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 June 30, 2004
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
Sandy Spring Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Maryland 52-1532952
- ------------------------ ---------------------------------------
(State of incorporation) (I.R.S. Employer Identification Number)
17801 Georgia Avenue, Olney, Maryland 20832 301-774-6400
- ------------------------------------- --------- ------------
(Address of principal office) (Zip Code) (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 July 20, 2004 is
14,521,700 shares.
SANDY SPRING BANCORP, INC.
INDEX
PAGE
- ----------------------------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at
June 30, 2004 and December 31, 2003......................................................1
Consolidated Statements of Income for the Six
Month Periods Ended June 30, 2004 and 2003..............................................2
Consolidated Statements of Cash Flows for the Six
Month Periods Ended June 30, 2004 and 2003 ..............................................4
Consolidated Statements of Changes in Stockholders' Equity for the
Six Month Periods Ended June 30, 2004 and 2003...........................................6
Notes to Consolidated Financial Statements...............................................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS......................................10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK .................................................................21
ITEM 4. CONTROLS AND PROCEDURES................................................................21
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND
ISSUER PURCHASES OF EQUITY SECURITIES.............................................22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................................... 22
SIGNATURES.................................................................................... 23
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(Dollars in thousands, except per share data) 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $41,399 $38,397
Federal funds sold 67,754 10,670
Interest-bearing deposits with banks 736 724
Residential mortgage loans held for sale (at fair value) 12,988 12,209
Investments available-for-sale (at fair value) 569,908 639,460
Investments held-to-maturity -- fair value of $322,896 (2004) and
$344,814 (2003) 322,448 337,634
Other equity securities 19,852 21,111
Total loans and leases 1,267,346 1,153,428
Less: allowance for credit losses (14,743) (14,880)
---------------- ----------------
Net loans and leases 1,252,603 1,138,548
Premises and equipment, net 40,498 37,679
Accrued interest receivable 13,025 13,661
Goodwill 7,642 7,642
Other intangible assets 10,473 11,446
Other assets 64,873 65,243
---------------- ----------------
Total assets $2,424,199 $2,334,424
================ ================
LIABILITIES
Noninterest-bearing deposits $417,400 $368,319
Interest-bearing deposits 1,264,152 1,193,511
---------------- ----------------
Total deposits 1,681,552 1,561,830
Short-term borrowings 384,436 413,223
Subordinated debentures 35,000 35,000
Other long-term borrowings 114,883 115,158
Accrued interest payable and other liabilities 12,238 15,764
---------------- ----------------
Total liabilities 2,228,109 2,140,975
STOCKHOLDERS' EQUITY
Common stock -- par value $1.00; shares authorized 50,000,000; shares issued
and outstanding 14,517,640 (2004) and 14,495,613 (2003)
14,518 14,496
Additional paid in capital 19,511 18,970
Retained earnings 161,459 153,280
Accumulated other comprehensive income 602 6,703
---------------- ----------------
Total stockholders' equity 196,090 193,449
---------------- ----------------
Total liabilities and stockholders' equity $2,424,199 $2,334,424
================ ================
See Notes to Consolidated Financial Statements.
1
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- --------------------------
(In thousands, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income:
Interest and fees on loans and leases $16,919 $16,252 $33,375 $32,871
Interest on loans held for sale 212 263 350 571
Interest on deposits with banks 2 4 5 7
Interest and dividends on securities:
Taxable 5,509 7,880 12,065 16,612
Exempt from federal income taxes 3,515 3,483 7,102 6,951
Interest on federal funds sold 88 109 147 215
------------------------------- --------------------------
TOTAL INTEREST INCOME 26,245 27,991 53,044 57,227
Interest Expense:
Interest on deposits 2,994 3,728 5,724 7,661
Interest on short-term borrowings 3,699 4,497 7,450 9,127
Interest on long-term borrowings 1,690 1,519 3,382 3,029
------------------------------- --------------------------
TOTAL INTEREST EXPENSE 8,383 9,744 16,556 19,817
------------------------------- --------------------------
NET INTEREST INCOME 17,862 18,247 36,488 37,410
Provision for Credit Losses 0 0 0 0
------------------------------- --------------------------
NET INTEREST INCOME AFTER PROVISION 17,862 18,247
FOR CREDIT LOSSES 36,488 37,410
Noninterest Income:
Securities gains 109 543 337 551
Service charges on deposit accounts 1,881 2,037 3,749 4,021
Gains on sales of mortgage loans 1,028 1,603 1,797 3,178
Fees on sales of investment products 666 666 1,295 1,187
Trust department income 984 758 1,738 1,478
Insurance agency commissions 1,030 922 2,151 1,941
Income from bank owned life insurance 613 710 1,243 1,319
Income from an early termination of a sublease 0 1,077 0 1,077
Visa check fees 497 494 921 919
Other income 1,433 1,240 2,569 2,136
------------------------------- --------------------------
TOTAL NONINTEREST INCOME 8,241 10,050 15,800 17,807
Noninterest Expenses:
Salaries and employee benefits 10,285 9,514 20,218 18,964
Occupancy expense of premises 1,815 1,533 3,443 3,117
Equipment expenses 1,324 1,099 2,514 2,140
Marketing 482 509 995 963
Outside data services 766 660 1,487 1,305
Amortization of intangible assets 487 664 973 1,329
Other expenses 2,996 2,644 5,295 4,762
------------------------------- --------------------------
TOTAL NONINTEREST EXPENSES 18,155 16,623 34,925 32,580
------------------------------- --------------------------
Income Before Income Taxes 7,948 11,674 17,363 22,637
Income Tax Expense 1,555 2,938 3,669 5,573
------------------------------- --------------------------
NET INCOME $6,393 $8,736 $13,694 $17,064
================ ============== ==========================
See Notes to Consolidated Financial Statements.
2
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (Continued)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- --------------------------
(In thousands, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Basic Net Income Per Share $0.44 $0.61 $0.94 $1.18
Diluted Net Income Per Share 0.43 0.60 0.93 1.16
Dividends Declared Per Share 0.19 0.18 0.38 0.36
See Notes to Consolidated Financial Statements.
