SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2003
------------------
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
--------------------- ------------------------
Commission File Number: O-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 of incorporation) (I.R.S. Employer Identification Number)
17801 Georgia Avenue, Olney, Maryland 20832
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(Address of principal office) (Zip Code)
301-774-6400
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(Telephone Number)
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
filing requirements for the past 90 days.
YES / X / NO / /
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).
YES / X / NO / /
The number of shares of common stock outstanding as of October 27, 2003
is 14,476,423 shares.
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SANDY SPRING BANCORP, INC.
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at
September 30, 2003, and December 31, 2002......................... 1
Consolidated Statements of Income for the Three and
Nine Month Periods Ended September 30, 2003 and 2002.............. 2
Consolidated Statements of Cash Flows for the
Nine Month Periods Ended September 30, 2003 and 2002.............. 4
Consolidated Statements of Changes in Stockholders' Equity
for the Nine Month Periods Ended September 30, 2003 and 2002...... 6
Notes to Consolidated Financial Statements........................ 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS..................... 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK................................................. 20
ITEM 4. CONTROLS AND PROCEDURES........................................... 21
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................. 21
SIGNATURES................................................................ 22
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
September 30, December 31,
(Dollars in thousands, except per share data) 2003 2002
- --------------------------------------------- ------------- ------------
ASSETS
<s> <c> <c>
Cash and due from banks $ 43,718 $ 38,998
Federal funds sold 6,265 9,135
Interest-bearing deposits with banks 927 813
Residential mortgage loans held for sale 9,390 38,435
Investments available-for-sale (at fair value) 735,158 685,586
Investments held-to-maturity -- fair value
of $353,332 (2003) and $346,862 (2002) 347,953 340,860
Other equity securities 21,367 19,812
Total loans and leases 1,099,541 1,063,853
Less: allowance for credit losses (15,049) (15,036)
---------- ----------
Net loans and leases 1,084,492 1,048,817
Premises and equipment, net 37,671 36,007
Accrued interest receivable 15,292 14,957
Goodwill 7,642 7,642
Other intangible assets, net 11,932 13,927
Other assets 60,780 52,415
---------- ----------
Total assets $2,382,587 $2,307,404
========== ==========
LIABILITIES
Noninterest-bearing deposits $ 350,700 $ 320,583
Interest-bearing deposits 1,207,520 1,171,629
---------- ----------
Total deposits 1,558,220 1,492,212
Short-term borrowings 495,551 488,214
Guaranteed preferred beneficial interests in the
Company's subordinated debentures 35,000 35,000
Other long-term borrowings 88,346 90,500
Accrued interest payable and other liabilities 15,847 23,454
---------- ----------
Total liabilities 2,192,964 2,129,380
STOCKHOLDERS' EQUITY
Common stock -- par value $1.00; shares
authorized 50,000,000; shares issued and
outstanding 14,474,374 (2003)
and 14,536,094 (2002) 14,474 14,536
Additional paid in capital 18,704 21,128
Retained earnings 149,249 131,939
Accumulated other comprehensive income 7,196 10,421
---------- ----------
Total stockholders' equity 189,623 178,024
---------- ----------
Total liabilities and stockholders' equity $2,382,587 $2,307,404
========== ==========
See Notes to Consolidated Financial Statements.
</Table>
1
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
(In thousands, except per share data) 2003 2002 2003 2002
- ------------------------------------- --------- -------- -------- -------
<s> <c> <c> <c> <c>
Interest Income:
Interest and fees on loans and leases $15,883 $18,342 $48,754 $54,304
Interest on loans held for sale 422 249 993 576
Interest on deposits with banks 2 (2) 9 15
Interest and dividends on securities:
Taxable 7,998 9,378 24,610 28,546
Exempt from federal income taxes 3,558 2,870 10,509 7,867
Interest on federal funds sold 49 130 264 386
------- ------- ------- -------
TOTAL INTEREST INCOME 27,912 30,967 85,139 91,694
Interest Expense:
Interest on deposits 3,230 4,893 10,891 15,213
Interest on short-term borrowings 4,389 4,182 13,516 11,846
Interest on long-term borrowings 1,518 2,046 4,547 6,165
------- ------- ------- -------
TOTAL INTEREST EXPENSE 9,137 11,121 28,954 33,224
------- ------- ------- -------
NET INTEREST INCOME 18,775 19,846 56,185 58,470
Provision for Credit Losses 0 395 0 2,565
------- ------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR CREDIT LOSSES 18,775 19,451 56,185 55,905
Noninterest Income:
Securities gains 106 791 657 1,021
Service charges on deposit accounts 2,027 1,917 6,048 5,748
Gains on sales of mortgage loans 1,906 1,000 5,084 2,479
Fees on sales of investment products 512 425 1,699 1,621
Trust department income 756 652 2,234 1,826
Insurance agency commissions 924 657 2,865 2,433
Income from bank owned life insurance 866 493 2,185 1,360
Income from an early termination of a sublease 0 0 1,077 0
Other income 1,654 1,680 4,709 4,610
------- ------- ------- -------
TOTAL NONINTEREST INCOME 8,751 7,615 26,558 21,098
Noninterest Expenses:
Salaries and employee benefits 9,932 9,396 28,896 28,122
Occupancy expense of premises, net 1,839 1,369 4,956 4,233
Equipment expenses 1,101 949 3,241 2,714
Marketing 477 438 1,440 1,414
Outside data services 643 594 1,948 1,841
Amortization of intangible assets 665 665 1,994 1,994
Other expenses 2,247 2,436 7,009 6,945
------- ------- ------- -------
TOTAL NONINTEREST EXPENSES 16,904 15,847 49,484 47,263
------- ------- ------- -------
Income Before Income Taxes 10,622 11,219 33,259 29,740
Income Tax Expense 2,404 3,015 7,977 7,842
------- ------- ------- -------
NET INCOME $ 8,218 $ 8,204 $25,282 $21,898
======= ======= ======= =======
</Table>
See Notes to Consolidated Financial Statements.
2
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (Continued)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
(In thousands, except per share data) 2003 2002 2003 2002
- ------------------------------------- ------ ------ ------ ------
Basic Net Income Per Share $0.57 $0.56 $1.75 $1.51
Diluted Net Income Per Share 0.56 0.56 1.72 1.49
Dividends Declared Per Share 0.19 0.17 0.55 0.51
See Notes to Consolidated Financial Statements.
