank in the past two years.
In addition to the availability of funds from the Bank, the future
dividend policy of the Company is subject to the discretion of the Board of
Directors and will depend upon a number of factors, including future earnings,
financial condition, cash needs, and general business conditions. If dividends
should be declared in the future, the amount of such dividends presently cannot
be estimated and it cannot be known whether such dividends would continue for
future periods.
CAPITAL REGULATIONS
The federal bank regulatory authorities have adopted risk-based capital
guidelines for banks and bank holding companies that are designed to make
regulatory capital requirements more sensitive to differences in risk profile
among banks and bank holding companies, account for off-balance sheet exposure,
and minimize disincentives for holding liquid assets. The resulting capital
ratios represent qualifying capital as a percentage of total risk-weighted
assets and off-balance sheet items. The guidelines are minimums, and the
regulators have noted that banks and bank holding companies contemplating
significant expansion programs should not allow expansion to diminish their
capital ratios and should maintain ratios well in excess of the minimums. The
current guidelines require all bank holding companies and federally-regulated
banks to maintain a minimum risk-based total capital ratio equal to 8%, of which
at least 4% must be Tier 1 capital. Tier 1 capital includes common stockholders'
equity before the unrealized gains and losses on securities available for sale,
qualifying perpetual preferred stock, and minority interests in equity accounts
of consolidated subsidiaries, but excludes goodwill and
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most other intangibles and excludes the allowance for loan and lease losses.
Tier 2 capital includes the excess of any preferred stock not included in Tier 1
capital, mandatory convertible securities, hybrid capital instruments,
subordinated debt and intermediate term-preferred stock, and general reserves
for loan and lease losses up to 1.25% of risk-weighted assets.
Under the guidelines, banks' and bank holding companies' assets are
given risk-weights of 0%, 20%, 50%, and 100%. In addition, certain off-balance
sheet items are given credit conversion factors to convert them to asset
equivalent amounts to which an appropriate risk-weight will apply. These
computations result in the total risk-weighted assets. Most loans are assigned
to the 100% risk category, except for first mortgage loans fully secured by
residential property and, under certain circumstances, residential construction
loans, both of which carry a 50% rating. Most investment securities are assigned
to the 20% category, except for municipal or state revenue bonds, which have a
50% rating, and direct obligations of or obligations guaranteed by the United
States Treasury or United States Government agencies, which have a 0% rating.
The federal bank regulatory authorities have also implemented a
leverage ratio, which is Tier 1 capital as a percentage of average total assets
less intangibles, to be used as a supplement to the risk-based guidelines. The
principal objective of the leverage ratio is to place a constraint on the
maximum degree to which a bank holding company may leverage its equity capital
base. The minimum required leverage ratio for top-rated institutions is 3%, but
most institutions are required to maintain an additional cushion of at least 100
to 200 basis points.
FDICIA established a new capital-based regulatory scheme designed to
promote early intervention for troubled banks and requires the FDIC to choose
the least expensive resolution of bank failures. The new capital-based
regulatory framework contains five categories of compliance with regulatory
capital requirements, including "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized." To qualify as a "well capitalized" institution, a bank must
have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less
than 6%, and a total risk-based capital ratio of no less than 10%, and the bank
must not be under any order or directive from the appropriate regulatory agency
to meet and maintain a specific capital level. As of December 31, 1998, the
Company and the Bank were qualified as "well capitalized." See "Item 6.
Management's Discussion and Analysis or Plan of Operation -- Capital."
Under the FDICIA regulations, the applicable agency can treat an
institution as if it were in the next lower category if the agency determines
(after notice and an opportunity for hearing) that the institution is in an
unsafe or unsound condition or is engaging in an unsafe or unsound practice. The
degree of regulatory scrutiny of a financial institution will increase, and the
permissible activities of the institution will decrease, as it moves downward
through the capital categories. Institutions that fall into one of the three
undercapitalized categories may be required to (i) submit a capital restoration
plan; (ii) raise additional capital; (iii) restrict their growth, deposit
interest rates, and other activities; (iv) improve their management; (v)
eliminate management fees; or (vi) divest themselves of all or part of their
operations. Bank holding companies controlling financial institutions can be
called upon to boost the institutions' capital and to partially guarantee the
institutions' performance under their capital restoration plans.
These capital guidelines can affect the Company in several ways. If the
Bank begins to grow at a rapid pace, a premature "squeeze" on capital could
occur making a capital infusion necessary. The requirements could impact the
Company's ability to pay dividends. The Company's present capital levels are
more than adequate; however, rapid growth, poor loan portfolio performance, or
poor earnings performance or a combination of these factors could change the
Bank's capital position in a relatively short period of time.
Effective January 1, 1997, the FDIC amended the risk-based capital
guidelines to incorporate a measure for market risk to cover all positions
located in an institution's trading account, and foreign exchange and commodity
positions wherever located. The effect of the rule is that it requires any bank
or bank holding company with significant exposure to market risk to measure the
risk and hold capital commensurate with that risk. Since the Bank does not
currently engage, nor has any plans to engage, in trading, foreign exchange or
commodity position activities, the rule does not have an effect on the Bank's
required capital levels.
8
<PAGE> 10
Both the Company and the Bank exceeded their respective regulatory
capital requirements at December 31, 1998. See "Management's Discussion and
Analysis or Plan of Operation -- Capital."
INTERSTATE BANKING AND BRANCHING RESTRICTIONS
On September 29, 1994, the federal government enacted the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking
Act"). This Act became effective on September 29, 1995, and permits eligible
bank holding companies in any state, with regulatory approval, to acquire
banking organizations in any other state. Effective June 1, 1997, the Interstate
Banking Act allowed banks with different home states to merge, unless a
particular state opts out of the statute. Consistent with the Interstate Banking
Act, Maryland adopted legislation in 1995 which permits interstate bank mergers
beginning September 29, 1995.
In addition, beginning June 1, 1997, the Interstate Banking Act
permitted national and state banks to establish de novo branches in another
state if there is a law in that state which applies equally to all banks and
expressly permits all out-of-state banks to establish de novo branches. In 1995,
Maryland adopted "opt-in" legislation by which Maryland adopted the federal
legislation effective September 29, 1995, before it automatically took effect on
June 1, 1997. The Maryland legislation permits out-of-state banks to establish
branches in Maryland by opening a de novo branch, by acquiring an existing
branch from a Maryland depository institution, or as a result of an interstate
merger with a Maryland banking organization, as long as such states grant
similar privileges for acquiring banking organizations in their states to
banking organizations in Maryland. Under Maryland law, the Bank may open
branches state-wide, subject to the prior approval of the Commissioner and the
FDIC. There are currently no definite plans for the Company to acquire any bank,
but the Company remains open to acquisitions as part of its strategic growth
plan.
RECENT LEGISLATIVE DEVELOPMENTS
From time to time, various bills are introduced in the United States
Congress and at the state legislative level with respect to the regulation of
financial institutions. Certain of these proposals, if adopted, could
significantly change the regulation of banks and the financial services
industry. The Company cannot predict whether any such proposals will be adopted
or, if adopted, how such proposals would affect the Company.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank's main office is located at 501 Idlewild Avenue, Easton,
Maryland on approximately 53,000 square feet of land at the corner of Idlewild
Avenue and Caulk Lane. The Bank also operates a branch facility at William Hill
Manor located on Dutchman's Lane in Easton with approximately 72 square feet of
leased space. This branch is limited to accepting deposits and cashing checks
and is open only for limited hours each business day. See Item 12. "Certain
Relationships and Related Transactions." In addition, the Bank operates a loan
production office in Denton, Maryland.
The Bank acquired the site for the main office for $281,000 and spent
approximately $1,081,000 for construction of the building, landscaping, paving,
and sidewalks. Construction of the main office was completed in June 1993. The
main office building is a two story building consisting of approximately 14,000
square feet. The Bank presently occupies only approximately 8,000 square feet
for housing the main branch of the Bank, the operations center of the Bank, and
the executive offices of the Company and the Bank. In July 1997, the Bank
completed improvements to the second floor of the main office building at a cost
of $243,792. The improvements provided approximately 5,100 additional square
feet of office space, of which the Bank occupies approximately 1,500 square
feet. The remaining additional space has been leased to two third parties.
One of the third party leases consists of 1,820 square feet with an
initial lease term of eight years and it commenced August 1, 1997. The annual
rent for this lease is $20,020. The other third party lease consists of 1,800
square feet with an initial lease term of five years and it commenced on July 1,
1997. The annual rent for this lease is $18,000. The annual rent on both leases
is subject to adjustment each year during the initial term and during the
renewal term, if any; provided, however, the annual rent shall only be
increased.
9
<PAGE> 11
The William Hill Manor branch office space is leased pursuant to a five
year lease dated July 1, 1995. Rent is fixed at $3,600 annually. At the end of
the current term, the lease provides an option to extend with rent increases
contingent on the performance of the Bank and based on the consumer price index.
The office space for the loan production office in Denton is leased
pursuant to a six month lease which commenced January 1, 1999. Rent for this
space is $600 per month. This lease provides for a six month extension term at
the discretion of the Bank.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company or
the Bank or any of their properties are subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the stockholders of the
Company during the fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In response to this Item, the information included on page 18 of the
Company's Annual Report to Stockholders for the year ended December 31, 1998, is
incorporated herein by reference.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
In response to this Item, the information included on pages 3 through
18 of the Company's Annual Report to Stockholders for the year ended December
31, 1998, is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
In response to this Item, the information included on pages 19 through
41 of the Company's Annual Report to Stockholders for the year ended December
31, 1998, is incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(A) OF
THE EXCHANGE ACT
In response to this Item, the information included on pages 2 through 5
and page 8 of the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 26, 1999, is incorporated herein by reference.
10
<PAGE> 12
ITEM 10. EXECUTIVE COMPENSATION
In response to this Item, the information included on pages 5 through 8
of the Company's Proxy Statement for the Annual Meeting of Stockholders to be
held on May 26, 1999, is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
In response to this Item, the information included on pages 8 through
10 of the Company's Proxy Statement for the Annual Meeting of Stockholders to be
held on May 26, 1999, is incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In response to this Item, the information included on page 10 of the
Company's Proxy Statement for the Annual Meeting of Stockholders to be held on
May 26, 1999, is incorporated herein by reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
3.1 Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.1 of Registration Statement on Form
S-18, File No. 33-43317).
3.2 Bylaws of the Company (incorporated by reference to Exhibit
3.2 of Registration Statement on Form S-18, File No.
33-43317).
10.1 Employment Agreement dated July 22, 1991, between the Company
and Thomas P. McDavid (incorporated by reference to Exhibit
10.1 of Registration Statement on Form S-18, File No.
33-43317).
10.2 Easton Bancorp, Inc. 1991 Stock Option Plan (incorporated by
reference to Exhibit 10.2 of Registration Statement on Form
S-18, File No. 33-43317).
10.3 Form of Warrant Agreement (incorporated by reference to
Exhibit 10.3 of Registration Statement on Form S-18, File No.
33-43317).
10.4 Agreement with Thomas P. McDavid dated March 6, 1998
(incorporated by reference to Exhibit 10.4 of the Quarterly
Report on Form 10-QSB filed by the Company for the quarter
ended March 31, 1998).
13 Annual Report to Stockholders for the year ended December 31,
1998.
21 Subsidiaries of the Company.
27 Financial Data Schedule (for SEC use only).
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the fourth
quarter of the year ended December 31, 1998.
11
<PAGE> 13
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
EASTON BANCORP, INC.
----------------------------------------
(Registrant)
By:/s/ W. David Hill
------------------------------------
W. David Hill
Chairman of the Board; Chief
Executive Officer
Date: March 26, 1999
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Sheila W. Bateman Director; Secretary March 26, 1999
- ------------------------------
Sheila W. Bateman
/s/ Jack H. Bishop Director March 26, 1999
- ------------------------------
Jack H. Bishop
Director
- ------------------------------
J. Parker Callahan, Jr.
/s/ J. Fredrick Heaton Director March 26, 1999
- ------------------------------
J. Fredrick Heaton
/s/ William C. Hill Director March 26, 1999
- ------------------------------
William C. Hill
Director; Chairman of the
/s/ W. David Hill Board; Chief Executive Officer March 26, 1999
W. David Hill (principal executive officer)
/s/ David F. Lesperance Director March 26, 1999
- ------------------------------
David F. Lesperance
/s/ Vinodrai Mehta Director March 26, 1999
Vinodrai Mehta
/s/ R. Michael S. Menzies Director; President March 26, 1999
- ------------------------------
R. Michael S. Menzies
/s/ Roger A. Orsini Director March 26, 1999
- ------------------------------
Roger A. Orsini
/s/ Mahmood S. Shariff Director March 26, 1999
- ------------------------------
Mahmood S. Shariff
Director; Treasurer (principal
/s/ Jerry L. Wilcoxon financial officer and principal March 26, 1999
- ---------------------- accounting officer)
Jerry L. Wilcoxon
</TABLE>
12
<PAGE> 14
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Sequential
Number Description Page Number
- ------ ----------- -----------
<S> <C> <C>
3.1 Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.1 of Registration Statement on Form
S-18, File No. 33-43317).
3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 of
Registration Statement on Form S-18, File No. 33-43317).
10.1 Employment Agreement dated July 22, 1991, between the Company and Thomas P.
McDavid (incorporated by reference to Exhibit 10.1 of Registration Statement
on Form S-18, File No. 33-43317).
