FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 1996
Commission File Number 0-19065
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SANDY SPRING BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Maryland 52-1532952
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) or No.)
17801 Georgia Avenue, Olney, Maryland 20832
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 774-6400.
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $1.00 per share
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO _____
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The registrant's Common Stock is traded on the NASDAQ National Market under the
symbol SASR. The aggregate market value of the 4,750,507 shares of Common Stock
of the registrant issued and outstanding held by nonaffiliates on March 10,
1997, was approximately $165.1 million based on the closing sales price of
$34.75 per share of the registrant's Common Stock on March 17, 1997. For
purposes of this calculation, the term "affiliate" refers to all directors and
executive officers of the registrant.
As of the close of business on March 10, 1997, 4,911,461 shares of the
registrant's Common Stock were outstanding.
Documents Incorporated By Reference
Parts I and II: Portions of the Annual Report to Shareholders for the year
ended December 31, 1996 (the "Annual Report").
Part III: Portions of the definitive proxy statement for the Annual
Meeting of Shareholders to be held on April 16, 1997 (the
"Proxy Statement").
FORWARD-LOOKING STATEMENTS
Part I and Part II of this Annual Report on Form 10-K contain forward-
looking statements, including statements of goals, intentions, and expectations,
regarding or based upon general economic conditions, interest rates,
developments in national and local markets, and other matters, and which, by
their nature, are subject to significant uncertainties. Because of these
uncertainties and the assumptions on which statements in this report are based,
the actual future results may differ materially from those indicated in this
report.
PART I
ITEM 1. BUSINESS
General
Sandy Spring Bancorp, Inc. ("Bancorp") is the one-bank holding company for
Sandy Spring National Bank of Maryland (the "Bank"). Bancorp is registered as a
bank holding company pursuant to the Bank Holding Company Act of 1956, as
amended (the "Holding Company Act"). As such, Bancorp is subject to supervision
and regulation by the Board of Governors of the Federal Reserve System (the
"Federal Reserve"). Bancorp began operating in 1988. The Bank traces its
origin to 1868, and is the oldest banking business based in Montgomery County,
Maryland. The Bank is independent, community oriented, and conducts a full-
service commercial banking business through 19 community offices located in
Montgomery, Howard, and Anne Arundel counties in Maryland. The Bank is a
national bank subject to supervision and regulation by the Office of the
Comptroller of the Currency (the "OCC"). The Bank's savings and deposit
accounts are insured by the Bank Insurance Fund ("BIF") administered by the
Federal Deposit Insurance Corporation (the "FDIC") to the maximum permitted by
law.
The Bank experiences substantial competition both in attracting and
retaining deposits and in making loans. Direct competition for deposits comes
from other commercial banks, savings associations, and credit unions located in
the Bank's primary market area of Montgomery, Howard, and Anne Arundel Counties
in Maryland. Additional significant competition for deposits comes from mutual
funds and corporate and government debt securities. As an alternative to
traditional deposit accounts, annuities are offered through Sandy Spring
Insurance Corporation, a wholly owned subsidiary of the Bank. The primary
factors in competing for loans are interest rates and loan origination fees and
the range of services offered by lenders. Competitors for loan originations
include other commercial banks, mortgage bankers, mortgage brokers, savings
associations, and insurance companies. Management believes the Bank is able to
compete effectively in its primary market area.
Bancorp's and the Bank's principal executive office is at 17801 Georgia
Avenue, Olney, Maryland 20832, and its telephone number is (301) 774-6400.
Regulation, Supervision, and Governmental Policy
Following is a brief summary of certain statutes and regulations that
significantly affect Bancorp and the Bank. This summary does not purport to be
complete and is qualified in its entirety by reference to these statutes and
regulations. A number of other statutes and regulations affect Bancorp and the
Bank but are not summarized below.
Bank Holding Company Regulation. Bancorp is registered as a bank holding
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company under the Holding Company Act and, as such, is subject to supervision
and regulation by the Federal Reserve. As a bank holding company, Bancorp is
required to furnish to the Federal Reserve annual and quarterly reports of its
operations and additional information and reports. Bancorp is also subject to
regular examination by the Federal Reserve.
Under the Holding Company Act, a bank holding company must obtain the prior
approval of the Federal Reserve before (i) acquiring direct or indirect
ownership or control of any class of voting securities of any bank or
2
bank holding company if, after the acquisition, the bank holding company would
directly or indirectly own or control more than 5% of the class; (2) acquiring
all or substantially all of the assets of another bank or bank holding company;
or (3) merging or consolidating with another bank holding company.
Under the Holding Company Act, any company must obtain approval of the
Federal Reserve prior to acquiring control of Bancorp or the Bank. For purposes
of the Holding Company Act, "control" is defined as ownership of more than 25%
of any class of voting securities of Bancorp or the Bank, the ability to control
the election of a majority of the directors, or the exercise of a controlling
influence over management or policies of Bancorp or the Bank.
The Change in Bank Control Act and the related regulations of the Federal
Reserve require any person or persons acting in concert (except for companies
required to make application under the Holding Company Act), to file a written
notice with the Federal Reserve before the person or persons acquire control of
Bancorp or the Bank. The Change in Bank Control Act defines "control" as the
direct or indirect power to vote 25% or more of any class of voting securities
or to direct the management or policies of a bank holding company or an insured
bank.
The Holding Company Act also prohibits, with certain exceptions, a bank
holding company from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of a company that is not a bank or a bank holding
company, or from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statute or by Federal Reserve regulation or order,
have been identified as activities closely related to the business of banking or
managing or controlling banks. The activities of Bancorp are subject to these
legal and regulatory limitations under the Holding Company Act and Federal
Reserve regulations. The Federal Reserve also has the power to order a holding
company or its subsidiaries to terminate any activity, or to terminate its
ownership or control of any subsidiary, when it has reasonable cause to believe
that the continuation of such activity or such ownership or control constitutes
a serious risk to the financial safety, soundness, or stability of any bank
subsidiary of that holding company.
The Federal Reserve has adopted guidelines regarding the capital adequacy
of bank holding companies, which require bank holding companies to maintain
specified minimum ratios of capital to total assets and capital to risk-weighted
assets. See "Regulatory Capital Requirements."
The Federal Reserve has the power to prohibit dividends by bank holding
companies if their actions constitute unsafe or unsound practices. The Federal
Reserve has issued a policy statement on the payment of cash dividends by bank
holding companies, which expresses the Federal Reserve's view that a bank
holding company should pay cash dividends only to the extent that the company's
net income for the past year is sufficient to cover both the cash dividends and
a rate of earnings retention that is consistent with the company's capital
needs, asset quality, and overall financial condition.
As a bank holding company, Bancorp is required to give the Federal Reserve
notice of any purchase or redemption of its outstanding equity securities if the
gross consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of Bancorp's consolidated net worth. The
Federal Reserve may disapprove such a purchase or redemption if it determines
that the proposal would violate any law, regulation, Federal Reserve order,
directive, or any condition imposed by, or written agreement with, the Federal
Reserve.
Bank Regulation. As a national bank, the Bank is subject to the primary
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supervision of the OCC under the National Bank Act. The prior approval of the
OCC is required for a national bank to establish or relocate an additional
branch office or to engage in any merger, consolidation, or significant purchase
or sale of assets.
The OCC regularly examines the operations and condition of the Bank,
including but not limited to its capital adequacy, reserves, loans, investments,
and management practices. These examinations are for the protection
3
of the Bank's depositors and the BIF. In addition, the Bank is required to
furnish quarterly and annual reports to the OCC. The OCC's enforcement
authority includes the power to remove officers and directors and the authority
to issue cease-and-desist orders to prevent a bank from engaging in unsafe or
unsound practices or violating laws or regulations governing its business.
The OCC has adopted regulations regarding the capital adequacy of national
banks, which require national banks to maintain specified minimum ratios of
capital to total assets and capital to risk-weighted assets. See "Regulatory
Capital Requirements."
No national bank may pay dividends from its paid-in capital. All dividends
must be paid out of current or retained net profits, after deducting reserves
for losses and bad debts. The National Bank Act further restricts the payment
of dividends out of net profits by prohibiting a national bank from declaring a
dividend on its shares of common stock until the surplus fund equals the amount
of capital stock or, if the surplus fund does not equal the amount of capital
stock, until one-tenth of a bank's net profits for the preceding half year in
the case of quarterly or semi-annual dividends, or the preceding two half-year
periods in the case of annual dividends, are transferred to the surplus fund.
The approval of the OCC is required prior to the payment of a dividend if
the total of all dividends declared by a national bank in any calendar year
would exceed the total of its net profits for that year combined with its
retained net profits for the two preceding years, less any required transfers to
surplus or a fund for the retirement of any preferred stock. In addition, the
Bank is prohibited by federal statute from paying dividends or making any other
capital distribution that would cause the Bank to fail to meet its regulatory
capital requirements. Further, the OCC also has authority to prohibit the
payment of dividends by a national bank when it determines that their payment
would be an unsafe and unsound banking practice.
The Bank is a member of the Federal Reserve System and its deposits are
insured by the FDIC to the legal maximum of $100,000 for each insured depositor.
Some of the aspects of the lending and deposit business of the Bank that are
subject to regulation by the Federal Reserve and the FDIC include reserve
requirements and disclosure requirements in connection with personal and
mortgage loans and deposit accounts. In addition, the Bank is subject to
numerous federal and state laws and regulations that include specific
restrictions and procedural requirements with respect to the establishment of
branches, investments, interest rates on loans, credit practices, the disclosure
of credit terms, and discrimination in credit transactions.
The Bank is subject to restrictions imposed by federal law on extensions of
credit to, and certain other transactions with, Bancorp and other affiliates,
and on investments in their stock or other securities. These restrictions
prevent Bancorp and the Bank's other affiliates from borrowing from the Bank
unless the loans are secured by specified collateral, and require those
transactions to have terms comparable to terms of arms-length transactions with
third persons. In addition, secured loans and other transactions and
investments by the Bank are generally limited in amount as to Bancorp and as to
any other affiliate to 10% of the Bank's capital and surplus and as to Bancorp
and all other affiliates together to an aggregate of 20% of the Bank's capital
and surplus. Certain exemptions to these limitations apply to extensions of
credit by, and other transactions between, the Bank to its subsidiaries. These
regulations and restrictions may limit Bancorp's ability to obtain funds from
the Bank for its cash needs, including funds for acquisitions and for payment of
dividends, interest, and operating expenses.
Under OCC regulations, national banks must adopt and maintain written
policies that establish appropriate limits and standards for extensions of
credit secured by liens or interests in real estate or are made for the purpose
of financing permanent improvements to real estate. These policies must
establish loan portfolio diversification standards; prudent underwriting
standards, including loan-to-value limits, that are clear and measurable; loan
administration procedures; and documentation, approval, and reporting
requirements. A bank's real estate lending policy must reflect consideration of
the Interagency Guidelines for Real Estate Lending Policies (the "Interagency
Guidelines") adopted by the federal bank regulators. The Interagency
Guidelines, among other things, call for internal loan-to-value limits for real
estate loans that are not in excess of the limits specified in the Guidelines.
The
4
Interagency Guidelines state, however, that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits.
The FDIC has established a risk-based deposit insurance premium assessment
system for insured depository institutions. Under the system, the assessment
rate for an insured depository institution depends on the assessment risk
classification assigned to the institution by the FDIC, based upon the
institution's capital level and supervisory evaluations. Institutions are
assigned to one of three capital groups -- well-capitalized, adequately
capitalized, or undercapitalized -- based on the data reported to regulators.