3
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
--------------------------
(Dollars in thousands) 2003 2002
- --------------------- ----------- ----------
Cash flows from operating activities:
Net income $ 25,282 $ 21,898
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,795 4,474
Provision for credit losses 0 2,565
Deferred income taxes 380 1,163
Origination of loans held for sale (356,944) (195,326)
Proceeds from sales of loans held for sale 391,073 193,771
Gains on sales of loans held for sale (5,084) (2,479)
Securities gains (657) (1,021)
Income from an early termination of a sublease (1,077) 0
Net increase in accrued interest receivable (335) (1,875)
Net increase in other assets (8,520) (10,358)
Net increase (decrease) in accrued expenses (8,529) (6,367)
Other - net 4,324 (1,382)
----------- -----------
Net cash provided by operating activities 44,708 5,063
Cash flows from investing activities:
Net decrease (increase) in interest-bearing deposits
with banks (114) 29
Purchases of investments held-to-maturity (102,429) (132,242)
Purchases of other equity securities (1,556) (2,882)
Purchases of investments available-for-sale (1,131,486) (768,586)
Proceeds from sales of investments available-for-sale 150,726 263,661
Proceeds from maturities, calls and principal
payments of investments held-to-maturity 95,174 43,053
Proceeds from maturities, calls and principal
payments of investments available-for-sale 924,733 539,401
Proceeds from sales of other real estate owned 78 40
Net increase in loans and leases (35,875) (70,515)
Proceeds from an early termination of a sublease 750 0
Expenditures for premises and equipment (3,592) (5,837)
----------- -----------
Net cash used by investing activities (103,591) (133,878)
Cash flows from financing activities:
Net increase in deposits 66,008 77,688
Net (decrease) increase in short-term borrowings (23,317) 45,973
Proceeds from long-term borrowings 28,500 40,239
Common stock purchased and retired (3,326) 0
Proceeds from issuance of common stock 840 646
Dividends paid (7,972) (7,398)
----------- -----------
Net cash provided by financing activities 60,733 157,148
----------- -----------
Net increase in cash and cash equivalents 1,850 28,333
Cash and cash equivalents at beginning of period 48,133 56,383
----------- -----------
Cash and cash equivalents at end of period $ 49,983 $ 84,716
=========== ===========
4
Sandy Spring Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Nine Months Ended
September 30,
-----------------
(Dollars in thousands) 2003 2002
- ---------------------- -------- ------
Supplemental Disclosures:
Interest payments $29,125 $22,627
Income tax payments 10,671 9,177
Noncash Investing and Financing Activities:
Transfers from loans to other real estate owned 187 29
Increase in premises and equipment from an early
termination of a sublease 1,168 0
Reclassification of borrowings from long-term to short-term 30,654 2,220
See Notes to Consolidated Financial Statements.
5
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accum-
ulated
Other
Compre- Total
Additional hensive Stock-
Common Paid-in Retained Income holders'
(Dollars in thousands, except per share data) Stock Capital Earnings (Loss) Equity
- -------------------------------------------- --------- ----------- ---------- -------- --------
Balances at January 1, 2003, as previously
reported $14,536 $21,128 $132,607 $10,421 $178,692
Less adjustments for the cumulative effect
on prior years of the understatement of
accrued interest on borrowings from the
Federal Home Loan Bank (Note 5) (668) (668)
-------- --------- -------- -------- --------
Balance at January 1, 2003, as adjusted 14,536 21,128 131,939 10,421 178,024
Comprehensive income:
Net income 25,282 25,282
Other comprehensive loss,
net of tax effects and
reclassification adjustment (3,225) (3,225)
--------
Total comprehensive income 22,057
Cash dividends - $0.55 per share (7,972) (7,972)
Common stock issued pursuant to:
Stock option plan - 30,814 shares 31 453 484
Employee stock purchase plan -
12,926 shares 13 343 356
Stock repurchases - 105,460 shares (106) (3,220) (3,326)
-------- --------- -------- -------- --------
Balances at September 30, 2003 $14,474 $18,704 $149,249 $ 7,196 $189,623
======== ========= ======== ======== ========
Balances at January 1, 2002, as previously
reported $14,484 $20,347 $111,906 $ 3,936 $150,673
Less adjustments for the cumulative effect
on prior years of the understatement of
accrued interest on borrowings from the
Federal Home Loan Bank (Note 5) (540) (540)
-------- --------- -------- -------- --------
Balance at January 1, 2002, as adjusted 14,484 20,347 111,366 3,936 150,133
Comprehensive income:
Net income 21,898 21,898
Other comprehensive income, net of tax
effects and reclassification adjustments 6,995 6,995
--------
Total comprehensive income 28,893
Cash dividends - $0.51 per share (7,398) (7,398)
Common stock issued pursuant to:
Stock option plan - 22,217 shares 22 320 342
Employee stock purchase plan - 11,216 shares 11 293 304
-------- --------- -------- -------- ---------
Balances at September 30, 2002 $14,517 $20,960 $125,866 $10,931 $172,274
======== ========= ======== ======== =========
See Notes to Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - General
The foregoing financial statements are unaudited. In the opinion of
management, all adjustments (comprising only normal recurring accruals)
necessary for a fair presentation of the results of the interim periods have
been included. These statements should be read in conjunction with the financial
statements and accompanying notes included in Sandy Spring Bancorp's 2002 Annual
Report to Shareholders. There have been no significant changes to the Company's
Accounting Policies as disclosed in the 2002 Annual Report. The results shown in
this interim report are not necessarily indicative of results to be expected for
the full year 2003.
The accounting and reporting policies of Sandy Spring Bancorp (the
"Company") conform to accounting principles generally accepted in the United
States of America and to general practices within the banking industry. Certain
reclassifications have been made to amounts previously reported to conform to
current classifications.
Consolidation has resulted in the elimination of all significant
intercompany accounts and transactions.
Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks and federal funds sold (which have original maturities
of three months or less).
New Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The Statement is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. There was no material impact on
the Company's financial condition or results of operations upon adoption of this
Statement.
In May 2003, the Financial Accounting Standards Board issued SFAS No.
150, "Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both a liability and equity. It requires that an issuer classify certain
financial instruments as a liability, although the financial instrument may
previously have been classified as equity. This Statement is effective for
financial instruments entered into or modified after May 31, 2003 and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. There was no material impact on the Company's financial condition or
results of operations upon adoption of this Statement.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("Interpretation No. 46"), which explains
identification of variable interest entities and the assessment of whether to
consolidate these entities. Interpretation No. 46 requires existing
unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among the
involved parties. The provisions of Interpretation No. 46 are effective for all
financial statements issued after January 1, 2003. The potential
de-consolidation of subsidiary trusts of bank holding companies formed in
connection with the issuance of trust preferred securities appears to be an
unintended consequence of FIN 46. It is currently unknown if, or when, the FASB
will address this issue. However, the Company believes that if required to
de-consolidate the trust, the de-consolidation will not have a material effect
on the Company's financial position or results of operations. The Company has no
significant variable interests in any entities which would require disclosure or
consolidation.