10.2 Easton Bancorp, Inc. 1991 Stock Option Plan (incorporated by reference to
Exhibit 10.2 of Registration Statement on Form S-18, File No. 33-43317).
10.3 Form of Warrant Agreement (incorporated by reference to Exhibit 10.3 of
Registration Statement on Form S-18, File No. 33-43317).
10.4 Agreement with Thomas P. McDavid dated March 6, 1998 (incorporated by
reference to Exhibit 10.4 of the Quarterly Report on Form 10-QSB filed by the
Company for the quarter ended March 31, 1998).
13 Annual Report to Stockholders for the year ended December 31, 1998.
21 Subsidiaries of the Company.
27 Financial Data Schedule (for SEC use only).
</TABLE>
<PAGE> 1
EXHIBIT 13
ANNUAL REPORT TO STOCKHOLDERS
DECEMBER 31, 1998
EASTON BANCORP, INC.
<PAGE> 2
Easton Bancorp, Inc.
March 1999
To our Stockholders:
As we approach the new millenium, your community bank is positioning to
deliver meaningful value to all of our stakeholders: stockholders, customers,
associates, and community. The attached financial statements reflect improved
earnings based mostly on the realization of a deferred tax credit that was
recognized in 1998. This credit is essentially a financial statement reward for
12 consecutive quarters of profitability and offsets increased loan loss
provisions. This produced a return on equity of 10.55% and earnings per share of
$0.79, up from $0.52 in 1997.
At year end your Board of Directors decided to expand our community
bank services to Caroline County and approved the formation of Denton Bank and
Trust, a division of Easton Bank & Trust Company. Mr. Jeffrey Heflebower was
elected Executive Vice President/Director and will spearhead our Caroline County
initiative that will begin as a loan production office and become a full service
banking branch upon receipt of regulatory approval. This effort, combined with
strategic objectives developed in our 1998 planning session, will significantly
expand our ability to grow earnings and stockholder value over the long term. We
celebrated our fifth anniversary this year with a commitment to deliver
personal, private, and professional banking services to the communities we
serve. By selecting Easton Bank & Trust for your banking needs, you too can
participate in our future success. On behalf of your Board of Directors and
associates, we thank you for your continued support.
/s/ W. David Hill /s/ R. Michael S. Menzies, Sr.
W. David Hill, DDS R. Michael S. Menzies, Sr.
Chairman of the Board President
501 Idlewild Avenue, P.O. Box 619, Easton, MD 21601
410-819-0300 FAX 410-819-8091
<PAGE> 3
EASTON BANCORP, INC.
EASTON BANK & TRUST COMPANY
OUR MISSION
Easton Bank & Trust Company is a community bank dedicated to the
delivery of personal, private, and professionally designed financial solutions
for individual and small business needs. Easton Bank & Trust is committed to
attaining superior results for its stockholders, customers, associates, and
community.
CORE VALUES
At Easton Bank & Trust, we believe our success is founded upon these
core values:
- - PROFITABILITY: We will constantly pursue profitability for the
stakeholders of the Company, including its stockholders, customers,
associates, and community.
- - TEAMWORK: As a team we will work together to produce a happy, healthy,
and fun work environment which results in the accomplishment of our
strategic objectives.
- - ABSOLUTE INTEGRITY: We will always treat customers, prospects, and
associates with respect, honesty, and confidentiality regarding
everything we say or do.
- - PROFESSIONALISM: As professionals we are committed to continuous,
lifelong learning, responsive and reliable quality service, personal
responsibility, and the courage to seek ambitious aspirations.
- - RELATIONSHIPS: We are in the business of personal service, which is
based upon trusting relationships.
- - EXCELLENCE: Our Core Values exist in pursuit of excellence and the
practice of the 7 Habits: Be Proactive, Begin with an End in Mind, Put
First Things First, Think Win Win, Seek First to Understand, Find
Synergy, and Keep the Saw Sharp.
2
<PAGE> 4
This Annual Report contains statements which constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These statements appear in a
number of places in this Annual Report and include all statements regarding the
intent, belief or current expectations of the Company, its directors or its
officers with respect to, among other things: (i) the Company's financing plans;
(ii) trends affecting the Company's financial condition or results of
operations; (iii) the Company's growth strategy and operating strategy; and (iv)
the declaration and payment of dividends. Investors are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, and that actual results may differ materially from
those projected in the forward-looking statements as a result of various factors
discussed herein and those factors discussed in detail in the Company's filings
with the Securities and Exchange Commission.
BUSINESS OF THE COMPANY
Easton Bancorp, Inc. (the "Company") was incorporated as a Maryland
corporation on July 19, 1991, to become a one-bank holding company by acquiring
all of the capital stock of Easton Bank & Trust Company (the "Bank") upon its
formation. The Bank commenced business on July 1, 1993, and the only activity of
the Company since then has been the ownership and operation of the Bank. The
Bank was organized as a nonmember state bank under the laws of the State of
Maryland. The Bank is engaged in a general commercial banking business,
emphasizing in its marketing the Bank's local management and ownership, from its
main office location in its primary service area, Talbot County, Maryland. In
addition, in February 1999 the Bank opened a loan production office in Denton,
Maryland, which is in Caroline County. The Bank offers a full range of deposit
services that are typically available in most banks and savings and loan
associations, including checking accounts, NOW accounts, savings accounts and
other time deposits of various types, ranging from daily money market accounts
to longer-term certificates of deposit. In addition, the Bank offers certain
retirement account services, such as Individual Retirement Accounts. The Bank
offers a full range of short- to medium-term commercial and personal loans. The
Bank also originates and holds or sells into the secondary market fixed and
variable rate mortgage loans and real estate construction and acquisition loans.
Other bank services include cash management services, safe deposit boxes,
travelers checks, direct deposit of payroll and social security checks, and
automatic drafts for various accounts.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the Company's financial condition and
results of operations should be read in conjunction with the Company's financial
statements and related notes and other statistical information included
elsewhere herein.
OVERVIEW
Consolidated income of the Company is derived primarily from operations
of the Bank. Fiscal year 1998 represented the Bank's fifth full year of
operations. The Bank has shown net income since the fourth quarter of 1995.
Based on this sustained history of profits, the Company has recorded its
deferred tax asset. As a result, the Company is reporting net income of $444,044
for 1998, compared to $289,921 for 1997.
RESULTS OF OPERATIONS
The Company reported net income of $444,044, or $.79 per share, for the
year ended December 31, 1998, which represents an increase of $154,123, or $.27
per share, from $289,921, or $.52 per share, for the year ended December 31,
1997. The primary reason for the change in profitability is the recognition of
the deferred tax asset. Management evaluated the need for an allowance to write
the deferred tax asset down and determined that since the Company had reported
net income for all quarters of the last three years, the deferred taxes were
realizable.
Net interest income increased $16,405, or 1.01%, to $1,645,852 in 1998
from $1,629,447 in 1997. This increase in net interest income was the result of
a $248,661 increase in interest income and a $232,256 increase in
3
<PAGE> 5
interest expense associated with the Bank's continued development of its deposit
and loan base. During the year, the Company experienced a decreasing net
interest spread to 3.69% in 1998 from 4.23% in 1997. The net interest margin
decreased to 3.84% in 1998 from 4.40% in 1997. The retarded growth in net
interest income and the declines in the interest spread and interest margin,
were the result of placing one loan, in the amount of $2.3 million, on
non-accrual status as of March 31, 1998. Lost interest on this nonperforming
asset totals in excess of $200,000 for 1998. The loan is secured by real estate
and is partially guaranteed by the U. S. Department of Agriculture Rural
Community & Development Program. The U. S. Government is responsible for 80% of
any deficiency after liquidation of the collateral. The largest real estate
parcel was sold in October, 1998, with settlement occurring on December 30,
1998. Because the sale was not ratified by the bankruptcy court, the proceeds
are held in escrow. Most of the funds are held in a noninterest-bearing account
with the Company. The other real estate that is collateral for the loan is under
contract of sale with settlement expected to occur by March 31, 1999.
The provision for loan losses was $224,281 in 1998, an increase of
$142,474 from the $81,807 provision in 1997. The provision increased because of
the nonperforming loan discussed above and because in 1998 the Company
experienced net charge-offs of $72,281 compared to net charge-offs for 1997 of
$36,060.
The Company had loans over ninety days delinquent on which the accrual
of interest had been discontinued totaling $1,143,251 and $42,446 as of December
31, 1998 and 1997, respectively. At December 31, 1998, the accrual of interest
had been discontinued on loans totaling $107,157 where the loans were less than
ninety days delinquent. The Company's allowance for loan losses as a percentage
of its year-end loans was 1.57% at December 31, 1998, compared to 1.08% at
December 31, 1997. Net charge-offs of $72,281 during 1998 resulted in a ratio of
net charge-offs to average loans of .21%. During 1997, the Company had net
charge-offs of $36,060 which was .11% of average loans.
Noninterest income increased $41,305, or 43.29%, to $136,720 in 1998
from $95,415 in 1997. Management increased the return and overdraft charges and
took a more aggressive position on waiving fees during 1998, which increased
these fees by $30,510. In June 1997, the Company implemented a service charge on
NOW accounts. The 1998 fees increased as the volume of NOW accounts increased
and as a result of a full year of these fees.
Noninterest expense increased $159,064, or 11.76%, to $1,512,198 in
1998 from $1,353,134 in 1997. The increase was the result of an increase of
$164,671 of compensation and related expenses due to annual increases and the
hiring of one full-time employee and one part-time employee. Also, on March 6,
1998, the Bank's former President and Chief Executive Officer, Thomas P.
McDavid, and the Company entered into a mutual agreement to accept the
resignation of Mr. McDavid, while honoring his employment contract through March
6, 1999. Mr. McDavid's compensation during his severance period was accrued in
1998 and totals $77,114 for the period from May 1, 1998 until March 6, 1999. On
May 1, 1998, the Bank hired a new President and Chief Executive Officer, R.
Michael S. Menzies, Sr.
The Company's efficiency ratio, which is noninterest expense as a
percentage of the sum of net interest income and noninterest income,
deteriorated to 84.83% in 1997, compared to 78.45% in 1997. This deterioration
is the result of other expenses increasing at a faster rate than the net
interest income.
NET INTEREST INCOME
The primary source of income for the Company is net interest income,
which is the difference between revenue on interest-earning assets, such as
investment securities and loans, and interest incurred on interest-bearing
sources of funds, such as deposits and borrowings. The level of net interest
income is determined primarily by the average balances of interest-earning
assets and funding sources and the various rate spreads between the
interest-earning assets and the Company's funding sources. The table "Average
Balances, Income and Expenses, and Rates" which follows shows the Company's
average volume of interest-earning assets and interest-bearing liabilities for
1998 and 1997 and related interest income/expense and yields. Changes in net
interest income from period to period result from increases or decreases in the
volume of interest-earning assets and interest-bearing liabilities, and
increases or decreases in the average rates earned and paid on such assets and
4
<PAGE> 6
liabilities. The volume of interest-earning assets and interest-bearing
liabilities is affected by the ability to manage the earning-asset portfolio
(which includes loans) and the availability of particular sources of funds, such
as noninterest bearing deposits. The table "Analysis of Changes in Net Interest
Income" shows the amount of net interest income change from rate changes and
from activity changes.
The key performance measure for net interest income is the "net margin
on interest-bearing assets," or net interest income divided by average
interest-earning assets. The Company's net interest margin for 1998 was 3.84%,
compared to 4.40% for 1997. The decrease is due primarily to the decline in
mortgage loan yields as a result of the large nonperforming loan discussed under
Results of Operations. As a result of the significant amount of fixed rate
loans, the Bank's income may increase in a falling interest rate environment and
decrease in a rising interest rate environment. Management of the Company
expects to increase the net margin on interest-earning assets to a level
comparable to the 1997 results. The net margin may decline or stay the same,
however, if competition increases, loan demand or quality decreases, or the cost
of funds rises faster than the return on loans. Although such expectations are
based on management's judgment, actual results will depend on a number of
factors that cannot be predicted with certainty, and fulfillment of management's
expectations cannot be assured.
The following table depicts interest income on earning assets and
related average yields as well as interest expense on interest-bearing
liabilities and related average rates paid for 1998 and 1997.