Well-capitalized institutions are institutions satisfying the following capital
ratio standards: (i) total risk-based capital ratio of 10.0% or greater; (ii)
Tier 1 risk-based capital ratio of 6.0% or greater; and (iii) Tier 1 leverage
ratio of 5.0% or greater. Adequately capitalized institutions are institutions
that do not meet the standards for well-capitalized institutions but that
satisfy the following capital ratio standards: (i) total risk-based capital
ratio of 8.0% or greater; (ii) Tier 1 risk-based capital ratio of 4.0% or
greater; and (iii) Tier 1 leverage ratio of 4.0% or greater. Institutions that
do not qualify as either well-capitalized or adequately capitalized are deemed
to be undercapitalized. Within each capital group, institutions are assigned to
one of three subgroups on the basis of supervisory evaluations by the
institution's primary supervisory authority and such other information as the
FDIC determines to be relevant to the institution's financial condition and the
risk it poses to the deposit insurance fund. Subgroup A consists of financially
sound institutions with only a few minor weaknesses. Subgroup B consists of
institutions with demonstrated weaknesses that, if not corrected, could result
in significant deterioration of the institution and increased risk of loss to
the deposit insurance fund. Subgroup C consists of institutions that pose a
substantial probability of loss to the deposit insurance fund unless effective
corrective action is taken. For the semi-annual period beginning June 30, 1995,
the assessment rate for institutions, such as the Bank, with deposits insured by
the Bank Insurance Fund of the FDIC was lowered to between 0.04% and .31% of
insured deposits from 0.23% to 0.31% of insured deposits and was subsequently
reduced to the statutory minimum of $1,000 for the most highly rated banks for
the semi-annual period beginning January 1, 1996. The Bank has been notified
that its assessment rate for the first six months of 1997 is the $1,000
statutory minimum, which also applied to it during 1996.
New Law. The operations of Bancorp and the Bank are affected by new
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federal and state laws. The federal Economic Growth and Regulatory Paperwork
Reduction Act of 1996 (the "New Act"), enacted in September 1996, includes
provisions that affect banks, bank holding companies, and savings associations.
The New Act had, and is expected to have in the future, its most significant
effect upon bank and savings associations that hold deposits assessed at Savings
Deposit Insurance Fund ("SAIF") rates. The Bank does not have "SAIF" assessed
deposits, and the direct impact on the Bank of the New Act was not material in
1996. Among other things, the New Act recapitalized the SAIF through a special
assessment on savings association deposits and bank deposits that had been
acquired from savings associations. The New Act may increase competition from
savings associations by equalizing, over time, the amount of federal insurance
premiums paid on savings association and bank deposits. The New Act also
provides that, beginning in 1997, institutions with deposits insured by the BIF,
as well as those with SAIF insured deposits, will be responsible for payment of
certain bonds issued in connection with the resolution of failed savings
associations. The result of these provisions will be somewhat higher federal
deposit insurance premiums for the Bank. These higher insurance premiums are
not expected to have a material adverse effect on the Bank or Bancorp.
The New Act also simplifies the regulatory approval process for new
activities of banks and bank holding companies, and reduces a number of other
regulatory burdens. None of these changes is expected to have a significant
effect on the Bancorp or the Bank.
Bank Secrecy Act Compliance. In the fourth quarter of 1996, the Bank
---------------------------
learned that it had not fully complied with certain requirements of the federal
Bank Secrecy Act and related regulations, including obligations to monitor and
file reports of certain types of currency transactions. Financial institutions
that fail to comply with the requirements of the Bank Secrecy Act may be subject
to penalties, including civil money penalties. It is not now known whether such
penalties or any other action will be sought against the Bank in connection with
its noncompliance, or, if they are, the amount or nature of such penalties.
Management believes that the Bank is now
5
in compliance with its current reporting obligations under the Bank Secrecy Act,
and is in discussion with appropriate federal regulatory authorities regarding
the steps it has taken and plans to take to remedy its past noncompliance. See
"Note 24 - Contingencies" of the Notes to the Consolidated Financial Statements
on page 46 of the Annual Report.
Regulatory Capital Requirements. The Federal Reserve and the OCC have
-------------------------------
established guidelines for maintenance of appropriate levels of capital by bank
holding companies and national banks, respectively. The regulations impose two
sets of capital adequacy requirements: minimum leverage rules, which require
bank holding companies and banks to maintain a specified minimum ratio of
capital to total assets, and risk-based capital rules, which require the
maintenance of specified minimum ratios of capital to "risk-weighted" assets.
The regulations of the Federal Reserve and the OCC require bank holding
companies and national banks, respectively, to maintain a minimum leverage ratio
of "Tier 1 capital" (as defined in the risk-based capital guidelines discussed
in the following paragraphs) to total assets of 3.0%. The capital regulations
state, however, that only the strongest bank holding companies and banks, with
composite examination ratings of 1 under the rating system used by the federal
bank regulators, would be permitted to operate at or near this minimum level of
capital. All other bank holding companies and banks are expected to maintain a
leverage ratio of at least 1% to 2% above the minimum ratio, depending on the
assessment of an individual organization's capital adequacy by its primary
regulator. A bank or bank holding company experiencing or anticipating
significant growth is expected to maintain capital well above the minimum
levels. In addition, the Federal Reserve has indicated that it also may
consider the level of an organization's ratio of tangible Tier 1 capital (after
deducting all intangibles) to total assets in making an overall assessment of
capital.
The risk-based capital rules of the Federal Reserve and the OCC require
bank holding companies and national banks to maintain minimum regulatory
capital levels based upon a weighting of their assets and off-balance sheet
obligations according to risk. The risk-based capital rules have two basic
components: a core capital (Tier 1) requirement and a supplementary capital
(Tier 2) requirement. Core capital consists primarily of common stockholders'
equity, certain perpetual preferred stock (noncumulative perpetual preferred
stock with respect to banks), and minority interests in the equity accounts of
consolidated subsidiaries; less all intangible assets, except for certain
mortgage servicing rights and purchased credit card relationships.
Supplementary capital elements include, subject to certain limitations, the
allowance for losses on loans and leases; perpetual preferred stock that does
not qualify as Tier 1 capital; long-term preferred stock with an original
maturity of at least 20 years from issuance; hybrid capital instruments,
including perpetual debt and mandatory convertible securities; and subordinated
debt and intermediate-term preferred stock.
The risk-based capital regulations assign balance sheet assets and credit
equivalent amounts of off-balance sheet obligations to one of four broad risk
categories based principally on the degree of credit risk associated with the
obligor. The assets and off-balance sheet items in the four risk categories are
weighted at 0%, 20%, 50% and 100%. These computations result in the total risk-
weighted assets.
The risk-based capital regulations require all banks and bank holding
companies to maintain a minimum ratio of total capital to total risk-weighted
assets of 8%, with at least 4% as core capital. For the purpose of calculating
these ratios: (i) supplementary capital is limited to no more than 100% of core
capital; and (ii) the aggregate amount of certain types of supplementary capital
is limited. In addition, the risk-based capital regulations limit the allowance
for loan losses that may be included in capital to 1.25% of total risk-weighted
assets.
In July 1996, the federal bank regulatory agencies, including the OCC,
issued a joint policy statement regarding the evaluation of commercial banks'
capital adequacy for interest rate risk. Under the policy, the OCC's assessment
of a bank's capital adequacy includes an assessment of the bank's exposure to
adverse changes in interest rates. The OCC has determined to rely on its
examination process for such evaluations rather than on standardized measurement
systems or formulas. The OCC may require banks that are found to have a high
level of interest rate
6
risk exposure or weak interest rate risk management systems to take corrective
actions. Management believes its interest rate risk management systems and its
capital relative to its interest rate risk are adequate.
The OCC has established regulations that classify national banks by capital
levels and provide for the OCC to take various "prompt corrective actions" to
resolve the problems of any bank that fails to satisfy the capital standards.
Under these regulations, a well-capitalized bank is one that is not subject to
any regulatory order or directive to meet any specific capital level and that
has a total risk-based capital ratio of 10% or more, a Tier 1 risk-based capital
ratio of 6% or more, and a leverage ratio of 5% or more. An adequately
capitalized bank is one that does not qualify as well-capitalized but meets or
exceeds the following capital requirements: a total risk-based capital ratio of
8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (i)
4% or (ii) 3% if the bank has the highest composite examination rating. A bank
that does not meet these standards is categorized as undercapitalized,
significantly undercapitalized, or critically undercapitalized, depending on its
capital levels. A national bank that falls within any of the three
undercapitalized categories established by the prompt corrective action
regulation is subject to severe regulatory sanctions. As of December 31, 1996,
the Bank was well-capitalized as defined in the OCC's regulations.
For information regarding Bancorp's and the Bank's compliance with their
respective regulatory capital requirements, see "Management's Discussion and
Analysis -- Capital Management--Regulatory Capital Requirements" on page 26 of
the Annual Report and "Note 22 - Regulatory Matters" of the Notes to the
Consolidated Financial Statements on pages 45 and 46 of the Annual Report.
Competition
The Bank competes within its market area with numerous bank subsidiaries of
larger bank holding companies, including the subsidiaries of regional and
national bank holding companies with principal operations in states other than
Maryland. It also competes with numerous independent banks, savings
associations, credit unions, and various other nonbank financial companies.
The banking business in Maryland generally, and the Bank's primary service
areas specifically, are highly competitive with respect to both loans and
deposits. As noted above, the Bank competes with many larger banking
organizations that have offices over a wide geographic area. These larger
institutions have certain inherent advantages, such as the ability to finance
wide-ranging advertising campaigns and promotions and to allocate their
investment assets to regions offering the highest yield and demand. They also
offer services, such as international banking, that are not offered directly by
the Bank (but are available indirectly through correspondent institutions), and,
by virtue of their larger total capitalization, such banks have substantially
higher legal lending limits, which are based on bank capital, than does the
Bank. The Bank can arrange loans in excess of its lending limit, or in excess
of the level of risk it desires to take, by arranging participations with other
banks. Other entities, both governmental and in private industry, raise capital
through the issuance and sale of debt and equity securities and indirectly
compete with the Bank in the acquisition of deposits.
In addition to competing with other commercial banks and savings
associations, commercial banks such as the Bank compete with nonbank
institutions for funds. For instance, yields on corporate and government debt
and equity securities affect the ability of commercial banks to attract and hold
deposits. Commercial banks also compete for available funds with mutual funds.
These mutual funds have provided substantial competition to banks for deposits,
and it is anticipated they will continue to do so in the future.
The Holding Company Act permits the Federal Reserve to approve an
application of an adequately capitalized and adequately managed bank holding
company to acquire control of, or acquire all or substantially all of the assets
of, a bank located in a state other than that holding company's home state. The
Federal Reserve may not approve the acquisition of a bank that has not been in
existence for the minimum time period (not exceeding five years) specified by
the statutory law of the host state. The Holding Company Act also prohibits the
Federal Reserve from approving an application if the applicant (and its
depository institution affiliates) controls or would control more
7
than 10% of the insured deposits in the United States or 30% or more of the
deposits in the target bank's home state or in any state in which the target
bank maintains a branch. The Holding Company Act does not affect the authority
of states to limit the percentage of total insured deposits in the state which
may be held or controlled by a bank or bank holding company to the extent such
limitation does not discriminate against out-of-state banks or bank holding
companies. The effect of these provisions of the Holding Company Act may be to
increase competition within the State of Maryland among banking and savings
associations located in Maryland and from banking companies located anywhere in
the country.
Federal banking laws also authorize the federal banking agencies, effective
June 1, 1997, to approve interstate merger transactions without regard to
whether such transactions are prohibited by the law of any state, unless the
home state of one of the banks adopts a law after the date of enactment of such
Act and prior to June 1, 1997 that applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks. In 1995,
however, the State of Maryland acted to authorize interstate mergers by enacting
legislation that allows out-of-state financial institutions to merge with
Maryland banks and to establish branches in Maryland, subject to certain
limitations. Maryland previously had enacted reciprocal interstate banking
statutes that authorized interstate bank and savings association acquisitions.
