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, 2005 ------------------ 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 ------- ------- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) YES NO X ------ ------- The number of shares of common stock outstanding as of October 20, 2005 is 14,773,483 shares. SANDY SPRING BANCORP, INC. INDEX PAGE - ---------------------------------------------------------------------------------------------------- PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets at September 30, 2005 and December 31, 2004.................................................1 Consolidated Statements of Income for the Three and Nine Month Periods Ended September 30, 2005 and 2004..........................................2 Consolidated Statements of Cash Flows for the Nine Month Periods Ended September 30, 2005 and 2004 .........................................3 Consolidated Statements of Changes in Stockholders' Equity for the Nine Month Periods Ended September 30, 2005 and 2004.....................................4 Notes to Consolidated Financial Statements...............................................5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS......................................11 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .................................................................21 ITEM 4. CONTROLS AND PROCEDURES................................................................21 PART II - OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS............................21 ITEM 6. EXHIBITS...............................................................................22 SIGNATURES.....................................................................................23 PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS Sandy Spring Bancorp, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS September 30, December 31, (Dollars in thousands, except per share data) 2005 2004 - ---------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 48,412 $ 43,728 Federal funds sold 12,639 5,467 Interest-bearing deposits with banks 802 610 Residential mortgage loans held for sale (at fair value) 25,826 16,211 Investments available-for-sale (at fair value) 271,022 346,903 Investments held-to-maturity -- fair value of $310,673 (2005) and $312,661 (2004) 301,227 305,293 Other equity securities 12,067 13,912 Total loans and leases 1,579,135 1,445,525 Less: allowance for loan and lease losses (16,268) (14,654) ----------- ----------- Net loans and leases 1,562,867 1,430,871 Premises and equipment, net 45,414 42,054 Accrued interest receivable 11,685 11,674 Goodwill 8,554 7,335 Other intangible assets 8,364 9,866 Other assets 74,481 75,419 ----------- ----------- Total assets $ 2,383,360 $ 2,309,343 =========== =========== LIABILITIES Noninterest-bearing deposits $ 467,957 $ 423,868 Interest-bearing deposits 1,336,931 1,308,633 ----------- ----------- Total deposits 1,804,888 1,732,501 Short-term borrowings 279,427 231,927 Subordinated debentures 35,000 35,000 Other long-term borrowings 29,246 94,608 Accrued interest payable and other liabilities 26,709 20,224 ----------- ----------- Total liabilities 2,175,270 2,114,260 STOCKHOLDERS' EQUITY Common stock -- par value $1.00; shares authorized 50,000,000; shares issued and outstanding 14,623,696 (2005) and 14,628,511 (2004) 14,624 14,629 Additional paid in capital 21,019 21,522 Retained earnings 172,369 156,315 Accumulated other comprehensive income 78 2,617 ----------- ----------- Total stockholders' equity 208,090 195,083 ----------- ----------- Total liabilities and stockholders' equity $ 2,383,360 $ 2,309,343 =========== =========== See Notes to Consolidated Financial Statements. 1 Sandy Spring Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME Three Months Ended Nine Months Ended September 30, September 30, ----------------------------- -------------------------- (In thousands, except per share data) 2005 2004 2005 2004 - ------------------------------------------------------------------------------------------------------------------------ Interest Income: Interest and fees on loans and leases $24,423 $18,142 $67,875 $51,337 Interest on loans held for sale 422 172 812 522 Interest on deposits with banks 32 3 58 8 Interest and dividends on securities: Taxable 2,925 5,472 9,210 17,537 Exempt from federal income taxes 3,275 3,678 10,284 10,780 Interest on federal funds sold 314 133 571 280 ------- ------- ------- ------- TOTAL INTEREST INCOME 31,391 27,600 88,810 80,464 Interest Expense: Interest on deposits 5,700 3,412 14,743 9,136 Interest on short-term borrowings 2,413 4,717 6,530 12,167 Interest on long-term borrowings 752 1,193 2,284 4,575 ------- ------- ------- ------- TOTAL INTEREST EXPENSE 8,865 9,322 23,557 25,878 ------- ------- ------- ------- NET INTEREST INCOME 22,526 18,278 65,253 54,586 Provision for loan and lease losses 600 0 1,600 0 ------- ------- ------- ------- NET INTEREST INCOME AFTER PROVISION 21,926 18,278 63,653 54,586 FOR LOAN AND LEASE LOSSES Noninterest Income: Securities gains 1,761 138 2,601 475 Service charges on deposit accounts 2,050 1,886 5,705 5,635 Gains on sales of mortgage loans 1,205 714 2,825 2,511 Fees on sales of investment products 473 475 1,558 1,770 Trust department income 1,116 813 2,932 2,551 Insurance agency commissions 1,114 944 4,149 3,095 Income from bank owned life insurance 570 556 1,684 1,688 Visa check fees 556 498 1,597 1,419 Other income 1,267 1,429 3,954 4,178 ------- ------- ------- ------- TOTAL NONINTEREST INCOME 10,112 7,453 27,005 23,322 Noninterest Expenses: Salaries and employee benefits 11,373 10,295 34,116 30,402 Occupancy expense of premises 2,099 1,861 5,987 5,304 Equipment expenses 1,415 1,380 4,031 3,894 Marketing 253 385 947 1,380 Outside data services 718 697 2,159 2,184 Amortization of intangible assets 501 486 1,502 1,459 Other expenses 2,385 2,779 7,592 8,074 ------- ------- ------- ------- TOTAL NONINTEREST EXPENSES 18,744 17,883 56,334 52,697 ------- ------- ------- ------- Income Before Income Taxes 13,294 7,848 34,324 25,211 Income Tax Expense 3,827 1,431 9,204 5,100 ------- ------- ------- ------- NET INCOME $ 9,467 $ 6,417 $25,120 $20,111 ======= ======= ======= ======= Basic Net Income Per Share $0.65 $0.44 $1.72 $1.39 Diluted Net Income Per Share 0.64 0.44 1.70 1.37 Dividends Declared Per Share 0.21 0.20 0.62 0.58 See Notes to Consolidated Financial Statements. 2 Sandy Spring Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) Nine Months Ended September 30, ----------------------------------- 2005 2004 - -------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 25,120 $ 20,111 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,025 5,609 Provision for loan and lease losses 1,600 0 Deferred Income Taxes (benefits) (1,402) (555) Origination of loans held for sale (251,021) (211,426) Proceeds from sales of loans held for sale 244,231 217,297 Gains on sales of loans held for sale (2,825) (2,511) Gains on sales of premises and equipment (21) 0 Securities gains (2,601) (475) Net (increase) decrease in accrued interest receivable (11) 612 Net (increase) decrease in other assets 2,693 3,224 Net increase in accrued expenses and other liabilities 6,486 546 Other - net 803 1,177 --------- --------- Net cash provided by operating activities 28,077 33,609 Cash flows from investing activities: Net (increase) decrease in interest-bearing deposits with banks (192) 212 Purchases of investments held-to-maturity 0 (25,035) Proceeds from sales of other equity securities 1,845 1,259 Purchases of investments available-for-sale (82,245) (397,218) Proceeds from sales of investments available-for-sale 85,491 217,988 Proceeds from the sales of other real estate owned 108 153 Proceeds from