5
<PAGE> 7
AVERAGE BALANCES, INCOME AND EXPENSES, AND RATES
<TABLE>
<CAPTION>
For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997
---------------------------------------- ----------------------------------------
Average Income/ Yield/ Average Income/ Yield/
ASSETS Balance Expenses Rate Balance Expenses Rate
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
Federal funds sold $ 5,426,336 $ 292,264 5.39% $ 4,061,651 $ 223,281 5.50%
Interest-bearing deposits 33,010 1,723 5.22% 3,819 211 5.53%
Investment securities:
U.S. Government agency 2,768,164 159,044 5.75% 1,302,055 77,907 5.98%
Other 140,860 10,487 7.44% 123,898 8,982 7.25%
----------- ---------- ----- ----------- ---------- -----
Total investment securities 2,909,024 169,531 5.83% 1,425,953 86,889 6.09%
----------- ---------- ----- ----------- ---------- -----
Loans:
Demand and time 3,247,262 278,469 8.58% 3,198,500 314,191 9.82%
Mortgage 29,060,941 2,499,682 8.60% 26,558,797 2,437,593 9.18%
Installment 2,633,811 284,975 10.82% 2,131,907 215,818 10.12%
----------- ---------- ----- ----------- ---------- -----
Total loans 34,942,014 3,063,126 8.77% 31,889,204 2,967,602 9.31%
Allowance for loan losses 446,883 -- -- 347,325 -- --
----------- ---------- ----- ----------- --------- -----
Total loans, net of allowance 34,495,131 3,063,126 8.88% 31,541,879 2,967,602 9.41%
----------- ---------- ----- ----------- ---------- -----
Total interest-earning assets 42,863,501 3,526,644 8.23% 37,033,302 3,277,983 8.85%
----------- ---------- ----- ----------- ---------- -----
Cash and due from banks 794,618 732,418
Premises and equipment 1,682,370 1,624,800
Other assets 446,850 330,160
----------- -----------
Total assets $45,787,339 $39,720,680
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
Savings and NOW deposits $ 8,498,077 $ 260,562 3.07% $ 7,806,635 $ 243,536 3.12%
Money market 4,600,749 164,972 3.59% 4,065,734 158,799 3.91%
Other time deposits 24,713,617 1,404,089 5.68% 21,408,000 1,224,459 5.72%
----------- ---------- ----- ----------- ---------- -----
Total interest-bearing deposits 37,812,443 1,829,623 4.84% 33,280,369 1,626,794 4.89%
Noninterest-bearing deposits 2,649,700 -- -- 1,947,430 -- --
----------- ---------- ----- ----------- ---------- -----
Total deposits 40,462,143 1,829,623 4.52% 35,227,799 1,626,794 4.62%
Borrowed funds 952,924 49,249 5.17% 478,005 21,742 4.55%
----------- ---------- ----- ----------- ---------- -----
41,415,067 1,878,872 4.54% 35,705,804 1,648,536 4.62%
---------- ----- ---------- -----
Other liabilities 161,931 143,505
Stockholders' equity 4,210,341 3,871,371
----------- -----------
Total liabilities and
stockholders equity $45,787,339 $39,720,680
=========== ===========
Net interest spread 3.69% 4.23%
===== =====
Net interest income $1,647,772 $1,629,447
========== ==========
Net interest income/margin 3.84% 4.40%
===== =====
</TABLE>
6
<PAGE> 8
ANALYSIS OF CHANGES IN NET INTEREST INCOME
<TABLE>
<CAPTION>
Year Ended December 31, 1998 Year Ended December 31, 1997
Compared with 1997 Compared with 1996
Variance Due To Variance Due To
------------------------------------------ -------------------------------------------
Total Rate Volume Total Rate Volume
----- ---- ------ ----- ---- ------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS
Interest-bearing deposits $ 1,512 $ (102) $ 1,614 $ (319) $ 16 $ (335)
Federal funds sold 68,983 (6,075) 75,058 (141,046) 7,075 (148,121)
Investment Securities:
U.S. Government Agency 81,137 (6,536) 87,673 39,044 7,346 31,698
Other 1,505 275 1,230 8,982 -- 8,982
Loans:
Demand and time (35,722) (40,510) 4,788 13,687 11,897 1,790
Mortgage 62,089 (167,608) 229,697 545,293 (4,947) 550,240
Installment 69,157 18,364 50,793 24,829 (8,760) 33,589
-------- --------- -------- --------- ------- ---------
Total interest income 248,661 (202,192) 450,853 490,470 12,627 477,843
-------- --------- -------- --------- ------- ---------
INTEREST-BEARING LIABILITIES
Savings and NOW deposits 17,026 (4,547) 21,573 7,372 (9,970) 17,342
Money-market deposits 6,173 (14,746) 20,919 70,617 15,260 55,357
Time deposits 179,630 (9,451) 189,081 67,168 (6,768) 73,936
Borrowed funds 27,507 5,898 21,609 9,511 6,704 2,807
-------- --------- -------- --------- ------- -------
Total interest expense 230,336 (22,846) 253,182 154,668 5,226 149,442
-------- --------- -------- --------- ------- ---------
Net interest income $ 18,325 $(179,346) $197,671 $ 335,802 $7,401 $ 328,401
======== ========= ======== ========= ======= =========
</TABLE>
COMPOSITION OF LOAN PORTFOLIO
Because loans are expected to produce higher yields than investment
securities and other interest-earning assets (assuming that loan losses are not
excessive), the absolute volume of loans and the volume as a percentage of
total earning assets is an important determinant of net interest margin.
Average loans, net of the allowance for loan losses, were $34,495,131 and
$31,541,879 during 1998 and 1997, respectively, which constituted 80.48% and
85.17%, respectively, of average interest-earning assets for the periods. At
December 31, 1998, the Company's loan to deposit ratio was 75.38%, compared to
91.06% at December 31, 1997. The Bank extends loans primarily to customers
located in and near Talbot County. In addition, the Bank opened a loan
production office in Denton, Maryland, in Caroline County, in February 1999.
There are no industry concentrations in the Bank's loan portfolio. The Bank
does, however, have a substantial portion of its loans in real estate and its
performance may be influenced by the real estate market in the region.
7
<PAGE> 9
The following table sets forth the composition of the Company's loan
portfolio as of December 31, 1998 and 1997, respectively.
COMPOSITION OF LOAN PORTFOLIO
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------
1998 1997
------------------------ ------------------------
Percent Percent
Amount of Total Amount Of Total
------ -------- ------ --------
<S> <C> <C> <C> <C>
Commercial $ 3,626,829 10.72% $ 2,270,375 6.46%
Real estate 22,544,807 66.64% 24,273,513 69.10%
Construction 2,459,321 7.27% 3,658,528 10.41%
Home equity 2,067,068 6.11% 2,067,995 5.89%
Consumer 3,133,773 9.26% 2,859,345 8.14%
----------- ------ ----------- -------
Total loans 33,831,798 100.00% 35,129,756 100.00%
====== =======
Less deferred loan origination fees 46,990 69,477
Less allowance for credit losses 530,000 378,000
----------- -----------
Net loans $33,254,808 $34,682,279
=========== ===========
</TABLE>
The following table sets forth the maturity distribution, classified
according to sensitivity to changes in interest rates, for selected components
of the Company's loan portfolio as of December 31, 1998.
LOAN MATURITY SCHEDULE AND SENSITIVITY TO CHANGES IN INTEREST RATES
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------
Over One
One Year Through Over Five
Or Less Five Years Years Total
------- ---------- ----- -----
<S> <C> <C> <C> <C>
Commercial $ 2,274,796 $ 1,318,052 $ 33,981 $ 3,626,829
Real estate 9,574,814 11,895,963 1,074,030 22,544,807
Construction 2,459,321 -- -- 2,459,321
Home equity 2,067,068 -- -- 2,067,068
Consumer 663,759 2,470,014 -- 3,133,773
----------- -------------- ----------- --------------
Total $17,039,758 $ 15,684,029 $ 1,108,011 $ 33,831,798
=========== ============== =========== ==============
Fixed interest rate $11,863,124 $ 15,195,762 $ 1,074,030 $ 28,132,916
Variable interest rate 5,176,634 488,267 33,981 5,698,882
----------- -------------- ----------- --------------
Total $17,039,758 $ 15,684,029 $ 1,108,011 $ 33,831,798
=========== ============== =========== ==============
</TABLE>
As of December 31, 1998, $28,132,916, or 83.16%, of the total loans were
fixed rate loans. The significant amount of fixed rate loans was the result of
the market demand of the Bank. With such a significant amount of fixed rate
loans, the Bank's income will decrease in a rising interest rate environment,
but will increase in a falling interest rate environment.
8
<PAGE> 10
The Company has the following commitments, lines of credit, and letters
of credit outstanding as of December 31, 1998 and 1997, respectively.
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Construction loans $1,639,393 $1,319,956
Lines of credit 2,012,998 1,472,709
Overdraft protection lines 186,670 144,026
Standby letters of credit 535,166 382,767
---------- ----------
Total $4,374,227 $3,319,458
========== ==========
</TABLE>
Loan commitments and lines of credit are agreements to lend to a
customer as long as there is no violation of any condition to the contract.
Loan commitments may have interest fixed at current rates, fixed expiration
dates, and may require the payment of a fee. Lines of credit generally have
variable interest rates. Such lines do not represent future cash requirements
because it is unlikely that all customers will draw upon their lines in full at
any time. Letters of credit are commitments issued to guarantee the performance
of a customer to a third party. Loan commitments and lines and letters of
credit are made on the same terms, including collateral, as outstanding loans.
The Company's exposure to credit loss in the event of nonperformance by the
borrower is represented by the contract amount of the commitment. Management is
not aware of any accounting loss the Company will incur by the funding of these
commitments but has included in the allowance for credit losses a provision for
losses.
LOAN QUALITY
The allowance for loan losses represents a reserve for potential losses
in the loan portfolio. The adequacy of the allowance for loan losses is
evaluated periodically based on a review of all significant loans, with a
particular emphasis on non-accruing, past due, and other loans that management
believes require attention. The determination of the reserve level rests upon
management's judgment about factors affecting loan quality and assumptions
about the economy. Management considers the year-end allowance appropriate and
adequate to cover possible losses in the loan portfolio; however, management's
judgment is based upon a number of assumptions about future events, which are
believed to be reasonable, but which may or may not prove valid. Thus, there
can be no assurance that charge-offs in future periods will not exceed the
allowance for loan loss or that additional increases in the loan loss allowance
will not be required.
For significant problem loans, management's review consists of an
evaluation of the financial strengths of the borrowers and guarantors, the
related collateral, and the effects of economic conditions. The Bank uses a
loan grading system where all loans are graded based on management's evaluation
of the risk associated with each loan. Based on the loan grading, a factor is
applied to the loan balance to reserve for potential losses. The overall
evaluation of the adequacy of the total allowance for loan losses is based on
an analysis of historical loan loss ratios, loan charge-offs, delinquency
trends, and previous collection experience, along with an assessment of the
effects of external economic conditions. The Bank is a relatively new
institution without a long history. Its current policy is to maintain an
allowance equal to the greater of one percent of gross loans or the results of
management's evaluation of the risk associated with each loan. This allowance
is increased for reserves for specific loans identified as substandard during
management's loan review.
The table "Allocation of Allowance for Loan Losses" which follows shows
the specific reserves applied by loan type and also the general allowance
included in the December 31, 1998 and 1997, allowance for loan losses.
The provision for loan losses is a charge to earnings in the current
period to replenish the allowance and maintain it at a level management has
determined to be adequate. At year-end 1998, the allowance for loan losses was
1.57% of outstanding loans, compared to 1.08% at year-end 1997.
9
<PAGE> 11
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
1998 1997
-------------- ------------
Amount Percent Amount Percent
------ ------- ------ -------
<S> <C> <C> <C> <C>
Commercial $ 59,183 11.17% $ 17,926 4.74%
Real estate 348,660 65.78% 214,117 56.64%
Construction 12,297 2.32% 18,293 4.84%
Home equity 12,842 2.42% 12,958 3.43%
Consumer 57,340 10.82% 31,445 8.32%
Commitments 39,678 7.49% 33,912 8.97%
General -- 0.00% 49,349 13.06%
-------- ------ -------- ------
Total $530,000 100.00% $378,000 100.00%
======== ====== ======== ======
</TABLE>
ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Balance at beginning of year $ 378,000 $ 332,253
Loan losses:
Commercial 44,331 8,244
Real Estate -- 18,278
Consumer 53,450 23,290
----------- -----------
Total loan losses 97,781 49,812
----------- -----------
Recoveries on loans previously charged off
Commercial 16,453 1,885
Real Estate -- 7,500
Consumer 9,047 4,367
----------- -----------
Total loan recoveries 25,500 13,752
----------- -----------
Net loan losses 72,281 36,060
Provision for loan losses charged to expense 224,281 81,807
----------- -----------
Balance at end of year $ 530,000 $ 378,000
=========== ===========
Total loans outstanding at end of year $33,831,799 $35,129,756
Allowance for loan losses to loans outstanding
at end of year 1.57% 1.08%
Net charge-offs to average loans .21% 0.11%
</TABLE>
As a result of management's ongoing review of the loan portfolio, loans
are classified as nonaccrual when it is not reasonable to expect collection of
interest under the original terms. These loans are classified as nonaccrual
even though the presence of collateral or the borrower's financial strength may
be sufficient to provide for ultimate repayment. Interest on nonaccrual loans
is recognized only when received. A delinquent loan is generally placed in
nonaccrual status when it becomes 90 days or more past due. When a loan is
placed in nonaccrual status, all interest which has been accrued on the loan
but remains unpaid is reversed and deducted from earnings as a reduction of
reported interest income. No additional interest is accrued on the loan balance
until the collection of both principal and interest becomes reasonably certain.
When a problem loan is finally resolved, there ultimately may be an actual
writedown or charge-off of the principal balance of the loan which would
necessitate additional charges to earnings.
10
<PAGE> 12
The Company had nonperforming loans totaling $1,250,408 and $42,466 as
of December 31, 1998 and 1997, respectively. Where real estate acquired by
foreclosure and held for sale is included with nonperforming loans, the result
comprises nonperforming assets. Loans are classified as impaired when the
collection of contractual obligations, including principal and interest, is
doubtful. Management has identified no significant impaired loans as of
December 31, 1998.
A potential problem loan is one in which management has serious doubts
about the borrower's future performance under the terms of the loan contract.
These loans are current as to principal and interest and, accordingly, they are
not included in the nonperforming assets categories. Management monitors these
loans closely in order to ensure that the Company's interests are protected. At
December 31, 1998, the Company had forty-two borrowers with loans considered by
management to be potential problem loans totaling approximately $645,656. The
level of potential problem loans is factored into the determination of the
adequacy of the allowance for loan losses.