The effect of the federal and Maryland law may be to increase competition within
the State of Maryland among banking and thrift institutions located in Maryland
and from the major regional and national bank holding companies that acquire
institutions in Maryland, many of which are larger than the Bank. The New Act,
described above, also may increase competition by reducing the deposit insurance
cost advantage on BIF insured deposits, such as those of the Bank, over SAIF
insured deposits, and by making acquisitions of savings associations more
attractive by resolving uncertainties over the costs of SAIF recapitalization.
Employees
As of February 25, 1997, Bancorp and the Bank employed 388 persons,
including executive officers, loan and other banking and trust officers, branch
personnel, and others. None of Bancorp's or the Bank's employees is represented
by a union or covered under a collective bargaining agreement. Management of
Bancorp and the Bank consider their employee relations to be excellent.
Executive Officers
The following table sets forth information regarding the executive officers
of Bancorp and the Bank who are not directors.
Name Age (1) Principal Position(s)
- ---- ------- ---------------------
James R. Farmer 45 Senior Vice President of the Bank
James H. Langmead 47 Vice President and Treasurer of Bancorp and Senior
Vice President and Chief Financial Officer of the
Bank
Lawrence T. Lewis 48 Senior Vice President of the Bank
Stanley L. Merson 40 Senior Vice President of the Bank
Frank H. Small 50 Senior Vice President of the Bank
________________
(1) At March 25, 1997
8
The principal occupation(s) and business experience of each executive
officer who is not a director for the last five years are set forth below.
James R. Farmer became a Senior Vice President of the Bank in 1994.
Prior to that, Mr. Farmer was Vice President of the Bank. Mr. Farmer has been
employed by the Bank since 1979.
James H. Langmead, CPA, became Vice President and Treasurer of Bancorp
and Senior Vice President and Chief Financial Officer of the Bank in 1995.
Prior to that, Mr. Langmead was a Senior Vice President of the Bank (from
January 1994), and Vice President and Controller of the Bank. Prior to joining
the Bank in 1992, Mr. Langmead was Executive Vice President of the Bank of
Baltimore.
Lawrence T. Lewis began his employment with the Bank in 1996 as Senior
Vice President. From January 1984 to December 1995, Mr. Lewis was a managing
director of Clark Melvin Securities Corporation.
Stanley L. Merson has been a Senior Vice President of the Bank since
1991 and was Vice President of the Commercial Loan Department prior to becoming
Senior Vice President. Mr. Merson has been employed by the Bank since 1982.
Frank H. Small became a Senior Vice President of the Bank in 1994.
Prior to that, Mr. Small was Vice President of the Bank. Before joining the
Bank in 1990, Mr. Small was Vice President in charge of branch operations at
Equitable Bank, N.A.
Tabular Financial Information
Loan Maturity Table. The following table sets forth information as of
December 31, 1996, regarding the loan maturities and interest rate sensitivity
for real estate-construction, commercial, and tax exempt loans (dollars in
thousands).
1 or Less Over 1-5 Over 5 Total
--------- -------- ------ -----
Real Estate Construction..................... $47,503 $ 151 $ 0 $ 47,654
Commercial................................... 48,538 18,828 1,101 68,467
Tax Exempt................................... 2 10 15 27
------- ------- -------- --------
Total .................................... $96,043 $18,989 $ 1,116 $116,148
======= ======= ======== ========
Rate Terms:
Fixed....................................... $13,774 $18,067 $ 1,101 $ 32,942
Variable or adjustable...................... 82,269 922 15 83,206
-------- ------- ------- --------
Total...................................... $96,043 $18,989 $ 1,116 $116,148
======== ======= ======= ========
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Credit Loss Allowance Table. The following table presents the
allocation of the allowance for credit losses for the past five years, along
with the percentage of total loans in each category (dollars in thousands).
December 31,
-----------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------- ------------- ------------- --------------- -------------
Loan Loan Loan Loan Loan
Amount Mix Amount Mix Amount Mix Amount Mix Amount Mix
------ ------- ------ ----- ------ ----- ------ ------- ------ -----
Amount applicable to:
Real estate--mortgage...... $ 425 72% $ 512 74% $1,581 76% $2,046 77% $1,756 81%
Real estate--construction.. 745 9 10 8 41 7 34 6 78 6
Consumer................... 193 6 181 6 136 6 324 5 353 6
Commercial................. 1,015 13 907 12 832 11 1,998 12 61 7
Tax exempt................. 0 0 0 0 0 0 0 0 0 0
Unallocated................ 4,013 4,987 4,073 2,279 $1,965
------ ------ ------ ------ ------
Total allowance for
credit losses........ $6,391 $6,597 $6,663 $6,681 $4,213
====== ====== ====== ====== ======
The Company's policies and practices regarding the allowance for
credit losses, including factors regularly analyzed by management in evaluating
the sufficiency of the allowance, are disclosed in the discussion of Credit Risk
Management on pages 26 and 27 and in Notes 1 and 6 of the Notes to the
Consolidated Financial Statements beginning on page 34 of the Annual Report.
(See also the discussion of loan portfolio composition and trends on pages 23
and 24 of the Annual Report.) The amount of unallocated allowance for credit
losses decreased to 62.8% of the total allowance at December 31, 1996, from
75.6% a year earlier. The percentage was 61.1% at December 31, 1994. The size
of the unallocated reserve at December 31, 1996 reflects management's assessment
of actual loss residing in the loan portfolio which has not been specifically
attributed to any category of loans. The size of the unallocated allowance at
December 31, 1996 was influenced by the merger with Annapolis Bancshares, Inc.,
consummated on August 29, 1996. The amount of potential loss identified in the
due diligence process with particular categories of loans in the existing
Annapolis portfolio is expected to increase, and the unallocated portion
decrease, as Bancorp continues to evaluate and manage this new portfolio.
In establishing the amount of the allowance for credit losses, and
allocating the allowance to particular categories of loans, management also
considered the increase in the amount and percentage to total loans attributable
to commercial and commercial real estate loans, which are viewed as entailing
greater risk than certain other categories of loans, and the resulting increase
in large loans. The significance of these factors, which are believed to have
contributed to the increase in both net charge-offs and nonperforming loans
during 1996 compared to 1995, was mitigated by the Company's historical loss
ratios and the continued concentration in types of credits considered to be of
relatively low risk. Consideration of these and other factors, when balanced
against each other, resulted in an unallocated allowance and in a total
allowance which management deemed appropriate at December 31, 1996.
The tabular financial information set forth on pages 18 through 29 of
the Annual Report is incorporated herein by reference.
ITEM 2. DESCRIPTION OF PROPERTY
Airpark
7653 Lindbergh Drive
Gaithersburg, Maryland 20879
(301) 774-8408
Annapolis
2024 West Street
Annapolis, Maryland 21401
(410) 266-3000
Ashton
1 Ashton Road
Ashton, Maryland 20861
(301) 774-8405
Aspenwood
(Aspenwood Residents
and Employees Only)
14400 Homecrest Road
Silver Spring, Maryland 20906
(301) 774-8406
Bedford Court
(Bedford Court Residents
and Employees Only)
3701 International Drive
Silver Spring, Maryland 20906
(301) 774-8407
Bethesda
7126 Wisconsin Avenue
Bethesda, Maryland 20814
(301) 951-0800
Executive Offices
17801 Georgia Avenue
Olney, Maryland 20832
(301) 774-6400
Burtonsville
3535 Spencerville Road
Burtonsville, Maryland 20866
(301) 774-8404
Clarksville
12276 Clarksville Pike
Clarksville, Maryland 21029
(410) 531-2650
Colesville
13300 New Hampshire Avenue
Silver Spring, Maryland 20904
(301) 774-8403
Damascus
26250 Ridge Road
Damascus, Maryland 20872
(301) 253-0133
East Gude Drive
1601 East Gude Drive
Rockville, Maryland 20850
(301) 570-8330
Gaithersburg Square
596 A North Frederick Avenue
Gaithersburg, Maryland 20877
(301) 963-3600
Layhill
14241 Layhill Road
Silver Spring, Maryland 20906
(301) 774-8406
Leisureworld Plaza
3801 International Drive
Silver Spring, Maryland 20906
(301) 774-8407
Lisbon
710-N Lisbon Centre Drive
Woodbine, Maryland 21797
(410) 442-1878
Montgomery Village
9921 Stedwick Road
Montgomery Village, Maryland 20879
(301) 990-3800
Olney
17801 Georgia Avenue
Olney, Maryland 20832
(301) 774-8402
Rockville
611 Rockville Pike
Rockville, Maryland 20852
(301) 217-0555
Sandy Spring
908 Olney-Sandy Spring Road
Sandy Spring, Maryland 20860
(301) 774-8401
Customer Service Center
(301) 774-8477
(800) 399-5919
10
ITEM 3. LEGAL PROCEEDINGS
Note 18 on page 43 of the Annual Report ("Litigation") is hereby
incorporated by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of 1996, through solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
RECENT STOCK PRICES AND DIVIDENDS
(Dollars in thousands, except per share data)
Shareholders received quarterly cash dividends totaling $3,620 in 1996 and
$2,755 in 1995. Regular dividends have been declared for ninety-six consecutive
years. The Company has increased its dividends per share each year for the past
sixteen years. Since 1991, dividends per share have risen at an annual compound
growth rate of 15.5%, with an increase of 21.9% in 1996.
Per share dividends, expressed as a percentage of earnings per share, were
33.1% in 1996 and 30.6% in 1995. The amount of dividends is established by the
Board of Directors in consideration of operating results, financial condition,
capital adequacy, regulatory requirements, shareholder returns and other
factors.
Shares issued under the dividend reinvestment plan totaled 35,273 in 1996
and 35,300 in 1995.
The number of common shareholders of record was approximately 2,400 as of
February 10, 1997 compared to approximately 2,000 a year earlier.
Shares of Sandy Spring Bancorp commenced trading on The Nasdaq Stock
Market's National Market on April 17, 1996 under the trading symbol SASR. Since
that date, the price information provided below reflects actual high and low
sales prices as quoted on The Nasdaq Stock Market. Prior to April 17, 1996,
sales prices reported below were based upon reports of broker transactions
published by third parties and any other transactions known to the Company to
have occurred in each quarter.
QUARTERLY STOCK INFORMATION
1996 1995
---------------------------------- ----------------------------------
Stock Price Range Per Share Stock Price Range Per Share
----------------- -----------------
Quarter Low High Dividend Low High Dividend
- ----------------------------------------------------------------------------------------------------------------
1st $35.00 $38.75 $0.18 $24.50 $26.25 $0.15
2nd 35.75 41.00 0.19 25.38 32.00 0.15
3rd 34.00 39.50 0.20 29.25 39.00 0.16
4th 31.25 34.75 0.21 35.00 39.00 0.18
- ----------------------------------------------------------------------------------------------------------------
Total $0.78 $0.64
===== =====
For information regarding regulatory restrictions on the Bank's and,
therefore, Bancorp's payment of dividends, see Note 11 -- "Stockholders' Equity"
on page 40 of the Annual Report, which is hereby incorporated by reference.