7
Note 2 - Stockholders' Equity
On March 26, 2003, the Board of Directors authorized the repurchase of
up to 5%, or approximately 727,000 shares, of the Company's outstanding common
stock, par value $1.00 per share, in connection with shares expected to be
issued under the Company's stock option and employee benefit plans and for other
corporate purposes. The share repurchases are expected to be made primarily on
the open market from time to time until March 31, 2005, or earlier termination
of the repurchase program by the Board. Repurchases under the program will be
made at the discretion of management based upon market, business, legal,
accounting and other factors. Bancorp purchased the equivalent of 49,560 shares
of its common stock under a prior share repurchase program, which expired on
March 31, 2003 and has purchased 55,900 shares under the current share
repurchase program through September 30, 2003.
Note 3 - Stock Option Plan
At September 30, 2003, the Company had options outstanding under two
stock-based employee compensation plans, the 1992 stock option plan (expired but
having outstanding options that may still be exercised) and the 1999 stock
option plan. The Company accounts for those plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effects on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", to
stock-based employee compensation for the periods indicated.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------------------
(In thousands, except per share data) 2003 2002 2003 2002
- ------------------------------------- -------------------------------------------------------------
Net income, as reported $ 8,218 $ 8,204 $ 25,282 $ 21,898
Less pro forma stock-based employee
compensation expense determined
under fair value based method, net
of related tax effects (248) (304) (745) $ (912)
-------------------------------------------------------------
Pro forma net income $ 7,970 $ 7,900 $ 24,537 $ 20,986
=============================================================
Net income per share:
Basic - as reported $ 0.57 $ 0.56 $ 1.75 $ 1.51
Basic - pro forma $ 0.55 $ 0.55 $ 1.69 $ 1.45
Diluted - as reported $ 0.56 $ 0.56 $ 1.72 $ 1.49
Diluted - pro forma $ 0.54 $ 0.54 $ 1.67 $ 1.43
Note 4 - Per Share Data
The calculations of net income per common share for the three and nine
month periods ended September 30, are as shown in the following table. Basic net
income per share is computed by dividing net income available to common
stockholders by the weighted average number of common shares outstanding and
does not include the impact of any potentially dilutive common stock
equivalents. The diluted earnings per share is derived by dividing net income
available to common
8
Note 4 (continued)
stockholders by the weighted average number of common shares outstanding
adjusted for the dilutive effect of outstanding stock options.
(Dollars and amounts in thousands, except Three Months Ended Nine Months Ended
Per share data) September 30, September 30,
- ----------------------------------------- -------------------- ---------------------
2003 2002 2003 2002
-------- -------- -------- --------
Basic:
Net income available to common stockholders $ 8,218 $ 8,204 $ 25,282 $ 21,898
Average common shares outstanding 14,472 14,515 14,496 14,503
Basic net income per share $ 0.57 $ 0.56 $ 1.75 $ 1.51
======== ======== ========= ========
Diluted:
Net income available to common stockholders $ 8,218 $ 8,204 $ 25,282 $ 21,898
Average common shares outstanding 14,472 14,515 14,496 14,503
Stock option adjustment 205 213 202 216
-------- -------- --------- --------
Average common shares outstanding-diluted 14,677 14,728 14,698 14,719
Diluted net income per share $ 0.56 $ 0.56 $ 1.72 $ 1.49
======== ======== ========= ========
There was no antidilutive effect of stock options for either the three or nine
months ended September 30, 2003 and September 30, 2002.
Note 5-Recent Developments
In November 2003, the Company discovered that accrued interest expense
on certain Federal Home Loan Bank ("FHLB") advances had been understated,
beginning in the first quarter of 1997. This accrual error was the result of a
mistake in the interest calculation formula for certain specific types of FHLB
advances, and was discovered as part of the Company's auditing process. This
Form 10-Q includes correction of this under-accrual for all periods shown. The
Company plans to amend its filings on Forms 10-Q and 10-K for the affected
periods. The maximum effect on earnings per share in any affected year is less
than one-cent.
The error was discovered after the Company had issued its earnings
release for the third quarter of 2003. Accordingly, certain financial data in
that earnings release differ from comparable information in this Form 10-Q,
which reflects correction of the under-accrual. The total amount of the
under-accrual is $1.03 million, or $727,000 after applicable income taxes, most
of which relates to periods prior to 2003. The cumulative amount of the
under-accrual for the nine-month period ended September 30, 2003 included in the
earnings release is $97,000, or $59,000 after applicable income taxes. The
difference in earnings per share as reported in the earnings release, and as
reported in this Form 10-Q was less than 1/2 cent for the three- month and
nine-month periods ended September 30, 2003. The following tables illustrate the
differences.
September 30, 2003 December 31, 2002
---------------------- ----------------------
Earnings As Earnings As
(In thousands, except per share data) Release Corrected Release Corrected
- ------------------------------------- ------- --------- ------- ---------
Balance Sheet:
Accrued interest payable and
other liabilities $ 15,120 $ 15,847 $ 22,786 $ 23,454
Retained earnings 149,976 149,249 132,607 131,939
Total stockholders' equity 190,350 189,623 178,692 178,024
Total assets 2,382,587 2,382,587 2,307,404 2,307,404
9
Three Months Ended
September 30,
---------------------------------------------
2003 2002
-------------------- --------------------
Earnings As Earnings As
Release Corrected Release Corrected
------- --------- ------- ---------
Income Statement
Interest on short-term borrowings $ 4,298 $ 4,389 $ 4,095 $ 4,182
Net interest income 18,866 18,775 19,933 19,846
Net income 8,273 8,218 8,257 8,204
Basic net income per share 0.57 0.57 0.56 0.56
Diluted net income per share 0.56 0.56 0.56 0.56
Nine Months Ended
September 30,
---------------------------------------------
2003 2002
---------------------------------------------
Earnings As Earnings As
Release Corrected Release Corrected
------- --------- ------- ---------
Income Statement
Interest on short-term borrowings $13,419 $13,516 $11,725 $11,846
Net interest income 56,282 56,185 58,591 58,470
Net income 25,341 25,282 21,971 21,898
Basic net income per share 1.75 1.75 1.51 1.51
Diluted net income per share 1.72 1.72 1.49 1.49
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Sandy Spring Bancorp makes forward-looking statements in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations that are subject to risks and uncertainties. These forward-looking
statements include: statements of goals, intentions, and expectations; estimates
of risks and of future costs and benefits; assessments of probable loan and
lease losses and market risk; and statements of the ability to achieve financial
and other goals. These forward-looking statements are subject to significant
uncertainties because they are based upon or are affected by: management's
estimates and projections of future interest rates and other economic
conditions; future laws and regulations; and a variety of other matters which,
by their nature, are subject to significant uncertainties. Because of these
uncertainties, Sandy Spring Bancorp's actual future results may differ
materially from those indicated. In addition, the Company's past results of
operations do not necessarily indicate its future results.
