-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Qp0hYUX58Qyzp28XZw1US246wlhmSdhOpCR6bWXWj3m2px78zYWx1rsIIdznXaOz K+avIgqWqDKQTHx91UgHAg== 0000950168-99-001194.txt : 19990416 0000950168-99-001194.hdr.sgml : 19990416 ACCESSION NUMBER: 0000950168-99-001194 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990108 FILED AS OF DATE: 19990415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SHORE BANCSHARES INC CENTRAL INDEX KEY: 0001035092 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 521974638 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-22345 FILM NUMBER: 99594564 BUSINESS ADDRESS: STREET 1: 109 NORTH COMMERCE ST CITY: CENTREVILLE STATE: MD ZIP: 21617-0400 BUSINESS PHONE: 4107581600 MAIL ADDRESS: STREET 1: P O BOX 400 CITY: CENTREVILLE STATE: MD ZIP: 21617-0400 EX-99 1 EXHIBIT 99 [SHORE BANCSHARES, INC. LETTERHEAD] Via Edgar - --------- Securities and Exchange Commission 450 Fifth Street, N.W. Washington, DC 20549 RE: Shore Bancshares, Inc. Form 10-K/A File Number 000-22345 Ladies and Gentlemen: On March 31, 1999, Shore Bancshares, Inc. (the "Company") filed its Annual Report on Form 10-K. Due to an error in the Edgar transmission beyond the Company's control, portions of the Company's Exhibit 13 to the Form 10-K, the 1998 Annual Report, were inadvertently deleted. Attached please find a Form 10-K/A, which is revised solely to include a complete and correct version of Exhibit 13. Please be advised that the remainder of the Form 10-K remains unchanged. If you have any questions regarding this filing, please do not hesitate to call. Very truly yours, /s/ Carol I. Brownawell Carol I. Brownawell Treasurer 10-K/A 2 SHORE BANCSHARES, INC. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A FOR ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 Commission File Number: 0-22345 Shore Bancshares, Inc. (Exact name of registrant as specified in its charter) Maryland 52-1974638 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 109 North Commerce Street Centreville, Maryland 21617 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including are code: (410) 758-1600 Securities registered under Section 12(b) of the Act: None Securities registered under Section 12(g) of the Act: Common Stock, Par Value $0.01 (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __x__ No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. _____ The aggregate market value of Shore Bancshares, Inc. voting stock held by non-affiliates as of February 22, 1999 was $60,727,755, based on the sales price as of that date. As of February 22, 1999, Shore Bancshares, Inc. had 1,913,516 shares of Common Stock $.01 Par Value outstanding. DOCUMENTS INCORPORATED BY REFERENCE Parts I, II and IV: Portions of the Annual Shareholders Report for the year ended December 31, 1998 (the "Annual Report".) Part III: Portions of the definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 20, 1999 (the "Proxy Statement".) 1 EX-13 3 EXHIBIT 13 [SHORE BANCSHARES, INC. LOGO HERE] 1998 Annual Report SELECTED FINANCIAL DATA
- ---------------------------------------------------------------------------------------------------------------------------------- For the Year 1998 1997 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income $ 7,087,069 $ 6,957,167 $ 6,265,431 $ 6,012,491 $ 6,097,626 Provision for credit losses -- -- -- -- 274,000 Net interest income after provision for credit losses 7,087,069 6,957,167 6,265,431 6,012,491 5,823,626 Non-interest income 872,645 909,049 999,423 877,386 856,585 Net income 2,218,939 2,370,198 2,307,742 2,138,500 2,030,864 - ---------------------------------------------------------------------------------------------------------------------------------- Per Share Data:* - ---------------------------------------------------------------------------------------------------------------------------------- Diluted net income $ 1.12 $ 1.18 $ 1.14 $ 1.06 $ 1.01 Cash dividends declared 0.51 0.485 0.46 0.43 0.30 Book value 11.45 11.67 10.97 10.35 9.59 Weighted average common shares 1,985,142 2,014,848 2,014,848 2,014,848 2,014,848 - ---------------------------------------------------------------------------------------------------------------------------------- At Year End - ---------------------------------------------------------------------------------------------------------------------------------- Total Assets $181,054,572 $175,115,011 $146,899,477 $138,100,669 $144,942,996 Loans, net of unearned income 111,196,511 109,167,283 88,892,757 87,049,483 79,329,222 Allowance for credit losses 1,348,805 1,403,747 1,503,268 1,478,555 1,481,501 Investment securities 47,118,489 48,742,568 43,652,747 37,131,443 53,209,881 Deposits 153,307,567 145,813,270 124,166,248 116,479,753 124,984,593 Long-term debt 5,000,000 5,000,000 -- -- - Stockholders' equity 21,904,235 23,514,810 22,095,951 20,849,348 19,332,344 Allowance for credit losses to non-performing loans 164.59% 311.94% 102.82% 83.72% 77.44% - ---------------------------------------------------------------------------------------------------------------------------------- Average Balances - ---------------------------------------------------------------------------------------------------------------------------------- Total assets $176,964,561 $165,695,678 $141,410,379 $139,313,160 $143,919,722 Total deposits and borrowings 152,715,842 141,504,846 118,945,631 118,224,470 124,027,077 Stockholders' equity 23,314,674 22,789,823 21,626,308 20,318,612 19,027,257 Return on average total assets 1.25% 1.43% 1.63% 1.54% 1.41% Return on average stockholders' equity 9.52% 10.40% 10.67% 10.52% 10.67% - ----------------------------------------------------------------------------------------------------------------------------------
* Per share data is restated to reflect the 2 for 1 stock split effected in the form of a 100% stock dividend on May 20, 1994, the July 1, 1996 2 for 1 stock split effected upon conversion to Shore Bancshares, Inc. and the 2 for 1 stock split effected in the form of a 100% stock dividend on March 31, 1998. The year ended December 31, 1997 reflects the merger of Kent Savings and Loan Association, Inc. on April 1, 1997 and accounted as a purchase transaction. 1 - ------------------------------------------------------------------------------- CONTENTS - ------------------------------------------------------------------------------- Letter to Stockholders 4 Management's Discussion and Analysis of Financial Condition and Results of Operations 5-15 Consolidated Financial Statements 16-37 Independent Auditors' Report 38 Market Price of and Dividends on Registrant's Common Equity and Related Stockholder Matters 39 Average Balances, Yields, and Rates 40 Rate and Volume Variance Analysis 41 Board of Directors 42 Officers 43 Employees and Offices 44 - ------------------------------------------------------------------------------- 2 BUSINESS PROFILE Shore Bancshares Inc. (the Company), a Maryland corporation, incorporated on March 15, 1996, became a registered bank holding company on July 1, 1996 under the Bank Holding Company Act of 1956, as amended. The Company engages in its business through its sole subsidiary, The Centreville National Bank of Maryland (the Bank), a national banking association. The Company's and Bank's main office is located at 109 North Commerce Street, Centreville, Queen Anne's County, Maryland. Banking business is conducted at 5 full service branch offices, all in Maryland with two located in Centreville, Queen Anne's County, a branch in Stevensville, Queen Anne's County, a Hillsboro location, serving Queen Anne's and Caroline Counties, and our most recent addition in Chestertown, Kent County. The Bank has been doing business in Centreville since 1876 and is engaged in both the commercial and consumer banking business. The Bank provides a wide range of personal banking services designed to meet the need of local consumers. The Bank engages in the financing of commerce and industry by providing credit and deposit services for small to medium sized businesses, local governments, and for the agricultural community in the Bank's market area. The Company's and the Bank's management are committed to providing personal, friendly, quality service to our customers while earning a reasonable return for our shareholders. Our commitment to the communities in which we operate and their economic vitality is a crucial element of our focus. We believe in giving back to the community we serve. We have grown and changed along with our local region. Shore Bancshares Inc. will continue to respond to the changing business environment through our investment in technology and products and services developed to meet the needs of our customers, while remaining true to our principle of excellent customer service. 3 To Our Stockholders: The Board of Directors and management of Shore Bancshares, Inc. are pleased to present the Annual Report for the year ended December 31, 1998. The year just past presented us with many challenges and opportunities. Renovations on The Centreville National Bank's Commerce Street offices are essentially complete. Interest rates declined during the year, resulting in the refinancing of many loans, calls being exercised on many investment securities, and reduced interest rate spread. This was the first full year amortizing the goodwill associated with the purchase of Kent Savings and the decision was made to close our subsidiary Eastern Shore Mortgage Corporation as a result of continuing operating losses. Our team working on the Year 2000 issue has continued to prepare our systems and procedures to minimize the impact on our ability to provide the level of service that you have come to expect. We are confident that we will be ready and that we will move smoothly from 1999 into the year 2000. As a result of the reduced interest rate spread, net income after taxes declined slightly to $2.2 million in 1998, a decrease of 6.4%. Total assets grew by $5.9 million to a new high of $181.0 million as of December 31, 1998. Your Board of Directors declared cash dividends totaling $0.51 per share, an increase of 5.1% over 1997. Our capital position continues to be strong and exceeds regulatory guidelines to be considered well capitalized. We look forward to another year of progress in 1999. Plans are underway to grow our branch network. We have made application to the Office of the Comptroller of the Currency for a new office to be located on Route 404 east of Denton, Maryland and we are actively seeking sites for other branches. In addition, we have recently entered into an agreement with PHH Mortgage Corporation, through our Independent Bankers Association membership which will enable us to continue to offer secondary mortgage market products, such as 30 year fixed rate mortgage loans, and generate fee income from their origination. We also continue to examine the list of services and products offered in our communities and to assess the need to expand our products. We recently introduced an unsecured line of credit, Direct Line, and we now offer Checking with no activity service charges for our depositors who use Direct Deposit for their payroll or other payments due to them. Our commitment to the communities we serve is our strength. The loyalty and dedication of our stockholders and customers is our gift. You have our pledge that we will never forget either. Thank you for your support. Please help us improve by offering your comments and suggestions. /s/ B. Vance Carmean, Jr. /s/ Daniel T. Cannon _________________________ ____________________ B. Vance Carmean, Jr. Daniel T. Cannon Chairman of the Board President 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is designed to provide a better understanding of the financial position of Shore Bancshares, Inc. (the Company), and should be read in conjunction with the audited Consolidated Financial Statements and Notes. Portions of this annual report contain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) with respect to the adequacy of the allowance for loan losses, interest rate risk, realization of deferred taxes, liquidity levels, and the Year 2000 issue, which, by their nature, are subject to significant uncertainties which are described in further detail in Item 1 of the Company's Form 10-K, under the heading "Risk Factors." The Company believes that the expectations reflected in such forward-looking statements are reasonable. However, because these uncertainties and the assumptions on which statements in this report are based, the actual future results may differ materially from those indicated in this report. ORGANIZATIONAL BACKGROUND On July 1, 1996, the Company commenced operations as the parent company of its sole subsidiary, The Centreville National Bank of Maryland ("the Bank"), which has conducted the business of banking since 1876. Since the Bank is the primary asset of the Company, the assets and liabilities of the Company are comprised almost entirely of the assets and liabilities of the Bank. The same is true for the income and expense of the Company. All data for periods on and after July 1, 1996 is presented in this analysis in consolidated form and is compared to like data for the Bank for prior years. RESULTS OF OPERATIONS OVERVIEW The Company reported $2.22 million in net income for 1998 or $1.12 diluted earnings per share compared to 1997 net income of $2.37 million or $1.18 diluted earnings per share and 1996 net income of $2.31 million or $1.14 per share diluted earnings. Per share items have been adjusted to reflect the 2 for 1 stock split paid in the form of a 100% stock dividend on March 31, 1998. Net income for 1998 reflects a slight decline after absorbing the added depreciation expense for the renovations at our Commerce Street office, a full year of goodwill amortization from the Kent Savings and Loan Association, F.A. (Kent Savings) purchase and the operating losses and write off of the remaining goodwill of Eastern Shore Mortgage Corporation. Declining interest rates resulted in the refinancing of many loans as well as the calls of investments securities, negatively impacting net income. The Company experienced growth in total assets of 3.39% and in total deposits of 5.14% in 1998. Return on average assets was 1.25%, 1.43%, and 1.63% in 1998, 1997, and 1996, respectively, which reflects the Company's growth in assets at a faster rate than the growth in earnings. Earnings reflect a shrinking net interest margin. The return on average stockholders' equity for 1998 was 9.52% compared to 10.40% and 10.67% in 1997 and 1996, respectively. NET INTEREST INCOME and NET INTEREST MARGIN Net interest income is the principal source of earnings for a banking company. It represents the difference between interest and fees earned on the loan and investment portfolios over the interest paid on deposits and borrowings. For the Company, the year ended December 31, 1998 was characterized by generally declining interest rates. During the prior year, 1997, rate activity reflected slightly increasing loan rates in the first quarter and declining rates in the fourth quarter. Deposit rates followed the same trends except that rate reductions began in the third quarter. Net interest income for 1996 reflects increasing loan rates and generally declining deposit rates until the second half of the year when deposit rates increased slightly. Net interest income (on a tax equivalent basis) for 1998 increased by $159 thousand or 2.2% compared to the year ended December 31, 1997, while 1997 increased by $688 thousand or 10.6% from the previous year ended December 31, 1996. During the three years ended December 31, 1998, 1997 and 1996 there have not been any material changes in the volume or quality of the Company's tax exempt securities that would have a significant effect on tax exempt interest income. The table titled "Average Balances, Yields and Rates" on page 40 sets forth the major components 5 of net interest income, on a tax equivalent basis, for 1998, 1997 and 1996. The table titled "Rate and Volume Variance Analysis" on page 41 illustrates the portion of the changes in net interest income which are attributable to changes in volume of average balances or to changes in yield on earning assets and rates paid on interest bearing liabilities. The information revealed by these tables is analyzed below. Interest rate spread is the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities (deposits and borrowings.) Interest rate spread for the years ended December 31, 1998, 1997 and 1996 was 3.65%, 3.82%, and 