maturities, calls and principal payments of investments held-to-maturity 3,627 40,977 Proceeds from maturities, calls and principal payments of investments available-for-sale 70,887 214,639 Net increase in loans and leases (133,683) (212,055) Expenditures for premises and equipment (7,010) (6,861) --------- --------- Net cash provided by (used in) investing activities (61,172) (165,941) Cash flows from financing activities: Net increase in deposits 72,387 147,812 Net increase (decrease) in short-term borrowings 7,138 (20,157) Proceeds from long-term borrowings 0 35,000 Retirement of long-term borrowings (25,000) 0 Common stock purchased and retired (1,437) (1,448) Proceeds from issuance of common stock 929 948 Dividends paid (9,066) (8,414) --------- --------- Net cash provided by financing activities 44,951 153,741 --------- --------- Net increase in cash and cash equivalents 11,856 21,409 Cash and cash equivalents at beginning of period 49,195 49,067 --------- --------- Cash and cash equivalents at end of period $ 61,051 $ 70,476 ========= ========= Supplemental Disclosures: Interest payments $ 23,434 $ 25,543 Income tax payments 9,185 4,303 Noncash Investing Activities: Transfers from loans to other real estate owned 73 0 Reclassification of borrowings from long-term to short-term 40,362 35,462 See Notes to Consolidated Financial Statements. 3 Sandy Spring Bancorp, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Accum- ulated Other Compre- Total Additional hensive Stock- (Dollars in thousands, except per share Common Paid-in Retained Income holders' data) Stock Capital Earnings (loss) Equity - -------------------------------------------------------------------------------------------------------------------------------- Balances at January 1, 2005 $14,629 $21,522 $156,315 $2,617 $195,083 Comprehensive income: Net income 25,120 25,120 Other comprehensive loss, net of tax effects and reclassification adjustment (2,539) (2,539) ----------- Total comprehensive income 22,581 Cash dividends - $0.62 per share (9,066) (9,066) Common stock issued pursuant to: Director stock purchase plan- 1,693 shares 2 54 56 Stock option plan - 23,486 shares 23 437 460 Employee stock purchase plan - 15,507 shares 16 397 413 Stock repurchases - 45,500 shares (46) (1,391) (1,437) ----------- ------------ ------------ ------------ ----------- Balances at September 30, 2005 $14,624 $21,019 $172,369 $78 $208,090 =========== ============ ============ ============ =========== Balances at January 1, 2004 $14,496 $18,970 $153,280 $6,703 $193,449 Comprehensive income: Net income 20,111 20,111 Other comprehensive loss, net of tax effects and reclassification adjustment (2,909) (2,909) ----------- Total comprehensive income 17,202 Cash dividends - $0.58 per share (8,414) (8,414) Common stock issued pursuant to: Director stock purchase plan- 1,120 shares 1 39 40 Stock option plan - 28,266 shares 28 458 486 Employee stock purchase plan - 14,417 shares 14 408 422 Stock repurchases - 46,312 shares (46) (1,402) (1,448) ----------- ------------ ------------ ------------ ----------- Balances at September 30, 2004 $14,493 $18,473 $164,977 $3,794 $201,737 =========== ============ ============ ============ =========== See Notes to Consolidated Financial Statements. 4 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 2004 Annual Report to Shareholders. There have been no significant changes to the Company's Accounting Policies as disclosed in the 2004 Annual Report. The results shown in this interim report are not necessarily indicative of results to be expected for the full year 2005. The accounting and reporting policies of Sandy Spring Bancorp (the "Company") and its wholly-owned subsidiary, Sandy Spring Bank (the "Bank"), together with its subsidiaries, Sandy Spring Insurance Corporation and The Equipment Leasing Company, conform to accounting principles generally accepted in the United States of America and to general practices within the financial services 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). Note 1 - New Accounting Pronouncements On September 30, 2004, the FASB issued FASB Staff Position ("FSP") Emerging Issues Task Force ("EITF") Issue No. 03-1-1 delaying the effective date of paragraphs 10-18 of EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," which provides guidance for determining the meaning of "other-than-temporarily impaired" and its application to certain debt and equity securities within the scope of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. The delay of the effective date of EITF 03-1 will be superceded concurrent with the final issuance of proposed FSP Issue 03-1-a. Proposed FSP Issue 03-1-a is intended to provide implementation guidance with respect to all securities analyzed for impairment under paragraphs 10-18 of EITF 03-1. In June 2005, the FASB decided to not provide additional guidance on the meaning of other-than-temporary impairment. The FASB will issue proposed FSP Issue 03-1-a as final. The final FSP, to be retitled FSP FAS 115-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" will replace the guidance set forth in paragraphs 10-18 of EITF 03-1 with references to existing guidance. FSP FAS 115-1 is expected to be issued in the fourth quarter of 2005. Management continues to closely monitor and evaluate how the provisions of EITF 03-1 and proposed FSP FAS 115-1 will affect the Company. Based on management's current evaluations, they do not anticipate that any material financial statement impact will result from the new accounting pronouncements. In December 2004, the FASB published FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("FAS 123 (R)" or the "Statement"). FAS 123 (R) requires that compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123 (R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. In April 2005, the Securities and Exchange Commission adopted a new rule amending Regulation S-X that delays the effective date of FAS 123 (R) to fiscal years beginning after June 15, 2005. The impact of this Statement on the Company in 2006 and beyond will depend upon various factors, among them being the Company's future compensation strategy. The pro forma compensation costs presented (in note 2 below) and in prior filings for the Company have been calculated using a binomial option pricing model and may not be indicative of amounts that should be expected in future periods. No decisions have been made as to whether the Company will apply the modified prospective or retrospective method of application. 5 In May 2005, the FASB published FASB Statement No. 154, "Accounting Changes and Error Corrections" ("FAS 154" or the "Statement"). FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The Statement also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed by this Statement. FAS 154 is effective for accounting changes and corrections of errors made in 2006. Management does not expect the adoption of this Statement to have a material impact on the Company's consolidated financial statements. Note 2 - Stock Option Plan At September 30, 2005, the Company had options outstanding under two stock-based employee compensation plans, the 1992 stock option plan and the 1999 stock option plan (both expired but having outstanding options that may still be exercised). 