3
Sandy Spring Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Six Months Ended
June 30,
-----------------------------------
2004 2003
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $13,694 $17,064
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 3,206 3,051
Provision for credit losses 0 0
Deferred Income Taxes (benefits) (354) 572
Origination of loans held for sale (156,736) (230,952)
Proceeds from sales of loans held for sale 157,754 243,549
Gains on sales of loans held for sale (1,797) (3,178)
Securities gains (337) (551)
Income from early termination of a sublease 0 (1,077)
Net decrease in accrued interest receivable 636 53
Net increase in other assets (770) (5,597)
Net increase (decrease) in accrued expenses and other liabilities 1,629 (6,154)
Other - net 698 811
-------------- ---------------
Net cash provided by operating activities 17,623 17,591
Cash flows from investing activities:
Net decrease (increase) in interest-bearing deposits with banks (12) 148
Purchases of investments held-to-maturity (22,109) (7,622)
Purchases of other equity securities 0 (166)
Proceeds from sales of other equity securities 1,259 0
Purchases of investments available-for-sale (316,378) (881,245)
Proceeds from sales of investments available-for-sale 166,480 71,760
Proceeds from the sales of other real estate owned 153 0
Proceeds from maturities, calls and principal payments of investments 37,207 95,174
held-to-maturity
Proceeds from maturities, calls and principal payments of investments 209,160 732,093
available-for-sale
Net increase in loans and leases (113,918) (6,022)
Proceeds from an early termination of a sublease 0 750
Expenditures for premises and equipment (5,087) (2,601)
-------------- ---------------
Net cash provided by (used in) investing activities (43,245) 2,269
Cash flows from financing activities:
Net increase in deposits 119,722 97,932
Net decrease in short-term borrowings (29,062) (72,153)
Proceeds from long-term borrowings 0 28,500
Common stock purchased and retired (20) (2,999)
Proceeds from issuance of common stock 583 455
Dividends paid (5,515) (5,223)
-------------- ---------------
Net cash provided by financing activities 85,708 46,512
-------------- ---------------
Net increase in cash and cash equivalents 60,086 66,372
Cash and cash equivalents at beginning of period 49,067 48,133
-------------- ---------------
Cash and cash equivalents at end of period $109,153 $114,505
============== ===============
4
Sandy Spring Bancorp and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Six Months Ended
June 30,
-------------------------------------
(Dollars in thousands) 2004 2003
- ------------------------------------------------------------------------------------- --------------- ----- ---------------
Supplemental Disclosures:
Interest payments $16,630 $19,988
Income tax payments 3,909 5,108
Noncash Financing Activities:
Transfers from loans to other real estate owned 0 187
Increase in premises and equipment from an early termination of a sublease 0 1,168
Reclassification of borrowings from long-term to short-term 275 30,709
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, 2004 $14,496 $18,970 $153,280 $6,703 $193,449
Comprehensive income:
Net income 13,694 13,694
Other comprehensive loss, net of tax
effects and reclassification adjustment (6,101) (6,101)
-----------
Total comprehensive income
7,593
Cash dividends - $0.38 per share (5,515) (5,515)
Common stock issued pursuant to:
Director stock purchase plan- 1,120 shares 1 39 40
Stock option plan - 12,480 shares 13 256 269
Employee stock purchase plan - 8,977
shares 9 265 274
Stock repurchases - 550 shares (1) (19) (20)
----------- ------------ ------------ ------------ -----------
Balances at June 30, 2004 $14,518 $19,511 $161,459 $602 $196,090
=========== ============ ============ ============ ===========
Balances at January 1, 2003 $14,536 $21,128 $131,939 $10,421 $178,024
Comprehensive income:
Net income 17,064 17,064
Other comprehensive income, net of tax
effects and reclassification
adjustment 1,304 1,304
-----------
Total comprehensive income
18,368
Cash dividends - $0.36 per share (5,223) (5,223)
Common stock issued pursuant to:
Stock option plan - 16,123 shares 16 220 236
Employee stock purchase plan - 7,987
shares 8 211 219
Stock repurchases - 95,060 shares (95) (2,904) (2,999)
----------- ------------ ------------ ------------ -----------
Balances at June 30, 2003 $14,465 $18,655 $143,780 $11,725 $188,625
=========== ============ ============ ============ ===========
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 2003 Annual
Report to Shareholders. There have been no significant changes to the Company's
Accounting Policies as disclosed in the 2003 Annual Report. The results shown in
this interim report are not necessarily indicative of results to be expected for
the full year 2004.
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 January 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, "Consolidation of Variable Interest Entities"
("FIN 46"), which explains identification of variable interest entities and the
assessment of whether to consolidate these entities. FIN 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 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. On December 17,
2003, the FASB revised FIN 46 (FIN 46R) and deferred the effective date of FIN
46 to no later than the end of the first reporting period that ends after March
15, 2004. Accordingly, the Company chose to postpone de-consolidation of the
trust preferred securities until March 31, 2004. Prior periods have been
restated. The overall effect on the Company's financial position as a result of
this deconsolidation was not material. The Company has no significant variable
interests in any entities which would require disclosure or consolidation.
Note 2 - Stock Option Plan
At June 30, 2004, 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.
7
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------
(In thousands, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 6,393 $ 8,736 $ 13,694 $ 17,064
Less pro forma stock-based employee
compensation expense determined
under fair value based method, net
of related tax effects (310) (248) (620) (497)
--------------------------------------------------------------------
Pro forma net income $ 6,083 $ 8,488 $ 13,074 $ 16,567
======================================================================
Net income per share:
Basic - as reported $ 0.44 $ 0.61 $ 0.94 $ 1.18
Basic - pro forma $ 0.42 $ 0.59 $ 0.90 $ 1.14
Diluted - as reported $ 0.43 $ 0.60 $ 0.93 $ 1.16
Diluted - pro forma $ 0.41 $ 0.58 $ 0.89 $ 1.13
Note 3 - Per Share Data
The calculations of net income per common share for the three month and
six month periods ended June 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 calculation method is derived by
dividing net income available to common 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 Six Months Ended
Per share data) June 30, June 30,
- --------------------------------------------------------------- ---------------------------- --- -----------------------------
2004 2003 2004 2003
---- ---- ---- ----
Basic:
Net income available to common stockholders $6,393 $8,736 $13,694 $17,064
Average common shares outstanding 14,514 14,479 14,510 14,508
Basic net income per share $0.44 $0.61 $0.94 $1.18
============= ============== ============ ================
Diluted:
Net income available to common stockholders $6,393 $8,736 $13,694 $17,064
Average common shares outstanding 14,514 14,479 14,510 14,508
Stock option adjustment 212 197 218 202
------------- -------------- ------------ ----------------
Average common shares outstanding-diluted 14,726 14,676 14,728 14,710
Diluted net income per share $0.43 $0.60 $0.93 $1.16
============= ============== ============ ================
Options for 188,768 shares of common stock were not included in
computing diluted net income per share for the three and six months ended June
30, 2004 because their effects are antidilutive. Options for 135,147 shares of
common stock were not included in computing diluted net income per share for the
three months ended June 30, 2003 because their effects were antidilutive. There
was no such effect for the six months ended June 30, 2003.