11
ITEM 6. SELECTED FINANCIAL DATA
HISTORICAL TRENDS IN FINANCIAL DATA 1992-1996(1)
(Dollars in thousands, except per share data)
1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS (for the year):
Interest income $ 66,621 $ 62,115 $ 51,578 $ 46,189 $ 48,177
Interest expense 30,233 29,342 21,496 19,793 23,129
Net interest income 36,388 32,773 30,082 26,396 25,048
Provision for credit losses 308 180 212 1,056 1,880
Net interest income after provision
for credit losses 36,080 32,593 29,870 25,340 23,168
Noninterest income 6,547 4,478 4,189 4,870 4,656
Noninterest expenses 25,344 22,424 21,462 18,340 16,243
Income before taxes and cumulative
effect of accounting change 17,283 14,647 12,597 11,870 11,581
Income tax expense 5,789 4,653 3,694 3,261 3,252
Income before cumulative effect of
accounting change 11,494 9,994 8,903 8,609 8,329
Cumulative effect of accounting change 0 0 0 0 744
Net income 11,494 9,994 8,903 8,609 9,073
PER SHARE DATA:
Net income $ 2.36 $ 2.09 $ 1.90 $ 1.92 $ 2.01(2)
Dividends declared 0.78 0.64 0.54 0.49 0.43
Book value 19.70 18.04 15.72 15.63 13.39
FINANCIAL CONDITION (at year end):
Assets $978,595 $876,203 $830,834 $784,274 $675,418
Deposits 806,341 743,592 700,340 676,422 602,073
Loans 523,166 492,540 457,052 374,740 313,924
Securities 361,806 290,786 309,622 314,283 285,120
Stockholders' equity 96,581 86,941 73,766 72,420 59,205
MEASUREMENTS (for the year):
Return on average assets 1.27% 1.18% 1.14% 1.23% 1.30%(2)
Return of average equity 12.81 12.37 12.24 13.55 16.95(2)
Average equity to average assets 9.90 9.57 9.28 9.10 7.65
Dividends declared to net income 33.05 30.62 28.42 25.52 21.39(2)
(1) Adjusted to give retroactive effect to a 2-for-1 stock split declared on
March 29, 1995 and, except with respect to dividends declared per share, the
acquisition of Annapolis Bancshares, Inc. on August 29, 1996, which was
accounted for as a pooling of interests.
(2) Excludes the cumulative benefit recorded in 1992 from the change in
accounting for income taxes.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
(Dollars in thousands, except per share data)
OVERVIEW
The Company's 1996 financial results and performance were favorable. During
1996, the Company recorded growth in core deposits, interest and noninterest
revenues, and net income. Substantially all profitability measures showed
improvement in 1996 when compared to 1995. At year-end 1996, capital remained
well above minimum regulatory requirements.
Also in 1996, Bancorp completed its second merger, when Annapolis
Bancshares, Inc. was merged into Sandy Spring Bancorp and The Bank of Annapolis
was merged into Sandy Spring National Bank. This transaction had little impact
on consolidated earnings growth for 1996, after merger related expenses were
recorded, but gives the Company opportunity for future growth in an attractive
new market. This merger was accounted for as a pooling of interests.
Accordingly, all financial data except dividend and stock price information have
been retroactively restated to include the operations and position of Annapolis
Bancshares.
In December 1996, Sandy Spring National Bank completed the acquisition of
an existing bank branch on Wisconsin Avenue in Bethesda from Bank of Maryland.
This acquisition provides a new business base along the Route 355 corridor and
is a natural extension of the Bank's branch system.
For 1996, net earnings amounted to $11,494 ($2.36 per share) versus $9,994
($2.09 per share) for 1995, a 15% increase. Return on average assets was 1.27%
compared to 1.18% for 1995, and return on average equity was 12.81% versus
12.37% for 1995. Total deposits grew by 8.4% while loan growth amounted to 6.2%.
Asset quality remains acceptable, as measured by net loans charged off and the
level of problem assets continuing to indicate moderate levels of risk.
The following more detailed discussion of our financial results is intended
to give you the reader a clear and succinct view of the various significant
components of our operating results and financial position. Please refer to the
Selected Glossary and Abbreviations on page 29 for further definition of
technical terms.
CHANGES IN NET INCOME PER COMMON SHARE
1995 to 1996 1994 to 1995
- ---------------------------------------------------------------------------
Prior year net income per share $ 2.09 $ 1.90
Change attributed to:
Net interest income 0.48 0.33
Provision for credit losses (0.02) 0.00
Noninterest income 0.28 0.04
Noninterest expenses (0.39) (0.13)
Income taxes (0.04) (0.01)
Increased shares outstanding (0.04) (0.04)
------ ------
Total 0.27 0.19
------ ------
NET INCOME PER SHARE $ 2.36 $ 2.09
====== ======
13
HISTORICAL TRENDS IN FINANCIAL DATA 1992-1996(1)
(Dollars in thousands, except per share data)
1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS (for the year):
Interest income $ 66,621 $ 62,115 $ 51,578 $ 46,189 $ 48,177
Interest expense 30,233 29,342 21,496 19,793 23,129
Net interest income 36,388 32,773 30,082 26,396 25,048
Provision for credit losses 308 180 212 1,056 1,880
Net interest income after provision
for credit losses 36,080 32,593 29,870 25,340 23,168
Noninterest income 6,547 4,478 4,189 4,870 4,656
Noninterest expenses 25,344 22,424 21,462 18,340 16,243
Income before taxes and cumulative
effect of accounting change 17,283 14,647 12,597 11,870 11,581
Income tax expense 5,789 4,653 3,694 3,261 3,252
Income before cumulative effect of
accounting change 11,494 9,994 8,903 8,609 8,329
Cumulative effect of accounting change 0 0 0 0 744
Net income 11,494 9,994 8,903 8,609 9,073
PER SHARE DATA:
Net income $ 2.36 $ 2.09 $ 1.90 $ 1.92 $ 2.01(2)
Dividends declared 0.78 0.64 0.54 0.49 0.43
Book value 19.70 18.04 15.72 15.63 13.39
FINANCIAL CONDITION (at year end):
Assets $978,595 $876,203 $830,834 $784,274 $675,418
Deposits 806,341 743,592 700,340 676,422 602,073
Loans 523,166 492,540 457,052 374,740 313,924
Securities 361,806 290,786 309,622 314,283 285,120
Stockholders' equity 96,581 86,941 73,766 72,420 59,205
MEASUREMENTS (for the year):
Return on average assets 1.27% 1.18% 1.14% 1.23% 1.30%(2)
Return of average equity 12.81 12.37 12.24 13.55 16.95(2)
Average equity to average assets 9.90 9.57 9.28 9.10 7.65
Dividends declared to net income 33.05 30.62 28.42 25.52 21.39(2)
(1) Adjusted to give retroactive effect to a 2-for-1 stock split declared on
March 29, 1995 and, except with respect to dividends declared per share, the
acquisition of Annapolis Bancshares, Inc. on August 29, 1996, which was
accounted for as a pooling of interests.
(2) Excludes the cumulative benefit recorded in 1992 from the change in
accounting for income taxes.
14
Sandy Spring Bancorp and Subsidiaries
CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES/(1)/
(Dollars in thousands and tax-equivalent)
1996 1995
-----------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Loans:(2)
Real estate(3) $417,161 $37,866 9.08% $400,176 $36,154 9.03%
Consumer 28,600 2,682 9.38 26,710 2,437 9.12
Commercial 62,999 6,125 9.72 54,677 5,320 9.73
Tax exempt 169 16 9.65 479 63 13.15
-------- ------- -------- -------
Total loans 508,929 46,689 9.17 482,042 43,974 9.12
Securities:
Taxable 250,763 15,062 6.01 234,354 13,769 5.88
Nontaxable 65,847 5,005 7.60 65,696 5,177 7.88
-------- ------- -------- -------
Total securities 316,610 20,067 6.34 300,050 18,946 6.31
Interest-bearing deposits
with banks 3,585 187 5.22 740 39 5.27
Federal funds sold 25,319 1,342 5.30 15,252 872 5.72
-------- ------- -------- -------
TOTAL EARNING
ASSETS 854,443 68,285 7.99 798,084 63,831 8.00
Less: allowance for
credit losses (6,668) (6,647)
Cash and due from banks 25,923 24,188
Premises and equipment, net 20,559 17,019
Other assets 12,305 11,174
-------- --------
Total Assets $906,562 $843,818
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing
demand deposits $ 96,940 $ 2,529 2.61% $ 86,688 $ 2,263 2.61%
Regular savings deposits 95,636 2,695 2.82 104,971 3,218 3.07
Money market
savings deposits 149,358 4,935 3.30 154,644 5,646 3.65
Time deposits 324,842 17,730 5.46 277,804 15,578 5.61
-------- ------- -------- -------
Total interest-bearing
deposits 666,776 27,889 4.18 624,107 26,705 4.28
Short-term borrowings 41,864 2,021 4.83 40,605 2,284 5.62
Long-term borrowings 4,854 323 6.65 6,097 353 5.79
-------- ------- -------- -------
TOTAL INTEREST-
BEARING
LIABILITIES 713,494 30,233 4.24 670,809 29,342 4.37
------- ---- ------- ----
Net interest income
and spread $ 38,052 3.75% $34,489 3.63%
Noninterest-bearing
demand deposits 100,127 90,260
Other liabilities 3,231 1,987
Stockholders' equity 89,710 80,762
-------- --------
Total liabilities and
stockholders' equity $906,562 $843,818
-------- --------
Interest income/
earning assets 7.99% 8.00%
Interest expense/
earning assets 3.54 3.68
---- ----
Net interest margin 4.45% 4.32%
==== ====
1994
-----------------------------------
Average Yield/
Balance Interest Rate
- ----------------------------------------------------------------
ASSETS
Loans:(2)
Real estate(3) $327,485 $27,046 8.26%
Consumer 20,357 1,765 8.67
Commercial 45,241 3,785 8.37
Tax exempt 611 77 12.60
-------- -------
Total loans 393,694 32,673 8.30
Securities:
Taxable 258,102 14,299 5.54
Nontaxable 75,136 5,911 7.87
-------- -------
Total securities 333,238 20,210 6.06
Interest-bearing deposits
with banks 1,028 38 3.70
Federal funds sold 13,948 549 3.94
-------- -------
TOTAL EARNING
ASSETS 741,908 53,470 7.21
Less: allowance for
credit losses (6,841)
Cash and due from banks 22,730
Premises and equipment, net 16,239
Other assets 10,332
--------
Total Assets $784,368
--------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing
demand deposits $ 87,591 $ 2,293 2.62%
Regular savings deposits 115,839 3,525 3.04
Money market
savings deposits 183,949 5,641 3.07
Time deposits 199,448 8,573 4.30
-------- -------
Total interest-bearing
deposits 586,827 20,032 3.41
Short-term borrowings 28,973 1,175 4.06
Long-term borrowings 5,149 289 5.61
-------- -------
TOTAL INTEREST-
BEARING
LIABILITIES 620,949 21,496 3.46
------- -----
Net interest income
and spread
Noninterest-bearing
demand deposits 90,238
Other liabilities 427
Stockholders' equity 72,754
--------
Total liabilities and
stockholders' equity $784,368
========
Interest income/
earning assets 7.21%
Interest expense/
earning assets 2.90
-----
Net interest margin 4.31%
=====
(1) Income and yields are presented on a tax-equivalent basis using the maximum
applicable federal income tax rate.
(2) Nonaccrual loans are included in the average balances.
(3) Includes residential mortgage loans held for sale.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
NET INTEREST INCOME
Net interest income for 1996 was $36,388, representing an increase of $3,615 or
11.0% from 1995. An 8.9% rise was achieved in 1995, compared to 1994, resulting
in net interest income of $32,773, up from $30,082. On a tax-equivalent basis,
net interest income amounted to $38,052 in 1996, representing a 10.3% annual
rise, and $34,489 in 1995, representing a 7.9% annual rise, preceded by $31,974
in 1994.
Since net interest income is the most important category of earnings,
performance in this area is emphasized by management. The analysis of net
interest income performance presented in the "Consolidated Average Balances,
Yields and Rates" table shows a 1996 net interest margin of 4.45%, up 13 basis
points, compared to 1995. The net interest margin for 1995 of 4.32% was
essentially the same as for 1994. The table entitled "Effect of Volume and Rate
Changes on Net Interest Income" shows that the increases in net interest income
during 1996 and 1995, compared to each prior year, were primarily driven by
increases in the volumes of earning assets.