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) 2005 2004 2005 2004 ------------------------------------------------------------------------------------------------------------------------- Net income, as reported $ 9,467 $ 6,417 $ 25,120 $ 20,111 Less pro forma stock-based employee compensation expense determined under fair value based method, net of related tax effects (304) (310) (849) (930) ----------------------------------------------------------------------- Pro forma net income $ 9,163 $ 6,107 $ 24,271 $ 19,181 ======================================================================= Net income per share: Basic - as reported $ 0.65 $ 0.44 $ 1.72 $ 1.39 Basic - pro forma $ 0.63 $ 0.42 $ 1.66 $ 1.32 Diluted - as reported $ 0.64 $ 0.44 $ 1.70 $ 1.37 Diluted - pro forma $ 0.62 $ 0.42 $ 1.65 $ 1.30 The Company has established the Sandy Spring Bancorp 2005 Omnibus Stock Plan (the "2005 Stock Plan") which was approved by shareholders at its 2005 annual meeting on April 20, 2005 and became effective on July 19, 2005. This plan replaces the 1999 Stock Option Plan and authorizes awards for up to 1,800,000 shares of Company stock over its ten-year term. No awards have yet been granted under the 2005 Stock Plan. The 2005 Stock Plan is administered by a committee (the "Committee") of at least three members of the Board of Directors who are independent directors. The Committee may grant options that qualify as incentive stock options under the Internal Revenue Code, other stock options, stock appreciation rights, and restricted stock to directors and key employees designated by the Committee. Note 3 - Per Share Data The calculations of net income per common share for the three month 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 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 Nine Months Ended Per share data) September 30, September 30, - ------------------------------------------------------------------------------------------------------------------------------ 2005 2004 2005 2004 ---- ---- ---- ---- Basic: Net income available to common stockholders $9,467 $6,417 $25,120 $20,111 Average common shares outstanding 14,620 14,499 14,626 14,506 Basic net income per share $0.65 $0.44 $1.72 $1.39 ============================ ============================= Diluted: Net income available to common stockholders $9,467 $6,417 $25,120 $20,111 Average common shares outstanding 14,620 14,499 14,626 14,506 Stock option adjustment 115 175 113 199 ---------------------------- ----------------------------- Average common shares outstanding-diluted 14,735 14,674 14,739 14,705 Diluted net income per share $0.64 $0.44 $1.70 $1.37 ============================ ============================= 6 Options for 364,335 shares and 187,907 shares of common stock were not included in computing diluted net income per share for the three months and nine months ended September 30, 2005 and 2004 respectively, because their effects are antidilutive. 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 2005 contribution will be approximately $2.0 million which will maintain the pension plan's fully funded status. Net periodic benefit cost for the three and nine month periods ended September 30 includes the following components: Three months Ended Nine months Ended - ------------------------------------------------------------------------------------------------------------------- September 30, September 30, (In thousands) 2005 2004 2005 2004 - ------------------------------------------------------------------------------------------------------------------- Service cost for benefits earned $ 406 $ 395 $ 1,217 $ 1,184 Interest cost on projected benefit obligation 273 232 819 697 Expected return on plan assets (288) (259) (862) (778) Amortization of prior service cost (15) (16) (47) (47) Recognized net actuarial loss 83 82 251 246 ------- ------- ------- ------- Net periodic benefit cost $ 459 $ 434 $ 1,378 $ 1,302 ======= ======= ======= ======= 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 $1.8 million and $594,000 for the nine month period ended September 30, 2005 and 2004, respectively and $467,000 and $201,000 for the three month period ended September 30, 2005 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 related to the performance based compensation benefit of $1.9 million and $14,000 for the nine months ended September 30, 2005 and 2004, respectively and $461,000 and $0 for the three months ended September 30, 2005 and 2004, respectively. 7 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 $420,000 and $233,000 for the nine months ended September 30, 2005 and 2004, respectively and $143,000 and $118,000 for the three months ended September 30, 2005 and 2004, respectively. The Company has an Executive Health Insurance Plan that provides for payment of defined medical and dental insurance costs 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 $128,000 and $193,000 for the nine months ended September 30, 2005 and 2004, respectively and $0 and $64,000 for the three months ended September 30, 2005 and 2004, respectively. Note 5 - Unrealized Losses on Investments Shown below is information that summarizes the gross unrealized losses and fair value for the Company's available-for-sale and held-to-maturity investment portfolios. Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position at September 30, 2005 and 2004 are as follows: Continuous unrealized losses (In thousands) existing for: ----------------------------------- Available for sale as of September 30, Less than 12 More than 12 Total Unrealized 2005 Fair Value months months Losses ------------------ ---------------- ------------------- ---------------- U.S. Agency $209,765 $ 953 $ 1,351 $ 2,304 U.S. Treasury Notes 595 5 0 5 Mortgage-backed 364 2 4 6 -------- -------- -------- -------- $210,724 $ 960 $ 1,355 $ 2,315 ======== ======== ======== ======== Continuous unrealized losses (In thousands) existing for: ----------------------------------- Available for sale as of September 30, Less than 12 More than 12 Total Unrealized 2004 Fair Value months months Losses ------------------ ---------------- ------------------- ---------------- U.S. Agency $281,877 $ 1,441 $ 475 $ 1,916 State and municipal 10,020 57 56 113 Mortgage-backed 9,172 89 3 92 Corporate Bonds 1,262 3 0 3 -------- -------- -------- -------- $302,331 $ 1,590 $ 534 $ 2,124 ======== ======== ======== ======== Approximately 100% and 99% of the bonds carried in the available-for-sale investment portfolio experiencing continuous losses as of September 30, 2005 and 2004 respectively are rated AAA. The securities representing the unrealized losses in the available-for-sale portfolio as of September 30, 2005 and 2004 all have modest duration risk (1.41 years in 2005 and 2.76 years in 2004), low credit risk, and minimal loss (approximately 1% in 2005 and 2004) when compared to book value. The unrealized losses that exist are the result of market changes in interest rates since the original purchase. These factors coupled with the fact that the Company has both the intent and ability to hold these investments for a period of time sufficient to allow for any anticipated recovery in fair value substantiates that the unrealized losses in the available-for-sale portfolio are temporary. 