Note 4-Pension, Profit Sharing, and Other Employee Benefit Plans
Defined Benefit Pension Plan
The Company has a qualified, noncontributory, defined benefit pension
plan covering substantially all employees. Benefits equal the sum of two parts:
(a) the benefit accrued as of December 31, 2000, based on the formula of 1.5% of
the highest five year average salary as of that date times years of service as
of that date, plus (b) 1.75% of each year's earnings after December 31, 2000
(1.75% of career average earnings). In addition, if the participant's age plus
years of service as of January 1, 2001, equal at least 60 and the participant
had at least 15 years of service at that date, he or she will receive an
additional benefit of 1% of year 2000 earnings for each of the first 10 years of
service completed after December 31, 2000. Early retirement is also permitted by
the Plan at age 55 after 10 years of service. The Company's funding policy is to
contribute at least the minimum amount necessary to keep the plan fully funded.
The plan invests primarily in a diversified portfolio of managed fixed income
and equity funds. Contributions provide not only for benefits attributed to
service to date, but also for the benefit expected to be earned in the coming
year. The Company, with input from its actuaries, estimates that the 2004
contribution will be approximately $1.5 million which will maintain the pension
plan's fully funded status.
8
Net periodic benefit cost for the three and six month periods ended
June 30 includes the following components:
Three months Ended Six months Ended
- -------------------------------------------------------------------------------------------------------------------
June 30, June 30,
(In thousands) 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------
Service cost for benefits earned $395 $285 $790 $569
Interest cost on projected benefit obligation 232 183 464 364
Expected return on plan assets (259) (197) (519) (395)
Amortization of prior service cost (16) (15) (31) (31)
Recognized net actuarial loss 82 73 164 147
----- ------ ------ ----
Net periodic benefit cost $434 $329 $868 $654
===== ===== ===== ====
Cash and Deferred Profit Sharing Plan
The Company has a qualified Cash and Deferred Profit Sharing Plan that
includes a 401 (k) provision with a Company match. The profit sharing component
is non-contributory and covers all employees after ninety days of service. The
401(k) plan provision is voluntary and also covers all employees after ninety
days of service. Employees contributing under the 401(k) provision receive a
matching contribution up to the first 4% of compensation based on years of
service and subject to employee contribution limitations. The Company match
includes a vesting schedule with employees becoming 100% vested after four years
of service. The Plan permits employees to purchase shares of Sandy Spring
Bancorp common stock with their profit sharing allocations, 401 (k)
contributions, Company match, and other contributions under the Plan. The
Company had expenses related to the qualified Cash and Deferred Profit Sharing
Plan of $372,000 and $393,000 for the six month period ended June, 2003 and
2004, respectively and $178,000 and $182,000 for the three month period ended
June 30, 2003 and 2004, respectively.
The Company also has a performance based compensation benefit which is
integrated with the Cash and Deferred Profit Sharing Plan and which provides
incentives to employees based on the Company's financial results as measured
against key performance indicator goals set by management. The Company had
expenses (benefits) related to the performance based compensation benefit of
$487,000 and $14,000 for the six months ended June 30, 2003 and 2004,
respectively and $43,000 and $(91,000) for the three months ended June 30, 2003
and 2004, respectively.
The Company has Supplemental Executive Retirement Agreements (SERAs)
with its executive officers, providing for retirement income benefits as well as
pre-retirement death benefits. Retirement benefits payable under SERAs, if any,
are integrated with other pension plan and Social Security retirement benefits
expected to be received by the executives. The Company is accruing the present
value of these benefits over the remaining years to the executives' retirement
dates. The Company had expenses related to the SERAs of $292,000 and $115,000
for the six months ended June 30, 2003 and 2004, respectively and $152,000 and
$119,000 for the three months ended June 30, 2003 and 2004, respectively.
The Company has an Executive Health Insurance Plan that provides for
payment of defined medical and dental insurance cost and out of pocket expenses
for selected executives and their families. Benefits, which are paid during both
employment and retirement, are subject to a $6,500 limitation for each executive
per year. The Company had expenses related to the Executive Health Insurance
Plan of $96,000 and $128,000 for the six months ended June 30, 2003 and 2004,
respectively and $64,000 for both the three months ended June 30, 2003 and 2004.
9
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
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, earnings expectations and
other expectations; estimates of risks and future costs and benefits;
assessments of probable loan and lease losses; assessments of 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, market behavior, 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 June 30, 2004, year-to-date average
commercial loans and leases and commercial real estate loans accounted for
approximately 42% of the Company's loan and lease portfolio, and year-to-date
average consumer and residential real estate loans accounted for approximately
58%. Based upon the most recent data available, consumer deposits account for
approximately 75% of total average deposits, while approximately 60% 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 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. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information changes, the financial statements could reflect different
estimates, assumptions, and judgments. Certain policies inherently have a
greater reliance on the use of estimates, assumptions, and judgments and as such
have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available. The 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 a
material effect.
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 measures 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.
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.