LIQUIDITY AND INTEREST RATE SENSITIVITY
The primary objective of asset/liability management is to ensure the
steady growth of the Company's primary source of earnings, net interest income.
Net interest income can fluctuate with significant interest rate movements. To
lessen the impact of these margin swings, the balance sheet should be
structured so that repricing opportunities exist for both assets and
liabilities in roughly equivalent amounts at approximately the same time
intervals. Imbalances in these repricing opportunities at any point in time
constitute interest rate sensitivity.
Liquidity represents the ability to provide steady sources of funds for
loan commitments and investment activities, as well as to provide sufficient
funds to cover deposit withdrawals and payment of debt and operating
obligations. These funds can be obtained by converting assets to cash or by
attracting new deposits.
Average liquid assets (cash and amounts due from banks, interest bearing
deposits in other banks, federal funds sold and investment securities) were
22.65% of average deposits for 1998, compared to 17.67% of average deposits for
1997. The Company considers its loan portfolio as an alternate source of
liquidity since it has available third parties who will buy participations in
loans.
Interest rate sensitivity may be controlled on either side of the
balance sheet. On the asset side, management can exercise some control on
maturities. Also, loans may be structured with rate floors and ceilings on
variable rate notes and by providing for repricing opportunities on fixed rate
notes. The Company's investment portfolio, including federal funds sold,
probably provides the most flexible and fastest control over rate sensitivity
since it generally can be restructured more quickly than the loan portfolio.
On the liability side, deposit products can be restructured so as to
offer incentives to attain the maturity distribution desired. Competitive
factors sometimes make control over deposits more difficult and less effective.
Interest rate sensitivity refers to the responsiveness of
interest-bearing assets and liabilities to changes in market interest rates.
The rate-sensitive position, or gap, is the difference in the volume of
rate-sensitive assets and liabilities at a given time interval. The general
objective of gap management is to actively manage rate-sensitive assets and
liabilities to reduce the impact of interest rate fluctuations on the net
interest margin. Management generally attempts to maintain a balance between
rate-sensitive assets and liabilities as the exposure period is lengthened to
minimize the overall interest rate risk to the Company.
The asset mix of the balance sheet is continually evaluated in terms of
several variables; yield, credit quality, appropriate funding sources, and
liquidity. Management of the liability mix of the balance sheet focuses on
expanding the various funding sources.
The interest rate sensitivity position at December 31, 1998, is
presented in the table "Interest Sensitivity Analysis." The difference between
rate-sensitive assets and rate-sensitive liabilities, or the interest rate
sensitivity gap, is shown at the bottom of the table. The Company was
liability-sensitive through the one-year period but asset-sensitive for longer
time horizons. For liability-sensitive institutions, if interest rates should
increase, the net
11
<PAGE> 13
interest margins should decline. Since all interest rates and yields do not
adjust at the same velocity, the gap is only a general indicator of rate
sensitivity.
INTEREST SENSITIVITY ANALYSIS
<TABLE>
<CAPTION>
December 31, 1998
--------------------------------------------------------------------------
After Three
Within but Within After One but
Three Twelve Within Five After Five
Months Months Years Years Total
------ ------ ----- ----- -----
<S> <C> <C> <C> <C> <C>
ASSETS
Earning assets:
Federal funds sold $ 7,269,903 $ -- $ -- $ -- $ 7,269,903
Investment securities
available for sale -- 451,673 4,137,728 396,225 4,985,626
Loans 9,330,334 8,349,045 15,728,660 423,759 33,831,798
------------ ------------ ----------- ----------- -----------
Total earning assets $ 16,600,237 $ 8,800,718 $19,866,388 $ 819,984 $46,087,327
============ ============ =========== =========== ===========
LIABILITIES
Interest-bearing liabilities:
Money market and NOW $ 9,008,316 $ -- $ -- $ -- $ 9,008,316
Savings deposits 4,497,360 -- -- -- 4,497,360
Club accounts -- 26,434 -- -- 26,434
Certificates $100,000 and over 1,890,405 1,949,654 1,238,331 -- 5,078,390
Certificates under $100,000 4,724,440 9,111,601 6,944,488 45,313 20,825,842
Note payable -- -- -- 1,000,000 1,000,000
Securities sold under
agreements to repurchase 281,019 -- -- -- 281,019
------------ ------------ ----------- ----------- -----------
Total interest-bearing liabilities $ 20,401,540 $ 11,087,689 $ 8,182,819 $ 1,045,313 $40,717,361
============ ============ =========== =========== ===========
Period gap $ (3,801,303) $ (2,286,971) $11,683,569 $ (225,329) $ 5,369,966
Cumulative gap $ (3,801,303) $ (6,088,274) $ 5,595,295 $ 5,369,966 $ 5,369,966
Ratio of cumulative gap to total
earning assets (8.25)% (13.21)% 12.14% 11.65% 11.65%
</TABLE>
As noted in the table "Loan Maturity Schedule and Sensitivity to Changes
in Interest Rates," as of December 31, 1998, approximately $6,086,150, or
17.99%, of the loan portfolio consisted of commercial loans and real estate
construction loans. Of this amount, $4,734,117, or 77.79%, matures within one
year.
The table "Investment Securities Maturity Distribution and Yields" shows
that as of December 31, 1998, $451,673 of the investment portfolio matures in
one year or less. Most of the debt securities mature within five years. All
debt securities of the Company have been classified as "available-for-sale."
The equity securities are comprised of Federal Home Loan Bank stock which is
also classified as "available-for-sale" even though the Company must hold this
stock to borrow from the Federal Home Loan Bank. Another source of liquidity is
the $6,000,000 secured line of credit the Company has from the Federal Home
Loan Bank, the $1,000,000 unsecured line of credit the Company has from a
correspondent bank, and the $1,500,000 secured line of credit the Company has
from another correspondent bank. The Company has used $1,000,000 of the Federal
Home Loan Bank line.
12
<PAGE> 14
INVESTMENT SECURITIES MATURITY DISTRIBUTION AND YIELDS
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------- -----------------------
Year-end Year-end
Book Value Yields Book Value Yields
---------- ------ ---------- ------
<S> <C> <C> <C> <C>
U.S. Government Agency securities
One year or less $ 451,673 5.7% $ 500,000 5.9%
Over one through five years 4,137,728 5.5% 1,000,000 6.1%
Over five years 250,625 5.8% -- --%
---------- ----- ---------- -----
Total U.S. Government Agency securities $4,840,026 5.6% $1,500,000 6.0%
========== ===== ========== =====
</TABLE>
DEPOSITS AND OTHER INTEREST-BEARING LIABILITIES
Average interest-bearing liabilities increased $5,006,993, or 14.83%,
to $38,765,367 in 1998, from $33,758,374 in 1997. Average interest-bearing
deposits increased $4,532,074, or 13.62%, to $37,812,443 in 1998, from
$33,280,369 in 1997. These increases resulted from increases in all categories
of interest-bearing deposits, except money market accounts, resulting from the
continued promotional efforts of management to increase the deposits and loans
of the Bank. At December 31, 1998, total deposits were $44,118,960, compared to
$38,088,152 at December 31, 1997, an increase of 15.84%.
The following table sets forth the deposits of the Company by category
as of December 31, 1998 and 1997, respectively.
DEPOSITS
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------
1998 1997
--------------------------------- -----------------------------
Percent of Percent of
Amount Deposits Amount Deposits
------ -------- ------ --------
<S> <C> <C> <C> <C>
Demand deposit accounts $ 4,682,618 10.61% $ 2,060,848 5.41%
NOW accounts 4,886,335 11.08% 4,270,427 11.21%
Money market accounts 4,121,981 9.34% 5,057,846 13.28%
Savings accounts 4,523,794 10.25% 3,581,048 9.40%
Time deposits less than
$100,000 20,825,842 47.21% 18,969,383 49.81%
Time deposits of $100,000
or over 5,078,390 11.51% 4,148,600 10.89%
----------- ------ ----------- ------
Total deposits $44,118,960 100.00% $38,088,152 100.00%
=========== ====== =========== ======
</TABLE>
Core deposits, which exclude certificates of deposit of $100,000 or
more, provide a relatively stable funding source for the Company's loan
portfolio and other earning assets. The Company's core deposits increased
$5,101,018 during 1998. Deposits, and particularly core deposits, have been the
Company's primary source of funding and have enabled the Company to meet both
its short-term and long-term liquidity needs. Management anticipates that such
deposits will continue to be the Company's primary source of funding in the
future. The Company's loan-to-deposit ratio was 75.38% at December 31, 1998,
and 91.06% at the end of 1997, with a 1998 ratio of average loans to average
deposits of 85.25%. The maturity distribution of the Company's time deposits
over $100,000 at December 31, 1998, is shown in the following table.
13
<PAGE> 15
MATURITIES OF CERTIFICATES OF DEPOSIT
AND OTHER TIME DEPOSITS OF $100,000 OF MORE
<TABLE>
<CAPTION>
December 31, 1998
-----------------------------------------------------------------------
After Three After Six
Within Through Through After
Three Six Twelve Twelve
Months Months Months Months Total
------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C>
Certificates of deposit
of $100,000 or more $1,890,405 $1,334,971 $614,683 $1,238,331 $5,078,390
</TABLE>
Large certificate of deposit customers tend to be extremely sensitive
to interest rate levels, making these deposits less reliable sources of funding
for liquidity planning purposes than core deposits. Some financial institutions
partially fund their balance sheets using large certificates of deposit
obtained through brokers. These brokered deposits are generally expensive and
are unreliable as long-term funding sources. Accordingly, the Company does not
accept brokered deposits.
Borrowed funds consist primarily of short-term borrowings in the form
of securities sold under agreements to repurchase and federal funds purchased
from correspondent banks. Average short-term borrowings were $396,897 and
$478,055 during 1998 and 1997, respectively. As previously noted, the Company's
primary funding source is core deposits, and it does not depend heavily on
purchased funds to support its earning asset base.
NONINTEREST INCOME
Noninterest income for 1998 was $136,720, compared to noninterest
income in 1997 of $95,415, an increase of $41,305, or 43.29%. Of this increase,
$30,510 is a result of the increase in return check and overdraft charges.
Management increased the return and overdraft charges and took a more aggressive
position on waiving fees during 1998 which increased these fees by $30,510. In
June 1997, the Company implemented a service charge on NOW accounts. The 1998
fees increased as the volume of NOW accounts increased and as a result of a full
year of these fees.
The following table presents the principal components of noninterest
income for the years ended December 31, 1998 and 1997, respectively.
NONINTEREST INCOME
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Service charges on deposit accounts $ 99,654 $62,588
Other noninterest revenue 37,066 32,827
-------- -------
Total noninterest income $136,720 $95,415
======== =======
Noninterest income as a percentage of average total assets 0.30% 0.24%
======== =======
</TABLE>
14
<PAGE> 16
NONINTEREST EXPENSE
Noninterest expense increased $159,064, or 11.76%, to $1,512,198 in
1998 from $1,353,134 in 1997. The increase was the result of an increase of
$164,671 of compensation and related expenses due to annual increases and the
hiring of one full-time employee and one part-time employee. Also, on March 6,
1998, the Bank's former President and Chief Executive Officer, Thomas P.
McDavid, and the Company entered into a mutual agreement to accept the
resignation of Mr. McDavid, while honoring his employment contract through March
6, 1999. Mr. McDavid's compensation during his severance period was accrued in
1998 and totals $77,114 for the period from May 1, 1998 until March 6, 1999. On
May 1, 1998, the Bank hired a new President and Chief Executive Officer, R.
Michael S. Menzies, Sr.
The following table presents the principal components of noninterest
expense for the years ended December 31, 1998 and 1997 respectively.
NONINTEREST EXPENSE
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Compensation and related expenses $ 909,209 $ 744,538
Occupancy expense 70,782 71,871
Furniture and equipment expense 87,647 99,050
Advertising 41,667 47,417
Professional fees 72,110 58,421
Data processing 84,332 77,487
Deposit assessment 4,620 3,712
Insurance 13,023 14,830
Loan reports and collection costs 6,598 8,086
Organizational expense amortization 23,482 46,964
Stationery and supplies 46,339 44,833
Telephone and postage 44,353 35,751
Other 108,036 100,174
---------- ----------
Total noninterest expense $1,512,198 $1,353,134
========== ==========
Noninterest expense as a percentage of average total assets 3.30% 3.41%
========== ==========
</TABLE>
CAPITAL
Under the capital guidelines of the Federal Reserve Board and the FDIC,
the Company and the Bank are currently required to maintain a minimum
risk-based total capital ratio of 8%, with at least 4% being Tier 1 capital.
Tier 1 capital consists of common stockholders' equity, qualifying perpetual
preferred stock, and minority interests in equity accounts of consolidated
subsidiaries, less certain intangibles. In addition, the Company and the Bank
must maintain a minimum Tier 1 leverage ratio (Tier 1 capital to total assets)
of at least 3%, but this minimum ratio is increased by 100 to 200 basis points
for other than the highest-rated institutions.
At December 31, 1998, the Company and the Bank exceeded their regulatory
capital ratios, as set forth in the following table.