EFFECT OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
1996 vs. 1995 1995 vs. 1994
--------------------------------------------------------------------------------------
Increase or in Average: (1)(2) Increase or in Average: (1)(2)
---------------------- ----------------------
(Tax-equivalent basis) (Decrease) Volume Rate (Decrease) Volume Rate
- ----------------------------------------------------------------------------------------------------------------------------------
Interest income from
earnings assets:
Loans $2,715 $2,464 $ 251 $11,301 $ 7,837 $3,464
Taxable securities 1,293 981 312 (530) (1,363) 833
Nontaxable securities (172) 12 (184) (734) (744) (10)
Other investments 618 687 (69) 324 42 282
------ -------
Total interest income 4,454 4,503 (49) 10,361 4,230 6,131
Interest expense on funding
of earnings assets:
Interest-bearing demand deposits 266 268 (2) (30) (24) (6)
Regular savings deposits (523) (274) (249) (307) (333) 26
Money market savings deposits (711) (188) (523) 5 (976) 981
Time deposits 2,152 2,578 (426) 7,005 3,945 3,060
Borrowings (293) 1 (294) 1,173 632 541
------ -------
Total interest expense............ 891 1,829 (938) 7,846 1,833 6,013
------ ------ ----- ------- ------- ------
Net interest income............... $3,563 $2,674 $ 889 $ 2,515 $ 2,397 $ 118
====== ====== ===== ======= ======= ======
(1) Variances are computed on a line-by-line basis and are non-additive.
(2) Combined rate/volume variances, a third element of the calculation, are
allocated to the volume and rate variances based on their relative size.
Interest Income
The Company's tax-equivalent interest income increased by 7.0% or $4,454 in
1996, compared to 1995, as a result of a 7.1% or $56,359 increase in average
earning assets accompanied by a modest decline in average yield earned on those
funds. During 1996, average loans, yielding 9.17%, rose $26,887 or 5.6%. Average
commercial loans increased by 15.2% or $8,322 in 1996. Management has targeted
commercial loans for growth, in part because they produce the highest rate
(average yield of 9.72% for 1996) of any major category of earning assets.
However, lower yielding average securities (yielding only 6.34%), increased
$16,560 in 1996, representing virtually the same percentage rise as achieved for
average loans. Less significantly, federal funds sold, which are short-term
investments primarily benefitting liquidity, increased $10,067 or 66.0%, and
earned an average yield of 5.30% for 1996. The Company generated a greater
amount of interest income in 1996 in the face of stiff industrywide competition
with banks and nonbanking entities for desirable lending opportunities.
Tax-equivalent interest income increased 19.4% or $10,361 in 1995, compared
to 1994, due to the combination of higher average earning assets, up 7.6%, and
higher average yield earned, up 79 basis points. However, when higher funding
costs are taken into consideration, the resulting interest rate spread achieved
on those earning assets declined 12 basis points in 1995 versus 1994.
Interest Expense
Interest expense increased $891 or 3.0% in 1996 compared to 1995, attributable
to the offsetting effects of 6.4% or $42,685 greater average interest-bearing
liabilities and a 13 basis point decline in the average rate paid for those
funds. Most of the rise in interest-bearing funds was generated by deposit
growth of 6.8% or $42,669. By contrast, average interest free funding of earning
assets increased 10.7% or $13,674 over the same period, primarily due to a rise
in demand deposits attributable in part to the introduction of a new product
around mid-year. By far, the largest increase in interest-bearing
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
deposits occurred in average time deposits, which were 16.9% or $47,038 above
1995, and comprised the most expensive deposit type, paying an average rate of
5.46% in 1996, compared to 4.18% for all interest-bearing deposits. In addition,
the average rate paid on time deposits declined only 15 basis points in 1996,
compared to 1995, much less than declines recorded by most other deposit and
borrowing categories.
In 1995, interest expense increased significantly more than interest
income, rising 36.5% or $7,846, reflecting the effects of a 91 basis point rise
in average rate on 8.0% higher average interest-bearing liabilities.
Interest Rate Performance
Interest rate performance has been relatively stable over the past three years.
The same interest rate spread was achieved in 1996 and 1994, with a small
decline in 1995. The net interest margin increased slightly in 1996, after
remaining virtually the same the prior two years. The change in margin was due
to the beneficial effects of the higher level of interest-free funding of
earning assets in 1996 than in 1995 as well as to growth in interest-bearing
deposits at favorable interest spreads. By maintaining, and then improving, its
net interest margin from 1994 to 1996, the Company has been able to preserve,
and then enhance, its net interest income performance during a period of
significant growth.
NONINTEREST INCOME
Total noninterest income rose 46.2% or $2,069 to $6,547 in 1996 from $4,478 in
1995. An increase of 6.9% or $289 was posted for 1995 versus 1994.
Securities gains totaled $30 in 1996 as compared with securities losses of
$279 in 1995 and $84 in 1994. The sale of available-for-sale debt securities
generated net losses of $66 for 1996 compared with $89 in net gains from sales
of available-for-sale equity securities and $7 in net gains from securities
calls, maturities and paydowns. During 1995, the sale of available-for-sale debt
securities generated $277 in net losses, while calls, maturities and paydowns
generated $2 in net losses.
Service charges on deposit accounts increased 15.4% or $395 during 1996. In
1995, an increase of 9.4% or $221 was realized. Management continuously monitors
the service fee structure and makes changes where appropriate.
Mortgage banking operations generated $825 in gains on loan sales of
$56,457 in 1996 as management placed great emphasis upon originations and sales
of residential mortgage loans in the secondary market at a profit margin, versus
building a mortgage portfolio on the Company's books. By comparison, gains of
$244 were realized on loan sales of $19,246 during 1995, and $175 in gains were
realized on loan sales of $15,476 in 1994.
Other noninterest income rose 40.3% or $784 in 1996 over 1995, with fees
from trust services, mutual funds and annuities increasing 44.2% or $385. Newer
fee based businesses, credit cards and debit cards (new in 1996), generated
another $118 in additional income during 1996, compared to 1995, and other fee
income increased 23.8% or $143. Among nonrecurring items, sales of other real
estate owned were responsible for $147 of the overall rise in other noninterest
income, while asset dispositions during 1996 versus 1995 resulted in net losses
of $47. Other noninterest income increased 11.1% or $194 in 1995 over 1994,
attributable in large part to fees for trust services, which rose 20.8% or $131,
and to gains on sales of student loans, which generated $131 in additional
income.
NONINTEREST EXPENSES
Noninterest expenses increased 13.0% or $2,920 in 1996 over 1995 and 4.5% or
$962 in 1995 over 1994. However, nonrecurring expenses significantly affected
these changes, reducing the size of the core increase in noninterest expenses by
$750 in 1996, compared to 1995, and by $342 in 1995, compared to 1994. Items of
nonrecurring expenses included an industry-wide FDIC insurance premium reduction
enacted in 1995, which effectively reduced noninterest expenses by $814 in 1996
and $692 in 1995, and merger related costs associated with the acquisition of
Annapolis Bancshares, Inc., which increased noninterest expenses in 1996 by
$724, along with costs of conversion to a new data processing center in 1995 and
early retirement benefits extended to certain long-term employees in 1995 and
1994. Excluding nonrecurring items, increases in core noninterest expenses
amounted to 17.5% or $3,670 in 1996 compared with an increase of 6.6% or $1,304
for 1995.
Salaries and employee benefits increased 13.5% or $1,721 in 1996 and 6.4%
or $767 in 1995. Excluding nonrecurring items, an increase of 14.8% or $1,842
was realized in 1996 compared with an increase of 6.6% or $766 for 1995. The
increase for 1996 was, for the most part, due to growth in staff, including
staffing for two new branches, and an expanded incentive program called
"Stakeholder" which relates compensation throughout the business to the
Company's performance as measured against key performance indicator goals.
Quarterly "Stakeholder" payouts amounted to $479 in 1996. The increase in salary
and benefit costs for 1995 was due significantly to merit increases.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
The Company's net income, as measured on a per employee basis, continue to
grow, which is favorable. The ratio of net income per average full-time-
equivalent employee was $33 for 1996, $31 for 1995 and $29 for 1994. Average
full-time equivalent employees increased in 1996 by 8.8% to 346, compared to 318
for 1995 and 310 for 1994. The increase in average full-time equivalent
employees is largely a reflection of the Company's expansion over the period.
All other noninterest expenses increased 12.4% or $1,199 in 1996 and
increased 2.1% or $195 in 1995. Excluding nonrecurring expenses, an increase of
21.4% or $1,828 was realized in 1996 compared with an increase of 6.7% or $538
for 1995. The increase for 1996 included a 95.7% or $560 rise in marketing
expenses due to intensified marketing associated with entry into new markets,
40.9% or $322 higher data services costs, reflecting growth and conversion to a
new provider with expanded capabilities in late 1995, a 58.1% or $291 increase
in building and grounds maintenance attributable to the merger, new branches and
maintenance of existing facilities, and a 100.0% or $181 rise in attorneys'
fees, in large part associated with merger activity, partially offset by a $370
increase in rental income which is netted against rental expenses. The increase
for 1995 included increases in equipment expenses, primarily depreciation
charges and software expenses, and in marketing expense, supply expenses, and
data services costs.
Operating Expense Performance
Management believes that the net overhead ratio (lower ratios indicate improved
productivity), which expresses the level of net operating expenses (noninterest
expenses less noninterest income) as a percentage of tax-equivalent net interest
income, is a good measure of overall operating expense performance and cost
management. During 1996, the Company's net overhead ratio was 49.4%, compared to
ratios of 52.0% achieved in 1995 and 54.0% in 1994. Ratios close to 50% are
considered desirable.
PROVISION FOR INCOME TAXES
Income tax expense amounted to $5,789 in 1996, compared with $4,653 in 1995 and
$3,694 in 1994. The Company's effective tax rate for 1996 was 33.5%, compared
with 31.8% in 1995 and 29.3% in 1994. The increase in effective tax rate has
been due primarily to a decline in the nontaxable component of income before
taxes each year. During 1996, the Company's taxable income surpassed $10,000,
triggering an increase in the applicable corporate tax rate from 34% to 35%.
This increased rate resulted in additional income tax expense of $24 for 1996 on
taxable earnings in excess of $10,000.
BALANCE SHEET ANALYSIS
During 1996, the Company's size, as measured by total assets, grew by $102,392
or 11.7%, to $978,595 at December 31, 1996 from $876,203 at December 31, 1995.
Earning assets at year end increased $97,977 or 12.0%, to $917,096 from
$819,119. The rise in loans, a core business for commercial banks, amounted to
$30,626 or 6.2% compared to a $71,020 or 24.4% increase in securities. On an
average basis, however, total loans increased $26,887 or 5.6% versus a $16,560
or 5.5% increase in average total securities. The types and characteristics of
the growth in loans is discussed in detail below.
LOANS
Real estate mortgage loans rose 3.4% to $376,205 in 1996. Included in this
category are commercial mortgages, which increased 12.5% during 1996 and
totalled $178,639 at December 31, 1996. These mortgages mainly consist of owner
occupied properties where an established banking relationship exists. Home
equity lines and home equity loans, types of real estate mortgages that permit
homeowning consumers to leverage their equity and possibly receive an income tax
deduction on the interest, increased 7.7% during 1996 to $65,420 at year end.
One to four family residential loans, down 11.5% in 1996, represented $116,444
of the real estate mortgage portfolio at December 31, 1996. This represents an
increased emphasis by the Company on mortgage banking, where most residential
mortgage loan production is sold in the secondary market rather than being
maintained as a loan asset. In this type of business, the bank serves as the
customer service and delivery channel for investors, while continuing to meet
the needs of area residents for funds to finance their homes. Other real estate
mortgages, including primarily residential lot loans, collectively rose 23.1% to
$15,702.
