EXHIBIT 13
SHORE BANCSHARES, INC.
2002
ANNUAL
REPORT
CONTENTS
Letter to Shareholders 1
Overview of Our Services 3
Consolidated Financial Highlights 4
Management's Discussion and Analysis of
Financial Condition and Results of Operations 5
Five Year Selected Financial Data 21
Consolidated Financial Statements 22
Independent Auditors' Report 43
Corporate Information 44
Affiliates 45
DEAR SHAREHOLDERS AND FRIENDS,
The Company achieved record earnings for the year ended December 31, 2002. Net
income increased 10% totaling $8,790,000 compared to $7,994,000 for 2001. On a
per share basis, diluted net income was $1.62 and $1.49 for 2002 and 2001,
respectively. The year 2002 also marked the beginning of something new for us.
Shore Bancshares entered the insurance business on May 1, 2002, upon completion
of its acquisition of the operations of The Avon Dixon Agency, Inc. and its
subsidiaries. In November, the Company expanded its insurance operation through
the purchase of W. M. Freestate & Sons, Inc. in Centreville. In addition, we
expanded our financial services through the formation of Wye Financial Services,
LLC, a registered investor advisory firm.
FINANCIAL RESULTS
The Company achieved significant growth in 2002. Total assets increased
$71,663,000 or 12.3% from $582,403,000 to 654,066,000 at December 31, 2001 and
2002, respectively. The growth resulted primarily from increased deposits of
$57,722,000 or 11.8% during 2002. Total Deposits at December 31, 2002 were
$545,192,000 compared to $487,470,000 one year ago. Deposit growth was used to
fund loans, which increased $46,833,000 or 11.9% totaling $439,539,000 at
December 31, 2002.
Short-term interest rates remained unchanged for most of the year, with only one
50 basis point reduction in the federal funds rate occurring in November 2002.
New York Prime fell a corresponding 50 basis points, from 4.75% to 4.25%. The
low interest rate environment impacted the Company's return on average earning
assets. Earnings generated by the increased volume of loans and other earning
assets were not enough to offset the effects of lower overall yields. The
Company was however able to increase net interest income through its deposit
pricing structure. Net interest income increased $ 1,991,000 as a result of a
$4,623,000 reduction in interest expense.
Return on average assets and return on average shareholder's equity were 1.42%
and 11.79%, respectively for 2002, compared to 1.42% and 11.70%, respectively
for 2001.
The $3,322,000 increase in noninterest income was primarily attributable to the
operations of the Company's insurance subsidiaries, which generated $2,872,000
in commission income. Customer demand for long term fixed rate financing
resulted in another new service offered by the Company. Wye Mortgage Group, a
division of the Centerville National Bank which began operating in September,
originates and sells long term fixed rate residential mortgage loans on the
secondary market. During 2002, Wye Mortgage generated approximately $114,000 in
fee income for the Company. The nondeposit investment program offered by the
Company generated approximately $87,000 of increased revenue in 2002. These
increased revenues were offset in part by the increased cost of operations
associated with new services and a new branch. Other noninterest expenses
increased $3,935,000, with approximately $2,655,000 of the increase resulting
from the operation of the insurance subsidiaries.
The Company continues to maintain capital ratios well in excess of the required
regulatory minimums, with a leverage capital ratio of 10.73% and a total risk
based capital ratio of 17.34% at December 31, 2002. Total stockholders' equity
was $78,028,000, a 9.9% increase over last year. Dividends paid to shareholders
were $0.60 per share for each of the years ended December 31, 2002 and 2001. The
Company's stock is listed on the NASDAQ Small Cap Market, quoted under the
symbol "SHBI".
BEYOND 2002
We were very pleased with the results of 2002 and look forward to the challenges
of 2003. With little room left for reductions in rates paid for deposits and the
possibility of future reductions in the short-term federal funds rate set by the
Federal Reserve Bank, managing the Company's net interest margin will be a
priority. The operations of the insurance subsidiaries should become a more
significant factor in the overall profitability of the Company, contributing a
full year of operations in 2003. In addition, we expect our new subsidiary, Wye
Financial Services, to grow as more customers become aware of our expanded
offering of investment products and investment advisory services.
In January 2003, the Company combined the separate bookkeeping and proof
departments of its bank subsidiaries into the "Shore Operations Center". This
departmental consolidation will result in a reduction of certain noninterest
expenses over time. It is the first area that the Company has studied and
combined, but will serve as the model for future consolidation projects. The
Chester branch of The Centreville National Bank was opened in February of 2003,
bringing the number of full service banking offices to twelve. The Talbot Bank
will begin construction of its new branch location in Cambridge during 2003,
which we feel will enhance the Bank's presence in that community.
IN CONCLUSION
Our commitment to excellence in customer service and our desire to expand
services and product offerings will continue in the upcoming year. Although
there is uncertainty about the future of the national economy, we remain certain
that the future of our Company is bright. Thanks to the dedicated staff of Shore
Bancshares, Inc. and its subsidiaries we have exceeded our expectations once
again.
Sincerely,
W. Moorhead Vermilye
President and CEO, Shore Bancshares, Inc.
President and CEO, The Talbot Bank
Daniel T. Cannon
Executive Vice President and COO, Shore Bancshares, Inc.
President and CEO, The Centreville National Bank
B. Vance Carmean, Jr.
Chairman of the Board, Shore Bancshares, Inc.
ABOUT SHORE BANCSHARES:
Shore Bancshares, Inc. ("Shore") is a financial holding company, which was
formed on March 15, 1996. Headquartered in Easton, Maryland, it is the sole
shareholder of The Talbot Bank of Easton, Maryland ("Talbot Bank") and The
Centreville National Bank of Maryland ("Centreville National Bank"),
collectively referred to as the "Banks". On May 1, 2002 Shore began operation of
its insurance subsidiaries, The Avon Dixon Agency, LLC and Elliott Wilson
Insurance, LLC, collectively referred to as the "Insurance Agencies". During
2002 Wye Financial Services, LLC ("Wye Financial"), a registered investment
advisory firm was formed.
ABOUT OUR BANK AFFILIATES:
Talbot Bank commenced operations in 1885 and is a Maryland chartered commercial
bank. The Centreville National Bank commenced operations in 1876 and is a
national banking association. The Banks operate twelve full service branches and
seventeen Automated Teller Machines ("ATM's"), providing a full range of
commercial and consumer banking products and services to individuals,
businesses, and other organizations in Kent, Queen Anne's, Caroline, Talbot and
Dorchester counties in Maryland. Deposits are insured by the Federal Deposit
Insurance Corporation ("FDIC").
CONSUMER BANKING SERVICES:
The Banks offer a wide variety of services to individuals within the communities
they serve. Consumer banking services include no-fee access to any account at
any affiliate Bank's ATM and the ability to make loan payments, deposits and
withdrawals at any affiliate branch office using Shore Banclink. Telephone
Banking is available to allow access to account information and funds transfer
24 hours per day, 7 days a week. A toll free number is available for this
service, allowing free access to an account from anywhere. Internet banking
services, including bill payer service is also available. Using the internet
banking solution, account activity can be reviewed, funds transferred, and bills
paid online.
Deposit products available to customers include various checking accounts,
savings and money market accounts, individual retirement accounts and
certificates of deposit. The Banks also offer mortgage loans, home equity loans,
installment loans, debit and credit cards, personal lines of credit, to meet a
variety of consumer financing needs. Safe deposit services are available at most
locations. Wye Mortgage Group, a division of Centreville National Bank, offers a
variety of long-term fixed rate residential mortgage products to our customers.
COMMERCIAL BANKING SERVICES:
The Banks are dedicated to serving the needs of the local communities in which
we operate. Our knowledge of the local business community enables us to meet the
individual needs of each commercial customer, by providing credit for working
capital, facilities financing and equipment purchases. Deposit products offered
to businesses include commercial checking, savings and related depository
services, including telephone and internet banking. Commercial loan products
include lines of credit, term loans, accounts receivable financing, commercial
and construction real estate loans, and other forms of secured financing. The
Business Manager program can alleviate the burden of receivables billing and
collection, improving customer cash flow. Commercial credit card programs are
available to suit the customers' individual needs.
INVESTMENT AND WEALTH MANAGEMENT SERVICES:
Asset management services, comprehensive financial and retirement planning and
estate planning are offered through Wye Financial Services, LLC. Our goal is to
provide true value by understanding customer goals and developing a plan that
will help them achieve those goals with the minimum amount of risk. Each
affiliate bank also offers a variety of non-deposit investment products,
including fixed and variable annuities and mutual funds, to its customers.
Investment advisors are available to design a plan to assist customers in
achieving their financial goals for retirement, saving for education, or to
implement a tax deferral strategy.
INSURANCE PRODUCTS AND SERVICES:
A full range of insurance products and services are available to customers
through our insurance affiliates, who operate from four full service offices
located in Talbot and Queen Anne's Counties. Elliott Wilson Insurance and The
Avon Dixon Agency are independent insurance agencies with over 150 years of
experience serving the needs of their neighbors in the Chesapeake Bay area.
Having access to over 20 insurance companies, we are able to provide quality,
economical solutions for our customer's insurance needs. There are over 40
licensed agents who can provide assistance with individual and business
insurance needs including: property and casualty insurance, life, marine,
individual health and long term care insurance. A full range of employee benefit
plans are available to businesses, including group life, health, disability and
long-term care. Pension and profit sharing plans and retirement plans for
executives and employees can be developed to suit the individual needs of the
business.
CONSOLIDATED FINANCIAL HIGHLIGHTS
Percent
Increase
Years ended December 31, 2002 2001 (Decrease)
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
FOR THE YEAR
Interest income $36,306 $38,938 (6.8%)
Interest expense 12,438 17,061 (27.1%)
Net interest income 23,868 21,877 9.1%
Net income 8,790 7,994 10.0%
Cash dividends 3,217 3,198 0.6%
- --------------------------------------------------------------------------------
AVERAGE
Total assets $621,141 $562,026 10.5%
Total loans 423,771 386,161 9.7%
Total deposits 517,253 466,772 10.8%
Stockholders' equity 74,545 68,332 9.1%
- --------------------------------------------------------------------------------
AT YEAR END
Total assets $654,066 $582,403 12.3%
Total loans 439,539 392,706 11.9%
Total deposits 545,192 487,470 11.8%
Stockholders' equity 78,028 70,971 9.9%
- --------------------------------------------------------------------------------
PER SHARE Net income per common share:
Basic $1.64 $1.50 9.3%
Diluted $1.62 $1.49 8.7%
Cash dividends $0.60 $0.60 0.0%
Book value at year-end $14.52 $13.31 9.1%
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PERFORMANCE OVERVIEW
Shore Bancshares, Inc. (the "Company") recorded a 10% increase in net income for
2002. Net income for the year ended December 31, 2002 was $8,790,000, compared
to $7,994,000 and $7,957,000 for the years ended December 31, 2001 and 2000,
respectively. Basic net income per share for 2002 was $1.64, an increase of 9.3%
over 2001. Basic net income per share was $1.50 for both 2001 and 2000. Diluted
net income per share was $1.62, an increase of 8.7%, compared to $1.49 and $1.48
for 2001 and 2000, respectively.
Return on average assets was 1.42% for 2002 and 2001, compared to 1.52% for
2000. Return on shareholders' equity for 2002 was 11.79% compared to 11.70% for
2001 and 12.98% for 2000. Average assets increased 10.5% totaling $621,141,000,
average loans increased 9.7% totaling $423,771,000, average deposits increased
10.8% totaling $517,253,000 and average shareholders' equity increased 9.1%
totaling $74,545,000 for the year ended December 31, 2002, when compared to
2001.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow general practices within the industries in which it operates. Application
of these principles requires management to make estimates, assumptions, and
judgments that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, the financial statements could reflect different
estimates, assumptions, and judgments. Certain policies inherently have a
greater reliance on the use of estimates, assumptions, and judgments and as such
have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available.
The most significant accounting policies followed by the Company are presented
in Note 1 to the consolidated financial statements. These policies, along with
the disclosures presented in the other financial statement notes and in this
financial review, provide information on how significant assets and liabilities
are valued in the financial statements and how those values are determined.
Based on the valuation techniques used and the sensitivity of financial
statement amounts to the methods, assumptions, and estimates underlying those
amounts, management has identified the determination of the allowance for credit
losses to be the accounting area that requires the most subjective or complex
judgments, and as such could be most subject to revision as new information
becomes available.
The allowance for credit losses represents management's estimate of probable
credit losses inherent in the loan portfolio as of the balance sheet date.
Determining the amount of the allowance for credit losses is considered a
critical accounting estimate because it requires significant judgment and the
use of estimates related to the amount and timing of expected future cash flows
on impaired loans, estimated losses on pools of homogeneous loans based on
historical loss experience, and consideration of current economic trends and
conditions, all of which may be susceptible to significant change. The loan
portfolio also represents the largest asset type on the consolidated balance
sheets. Note 1 to the consolidated financial statements describes the
methodology used to determine the allowance for credit losses and a discussion
of the factors driving changes in the amount of the allowance for credit losses
is included in the Credit Risk Management section of this financial review.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
Note 1 to the consolidated financial statements discusses new accounting
policies adopted by the Company during 2002 and the expected impact of
accounting policies recently issued or proposed but not yet required to be
adopted. To the extent the adoption of new accounting standards materially
affects the Company's financial condition, results of operations, or liquidity,
the impacts are discussed in the applicable section(s) of this financial review
and notes to the consolidated financial statements.
FORWARD LOOKING STATEMENTS
Portions of this Annual Report contain forward-looking statements within the
meaning of The Private Securities Litigation and Reform Act of 1995. Such
statements are not historical facts and include expressions about the Company's
confidence, policies, and strategies, the adequacy of the allowance for credit
losses, realization of deferred taxes, interest rate risk, capital levels and
liquidity. Such forward-looking statements involve certain risks and
uncertainties, including general economic conditions, competition in the
geographic and business areas in which the Company and its affiliates operate,
inflation, fluctuations in interest rates, legislation, and governmental
regulation. These risks and uncertainties are described in more detail in Part
I, Item 1 of the Company's Form 10-K, under the heading "Risk Factors". Actual
results may differ materially from such forward-looking statements, and the
Company assumes no obligation to update forward-looking statements at any time.
RESULTS OF OPERATIONS
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income remains the most significant component of the Company's
earnings. It is the excess of interest and fees earned on loans, federal funds
sold, and investment securities, over interest paid on deposits and borrowings.
Interest income declined in 2002 and 2001 as a result of lower overall yields on
earning assets, however a greater relative reduction in interest expense
resulted in increased net interest income for both years when compared to the
prior year. The Federal Reserve reduced short-term interest rates once in 2002
compared to a record setting eleven reductions during 2001. The federal funds
rate declined 50 basis points from 1.75 % at the beginning of 2002 to 1.25% at
December 31, 2002. Rate reductions during 2001 resulted in a decline in the
federal funds rate from 6.50% at the beginning of the year to 1.75% at December
31, 2001. New York Prime interest rate, which is the index most commonly used to
price loans, fell a corresponding 50 basis points to 4.25% at December 31, 2002
from 4.75% at January 1, 2002. In 2001, New York Prime fell 475 basis points
from 9.50% at January 1, 2001 to 4.75% at December 31, 2001. The rate paid for
interest bearing liabilities decreased 132 basis points from 3.92% for the year
ended December 31, 2001 to 2.60% for the year ended December 31, 2002. The
average balance of earning assets increased during 2002, totaling $587,100,000,
compared to $534,224,000 for 2001; however, the yield on earning assets declined
111 basis points to 6.24%. On a tax equivalent basis, net interest income for
2002 was $24,184,000, compared to $22,191,000 for 2001 and $21,926,000 for 2000,
representing an increase of 9.0% and 1.2% for 2002 and 2001, respectively.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth the major components of net interest income, on a
tax equivalent basis, as of December 31, 2002, 2001 and 2000.