10
Table 1 - GAAP based and traditional efficiency ratios
Three Months Ended Six Months Ended
- --------------------------------------------------------------------------------------------------------------------------
June 30, June 30,
- --------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------------
Noninterest expenses-GAAP based $ 18,155 $ 16,623 $ 34,925 $ 32,580
Net interest income plus noninterest income-
GAAP based 26,103 28,297 52,288 55,217
Efficiency ratio-GAAP based 69.55% 58.74% 66.79% 59.00%
============ =========== ============= ===========
Noninterest expenses-GAAP based $ 18,155 $ 16,623 $ 34,925 $ 32,580
Less non-GAAP adjustment:
Amortization of intangible assets 487 664 973 1,329
------------- ------------ ------------- -----------
Noninterest expenses-traditional ratio 17,668 15,959 33,952 31,251
Net interest income plus noninterest income-
GAAP based 26,103 28,297 52,288 55,217
Plus non-GAAP adjustment:
Tax-equivalency 1,919 1,809 3,884 3,855
Less non-GAAP adjustments:
Securities gains (losses) 109 543 337 551
Income from an early termination of
a sublease 0 1,077 0 1,077
------------- ------------ ------------- -----------
Net interest income plus noninterest
Income - traditional ratio 27,913 28,486 55,835 57,444
Efficiency ratio - traditional 63.30% 56.02% 60.81% 54.40%
============= ============ ============= ===========
A. FINANCIAL CONDITION
The Company's total assets were $2,424,199,000 at June 30, 2004,
compared to $2,334,424,000 at December 31, 2003, increasing $89,775,000 or 4%
during the first six months of 2004. Earning assets increased by 4%, to
$2,261,032,000 at June 30, 2004, from $2,175,236,000 at December 31, 2003.
Total loans and leases, excluding loans held for sale, increased 10% or
$113,918,000 during the first six months of 2004, to $1,267,346,000. During this
period, all three major loan categories showed increases. These increases
occurred in residential real estate loans, which increased by $36,929,000 or 9%,
attributable in large part to residential construction loan growth, consumer
loans which increased by $41,911,000 or 17%, primarily reflecting higher home
equity lines and commercial loans and leases which increased by $35,078,000 or
7%, due predominantly to growth in commercial loans secured by real estate.
Residential mortgage loans held for sale increased by $779,000 from December 31,
2003, to $12,988,000 at June 30, 2004.
Table 2 - Analysis of Loans and Leases
The following table presents the trends in the composition of the loan and lease
portfolio at the dates indicated:
(In thousands) June 30, 2004 % December 31, 2003 %
- ----------------------------------------------------------------------------------------------------------------------
Residential real estate $ 456,558 36% $ 419,629 36%
Commercial loans and leases 526,017 42 490,939 43
Consumer 284,771 22 242,860 21
------------ ----------- ------------- -----------
Total Loans and Leases 1,267,346 100% 1,153,428 100%
=========== ===========
Less: Allowance for credit losses (14,743) (14,880)
----------- ------------
Net loans and leases $ 1,252,603 $ 1,138,548
=========== ============
11
The total investment portfolio decreased by 9% or $85,997,000 from
December 31, 2003, to $912,208,000 at June 30, 2004, as management decreased the
amount of leverage on the balance sheet to mitigate interest rate risk in the
event of rising rates. The decrease was driven primarily by a decline of
$69,552,000 or 11% of available-for-sale securities. The aggregate of federal
funds sold and interest-bearing deposits with banks increased by $57,096,000
during the first six months of 2004, reaching $68,490,000 at June 30, 2004.
Table 3 - Analysis of Deposits
The following table presents the trends in the composition of deposits at the
dates indicated:
(In thousands) June 30, 2004 % December 31, 2003 %
- --------------------------------------------------------------------------------------------------------------------------
Noninterest-bearing deposits $ 417,400 25% $ 368,319 24%
Interest-bearing deposits:
Demand 230,574 14 224,272 14
Money market savings 362,644 21 376,722 24
Regular savings 230,773 14 187,510 12
Time deposits less than $100,000 269,164 16 269,938 17
Time deposits $100,000 or more 170,997 10 135,069 9
------------ ------- ----------- ------
Total interest-bearing 1,264,152 75 1,193,511 76
------------ ------- ----------- ------
Total deposits $ 1,681,552 100% $ 1,561,830 100%
============ ======= =========== ======
Total deposits were $1,681,552,000 at June 30, 2004, increasing
$119,722,000 or 8% from $1,561,830,000 at December 31, 2003. First half-year
growth rates of 13% were achieved in 2004 for noninterest-bearing demand
deposits (up $49,081,000), 23% for interest-bearing regular savings (up
$43,263,000), 27% for time deposits of $100,000 or more (up $35,928,000) and 3%
for interest-bearing demand deposits (up $6,302,000). Over the same period,
decreases of 4% were recorded for money market savings (down $14,078,000) and
less than 1% for time deposits of less than $100,000.
Total borrowings were $534,319,000 at June 30, 2004, which represented
a decrease of $29,062,000 or 5% from December 31, 2003, primarily reflecting a
decrease in short-term borrowings as management decreased the leverage in the
balance sheet.
MARKET RISK AND INTEREST RATE SENSITIVITY
OVERVIEW
The Company's net income is largely dependent on its net interest
income. Net interest income is susceptible to interest rate risk to the degree
that interest-bearing liabilities mature or reprice on a different basis than
interest-earning assets. When interest-bearing liabilities mature or reprice
more quickly than interest-earning assets in a given period, a significant
increase in market rates of interest could adversely affect net interest income.
Similarly, when interest-earning assets mature or reprice more quickly than
interest-bearing liabilities, falling interest rates could result in a decrease
in net interest income. Net interest income is also affected by changes in the
portion of interest-earning assets that are funded by interest-bearing
liabilities rather than by other sources of funds, such as noninterest-bearing
deposits and stockholders' equity.
The Company's Board of Directors has established a comprehensive
interest rate risk management policy, which is administered by Management's
Asset Liability Management Committee ("ALCO"). The policy establishes limits of
risk, which are quantitative measures of the percentage change in net interest
income (a measure of net interest income at risk) and the fair value of equityd
capital (a measure of economic value of equity ("EVE") at risk) resulting from a
hypothetical change in U.S. Treasury interest rates for maturities from one day
to thirty years. The Company measures 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 the 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. As with any method of gauging interest rate risk, there are
certain shortcomings inherent in the interest rate modeling methodology used by
the Company. When interest rates change, actual movements in different
categories of interest-earning assets and interest-bearing liabilities, loan
prepayments, and withdrawals of time and other deposits, may deviate
significantly from assumptions used in the model. Finally, the methodology does
not measure or reflect the impact that higher rates may have on adjustable-rate
loan customers' ability to service their debts, or the impact of rate changes on
demand for loan, lease, and deposit products.
12
The Company prepares a current base case and eight alternative
simulations, at least once a quarter, and reports the analysis to the Board of
Directors. In addition, more frequent forecasts are produced when interest rates
are particularly uncertain or when other business conditions so dictate.