3.87%, respectively. Interest rate spread in 1998 decreased 17 basis points compared to the prior year as a result of the decreased yield on average interest earning assets of 12 basis points and an increase in the yield on average interest bearing liabilities of 5 basis points. The 4.3% increase in total average loans was the result of loan growth and a full year of Kent Savings assets which increased total interest income in 1998 despite a decrease in loan yields. A change in the balance sheet mix also accounted for a decrease in interest rate spread. As a result of a lower interest rate environment, the Company experienced a large number of calls of investment securities. These securities were replaced with lower yielding investments. To maintain as much of the investment yield as prudent, a portion of the called investments were replaced with municipal bonds. The average balance in municipal bonds increased $1.6 million or 18.3% providing a higher tax equivalent yield than U.S. Treasuries and Government agency bonds in the current market. Despite some loan rate increases during 1998, overall loan yield decreased 10 basis points compared to 1997. Fourth quarter loan rate decreases and more significantly, loans refinanced with the Company or other lenders are reflected in decreased loan yield. Total loans as a percentage of total interest earning assets has decreased 2.2%. However, the average balances in each loan category have increased improving interest income. The composition of deposits changed as well. Other Time and IRA deposit average balances have increased. These are more costly deposits which account for increased deposit interest expense. Despite lowering deposit rates in the first and fourth quarters of 1998, the change in deposit mix provided higher yields on deposits, on average, for 1998 compared to the prior year. The 1997 interest rate spread decreased compared to 1996 by 5 basis points. The rate spread variance reflects a decrease in yield on earning assets of 2 basis points as a result of a lower yielding loan portfolio and growth in the investment securities portfolio, a lower yielding asset when compared to loans. The yield on the loan portfolio was impacted by the introduction of the Kent Savings loans which had yields slightly less than the loans originated by the Company prior to the acquisition. The yield on Federal funds and securities portfolio actually increased over 1996 by 13 basis points and 7 basis points, respectively. Interest-bearing liabilities' yield increased 3 basis points over 1996, reflecting the higher cost of the $5 million Federal Home Loan Bank of Atlanta (FHLB) long term borrowing and IRA deposits. Other deposit accounts actually reflected a reduced yield compared to the previous year. Net interest margin is calculated as tax equivalent net interest income divided by average earning assets and represents the Company's net yield on its earning assets. The net interest margin for 1998 decreased to 4.45% from 4.64% the previous year. This change is the result of repricing as previously discussed and is illustrated in the table titled "Rate/Volume Variance Analysis" on page 41. When comparing 1998 verses 1997, repricing reduced the net interest income $104 thousand and volume changes provided $263 thousand for a net increase of $159 thousand. Average earning assets increased at rate of 6.6% while net interest income increased at a rate of 2.2% which resulted in a decline in net interest margin. Loan growth, specifically commercial mortgages, adjustable rate mortgage loans and home equity loans accounted for the volume increases. For 1997, the net interest margin decreased to 4.64% from 4.85% in 1996. This decrease is the result of earning assets growing 15.5% while net interest income grew at a rate of 10.6%. Comparing 1997 and 1996 shows that changes in rates increased net interest margin $6 thousand, while changes in volume provided $682 thousand for a net increase of $688 thousand. Volume increases accounted for the growth in net interest income and is attributed to the Kent Savings merger. Excluding the $20.3 million in total loans from Kent Savings, loan growth was flat. The majority of the $6.3 million growth in average investment securities is attributed, primarily, to the purchase of bonds to leverage the FHLB borrowing. 6 Management and the Board of Directors monitor interest rates on a regular basis to assess the Company's competitive position and to maintain a reasonable and profitable interest rate spread. The Company also considers the maturity distribution of loans, investments, and deposits and its effect on net interest income as interest rates rise and fall over time. For additional analysis see the Notes to the Consolidated Financial Statements. PROVISION and ALLOWANCE FOR CREDIT LOSSES For the year ended December 31, 1998, the Bank recorded net charge offs of $55 thousand compared to net charge offs of $115 thousand in 1997 and net recoveries of $25 thousand in 1996. Internal loan review, in particular, is effective in identifying problem credits and in achieving timely recognition of potential and actual losses within the loan portfolio. Improved overall credit quality and increased collection efforts have also contributed to the relatively small amount of net charge offs in 1998 and 1997 and net recoveries in 1996. Gross charge offs amounted to $104 thousand, $158 thousand and $78 thousand in 1998, 1997, and 1996, respectively, the majority of which were installment loans. Efforts to collect charged off loans are continuing and are evidenced by the amount of recoveries, totaling $49 thousand in 1998, $44 thousand in 1997, and $103 thousand in 1996. Provision for credit losses is an estimate of the amount necessary to maintain the allowance for loan losses at a level sufficient to absorb potential losses in the loan portfolio. The provision for credit losses has followed the same general trend as the amount of charge offs. No provision for credit losses was charged to expense in 1998, 1997, or 1996. $15 thousand was added to the allowance in 1997 upon the merger with Kent Savings. The allowance for credit losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Management's quarterly evaluation of the adequacy of the allowance is based on analysis of the loan portfolio and its known and inherent risks, assessment of current economic conditions, the Year 2000 issue, diversification and size of the portfolio, adequacy of the collateral, past and anticipated loss experience and the amount of non-performing loans. The allowance for credit losses has remained relatively unchanged despite the increase in outstanding loan balances. The allowance for credit losses of $1.3 million as of December 31, 1998 amounted to 1.21% of the outstanding loan portfolio. The allowance for credit losses of $1.4 million as of December 31, 1997 represented 1.29% of gross loans. The decrease in the percentage of allowance to outstanding loans, despite the increasing outstanding gross loans, is justified by lower levels of classified loans. Past due loan levels have remained relatively unchanged, however, they consist primarily of loans secured by real estate. Analysis by loan review and internal audit supports the adequacy of the allowance. This reduction in percentage of allowance to outstanding loans reflects improvements in credit quality achieved through better credit underwriting and more aggressive collection efforts and is further evidenced by lower past due loan totals as a percentage of outstanding loans. In management's opinion, the allowance for credit losses is adequate as of December 31, 1998. See Note 4 in the Notes to the Consolidated Financial Statements. NONINTEREST INCOME Noninterest income consists of service charges and fees, gains on sale of securities, earnings or losses from unconsolidated subsidiaries and various other income items. For the year ended December 31, 1998, noninterest income decreased $36 thousand or 4.0% compared to the prior year. The decrease was due largely to a $61 thousand operating loss and writedown of the investment in our unconsolidated subsidiary, Eastern Shore Mortgage Company. Combined with reduced earnings of our other unconsolidated subsidiary, Delmarva Data Center, equity earnings from unconsolidated subsidiaries decreased $93 thousand compared to 1997. This decrease was offset by an increase of $22 thousand in total service charges on deposit accounts primarily the result of increased levels of checks drawn against insufficient funds as well as ATM fees. Noninterest income decreased $90 thousand or 9.0% in 1997 compared to the year ended December 31, 1996. However, excluding the securities gains, noninterest income actually increased $105 thousand or 13.2%. Increased service 7 charges from a rise in the number of checks drawn against insufficient funds accounted for $46 thousand of the increase. Increase in value of life insurance of $31 thousand and $47 thousand increase in earnings from unconsolidated subsidiaries also contributed to the improvement in non-interest income. NONINTEREST EXPENSES The year ended December 31, 1998 reflected a $297 thousand or 6.8% increase in noninterest expense compared to December 31, 1997. Salaries and benefits accounted for $144 thousand of the increase as a result of the additional salary and benefit costs of 3 full time equivalent staff as well as cost of living and insurance premium increases. Facility improvements and equipment upgrades resulted in increased depreciation expense, maintenance costs and equipment service contracts. This trend which began in 1997 continues in 1998 when a full year of depreciation expense was recorded for the Commerce Street renovation. The Company began the Commerce Street renovation in January 1997, and anticipates completion of this office in 1999. Larger buildings are more costly to maintain and the additional investment will be depreciated over the estimated useful life of the asset. In addition to the increased depreciation and maintenance expenses, opportunity costs negatively impact the bottom line. However, the renovations provide a long term benefit for customers and staff. The impact of this additional maintenance and depreciation expense is not expected to have a material effect on the Company's net income in the future. Facility costs are expected to increase in 1999 with the addition of two new branch locations; one in Denton, Maryland (Caroline County) and the other in Chester, Maryland, (Queen Anne County.) Increases were noted in marketing. The Company has adopted a full scale marketing program including direct mail, cable television commercials and product promotion. Marketing plays a significant role in banking today, more so than in the past. As the banking industry continues to consolidate, both banking and non-banking companies are competing much more aggressively. Direct competition for deposits comes from other commercial banks, savings banks, savings and loan associations, and credit unions as well as brokerage houses, mutual funds and the securities market. The Bank also competes with the same banking entities for loans, as well as with mortgage banking companies and institutional lenders. Significant growth was also noted in amortization expense primarily as a result of two items; the recording of a full year amortization ($140 thousand) of the goodwill produced from the Kent Savings merger and, after continuing losses, the write off of the remaining $24 thousand goodwill balance associated with Eastern Shore Mortgage Corporation. The year ended December 31, 1997 reflected a $583 thousand increase or 15.4% when compared to 1996. A significant portion, or $248 thousand, of the increase is related to employee salaries and benefits. The number of full time equivalent employees increased by 4 when comparing the year ended December 31, 1997 to the same period in 1996, primarily the result of additional staff positions as well as a branch manager position with the addition of the Kent Branch. Salaries and benefits also include cost of living increases and benefit cost increases. FDIC insurance premiums increased in 1997 with the inclusion of Savings Association Insurance Fund (SAIF) deposits from Kent Savings. Premises and fixed assets expenses continued to increase. Facility improvements and equipment upgrades resulted in increased depreciation expense, maintenance costs and equipment service contracts. INCOME TAXES For 1998, the effective tax rate for the Company increased slightly to 32.7% compared to 32.3% for 1997 and 33.7% for 1996. The reduction in effective tax rate in 1998 and 1997 resulted from a $12 thousand and $51 thousand, respectively, rehabilitation tax credits associated with the renovations of the main office. The Company's income tax expense differs from the amount computed at statutory rates primarily due to tax-exempt interest from certain loans and investment securities and, in 1998 and 1997, the rehabilitation tax credits. Note 12 to the Consolidated Financial Statements includes a reconciliation of the Federal tax expense computed using the Federal statutory rate of 34% and provides additional detail. 8 The Company noted a decrease in state income taxes beginning in 1996 as the Maryland legislature exempted a portion of the interest from securities issued by the United States Treasury, bank-qualified Maryland municipals, and some United States Government agencies. This change in state income taxes has not had a material impact on liquidity, financial condition or operations. Deferred tax assets and liabilities are based on the differences between financial statement and tax bases of assets and liabilities. The tax effect of these differences is calculated using current statutory rates. Management believes it is more likely than not that all deferred tax assets will be realized and therefore no valuation allowance is deemed necessary. INVESTMENT SECURITIES Investment securities classified as available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the asset/liability management strategy. Available for sale securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity net of income taxes. Investment securities classified as held to maturity are those that management has both the positive intent and ability to hold to maturity, and are reported at amortized cost. The Company does not currently follow a strategy of making securities purchases with a view to near-term sales, and, therefore, does not own trading securities. At December 31, 1998 the Company had 49% of the portfolio designated as available for sale and 51% held to maturity compared to 19% and 81% as of December 31, 1997. The increase in percentage of securities designated as available for sale is to cover potential growth and liquidity needs. The Company manages the investment portfolios within policies which seek to achieve desired levels of liquidity, manage interest rate sensitivity risk, meet earnings objectives, and provide required collateral support for deposit activities. The Company does not generally invest in structured notes or other derivative securities. Total investment securities amounted to $47.1 million and $48.7 million as of December 31, 1998 and 1997, respectively. The slightly lower level of investments in securities resulted primarily from the investments called at a rate faster than they were replaced. Excluding the U.S. Government and U.S. Government sponsored agencies, the Company had no concentrations of investment securities from any single issuers that exceeded 10% of shareholders' equity. Note 3 to the Consolidated Financial Statements provides detail by type and contractual maturity for the years ended December 31, 1998 and 1997. LOAN PORTFOLIO The Company is actively engaged in originating loans to customers in Queen Anne's, Caroline, Kent, and Talbot Counties in the State of Maryland. The Company has policies and procedures designed to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for credit losses. These policies, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan and the experience of the lending officer. Note 4 to the Consolidated Financial Statements presents the composition of the Company's loan portfolio by significant concentration. The Company had no loan concentrations exceeding 10% of total loans which are not otherwise disclosed. Company policy is to make the majority of its loan commitments in the market area it serves. The Company attempts to reduce risk through its management's familiarity with the credit histories of loan applicants and in-depth knowledge of the risk to which a given credit is subject. Lending in a limited market area does subject the Company to economic conditions of that market area. The Company had no foreign loans in its portfolio as of December 31, 1998. The Company places a loan in non-accrual status whenever there is substantial doubt about the ability of a borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan and the overall economic situation of the borrower when making a non-accrual decision. Non-accrual loans are closely monitored by management . A non-accruing loan is restored to current status when the 9 prospects of future contractual payments are no longer in doubt. At December 31, 1998 and 1997, $55 thousand and $199 thousand, respectively, of non-accrual loans were secured by collateral with an estimated value of $343 thousand of December 31, 1998 and $1.1 million as of December 31, 1997. DEPOSITS Deposit liabilities grew $7.5 million or 5.1% to $153.3 million compared to $145.8 million in 1997. Average deposits increased at a rate of 5.3%. The table below presents the average balance of deposits and percentage of each category to total average deposits. The average balance of other time deposits grew 12.9% and the average balance of noninterest bearing demand deposits grew 18.6% compared to the year ended December 31, 1997. This is the result of the introduction of new products and product features as well as competitive pricing. The Company continues to experience strong competition from other commercial banks, credit unions, the stock market and mutual funds. The Company does not accept brokered deposits, nor does it rely on purchased deposits as a funding source for loans. The Company has no foreign banking offices. Average Balance of Deposits and the Percentage of each Category to Total Average Deposits