(Dollars in thousands) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Average Interest Yield/ Average Interest Yield/ Average Interest Yield/
Balance (1) Rate Balance (1) Rate Balance (1) Rate
------------------------------- ------------------------------- -------------------------------
Earning Assets:
Investment securities:
Taxable $115,012 $5,641 4.91% $104,547 $ 5,977 5.72% $109,687 $ 6,688 6.10%
Non-taxable 11,058 733 6.63 9,892 673 6.80 11,149 756 6.78
Loans (2)(3) 423,771 29,646 7.00 386,161 31,320 8.11 367,075 31,700 8.64
Interest bearing deposits 9,849 149 1.52 10,701 370 3.46 - - -
Federal funds sold 27,410 453 1.65 22,923 912 3.98 10,397 670 6.44
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total earning assets 587,100 36,622 6.24% 534,224 39,252 7.35% 498,308 39,814 7.99%
--------- --------- ---------
Cash and due from banks 16,757 14,815 12,292
Other assets 21,550 17,240 18,243
Allowance for credit losses (4,266) (4,253) (4,122)
--------- --------- ---------
Total assets $621,141 $562,026 $524,721
========= ========= =========
Interest bearing liabilities:
Demand $91,939 $ 762 .83% $ 86,100 $ 1,494 1.74% $ 76,232 $ 1,990 2.61%
Savings 126,947 1,809 1.43 99,259 2,409 2.43 102,651 3,065 2.99
Certificates of deposit
$100,000 or more 87,761 3,032 3.45 76,580 4,026 5.26 71,111 4,071 5.72
Other time 145,539 6,340 4.36 148,706 8,307 5.59 134,245 7,351 5.48
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Interest bearing deposits 452,186 11,943 2.64 410,645 16,236 3.95 384,239 16,477 4.29
Short-term borrowings 20,986 243 1.16 19,315 554 2.87 21,522 1,096 5.09
Long-term debt 5,000 252 5.04 5,000 271 5.42 5,000 315 6.30
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total interest bearing
liabilities 478,172 12,438 2.60% 434,960 17,061 3.92% 410,761 17,888 4.36%
--------- --------- --------- --------- ---------
Noninterest bearing deposits 65,067 56,127 50,058
Other liabilities 3,357 2,607 2,617
Stockholders' equity 74,545 68,332 61,285
--------- --------- ---------
Total liabilities and
stockholders' equity $621,141 $562,026 $524,721
========= ========= =========
Net interest spread $24,184 3.64% $22,191 3.43% $21,926 3.63%
========== ========= =========
Net interest margin 4.12% 4.15% 4.40%
<FN>
(1) All amounts are reported on a tax equivalent basis computed using the
statutory federal income tax rate of 34% exclusive of the alternative minimum
tax rate and nondeductible interest expense. The taxable equivalent adjustment
amounts utilized in the above table to compute yields aggregated $316 in 2002,
$314 in 2001, amd $334 in 2000.
(2) Average loan balances include nonaccrual loans.
(3) Interest income on loans includes amortized loan fees, net of costs, for
each category and yields are stated to include all.
</FN>
The Company's tax equivalent yield on loans declined in 2002 and 2001 as new
loans and loans refinanced with the Company were recorded at rates which were
much lower than the year before. Increased volume of loans during both 2002 and
2001 was not enough to offset the affects of declining interest rates. The lower
overall yield on loans caused a reduction in interest income of $4,328,000,
while increased loan volume only generated an additional $2,654,000 of interest
income. The tax equivalent yield on earning assets was 6.24% for 2002, compared
to 7.35% and 7.99% for 2001 and 2000, respectively.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Growth in the average balance of earning assets was $52,876,000 or 9.9% for the
year ended December 31, 2002. Average loans increased $37,610,000 or 9.7%,
totaling $423,771,000, compared to an increase of $19,086,000 or 5.2% during
2001. The average balance of investment securities increased $11,631,000 and
federal funds sold and interest bearing deposits in other banks increased
$3,635,000. In 2001, the average balance of earning assets increased $35,916,000
or 7.2%, driven primarily by growth in interest bearing deposits and federal
funds sold, with lower overall yields than other earning assets. As a percentage
of total average earning assets, loans and investment securities totaled 72.2%
and 21.5%, respectively, for 2002, compared to 72.3% and 21.4%, respectively,
for 2001.
The following Rate/Volume Variance Analysis identifies the portion of the
changes in net interest income, which are attributable to changes in volume of
average balances or to changes in the yield on earning assets and rates paid on
interest bearing liabilities.
2002 OVER (UNDER) 2001 2001 OVER (UNDER) 2000
---------------------- ----------------------
TOTAL CAUSED BY TOTAL CAUSED BY
--------- ---------
(DOLLARS IN THOUSANDS) VARIANCE RATE VOLUME VARIANCE RATE VOLUME
- -------------------------------------------------------------------------------------------------------------------------------
Interest income from earning assets:
Interest Bearing Deposits $(221) $ (209) $ (12) $ 370 $ - $ 370
Federal funds sold (459) (554) 95 242 (113) 355
Taxable investment securities (336) (858) 522 (711) (411) (300)
Non-taxable investment securities 60 (17) 77 (83) 2 (85)
Loans (1,674) (4,328) 2,654 (380) (1,949) 1,569
- -------------------------------------------------------------------------------------------------------------------------------
Total interest income (2,630) (5,966) 3,336 (562) (2,471) 1,909
- -------------------------------------------------------------------------------------------------------------------------------
Interest expense on deposits and borrowed funds:
Interest bearing demand (732) (784) 52 (496) (808) 312
Savings deposits (600) (1,069) 469 (656) (557) (99)
Time deposits (2,961) (3,267) 306 911 (608) 1,519
Short term borrowings (311) (349) 38 (542) (494) (48)
Long term debt (19) (19) - (44) (44) -
- -------------------------------------------------------------------------------------------------------------------------------
Total interest expense (4,623) (5,488) 865 (827) (2,511) 1,684
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income $1,993 $(478) $ 2,471 $ 265 $ 40 $ 225
- -------------------------------------------------------------------------------------------------------------------------------
THE RATE AND VOLUME VARIANCE FOR EACH CATEGORY HAS BEEN ALLOCATED ON A
CONSISTENT BASIS BETWEEN RATE AND VOLUME VARIANCES, BASED ON A PERCENTAGE OF
RATE, OR VOLUME, VARIANCE TO THE SUM OF THE ABSOLUTE TWO VARIANCES.
The Company's net interest margin (its tax equivalent net interest income
divided by average earning assets) represents the net yield on earning assets.
The net interest margin is managed through loan and deposit pricing and
assets/liability strategies. Short-term rates declined an additional 50 basis
points in 2002 after a record setting decline of 475 basis points in 2001. The
Company's net interest margin declined 3 basis points for 2002, from 4.15% to
4.12%, compared to a 25 basis point decline for 2001. The decrease was the
result of lower yields on interest earning assets. The Company's net interest
spread, which is the difference between the average yield on earning assets and
the rate paid for interest bearing liabilities, increased from 3.43% in 2001 to
3.64% for 2002.
The Company continued to reduce the rates paid for interest bearing liabilities
during 2002, resulting in an overall decline of 132 basis points. Interest
expense for 2002 decreased $4,623,000. Lower rates accounted for a $5,488,000
reduction in interest expense, while the increased volume of deposits and other
interest bearing liabilities generated additional interest expense of $865,000
for 2002. The average rate paid for certificates of deposit of $100,000 or more
decreased 181 basis points, and for all other time deposits the decrease was 123
basis points. Average interest bearing demand deposits increased $5,839,000
during the year, and the rate paid for those deposits decreased 91 basis points
to .83%, compared to 1.74% for 2001 and 2.61% for 2000. The rate paid for
short-term borrowings, which consist primarily of securities sold under
agreements to repurchase, decreased 171 basis points to 1.16%, compared to 2.87%
in 2001. The rate paid on the Company's long-term debt was 5.04% for 2002,
compared to 5.42% and 6.30% for 2001 and 2000, respectively.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
NONINTEREST INCOME
Noninterest income increased $3,322,000 or 125.5% in 2002, compared to a
decrease of $458,000 or 14.8% in 2001. Insurance commissions from the acquired
insurance agencies, which began operating May 1, 2002, accounted for $2,872,000
of this increase. Service charges on deposit accounts increased $38,000 and
$126,000 for 2002 and 2001, respectively. Gains on sales of securities increased
$16,000. Other service charges and fees increased $211,000 or 56.9% as a result
of an increase in commissions on the sale of nondeposit products of $87,000,
increased ATM and debit card fee income of $43,000 and income generated by the
insurance agencies for services provided to customers $51,000. Other noninterest
income increased $174,000 or 48.5% in 2002 primarily as a result of income
generated from the sale of loans on the secondary market totaling $116,000.
Mortgage loans that are to be sold in the secondary market are not generally
funded by the Company, however the Company receives a commission upon
settlement.
The following table summarizes noninterest income of the Company as of December
31:
YEARS ENDED CHANGE FROM PRIOR YEAR
2002/01 2001/00
(DOLLARS IN THOUSANDS) 2002 2001 2000 AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Service charges on deposit accounts $1,915 $1,877 $1,751 $38 2.0% $126 7.2%
Other service charges and fees 582 371 376 211 56.9 (5) (1.3)
Gain (loss) on sale of securities 26 10 (48) 16 160.0 58 120.8
Gain on life insurance policies - - 750 - - (750) (100.0)
Earnings from unconsolidated subsidiaries 40 29 15 11 37.9 14 93.3
Insurance agency commissions 2,872 - - 2,872 100.0 - -
Other noninterest income 533 359 260 174 48.5 99 38.1
- ------------------------------------------------------------------------------------------------------------------------------------
Total $5,968 $2,646 $3,104 $3,322 125.5 % $(458) (14.8%)
- ------------------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSES
Total noninterest expense increased $3,934,000 or 32.7% in 2002, compared to an
increase of $122,000 or 1.0% in 2001. The increase is primarily attributable to
the operation of the insurance subsididaries, which were acquired in 2002. The
following increases in noninterest expenses related to the operation of the
insurance agencies for eight months during 2002: salaries and employee benefits
$1,949,000, occupancy and equipment expense $249,000 and other noninterest
expense $457,000. Amortization of other intangible assets totaling $122,000 is
attributable to the operation of the insurance subsidiaries for eight months of
2002. See Note 8 to the consolidated financial statements for further
information regarding the impact of goodwill and other intangible assets on the
financial statements. The additional amount of increases in each category of
noninterest expense are attributable to full year effect of operating of a new
branch of The Centreville National Bank, which opened in April of 2001, start up
costs resulting from a branch opening in 2003 and general increased costs of
operations. During 2001, the Banks began using image technology, which, combined
with growth in customer bases and other enhanced services, contributed to the
overall increase in data processing costs of $95,000. The Company had 222
full-time equivalent employees at December 31, 2002, compared to 163 and 154 at
December 31, 2001 and 2000, respectively. Other operating expenses declined in
2001, as a result of non-recurring merger related expenses in 2000.
The following table summarizes noninterest expense of the Company as of
December 31:
YEARS ENDED CHANGE FROM PRIOR YEAR
2002/01 2001/00
(DOLLARS IN THOUSANDS) 2002 2001 2000 AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits $9,573 $6,725 $6,472 $2,848 42.3% $253 3.9%
Occupancy and equipment 1,758 1,512 1,373 246 16.3 139 10.2
Data processing 889 859 764 30 3.5 95 12.3
Directors' fees 472 418 411 54 12.9 7 1.7
Amortization of goodwill and
and other intangible assets 129 147 147 (18) (12.2) - -
Other operating expenses 3,139 2,365 2,737 774 32.7 (372) (13.6)
- ------------------------------------------------------------------------------------------------------------------------------------
Total $15,960 $12,026 $11,904 $3,934 32.7 % $122 1.0%
- ------------------------------------------------------------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INCOME TAXES
Income tax expense was $4,730,000 for 2002, compared to $4,277,000 for 2001 and
$4,398,000 for 2000. The effective tax rates on earnings were 35.0%, 34.9% and
35.6%, respectively.
REVIEW OF FINANCIAL CONDITION
Asset and liability composition, asset quality, capital resources, liquidity,
market risk and interest sensitivity are all factors which affect the Company's
financial condition.
ASSETS
Total assets increased 12.3% to $654,066,000 at December 31, 2002, compared to
an increase of 5.3% for 2001. Average total assets were $621,141,000, an
increase of 10.5% in 2002. Average total assets increased 7.1% in 2001, totaling
$562,026,000 for the year. The loan portfolio represents 72.2% of average
earning assets and is the primary source of income for the Company.
Funding for loans is provided primarily by core deposits and short-term
borrowings. Total deposits increased 11.8% to $545,192,000 at December 31, 2002,
compared to a 4.9% increase for 2001.
The following table sets forth the average balance of the components of
average earning assets as a percentage of total average earning assets as of
December 31.
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Investment securities 21.47% 21.42% 24.25% 27.23% 25.88%
Loans 72.18 72.28 73.66 68.62 68.80
Interest bearing deposits
with other Banks 1.68 2.00 -
Federal funds sold 4.67 4.30 2.09 4.15 5.32
------- ------- ------- ------- -------
100.00% 100.00% 100.00% 100.00% 100.00%
====== ====== ====== ====== ======
INTEREST BEARING DEPOSITS WITH OTHER BANKS AND FEDERAL FUNDS SOLD
The Company invests excess cash balances in interest bearing accounts or federal
funds sold, with its correspondent banks. These liquid investments are
maintained at a level necessary to meet the immediate liquidity needs of the
Company. The average balance of interest bearing deposits with other banks and
federal funds sold increased $3,635,000 to $37,259,000 during 2002 and
$23,227,000 to $33,624,000 during 2001.
INVESTMENT SECURITIES
The investment portfolio is structured to provide liquidity for the Company and
also plays an important role in the overall management of interest rate risk.
Investment securities in the held to maturity category are stated at cost
adjusted for amortization of premiums and accretion of discounts. The Company
has the intent and ability to hold such securities until maturity. Investment
securities available for sale are stated at estimated fair value based on quoted
market prices. They represent securities which may be sold as part of the
Company's asset/liability strategy or which may be sold in response to changing
interest rates. Net unrealized holding gains and losses on these securities are
reported net of related income taxes as accumulated other comprehensive income,
a separate component of stockholders' equity. At December 31, 2002, the Company
had classified 89% of the portfolio as available for sale and 11% as held to
maturity, compared to 91% and 9%, one year ago. The percentage of securities
designated as available for sale reflects the amount needed to support the
anticipated growth and liquidity needs of the Company. With the exception of
municipal securities, it is the general practice of the Company to classify all
newly purchased securities as available for sale.
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
At December 31, 2002, investment securities available for sale were
$110,864,000, a decrease of $4,068,000 or 3.5% compared to $114,932,000 one year
ago. U.S. Government Agency bonds totaled $68,087,000 or 61.4% and $67,647,000
or 58.9% of the available for sale portfolio at December 31, 2002 and 2001,
respectively. Mortgage-backed securities totaled $32,237,000 or 29.1% and
$32,877,000 or 28.6% of the available for sale portfolio at December 31, 2002
and 2001. During 2002, proceeds from matured or called bonds were typically
reinvested in U.S. Government Agency bonds with maturities less than 5 years.
Earnings on certain U.S. Government Agency Bonds are exempt from state income
tax and producing higher effective returns without affecting the overall credit
risk and liquidity of the portfolio. In 2001, the Company invested in both U.S.
Government Agency bonds and mortgage-backed securities. Investments made in
mortgage-backed securities had higher overall yields than U.S. Government Agency
bonds. Investment securities held to maturity totaled $13,124,000 at December
31, 2002, compared to $10,896,000 one year ago. Growth in the held to maturity
category was the result of investments made in tax-exempt municipal bonds during
2002. The Company does not invest in structured notes or other derivative
securities.
The following table sets forth the maturities and weighted average yields of the
investment portfolio based upon the earliest possible repricing date as of
December 31, 2002.