8 Gross unrealized losses and fair value by length of time that the individual held-to-maturity securities have been in a continuous unrealized loss position a September 30, 2005 and 2004 are as follows: Continuous unrealized losses (In thousands) existing for: ----------------------------------- Held to Maturity as of September 30, Less than 12 More than 12 Total Unrealized 2005 Fair Value months months Losses ------------------ ---------------- ------------------- ---------------- U.S. Agency $34,021 $ 375 $ 0 $ 375 State and municipal 16,376 17 121 138 ------- ------- ------- ------- $50,397 $ 392 $ 121 $ 513 ======= ======= ======= ======= Continuous unrealized losses (In thousands) existing for: ----------------------------------- Held to Maturity as of September 30, Less than 12 More than 12 Total Unrealized 2004 Fair Value months months Losses ------------------ ---------------- ------------------- ---------------- U.S. Agency $21,320 $ 19 $ 0 $ 19 State and municipal 59,353 298 580 878 ------- ------- ------- ------- $80,673 $ 317 $ 580 $ 897 ======= ======= ======= ======= Approximately 97% and 87% of the bonds carried in the held-to-maturity investment portfolio experiencing continuous unrealized losses as of September 30, 2005 and 2004, respectively, are rated AAA and 3% and 13% as of September 30, 2005 and 2004, respectively, are rated Aa1. The securities representing the unrealized losses in the held-to-maturity portfolio all have modest duration risk (3.98 years in 2005 and 3.39 years in 2004), low credit risk, and minimal losses (approximately 1% in 2005 and 2004) when compared to book value. The unrealized losses that exist are the result of market changes in interest rates since the original purchase. These factors coupled with the Company's intent and ability to hold these investments for a period of time sufficient to allow for any anticipated recovery in fair value substantiates that the unrealized losses in the held-to-maturity portfolio are temporary. Note 6 - Segment Reporting The Company operates in three operating segments--Community Banking, Insurance, and Leasing. Only Community Banking presently meets the threshold for reportable segment reporting; however, the Company is disclosing separate information for all three operating segments. Each of the operating segments is a strategic business unit that offers different products and services. The Insurance and Leasing segments are businesses that were acquired in separate transactions where management at the time of acquisition was retained. The accounting policies of the segments are the same as those described in Note 1 to the consolidated financial statements. However, the segment data reflect intersegment transactions and balances. The Community Banking segment is conducted through Sandy Spring Bank and involves delivering a broad range of financial products and services, including various loan and deposit products to both individuals and businesses. Parent company income is included in the Community Banking segment, as the majority of parent company activities are related to this segment. Major revenue sources include net interest income, gains on sales of mortgage loans, trust income, fees on sales of investment products and service charges on deposit accounts. Expenses include personnel, occupancy, marketing, equipment and other expenses. Included in Community Banking expenses are noncash charges associated with amortization of intangibles related to acquired entities totaling $446,000 for both of the quarters ended September 30, 2005 and 2004. For the first nine months ended September 30, 2005 and 2004, such amortization totaled $1.3 million in both periods. The Insurance segment is conducted through Sandy Spring Insurance Corporation, a subsidiary of the Bank, and offers annuities as an alternative to traditional deposit accounts. Sandy Spring Insurance Corporation operates the Chesapeake Insurance Group, a general insurance agency located in Annapolis, Maryland, and Wolfe and Reichelt Insurance Agency, located in Burtonsville, Maryland. Major sources of revenue are insurance commissions from commercial lines and personal lines. Expenses include personnel and support charges. The Leasing segment is conducted through The Equipment Leasing Company, a subsidiary of the Bank that provides leases for such items as computers, telecommunications systems and equipment, medical equipment and point-of-sale systems for retail businesses. Equipment leasing is conducted through vendors located primarily in states along the east coast from New Jersey to Florida and in Illinois. The typical lease is a "small ticket" by industry standards, averaging less than $30,000, with individual leases generally not exceeding $250,000. Major revenue sources include interest income. Expenses include personnel and support charges. 9 Information about operating segments and reconciliation of such information to the consolidated financial statements follows: (In thousands) Community Inter-Segment Banking Insurance Leasing Elimination Total - -------------------------------------------------------------------------------------------------------------------------- Quarter ended September 30, 2005 Interest income $ 31,062 $ 12 $ 472 $ (155) $ 31,391 Interest expense 8,877 0 143 (155) 8,865 Provision for loan and lease losses 600 0 0 0 600 Noninterest income 8,819 1,220 233 (160) 10,112 Noninterest expenses 17,503 1,151 250 (160) 18,744 ---------- ---------- ---------- ---------- ---------- Income (loss) before income taxes 12,901 81 312 0 13,294 Income tax expense 3,671 32 124 0 3,827 ---------- ---------- ---------- ---------- ---------- Net income (loss) $ 9,230 $ 49 $ 188 $ 0 $ 9,467 ========== ========== ========== ========== ========== Assets $2,382,801 $ 9,669 $ 25,051 $ (34,161) $2,383,360 Quarter ended September 30, 2004 Interest income $ 27,331 $ 3 $ 386 (120) $ 27,600 Interest expense 9,326 0 116 (120) 9,322 Provision for loan and lease losses 0 0 0 0 0 Noninterest income 6,183 1,116 253 (99) 7,453 Noninterest expense 16,855 890 237 (99) 17,883 ---------- ---------- ---------- ---------- ---------- Income before income taxes 7,333 229 286 0 7,848 Income tax expense 1,201 90 140 0 1,431 ---------- ---------- ---------- ---------- ---------- Net income $ 6,132 $ 139 $ 146 $ 0 $ 6,417 ========== ========== ========== ========== ========== Assets $2,505,728 $ 7,868 $ 19,074 $ (26,368) $2,506,302 10 (In thousands) Community Inter-Segment Banking Insurance Leasing Elimination Total - -------------------------------------------------------------------------------------------------------------------------- Year to Date September 30, 2005 Interest income $ 87,844 $ 25 $ 1,324 $ (383) $ 88,810 Interest expense 23,582 0 358 (383) 23,557 Provision for loan and lease losses 1,600 0 0 0 1,600 Noninterest income 22,152 4,564 817 (528) 27,005 Noninterest expenses 52,793 3,405 664 (528) 56,334 ---------- ---------- ---------- ---------- ---------- Income (loss) before income taxes 32,021 1,184 1,119 0 34,324 Income tax expense 8,292 469 443 0 9,204 ---------- ---------- ---------- ---------- ---------- Net income (loss) $ 23,729 $ 715 $ 676 $ 0 $ 25,120 ========== ========== ========== ========== ========== Assets $2,382,801 $ 9,669 $ 25,051 $ (34,161) $2,383,360 Year to Date September 30, 2004 Interest income $ 79,611 $ 6 $ 1,223 (376) $ 80,464 Interest expense 25,885 0 369 (376) 25,878 Provision for loan and lease losses 0 0 0 0 0 Noninterest income 19,183 3,709 775 (345) 23,322 Noninterest expense 49,710 2,673 659 (345) 52,697 ---------- ---------- ---------- ---------- ---------- Income before income taxes 23,199 1,042 970 0 25,211 Income tax expense 4,276 413 411 0 5,100 ---------- ---------- ---------- ---------- ---------- Net income $ 18,923 $ 629 $ 559 $ 0 $ 20,111 ========== ========== ========== ========== ========== Assets $2,505,728 $ 7,868 $ 19,074 $ (26,368) $2,506,302 Note 7 - Subsequent Events On October 3, 2005 the Company completed its acquisition of West Financial Services, Inc. (WFS) located in McLean, Virginia. WFS is an asset management and financial planning company with over $550 million in assets under management. Under the terms of the acquisition agreement, the shareholders of WFS received a combination of stock and cash totaling approximately $5.9 million. Additional payments may be made in 2006, 2007 and 2008, contingent on the financial results attained by WFS over the above periods. The acquisition is being accounted for using purchase accounting, which requires the Company to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining purchase price being recorded as an intangible asset and/or goodwill. Any subsequent contingent payments described above will be recorded as goodwill. The Company expects to record certain intangible assets and goodwill as a result of the acquisition accounting. The Company is in the process of completing its fair value analysis and will determine the allocation of the purchase price to the fair value of net assets acquired and goodwill during the fourth quarter of 2005. 