- ------------------------------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------------------------------ Interest-bearing liabilities Super NOW accounts $ 18,433 12.48% $ 17,215 12.28% Money market deposit accounts 18,886 12.79 21,028 15.00 Time, $100,000 or more 12,698 8.60 13,298 9.49 Other time deposits 46,305 31.35 41,023 29.27 IRA deposits 15,430 10.45 14,733 10.51 Savings deposits 17,819 12.06 16,636 11.87 Demand deposits 18,144 12.27 16,216 11.58 - ------------------------------------------------------------------------------------------------------ $147,715 100.00% $140,149 100.00% - ------------------------------------------------------------------------------------------------------
LIQUIDITY MANAGEMENT Liquidity describes the ability of the Company to meet financial obligations that arise out of the ordinary course of business. Liquidity is needed primarily to meet borrower and depositor withdrawal requirements and to fund current and planned expenditures. The Company maintains its asset liquidity position internally through short term investments, the maturity distribution of the investment portfolio, loan repayments and income from earning assets. As indicated in the Consolidated Statements of Cash Flows, primary sources of cash are the maturity of investment securities and deposit growth. A substantial portion of the investment portfolio contains readily marketable securities that could be converted to cash immediately. Refer to Note 3 of the Consolidated Financial Statements for a table showing the maturity distribution of the Company's securities portfolio and the related estimated fair value. On the liability side of the balance sheet, liquidity is affected by the timing of maturing deposits and the ability to generate new deposits or borrowings as needed. Other sources, not currently in use, are available through borrowings from the Federal Reserve Bank, the Federal Home Loan Bank of Atlanta (FHLB) and from lines of credit approved at correspondent banks. As of December 31, 1997 the Company had outstanding loan commitments and unused lines of credit of $17.4 million. Of this total, management expects to fund $6 million within one year. During 1998, the $1.6 million or 3.3% decrease in investment securities and $7.4 million or 5.1% increase in deposits funded the $2.0 million increase in loans with the remaining funds placed into federal funds sold. Loan growth of $19.9 million or 22.4% and deposit growth of $21.6 million or 17.4% in 1997 resulted primarily from the Kent Savings merger. Investment security growth was funded by the long-term borrowing from the Federal Home Loan Bank of Atlanta. Management knows of no trend or event which will have a material impact on the Company's ability to maintain liquidity at satisfactory levels. 10 MARKET RISK MANAGEMENT Market risk is the risk of loss that arises from changes in interest rates, foreign currency exchange prices, commodity prices, equity prices, and other market changes that affect market sensitive financial instruments. The market risk for the Company is composed primarily of interest rate risk, which is the exposure of the Bank's earnings and capital arising from future interest rate changes. This risk is a normal part of the banking business because assets and liabilities do not reprice at the same rate, nor do they move to the same degree as rates change. In addition, the maturity distribution of the Bank's assets and liabilities do not match for given periods of time. The Bank's interest rate sensitivity position is managed to maintain an appropriate balance between the maturity and repricing characteristics of assets and liabilities that is consistent with the Bank's liquidity, growth, earnings and capital adequacy goals. The Board of Directors has adopted an Asset / Liability Management Policy, which is administered by the Asset / Liability Committee. The Committee is responsible for monitoring the Bank's interest rate sensitivity position and recommending policies to limit exposure to interest rate risk while maximizing net interest income. One of the primary tools for monitoring interest rate sensitivity is "Gap Analysis." This tool provides a general understanding of maturity and repricing patterns of interest sensitive assets and liabilities. "Positive gap" occurs when more assets reprice within a specific interval and "negative gap" occurs when more liabilities reprice within a specific interval. The following table summarizes the Company's interest sensitivity at December 31, 1998 based on contractual maturity if fixed rate or earliest repricing date if variable rate. INTEREST RATE SENSITIVITY ANALYSIS December 31, 1998 (ALL DOLLAR AMOUNTS IN THOUSANDS)
- ----------------------------------------------------------------------------------------------------------------------- AFTER 3 AFTER 1 NON- MONTHS- YEAR- INTEREST TOTAL WITHIN WITHIN WITHIN AFTER SENSITIVE ALL 3 MONTHS 1 YEAR 5 YEARS 5 YEARS FUNDS CATEGORIES - ----------------------------------------------------------------------------------------------------------------------- ASSETS Loans $19,786 $11,554 $41,126 $38,455 ($ 1,073) $109,848 Investment Securities 2,068 1,360 28,190 13,539 45,157 Investments in Equity Securities 893 1,068 1,961 Federal Funds Sold 9,752 9,752 Non-interest earning assets 14,336 14,336 ----------- --------- --------- -------- --------- ---------- TOTAL ASSETS 32,499 12,914 69,316 51,994 14,331 181,054 ----------- --------- --------- -------- --------- ---------- LIABILITIES Time Certificates of Deposit over $100,000 1,192 5,649 8,516 15,357 All Other Time Deposits 11,714 16,507 34,167 62,388 Savings and Money Market Deposits 35,322 35,322 Interest-bearing Transaction 20,467 20,467 Other borrowed funds 5,000 5,000 Noninterest-bearing Liabilities 20,616 20,616 ----------- --------- --------- -------- --------- ---------- TOTAL LIABILITIES 68,695 27,156 42,683 0 20,616 $159,150 ----------- --------- --------- -------- --------- ---------- NET(ASSETS LESS LIABILITIES) ($36,196) ($14,242) $26,633 $51,994 ($ 6,285) =========== ========= ========= ======== ========= Interest Sensitivity Gap Asset Sensitive (Liability Sensitive) ($36,196) ($50,438) ($23,805) $28,189 $21,904 =========== ========= ========= ======== ========= Interest Sensitivity GAP / Total Assets -19.99% -27.86% -13.15% 15.57% 12.10% =========== ========= ========= ======== =========
11 The following assumptions were made in preparation of the "Interest Rate Sensitivity Analysis": Fixed rate loans are grouped in the appropriate category based on scheduled amortization. Variable rate loans are classified based on the next available repricing opportunity. Noninterest sensitive loans consists of the net of nonaccrual loans, allowance for credit losses and deferred fees and costs. Taxable and nontaxable investment securities are categorized by final maturity date or, if applicable, a definite call date. Investment in equity securities within three months consists of a U.S. Government securities mutual fund. Noninterest sensitive funds combines Federal Reserve Bank and Federal Home Loan Bank of Atlanta stocks. Time deposits with contractual maturities are categorized based on the effective maturity of the deposit. Savings, money market and interest-bearing transaction accounts are assumed to be subject to repricing within a year, and generally within three months of a rate change, based on the Company's historical experience. The Bank uses earnings simulation modeling to measure the effect specific rate changes would have on one year of net interest income. Key assumptions include calls and maturities of investment securities, depositors' rate sensitivity, maturity dates of fixed rate loans and investment securities and repricing date of variable rate loans. As with any method of gauging risk, there are inherent shortcomings and actual results may deviate significantly from assumptions used in the model. Actual results will differ from simulated results due to timing , magnitude and frequency of interest-rate changes as well as changes in market conditions and management strategies. At December 31, 1998 the Bank's estimated earnings sensitivity profile reflected a modest sensitivity to interest rate changes. Based on an assumed 100 basis point immediate change in interest rates the Bank's net interest income would decrease by $64 thousand if rates were to increase by that amount and would increase $70 thousand if rates would decline a similar amount. CAPITAL RESOURCES AND ADEQUACY Total stockholders' equity as of December 31, 1998 decreased $1.6 million or 6.8% compared to the prior year. Earnings of $2.2 million added to stockholders' equity. The change in accumulated other comprehensive income accounted for a $5 thousand reduction and dividends paid also decreased stockholders' equity by $1.0 million. Dividends paid per share increased 5.1% over the prior year without negatively impacting the Company's capital position. A stock repurchase of $2.8 million accounted for the majority of the decrease. On September 16, 1998 the Company repurchased 101,322 shares or approximately 5% of its outstanding common stock at $27.75 per share. The Board of Directors and management believe it was in the best interest of the Company and its shareholders to have repurchased the stock considering the Company's high level of capital and to lessen the dilutive effect of the stock-based employee and incentive plans approved at the Company's 1998 Annual Meeting. The repurchase of common shares also increases each remaining shareholder's relative percentage of ownership in the Company. Total stockholders' equity increased $1.4 million or 6.4% in 1997 to $23.5 million from $22.1 million at December 31, 1996. Earnings of $2.4 million was the primary contributor to this increase. The change in accumulated other comprehensive income accounted for a $26 thousand improvement and dividends paid reduced stockholders' equity $977 thousand. One measure of capital adequacy is the leverage capital ratio which is calculated by dividing average total assets for the most recent quarter into Tier 1 capital, which for the Company subtracts goodwill from total stockholders' equity . The regulatory minimum for this ratio is 4%. The leverage capital ratio as of December 31, 1998 was 11.08% for the Company, and as of December 31, 1997 was 12.23%. Another measure of capital adequacy is the risk based capital ratio or the ratio of total capital to risk adjusted assets. Total capital is composed of both core capital (Tier 1) and supplemental capital (Tier 2) including adjustments for off balance sheet items such as letters of credit and taking into account the different degrees of risk among various assets. 12 Federal banking regulators require a minimum total risk based capital ratio of 8%. As of December 31, 1998, the Company's ratio was 21.05%. The Bank's ratio at December 31, 1997 was 23.61%. According to FDIC capital guidelines, the Bank is considered to be "Well Capitalized." On December 5, 1996 the Company entered into an agreement to acquire Kent Savings and Loan Association, F.A.(Kent Savings) of Chestertown, Maryland. The effective date of the merger was April 1, 1997 and was accounted for as a purchase transaction. Under the terms of the agreement, the Company paid approximately $5.1 million for all of the outstanding shares of Kent Savings. As of March 31, 1997, total assets of Kent Savings were approximately $24.0 million and total stockholders' equity was approximately $2.9 million. Management knows of no other trend or event which will have a material impact on capital. Please also refer to Note 16 in the Consolidated Financial Statements for additional discussion of regulatory matters. FUTURE TRENDS This is a Year 2000 Readiness Disclosure under the Year 2000 Information and Readiness Disclosure Act of 1998. The "Year 2000 Issue", which is common to most corporations, including banks, is a general term used to describe the problems that may result from the improper processing of dates and date-sensitive calculations as the Year 2000 approaches. This issue is caused by the fact that many of the world's existing computer programs use only two digits to identify the year in the date field of a program. These programs could experience serious malfunctions when the last two digits of the year change to "00" as a result of identifying a year designated "00" as the year 1900 rather than the Year 2000. The Company formed a Year 2000 Committee, which is comprised of a cross-section of the Company's employees, in the fourth quarter of 1997. This Committee is leading the Company's Year 2000 efforts to ensure that the Company is properly prepared for the Year 2000. The Company's Board of Directors has approved a plan submitted by the Year 2000 Committee that was developed in accordance with guidelines set forth by the Federal Financial Institutions Examination Council. This plan has five primary phases related to internal Year 2000 compliance: 1. Awareness -- this phase is ongoing and is designed to inform the Company's Board of Directors (the "Board") and Executive management ("Management"), employees, customers and vendors of the impact of the Year 2000 Issue. Since January 1998, the Board has been apprised of the Company's efforts at their regular meetings. In addition, customers and the community continue to be updated with respect to the Company's Year 2000 efforts through mailings, published articles, lobby brochures and a Year 2000 Readiness Disclosure posted in the branch lobbies. A public seminar was presented in April 1998. The Company's ongoing outreach efforts include Year 2000 presentations to business organizations and community groups. 2. Assessment -- during this phase an inventory was conducted of all known Company processes that could reasonably be expected to be impacted by the Year 2000 Issue and their related vendors, if applicable. The identification process included information technology and communication systems such as personal computers, local area networks and servers, ATM modems, printers, copy machines, facsimile machines, telephones and the operating systems and software for these systems. It also included non-information technology systems, such as heating, air conditioning and vault controls, alarm systems, surveillance systems, and postage meters. The Company inventoried all the systems listed above in the second and third quarters of 1998 and performed an initial assessment of potential risks from either under or nonperformance arising from incorrect processing and usage of dates after December 31, 1999. All outside servicers and major vendors were contacted to ascertain their individual levels of Year 2000 compliance. From vendor responses and/or certifications of Year 2000 compliance the Company determined that all vendors and service providers who provide mission critical and significant systems to the Company are addressing Year 2000 compliance for the products and services they provide to the Company and the Company expects all of the mission critical and significant vendors to be Year 2000 compliant by December 31, 1999. The assessment phase is complete, although it is updated periodically as necessary. 