ANALYSIS OF CAPITAL
<TABLE>
<CAPTION>
Required
Company Bank Minimums
------- ---- --------
<S> <C> <C> <C>
Tier 1 risk-based capital ratio 12.6% 12.5% 4.0%
Total risk-based capital ratio 13.9% 13.7% 8.0%
Tier 1 leverage ratio 10.1% 10.0% 3.0%
</TABLE>
15
<PAGE> 17
ACCOUNTING RULE CHANGES
Statement No. 130 of the Financial Accounting Standards Board
("FASB"), Reporting Comprehensive Income, requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. Comprehensive income of the
Company would include unrealized gains and losses on securities available for
sale, net of tax. FASB 130 is effective for years beginning after December 15,
1997. The Company adopted FASB 130 in the financial statements for the
year-ended December 31, 1998 with restatement of prior periods.
FASB Statement No. 131, Disclosures about Segments of an
Enterprise and Related Information, requires that a public company report
financial and descriptive information about its reportable operating segments.
Operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by management in
deciding how to allocate resources and in assessing performance. Generally,
financial information is required to be reported on the basis that is used
internally for evaluating segment performance and deciding how to allocate
resources to segments. FASB 131 was effective for financial statements for
periods beginning after December 15, 1997. The standard had no effect on the
Company's financial statements.
FASB Statement No. 132, Employers' Disclosures about Pension
and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88,
and 106, standardizes the disclosure requirements for pension and postretirement
benefits. It requires additional information on the changes in benefit
obligations and fair values of plan assets and eliminates certain disclosures
that are no longer useful. It was effective for fiscal years beginning after
December 15, 1997. FASB 132 had no effect on the financial statements of the
Company since the Company does not have a defined benefit plan or offer
postretirement benefits.
FASB Statement No. 133, Accounting for Derivative Instruments
and Hedging Activities, requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. FASB 133 is effective for fiscal years
beginning after June 15, 1999. The Company elected early adoption of this
pronouncement, taking advantage of a provision in the Statement allowing a one
time transfer of securities from the held-to-maturity portfolio.
FASB Statement No. 134, Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise, is an amendment of FASB Statement No. 65. After
the securitization of a mortgage loan held for sale, any retained
mortgage-backed securities shall be classified in accordance with the provisions
of FASB 115. However, a mortgage banking enterprise must classify as trading any
mortgage-backed securities that it commits to sell before or during the
securitization process. This Statement shall be effective for the first fiscal
quarter beginning after December 15, 1998. The Company's financial statements
were not impacted by this Statement.
Statement of Position 98-5 of the Accounting Standards
Executive Committee of the American Institute of Certified Public Accountants,
Reporting on the Costs of Start-up Activities, requires that start-up costs and
organization costs be expensed as incurred. Prior to 1998, organization costs
were amortized over five years. This Statement, which is effective for fiscal
years beginning after December 15, 1998, requires that the unamortized balance
of organization costs be written off when the Statement is adopted. Although
this had no current effect in the financial statements of the Company, it will
require startup costs of new ventures to be expensed as incurred.
IMPACT OF INFLATION
Unlike most industrial companies, the assets and liabilities
of financial institutions, such as the Company and the Bank, are primarily
monetary in nature. Therefore, interest rates have a more significant affect on
the Company's performance than do the effects of changes in the general rate of
inflation and changes in prices. In addition, interest rates do not necessarily
move in the same direction or in the same magnitude as the prices of goods and
services. As discussed previously, management seeks to manage the relationships
between interest
16
<PAGE> 18
sensitive assets and liabilities in order to protect against wide interest rate
fluctuations, including those resulting from inflation. See "Liquidity and
Interest Rate Sensitivity" above.
INDUSTRY DEVELOPMENTS
Certain recently enacted and proposed legislation could have an effect
on both the costs of doing business and the competitive factors facing the
financial institutions industry. The Company is unable at this time to assess
the impact of this legislation on its financial condition or results of
operations.
YEAR 2000 ISSUES
The Year 2000 issue relates to computer programs that use only two
digits to identify a year in the date field. Unless corrected, these programs
could read the year 2000 as the year 1900 and likely would adversely affect any
number of calculations that are made using the date field. Financial
institutions are highly computerized organizations and the Year 2000 issue
represents a significant risk to the industry. The Company faces the same risks
as the industry. The failure of a major loan or deposit system due to the Year
2000 issue could result in interest and balances being calculated inaccurately.
Such failures could have a significant impact on a financial institution's
operations and liquidity.
Management has a Year 2000 Committee, which reports to the Board,
responsible for assessing progress in the Company's plans to minimize the
effects of the Year 2000 issue. In its assessment of the Year 2000 issue, the
committee identified five major phases: Awareness, Assessment, Renovation,
Validation and Implementation.
The awareness phase is a continuing effort to educate employees,
customers, business partners and vendors of the impact of the Year 2000 issue.
The effort is well under way through communication with the appropriate
constituencies and training for all employees. During the assessment phase,
which was completed by March 31, 1998, a detailed list was compiled of all
vendors, hardware, software, and equipment owned or used by the Company. Each
item was assigned a priority based on its importance to the operations of the
Company and the risk associated with non-compliance. All manufacturers, software
providers and vendors were requested to provide information relating to the
readiness of their product or process for the Year 2000. The mission critical
areas were identified as the third party data processor, the loan documentation
and compliance software, the new accounts platform software, the proof machines,
the microfilmer and fische reader and the security system. The Company has also
assessed non-information technology systems, including the alarm systems of the
Company.
The validation phase consisted of testing all mission critical hardware
and software for Year 2000 readiness. Validation of the core banking systems has
been completed. Test transactions were processed on loan and deposit accounts to
validate the accuracy of our third party data processing service provider.
Validation tests were also run on the loan and compliance software and the
Federal Reserve Bank FedLine system. All tests were successful and no Year 2000
problems were indicated. Contingency planning for all mission critical functions
is underway and will be completed by June 1999.
Of concern to management is the amount of funds which may be necessary
to have in the Bank and the ATM at the end of 1999 in the event customers desire
to withdraw extra cash. The Company is currently working to estimate the most
likely level of cash requirements, the source of these funds, and the required
level of security and insurance for the additional cash. It may be necessary to
build significant levels of cash at the end of 1999 which could reduce earning
assets or increase borrowings for a period of time, thereby negatively affecting
earnings. In addition, it may be necessary to purchase commitments from current
cash sources to guarantee funds availability and to purchase commitments from
vendors who transport cash.
Another concern is the preparedness of the Bank's customers for the
Year 2000 issue. For example, commercial loan customers may be unable to repay
their loans from the Bank if their business is negatively impacted by the Year
2000 issue. Management continues to attempt to address this issue by educating
its customers as to the possible consequences of not being prepared for the Year
2000 issue. In addition, loan underwriting for the past year has included issues
relating to the customer's preparedness for the Year 2000 and their reliance on
computers in their business operations.
17
<PAGE> 19
The Company's total costs associated with the Year 2000 issue will
primarily include the costs incurred to upgrade the existing software and
hardware not currently Year 2000 compliant. The Company expects that these costs
will be incurred in the normal course of business as software and hardware is
ordinarily upgraded to keep pace with technological advances. The Company
estimates that $1,000 has been spent to date which could be related to the Year
2000 issue. The Company does not track internal costs for personnel devoted to
the Year 2000 issue; however, one individual has spent significant time on the
project and many individuals have spent numerous hours working on the Year 2000
issue.
MARKET FOR COMPANY'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
The Company's Articles of Incorporation authorize it to issue up to
5,000,000 shares of its common stock, par value $0.10 per share (the "Common
Stock"). The Company closed its initial public offering (the "Initial
Offering") of Common Stock on December 31, 1992, in which the Company offered
for sale a minimum of 535,000 shares and a maximum of 700,000 shares at a
purchase price of $10.00 per share. As a result of the Initial Offering,
559,328 shares of the Common Stock were issued.
As of March 19, 1999, there were approximately 500 holders of record of
the Common Stock and 560,318 shares of Common Stock issued and outstanding. In
addition, there were approximately 236,557 shares of Common Stock issuable
pursuant to warrants which may be issued in the next 60 days. There is no
established public trading market in the stock, and there is no likelihood that
a trading market will develop in the near future. The development of a trading
market may be inhibited because a large portion of the Company's shares is held
by insiders. Transactions in the Common Stock are infrequent and are negotiated
privately between the persons involved in those transactions.
All outstanding shares of Common Stock of the Company are entitled to
share equally in dividends from funds legally available, when, as, and if
declared by the Board of Directors. No dividends have been paid to date on the
Common Stock, and it is anticipated that earnings will be retained for the
foreseeable future in order to expand the Bank's capital base to support
deposit growth. The Company currently has no source of income other than
dividends and other payments received from the Bank. It is unlikely that any
cash dividends will be paid in the near future.
18
<PAGE> 20
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Easton Bancorp, Inc. and Subsidiary
Easton, Maryland
We have audited the consolidated balance sheets of Easton Bancorp, Inc.
and Subsidiary as of December 31, 1998, 1997, and 1996, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Easton
Bancorp, Inc. and Subsidiary as of December 31, 1998, 1997, and 1996, and the
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles.
/s/ Rowles & Company LLP
Salisbury, Maryland
January 26, 1999
19
<PAGE> 21
EASTON BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
------------ ------------ ------------
Assets
<S> <C> <C> <C>
Cash and due from banks $ 976,682 $ 642,726 $ 1,211,182
Federal funds sold 7,269,903 3,739,622 2,824,727
Investment in Federal Home Loan Bank stock 145,600 124,500 121,600
Investment securities available for sale 4,840,026 -- --
Investment securities held to maturity (market value of
$1,502,794 and $1,247,275) -- 1,500,000 1,250,000
Loans, less allowance for credit losses of
$530,000, $378,000, and $332,253 33,254,808 34,682,279 30,062,431
Premises and equipment 1,662,127 1,713,683 1,515,354
Intangible assets 1,853 30,261 84,503
Accrued interest receivable 246,470 248,303 181,009
Loan payment held in escrow 1,175,000 -- --
Other assets 92,924 58,323 44,134
Deferred income taxes 401,551 -- --
------------ ------------ ------------
Total assets $ 50,066,944 $ 42,739,697 $ 37,294,940
============ ============ ============
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing $ 4,682,618 $ 2,060,848 $ 1,719,187
Interest-bearing 39,436,342 36,027,304 31,039,372
------------ ------------ ------------
Total deposits 44,118,960 38,088,152 32,758,559
Accrued interest payable 95,611 99,980 93,684
Securities sold under agreements to repurchase 281,019 481,490 574,328
Note payable 1,000,000 -- --
Other liabilities 111,685 57,363 145,578
------------ ------------ ------------
Total liabilities 45,607,275 38,726,985 33,572,149
------------ ------------ ------------
Stockholders' equity
Common stock, par value $.10 per share; authorized
5,000,000 shares, issued and outstanding 560,318
in 1998 and 559,328 in 1997 and 1996 56,032 55,933 55,933
Additional paid-in capital 5,227,487 5,217,686 5,217,686
Retained earnings (deficit) (816,863) (1,260,907) (1,550,828)
------------ ------------ ------------
4,466,656 4,012,712 3,722,791
Accumulated other comprehensive income (6,987) -- --
------------ ------------ ------------
Total stockholders' equity 4,459,669 4,012,712 3,722,791
------------ ------------ ------------
Total liabilities and stockholders' equity $ 50,066,944 $ 42,739,697 $ 37,294,940
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
20
<PAGE> 22
EASTON BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
INTEREST REVENUE
Loans, including fees $3,063,126 $2,967,602 $2,383,793
Deposits in banks 1,723 211 530
U.S. Government agency securities 159,044 77,907 38,863
Federal funds sold 292,264 223,281 364,327
Other 10,487 8,982 --
---------- ---------- ----------
Total interest revenue 3,526,644 3,277,983 2,787,513
---------- ---------- ----------
INTEREST EXPENSE
Interest on deposits 1,831,543 1,626,794 1,481,637
Interest on borrowed funds 49,249 21,742 12,231
---------- ---------- ----------
Total interest expense 1,880,792 1,648,536 1,493,868
---------- ---------- ----------
Net interest income 1,645,852 1,629,447 1,293,645
PROVISION FOR CREDIT LOSSES 224,281 81,807 18,699
---------- ---------- ----------
Net interest income after provision for credit losses 1,421,571 1,547,640 1,274,946
---------- ---------- ----------
OTHER OPERATING REVENUE
Service charges on deposit accounts 99,654 62,588 68,660
Other noninterest revenue 37,066 32,827 44,428
---------- ---------- ----------
Total other operating revenue 136,720 95,415 113,088
---------- ---------- ----------
OTHER EXPENSES
Compensation and related expenses 909,209 744,538 673,944
Occupancy 70,782 71,871 75,310
Furniture and equipment 87,647 99,050 92,704
Other operating 444,560 437,675 354,962
---------- ---------- ----------
Total other expenses 1,512,198 1,353,134 1,196,920
---------- ---------- ----------
Income before income taxes 46,093 289,921 191,114
Income tax benefit 397,951 -- --
---------- ---------- ----------
NET INCOME $ 444,044 $ 289,921 $ 191,114
========== ========== ==========
Earnings per common share
Basic $ 0.79 $ 0.52 $ 0.34
Diluted $ 0.74 $ 0.48 $ 0.32
</TABLE>
The accompanying notes are an integral part of these financial statements.