1 YEAR OR LESS 1-5 YEARS 5-10 YEARS OVER 10 YEARS
-------------- --------- ---------- -------------
Carrying Average Carrying Average Carrying Average Carrying Average
(Dollars in thousand) Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------------------------
Held to Maturity:
Obligations of states and
political subdivisions (1) $ 1,476 6.16% $ 3,174 6.54% $4,296 6.28% $4,171 6.09%
Mortgage backed securities - - 7 9.38 - - - -
------------------------------------------------------------------------------------------------
Total Held to Maturity $ 1,476 6.16% $ 3,181 6.55% $4,296 6.28% $4,171 6.09%
================================================================================================
Available for Sale:
U.S. Treasury and other
U.S. government agencies $15,374 4.77% $52,714 3.81% $1,064 4.96% $ - -%
Obligations of states and
political subdivisions (1) 111 6.23 - - - - - -
Mortgage backed securities 6,559 5.29 22,973 5.29 1,762 5.50 944 5.91
Other securities - - - - - - 9,363 4.95
----------------------------------------------------------------------------------------------
Total Available for Sale $ 22,044 4.93% $75,687 4.26% $2,826 5.30% $10,307 5.04%
==============================================================================================
(1) Yields adjusted to reflect a tax equivalent basis assuming a federal tax
rate of 34%.
LOANS
Loans grew 11.9% in 2002, compared to 2.7% in 2001and 10.6% in 2000. Most of the
growth was concentrated in loans secured by real estate, which increased
$41,116,000 or 14%. Commercial, financial and agricultural loans increased
$3,009,000 or 5.1%, and real estate construction loans increased $5,099,000 or
25.2%. A healthy local real estate market and low interest rates were the
driving force behind the record growth. A decline in consumer loans of
$2,391,000 or 13.9% resulted in 2002 as many homeowners taking advantage of the
low interest rate environment during the year refinanced their residential
mortgage loans, paying off consumer debt with equity from their homes. Loans,
net of unearned income, totaled $439,539,000 at December 31, 2002, an increase
of $46,833,000 when compared to 2001. Loans, net of unearned income, totaled
$392,706,000 on December 31, 2001, an increase of $10,200,000 or 2.7% when
compared to 2000. Loan growth occurred in all components of the loan portfolio
during 2001. Commercial loans increased $4,311,000 or 7.9%, construction loans
increased $1,668,000 or 9%, mortgage loans increased $2,785,000 or 1%, and
consumer loans increased $1,436,000 or 7.9% for the year ended December 31,
2001. Growth in loans for the year 2001 was difficult because of the number of
loans paid off as borrowers sought long-term fixed rate financing that the
Company did not offer due to the increased interest rate risk associated with
it. However, during September 2002, the Company began to originate and sell
long-term fixed rate residential mortgage loans on the secondary market.
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table below sets forth trends in the composition of the loan portfolio over
the past five years.
December 31,
(Dollars in thousands) 2002 2001 2000 1999 1998
-----------------------------------------------------------------------
Commercial, financial and agricultural $ 61,962 $ 58,953 $ 54,642 $ 55,468 $ 42,109
Real estate - construction 25,354 20,255 18,587 15,643 13,228
Real estate - mortgage 335,037 293,921 291,136 258,443 235,830
Consumer 17,186 19,577 18,141 16,237 14,393
---------- ---------- --------- --------- ---------
Total Loans $439,539 $392,706 $382,506 $345,791 $305,560
======== ======== ======== ======== ========
The table below sets forth the maturities and interest rate sensitivity of the
loan portfolio at December 31, 2002.
Maturing
Maturing After one Maturing
Within But Within After Five
One Year Five Years Years Total
Real Estate Construction
and land development $ 20,896 $4,409 $ 49 $ 25,354
Commercial, financial and agricultural 36,097 18,455 7,410 61,962
Mortgage 62,273 171,207 101,557 335,037
Consumer 6,144 9,012 2,030 17,186
-------- ------- -------- --------
Total $125,410 $203,083 $111,046 $439,539
======== ======== ======== ========
Rate Terms:
Fixed-Interest Rate Loans $61,236 $165,389 $41,714 $268,339
Adjustable-Interest Rate Loans 64,174 37,694 69,332 171,200
------- ------- -------- ---------
Total $125,410 $203,083 $111,046 $439,539
======== ======== ======== ========
DEPOSITS
The Company primarily utilizes core deposits to fund its earning assets. At
December 31, 2002 and 2001, deposits provided funding for 88% and 87% of average
earning assets, respectively. Average deposits increased 10.8% in 2002, compared
to a 7.5% increase in 2001. The average rate paid on interest bearing deposits
decreased 132 basis points to 2.60% for 2002, compared to 3.92% for 2001. Growth
in deposits occurred in all categories, except certificates of deposit and other
time deposits less than $100,000. On a percentage basis the average balance of
money management deposits increased in 2002 when compared to 2001. Increased
deposits in 2002 and 2001 were partly driven by depositors looking for principal
protection despite low rates being paid on these accounts. During 2002, the
average balance of noninterest bearing demand deposits increased $8,940,000 or
15.9%, NOW and SuperNOW increased $5,838,000 or 6.8%, savings increased
$5,505,000 or 18.1%, money management increased $22,184,000 or 32.2% and
certificates of deposit $100,000 or more increased $11,181,000 or 14.6% when
compared to 2001. The average balance of certificates of deposit less than
$100,000 and other time deposits decreased $3,167,000 or 2.1% during 2002. The
overall rate paid for interest bearing deposits declined in 2002 as certificates
of deposit with higher rates matured and were reinvested in lower yielding
certificates of deposit or savings accounts.
The Company does not accept brokered deposits, nor does it rely on purchased
deposits as a funding source for loans.
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth the average balances of deposits and the
percentage of each category to total deposits for the years ended December 31.
(Dollars in thousands) Average Balances
- ---------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
Noninterest-bearing demand $65,067 12.58% $56,127 12.02% $50,058 11.53%
Interest bearing deposits
NOW and Super NOW 91,938 17.77 86,100 18.45 76,232 17.55
Savings 35,885 6.93 30,380 6.51 30,863 7.11
Money management 91,063 17.61 68,879 14.76 71,788 16.53
CD's and other time deposits
less than $100,000 145,539 28.14 148,706 31.86 134,245 30.91
CD's $100,000 or more 87,761 16.97 76,580 16.40 71,111 16.37
-------- ----- -------- ------ -------- ------
$517,253 100.00% $466,772 100.00% $434,297 100.00%
======== ======= ======== ======= ======== =======
The following table sets forth the maturity ranges of certificates of deposit
with balances of $100,000 or more on December 31, 2002 (in thousands).
Three months or less $46,991
Over three through twelve month 17,374
Over twelve months 35,279
--------
$99,644
SHORT-TERM BORROWINGS
Short-term borrowings consist primarily of securities sold under agreement to
repurchase. These short-term obligations are issued in conjunction with cash
management services for deposit customers. The average balance of these
borrowings increased $1,671,000 or 8.7% in 2002, compared to a decrease of
$2,207,000 or 10.3% in 2001. In order to meet short-term liquidity needs the
Company may borrow from a correspondent bank under a federal funds line of
credit arrangement, however no such borrowings occurred during 2002.
The following table sets forth the Company's position with respect to short-term
borrowings.
(Dollars in thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
INTEREST INTEREST INTEREST
BALANCE RATE BALANCE RATE BALANCE RATE
- ----------------------------------------------------------------------------------------------------------------------------
FEDERAL FUNDS PURCHASED AND SECURITIES SOLD
UNDER AGREEMENTS TO REPURCHASE:
Average outstanding for the year $20,986 1.15% $19,315 2.87% $21,522 5.09%
Outstanding at year end 22,008 0.90% 17,054 1.15% 16,252 4.96
Maximum outstanding at any month end 28,585 - 25,175 - 32,498 -
CAPITAL MANAGEMENT
The Company continues to maintain capital at levels in excess of the risk based
capital guidelines adopted by the federal banking agencies. Total stockholders'
equity was $78,028,000 at December 31, 2002, 9.9% higher than the previous year.
Stockholders' equity was $70,971,000 at December 31, 2001, an increase of 9.1%
over December 31, 2000. The increase in stockholders' equity in 2002 is
primarily due to earnings of the Company for the year of $8,790,000, reduced by
dividends paid on common stock of $3,217,000. The Company recorded an additional
$800,000 in stockholders' equity in 2002 as a result of the issuance of 39,037
shares of common stock for acquisitions.
The Company records unrealized holding gains (losses), net of tax, on investment
securities available for sale as accumulated other comprehensive income (loss),
a separate component of stockholder's equity. As of December 31, 2002, the
portion of the Banks' investment portfolio designated as "available for sale"
had unrealized holding gains, net of tax, of $1,152,000, compared to $466,000 at
December 31, 2001.
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table compares the Company's capital ratios as of December 31 to
the regulatory requirements.
Regulatory
(Dollars in thousands) 2002 2001 Requirements
- --------------------------------------------------------------------------------
Tier 1 capital $ 68,799 $ 68,657
Tier 2 capital 9,229 2,313
- --------------------------------------------------------------------------------
Total capital, less deductions $ 78,028 $ 70,970
Risk-adjusted assets $449,988 $ 402,436
Risk-based capital ratios:
Tier 1 15.29% 17.06% 4.0%
Total capital 17.34% 17.64% 8.0%
Total capital $ 68,799 $ 68,657
- --------------------------------------------------------------------------------
Total adjusted assets $641,378 $579,349
Leverage capital ratio 10.73% 11.85% 4.0%
- --------------------------------------------------------------------------------
Management knows of no trends or demands, commitments, events or uncertainties,
which will materially affect capital.
RISK MANAGEMENT
The Board of Directors is the foundation for effective corporate governance and
risk management. The Board demands accountability of management, keeping the
interests of stockholders' in focus. Through its Asset/Liability and Audit
Committees, the Board actively reviews critical risk positions, including
market, credit, liquidity and operational risk. The Company's goal in managing
risk is to reduce earnings volatility, control exposure to unnecessary risk, and
ensure appropriate returns for risk assumed. Senior members of management
actively manage risk at the product level, supplemented with corporate level
oversight through the Asset/Liability Committee and internal audit function. The
risk management structure is designed to identify risk issues through a
systematic process, enabling timely and appropriate action to avoid and mitigate
risk.
CREDIT RISK MANAGEMENT
The Company's loan portfolio is subject to varying degrees of credit risk.
Credit risk is mitigated through portfolio diversification, limiting exposure to
any single industry or customer, collateral protection and standard lending
policies and underwriting criteria. The following discussion provides
information and statistics on the overall quality of the Company's loan
portfolio. Note 1 of the notes to consolidated financial statements describes
the accounting policies related to nonperforming loans and charge-offs and
describes the methodologies used to develop the allowance for credit losses,
including both the specific and nonspecific components. Management believes the
policies governing nonperforming loans and charge-offs are consistent with
regulatory standards. The amount of the allowance for credit losses and the
resulting provision are reviewed monthly by senior members of management and
approved quarterly by the Board of Directors.
The allowance is increased by provisions for credit losses charged to expense
and recoveries of loans previously charged-off. It is decreased by loans
charged-off in the current period. Provisions for credit losses are made to
bring the allowance for credit losses within the range of balances that are
considered appropriate based upon the allowance methodology and to reflect
losses within the loan portfolio as of the balance sheet date. The Company
recorded a provision for credit losses of $356,000 in 2002, compared to $226,000
in 2001 and $437,000 in 2000. Net charge-offs were $428,000 in 2002, $236,000 in
2001 and $229,000 in 2000. While the local economy does not seem to be showing
signs of weakness or recession exhibited elsewhere in the nation, management is
aware that the effects of continued weakness in the national economy could
result in future higher loss levels for the Company. The ratio of net
charge-offs to average loans was .10% in 2002, compared to .06% in 2001. At
December 31, 2002, the allowance for credit losses was $4,117,000, or .97% of
outstanding loans, and 534% of total nonaccrual loans. This compares to an
allowance of $4,189,000, or 1.08% of outstanding loans and 444% of nonaccrual
loans, at December 31, 2001, and an allowance for credit losses of $4,199,000,
or 1.14% of outstanding loans and 674% of nonaccrual loans, at December 31,
2000.
The adequacy of the allowance for credit losses is determined based upon
management's estimate of the inherent risks associated with lending activities,
estimated fair value of collateral, past experience and present indicators such
as loan delinquency trends, nonaccrual loans and current market conditions.
Management believes the allowance is adequate; however, future changes in the
composition of the loan portfolio and financial condition of borrowers may
result in additions to the allowance. Examination of the portfolio and allowance
by various regulatory agencies and consultants engaged by the Company may result
in the need for
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
additional provisions based upon information available at the time of the
examination.
Each of the Company's bank subsidiaries maintains a separate allowance for
credit losses, which is only available to absorb losses from their respective
loan portfolios. Each bank's allowance is subject to regulatory examination and
determination as to its adequacy.
The allowance for credit losses is comprised of two parts: the specific
allowance and the nonspecific allowance. The specific allowance is the portion
of the allowance that results from management's evaluation of specific loss
allocations for identified problem loans and pooled reserves based on historical
loss experience for each loan category. The nonspecific allowance is determined
based on management's assessment of industry trends and economic factors in the
markets in which the Company operates. The determination of the nonspecific
allowance involves a higher risk of uncertainty and considers current risk
factors that may not have yet manifested themselves in the Company's historical
loss factors.
The specific allowance is based on quarterly analysis of the loan portfolio by
each Bank and is determined based upon the analysis of collateral values, cash
flows and guarantor's financial capacity, whichever are applicable. In addition,
allowance factors are applied to internally classified loans for which specific
allowances have not been determined and historical loss factors are applied to
homogenous pools of unclassified loans. Historical loss factors may be adjusted
by management in situations where no historical losses have occurred or where
current conditions are not reflective of the specific history of the Company.
The nonspecific allowance is based upon management's evaluation of external
conditions, the effects of which are not directly measured in the determination
of the specific allowance. The conditions evaluated in connection with the
nonspecific allowance include: general economic and business conditions
affecting the Company's primary lending area; credit quality trends; collateral
values; loan values; loan volumes and concentrations; seasoning of the loan
portfolio; specific industry conditions within the portfolio segments; recent
loss experience; duration of the current business cycle; bank regulatory
examination results; and findings of internal loan review personnel. Management
reviews the conditions which impact the nonspecific allowance quarterly and to
the extent any of these conditions relate to specifically identifiable loans may
reflect the adjustment in the specific allowance. Where any of these conditions
is not related to a specific loan or loan category, management's evaluation of
the probable loss related to the condition is reflected in the nonspecific
allowance.
Management's decision regarding the amount of the provision is influenced by
growth in commercial and real estate loan balances. In 2002, the Company
experienced its highest level of charge-offs in five years. Charge-offs were
$538,000, compared to $335,000 and $378,000 in 2001 and 2000, respectively. Past
due and nonaccrual loans declined in 2002. In 2001, past due and nonaccrual
loans increased; however, they represented primarily well-secured loans with
limited exposure to the Company. In 2000, nonaccrual loans declined and net
charge offs increased due to a reduction in recoveries of $100,000.
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth a summary of the Company's loan loss experience
for the years ended December 31.