THE COMPANY
The Company is the registered bank holding company for Sandy Spring
Bank (the "Bank"), headquartered in Olney, Maryland. The Bank operates thirty
community offices in Anne Arundel, Frederick, Howard, Montgomery, and Prince
George's Counties in Maryland, together with an insurance subsidiary and an
equipment leasing company.
The Company offers a broad range of financial services to consumers and
businesses in this market area. Through September 30, 2003, year-to-date average
commercial loans and leases and commercial real estate loans accounted for
approximately 43% of the Company's loan and lease portfolio, and year-to-date
average consumer and residential real estate loans accounted for approximately
57%. Based upon the most recent data available, consumer deposits account for
approximately 75% of total average deposits, while approximately 55% of the
Company's revenues are derived from consumer loans, consumer deposits and other
retail services. The Company has established a strategy of independence, and
intends to establish or acquire additional offices, banking organizations, and
nonbanking organizations as appropriate opportunities may arise.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America (GAAP)
and follow general practices within the industry in which it operates.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. Because the Company makes use of estimates,
assumptions and judgments in applying its accounting policies, changes in these
estimates, assumptions and judgments may have a material impact on the
presentation of the Company's financial condition, changes in financial
condition, or results of operations for a reporting period. The estimates,
assumptions, and judgments are based on information available as of the dates
that the financial statements were prepared. As this information changes over
time, the estimates, assumptions, and judgments on which the financial
statements were based may no longer be accurate. Certain policies inherently
rely more on the use of estimates, assumptions, and judgments and are more
likely to produce results that could be materially different than originally
reported.
Estimates, assumptions, and judgments are necessary when assets and
liabilities are required to be recorded at fair value, when a decline in the
value of an asset not carried on the financial statements at fair value warrants
an impairment write-down or valuation allowance to be established, or when the
amount of an asset or liability is contingent upon a future event. Carrying
assets and liabilities at fair value inherently results in more financial
statement volatility. The fair values and the information used to record
valuation adjustments for certain assets and liabilities are based either on
quoted market prices or are provided by other third-party sources, when
available. The estimates used in management's assessment of the adequacy of the
allowance for credit losses require that management make assumptions about
matters that are uncertain at the time of estimation. Differences in these
assumptions and differences between the estimated and actual losses could have
such a material effect.
11
NON-GAAP FINANCIAL MEASURE
The Company has for many years used a traditional efficiency ratio that
is a non-GAAP financial measure as defined in Commission Regulation G and Item
10 of U.S. Securities and Exchange Commission Regulation S-K. This traditional
efficiency ratio is used as a measure of operating expense control and
efficiency of operations. Management believes that its traditional ratio better
focuses attention on the operating performance of the Company over time than
does a GAAP-based ratio, and that it is highly useful in comparing
period-to-period operating performance of the Company's core business
operations. It is used by management as part of its assessment of its
performance in managing noninterest expenses. However, this measure is
supplemental, and is not a substitute for an analysis of performance based on
GAAP measures. The reader is cautioned that the traditional efficiency ratio
used by the Company may not be comparable to GAAP or non-GAAP efficiency ratios
reported by other financial institutions.
In general, the efficiency ratio is total noninterest expenses as a
percentage of net interest income plus total noninterest income. This is a GAAP
financial measure. Noninterest expenses used in the calculation of the
traditional, non-GAAP efficiency ratio exclude intangible asset amortization.
Income for the traditional ratio is increased for the favorable effect of
tax-exempt income, and excludes securities gains and losses, which can vary
widely from period to period without appreciably affecting operating expenses,
and income from an early termination of a sublease in the second quarter of
2003. The traditional measure is different from the GAAP-based efficiency ratio.
The GAAP-based measure is calculated using noninterest expense and income
amounts as shown on the face of the Consolidated Statements of Income. The
traditional and GAAP-based efficiency ratios are presented and reconciled in
Table 1.
Table 1 - Reconciliation of GAAP-based and traditional efficiency ratios
Three Months Ended Nine Months Ended
- --------------------------------------------------------------------------------------------------
September 30, September 30,
- --------------------------------------------------------------------------------------------------
(Dollars in thousands) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------
Noninterest expenses-GAAP based $ 16,904 $ 15,847 $ 49,484 $ 47,263
Net interest income plus noninterest income-
GAAP based 27,526 27,461 82,743 79,568
Efficiency ratio-GAAP based 61.41% 57.71% 59.80% 59.40%
========= ========== ======== ========
Noninterest expenses-GAAP based $ 16,904 $ 15,847 $ 49,484 $ 47,263
Less non-GAAP adjustment:
Amortization of intangible assets 665 665 1,994 1,994
--------- ---------- -------- --------
Noninterest expenses-traditional ratio 16,239 15,182 47,490 45,269
Net interest income plus noninterest income-
GAAP based 27,526 27,461 82,743 79,568
Plus non-GAAP adjustment:
Tax-equivalency 2,148 1,922 6,003 5,061
Less non-GAAP adjustments:
Securities gains 106 791 657 1,021
Income from an early termination of
a sublease 0 0 1,077 0
--------- ---------- -------- --------
Net interest income plus noninterest
Income - traditional ratio 29,568 28,592 87,012 83,608
Efficiency ratio - traditional 54.92% 53.10% 54.58% 54.14%
========= ========== ======== ========
A. FINANCIAL CONDITION
The Company's total assets were $2,382,587,000 at September 30, 2003,
compared to $2,307,404,000 at December 31, 2002, increasing $75,183,000 or 3%
during the first nine months of 2003. Earning assets increased $62,107,000 or 3%
to $2,220,601,000 at September 30, 2003, from $2,158,494,000 at December 31,
2002.
12
Total loans and leases, which exclude loans held for sale, increased 3%
or $35,688,000 during the first nine months of 2003, to $1,099,541,000. Of the
three major loan categories, residential real estate increased the most during
this period, up $34,089,000 or 10%, attributable to residential mortgage loan
growth. Commercial loans and leases increased $2,388,000 or 1%, with commercial
mortgages contributing the most to the increase, while consumer loans decreased
by $789,000. Finally, residential mortgage loans held for sale decreased
$29,045,000 from December 31, 2002, to $9,390,000 at September 30, 2003. The
changes in loan balances were caused primarily by a generally weaker economic
climate which depressed loan production and historically low interest rates,
which increased loan refinancings.