If a measure of risk produced by the alternative simulations of the
entire balance sheet or of the Company's leverage program violates policy
guidelines, ALCO is required to develop a plan to restore the measure of risk to
a level that complies with policy limits within two quarters.
The Company's interest rate risk management goals are (1) to increase
net interest income at a growth rate consistent with the growth rate of total
assets and, (2) to minimize fluctuations in net interest margin as a percentage
of earning assets. Management attempts to achieve these goals by balancing,
within policy limits, the volume of floating-rate liabilities with a similar
volume of floating-rate assets; by keeping the average maturity of fixed-rate
asset and liability contracts reasonably matched; by maintaining a pool of
administered core deposits; and by adjusting pricing rates to market conditions
on a continuing basis.
The balance sheet is subject to quarterly testing for eight alternative
interest rate shock possibilities to indicate the inherent interest rate risk.
Average interest rates are shocked by +/- 100, 200, 300, and 400 basis points
("bp"), although the Company may elect not to use particular scenarios that it
determines are impractical in a current rate environment. It is management's
goal to structure the balance sheet so that net interest earnings at risk over a
twelve-month period and the economic value of equity at risk do not exceed
policy guidelines at the various interest rate shock levels.
The Company augments its quarterly interest rate shock analysis with
alternative external interest rate scenarios on a monthly basis. These
alternative interest rate scenarios may include non-parallel rate ramp and
non-parallel yield curve twists.
ANALYSIS OF POSSIBLE OUTCOMES
Measures of net interest income at risk produced by simulation analysis
are indicators of an institution's short-term performance in alternative rate
environments. These measures are typically based upon a relatively brief period,
usually one year. They do not necessarily indicate the long-term prospects or
economic value of the institution.
ESTIMATED CHANGES IN NET INTEREST INCOME
---------------------------------------------------------------------------------------------------
CHANGE IN NET INTEREST INCOME: + 400 BP + 300 BP + 200 BP + 100 BP - 100 BP
---------------------------------------------------------------------------------------------------
POLICY LIMIT 30% 25% 20% 15% 15%
June 2004 -1.77 -0.70 +1.65 +4.53 -6.70
December 2003 -6.61 -3.80 -2.30 -0.62 -9.17
As shown above, measures of net interest income at risk improved from
December 31, 2003 at all interest rate shock levels. Specifically, at the +200bp
shock level, the measure moved from -2.30% to +1.65%, well within the policy
limit of 20%. Although assumed to be unlikely, our largest exposure is at the
- -100bp level, with a measure of -6.70% compared to -9.17% at December 31, 2003.
This is also well within our prescribed policy limit of 15%. The reduction in
the net interest income sensitivity is consistent with management's decision to
reduce the duration and size of the investment portfolio during the first six
months of 2004 in anticipation of rising interest rates in the future.
The measures of equity value at risk indicate the ongoing economic
value of the Company by considering the effects of changes in interest rates on
all of the Company's cash flows, and discounting the cash flows to estimate the
present value of assets and liabilities.. The difference between these
discounted values of the assets and liabilities is the economic value of equity,
which, in theory, approximates the fair value of the Company's net assets.
ESTIMATED CHANGES IN ECONOMIC VALUE OF EQUITY (EVE)
---------------------------------------------------------------------------------------------------------------
DECREASE IN ECONOMIC VALUE OF EQUITY: + 400 BP + 300 BP + 200 BP + 100 BP - 100 BP
---------------------------------------------------------------------------------------------------------------
POLICY LIMIT 60% 40% 22.5% 10.0% 12.5%
June 2004 -42.65 -32.12 -17.61 -4.15 -2.98
December 2003 -47.83 -34.66 -20.41 -3.98 -10.17
Measures of the economic value of equity (EVE) at risk also improved
over year-end 2003 at all interest rate shock levels with the exception of the
+100bp. A reduced duration in the investment portfolio is the key contributor to
the improved risk position. The economic value of equity exposure at +200bp is
now -17.61% compared to -20.41% at year-end 2003, and is well within the policy
limit of 22.5%, as are measures at all other shock levels.
13
LIQUIDITY
Liquidity is measured using an approach designed to take into account
loan and lease payments, maturities, calls and pay-downs 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 June 30, 2004 showed short-term
investments exceeding short-term borrowings over the subsequent 90 days by
$105,607,000, which increased from $69,038,000 at December 31, 2003. This excess
of liquidity over projected requirements for funds indicates that the Company
can increase its loans and other earning assets without incurring additional
borrowing.
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
$708,215,000 from the Federal Home Loan Bank of Atlanta, of which approximately
$360,433,000 was outstanding at June 30, 2004. 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 $260,987,000
at June 30, 2004, against which there were outstandings of approximately
$25,000,000. Based upon its liquidity analysis, including external sources of
liquidity available, management believes the liquidity position is appropriate
at June 30, 2004.
The following is a schedule of significant commitments at June 30,
2004:
(In thousands)
Commitments to extend credit:
Unused lines of credit (home equity and business) $365,647
Other commitments to extend credit $167,133
Standby letters of credit $ 39,571
--------
$572,351
========
CAPITAL MANAGEMENT
The Company recorded a total risk-based capital ratio of 14.89% at June
30, 2004, compared to 15.51% at December 31, 2003; a tier 1 risk-based capital
ratio of 13.93%, compared to 14.34%; and a capital leverage ratio of 8.97%,
compared to 8.67%. Capital adequacy, as measured by these ratios, was well above
regulatory requirements. Management believes the level of capital at June 30,
2004, is appropriate.
Stockholders' equity for June 30, 2004, totaled $196,090,000,
representing an increase of $2,641,000 or 1% from $193,449,000 at December 31,
2003. 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 91% or $6,101,000 from December 31, 2003
to $602,000 at June 30, 2004.
Internal capital generation (net income less dividends) added
$8,179,000 to total stockholders' equity during the first six months of 2004.
When internally formed capital is annualized and expressed as a percentage of
average total stockholders' equity, the resulting rate was 8% compared to 12%
reported for the full-year 2003.
External capital formation (equity created through the issuance of
stock under the employee stock purchase plan, stock option plan and the director
stock purchase plan) totaled $583,000 during the six month period ended June 30,
2004. However, share repurchases amounted to $20,000 from December 31, 2003
through June 30, 2004, for a net increase in stockholders' equity from these
sources of $563,000.