21
<PAGE> 23
EASTON BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
<TABLE>
<CAPTION>
Accumulated
Additional Retained other
Common stock paid-in earnings comprehensive Comprehensive
Shares Par value capital (deficit) income income
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 559,328 $55,933 $5,217,686 $(1,741,942) $ --
Net income -- -- -- 191,114 -- $ 191,114
-------- ------- ---------- ----------- ------- =========
Balance, December 31, 1996 559,328 55,933 5,217,686 (1,550,828) --
Net income -- -- -- 289,921 -- $ 289,921
-------- ------- ---------- ----------- ------- =========
Balance, December 31, 1997 559,328 55,933 5,217,686 (1,260,907) --
Net income -- -- -- 444,044 -- $ 444,044
Unrealized loss on investment
securities available for sale net
of income taxes -- -- -- -- (6,987) (6,987)
---------
Comprehensive income $ 437,057
=========
Stock options exercised 990 99 9,801 -- --
-------- ------- ---------- ----------- -------
BALANCE, DECEMBER 31, 1998 560,318 $56,032 $5,227,487 $ (816,863) $(6,987)
======== ======= ========== =========== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
22
<PAGE> 24
EASTON BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Interest received $ 3,506,575 $ 3,224,496 $ 2,758,551
Fees, commissions, and rent received 145,640 37,312 112,868
Interest paid (1,885,161) (1,642,240) (1,501,293)
Payments to suppliers and employees (1,376,221) (1,240,368) (918,846)
----------- ----------- -----------
390,833 379,200 451,280
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Loans originated, net of principal repayments 50,677 (4,715,462) (5,948,662)
Purchase of investment securities
Available for sale (5,772,279) -- --
Held to maturity (250,100) (1,502,900) (871,600)
Proceeds from maturities of investment securities
Available for sale 1,400,081 -- --
Held to maturity 1,250,000 1,250,000 --
Proceeds from sale of other real estate owned -- -- 113,804
Purchase of premises and equipment, including
construction in progress (44,234) (298,893) (15,287)
Cash paid for organization costs and software (978) (2,261) (2,456)
----------- ----------- -----------
(3,366,833) (5,269,516) (6,724,201)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in
Time deposits 2,786,249 2,994,134 1,783,022
Other deposits 3,244,559 2,335,459 2,737,542
Securities sold under agreements to repurchase (200,471) (92,838) 296,965
Advance under note payable 1,000,000 -- --
Proceeds from stock options exercised 9,900 -- --
----------- ----------- -----------
6,840,237 5,236,755 4,817,529
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,864,237 346,439 (1,455,392)
Cash and cash equivalents at beginning of year 4,382,348 4,035,909 5,491,301
----------- ----------- -----------
Cash and cash equivalents at end of year $ 8,246,585 $ 4,382,348 $ 4,035,909
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
23
<PAGE> 25
EASTON BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Continued)
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES
Net income $ 444,044 $ 289,921 $ 191,114
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
Provision for credit losses 224,281 81,807 18,699
Depreciation 95,790 100,564 97,411
Amortization of intangibles 29,386 56,503 55,797
Securities amortization, net of accretion 2,812 -- --
Deferred income taxes (397,951) -- --
Gain on sale of other real estate owned -- -- (4,061)
Gain on calls of securities (2,227) -- --
Decrease (increase) in
Accrued interest receivable 1,833 (67,294) (24,526)
Other assets (34,601) (14,189) (6,864)
Increase (decrease) in
Deferred loan origination fees (22,487) 13,807 (4,436)
Accrued interest payable (4,369) 6,296 (7,425)
Other liabilities 54,322 (88,215) 135,571
--------- --------- ---------
$ 390,833 $ 379,200 $ 451,280
========= ========= =========
NONCASH ACTIVITY
Other real estate acquired in lieu of foreclosure $ -- $ -- $ 109,743
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
24
<PAGE> 26
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies in the financial statements
conform to generally accepted accounting principles and to general
practices within the banking industry. Management makes estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements. These estimates and assumptions may affect the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
Business
Easton Bancorp, Inc. is a one-bank holding company. Easton Bank &
Trust Company is a financial institution operating primarily in Talbot
County. The Bank offers deposit services and loans to individuals, small
businesses, associations, and government entities. Other services
include direct deposit of payroll and social security checks, automatic
drafts from accounts, automated teller machine services, cash management
services, safe deposit boxes, money orders, and travelers cheques. The
Bank also offers credit card services and discount brokerage services
through a correspondent.
Principles of consolidation
The consolidated financial statements of Easton Bancorp, Inc.
include the accounts of its wholly owned subsidiary, Easton Bank & Trust
Company. Intercompany accounts and transactions have been eliminated.
Cash equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash on hand, amounts due from banks, and federal funds sold.
Investment securities
As securities are purchased, management determines if the
securities should be classified as held to maturity or available for
sale. Securities which management has the intent and ability to hold to
maturity are recorded at amortized cost which is cost adjusted for
amortization of premiums and accretion of discounts to maturity.
Securities which may be sold before maturity are classified as available
for sale and carried at fair value with unrealized gains and losses
included in stockholders' equity on an after tax basis.
During 1998, the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities, which established accounting and reporting standards for
derivative instruments. The Statement also provided an opportunity, at
adoption only, to transfer securities from the held to maturity
portfolio with no adverse consequences.
Loan payment held in escrow
Loan payment held in escrow represents funds due the Company from a
loan settlement occurring in December, 1998. The funds were placed in an
escrow account pending approval of the transaction by the bankruptcy
court. Most of the funds held in escrow were placed in a
noninterest-bearing account with the Company.
25
<PAGE> 27
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans and allowance for credit losses
Loans are stated at face value less deferred origination fees and
the allowance for credit losses.
Interest on loans is credited to income based on the principal
amounts outstanding. Origination fees are recorded as income over the
contractual life of the related loans as an adjustment of yield.
The accrual of interest is discontinued when any portion of the
principal or interest is ninety days past due and collateral is
insufficient to discharge the debt in full.
The allowance for credit losses represents an amount which, in
management's judgment, will be adequate to absorb possible losses on
existing loans that may become uncollectible. If the current economy or
real estate market were to suffer a severe downturn, the estimate for
uncollectible accounts would need to be increased. Management's judgment
in determining the adequacy of the allowance is based on evaluations of
the collectibility of loans. These evaluations take into consideration
such factors as changes in the nature and volume of the loan portfolio,
overall portfolio quality, review of specific problem loans, and current
economic conditions that may affect the borrowers' ability to pay.
Loans are considered impaired when, based on current information,
management considers it unlikely that the collection of principal and
interest payments will be made according to contractual terms.
Generally, loans are not reviewed for impairment until the accrual of
interest has been discontinued.
Premises and equipment
Premises and equipment are recorded at cost less accumulated
depreciation and amortization. Depreciation and amortization are
computed over the estimated useful lives using the straight-line method.
Leasehold improvements are amortized over the terms of the lease or the
estimated useful lives of the improvements, whichever is shorter.
Earnings per share
Basic earnings per common share are determined by dividing net
income by the weighted average number of shares of common stock
outstanding. Diluted earnings per share are calculated including the
average dilutive common stock equivalents outstanding during the period.
Dilutive common equivalent shares consist of stock options and
warrants, calculated using the treasury stock method. In loss periods,
dilutive common equivalent shares are excluded since the effect would be
antidilutive.
Stock options
The Company accounts for stock options under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees
("APB No. 25").
Comprehensive income
The Company adopted Statement No. 130 of the Financial Accounting
Standards Board, Reporting Comprehensive Income, in 1998. Comprehensive
income includes net income and the unrealized gains and losses on
securities available for sale. Comprehensive income for the years ended
December 31, 1997 and 1996 was the same as net income.
26
<PAGE> 28
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
2. CASH AND DUE FROM BANKS
The Bank normally carries balances with other banks that exceed the
federally insured limit. The average balances carried in excess of the
limit, including unsecured federal funds sold to the same banks, were
approximately $5,244,225, $4,069,486, and $6,865,970 for 1998, 1997, and
1996, respectively.
Banks are required to carry noninterest-bearing cash reserves at
specified percentages of deposit balances. The Bank's normal amount of
cash on hand and on deposit with other banks is sufficient to satisfy
the reserve requirements.
3. INVESTMENT SECURITIES
Investment securities are summarized as follows:
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Market
cost gains losses value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
December 31, 1998 - Available for sale
U.S. Government agencies $ 4,850,613 $ 7,311 $17,898 $ 4,840,026
=========== ======= ======= ===========
December 31, 1997 - Held to maturity
U.S. Government agencies $ 1,500,000 $ 2,794 $ - $ 1,502,794
=========== ======= ======= ===========
December 31, 1996 - Held to maturity
U.S. Government agencies $ 1,250,000 $ - $ 2,725 $ 1,247,275
=========== ======= ======= ===========
</TABLE>
During 1998, securities with an amortized cost of $500,000 and fair
value of $501,953 were transferred from the held to maturity portfolio
to the available for sale portfolio.
Pledged securities and the amortized cost and estimated market
value of investment securities, by contractual maturity, are shown
below. Actual maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 December 31, 1997 December 31, 1996
------------------------ ----------------------- -----------------------
AMORTIZED MARKET Amortized Market Amortized Market
COST VALUE cost value cost value
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Due
One year or less $ 449,898 $ 451,673 $ 500,000 $ 500,771 $ 500,000 $ 499,453
After one year
through five years 4,150,155 4,137,728 1,000,000 1,002,023 750,000 747,822
After five years 250,560 250,625 - - - -
---------- ---------- ---------- ---------- ---------- ----------
$4,850,613 $4,840,026 $1,500,000 $1,502,794 $1,250,000 $1,247,275
========== ========== ========== ========== ========== ==========
</TABLE>
Securities were pledged as collateral for repurchase agreements.
27
<PAGE> 29
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
4. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Major classifications of loans are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Commercial $ 4,405,479 $ 2,270,375 $ 2,473,468
Real estate 22,174,739 24,273,513 21,371,852
Construction 2,459,322 3,658,528 2,624,709
Home equity 2,067,068 2,067,995 1,607,606
Consumer 2,725,190 2,859,345 2,372,719
----------- ----------- -----------
33,831,798 35,129,756 30,450,354
Less deferred loan origination fees 46,990 69,477 55,670
Less allowance for credit losses 530,000 378,000 332,253
----------- ----------- -----------
Loans, net $33,254,808 $34,682,279 $30,062,431
=========== =========== ===========
</TABLE>
The residential mortgage portfolio is pledged as collateral under
lines of credit from correspondents and the Federal Home Loan Bank.
The rate repricing distribution of the loan portfolio follows:
<TABLE>
<S> <C> <C> <C>
Immediately $ 3,558,109 $ 4,110,743 $ 3,267,806
Within one year 14,121,270 12,664,592 9,864,200
Over one to five years 15,728,660 18,346,404 16,715,036
Over five years 423,759 8,017 603,312
----------- ----------- -----------
$33,831,798 $35,129,756 $30,450,354
=========== =========== ===========
</TABLE>
Transactions in the allowance for credit losses are as follows:
<TABLE>
<S> <C> <C> <C>
Beginning balance $ 378,000 $ 332,253 $ 260,000
Provision charged to operation 224,281 81,807 18,699
Recoveries 25,500 13,752 81,610
----------- ----------- -----------
627,781 427,812 360,309
Charge-offs 97,781 49,812 28,056
----------- ----------- -----------
Ending balance $ 530,000 $ 378,000 $ 332,253
=========== =========== ===========
</TABLE>
Management has identified no significant impaired loans.
28
<PAGE> 30
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Nonaccrual loans and loans past due 90 days or more are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Nonaccrual
Commercial $ 64,707 $ 13,785 $ 7,333
Mortgage 2,184,971 -- --
Installment 68,574 28,661 5,725
----------- ----------- -----------
$ 2,318,252 $ 42,446 $ 13,058
=========== =========== ===========
Interest not accrued $ 237,114 $ 1,388 $ 449
=========== =========== ===========
Loans past due ninety days or more,
still accruing interest $ 25,022 $ 218,055 $ 261,664
=========== =========== ===========
</TABLE>
The interest not accrued includes $113,226 of interest from the
nonaccrual loan which will be paid off from the loan payment held in
escrow.
The following commitments, lines of credit, and letters of credit
are outstanding as of December 31:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Construction loans $1,639,393 $1,319,956 $1,650,040
Lines of credit, including home equities 2,012,998 1,472,709 1,257,319
Overdraft protection lines 186,670 144,026 93,997
Standby letters of credit 535,166 382,767 44,563
---------- ---------- ----------
$4,374,227 $3,319,458 $3,045,919
========== ========== ==========
</TABLE>
Loan commitments and lines of credit are agreements to lend to a
customer as long as there is no violation of any condition to the
contract. Loan commitments may have rates fixed at current market
interest, fixed expiration dates, and may require payment of a fee.
Lines of credit generally have variable interest rates. Such lines do
not represent future cash requirements because it is unlikely that all
customers will draw upon their lines in full at any time.
Letters of credit are commitments issued to guarantee the
performance of a customer to a third party.
Loan commitments, lines of credit and letters of credit are made on
the same terms, including collateral, as outstanding loans. The
Company's exposure to credit loss in the event of nonperformance by the
borrower is represented by the contract amount of the commitment.
Management includes an assessment of potential loss from funding these
commitments in its allowance for credit losses.