Table 2 - Analysis of Loans and Leases
The following table presents the composition of the loan and lease portfolio at
the dates indicated:
(In thousands) September 30, 2003 % December 31, 2002 %
- --------------------------- ------------------ ----------- ------------------ ------
Residential real estate $ 388,762 35% 354,673 33%
Commercial loans and leases 478,402 44 476,014 45
Consumer 232,377 21 233,166 22
------------------- ----------- ---------------- -----
Total Loans and Leases 1,099,541 100% 1,063,853 100%
=========== =====
Less: Allowance for credit losses (15,049) (15,036)
------------------- ----------------
Net loans and leases $ 1,084,492 $ 1,048,817
=================== ================
The total investment portfolio increased by 6% or $58,220,000 from
December 31, 2002, to $1,104,478,000 at September 30, 2003. The increase was
driven by $49,572,000 or 7% higher available-for-sale securities, an increase of
$7,093,000 (up 2%) in held-to-maturity securities and a rise of $1,555,000 (up
8%) in other equity securities. This increase in investments was due largely to
the high level of loan refinancings (as the result of historically low interest
rates) which limited the overall growth of the loan portfolio. The aggregate of
federal funds sold and interest-bearing deposits with banks decreased by
$2,756,000 during the first nine months of 2003, to $7,192,000 at September 30,
2003.
Total deposits were $1,558,220,000 at September 30, 2003, increasing
$66,008,000 or 4% from $1,492,212,000 at December 31, 2002. All major deposit
categories either increased or remained essentially level, comparing September
30, 2003 with December 31, 2002. Noninterest-bearing demand deposits grew by 9%
or $30,117,000 over the nine-month period, while interest-bearing deposits rose
3% or $35,891,000 during the same period.
Total borrowings were $618,897,000 at September 30, 2003, which
represented an increase of $5,183,000 or 1% from December 31, 2002, primarily
reflecting an increase in short-term borrowings.
Table 3 - Analysis of Deposits
The following table presents the composition of deposits at the dates indicated:
(In thousands) September 30, 2003 % December 31, 2002 %
- --------------------------- ------------------ ----------- ----------------- --------
Noninterest-bearing deposits $ 350,700 23% $ 320,583 21%
Interest-bearing deposits:
Demand 203,579 13 185,381 12
Money market savings 399,112 25 398,539 27
Regular savings 181,667 12 153,294 10
Time deposits less than $100,000 287,272 18 308,168 21
Time deposits $100,000 or more 135,890 9 126,247 9
------------------ ----------- ----------------- --------
Total interest-bearing 1,207,520 77 1,171,629 79
------------------ ----------- ----------------- --------
Total deposits $ 1,558,220 100% $1,492,212 100%
================== =========== ================= ========
13
MARKET RISK MANAGEMENT
The Company intends to effectively manage the potential adverse impacts
that changing interest rates may have on its short-term earnings, long- term
value, and liquidity by employing simulation analysis through use of computer
modeling. The simulation model captures optionality factors such as call
features and interest rate caps and floors imbedded in investment and loan
portfolio contracts. At September 30, 2003, as at December 31, 2002, the
simulation of a hypothetical, parallel change of minus 200 or more basis points
in U.S. Treasury interest rates was not practical, due to historically low
prevailing interest yields and rates (See Table 4). Therefore, the Company again
chose to apply a plus 200 basis point change and a minus 100 basis point change
when evaluating its interest rate risk position. Measured from September 30,
2003, the simulation analysis estimates that net interest income would decline
(as computed) by 9.12% over a twelve month period given a decrease in interest
rates of 100 basis points compared to a policy limit of 15%. In terms of equity
capital on a fair value basis, the simulation analysis estimates that the fair
value of equity capital would decline (as computed) by 23.28% given an increase
in interest rates of 200 basis points compared to a policy limit of 27.5%.
LIQUIDITY
Liquidity is measured using an approach designed to take into account
loan and lease payments, maturities, calls and paydowns of securities, earnings,
growth, mortgage banking activities, leverage programs, investment portfolio
liquidity, and other factors. Through this approach, implemented by the funds
management subcommittee under formal policy guidelines, the Company's liquidity
position is measured weekly, looking forward thirty, sixty and ninety days. The
measurement is based upon the asset-liability management model's projection of a
funds sold or purchased position, along with ratios and trends developed to
measure dependence on purchased funds, leverage limitations and core growth.
Resulting projections as of September 30, 2003 showed short-term borrowings
exceeding short-term investments over the subsequent 90 days by $24,676,000.
This position was below the $21,542,000 excess at December 31, 2002. This
temporary shortfall of liquidity over projected requirements for funds indicates
that the Company will need to incur additional borrowing to fund any growth in
loans and other earning assets.
The Company also has external sources of funds, which can be drawn upon
when required. The main source of external liquidity is a line of credit for
$707,185,000 from the Federal Home Loan Bank of Atlanta, of which approximately
$390,718,000 was outstanding at September 30, 2003. Other external sources of
liquidity available to the Company in the form of lines of credit granted by the
Federal Reserve, correspondent banks and other institutions totaled $262,237,000
at September 30, 2003, against which there were outstandings of approximately
$64,000,000. Based upon its liquidity analysis, including external sources of
liquidity available, management believes the liquidity position is appropriate
at September 30, 2003.
CAPITAL MANAGEMENT
The Company recorded a total risk-based capital ratio of 15.60% at
September 30, 2003, compared to 14.95% at December 31, 2002; a tier 1 risk-based
capital ratio of 14.40%, compared to 13.72%; and a capital leverage ratio of
8.37%, compared to 8.08%. Capital adequacy, as measured by these ratios, was
well above regulatory requirements. Management believes the level of capital at
September 30, 2003, is appropriate.
Stockholders' equity for September 30, 2003, totaled $189,623,000,
representing an increase of $11,599,000 or 7% from $178,024,000 at December 31,
2002. Accumulated other comprehensive income, a component of stockholders'
equity comprised of unrealized gains and losses on available-for-sale
securities, net of taxes, decreased by $3,225,000 from December 31, 2002 to
September 30, 2003.
Internal capital generation (net income less dividends) added
$17,310,000 to total stockholders' equity during the first nine months of 2003.
When internally formed capital is annualized and expressed as a percentage of
average total stockholders' equity, the resulting rate was 13% for both the
first nine months of 2003 and the year 2002.
External capital formation (equity created through the issuance of
stock under the employee stock purchase plan and the stock option plan) totaled
$840,000 during the nine month period ended September 30, 2003. However, share
repurchases amounted to $3,326,000 from December 31, 2002 through September 30,
2003, for a net decrease in stockholders' equity from these sources of
$2,486,000.