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 the Management's Discussion and Analysis of Financial Condition and Results of Operations and other portions of this Form 10-Q 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 of 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-one community offices in Anne Arundel, Carroll, Frederick, Howard, Montgomery, and Prince George's Counties in Maryland, together with an insurance subsidiary, an equipment leasing company and, effective October 3, 2005, an investment advisory company in McLean, Virginia. The Company offers a broad range of financial services to consumers and businesses in this market area. Through September 30, 2005, 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%. 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. 11 CRITICAL ACCOUNTING POLICIES The Company's financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") 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 loan and lease 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 is 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. Table 1 - GAAP based and traditional efficiency ratios Three Months Ended Nine Months Ended - ------------------------------------------------------------------------------------------------------------------------------- September 30, September 30, - ------------------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) 2005 2004 2005 2004 - ------------------------------------------------------------------------------------------------------------------------------- Noninterest expenses-GAAP based $18,744 $17,883 $56,334 $52,697 Net interest income plus noninterest income- GAAP based 32,638 25,731 92,258 77,908 Efficiency ratio-GAAP based 57.43% 69.50% 61.06% 67.64% ======= ======= ======= ======= Noninterest expenses-GAAP based $18,744 $17,883 $56,334 $52,697 Less non-GAAP adjustment: Amortization of intangible assets 501 486 1,502 1,459 ------- ------- ------- ------- Noninterest expenses-traditional ratio 18,243 17,397 54,832 51,238 Net interest income plus noninterest income- GAAP based 32,638 25,731 92,258 77,908 Plus non-GAAP adjustment: Tax-equivalency 1,853 2,175 5,328 6,059 Less non-GAAP adjustments: Securities gains (losses) 1,761 138 2,601 475 ------- ------- ------- ------- Net interest income plus noninterest Income - traditional ratio 32,730 27,768 94,985 83,492 Efficiency ratio - traditional 55.74% 62.65% 57.73% 61.37% ======= ======= ======= ======= 12 A. FINANCIAL CONDITION The Company's total assets were $2,383,360,000 at September 30, 2005, compared to $2,309,343,000 at December 31, 2004, increasing $74,017,000 or 3% during the first nine months of 2005. Earning assets increased by 3%, to $2,202,718,000 at September 30, 2005, from $2,133,921,000 at December 31, 2004. Total loans and leases, excluding loans held for sale, increased 9% or $133,610,000 during the first nine months of 2005, to $1,579,135,000. During this period, all three major loan categories showed increases. These increases occurred in residential real estate loans, which increased by $34,544,000 or 7%, attributable in large part to residential mortgage loan growth; in consumer loans which increased by $18,291,000 or 6%, primarily reflecting higher home equity lines; and in commercial loans and leases, which increased by $80,775,000 or 13%, due predominantly to growth in commercial loans secured by real estate. Residential mortgage loans held for sale increased by $9,615,000 from December 31, 2004, to $25,826,000 at September 30, 2005. 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) September 30, 2005 % December 31, 2004 % - ---------------------------------------------------------------------------------------------------------------------------------- Residential real estate $ 544,348 34% $ 509,804 35% Commercial loans and leases 707,394 45 626,619 43 Consumer 327,393 21 309,102 22 ----------- --------- ----------- ---------- Total Loans and Leases 1,579,135 100% 1,445,525 100% ========= ========== Less: Allowance for credit losses (16,268) (14,654) ----------- ----------- Net loans and leases $ 1,562,867 $ 1,430,871 =========== =========== The total investment portfolio decreased by 12% or $81,792,000 from December 31, 2004, to $584,316,000 at September 30, 2005, primarily to support loan growth. The decrease was driven primarily by a decline of $75,881,000 or 22% of available-for-sale securities. The aggregate of federal funds sold and interest-bearing deposits with banks increased by $7,364,000 during the first nine months of 2005, reaching $13,441,000 at September 30, 2005. Table 3 - Analysis of Deposits The following table presents the trends in the composition of deposits at the dates indicated: (In thousands) September 30, 2005 % December 31, 2004 % - ---------------------------------------------------------------------------------------------------------------------------------- Noninterest-bearing deposits $ 467,957 26% $ 423,868 25% Interest-bearing deposits: Demand 227,960 13 241,378 14 Money market savings 374,309 21 371,517 21 Regular savings 207,646 11 228,301 13 Time deposits less than $100,000 291,010 16 275,671 16 Time deposits $100,000 or more 236,006 13 191,766 11 ---------- --- ---------- --- Total interest-bearing 1,336,931 74 1,308,633 75 ---------- --- ---------- --- Total deposits $1,804,888 100% $1,732,501 100% ========== === ========== === Total deposits were $1,804,888,000 at September 30, 2005, increasing $72,387,000 or 4% from $1,732,501,000 at December 31, 2004. During the first nine months of 2005, growth rates of 10% were achieved for noninterest-bearing demand deposits (up $44,089,000), 1% for money market savings (up $2,792,000), 6% for time deposits of less than $100,000 (up $15,339,000) and 23% for time deposits of $100,000 or more (up $44,240,000). Over the same period, decreases of 9% were recorded for interest-bearing regular savings (down $20,655,000), and 6% for interest bearing demand deposits (down $13,418,000). 13 Total borrowings were $343,673,000 at September 30, 2005, which represented a decrease of $17,862,000 or 5% from December 31, 2004, primarily reflecting management's efforts to reduce the overall cost of funds. 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 equity 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. 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 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 ramps and non-parallel yield curve twists. ANALYSIS 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. 14 ESTIMATED CHANGES IN NET INTEREST INCOME -------------------------------------------------------------------------------------------------------------------------- CHANGE IN NET INTEREST INCOME: + 400 BP + 300 BP + 200 BP + 100 BP - 100 BP - 200 BP -------------------------------------------------------------------------------------------------------------------------- POLICY LIMIT 30% 25% 20% 15% 15% 20% September 2005 +2.63 +0.78 -0.58 +0.27 -0.12 -6.53 December 2004 +0.97 -0.06 -0.48 +0.62 -2.45 All of the above measures of net interest income at risk remained well within prescribed policy limits. Although assumed to be unlikely, our largest exposure is at the -200bp level, with a measure of -6.53%. This is also well within our prescribed policy limit of 20%. The -200bp shock level was not measured at December 31, 2004, because it was determined to be impractical due to the rate environment at that time. The maintenance of the net interest income sensitivity is consistent with management's decision to reduce the size and duration of the investment portfolio in the third quarter of 2005 in anticipation of rising interest rates in the future and to support the funding of loan growth. 