(Dollars in thousands) 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
Balance, beginning of year $ 4,189 $ 4,199 $ 3,991 $ 3,931 $ 3,942
--------- -------- -------- -------- --------
Loans charged off:
Real estate loans (86) (5) (61) (121) (69)
Installment loans (170) (155) (73) (146) (122)
Commercial and other (282) (175) (244) (162) (193)
------- ------- ------ ------ -------
(538) (335) (378) (429) (384)
------- ------- ------ ------ -------
Recoveries:
Real estate loans 16 2 18 50 26
Installment loans 76 60 50 43 57
Commercial and other 18 37 81 156 50
------- ------- -------- --------- -----
110 99 149 249 133
------- ------- -------- --------- -------
Net losses charged off (428) (236) (229) (180) (251)
Provision for credit losses 356 226 437 240 240
------- -------- ------- ------- -------
Balance, end of year $ 4,117 $ 4,189 $ 4,199 $ 3,991 $ 3,931
------- ------- ------- ------- -------
Average loans outstanding $423,771 $386,161 $367,075 $324,507 $297,786
======== ======== ======== ======== ========
Percentage of net charge-offs to average
loans outstanding during the year .10% .06% .06% .06% .08%
Percentage of allowance for loan losses
at year-end to average loans 0.97% 1.08% 1.14% 1.23% 1.32%
Total non-accrual loans of the Company declined during 2002, representing .18%
of total loans, net of unearned income at December 31, 2002, compared to .24%
one year earlier. Loan delinquencies decreased to $374,000 for 2002, compared to
$1,532,000 for 2001.
The following table summarizes the past due and non-performing assets of the
Company as of December 31.
(Dollars in thousands) 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------
Non-performing assets:
Non-accrual loans $771 $ 943 $ 623 $1,812 $ 873
Other real estate and other assets owned 54 56 14 137 164
------ ----- ----- ------ -------
Total non-performing assets 825 999 637 1,949 1,037
Past due loans 374 1,532 1,333 1,333 1,436
------ ------ ------ ------- -------
Total non-performing assets and past due loans $1,199 $2,531 $1,970 $3,282 $2,473
====== ====== ====== ====== ======
Non-accrual loans to total loans at period end .18% .24% .16% .52% .29%
Non-accrual loans and past due loans,
to total loans at period end .26% .64% .51% .91% .76%
During 2002 there was no change in the methods or assumptions affecting the
allowance methodology. Despite a higher provision for credit losses, the
allowance decreased $72,000 or 1.7% during 2002 as the result of higher levels
of charge-offs in the consumer and commercial categories. The quality of the
loan portfolio was strong with nonaccrual loans and delinquencies at December
31, 2002 lower than at December 31, 2001. The nonspecific allowance at December
31, 2002 was 2.0% of the total allowance, compared to 4.4% one year ago. The
allowance pertaining to commercial, financial and agricultural loans represented
45.4% of the total allowance at December 31, 2002, compared to 37.3% at December
31, 2001. The increase related to the analysis of specific commercial loans with
identifiable potential losses. The amount of the reserve allocated to real
estate mortgage loans declined from 45.8% at December 31, 2001 to 44.4% at
December 31, 2002 due to fewer specific losses identified in that category. The
Company's loans are primarily made in Kent, Queen Anne, Talbot, Caroline and
Dorchester Counties on Maryland's Eastern Shore.
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Real estate mortgage loans represented 76.2% of the portfolio at December 31,
2002, compared to 74.8% at December 31, 2001. The Company has experienced low
loss levels with respect to these loans as a result of its substantial
experience in the markets it serves as well as its conservative lending
practices.
The following table sets forth the allocation of the allowance for credit losses
and the percentage of loans in each category to total loans for the years ended
December 31,
2002 2001 2000 1999 1998
(IN THOUSANDS) AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- ----------------------------------------------------------------------------------------------------------------------------------
Commercial, Financial and Agricultural $1,869 14.1% $1,563 15.0% $1,694 14.3% $1,437 16.1% $947 13.8%
Real Estate-Construction 172 5.8 135 5.2 126 4.9 108 4.5 148 4.3
Real Estate-Mortgage 1,825 76.2 1,918 74.8 1,807 76.1 1,991 74.7 1,628 77.2
Consumer 169 3.9 387 5.0 412 4.7 438 4.7 296 4.7
Nonspecific 82 - 186 - 160 - 17 - 912 -
-------------------------------------------------------------------------------------------
$4,117 100% $4,189 100% $4,199 100% $3,991 100% $3,931 100%
===========================================================================================
LIQUIDITY MANAGEMENT
Liquidity describes the ability of the Company to meet financial obligations
that arise during the normal course of business. Liquidity is primarily needed
to meet the borrowing and deposit withdrawal requirements of customers and to
fund current and planned expenditures. Liquidity is derived through increased
customer deposits, maturities in the investment portfolio, loan repayments and
income from earning assets. To the extent that deposits are not adequate to fund
customer loan demand, liquidity needs can be met in the short-term funds
markets. The Company has arrangements with correspondent banks whereby it has
$17,000,000 available in federal funds lines of credit and a reverse repurchase
agreement available to meet any short-term needs which may not otherwise be
funded by its portfolio of readily marketable investments that can be converted
to cash. The Banks are also members of the Federal Home Loan Bank of Atlanta,
which provides another source of liquidity.
At December 31, 2002, the Company's loan to deposit ratio was 81%, the same as
one year ago. Investment securities available for sale totaling $110,864,000
were available for the management of liquidity and interest rate risk. Cash and
cash equivalents at December 31, 2002 were $69,468,000, up $17,830,000 from one
year ago. Management is not aware of any demands, commitments, events or
uncertainties that will materially affect the Company's ability to maintain
liquidity at satisfactory levels.
MARKET RISK MANAGEMENT
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to changes in interest rates, exchange rates or
equity pricing. The Company's principal market risk is interest rate risk that
arises from its lending, investing and deposit taking activities. The Company's
profitability is dependent on the Banks' net interest income. Interest rate risk
can significantly affect net interest income to the degree that interest bearing
liabilities mature or reprice at different intervals than interest earning
assets. The Asset/Liability Committee of the Board of Directors (the "ALCO") of
both Banks oversees the management of interest rate risk. The ALCO's primary
purpose is to manage the exposure of net interest margins to unexpected changes
due to interest rate fluctuations. These efforts affect the loan pricing and
deposit rate policies of the Company as well as the asset mix, volume
guidelines, and liquidity and capital planning.
The Company does not utilize derivative financial or commodity instruments or
hedging strategies in its management of interest rate risk. Since the Company is
not exposed to market risk from trading activities and does not utilize hedging
strategies or off-balance sheet management strategies, the ALCO relies on "gap"
analysis as its primary tool in managing interest rate risk. Gap analysis
summarizes the amount of interest sensitive assets and liabilities which will
reprice over various time intervals. The difference between the volume of assets
and liabilities repricing in each interval is the interest sensitivity "gap".
"Positive gap" occurs when more assets reprice in a given time interval, while
"negative gap" occurs when more liabilities reprice. As of December 31, 2002,
the Company had a negative gap position within the one-year repricing interval.
The negative gap position could have a negative effect on the Company's net
interest margin if short-term interest rates continue to decline in 2003. Rates
paid for interest bearing liabilities are approaching their theoretical floors
with very little room left for reductions in the rates being paid to depositors.
The following table summarizes the Company's interest sensitivity at December
31, 2002. Loans, federal funds sold, time deposits and short term borrowings are
classified based upon contractual maturities if fixed-rate or earliest repricing
date if variable rate. Investment securities are classified by contractual
maturities or, if they have call provisions, by the most likely repricing date.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
3 Months 1 Year Non-
Within through through After Sensitive
December 31, 2002 3 Months 12 Months 5 Years 5 Years Funds Total
- -----------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
ASSETS:
Loans $157,510 $43,783 $202,629 $35,593 $ (4,093) $435,422
Investment securities 4,460 13,397 59,114 38,930 8,087 123,988
Interest bearing deposits with other banks 20,006 - - - - 20,006
Federal funds sold 27,141 - - - - 27,141
Other Assets - - - - 47,509 47,509
- -----------------------------------------------------------------------------------------------------------------------------------
Total Assets $209,117 $57,180 $261,743 $74,523 $51,503 $654,066
- -----------------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Certificates of deposit $100,000 and over $46,991 $17,374 $35,279 $ - $ - $99,644
Other time deposits 26,827 42,723 75,000 - - 144,550
Savings and money market 131,454 - - - - 131,454
NOW and SuperNOW 99,434 - - - - 99,434
Noninterest bearing demand - - - - 70,110 70,110
Short term borrowings 22,008 - - - - 22,008
Long-term debt - - 5,000 - - 5,000
Other liabilities - - - - 3,838 3,838
STOCKHOLDERS' EQUITY - - - - 78,028 78,028
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $326,714 $60,097 $115,279 $ - $151,976 $654,066
- -----------------------------------------------------------------------------------------------------------------------------------
Excess $(117,597) $(2,917) $146,464 $74,523 $(100,473)
Cumulative Excess $(117,597) $(120,514) $25,950 $100,473 $ -
Cumulative Excess as percent of total (17.98)% (18.43)% 3.97% 15.36% -
In addition to gap analysis, the Banks utilize simulation models to quantify the
effect a hypothetical immediate plus or minus 200 basis point change in rates
would have on net interest income and the fair value of capital. The model takes
into consideration the effect of call features of investments as well as
prepayments of loans in periods of declining rates. When actual changes in
interest rates occur, the changes in interest earning assets and interest
bearing liabilities may differ from the assumptions used in the model. As of
December 31, 2002, the model produced the following sensitivity profile for net
interest income and the fair value of capital.
Immediate Change in Rates Policy
+200 Basis Points -200 Basis Points Limit
- --------------------------------------------------------------------------------
% Change in Net Interest Income 4.59% (12.21)% + 25%
--
% Change in Fair Value of Capital 1.68% (0.60)% + 15%
--
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
STOCK LISTING
The Company's common is listed on the Nasdaq Small Cap Market under the symbol
SHBI. Prior to April 2001, the Company's stock was
quoted on the OTC Bulletin Board under the symbol SHBI and was traded
infrequently. Price information prior to April 2001 is based upon the
participation of market makers for the Company's stock and actual transfers
recorded by the transfer agent.
RECENT STOCK PRICES AND DIVIDENDS
The Board of Directors establishes the amount of the dividend to be paid each
quarter based upon such factors as operating results, financial condition,
capital adequacy, regulatory requirements, and shareholder return. Shareholders
received dividends totaling $3,217,000 in 2002 and $3,198,000 in 2001. The ratio
of dividends per share to net income per share was 36.6% in 2002 compared to 40%
in 2001.
The following table indicates cash dividends paid per share for each quarter of
2002, 2001 and 2000 and the ranges of representative sales prices for the stated
periods.
2002 2001 2000
Price Range Dividends Price Range Dividends Price Range Dividends
High Low Paid High Low Paid High Low Paid
First Quarter $18.20 - 20.90 $ .15 $ 17.50 - 13.50 $ .15 $ 21.00 - 18.00 $.12
Second Quarter 19.52 - 22.00 .15 20.00 - 14.75 .15 19.00 - 12.00 .12
Third Quarter 19.55 - 22.00 .15 20.45 - 18.88 .15 22.00 - 13.00 .12
Fourth Quarter 21.50 - 23.49 .15 19.25 - 17.10 .15 18.25 - 11.00 .16
----- ----- ----
$.60 $ .60 $.52
==== ===== ====
The ability of the Company to pay dividends is limited by federal and Maryland
law. The Company may pay dividends only out of prior operating earnings. For
more information regarding these restrictions, see the Risk Factors in Part I,
Item 1 of the Company's Annual Report on Form 10-K for the year ended December
31, 2002 under the heading "The Company's Ability to Pay Dividends is Limited".
SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data for the five
years ended December 31, 2002 and is qualified in its entirety by the detailed
information and financial statements, including notes thereto, included
elsewhere or incorporated by reference in this annual report. This data should
be read in conjunction with the financial statements and related notes thereto,
included elsewhere in this annual report and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Years Ended December 31,
(Dollars in thousands, except per shares data) 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS:
Interest income $36,306 $38,938 $39,480 $35,435 $34,058
Interest expense 12,438 17,061 17,888 16,039 15,386
------- ------ ------ ------ ------
Net interest income 23,868 21,877 21,592 19,396 18,672
Provision for credit losses 356 226 437 240 240
--------- ------ -------- -------- --------
Net interest income after provision for credit losses 23,512 21,651 21,155 19,156 18,432
Noninterest income 5,968 2,646 3,104 2,138 1,660
Noninterest expenses 15,960 12,026 11,904 10,961 10,634
------ ------ ------ ------ -------
Income before taxes 13,520 12,271 12,355 10,333 9,458
Income taxes 4,730 4,277 4,398 3,528 3,224
------ ------- ------- ------- ------
NET INCOME $8,790 $ 7,994 $ 7,957 $ 6,805 $6,234
======= ======= ======= ======= ======
PER SHARE DATA:
Net income - basic $1.64 $1.50 $1.50 $1.28 $1.16
Net income - diluted 1.62 1.49 1.48 1.27 1.15
Dividends paid .60 .60 .52 .45 .40
Book value (at year end) 14.52 13.31 12.21 11.00 10.58
Tangible book value (at year end) (1) 13.08 13.03 11.91 10.67 10.22
FINANCIAL CONDITION (AT YEAR END):
Assets $654,066 $582,403 $553,097 $518,217 $483,308
Deposits 545,192 487,470 464,485 436,021 403,237
Total loans, net of unearned income
and allowance for credit losses 435,422 388,516 378,307 341,800 301,629
Stockholders' equity 78,028 70,971 65,024 58,485 56,188
PERFORMANCE RATIOS (FOR THE YEAR):
Return on average assets 1.42% 1.42% 1.52% 1.37% 1.37%
Return on average stockholders' equity 11.79% 11.70% 12.98% 11.85% 11.16%
Net interest margin 4.12% 4.15% 4.40% 4.18% 4.40%
Efficiency ratio(2) 53.49% 49.04% 48.20% 50.90% 52.30%
Dividend payout ratio 36.60% 40.00% 34.97% 35.34% 34.39%
Average stockholders' equity to average total assets 12.00% 12.16% 11.68% 11.53% 12.25%
(1) Total stockholders' equity, net of goodwill and other intangible assets,
divided by the number of shares of common stock outstanding at year end.
(2) Noninterest expenses as a percentage of total revenue(net interest income
plus total noninterest income). Lower ratios idicate improved productivity.
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 22,321,279 $ 17,424,346
Interest bearing deposits with other banks 20,005,728 14,178,789
Federal funds sold 27,141,300 20,035,061
Investment securities:
Available for sale - at fair value 110,863,542 114,932,289
Held to maturity - at amortized cost - fair value of
(2002) $13,379,216 and (2001) $11,041,923 13,124,236 10,896,293
Loans, less allowance for credit losses (2002) $4,116,598
(2001) $4,189,368 435,422,089 388,516,236
Insurance premiums receivable 1,619,158 --
Premises and equipment, net 8,533,848 7,224,093
Accrued interest receivable on loans and investment securities 2,958,439 3,320,923
Investment in unconsolidated subsidiary 1,165,567 1,125,567
Goodwill 5,990,132 1,439,553
Other intangible assets 1,796,687 35,288
Deferred income taxes 270,130 681,441
Other real estate 54,116 56,116
Other assets 2,800,242 2,537,486
------------- ------------
Total assets $654,066,493 $582,403,481
============ ============
LIABILITIES
Deposits:
Noninterest bearing demand $ 70,109,964 $ 65,305,024
NOW and Super NOW 99,434,204 91,287,765
Certificates of deposit, $100,000 or more 99,643,911 75,096,165
Other time and savings 276,003,835 255,780,674
------------- -------------
545,191,914 487,469,628
Accrued interest payable 636,743 784,994
Short term borrowings 22,008,117 17,053,864
Long term debt 5,000,000 5,000,000
Other liabilities 3,201,819 1,124,362
--------------- ---------------
Total liabilities 576,038,593 511,432,848
------------- -------------
STOCKHOLDERS' EQUITY
Common stock, par value $.01, authorized 35,000,000 shares;
issued and outstanding (2002) 5,372,064 shares;
(2001) 5,332,947 shares 53,721 53,330
Additional paid in capital 23,837,608 23,039,084
Retained earnings 52,984,735 47,411,873
Accumulated other comprehensive income 1,151,836 466,346
-------------- ------------
Total stockholders' equity 78,027,900 70,970,633
-------------- ------------
Total liabilities and stockholders' equity $654,066,493 $582,403,481
============= ============
The notes to consolidated financial statements are an integral part of these
statements.