Dividends for the first six months of the year were $0.38 per share in
2004, compared to $0.36 per share in 2003, for respective dividend payout ratios
(dividends declared per share to diluted net income per share) of 41% versus
31%.
14
B. RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2004, AND 2003
Net income for the first six months of the year decreased $3,370,000 or
20% to $13,694,000 in 2004 from $17,064,000 in 2003, representing annualized
returns on average equity of 14.03% and 18.91%, respectively. First half-year
diluted earnings per share (EPS) were $0.93 in 2004, compared to $1.16 in 2003.
The net interest margin decreased by 14 basis points to 3.70% for the
six months ended June 30, 2004, from 3.84% for the same period of 2003, as the
net interest spread decreased by 13 basis points. These results reflect lower
average interest rates in the first half-year of 2004 as more assets repriced
down than liabilities during the six months ended June 30, 2004.
TABLE 4 - CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES
(Dollars in thousands and tax equivalent)
For the six months ended June 30,
2004 2003
------------------------------------------------------------------------------
Average Annualized Average Average Annualized Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
(1) (1)
------------------------------------------------------------------------------
Assets
Total loans and leases (2) $ 1,218,625 $67,707 5.56% $1,080,749 $ 67,264 6.22%
Total securities 944,038 46,157 4.89 1,049,040 55,287 5.27
Other earning assets 31,486 304 0.97 38,387 443 1.15
------------- ---------- ---------- ---------
TOTAL EARNING ASSETS 2,194,149 114,168 5.20% 2,168,176 122,994 5.67%
Nonearning assets 162,627 150,095
------------- ----------
Total assets $ 2,356,776 $ 2,318,271
============= ===========
Liabilities and Stockholders' Equity
Interest-bearing demand deposits $ 227,254 $655 0.29% $ 192,468 $484 0.25%
Money market savings deposits 371,988 2,018 0.54 402,550 3,017 0.75
Regular savings deposits 202,253 719 0.36 163,187 530 0.32
Time deposits 420,101 8,119 1.93 443,508 11,417 2.57
------------- ----------- ----------- ---------
Total interest-bearing deposits 1,221,596 11,511 0.94 1,201,713 15,448 1.29
Short-term borrowings 391,907 14,744 3.76 477,097 18,275 3.83
Long-term borrowings 150,000 6,727 4.48 121,607 6,058 4.98
------------- ----------- ----------- ---------
Total interest-bearing liabilities 1,763,503 32,982 1.87 1,800,417 39,781 2.21
------ ------
Noninterest-bearing demand deposits 376,361 311,097
Other noninterest-bearing liabilities 20,673 24,830
Stockholders' equity 196,239 181,927
------------- -----------
Total liabilities and stockholders'
equity $ 2,356,776 $2,318,271
============= ===========
Net interest spread 3.33% 3.46%
============ =============
Net interest margin (3) 3.70% 3.84%
============ =============
Ratio of average earning assets to
Average interest-bearing liabilities 124.42% 120.43%
============= ============
(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 (on an annual basis) to compute yields were
$7,810,000 and $7,774,000 for the six months ended June 30, 2004 and 2003,
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
NET INTEREST INCOME
Net interest income for the first six months of the year was
$36,488,000 in 2004, a decrease of 2% from $37,410,000 in 2003, due to lower
interest rates on loans and investment securities and lower investment
securities balances, offset in part by the effects of loan growth, reduced
interest rates on deposits and borrowings, and lower borrowing balances.
Non-GAAP tax-equivalent net interest income, which takes into account the
benefit of tax advantaged investment securities, also decreased by 2%, to
$40,372,000 in 2004 from $41,265,000 in 2003. The effects of average balances,
yields and rates are presented in table 4.
For the first six months, total interest income decreased by $4,183,000
or 7% in 2004, compared to 2003. On a non-GAAP tax-equivalent basis, interest
income also decreased by 7%. Average earning assets rose by 1% over the prior
period, to $2,194,149,000 from $2,168,176,000, while the average yield earned on
those assets decreased by 47 basis points to 5.20%. Comparing the first six
months of 2004 versus 2003, average total loans and leases grew by 13% to
$1,218,625,000 (56% of average earning assets, versus 50% a year ago), while
recording a 66 basis point decline in average yield to 5.56%. Average
residential real estate loans increased by 21% (reflecting increases in both
mortgage and construction lending); average consumer loans increased by 13%
(attributable primarily to home equity line growth); and, average commercial
loans and leases grew by 6% (due to increases in commercial mortgages and other
commercial loans and leases, partially offset by a decline in construction
loans). Over the same period, average total securities decreased by 10% to
$944,038,000 (43% of average earning assets, versus 48% a year ago), while the
average yield earned on those assets also decreased, by 38 basis points to
4.89%.
Interest expense for the first six months of the year decreased by
$3,261,000 or 16% in 2004, compared to 2003. Average total interest-bearing
liabilities decreased by 2% over the prior year period, while the average rate
paid on these funds also decreased, by 34 basis points to 1.87%. As shown in
Table 4, money market savings deposits, time deposits and short and long-term
borrowings recorded declines in average rate. These declines were partially
offset by slight increases in the rates paid on interest-bearing demand deposits
and regular savings deposits.
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, limiting 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 loan and lease portfolio. The
allowance is based on careful, continuous review and evaluation of the loan and
lease 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 represents an estimation made
pursuant to Statement of Financial Accounting Standards ("SFAS") No. 5,
"Accounting for Contingencies," or SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan." The adequacy of the allowance is determined through
careful and continuous evaluation of the credit portfolio, and involves
consideration of a number of factors, as outlined below, to establish a prudent
level. Determination of the allowance is inherently subjective and requires
significant estimates, including estimated losses on pools of homogeneous loans
and leases based on historical loss experience and consideration of current
economic trends, which may be susceptible to significant change. Loans and
leases deemed uncollectible are charged against the allowance, while recoveries
are credited to the allowance. Management adjusts the level of the allowance
through the provision for credit losses, which is recorded as a current period
operating expense. The Company's systematic methodology for assessing the
appropriateness of the allowance includes: (1) the formula allowance reflecting
historical losses, as adjusted, by credit category and (2) the specific
allowance for risk-rated credits on an individual or portfolio basis.