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 -200 BP ---------------------------------------------------------------------------------------------------------------------------- POLICY LIMIT 60% 40% 22.5% 10.0% 12.5% 22.5% September 2005 -8.47 -5.57 -3.06 -0.70 -1.69 -7.88 December 2004 -22.44 -17.07 -9.98 -2.12 -1.04 Measures of the economic value of equity (EVE) at risk improved over year-end 2004 in all but the -100bp interest rate shock level. A reduction in the size of the investment portfolio, as well as core deposit balance growth and an increase in core deposit estimated lives were key contributors to the improved risk position. The -200bp shock level was not measured at December 31, 2004, because it was determined to be impractical due to the rate environment at that time. The economic value of equity exposure at +200bp is now -3.06% compared to -9.98% at year-end 2004, and is well within the policy limit of 22.5%, as are measures at all other shock levels. 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, investment portfolio liquidity, and other factors. Through this approach, implemented by the funds management subcommittee of ALCO under formal policy guidelines, the Company's liquidity position is measured weekly, looking forward at thirty-day intervals out to 180 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 and core growth. Resulting projections as of September 30, 2005 showed short-term investments exceeding short-term borrowings over the subsequent 90 days by $57,946,000, which increased from a shortfall of $34,799,000 at December 31, 2004. 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 $703,031,000 from the Federal Home Loan Bank of Atlanta, of which $124,696,000 was outstanding at September 30, 2005. 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 $269,614,000 at September 30, 2005, against which there were outstandings of $25,000,000. Based upon its liquidity analysis, including external sources of liquidity available, management believes the liquidity position is appropriate at September 30, 2005. The following is a schedule of significant commitments at September 30, 2005: (In thousands) Commitments to extend credit: Unused lines of credit (home equity and business) $370,090 Other commitments to extend credit 164,824 Standby letters of credit 37,006 -------- $571,920 15 CAPITAL MANAGEMENT The Company recorded a total risk-based capital ratio of 13.90% at September 30, 2005, compared to 13.82% at December 31, 2004; a tier 1 risk-based capital ratio of 12.97%, compared to 12.92%; and a capital leverage ratio of 9.55%, compared to 8.67%. Capital adequacy, as measured by these ratios, was well above regulatory requirements. Management believes the level of capital at September 30, 2005, is appropriate. Stockholders' equity for September 30, 2005, totaled $208,090,000, representing an increase of $13,007,000 or 7% from $195,083,000 at December 31, 2004. 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 97% or $2,539,000 from December 31, 2004 to $78,000 at September 30, 2005. Internal capital generation (net income less dividends) added $16,054,000 to total stockholders' equity during the first nine months of 2005. When internally formed capital is annualized and expressed as a percentage of average total stockholders' equity, the resulting rate was 11% compared to 2% reported for the full-year 2004. 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 $929,000 during the nine month period ended September 30, 2005. However, share repurchases amounted to $1,437,000 from December 31, 2004 through September 30, 2005, for a net decrease in stockholders' equity from these sources of $508,000. Dividends for the first nine months of the year were $0.62 per share in 2005, compared to $0.58 per share in 2004, for respective dividend payout ratios (dividends declared per share to diluted net income per share) of 36% versus 42%. B. RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2005 AND SEPTEMBER 30, 2004 Net income for the first nine months of the year increased $5,009,000 or 25% to $25,120,000 in 2005 from $20,111,000 in 2004, representing annualized returns on average equity of 16.74% and 13.65%, respectively. Diluted earnings per share (EPS) for the first nine months of the year were $1.70 in 2005, compared to $1.37 in 2004. The primary factor driving the growth in net income was the increase in the net interest income that was due primarily to the balance sheet repositioning completed in the fourth quarter of 2004. The increase in noninterest income, due primarily to the increase in securities gains and insurance agency commissions, was offset by an increase in noninterest expenses, largely resulting from increased salary and employee benefits expenses. The net interest margin increased by 76 basis points to 4.39% for the nine months ended September 30, 2005, from 3.63% for the same period of 2004, as the net interest spread increased by 71 basis points. These results reflect to a large extent the balance sheet repositioning accomplished in the fourth quarter of 2004. TABLE 4 - CONSOLIDATED AVERAGE BALANCES, YIELDS AND RATES (Dollars in thousands and tax equivalent) For the nine months ended September 30, 2005 2004 ------------------------------------------------------------------------------------- Average Annualized Average Average Annualized Average Balance Interest Yield/Rate Balance Interest Yield/Rate (1) (1) ------------------------------------------------------------------------------------- Assets Total loans and leases (2) $1,514,796 $ 91,769 6.06% 1,253,243 $ 69,234 5.52% Total securities 608,712 33,162 5.45 942,167 45,656 4.85 Other earning assets 27,169 838 3.08 34,211 384 1.12 ---------- ---------- ---------- ----------- TOTAL EARNING ASSETS 2,150,677 125,769 5.85% 2,229,621 115,274 5.17% Nonearning assets 177,908 165,415 ---------- ---------- Total assets $2,328,585 $2,395,036 ========== ========== Liabilities and Stockholders' Equity Interest-bearing demand deposits $ 238,118 $ 630 0.26% $ 230,598 $ 671 0.29% Money market savings deposits 376,951 5,608 1.49 368,261 2,143 0.58 Regular savings deposits 220,055 765 .35 211,241 762 0.36 Time deposits 485,045 12,709 2.62 430,664 8,628 2.00 ---------- ---------- ---------- ----------- Total interest-bearing deposits 1,320,169 19,712 1.49 1,240,764 12,204 0.98 Short-term borrowings 281,771 8,654 3.07 405,277 16,013 3.95 Long-term borrowings 66,490 3,036 4.57 144,825 6,049 4.18 ---------- ---------- ---------- ----------- Total interest-bearing liabilities 1,668,430 31,402 1.88 1,790,866 34,266 1.91 ----------- ----------- Noninterest-bearing demand deposits 438,455 386,194 Other noninterest-bearing liabilities 21,044 21,125 Stockholders' equity 200,656 196,851 ---------- ----------- Total liabilities and stockholders' equity $2,328,585 $2,395,036 ========== =========== Net interest spread 3.97% 3.26% ========== ========== Net interest margin (3) 4.39% 3.63% ========== ========== Ratio of average earning assets to Average interest-bearing liabilities 128.90% 124.50% ========== ========== (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 $7,124,000 and $8,093,000 for the nine months ended September 30, 2005 and 2004, 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. 