Real estate construction loans increased 14.2% to $47,654 from 1995,
attributable to a substantial rise in residential construction activity. The
Company conducts its commercial construction lending in the markets it knows and
understands, works selectively with local, top-quality builders and developers,
and requires substantial equity from its borrowers.
The consumer loan portfolio rose 7.1% to $30,813 at December 31, 1996. In
recent years, much of consumer lending has shifted from traditional installment
credits into home equity lines and credit cards. During 1996, the Company
achieved a 6.6% increase in home equity lines, which are included above in real
estate mortgage loans. Credit cards, introduced in 1995, are showing growth,
more than doubling in 1996 to an outstanding balance of $1,321 at year end.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
Consumer lending continues to be important to the full service community banking
business conducted by the Company despite a smaller balance sheet presence in
recent years.
Commercial loans advanced the most among the major categories on a
percentage basis, up 18.6% to $68,467 during 1996. For the most part, these are
loans to a diverse cross-section of small to mid-size local businesses, many of
whom are existing customers of the Company. These types of banking relationships
are a natural fit for the Company, which is experienced in serving and lending
to this market segment and has knowledge of the marketplace through its
community roots and involvement. The Company continues to place special emphasis
on this part of its loan portfolio in its business planning.
Analysis of Loans
The following table presents the trends in the composition of the loan portfolio
over the previous five years.
December 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
Real estate -- mortgage(1) $376,205 $363,927 $345,547 $286,542 $252,706
Real estate -- construction(2) 47,654 41,725 31,853 21,770 18,592
Consumer 30,813 28,762 28,892 19,352 17,906
Commercial 68,467 57,718 50,224 46,405 23,477
Tax exempt 27 408 536 671 1,243
-------- -------- -------- -------- --------
TOTAL LOANS $523,166 $492,540 $457,052 $374,740 $313,924
======== ======== ======== ======== ========
(1) Consists of fixed and adjustable rate first and second home mortgage loans,
home equity lines of credit and commercial mortgage loans.
(2) Includes both residential and commercial properties.
Securities
The investment portfolio, in the aggregate, increased 24.4% or $71,020 during
1996 to $361,806 at December 31, 1996 from $290,786 at December 31, 1995.
Investments are managed to generate interest revenue, provide liquidity and
achieve asset/liability management goals. During 1996, funds provided by the
increase in deposits exceeded the increase in the loan portfolio, and the excess
was invested primarily in securities. A significant portion of the rise in
investments occurred toward the end of 1996, when funds were borrowed from the
Federal Home Loan Bank of Atlanta and invested in securities at a favorable
interest rate spread in order to leverage the balance sheet and enhance the
return on shareholders' equity (see discussion on page 25 in "Deposits and
Short-term Borrowings" section). On an average basis, aggregate investments rose
5.5% during 1996, compared to 1995.
Analysis of Securities
The composition of Securities at December 31 for each of the latest three fiscal
years was:
1996 1995 1994
- -------------------------------------------------------------------------
AVAILABLE-FOR-SALE(1)
U.S. Treasury $ 26,940 $ 15,991 $ 23,272
U.S. Agency 145,275 70,106 23,579
State and municipal 26,628 35,330 39,836
Corporate debt obligations 1,483 2,458 3,260
Mortgage-backed securities(2) 31,876 40,282 37,307
Marketable equity securities 2,221 1,786 518
-------- -------- --------
Total 234,423 165,953 127,772
HELD-TO-MATURITY AND OTHER EQUITY
U.S. Treasury 0 500 1,499
U.S. Agency 42,932 40,185 79,816
State and municipal 37,152 30,522 29,717
Mortgage-backed securities(2) 42,188 48,579 65,902
Certificates of deposit 0 100 0
Other equity securities 5,111 4,947 4,916
-------- -------- --------
Total 127,383 124,833 181,850
-------- -------- --------
TOTAL SECURITIES(3) $361,806 $290,786 $309,622
======== ======== ========
(1) At estimated fair value.
(2) Mortgage-backed securities are either issued by a federal agency or are
secured by U.S. Agency collateral and therefore are believed to be high-
quality.
(3) The outstanding balance of no single issuer, except for the U.S. Government
and U.S. Government Agency securities, exceeded ten percent of stockholders'
equity at December 31, 1996, 1995 or 1994.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
Maturities and weighted average yields for investments available-for-sale
and held-to-maturity at December 31, 1996, are shown below:
Years to Maturity
---------------------------------------------------------------------------------------
Within Over 1 Over 5 Over
1 through 5 through 10 10
---------------------------------------------------------------------------------------
Amount Yield Amount Yield Amount Yield Amount Yield
- -----------------------------------------------------------------------------------------------------------------------
INVESTMENTS
AVAILABLE-FOR-SALE(1)
U.S. Treasury $12,996 5.61% $ 13,957 5.63% $ 0 0% $ 0 0%
U.S. Agency 8,998 5.55 131,520 6.16 4,999 6.78 0 0
State and municipal(2) 4,374 8.18 19,639 7.68 2,264 6.61 0 0
Corporate debt obligations 0 0 500 5.76 1,000 5.65 0 0
Mortgage-backed
securities 3,061 6.18 16,553 5.93 9,734 6.06 2,847 6.74
------- -------- ------- -------
Total debt securities $29,429 6.03% $182,169 6.26% $17,997 6.31% $ 2,847 6.74%
======= ======== ======= =======
Marketable equity securities
TOTAL INVESTMENTS
AVAILABLE-FOR-SALE
INVESTMENTS HELD-
TO-MATURITY
U.S. Agency $ 0 0% $20,090 5.86% $ 9,320 7.04% $13,522 7.93%
State and municipal(2) 0 0 18,113 7.51 18,439 7.02 600 7.79
Mortgage-backed
securities 12,926 6.32 29,262 6.89 0 0 0 0
------- -------- ------- ------
TOTAL INVESTMENTS
HELD-TO-MATURITY $12,926 6.32% $ 67,465 6.75% $27,759 7.03% $14,122 7.92%
======= ======== ======= =======
- ----------------------------------------------------
TOTAL YIELD
- ----------------------------------------------------
INVESTMENTS
AVAILABLE-FOR-SALE(1)
U.S. Treasury $ 26,953 5.63%
U.S. Agency 145,517 6.14
State and municipal(2) 26,277 7.68
Corporate debt obligations 1,500 5.69
Mortgage-backed
securities 32,195 6.07
--------
Total debt securities 232,442 6.24%
Marketable equity securities 470
--------
TOTAL INVESTMENTS
AVAILABLE-FOR-SALE $232,912
========
INVESTMENTS HELD-
TO-MATURITY
U.S. Agency $ 42,932 6.76%
State and municipal(2) 37,152 7.28%
Mortgage-backed
securities 42,188 6.76%
--------
TOTAL INVESTMENTS
HELD-TO-MATURITY $122,272 6.92%
========
(1) Amounts shown at amortized cost without market value adjustments required by
FASB 115 (see Notes 1 and 4 of Notes to the Consolidated Financial
Statements).
(2) The yields on state and municipal securities have been calculated on a tax-
equivalent basis using the maximum applicable federal income tax rate.
Other Earning Assets
Residential mortgage loans held for sale increased 69.0% or $3,260 in 1996.
Originations and sales of these loans, and the resulting gains on sales,
increased substantially as presented on the Consolidated Statements of Cash
Flows, reflecting the change to a mortgage banking philosophy of residential
mortgage lending.
The aggregate of federal funds sold and interest-bearing deposits with
banks decreased 22.3% or $6,929 in 1996.
Deposits and Short-term Borrowings
Total deposits increased 8.4% or $62,749 during 1996 to $806,341 at December 31,
1996 from $743,592 at December 31, 1995. Noninterest-bearing deposits increased
22.0% or $21,077, attributable primarily to growth in commercial checking
balances and the introduction of a "free" checking account product around mid-
year. Interest-bearing deposits increased 6.4% or $41,672 in 1996, with the
majority of the rise occurring in time deposits for amounts less than $100,000.
Short-term borrowings increased 95.7% or $33,323 in 1996 to $68,127 at
December 31, 1996 from $34,804 at December 31, 1995. Borrowings from the Federal
Home Loan Bank of Atlanta increased $17,200, reflecting funds borrowed late in
the year and invested in securities in order to leverage the balance sheet and
enhance the shareholders' return on investment. Repurchase agreements, the other
major category of short-term borrowings, increased 44.6% or $13,639, due
primarily to an increase in sweep accounts associated with cash management
services to commercial customers.
CAPITAL MANAGEMENT
During 1996, stockholders' equity increased 11.1% or $9,640 to $96,581 at
December 31, 1996 from $86,941 at December 31, 1995. The increase for 1996 was,
for the most part, due to internal capital generation, which represents net
earnings less dividends as a percent of average equity. The resulting internal
capital generation rate was 8.7% for 1996, compared with 8.8% for 1995 and 9.0%
for 1994. The amount of the increase in stockholders' equity attributable to
internal capital generation was $7,776 in 1996, $7,096 in 1995 and $6,528 in
1994. External capital formation from dividend reinvestment, the exercise of
warrants, and employee stock purchases under the Company's stock option and
profit sharing plans totaled $1,741 in 1996, $2,379 in 1995 and $1,063 in 1994.
The ratio of average equity to average assets amounted to 9.90% for 1996,
compared with 9.57% for 1995 and 9.28% for 1994.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
Regulatory Capital Requirements
The Company achieved a total risk-based capital ratio of 17.56% at December 31,
1996, compared to 17.67% at December 31, 1995, a Tier 1 risk-based capital ratio
of 16.44% compared to 16.42%, and a capital leverage ratio of 10.38% compared to
10.09%. A discussion of these quantitative measures of capitalization and the
regulatory capital requirements which pertain to them, along with a presentation
of the Company's and the Bank's capital and ratios compared to the various
regulatory standards, appears in Note 22 of the Notes to the Consolidated
Financial Statements. At December 31, 1996, the Company and its banking
subsidiary exceeded all capital requirements and were considered to be "well-
capitalized" under regulatory definitions.
Management monitors historical and projected earnings, dividends and asset
growth, as well as risks associated with the various types of on- and off-
balance sheet assets, in order to determine the appropriate capital levels and
the action needed, if any, to preserve capital adequacy.
CREDIT RISK MANAGEMENT
The allowance for credit losses is a valuation reserve established by management
in an amount it deems adequate to absorb losses on loans which may become
uncollectible. The adequacy of the allowance for credit losses is determined
through careful and continuous review and evaluation of the loan portfolio and
involves the balancing of a number of factors to establish a prudent level.
Management records provisions for credit losses in order to increase the
allowance to the level it deems adequate. Loan charge-offs decrease the
allowance. Management believes that the allowance for credit losses is adequate.
The level of nonperforming loans increased to $4,655 (.89% of year-end
loans) at December 31, 1996 from $898 (.18% of year-end loans) at December 31,
1995, due to increases in nonaccrual loans and loans which are past due 90 days
or more. The rise in nonaccruals involved loans to a single borrower which
management believes will be collected in full during 1997. The increase in loans
reported as 90 days or more past due was attributable primarily to the inclusion
of credit line expirations at December 31, 1996, which were not included in
prior years, and to Annapolis Bancshares credits, which became subject to the
Company's more stringent loan review and classification practices subsequent to
the merger. It is anticipated that many of the expired lines of credit, which
are still current as to principal and interest payments, will be renewed or
otherwise return to performing status. The Company also had an increase in loans
90 or more days past due associated with growth and diversification of the loan
portfolio. The allowance for credit losses represented 137% of nonperforming
loans at December 31, 1996, compared to coverage of 735% a year earlier, with
the change attributable to an increase in the level of nonperforming loans.