29
<PAGE> 31
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
5. PREMISES AND EQUIPMENT
A summary of premises and equipment and the related depreciation
expense is as follows:
<TABLE>
<CAPTION>
Estimated
useful lives 1998 1997 1996
------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Land - $ 295,211 $ 295,211 $ 295,211
Land improvements 20 years 40,512 40,512 40,512
Building 10-40 years 1,298,872 1,298,872 1,050,407
Furniture, fixtures, and equipment 5-10 years 542,701 518,624 468,195
---------- ---------- ----------
2,177,296 2,153,219 1,854,325
Accumulated depreciation 515,169 439,536 338,971
---------- ---------- ----------
Net premises and equipment $1,662,127 $1,713,683 $1,515,354
========== ========== ==========
Depreciation expense $ 95,790 $ 100,564 $ 97,411
========== ========== ==========
</TABLE>
6. INTANGIBLE ASSETS
A summary of intangible assets and the related amortization
follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Organization costs $ -- $234,820 $234,820
Computer software 44,340 44,032 42,940
-------- -------- --------
44,340 278,852 277,760
Accumulated amortization 42,487 248,591 193,257
-------- -------- --------
Net intangible assets $ 1,853 $ 30,261 $ 84,503
======== ======== ========
Amortization expense $ 29,386 $ 56,503 $ 55,797
======== ======== ========
</TABLE>
7. DEPOSITS
Major classifications of interest-bearing deposits are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Money market and NOW $ 9,008,316 $ 9,328,273 $ 7,660,738
Savings 4,523,794 3,581,048 3,254,785
Other time 25,904,232 23,117,983 20,123,849
----------- ----------- -----------
$39,436,342 $36,027,304 $31,039,372
=========== =========== ===========
</TABLE>
30
<PAGE> 32
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
7. DEPOSITS (Continued)
Included in other time deposits are certificates of deposit issued
in denominations of $100,000 or more. The maturities and related
interest expense of these deposits follow:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Three months or less $1,890,405 $1,116,056 $1,210,112
Three to twelve months 1,949,654 1,452,974 1,547,716
One to five years 1,238,331 1,579,570 1,371,563
---------- ---------- ----------
$5,078,390 $4,148,600 $4,129,391
========== ========== ==========
Interest expense $ 265,607 $ 234,217 $ 296,856
========== ========== ==========
</TABLE>
8. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Bank has repurchase agreements that are collateralized by
government agency securities owned by the Bank. During the year ended
December 31, 1998 and 1997, the following applied to these repurchase
agreements:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Maximum amount outstanding $ 540,941 $ 594,632
Average amount outstanding 466,466 478,005
Average rate paid during the year 4.81% 4.55%
Investment securities underlying the agreements at year end
Carrying value $ 424,911 $ 675,000
Estimated fair value 426,649 676,095
</TABLE>
Secured lines of credit of $425,000 from correspondent banks have
been pledged as additional collateral for these agreements.
9. LONG-TERM DEBT AND LINES OF CREDIT
The Company may borrow up to $6,000,000 from the Federal Home Loan
Bank (FHLB) through any combination of notes or line of credit advances.
The line of credit interest rate is a variable rate set daily by the
lender. Both the notes payable and the line of credit are secured by a
floating lien on all of the Company's residential first mortgage loans.
The Company was required to purchase shares of capital stock in the FHLB
as a condition to obtaining the line of credit.
The Company has a note payable to the Federal Home Loan Bank in the
amount of $1,000,000. The loan was advanced June 23, 1998, with interest
fixed at 5.51% and a final maturity of June 23, 2008. The FHLB has the
option to convert the loan to a floating rate note on June 23, 2003.
In addition to the line of credit available from the FHLB, the
Company has federal funds lines and other lines of credit from
correspondent banks totaling $2,500,000.
31
<PAGE> 33
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
10. INCOME TAXES
The Company has not incurred any income tax liability since its
inception. The Company had net operating loss carryforwards of $931,128,
$1,147,924, and $1,432,564 available to offset future taxable income as
of December 31, 1998, 1997, and 1996, respectively.
The statutory federal income tax rate was 34% for 1998, 1997, and
1996. The Company's effective tax rate was zero in each year due to the
net operating losses. The provision (benefit) for income taxes is
reconciled as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Income before income taxes $ 46,093 $ 289,921 $ 191,114
========= ========= =========
Tax provision at statutory rates $ 15,671 $ 98,573 $ 64,979
Increase (decrease) resulting from
State income taxes, less federal benefit -- 13,377 8,822
Nondeductible expenses 2,313 3,346 1,649
Net operating loss carryover and adjustment of
valuation allowance (415,935) (115,296) (75,450)
--------- --------- ---------
Provision (benefit) for income taxes $(397,951) $ -- $ --
========= ========= =========
</TABLE>
The components of the deferred tax assets and liabilities as of
December 31, are as follows:
<TABLE>
<S> <C> <C> <C>
Deferred tax assets
Allowance for credit losses $ 162,357 $ 124,849 $ 93,255
Deferred loan origination fees -- 992 1,033
Net operating loss carryforward 316,584 435,721 553,257
Start-up costs -- 8,238 22,398
Unrealized loss on securities available for sale 3,600 -- --
--------- --------- ---------
482,541 569,800 669,943
--------- --------- ---------
Deferred tax liabilities
Depreciation 44,281 45,537 46,980
Cash method of accounting 36,709 59,417 34,741
--------- --------- ---------
80,990 104,954 81,721
--------- --------- ---------
Net deferred tax asset before valuation allowance 401,551 464,846 588,222
Valuation allowance -- (464,846) (588,222)
--------- --------- ---------
Net deferred tax asset $ 401,551 $ -- $ --
========= ========= =========
</TABLE>
32
<PAGE> 34
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
11. OTHER OPERATING EXPENSES
Other operating expenses are comprised as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Advertising $ 41,667 $47,417 $35,332
Professional fees 72,110 58,421 44,890
Data processing 84,332 77,487 65,372
Deposit assessment 4,620 3,712 2,000
Insurance 13,023 14,830 21,435
Loan reports and collection costs 6,598 8,086 2,491
Organizational expense amortization 23,482 46,964 46,964
Postage 27,128 21,813 21,128
Proxy and transfer agent costs 16,762 15,141 2,701
Software amortization 5,904 9,539 8,833
Stationery and supplies 46,339 44,833 35,119
Telephone 17,225 13,938 12,987
Other 85,370 75,494 55,710
--------- -------- --------
$ 444,560 $437,675 $354,962
========= ======== ========
</TABLE>
12. LEASE COMMITMENTS
The Bank is currently leasing branch facilities from a related
party. The initial two year term of the lease began July 1, 1993. The
second lease term, for a period of five years, began July 1, 1995. Rent
is fixed at $300 per month. There are options to extend beyond the
initial lease terms with rent increases that are contingent on the
performance of the Bank and based on the consumer price index of Easton.
<TABLE>
<CAPTION>
Minimum lease payments Amount
---------------------- ------
<S> <C>
1999 $ 3,600
2000 1,800
-------
$ 5,400
=======
</TABLE>
Rent expense was $3,600 for each of the years ended December 31,
1998, 1997, and 1996.
13. STOCK WARRANTS
The organizers of the Corporation and certain partnerships
controlled by the organizers have purchased 272,574 shares of common
stock sold in the initial offering and hold warrants to purchase up to
207,800 additional shares of common stock. The warrants are exercisable
at a price of $10 per share for a period of 10 years and expire June 30,
2003.
33
<PAGE> 35
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
14. STOCK OPTION PLANS
The Corporation had an employment agreement with an executive
officer that provided for options to purchase, for $10 per share, 2,797
shares each year for four years and, at the end of year five, to receive
an option for 5,593 shares. The officer had to meet performance criteria
established by the Board of Directors. Each option was exercisable for a
period of seven years following the date of grant, but the options were
forfeited when the officer left the employment of the Company.
The Corporation has adopted a stock option plan, covering 35,000
shares of common stock, intended to qualify as incentive stock options
under Section 422 of the Internal Revenue Code. The plan provides for
granting options to purchase shares of the common stock to the officers
and other key employees of the Corporation and the Bank. No options have
been granted.
A summary of the status of the Company's performance-based stock
option plans follows:
<TABLE>
<CAPTION>
Shares 1998 1997 1996
------------------------------ ------ ----- -----
<S> <C> <C> <C>
Outstanding, beginning of year 8,390 5,593 --
Granted -- 2,797 5,593
Exercised (990) -- --
Forfeited (7,400) -- --
------ ----- -----
Outstanding, end of year -- 8,390 5,593
====== ===== =====
</TABLE>
The Bank applies APB No. 25 in accounting for the stock option
plan. Accordingly, no compensation expense has been recognized for the
stock options granted. Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation (SFAS No. 123), was issued
in October, 1995 to establish accounting and reporting standards for
stock-based employee compensation plans. SFAS No. 123 requires
measurement of compensation expense provided by stock-based plans using
a fair value based method of accounting, and recognition of the
compensation expense in the statement of income or disclosure in the
notes to the financial statements.
The weighted average fair value of options granted during 1997 and
1996 has been estimated using the Black-Scholes option-pricing model
with the following assumptions:
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Dividend yield 0.00% 0.00%
Risk-free interest rate 5.75% 6.00%
Expected volatility 4.50% 20.00%
Expected life in years 7 7
</TABLE>
34
<PAGE> 36
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
14. STOCK OPTION PLANS (Continued)
Had compensation been determined in accordance with the provisions
of SFAS No. 123, the Company's net income and earning per share during
1997 and 1996 would have been reduced to the following pro forma
amounts:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Net income
As reported $ 289,921 $ 191,114
Pro forma 282,955 184,819
Basic earnings per share
As reported 0.52 0.34
Pro forma 0.51 0.33
Diluted earnings per share
As reported 0.48 0.32
Pro forma 0.47 0.31
</TABLE>
During 1996, the Company granted 2,796 options related to
performance for 1994. They are not included in the reported pro forma
amounts.
15. RELATED PARTY TRANSACTIONS
The executive officers and directors of the Corporation enter into
loan transactions with the Bank in the ordinary course of business. The
terms of these transactions are similar to the terms provided to other
borrowers entering into similar loan transactions. A summary of the
activity of loans to officers and directors follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Beginning balance $ 2,052,138 $ 2,441,843 $ 2,067,392
Advances 412,312 465,854 936,266
Repayments (445,578) (855,559) (561,815)
----------- ----------- -----------
Ending balance $ 2,018,872 $ 2,052,138 $ 2,441,843
=========== =========== ===========
</TABLE>
The Corporation engaged a firm owned by one of the organizers to
construct the Bank's main office and remodel the second floor. The
general contractor was paid $457 in 1998 and $240,028 in 1997.
The Bank paid rent to a company that is owned by a director. Annual
rental payments of $3,600 were paid for each of the three years ended
December 31, 1998.
During 1998, 1997, and 1996, the Bank leased office space to a
director for $7,938 each year.
A director is a partner in a law firm which periodically provides
services to the Company or Bank. During 1997, the Bank paid $897 to this
law firm.
35
<PAGE> 37
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
16. CAPITAL STANDARDS
The Federal Reserve Board and the Federal Deposit Insurance
Corporation have adopted risk-based capital standards for banking
organizations. These standards require ratios of capital to assets for
minimum capital adequacy and to be classified as well capitalized under
prompt corrective action provisions. The capital ratios and minimum
capital requirements of the Bank are as follows:
<TABLE>
<CAPTION>
Minimum To be
Actual capital adequacy well capitalized
--------------- ------------------ ----------------
(in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- -------- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1998
----------------------------
Total capital
(to risk-weighted assets) $ 4,691 13.73% $ 2,733 8.0% $ 3,417 10.0%
Tier 1 capital
(to risk-weighted assets) $ 4,263 12.48% $ 1,367 4.0% $ 2,050 6.0%
Tier 1 capital
(to average fourth
quarter assets) $ 4,263 8.78% $ 1,943 4.0% $ 2,429 5.0%
December 31, 1997
----------------------------
Total capital
(to risk-weighted assets) $ 4,303 13.15% $ 2,619 8.0% $ 3,273 10.0%
Tier 1 capital
(to risk-weighted assets) $ 3,925 11.99% $ 1,309 4.0% $ 1,964 6.0%
Tier 1 capital
(to average fourth
quarter assets) $ 3,925 9.18% $ 1,710 4.0% $ 2,137 5.0%
December 31, 1996
----------------------------
Total capital
(to risk-weighted assets) $ 3,893 13.90% $ 2,234 8.0% $ 2,792 10.0%
Tier 1 capital
(to risk-weighted assets) $ 3,561 12.80% $ 1,117 4.0% $ 1,675 6.0%
Tier 1 capital
(to average fourth
quarter assets) $ 3,561 9.80% $ 1,454 4.0% $ 1,818 5.0%
</TABLE>
Tier 1 capital consists of capital stock, surplus, and
undivided profits. Total capital includes a limited amount of the
allowance for credit losses. In calculating risk-weighted assets,
specified risk percentages are applied to each category of asset and
off-balance sheet items.
Failure to meet the capital requirements could affect the Bank's
ability to pay dividends and accept deposits and may significantly
affect the operations of the Bank.
36
<PAGE> 38
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
17. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments
are summarized below. The fair values of a significant portion of these
financial instruments are estimates derived using present value
techniques and may not be indicative of the net realizable or
liquidation values. Also, the calculation of estimated fair values is
based on market conditions at a specific point in time and may not
reflect current or future fair values.