The formula allowance that is based upon historical loss factors, as
adjusted, establishes allowances for the major loan and lease categories based
upon adjusted historical loss experience over the prior eight quarters, weighted
so that losses in the most recent quarters have the greatest effect. The factors
used to adjust the historical loss experience address various risk
characteristics of the Company's loan and lease portfolio including (1) trends
in delinquencies and other non-performing loans, (2) changes in the risk profile
related to large loans in the portfolio, (3) changes in the categories of loans
comprising the loan portfolio, (4) concentrations of loans to specific industry
segments, (5) changes in economic conditions on both a local and national level,
(6) changes in the Company's credit administration and loan and lease portfolio
management processes and (7) quality of the Company's credit risk identification
processes.
The specific allowance is used to allocate an allowance for internally
risk rated commercial loans where significant conditions or circumstances
indicate that a loss may be imminent. 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 allowance is established based on
the Company's calculation of the potential loss embedded in the individual loan.
Allowances are also established by application of credit risk factors to other
internally risk rated loans, individual consumer and residential loans and
commercial leases having reached nonaccrual or 90-day past due status, 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. Additional allowances may also be
established in special circumstances involving a particular group of credits or
portfolio within a risk category when management becomes aware that losses
incurred may exceed those determined by application of the risk factor alone.
16
The amount of the allowance is reviewed monthly by the senior loan
committee, and reviewed and approved by the Board of Directors quarterly.
There were no provisions for credit losses in the first six months of
2004 or 2003. The Company experienced net charge-offs during the first six
months of 2004 and 2003 of $137,000 and $3,000, respectively.
Management believes that the allowance is adequate. However, its
determination requires significant judgment, 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 the Sandy Spring
Bank, periodically review the credit portfolio and the allowance. Such review
may result in additional provisions based on these third-party judgments of
information available at the time of each examination. During the first six
months of 2004, there were no changes in estimation methods or assumptions that
affected the allowance methodology. The allowance for credit losses was 1.16% of
total loans and leases at June 30, 2004 and 1.29% at December 31, 2003. The
allowance decreased during the first six months of 2004 by $137,000 (the amount
of net charge-offs for the period), from $14,880,000 at December 31, 2003, to
$14,743,000 at June 30, 2004. The stability of the allowance reflects the
required reserve computed by the allowance methodology at June 30, 2004,
compared to December 31, 2003. In spite of loan growth, the required reserve
declined due to a decrease in internally risk-rated commercial loans and
management's analysis of improving economic trends.
Nonperforming loans and leases increased by $135,000 to $2,990,000 from
December 31, 2003 to June 30, 2004, while nonperforming assets increased by
$58,000 to $2,990,000. Expressed as a percentage of total assets, nonperforming
assets decreased to 0.12% at June 30, 2004 from 0.13% at December 31, 2003. The
allowance for credit losses represented 493% of nonperforming loans and leases
at June 30, 2004, compared to coverage of 521% at December 31, 2003. Significant
variation in this coverage ratio may occur from period to period because the
amount of nonperforming loans and leases depends largely on the condition of a
small number of individual credits and borrowers relative to the total loan and
lease portfolio. Other real estate owned was $0 at June 30, 2004, and $77,000 at
December 31, 2003. The balance of impaired loans and leases was $856,000 at June
30, 2004, with specific reserves against those loans of $278,000, compared to
$336,000 at December 31, 2003, with specific reserves of $120,000.
17
Table 5 -- Analysis of Credit Risk
(Dollars in thousands)
Activity in the allowance for credit losses is shown below:
Six Months Ended Twelve Months Ended
June 30, 2004 December 31, 2003
- --------------------------------------------------------------------------------------------------------
Balance, January 1 $14,880 $15,036
Provision for credit losses 0 0
Loan charge-offs:
Residential real estate (21) (148)
Commercial loans and leases (74) (122)
Consumer (117) (87)
------------ --------------
Total charge-offs (212) (357)
Loan recoveries:
Residential real estate 25 126
Commercial loans and leases 45 63
Consumer 5 12
-------------- --------------
Total recoveries 75 201
-------------- --------------
Net charge-offs (137) (156)
-------------- --------------
Balance, period end $14,743 $14,880
============== ==============
Net charge-offs to average loans and
leases (annual basis) (0.02)% (0.01)%
Allowance to total loans and leases 1.16% 1.29%
The following table presents nonperforming assets at the dates indicated:
June 30, December 31,
2004 2003
- ---------------------------------------------------------------------------------------------------
Non-accrual loans and leases $674 $522
Loans and leases 90 days past due 2,316 2,333
-------------- --------------
Total nonperforming loans and leases* 2,990 2,855
Other real estate owned 0 77
-------------- --------------
Total nonperforming assets $2,990 $2,932
============== ==============
Nonperforming assets to total assets 0.12% 0.13%
- ----------------------------------------------------------------------------------------------------
* Those performing credits considered potential problem credits (which the
Company classifies as substandard), as defined and identified by management,
amounted to approximately $6,732,000 at June 30, 2004, compared to $16,793,000
at December 31, 2003. 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
NONINTEREST INCOME AND EXPENSES
Total noninterest income was $15,800,000 for the six-month period ended
June 30, 2004, an 11% or $2,007,000 decrease from the same period of 2003. This
decline was mainly the result of decreases in gains on sales of mortgage loans
(down $1,381,000 or 43%), reflecting lower levels of mortgage banking activity,
securities gains (down $214,000 or 39%) and nonrecurring income of $1,077,000
recorded in 2003 from the early termination of a sublease. Partially offsetting
these decreases were increases in trust department income (up $260,000 or 18%),
insurance agency commissions (up $210,000 or 11%) and fees on sales of
investment products (up $108,000 or 9%), reflecting management's desire to both
increase and diversify its sources of noninterest income. Also, other income
increased $433,000 or 20%, due primarily to increases in gains on sales of other
real estate owned and gains on sales of SBA loans.
Total noninterest expenses were $34,925,000 for the six-month period
ended June 30, 2004, a 7% or $2,345,000 increase from the first half-year of
2003. 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. Most of the rise in noninterest expenses during the first half-year of
2004 occurred in salaries and employee benefits (up $1,254,000 or 7%),
attributable to a larger staff and merit increases, occupancy expenses (up
$326,000 or 10%) which increased due to an expanded branch network and the
opening of a new operations center, equipment expenses (up $374,000 or 17%) and
other expenses (up $533,000 or 11%) which increased mainly as the result of an
increase in professional fees. The Company opened a new branch in June 2003 and
another in August 2003. Average full-time equivalent employees increased to 602
during the first six months of 2004, from 558 during the like period in 2003, an
8% increase. The ratio of net income per average full-time-equivalent employee
after completion of the first six months of the year was $23,000 in 2004 and
$31,000 in 2003 (which includes after-tax income from an early termination of a
sublease).