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans, including fees $29,604,305 $31,256,323 $31,619,234
Interest and dividends on investment securities:
Taxable 5,615,608 5,955,160 6,691,678
Tax-exempt 483,731 443,986 499,215
Federal funds sold 453,458 912,517 669,823
Other interest 149,300 369,903 -
----------- ------------ ------------
Total interest income 36,306,402 38,937,889 39,479,950
----------- ------------ ------------
INTEREST EXPENSE
NOW and Super NOW accounts 753,898 1,483,160 1,989,954
Certificates of deposit, $100,000 or more 3,031,783 4,025,784 4,071,479
Other time and savings 8,157,742 10,727,057 10,414,939
Interest on short term borrowings 243,001 554,585 1,096,149
Interest on long term debt 251,952 270,602 315,467
----------- ------------ ------------
Total interest expense 12,438,376 17,061,188 17,887,988
----------- ------------ ------------
NET INTEREST INCOME 23,868,026 21,876,701 21,591,962
PROVISION FOR CREDIT LOSSES 356,066 226,000 437,045
----------- ------------ -------------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 23,511,960 21,650,701 21,154,917
NONINTEREST INCOME
Service charges on deposit accounts 1,915,103 1,876,591 1,750,652
Gain (loss) on sale of securities 26,126 9,631 (47,839)
Gain on life insurance policies - - 750,004
Insurance agency commissions 2,871,620 - -
Other operating income 1,155,640 759,906 650,739
---------- ---------- ----------
5,968,489 2,646,128 3,103,556
---------- ---------- ----------
NONINTEREST EXPENSE
Salaries and wages 7,386,228 5,046,246 4,783,091
Employee benefits 2,187,051 1,678,466 1,688,893
Occupancy expense 1,019,380 824,164 714,775
Furniture and equipment expense 738,362 687,548 657,696
Data processing 889,329 858,635 764,413
Directors' fees 471,618 417,559 410,788
Goodwill amortization - 140,445 140,445
Amortization of other intangible assets 129,484 6,943 6,943
Other operating expenses 3,139,012 2,365,871 2,736,641
---------- ---------- ----------
15,960,464 12,025,877 11,903,685
---------- ---------- ----------
INCOME BEFORE INCOME TAXES 13,519,985 12,270,952 12,354,788
Federal and state income taxes 4,729,841 4,276,857 4,397,824
---------- ---------- ----------
NET INCOME $ 8,790,144 $ 7,994,095 $ 7,956,964
=========== =========== ===========
Basic earnings per common share $1.64 $1.50 $1.50
===== ===== =====
Diluted earnings per common share $1.62 $1.49 $1.48
===== ===== =====
The notes to consolidated financial statements are an integral part of these
statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2002, 2001 and 2000
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID IN RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
------------ ------------ ------------ ------------- ------------
Balances, January 1, 2000 $ 53,148 $ 22,776,437 $ 37,429,483 ($1,773,696) $ 58,485,372
Comprehensive income:
Net income - - 7,956,964 - 7,956,964
Other comprehensive income, net of tax:
Unrealized loss on available for
sale securities, net of reclassification
adjustment of $(7,148) - - - 1,219,752 1,219,752
------------
Total comprehensive income - - - - 9,176,716
------------ ------------ ------------ ------------- ------------
Shares repurchased and retired (1) (1,461) - - (1,462)
9,191 shares issued under 401(k) plan 92 143,044 - - 143,136
Exercise of stock options 5 5,687 - - 5,692
Fractional shares redeemed (2) - (2,546) - (2,548)
Cash dividends paid, $.52 per share - - (2,782,653) - (2,782,653)
------------ ------------ ------------ ------------- ------------
Balances, December 31, 2000 53,242 22,923,707 42,601,248 (553,944) 65,024,253
Comprehensive income:
Net income - - 7,994,095 - 7,994,095
Other comprehensive income, net of tax:
Unrealized gain on available for
sale securities, net of reclassification
adjustment of $(7,110) - - - 1,020,290 1,020,290
-----------
Total comprehensive income - - - - 9,014,385
-----------
Shares repurchased and retired - (1,020) - (1,020)
2,722 shares issued under 401(k) plan 27 41,143 - - 41,170
Exercise of stock options 61 75,254 - - 75,315
Premium received on issuance of
shares in unconsolidated subsidiary 14,170 14,170
Cash dividends paid $.60 per share - - (3,197,640) - (3,197,640)
------------ ------------ ------------ ------------- ------------
Balances, December 31, 2001 53,330 23,039,084 47,411,873 466,346 70,970,633
COMPREHENSIVE INCOME:
NET INCOME - - 8,790,144 - 8,790,144
OTHER COMPREHENSIVE INCOME, NET OF TAX:
UNREALIZED GAIN ON AVAILABLE FOR
SALE SECURITIES, NET OF RECLASSIFICATION
ADJUSTMENT OF $(416) - - - 685,490 685,490
-------------
TOTAL COMPREHENSIVE INCOME - - - - 9,475,634
-------------
SHARES REPURCHASED AND RETIRED (12) (20,832) - - (20,844)
SHARES ISSUED IN ACQUISTION OF 390 799,610 800,000
INSURANCE AGENCIES
SHARES ISSUED FOR EMPLOYEE STOCK
PURCHASE PLAN 13 19,746 - - 19,759
CASH DIVIDENDS PAID $.60 PER SHARE - - (3,217,282) - (3,217,282)
------------ ------------ ------------ ------------- ------------
BALANCES, DECEMBER 31, 2002 $ 53,721 $ 23,837,608 $ 52,984,735 $ 1,151,836 $ 78,027,900
============ ============ ============ ============= ============
The notes to consolidated financial statements are an integral part of these
statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 8,790,144 $ 7,994,095 $ 7,956,964
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,266,580 995,676 926,318
Discount accretion on debt securities (110,316) (131,060) (25,244)
(Gain) loss on sale of securities (26,126) (9,631) 47,839
Gain on life insurance policies -- -- (750,004)
Provision for credit losses, net (72,770) (9,640) 208,450
Deferred income taxes (19,996) (136,433) (89,489)
(Gain) loss on disposal of premises and equipment (1,125) 328 2,651
Loss on other real estate owned 4,000 5,000 17,566
Net changes in:
Insurance premiums receivable (1,619,158) -- --
Accrued interest receivable 362,484 1,012,644 (748,988)
Other assets (302,756) (367,486) 304,442
Accrued interest payable (148,251) (220,884) 324,618
Other liabilities 2,077,457 (205,051) 233,412
------------- ------------- -------------
Net cash provided by operating activities 10,200,167 8,927,558 8,408,535
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale 3,017,109 5,509,843 8,116,313
Proceeds from maturities and principal payments
of securities available for sale 79,132,663 77,482,056 93,159,085
Purchases of securities available for sale (77,385,015) (101,367,542) (96,272,930)
Proceeds from maturities and principal payments
of securities held to maturity 3,991,642 13,274,235 3,580,036
Purchases of securities held to maturity (6,223,062) (1,622,415) (311,170)
Net increase in loans (46,878,083) (9,588,339) (36,982,347)
Purchase of loans -- (980,837) --
Proceeds from sale of loans -- 322,710 --
Purchase of premises and equipment (1,599,409) (738,686) (1,256,773)
Proceeds from sale of other real estate owned 43,000 -- 372,494
Proceeds from life insurance policies -- -- 1,170,966
Proceeds from sale of premises and equipment 22,000 -- 20,700
Acquisition, net of stock issued (5,949,073) -- --
------------- ------------- -------------
Net cash used in investing activities (51,828,228) (17,708,975) (28,403,626)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand, NOW,
money market, and savings deposits 36,418,059 20,424,729 13,849,924
Net increase in certificates of deposit 21,304,227 2,559,913 14,614,017
Net increase (decrease) in short term borrowings 4,954,253 801,682 (681,126)
Proceeds from issuance of common stock 19,759 116,485 148,828
Repurchase of common stock (20,844) (1,020) (4,010)
Dividends paid (3,217,282) (3,197,640) (2,782,653)
------------- ------------- -------------
Net cash provided by financing activities 59,458,172 20,704,149 25,144,980
------------- ------------- -------------
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
----------- ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 17,830,111 11,922,732 5,149,889
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 51,638,196 39,715,464 34,565,575
----------- ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $69,468,307 $51,638,196 $39,715,464
=========== =========== ===========
Supplemental cash flows information:
Interest paid $12,586,627 $17,282,072 $17,563,370
=========== =========== ===========
Income taxes paid $ 4,680,382 $4,439,933 $ 4,108,127
=========== ========== ===========
Transfers from loans to other real estate $ 45,000 $ 47,000 $ 267,060
=========== ========== ===========
The notes to consolidated financial statements are an integral part of these
statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2002, 2001 and 2000
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Shore Bancshares,
Inc. and its affiliates (the "Company"), with all significant intercompany
transactions eliminated. The investments in subsidiaries are recorded on the
Company's books on the basis of its equity in the net assets of the
subsidiaries. The accounting and reporting policies of the Company conform to
accounting principles generally accepted in the United States of America and to
prevailing practices within the industry in which it operates. For purposes of
comparability, certain reclassifications have been made to amounts previously
reported to conform with the current period presentation.
NATURE OF OPERATIONS
The Company provides commercial banking services from its locations in Talbot,
Queen Anne's, Kent, Caroline, and Dorchester Counties, Maryland. Its primary
source of revenue is from providing commercial, real estate and consumer loans
to customers located on Maryland's Eastern Shore. A full range of insurance and
investment services are offered through the Company's nonbank subsidiaries.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The allowance for credit losses is a material estimate that is particularly
susceptible to significant changes in the near-term. Management believes that
the allowance for credit losses is sufficient to address the probable losses in
the current portfolio. While management uses available information to recognize
losses on loans, future additions to the allowance may be necessary based on
changes in economic conditions. In addition, various regulatory agencies, as an
integral part of their examination processes, periodically review the Company's
allowance for credit losses. Such agencies may require the Company to recognize
additions to the allowance based on their judgements about information available
to them at the time of their examination.
INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities available for sale are stated at estimated fair value
based on quoted market prices. They represent those securities which management
may sell as part of its asset/liability strategy or which may be sold in
response to changing interest rates, changes in prepayment risk or other similar
factors. The cost of securities sold is determined by the specific
identification method. Net unrealized holding gains and losses on these
securities are reported as accumulated other comprehensive income, a separate
component of stockholders' equity, net of related income taxes.
INVESTMENT SECURITIES HELD TO MATURITY
Investment securities held to maturity are stated at cost adjusted for
amortization of premiums and accretion of discounts. The Company intends and has
the ability to hold such securities until maturity.
LOANS
Loans are stated at their principal amount outstanding net of any deferred fees
and costs. Interest income on loans is accrued at the contractual rate based on
the principal amount outstanding. Fees charged and costs capitalized for
originating loans are being amortized substantially on the interest method over
the term of the loan. A loan is placed on nonaccrual when it is specifically
determined to be impaired or when principal or interest is delinquent for 90
days or more. Any unpaid interest previously accrued on those loans is reversed
from income. Interest income generally is not recognized on specific impaired
loans unless the likelihood of further loss is remote. Interest payments
received on such loans are applied as a reduction of the loan principal balance.
Interest income on other nonaccrual loans is recognized only to the extent of
interest payments received.
Loans are considered impaired when it is probable that the Company will not
collect all principal and interest payments according to the loan's contractual
terms. The impairment of a loan is measured at the present value of expected
future cash flows using the loan's effective interest rate, or at the loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. Impaired loans do not include groups of smaller balance
homogeneous loans such as residential mortgage and consumer installment loans
that are evaluated collectively for impairment. Reserves for probable credit
losses related to these loans are based upon historical loss ratios and are
included in the allowance for credit losses.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is maintained at a level believed adequate by
management to absorb probable losses inherent in the loan portfolio as of the
balance sheet date and is based on the size and current risk characteristics of
the loan portfolio, an assessment of individual problem loans and actual loss
experience, current economic events in specific industries and geographical
areas, including unemployment levels, and other pertinent factors, including
regulatory guidance and general economic conditions. Determination of the
allowance is inherently subjective as it requires significant estimates,
including the amounts and timing of expected future cash flows on impaired
loans, estimated losses on pools of homogeneous loans that are based on
historical loss experience, and consideration of current economic trends, all of
which may be susceptible to significant change. Loan losses are charged off
against the allowance, while recoveries of amounts previously charged off are
credited to the allowance. A provision for credit losses is charged to
operations based on management's periodic evaluation of the factors previously
mentioned, as well as other pertinent factors. Evaluations are conducted at
least quarterly and more often if deemed necessary.
The allowance for credit losses consists of a specific component and a
nonspecific component. The components of the allowance for credit losses
represent an estimation done pursuant to either Statement of Financial
Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies," or SFAS No.
114 "Accounting by Creditors for Impairment of a Loan." The specific component
of the allowance for credit losses reflects expected losses resulting from
analysis developed through credit allocations for individual loans and
historical loss experience for each loan category. The specific credit
allocations are based on a regular analysis of all loans over a fixed-dollar
amount where the internal credit rating is at or below a predetermined
classification. The historical loan loss element is determined statistically
using a loss migration analysis that examines loss experience and the related
internal grading of loans charged off. The loss migration analysis is performed
quarterly and loss factors are updated regularly based on actual experience. The
specific component of the allowance for credit losses also includes
consideration of concentrations and changes in portfolio mix and volume.
The nonspecific portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates, and risk factors that have not yet manifested themselves in loss
allocation factors. In addition, the nonspecific allowance includes a component
that explicitly accounts for the inherent imprecision in loan loss migration
models. Historical loss experience data used to establish allocation estimates
may not precisely correspond to the current portfolio. The uncertainty
surrounding the strength and timing of economic cycles, including management's
concerns over the effects of the prolonged economic downturn in the current
cycle, also affects the allocation model's estimates of loss. The historical
losses used in the migration analysis may not be representative of actual losses
inherent in the portfolio that have not yet been realized.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are calculated using the
straight-line method over the estimated useful lives of the assets. Useful lives
range from three to ten years for furniture, fixtures and equipment; three to
five years for software, hardware, and data handling equipment; and ten to forty
years for buildings and building improvements. Land improvements are amortized
over a period of fifteen years; and leasehold improvements are amortized over
the term of the respective lease. Maintenance and repairs are charged to expense
as incurred, while improvements which extend the useful life of an asset are
capitalized and depreciated over the estimated remaining life of the asset.
Long-lived assets are evaluated periodically for impairment when events or
changes in circumstances indicate the carrying amount may not be recoverable.
Impairment exists when the expected undiscounted future cash flows of a
long-lived asset are less than its carrying value. In that event, the Company
recognizes a loss for the difference between the carrying amount and the
estimated fair value of the asset.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of the cost of an acquisition over the fair value
of the net assets acquired. Other intangible assets represent purchased assets
that also lack physical substance but can be distinguished from goodwill because
of contractual or other legal rights or because the asset is capable of being
sold or exchanged either on its own or in combination with a related contract,
asset or liability. On January 1, 2002, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets". Under the provisions of SFAS No. 142,
goodwill is no longer ratably amortized into the income statement over an
estimated life, but rather is tested at least annually for impairment.
Intangible assets that have finite lives continue to be amortized over their
estimated useful lives and also continue to be subject to impairment testing.
All of the Company's other intangible assets have finite lives and are amortized
on a straight-line basis over varying periods not exceeding fifteen years. Prior
to adoption of SFAS No. 142, the Company's goodwill was amortized on a
straight-line basis over fifteen years. Note 8 includes a summary of the
Company's goodwill and other intangible assets as well as further detail about
the effect of the adoption of SFAS No. 142.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OTHER REAL ESTATE
Other real estate represents assets acquired in satisfaction of loans either by
foreclosure or deeds taken in lieu of foreclosure. Properties acquired are
recorded at the lower of cost or fair value less estimated selling costs at the
time of acquisition with any deficiency charged to the allowance for credit
losses. Thereafter, costs incurred to operate or carry the properties as well as
reductions in value as determined by periodic appraisals are charged to
operating expense. Gains and losses resulting from the final disposition of the
properties are included in noninterest expense.