Dividends for the first nine months of the year were $0.55 per share
in 2003, compared to $0.51 per share in 2002, for respective dividend payout
ratios (dividends declared per share to diluted net income per share) of 32%
versus 34%.
14
Sandy Spring Bancorp, Inc. and Subsidiaries
TABLE 4 - CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES
For the Nine months ended September 30,
(Dollars in thousands and tax equivalent) 2003 2002
- ----------------------------------------- -----------------------------------------------------
Average Average
Average Yield/Rate Average Yield/Rate
Balance (1) Balance (1)
----------------------------------------------------
Assets
Total loans and leases (2) $1,095,085 6.07% $1,045,525 7.01%
Total securities 1,060,939 5.18 912,161 6.04
Other earning assets 32,772 1.11 32,565 1.64
---------- ----------
TOTAL EARNING ASSETS 2,188,796 5.56% 1,990,251 6.48%
Nonearning assets 151,540 133,528
---------- ----------
Total assets $2,340,336 $2,123,779
========== ==========
Liabilities and Stockholders' Equity
Interest-bearing demand deposits $ 197,284 0.24% $ 172,570 0.30%
Money market savings deposits 404,196 0.65 384,180 1.20
Regular savings deposits 168,708 0.31 140,477 0.94
Time deposits 439,947 2.49 424,271 3.27
---------- ----------
Total interest-bearing deposits 1,210,135 1.20 1,121,498 1.81
Short-term borrowings 472,100 3.82 444,250 3.54
Long-term borrowings 122,208 4.96 114,473 7.18
---------- ----------
Total interest-bearing liabilities 1,804,443 2.14 1,680,221 2.64
--------- -------
Noninterest-bearing demand deposits 325,933 271,826
Other noninterest-bearing liabilities 25,455 13,262
Stockholders' equity 184,505 158,470
---------- ----------
Total liabilities and stockholders' equity $2,340,336 $2,123,779
========== ==========
Net interest spread 3.42% 3.84%
========= =======
Net interest margin (3) 3.80% 4.25%
========= =======
Ratio of average earning assets to
Average interest-bearing liabilities 121.30% 118.45%
========== ==========
(1) Interest income includes the effects of taxable-equivalent adjustments
(reduced by the Nondeductible portion of interest expense) using the
appropriate federal income tax rate of 35% and, where applicable, the
marginal state income tax rate of 7.00% (or a combined marginal federal and
state rate of 39.55%), to increase tax-exempt interest income to a
taxable-equivalent basis. The net taxable-equivalent adjustment amounts
utilized in the above table to compute yields were $8,026,000 and $6,767,000
in the nine month periods ended September 30, 2003 and 2002, respectively.
(2) Non-accrual loans are included in the average balances.
(3) Net interest margin = annualized net interest income on a tax-equivalent
basis divided by total interest-earning assets.
15
B. RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Net income for the first nine months of the year increased $3,384,000
or 15% to $25,282,000 in 2003 from $21,898,000 in 2002, representing annualized
returns on average equity of 18.32% and 18.48%, respectively. Diluted earnings
per share (EPS) for the first nine months of each year were $1.72 in 2003,
compared to $1.49 in 2002.
The net interest margin decreased by 45 basis points to 3.80% for the
nine months ended September 30, 2003, from 4.25% for the same period of 2002, as
the net interest spread decreased by 42 basis points. The compression of the net
interest margin was the result of lower interest rates given the Company's asset
sensitive risk position, a smaller percentage of average loans to total earning
assets, and a 73 basis point decline (from 107 basis points to 34 basis points)
in the margin earned in the Company's leverage programs.
NET INTEREST INCOME
Net interest income for the first nine months of the year was
$56,185,000 in 2003, a decrease of 4% from $58,470,000 in 2002, reflecting a
decline in net interest margin partially offset by a higher volume of average
earning assets. Non-GAAP tax-equivalent net interest income, which takes into
account the benefit of tax advantaged investment securities, decreased by 2% to
$62,188,000 in 2003, from $63,531,000 in 2002. The effects of average balances,
yields and rates are presented in Table 4.
For the first nine months, total interest income decreased by
$6,555,000 or 7% in 2003, compared to 2002. On a non-GAAP tax-equivalent basis,
interest income decreased by 6%. Average earning assets rose 10% over the prior
period, to $2,188,796,000 from $1,990,251,000, while the average yield earned on
those assets decreased by 92 basis points to 5.56%. Comparing the first nine
months of 2003 versus 2002, average total loans and leases grew by 5% to
$1,095,085,000 (50% of average earning assets, versus 53% a year ago), while
recording a 94 basis point decline in average yield to 6.07%. Average
residential real estate loans increased by 8% (reflecting an increase in
mortgage lending, partially offset by a similar percentage decline in
construction lending); average commercial loans and leases grew by 5% (due to
increases in mortgages and other commercial loans, partially offset by declines
in construction and leasing), and, average consumer loans increased slightly
(attributable to home equity line growth). Over the same period, average total
securities rose by 16% to $1,060,939,000 (48% of average earning assets, versus
46% a year ago), while the average yield earned on those assets decreased by 86
basis points to 5.18%.
Interest expense for the first nine months of the year decreased by
$4,270,000 or 13% in 2003, compared to 2002. Average total interest-bearing
liabilities rose 7% over the prior year period, while the average rate paid on
these funds decreased by 50 basis points to 2.14%. As shown in Table 4, all
major deposit categories and both short and long term borrowings grew in
conjunction with generally declining average interest rates.
CREDIT RISK MANAGEMENT
The Company's loan and lease portfolio (the "credit portfolio") is
subject to varying degrees of credit risk. Credit risk is mitigated through
portfolio diversification, which limits exposure to any single customer,
industry or collateral type. The Company maintains an allowance for credit
losses (the "allowance") to absorb losses inherent in the credit portfolio. The
allowance is based on careful, continuous review and evaluation of the credit
portfolio, along with ongoing, quarterly assessments of the probable losses
inherent in that portfolio, and, to a lesser extent, in unused commitments to
provide financing.
The allowance for credit losses is an estimate of the losses that may
be sustained in the loan and lease portfolio. The allowance is based on two
basic principles of accounting: (1) SFAS No. 5, "Accounting for Contingencies",
which requires that losses be accrued when they are probable of occurring and
estimable, and (2) SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan", which requires that losses on impaired loans be accrued based on
differences between the loan balance and the value of collateral, the present
value of future cash flows, or values that are observable in the secondary
market. Management determines the appropriate amount of the allowance using the
systematic methodology described below.