Significant variation in the coverage ratio may occur from period to period
because the amount of nonperforming loans depends largely on the condition of a
small number of individual loans and borrowers relative to the total loan
portfolio. There were no real estate owned properties at December 31, 1996 as
compared to a modest $47 at December 31, 1995. The balance of impaired loans was
$1,280 at December 31, 1996 and the reserve on these loans was $127. There were
no impaired loans at December 31, 1995. Although $590 of loans were classified
as being in nonaccrual status at December 31, 1995, the insignificant delay of
projected payments caused the loans not to be classified as impaired.
The major concentrations of credit risk for the Company arise by customer
location, because it operates only in three counties in the State of Maryland,
and by loan portfolio composition. Real estate secured credits represented 81.0%
of total loans at December 31, 1996, and 82.4% at December 31, 1995. In the
past, the Company has experienced low loss levels, especially in real estate
secured loans, through various economic cycles and conditions. The risk of the
Company's real estate loan concentration is mitigated by the nature of real
estate collateral, the Bank's substantial experience in most of its markets and
its intention to maintain risk averse lending practices.
The provision for credit losses charged against earnings was $308 in 1996
compared with $180 in 1995, an increase of 71.1%. The provision was $211 in
1994. In each year, net charge-offs exceeded the provision for credit losses.
The ratio of net charge-offs to average loans was .10% in 1996, compared to .05%
in 1995 and .06% in 1994. The allowance for credit losses was decreased to
$6,391 (1.22% of year-end loans) at December 31, 1996 from $6,597 (1.34% of
year-end loans) at December 31, 1995. The allowance has been maintained at
levels believed consistent with the increased risk potential inherent in the
increase in the amount and percentage to total loans attributable to commercial
and commercial real estate loans (see the discussion of loan growth earlier in
this report), which are viewed as entailing greater risk than certain other
categories of loans, and the associated increase in large loans, as balanced
against other factors, as described above. For additional discussion of the
allowance for credit losses, see Note 1 of the Notes to the Consolidated
Financial Statements.
21
Analysis of Credit Risk
Activity in the allowance for credit losses for the preceding five years ended December 31 is shown below:
1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------
Balance, January 1 $6,597 $6,663 $6,681 $4,213 $2,957
Provision for credit losses 308 180 211 1,057 1,880
Allowance from merger transaction 0 0 0 1,158 0
Loan charge-offs:
Real estate - mortgage (3) (33) (135) 0 (506)
Real estate - construction 0 0 0 0 0
Consumer (143) (209) (32) (104) (243)
Commercial (469) (507) (342) (29) (76)
------ ------ ------ ------ ------
Total charge-offs (615) (749) (509) (133) (825)
Loan recoveries:
Real estate - mortgage 0 153 16 54 0
Real estate - construction 0 0 0 0 5
Consumer 37 30 40 79 61
Commercial 64 320 224 253 135
------ ------ ------ ------ ------
Total recoveries 101 503 280 386 201
------ ------ ------ ------ ------
Net recoveries (charge-offs) (514) (246) (229) 253 (624)
------ ------ ------ ------ ------
BALANCE, DECEMBER 31 $6,391 $6,597 $6,663 $6,681 $4,213
====== ====== ====== ====== ======
Net charge-offs to average loans 0.10% 0.05% 0.06% * 0.19%
Allowance to total loans 1.22% 1.34% 1.46% 1.78% 1.34%
* The Company had net recoveries in 1993.
The following table presents nonperforming assets for a five year period:
December 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------
Nonaccrual loans/(1)/ $1,291 $ 590 $ 866 $2,969 $ 508
Loans 90 days past due 3,337 272 832 517 953
Restructured loans 27 36 44 394 0
------ ------ ------ ------ ------
Total nonperforming loans/(2)//(3)/ 4,655 898 1,742 3,880 1,461
Other real estate owned, net 0 47 277 1,387 999
------ ------ ------ ------ ------
TOTAL NONPERFORMING ASSETS $4,655 $ 734 $2,019 $5,267 $2,460
====== ====== ====== ====== ======
NONPERFORMING ASSETS TO TOTAL ASSETS 0.48% 0.11% 0.24% 0.67% 0.36%
/(1)/ Gross interest income that would have been recorded in 1996 if nonaccrual
loans had been current and in accordance with their original terms was
$192, while interest actually recorded on such loans was $89.
/(2)/ Those performing loans considered potential problem loans, as defined and
identified by management, amounted to $3,440 at December 31, 1996.
Although these are loans where known information about the borrowers'
possible credit problems causes management to have doubts as to the
borrowers' ability to comply with the present loan repayment terms, most
are well collateralized and are not believed to present significant risk
of loss. Loans classified for regulatory purposes not included in
nonperforming loans consist only of "other loans especially mentioned" and
do not in management's opinion, represent or result from trends or
uncertainties reasonably expected to materially impact further operating
results, liquidity or capital resources or represent material credits
where known information about the borrowers' possible credit problems
causes management to have doubts as to the borrowers' ability to comply
with the loan repayment terms.
/(3)/ Installment loans past due by 90 days or more are included in the totals
for the "loans 90 days past due" line in the table above and were
immaterial at December 31, 1996 and 1995.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Liquidity
The Company's liquidity position, considering both internal and external sources
available, exceeded anticipated short- and long-term funding needs at December
31, 1996. Core deposits, considered to be stable funds sources and defined to
include all deposits except time deposits of $100,000 or more, equaled 81.7% of
total earning assets at December 31, 1996. In addition, substantial amortizing
residential mortgage loans, maturities, calls and paydowns of securities,
deposit growth and earnings contribute a flow of funds available to meet
liquidity requirements. In assessing liquidity, management considers operating
requirements, the seasonality of deposit flows, investment, loan and deposit
maturities, expected fundings of loans and deposit withdrawals, and the market
values of available-for-sale investments, so that sufficient funds are available
on short notice to meet obligations as they arise and to ensure that the Company
is able to pursue new business opportunities.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
Internally generated funds on hand at December 31, 1996, consisting of cash
and cash equivalents, interest-bearing deposits with banks, residential mortgage
loans held for sale, maturities of investments held-to-maturity due within one
year at fair value and investments available-for-sale, totalled $312,390 or
31.9% of total assets.
The primary external source of liquidity available is a line of credit for
$145,000 with the Federal Home Loan Bank of Atlanta of which $20,200 was
outstanding at December 31, 1996. Core deposits increased by $56,862 during
1996, while loans grew by $30,626, so that borrowed funds were not required to
support loan growth. As discussed previously in the section entitled "Deposits
and Short-term Borrowings", Federal Home Loan Bank advances increased in 1996
due to management's desire to leverage the balance sheet at favorable interest
spreads to enhance return on stockholder's equity.
The Company's time deposits of $100,000 or more represented 7.1% of total
deposits at December 31, 1996 and are shown by maturity in the table below.
Months to Maturity
------------------------------------------------
3 or Over 3 Over 6 Over
less to 6 to 12 12 TOTAL
- ----------------------------------------------------------------------------------------
Time deposits--$100,000 or more $23,373 $9,735 $10,399 $13,667 $57,174
======= ====== ======= ======= =======
Interest Rate Sensitivity
The Bank's interest rate sensitivity, as measured by the repricing of its
interest sensitive assets and liabilities at December 31, 1996 is presented in
the following table. As indicated in the note to the table, the data is based in
part on assumptions that are regularly reviewed for propriety. The accompanying
analysis indicates a moderate level of interest rate risk based on the Bank's
having about 51% of its rate sensitive assets versus about 49% of its rate
sensitive liabilities subject to maturity or repricing within a one year period
from December 31, 1996 (termed GAP analysis). By managing to approximately match
the dollar amount of assets and liabilities whose interest rates are subject to
change, the Bank seeks to control the risk that a net interest margin decline
would have a pronounced adverse impact on its revenues (net interest income).
While the Bank's senior management, through its Asset Liability Management
Committee (ALCO), has a preference for maintaining a moderate level of interest
rate risk as measured by the repricing GAP, the Company's interest rate risk
policies are guided by results of simulation analysis which takes into account
more factors than does simple GAP analysis. The ALCO analyzes balance sheet,
income statement, and margin trends monthly. A detailed quarterly interest rate
risk profile is performed for ALCO and is reviewed with the Board of Directors.
The Bank's Board of Directors has established a comprehensive interest rate
risk management policy, which is administered by ALCO. The policy establishes
limits of risk, which are quantitative measures of percentage change in net
interest income and equity capital resulting from a hypothetical plus or minus
200 basis point change in U.S. Treasury interest rates for maturities from one
month to thirty years. By employing simulation analysis through use of a
computer model, the Bank intends to effectively manage the potential adverse
impacts that changing interest rates can have on the institution's short term
earnings, long term value, and liquidity. Measured from December 31, 1996, the
simulation analysis indicates that the Bank's net interest income would decline
by 8.1% over a twelve month period given a decline in interest rates of 200
basis points, against a policy limit of 15%. In terms of equity capital on a
fair value basis, a 200 basis point decline in interest rates, is estimated to
reduce the fair value of capital (as computed) by 18.5% as compared to a policy
limit of 25%. The simulation model captures optionality factors such as call
features and interest rate caps and floors imbedded in investment and loan
portfolio contracts.
In addition to the potential adverse impact that changing interest rates
may have on the Bank's interest margin and operating results, potential adverse
impacts on liquidity can occur as a result of changes in the estimated cash
flows from investment, loan and deposit portfolios. The Bank manages this
inherent risk by maintaining a sizeable portfolio of available for sale
investments as well as a secondary source of liquidity from Federal Home Loan
Bank advances.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollars in thousands)
The following schedule sets out the time frames from December 31, 1996 in
which the Bank's rate sensitive assets and liabilities are subject to repricing:
-----------------------------------------------------------
0-90 91-365 Over 1-3 Over 3-5 Over 5
Days Days Years Years Years
- --------------------------------------------------------------------------------------------------------
RATE SENSITIVE ASSETS:
Loans $180,441 $ 92,100 $162,500 $ 47,186 $ 40,939
Taxable securities 72,898 78,826 105,662 18,349 15,555
Nontaxable securities 1,980 3,935 17,110 19,395 21,009
Other investments 42,023 0 0 0 0
-------- -------- -------- -------- --------
TOTAL 297,342 174,861 285,272 84,930 77,503
RATE SENSITIVE LIABILITIES:
Noninterest-bearing demand deposits 11,711 3,513 42,159 42,159 17,566
Interest-bearing demand deposits 5,936 17,808 47,487 27,701 0
Regular savings deposits 4,749 14,246 37,989 36,408 1,583
Money market savings deposits 13,974 41,922 111,794 0 0
Time deposits 107,022 146,882 67,733 16,235 28
Short-term borrowings and other rate
sensitive liabilities 55,930 12,002 1,000 0 3,920
-------- -------- -------- -------- --------
TOTAL................................. 199,322 236,373 308,162 122,503 23,097
-------- -------- -------- -------- --------
CUMULATIVE GAP........................ $ 98,020 $ 36,508 $ 13,618 $(23,955) $ 30,451
======== ======== ======== ======== ========
As a percent of total assets 10.02% 3.73% 1.39% (2.45)% 3.11%
CUMULATIVE RATE SENSITIVE ASSETS
TO RATE SENSITIVE LIABILITIES 1.49 1.08 1.02 0.97 1.03
NOTE: This analysis is based upon a number of significant assumptions including
the following: Loans are repaid/rescheduled by contractual maturity and
repricings. Securities, except mortgage-backed securities, are repaid according
to contractual maturity adjusted for call features. Mortgage-backed security
repricing is adjusted for estimated early paydowns. In order to reflect the
temporary seasonal influx of noninterest-bearing demand deposits at year end,
which inflates short-term rate sensitive assets, such deposits in excess of
their average balance for the year are shown in 0-90 days. Interest-bearing
demand, regular savings and money market savings deposits are estimated to
exhibit some rate sensitivity based on management's analysis of deposit
withdrawals. Time deposits are shown in the table based on contractual maturity.