13 3. Renovation and/or replacement -- this phase includes programming code enhancements, hardware and software upgrades, system replacements, vendor certification and any other changes necessary to make any hardware, software and other equipment Year 2000 compliant. The Company does not perform in-house programming, and thus is dependent on external vendors to ensure and modify, if needed, the hardware, software or other services they provide to the Company for Year 2000 compliance. The Company's primary service provider has a comprehensive Year 2000 Plan in place and has successfully completed Year 2000 testing of their mission critical systems. 4. Testing -- The next phase for the Company under the plan is to complete a comprehensive testing of all known processes. As noted in the renovation and/or replacement phase above, the Company's primary service provider has already successfully tested their system for Year 2000 compliance. The next step, which is scheduled for the first and second quarters of fiscal 1999, is to complete testing of the Company's network mission critical software applications and hardware. The Company has performed Year 2000 testing of all employee computer work stations, and is in the process of updating or replacing work stations which are not Year 2000 compliant. The testing of the remainder of the Company's processes is expected to be substantially complete by June 1999. 5. Implementation -- this phase will occur when Year 2000 processing commences. On some applications the Company is already entering dates greater than December 31, 1999 into their systems. In these situations no adverse events have been noted. The significant part of the implementation phase will occur after December 31,1999. The Company is in the process of developing contingency plans for processes that do not process information reliably and accurately after December 31, 1999. The contingency plans for all systems should be substantially complete by the end of the second calendar quarter of fiscal 1999. Senior management completed a contingency plan to provide operating alternatives for continuation of services to the Company's customers in the event of systems or communication failures at the beginning of the Year 2000. Contingency plans will be updated as necessary. Based on preliminary planning during development of the contingency plan, management expects that the Company will be able to continue to operate in the Year 2000 even if some systems fail. At the end of December 1999, the Company will generate paper and systems backup of all customer and general ledger accounts. Due to the size of the Company, the Company expects that it will be able to operate with all transactions processed manually until normal operations can be restored. This procedure could require changing of schedules and hiring of temporary staff, which would increase cost of operations. If this procedure were to continue for any extended period of time, or if the Company ultimately had to change data service providers, the cost could be material. The Company is in the process of assessing the Year 2000 readiness of significant borrowers and depositors. The Company has completed its initial review of these significant relationships and assessed the risks these relationships may pose to the Company. The Company will continue to monitor the risk and expects any potential losses to the Company caused by Year 2000 problems of significant borrowers and depositors not to be material. This step is not expected to require a significant amount of time or resources. As of December 31, 1998 the following chart shows the current and projected status of the Company's Year 2000 compliance efforts: Phase 9/30/98 12/31/98 3/31/99 6/30/99 ------------------------------------------------------------------ Awareness 100% 100% 100% 100% Assessment 98 98 100 100 Renovation 89 96 100 100 Validation 58 78 85 100 Implementation 54 67 80 100 14 The Company expensed approximately $47 thousand on Year 2000 costs in 1998. Based on an analysis of projected expenses performed during the first quarter of 1998 and subsequent updates, the total cost of the Year 2000 project is currently estimated at $110 thousand. Funding of the Year 2000 project costs has come and is expected to come from normal operating cash flow. Additional costs including staff time will be expensed in the normal course of business and will not have a material impact on the Company's results of operations, liquidity, capital resources or financial condition. However, the expenses associated with the Year 2000 issue will directly reduce otherwise reported net income for the Company. Should the Company have to resort to alternative operating procedures due to major systems or communications failures at the beginning of the Year 2000, the extra cost could be material. Management of the Company believes that the potential effects on the Company's internal operations of the Year 2000 Issue can and will be addressed prior to the Year 2000. However, if required modifications or conversions are not made or are not completed on a timely basis prior to the Year 2000, the Year 2000 Issue could disrupt normal business operations. The most reasonably likely worst case Year 2000 scenarios foreseeable at this time would include the Company temporarily not being able to process, in some combination, various types of customer transactions. This could affect the ability of the Company to, among other things, originate new loans, post loan payments, accept deposits or allow immediate withdrawals, and, depending on the amount of time such a scenario lasted, could have a material adverse effect on the Company. Because of the serious implications of these scenarios, the primary emphasis of the Company's Year 2000 efforts is to correct, with complete replacement if necessary, any systems or processes whose Year 2000 test results are not satisfactory prior to the Year 2000. Nevertheless, should one of the most reasonably likely worst case scenarios occur in the Year 2000, the Company, as noted above, is in the process of formalizing a contingency plan that would allow for limited transactions until the Year 2000 problems are fixed. The costs of the Year 2000 project and the date on which the Company plans to complete Year 2000 compliance are based on management's best estimates, which were derived using numerous assumptions of future events such as the availability of certain resources (including internal and external resources), third party vendor plans and other factors. However, there can be no guarantee that these estimates will be achieved at the cost disclosed or within the timeframe indicated, and actual results could differ materially from these plans. Factors that might affect the timely and efficient completion of the Company's Year 2000 project include, but are not limited to, vendor's ability to adequately correct or convert software and the effect on the Company's ability to test its systems, the availability and cost of personnel trained in the Year 2000 area, the ability to identify and correct all relevant computer programs and similar uncertainties. Bank regulatory agencies have recently issued additional guidance under which they are assessing Year 2000 readiness. The failure of a financial institution to take appropriate action to address deficiencies in the Year 2000 project management process may result in enforcement actions which could have a material adverse effect on such institution, result in the imposition of civil money penalties or result in the delay (or receipt of an unfavorable or critical evaluation of management of a financial institution in connection with regulatory review) of applications seeking to acquire other entities or otherwise expand the institution's activities. Ultimately, the success of the Company's efforts to address the Year 2000 issue depends to a large extent not only on the corrective measures that the Company undertakes, but also on the efforts undertaken by businesses and other independent entities who provide data to, or receive data from, the Company such as borrowers, vendors or customers. In particular, the Company's credit risk associated with its borrowers may increase as a result of problems such borrowers may have resolving their own Year 2000 issues. Although it is not possible to evaluate the magnitude of any potential increased credit risk at this time, the impact of the Year 2000 issue on borrowers could result in increases in problem loans and credit losses in future years. From now until 2000, the Company will endeavor to monitor the Year 2000 efforts of its borrowers and will implement a course of action and procedures designed to reduce any increased potential risk as a result of Year 2000 issues. 15 CONSOLIDATED BALANCE SHEETS December 31, 1998 and 1997
- ---------------------------------------------------------------------------------------------------------------------------- 1998 1997 - ---------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 4,536,510 $ 5,091,798 Federal funds sold 9,752,503 3,503,900 Investment securities available for sale, at fair value 23,202,856 9,444,463 Investment securities held to maturity, fair value of $24,253,286 (1998) and $39,498,436 (1997) 23,915,633 39,298,105 Loans, less allowance for credit losses of $1,348,805 (1998) and $1,403,747 (1997) 109,847,706 107,763,536 Premises and equipment, net 3,369,014 3,258,876 Accrued interest receivable 1,354,754 1,475,994 Investment in unconsolidated subsidiaries 1,167,306 1,187,206 Goodwill 1,917,009 2,087,803 Other assets 1,991,281 2,003,330 - ---------------------------------------------------------------------------------------------------------------------------- Total assets $181,054,572 $175,115,011 - ---------------------------------------------------------------------------------------------------------------------------- LIABILITIES: Deposits: Noninterest-bearing demand $ 19,773,634 $ 17,727,129 Interest-bearing transaction 20,467,422 19,176,281 Savings and money market 35,321,550 37,575,341 Time, $100,000 or more 15,357,184 13,473,763 Other time 62,387,777 57,860,756 - ---------------------------------------------------------------------------------------------------------------------------- Total deposits 153,307,567 145,813,270 Long-term debt 5,000,000 5,000,000 Accrued interest payable 208,433 189,276 Other liabilities 634,337 597,655 - ---------------------------------------------------------------------------------------------------------------------------- Total liabilities 159,150,337 151,600,201 - ---------------------------------------------------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY: Common stock, $.01 par value; authorized 10,000,000 shares; issued and outstanding: 1,913,516 shares (1998) and 1,007,424 shares (1997) 19,135 10,074 Surplus 10,064,166 10,064,166 Retained earnings 11,865,853 13,480,311 Accumulated other comprehensive income (44,919) (39,741) - ---------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 21,904,235 23,514,810 - ---------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $181,054,572 $175,115,011 - ----------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 16 CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1998, 1997 and 1996
- ------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------ INTEREST INCOME: Interest and fees on loans $ 9,701,677 $ 9,346,631 $ 8,103,983 Interest and dividends on investment securities: Taxable 2,269,577 2,286,192 1,834,979 Tax-exempt 473,689 417,895 424,202 Interest on federal funds sold 565,449 354,331 378,246 - ------------------------------------------------------------------------------------------------------------------------ Total interest income 13,010,392 12,405,049 10,741,410 - ------------------------------------------------------------------------------------------------------------------------ INTEREST EXPENSE: Interest on deposits 5,636,282 5,370,057 4,475,979 Interest on long-term debt 287,041 77,825 -- - ------------------------------------------------------------------------------------------------------------------------ Total interest expense 5,923,323 5,447,882 4,475,979 - ------------------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME 7,087,069 6,957,167 6,265,431 PROVISION FOR CREDIT LOSSES -- -- -- - ------------------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 7,087,069 6,957,167 6,265,431 - ------------------------------------------------------------------------------------------------------------------------ NONINTEREST INCOME: Service charges on deposit accounts 686,571 664,708 639,631 Gains on sales of investment securities 6,495 8,568 203,997 Equity in net (loss) income of unconsolidated subsidiaries (19,900) 72,978 25,884 Other income 199,479 162,795 129,911 - ------------------------------------------------------------------------------------------------------------------------ Total noninterest income 872,645 909,049 999,423 - ------------------------------------------------------------------------------------------------------------------------ NONINTEREST EXPENSES: Salaries and employee benefits 2,381,839 2,238,125 1,990,238 Premises and equipment expenses 604,248 577,544 552,368 Marketing and promotion 159,402 142,101 92,450 Stationery, printing and supplies 147,433 160,037 120,105 Professional fees 78,679 114,601 175,957 Director and committee fees 211,734 195,007 178,054 Outside data processing 326,668 283,164 248,579 Amortization of goodwill 170,794 116,383 11,489 Other expenses 582,049 539,073 414,194 - ------------------------------------------------------------------------------------------------------------------------ Total noninterest expenses 4,662,846 4,366,035 3,783,434 - ------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE TAXES ON INCOME 3,296,868 3,500,181 3,481,420 FEDERAL AND STATE INCOME TAXES 1,077,929 1,129,983 1,173,678 - ------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 2,218,939 $ 2,370,198 $ 2,307,742 - ------------------------------------------------------------------------------------------------------------------------ Basic earnings per common share $ 1.12 $ 1.18 $ 1.14 - ------------------------------------------------------------------------------------------------------------------------ Diluted earnings per common share $ 1.12 $ 1.18 $ 1.14 - ------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 17 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Years Ended December 31, 1998, 1997 and 1996