16 NET INTEREST INCOME Net interest income for the first nine months of the year was $65,253,000 in 2005, an increase of 20% from $54,586,000 in 2004, due primarily to the balance sheet repositioning completed in the fourth quarter of 2004 and a 21% increase in average loans compared to the first nine months of 2004. Non-GAAP tax-equivalent net interest income, which takes into account the benefit of tax advantaged investment securities, also increased by 16%, to $70,581,000 in 2005 from $60,645,000 in 2004. The effects of average balances, yields and rates are presented in Table 4. For the first nine months, total interest income increased by $8,346,000 or 10% in 2005, compared to 2004. On a non-GAAP tax-equivalent basis, interest income increased by 9%. Average earning assets declined by 4% versus the prior period, to $2,150,677,000 from $2,229,621,000, while the average yield earned on those assets increased by 68 basis points to 5.85%. Comparing the first nine months of 2005 versus 2004, average total loans and leases grew by 21% to $1,514,796,000 (70% of average earning assets, versus 56% a year ago), while recording a 54 basis point increase in average yield to 6.06%. Average residential real estate loans increased by 17% (reflecting increases in both mortgage and construction lending); average consumer loans increased by 18% (attributable primarily to home equity line growth); and, average commercial loans and leases grew by 26% (due to increases in all categories of commercial loans and leases). Over the same period, average total securities decreased by 35% to $608,712,000 (28% of average earning assets, versus 42% a year ago), while the average yield earned on those assets increased by 60 basis points to 5.45%. Interest expense for the first nine months of the year decreased by $2,321,000 or 9% in 2005 compared to 2004. Average total interest-bearing liabilities decreased by 7% over the prior year period, while the average rate paid on these funds also decreased, by 3 basis points to 1.88%. As shown in Table 4, interest-bearing demand deposits, regular savings deposits and short-term borrowings recorded declines in average rate. These declines were partially offset by increases in the rates paid on money market savings deposits, time deposits and long-term borrowings. Table 5 - Effect of Volume and Rate Changes on Net Interest Income 2005 vs. 2004 2004 vs. 2003 ----------------------------------------------------------------------------------------------------------------------- Increase Due to Change Increase Due to Change Or In Average:* Or In Average:* (In thousands and tax equivalent) (Decrease) Volume Rate (Decrease) Volume Rate ----------------------------------------------------------------------------------------------------------------------- Interest income from earning assets: Loans and leases $ 16,828 $ 11,534 $ 5,294 $ 2,426 $ (4,336) $ 6,762 Securities (8,823) (10,576) 1,753 (6,802) (3,733) (3,069) Other investments 341 (70) 411 15 12 3 --------------- ----------- ---------- --------- ---------- ---------- Total interest income 8,346 888 7,458 (4,361) (8,057) 3,696 Interest expense on funding of earning assets: Interest-bearing demand deposits (32) 16 (48) 142 66 76 Regular savings deposits 2 23 (21) 183 108 75 Money market savings deposits 2,590 39 2,551 (359) (166) (193) Time deposits 3,047 889 2,158 (1,719) (169) (1,550) Total borrowings (7,928) (5,434) (2,494) (1,321) (1,345) 24 -------------- ----------- ---------- --------- ---------- ---------- Total interest expense (2,321) (4,467) 2,146 (3,074) (1,506) (1,568) -------------- ----------- ---------- --------- ---------- ---------- Net interest income $ 10,667 $ 5,355 $ 5,312 $ (1,287) $ (6,551) $ 5,264 ============== =========== ========== ========= =========== =========== * Where volume and rate have a combined effect that cannot be separately identified with either, the variance is allocated to volume and rate based on the relative size of the variance that can be separately identified with each. 17 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. 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. 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. The amount of the allowance is reviewed monthly by the senior loan committee, and reviewed and approved by the Board of Directors quarterly. 18 The provision for loan and lease losses totaled $1.6 million for the first nine months of 2005 compared to none in the same period of 2004. The Company experienced net charge-offs (recoveries) during the first nine months of 2005 and 2004 of ($14,000) and $88,000, 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, 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 nine months of 2005, there were no changes in estimation methods or assumptions that affected the allowance methodology. The allowance for loan and lease losses was 1.03% of total loans and leases at September 30, 2005 and 1.01% at December 31, 2004. The allowance increased during the first nine months of 2005 by $1.6 million, from $14,654,000 at December 31, 2004, to $16,268,000 at September 30, 2005. The increase in the allowance during the first nine months of 2005 was due to the increased provision for loan and lease losses mentioned above which was due primarily to growth in the size of the loan portfolio. Nonperforming loans and leases increased by $1,532,000 from $1,789,000 at December 31, 2004 to $3,321,000 at September 30, 2005, while nonperforming assets increased by $1,514,000 for the same period to $3,321,000 at September 30, 2005. Expressed as a percentage of total assets, nonperforming assets increased to 0.14% at September 30, 2005 from 0.08% at December 31, 2004. The allowance for loan and lease losses represented 490% of nonperforming loans and leases at September 30, 2005, compared to coverage of 819% at December 31, 2004. The increase in nonperforming loans and leases was due primarily to four commercial loans totaling $1.5 million that are either pending permanent outside take-out financing or are well-secured by collateral and thus no significant losses are expected. 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 September 30, 2005 and $18,000 at December 31, 2004. The balance of impaired loans and leases was $985,000 at September 30, 2005, with specific reserves against those loans of $560,000, compared to $690,000 at December 31, 2004, with specific reserves of $251,000. Table 6 -- Analysis of Credit Risk (Dollars in thousands) Activity in the allowance for credit losses is shown below: Nine Months Ended Twelve Months Ended September 30, 2005 December 31, 2004 - --------------------------------------------------------------------------------------------------------- Balance, January 1 $ 14,654 $ 14,880 Provision for credit losses 1,600 0 Loan charge-offs: Residential real estate 0 (109) Commercial loans and leases (70) (173) Consumer (30) (214) -------- -------- Total charge-offs (100) (496) Loan recoveries: Residential real estate 49 54 Commercial loans and leases 57 169 Consumer 8 47 -------- -------- Total recoveries 114 270 -------- -------- Net recoveries (charge-offs) 14 (226) -------- -------- Balance, period end $ 16,268 $ 14,654 ======== ======== Net recoveries (charge-offs) to average loans and leases (annual basis) 0.00% (0.02)% Allowance to total loans and leases 1.03% 1.01% 19 The following table presents nonperforming assets at the dates indicated: September 30, 2005 December 31, 2005 - ---------------------------------------------------------------------------------------------------- Non-accrual loans and leases $1,032 $ 746 Loans and leases 90 days past due 2,289 1,043 ------ ------ Total nonperforming loans and leases* 3,321 1,789 Other real estate owned 0 18 ------ ------ Total nonperforming assets $3,321 $1,807 ====== ====== Nonperforming assets to total assets 0.14% 0.08% - ---------------------------------------------------------------------------------------------------- * Those performing credits considered potential problem credits (which the Company classifies as substandard), as defined and identified by management, amounted to approximately $8,092,000 at September 30, 2005, compared to $7,801,000 at December 31, 2004. 