SELECTED GLOSSARY AND ABBREVIATIONS
Basis Point: One hundredth of one percent. An increase in yield from 7.00% to
7.50% could be expressed as a change of 50 basis points.
Book Value Per Share: Total stockholders' equity divided by the number of shares
of common stock outstanding at year-end.
Capital Leverage Ratio: Year-end core capital (stockholders' equity less
intangibles and the net unrealized gain or loss on investments available-for-
sale) as a percentage of average total assets for the fourth quarter.
The Company: Sandy Spring Bancorp, Sandy Spring National Bank of Maryland and
Sandy Spring Insurance Corporation.
Internal Capital Generation Rate: The percent of return on average equity
multiplied by the percent of earnings retained (net earnings less dividends).
Net Interest Margin: Fully tax-equivalent net interest income as a percentage of
average earning assets.
Net Interest Spread: Fully tax-equivalent yield on earning assets less the
average rate paid on interest-bearing liabilities.
Net Overhead Ratio: A measure of cost management and productivity. Net overhead
(noninterest expenses less non-interest income) divided by fully tax-
equivalent net interest income.
Nonperforming Assets: The sum of loans which are nonaccrual, 90 days past due or
restructured and other real estate owned.
Return on Average Assets: Net income as a percentage of average total assets.
Return on Average Equity: Net income as a percentage of average total
stockholders' equity.
Total Risk-based Capital Ratio: Qualifying regulatory capital (stockholders'
equity less intangibles and the net unrealized gain or loss on investments
available-for-sale, plus a portion of the allowance for credit losses) as a
percentage of risk-adjusted total assets.
Tax-Equivalent Net Interest Income: Interest income, plus the addition of tax
savings from nontaxable loans and investments, less interest expense.
Tier 1 Risk-based Capital Ratio: Regulatory core capital (stockholders' equity
less intangibles and the net unrealized gain or loss on investments available-
for-sale) as a percentage of risk-adjusted total assets.
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages 30 through 47 of the Annual Report are hereby incorporated by
reference. The remaining information appearing in the Annual Report to
Shareholders is not deemed to be filed as part of this Report, except as
expressly provided herein.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
25
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and nominees for directors of Bancorp and
compliance with Section 16(a) of the Securities Exchange Act of 1934 is included
under the captions entitled "Election of Directors -- Information as to Nominees
and Continuing Directors" on pages 3 through 5 of the Proxy Statement, and
"Compliance with Section 16(a) of the Securities Exchange Act of 1934" on pages
15 and 16 of the Proxy Statement, and is hereby incorporated by reference.
Information concerning the executive officers of Bancorp is included under
the caption entitled "Item 1. Business -- Executive Officers" of this report
and is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding the compensation of Bancorp's directors and executive
officers is included under the captions "Executive Compensation," "Report of the
Human Resources Committee," and "Stock Performance Graph" on pages 6 through 14
of the Proxy Statement, and is hereby incorporated by reference.
26
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding beneficial ownership of Bancorp's common stock by
certain beneficial owners and directors and executive officers of Bancorp is
included under the caption "Stock Ownership of Management" on page 2 of the
Proxy Statement and is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions with
management is included under the caption "Transactions and Relationships with
Management" on page 15 of the Proxy Statement and is hereby incorporated by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following consolidated financial statements of Bancorp included in the
Annual Report to Shareholders for the year ended December 31, 1996, are
incorporated herein by reference in Item 8 of this Report. The remaining
information appearing in the Annual Report to Shareholders is not deemed to
be filed as part of this Report, except as expressly provided herein.
The following financial statements are filed as a part of this report:
Consolidated Balance Sheets at December 31, 1995 and 1996
Consolidated Statements of Income for the years ended December 31,
1994, 1995 and 1996
Consolidated Statements of Cash Flows for the years ended December 31,
1994, 1995 and 1996
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 1994, 1995 and 1996
Notes to the Consolidated Financial Statements
Report of Independent Auditors
All financial statement schedules have been omitted as the required
information is either inapplicable or included in the consolidated
financial statements or related notes.
27
The following exhibits are filed as a part of this report:
Exhibit No. Description Incorporated by Reference to:
- ----------------------------------------------------------------------------------------------------------------
3(a) Articles of Incorporation of Sandy Spring Exhibit 3.1 to Form 10-Q for the Quarter
Bancorp, Inc., as Amended Ended June 30, 1996, SEC File No. 0-
19065.
3(b) Bylaws of Sandy Spring Bancorp, Inc. Exhibit 3.2 to Form 8-K dated May 13,
1992, SEC File No. 0-19065.
10(a)* Sandy Spring Bancorp, Inc., Cash and Deferred Exhibit 10(b) to Form 10-K for the year
Profit Sharing Plan and Trust, as Amended ended December 31, 1989, SEC File No. 0-
19065, Exhibits 4.2, 4.3, 4.4, and 4.5 to
Form S-8 and Post Effective Amendment
No. 2 to Form S-8 Registration Statements
No. 33-29316 and 33-48453, filed with the
Securities and Exchange Commission on
December 16, 1996.
10(b)* Sandy Spring Bancorp, Inc. 1982 Incentive Exhibit 10(c) to Form 10-Q for the quarter
Stock Option Plan ended June 30, 1990, SEC File No. 0-
19065.
10(c)* Sandy Spring Bancorp, Inc. 1992 Stock Option Exhibit 10(i) to Form 10-K for the year
Plan ended December 31, 1991, SEC File No. 0-
19065.
10(d)* Sandy Spring Bancorp, Inc. Amended and Exhibit 4 to Registration Statement on
Restated Stock Option Plan for Employees of Form S-8, Registration Statement No. 333-
Annapolis Bancshares, Inc. 11-049.
10(e)* Sandy Spring National Bank of Maryland Exhibit 10(g) to Form 10-K for the year
Executive Health Insurance Plan ended December 31, 1991, SEC File No. 0-
19065.
10(f)* Sandy Spring National Bank of Maryland Exhibit 10(k) to Form 10-K for the year
Executive Health Expense Reimbursement Plan ended December 31, 1991, SEC File No. 0-
19065.
10(g)* Employment Agreement with Hunter R. Hollar, Exhibit 10(e) to Form 10-K for the year
as Amended ended December 31, 1990, SEC File No. 0-
19065, and Exhibit 10(f) to Form 10-K for
the year ended December 31, 1991, SEC
File No. 0-19065.
10(h)* Forms of Supplemental Executive Retirement Exhibit 10(g) to Form 10-K for the year
Agreements with Willard H. Derrick, Hunter R. ended December 31, 1991, SEC File No. 0-
Hollar, Thomas O. Keech and A. Hardy 19065.
Pickett, with 1992 Amendments
10(i)* Forms of Executive Severance Agreements with Exhibit 10(h) to Form 10-K for the year
Willard H. Derrick, Thomas O. Keech and A. ended December 31, 1991, SEC File No. 0-
Hardy Pickett, with 1992 Amendments 19065.
28
Exhibit No. Description Incorporated by Reference to:
- ----------------------------------------------------------------------------------------------------------------
13 Specified Portions of the 1996 Annual Report
to Shareholders
21 Subsidiaries
23 Consent of Independent Auditors
24 Power of Attorney
27 Financial Data Schedule
* Management Contract or Compensatory Plan or Arrangement filed pursuant to Item
14(c) of this Report.
(b) No Current Reports on Form 8-K were filed during the three month period
ended December 31, 1996.
(c) Exhibits to this Form 10-K are attached or incorporated by reference as
stated above.
(d) None.
29
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
SANDY SPRING BANCORP, INC.
(Registrant)
By: /s/ Hunter R. Hollar
--------------------
Hunter R. Hollar
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of March 20, 1997.
Principal Executive Officer and Director: Principal Financial and
Accounting Officer:
/s/ Hunter R. Hollar /s/ James H. Langmead
- -------------------- ---------------------
Hunter R. Hollar James H. Langmead
President and Chief Executive Officer Vice President and Treasurer
A majority of the directors of Bancorp executed a power of attorney
appointing Marjorie S. Holsinger as their attorney-in-fact, empowering her to
sign this report on their behalf. This power of attorney has been filed with the
Securities and Exchange Commission under Part IV, Exhibit 24 of this Form 10-K
for the year ended December 31, 1996. This report has been signed below by such
attorney-in-fact as of March 20, 1997.
By: /s/ Marjorie S. Holsinger
-------------------------
Marjorie S. Holsinger
Attorney-in-Fact for Majority of the
Directors of Bancorp
INDEX TO EXHIBITS
Exhibit No. Description Incorporated by Reference to:
- ----------------------------------------------------------------------------------------------------------------
3(a) Articles of Incorporation of Sandy Spring Exhibit 3.1 to Form 10-Q for the Quarter
Bancorp, Inc., as Amended Ended June 30, 1996, SEC File No. 0-
19065.
3(b) Bylaws of Sandy Spring Bancorp, Inc. Exhibit 3.2 to Form 8-K dated May 13,
1992, SEC File No. 0-19065.
10(a)* Sandy Spring Bancorp, Inc., Cash and Deferred Exhibit 10(b) to Form 10-K for the year
Profit Sharing Plan and Trust, as Amended ended December 31, 1989, SEC File No. 0-
19065, Exhibits 4.2, 4.3, 4.4, and 4.5 to
Form S-8 and Post Effective Amendment
No. 2 to Form S-8 Registration Statements
No. 33-29316 and 33-48453, filed with the
Securities and Exchange Commission on
December 16, 1996.
10(b)* Sandy Spring Bancorp, Inc. 1982 Incentive Exhibit 10(c) to Form 10-Q for the quarter
Stock Option Plan ended June 30, 1990, SEC File No. 0-
19065.
10(c)* Sandy Spring Bancorp, Inc. 1992 Stock Option Exhibit 10(i) to Form 10-K for the year
Plan ended December 31, 1991, SEC File No. 0-
19065.
10(d)* Sandy Spring Bancorp, Inc. Amended and Exhibit 4 to Registration Statement on
Restated Stock Option Plan for Employees of Form S-8, Registration Statement No. 333-
Annapolis Bancshares, Inc. 11-049.
10(e)* Sandy Spring National Bank of Maryland Exhibit 10(g) to Form 10-K for the year
Executive Health Insurance Plan ended December 31, 1991, SEC File No. 0-
19065.
10(f)* Sandy Spring National Bank of Maryland Exhibit 10(k) to Form 10-K for the year
Executive Health Expense Reimbursement Plan ended December 31, 1991, SEC File No. 0-
19065.
10(g)* Employment Agreement with Hunter R. Hollar, Exhibit 10(e) to Form 10-K for the year
as Amended ended December 31, 1990, SEC File No. 0-
19065, and Exhibit 10(f) to Form 10-K for
the year ended December 31, 1991, SEC
File No. 0-19065.
10(h)* Forms of Supplemental Executive Retirement Exhibit 10(g) to Form 10-K for the year
Agreements with Willard H. Derrick, Hunter R. ended December 31, 1991, SEC File No. 0-
Hollar, Thomas O. Keech and A. Hardy 19065.
Pickett, with 1992 Amendments
10(i)* Forms of Executive Severance Agreements with Exhibit 10(h) to Form 10-K for the year
Willard H. Derrick, Thomas O. Keech and A. ended December 31, 1991, SEC File No. 0-
Hardy Pickett, with 1992 Amendments 19065.
13 Specified Portions of the 1996 Annual Report
to Shareholders
Exhibit No. Description Incorporated by Reference to:
- ----------------------------------------------------------------------------------------------------------------
21 Subsidiaries
23 Consent of Independent Auditors
24 Power of Attorney
27 Financial Data Schedule
* Management Contract or Compensatory Plan or Arrangement filed pursuant to Item
14(c) of this Report.