SHORT TERM BORROWINGS
Short term borrowing are comprised primarily of repurchase agreements which are
securities sold to the Company's customers, at the customers' request, under a
continuing "roll-over" contract that matures in one business day. The underlying
securities sold are U.S. Treasury notes or Government Agency bonds, which are
segregated from the Company's other investment securities by its safekeeping
agents.
INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax return.
Income tax expense is based on the results of operations, adjusted for permanent
differences between items of income or expense reported in the financial
statements and those reported for income tax purposes.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized as income or
expense in the period that includes the enactment date.
STATEMENT OF CASH FLOWS
Cash and demand balances due from banks, interest bearing deposits with other
banks and federal funds sold are considered "cash and cash equivalents" for
financial reporting purposes.
STOCK-BASED COMPENSATION
The Company's, stock-based compensation plans are accounted for based on the
intrinsic value method set forth in Accounting Principles Board (APB) Opinion
25, "Accounting for Stock Issued to Employees", and related interpretations. For
disclosure purposes net income and earnings per share are provided as if the
fair value method has been applied in accordance with SFAS Nos. 123 and 148.
ADVERTISING COSTS
Advertising costs are generally expensed as incurred.
RECENT ACCOUNTING PRONOUNCEMENTS
In October 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", which
addresses how and when to measure impairment on long-lived assets and how to
account for long-lived assets that an entity plans to dispose of either through
sale, abandonment, exchange, or distribution to owners. The statement's
provisions supersede SFAS 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of", which addressed asset
impairment, and certain provisions of APB Opinion 30 related to reporting the
effects of the disposal of a business segment and requires expected future
operated losses from discontinued operations to be recorded in the period in
which the losses are incurred rather than the measurement date. Under SFAS 144,
more dispositions may qualify for discontinued operations treatment in the
income statement. The provisions of SFAS 144 became effective for the Company on
January 1, 2002, and did not have a material impact on results of operations,
financial position, or liquidity.
In October 2002, the Financial Accounting Standards Board issued SFAS No. 147,
"Acquisitions of Certain Financial Institutions". SFAS No. 147 amends SFAS No.
72 "Accounting for Certain Acquisitions of Banking and Thrift Institutions".
SFAS No. 147 addresses unidentifiable intangible assets resulting from
acquisitions of entire or less-than-whole financial institutions where the fair
value of liabilities assumed exceeds the fair value of tangible and identifiable
intangible assets acquired. The Statement allows for the recognition of goodwill
where the transaction in which an unidentifiable intangible asset arose was a
business combination. The transitional provisions of SFAS No. 147 allow for the
reclassification of unidentifiable intangible assets that meet certain criteria
to goodwill and the restatement of earnings for any amortization of the
reclassified goodwill that occurred since SFAS No. 142 was adopted. Transitional
provisions were effective on October 1, 2002, with earlier application
permitted. Acquisition of bank branches by the Company did not meet the criteria
of a business combination and therefore the adoption of SFAS No. 147 had no
effect on the financial position or results of operations of the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure", which amends SFAS 123, "Accounting
for Stock -Based Compensation". SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require additional and more frequent
disclosure in financial statements about the effects of stock-based
compensation. Adoption of SFAS No. 148 had no effect on the financial position
or results of operations of the Company.
NOTE 2. ACQUISITIONS
On May 1, 2002, the Company completed its acquisition of certain assets of The
Avon-Dixon Agency, Inc., a full service insurance agency, and its subsidiaries,
all located in Easton, Maryland. The initial purchase price was $5,600,000 which
was paid in the form of $4,800,000 cash and 39,037 shares of the Company's
common stock valued at $800,000. An additional $1,400,000 may be payable if
specific performance criteria set forth in the purchase agreement are realized.
The Company recorded approximately $4,082,000 of goodwill and $1,542,000 of
other intangible assets as a result of the acquisition. On November 1, 2002 the
Company's subsidiary, The Avon-Dixon Agency, LLC acquired certain assets of W.
M. Freestate & Son, Inc. a full service insurance agency located in Centreville,
Maryland. The Company is now offering a full range of insurance products and
services to its customers.
NOTE 3. CASH AND DUE FROM BANKS
The Federal Reserve requires banks to maintain certain minimum cash balances
consisting of vault cash and deposits in the Federal Reserve Bank or in other
commercial banks. Such balances averaged approximately $8,370,000 and $7,049,000
during 2002 and 2001, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. INVESTMENT SECURITIES
The amortized cost and estimated fair values of investment securities are as
follows:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE SECURITIES: COST GAINS LOSSES VALUE
- ---------------------------------- --------------- --------------- -------------- -------------
DECEMBER 31, 2002:
U.S. Treasury securities $ 1,031,871 $ 32,509 $ -- $ 1,064,380
Obligations of U.S. Government agencies
and corporations 66,775,750 1,311,649 -- 68,087,399
Obligations of states and political subdivisions 110,000 1,440 -- 111,440
Other securities:
Mortgage backed securities 31,242,556 998,202 3,375 32,237,383
Federal Home Loan Bank stock 2,154,000 -- -- 2,154,000
Federal Reserve Bank stock 302,250 -- -- 302,250
Federal Home Loan Mortgage Corporation
Cumulative preferred stock 5,980,513 -- 350,588 5,629,925
Equity securities 1,390,036 2,078 115,349 1,276,765
------------ ------------ ------------ ------------
$108,986,976 $ 2,345,878 $ 469,312 $110,863,542
============ ============ ============ ============
December 31, 2001:
U.S. Treasury securities $ 5,076,925 $ 95,265 $ -- $ 5,172,190
Obligations of U.S. Government agencies
and corporations 66,401,110 1,288,871 42,613 67,647,368
Obligations of states and political subdivisions 210,000 3,246 -- 213,246
Other securities:
Mortgage backed securities 33,025,586 113,745 262,510 32,876,821
Federal Home Loan Bank stock 1,786,100 -- -- 1,786,100
Federal Reserve Bank stock 302,250 -- -- 302,250
Federal Home Loan Mortgage Corporation
Cumulative preferred stock 5,980,513 -- 300,588 5,679,925
Equity securities 1,390,036 1,765 137,412 1,254,389
------------ ------------ ------------ ------------
$114,172,520 $ 1,502,892 $ 743,123 $114,932,289
============ ============ ============ ============
HELD TO MATURITY SECURITIES:
DECEMBER 31, 2002
Obligations of states and political subdivisions $ 13,116,712 $ 293,804 $ 39,530 $ 13,370,986
Mortgage backed securities 7,524 706 -- 8,230
------------ ------------ ------------ ------------
$ 13,124,236 $ 294,510 $ 39,530 $ 13,379,216
============ ============ ============ ============
December 31, 2001:
Obligations of U.S. Government agencies
and corporations $ 1,576,772 $ 5,470 $ -- $ 1,582,242
Obligations of states and political subdivisions 9,307,674 154,008 14,876 9,446,806
Mortgage backed securities 11,847 1,028 -- 12,875
------------ ------------ ------------ ------------
$ 10,896,293 $ 160,506 $ 14,876 $ 11,041,923
============ ============ ============ ============
The amortized cost and estimated fair values of investment securities by
maturity date at December 31, 2002 are as follows:
AVAILABLE FOR SALE HELD TO MATURITY
-------------------------------------------------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
------------- ------------- ------------- ------------
Due in one year or less $ 21,542,227 $ 22,043,814 $ 1,475,503 $ 1,495,584
Due after one year through five years 73,932,928 75,686,541 3,181,674 3,316,468
Due after five years through ten years 2,764,962 2,825,944 4,296,063 4,380,370
Due after ten years 920,060 944,303 4,170,996 4,186,794
------------- ------------- ------------- ------------
99,160,177 101,500,602 13,124,236 13,379,216
Investments in equity securities 9,826,799 9,362,940 - -
------------- ------------- ------------- ------------
$108,986,976 $110,863,542 $13,124,236 $13,379,216
============= ============= ============= ============
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The maturity date for mortgage backed securities is determined by its expected
maturity. The maturity date for the remaining debt securities is determined
using its contractual maturity date.
The following table sets forth the amortized cost and estimated fair values of
securities which have been pledged as collateral for obligations to federal,
state and local government agencies and other purposes as required or permitted
by law.
DECEMBER 31, 2002 DECEMBER 31, 2001
-------------------------- --------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
----------- ----------- ----------- -----------
Available for sale $80,957,596 $82,929,770 $68,120,674 $69,492,758
Held to maturity 1,602,339 1,619,188 3,316,387 3,369,126
----------- ----------- ----------- -----------
$82,559,935 $84,548,958 $71,437,061 $72,861,884
=========== =========== =========== ===========
There were no obligations of states and political subdivisions whose carrying
value, as to any issuer, exceeded 10% of stockholders' equity at December 31,
2002 or 2001.
Proceeds from sales of investment securities were $3,017,109, $5,509,843, and
$8,116,313 for the years ended December 31, 2002 2001, and 2000, respectively.
NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The Company grants residential mortgage, consumer and commercial loans to
customers primarily in Talbot, Queen Anne's, Kent, Caroline and Dorchester
Counties in Maryland. The principal categories of the loan portfolio at December
31 are summarized as follows:
2002 2001
-------------- --------------
Real estate loans:
Construction and land development $ 25,354,196 $ 20,255,290
Secured by farmland 13,447,623 14,705,994
Secured by residential properties 217,302,483 184,949,866
Secured by non-farm, nonresidential properties 104,308,342 94,214,420
Loans to farmers (loans to finance agricultural production and other loans) 3,697,703 3,100,465
Commercial and industrial loans 55,238,077 51,744,215
Loans to individuals for household, family, and other personal expenditures 16,889,122 19,291,850
Obligations of States and political subdivisions in the United States, tax-exempt 2,991,206 4,070,462
All other loans 285,585 272,617
--------------- ---------------
439,514,337 392,605,179
Net deferred loan costs 24,350 100,425
--------------- ---------------
439,538,687 392,705,604
Allowance for credit losses (4,116,598) (4,189,368)
--------------- ---------------
$435,422,089 $388,516,236
=============== ===============
In the normal course of banking business, loans are made to officers and
directors and their affiliated interests. These loans are made on substantially
the same terms and conditions as those prevailing at the time for comparable
transactions with outsiders and are not considered to involve more than the
normal risk of collectibility. As of December 31, 2002 and 2001, such loans
outstanding, both direct and indirect (including guarantees), to directors,
their associates and policy-making officers, totaled approximately $11,203,000
and $5,942,000, respectively. During 2002 and 2001, loan additions were
approximately $10,880,000 and $1,295,000, and loan repayments were approximately
$5,619,000 and $2,764,000, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity in the allowance for credit losses is summarized as follows:
2002 2001 2000
---------- ----------- ----------
Balance, beginning of year $4,189,368 $4,199,008 $3,990,558
---------- ---------- ----------
Loans charged off:
Real estate loans (86,623) (5,338) (60,752)
Installment loans (170,187) (154,631) (72,650)
Commercial and other (282,081) (175,225) (244,170)
----------- ---------- ----------
(538,891) (335,194) (377,572)
----------- ---------- ----------
Recoveries:
Real estate loans 15,541 1,847 18,047
Installment loans 76,177 60,694 50,339
Commercial and other 18,337 37,013 80,591
---------- ---------- -----------
110,055 99,554 148,977
---------- ---------- -----------
Net loans charged off (428,836) (235,640) (228,595)
Provision 356,066 226,000 437,045
---------- ---------- -----------
Balance, end of year $4,116,598 $4,189,368 $ 4,199,008
========== ========== ===========
Information with respect to impaired loans and the related valuation allowance
as of December 31 is as follows:
2002 2001 2000
----------- ----------- ----------
Impaired loans with valuation allowance $433,091 $ 560,539 $ -
Impaired loans with no valuation allowance 379,355 382,537 640,092
----------- ----------- ----------
Total impaired loans $812,446 $ 943,076 $640,092
=========== =========== ==========
Allowance for loan losses related to impaired loans $ 116,024 $ 76,935 $ -
Allowance for loan losses related to other than impaired loans 4,000,574 4,112,433 4,199,008
----------- ----------- ----------
Total allowance for loan losses $4,116,598 $4,189,368 $4,199,008
=========== =========== ==========
Interest income on impaired loans recorded on the cash basis $ 78,312 $ 19,467 $ 22,304
=========== =========== ==========
Average recorded investment in impaired loans for the year $471,469 $ 644,549 $1,230,048
=========== =========== ==========
NOTE 6. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31 is as follows:
2002 2001
------------ -------------
Land $2,115,542 $ 1,768,393
Buildings and land improvements 7,123,036 6,317,658
Furniture and equipment 4,924,664 4,321,221
------------ -------------
14,163,242 12,407,272
Accumulated depreciation (5,629,394) (5,183,179)
------------ -------------
$ 8,533,848 $ 7,224,093
============ =============
Depreciation expense totaled $576,390, 553,000 and $556,000 for the years ended
December 31, 2002, 2001 and 2000 respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company leases facilities under operating leases. Rental expense for the
years ended December 31, 2002, 2001and 2000 was $267,418, $147,198 and $91,701,
respectively. Future minimum annual rental payments are approximately as
follows:
2003 $ 343,321
2004 271,922
2005 97,532
2006 33,190
2007 8,200
Thereafter 11,917
NOTE 7. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY
The Company owns 29.25% of the outstanding common stock of the Delmarva Bank
Data Processing Center, Inc. ("DBDPC"). The investment is carried at cost,
adjusted for the Company's equity in DBDPC's undistributed income.
DECEMBER 31
---------------------------------------------
2002 2001 2000
------------ ------------ ------------
Balance, beginning of year $1,125,567 $ 1,082,128 $1,057,331
Premium received on issuance of stock - 14,170 -
Equity in net income 40,000 29,269 24,797
------------ ------------ ------------
Balance, end of year $ 1,165,567 $ 1,125,567 $ 1,082,128
============ ============ ============
Data processing and other expenses paid to DBDPC totaled approximately
$1,063000, $954,000, and $893,000 for the years ended December 31, 2002, 2001
and 2000, respectively.
NOTE 8. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, goodwill is no longer being amortized but rather
tested for impairment under the provisions of SFAS No. 142. The acquired
intangible assets apart from goodwill will continue to be amortized over their
remaining estimated lives.
The significant components of goodwill and acquired intangible assets are as
follows:
2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED
GROSS NET AVERAGE GROSS NET AVERAGE
CARRYING ACCUMULATED CARRYING REMAINING CARRYING ACCUMULATED CARRYING REMAINING
AMOUNT AMORTIZATION AMOUNT LIFE AMOUNT AMORTIZATION AMOUNT LIFE
- -----------------------------------------------------------------------------------------------------------------------------------
Goodwill $6,657,250 $667,118 $5,990,132 $2,106,671 $667,118 $1,439,553
Unidentifiable intangible
resulting from branch
acquisitions 104,144 75,799 28,345 4.1 104,144 68,856 35,288 5.1
Insurance expirations 1,270,000 47,444 1,222,556 14.8 - - - -
Other identifiable
intangibles 620,883 75,097 545,786 4.8 - - - -
--------------------------------------------------------------------------------------------------------
Total $8,652,277 $865,458 $7,786,819 $2,210,815 $735,974 $1,474,841
========================================================================================================
Future annual estimated annual amortization expense, excluding goodwill:
2003 208,843
2004 208,843
2005 208,843
2006 208,843
2007 133,749
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under the provisions of SFAS No. 142, goodwill was subjected to an initial
assessment for impairment as of January 1, 2002. The Company also performed an
annual test for impairment. As a result of both the initial and annual
assessment reviews, the Company determined that there was no impairment of
goodwill. The Company will continue to review goodwill on an annual basis for
impairment and as events occur or circumstances change.