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. This could result in their reclassification as nonperforming credits in the future, but most are well collateralized and are not believed to present significant risk of loss. NONINTEREST INCOME AND EXPENSES Total noninterest income was $27,005,000 for the nine-month period ended September 30, 2005, a 16% or $3,683,000 increase from the same period of 2004. Net securities gains, which are included in noninterest income, were $2,601,000 in 2005 versus $475,000 in 2004. The increase in net securities gains was due primarily to a gain on the sale of stock in another financial institution. Excluding net securities gains, noninterest income increased 7% or $1,557,000 over the prior year period. Excluding such securities gains, the increase in noninterest income for the first nine months of 2005 was due primarily to an increase of $1,054,000 or 34% in insurance agency commissions, resulting from higher premiums from existing commercial property and casualty lines ($586,000) and the acquisition of a small insurance agency ($468,000) in December, 2004. In addition, Visa check fees increased $178,000 or 13% reflecting a growing volume of electronic checking transactions, trust department income increased $381,000 or 15%, and the gain on sale of mortgage loans increased $314,000 or 13%. These increases were somewhat offset by a decline in fees on sales of investment products of $212,000 or 12% due largely to an increased emphasis on the sale of investment products that pay annual fees as opposed to one-time up-front fees. This strategy provides a more consistent long-term source of income and is consistent with the Bank's long-term client relationship management goals. Total noninterest expenses were $56,334,000 for the nine-month period ended September 30, 2005, a 7% or $3,637,000 increase from the same period in 2004. 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 nine months of 2005 occurred in salaries and employee benefits which increased $3,714,000 or 12% as a result of higher incentive compensation costs and increased benefits expenses. Occupancy and equipment expenses increased $683,000 or 13%, as a result of the opening of the Bank's Columbia Center office facility in the second quarter of 2004 and the opening of two new branches in 2005. Average full-time equivalent employees decreased to 582 during the first nine months of 2005, from 585 during the like period in 2004, a 1% decrease. The ratio of net income per average full-time-equivalent employee after completion of the first nine months of the year was $43,000 in 2005 and $34,000 in 2004. INCOME TAXES The effective tax rate increased to 26.8% for the nine-month period ended September 30, 2005, from 20.2% for the prior year period. This increase was primarily due to a decline in the amount of state tax-advantaged investments, the growth in the loan portfolio and the increase in noninterest income which is taxed at a full statutory rate. 20 C. RESULTS OF OPERATIONS - THIRD QUARTER 2005 AND 2004 Third quarter net income of $9,467,000 ($0.64 per share-diluted) in 2005 was $3,050,000 or 48% above net income of $6,417,000 ($0.44 per share-diluted) shown for the same quarter of 2004. Annualized returns on average equity for these periods were 18.31% in 2005 versus 12.89% in 2004. Third quarter net interest income was $22,526,000 in 2005, an increase of 23% from $18,278,000 in 2004, reflecting an 85 basis point increase in net interest margin due largely to the balance sheet repositioning completed in the fourth quarter of 2004 and a 19% increase in average loans and leases. Non-GAAP tax-equivalent net interest income, which takes into account the benefit of tax advantaged investment securities, increased by 19%. The provision for loan and lease losses totaled $600,000 in the third quarter of 2005 compared to none in the third quarter of 2004. The Company experienced net charge-offs (recoveries) during the third quarter of 2005 and 2004 of $5,000 and ($48,000) respectively. Third quarter noninterest income was $10,112,000 in 2005, representing a 36% or $2,659,000 increase from the same period of 2004. Net securities gains, which are included in noninterest income, were $1,761,000 in the third quarter of 2005 versus $138,000 in the third quarter of 2004. Excluding net securities gains, noninterest income increased $1,036,000 or 14% compared with the prior year period. Compared to the third quarter of 2004, the third quarter of 2005 reflected an increase of $170,000 or 18% in insurance agency commissions due primarily to higher premiums from commercial property and casualty lines ($38,000) and the acquisition of a small insurance agency ($132,000) in December 2004. In addition, trust department income increased $303,000 or 37% and the gain on sale of mortgage loans increased $491,000 or 69% compared to the same period in 2004. Third quarter noninterest expenses increased 5% or $861,000 to $18,744,000 in 2005 from $17,883,000 in 2004. This increase was mainly the result of increases in salaries and employee benefits of $1,078,000 or 10% due primarily to higher incentive compensation costs and increased benefits expenses. This increase was partially offset by a 34% decrease in marketing costs due mainly to advertising initiatives conducted in 2004 that were not continued in 2005. Other non-interest expense also declined by 14% due largely to the amortization of debt issuance costs related to the redemption of trust-preferred securities in 2004. The third quarter effective tax rate increased to 28.8%, from the 18.2% recorded in the third quarter of 2004. This increase was primarily due to a decline in the amount of state tax advantaged investments, the growth in the loan portfolio and the increase in noninterest income which is taxed at a full statutory rate. 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, 2004. 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 September 30, 2005, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II - OTHER INFORMATION Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES The Company made no purchases of its common stock during the three months ended September 30, 2005. 21 On May 24, 2005, the Company publicly announced a stock repurchase program that permits the repurchase of up to 5%, or approximately 732,000 shares, of its outstanding common stock. The current program replaced a similar plan that expired on March 31, 2005. Repurchases under the program may be made on the open market and in privately negotiated transactions from time to time until March 31, 2007, 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. At September 30, 2005, a total of 686,634 shares remained under the plan. On October 3, 2005, the Company issued 145,534 shares to shareholders of West Financial Services, Inc. ("WFS") at a price of $34.64 in a private placement exempt from registration under Section 4 of the Securities Act of 1933. These shares were part of the consideration for the acquisition of WFS pursuant to an agreement dated July 18, 2005. Additional shares may be issued under the agreement in the future. Item 6. 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 22 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 4, 2005 By: /S/ PHILIP J. MANTUA ----------------------------------------------------- Philip J. Mantua Executive Vice President and Chief Financial Officer Date: November 4, 2005 23