The Company's allowance for credit losses has three basic components:
the formula allowance reflecting historical losses by credit category, the
specific allowance for risk rated credits on an individual or portfolio basis,
and the nonspecific allowance which considers risk factors not evaluated by the
other two components of the methodology. Each of these components is based upon
estimates that can and do change when the actual events occur.
16
The formula allowance establishes allowances for the major loan
categories based upon their respective historical loss experience over the prior
eight quarters, weighted so that losses in the most recent quarters have the
greatest impact. The use of these factors in the methodology, because of their
relationship to actual results, is intended to narrow differences between
estimated and realized losses.
The specific allowance is used to allocate an allowance for internally
risk rated loans where significant conditions or circumstances indicate that a
loss may have been incurred. Analysis resulting in specific allowances,
including those on loans identified for evaluation of impairment, includes
consideration of the borrower's overall financial condition, resources and
payment record, support available from financial guarantors and the sufficiency
of collateral. These factors are combined to estimate the probability and
severity of inherent losses. Then a specific reserve is established based on the
Company's calculation of the loss embedded in the individual loan. Additional
allowances are established by application of credit risk factors to other
internally risk rated loans, individual consumer and residential loans and
commercial leases that are classified as nonaccrual or are 90-day past due, and
unfunded commitments. Each risk rating category is assigned a credit risk factor
based on management's estimate of the associated risk, complexity, and size of
the individual loans within the category. Allowances may also be established in
special circumstances involving a particular group of credits or portfolio
within a risk rating category when management becomes aware that losses incurred
may exceed those determined by use of the risk factor for that general credit
category.
A nonspecific allowance is primarily based upon management's regular
evaluation of the following factors (which are included in federal bank
regulatory guidelines): trends in delinquencies and nonaccruals, size of credits
relative to the allowance, volume trends, concentrations, economic conditions,
credit administration and management, and the quality of the risk identification
system. Additional factors which may also be considered include changes in
underwriting standards, such as acceptance of higher loan to value ratios.
Evaluation of the effects of these factors on estimated losses involves a high
degree of uncertainty including the strength and timing of economic cycles and
concerns over the effects of a prolonged economic downturn in the current cycle.
The required analysis is regularly and carefully undertaken by management, and
the weights given to these factors are revised as conditions indicate.
The amount of the allowance is reviewed monthly by the senior loan
committee, and reviewed and approved by the Board of Directors quarterly.
During the first nine months of the year, there was no provision for
credit losses in 2003, compared to $2,565,000 in 2002. The Company has
experienced net recoveries during the first nine months of 2003 of $13,000,
compared to net recoveries of $2,000 for the same period of 2002.
Management believes that the allowance is adequate. However, its
determination requires significant judgement, and estimates of probable losses
inherent in the credit portfolio can vary significantly from the amounts
actually observed. While management uses available information to recognize
probable losses, future additions to the allowance may be necessary based on
changes in the credits comprising the portfolio and changes in the financial
condition of borrowers, such as may result from changes in economic conditions.
In addition, various regulatory agencies, as an integral part of their
examination process, and independent Consultants engaged by Sandy Spring Bank,
periodically review the credit portfolio and the allowance. Such reviews may
result in additional provisions based on these third-party judgments of
information available at the time of each examination. During the first nine
months of 2003, there were no changes in estimation methods that affected the
allowance methodology. The allowance for credit losses was 1.37% of total loans
and leases at September 30, 2003 and 1.41% at December 31, 2002.
The allowance increased during the first nine months of 2003 by $13,000
(the amount of net recoveries for the period), from $15,036,000 at December 31,
2002 to $15,049,000 at September 30, 2003. The stability of the allowance
reflects the required reserve computed by the allowance methodology at September
30, 2003, compared to December 31, 2002. The amount of the required reserve was
affected by minimal loan growth, no significant shift in risk concentration
within the loan and lease portfolio, the decline in the specific reserve for a
single commercial construction credit and lower net charge-offs.
17
Table 5 -- Analysis of Credit Risk
Activity in the allowance for credit losses is shown below:
Nine Months Ended Twelve Months Ended
(Dollars in thousands) September 30, 2003 December 31, 2002
- ----------------------------------------- ------------------ --------------------
Balance, January 1 $ 15,036 $ 12,653
Provision for credit losses 0 2,865
Loan charge-offs:
Residential real estate (65) (165)
Commercial loans and leases (54) (467)
Consumer (69) (158)
---------------- ------------------
Total charge-offs (188) (790)
Loan recoveries:
Residential real estate 127 0
Commercial loans and leases 65 284
Consumer 9 24
---------------- ------------------
Total recoveries 201 308
---------------- ------------------
Net recoveries (charge-offs) 13 (482)
---------------- ------------------
Balance, period end $ 15,049 $ 15,036
================ ==================
Net recoveries (charge-offs) to average
loans and leases (annual basis) 0.00% (0.05)%
Allowance to total loans and leases 1.37% 1.41%
The following table presents nonperforming assets at the dates indicated:
September 30, December 31,
2003 2002
- -----------------------------------------------------------------------------
Non-accrual loans and leases $ 564 $ 588
Loans and leases 90 days past due 2,612 2,157
---------- ----------
Total nonperforming loans and leases* 3,176 2,745
Other real estate owned 125 0
---------- ----------
Total nonperforming assets $ 3,301 $ 2,745
========== ==========
Nonperforming assets to total assets 0.14% 0.12%
- ----------------------------------------------------------------------------
* Those performing credits considered potential problem credits (which
Bancorp classifies as substandard), as defined and identified by
management, amounted to approximately $7,576,000 at September 30, 2003,
compared to $5,962,000 at December 31, 2002. Although these are credits
where known information about the borrowers' possible credit problems
causes management to have doubts as to their ability to comply with the
present repayment terms, which could result in their reclassification as
nonperforming credits in the future, most are well collateralized and are
not believed to present significant risk of loss.
18
CREDIT RISK MANAGEMENT CONTINUED
Nonperforming loans and leases increased by $431,000 to $3,176,000
while nonperforming assets increased by $556,000 to $3,301,000 from December 31,
2002 to September 30, 2003. Expressed as a percentage of total assets,
nonperforming assets increased to 0.14% at September 30, 2003 from 0.12% at
December 31, 2002. The allowance for credit losses represented nearly 4.7 times
nonperforming loans and leases at September 30, 2003, compared to coverage of
nearly 5.5 times at December 31, 2002. Significant variation in this coverage
ratio may occur from period to period because the amount of nonperforming loans
and leases consists of a small number of individual credits and borrowers
relative to the total loan and lease portfolio. Other real estate owned totaled
$125,000 at September 30, 2003, compared to no such assets on the balance sheet
at December 31, 2002. The balance of impaired loans and leases was $159,000 at
September 30, 2003, with specific reserves against those loans of $54,000,
compared to $170,000 at December 31, 2002, with no reserves.