- ---------------------------------------------------------------------------------------------------------------------------------- Accumulated Other Total Common Retained Comprehensive Stockholders' Stock Surplus Earnings Income Equity - ---------------------------------------------------------------------------------------------------------------------------------- Balances at January 1, 1996 $ 10,074 $ 10,064,166 $ 10,706,407 $ 68,701 $ 20,849,348 Comprehensive income: Net income -- -- 2,307,742 -- 2,307,742 Other comprehensive income, net of tax: Unrealized loss on available for sale securities -- -- -- (134,307) (134,307) - ---------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income -- -- -- -- 2,173,435 - ---------------------------------------------------------------------------------------------------------------------------------- Cash dividends declared ($.46 per common share)* -- -- (926,832) -- (926,832) - ---------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1996 10,074 10,064,166 12,087,317 (65,606) 22,095,951 Comprehensive income: Net income -- -- 2,370,198 -- 2,370,198 Other comprehensive income, net of tax: Unrealized gain on available for sale securities -- -- -- 25,865 25,865 - ---------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income -- -- -- -- 2,396,063 - ---------------------------------------------------------------------------------------------------------------------------------- Cash dividends declared ($.485 per common share)* -- -- (977,204) -- (977,204) - ---------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1997 10,074 10,064,166 13,480,311 (39,741) 23,514,810 Comprehensive income: Net income -- -- 2,218,939 -- 2,218,939 Other comprehensive income, net of tax: Unrealized loss on available for sale securities of $7,101, net of reclassification adjustment of $1,923 -- -- -- (5,178) (5,178) - ---------------------------------------------------------------------------------------------------------------------------------- Total comprehensive income -- -- -- -- 2,213,761 - ---------------------------------------------------------------------------------------------------------------------------------- Two-for-one split effected in the form of a 100% stock dividend 10,074 -- (10,074) -- -- Stock repurchased and retired (1,013) -- (2,810,950) -- (2,811,963) Cash dividends declared ($.51 per common share)* -- -- (1,012,373) -- (1,012,373) - ---------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1998 $19,135 $10,064,166 $11,865,853 ($44,919) $21,904,235 - ----------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. * Restated to reflect a two-for-one stock split on March 31, 1998. 18 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,218,939 $ 2,370,198 $ 2,307,742 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 457,337 424,302 296,599 Equity in net earnings of unconsolidated subsidiaries 19,900 (72,978) (25,844) Provision for credit losses, net (54,942) (114,521) 24,713 Deferred income taxes (31,239) 265,591 59,892 Net (gains) losses on sales of assets (5,101) 37,920 (205,286) Decrease (increase) in accrued interest receivable 121,240 10,317 (48,626) Decrease (increase) in other assets 46,725 (1,346,040) 34,117 Increase (decrease) in accrued interest payable 19,157 (118,486) 7,162 Increase (decrease) in other liabilities 36,682 (88,744) (141,452) - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 2,828,698 1,367,559 2,309,017 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of investment securities held to maturity 34,267,718 16,220,939 752,344 Proceeds from maturities of investment securities available for sale 2,651,227 1,081,113 10,776,721 Proceeds from sales of investment securities available for sale -- 3,373,351 957,127 Purchase of investment securities held to maturity (18,767,297) (22,899,682) (11,034,144) Purchase of investment securities available for sale (16,499,297) (1,693,125) (7,988,166) (Increase) decrease in loans, net (2,029,228) 46,114 (1,963,160) Purchase of premises and equipment (428,467) (1,276,182) (210,521) Proceeds from sale of premises and equipment -- 301 7,200 Investment in unconsolidated subsidiary -- -- (15,000) Proceeds from sale of other real estate owned -- -- 118,070 Acquisition, net of cash acquired -- (2,799,492) -- - --------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (805,344) (7,946,663) (8,599,529) - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase in demand, transaction, savings, and money market deposits 1,083,855 6,923,212 2,928,474 Increase (decrease) in time deposits 6,410,442 (6,033,946) 4,758,021 Proceeds from long-term debt -- 5,000,000 -- Cash dividends paid (1,012,373) (977,204) (926,832) Common stock repurchased and retired (2,811,963) -- -- - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 3,669,961 4,912,062 6,759,663 - --------------------------------------------------------------------------------------------------------------------------------- Net Increase (Decrease) in cash and cash equivalents 5,693,315 (1,667,042) 469,151 - --------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of year 8,595,698 10,262,740 9,793,589 - --------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 14,289,013 $ 8,595,698 $10,262,740 - --------------------------------------------------------------------------------------------------------------------------------- Supplemental cash flows information: Interest paid $ 5,617,125 $ 5,416,606 $ 4,468,817 - --------------------------------------------------------------------------------------------------------------------------------- Income taxes paid $ 1,239,695 $ 1,120,005 $ 1,099,707 - --------------------------------------------------------------------------------------------------------------------------------- Noncash investing activities: Transfers from loans to other real estate owned $ -- $ -- $ (119,886) - ---------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1998, 1997 and 1996 - -------------------------------------------------------------------------------- Note 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements include the accounts of Shore Bancshares, Inc. (the "Company") and its subsidiary, The Centreville National Bank of Maryland (the "Bank") with all significant intercompany transactions eliminated. The investment in subsidiary is recorded on the Company's books on the basis of its equity in the net assets of the subsidiary. The accounting and reporting policies of the Company conform to generally accepted accounting principles and to general practices in the banking industry. Certain reclassifications have been made to amounts previously reported to conform with the classifications made in 1998. NATURE OF OPERATIONS The Company, through its bank subsidiary, provides domestic financial services primarily in the Maryland counties of Queen Anne's, Kent and Caroline. The primary financial services include real estate, commercial and consumer lending, as well as traditional demand deposits and savings products. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. INVESTMENT SECURITIES Investment securities that management has the ability and intent to hold to maturity are classified as held to maturity and carried at cost, adjusted for amortization of premium and accretion of discounts. Other investment securities are classified as available for sale and are carried at estimated fair value. Unrealized gains and losses on investment securities available for sale, net of related deferred income taxes, are recognized as direct increases or decreases in stockholders' equity. The cost of investment securities sold is determined using the specific identification method. LOANS Loans are stated at the principal amount outstanding, net of unearned income. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company's policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. Fees charged and costs capitalized for originating mortgage loans are being amortized on the interest method over the term of the loan. ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses is established through a provision for credit losses charged to expense. Loans are charged against the allowance for credit losses when management believes that the collectibility of the principal is unlikely. The allowance, based on evaluations of the collectibility of loans and prior loan loss experience, is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, 20 review of specific problem loans, and current economic conditions and trends that may affect the borrowers' ability to pay. While management believes it has established the allowance for credit losses in accordance with generally accepted accounting principles and has taken into account the views of its regulators and the current economic environment, there can be no assurance that in the future the Company's and the Bank's regulators or its economic environment will not require further increases in the allowance. LONG-LIVED ASSETS Premises and equipment are stated at cost less accumulated depreciation. Depreciation of physical properties is computed on the straight-line method over the estimated useful lives of the properties. Expenditures for maintenance, repairs, and minor renewals are charged to operating expenses; expenditures for betterments are charged to the property accounts. Upon retirement or other disposition of properties, the carrying value and the related accumulated depreciation are removed from the accounts. Long-lived assets are evaluated regularly for other-than-temporary impairment. If circumstances suggest that their value may be impaired and the write-down would be material, an assessment of recoverability is performed prior to any write-down of the assets. OTHER REAL ESTATE OWNED Real estate acquired in foreclosure of loans is carried at cost or fair value, less estimated costs of disposal, whichever is lower. Fair value is based on independent appraisals and other relevant factors. At the time of acquisition, any excess of loan balance over fair value is charged to the allowance for credit losses. Any subsequent reduction in value, as well as any operating expenses, are included in other operating expenses. INCOME TAXES Income tax expense is based on the results of operations, adjusted for permanent differences between items of income or expense reported in the financial statements and those reported for tax purposes. Under the liability method, deferred income taxes are determined based on the differences between the financial statement carrying amounts and the income tax bases of assets and liabilities and are measured at the enacted tax rates that will be in effect when these differences reverse. EARNINGS PER SHARE Basic earnings per share is calculated based on the weighted average number of shares outstanding during the period. For the years ended December 31, 1998, 1997 and 1996, the Company had no common stock equivalents. NEW ACCOUNTING STANDARDS In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 125), which provides new accounting and reporting standards for sales, securitizations, and servicing of receivables and other financial assets and extinguishments of liabilities. SFAS 125 is effective for transactions occurring after December 31, 1996, except for the provisions relating to repurchase agreements, securities lending and other similar transactions and pledged collateral, which have been delayed until after December 31, 1997 by SFAS 127, Deferral of the Effective Date of Certain Provisions of SFAS Statement No. 125, an amendment of SFAS 125. Adoption of SFAS 125 was not material; SFAS 127 was adopted as required in 1998 and did not have a material financial impact on the Company. 21 In June 1997, Statement of Financial Accounting Standards No. 130 Reporting Comprehensive Income (SFAS 130), was issued and establishes standards for reporting and displaying comprehensive income and its components. SFAS 130 requires comprehensive income and its components, as recognized under the accounting standard, to be displayed in a financial statement with the same prominence as other financial statements. The Company adopted the standard, as required, beginning in 1998. Adoption of this disclosure requirement did not have a material impact on the Company. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information (SFAS 131), which establishes new standards for reporting information about operating segments in annual and interim financial statements. The standard requires descriptive information about the way that operating segments are determined, the products and services provided by the segments and the nature of differences between reportable years beginning after December 15, 1997. Operating segments are defined under the standard based on the availability and utilization of discrete financial information as well as the necessity for this discrete financial information to meet certain quantitative thresholds. Management believes that it has no components that qualify as an operating segment under SFAS 131 for the year ended December 31, 1998. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The provisions of this statement require that derivative instruments be carried at fair value on the balance sheet. The statement allows derivative instruments to be used to hedge various risks and sets forth specific criteria to be used to determine when hedge accounting can be used. The statement also provides for offsetting changes in fair value or cash flows of both the derivative and the hedged asset or liability to be recognized in earnings in the same period; however, any changes in fair value or cash flow that represent the ineffective portion of a hedge are required to be recognized in earnings and cannot be deferred. For derivative instruments not accounted for as hedges, changes in fair value are required to be recognized in earnings. The provisions of this statement become effective for quarterly and annual reporting beginning January 1, 2000, and allow for early adoption in any quarterly period after June 1998. The Company will adopt SFAS 133 as required in 2000. It is expected that adoption of this standard will have no material impact. CASH AND CASH EQUIVALENTS The Company has included cash and due from banks and federal funds sold as cash and cash equivalents for the purpose of reporting cash flows. Note 2 ACQUISITIONS On April 1, 1997 the Company completed the acquisition of Kent Savings and Loan Association for a purchase price of $5,111,000 in cash. The transaction was accounted for as a purchase and, therefore, results of operations subsequent to March 31, 1997 are included in the consolidated statements of income and cash flows from the date of acquisition. The excess cost over the estimated fair value of the tangible net assets acquired was approximately $2,107,000 and is being amortized on a straight-line basis over 15 years. 22 Note 3 INVESTMENT SECURITIES The amortized cost and fair value of investment securities at December 31, 1998 are as follows:
----------------------------------------------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------------------------------------------------------------------- Available for Sale U.S. Treasury securities $ 4,984,665 $75,962 $ -- $ 5,060,627 Obligations of U.S. Government agencies and corporations 16,213,717 10,766 (43,846) 16,180,637 U.S. Government Securities Mutual Fund 1,010,001 -- (116,559) 893,442 Federal Reserve Bank stock 302,250 -- -- 302,250 Federal Home Loan Bank of Atlanta stock 765,900 -- -- 765,900 ----------------------------------------------------------------------------------------------------------- $23,276,533 $86,728 $(160,405) $23,202,856 ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------------------------------------------------------------------- Held to Maturity Obligations of U.S. Government agencies and corporations $14,503,181 $ 96,949 $ -- $14,600,130 Obligations of states and political subdivisions 9,412,452 240,704 -- 9,653,156 ----------------------------------------------------------------------------------------------------------- $23,915,633 $337,653 $ -- $24,253,286 -----------------------------------------------------------------------------------------------------------
23 The amortized cost and fair value of investment securities at December 31, 1997 are as follows:
----------------------------------------------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------------------------------------------------------------------- Available for Sale U.S. Treasury securities $6,965,733 $48,176 $ -- $7,013,909 Obligations of U.S. Government agencies and corporations 465,328 9,448 (6) 474,770 U.S. Government Securities Mutual Fund 1,010,001 -- (122,367) 887,634 Federal Reserve Bank stock 302,250 -- -- 302,250 Federal Home Loan Bank of Atlanta stock 765,900 -- -- 765,900 ----------------------------------------------------------------------------------------------------------- $9,509,212 $57,624 $(122,373) $9,444,463 ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------------------------------------------------------------------- Held to Maturity Obligations of U.S. Government and other government agencies and corporations $29,088,534 $ 47,182 $(22,780) $29,112,936 Obligations of states and political subdivisions 10,209,571 185,246 (9,317) 10,385,500 ----------------------------------------------------------------------------------------------------------- $39,298,105 $232,428 $(32,097) $39,498,436 -----------------------------------------------------------------------------------------------------------
Gross realized gains and gross realized losses on sales and calls of investment securities available for sale are as follows:
----------------------------------------------------------------------------------------------------------- 1998 1997 1996 ----------------------------------------------------------------------------------------------------------- Gross realized gains: U.S. Treasury securities $ -- $ 8,103 $ -- Obligations of U.S. Government agencies and corporations -- -- 7 Obligations of states and political subdivisions 6,495 -- -- Sallie Mae stock -- 2,313 203,990 ----------------------------------------------------------------------------------------------------------- 6,495 10,416 203,997 Gross realized losses: U.S. Treasury securities -- 325 -- Obligations of U.S. Government agencies and corporations -- 1,524 -- ----------------------------------------------------------------------------------------------------------- Net realized gains $6,495 $ 8,567 $203,997 -----------------------------------------------------------------------------------------------------------
Proceeds from sales and calls of investment securities were $306,495, $3,373,351, and $957,127 for the years ended December 31, 1998, 1997 and 1996, respectively. 24 The amortized cost and fair value of investment securities by contractual maturity is as follows:
------------------------------------------------------------------------------------------------------------------ December 31, 1998 ------------------------------------------------------------------------------------------------------------------ Available for Sale Held to Maturity ------------------------------------------------------------------------------------------------------------------ Amortized Fair Amortized Fair Cost Value Cost Value ------------------------------------------------------------------------------------------------------------------ Amounts maturing: One year or less $ 1,499,627 $ 1,506,094 $ 1,921,582 $ 1,936,596 After one year through five years 15,508,696 15,555,229 12,634,696 12,761,980 After five years through ten years 4,075,446 4,060,391 9,198,027 9,391,028 After ten years 114,613 119,550 161,328 163,682 ------------------------------------------------------------------------------------------------------------------ 21,198,382 21,241,264 23,915,633 24,253,286 Investments in equity securities and mutual funds 2,078,151 1,961,592 -- -- ------------------------------------------------------------------------------------------------------------------ $23,276,533 $23,202,856 $23,915,633 $24,253,286 ------------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------------ December 31, 1997 ------------------------------------------------------------------------------------------------------------------ Available for Sale Held to Maturity ------------------------------------------------------------------------------------------------------------------ Amortized Fair Amortized Fair Cost Value Cost Value ------------------------------------------------------------------------------------------------------------------ Amounts maturing: One year or less $2,091,729 $2,098,345 $10,161,118 $10,173,623 After one year through five years 5,020,609 5,062,859 21,296,112 21,378,018 After five years through ten years 124,421 127,032 7,840,875 7,946,795 After ten years 194,302 200,443 -- -- ------------------------------------------------------------------------------------------------------------------ 7,431,061 7,488,679 39,298,105 39,498,436 Investments in equity securities and mutual funds 2,078,151 1,955,784 -- -- ------------------------------------------------------------------------------------------------------------------ $9,509,212 $9,444,463 $39,298,105 $39,498,436 ------------------------------------------------------------------------------------------------------------------
The Company has pledged certain investment securities as collateral for deposits of certain government agencies and municipalities at December 31 as follows:
------------------------------------------------------------------------------------------------------------------ 1998 1997 ------------------------------------------------------------------------------------------------------------------ Amortized cost $15,783,184 $17,415,482 Fair value 15,962,587 17,337,504 ------------------------------------------------------------------------------------------------------------------
25 Note 4 LOANS AND ALLOWANCE FOR CREDIT LOSSES The Company makes loans to customers primarily in the Maryland counties of Queen Anne's, Kent and Caroline, in an economy closely tied to the agricultural industry. A substantial portion of the Company's loan portfolio consists of residential and commercial real estate mortgages. The Bank's loan portfolio at December 31 is as follows:
- --------------------------------------------------------------------------------------------------------- 1998 1997 - --------------------------------------------------------------------------------------------------------- Real estate: Construction and land development $ 4,487,910 $ 2,945,617 Commercial 14,459,230 12,973,142 Residential 76,483,152 78,273,549 Commercial 8,447,857 8,352,569 Consumer 7,318,362 6,622,406 - --------------------------------------------------------------------------------------------------------- 111,196,511 109,167,283 Less: Allowance for credit losses (1,348,805) (1,403,747) - --------------------------------------------------------------------------------------------------------- Loans-- net $109,847,706 $107,763,536 - ---------------------------------------------------------------------------------------------------------
Loans on which the accrual of interest has been discontinued amounted to approximately $55,000, $199,000, and $872,000 at December 31, 1998, 1997, and 1996, respectively. If interest on those loans had been accrued, such income would have approximated $5,000, $33,000 and $58,000 for 1998, 1997 and 1996, respectively. In the normal course of banking business, loans are made to officers and directors and their affiliated interests. In the opinion of management, these loans are consistent with sound banking practices, are within regulatory lending limitations, and do not involve more than the normal risk of collectibility. Loans outstanding to such parties totaled $2,155,000 and $1,673,000 at December 31, 1998 and 1997, respectively. During 1998, $824,000 of new loans were made and repayments totaled $342,000. 26 Changes in the allowance for credit losses are as follows:
------------------------------------------------------------------------------------------------------ 1998 1997 1996 ------------------------------------------------------------------------------------------------------ Balance at beginning of year $1,403,747 $1,503,268 $1,478,555 ------------------------------------------------------------------------------------------------------ Recoveries: Real estate loans -- -- 10,421 Consumer loans 23,631 40,080 25,599 Commercial and other loans 25,641 4,330 66,791 ------------------------------------------------------------------------------------------------------ 49,272 44,410 102,811 ------------------------------------------------------------------------------------------------------ Allowance applicable to loans of acquired institution -- 15,000 -- ------------------------------------------------------------------------------------------------------ Provision for credit losses -- -- -- ------------------------------------------------------------------------------------------------------ Loans charged-off: Real estate loans (14,239) (22,288) (10,421) Consumer loans (89,658) (99,441) (62,699) Commercial and other loans (317) (37,202) (4,978) ------------------------------------------------------------------------------------------------------ (104,214) (158,931) (78,098) ------------------------------------------------------------------------------------------------------ Balance at end of year $1,348,805 $1,403,747 $1,503,268 ------------------------------------------------------------------------------------------------------
Impaired loans are accounted for in accordance with Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, as amended by Statement No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. Statement No. 114 requires that impaired loans, within its scope, be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. The statement excludes smaller balance and homogeneous loans such as consumer and residential mortgage loans from impairment reporting. Information with respect to impaired loans at December 31 is as follows:
------------------------------------------------------------------------------------------------------ 1998 1997 ------------------------------------------------------------------------------------------------------ Impaired loans with a valuation allowance $ -- $ -- Impaired loans without a valuation allowance 55,000 199,070 ------------------------------------------------------------------------------------------------------ Total impaired loans $ 55,000 $ 199,070 ------------------------------------------------------------------------------------------------------ Allowance for credit losses related to impaired loans -- -- Allowance for credit losses related to other than impaired loans 1,348,805 1,403,747 ------------------------------------------------------------------------------------------------------ Total allowance for credit losses $1,348,805 $1,403,747 ------------------------------------------------------------------------------------------------------ Average impaired loans for the year $ 583,654 $ 631,749 ------------------------------------------------------------------------------------------------------ Interest income on impaired loans recognized on the cash basis $ 8,815 $ 26,740 ------------------------------------------------------------------------------------------------------
The Company recognizes interest income on impaired loans on a cash basis if the borrower demonstrates the ability to meet the contractual obligation and collateral is sufficient. If there is doubt regarding the borrowers ability to make payments or the collateral is not sufficient, payments received are accounted for as a reduction in principal. 27 Note 5 PREMISES AND EQUIPMENT Premises and equipment at December 31 consist of the following:
----------------------------------------------------------------------------------------------------------------- 1998 ----------------------------------------------------------------------------------------------------------------- Accumulated Cost Depreciation Net ----------------------------------------------------------------------------------------------------------------- Land $ 267,947 $ -- $ 267,947 Buildings and land improvements 2,959,727 632,436 2,327,291 Furniture, equipment, and software 1,922,384 1,148,608 773,776 ----------------------------------------------------------------------------------------------------------------- $5,150,058 $1,781,044 $3,369,014 ----------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------- 1997 ----------------------------------------------------------------------------------------------------------------- Accumulated Cost Depreciation Net ----------------------------------------------------------------------------------------------------------------- Land $ 265,914 $ -- $ 265,914 Buildings and land improvements 2,785,789 553,128 2,232,661 Furniture and equipment 1,695,669 935,368 760,301 ----------------------------------------------------------------------------------------------------------------- $4,747,372 $1,488,496 $3,258,876 -----------------------------------------------------------------------------------------------------------------
Note 6 INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES The Company owns 33% of the outstanding common stock of the Delmarva Bank Data Processing Center, Inc. (DBDPC.) The investment is carried at cost, adjusted for the Company's equity in the DBDPC's undistributed net income. 28
---------------------------------------------------------------------------------- 1998 1997 1996 ---------------------------------------------------------------------------------- Balance at beginning of year $1,007,809 $ 934,831 $876,889 Equity in net income 41,600 72,978 57,942 ---------------------------------------------------------------------------------- Balance at end of year $1,049,409 $1,007,809 $934,831 ----------------------------------------------------------------------------------
Data processing expense paid to DBDPC totaled approximately $266,000, $248,000 and $211,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company owns 33% of the outstanding common stock of Eastern Shore Mortgage Corporation (ESMC.) The investment is carried at cost, adjusted for the Company's equity in ESMC's undistributed net earnings. The excess of cost over the Company's equity in ESMC's underlying net assets at dates of acquisition, amounting to $48,085, has been classified as goodwill and was amortized over 15 years. As a result of ESMC's history of continuing losses, the remaining goodwill balance of $24,308 was written off during 1998.
---------------------------------------------------------------------------------- 1998 1997 1996 ---------------------------------------------------------------------------------- Balance at beginning of year $179,397 $179,397 $196,495 Equity in net loss (61,500) -- (32,098) Capital contribution -- -- 15,000 ---------------------------------------------------------------------------------- Balance at end of year $117,897 $179,397 $179,397 ----------------------------------------------------------------------------------
Interest income from this affiliate totaled approximately $31,500, $39,000 and $21,000 for the years ended December 31, 1998, 1997 and 1996, respectively. There were no outstanding loans to this affiliate at December 31, 1998. Note 7 DEPOSITS Certificates of deposit in amounts of $100,000 or more and their remaining maturities at December 31 are as follows:
--------------------------------------------------------------------------- 1998 1997 --------------------------------------------------------------------------- Three months or less $ 1,191,746 $ 2,359,614 Three months through twelve months 5,649,278 5,613,156 Over twelve months 8,516,160 5,500,993 --------------------------------------------------------------------------- $15,357,184 $13,473,763 ---------------------------------------------------------------------------
Interest expense on deposits for each of the years ended December 31 is as follows:
------------------------------------------------------------------------------------ 1998 1997 1996 ------------------------------------------------------------------------------------ Interest bearing transaction $ 513,745 $ 510,209 $ 489,827 Savings and money market 1,172,510 1,223,276 1,027,146 Time, $100,000 or more 789,210 786,304 705,707 Other time 3,160,817 2,850,268 2,253,299 ------------------------------------------------------------------------------------ $5,636,282 $5,370,057 $4,475,979 ------------------------------------------------------------------------------------
29 At December 31, 1998 and 1997, the Bank had deposits of approximately $2,600,000 and $4,500,000, respectively, from a local County government. Note 8 SHORT-TERM BORROWINGS The Company has commitments from correspondent banks under which it can purchase up to $7,000,000 in federal funds and secured reverse repurchase agreements on a short-term basis. No borrowings were outstanding under these arrangements during 1998 or 1997. Note 9 LONG-TERM DEBT As of December 31, 1998, the Company had a convertible advance from the Federal Home Loan Bank of Atlanta in the amount of $5,000,000 at an interest rate of 5.66%. The advance is callable September 24, 1999 and is due September 24, 2002. The Bank has pledged its wholly owned residential first mortgage loan portfolio under a blanket floating lien as collateral for this advance. Note 10 RETIREMENT PLAN The Company has a 401(k) profit sharing plan covering substantially all full-time employees. The plan requires the Company to match 50% of employee contributions of up to 6% of compensation as defined under the plan and permits additional contributions at the discretion of management. Expense under this plan totaled $133,000, $130,000, and $137,330 for the years ended December 31, 1998, 1997 and 1996, respectively. Note 11 DEFERRED COMPENSATION The Company has agreements with certain directors under which they have deferred part of their fees and compensation. The amounts deferred are invested in insurance policies, owned by the Company, on the lives of the respective individuals. Amounts to be available under the policies are to be paid to the individuals as retirement benefits over future years. Cash surrender values and the accrued benefit obligation included in other assets and other liabilities at December 31 are as follows:
-------------------------------------------------------------------------------------- 1998 1997 -------------------------------------------------------------------------------------- Cash surrender value $1,705,646 $1,654,838 Accrued benefit obligations 533,601 529,106 --------------------------------------------------------------------------------------
30 Note 12 INCOME TAXES Components of income tax expense for each of the years ended December 31 are as follows:
----------------------------------------------------------------------------------- 1998 1997 1996 ----------------------------------------------------------------------------------- Currently payable: Federal $1,014,000 $ 773,337 $ 929,996 State 95,168 171,201 183,790 ----------------------------------------------------------------------------------- 1,109,168 944,538 1,113,786 ----------------------------------------------------------------------------------- Deferred income taxes: Federal (25,577) 151,833 49,036 State (5,662) 33,612 10,856 ----------------------------------------------------------------------------------- (31,239) 185,445 59,892 ----------------------------------------------------------------------------------- $1,077,929 $1,129,983 $1,173,678 -----------------------------------------------------------------------------------
Components of the Company's deferred tax assets and liabilities at December 31 are as follows:
-------------------------------------------------------------------------------------------------------- 1998 1997 -------------------------------------------------------------------------------------------------------- Deferred tax assets: Allowance for credit losses $196,895 $161,513 Deferred compensation 125,317 132,213 Interest income 2,525 2,525 Unrealized loss on investment securities available for sale 28,333 25,009 -------------------------------------------------------------------------------------------------------- Total deferred tax assets 353,070 321,260 -------------------------------------------------------------------------------------------------------- Deferred tax liabilities: Cash to accrual conversion 37,109 53,356 Discount accretion 15,477 44,517 Depreciation 38,992 54,639 Federal Home Loan Bank dividends 27,613 27,613 Undistributed income of unconsolidated subsidiaries 61,329 59,824 Loan origination fees and costs 70,739 14,058 -------------------------------------------------------------------------------------------------------- Total deferred tax liabilities 251,259 254,007 -------------------------------------------------------------------------------------------------------- Net deferred tax assets $101,811 $ 67,253 --------------------------------------------------------------------------------------------------------
31 A reconciliation between income tax expense and taxes computed at the maximum statutory federal rate for 1987, 1997 and 1996 is as follows:
---------------------------------------------------------------------------------------------------------------- 1998 1997 1996 ---------------------------------------------------------------------------------------------------------------- Percent Percent Percent of of of Pretax Pretax Pretax Amount Income Amount Income Amount Income ---------------------------------------------------------------------------------------------------------------- Computed at statutory rate $1,120,935 34.0% $1,190,178 34.0% $1,183,683 34.0% Increases (decreases) in tax resulting from: Tax-exempt interest income (144,442) (4.4) (130,930) (3.7) (138,947) (4.0) State income taxes, net of federal income tax benefit 65,051 2.0 101,760 2.9 128,157 3.7 Loss (earnings) of unconsolidated subsidiaries 5,413 .2 (9,139) (.3) (7,030) (.2) Goodwill amortization 55,709 1.7 37,211 1.1 -- .0 Rehabilitation tax credit (11,616) (.4) (51,245) (1.5) -- .0 Other -- net (13,121) (.4) (7,852) (.2) 7,815 .2 ---------------------------------------------------------------------------------------------------------------- Actual tax expense $1,077,929 32.7% $1,129,983 32.3% $1,173,678 33.7% ----------------------------------------------------------------------------------------------------------------
Note 13 STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS The Company's 1998 Stock Option Plan was approved by stockholders on April 21, 1998 and provides for the granting of incentive and nonqualified options to directors, executive officers and key employees on a periodic basis at the discretion of the Company's Executive Committee. The Company has reserved 80,000 shares of common stock under the Plan and no more than 16,000 shares may be granted under the Plan in any calendar year. The Company's 1998 Employee Stock Purchase Plan which was also approved by stockholders on April 21, 1998, allows employees to receive options to purchase common stock at an amount equal to 85% of the fair market value of the common stock. The Company has reserved 20,000 shares of common stock for issuance upon the exercise of options under the Plan. Options to purchase no more than 4,000 shares may be granted under the Plan in any calendar year. No options were granted under either plan during 1998. 32 Note 14 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments may include commitments to extend credit, standby letters of credit and purchase commitments. The Company uses these financial instruments to meet the financing needs of its customers. Financial instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks and management does not anticipate any losses which would have a material effect on the accompanying financial statements. Outstanding loan commitments and lines and letters of credit at December 31 are as follows:
------------------------------------------------------------------------------ 1998 1997 ------------------------------------------------------------------------------ Loan commitments $ 3,031,900 $ 1,440,050 ------------------------------------------------------------------------------ Unused lines of credit $14,369,978 $10,853,207 ------------------------------------------------------------------------------ Letters of credit $ 1,377,434 $ 1,769,618 ------------------------------------------------------------------------------
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments. The collateral is based on management's credit evaluation of the counterparty. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Each customer's credit-worthiness is evaluated on a case-by-case basis. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. 33 Note 15 FAIR VALUE OF FINANCIAL INSTRUMENTS The following table shows the carrying values and the related estimated fair value of the Company's financial instruments at December 31:
---------------------------------------------------------------------------------------------------------------- 1998 1997 ---------------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ---------------------------------------------------------------------------------------------------------------- Financial assets: Cash and due from banks $ 4,536,510 $ 4,536,510 $ 5,091,798 $ 5,091,798 Federal funds 9,752,503 9,752,503 3,503,900 3,503,900 Investment securities available for sale 23,276,533 23,202,856 9,444,463 9,444,463 Investment securities held to maturity 23,915,633 24,253,286 39,298,105 39,498,436 Loans, net of allowance for credit losses 109,847,706 114,005,000 107,763,536 110,420,000 Accrued interest receivable 1,354,754 1,354,754 1,475,994 1,475,994 ---------------------------------------------------------------------------------------------------------------- 1998 1997 ---------------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ---------------------------------------------------------------------------------------------------------------- Financial liabilities: Deposits $153,307,567 $155,088,000 $145,813,270 $145,907,000 Accrued interest payable 208,433 208,433 189,276 189,276 Long-term debt 5,000,000 5,156,000 5,000,000 4,921,000 Unrecognized financial instruments: Commitments to extend credit 17,401,878 17,401,878 12,293,257 12,293,257 Standby letters of credit 1,377,434 1,377,434 1,769,618 1,769,618 ----------------------------------------------------------------------------------------------------------------
For purposes of the above disclosures of estimated fair value, the following assumptions were used. The estimated fair value for cash and due from banks and federal funds sold is considered to approximate cost. The estimated fair value for securities available for sale and securities held to maturity are based on quoted market values from the individual securities or for equivalent securities. The estimated fair value of loans is determined by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The estimated fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The estimated fair value of fixed maturity certificates of deposits is estimated using the rates currently offered for deposits of similar remaining maturities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. 34 Other assets, such as property and equipment, and certain liabilities of the Bank that are not defined as financial instruments are not included in the above disclosures. Also, nonfinancial instruments typically not recognized in the financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the trained work force, customer goodwill, and similar items. Note 16 REGULATORY MATTERS The Company is required to maintain noninterest-bearing deposits with the Federal Reserve Bank. During 1998 and 1997, the daily average balances were approximately $2,263,000 and $2,247,000, respectively. The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitive measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitive measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1998, that the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 1998, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. 35 The Company's and the Bank's actual capital amounts and ratios are also presented in the table.
------------------------------------------------------------------------------------------------------------------ To Be Well For Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions ------------------------------------------------------------------------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio ------------------------------------------------------------------------------------------------------------------ As of December 31, 1998: Total Capital (to Risk Weighted Assets): Company $21,220,000 21.05% $8,069,000 8.00% $10,086,000 10.00% Bank $21,127,000 21.20% $7,972,000 8.00% $ 9,965,000 10.00% Tier I Capital (to Risk Weighted Assets): Company $19,959,000 19.80% $4,034,000 4.00% $ 6,051,000 6.00% Bank $19,880,000 19.95% $3,986,000 4.00% $ 5,979,000 6.00% Tier I Capital (to Average Assets): Company $19,959,000 11.08% $7,206,000 4.00% $ 9,008,000 5.00% Bank $19,880,000 11.04% $7,206,000 4.00% $ 9,008,000 5.00% As of December 31, 1997: Total Capital (to Risk Weighted Assets): Company $22,633,000 23.61% $7,669,000 8.00% $ 9,586,000 10.00% Bank $22,482,000 23.91% $7,523,000 8.00% $ 9,403,000 10.00% Tier I Capital (to Risk Weighted Assets): Company $21,432,000 22.35% $3,836,000 4.00% $ 5,754,000 6.00% Bank $21,304,000 22.66% $3,761,000 4.00% $ 5,641,000 6.00% Tier I Capital (to Average Assets): Company $21,432,000 12.23% $7,010,000 4.00% $ 8,762,000 5.00% Bank $21,304,000 12.16% $7,008,000 4.00% $ 8,760,000 5.00% ------------------------------------------------------------------------------------------------------------------
Banking regulations also limit the amount of dividends that may be paid without prior approval of the Bank's regulatory agencies. Regulatory approval is required to pay dividends which exceed the Bank's net profits for the current year plus its retained net profits for the preceding two years. The amount of dividends that the Bank could have paid to the Company without approval from bank regulatory agencies at December 31, 1998 was approximately $4,000,000. 36 Note 17 PARENT COMPANY FINANCIAL INFORMATION Condensed financial information for Shore Bancshares, Inc. (Parent Company only) is as follows: CONDENSED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 - ------------------------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------------------------- ASSETS: Investment in subsidiary $21,870,938 $23,475,091 Other assets 33,297 39,719 - ------------------------------------------------------------------------------- TOTAL ASSETS $21,904,235 $23,514,810 - ------------------------------------------------------------------------------- LIABILITIES -- -- - ------------------------------------------------------------------------------- STOCKHOLDERS' EQUITY: Common stock 19,135 10,074 Surplus 10,064,166 10,064,166 Retained earnings 11,820,934 13,440,570 - ------------------------------------------------------------------------------- Total stockholders' equity 21,904,235 23,514,810 - ------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $21,904,235 $23,514,810 - ------------------------------------------------------------------------------- CONDENSED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 - ------------------------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------------------------- INCOME-- Dividends from subsidiary $ 3,824,336 $ 1,025,855 OPERATING EXPENSES 9,731 9,944 - ------------------------------------------------------------------------------- INCOME BEFORE INCOME TAX BENEFIT AND EQUITY IN UNDISTRIBUTED EARNINGS OF SUBSIDIARY 3,814,605 1,015,911 INCOME TAX BENEFIT 3,309 3,382 - ------------------------------------------------------------------------------- INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS OF SUBSIDIARY 3,817,914 1,019,293 EQUITY IN UNDISTRIBUTED EARNINGS OF SUBSIDIARY (1,598,975) 1,350,905 - ------------------------------------------------------------------------------- NET INCOME $ 2,218,939 $ 2,370,198 - ------------------------------------------------------------------------------- CONDENSED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 - ------------------------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------------------------- NET INCOME $ 2,218,939 $ 2,370,198 - ------------------------------------------------------------------------------- ADJUSTMENT TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Equity in undistributed earnings of subsidiary 1,598,975 (1,350,905) Net decrease in other assets 6,422 4,435 Net decrease in accounts payable -- (46,525) - ------------------------------------------------------------------------------- Net cash provided by operating activities 3,824,336 977,203 CASH FLOWS FROM FINANCING ACTIVITIES: - ------------------------------------------------------------------------------- Dividends paid (1,012,373) (977,203) Stock repurchased and retired (2,811,963) -- Net cash used in financing activities (3,824,336) (977,203) - ------------------------------------------------------------------------------- CASH AT BEGINNING OF YEAR -- -- - ------------------------------------------------------------------------------- CASH AT END OF YEAR $-- $-- - ------------------------------------------------------------------------------- 37 (STEGMAN & COMPANY LOGO) INDEPENDENT AUDITORS' REPORT ---------------------------- The Stockholders and Board of Directors Shore Bancshares, Inc. Centreville, Maryland We have audited the accompanying consolidated balance sheets of Shore Bancshares, Inc. and Subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Shore Bancshares, Inc. and Subsidiary as of December 31, 1998 and 1997, and the consolidated results of their operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Stegman & Company Baltimore, Maryland January 8, 1999 38 MARKET PRICE OF AND DIVIDENDS ON REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION AND DIVIDENDS There is no established public trading market for the Company's Shares. Accordingly, there is no comprehensive record of trades or the prices of any such trades. The following table reflects stock prices for Company shares to the extent such information is available to management of the Company as well as dividends paid per share for each quarter. All prices and dividends have been restated to reflect the effect of the two for one stock split effected in the form of a 100% stock dividend on March 31, 1998.