INCOME TAXES
The effective tax rate decreased to 21.1% for the six-month period
ended June 30, 2004, from 24.6% for the prior year period. This decline was
primarily due to an increase in tax-advantaged investment interest income as a
percentage of total income before taxes.
C. RESULTS OF OPERATIONS - SECOND QUARTER 2004 AND 2003
Second quarter net income of $6,393,000 ($0.43 per share-diluted) in
2004 was $2,343,000 or 27% below net income of $8,736,000 ($0.60 per
share-diluted) shown for the same quarter of 2003. Annualized returns on average
equity for these periods were 13.07% in 2004 versus 19.04% in 2003.
Second quarter net interest income was $17,862,000 in 2004, a decrease
of 2% from $18,247,000 in 2003, reflecting a 16 basis point decline in net
interest margin partially offset by a 2% 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%.
There were no second quarter provisions for credit losses in 2004 or
2003. Net charge-offs of $132,000 were recorded for the three-month period ended
June 30, 2004, compared to net recoveries of $10,000 for the three-month period
ended June 30, 2003.
Second quarter noninterest income was $8,241,000 in 2004, representing
an 18% or $1,809,000 decrease from the same period of 2003. This decrease was
mainly the result of decreases in gains on sales of mortgage loans (down
$575,000 or 36%), securities gains (down $434,000 or 80%) and service charges on
deposit accounts (down $156,000 or 8%). In addition, noninterest income for the
first six months of 2003 included nonrecurring income of $1,077,000 from the
early termination of a sublease. Partially offsetting this decrease, were
increases in trust department income (up $226,000 or 30%), insurance agency
commissions (up $108,000 or 12%) and other income (up $193,000 or 16%).
Second quarter noninterest expenses increased 9% or $1,532,000 to
$18,155,000 in 2004 from $16,623,000 in 2003. This increase was mainly the
result of increases in salaries and employee benefits (up $771,000 or 8%),
occupancy expense (up $282,000 or 18%), equipment expenses (up $225,000 or 20%)
and other expenses (up $352,000 or 13%).
The second quarter effective tax rate decreased to 19.6%, from the
25.2% recorded in the second quarter of 2003. This decrease was primarily due to
an increase in tax-advantaged investment interest income as a percentage of
total income before taxes.
19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Financial Condition - Market Risk and Interest Rate Sensitivity"
in Management's Discussion and Analysis of Financial Condition and Results of
Operations, above, which is incorporated herein by reference. Management has
determined that no additional disclosures are necessary to assess changes in
information about market risk that have occurred since December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Company's Chief Executive Officer and 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 June 30, 2004, that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.
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PART II - OTHER INFORMATION
Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF
EQUITY SECURITIES
The following table provides information on the Company's purchases of its
common stock during the six months ended June 30, 2004.
Issuer Purchases of Equity Securities (1)
- -----------------------------------------------------------------------------------------------------------------------------
(c) Total Number of (d) Maximum Number
Shares Purchased as that May Yet Be
Part of Publicly Purchased Under the
(a) Total Number of (b) Average Price Paid Announced Plans or Plans or Programs
Period Shares Purchased per Share Programs (2)(3)
- -----------------------------------------------------------------------------------------------------------------------------
January 2004 0 NA 0 670,904
February 2004 0 NA 0 670,904
March 2004 550 $36.05 550 670,354
April 2004 0 NA 0 670,354
May 2004 0 NA 0 670,354
June 2004 0 NA 0 670,354
- -----------------------------------------------------------------------------------------------------------------------------
(1) Includes purchases of the Company's stock made by or on behalf of the
Company or any affiliated purchasers of the Company as defined in Securities and
Exchange Commission Rule 10b-18.
(2) On March 26, 2003, the Company publicly announced a stock repurchase program
that permits the repurchase of up to 5%, or 726,804 shares, of its outstanding
common stock. The current program replaced a similar plan that expired on March
31, 2003. Repurchases under the program may be made on the open market and in
privately negotiated transactions from time to time until March 31, 2005, or
earlier termination of the program by the Board. The repurchases are made in
connection with shares expected to be issued under the Company's stock option
and benefit plans, as well as for other corporate purposes. In 2003, a total of
55,900 shares were repurchased under the current program and 49,560 shares were
purchased under the previous program.
(3) Indicates the number of shares remaining under the plan at the end of the
indicated month.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's annual shareholders' meeting held on April 21, 2004, the
shareholders of the Company elected five directors by the following vote:
Nominee For Against Withheld
- --------------------------------------------------------------------------------
Solomon Graham 11,031,193 136,709 0
Gilbert L. Hardesty 11,029,619 138,283 0
Charles F. Mess 10,808,218 359,684 0
Lewis R. Schumann 10,944,219 223,680 0
W. Drew Stabler 11,078,435 89,464 0
There were no solicitations in opposition to management's nominees and all such
nominees were elected. All five director-nominees were incumbent directors
previously elected by the shareholders to three-year terms. Directors continuing
in office are Susan D. Goff, Robert L. Mitchell, Robert L. Orndorff, Jr., David
E. Rippeon, John Chirtea, Hunter R. Hollar, and Craig A. Ruppert.
21
Also at the annual meeting, the shareholders ratified the appointment of
McGladrey & Pullen, LLP, as the independent auditors for 2004 by the following
vote:
Broker
For Against Witheld Non Votes
---------------------------------------------------------------
10,898,728 73,671 195,500 3,000
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit 31(a) and (b) Rule 13a-14(a) / 15d-14(a) Certifications
Exhibit 32 (a) and (b) 18 U.S.C. Section 1350 Certifications
(b) Reports on Form 8-K.
On April 15, 2004, 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 for March 31, 2004, and the
quarter then ended.
On July 15, 2004, 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 for June 30, 2004, and the quarter
then ended.
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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: August 4, 2004
By: /S/ JAMES H. LANGMEAD
---------------------------------------
James H. Langmead
Executive Vice President and Chief Financial Officer
Date: August 4, 2004
23