The Company adopted SFAS No. 142 effective January 1, 2002. The following
presents the pro forma effects of applying SFAS No. 142 to years ended December
31, 2001 and 2000.
Years ended December 31,
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
Goodwill amortization:
Pre-tax $ - $147,388 $147,388
After -tax - 144,706 144,706
Net income:
Reported $8,790,144 $7,994,095 $7,956,964
Add back: goodwill amortization, net of tax effect - 144,706 144,706
Adjusted net income 8,790,144 8,138,801 8,101,670
Basic net income per share:
Reported $1.64 $1.50 $1.50
Goodwill amortization .00 .03 .02
Adjusted net income per share $1.64 $1.53 $1.52
Diluted net income per share:
Reported $1.62 $1.49 $1.48
Goodwill amortization .00 .02 .02
Adjusted net income per share $1.62 $1.51 $1.50
NOTE 9. SIGNIFICANT DEPOSITS
The approximate maturities of certificates of deposit of $100,000 or more at
December 31 are as follows:
2002 2001
----------------------------------
Three months or less $46,991,000 $35,447,000
Over three through twelve months 17,374,000 19,794,000
Over twelve months 35,279,000 19,855,000
---------- -----------
$99,644,000 $75,096,000
=========== ===========
NOTE 10. SHORT TERM BORROWINGS
Short term borrowings, at December 31, 2002, consisted of securities sold under
agreements to repurchase. These short term obligations represent securities sold
to customers, at the customers' request, under a "roll-over" contract that
matures in one business day. The underlying securities sold are U.S. Treasury
Notes or Government agency securities, which are segregated, in the Company's
custodial accounts from other investment securities. From time to time in order
to meet short term liquidity needs the Company may borrow from a correspondent
federal funds line of credit arrangement or a secured reverse repurchase
agreement. The following table summarizes certain information for short term
borrowings:
2002 2001
---- ----
Average amount outstanding during the year $20,986,113 $19,315,474
Weighted average interest rate during the year 1.15% 2.87%
Amount outstanding at year end $22,008,117 $17,053,864
Weighted average rate at year end .90% 1.15%
Maximum amount at any month end $28,585,030 $25,174,790
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. LONG TERM DEBT
As of December 31, 2002, the Company had a convertible advance from the Federal
Home Loan Bank of Atlanta in the amount of $5,000,000 at an interest rate of
4.97%. The advance is due March 29, 2006 and has a one time call provision in
2004 . The Company has pledged its wholly owned residential real estate mortgage
loan portfolio under a blanket floating lien as collateral for this advance.
NOTE 12. BENEFIT PLANS
401(K) AND PROFIT SHARING PLAN
The Company has a 401(k) and profit sharing plan covering substantially all
full-time employees. The 401(k) plan calls for matching contributions by the
Company. The Company makes discretionary contributions to the profit sharing
plan based on profits. Company contributions to this plan included in expense
totaled $592,413 (2002), $387,764 (2001), and $407,384 (2000).
DEFINED BENEFIT PENSION PLAN
During 2000, the Company terminated its defined benefit pension plan, which had
been frozen since 1995. All benefits were distributed to plan participants in
2000. The Plan covered substantially all full-time employees of a bank
subsidiary with more than six months of service. Expense associated with the
plan for the year ended December 31, 2000 was $89,760.
NOTE 13. STOCK OPTION PLANS
The Company has two active stock option plans whereby incentive or nonqualified
stock options may be granted periodically to directors, executive officers, and
key employees at the discretion of the Company's Compensation Committee. The
plans provide for both immediate and graduated vesting schedules and allow for
up to 123,860 options of common stock to be granted. The plans were adopted in
1998 and 1995 and the options granted have a life not to exceed ten years.
The Company also has an Employee Stock Purchase Plan that was adopted in 1998
and allows employees to receive options to purchase common stock at an amount
equivalent to 85% of the fair market value of the common stock. The Company has
reserved 20,000 shares of common stock for issuance under the plan.
Following is a summary of changes in shares under option for all plans for the
years indicated:
YEAR ENDED DECEMBER 31,
2002 2001
NUMBER WEIGHTED AVERAGENUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE
------------------------------- --------------------------------
Outstanding at beginning of year 112,546 $ 9.67 120,414 $9.82
Granted 29,423 19.75 - -
Exercised (2,012) 16.35 (6,853) (10.39)
Expired/Cancelled (423) 17.31 (1,015) (26.44)
-------- --------
Outstanding at end of year 139,534 $11.52 112,546 $9.67
======== ========
Weighted average fair value of options
granted during the year $ 7.91 $ -
======== =======
The following summarizes information about options outstanding at December 31,
2002:
OPTIONS OUTSTANDING AND EXERCISABLE
-----------------------------------
OPTIONS OUTSTANDING WEIGHTED AVERAGE
-------------------
REMAINING
EXERCISE PRICE NUMBER NUMBER CONTRACT LIFE
--------------- ------ ------ --------------
$ 6.85 52,549 52,549 2.61
8.78 47,880 47,880 3.95
32.00 5,500 3,300 6.05
21.00 5,500 2,200 7.05
16.97 6,980 6,980 1.26
19.75 21,125 0 9.42
-------- --------
139,534 112,909
======== ========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
options that vest during the years ended December 31, 2002 and 2000. No options
were granted during 2001.
2002 2000
-------- --------
Dividend yield 2.20% 1.68%
Expected volatility 15.00% 15.00%
Risk free interest 4.58% 5.68%
Expected lives (in years) 10 10
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-based Compensation" and SFAS No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure", but applies APB Opinion
No. 25 and related interpretations in accounting for its plans. No compensation
expense related to the plans was recorded during the years ended December 31,
2002, 2001, and December 31, 2000. If the Company had elected to recognize
compensation cost based on fair value at the vesting dates for awards under the
plans consistent with the method prescribed by SFAS No. 123, net income and
earnings per share would have been changed to the pro forma amounts as follows
for the years ended December 31:
2002 2001 2000
---------- ---------- ----------
Net income:
As reported $8,790,144 $7,994,095 $7,956,964
Less pro forma stock-based compensation
expense determined under the fair value
method, net of related tax effects (29,700) (18,234) (21,378)
---------- ---------- ----------
Pro forma net income $8,760,444 $7,975,861 $7,935,586
========== ========== ==========
Basic net income per share:
As reported $1.64 $1.50 $1.50
Pro forma 1.64 1.50 1.49
Diluted earnings per share
As reported $1.62 $1.49 $1.48
Pro forma 1.62 1.48 1.47
The pro forma amounts are not representative of the effects on reported net
income for future years.
NOTE 14. DEFERRED COMPENSATION
The Company has a supplemental deferred compensation plan to provide retirement
benefits to its President and Chief Executive Officer. The plan calls for fixed
annual payments of $20,000 to be credited to the participant's account. The
participant is 100% vested in amounts credited to his account. Contributions to
the plan were $20,000 in 2002, 2001 and 2000.
The Company also has agreements with certain directors under which they have
deferred part of their fees and compensation. The amounts deferred are invested
in insurance policies, owned by the Company, on the lives of the respective
individuals. Amounts available under the policies are to be paid to the
individuals as retirement benefits over future years. Cash surrender values and
the accrued benefit obligation included in other assets and other liabilities at
December 31, are as follows:
2002 2001
---- ----
Cash surrender value $1,910,401 $ 1,828,724
Accrued benefit obligations 563,772 519,743
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15. INCOME TAXES
Income taxes included in the balance sheets as of December 31 are as follows:
2002 2001
--------- ----------
Federal income taxes currently payable (receivable) $90,539 $ (35,026)
State income taxes currently payable 220,630 4,255
Deferred income tax benefits 270,130 681,441
Components of income tax expense for each of the three years ended December 31
are as follows:
2002 2001 2000
----------- ----------- -----------
Currently payable:
Federal $4,091,475 $3,897,184 $4,036,794
State 670,478 521,055 450,519
----------- ----------- -----------
4,761,953 4,418,239 4,487,313
----------- ---------- -----------
Deferred income tax benefits:
Federal (27,431) (115,756) (73,267)
State (4,681) (25,626) (16,222)
------------ ------------- -------------
(32,112) (141,382) (89,489)
----------- ------------ ------------
$4,729,841 $4,276,857 $4,397,824
========== ========== ==========
A reconciliation of tax computed at the statutory federal tax rates of 34% to
the actual tax expense for the three years ended December 31 follows:
2002 2001 2000
---------- ---------- ----------
Tax at federal statutory rate 35.0% 35.0% 34.0%
Tax effect of:
Tax-exempt income (2.0) (1.8) (1.9)
Non-deductible expenses .1 .5 1.5
State income taxes, net of federal benefit 3.2 2.4 2.3
Other (1.3) (1.2) (.3)
---------- ---------- ----------
Income tax expense 35.0% 34.9% 35.6%
========== ========== ==========
Significant components of the Company's deferred tax assets and liabilities as
of December 31 are as follows:
2002 2001
----------- -----------
Deferred tax assets:
Allowance for credit losses $1,319,725 $1,221,480
Provision for off balance sheet commitments 40,249 18,538
Loan interest - 6,106
Provision for loss on other real estate 1,931 1,931
Loan fees 19,290 23,264
Deferred compensation 208,790 186,816
---------- -----------
Total deferred tax assets 1,589,985 1,458,135
---------- -----------
Deferred tax liabilities:
Depreciation 227,769 159,719
Federal Home Loan Bank stock dividend 27,613 27,613
Undistributed income of unconsolidated subsidiary 63,702 60,585
Loan origination fees and costs 212,556 184,630
Unrealized gains on available for sale securities 724,729 293,423
Other 63,486 50,724
----------- ----------
Total deferred tax liabilities 1,319,855 776,694
----------- ----------
Net deferred tax assets $ 270,130 $ 681,441
=========== ==========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16. EARNINGS PER COMMON SHARE
Basic earnings per share is derived by dividing net income available to common
stockholders by the weighted-average number of common shares outstanding and
does not include the effect of any potentially dilutive common stock
equivalents. Diluted earnings per share is derived by dividing net income by the
weighted-average number of shares outstanding, adjusted for the dilutive effect
of outstanding stock options and warrants. For the year ended December 31, 2002
options for 5,500 shares of common stock were excluded from computing diluted
earnings per share because their effects are antidilutive.
2002 2001 2000
----------- ------------- -------------
Basic:
Net income (applicable to common stock) $8,790,144 $7,994,095 $7,956,964
Average common shares outstanding 5,358,969 5,330,022 5,318,377
Basic earnings per share $1.64 $1.50 $1.50
Diluted:
Net income (applicable to common stock) $8,790,144 $7,994,095 $7,956,964
Average common shares outstanding 5,358,969 5,330,022 5,318,377
Diluted effect of stock options 69,609 52,376 70,109
------------ ------------ --------------
Average common shares outstanding - diluted 5,428,578 5,382,398 5,388,486
Diluted earnings per share $1.62 $1.49 $1.48
NOTE 17. REGULATORY CAPITAL REQUIREMENTS
The Company and the Banks are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators, that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Banks
must meet specific capital guidelines that involve quantitative measures of the
Banks' assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Banks' capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Banks to maintain amounts and ratios (set forth in the table below)
of total and Tier 1 capital (as defined in the regulations) to risk-weighted
assets (as defined), and of Tier 1 capital (as defined) to average assets.
Management believes as of December 31, 2002, that the Company and the Banks met
all capital adequacy requirements to which they are subject.
As of December 31, 2002, the most recent notification from the Federal Deposit
Insurance Corporation and the Office of the Comptroller of the Currency
categorized the Banks as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Banks must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the Banks' category.
A comparison of the Company's and Banks' capital as of December 31, 2002 and
2001 with the minimum requirements is presented below:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
TO BE WELL
CAPITALIZED UNDER
CORRECTIVE FOR CAPITAL PROMPT
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------ ----------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ---------- ------ --------- --------
AS OF DECEMBER 31, 2002:
TOTAL CAPITAL (TO RISK WEIGHTED ASSETS):
COMPANY $78,028,000 17.34% $35,999,040 8.00%
THE TALBOT BANK $44,747,000 14.42% $24,828,080 8.00% $31,035,100 10.00%
THE CENTREVILLE NATIONAL BANK $26,230,000 18.96% $11,070,080 8.00% $13,837,600 10.00%
TIER 1 CAPITAL (TO RISK WEIGHTED ASSETS):
COMPANY $68,799,000 15.29% $17,999,520 4.00%
THE TALBOT BANK $43,980,000 14.17% $12,414,040 4.00% $18,621,060 6.00%
THE CENTREVILLE NATIONAL BANK $24,086,000 17.41% $5,535,040 4.00% $8,302,560 6.00%
TIER 1 CAPITAL (TO AVERAGE ASSETS):
COMPANY $68,799,000 10.73% $25,655,120 4.00%
THE TALBOT BANK $43,980,000 11.06% $15,902,760 4.00% $19,878,450 5.00%
THE CENTREVILLE NATIONAL BANK $24,086,000 10.01% $9,623,640 4.00% $12,029,550 5.00%
As of December 31, 2001:
Total Capital (to Risk Weighted Assets):
Company $70,970,000 17.64% $32,195,000 8.00%
The Talbot Bank $44,570,000 16.28% $21,896,000 8.00% $27,370,000 10.00%
The Centreville National Bank $25,957,000 20.22% $10,272,000 8.00% $12,840,000 10.00%
Tier 1 Capital (to Risk Weighted Assets):
Company $68,657,000 17.06% $16,097,000 4.00%
The Talbot Bank $43,730,000 15.98% $10,948,000 4.00% $16,422,000 6.00%
The Centreville National Bank $24,484,000 19.07% $5,136,000 4.00% $7,704,000 6.00%
Tier 1 Capital (to Average Assets):
Company $68,657,000 11.85% $23,174,000 4.00%
The Talbot Bank $43,730,000 12.38% $14,128,000 4.00% $17,659,000 5.00%
The Centreville National Bank $24,484,000 10.85% $9,029,000 4.00% $11,287,000 5.00%
Bank and holding company regulations, as well as Maryland law, impose certain
restrictions on dividend payments by the Banks, as well as restricting
extensions of credit and transfers of assets between the Banks and the Company.
At December 31, 2002, the Banks could have paid dividends to the parent company
of approximately $8,371,000 without the prior consent and approval of the
regulatory agencies. The Company had outstanding net receivables from the Banks
of $0 and $17,906 at December 31, 2002 and 2001, respectively.
NOTE 18. LINES OF CREDIT
The Banks had $17,000,000 in unsecured federal funds lines of credit and a
reverse repurchase agreement available on a short term basis from correspondent
banks. In addition, the Banks have credit availability of approximately
$86,604,000 from the Federal Home Loan Bank of Atlanta. The Banks have pledged
as collateral, under blanket lien, all qualifying residential loans under
borrowing agreements with the Federal Home Loan Bank. At December 31, 2002 and
2001, the Federal Home Loan Bank had issued a letters of credit in the amounts
of $20,000,000 and $15,000,000, respectively, on behalf of the Talbot Bank to a
local government entity as collateral for its deposits.
NOTE 19. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
CASH AND CASH EQUIVALENTS
For those short-term instruments, the carrying amount is a reasonable estimate
of fair value.
INVESTMENT SECURITIES
For all investments in debt securities, fair values are based on quoted market
prices. If a quoted market price is not available, fair value is estimated using
quoted market prices for similar securities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LOAN RECEIVABLES
The fair value of categories of fixed rate loans, such as commercial loans,
residential mortgage, and other consumer loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities.
Other loans, including variable rates loans, are adjusted for differences in
loan characteristics.
FINANCIAL LIABILITIES
The fair value of demand deposits, savings accounts, and certain money market
deposits is the amount payable on demand at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities. These estimates do not
take into consideration the value of core deposit intangibles. The fair value of
securities sold under agreements to repurchase and long-term debt is estimated
using the rates offered for similar borrowings.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT
The fair value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counter parties.