NONINTEREST INCOME AND EXPENSES
Total noninterest income was $26,558,000 for the nine-month period
ended September 30, 2003, a 26% or $5,460,000 increase from the same period of
2002. On a non-GAAP basis, noninterest income, excluding the effects of
securities gains ($657,000 in 2003 versus $1,021,000 in 2002) and income of
$1,077,000 from the early termination of a sublease during the second quarter of
2003, increased 24% or $4,747,000. The income from the early termination of a
sublease reflects the proceeds from a negotiated settlement with a sub-tenant of
a Bank leased facility. The Bank currently intends to renovate the vacated space
for its own use. The primary reason for the growth in total noninterest income
was a $2,605,000 increase in mortgage banking revenues to $5,084,000 due mainly
to the sizable increase in the volume of refinancings resulting from the
continued low interest rate environment. Other major contributors to the
increase included income from Bank Owned Life Insurance (up $825,000 or 61%),
income from trust operations (up $408,000 or 22%), insurance commissions (up
$432,000 or 18%), and service charges on deposit accounts (up $300,000 or 5%).
Noninterest income performance reported above reflects management's desire to
both grow and diversify its sources of noninterest income.
Total noninterest expenses were $49,484,000 for the nine-month period
ended September 30, 2003, a 5% or $2,221,000 increase from the first three
quarters of 2002. The Company incurs additional costs in order to enter new
markets, provide new services, and support the growth of the Company. Management
controls its operating expenses, however, with the goal of maximizing
profitability over time.
The rise in total noninterest expenses during the first three quarters
of 2003, compared to the same period of 2002, was principally driven by higher
equipment expenses (up 19% or $527,000) and occupancy expenses (up 17% or
$723,000). Salaries and benefits increased 3% or $774,000 versus the prior year
period. The Company opened two new branches in 2003 located in Urbana, Maryland
and Frederick, Maryland. Average full-time equivalent employees increased to 564
during the first nine months of 2003, from 536 during the like period in 2002, a
5% increase. The ratio of net income per average full-time-equivalent employee
after completion of the first nine months of the year was $45,000 in 2003, which
includes after-tax income from an early termination of a sublease, and $41,000
in 2002.
INCOME TAXES
The effective tax rate was 24.0% for the nine-month period ended
September 30, 2003 compared to 26.4% for the prior year period. This decline
reflects an increase in tax-advantaged investments and a significant increase in
income from bank owned life insurance.
19
C. RESULTS OF OPERATIONS - THIRD QUARTER 2003 AND 2002
Third quarter net income of $8,218,000 ($0.56 per share-diluted) in
2003 was $14,000 above net income of $8,204,000 ($0.56 per share-diluted) for
the same quarter of 2002. Annualized returns on average equity for these periods
were 17.35% in 2003 versus 19.51% in 2002.
Third quarter net interest income was $18,775,000 in 2003, a decrease
of 5% from $19,846,000 in 2002, reflecting a 50 basis point decline in net
interest margin partially offset by a 9% higher volume of average earning
assets. Non-GAAP tax-equivalent net interest income, which takes into account
the benefit of tax advantaged investment securities, decreased by 4%.
There was no third quarter provision for credit losses in 2003,
compared to a provision of $395,000 in the same quarter of 2002. The third
quarter provision in 2002 reflected the impact of continued growth in loans,
increases in watch listed credits, the seasoning of substantial loan growth over
the prior eighteen months, considerations associated with the general economic
environment, and other factors considered in the Company's allowance
methodology. Net recoveries of $16,000 were recorded for three-month period
ended September 30, 2003, compared to net charge-offs of $86,000 for the
three-month period ended September 30, 2002.
Total third quarter noninterest income was $8,751,000 in 2003,
representing a 15% or $1,136,000 increase from the same period of 2002. On a
non-GAAP basis, noninterest income, excluding the effects of securities gains of
$106,000 in 2003 versus $791,000 in 2002, increased 27% or $1,821,000. Almost
half of this increase was attributable to higher gains on sales of mortgage
loans. Virtually all of the other major sources of noninterest income also
showed significant increases, including income from bank owned life insurance
(up $373,000 or 76%), trust department income (up $104,000 or 16%), fees on
sales of investment products (up $87,000 or 20%) and insurance agency
commissions (up $267,000 or 41%).
Third quarter noninterest expenses increased 7% or $1,057,000 to
$16,904,000 in 2003 from $15,847,000 in 2002, resulting from a $536,000 or 6%
rise in salaries and benefits, a $470,000 or 34% increase in occupancy expense,
a $152,000 or 16% increase in equipment expenses along with many small increases
in many other expense categories. The Company opened two new branches in 2003
located in Urbana, Maryland and Frederick, Maryland, which contributed to the
increases in noninterest expense.
The third quarter effective tax rate was 22.6% in 2003, compared to
26.9% recorded in 2002. This decline reflects an increase in tax-advantaged
investments and a significant increase in income from bank owned life insurance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Financial Condition - Market Risk Management" in Management's
Discussion and Analysis of Financial Condition and Results of Operations, above.
Management has determined that no additional disclosures are necessary to assess
changes in information about market risk that have occurred since December 31,
2002.
20
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of its Chief Executive Officer and the Chief Financial Officer,
evaluated as of the last day of the period covered by this report, the
effectiveness of the design and operation of the Company's disclosure controls
and procedures, as defined in Rule 13a-15 under the Securities Exchange Act of
1934. Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
adequate. There were no significant changes in the Company's internal controls
over financial reporting (as defined in Rule 13a-15 under the Securities Act of
1934) during the quarter ended September 30, 2003, that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit 31 Rule 13a-14(a) /15d-14(a) Certifications
Exhibit 32 U.S.C. Section 1350 Certifications
(b) Reports on Form 8-K.
On July 15, 2003, the Company furnished, under Item 9 and Item 12, its
news release including results of operations and financial condition and related
information concerning non-GAAP financial measures.
On September 8, 2003, the Company furnished, under items 9 and Item 11,
its notice with respect to a temporary suspension of trading under the Sandy
Spring Bancorp, Inc. Profit Sharing Plan.
On October 15, 2003, the Company furnished under Item 9 and Item 12,
its news release including results of operations and financial condition and
related information concerning non-GAAP financial measures.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this quarterly 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
Date: November 13, 2003
By: /s/ JAMES H. LANGMEAD
-------------------------------------
James H. Langmead
Executive Vice President and
Chief Financial Officer
Date: November 13, 2003
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