- ------------------------------------------------------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------------------------------------------------------- PRICE RANGE DIVIDENDS Price Range Dividends HIGH LOW PAID High Low Paid - ------------------------------------------------------------------------------------------------------------- First Quarter $23.25 $22.50 $0.12 $17.75 $16.50 $0.115 Second Quarter 33.50 24.00 0.12 18.25 17.50 0.115 Third Quarter 34.00 27.75* 0.12 20.00 16.50 0.115 Fourth Quarter 33.00 31.00 0.15 22.00 20.25 0.14 - ------------------------------------------------------------------------------------------------------------ $0.51 $0.485 - ------------------------------------------------------------------------------------------------------------
* Price reflects stock repurchased and retired September 16, 1998. There are no contractual restrictions that currently limit the Company's ability to pay dividends or that the Company reasonably believes are likely to limit materially the future payment of dividends on the Company's Shares. Banking regulators, however, limit under certain circumstances the amount of dividends that may be paid without prior approval of the Bank's regulatory agencies. STOCKHOLDERS As of February 22, 1999, a total of 1,913,516 shares of Shore Bancshares, Inc. common stock was held by approximately 1,102 registered and beneficial owners. 39 AVERAGE BALANCES, YIELDS AND RATES (Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------ FOR THE YEAR ENDED DECEMBER 31, 1998 For the Year Ended December 31, 1997 - ------------------------------------------------------------------------------------------------------------------------------ AVERAGE INCOME/ YIELD/ Average Income/ Yield/ BALANCE EXPENSE RATE Balance Expense Rate - ------------------------------------------------------------------------------------------------------------------------------ ASSETS Federal funds sold $ 10,142,579 $ 565,449 5.58% $ 6,493,959 $ 354,331 5.46% Investment securities: U.S. Treasury securities and obligations of U.S. government agencies 33,866,198 2,104,154 6.21 32,996,468 2,102,149 6.37 Obligations of States and political subdivisions (1) 10,479,431 739,527 7.06 8,858,428 673,659 7.60 All other investment securities 1,999,592 143,606 7.18 2,396,970 143,558 5.99 - ------------------------------------------------------------------------------------------------------------------------------ Total investment securities 46,345,221 2,987,287 6.45 44,251,866 2,919,366 6.60 Loans, net of unearned income (2) (3) Commercial loans 9,482,733 983,333 10.37 9,293,896 982,599 10.57 Installment loans 5,768,858 573,173 9.94 5,264,677 536,637 10.19 Mortgage loans 92,928,827 8,145,171 8.76 89,183,164 7,827,395 8.78 - ------------------------------------------------------------------------------------------------------------------------------ Total loans 108,180,418 9,701,677 8.97 103,741,737 9,346,631 9.01 - ------------------------------------------------------------------------------------------------------------------------------ TOTAL INTEREST EARNING ASSETS 164,668,218 $ 13,254,413 8.05% 154,487,562 $ 12,620,328 8.17% Cash and due from banks 4,066,234 4,012,120 Other assets 9,614,821 8,641,143 Allowance for credit losses (1,384,712) (1,445,147) - ------------------------------------------------------------------------------------------------------------------------------ TOTAL ASSETS $ 176,964,561 $165,695,678 - ------------------------------------------------------------------------------------------------------------------------------ LIABILITIES Interest-bearing liabilities Super NOW accounts $ 18,432,796 $ 513,745 2.79% $ 17,214,551 $ 510,209 2.96% Money market deposit accounts 18,886,098 630,397 3.34 21,027,750 702,261 3.34 Time, $100,000 or more 12,697,789 689,999 5.43 13,297,892 704,290 5.30 Other time deposits 46,304,774 2,481,333 5.36 41,023,454 2,135,522 5.21 IRA deposits 15,429,668 778,695 5.05 14,732,561 796,760 5.41 Savings deposits 17,819,091 542,113 3.04 16,636,078 521,015 3.13 Other borrowed funds 5,001,849 287,041 5.74 1,356,164 77,825 5.74 - ------------------------------------------------------------------------------------------------------------------------------ TOTAL INTEREST BEARING LIABILITIES 134,572,065 5,923,323 4.40% 125,288,450 5,447,882 4.35% Demand deposits 18,143,777 16,216,396 Other liabilities 934,045 1,401,009 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities 153,649,887 142,905,855 Stockholders' equity 23,314,674 22,789,823 - ------------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 176,964,561 $165,695,678 - ------------------------------------------------------------------------------------------------------------------------------ Net interest income and interest rate spread $ 7,331,090 3.65% $ 7,172,446 3.82% Net interest income as a percent of earning assets 4.45% 4.64% - ------------------------------------------------------------------------------------------------------------------------------ - ----------------------------------------------------------------------------------- For the Year Ended December 31, 1996 - ----------------------------------------------------------------------------------- Average Income/ Yield/ Balance Expense Rate - ----------------------------------------------------------------------------------- ASSETS Federal funds sold $ 7,095,343 $ 378,246 5.33% Investment securities: U.S. Treasury securities and obligations of U.S. government agencies 27,640,017 1,703,420 6.16 Obligations of States and political subdivisions (1) 8,896,963 683,213 7.68 All other investment securities 1,387,606 91,075 6.56 - ----------------------------------------------------------------------------------- Total investment securities 37,924,586 2,477,708 6.53 Loans, net of unearned income (2) (3) Commercial loans 10,263,061 1,074,769 10.47 Installment loans 5,097,131 512,414 10.05 Mortgage loans 73,406,929 6,516,800 8.88 - ----------------------------------------------------------------------------------- Total loans 88,767,121 8,103,983 9.13 - ----------------------------------------------------------------------------------- TOTAL INTEREST EARNING ASSETS 133,787,050 $ 10,959,937 8.19% Cash and due from banks 3,589,220 Other assets 5,503,965 Allowance for credit losses (1,469,856) - ----------------------------------------------------------------------------------- TOTAL ASSETS $ 141,410,379 - ----------------------------------------------------------------------------------- LIABILITIES Interest-bearing liabilities Super NOW accounts $ 16,022,439 $ 489,828 3.06% Money market deposit accounts 19,112,185 639,654 3.35 Time, $100,000 or more 11,632,139 633,460 5.45 Other time deposits 30,099,425 1,582,081 5.26 IRA deposits 14,451,599 738,622 5.11 Savings deposits 12,324,479 392,334 3.18 Other borrowed funds -- -- -- - ----------------------------------------------------------------------------------- TOTAL INTEREST BEARING LIABILITIES 103,642,266 4,475,979 4.32% Demand deposits 15,303,365 Other liabilities 838,440 - ----------------------------------------------------------------------------------- Total liabilities 119,784,071 Stockholders' equity 21,626,308 - ----------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 141,410,379 - ----------------------------------------------------------------------------------- Net interest income and interest rate spread $ 6,483,958 3.87% Net interest income as a percent of earning assets 4.85% - -----------------------------------------------------------------------------------
1. All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate of 34%, exclusive of the alternative minimum tax rate and nondeductible interest expense. 2. Loan fee income is included in interest income for each loan category and yields are stated to include all. Fees approximated $81,000, $84,000 and $88,000 for 1998, 1997 and 1996, respectively. 3. Balances of nonaccrual loans and related income have been included for computational purposes. 40 RATE AND VOLUME VARIANCE ANALYSIS (Unaudited)
- ------------------------------------------------------------------------------------------------------------ 1998 COMPARED TO 1997 1997 compared to 1996 - ------------------------------------------------------------------------------------------------------------ INCREASE CHANGE DUE TO Increase Change due to INTEREST INCOME (DECREASE) RATE (2) VOLUME (Decrease) Rate (2) Volume - ------------------------------------------------------------------------------------------------------------ Federal funds sold $211,118 $ 12,038 $199,080 ($ 23,915) $ 8,144 ($ 32,059) - ------------------------------------------------------------------------------------------------------------ U.S. Treasury securities and obligations of U.S. government agencies 2,005 (53,404) 55,409 398,729 68,618 330,111 Tax-exempt obligations of State and political subdivisions (1) 65,868 (57,405) 123,273 (9,554) (6,595) (2,959) All other investment securities 48 23,848 (23,800) 52,483 (13,766) 66,249 - ------------------------------------------------------------------------------------------------------------ Total investment securities 67,921 (86,961) 154,882 441,658 48,257 393,401 - ------------------------------------------------------------------------------------------------------------ Commercial loans 734 (19,231) 19,965 (92,170) 9,323 (101,493) Installment loans 36,536 (14,856) 51,392 24,223 7,380 16,843 Mortgage loans 317,776 (10,972) 328,748 1,310,595 (89,962) 1,400,557 - ------------------------------------------------------------------------------------------------------------ Total loans (3) 355,046 (45,059) 400,105 1,242,648 (73,259) 1,315,907 - ------------------------------------------------------------------------------------------------------------ Total interest income $634,085 ($119,982) $754,067 $1,660,391 ($16,858) $1,677,249 - ------------------------------------------------------------------------------------------------------------ INTEREST EXPENSE Super NOW accounts $ 3,536 ($ 32,571) $ 36,107 $20,381 ($16,064) $ 36,445 Money market deposit accounts (71,864) (340) (71,524) 62,607 (1,504) 64,111 Time deposits of $100,000 or more (14,291) 17,492 (31,783) 70,830 (19,883) 90,713 Other time deposits 345,811 70,886 274,925 553,441 (20,746) 574,187 IRA deposits (18,065) (55,766) 37,701 58,138 43,778 14,360 Savings deposits 21,098 (15,952) 37,050 128,681 (8,573) 137,254 Other borrowed funds 209,216 -- 209,216 77,825 -- 77,825 - ------------------------------------------------------------------------------------------------------------ Total interest expense $475,441 ($ 16,251) $491,692 $ 971,903 ($22,992) $ 994,895 - ------------------------------------------------------------------------------------------------------------ Net interest margin/income $158,644 ($103,731) $262,375 $ 688,488 $6,134 $ 682,354 - ------------------------------------------------------------------------------------------------------------
1. Income and yields are computed on a tax equivalent basis using the statutory federal income tax rate of 34%, exclusive of the alternative minimum tax and nondeductible interest expense. 2. Variances caused by the change in yield/rate times the average balance are allocated to rate. 3. Balances of nonaccrual loans and related income have been included for computational purposes. 41 DIRECTORS Shore Bancshares, Inc. The Centreville National Bank of Maryland (AS OF MARCH 1, 1999) - -------------------------------------------------------------------------------- J. Robert Barton Retired President and CEO, The Centreville National Bank of Maryland Paul M. Bowman Attorney, Law Office of Paul M. Bowman David C. Bryan Member, Law Offices of Fountain, Bryan and Ritter, LLC Daniel T. Cannon President, Shore Bancshares, Inc. President and CEO, The Centreville National Bank of Maryland B. Vance Carmean, Jr. President, Carmean Grain, Inc. Mark M. Freestate President, W.M. Freestate & Son, Inc. Thomas K. Helfenbein Funeral Director and Partner Fellows, Helfenbein & Newnam Funeral Home Neil R. LeCompte Certified Public Accountant, Office of Neil R. LeCompte Susanne K. Nuttle Retired Vice President, The Centreville National Bank of Maryland Jerry F. Pierson President, Jerry F. Pierson, Inc. Wm. Maurice Sanger President, F.W., Inc. President, Cloverbay Development Corporation Walter E. Schmidt Vice President, Schmidt Ventures, Inc. DIRECTORS EMERITI Shore Bancshares, Inc. - -------------------------------------------------------------------------------- Sydney G. Ashley The Centreville National Bank of Maryland - -------------------------------------------------------------------------------- Sydney G. Ashley Royden N. Powell, Jr. Madison B. Bordley, Jr. William E. Sylvester William H. Harris William E. Thompson James O Pippin, Jr. Howard Wood 42 OFFICERS (AS OF MARCH 1, 1999) - --------------------------------------------------------------------------------
SHORE BANCSHARES, INC. - ---------------------- B. Vance Carmean, Jr ................................................Chairman of the Board Jerry F. Pierson ..............................................Vice President of the Board Daniel T. Cannon ................................................................President Carol I. Brownawell .............................................................Treasurer Mary C. Quimby ..................................................................Secretary THE CENTREVILLE NATIONAL BANK OF MARYLAND - ----------------------------------------- Daniel T. Cannon ............................................................President/CEO Carol I. Brownawell ..........................................Executive Vice President/CFO Timothy J. Berrigan ........................................................Vice President Thomas E. Beery ........................................................Vice President/SLO Rita B. Mielke .........................................................Vice President/COO Pamela C. Satchell .........................................................Vice President Carolyn D. Spicher .........................................................Vice President William E. Stoops ..........................................................Vice President David E. Thompson ..........................................................Vice President Ralph F. Twilley ...........................................................Vice President Katharine M. Crook ...............................................Assistant Vice President Cassandra A. Guy .................................................Assistant Vice President Kathryn C. Walls .................................................Assistant Vice President Elizabeth T. Clough ...............................................................Cashier Brenda M. Beaver ........................................................Assistant Cashier Lorrie S. Greenwood .....................................................Assistant Cashier Florance R. Walls .......................................................Assistant Cashier
43 THE CENTREVILLE NATIONAL BANK OF MARYLAND EMPLOYEES (AS OF MARCH 1, 1999) - -------------------------------------------------------------------------------- Maryanne C. Alderson Barri G. Horney Janice S. Barkley Constance M. Lee Joyce D. Bradley Edith P. Legg Gertrude E. Brown Joyce S. Moore Phyllis B. Carroll Corinne C. Palmer Lois F. Carter Nancy L. Park Susan C. Childress Gina A. Paul Barry P. Coleman, Jr Howard S. Pinder, Sr. Vonda K. Collier Mary C. Quimby Rochelle L. Corkell Lisa A. Robinson Connie L. Crossman Shartinese D. Rochester Jeanene L. Earl Robin J. Rust Lisa S. Fleetwood Donna M. Schaeffer Virginia Lynn Foster Teresa M. Schelhouse Margaret A. Fuller Wanda L. Shawyer Goldie J. Garner Phyllis S. Skinner Heather P. Garner Karen A. Stanavich Francis M. Gibson, Jr. Cheryl T. Stansbury Jessica C. Grande Donna J. Stevens W. Allen Greiner Barbara B. Stoops Christina A. Guy Deborah H. Thomas Ann M. Haddaway James W. Thompson, III Donna J. Hallock Katherine A. Thompson Lisa R. Harris Ronald J. Walters Tera Y. Henry Diane B. Whitby Gail F. Hickman THE CENTREVILLE NATIONAL BANK OF MARYLAND OFFICES - -------------------------------------------------------------------------------- MAIN OFFICE STEVENSVILLE OFFICE - ----------------------------------- ------------------------------------- 109 N. Commerce St. -- PO Box 400 408 Thompson Creek Road -- PO Box 279 Centreville, MD 21617 Stevensville, MD 21666 Phone (410) 758-1600 Phone (410) 643-2233 Fax (410) 758-2364 Fax (410) 643-4215 ROUTE 213 SOUTH OFFICE HILLSBORO OFFICE - ----------------------------------- ------------------------------------- 2609 Centreville Road -- PO Box 400 21913 Shore Highway --PO Box 118 Centreville, MD 21617 Hillsboro, MD 21641 Phone (410) 758-2414 Phone (410) 820-2121 Fax (410) 758-3867 Fax (410) 820-1341 KENT OFFICE ---------------------------------- 305 East High Street -- PO Box 388 Chestertown, MD 21620 Phone (410) 778-1299 Fax (410) 778-6084 44 -----END PRIVACY-ENHANCED MESSAGE-----