The estimated fair values of the Company's financial instruments, excluding
goodwill, as of December 31 are as follows:
2002 2001
------------------------------------- ------------------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------------ ------- ---------------
Financial assets:
Cash and cash equivalents $ 69,468,306 $ 69,469,000 $ 51,638,196 $ 51,638,000
Investment securities 123,987,778 124,243,000 125,828,582 125,974,000
Loans 438,544,965 445,314,000 392,705,604 395,561,000
Less: allowance for loan losses (4,116,598) (4,117,000) (4,189,368) (4,189,000)
------------ ------------ ------------ ------------
$627,884,451 $634,909,000 $565,983,014 $568,984,000
============ ============ ============ ============
Financial liabilities:
Deposits $546,487,433 $551,415,000 $487,469,628 $490,970,000
Short term borrowings 22,008,117 22,008,000 17,053,864 17,054,000
Long-term debt 5,000,000 5,377,000 5,000,000 5,133,000
------------ --------------- --------------- ---------------
$573,495,550 $578,800,000 $509,523,492 $513,157,000
============ ============ ============ ============
Unrecognized financial instruments:
Commitments to extend credit $120,245,000 $120,245,000 $ 108,652,000 $ 108,652,000
Standby letters of credit 6,660,000 6,660,000 7,628,000 7,628,000
------------ ------------ ------------- -------------
$126,905,000 $126,905,000 $116,280,000 $116,280,000
============= ============= ============ ============
NOTE 20. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, to meet the financing needs of its customers,
the Company is a party to financial instruments with off-balance sheet risk.
These financial instruments include commitments to extend credit and standby
letters of credit. The Company's exposure to credit loss in the event of
nonperformance by the other party to these financial instruments is represented
by the contractual amount of the instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance sheet instruments. The Company generally requires collateral or other
security to support the financial instruments with credit risk. The amount of
collateral or other security is determined based on management's credit
evaluation of the counterparty. The Company evaluates each customer's
creditworthiness on a case-by-case basis.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Letters of
credit are conditional commitments issued by the Company to guarantee the
performance of a customer to a third party. Letters of credit and other
commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the letters of credit and
commitments are expected to expire without being drawn upon, the total
commitment amount does not necessarily represent future cash requirements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commitments outstanding as of December 31 are as follows:
2002 2001
------------- -------------
Commitments to extend credit $119,844,000 $108,652,000
Letters of credit 6,660,000 7,628,000
------------ ------------
$126,504,000 $116,280,000
============ ============
NOTE 21. CONTINGENCIES
In the normal course of business, the Company may become involved in litigation
arising from banking, financial, and other activities of the Company.
Management, after consultation with legal counsel, does not anticipate that the
future liability, if any, arising out of these matters will have a material
effect on the Company's financial condition, operating results, or liquidity.
NOTE 22. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Shore Bancshares, Inc. (Parent Company Only)
is as follows:
Condensed Balance Sheets
December 31, 2002 and 2001
2002 2001
------------- -------------
Assets:
Cash $ 47,732 $ 26,441
Investment in subsidiaries 77,484,257 70,527,357
Investment in equity securities 380,035 380,035
Income taxes receivable 194,887 84,034
Other assets 27,657 79,803
------------- -------------
Total assets $ 78,134,568 $ 71,097,670
============ =============
Liabilities:
Accounts payable $ 47,677$ 119,210
Deferred tax liability 58,991 -
Due to subsidiaries - 7,827
------------- -------------
106,668 127,037
Stockholders' equity:
Common stock 53,721 53,330
Additional paid in capital 23,837,608 23,039,084
Retained earnings 52,984,735 47,411,873
Accumulated other comprehensive income 1,151,836 466,346
------------- -------------
Total stockholders' equity 78,027,900 70,970,633
------------- -------------
Total liabilities and stockholders' equity $ 78,134,568 $ 71,097,670
============= =============
Condensed Statements of Income
For the years ended December 31, 2002, 2001 and 2000
2002 2001 2000
------------ -------------- -------------
Dividends from subsidiaries $9,096,080 $ 3,489,328 $2,782,653
Other investment income 11,000 11,000 10,000
Interest income 608 963 2,382
------------ -------------- -------------
9,107,688 3,501,291 2,795,035
Operating expenses 182,591 161,012 396,816
------------ ------------ -----------
Income before income tax benefit and
equity in undistributed income of subsidiary 8,925,097 3,340,279 2,398,219
Income tax benefit 49,134 51,167 6,227
------------ ------------- -------------
Income before equity in undistributed income of subsidiary 8,974,231 3,391,446 2,404,446
Equity in undistributed income (loss) of subsidiary (184,087) 4,602,649 5,552,518
----------- ----------- -----------
Net income $8,790,144 $7,994,095 $7,956,964
========== ========== ==========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Statements of Cash Flows
For the years ended December 31, 2002, 2001 and 2000
2002 2001 2000
---- ----- ----
Cash flows from operating activities:
Net income $ 8,790,144 $ 7,994,095 $ 7,956,964
Adjustments to reconcile net income to cash provided
by operating activities:
Equity in undistributed loss (income) of subsidiaries 184,087 (4,602,649) (5,552,518)
Net (increase) decrease in other assets (58,707) (157,610) 8,153
Net (decrease) increase in other liabilities (20,369) (216,736) 343,774
----------- ----------- -----------
Net cash provided by operating activities 8,895,155 3,017,100 2,756,373
----------- ----------- -----------
Cash flows from investing activities:
Sale of securities under agreement to resell -- -- 18,140
Purchase of other equity securities -- -- (100,035)
Acquisition, net of stock issued (5,105,497) -- --
Investment in subsidiaries (550,000) -- --
----------- ----------- -----------
Net cash used by investing activities (5,655,497) -- (81,895)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 19,759 116,485 148,828
Repurchase of common stock (20,844) (1,020) (4,010)
Dividends paid (3,217,282) (3,197,640) (2,782,653)
----------- ----------- -----------
Net cash used by financing activities (3,218,367) (3,082,175) (2,637,835)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 21,291 (65,075) 36,643
Cash and cash equivalents at beginning of year 26,441 91,516 54,873
----------- ----------- -----------
Cash and cash equivalents at end of year $ 47,732 $ 26,441 $ 91,516
=========== =========== ===========
NOTE 23. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
A summary of selected consolidated quarterly financial data for the two years
ended December 31, 2002 is reported as follows:
FIRST SECOND THIRD FOURTH
(IN THOUSANDS, EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER
- --------------------------------------------------------------------------------
2002
INTEREST INCOME $ 8,805 $ 9,174 $ 9,335 $8,992
NET INTEREST INCOME 5,501 5,941 6,305 6,121
PROVISION FOR CREDIT LOSSES 132 79 66 79
INCOME BEFORE INCOME TAXES 2,765 3,294 3,826 3,635
NET INCOME 1,740 2,157 2,488 2,405
BASIC EARNINGS PER COMMON SHARE $0.33 $0.40 $0.46 $0.45
DILUTED EARNINGS PER COMMON SHARE $0.32 $0.40 $0.46 $0.44
2001
Interest income $ 10,141 $ 9,781 $9,687 $ 9,329
Net interest income 5,456 5,369 5,472 5,580
Provision for credit losses 57 55 56 58
Income before income taxes 2,816 3,027 3,129 3,299
Net Income 1,801 2,011 2,018 2,164
Basic earnings per common share $.34 $.38 $.37 $.41
Diluted earnings per common share $.34 $.37 $.37 $.39
INDEPENDENT AUDITORS' REPORT
Audit Committee of the Board of Directors
and the Stockholders of
Shore Bancshares, Inc.
We have audited the accompanying consolidated balance sheets of Shore
Bancshares, Inc. as of December 31, 2002 and 2001, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Shore
Bancshares, Inc. as of December 31, 2002 and 2001, and the consolidated results
of its operations and cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
Baltimore, Maryland
January 17, 2003
Shore Bancshares, Inc. Board of Directors
BOARD OF DIRECTORS
Herbert L. Andrew, III
Farmer
Blenda W. Armistead
Investor
Lloyd L. Beatty, Jr.
Certified Public Accountant
President, Darby Advisors, Inc.
Paul M. Bowman
Attorney, Law Offices of Paul M. Bowman
David C. Bryan
Of Counsel, Ewing, Dietz, Fountain and Kehoe, PA
Daniel T. Cannon
Executive Vice President & COO, Shore Bancshares, Inc
President & CEO, The Centreville National Bank of Maryland
B. Vance Carmean, Jr.
Cahirman of the Board, Shore Bancshares, Inc.
President, Carmean Grain, Inc.
Richard C. Granville
Investor
Kevin P. LaTulip
President, Avon Dixon Agency, LLC, Elliott Wilson Insurance, LLC,
Mubell Finance, LLC, and Wye Financial Service, LLC
Neil R. LeCompte
Certified Public Accountant, Office of Neil R. LeCompte
David L. Pyles
Investor
W. Moorhead Vermilye
President & CEO, Shore Bancshares, Inc..
President & CEO, The Talbot Bank of Easton, Maryland
OFFICERS
W. Moorhead Vermilye President & CEO
Daniel T. Cannon Executive Vice President & COO
Susan E. Leaverton Treasurer
Carol I. Brownawell Secretary
SHAREHOLDER RECORDS
Inquiries relating to shareholder records, stock transfers,
change of ownership or address and dividend payments
should be directed to the Company's transfer agent, The
Centreville National Bank of Maryland
at (410) 758-1600 or (877) 758-1600. Or visit our website at www.shbi.net
THE CENTREVILLE NATIONAL BANK OF MARYLAND
DIRECTORS EXECUTIVE OFFICERS
---------- ------------------
Paul M. BowmanDaniel T. Cannon President & CEO
Attorney, Law office of Paul M. Bowman Carol I. Brownawell Executive Vice President & CFO
Thomas E. Beery Vice President & SLO
David C. Bryan Timothy J. Berrigan Vice President-Information Systems
Of Counsel, Law Offices of Ewing, Dietz, Rita B. Mielke Vice President & COO
Fountain and Kehoe, PA. Pamela C. Satchell Vice President - Human Resources
Kathryn C. Walls Vice President - Marketing
Daniel T. Cannon
Executive Vice President and COO, Shore Bancshares, Inc. OFFICES
-------
President and CEO, The Centreville National Bank Main Office
109 N. Commerce Street
B. Vance Carmean Centreville, Maryland 21617
President Carmean Grain, Inc. Chairman of the Board,
Shore Bancshares, Inc.
Route 213 South Office
Ann B. Collier 2609 Centreville Road
Former Educator and Farmer Centreville, Maryland 21617
Stevensville Office
Mark M. Freestate 408 Thompson Creek Road
Vice President, Avon Dixon Agency, LLC Stevensville, Maryland 21666
Vice Chairman of the Board, The Centreville National Bank
Kent Office
305 East High Street
Thomas K. Helfenbein Chestertown, Maryland 21620
Funeral Director and Partner,
Fellows, Helfenbein & Newnam Funeral Home Hillsboro Office
21913 Shore Highway
Neil R. LeCompte Hillsboro, Maryland 21641
Certified Public Accountant, Office of
Neil R. LeCompte Denton Office
850 S. 5th Street
Susanne K. Nuttle Denton, Maryland 21629
Retired Vice President, The Centreville National Bank
Chester Office
Jerry F. Pierson 300 Castle Marina Road
President, Jerry F. Pierson, Inc. Chester, Maryland 21619
Chairman of the Board, The Centreville National Bank
Wye Mortgage Group
Wm. Maurice Sanger 109 N. Commerce Street
President F.W., Inc. Centreville,
President Cloverbay Development Corporation Maryland 21617
ATM LOCATION
William E. Sylvester, Jr.
President, Norwich Fluids, Inc. Queenstown Harbor Golf Links
Queenstown, Maryland 21658
Mary Ellen M. Valliant
President, Valliant and Associates Phone (410) 758-1600
Investment Management, LLC Fax (410) 758-2364
E-Mail: DIRECTIONS@CNBMC.COM
website: HTTP://WWW.CNBMD.COM
THE TALBOT BANK OF EASTON, MARYLAND
DIRECTORS EXECUTIVE OFFICERS
Herbert L. Andrew, III W. Moorhead Vermilye President & CEO
Farmer Jerome M. McConnell Executive Vice President & SLO
Matthew I. Werner Senior Vice President & COO
Blenda W. Armistead Susan E. Leaverton Vice President & CFO
Investor Robert J. Meade Vice President - Human Resources
Lloyd L. Beatty, Jr. OFFICES
-------
Certified Public Accountant
President, Darby Advisors, Inc. Main Office
18 E. Dover Street
Donald D. Casson Easton, Maryland 21601
Certified Public Accountant
Real Estate Broker Tred Avon Square Branch
Chairman of the Board, The Talbot Bank 210 Marlboro Road
Easton, Maryland 21601
Gary L. Fairbank
Owner, Fairbank Tackle St. Michaels Branch
1013 S. Talbot Street
Richard C. Granville St. Michaels, Maryland 21663
Investor
Elliott Road Branch
Jerome M.McConnell 8275 Elliott Road
Executive Vice President, The Talbot Bank Easton, Maryland 21601
Shari L, McCord Cambridge Branch
Investor 2745 Dorchester Square
Cambridge, Maryland 21613
David L. Pyles
Investor ATM LOCATIONS
Stephen M. Shearer Memorial Hospital at Easton
Owner, Shearer the Jeweler 219 S. Washington Street
Easton, Maryland 21601
Christopher F. Spurry
President, Spurry & Associates, Inc. Sailwinds Amoco
511 Maryland Avenue
David P. Valliant Cambridge, Maryland 21613
Investor
Talbottown
W.Moorhead Vermilye 218 N. Washington Street
President & CEO, Shore Bancshares, Inc. Easton, Maryland 21601
President & CEO, The Talbot Bank
Chesapeake Bay Outfitters
100 N. Talbot Street
St. Michaels, Maryland 21663
Phone (410) 822-1400
Fax (410) 820-4238
E-Mail: INFO@TALBOT-BANK.COM
--------------------
website: HTTP://WWW.TALBOT-BANK.COM
--------------------------
THE AVON DIXON AGENCY, LLC
BOARD OF DIRECTORS EXECUTIVE OFFICERS
Kevin P. LaTulip, Chairman Kevin P. LaTulip President
Terry M. Meade Terry M. Mead Executive Vice President
William L. Lane, Jr.
David C. Lee OFFICES
-------
Sally E. McClellan
Leonard "Jay" Dayton, Jr. Easton Office
Edward "Ned" McDonald 106 N. Harrison Street
Mark M. Freestate Easton, Maryland 21601
Grasonville Office
301 Saddler Road
Grasonville, Maryland 21638
Centreville Office
195 Lawyers Row
Centreville, Maryland 21617
Phone (410) 822-0506
Fax (410) 822-5629
website: HTTP://WWW.AVONDIXON.COM
------------------------
ELLIOTT WILSON INSURANCE, LLC
BOARD OF DIRECTORS EXECUTIVE OFFICERS
Kevin P. LaTulip Kevin P. LaTulip President
Terry M. Mead Terry M. Mead Executive Vice President
Erika S. Wilson
Edward "Ned" McDonald OFFICES
-------
9707 Ocean Gateway
Easton, Maryland 21601
Phone (410) 820-7797
Fax (410) 820-7754
website: HTTP://ELLIOTTWILSON.COM
------------------------
WYE FINANCIAL SERVICES, LLC
BOARD OF DIRECTORS EXECUTIVE OFFICERS
Kevin P. LaTulip, Chairman Kevin P. LaTulip President
Terry M. Mead James M. Vermilye Vice President
James M. Vermilye
Susan E. Leaverton OFFICES
-------
Daniel T. Cannon
106 N. Washington Street
Easton, Maryland 21601
Phone (410) 763-8543
Fax (410) 763-8557
website: http://www.wyefinancial.com