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
------------------------- --------------------------- -------------------------
CARRYING FAIR Carrying Fair Carrying Fair
AMOUNT VALUE amount value amount value
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Financial assets
Cash and due from banks $ 976,682 $ 976,682 $ 642,726 $ 642,726 $ 1,211,182 $ 1,211,182
Federal funds sold 7,269,903 7,269,903 3,739,622 3,739,622 2,824,727 2,824,727
Investment securities 4,985,626 4,985,626 1,624,500 1,627,294 1,371,600 1,368,875
Loans, net 33,254,808 33,271,318 34,682,279 34,599,709 30,062,431 29,907,317
Accrued interest receivable 246,470 246,470 248,303 248,303 181,009 181,009
Loan payment held
in escrow 1,175,000 1,175,000 -- -- -- --
Financial liabilities
Noninterest-bearing
deposits $ 4,682,618 $ 4,682,618 $ 2,060,848 $ 2,060,848 $ 1,719,187 $ 1,719,187
Interest-bearing deposits
and securities sold under
agreements to repurchase 39,717,361 41,076,792 36,508,794 36,779,633 31,613,700 31,887,840
Accrued interest payable 95,611 95,611 99,980 99,980 93,684 93,684
Note payable 1,000,000 1,000,000 -- -- -- --
</TABLE>
The fair values of U.S. Government agency securities are determined
using market quotations.
The fair value of fixed-rate loans is estimated to be the present
value of scheduled payments discounted using interest rates currently in
effect for loans of the same class and term. The fair value of
variable-rate loans, including loans with a demand feature, is estimated
to equal the carrying amount. The valuation of loans is adjusted for
possible loan losses.
The fair value of interest-bearing checking, savings, and money
market deposit accounts is equal to the carrying amount. The fair value
of fixed-maturity time deposits is estimated based on interest rates
currently offered for deposits of similar remaining maturities.
It is not practicable to estimate the fair value of outstanding
loan commitments, unused lines, and letters of credit.
37
<PAGE> 39
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
18. PARENT COMPANY FINANCIAL INFORMATION
The balance sheets and statements of income and cash flows for
Easton Bancorp, Inc. (Parent Only) follow:
<TABLE>
<CAPTION>
DECEMBER 31,
BALANCE SHEETS 1998 1997 1996
----------- ----------- ----------
Assets
<S> <C> <C> <C>
Cash $ 40,648 $ 64,491 $ 91,153
Investment in subsidiary 4,350,689 3,945,641 3,623,899
Organization costs -- 2,580 7,739
Deferred income taxes 68,332 -- --
----------- ----------- ----------
Total assets $ 4,459,669 $ 4,012,712 $3,722,791
=========== =========== ==========
Liabilities and Stockholders' Equity
Stockholders' equity
Common stock, par value $.10 per share;
authorized 5,000,000 shares; issued
and outstanding 560,318 in 1998 and 559,328
shares in 1997 and 1996 $ 56,032 $ 55,933 $ 55,933
Additional paid-in capital 5,227,487 5,217,686 5,217,686
Retained earnings (deficit) (816,863) (1,260,907) (1,550,828)
----------- ----------- ----------
4,466,656 4,012,712 3,722,791
Accumulated other comprehensive income (6,987) -- --
----------- ----------- ----------
Total stockholders' equity 4,459,669 4,012,712 3,722,791
----------- ----------- ----------
Total liabilities and stockholders' equity $ 4,459,669 $ 4,012,712 $3,722,791
=========== =========== ==========
</TABLE>
38
<PAGE> 40
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
18. PARENT COMPANY FINANCIAL INFORMATION (Continued)
<TABLE>
<CAPTION>
Years Ended December 31,
STATEMENTS OF INCOME 1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Interest revenue $ 1,921 $ 3,002 $ 3,327
Equity in undistributed income of subsidiary 412,035 321,742 205,534
--------- --------- ---------
413,956 324,744 208,861
--------- --------- ---------
Expenses
Furniture and equipment 68 49 49
Other 38,176 34,774 17,698
--------- --------- ---------
38,244 34,823 17,747
--------- --------- ---------
Income before income taxes 375,712 289,921 191,114
Income taxes 68,332 -- --
--------- --------- ---------
Net income $ 444,044 $ 289,921 $ 191,114
========= ========= =========
STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
Interest received $ 1,921 $ 3,002 $ 3,327
Cash paid for operating expenses (35,664) (29,664) (12,588)
--------- --------- ---------
(33,743) (26,662) (9,261)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from options exercised 9,900 -- --
--------- --------- ---------
NET (DECREASE) IN CASH (23,843) (26,662) (9,261)
--------- --------- ---------
Cash and equivalents at beginning of year 64,491 91,153 100,414
--------- --------- ---------
Cash and equivalents at end of year $ 40,648 $ 64,491 $ 91,153
========= ========= =========
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
Net income $ 444,044 $ 289,921 $ 191,114
Adjustments to reconcile net income to net
cash used in operating activities
Undistributed net income of subsidiary (412,035) (321,742) (205,534)
Deferred income taxes (68,332) -- --
Amortization 2,580 5,159 5,159
--------- --------- ---------
$ (33,743) $ (26,662) $ (9,261)
========= ========= =========
</TABLE>
39
<PAGE> 41
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
19. PROFIT SHARING PLAN
In 1996, the Bank adopted a defined contribution profit sharing
plan under Section 401(k) of the Internal Revenue Code. The plan covers
substantially all of the employees and allows discretionary Bank
contributions. During 1998, the Board of Directors approved
contributions matching 25% of employee contributions which totaled
$4,794. In 1997 and 1996 the approved contributions matched 10% of
employee contributions totaling $1,913 and $1,605, respectively.
20. EARNINGS PER SHARE
Diluted earnings per share are calculated as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
NET INCOME $ 444,044 $ 289,921 $ 191,114
========== ========== ==========
Average shares outstanding 560,071 559,328 559,328
---------- ---------- ----------
Dilutive average shares
outstanding under options
and warrants 209,832 215,490 209,897
Exercise price $ 10.00 $ 10.00 $ 10.00
Assumed proceeds on exercise $2,098,320 $2,154,900 $2,098,970
Average market value $ 12.50 $ 12.49 $ 12.41
Less: Treasury stock purchased
with assumed proceeds
from exercise 167,866 172,530 169,135
Average shares and common
stock equivalents 602,037 602,288 600,090
DILUTED EARNINGS PER SHARE $ 0.74 $ 0.48 $ 0.32
========== ========== ==========
</TABLE>
The stock of the Company is not traded on any public exchange. The
market values are derived from trades known to management. Private sales
may occur where management of the Company is unaware of the sales price.
40
<PAGE> 42
EASTON BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
21. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of
operations:
<TABLE>
<CAPTION>
Three months ended
------------------------------------------------------------
December 31, September 30, June 30, March 31,
------------ ------------- -------- ---------
1998
- ----
<S> <C> <C> <C> <C>
Interest revenue $ 918,254 $ 920,983 $ 857,747 $ 829,660
Interest expense 482,515 488,958 461,264 448,055
Net interest income 435,739 432,025 396,483 381,605
Provision for loan losses 61,724 91,212 34,812 36,533
Net income 63,880 343,547 9,018 27,599
Comprehensive income 54,198 347,835 7,425 27,599
Earnings per share - basic 0.11 0.61 0.02 0.05
Earnings per share - diluted 0.10 0.57 0.02 0.05
1997
- ----
Interest revenue $ 892,249 $ 830,754 $ 800,830 $ 754,150
Interest expense 449,961 417,765 401,518 379,292
Net interest income 442,288 412,989 399,312 374,858
Provision for loan losses 32,056 8,285 19,608 21,858
Net income 89,475 73,323 63,367 63,756
Comprehensive income 89,475 73,323 63,367 63,756
Earnings per share - basic 0.17 0.13 0.11 0.11
Earnings per share - diluted 0.15 0.12 0.10 0.11
1996
- ----
Interest revenue $ 741,826 $ 694,753 $ 699,932 $ 651,002
Interest expense 373,791 367,737 386,380 365,960
Net interest income 368,035 327,016 313,552 285,042
Provision for loan losses (15,463) 9,066 21,297 3,799
Net income 75,586 61,304 29,547 24,677
Comprehensive income 75,586 61,304 29,547 24,677
Earnings per share - basic 0.14 0.11 0.05 0.04
Earnings per share - diluted 0.13 0.10 0.05 0.04
</TABLE>
THE FOLLOWING COMMENT IS REQUIRED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION
"This statement has not been reviewed or confirmed for accuracy or relevance by
the Federal Deposit Insurance Corporation."
41
<PAGE> 43
DIRECTORS AND EXECUTIVE OFFICERS OF
EASTON BANCORP, INC.
<TABLE>
<S> <C>
W. David Hill, DDS President, William Hill Manor, Inc.
Chairman/Chief Executive Officer
R. Michael S. Menzies, Sr. President and Chief Executive Officer
President Easton Bank & Trust Company
Sheila W. Bateman Chief Administrative Officer
Secretary Caulk Management Company
Jerry L. Wilcoxon Chief Financial Officer
Treasurer Black Oak Computer Service, Inc.
Jack H. Bishop, DDS Dentist, Jack H. Bishop, DDS
J. Parker Callahan, Jr. Farmer
J. Fredrick Heaton, DMD Endodontist, J. Fredrick Heaton,
DMDPA
William C. Hill President, Hill's Drug Store, Inc.
David F. Lesperance President,
Lesperance Construction Company
Vinodrai Mehta, MD Physician, Vinodrai Mehta, MD
Roger A. Orsini, MD Plastic & Reconstructive Surgeon
President of Shore Aesthetic
& Reconstructive Associates
Mahmood S. Shariff, MD Cardiologist, Mahmood S. Shariff, MD
</TABLE>
All of the persons noted above are directors of Easton Bancorp, Inc.
42
<PAGE> 44
DIRECTORS, OFFICERS AND ASSOCIATES OF
EASTON BANK & TRUST COMPANY
DIRECTORS
W. David Hill, DDS
Chairman of the Board
<TABLE>
<S> <C>
Sheila W. Bateman, CPS - Secretary Jerry L. Wilcoxon, CPA - Treasurer
Jack H. Bishop, DDS M. Linda Kildea
J. Parker Callahan, Jr. Pamela H. Lappen
Charles T. Capute David F. Lesperance
Walter E. Chase, Sr. Vinodrai Mehta, MD
Stephen W. Chitty R. Michael S. Menzies, Sr.
J. Fredrick Heaton, DMD Roger A. Orsini, MD
Jeffrey N. Heflebower Marian H. Shannahan
Thomas E. Hill Mahmood S. Shariff, MD
William C. Hill James B. Spear, Sr.
William R. Houck, DDS Myron Szczukowski, Jr. MD
OFFICERS
R. Michael S. Menzies, Sr. Jeffrey N. Heflebower
President/Chief Executive Officer Executive Vice President
Delia B. Denny Pamela A. Mussenden
Senior Vice President Senior Vice President/Treasurer
Gene Fischgrund Barbara M. Ostrander
Senior Vice President Vice President
Rose K. Kleckner
Assistant Treasurer
</TABLE>
ASSOCIATES
Roxanne M. Atwater, Operations Assistant
Terri L. Brannock, Branch Manager
Kathleen K. Cook, Credit Risk Manager
Brenda L. Forbes, Customer Service Representative
Lesta R. Gunther, Operations Assistant
Susan D. Haschen, Operations Administrator
Anne H. Hughes, Credit Administrative Assistant
Laura M. King, Customer Service Representative
Tracy T. Lednum, Customer Service Representative
Amy C. Lynch, Credit Administrative Assistant
Kerri A. Morris, Customer Service Representative
Carol S. Nottingham, Receptionist
Kimberly D. Rada, Senior Customer Service Representative
Bridget A. Schettini, Customer Service Representative
Kelly A. Tibbitt, Financial Service Representative
Jacqueline D. Wilson, Lending Specialist
Sherry L. Winstead, Customer Service Representative
Easton Bank & Trust Company is a member of F.D.I.C.
43
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
Easton Bank & Trust Company, a state bank organized under the laws of
the State of Maryland.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS FOR THE PERIOD ENDED DECEMBER 31,
1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
INCLUDED AS PART OF EXHIBIT 13 TO THIS FORM 10-KSB.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 976,682
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 7,269,903
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 4,985,626
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 33,254,808
<ALLOWANCE> 530,000
<TOTAL-ASSETS> 50,066,944
<DEPOSITS> 44,118,960
<SHORT-TERM> 281,019
<LIABILITIES-OTHER> 207,296
<LONG-TERM> 1,000,000
0
0
<COMMON> 56,032
<OTHER-SE> 4,410,624
<TOTAL-LIABILITIES-AND-EQUITY> 50,066,944
<INTEREST-LOAN> 3,063,126
<INTEREST-INVEST> 159,044
<INTEREST-OTHER> 304,474
<INTEREST-TOTAL> 3,526,644
<INTEREST-DEPOSIT> 1,831,543
<INTEREST-EXPENSE> 1,880,792
<INTEREST-INCOME-NET> 1,645,852
<LOAN-LOSSES> 224,281
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,512,198
<INCOME-PRETAX> 46,093
<INCOME-PRE-EXTRAORDINARY> 46,093
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 444,044
<EPS-PRIMARY> .79
<EPS-DILUTED> .74
<YIELD-ACTUAL> 3.69
<LOANS-NON> 1,250,408
<LOANS-PAST> 25,022
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 645,656
<ALLOWANCE-OPEN> 378,000
<CHARGE-OFFS> 97,781
<RECOVERIES> 25,500
<ALLOWANCE-CLOSE> 530,000
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 530,000
</TABLE>
